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Functions of RBI
Functions of RBI:
❖ Lender of Last Resort: The Reserve Bank of India is the lender of last resort, i.e, when any bank fails to get
funds from all the sources then they can always fall back on RBI.
❖ Controller of Credit: RBI is the controller of the credit created by the commercial banks of India. It controls
the credit on the basis of two methods also known as Credit Controllers. These methods are as follows:
➢ Quantitative Methods
➢ Qualitative Methods
Quantitative Method: Qualitative Method:
❖ Repo rate ❖ Rationing of credit
❖ Reverse Repo rate ❖ Regulating loans for consumption purposes
❖ Bank rate ❖ Variation in margin requirements
❖ CRR - Cash Reserve Ratio ❖ Moral suasion
❖ SLR - Statutory Liquidity Ratio ❖ Direct action
❖ SDF - Standing Deposit Facility
❖ MSF - Marginal Standing Facility
Below is the explanation of the Quantitative Methods:
Repo Rate:
❖ The Repo Rate stands for Repurchase Rate and it is the key policy interest rate of the RBI.
❖ It is the interest rate at which the central bank lends money to the commercial banks for short periods
(typically less than a year).
❖ Repo Rate plays a crucial role in a country’s monetary policy and has significant implications for the economy.
❖ The current rate is 6.5%
❖ At the time of inflation, RBI increases this rate and at the time of slowdown in the country the RBI will decrease
this rate.
❖ The central bank in India i.e. the Reserve Bank of India (RBI) uses the Repo rate to regulate liquidity in the
economy. In banking, Repo rate is related to the ‘repurchase option’ or ‘repurchase agreement'. When there
is a shortage of funds, commercial banks borrow money from the central bank which is repaid according to the
repo rate applicable.
❖ The central bank provides these short-term loans against securities such as treasury bills or government
bonds.
❖ This monetary policy is used by the central bank to control inflation or increase the liquidity of banks.
The government increases the repo rate when they need to control prices and restrict borrowing.
❖ On the other hand, the repo rate is decreased when there is a need to infuse more money into the market
and support economic growth.
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❖ An increase in repo rate means commercial banks have to pay more interest for the money lent to them
and therefore, a change in repo rate eventually affects public borrowings such as home loans, EMIs, etc. From
interest charged by commercial banks on loans to the returns from deposits, various financial and investment
instruments are indirectly dependent on the repo rate.
Cash Reserve Ratio (CRR):
❖ Cash Reserve Ratio is the ratio that a bank is required to maintain with the Reserve Bank of its total deposits
(Net Demand and Time Liabilities) as on the last Friday of the second preceding fortnight that RBI may notify
from time to time.
❖ It is the minimum percentage of a bank's Total Demand and Time Liabilities (DTL) (adjusted for certain
exemptions) that Scheduled commercial banks (SCB) is obliged to deposit with the Central Bank (RBI) in
the form of cash.
❖ RBI does not pay any interest on CRR balances maintained by SCBs with RBI. The provisions of the RBI
Act do not prescribe any range (ceiling rate or floor rate) for fixing CRR.
❖ The current CRR is 4.5%.
❖ When the Reserve Bank of India increases the CRR it is known as Tight Monetary Policy.
❖ When the Reserve Bank of India decreases the CRR it is known as Liberal Monetary Policy.
❖ In order to decrease the money supply, the RBI increases CRR, and vice versa and thus controls inflation.
❖ CRR is maintained on an average basis during the fortnight. All SCBS are required to daily maintain a
minimum CRR balance of 95 percent of the average requirement. If the SCB fails to maintain CRR as fixed
by RBI, then it is liable to pay penal interest at 3 percent per annum above the bank rate, on the shortfall
amount. If the shortfall continues for the next succeeding day, penal interest is to be paid at Bank Rate +
5 per cent.
❖ CRR is defined under section 42 of the RBI Act 1934 and currently, there is no upper and lower limit of
CRR.
Statutory Liquidity Ratio (SLR):
❖ It is the percentage of Net Demand and Time Liabilities (NDTL) of SCBs that are to be kept with them only,
in the form of:
➢ Cash, or
➢ Gold, valued at a price not exceeding the current market price or
➢ Other instruments of SLR Securities:
✓ Certain dated securities or GoI Bonds,
✓ Treasury bills of the Government of India,
✓ State Development Loans of the State Governments issued under their Market Borrowing
Programme and
✓ Any other instrument notified by RBI.
❖ Any combination of the above three.
❖ Every bank shall maintain in India such a percentage of the total of its demand and time liabilities.
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❖ In India, as on the last Friday of the second preceding fortnight as Reserve Banks specify from time to
time and such assets shall be maintained as may be specified (Cash, gold, government securities).
❖ The current SLR is 18%.
❖ Under this every bank in India shall maintain its total deposits with itself in the form of cash, gold, and
government securities.
❖ SLR is defined under section 24 of the Banking regulation act, 1949 and currently there is an upper limit of
SLR as 40% and there is no lower limit to it.
❖ The purpose of maintaining this ratio is that on one hand, it enables the Government to borrow from the banking
system and on the other hand to have enough cash so as to run the bank.
❖ In the time of inflation, RBI increases SLR and in the time of deflation, RBI decreases SLR.
Standing Deposit Facility (SDF):
❖ It is the rate at which the RBI accepts uncollateralized deposits from the banks.
❖ The SDF rate is placed at 25 basis points (0.25%) below the policy Repo Rate.
❖ With the introduction of SDF in April 2022, the SDF rate replaced the fixed Repo Rate as the floor of the
interest rate corridor.
❖ The current SDF rate is 6.25%.
❖ In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF, an
additional tool for absorbing liquidity without any collateral.
❖ SDF is a monetary tool that allows banks to park their access liquidity with RBI without any collateral.
❖ RBI has introduced this tool to absorb excess liquidity in the market as it plays an important role in determining
the policy rates
❖ By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of
monetary policy.
❖ The SDF is also a financial stability tool in addition to its role in liquidity management.
❖ The SDF will replace the Fixed Rate Reverse Repo (FRRR) as the floor of the liquidity adjustment facility
corridor. Both the standing facilities: The MSF (marginal standing facility) and the SDF will be available
on all days of the week, throughout the year.
Reverse Repo Rate:
❖ This is the rate the central bank of a country pays its commercial banks to park their excess funds in the
central bank.
❖ The Reverse repo rate is also a monetary policy used by the central bank (which is RBI in India) to regulate
the flow of money in the market.
❖ When in need, the central bank of a country borrows money from commercial banks and pays them interest as
per the reverse repo rate applicable.
❖ At a given point in time, the reverse repo rate provided by RBI is generally lower than the repo rate. While
the Repo rate is used to regulate liquidity in the economy, the Reverse Repo rate is used to control cash flow in
the market.
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❖ When there is inflation in the economy, RBI increases the reverse repo rate to encourage commercial banks
to make deposits in the central bank and earn returns. This in turn absorbs excessive funds from the market
and reduces the money available for the public to borrow.
Fixed Reverse Repo Rate:
❖ The interest rate at which the RBI absorbs deposits from the bank against the collaterals of eligible
government securities.
❖ Following the introduction of SDF, the Fixed Reverse Repo Rate operations will be at the discretion of the RBI
for the purposes specified from time to time.
❖ Currently, this rate is fixed at 3.35%.
❖ The Repo and Reverse Repo Rates are given under Section 17 (12AB) of the RBI Act, 1934.
Open Market Operation (OMO):
❖ Open market operation is an operation which is conducted by RBI in India from time to time to absorb or
inject liquidity into the system.
❖ Under OMO, RBI sales and purchases of government securities and treasury bills.
❖ The objective of OMO is to regulate the money supply in the economy.
❖ RBI carries out the OMO through commercial banks and does not directly deal with the public.
❖ When the RBI wants to increase the money supply in the economy, it purchases government securities from
the market and it sells government securities to suck out liquidity from the system.
❖ It generally sells government securities in the times of inflation and it buys the government securities at time
of slowdown.
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