The Role of RBI in Indian Economy

History of RBI
•The Imperial bank of India played the role of Central bank of India prior to
setting up of RBI.
•The idea was initially proposed by Hilton Young commission to create a central
bank in 1926.
•This led to the establishment of RBI through the RBI Act,1934 and it started its
operations on April 1st , 1935.
Initial Shareholding

•It was a privately held bank in the beginning with a start up capital of Rs 5 crore
maximally contributed by private shareholders.
•It was only in 1948 that the RBI was nationalized and it became an institution
owned by the government of India.
•On 1st Jan, 1949, The RBI started to function as a completely nationalised Bank.
Assistive Bodies
2 Assistive bodies
Chaired by RBI Governor
1. BFS(Board of Financial Supervision)
2. Board for Payment and Settlement Systems
 Board for Financial Supervision

Established in 1994 and chaired by RBI Governor and supervises commercial

banks, financial institutions and NBFC’s
I. Restructuring of the system of bank inspections
II. Introduction of off-site surveillance
 Board for Payment and settlement systems

Established in 2005 and chaired by RBI governor

I. Policies for regulation and supervision
II. Deals with transactions like NEFT, Credit card transactions
III. Authorisation of various Payment and Settlement Systems
Local Bodies

•4 Local boards representing 4 regions of the country located at Chennai, Kolkata, Mumbai and
New Delhi.
•Members appointed by Central Government.
•Each board has 5 members.
Monetary Policies of RBI
Economic policies for Stabilization

Economic Policy

Fiscal Policy Monetary Policy

Definition:

• The part of the economic policy which regulates the level of

money in the economy in order to achieve certain objectives
• In INDIA,RBI controls the monetary policy. It is announced
twice
a year, through which RBI , regulate the price stability for the
economy.
 Objectives of monetary policy:

• Maximum feasible output.

• High rate of growth.
• Fuller employment.
• Price stability.
• Greater equality in of income and wealth.
• the distribution
Healthy balance in balance of payments(BOP).
Instruments / Tools Of Monetary Policy

Tools of
Monetary Policy

Quantitative / Qualitative /
Traditional Selective
Measures Measures
 Quantitative Measures

Quantitative
Measures

Open Market Discount Rate / Cash Reserve

Others…
Operations Bank Rate Ratio (CRR)
(OMO)
1) Open Market Operations ( OMO)

• RBI sells or buys government securities in open market

depend upon - it wants to increase the liquidity or
reduce it.
• RBI sells government securities
It reduces liquidity (stock of money) in the
economy.So
overall it reduces the money supply available with
banks,
• RBIratebuys
Reduces the capital available for lending and interest
goes securities
up.
Increases the money supply available with banks , so
interest rate moves down and business activities like
new investments, capacity expansion goes up.
 The sale of govt. bonds and securities effect
both demand and supply of credit

• Supply of Credit
• The Govt. bonds are bought by cheques drawn on the commercial bank in favour
of the central bank. So money gets transferred from the buyers account to central
bank account. So this reduces total deposits with the commercial bank and their
cash reserve and also their cash creation capacity.

• When Commercial Bank buys, their cash reserve goes down leads to fall in flow of
credit.

• Demand for Credit

Selling of Bonds by Central Bank, Interest rate goes up. Reduces demand for
credit
 2) Discount Rate / Bank Rate ( 9%)

Bank rate is the minimum rate at which the central bank provides loans to
the commercial banks. It is also called the discount rate.
or
Is the interest rate charged on borrowings ( Loans and Advances)

made by the commercial bank from the central bank.

• Central Bank can change this rate – depending upon Expansion or

Contraction of credit flow.
• A fall in Bank Rate- Expansionary Monetary Policy
• A rise in Bank Rate – Contractionary Monetary Policy
The action of the Central Bank effects the flow of
credit :

1) Rise or fall in rate of Central Bank raises its rate leads to rate
change of commercial bank. So demand for funds by borrowers

get effected.
2) Bankers lending rates get adjusted to deposit rates. Rise in

deposit rate turns borrowers into depositors.

3) Rise in in Bank rate reduces the net worth of Govt. Bonds against

which commercial banks borrow funds from the central bank.

They find it difficult to maintain high cash reserve.
 3) Cash Reserve Ratio (CRR) ( 4% )

All commercial banks are required to keep a certain amount of its

deposits in cash with RBI. This percentage is called the

Cash Reserve Ratio.

• To prevent shortage of cash

• To control Money supply
• In Contractionary policy the bank raises the CRR
• In Expansionary policy bank reduces the CRR
• A hike in CRR will lead to high interest rate,
credit rationing, huge decline in investment
and large reduction in National Income and Employment
 Other Methods…….

1) Statutory Liquidity Requirement

( SLR) ( 18% )
• Another kind of reserve, in addition to CRR.

• It’s the proportion of the total deposits which commercial banks are

required to maintain with the central bank in the form of liquid assets
- Cash reserve, Gold, Government Bonds

• This measure was undertaken to prevent the commercial bank to

liquidate their liquid assets when CRR is raised.
 2) Reporate ( 4%)

• Whenever the banks have any shortage of funds they can borrow
it from RBI.
• Repo rate is the rate at which our banks borrow rupees from RBI.
• A reduction in the repo rate will help banks to get money at a
cheaper rate.
• When the repo rate increases borrowing from RBI becomes more
expensive.
• The repo rate transactions are for very short duration
• It denotes injection of liquidity.
3) Reverse Reporate ( 7%)

• A reverse repo rate is the interest rate earned by a bank for

lending money to the RBI in exchange for Government securities.

• Reverse repo is an arrangement where RBI sells the securities to

the bank for a short term on a specified date.

• RBI us his tool when there is to much liquidity in the banking

system.

• Reverse reporate means absorption of liquidity.

• They give money to depositors at 4% and turn around and lend

that money to others that want to buy a home or expand their
business at 6-8% or higher depending on the risk.
 Qualitative Measures

Qualitative
Measures

Change in
Credit Rationing Moral Suasion Direct Control
Lending
Margin
1) Credit Rationing

• Shortage of funds, priority and weaker industries get

starved of necessary funds.

• Central Bank does credit rationing
• Imposition of upper limits on the credit available to large industries.
• Charging higher interest rate on bank loans beyond a limit

2) Change in Lending Margins

• Bank provides loans upto a certain percentage of value of mortgaged

property.

• The gap between the value of the mortgaged property and amount
advanced is called as lending margin.

• Central Bank has the authority to determine the lending margin

with the view to decrease and increase the bank credit
• The objective is to control speculative activity in the stock market.
3) Moral Suasion

• It’s a Psychological instrument instrument of monetary policy

• Persuading and convincing the commercial bank to
advance credit in accordance with directive of the central bank.
• The Central bank uses moral pressure on the commercial bank
by going public on the unhealthy banking practices.

4) Direct Controls
• Where all the methods become ineffective
• Central bank gives clear directives to banks to carry out their lending
activity in a specified manner.
 Monetary Policy to Control Recession

Problem: Recession
Measures:
1) Central Banks buy securities through OMO
2) Lowers Bank Rate
3) Reduces CRR

Money Supply Increases

Interest Rate Falls

Investment Increases

Aggregate Demand Increases

Aggregate Output increases

 Monetary Policy to Control Inflation
Problem: Inflation
Measures:
1) Central Banks sells securities through OMO
2) Increases Bank Rate
3) Raises CRR

Money Supply Decreases

Interest Rate Rises

Investment Declines

Aggregate Demand Declines

Price Level Falls

 Limitations Of Monetary Policy

1) Time Lags
• Time taken in – Implementation and working
• ‘Inside lag’ or preparatory time
• ‘Outside lag’ or response time
• If the time lag are long, the policy may become ineffective
• The response time lag of monetary policy are longer than fiscal policy

2) Problem In forecasting
• Its important to forecast the effect of monetary actions
• However prediction of the outcome and formulation of the policy is a
difficult task

3) Non- Banking Financial Intermediaries

Huge share in financial operation reduces the effectiveness of monetary policy

4) Underdevelopment of Money and Capital Market

Markets are fragmented, unorganised and does work independently
 highlights of RBI’s Current bi-monthly monetary
policy statement:

• Short-term lending (Repo) rate unchanged at 4%

• Cash reserve ratio (CRR) unchanged at 4%
• SLR cut by 0.5% to 22.5% to unlock banking funds which was further
decreased to 22 in next bi-monthly monetary policy ( 5 August 2014).
• Further policy tightening will not be warranted if inflation continues to
decline
• “We are giving time to our financial institutions to adjust to the
new economy,” said Governor Raghuram Rajan
• Rbi expect economic growth for 2014-15 to be between 5-6%
 Analysis Of Current Monetary Policy
• Amidst the problems of inflation and Growth , Conservative approach is
followed... against the expectation of Long term RBI watchers .
• RBI has focussed on disinflation First, Rather than Growth
• We are not against growth but we think growth will be most benefited if we
disinflate the economy,” Dr. Rajan said.
• The RBI is expecting a robust growth revival after sometime .
• By decreasing SLR liquity is improved in economy ...
• The SLR cuts would release substantial sums for banks to invest.
• The monetary and liquidity measures have entirely been in line with expectations
• RBI has concentrated on getting Revenue as repo rate has not been decreased.
Issuer of Currency
•The Reserve Bank is the nation’s sole note issuing authority.

•RBI is responsible for the design and production and overall management of the nation’s
currency.

•The RBI is authorized to issue notes up to value of Rupees ten thousands and coin up to one
thousand.
Continued..
•Changes and upgrades security Features in bank notes.

•Coins are minted by Government of India.

•There are four printing presses:

◦ Madhya Pradesh
◦ Maharashtra
◦ Karnataka
◦ West Bengal
Banker and Debt Manager to
Government
•Managing the government‘s banking transactions is a key RBI role.

•RBI maintains its accounts, receives money into and makes payments out of these accounts and
facilitates the transfer of government funds.

•It also acts as banker to state governments.

 Ways and Means Advance

• The limit on overdraft is decided during the start of a financial year.

• This is valid for a short period of 10-14 days
Banker’s Bank
•All banks operating in the country have accounts with RBI, just as individuals and businesses
have accounts with their banks.

•Enables smooth, swift and seamless settlement of inter-bank obligations.

•Tools:-
◦ Non-interest earning current accounts
◦ Deposit Account Department
◦ Remittance facilities
◦ Loans and advances
Lender Of Last Resort
•As a Banker to Banks, RBI also acts as the ‘lender of the last resort.

•The Reserve Bank extends this facility to protect the interest of the depositors of the bank and
to prevent possible failure of the bank.

•This prevents instability in the economy.

 Regulatory role
•Regulates and Supervises the various entities of the financial system.
•Different departments of the RBI oversee the various entities.
 Regulatory role
Commercial Banks Urban Cooperative Regional Rural Non-Banking
and Development Banks: Banks(RRB) : Financial
Financial Companies:
Institutions:
Regulated by Regulated and Regulated by Regulated and
Department of Supervised by Department of Supervised by
Banking Regulation. Department of Co- Banking Regulation Department of
operarive banking and supervised by Non-banking
and Regulation. NABARD. Supervision.
 Department of Banking Regulation
•Exercises regulatory powers in respect of commercial banks and Regional Rural
Banks (RRBs) as per the provisions contained in the Banking Regulation Act,
1949, the Reserve Bank of India Act, 1934, the Regional Rural Banks Act, 1975.
•Licensing, branch expansion , management and methods of operations, amount
of liquidity, amalgamation, reconstruction etc.
•Regulatory oversight of DFI’s like the Exim Bank, IIBI, NABARD, NHB etc.
•Striving to bring the regulatory standards of commercial banks/FI’s on par with
the international best practices.
 Department of Co-operative Banking and
Regulation
•Registered under the provisions of either the State Cooperative Societies Act of
the State concerned or the Multi State Cooperative Societies Act, 2002.
•Functions:
o To issue licence to UCBs/StCBs/DCCBs.
o To authorise UCBs/StCBs to open branches.
o To grant permission for extension of area of operations of UCBs.
o To impart training to the officials of UCBs/StCBs/DCCBs to upscale their knowledge,
skill and expertise as part of developmental functions.
•Supervisory Functions:
o On-site inspection(CAMELS)
o Off-site monitoring.
 Department of Supervision, NABARD
•Under the Banking Regulation Act 1949, NABARD is empowered to undertake
inspection of Regional Rural Banks.
•The Board of Supervision (BoS) has been constituted by NABARD. The BoS
serves as an Internal Committee to the Board of Directors of NABARD.
•Functions:
o On-site inspection
o Off-site surveillance
o Monitoring Frauds and Misappropriations.
o Monitors and follows up the complaints and grievances received against the
supervised entities.
 Department of Non-banking Supervision
•Supervision of Non-Banking Financial Companies (NBFCs) under the provisions contained
under Chapter III B and C and Chapter V of the Reserve Bank of India Act, 1934.
•Promoting and fostering a robust and sound non-banking financial sector.
•Regulatory Functions:
o Issuance and cancellation of Certificate of Registration (CoR).
o To frame policies on regulation and supervision of NBFC’s including MGC/SC/RC’s.
•Supervisory Functions:
o To ensure adherence by NBFCs to the policies laid down by the Department of Non-Banking
Regulation (DNBR) with the help of the respective Regional Offices (ROs).
o To supervise regulated entities through on-site and off-site monitoring.
o To conduct public awareness programmes, depositors' education and to conduct workshops /
seminars for trade and industry organisations.
 References
•https://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=Depts.htm#DBR1
•https://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=Depts.htm#DCBR1
•https://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=Depts.htm#DNBS1
•https://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=Depts.htm#DCBR1
•https://www.nabard.org/about-departments.aspx?id=5&cid=469
Development
•Development of the Financial System

•Development of Agriculture

•Provision of Industrial Finance

•Provisions of Training
- NIBM
•Collection of Data

•Publication of the Reports

•Promotion of Banking Habits

•Promotion of Export.
Children of RBI
Deposit Insurance and Credit Guarantee Corporation : Insurer of deposits in banks

Unit Trust of India: The first Mutual Fund of India.

Industrial Development Bank of India : a development finance institution for industry

National Bank of Agriculture and Rural Development : for promoting rural and
agricultural credit
Discount and Finance House of India : a money market intermediary and a
primary dealer in government securities

National Housing Bank : for promoting and regulating housing finance

Securities and Trading Corporation of India : a primary dealer of government

securities .
Tools
•Directed credit for lending to priority sector and weaker sections

•Lead Bank Scheme

•Sector specific refinance

•Strengthening and supporting small local banks

•Financial inclusion
Foreign exchange regime followed by RBI
Foreign exchange regime
Exchange-rate regime is the way an authority manages its
currency in relation to other currencies and the foreign exchange
market.
Types of foreign exchange regimes
•A fixed or pegged exchange rate –
The central bank manipulates the value of
country’s currency.
•A floating exchange rate –
The value of the currency completely depends on market forces.
•A pegged float exchange rate –
The rate is allowed to fluctuate around a central value which is adjusted
periodically.
Fixed exchange regime

To control the currency value central bank uses many approaches such as
•If it wants to strengthen the currency –
It sells the foreign currency reserves it holds to increase the supply of foreign currency reducing
the exchange rate.
It increases interest rates to reduce the cash in circulation which increases the demand for the
currency appreciating its value.
•If it wants to weaken its currency –
Printing its currency and buying foreign currency in exchange increasing the demand for foreign
currency in the market increasing the exchange rate.
It decreases interest rates to increase the cash in circulation which reduces the demand for the
currency depreciating its value.
RBI Foreign exchange regime
•Post independence, India’s exchange rate was fixed by the RBI against pound
sterling, under the fixed or pegged exchange rate mechanism.
•Subsequently the exchange rate under the fixed exchange rate mechanism was
changed to dollars and then to a basket of currencies.
•The first step at reforms in exchange rate management was taken in 1993, and
then referred to as ‘Liberalized Exchange Rate Management System’ or LERMS.
Liberalized Exchange Rate Management System
•Under LERMS there was a ‘dual exchange rate’, one officially decided by the RBI
and the other through market forces.
•All foreign exchange transactions upto 40% was to be at the official rate and the
remaining at the market rate.
•Under this the dollar was used as intervention currency, which implied that
primary exchange rate, all official government statistics would be dominated in
U.S. dollar in terms of global trends and convenience.
•However, after 1999 the official rate was discontinued and exchange rate
became market-determined exchange rate (MDER).
 Market-determined exchange rate
•Under MDER the forces of demand and supply of dollars in India determine the exchange rate.
•Any surge in the inflow of dollars leads to the rupee gaining value (appreciation). This renders
imports cheaper and exports expensive.
•To prevent impact on exports under MDER, the RBI purchases dollars by creating an artificial
demand for the excess dollars in circulation.
•Any act of purchase of dollars by the RBI impacts liquidity as rupees get released into the
system creating inflationary pressures.
•In such circumstances the RBI simultaneously goes for the reverse repo auction to soak up the
excess liquidity created on account of purchase of dollars by the RBI.
•The is done under the Market Stabilization Scheme (MSS).
Market-determined exchange rate
•In adverse circumstances of demand for dollars going up more than the supply
of dollars, it results in rupee losing value (depreciation).
•Though it can positively impact exports and discourage imports, it is usually
seen as an erosion of faith in the home currency and can escalate into a
currency crisis.
•In such circumstances the government sells foreign currency to augment the
supply of dollars.
History of rupee dollar exchange rate
Final points
•Since our country adopted MDER, any act of interference by a Central Bank like
the RBI in influencing the exchange rate is called as ‘dirty floats’ or ‘managed
floats’.
•Thus RBI instead of targeting any exchange rate, intervenes in the foreign
exchange market only to manage the volatility and disruptions to the macro
economic situation.