THE ROLE OF RESERVE BANK OF INDIA IN

THE INDIAN BANKING SYSTEM

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 GROUP MEMBERS

SR. NO NAME WRO NUMBER

1. KRISTO GEORGE (GL) WR00701276

2. POONAM YADAV WRO0645538

3. VARUN PAREKH WRO0701820

4. MANALI SARAIYA WRO0701876

5. ANAMIKA SHARMA WRO0701792

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 TABLE OF CONTENTS

SR.NO TOPIC NAME PAGE NO

1. INTRODUCTION TO RESERVE 4
BANK OF INDIA

2. 5

HISTORY OF RBI

3. POWERS OF RBI 6

4. STRUCTURE OF INDIAN 7
BANKING SYSTEM

5. ROLE OF RBI IN INDIAN 9

BANKING SYSTEM

6. MONETARY POLICY OF RBI 13

7. CONCLUSION 22

8. BIBLIOGRAPHY 23

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 Introduction Of Reserve Bank of India

The Reserve Bank of India (RBI) was established on April 1, 1935 in accordance with the provisions of the Reserve
Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are
formulated.

Though originally privately owned, since nationalisation in 1949, The Preamble of the Reserve Bank of India
describes the basic functions of the Reserve Bank as:
“to regulate the issue of Bank notes and 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; to have a modern monetary policy
framework to meet the challenge of a

Reserve Bank of India Act, 1934

Reserve Bank of India Act, 1934 is Act, which was amended in 1936, were meant to provide a framework for the
supervision of banking firms in India.
The Act contains the definition of the so-called scheduled banks, as they are mentioned in the 2nd Schedule of the
Act. These are banks which were to have paid up capital and reserves above 5 lakh.[2]

There are various section in the RBI Act but the most controversial and confusing section is Section 7.

Although this section has been used only once by the central govt, it puts a restriction on the autonomy of the RBI.
Section 7 states that central government can legislate the functioning of the RBI through the RBI board, and the RBI
is not an autonomous body.

Section 17 of the Act defines the manner in which the RBI(the central bank of India) can conduct business. The RBI
can accept deposits from the central and state governments without interest. It can purchase and discount bills of
exchange from commercial banks. It can purchase foreign exchange from banks and sell it to them. It can provide
loans to banks and state financial corporations. It can provide advances to the central government and state
governments. It can buy or sell government securities. It can deal in derivative, repo and reverse repo.[2]

Section 18 deals with emergency loans to banks.

Section 21 states that the RBI must conduct banking affairs for the central government and manage public debt.
Section 22 states that only the RBI has the exclusive rights to issue currency notes in India. Section 24 states that the
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 maximum denomination a note can be is ₹10,000 (US$140).

Section 26 of Act describes the legal tender character of Indian bank notes.

Section 28 allows the RBI to form rules regarding the exchange of damaged and imperfect notes.[2]

Section 31 states that in India, only the RBI or the central government can issue and accept promissory notes that are
payable on demand.
However, cheques, that are payable on demand, can be issued by anyone.

Section 42(1) says that every scheduled bank must have an average daily balance with the RBI. The amount of the
deposit shall be more that a certain percentage of its net time and demand liabilities in India.

The Reserve Bank of India is also known as the Nation’s Central Bank. According to the bank dossiers, it began
operations on April 01, 1935. In the following section, we will know more about how the bank came into being. We
will also see the historic acts and the decisions that the bank has been a part of. Finally, we will summarise by listing
the functions of the Reserve Bank Of India. Let us also see the history of the history of RBI.

Origin & History Of The Reserve Bank Of India Origin Timeline

1926: The Royal Commission on Indian Currency and Finance recommended the creation of a central bank for India.

1927: A bill to give effect to the above recommendation was introduced in the Legislative

Assembly. But it was later withdrawn due to lack of agreement among various sections of people.

1933: The White Paper on Indian Constitutional Reforms recommended the creation of a Reserve Bank. A fresh bill
was introduced in the Legislative Assembly.

1934: The Bill was passed and received the Governor General’s assent

1935: The Reserve Bank commenced operations as India’s central bank on April 1 as a private shareholders’ bank with
a paid up capital of rupees five crores (rupees fifty million).

1942: The Reserve Bank ceased to be the currency issuing authority of Burma (now Myanmar).

1947: The Reserve Bank stopped acting as banker to the Government of Burma.

1948: The Reserve Bank stopped rendering central banking services to Pakistan.

1949: The Government of India nationalized the Reserve Bank under the Reserve Bank (Transfer of Public
Ownership) Act, 1948.

Currently, the Bank’s Central Office, located at Mumbai, has twenty-seven departments. (Box No.3) These
departments frame policies in their respective work areas. They are headed by senior officers in the rank of Chief
General Manager.

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 Historic Details History of RBI

The origins of the Reserve Bank of India 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 undergone
numerous changes, as the nature of the Indian economy and financial sector changed.

There were several causes for the creation of a central bank. Though the rupee was the common currency, there were
several species of rupee coins of different values in circulation. The authorities, however, endeavored to evolve a
standard coin. For many years, the Sicca of Murshidabad was, in theory, the standard coin, and the rates of exchange of
thevarious rupees in terms of the Sicca rupee varied, the discount being called the batta.

The Government received enquiries from the Collectors as to the batta they should charge on the different species they
received from zamindars and farmers. The proposed bank was to fix the value, in Sicca rupees, of the bills it had to
issue in return for the money received from the Collectors, on the basis of the same batta. Thus, the bank was expected
to assist in stabilizing inland exchange and in enforcing the Sicca coin as the standard coin of the Provinces.

POWERS OF RESERVE BANK OF INDIA

 Inspecting the bank & its book and account

― As per section 35 (1) the Reserve bank at any time may and on being directed so to do by the Central
Government shall cause an inspection to be made by one or more of its officers of any banking
company and its books and accounts and shall supply to the banking company a copy of its report on
the inspection.

 To give Direction Section 35 (A)

― In the Public Interest

― To prevent the affairs of any banking company being conducted in a manner detrimental to the
interests of the depositors or in a manner prejudicial to the interests of the banking company.

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  Issuing Directions to banking companies to initiate insolvency resolution process

― The Central Government may, by order, authorize the Reserve Bank to issue directions to any
banking company or banking companies to initiate insolvency resolution process in respect of a
default, under the provisions of the Insolvency and Bankruptcy Code, 2016.

Structure of banking in India

Meaning of Structure:
An organizational structure defines how activities such as task allocation, coordination, and supervision are directed
toward the achievement of organizational aims. Organizational structure affects organizational action and provides the
foundation on which standard operating procedures and routines rest.

Structure of banking in India

Central Bank (RBI)

I. Scheduled Banks–Scheduled Banks are those banks which are listed in the Second Schedule to the
Reserve Bank of India Act, 1934. The Banks satisfying the following conditions are only included in the
Second Schedule.That the Bank’s paid up capital plus free reserves are not less than Rs. 5.00 lakh,
andThat the affairs of the Bank are not conducted to the detrimental interest of the depositors.

(1) Commercial Banks - A commercial bank is a type of bank that provides services such as accepting
deposits, making business loans, and offering basic investment products that is operated as a business for profit.It can
also refer to a bank, or a division of a large bank, which deals with corporations or large/middle-sized business to
differentiate it from a retail bank and an investment bank.

a) Public Sector Banks -Public Sector Banks (PSBs) are a major type of bank in India, where a majority
stake (i.e. more than 50%) is held by a government. The shares of these banks are listed on stock exchanges.
There are a total of 12 Public Sector Banks alongside 1 state-owned Payments Bank in India.

i. Nationalised Banks-Any Bank where the Government of a Country has a stake of 51% or higher is
called a Nationalized Bank. ... The reason they are all called Nationalized Banks are because the Government
forcibly bought their majority shareholdings in the year 1969 and Nationalized them from their private status.

ii. SBI & Associate Banks - State Bank of India (SBI) is the country's largest commercial bank, in
terms of assets, deposits, and employees..SBI, along with its associate banks, offers micro-financing to entities
such as self-help groups in rural areas that would otherwise have no access to formal credit channels.

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B) Private Sector Banks - The private sector banks in India are banks where the majority of the shares or
equity are not held by the government but by private share holders.

In 1969 all major banks were nationalised by the Indian government. However, since a change in government policy in
the 1990s, old and new private sector banks have re-emerged. The private sector banks are split into two groups by
financial regulators in India, old and new. The old private sector banks existed prior to nationalisation in 1968 and kept
their independence because they were either too small or specialist to be included in nationalisation. The new private
sector banks are those that have gained their banking license since the change of policy in the 1990s.

(C) ForeignBanks -A foreign bank is a type of International Bank that is obligated to follow the regulations
of both the home and host countries. Because the foreign banks’ loan limits are based on the parent bank’s capital,
foreign banks can provide more loans than subsidiary banks.” Foreign Banks are present in India either as
representative offices or as branches. A bank may choose to open foreign bank branches to meet the needs of
multinational corporate customers.

The branch form of presence which means that the foreign bank has its physical branch in India. Second is the presence
through Representative Offices in India, which are not actually a branch. Foreign banks often have correspondent
banking relationships with domestic banks and provide a useful platform for foreign banks to access opportunities for
foreign currency lending to Indian corporate and financial institutions. Foreign banks are defined as banks from a
foreign country working in India through branches. RBI has provided rules and guidelines for a foreign bank to
establish and operate in India.

(D) Regional Rural Banks-Regional Rural Banks(RRBs) are Indian Scheduled Commercial Banks
(Government Banks) operating at regional level in different States of India. They have been created with a view of
serving primarily the rural areas of India with basic banking and financial services. However, RRBs may have
branches set up for urban operations and their area of operation may include urban areas too.
The area of operation of RRBs is limited to the area as notified by Government of India covering one or more districts
in the State. RRBs also perform a variety of different functions. RRBs perform various functions in following
headsCo-operative Banks - Cooperative banking is retail and commercial banking organized on a cooperative basis.
Cooperative banking institutions take deposits and lend money in most parts of the world.

Unscheduled Banks - Non-scheduled banks are the banks which do not comply with the rules specified by the
Reserve Bank of India, or say the banks which do not come under the category of scheduled banks.Non-Scheduled
banks are not allowed to borrow money from RBI for regular banking purposes. It cannot become member of clearing
house. No such provision of submitting periodic returns.

(A) Co-operative Banks- Cooperative banking, as discussed here, includes retail banking carried out by
credit unions, mutual savings banks, building societies and cooperatives, as well as commercial banking services
provided by mutual organizations (such as cooperative federations) to cooperative businesses.

i. Urban Co-Operative Bank- The term Urban Co-operative Banks (UCBs), though not formally
defined, refers to primary cooperative banks located in urban and semi-urban areas. ... Cooperative societies are based
on the principles of cooperation, - mutual help, democratic decision making and open membership.

ii. States Co-Operative Banks – State Co-Operative Banks are apex Bank of Co-Operative Banks in
each states. The state co-operative banks are registered under state co-operative Societies Act and Licensed by RBI.
The three stage co-operative structure

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  Apex Bank state level – State co- operative bank
 District Level – District Co- operative Bank
 Base Level – Primary Co – Operative Banks & Co – Operative Socities.

Unscheduled Banks - Non-scheduled banks are the banks which do not comply with the rules specified by the Reserve
Bank of India, or say the banks which do not come under the category of scheduled banks.Non-Scheduled banks are
not allowed to borrow money from RBI for regular banking purposes.It cannot become member of clearing house.No
such provision of submitting periodic returns.

Roles of RBI in banking system:-

1. Issue of bank notes:

The reserve bank of India has the sole right to issue currency notes except one rupee notes which are issued
the ministry of finance. Currency notes issued by the reserve bank are declared unlimited legal tender
throughout the country.

This concentration of notes issue function with the reserve bank has a number of advantage:(i) it brings
uniformity in notes issue; (ii) it is easier to control and regulate credit in accordance with the requirement in
the economy and (iii) it makes possible effective state supervision and(iv) it keeps faith of public in the
paper currency.

2. Bankers to government:
As banker to the government the reserve bank manages the banking needs of the government. It has to
maintain and operate the government’s deposit accounts. It collects receipts of funds and makes payments
on behalf of the government. It represent the government of India as the member of IMF and the world
bank.

3. Custodian of cash reserves of commercial banks:

The commercial banks hold deposits in the reserve bank and letter has the custody of the cash reserve of the
commercial banks.

4. Custodian of country’s foreign currency:

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 payment position.

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5. Lender of last resort:
The commercial banks approach the reserve bank in times of emergency to tide over financial difficulties,
and reserve bank comes to their rescue though it might charge a higher rate of interest.

6. Central clearance:
Since commercial banks have their surplus cash reserve 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.

7. Controller of credit:
Since credit money forms the most important part of supply of money, and since the supply of money has
important implications for economic stability. The importance of controlled by the reserve bank in
accordance with the economic priorities of the government.

Goals:-
The another roles of RBI are related to the Indian economy and the banks are an instrument to help RBI
make changes according to different macroeconomic facets of the Indian economy.

Explanation in simpler words:

There are 3 ultimate goals of a central bank, including RBI-

i. Growth – higher the better, but should be sustainable.

ii. Inflation – under control (RBI feels comfortable at 4-5 % inflation rate, but in US even 2-3 % is
considered high).

iii. Unemployment – at the natural rate of unemployment (not 0%! There is always an average level of
unemployment in the long term, called natural rate of unemployment).

To achieve these ‘Ultimate Goals’, RBI changes/adjusts its intermediate goals according to level of growth,
inflation, unemployment and fiscal policies (i.e. the policy of the ruling government).

These intermediate goals are –

1. Money Supply: The total stock of money circulating in an economy is the money supply. The circulating money
involves the currency, printed notes, money in the deposit accounts and in the form of other liquid assets.

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2. Interest Rate:An interest rate is the percentage of principal charged by the lender for the use of its money. The
principal is the amount of money lent. As a result, banks pay you an interest rate on deposits. They are borrowing that
money from you. Anyone can lend money and charge interest, but it's usually banks. They use the deposit from
savings or checking accounts to fund loans. They pay interest rates to encourage people to make deposits.

3. Credit:It is generally defined as a contractual agreement in which a borrower receives something of value
now and agrees to repay the lender at a later date generally with interest.

4. Exchange Rate: In finance, an exchangerate is the rate at which one currency will be exchanged for
another. It is also regarded as the value of one country's currency in relation to another currency.For
example, how many U.S. dollars does it take to buy one euro? As of February 23, 2019, the exchange rate is
1.13, meaning it takes $1.13 to buy €1

All of these intermediate goals, which contribute to achieve the ultimate goals, are to be controlled by the
central bank.

RBI also regulates opening of new ATM’S provide efficient means of fund transfer for all banks. Enable banks to
maintain their accounts with RBI for statutory reserve requirement and maintenance of transaction balances.

 As a banker of banks, RBI: enable smooth and swift clearing and settlement of Inter-bank transaction.

 Why RBI is called as banker’s bank? Reason is i) It provides loans to bank’s ii) Accept deposits of banks. iii)
Rediscount the bills of bank’s branches of commercial banks.

 Its objectives are to maintain public confidence in the system, protect depositors' interest and provide cost-
effective banking services to the public. The Banking Ombudsman Scheme has been formulated by the
Reserve Bank of India (RBI) for effective addressing of complaints by bank customers.

 It regulates and supervises banks and other financial institutions. The RBI plays a
vital role in economicgrowth of the country and maintaining price stability. RBI and financial literacy: - The
central bank plays a key role in creating financial awareness among the masses through various medium,
including television.

 Deregulation of the banking sector and the development of the financial sector encouraged many banks to
undertake non-traditional banking activities, also known as Para-banking.

 The Reserve Bank has permitted banks to undertake diversified activities, such as, asset management,
mutual funds business, insurance business, merchant banking activities, factoring services, venture capital,
card business, equity participation in venture funds and leasing, etc.

 While some of the activities are permitted to be undertaken departmentally, some other activities are to be
undertaken through subsidiary mode.

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 Banks were supervised under what is known as the CAMELS model, an abbreviation for (Capital
Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity to market risk). This approach
focused on the monitoring and examination of financial condition of banks and their compliance with the
rules and regulations.

 Under this model, onsite examination is carried out on an annual basis supported by offsite surveillance. The
CAMELS approach was focused on solvency and liquidity of the banks and primarily aimed at limiting the
risk of loss to depositors. This approach has the drawback of being a 'Single-Size Fit' approach and also is
found to be behind the curve when it comes to keeping pace with innovation in the financial sector. The
global financial crisis revealed that though many countries had similar financial systems and operated under
more or less the same set of rules (Basel Standards), some of them were less affected. One of the reasons
attributed to this upshot is “better supervision”. Given the inherent weaknesses in the CAMELS model,
which may have contributed to the lax supervision in existence before the crisis, a move towards a risk-based
or risk-focused approach to supervision is gaining momentum in many countries. There are primarily two
reasons for this shift towards risk-based supervision.

 First, there is a growing recognition that banking in the traditional sense of accepting deposits for the
purpose of lending is no longer in vogue and banks and banking is becoming complex.

 Second and 73 equally important is the realization that supervisory resources are scarce and need to be
optimally deployed to meet supervisory goals. Thus, there was a need for a robust supervisory framework,
which proactively identifies incipient risks and takes measures to address them. Recognizing this, the RBI
constituted a High-Level Steering Committee under the Chairmanship of former Deputy Governor, K C
Chakrabarty, in August 2011, to review the supervisory processes for commercial banks.

 The regulator,industry and academics had representation in the Committee. The Committee, inter alia,
recommended a shift to a risk-based approach to supervision from the existing compliance-based approach.
The RBI migrated to a risk-based supervisory (RBS) framework from 2013 onwards. Based on the
recommendations of the committee, a risk-based approach to supervision was implemented from 2013
onwards in a phased manner. All the scheduled commercial banks in India are now under the RBS
framework and the erstwhile CAMELS framework are no longer in vogue. Some of the institutions that have
moved to a risk-based supervisory framework

 The RBI undertakes supervision of the commercial banks located in India as well as branches of Indian
banks located outside India under various provisions of the BR Act, 1949. The Department of Banking
Supervision (DBS) is responsible for supervision of scheduled commercial banks, including small finance
banks and payments banks. set up the Board for Financial Supervision (BFS), a sub-committee of the Central
Board of RBI, in November 1994, with the objective of dedicated and integrated supervision of all credit
institutions, i.e., banks, development financial institutions and non-banking financial companies.

 Moreover, banks also enjoy Government protection in terms of liquidity support and depositor guarantee.
This in turn can potentially lead to moral hazard issues, such as excessive risk taking and consequent
impairment of balance sheet. From a systemic perspective, failure of banks can cause immense damage to

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 the real economy as an impaired banking system cannot perform the essential function of financial
intermediation between savers and borrowers. Therefore, effective supervision of banks is essential to ensure
that banks adhere to the rules and regulation in letter and in spirit as well as their risk culture and risk
governance does not pose threat to its solvency.

Hence above mentioned are the important roles of RBI in Indian banking sector.

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 MONETARY POLICY
Monetary policy is the policy adopted by the monetary authority of a country that controls either the interest
rate payable on very short-term borrowing or the money supply, often targeting inflation or the interest rate to
ensure price stability and general trust in the currency.

Further goals of a monetary policy are usually to contribute to the stability of gross domestic product, to achieve and
maintain low unemployment, and to maintain predictable exchange rates with other currencies.

Monetary economics provides insight into how to craft an optimal monetary policy. In developed countries, monetary
policy has been generally formed separately from fiscal policy, which refers to taxation, government spending,
and associated borrowing.

HISTORY
Monetary policy is associated with interest rates and availability of credit. Instruments of monetary policy have
included short-term interest rates and bank reserves through the monetary base. For many centuries there were only
two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest
rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of
monetary policy during this time. Monetary policy was seen as an executive decision, and was generally in the hands
of the authority with seigniorage, or the power to coin. With the advent of larger trading networks came the ability to
set the price between gold and silver, and the price of the local currency to foreign currencies. This official price could
be enforced by law, even if it varied from the market price.

Paper money originated from promissory notes called "jiaozi" in 7th century China. Jiaozi did not replace metallic
currency, and were used alongside the copper coins. The successive Yuan Dynasty was the first government to use
paper currency as the predominant circulating medium. In the later course of the dynasty, facing massive shortages of
specie to fund war and their rule in China, they began printing paper money without restrictions, resulting
in hyperinflation.

With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them with
gold, the idea of monetary policy as independent of executive action began to be established. [9] The goal of monetary
policy was to maintain the value of the coinage, print notes which would trade at par to specie, and prevent coins from
leaving circulation. The establishment of central banks by industrializing nations was associated then with the desire to
maintain the nation's peg to the gold standard, and to trade in a narrow band with other gold-backed currencies. To
accomplish this end, central banks as part of the gold standard began setting the interest rates that they charged, both
their own borrowers, and other banks who required liquidity. The maintenance of a gold standard required almost
monthly adjustments of interest rates. The gold standard is a system under which the price of the national currency is
measured in units of gold bars and is kept constant by the government's promise to buy or sell gold at a fixed price in
terms of the base currency. The gold standard might be regarded as a special case of "fixed exchange rate" policy, or as

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a special type of commodity price level targeting. Nowadays this type of monetary policy is no longer used by any
country.[10]

Therefore, monetary decisions today take into account a wider range of factors, such as:

 short-term interest rates;

 long-term interest rates;
 velocity of money through the economy;
 exchange rates;
 credit quality;
 bonds and equities (debt and corporate ownership);
 government versus private sector spending/savings;
 international capital flows of money on large scales;
 financial derivatives such as options, swaps, futures contracts, etc.

The Objectives of Monetary Policy:

Monetary policy in an underdeveloped country plays an important role in increasing the growth rate of the economy by
influencing the cost and availability of credit, by controlling inflation and maintaining equilibrium the balance of
payments.

To Control Inflationary Pressures:

To control inflationary pressures arising in the process of development, monetary policy requires the use of both
quantitative and qualitative methods of credit control. Of the instruments of monetary policy, the open market
operations are not successful in controlling inflation in underdevelopment countries because the bill market is small
and undeveloped.

Commercial banks keep an elastic cash-deposit ratio because the central bank’s control over them is not complete.
They are also reluctant to invest in government securities due to their relatively low interest rates. Moreover, instead of
investing in government securities, they prefer to keep their reserves in liquid form such as gold, foreign exchange and
cash. Commercial banks are also not in the habit of redics counting or borrowing from the central bank.

The bank rate policy is also not so effective in such countries due to: (i) the lack of bills of discount; (ii) the narrow
size of the bill market; (iii) a large non-monetised sector where barter transactions take place; (iv) the existence of
indigenous banks which do not discount bills with the central bank; (v) the habit of the commercial banks to keep large
cash reserves; and (vi) the existence of a large unorganised money market.

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To Achieve Price Stability:

Monetary policy is an important instrument for achieving price stability k brings a proper adjustment between the
demand for and supply of money. An imbalance between the two will be reflected in the price level. A shortage of
money supply will retard growth while an excess of it will lead to inflation. As the economy develops, the demand for
money increases due to the gradual monetization of the non-monetized sector, and the increase in agricultural and
industrial production. These will lead to increase in the demand for transactions and speculative motives. So the
monetary authority will have to raise the money supply more than proportionate to the demand for money in order to
avoid inflation.

To Bridge BOP Deficit:

Monetary policy in the form of interest rate policy plays an important role in bridging the balance of payments deficit.
Underdeveloped countries develop serious balance of payments difficulties to fulfill the planned targets of
development. To establish infrastructure like power, irrigation, transport, etc. and directly productive activities like iron
and steel, chemicals, electrical, fertilisers, etc., underdeveloped countries have to import capital equipment, machinery,
raw materials, spares and components thereby raising their imports. But exports are almost stagnant. They are high-
price due to inflation. As a result, an imbalance is created between imports and exports which lead to disequilibrium in
the balance in payments. Monetary policy can help in narrowing the balance of payments deficit through high rate of
interest. A high interest rate attracts the inflow of foreign investments and helps in bridging the balance of payments
gap.

Interest Rate Policy:

A policy to high interest rate in an underdeveloped country also acts as an incentive to higher savings, develops
banking habits and speeds up the monetization of the economy which are essential for capital formation and economic
growth. A high interest rate policy is also anti-inflationary in nature, for it discourages borrowing and investment for
speculative purposes, and in foreign currencies.

Further, it promotes the allocation of scarce capital resources in more productive channels. Certain economists favour a
low interest rate policy in such countries because high interest rates discourage investment. But empirical evidence
suggests that investment in business and industry is interest-inelastic in underdeveloped countries because interest
forms a very low proportion of the total cost of investment. Despite these opposite views, it is advisable for the
monetary authority to follow a policy of discriminatory interest rate-charging high interest rates for non-essential and
unproductive uses and low interest rates for productive uses.

To Create Banking and Financial Institutions:

One of the objectives of monetary policy in an underdeveloped country is to create and develop banking and financial
institutions in order to encourage, mobilise and channelise savings for capital formation. The monetary authority

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should encourage the establishment of branch banking in rural and urban areas.¬Such a policy will help in monetizing
the non-¬monetized sector and encourage saving and investment for capital formation. It should also organise and
develop money an capital market. These are essential for the success of a development oriented monetary policy which
also includes debt management.

Debt Management:

Debt management is one of the important functions of monetary policy in an underdeveloped country. It aims at proper
timing and issuing of government bonds, stabilising their prices and minimising the cost of servicing the public debt.

The primary aim of debt management is to create conditions in which public borrowing can increase from year to year.
Public borrowing is essential in such countries in order to finance development programmes and to control the money
supply. But public borrowing must be at cheap rates. Low interest rates raise the price of government bonds and make
them more attractive to the public. They also keep the burden of the debt low.

Thus an appropriate monetary policy, as outlined above, helps in controlling inflation, bridging balance of payments
gap, encouraging capital formation and promoting economic growth.

Types of Monetary Policy

There are two common types of monetary policy:

1. Expansionary Policy

2. Contractionary Policy

Expansionary monetary Policy

The basic objective of expansionary policy is to boost aggregate demand to make up for shortfalls in private demand. It
is based on the ideas of Keynesian economics, particularly the idea that the main cause of recessions is a deficiency in
aggregate demand. Expansionary policy is intended to boost business investment and consumer spending by injecting
money into the economy either through direct government deficit spending or increased lending to businesses and
consumers.

From a fiscal policy perspective, the government enacts expansionary policies through budgeting tools that provide
people with more money. Increasing spending and cutting taxes to produce budget deficits means that the government
is putting more money into the economy than it is taking out. Expansionary fiscal policy includes tax cuts, transfer
payments, rebates and increased government spending on projects such as infrastructure improvements.

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Contractionary Monetary Policy

Contractionary policy is a monetary measure referring either to a reduction in government spending—particularly

deficit spending—or a reduction in the rate of monetary expansion by a central bank. It is a type of macroeconomic
tool designed to combat rising inflation or other economic distortions created by central banks or government
interventions. Contractionary policy is the polar opposite of expansionary policy.

Governments engage in contractionary fiscal policy by raising taxes or reducing government spending. In their crudest
form, these policies siphon money from the private economy, with hopes of slowing down unsustainable production or
lowering asset prices. In modern times, an increase in the tax level is rarely seen as a viable contractionary measure.
Instead, most contractionary fiscal policies unwind previous fiscal expansion, by reducing government expenditures –
and even then, only in targeted sectors.

The Instruments of Monetary Policy

The instruments of monetary policy are classified under two heads:

1. Quantitative Instruments

2. Qualitative Instruments

Quantitative Instruments

The quantitative or general measures influence the total volume of the credit . The quantitative measures of credit
control are :

A. Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at which it rediscounts first class bills of exchange
and government securities held by the commercial banks. When the central bank finds that inflation has been
increasing continuously, it raises the bank rate so borrowing from the central bank becomes costly and commercial
banks borrow less money from it (RBI).

The commercial banks, in reaction, raise their lending rates to the business community and borrowers who further
borrow less from the commercial banks. There is contraction of credit and prices are checked from rising further. On
the contrary, when prices are depressed, the central bank lowers the bank rate.

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It is cheap to borrow from the central bank on the part of commercial banks. The latter also lower their lending rates.
Businessmen are encouraged to borrow more. Investment is encouraged and followed by rise in Output, employment,
income and demand and the downward movement of prices is checked.

B. Cash Reserve Ratio(CRR)

Cash Reserve Ratio refers to the fraction of the total net demand and time liabilities of a scheduled commercial bank in
India which it should maintain as cash deposit with the reserve Bank. The RBI may set the ratio in keeping with the
broad objective of maintaining monetary stability in the economy. This requirement applies uniformly to all scheduled
banks in the country irrespective of it’s size or financial position.

C.Statutory Liquidity Ratio(SLR)

The Statutory Liquidity Ratio (SLR) refers to the proportion of deposits the commercial bank is required to maintain
with them in the form of liquid assets in addition to the cash reserve ratio. It can be in the following Forms:

(i) Cash

(ii) Gold,or

(iii) Investments in un-encumbered instruments that include:

(a) Treasury Bills of the government of India

(b) Dated securities including those issued by the Government of India from time to time under the
market borrowings programme and the market stabilization Scheme(MSS).

(d) Marginal Standing Facility

The marginal Standing Facility(MSF) refers to the facility under which scheduled Commercial Banks can borrow
additional amount of overnight money from the central bank over and above what is available to them through the LAF
window by dipping into their statutory Liquidity Ratio(SLR) upto a Limit at a penal rate of Interest.This provides a
safety valve against unexpected liquidity shocks to the banking system.this scheme has been introduced by the RBI

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with main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth
monetary transmission in the financial system.

(e) . Open Market Operations:

Open market operations refer to sale and purchase of securities in the money market by the central bank of the country.
When prices start rising and there is need to control them, the central bank sells securities. The reserves of commercial
banks are reduced and they are not in a position to lend more to the business community or general public.

Further investment is discouraged and the rise in prices is checked. Contrariwise, when recessionary forces start in the
economy, the central bank buys securities. The reserves of commercial banks are raised so they lend more to business
community and general public. It further raises Investment, output, employment, income and demand in the economy
hence the fall in price is checked.

Qualitative Instruments

a. Change in Marginal Requirements

Under this method, the central bank effects a change in the marginal requirement to control and release funds. When
the central bank feels that prices are rising on account of stock-piling of some commodities by the traders, then the
central bank controls credit by raising the marginal requirements. (Marginal requirement is the difference between the
market value of the assets and its maximum loan value). Let us suppose, a borrower pledged goods worth Rs. 1000 as
security with a bank and gets a loan amounting to Rs. 800.

Thus marginal requirement is Rs. 200 or 20 percent. If this margin is raised, the borrower will have to pledge goods of
greater value to secure loan of a given amount. This would reduce money supply and inflation would be curtailed.
Similarly, in case of depression, central bank reduces margin requirement. This will in turn raise the credit creating
capacity of the commercial banks. Therefore, margin requirement is a significant tool in the hands of central authority
during inflation and depression.

2. Regulation of consumer credit:

During inflation, this method is followed to control excess spending of the consumers. Generally the hire purchase
facilities or installment methods are used to reduce to the minimum to curb the expenditure on consumption. On the
contrary, during depression period, more credit facilities are allowed so that consumer may spend more and more to
pull the economy out of depression.

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3. Direct Action:
This method is adopted when some commercial banks do not co-operate with the central bank in controlling the credit.
Thus, central bank takes direct action against the defaulter. The central bank may take direct action in a number of
ways as under.

(i).It may refuse rediscount facilities to banks which do not follow it’s directives.
(ii). It may change rates over and above the bank rate.
(iii).Any other restrictions on the defaulter.

5. Moral Suasion Or advice

In recent years, the central bank has used moral suasion alsoas a tool of Credit control. Moral suasion is ageneralterm
describing a variety of informal methods used by the central bankto persuade commercial banks in aparticular
manner. Moral suasion takes the form of directive and publicity.

Monetary Policy Committee

Monetary Policy Committee (MPC) constituted by the Central Government as per the Section 45ZB of the amended
RBI Act, 1934. The first meeting of the MPC was held on October 3 and 4, 2016. This committee decides various
policy rates like Repo rate, Reverse repo rate, MSF and Liquidity Adjustment Facility etc. On 4th October, 2019 the
RBI Monetary Policy committee has cut the repo rate by 25 bps to 5.15%. Now the repo rate stands at 5.15%, the
lowest since March 2010.

Monetary Policy Committee (MPC) is a 6 member committee formed after the amendment in the RBI Act, 1934
through the Finance Act, 2016. The basic objective of MPC is to maintain price stability and accelerate the growth rate
of the economy. The Monetary Policy Committee of India is responsible for fixing the benchmark interest rate in India.
The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each
such meeting.

The committee comprises six members - three officials of the Reserve Bank of India and three external members
nominated by the Government of India. They need to observe a "silent period" seven days before and after the rate
decision for "utmost confidentiality". The Governor of Reserve Bank of India is the chairperson ex officio of the
committee. Decisions are taken by majority with the Governor having the casting vote in case of a tie. The current
mandate of the committee is to maintain 4% annual inflation until 31 March 2021 with an upper tolerance of 6% and a
lower tolerance of 2%.

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The committee was created in 2016 to bring transparency and accountability in fixing India's Monetary Policy. The
monetary policy are published after every meeting with each member explaining his opinions. The committee is
answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.

Composition

The composition of the current and first monetary policy committee is as follows:

1. Governor of the Reserve Bank of India – Chairperson, ex officio - Shaktikanta Das

2. Deputy Governor of the Bank, in charge of Monetary Policy—Member, ex officio - BP Kanungo
3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member,; - Michael Patra
4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
5. Professor Pami Dua, Director, Delhi School of Economics – Member;
6. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad - Member

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 CONCLUSION
 Central bank plays an important role in achieving economic growth of a developing country.

 It promotes economic growth with stability.

 It helps in attaining full employment balance of payment disequilibrium and in stabilizing exchange rate.

 RBI is an autonomous body promoted by the Government of india and is headquartered at Mumbai.

 RBI is the primary regulator for banking and non-banking financial Institutions.

 The RBI operates a number of government mints that produce currency and coins.

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 BIBLIOGRAPHY

 Chapter on Money and Banking

(CA-CPT: Macroeconomics)

 RBI official Website(www.rbi.org.in)

 Economic Times
 Slideshare.net
 Google search engine

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