Monetary Policy
Monetary policy is all about supply of currency in the country. If we are talking about supply of currency then the term has a wide meaning, since the supply of currency is affected by many means and in turn affects many other variables. It is a country¶s central bank that controls the supply of money. Monetary policy has direct bearing on inflation and commercial bank interest rate. So even the slightest change in the monetary policy affects inflation and bank interest rate. The central bank designs the monetary policy in keeping with the government¶s economic poll. Monetary policy is about expansion and contraction of money and the central bank is the implementing body of the monetary policy Given below is the study of money supply and our central bank, i.e., the Reserve Bank of India (RBI).
Measures of Money Supply in India (Monetary Aggregates)
There are two basic measures of money globally narrow and broad. The former usually consists of the currency with the public and demand deposits with banks. The latter includes the time deposits with banks. Till 1998, the RBI calculated four components of money supply in India, now termed as old money measures. These are known as money stock measures of monetary aggregates. Old Money Aggregates/Measures are as follows: M1 = Currency with the public, i.e., coins and currency notes + demand deposits with banks + other deposits with RBI. M2 = M1 + Post Office savings. M3 = M1 + time deposits of the public with banks; this is also known as broad money. M4 = M3 + saving and time deposits with the post office. Out of the four concepts of money supply, RBI emphasises only two concepts, viz., ordinary money or narrow money (M1) and money supply in the broad sense (M3), which consists of M1 plus time deposit of people with the bank. M3 is also referred to as broad money or aggregate monetary resource of the people.
New Monetary Aggregates
MO = Currency in Circulation + Bankers Deposits with the RBI + µOther¶ Deposits with the RBI. Ml (NM1) = Currency with the Public + Demand Deposits with the Banking System + µOther¶ Deposits with the RBI. M2 (NM2) = M1 + Time Liabilities Portion of Savings Deposits with the Banking System + Certificates of Deposit issued by Banks + Term Deposits of residents with a contractual maturity of up to and including one year with the Banking System (excluding CDs). M3(NM3) = M2 + Term Deposits of residents with a contractual maturity of over one year with the Banking System + Call/Term borrowings from µNon-depository¶ Financial Corporations by the Banking System. There are three major changes in the new and old monetary aggregates. New intermediate monetary aggregate, which is to be referred to as NM2, comprises of currency and resident¶s short-term bank deposits that would stand between narrow money (M1,wbich includes only the non-interest bearing monetary liabilities of the banking sector) and broad money (M3). The new broad money aggregate (referred to as NM3 for purpose of clarity) in the Monetary Survey would comprise of NM2, long-term deposits of residents, and call/term borrowings from non-bank sources which have emerged as an important source of resource mobilisation for banks. The critical difference between M3 and NM3, essentially, lies in the treatment of non-resident repatriable fixed foreign currency liabilities of the banking system in the money supply compilation. Post office deposits have been dropped from the new money and thus the old concept of M2 and M4 concepts have been dropped.
Liquidity Measures
Three liquidity measures have been designed recently which are referred to as Li, L2, and L3. These are defined as follows: L1 = NM3 + Postal Deposits. L2 = L1 + Liabilities of the financial institutions. L3 = L2 + Public deposits with non-bank finance Companies.
Factors Affecting Money Supply in India
There are five sources which contribute to the aggregate monetary resources in the country (M3): a. Net bank credit to the Govt. b. Bank credit to the commercial sector. c. Net foreign exchange assets of the banking sector. d. Government currency liabilities to the public. e. Non monetary liabilities of the banking sector.
Net Bank Credit to the Government
There are two types of bank credit to the government RBI credit to the Central and State Government and others banks¶ credit to the Central and State Government. The government provides its securities to the RBI against which it receives loans from the RBI. The RBI prints and issues currency notes against govt. securities. This increases money supply in the country and when the government buys back its securities, it reduces the supply. Similarly, when the government borrows from commercial banks, it also increases the supply of money with the public.
Bank Credit to the Commercial Sector
When banks lend to customers it increases the supply of money in the hands of the public. Lending by the commercial sector has a multiplier effect. When banks lend to the customer, they do not hand over currency to him, but instead allow him the facility of withdrawl by cheque. These cheques come back to the banking system as fresh deposits. By giving more such loans, banks multiply their deposits. More bank loans mean more supply of money and more investment.
Foreign Exchange Assets
Foreign exchange assets acquired by the banking system are also a source of money supply. When an exporter receives a payment in foreign exchange (forex) he surrenders it to the bank, which in turn gives him local currency. This increases supply of money in the country. On the other hand, when an importer asks for foreign exchange to import, he gives local currency to the bank and supply of money in the country is reduced.
Government Currency Liabilities to the Public
The Government of India prints/mints one rupee notes, rupee coins and small coins (50 paisa, 25 Paisa etc.) which constitute the government¶s currency liabilities to the public. This leads to increase in the volume of money supply and the government¶s currency liabilities to the public.
Non-Monetary Liabilities of the Banking Sector
Non-monetary liabilities of the RBI and other banks are deducted before we calculate the stock of money. These liabilities of bank include their paid up capital and reserves, pension fund, provident fund and other liabilities like bills payable over other assets of banks, errors and omission, etc. Since they are liabilities of the banking system, they have to be deducted to arrive at the money stock (M3).
Need to Regulate the Supply of Money
The supply of money has a direct impact on inflation, level of investment, employment generation, interest rate, etc. It is clear that supply of money has an effect on every aspect of the economy and has a close relationship with development. Supply of money is a sensitive issue as even a slight imbalance can create havoc in the form of deflation or hyperinflation in the country. In the initial stages of perestroika in the erstwhile USSR, because of imbalances in supply of money, the value of the Russian trouble decreased to such an extent much that people used to carry bags full of money to purchase bread. Every country manages supply of money in the national interest through its central bank.
Money Supply and Inflation
There is a direct relationship between the supply of money and inflation. It is based on the simple fundamental of demand and supply. The value of a currency is defined by its purchasing power. As the supply of money increases its value decreases. Decrease in purchasing power means an increase in inflation. When the supply of money increases with the people it gives them more purchasing power, results in an increase in demand. Prices rise if demand increases without a correspondent increment in supply. This doesn¶t mean that money supply is directly proportional to inflation. Because increment in supply of money not only increases the demand, it also increases investment, i.e., supply. Part of the increased money also goes into savings. This is the reason that with an increase in money supply, the government promotes investment and savings so that it does not have an inflationary impact. There is thus a close relationship between inflation and supply of money, but not a proportional relation.
Supply of Money, Interest Rate and Investment
The supply of money also has an impact on interest rates and level of investment. In fact, economists propounded the theory that to boost development and to create employment, the government should expand money. Here too, the fundamentals are the same. As supply of money increases its value goes down price of money is its interest rate. So when banks get more money, they provide loans at low rates. This increases the level of investment in the country because more people go for investments with low interest rates. This results in creation of employment, which results in an increase in purchasing power. This in turn increases demand and results in inflation, which again works as a catalyst for investment. So it is clear that there is cyclical relation between money supply, inflation, interest and investment. We can put the four things in the following manner:
Relation between supply of money and inflation
Supply of Money Low Interest Rate
Inflation
Higher Investment
Increase Demand
Employment
Monetary Management
It is the central bank of a country that is responsible for the regulation of supply of money. In India it is the RBI which manages the supply of money.
Reserve Bank of India
In 1921, the govt. of India established the Imperial Bank as the central bank of India. But it was not very successful. Upon the recommendation of the Central Banking Enquiry Committee, on April 1, 1935, the Reserve Bank of India began working. The entire share capital of RBI was initially owned by private shareholders. It was nationalised in 1949. Its head office is in Mumbai and it has branches in New Delhi, Kolkata, Chennai, Bangalore, Kanpur, Ahmedabad, Hyderabad, Patna and Nagpur. The State Bank of India works as its Agent in the cities where the RBI does not have an office. The Preamble of the RBI Act, 1934 states that, ³Whereas it is expedient to constitute a Reserve Bank of India to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in (India) and generally to operate the currency and credit system of the country to its advantage.´
Functions of the Reserve Bank of India
1. Issue of Currency: The RBI has the sole right to issue currency notes. To issue notes, it follows a minimum reserve system. According to RBI (Amendment Act) modified in 1957, the bank has to keep a minimum reserve of Rs.. 200 crore, of which Rs.15 crore has to be in gold coins and bullion and Rs. 85 crore in foreign securities. Although one rupee coins and notes as well as coins of smaller denominations are issued by the Government of India, they are put into circulation through, the RBI. The Bank also exchanges notes and coins of one denomination into¶ those of other denominations as demanded by the¶ public. The RBI has 15 full-fledged issue offices and 2 sub-offices, along with 4,127 currency chests where the, stock of new and reissuable notes, rupees and coins are stored at the end of March 1997. 2. Banker to Government: The Reserve Bank of India acts as the banker to the central government as also to the governments of the constituent units of India¶s federal system. Banks transact the banking business of the Government of India and accordingly perform the following functions: accept money on account of the government, make payment on its behalf, and carry out exchange remittance and other banking operations, including the management of public debt. The RBI plays an important role in. financing government expenditure. In addition to financial transaction, the Bank acts as the agent of the government in respect of India¶s membership of the International Monetary Fund and International Bank of Restructuring and Development. It also acts as an adviser to the government on banking and financial matters. Ways and Means Advances: The Bank can make ³Ways and Means Advances´, i.e., temporary advances to both the Central and, state governments to bridge the temporary gap between receipts and payments. The maximum maturity period of these advances is three months.
3. Banker¶s Bank: RBI has extensive powers to control the commercial banking system. All scheduled banks are under a statutory obligation to maintain a certain minimum of cash reserve which is to be decided by the RBI against their demand and time liabilities. With this, the RBI determines¶ deposits/credit creating ability of the bank. The RBI provides financial assistance to scheduled commercial banks and state co-operative banks in the form of discounting of legible bills, loans advances against approved securities. The RBI is expected to help banks in their crises. RBI is not only a banker¶s bank but it also works as a lender of last resort. 4. Controller of Credit: The RBI functions as the controller of credit. As such, it regulates the guard of credit and the rate at which it is made available. It does this through the use of general and select controls. 5. Exchange Management and Control: The RBI is required to stabilise the external value of~ rupee. For this purpose, it functions as the custodian of the nation¶s foreign exchange reserves. It is obligatory for the RBI to buy and sell currencies of all the members of the IMF. In this field the RBI has following dimensions: a. To administer the µforeign exchange control¶. b. To choose the exchange rate system and fix or manage the exchange rate between the rupee other currencies. c. To exchange reserve. d. To interact or negotiate with the monetary authorities of the Sterling Area, Asian Clearing Union and other countries, and with international financial institutions such as the IMF, World Bank and the Asian Development Bank. The RBI administers µexchange control¶ in terms of the Foreign Exchange Management Act (FEMA). The objective of exchange control is to limit the demand of foreign exchange in keeping with supply. The EBI manages this through the buying and selling of foreign exchange from and to scheduled banks, which are the authorised dealers in the Indian Foreign Exchange market. The Bank also manages the investment of reserves in gold accounts abroad and the shares and securities issued by foreign government and international banks or financial institutions. The role of the RBI as a participant in the foreign exchange market, and as a stabiliser of the market and of the rupee exchange rate has become all the more important with the introduction floating exchange rate system and the rupee convertibility on trade, current and capital accounts.
6. Collection and Publication of Data: The RBI has been entrusted with the task of collection and compilation of statistical information relating to banking and other financial sectors of the economy. 7. Supervisory Function: The RBI has a wide power of supervision and control over commercial 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 authorised to carry out periodical inspection of banks and to call for returns and necessary information from them, it has the following powers in this field: a. To issue licenses for the establishment of new banks. b. To prescribe minimum requirement regarding paid up capital and reserves, transfer to reserve fund and maintenance of cash reserve and other liquid assets. c. To inspect the working of banks in India as well as abroad in respect of their organizational set up, branch expansion, mobilisation of deposits, investment and credit portfolio management, credit appraisal, region -wise performance, man power planning and so on. d. To conduct ad hoc investigation into complaints, irregularities and frauds in respect of banks from time to time. e. To control methods of operation of banks so that they do not fritter away funds in improper investments and injunctions advances. f. To control appointment, reappointment termination of appointment of the chairman and chief executive officers of private sector banks. g. To approve or force amalgamations. In keeping with the recommendations of the Narshimhan Committee (1991), the RBI¶s functions of bank supervision was separated from its traditional central banking function by the creation of a Separate Department of Supervision (DOS). The Board of Financial Supervision was set up to oversee the IFS. The RBI performs many development and promotional functions. . It has done valuable work in aiding development and in promoting saving and bunking habits. The RBI established Deposit Insurance Corporation of India in 1962 to provide securities to depositors against frequent bank failures. The RBI played an important role in the establishment of UTI, IFCI, SFC, IDBI, and Agriculture Refinance Corporation, etc.
8. Promoter of the Financial System: The RBI delivers various promotional and development services strengthen the country¶s banking and financial structure. 9. Money Market: In order to increase the strength and viability of the banking system, it carried out a programme of amalgamations and mergers of weak banks with the strong ones. When the social control of banks was introduced in 1968, it was the responsibility of the RBI to administer it in the country to achieve the desired objectives. After the nationalisation of banks it was the responsibility of the RBI to develop banking interest in the national interest. With the help of a. statutory provision for licensing and branch expansion of banks, the RBI has been trying to bring about an appropriate geographical distribution of bank branches. In order to ensure the security of deposits with banks, the RBI in 1962, took the initiative to create the Deposits Insurance Corporations. 10. Agriculture Sector: The RBI directs and increases the flow of credit to the agricultural sector. It has appointed a separate deputy governor in charge of rural credit. It has conducted many studies and research on the problem of rural credit. It has created a data base on rural credit through various surveys. The RBI has been strengthening the co-operative banking structure through the provision of finance, supervision, and inspection to increase the supply of agricultural credit. It provides short term finance at a concessional rate for seasonal agriculture operations and marketing of crops through co-operative banks. It established the Agricultural Refinance Cooperation (now known as NABARD) in July 1963 for providing medium²term and long-term finance for agriculture. It also helped in establishing an Agriculture Finance Corporation.
11. Industrial Finance:
The RBI has either created or has advised and helped in creation of many development institutions and financial institution at the centre and state level. These include IDBI, SIDBI, NHB, NCB and UTI. Through these institutions, the RBI has been providing short-term and long-term funds to the agriculture and rural sectors, to small scale industries, to medium and large industries and to the export sector.
Monetary Policy
From its inception, the RBI has followed the policy of controlled expansion, i.e., adequate financing of economic growth while ensuring reasonable price stability. Expansion of money is required in developing country for the purpose of development and investment. But this expansion results in inflation. So the RBI has to be cautious in order to achieve a trade-off between expansion and inflation. Not only this also manages the forex exchange rate through open market operations, as after liberalisation it is the market forces that decide the exchange rate.
The keynote of monetary policy can be said to be controlled expansion of bank credit and money supply, with special attention to seasonal requirement for credit. The RBI regards money supply volume of bank credits as the two major intermediate variables, but it seeks to control the former through the latter. It is said that money supply doesn¶t change on its own; it changes because of certain underlying development with regard to bank credit.
RBI and Credit Control
For the sake of credit control, the RBI resorts to bank rate manipulations, open market operations requirement changes, direct action, and rationing of credit and moral suasion. Apart from employing traditional methods of credit control, it directly influences commercial banks¶ lending policy, rate of interest and form of securities against loans and portfolio distribution. The instrument of monetary policy (methods of credit control) may be broadly divide into the following parts:
a. b. c. d. e. f. g. h. l. j. k. l. Open Market Operations Bank Rate Direct Regulation of Interest Rates on Commercial Banks¶ Deposits and Loans Cash Reserve Ratio (CRR) Statutory liquidity Ratio (SLR) Direct Credit Allocation and Credit Rationing Selective Credit Controls (SCC) Credit Authorisation Scheme (CAS) Fixation of Inventory and Credit Norms Credit Planning Moral Suasion Liquidity Adjustment Facility (LAF)
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doc_875614836.ppt
Monetary policy is all about supply of currency in the country. If we are talking about supply of currency then the term has a wide meaning, since the supply of currency is affected by many means and in turn affects many other variables. It is a country¶s central bank that controls the supply of money. Monetary policy has direct bearing on inflation and commercial bank interest rate. So even the slightest change in the monetary policy affects inflation and bank interest rate. The central bank designs the monetary policy in keeping with the government¶s economic poll. Monetary policy is about expansion and contraction of money and the central bank is the implementing body of the monetary policy Given below is the study of money supply and our central bank, i.e., the Reserve Bank of India (RBI).
Measures of Money Supply in India (Monetary Aggregates)
There are two basic measures of money globally narrow and broad. The former usually consists of the currency with the public and demand deposits with banks. The latter includes the time deposits with banks. Till 1998, the RBI calculated four components of money supply in India, now termed as old money measures. These are known as money stock measures of monetary aggregates. Old Money Aggregates/Measures are as follows: M1 = Currency with the public, i.e., coins and currency notes + demand deposits with banks + other deposits with RBI. M2 = M1 + Post Office savings. M3 = M1 + time deposits of the public with banks; this is also known as broad money. M4 = M3 + saving and time deposits with the post office. Out of the four concepts of money supply, RBI emphasises only two concepts, viz., ordinary money or narrow money (M1) and money supply in the broad sense (M3), which consists of M1 plus time deposit of people with the bank. M3 is also referred to as broad money or aggregate monetary resource of the people.
New Monetary Aggregates
MO = Currency in Circulation + Bankers Deposits with the RBI + µOther¶ Deposits with the RBI. Ml (NM1) = Currency with the Public + Demand Deposits with the Banking System + µOther¶ Deposits with the RBI. M2 (NM2) = M1 + Time Liabilities Portion of Savings Deposits with the Banking System + Certificates of Deposit issued by Banks + Term Deposits of residents with a contractual maturity of up to and including one year with the Banking System (excluding CDs). M3(NM3) = M2 + Term Deposits of residents with a contractual maturity of over one year with the Banking System + Call/Term borrowings from µNon-depository¶ Financial Corporations by the Banking System. There are three major changes in the new and old monetary aggregates. New intermediate monetary aggregate, which is to be referred to as NM2, comprises of currency and resident¶s short-term bank deposits that would stand between narrow money (M1,wbich includes only the non-interest bearing monetary liabilities of the banking sector) and broad money (M3). The new broad money aggregate (referred to as NM3 for purpose of clarity) in the Monetary Survey would comprise of NM2, long-term deposits of residents, and call/term borrowings from non-bank sources which have emerged as an important source of resource mobilisation for banks. The critical difference between M3 and NM3, essentially, lies in the treatment of non-resident repatriable fixed foreign currency liabilities of the banking system in the money supply compilation. Post office deposits have been dropped from the new money and thus the old concept of M2 and M4 concepts have been dropped.
Liquidity Measures
Three liquidity measures have been designed recently which are referred to as Li, L2, and L3. These are defined as follows: L1 = NM3 + Postal Deposits. L2 = L1 + Liabilities of the financial institutions. L3 = L2 + Public deposits with non-bank finance Companies.
Factors Affecting Money Supply in India
There are five sources which contribute to the aggregate monetary resources in the country (M3): a. Net bank credit to the Govt. b. Bank credit to the commercial sector. c. Net foreign exchange assets of the banking sector. d. Government currency liabilities to the public. e. Non monetary liabilities of the banking sector.
Net Bank Credit to the Government
There are two types of bank credit to the government RBI credit to the Central and State Government and others banks¶ credit to the Central and State Government. The government provides its securities to the RBI against which it receives loans from the RBI. The RBI prints and issues currency notes against govt. securities. This increases money supply in the country and when the government buys back its securities, it reduces the supply. Similarly, when the government borrows from commercial banks, it also increases the supply of money with the public.
Bank Credit to the Commercial Sector
When banks lend to customers it increases the supply of money in the hands of the public. Lending by the commercial sector has a multiplier effect. When banks lend to the customer, they do not hand over currency to him, but instead allow him the facility of withdrawl by cheque. These cheques come back to the banking system as fresh deposits. By giving more such loans, banks multiply their deposits. More bank loans mean more supply of money and more investment.
Foreign Exchange Assets
Foreign exchange assets acquired by the banking system are also a source of money supply. When an exporter receives a payment in foreign exchange (forex) he surrenders it to the bank, which in turn gives him local currency. This increases supply of money in the country. On the other hand, when an importer asks for foreign exchange to import, he gives local currency to the bank and supply of money in the country is reduced.
Government Currency Liabilities to the Public
The Government of India prints/mints one rupee notes, rupee coins and small coins (50 paisa, 25 Paisa etc.) which constitute the government¶s currency liabilities to the public. This leads to increase in the volume of money supply and the government¶s currency liabilities to the public.
Non-Monetary Liabilities of the Banking Sector
Non-monetary liabilities of the RBI and other banks are deducted before we calculate the stock of money. These liabilities of bank include their paid up capital and reserves, pension fund, provident fund and other liabilities like bills payable over other assets of banks, errors and omission, etc. Since they are liabilities of the banking system, they have to be deducted to arrive at the money stock (M3).
Need to Regulate the Supply of Money
The supply of money has a direct impact on inflation, level of investment, employment generation, interest rate, etc. It is clear that supply of money has an effect on every aspect of the economy and has a close relationship with development. Supply of money is a sensitive issue as even a slight imbalance can create havoc in the form of deflation or hyperinflation in the country. In the initial stages of perestroika in the erstwhile USSR, because of imbalances in supply of money, the value of the Russian trouble decreased to such an extent much that people used to carry bags full of money to purchase bread. Every country manages supply of money in the national interest through its central bank.
Money Supply and Inflation
There is a direct relationship between the supply of money and inflation. It is based on the simple fundamental of demand and supply. The value of a currency is defined by its purchasing power. As the supply of money increases its value decreases. Decrease in purchasing power means an increase in inflation. When the supply of money increases with the people it gives them more purchasing power, results in an increase in demand. Prices rise if demand increases without a correspondent increment in supply. This doesn¶t mean that money supply is directly proportional to inflation. Because increment in supply of money not only increases the demand, it also increases investment, i.e., supply. Part of the increased money also goes into savings. This is the reason that with an increase in money supply, the government promotes investment and savings so that it does not have an inflationary impact. There is thus a close relationship between inflation and supply of money, but not a proportional relation.
Supply of Money, Interest Rate and Investment
The supply of money also has an impact on interest rates and level of investment. In fact, economists propounded the theory that to boost development and to create employment, the government should expand money. Here too, the fundamentals are the same. As supply of money increases its value goes down price of money is its interest rate. So when banks get more money, they provide loans at low rates. This increases the level of investment in the country because more people go for investments with low interest rates. This results in creation of employment, which results in an increase in purchasing power. This in turn increases demand and results in inflation, which again works as a catalyst for investment. So it is clear that there is cyclical relation between money supply, inflation, interest and investment. We can put the four things in the following manner:
Relation between supply of money and inflation
Supply of Money Low Interest Rate
Inflation
Higher Investment
Increase Demand
Employment
Monetary Management
It is the central bank of a country that is responsible for the regulation of supply of money. In India it is the RBI which manages the supply of money.
Reserve Bank of India
In 1921, the govt. of India established the Imperial Bank as the central bank of India. But it was not very successful. Upon the recommendation of the Central Banking Enquiry Committee, on April 1, 1935, the Reserve Bank of India began working. The entire share capital of RBI was initially owned by private shareholders. It was nationalised in 1949. Its head office is in Mumbai and it has branches in New Delhi, Kolkata, Chennai, Bangalore, Kanpur, Ahmedabad, Hyderabad, Patna and Nagpur. The State Bank of India works as its Agent in the cities where the RBI does not have an office. The Preamble of the RBI Act, 1934 states that, ³Whereas it is expedient to constitute a Reserve Bank of India to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in (India) and generally to operate the currency and credit system of the country to its advantage.´
Functions of the Reserve Bank of India
1. Issue of Currency: The RBI has the sole right to issue currency notes. To issue notes, it follows a minimum reserve system. According to RBI (Amendment Act) modified in 1957, the bank has to keep a minimum reserve of Rs.. 200 crore, of which Rs.15 crore has to be in gold coins and bullion and Rs. 85 crore in foreign securities. Although one rupee coins and notes as well as coins of smaller denominations are issued by the Government of India, they are put into circulation through, the RBI. The Bank also exchanges notes and coins of one denomination into¶ those of other denominations as demanded by the¶ public. The RBI has 15 full-fledged issue offices and 2 sub-offices, along with 4,127 currency chests where the, stock of new and reissuable notes, rupees and coins are stored at the end of March 1997. 2. Banker to Government: The Reserve Bank of India acts as the banker to the central government as also to the governments of the constituent units of India¶s federal system. Banks transact the banking business of the Government of India and accordingly perform the following functions: accept money on account of the government, make payment on its behalf, and carry out exchange remittance and other banking operations, including the management of public debt. The RBI plays an important role in. financing government expenditure. In addition to financial transaction, the Bank acts as the agent of the government in respect of India¶s membership of the International Monetary Fund and International Bank of Restructuring and Development. It also acts as an adviser to the government on banking and financial matters. Ways and Means Advances: The Bank can make ³Ways and Means Advances´, i.e., temporary advances to both the Central and, state governments to bridge the temporary gap between receipts and payments. The maximum maturity period of these advances is three months.
3. Banker¶s Bank: RBI has extensive powers to control the commercial banking system. All scheduled banks are under a statutory obligation to maintain a certain minimum of cash reserve which is to be decided by the RBI against their demand and time liabilities. With this, the RBI determines¶ deposits/credit creating ability of the bank. The RBI provides financial assistance to scheduled commercial banks and state co-operative banks in the form of discounting of legible bills, loans advances against approved securities. The RBI is expected to help banks in their crises. RBI is not only a banker¶s bank but it also works as a lender of last resort. 4. Controller of Credit: The RBI functions as the controller of credit. As such, it regulates the guard of credit and the rate at which it is made available. It does this through the use of general and select controls. 5. Exchange Management and Control: The RBI is required to stabilise the external value of~ rupee. For this purpose, it functions as the custodian of the nation¶s foreign exchange reserves. It is obligatory for the RBI to buy and sell currencies of all the members of the IMF. In this field the RBI has following dimensions: a. To administer the µforeign exchange control¶. b. To choose the exchange rate system and fix or manage the exchange rate between the rupee other currencies. c. To exchange reserve. d. To interact or negotiate with the monetary authorities of the Sterling Area, Asian Clearing Union and other countries, and with international financial institutions such as the IMF, World Bank and the Asian Development Bank. The RBI administers µexchange control¶ in terms of the Foreign Exchange Management Act (FEMA). The objective of exchange control is to limit the demand of foreign exchange in keeping with supply. The EBI manages this through the buying and selling of foreign exchange from and to scheduled banks, which are the authorised dealers in the Indian Foreign Exchange market. The Bank also manages the investment of reserves in gold accounts abroad and the shares and securities issued by foreign government and international banks or financial institutions. The role of the RBI as a participant in the foreign exchange market, and as a stabiliser of the market and of the rupee exchange rate has become all the more important with the introduction floating exchange rate system and the rupee convertibility on trade, current and capital accounts.
6. Collection and Publication of Data: The RBI has been entrusted with the task of collection and compilation of statistical information relating to banking and other financial sectors of the economy. 7. Supervisory Function: The RBI has a wide power of supervision and control over commercial 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 authorised to carry out periodical inspection of banks and to call for returns and necessary information from them, it has the following powers in this field: a. To issue licenses for the establishment of new banks. b. To prescribe minimum requirement regarding paid up capital and reserves, transfer to reserve fund and maintenance of cash reserve and other liquid assets. c. To inspect the working of banks in India as well as abroad in respect of their organizational set up, branch expansion, mobilisation of deposits, investment and credit portfolio management, credit appraisal, region -wise performance, man power planning and so on. d. To conduct ad hoc investigation into complaints, irregularities and frauds in respect of banks from time to time. e. To control methods of operation of banks so that they do not fritter away funds in improper investments and injunctions advances. f. To control appointment, reappointment termination of appointment of the chairman and chief executive officers of private sector banks. g. To approve or force amalgamations. In keeping with the recommendations of the Narshimhan Committee (1991), the RBI¶s functions of bank supervision was separated from its traditional central banking function by the creation of a Separate Department of Supervision (DOS). The Board of Financial Supervision was set up to oversee the IFS. The RBI performs many development and promotional functions. . It has done valuable work in aiding development and in promoting saving and bunking habits. The RBI established Deposit Insurance Corporation of India in 1962 to provide securities to depositors against frequent bank failures. The RBI played an important role in the establishment of UTI, IFCI, SFC, IDBI, and Agriculture Refinance Corporation, etc.
8. Promoter of the Financial System: The RBI delivers various promotional and development services strengthen the country¶s banking and financial structure. 9. Money Market: In order to increase the strength and viability of the banking system, it carried out a programme of amalgamations and mergers of weak banks with the strong ones. When the social control of banks was introduced in 1968, it was the responsibility of the RBI to administer it in the country to achieve the desired objectives. After the nationalisation of banks it was the responsibility of the RBI to develop banking interest in the national interest. With the help of a. statutory provision for licensing and branch expansion of banks, the RBI has been trying to bring about an appropriate geographical distribution of bank branches. In order to ensure the security of deposits with banks, the RBI in 1962, took the initiative to create the Deposits Insurance Corporations. 10. Agriculture Sector: The RBI directs and increases the flow of credit to the agricultural sector. It has appointed a separate deputy governor in charge of rural credit. It has conducted many studies and research on the problem of rural credit. It has created a data base on rural credit through various surveys. The RBI has been strengthening the co-operative banking structure through the provision of finance, supervision, and inspection to increase the supply of agricultural credit. It provides short term finance at a concessional rate for seasonal agriculture operations and marketing of crops through co-operative banks. It established the Agricultural Refinance Cooperation (now known as NABARD) in July 1963 for providing medium²term and long-term finance for agriculture. It also helped in establishing an Agriculture Finance Corporation.
11. Industrial Finance:
The RBI has either created or has advised and helped in creation of many development institutions and financial institution at the centre and state level. These include IDBI, SIDBI, NHB, NCB and UTI. Through these institutions, the RBI has been providing short-term and long-term funds to the agriculture and rural sectors, to small scale industries, to medium and large industries and to the export sector.
Monetary Policy
From its inception, the RBI has followed the policy of controlled expansion, i.e., adequate financing of economic growth while ensuring reasonable price stability. Expansion of money is required in developing country for the purpose of development and investment. But this expansion results in inflation. So the RBI has to be cautious in order to achieve a trade-off between expansion and inflation. Not only this also manages the forex exchange rate through open market operations, as after liberalisation it is the market forces that decide the exchange rate.
The keynote of monetary policy can be said to be controlled expansion of bank credit and money supply, with special attention to seasonal requirement for credit. The RBI regards money supply volume of bank credits as the two major intermediate variables, but it seeks to control the former through the latter. It is said that money supply doesn¶t change on its own; it changes because of certain underlying development with regard to bank credit.
RBI and Credit Control
For the sake of credit control, the RBI resorts to bank rate manipulations, open market operations requirement changes, direct action, and rationing of credit and moral suasion. Apart from employing traditional methods of credit control, it directly influences commercial banks¶ lending policy, rate of interest and form of securities against loans and portfolio distribution. The instrument of monetary policy (methods of credit control) may be broadly divide into the following parts:
a. b. c. d. e. f. g. h. l. j. k. l. Open Market Operations Bank Rate Direct Regulation of Interest Rates on Commercial Banks¶ Deposits and Loans Cash Reserve Ratio (CRR) Statutory liquidity Ratio (SLR) Direct Credit Allocation and Credit Rationing Selective Credit Controls (SCC) Credit Authorisation Scheme (CAS) Fixation of Inventory and Credit Norms Credit Planning Moral Suasion Liquidity Adjustment Facility (LAF)
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