Derivatives

A security whose price is dependent upon or derived from one or more underlying assets. The derivative
itself is merely a contract between two or more parties. Its value is determined by fluctuations in the
underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies,
interest rates and market indexes. Most derivatives are characterized by high leverage.
Futures contracts, forward contracts, options and swaps are the most common types of derivatives.
Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on
weather data, such as the amount of rain or the number of sunny days in a particular region.
Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative
purposes. For example, a European investor purchasing shares of an American company off of an
American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding
that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified
exchange rate for the future stock sale and currency conversion back into Euros.

FORWARD CONTRACT
A customized contract between two parties to buy or sell an asset at a specified price on a future date. A
forward contract can be used for hedging or speculation, although its non-standardized nature makes it
particularly apt for hedging. Unlike standard futures contracts, a forward contract can be customized to
any commodity, amount and delivery date. A forward contract settlement can occur on a cash or
delivery basis. Forward contracts do not trade on a centralized exchange and are therefore regarded as
over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack
of a centralized clearinghouse also gives rise to a higher degree of default risk. As a result, forward
contracts are not as easily available to the retail investor as futures contracts.
EXAMPLE : On January 1, 2009 Company X agrees to buy from Company Y 100 pounds of coffee on April
1, 2009 at a price of $5.00 per pound. If on April 1, 2009 the spot price (also known as the market price)
of coffee is greater than $5.00, at say $6.00 a pound, the buyer has gained. Rather than having to pay
$6.00 a pound for coffee, it only needs to pay $5.00. However, the buyer's gain is the seller's loss. The
seller must now sell 100 pounds of coffee at only $5.00 per pound when it could sell it in the open
market for $6.00 per pound. Rather than the buyer giving the seller $500 for 100 pounds of coffee as he
would for physical delivery, the seller simply pays the buyer $100. The $100 is the cash difference
between the agreed upon price and the current spot price, or ($6.00-$5.00)*100.

Forward Rate
A rate applicable to a financial transaction that will take place in the future. Forward rates are based on
the spot rate, adjusted for the cost of carry and refer to the rate that will be used to deliver a currency,
bond or commodity at some future time. It may also refer to the rate fixed for a future financial
obligation, such as the interest rate on a loan payment.
In forex, the forward rate specified in an agreement is a contractual obligation that must be honored by
the parties involved. For example, consider an American exporter with a large export order pending for
Europe, and undertakes to sell 10 million euros in exchange for dollars at a rate of 1.35 euros per U.S.
dollar in six months' time. The exporter is obligated to deliver 10 million euros at the specified rate on
the specified date, regardless of the status of the export order or the exchange rate prevailing in the
spot market at that time. Forward rates are widely used for hedging purposes in the currency markets,
since currency forwards can be tailored for specific requirements, unlike futures, which have fixed
 contract sizes and expiry dates and therefore cannot be customized.
In the context of bonds, forward rates are calculated to determine future values. For example, an
investor can purchase a one-year Treasury bill or buy a six-month bill and roll it into another six-month
bill once it matures. The investor will be indifferent if they both produce the same result. The investor
will know the spot rate for the six-month bill and the one-year bond, but he or she will not know the
value of a six-month bill that is purchased six months from now. Given these two rates though, the
forward rate on a six-month bill will be the rate that equalizes the dollar return between the two types
of investments mentioned earlier.

FUTURE CONTRACT
A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a
particular commodity or financial instrument at a pre-determined price in the future. Futures contracts
detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a
futures exchange. Some futures contracts may call for physical delivery of the asset, while others are
settled in cash.
The payment and delivery of the asset is made on the future date termed as delivery date. The buyer in
the futures contract is known as to hold a long position or simply long. The seller in the futures contracts
is said to be having short position or simply short.
The underlying asset in a futures contract could be commodities, stocks, currencies, interest rates and
bond. The futures contract is held at a recognized stock exchange. The exchange acts as mediator and
facilitator between the parties. In the beginning both the parties are required by the exchange to put
beforehand a nominal account as part of contract known as the margin.
Since the futures prices are bound to change every day, the differences in prices are settled on daily
basis from the margin. If the margin is used up, the contractee has to replenish the margin back in the
account. This process is called marking to market. Thus, on the day of delivery it is only the spot price
that is used to decide the difference as all other differences had been previously settled.
Futures can be used to hedge against risk or speculate the prices.

CURRENCY OPTION
A contract that grants the holder the right, but not the obligation, to buy or sell currency at a specified
exchange rate during a specified period of time. For this right, a premium is paid to the broker, which
will vary depending on the number of contracts purchased. Currency options are one of the best ways
for corporations or individuals to hedge against adverse movements in exchange rates.
Investors can hedge against foreign currency risk by purchasing a currency option put or call. For
example, assume that an investor believes that the USD/EUR rate is going to increase from 0.80 to 0.90
(meaning that it will become more expensive for a European investor to buy U.S dollars). In this case,
the investor would want to buy a call option on USD/EUR so that he or she could stand to gain from an
increase in the exchange rate (or the USD rise)
 Call option – the right to buy an asset at a fixed date and price.
 Put option – the right to sell an asset a fixed date and price.
 Foreign exchange option – the right to sell money in one currency and buy money in another currency
at a fixed time and relative price.
 Strike price – the asset price at which the investor can exercise an option.
 Spot price – the price of the asset at the time of the trade.
 Forward price – the price of the asset for delivery at a future time.
 Notional – the amount of each currency that the option allows the investor to sell or buy.
 Ratio of nationals’ – the strike, not the current spot or forward.

SWAP
A swap is a derivative in which two counterparties exchange cash flows of one party's financial
instrument for those of the other party's financial instrument. The benefits in question depend on the
type of financial instruments involved. For example, in the case of a swap involving two bonds, the
benefits in question can be the periodic interest (coupon) payments associated with such bonds.
Specifically, two counterparties agree to exchange one stream of cash flows against another stream.
These streams are called the legs of the swap. The swap agreement defines the dates when the cash
flows are to be paid and the way they are accrued and calculated.[1] Usually at the time when the
contract is initiated, at least one of these series of cash flows is determined by an uncertain variable
such as a floating interest rate, foreign exchange rate, equity price, or commodity price.[1]
The cash flows are calculated over a notional principal amount. Contrary to a future, a forward or
an option, the notional amount is usually not exchanged between counterparties. Consequently, swaps
can be in cash or collateral.
Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the
expected direction of underlying prices.[2]
Swaps were first introduced to the public in 1981 when IBM and the World Bank entered into a swap
agreement.
Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties. Some types of
swaps are also exchanged on futures markets.

FOREX MARKET
The market in which participants are able to buy, sell, exchange and speculate on currencies. The forex
markets is made up of banks, commercial companies, central banks, investment management firms,
hedge funds, and retail forex brokers and investors. The currency market is considered to be the largest
financial market in the world, processing trillions of dollars worth of transactions each day.
The foreign exchange markets isn't dominated by a single market exchange, but involves a global
network of computers and brokers from around the world. Central banks use their massive buying and
selling capabilities to alter exchange rates through their open market activities and in many cases will do
so not with profit in mind, but rather for any number of policy reasons. Forex brokers act as market
makers as well, and may post bid and ask prices for a currency pair that differs from the most
competitive bid in the market.
The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the
trading of currencies. In terms of volume of trading, it is by far the largest market in the world.[1] The
main participants in this market are the larger international banks. Financial centres around the world
function as anchors of trading between a wide range of multiple types of buyers and sellers around the
clock, with the exception of weekends. The foreign exchange market determines the relative values of
different currencies.[2] The foreign exchange market works through financial institutions, and it operates
on several levels.
The foreign exchange market assists international trade and investments by enabling currency
conversion. For example, it permits a business in the United States to import goods from theEuropean
Union member states, especially Eurozone members, and pay Euros, even though its income is in United
States dollars.

INTREST RATE SWAP

In an interest rate swap, each counterparty agrees to pay either a fixed or floating rate denominated in a
particular currency to the other counterparty. The fixed or floating rate is multiplied by a notional
principal amount (say, USD 1 million) and an accrual factor given by the appropriate day count
convention. When both legs are in the same currency, this notional amount is typically not exchanged
between counterparties, but is used only for calculating the size of cashflows to be exchanged. When
the legs are in different currencies, the respective notional amounts are typically exchanged at the start
and the end of the swap.
The most common interest rate swap is one where one counterparty A pays a fixed rate (the swap rate)
to counterparty B, while receiving a floating rate indexed to a reference rate (such
as LIBOR or EURIBOR orMIBOR). By market convention, the counterparty paying the fixed rate is called
the "payer" (while receiving the floating rate), and the counterparty receiving the fixed rate is called the
"receiver" (while paying the floating rate).
A pays fixed rate to B (A receives floating rate)
B pays floating rate to A (B receives fixed rate)
Currently, A borrows from Market @ LIBOR +1.5%. B borrows from Market @ 8.5%.
Consider the following swap in which Party A agrees to pay Party B periodic fixed interest rate payments
of 8.65%, in exchange for periodic variable interest rate payments of LIBOR + 70 bps (0.70%) in the same
currency. Note that there is no exchange of the principal amounts and that the interest rates are on a
"notional" (i.e. imaginary) principal amount. Also note that the interest payments are settled in net (e.g.
Party A pays (LIBOR + 1.50%)+8.65% - (LIBOR+0.70%) = 9.45% net). The fixed rate (8.65% in this
example) is referred to as the swap rate.[2]
At the point of initiation of the swap, the swap is priced so that it has a net present value of zero. If one
party wants to pay 50 bps above the par swap rate, the other party has to pay approximately 50bps over
LIBOR to compensate for this.

A is currently paying floating, but wants to pay fixed. B is currently paying fixed but wants to pay
floating. By entering into an interest rate swap, the net result is that each party can 'swap' their existing
obligation for their desired obligation. Normally, the parties do not swap payments directly, but rather
each sets up a separate swap with a financial intermediary such as a bank. In return for matching the
two parties together, the bank takes a spread from the swap payments.
Financial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a
broad range of organizations that deal with the management of money. Among these organizations are
banks, credit card companies, insurance companies, consumer finance companies, stock brokerages,
investment funds and some government sponsored enterprises.
Foreign
Banking Investment
exchange Insurance
services services
services

Asset
Issuance of Currency Insurance
manageme
checkbooks Exchange brokerage
nt
Provide Foreign Hedge fund
personal Reinsuranc
Currency manageme
loans, e
Banking nt
commercia
l loans Wire
transfer
ATMs

In general, all types of activities, which are of a financial nature could be brought under the term
'financial services'. The term financial services' in a broad, sense means "mobilizing and allocating
savings". Thus it includes all activities involved in the transformation of savings into investment.
The financial intermediaries in India can be traditionally classified into two:
i. Capital Market intermediaries and ii. Money market intermediaries.
The capital market intermediaries consist of term lending institutions and investing institutions which
mainly provide long term funds. On the other hand, money market consists of commercial banks, co-
operative banks and other agencies which supply only short term funds. Hence, the term 'financial
services industry' includes all kinds of organizations which intermediate .and facilitate financial
transactions of both individuals and corporate customers.

SPOT RATE
The price quoted for immediate settlement on a commodity, a security or a currency. The spot rate, also
called “spot price,” is based on the value of an asset at the moment of the quote. This value is in turn
based on how much buyers are willing to pay and how much sellers are willing to accept, which depends
on factors such as current market value and expected future market value. As a result, spot rates change
frequently and sometimes dramatically.
In currency transactions, the spot rate is influenced by the demands of individuals and businesses
wishing to transact in a foreign currency, as well as by forex traders. The spot rate from a foreign
exchange perspective is also called the “benchmark rate,” “straightforward rate” or “outright rate.”
The spot rate is also used in determining a forward rate—the price of a future financial transaction—
since a commodity, security or currency’s expected future value is based in part on its current value and
in part on the risk-free rate and the time until the contract matures. Traders can extrapolate an
unknown spot rate if they know the futures price, risk-free rate and time to maturity
FORWARD RATE PREMIUM
When dealing with foreign exchange (FX), a situation where the spot futures exchange rate, with respect
to the domestic currency, is trading at a higher spot exchange rate then it is currently. A forward
premium is frequently measured as the difference between the current spot rate and the forward rate,
but any expected future exchange rate will suffice. It is a reasonable assumption to make that the future
spot rate will be equal to the current futures rate. According to the forward expectation's theory of
exchange rates, the current spot futures rate will be the future spot rate. This theory is routed in
empirical studies and is a reasonable assumption to make in the long term.

FORWARD RATE DISCOUNT

In a foreign exchange situation where the domestic current spot exchange rate is trading at a higher
level then the current domestic futures spot rate for a maturity period. A forward discount is an
indication by the market that the current domestic exchange rate is going to depreciate in value against
another currency.
A forward discount means the market expects the domestic currency to depreciate against another
currency, but that is not to say that will happen. Although the forward expectation's theory of exchange
rates states this is the case, the theory does not always hold.

CROSS RATE
The currency exchange rate between two currencies, both of which are not the official currencies of the
country in which the exchange rate quote is given in. This phrase is also sometimes used to refer to
currency quotes which do not involve the U.S. dollar, regardless of which country the quote is provided
in.
For example, if an exchange rate between the Euro and the Japanese Yen was quoted in an American
newspaper, this would be considered a cross rate in this context, because neither the euro or the yen is
the standard currency of the U.S. However, if the exchange rate between the euro and the U.S. dollar
were quoted in that same newspaper, it would not be considered a cross rate because the quote
involves the U.S. official currency.

Nostro Account Definition.

A Nostro Account is an account denominated in a foreign currency established through your local bank
at a bank in the respective country of the currency desired. The terms "nostro" and "vostro" are derived
from Latin terms meaning "ours" and "yours" respectively. A nostro account is our account in a different
country and a vostro account is a foreigner's account in our country. A nostro account is always in
foreign Currency while a vostro account is in Home currency. (thanks P Goyal for the fb comment)
For example, if you live in the United States and ask you local bank to set up a Euro account for you,
they will most likely open a "Nostro Account" with a correspondent agent bank in the European Union
that they have a banking relationship with for that specific purpose. The Euro bank will set up the
account, but it is not a typical checking account. These accounts are treated differently on the books of
the bank. Transactions to and from these accounts may only be wire transfers to ensure identity
credentials are monitored and that special handling is used. Generally, companies will use these types of
accounts when they often either buy or sell in another country but do not have a physical presence that
would afford them usage of a typical checking account arrangement.
VOSTRO ACCOUNT
A vostro bank account is an account that one party is holding for another party. In a vostro account, the
administrators are not actually the owners of the money. They must keep this account solvent on behalf
of its owner. Vostro account administrators, often banks, frequently pay interest to other parties for the
use of their money.
Vostro accounts are just a way of talking about who owns the capital invested in them. To a customer who
puts money into a bank account, that account is a “nostro” account, meaning that it belongs to that
person. From the standpoint of the bank, it is a “vostro” account, meaning that it is not the bank’s own
money, but the customer’s, and the bank bears a responsibility for good accounting of the customer’s
money. This makes sense, since “voster” in Latin or “vuestra” in Spanish means “yours.”
A vostro account can be useful in the Forex, or foreign exchange, industries, where money needs to “go
to market” in foreign markets and be traded into foreign currency, or alternately, kept as a foreign
currency to that destination market. Parties holding vostro accounts are acting on behalf of their
customers to get returns. This also happens in a wide variety of stock trading orstock options trading
situations, where a broker is the party that holds the vostro account for clients.

BANK ACCOUNT
A bank account is a financial account between a bank customer and a financial institution. A bank
account can be a deposit account, a credit card, or any other type of account offered by a financial
institution. The financial transactions which have occurred within a given period of time on a bank
account are reported to the customer on a bank statement and the balance of the account at any point
in time is the financial position of the customer with the institution. a fund that a customer has
entrusted to a bank and from which the customer can make withdrawals.
Bank accounts may have a positive, or credit balance, where the bank owes money to the customer; or a
negative, or debit balance, where the customer owes the bank money.[1]
Broadly, accounts opened with the purpose of holding credit balances are referred to as deposit
accounts; whilst accounts opened with the purpose of holding debit balances are referred to as loan
accounts. Some accounts can switch between credit and debit balances.
Some accounts are categorized by the function rather than nature of the balance they hold, such
as savings account.
All banks have their own names for the various accounts which they open for customers.
Types of accounts
 Deposit  Savings account  Other accounts
account  Individual Savings Account  Loan account
 Checking  Time deposit/certificate of deposit  Joint account
account  Tax-Exempt Special Savings  Low-cost account
 Current Account  Numbered bank account
account  Tax-Free Savings Account  Negotiable Order of Withdrawal account
 Personal  Money market account  fixed deposit
account  savings
 Transaction
deposit
CORRESPONDENT BANK
A financial institution that provides services on behalf of another, equal or unequal, financial institution.
A correspondent bank can conduct business transactions, accept deposits and gather documents on
behalf of the other financial institution. Correspondent banks are more likely to be used to conduct
business in foreign countries, and act as a domestic bank's agent abroad.
Correspondent banks are used by domestic banks in order to service transactions originating in foreign
countries, and act as a domestic bank's agent abroad. This is done because the domestic bank may have
limited access to foreign financial markets, and cannot service its client accounts without opening up a
branch in another country.

SHIFT
A member-owned cooperative that provides safe and secure financial transactions for its members.
Established in 1973, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) uses a
standardized proprietary communications platform to facilitate the transmission of information about
financial transactions. This information, including payment instructions, is securely exchanged between
financial institutions.
SWIFT neither holds funds nor manages client accounts. It began operating in 15 countries in 1973 and
now operates in 210 countries. By April 2012, the co-op was delivering an average of 18,306,753
messages a day - up from 12,265,837 messages per day in January 2007.

SWIFT is headquartered in Belgium and has offices in the United States, Brazil, Australia, India, Japan,
Korea, Austria, Belgium, France, Germany, Italy, South Africa, Spain, Sweden, Switzerland, the United
Kingdom, UAE and Russian Federation.

CHIPS
The Clearing House Interbank Payments System (CHIPS) is a United States private clearing house for
large-value transactions. By 2010 it settling well over US$1 trillion a day in around 250,000 interbank
payments. Together with the Fedwire Funds Service (which is operated by the Federal Reserve Banks),
CHIPS forms the primary U.S. network for large-value domestic and international USD payments (where
it has a market share of around 96%). CHIPS transfers are governed by Article 4A of Uniform Commercial
Code.
Unlike the Fedwire system which is part of a regulatory body CHIPS is owned by the financial
institutions that use it. Banks typically prefer to make payments of higher value as long as they are less
time-sensitive in nature by CHIPS instead of Fedwire, as CHIPS is less expensive (both by charges and by
funds required). One of the reasons is that Fedwire is a real-time gross settlement system, while CHIPS
allows payments to be netted.
Only the largest banks dealing in U.S. dollars participate in CHIPS; about 70% of these are non-U.S.
banks. Smaller banks have not found it cost effective to participate in CHIPS, but many have accounts at
CHIPS-participating banks to send and receive payments.
CHAPS
A British company that facilitates the trading of European currency. CHAPS provides same-day fund
transfers for the sterling and the euro. CHAPS transfers are used when money needs to be moved from
one account to another. CHAPS transfers are fairly costly, with an average fee of 30 pounds per transfer.
CHAPS eliminates float time that occurs with cheque writing and prohibits the sender from rescinding
the payment.
CHAPS was first established in London in 1984. It is currently used by 19 settlement banks (including the
Bank of England) and over 400 submember institutions. In 2004, CHAPS averaged 130,000 transactions
per day, moving 300 billion pounds sterling. New, lower cost transfers have recently become available
from the CHAPS system.

FEDWIRE
A real-time gross settlement system (RTGS) of central bank money used in the United States by its
Federal Reserve Banks to settle final payments in U.S. dollars electronically between its member
institutions.
Owned and operated by the 12 Federal Reserve Banks, the Fedwire is a networked system for payment
processing between the member banks themselves, or other Fedwire member participants. Members
can consist of depository financial institutions in the United States, as well as U.S. branches of certain
foreign banks or government groups, provided that they maintain an account with a Federal Reserve
Bank.
While the Fedwire is not managed for a profit, law does mandate the Fedwire charge fees for use of the
service in order to recoup costs. Both participants in a given transaction will pay a small fee.
The Fedwire system processes trillions of dollars daily, and it includes an overdraft system covers
participants with existing and approved accounts. It has been in operation in some format for nearly 100
years, and as such, the Fedwire system is designed to be highly reliable. It often processes high dollar
values, and critical recurring payments domestically and abroad.

Foreifting and Factoring.

Forfeiting and factoring are services in international market given to an exporter or seller. Its main
objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and
factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is a
shorttermed receivables (within 90 days) and is more related to receivables against commodity sales.
Definition of Forfeiting
The terms forfeiting is originated from a old French word ‘forfait’, which means to surrender ones right
on something to someone else. In international trade, forfeiting may be defined as the purchasing of an
exporter’s receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees
the exporter from credit and the risk of not receiving the payment from the importer.
How forfeiting Works in International Trade
The exporter and importer negotiate according to the proposed export sales contract. Then the
exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about
the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the
discount rate.
The exporter then quotes a contract price to the overseas buyer by loading the discount rate and
commitment fee on the sales price of the goods to be exported and sign a contract with the forfeiter.
Export takes place against documents guaranteed by the importer’s bank and discounts the bill with the
forfeiter and presents the same to the importer for payment on due date.
Benefits to Exporter
 100 per cent financing : Without recourse and not occupying exporter's credit line That is to say
once the exporter obtains the financed fund, he will be exempted from the responsibility to repay
the debt.
 Improved cash flow : Receivables become current cash in flow and its is beneficial to the exporters
to improve financial status and liquidation ability so as to heighten further the funds raising
capability.
 Reduced administration cost : By using forfeiting , the exporter will spare from the management of
the receivables. The relative costs, as a result, are reduced greatly.
 Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax
refund in advance just after financing.
 Risk reduction : forfeiting business enables the exporter to transfer various risk resulted from
deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the
forfeiting bank.
 Increased trade opportunity : With forfeiting, the export is able to grant credit to his buyers freely,
and thus, be more competitive in the market.
Benefits to Banks
Forfeiting provides the banks following benefits:
 Banks can offer a novel product range to clients, which enable the client to gain 100% finance, as
against 8085% in case of other discounting products.
 Bank gain fee based income.
 Lower credit administration and credit follow up.
Definition of Factoring
Definition of factoring is very simple and can be defined as the conversion of credit sales into cash. Here,
a financial institution which is usually a bank buys the accounts receivable of a company usually a client
and then pays up to 80% of the amount immediately on agreement. The remaining amount is paid to
the client when the customer pays the debt. Examples includes factoring against goods purchased,
factoring against medical insurance, factoring for construction services etc.
Characteristics of Factoring
1. The normal period of factoring is 90150 days and rarely exceeds more than 150 days.
2. It is costly.
3. Factoring is not possible in case of bad debts.
4. Credit rating is not mandatory.
5. It is a method of offbalance sheet financing.
6. Cost of factoring is always equal to finance cost plus operating cost.
CENTRAL BANK
The central bank has been described as "the lender of last resort", which means that it is responsible for
providing its economy with funds when commercial banks cannot cover a supply shortage. In other
words, the central bank prevents the country's banking system from failing. However, the primary goal
of central banks is to provide their countries' currencies with price stability by controllinginflation. A
central bank also acts as the regulatory authority of a country'smonetary policy and is the sole provider
and printer of notes and coins in circulation. Time has proved that the central bank can best function in
these capacities by remaining independent from government fiscal policy and therefore uninfluenced by
the political concerns of any regime. The central bank should also be completely divested of any
commercial banking interests.
The Rise of the Central Bank
Today the central bank is government owned but separate from the country's ministry of finance.
Although the central bank is frequently termed the "government's bank" because it handles the buying
and selling of government bonds and other instruments, political decisions should not influence central
bank operations. Of course, the nature of the relationship between the central bank and the ruling
regime varies from country to country and continues to evolve with time. To ensure the stability of a
country's currency, the central bank should be the regulator and authority in the banking and monetary
systems.
Functions of a central bank may include:
 Implementing monetary policies.
 determining Interest rates
 controlling the nation's entire money supply
 the Government's banker and the bankers' bank ("lender of last resort")
 managing the country's foreign exchange and gold reserves and the Government's stock register
 regulating and supervising the banking industry
 setting the official interest rate – used to manage both inflation and the country's exchange rate –
and ensuring that this rate takes effect via a variety of policy mechanisms

The Reserve Bank of India is India's Central Banking Institution, which controls the Monetary Policy of
the Indian Rupee. It commenced its operations on 1 April 1935 during the British Rule in accordance
with the provisions of the Reserve Bank of India Act, 1934.[4] The original share capital was divided into
shares of 100 each fully paid, which were initially owned entirely by private shareholders.[5] Following
India's independence on 15 - August - 1947, the RBI was nationalised in the year of 1 January 1949.
The RBI plays an important part in the Development Strategy of the Government of India. It is a member
bank of the Asian Clearing Union. The general superintendence and direction of the RBI is entrusted
with the 20-member Central Board of Directors: theGovernor (Dr. Raghuram Rajan), 4 Deputy
Governors, 1 Finance Ministry representatives, 10 government-nominated directors to represent
important elements from India's economy, and 4 directors to represent local boards headquartered at
Mumbai, Kolkata, Chennai and New Delhi. Each of these local boards consists of 5 members who
represent regional interests, and the interests of co-operative and indigenous banks.The bank is also
active in promoting financial inclusion policy and is a leading member of the Alliance for Financial
Inclusion (AFI).
FAILURES RBI.
1. Lack of Adjustment in the Money Market:
Reserve Bank has succeeded in controlling the organised sector of the Money Market, but not the
unorganised one. It has virtually failed in regulating or controlling the activities of rural money lenders
and other indigenous bankers.
These bankers just do not come within the scope of the Reserve Bank.
2. Lack of Uniformity in the Rate of Interest:
Because of the lack of control on different sectors of the money market, different rates of interest
continue to prevail. Outside the organised sector of the money market, rates of interest are exorbitantly
higher than the bank rate. Reserve Bank has rather miserably failed in this regard.
3. Lack of Bill Market:
Reserve Bank prepared a plan for the development of Bill Market in 1952. But till date there is no
independent and organised widespread bill market in India. Bill Market in India does not receive first-
rate Discountable Bills.
4. Insufficient Availability of Agricultural Credit:
Despite the fact that lot of steps have been initiated by the Reserve Bank to provide enough agricultural
credit, its availability continues to be far behind its requirement. Agricultural credit it still being
dominated by rural money lenders and other indigenous bankers who charge very high interest rates.
5. Insufficient Banking Facility:
During 46-years, after independence, Reserve Bank has tried to spread banking activity in all parts of the
country. Yet it is not sufficient in view of the large size of population. Also, most of the banking activity is
concentrated in urban areas. People in small villages and sub-urban areas still deprived of the banking
facility.
6. Instability in the Internal Value of the Rupee:
Instability in the internal value of the rupee has been the biggest failure of the Reserve Bank. Because of
the ever increasing circulation of money, prices have been rising almost non-stop. Value of the rupee
has been reduced to just 7 Paise during the last 47-years or so.
7. Failure of the Banks:
Reserve Bank has also failed as a Bank of the Bankers its lack of assistance to the Commercial Banks
caused their closure. Between 1939 to 1946 nearly 444 banks failed in the country. Closure of three
banks in 1985 is also a notable point. Failure of the banks erodes faith of the people in the banking
system.
8. Failure in Getting Sufficient Share in Foreign Exchange Business for the Indian Banks:
The Reserve Bank has yet not succeeded in getting the Commercial Banks any notable foreign exchange
business. Foreign exchange business almost continues to be a monopoly of foreign banks. Some of the
Indian Banks have opened their branches abroad, but not with any notable success so far.
9. Share Scam:
In 1992-93, country witnessed large scale share scam involving hundreds of crores of rupees. It was a
glaring example of the failure of Reserve Bank of India.
ACHIEVEMENTS RBI:
1. Flexible Monetary Policy:
The Reserve Bank has adopted a flexible monetary policy. It has introduced changes in monetary
regulations keeping in view the seasonal character of Indian money market. The pressure of seasonal
demand has been adequately met.
On account of it the seasonal fluctuations in money rates have been negligible.
2. Stable Structure of Interest Rates:
The interest rate policy of the Reserve Bank has resulted into a relatively stable structure of interest
rates in the economy. The bank initially adopted cheap money policy from its beginning.
The bank rate remained unchanged at the low level of 3 percent upto 1951. Some upward changes have
been made in subsequent years to combat inflationary pressure. The Bank rate has remained
substantially lower than the market rate of interest. The bank rate has remained more or less stable.
3.. Cheap Remittance Facilities:
The Reserve Bank has introduced very cheap remittance facilities. These have been widely used by the
commercial banks, the Government and cooperative banks.
5. Successful Management of Public Debt:
The Reserve Bank has successfully managed the public debt. It has floated loans for the Government at
low rates of interest. It has helped in raising funds for the expansion of public sector in the economy. It
has also provided short term advances to the Government.
6. Exchange Stability:
The Reserve Bank has succeeded in maintaining the exchange stability to a large extent. The Bank has
maintained the exchange value of the rupee at a relatively higher rate than would have prevailed in the
market.
It has made judicious use of exchange control measures to keep the demand for foreign exchange
within the limits of the available supplies.
7. Enhanced Public Confidence in Banking Sector:
The Reserve Bank has taken appropriate measures to enhance public confidence in the banking systems.
Bank strictly supervises the working of the Commercial banks so as to avoid their failures.
The Deposits Insurance System has also been introduced to protect the interests of the depositors. It
has proved an important factor in promoting depositors’ confidence in banks.
8. Central Authority of Indian Money Market:
The Reserve Bank has functioned as the central authority in the Indian money market. It has supervised
and controlled commercial banks, cooperative banks and non-banking finance companies accepting
deposits from the public.
9. Development of Bill Market:
The Reserve Bank has made serious efforts to develop a sound bill market in India. It has imparted a
substantial degree of elasticity to the credit structure of the country by introducing the several Bill
Market Schemes.
10. Rational Allocation of Credit:
The Reserve Bank has adopted measures to distribute credit to all productive sectors in accordance with
social objectives and priorities. The scheme of Differential Interest Rates was introduced to grant loans
at concessional rates to weaker sections of the society. The priority sector including agriculture, small
scale industries, exports, trades etc., get credit at low rate of interest.
11. Monetary Stability:
The Bank has made a rational use of quantitative and qualitative measures of credit control to maintain
monetary stability. These controls were generally employed in the direction of greater restraint in the
context of persistent imbalances in the economy. It has tried to control the pace of monetary expansion.
12. Contribution to Economic Development:
The Reserve Bank has played an active role in promoting economic development of the Indian economy.
It has helped in setting up a sound structure of Development Banking. Several Industrial, Agricultural,
Export and other specialised financial institutions have been established.
The Reserve Bank has helped in building up a well-differential structure of financial institutions to cater
to the requirements I of the different sectors of the economy.