RBI & its Monetary Policy

Presentationby

Macro Economics

LIST OF CONTENTS• RBI’s History• Need for RBI• Functions of RBI• Non-Monitory functions of RBI• Monitory functions of RBI• Tools of Monitory Policy

– Quantitative tools– Qualitative tools

• Selective and Direct credit controls• Current Monitory Policy• Purchase Power Parity (PPP) 2/20

Reserve Bank of India

• The central bank of the country--Reserve Bank of India (RBI).

• Established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission.

• The share capital was divided into shares of Rs. 100 each fully paid up which was entirely owned by private shareholders in the beginning.

• The Government held shares of nominal value of Rs. 2,20,000.

• Reserve Bank of India was nationalized in the year 1949

• No of members on central board is 20 (incl. governor and 4 deputy governors)

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Need for the Reserve Bank

• The Reserve Bank of India Act, 1934 was commenced on April 1, 1935.

• The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank.

The Bank was constituted for the need of following:

• To regulate the issue of banknotes • To maintain reserves with a view to securing

monetary stability and • To operate the credit and currency system of the

country to its advantage. 4/20

Functions of Reserve Bank of IndiaThe Reserve Bank of India Act of 1934 contains all the important functions of a central bank to the Reserve Bank of India.

•Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations.

•Banker to Government

The second important function of the reserve bank of India is to act as government banker, agent and adviser. RBI carries out banking operations (e.g. to receive and make payments, carry cash reserves) for all governments except J&K—acts as advisor to govt on all monetary and banking matters.

•Bankers' Bank and Lender of the Last Resort

The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency. Banks have been asked to keep cash reserves equal to 3 percent of their aggregate deposit liabilities.

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Functions of Reserve Bank of India

• Controller of CreditThe Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations.

• Controller of money market The Reserve Bank of India is armed with many more powers to control

the Indian money market

• Custodian of foreign exchange reservesBesides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies.

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A) TRADITIONAL FUNCTIONS1. Monopoly of currency notes issue2. Banker to the Government(both the central and state)3. Agent and advisor to the Government4. Banker’s Bank5. Acts as the clearing house of the country6. Lender of the last resort (B R P)7. Custodian of the foreign exchange reserves8. Maintaining the external value of domestic currency9. Controller of forex and credit (Credit Policy)10. Ensures the internal value of the currency11. Publishes the Economic statistical data12. Fight against economic crisis and ensures stability of Economy.

B) PROMOTIONAL FUNCTIONS

1. Promotion of banking habit and expansion of banking systems.

2. Provides refinance for export promotion. (E P C G)

3. Expansion of the facilities for the provision of the agricultural credit through NABARD.

4. Extension of the facilities for the small scale industries.

5. Helping the Co-operative sectors.

6. Prescribe the minimum statutory requirement. (SLR)

7. Innovating the new banking business transactions.

C) SUPERVISORY FUNCTIONS

1. Granting license to Banks.2. Inspecting and making enquiry or determining position in respect of matters under various sections of RBI and Banking regulations.3. Periodical review of the work of the commercial banks.4. Giving directives to commercial banks.5. Control the non-banking finance corporations.6. Ensuring the health of financial system through on-site and off-site verification.

Non Monetary Functions

Role as Supervisor• RBI enjoys wide powers of supervision and control over commercial and

co-operative banks, relating to• licensing and establishments,• branch expansion, • liquidity of their assets, • management and methods of working, • amalgamation,• reconstruction, • and liquidation. • The RBI is authorized to carry out periodical inspections of the banks and

to call for returns and necessary information from them..

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Non Monetary Functions

Promotional functions

The major function of Reserve Bank is to promote banking habit, extend banking facilities to rural and semi-urban areas, and establish and promote new specialized financing agencies.

Accordingly, the Reserve Bank has helped in the setting up of the• IFCI • SFC • Deposit Insurance Corporation in 1962• Unit Trust of India in 1964,• Industrial Development Bank of India in 1964

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Monetary Policy

What is monetary policy?

A macroeconomic policy tool used to influence interest rates, inflation, and credit availability through changes in the supply of money available in the economy. In India it is also called the Reserve Bank of India’s ‘Credit Policy’ as the stress is primarily on directing credit.

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Monetary Policy of RBICONTROLLED EXPANSION(1951-72)

• Speed up economic development in the country to raise national income and standard of living.

• To prevent heavy depreciation of the rupee.

• Maintaining the momentum of economic growth. To consider measures in a calibrated manner to respond to evolving circumstances with a view to stabilizing inflationary expectations.

RBI’s ANTI-INFLATIONARY POLICY SINCE 1972

• Economic aims given above were nearly the same but policy of CONTROLLED EXPANSION was changed to CREDIT RESTRAINT.

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TOOLS OF MONETARY POLICY

There are two kinds of tools:

Quantitative tools –control the volume of credit and inflation, indirectly.

Qualitative tools –they control the supply of money in selective sectors of the economy.

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Quantitative Tools• Bank Rate

Bank Rate is the rate at which RBI allows finance to commercial banks. Bank Rate is a tool, which RBI uses for short-term purposes. Any revision in Bank Rate by RBI is a signal to banks to revise deposit rates as well as Prime Lending Rate.

Role of bank rate is limited in India becauseThe structure of interest rates is administered by RBICommercial banks enjoy specific refinance facilities.

• CRRAll scheduled commercial banks are required to maintain a fortnightly minimum average daily cash reserve equivalent with RBI .The apex bank is empowered to vary this ratio between 3 and 15 per cent. RBI uses CRR either to impound the excess liquidity or to release funds needed for the economy from time to time.

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• SLR

Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold etc, in addition to cash reserve requirements. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). Present SLR is 24%.

• Repos and Reverse Repo

RBI is empowered to enter a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a predetermined price. Such a transaction is called a Repo when viewed from the prospective of the seller of securities (the party acquiring fund) and Reverse Repo when described from the point of view of the supplier of funds. Thus, whether a given agreement is termed as Repo or a Reverse Repo depends on which party initiated the transaction.

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• An instrument of monetary policy• It involves buying and selling of govt. securities by the

RBI to influence the volume of cash reserves with commercial banks and thus influence their loans and advances

• To contract the flow of credit ,RBI starts selling govt securities

• To increase the credit flow RBI starts purchasing the govt securities.

OPEN MARKET OPERATIONS

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Selective and Direct Credit Control Or Qualitative Measures

• The main objective is to check speculation and rising prices

• The RBI issues directives to banks relating to the purpose for which advances may or may not be

made• The margins to be maintained in respect of secured

advances• The maximum amount of advance to any borrower• The maximum amt. of guarantee that can be given

on behalf of any firm

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Kinds of Selective Credit Controls

• Specifies minimum margins for lending against specific securities

• Ceiling on amt of credit for certain purposes to stem the flow of credit to speculative and non productive sectors

• Charges discriminatory rate of interest on certain types of advances

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Monetary Policy 2005-06

Key Figures• Reverse Repo Rate Hiked by 25 bps, stands at 5%• Repo Rate Unchanged at 6%• Bank Rate Unchanged at 6%• CRR Unchanged at 5%• Inflation FY06 5-5.5%• GDP FY06 Target 7%

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Current Monetary Policy

Key Figures• Reverse Repo 4%• Repo Rate 4.25%• Bank Rate 6%• CRR Unchanged 5.5%• Inflation 5.07%

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Purchase Power Parity

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