RESERVE BANK OF INDIA

 Regulation of Currency
One of the most important functions of a central
bank is the issue and regulation of currency.
The central bank everywhere enjoys the
monopoly of note issue. The central banks are
vested with the monopoly of note issue for
the following reasons:
 to ensure uniformity in the note issue which

will facilitate trade and exchange within the

country
 to impart the notes with a distinct prestige,
 to restrict or expand the supply of notes
according to the requirements of the
economy,
 to bring stability in the monetary standard
and create confidence among the public,
 to influence and control credit creation by
commercial banks.
2. Banker, Agent and Adviser to the Government
 The central bank acts as banker, agent and adviser to the
government banker to the government, the central
bank receives deposits and makes payment on behalf
of the government. It buys and sells foreign currencies
on behalf government.
 As an agent, the central bank makes short-term loans to
the government period not exceeding 90 days. It
undertakes the issue of new loans and bills, redeems
old securities and renews them according to market
conditions. Thus the central bank manages the public
debt programmed. It administers equalisation fund
and clearing agreements whenever they are introduced
stabilizing exchange rate.
 The central bank advises the government on economic
and monetary devaluation or revaluation or currency,
deficit financing, balance of payments etc.
3. Banker's Bank
The central bank acts as banker's bank in three
different capacities:
(i) Custodian of cash reserve of commercial banks.
(ii) Lender of last resort.
(iii) Bank of central clearance, settlement and transfer.

Custodian of the cash reserve of commercial banks:

A central bank is the custodian of the cash reserves of
the commercial banks operating in the country.
All the commercial banks keep a part of their cash
reserves with the central bank. practice of keeping
cash with the central bank is compulsory in
countries like USA and India and customary in
England.
 There are many advantages in keeping cash
reserve with the central bank:
(a) The centralization of reserves is a great source of
strength to the banking system in the country.
(b) The centralization of reserves serves as the basis of
a large and more elastic credit structure. In the
absence of such a centralization every individual
bank is able to create large credit with the same
amount of deposit.
(c) The central bank can employ these funds
effectively during periods of seasonal demands
and to meet financial crisis in the market,
(d) The central bank can provide additional funds on
a temporary basis to commercial banks to
overcome the financial difficulties.
(e) It is also an effective tool of credit control.
(ii) Lender of last resort : When commercial banks are not
able to secure financial accommodation from other
sources, then as a last resort, they can approach the
central bank for necessary facilities. The central bank,
in such a case, will be prepared to grant
accommodation against eligible securities. By lender of
last resort, the central ink assumes the responsibility of
meeting directly or indirectly all reasonable demands
for funds in times of emergency.
This practice benefits the commercial banks in the
following ways:
 The banks can carry on their activities on the basis of
small cash reserve.
 The system helps commercial banks to maintain the
liquidity of their financial resources.
 By this function, the central bank gets an opportunity
to establish control over the banking system of the
country.
Bank of clearance, settlement and transfer. The
central bank acts as the Bring house for
commercial banks keep their accounts and.
maintain cash serve with the central bank. So it is
easier for the central bank to act as the clearing
house of the country. The central-bank settles the
claims and counter claims of the banks by making
transfer entries in their account. To transfer and lie
claims of one bank upon others, the central, bank
operates a separate department in big cities and
trade centers. This department is known as
'clearing house”
 The clearing house operations are quite significant.
They are of great convenience to the banking
system.
4. Custodian of Foreign Exchange Reserves
The central hank keeps and manages the foreign
exchange reserves country: Funds coming from
and going out to foreign countries are channeled
through the central bank. All the incomes in
foreign currencies accrued into central bank in the
foreign exchange accounts and payments are met
from these accounts. All the balances are kept
under the custody of the bank. Further the central
banks in most countries maintain both gold and
foreign currencies reserves against note issue and
also to meet adverse balance of payments, it a fixes
the exchange rate of domestic currency in terms of
foreign currencies a maintain stability in exchange
rates. The central bank also manages exchange
control operations in accordance with the rules
laid down by the government.
5. Research and Data Collection
In addition to the above functions, a modern
central bank collects publishes important
monetary data pertaining to the working of
the banking system and the economy as a
whole. It helps to understand the nature and
magnitude problems facing the economy and
seek solutions thereof.
6. METHODS OF CREDIT CONTROL
 The most important function of the central bank is to
control credit by commercial banks. Money and
credit represent a powerful force for good evil in the
economy. Money cannot manage itself. So it is the
duty of the central bank to ensure that money and
credit is properly managed so that inflation and
deflationary pressures can be controlled in the
economy. In modern times bank credit has become
the important source of money and commercial have
unlimited power to expand or contract credit. A
central bank has a important of weapons to control
credit created by commercial banks.
Methods of credit control are broadly divided into two:
 Quantitative credit control methods.
 Qualitative or selective credit control methods.
 The quantitative methods aim to control the
total quantity and cost of re­created by banks,
whereas the qualitative methods control the
use and direct of credit. The quantitative
methods are traditional and indirect. They
include bank rate policy, open market
operations and variable reserve ratio.
 The qualitative controls are direct which
consist of regulation of consumer credit,
margin requirements, rationing of credit,
direct action, moral suasion and publicity
 BANK RATE POLICY
Commercial banks rediscount their bills of
exchange with the central bank, times of need.
Similarly they borrow from the central bank
against approved securities. For this service the
central bank charges a rate, which is called
bank rate. Thus the bank rate or discount rate is
the rate at which the central bank prepared to
discount the first class bills of exchange and
government specific held by the commercial
banks. The bank of England was the first to
develop bank rate as a weapon to credit
control.
Working of the Bank Rate Policy
When the central bank feels that the inflation in
the country is on account of excessive creation
of credit by commercial banks it raises the
banks' rate. Following this, the lending rate of
commercial banks go up. A rise in interest rate
discourages flesh loans and puts pressure on
borrowers to repay their past debts. As a result
Business activities are curtailed. Fall in
business activities leads to contraction of
income and expenditure, reduction in demand
for goods and services and ultimately fall in
prices. Thus raising of bank rate controls
inflations.
 The opposite happens in times of deflation.
The central bank reduces the bank rate to
expand credit. Following this the commercial
banks reduce their lending rates. As the cost
of loan is low, businessmen are encouraged to
borrow and make investment. Consequently
production, employment and price Increase.
Thus lowering of the bank rate offsets the
deflationary tendencies in the economy.
 Limitations of Bank Rate Policy
The efficacy of the bank rate as an instrument of credit
control has the following limitations:
 The success of the bank rate policy depends upon the
extent to which other other market rates move in line
with the bank rate. If the market rates do not change
along with the bank rate, the changes in the bank rate
becomes ineffective. Such a relationship is possible
only when the money market is fully developed and
the banking system of the country is well organized. In
countries like UK and USA the bank rate policy has
been successful but in underdeveloped countries has
not succeeded to that extent.
 The effectiveness of the bank rate policy depends upon
the existence of eligible bills of exchange. Nowadays
the use of bills of exchange as an instrument of
financing trade and commerce has reduced
considerably. The cash credit an overdraft are the most
convenient methods of borrowing for businessmen.
The absence of rediscounting makes the bank rate
policy ineffective instrument credit control.
 The bank rate will not succeed if banks have
excess cash reserve. Bank may secure large
funds due to deficit financing by the
government. The creation of money by
government to finance development schemes
finds its way to commercial banks and they are
in the position to lend more without resorting
rediscounting or borrowing from the central
bank. Thus the commercial bank are not
completely dependent on the central bank and
consequently the bank rate is not successful.
 The commercial banks must be in the habit of rediscounting or
borrowing from the central bank. In underdeveloped money
market the banks do no approach the central bank for
borrowing. In the absence of such a practice, bank rate
becomes ineffective.
 The economic system of the country must be elastic for the
success of the bank rate policy. That is the cost of production,
wages, interest rates etc., should respond to the changes in the
bank rate. Nowadays the economic system has become rigid in
all the countries. The government's control over wages, price
and business etc., has been responsible for the rigidity of the
economic system As a result of this, the bank rate policy has
become ineffective.
 The success of the bank rate policy depends on the effect it
produces on entrepreneurial activities. In practice the
entrepreneurial activities are not adversely affected by the
changes in the market rate of interest but by the margin of
profit. If they expect higher return they will borrow and invest
in spite of the increase in rate of interest. Besides, the
investments in public sector are not governed by the changes
in the rate of interest. Therefore it is difficult to establish
relationship between the rate of interest and investment.
Open Market Operations
 Open market operations mean, buying and selling of
commercial paper and government securities in the market
by the central bank. The method of open market operation
is as follows:
 In periods of inflation, the central bank sells the securities
in the market. If he buyers are individual, firms etc., they
make payments by withdrawing from heir deposits with
the banks. If the buyers are commercial banks their cash
holding it the central bank gets reduced. So the banks are
forced to stop granting fresh loans and recall loans already
granted and the investment activity in the country gets
slackened and the inflationary situation reduced.
 I During the periods of depression the central bank
purchases securities in the pen market and pays cash to
the sellers of securities. The public deposit their money
with the banks. This increases the cash balances of
commercial banks which is used to give fresh loans.
Consequently the economic activity increases leading to a
rise in the level of investment, employment and price.
 Limitations
The policy of open market operations has certain limitations.
 In many countries, especially in underdeveloped countries,
the money market is not well organized and developed.
They do not have broad and active security market and also
bill market. So open market operations are not successful.
 In a number of countries the cash reserves of commercial
banks do not increase or decrease in accordance with the
sale of purchase or securities. When the banks maintain
higher cash reserves than they are required to do or if then
maintain other type of secret reserve, the policy will not be
successful.
 The open market operations can be successful only when
commercial banks do not approach the central bank for
accommodation. If the banks have direct access to the
central bank, the reduction in cash reserve will be
neutralized by the banks through borrowing from the
central bank. Similarly, commercial banks may repay the
loans to the central bank when the cash reserve is increased
instead of granting more credit.
VARIABLE RESERVE RATIO
 Variable reserve ratio as a method of credit control
was suggested by Keynes in 1930. This method
was introduced by Federal Reserve System of USA
in 1935. Now in almost all countries of the world,
the central bank adopts this instrument an
effective credit control.
 Every commercial bank is required by law to
maintain certain percentage of Its deposit with the
central bank which is called the reserve ratio. The
central bank has the power to change the
percentage of cash reserves to be kept with it. By
changing the reserve requirement the central bank
is able to effect the amount cash with the
commercial banks and force them to curtail or
expand credit.
 LIMITATIONS
 The variable reserve ratio is subject to a number of
limitations.
(1)The commercial banks usually possess large
excessive cash reserves. When central bank raises
the ratio, they transfer a part of the excess reserve.
They stick to the legal requirement of cash to
deposit and continue to create credit.
(2)This method affects different banks differently.
Banks having large reserves not suffer much
compared to banks having little or no reserves.
This policy is also discriminatory in the sense that
the non-banking financial intermediary like co-
operative societies, development banks etc., are not
affected by verification in reserve requirements.
3. This policy is inflexible in the sense that the reserve
ratio is applicable all regions of the country
without regard to local situation. More credit ma
required in one region and it may be superfluous
in the other region. Raising reserve ration is not
justified in the former case whereas it is
appropriate latter region.
4. It introduces an element of uncertainty in the
working of banks. Bar-not know when the reserve
ratio will be changed. So Keynes has suggested the
reserve ratio should be changed after giving
reasonable notice and by as percentage.
5. Variable reserve ratio restricts the freedom of
commercial banks. Even sufficient funds are
available the banks may not expand credit on
account of that the ratio may be raised after
sometime.
6. The employment of this weapon may have
depressive effect on securities market. When the
central bank suddenly increases the reserve ratio,
the banks may be forced to sell the securities to
maintain the requirement. This widespread selling
of securities may bring down the prices of
securities collapse the security market.
7. Finally the success of this system depends on the
willingness of businessmen to borrow and invest.
During period of inflation, the banks may
reduce credit even though the reserve ratio is
raised. Similarly during periods depression banks
may not be able to expand credit if the
businessmen pessimistic about the future.
THANK
YOU