Chapter 1: INTRODUCTION and OVERVIEW OF BANKING

1) Evolution of banking
2) Meaning and definition of bank,
3) Functions of Bank- Primary Functions, Secondary Functions
4) Banking structure in India
5) RBI, Commercial, Rural and Cooperative banks their role and significance,
functions,
6) SLR, CRR: Concepts, Banking Ratios

1. Evolution of banking
Genesis Indian Banking System for the last two centuries has seen many
developments. An indigenous banking system was being carried out by the
businessmen called Sharoffs, Seths, Sahukars, Mahajans, Chettis, etc. since ancient
time. They performed the usual functions of lending moneys to traders and craftsmen
and sometimes placed funds at the disposal of kings for financing wars. The
indigenous bankers could not, however, develop to any considerable extent the
system of obtaining deposits from the public, which today is an important function of
a bank. Modern banking in India originated in the last decades of the 18th century.
The first banks were The General Bank of India which started in 1786, and the Bank
of Hindustan. Thereafter, three presidency banks namely the Bank of Bengal (this
bank was originally started in the year 1806 as Bank of Calcutta and then in the year
1809 became the Bank of Bengal) , the Bank of Bombay and the Bank of Madras,
were set up. For many years the Presidency banks acted as quasi-central banks. The
three banks merged in 1925 to form the Imperial Bank of India. Indian merchants in
Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of
the economic crisis of 1848-49. Bank of Upper India was established in 1863 but
failed in 1913. The Allahabad Bank, established in 1865 , is the oldest survived Joint
Stock bank in India . Oudh Commercial Bank, established in 1881 in Faizabad, failed
in 1958. The next was the Punjab National Bank, established in Lahore in 1895,
which is now one of the largest banks in India. The Swadeshi movement inspired
local businessmen and political figures to found banks of and for the Indian
community during 1906 to 1911. A number of banks established then have survived
to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda,
Canara Bank and Central Bank of India. A major landmark in Indian banking history
took place in 1934 when a decision was taken to establish ‘Reserve Bank of India’
which started functioning in 1935. Since then, RBI, as a central bank of the country,
has been regulating banking system

2. Meaning and definition of bank,

A bank is a financial institution licensed to receive deposits and make loans. Banks
may also provide financial services such as wealth management, currency exchange,
and safe deposit boxes. There are several different kinds of banks including retail
banks, commercial or corporate banks, and investment banks. In most countries,
banks are regulated by the national government or central bank
 Banks are a very important part of the economy because they provide vital services
for both consumers and businesses. As financial services providers, they give you a
safe place to store your cash. Through a variety of account types such as checking and
savings accounts, and certificates of deposit (CDs), you can conduct routine banking
transactions like deposits, withdrawals, check writing, and bill payments.

2.1 Role of Commercial Bank

Commercial banks play an important and active role in the economic
development of a country. If the banking system in a country is effective,
efficient and disciplined it brings about a rapid growth in the various sectors of
the economy. The following is the significance of commercial banks in the
economic development of a country:

A. Promotion of capital formation: Commercial banks accept deposits from

individuals and businesses, these deposits are then made available to the
businesses which make use of them for productive purposes in the country.
B. Encourage to Invest in new enterprises: Businessmen normally hesitate to
invest their money in risky enterprises. The commercial banks generally
provide short and medium term loans to entrepreneurs to invest in new
enterprises and adopt new methods of production. The provision of timely
credit increases the productive capacity of the economy.
C. Promotion of trade and industry: With the growth of commercial
banking, there is vast expansion in trade and industry. The use of bank draft,
check, bill of exchange, credit cards and letters of credit etc has
revolutionized both national and international trade.
D. Development of agriculture: The commercial banks particularly in
developing countries are now providing credit for development of
agriculture and small scale industries in rural areas. The provision of credit
to agriculture sector has greatly helped in raising agriculture productivity
and income of the farmers.
E. Balanced development of different States: The commercial banks play an
important role in achieving balanced development in different states of the
country. They help in transferring surplus capital from developed regions to
the less developed regions.
F. Influencing economic activity: The banks can also influence the economic
activity of the country through its influence on a. Availability of credit b.
The rate of interest If the commercial banks are able to increase the amount
of money in circulation through credit creation or by lowering the rate of
interest, it directly affects economic development.
G. Implementation of Monetary policy: The central bank of the country
controls and regulates volume of credit through the active cooperation of the
banking system in the country. It helps in bringing price stability and
promotes economic growth within the shortest possible period of time.
H. Encourage for Export promotion: In order to increase the exports of the
country, the commercial banks have established export promotion cells.
They provide information about general trade and economic conditions both
inside and outside the country to its customers. The banks are therefore,
making positive contribution in the process of economic development.

3. Functions of Bank- Primary Functions, Secondary Functions

Important functions of Commercial Banks are given below:
1. PRIMARY FUNCTIONS
Primary banking functions of the commercial banks include:
i) Acceptance of deposits,
ii) Advancing loans,
iii) Creation of credit
iv) Clearing of cheques,
v) Financing foreign trade,
vi) Remittance of funds

i) ACCEPTANCE OF DEPOSITS
Commercial bank accepts various types of deposits from public especially from its clients.
These deposits are payable after a certain time period. Banks generally accept three types of
deposits viz., (a) Current Deposits (b) Savings Deposits (c) Fixed Deposits and d) Recurring
Deposit. (a) Current Deposits: These deposits are also known as demand deposits. These
deposits can be withdrawn at any time. Generally, no interest is allowed on current deposits,
and in case, the customer is required to leave a minimum balance undrawn with the bank. (b)
Savings Deposits: This is meant mainly for professional men and middle class people to help
them deposit their small savings. It can be opened without any introduction. Money can be
deposited at any time but the maximum cannot go beyond a certain limit.
(c) Fixed Deposits: These deposits are also known as time deposits. These deposits cannot
be withdrawn before the expiry of the period for which they are deposited or without giving a
prior notice for withdrawal.
d) Recurring Deposit: Recurring Deposits are a special kind of Term Deposits offered by
banks in India which help people with regular incomes to deposit a fixed amount every
month into their Recurring Deposit account and earn interest at the rate applicable to Fixed
Deposits. It is similar to making FDs of a certain amount in monthly installments, for
example Rs 1000 every month.

ii) ADVANCING LOANS

Loans are made against personal security, gold and silver, stocks of goods and other assets.
The second primary function of a commercial bank is to make loans and advances to all
types of persons, particularly to businessmen and entrepreneurs. The most common way of
advancing loans are given below:

(a) Overdraft Facilities: In this case, the depositor in a current account is allowed to draw
over and above his account up to a previously agreed limit. Suppose a businessman has only
Rs. 6,000/- in his current account in a bank but requires Rs. 12,000/- to meet his expenses. He
may approach his bank and borrow the additional amount of Rs. 6,000/-.

(b) Cash Credit: Under this account, the bank gives loans to the borrowers against certain
security. But the entire loan is not given at one particular time, instead the amount is credited
into his account in the bank; but under emergency cash will be given. The borrower is
required to pay interest only on the amount of credit availed to him.

(c) Discounting Bills of Exchange: This is another type of lending which is very popular
with the modern banks. The holder of a bill can get it discounted by the bank, when he is in
need of money. After deducting its commission, the bank pays the present price of the bill
to the holder. Such bills form good investment for a bank.

(d) Money at Call: Banks grant loans for a very short period, generally not exceeding 7 days
to the borrowers, usually dealers or brokers in stock exchange markets against collateral
securities like stock or equity shares, debentures, etc., offered by them. Such advances are
repayable immediately at short notice hence; they are described as money at call or call
money.

(e) Term Loans: Banks give term loans to traders, industrialists and now to agriculturists
also against some collateral securities. Term loans are so-called because their maturity period
varies between 1 to 10 years.

(f) Consumer Credit: Banks also grant credit to households in a limited amount to buy
some durable consumer goods such as television sets, refrigerators, etc., or to meet some
personal needs like payment of hospital bills etc. Such consumer credit is made in a lump
sum and is repayable in instalments in a short time.

(g) Miscellaneous Advances: The other forms of bank advances there are packing credits
given to exporters for a short duration, export bills purchased/discounted, import finance-
advances against import bills, finance to the self-employed, credit to the public sector and
credit to the cooperative sector.

iii) CREATION OF CREDIT

Credit creation is the multiple expansions of banks demand deposits. It is an
open secret now that banks advance a major portion of their deposits to the
borrowers and keep smaller parts of deposits to the customers on demand. Even
then the customers of the banks have full confidence that the depositor’s lying in
the banks is quite safe and can be withdrawn on demand.

iv) PROMOTE THE USE OF CHEQUES, DD OR ONLINE

TRANSACTIONS

The commercial banks render an important service by providing to their

customers a cheap medium of exchange like cheques. It is found much more
convenient to settle debts through cheques rather than through the use of cash.
The cheque is the most developed type of credit instrument in the money
market.

v) FINANCING FOR INTERNAL AND FOREIGN TRADE

The bank finances internal and foreign trade through discounting of exchange
bills. Sometimes, the bank gives short-term loans to traders on the security of
commercial papers. This discounting business greatly facilitates the movement
of internal and external trade.

vi) REMITTANCE OF FUNDS

Commercial banks, on account of their network of branches throughout the
country, also provide facilities to remit funds from one place to another for their
customers by issuing bank drafts, mail transfers or telegraphic transfers on
nominal commission charges. As compared to the postal money orders or other
instruments, bank drafts have proved to be a much cheaper mode of transferring
money and have helped the business community considerably.

2. SECONDARY FUNCTIONS
Secondary banking functions of the commercial banks include:
i) Agency Services
ii) General Utility Services

i) AGENCY SERVICES
Commercial banks act as attorney for their clients. They buy and sell shares and
bonds, receive and pay utility bills, premiums, dividends, rents and interest for
their clients. Banks also perform certain agency functions for and on behalf of
their customers. The agency services are of immense value to the people at
large. The various agency services rendered by banks are as follows:
(a) Collection and Payment of Credit Instruments: Banks collect and pay
various credit instruments like cheques, bills of exchange, promissory notes etc.,
on behalf of their customers.

(b) Purchase and Sale of Securities: Banks purchase and sell various securities
like shares, stocks, bonds, debentures on behalf of their customers.

(c) Collection of Dividends on Shares: Banks collect dividends and interest on

shares and debentures of their customers and credit them to their accounts.

(d) Acts as Correspondent: Sometimes banks act as representative and

correspondents of their customers. They get passports, traveler’s tickets and
even secure air and sea passages for their customers.
(e) Income-tax Consultancy: Banks may also employ income tax experts to
prepare income tax returns for their customers and to help them to get refund of
income tax.

(f) Execution of Standing Orders: Banks execute the standing instructions of

their customers for making various periodic payments. They pay subscriptions,
rents, insurance premium etc., on behalf of their customers.

(g) Acts as Trustee and Executor: Banks preserve the ‘Wills’ of their
customers and execute them after their death.

ii) GENERAL UTILITY SERVICES

General utility services are those services which are rendered by commercial
banks not only to the customers but also to the general public. In addition to
agency services, the modern banks provide many general utility services for the
community as given below:
a) Safety Locker Facility
b) Collection of Cheque amount
c) Issuing Letter of Credit
d) Bank Drafts
e) ATM
f) Debit Card
g) Credit Card
h) Tele-Banking

a) Safety Locker Facility

A bank undertakes the safe custody of the customer’s valuables and documents
by providing a safe deposit vault. These are kept in specially constructed strong
rooms. There are lockers available to the customer on a nominal charge. There
are two keys for each locker, one is given to the customer and the other remains
with the Bank Manager. The locker is opened as well as closed by both the keys
one after another.

b) Collection of Cheques
The customers deposit cheques, bills of exchange and promissory note into their
accounts with the banks. These instruments are collected by the bank on behalf
of their customers and credited to their accounts. These services are provided by
the cheques, bills and promissory notes issued on branches out of the city are
collected with some nominal charges for postage etc. this is a very popular and
essential service provided by the banks to their customers.
c) Issuing Letter of Credit
A letter of credit is a commercial instrument of assured payment. It is widely
used by the businessman for various purposes. The bank undertakes to make
payment to a seller on production of documents stipulated in the letter of credit.
It specifies as to when payment is to be made which may be either on
presentation of documents by the paying bank or at some future date depending
upon the terms stipulated in the letter.

d) Bank Drafts
A bank draft is an order from one branch to another branch of the same bank to
pay a specified sum of money to a person named therein or to his order. A draft
is always payable on demand. Banks issue drafts at the request of the customers
on their branches at the place of destination for remitting money from one place
to another place.

e) Automated Teller Machine (ATM)

ATM is a channel of banking service to its customers. It’s traditional and
primary use is to dispense cash upon insertion of a plastic card and its unique
PIN i.e. Personal Identification Number. The banks issue ATM card to their
customers having current or savings account holding a certain minimum balance
in their accounts.

f) Debit Card
A debit card is a plastic card that provides an alternative payment method to
cash when making purchases. Functionally, it can be called an electronic check,
as the funds are withdrawn directly from either the bank account or from the
remaining balance on the card. In some cases, the cards are designed
exclusively for use on the Internet, and so there is no physical card.
g) Credit Card
A credit card is an instrument of payment. It is a source of revolving credit. The
cards are plastic cards issued by the banks to their customers. The name of the
customer, card number and expiry date are printed on the plastic cards. Some
banks also use the photograph of the customers on the credit card. The
cardholder can buy goods or services from various merchant establishments
where such arrangements exist.

h) Tele Banking
Telephone banking is a service provided by a Commercial Banks, which allows
its customers to perform transactions over the telephone. Most telephone
banking services use an automated phone answering system with phone keypad
response or voice recognition capability.
 4. Banking structure in India
Banking System in India or the Indian Banking System can be segregated into three distinct
phases:

(a) Scheduled Banks: Scheduled Banks in India are the banks which are listed in the
Second Schedule of the Reserve Bank of India Act1934. The scheduled banks enjoy
several privileges as compared to non- scheduled banks. Scheduled banks are entitled
to receive refinance facilities from the Reserve Bank of India. They are also entitled
for currency chest facilities. They are entitled to become members of the Clearing
House. Besides commercial banks, cooperative banks may also become scheduled
banks if they fulfill the criteria stipulated by RBI

(b) Non-scheduled banks: These are those banks which are not included in the Second
Schedule of the Reserve Bank of India. Usually those banks which do not conform to
the norms of the Reserve Bank of India within the meaning of the RBI Act or
according to specific functions etc. or according to the judgement of the Reserve
Bank, are not capable of serving and protecting the interest of depositors are classified
as non-scheduled banks.

COMMERCIAL BANKS

A. Public Sector Banks The term ‘public sector banks’ by itself connotes a situation
where the major/full stake in the banks are held by the Government. Till July,1969,
there were only 8 Public Sector Banks .When 14 commercial banks (total 20 banks)
were nationalized in 1969, 100% ownership of these banks were held by the
Government of India. Subsequently, six more private banks were nationalized in
1980. However, with the changing in time and environment, these banks were
allowed to raise capital through IPOs and there by the share holding pattern has
changed. By default the minimum 51% shares would be kept by the Government of
 India, and the management control of these nationalized banks is only with Central
Government. Since all these banks have ownership of Central Government, they can
be classified as public sector banks. Apart from the nationalized banks, State Bank of
India, and its associate banks, IDBI Bank and Regional Rural Banks are also included
in the category of Public Sector banks
B. Private Sector Banks
The major stakeholders in the private sector banks are individuals and corporate.
When banks were nationalized under two tranches (in 1969 and in 1980), all banks
were not included. Those non nationalized banks which continue operations even
today are classified as Old Generation Private Sector Banks.. Like The Jammu &
Kashmir Bank Ltd, the Federal Bank, the Laxmi Vilas Bank etc. In July 1993 on
account of banking sector reforms the Reserve Bank of India allowed many new
banks to start banking operations. Some of the leading banks which were given
licenses are: UTI bank (presently called Axis Bank) ICICI Bank, HDFC Bank, Kotak
Mahindra Bank, Yes Bank etc., these banks are recognized as New Generation
Private Sector Banks. Ten banks were licensed on the basis of guidelines issued in
January 1993. The guidelines were revised in January 2001 based on the experience
gained from the functioning of these banks, and fresh applications were invited.
C. Foreign Banks
The other important segment of the commercial banking is that of foreign banks.
Foreign banks have their registered offices outside India, and through their branches
they operate in India. Foreign banks are allowed on reciprocal basis. They are allowed
to operate through branches or wholly owned subsidiaries. These foreign banks are
very active in Treasury (forex) and Trade Finance and Corporate Banking activities.
These banks assist their clients in raising External Commercial Borrowings through
their branches outside India or foreign correspondents. They are active in loan
syndication as well. Foreign banks have to adhere to all local laws as well as
guidelines and directives of Indian Regulators such as Reserve Bank of India,
Insurance and Regulatory Development Authority, Securities Exchange Board of
India. The foreign banks have to comply with the requirements of the Reserve Bank
of India in respect to Priority Sector lending, and Capital Adequacy ratio and other
norms. Total foreign banks as on 31st March 2013 were 43 having 331 branches.
Besides these, 46 foreign banks have their representative offices in India as on 31st
March 2013.

CO-OPERATIVE BANKING SYSTEM

Cooperative banks play an important role in the Indian Financial System, especially at
the village level. The growth of Cooperative Movement commenced with the passing
of the Act of 1904. A cooperative bank is a cooperative society registered or deemed
to have been registered under any State or Central Act. If a cooperative bank is
operating in more than one State, the Central Cooperative Societies Act is applicable.
In other cases the State laws are applicable. Apart from various other laws like the
Banking Laws (Application to Co-operative Societies) Act, 1965 and Banking
Regulation (Amendment) and Miscellaneous Provisions Act, 2004, the provisions of
 the RBI Act, 1934 and the BR Act, 1949 would also be applicable for governing the
banking activities.

A. Short Term Agricultural Credit institutions the short term credit structure consists
of the Primary Agricultural Credit Societies at the base level, which are affiliated
at the district level into the District Central Cooperative bank and further into the
State Cooperative Bank at the State level. Being federal structures, the
membership of the DCCB comprises all the affiliated PACS and other functional
societies and for the SCB, the members are the affiliated DCCBs. The DCCB
being the middle tier of the Cooperative Credit Structure, is functionally
positioned to deal with the concerns of both the upper and lower tiers. This very
often puts the DCCB in a position of balancing competing concerns. While the
SCB may managing District Central Cooperative wish the DCCB to prioritize its
task in a particular manner, the PACs may have their own demands on the DCCB.
Balancing these competing concerns could often be a dilemma for the DCCBs.

B. Long Term Agricultural Credit Institutions The long term cooperative credit
structure consists of the State Cooperative Agriculture & Rural Development
Banks (SCARDBs) and Primary Cooperative Agriculture & Rural Development
Banks (PCARDBs) which are affiliated to the SCARDBs. The total No. of
SCARDB’s are 19; of which 10 have Federal Structure, 7 have Unitary Structure
and 2 have Mixed Structure (i.e. operating through PCARDBs as well as its own
branches).Loans are given to members on the mortgages of their land usually up
to 50% of their value in some states or up to 30 times the land revenue payable in
other states, duly taking into account their need and repayment capacity

C. Urban Cooperative Banks The term Urban Cooperative Banks (UCBs), although
not formally defined, refers to the primary cooperative banks located in urban and
semi-urban areas. These banks, until 1996, were allowed to lend money only to
non-agricultural purposes. This distinction remains today. These banks have
traditionally been around communities, localities working out in essence, loans to
small borrowers and businesses. Today their scope of operation has expanded
considerably. The urban co-operative banks can spread operations to other States
and such banks are called as multi state cooperative banks. They are governed by
the Banking Regulations Act 1949 and Banking Laws (Cooperative Societies)
Act, 1965. The total number of UCBs stood at 1,618 as on 31st March 2012.
Scheduled UCBs are banks included in the Second Schedule of the RBI Act, 1934
and include banks that have paid-up capital and reserves of not less than 5 lacs
and carry out their business in the interest of depositors to the satisfaction of the
Reserve Bank.

5. Evolution of the Reserve Bank of India

 The origins of the Reserve Bank of India (RBI) can be traced to 1926, when the Royal
Commission on Indian Currency and Finance – also known as the Hilton Young Commission
– recommended the creation of a central bank for India to separate the control of currency
and credit from the Government and to augment banking facilities throughout the country.
The Reserve Bank of India Act of 1934 established the Reserve Bank and set in motion a
series of actions culminating in the start of operations in 1935. Since then, the Reserve Bank's
role and functions have evolved, as the nature of the Indian economy and financial sector
changed. Though started as a private shareholders' bank, the Reserve Bank was nationalised
in 1949.
The Preamble to the Reserve Bank of India Act, 1934, under which it was constituted,
specifies its objective as “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”. The primary role of the RBI, as the Act suggests, is
monetary stability, that is, to sustain confidence in the value of the country's money or
preserve the purchasing power of the currency. Ultimately, this means low and stable
expectations of inflation, whether that inflation stems from domestic sources or from changes
in the value of the currency, from supply constraints or demand pressures. In addition, the
RBI has two other important mandates; inclusive growth and development, as well as
financial stability.
In a country where a large section of the society is still poor, inclusive growth assumes great
significance. Access to finance is essential for poverty alleviation and reducing income
inequality. One of the core functions of the RBI, therefore, is to promote financial inclusion
that leads to inclusive growth. As the central bank of a developing country, the
responsibilities of the RBI also include the development of financial markets and institutions.
Broadening and deepening of financial markets and increasing their liquidity and resilience,
so that they can help allocate and absorb the risks entailed in financing India's growth is a key
objective of the RBI

Functions of RBI
I. Issue Functions - Legal Background Right to issue bank notes is one of the key central
banking functions the RBI is 9 mandated to do. Section 22 of the RBI Act confers the
RBI with the sole right to issue bank notes in India. The issue of bank notes shall be
conducted by a department called the Issue Department, which shall be separated and
kept wholly distinct from the Banking Department. The RBI Act enables the RBI to
recommend to Central Government the denomination of bank notes, which shall be two
rupees, five rupees, ten rupees, twenty rupees, fifty rupees, one hundred rupees, five
hundred rupees, one thousand rupees, five thousand rupees and ten thousand rupees or
other denominations not exceeding ten thousand rupees.
II. Banker’s Bank:
As bankers’ bank, the RBI holds a part of the cash reserves of commercial banks and
lends them funds for short periods. All banks are required to maintain a certain
percentage (lying between 3 per cent and 15 per cent) of their total liabilities. The main
objective of changing this cash reserve ratio by the RBI is to control credit.

The RBI provides financial assistance to commercial banks and State cooperative banks
through rediscounting of bills of exchange. As the RBI meets the need of funds of
commercial banks, the RBI functions as the Tender of the last resort
 III. Banker to the Government:
The RBI acts as the banker to the government of India and State Governments (except
Jammu and Kashmir). As such it transacts all banking business of these Governments

(i) Accepts and pays money on behalf of the Government.

(ii) It carries out exchange remittances and other banking operations.

IV. Controller of Credit:

The RBI controls the total supply of money and bank credit to sub serve the country’s
interest. The RBI controls credit to ensure price and exchange rate stability.

To achieve this, the RBI uses all types of credit control instruments, quantitative,
qualitative and selective. The most extensively used credit instrument of the RBI is the
bank rate. The RBI also relies greatly on the selective methods of credit control. This
function is so important that it requires special treatment.

V. Exchange Management and Control:

One of the essential central banking functions performed by the Bank is that of
maintaining the external value of rupee. The external stability of the currency is closely
related to its internal stability the inherent economic strength of the country and the way
it conducts its economic and monetary affairs.

Domestic, fiscal and monetary policies have, therefore, an important role in maintaining
the external value of the currency. Reserve Bank of India has a very important role to play in
this area.

VI. Custodian of Cash Reserves of Commercial Banks:

The commercial banks hold deposits in the Reserve Bank and the latter has the custody
of the cash reserves of the commercial banks.

VII. Custodian of Country’s Foreign Currency Reserves:

The Reserve Bank has the custody of the country’s reserves of international currency,
and this enables the Reserve Bank to deal with crisis connected with adverse balance
of payments position.
VIII. Central Clearance and Accounts Settlement:
Since commercial banks have their surplus cash reserves deposited in the Reserve Bank,
it is easier to deal with each other and settle the claim of each on the other through book
keeping entries in the books of the Reserve Bank. The clearing of accounts has now
become an essential function of the Reserve Bank.

Monetary Policies

Meaning: Monetary policy is the macroeconomic policy laid down by the central
bank. It involves management of money supply and interest rate and is the demand
side economic policy used by the government of a country to achieve macroeconomic
objectives like inflation, consumption, growth and liquidity.
 In other words monetary policy, the demand side of economic policy, refers to the
actions undertaken by a nation's central bank to control money supply to
achieve macroeconomic goals that promote sustainable economic growth.

Tools of monetary policies

I. Quantitative Tools
1. Cash Reserve Ratio (CRR)
CRR is a certain minimum amount of deposit that the commercial banks have to
hold as reserves with the central bank. CRR is set according to the guidelines of
the central bank of a country.
Example: When someone deposits Rs 100 with a bank, it increases the deposits
of the bank by Rs 100. If the CRR is 9%, then the bank will have to hold
additional Rs 9 with the central bank. This means that the commercial bank will
be able to use only Rs 91 for investments and/or lending or credit purpose.

2. Statutory Liquidity ratio:

Every bank must have a specified portion of their Net Demand and Time
Liabilities (NDTL) in the form of cash, gold, or other liquid assets by the day’s
end. The ratio of these liquid assets to the demand and time liabilities is called the
Statutory Liquidity Ratio (SLR). The Reserve Bank of India has the authority to
increase this ratio by up to 40%. An increase in the ratio constricts the ability of
the bank to inject money into the economy.
3. Repo rate :
Repo rate is the rate at which the central bank of a country (Reserve Bank of India
in case of India) lends money to commercial banks in the event of any shortfall of
funds. Repo rate is used by monetary authorities to control inflation.

4. Reverse repo rate

Reverse repo rate is the rate at which the central bank of a country (Reserve Bank
of India in case of India) borrows money from commercial banks within the
country. It is a monetary policy instrument which can be used to control the
money supply in the country.
5. Base or Bank Rate:
Base rate is the minimum rate set by the Reserve Bank of India below which
banks are not allowed to lend to its customers.

Description: Base rate is decided in order to enhance transparency in the credit

market and ensure that banks pass on the lower cost of fund to their customers.
Loan pricing will be done by adding base rate and a suitable spread depending on
the credit risk premium.
6. Open market operation
It is the sale and purchase of government securities and treasury bills by RBI or the
central bank of the country. The objective of OMO is to regulate the money supply in
the economy. It takes place When the RBI wants to increase the money supply in the
 economy, it purchases the government securities from the market and it sells
government securities to suck out liquidity from the system.

II. Qualitative tools

Unlike quantitative tools which have a direct effect on the entire economy’s money
supply, qualitative tools are selective tools that have an effect in the money supply of a
specific sector of the economy.
1. Margin requirements – The RBI prescribes a certain margin against collateral,
which in turn impacts the borrowing habit of customers. When the margin
requirements are raised by the RBI, customers will be able to borrow less.
2. Moral suasion – By way of persuasion, the RBI convinces banks to keep money
in government securities, rather than certain sectors.
3. Selective credit control – Controlling credit by not lending to selective
industries or speculative businesses