ECONOMICS

PROJECT
PROJECT 2
 INTRODUCTION OF RBI
The Reserve Bank of India (RBI) is India's central
banking institution, which controls the monetary
policy of the Indian rupee. It commenced its
operations on 1 April 1935 in accordance with
the Reserve Bank of India Act, 1934. The original
share capital was divided into shares of 100 each fully
paid, which were initially owned entirely by private
shareholders. Following India's independence on 15
August 1947, the RBI was nationalized on 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 21-member central board of directors:
the governor; four deputy governors; two finance
ministry representatives (usually the Economic Affairs
Secretary and the Financial Services Secretary); ten
government-nominated directors to represent
important elements of India's economy; and four
directors to represent local boards headquartered at
Mumbai, Kolkata, Chennai and the capital New
Delhi. Each of these local boards consists of five
members who represent regional interests, the
interests of co-operative and indigenous banks.
The central bank was an independent apex
monetary authority which regulates banks and
provides important financial services like storing of
foreign exchange reserves, control of inflation, and
monetary policy report till August 2016. A central
bank is known by different names in different
countries. The functions of a central bank vary from
country to country and are autonomous or quasi-
autonomous body and perform or through another
agency vital monetary functions in the country. A
central bank is a vital financial apex institution of an
economy and the key objects of central banks may
differ from country to country still they perform
activities and functions with the goal of maintaining
economic stability and growth of an economy.
The bank is also active in promoting financial
inclusion policy and is a leading member of
the Alliance for Financial Inclusion(AFI). The bank is
often referred to by the name Mint Street. RBI is also
known as banker's bank.
HISTORY OF RBI
The Reserve Bank of India is the central bank of the
country. Central banks are a relatively recent
innovation and most central banks, as we know them
today, were established around the early twentieth
century.
The Reserve Bank of India was set up on the basis of
the recommendations of the Hilton Young
Commission. The Reserve Bank of India Act, 1934 (II of
1934) provides the statutory basis of the functioning of
the Bank, which commenced operations on April 1,
1935.
The Bank was constituted to
* Regulate the issue of banknotes
* Maintain reserves with a view to securing
monetary stability and
* To operate the credit and currency system of the
country to its advantage.

The Bank began its operations by taking over from

the Government the functions so far being performed
by the Controller of Currency and from the Imperial
Bank of India, the management of Government
accounts and public debt. The existing currency offices
at Calcutta, Bombay, Madras, Rangoon, Karachi,
Lahore and Cawnpore (Kanpur) became branches of
the Issue Department. Offices of the Banking
Department were established in Calcutta, Bombay,
Madras, Delhi and Rangoon.
Burma (Myanmar) seceded from the Indian Union in
1937 but the Reserve Bank continued to act as the
Central Bank for Burma till Japanese Occupation of
Burma and later up to April, 1947. After the partition
of India, the Reserve Bank served as the central bank
of Pakistan up to June 1948 when the State Bank of
Pakistan commenced operations. The Bank, which
was originally set up as a shareholder's bank, was
nationalized in 1949.
An interesting feature of the Reserve Bank of India
was that at its very inception, the Bank was seen as
playing a special role in the context of development,
especially Agriculture. When India commenced its
plan endeavors, the development role of the Bank
came into focus, especially in the sixties when the
Reserve Bank, in many ways, pioneered the concept
and practice of using finance to catalyze
development. The Bank was also instrumental in
institutional development and helped set up
institutions like the Deposit Insurance and Credit
Guarantee Corporation of India, the Unit Trust of
India, the Industrial Development Bank of India, the
National Bank of Agriculture and Rural
Development, the Discount and Finance House of
India etc. to build the financial infrastructure of the
country.
With liberalization, the Bank's focus has shifted back
to core central banking functions like Monetary
Policy, Bank Supervision and Regulation, and
Overseeing the Payments System and onto
developing the financial markets.
 FUNCTIONS OF RBI
Functions of Reserve Bank
1. Issue of Notes — The Reserve Bank has the
monopoly for printing the currency notes in the
country. It has the sole right to issue currency notes of
various denominations except one rupee note (which
is issued by the Ministry of Finance). The Reserve
Bank has adopted the Minimum Reserve System for
issuing/printing the currency notes. Since 1957, it
maintains gold and foreign exchange reserves of Rs.
200 Cr. of which at least Rs. 115 cr. should be in gold
and remaining in the foreign currencies.

2. Banker to the Government–The second important

function of the Reserve Bank is to act as the Banker,
Agent and Adviser to the Government of India and
states. It performs all the banking functions of the
State and Central Government and it also tenders
useful advice to the government on matters related
to economic and monetary policy. It also manages
the public debt of the government.
3. Banker’s Bank:- The Reserve Bank performs the
same functions for the other commercial banks as the
other banks ordinarily perform for their customers.
RBI lends money to all the commercial banks of the
country.

Structure of Banking Sector in India

4. Controller of the Credit:- The RBI undertakes the
responsibility of controlling credit created by the
commercial banks. RBI uses two methods to control
the extra flow of money in the economy. These
methods are quantitative and qualitative techniques
to control and regulate the credit flow in the country.
When RBI observes that the economy has sufficient
money supply and it may cause inflationary situation
in the country then it squeezes the money supply
through its tight monetary policy and vice versa.

Where do Printing of Security Papers, Notes and

Minting take Place in India?
5. Custodian of Foreign Reserves:-For the purpose of
keeping the foreign exchange rates stable, the
Reserve Bank buys and sells the foreign currencies
and also protects the country's foreign exchange
funds. RBI sells the foreign currency in the foreign
exchange market when its supply decreases in the
economy and vice-versa. Currently India has Foreign
Exchange Reserve of around US$ 360bn.

6. Other Functions:-The Reserve Bank performs a

number of other developmental works. These works
include the function of clearing house arranging credit
for agriculture (which has been transferred to
NABARD) collecting and publishing the economic
data, buying and selling of Government securities (gilt
edge, treasury bills etc)and trade bills, giving loans to
the Government buying and selling of valuable
commodities etc. It also acts as the representative of
Government in International Monetary Fund (I.M.F.)
and represents the membership of India.
New department constituted in RBI:- On July 6,
2005 a new department, named financial market
department in reserve bank of India was
constituted for surveillance on financial markets.

This newly constituted dept. will separate the

activities of debt management and monetary
operations in future. This department will also
perform the duties of developing and monitoring
the instruments of the money market and also
monitoring the government securities and foreign
money markets.

So it can be concluded that as soon as the our

country is growing the role of RBI is going to be
very crucial in the upcoming years.
 METHODS OF CREDIT CONTROL

METHODS OF
CREDIT
CONTROL

QUANTITATIVE QUALITATIVE

Credit control is most important function of Reserve

Bank of India. Credit control in the economy is
required for the smooth functioning of the economy.
By using credit control methods RBI tries to maintain
monetary stability. There are two types of methods:
Quantitative control to regulates the volume of total
credit. Qualitative Control: to regulate the flow of
credit.
Here is a brief description of the quantitative and
qualitative measures of credit control.
 QUANTITATIVE METHODS:
The following are the quantitative methods
of credit control:
1. Variation in the Bank Rate: The bank
rate is the minimum official rate at which
the central bank rediscounts ‘eligible paper’
presented by the discount hours or make
loan to them. It may also mean the
minimum rate of interest at which the
central bank lends to the banking system
against some approved securities. The
central bank controls the volume of bank
credit by raising or lowering its bank rate.
The importance of the bank rate lies in the
fact that it acts as pace-setter to the other
market rates of interest, both short-run
and long-run, and that its variation affects
both cost and availability of bank credit.
The raising of the bank rate as done during
inflation leads to an increase in market
interest rates.

As a result there is a fall in borrowing from

the banks and the volume of credit will
automatically fall. The lowering of the
bank rate, as done during deflation, on the
other hand, causes a fall in market interest
rates. As a result borrowing from the banks
increases and the volume of credit expands.
The bank rate has been revised by the
Reserve Bank several times in the past.
Limitations: But the bank rate policy is not
very effective in the absence of a well-
developed bill market in the country.
Besides, in reality there may not exist a
close relation between the bank rate and
the other rates of interest as is postulated in
theory.
Furthermore, the bank rate policy becomes
ineffective in the underdeveloped money
markets as the banks do not approach the
central bank very frequently for obtaining
credit facilities. For all these reasons, Keynes
regarded the bank rate as an ineffective
instrument of monetary (credit) control.
And, in fact, its importance has diminished
in recent years.
2. Open Market Operations: The technique
of open market operations refers broadly
to the purchase and sale by the central
bank of a variety of assets particularly
government securities. The sale of securities
by the central bank to commercial banks
or to the public causes the banks to make
payments to the central bank; as a result
the cash balances of the banks fall, their
power to lend decreases and ultimately the
volume of bank credit declines.
The purchase of securities, on the other
hand, by the central bank from member
banks (or from the public at large) causes
the central bank to make payments to the
banks. As a result the cash balances of
member banks increase their power to lend
increases and the volume of credit expands.
So, the sale operation of the central bank
causes a contraction of credit and the
purchase operations, an expansion of
credit. It is to be noted that in actual
practice the high bank rate is combined
with the sale operations during inflation for
credit contraction and the low bank rate
with the purchase operations during
deflation for credit expansion.
Limitations: But this method becomes
ineffective in reducing credit where the
commercial banks have excess cash
balances. Furthermore, these opera-tions
cannot be carried out effectively in the
absence of a broad and well- developed
market for government securities. Finally, it
is not much effective in countries like India
where people are not in the habit of
buying securities as a matter of routine.
3. Variable Reserve Ratio: The cash reserve
ratio (CRR) refers to a certain percentage
of a bank’s deposits which the bank keeps
in cash, by law or convention, with the
central bank as a reserve. The central bank
can control the total volume of bank credit
by raising or lowering this cash reserve
ratio. The raising of the CRR causes a
contraction of bank credit, because when
the CRR is high the banks are to keep
larger reserves at the central bank and
their power to give credit is reduced.
The lowering of the CRR, on the other
hand, causes an expansion of credit as the
banks are to keep a smaller reserve at the
central bank and so get a larger fund for
lending. In India, the Reserve Bank at
present can vary the CRR from 3% to 15%
of the total deposits of the banks. The
reserve ratio was raised from 9% to 9½% of
total deposits in February 1987.
Incremental CRR: For tightening credit
restraint and for managing excess liquidity
in the banking system, a central bank can
ask for an additional CRR for excess
deposits accumulated from a specified
date. This technique is followed in India
and is known as impounding or excess
deposits through incremental CRR.
Limitations: J.M. Keynes strongly advocated
this weapon of credit control. Although this
method can bring about a quick reduction
in the bank credit by a mere stroke of pen,
it is considered to be highly discriminatory
as it affects the different banks differently –
affecting smaller banks more adversely
than their larger counterparts.
 QUALITATIVE OR SELECTIVE
METHODS OF CREDIT CONTROL:
The following are the major qualitative
methods of credit control or selective credit
controls:
a. Minimum margin requirements: This
weapon is selective in respect of the field of
its application. In a second advance, the
margin refers to the amount of cash one
must put up in, to be eligible to borrow
from a bank. Thus, if a loan of Rs. 9,000 is
secured by a stock worth of Rs 10 000 the
margin is said to be Rs.1, 000 or 10% of the
value of the stock. Therefore with a 10%
margin requirement, one can borrow 90%
of the valu6 of the security.
During inflation the central bank raises the
margin in respect of loans taken against
some speculative, essential commodities.
The Reserve Bank of India gives frequent
instructions to other banks to keep higher
margins for giving loans against essential
commodities like paddy or rice, wheat,
oilseeds, cotton-textile, sugar, pulses, edible
oils, etc. in order to restrict speculative
credit and to curb speculative rise in their
prices on account of short supply.
This method is highly effective (as found in
the underdeveloped money market of
India) because it can strike at the strategic
spot of the economy for controlling the
inflationary rise in prices. But it is difficult,
in practice, to select the commodities to be
brought under such control or to determine
the proper margin for advances.
b. Consumer Credit Regulation: Originated
in the U.S.A. during the World War II, this
technique is based on the observation that
the monetary demand for durable
consumer goods is extremely unstable.
Under this method, the central bank
controls the bank advances intended for
the installment buying of consumers’
durable such as automobiles, household
furniture, refrigerators, etc. Such control is
exercised by regulating the terms and
amount of down payments and the period
of repayment.
3. Other Methods: Besides, there are some
other methods of credit. Al-though
qualitative in character, they are yet
treated as minor ones.
These are as follows:
1. Rationing of Credit:
The central bank, by this method,
introduces the quota system regulating
bank loans or fixes the maximum limit of
bank advances for different purposes.
2. Direct Orders: The central bank, being
the supreme monetary author-ity
sometimes gives direct orders or instructions
(e.g., Credit Authorization Scheme in India)
to other banks to follow a particular policy
of monetary control.
3. Moral Suasion: Moral suasion implies
informal suggestions or recom-mendations
through circulars which the central bank
may make to other banks for credit
regulation. The banks are persuaded to
implement these suggestions.
 PRESENT RATES

Policy Repo Rate :6.50%

Reverse Repo Rate :6.25%
Marginal Standing Facility :6.75%
Rate
Bank Rate :6.75%
CRR 4%
SLR 19.5%