Introduction

Reserve Bank of India (RBI) is the central bank of the country. It is a statutory body. It was
inaugurated in April 1935. Initially, the ownership of almost all the share capital was in the hands of
non-government shareholders. So, in order to prevent the centralisation of the shares in few hands,
the RBI was nationalised on January 1, 1949. Currently, Shashikanta Das is the Governor of the
RBI. The central bank is an independent apex monetary authority which regulates banks and
provides important financial services like storing of foreign exchange reserves, control of inflation,
monetary policy report. A central bank is known by different names in different countries. A central
bank is a vital financial apex institution of an economy and the key objects of central banks may
differ from country to country still they perform activities and functions with the goal of
maintaining economic stability and growth of an economy.
 Functions of the Reserve Bank of India:
By the Reserve Bank of India Act of 1934, all the important functions of a central bank have been
entrusted to the Reserve Bank of India.

(i) Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the RBI has the sole right to issue bank notes of
all denominations except one rupee note, which is issued by the Ministry of Finance. The RBI has a
separate Issue Department which is entrusted with the issue of currency notes. The assets and
liabilities of the Issue Department are kept separate from those of the Banking Department. Since
1957, the Reserve Bank of India is required to maintain gold and foreign exchange reserves of
Rs.200 crores, of which at least Rs.115 crores should be in gold. The system as it exists today is
known as the ‘minimum reserve system’.

(ii) Bankers to Government

The second important function of the Reserve Bank of India is to act as Government banker, agent
and adviser. The RBI is an agent of central Government and of all state Government in India. It has
the obligation to transact Government business, viz., to keep the cash balances as deposits free of
interest, to receive and to make payments on behalf of the Government and to carry out their
exchange remittances and other banking operations. It helps the Government-both the Union and
the States to float new loans and to manage public debt. It also makes ways and means advances to
the Governments for 90 days. It makes loans and advances to the states and local authorities. It acts
as adviser to the Government on all monetary and banking matters.

(iii) Bankers’ Bank and Lender of the last resort

The Reserve Bank of India acts as the bankers’ bank. According to the provisions of the Banking
Companies Act of 1949, every scheduled bank was required to maintain with RBI a cash balance
equivalent to 5 percent of its demand liabilities and 2 per cent of its time liabilities in India. By an
amendment of 1962, the distinction between demand and time liabilities was abolished and banks
have been asked to keep cash reserves equal to 3 percent of their aggregate deposit liabilities. The
minimum cash requirements can be changed by the Reserve Bank of India.
The scheduled banks can borrow from the RBI on the basis of eligible securities or get financial
accommodation in times of need or stringency by re-discounting bills of exchange. Since
commercial banks can always expect the RBI to come to their help in times of banking crisis, the
RBI becomes not only the bankers’s bank but also the lender of the last resort.

(iv) Controller of Credit

The Reserve Bank of India is the controller of credit, i.e., it has the power to influence the volume
of credit created by banks in India. It can do so through changing the Bank rate or through open
market operations. According to the Banking Regulation Act of 1949, the RBI can ask any
particular bank or the whole banking system not to lend to particular groups or persons on the basis
of certain types of securities. Since 1956, selective controls of credit are increasingly being used by
the RBI.
The Reserve Bank of India is armed with many more powers to control the India money market.
Every bank has to get a licence from the RBI to do banking business within India; the licence can
be cancelled by the RBI if certain stipulated conditions are not fulfilled. Every bank will have to get
the permission from the RBI for opening a new branch. Each scheduled bank must send a weekly
return to the RBI showing, in detail, its assets and liabilities. This power of the RBI to call for
information is also intended to give it effective control of the credit system. The RBI has also the
power to inspect the accounts of any commercial bank.
As supreme banking authority in the country, the Reserve Bank of India, therefore, has the
following powers:
• It holds the cash reserves of all the scheduled banks.
• It controls the credit operations of banks through quantitative and qualitative controls.
• It controls the banking system through the system of licensing, inspection and calling for
information.
• It acts as the lender of the last resort by providing rediscount facilities to scheduled banks.

(v) Custodian of Foreign Exchange Reserves

The Reserve Bank of India has the responsibility to maintain the official rate of exchange.
According to the Reserve Bank of India Act of 1934, the Bank was required to buy and sell at fixed
rates any amount of sterling in lots of not less than Rs. 10,000. Though there were periods of
extreme pressure in favour of or against the rupee. After India became a member of the
International Monetary Fund in 1946, the Reserve Bank has the responsibility of maintaining fixed
exchange rates with all other member countries of the I.M.F. Besides maintaining the rate of
exchange of the rupee, the RBI has to act as the custodian of India’s reserve of international
currencies. The vast sterling balances were acquired and managed by the RBI. Further the RBI has
the responsibility of administering the exchange controls of the country.

(vi) Supervisory Functions

In addition to its traditional central banking functions, the RBI has certain non-monetary functions
of the nature of supervision of banks and promotion of sound banking in India. The Reserve Banks
of India Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of
supervision and control over commercial and co-operative banks, relating to licensing and
establishments, branch expansion, liquidity of their assets, management and methods of working,
amalgamation, reconstruction, and liquidation. The RBI is authorized to carryout periodical
inspections of the banks and to call for return and necessary information from them. The
nationalization of 14 major India scheduled banks in July 1969 has imposed new responsibilities on
the RBI for directing the growth of banking and credit policies towards more rapid development of
the economy and realization of certain desired objectives. The supervisory functions of the RBI
have helped a great deal in improving the standard of banking in India to develop on sound lines
and to improve the methods of their operation.

(vii) Promotional Functions

With economic growth assuming a new urgency since Independence, the range of the RBI’s
functions has steadily widened. The RBI now performs a variety of developmental and promotional
functions, which, at one time, were regarded as outside the normal scope of central banking. The
RBI was asked to promote banking habit, extend banking facilities to rural and semi-urban areas,
and establish and promote new specialized financing agencies. Accordingly, the RBI has helped in
the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962, the Unit
Trust of India in 1964, the Industrial Development Bank of India in 1964, the Agricultural
Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of India in
1972. These institutions were set up directly or indirectly by the RBI to promote saving habit and to
mobilise saving, and to provide industrial finance as well as agricultural finance. As far back as
1935, the Reserve Bank of India set up the Agricultural Credit Department to provide agricultural
credit. But only since 1951 the RBI’s role in this field has become extremely important. The RBI
has developed the co-operative credit movement to encourage saving, to eliminate money-lenders
from the villages and to route its short term credit to agriculture. It has set up the Agricultural
Refinance and Development Corporation to provide long-term finance to farmers.
 Credit Control Policy of the Reserve Bank of India
Since 1955-56 and particularly after 1973-74, the inflationary rise in price has been steadily
mounting. Increased Government expenditure financed through deficit spending has the direct
effect of pushing up the prices, wages and incomes. Shortfalls in production, and hoarding and
speculation in essential commodities have contributed to this inflationary pressure. RBI has various
weapons of control and, through using them; it hopes to achieve its monetary policy. These weapons
of control are broadly two:
(a) Quantitative controls
(b) Qualitative controls

(a) Quantitative controls

These methods are called traditional methods because they have been in use for decades. Through
these methods, the credit creation is controlled by changing the cash reserves of commercial banks.
They are designed to affect the lendable resources of commercial banks either directly affecting
their reserve base or by making the cost of funds cheaper or dearer to them. The important methods
of this nature are explained herein below:
(i) Bank Rate
This is the rate at which the RBI lends money to other banks or financial institutions. If the bank
rate goes up, long-term interest rates also tend to move up, and vice-versa. Thus, it can said that in
case bank rate is hiked, in all likelihood banks will hikes their own lending rates to ensure and they
continue to make a profit.
The bank rate or the central banks’s rediscount rate is an important monetary instrument in modern
economies. It’s most useful role is to signal and clarify the RBI’s monetary and interest rate stance
to all participants in the financial sector and particularly to banks. If monetary policy is effective
and credible, a change in the bank rate will result in a change in prime lending rate of banks and
thus act as an independent instrument of monetary control. However, the role of the bank rate as an
instrument of monetary policy has been very limited in India because of these basic factors:
• The structure of interest rates is administered by RBI- they are not automatically linked to the
bank rate;
• Commercial banks enjoy specific refinance facilities, and not necessarily rediscount their eligible
securities with RBI at bank rate; and
• The bill marked is under-developed and the different sub-markets of the money market are not
influenced by the bank rate.
In other words, the bank rate in India is not the “pace setter” to the other market rates of interest and
the money market rates do not automatically adjust themselves to changes in the bank rate. At
sometime, the deposit rates and lending rates of banks (and of development finance instaurations)
are not related to the bank rate. Since the later part of 1995, India passed through a severe liquidity
crunch and as a result the prime lending rates were ruling high. Industrial production was affected
adversely. One step which RBI took was to reduce the bank rate from 12 to 11 percent in April
1997, and gradually to 6.5 percent. The current Bank Rate is 4.25%. The Bank Rate last witnessed a
change in its level on May 22, 2020 when it declined by 0.40% from its previous level of 4.65%.
The reduction of the bank rate was to help in the reduction of other interest rates and thus stimulate
borrowing from banks.

(ii) Cash Reserve Ratio

Banks in India are required to hold a certain proportion of their deposits in the form of cash.
However, actually Banks don not hold these as cash with themselves, but deposit such case with
Reserve Bank of India / currency chests, which is considered as equivlanet to holding cash with
themselves.. This minimum ratio (that is the part of the total deposits to be held as cash) is
stipulated by the RBI and is known as the Cash Reserve Ratio. Thus, When a bank’s deposits
increase by Rs. 100, and if the cash reserve ratio is 9%, the banks will have to hold additional Rs 9
with RBI and bank will be able to use only Rs 91 for investments and lending / credit purpose.
Therefore, higher the CRR, the lower is the amount that banks will be able to use for lending and
investment. This power of RBI to reduce the lendable amount by increasing the CRR, makes it an
instrument in the hands of a central bank through which it can control the amount that banks lend.
Thus, it is a tool used by RBI to control liquidity in the banking system.
Under the RBI Act, 1934, the commercial bank has to keep certain minimum cash reserve with RBI.
Initially, it was 5 percent against demand deposits and 2 per cent against time deposits- these are
known as the statutory cash reserve requirement between 3 per cent and 15 percent of the total
demand and time deposits.
The purpose of reducing CRR is to leave large cash reserves with banks so as to enable them to
expand bank credit. It may be mentioned that the Indian economy has been reeling under serious
economic recession for many years and reduction of CRR and expansion of bank credit to industry
and trade is one method to stimulate the Indian economy. RBI has been pursuing its medium term
objective of reducing CRR to the statutory minimum of 3 percent. Currently, the CRR is 4 per
cent

(iii) Statutory Liquidity Ratio

This term is used by bankers and indicates the minimum percentage of deposits that the bank has to
maintain in form of gold, cash or other approved securities. Thus, we can say that it is the ratio of
cash and some other approved to liabilities (deposits) which regulates the credit growth in India.
Apart from cash reserve requirement which commercial banks have to keep with RBI, all
commercial banks have to maintain liquid assets in the form of cash, gold and unencumbered
approved securities equal to not less than 25 percent of their total demand and time deposit
liabilities, This is known as the statutory liquidity requirement; this is in addition to statutory cash
reserve requirements. Maintenance of adequate liquid assets is a basic principle of sound banking.
Hence commercial banks in India have been required by the Banking Regulation Act, 1949, to
maintain minimum ratio of liquidity ratio. Accordingly, it raised the liquidity ratio from 25 percent
gradually and finally to 38.5 percent. RBI has stepped up the liquidity ratio for two reasons:
• Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources
in liquid form and thus reduces their capacity to grant loans and advances to business and
industry- thus it is anti inflationary in impact, and
• A higher liquidity ratio diverts banks from loans and advances to investment in government and
other approved securities. In other words, a higher SLR was used to divert bank funds to finance
Government expenditure.
It may be mentioned here that stepping up statutory liquidity requirements and the cash reserve ratio
have the same effects, viz., they reduce the capacity of commercial banks to expand credit to
business and industry and thus are anti-inflationary.
After accepting Narasimham Committee (1991) recommendation, RBI reduced the SLR by
successive steps to 25 per cent in October 1997. There is now a demand to abolish SLR altogether.
Currently, the rate of SLR is 18.50%.

(iv) Open Market Operations of RBI

These are the operations carried by the RBI who conducts buying & selling operations in terms of
first class securities predominately Government securities buying & selling to banks & financial
institutions. These are day to day basis Government securities. A government piece of paper
promising to repay the amount written on it (interest). In economies with well –developed money
markets, central banks use open market operation, i.e. buying and selling eligible securities by the
central bank in the money market- to influence the volume of cash reserves with commercial banks
and thus influence the volume of loans and advances they can make to the industrial and loans and
advances they can make to the industrial and commercial sectors. RBI had not used this weapon for
many years.
Since 1991, the enormous inflow of foreign funds into India created the problem of excess liquidity
with the banking Sector and RBI undertook large scale open market operations. When RBI sells
Government securities in the commercial banks and thereby, reduces the ability of banks to lend to
the industrial and commercial sectors. At any given time, the banks’ capacity to create credit – i.e.,
to give fresh loans- depends upon their surplus cash that is the amount of cash reserves in excess of
their statutory CRR. Once the surplus cash is eliminated and even part of the statutory CRR is
reduced, the banks have to contract their credit supply so as to generate some cash reserves to meet
their statutory CRR. As a result, the supply of bank credit which involves the creation of demand
deposits, falls and money supply contracts.
(v) Prime Lending Rate

It is that rate of interest at which bank gives loans to its prime borrowers or to blue chip, high
profile borrowers like corporate. Money are call on short note means inter bank loans on a day to
day basis that is loans given by one bank to another on a day to day basis Rate of interest that
prevails in market on day to day basis call money rate depends on demands and supply on day to
day basis it is nothing to do with RBI.

(vi) REPO AND REVERSE REPO

Repo rate is the rate at which the RBI lends shot-term money to the banks. When the repo rate
increases, borrowing from RBI becomes more expensive. Therefore, we can say that in case, RBI
wants to make it more expensive for the banks to borrow money, it increases the repo rate;
similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate
Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI.
The RBI uses this tool when it feels there is too much money floating in the banking system. An
increase in the reverse repo rate means that the RBI will borrow money from the banks at a higher
rate of interest. As a result, banks would prefer to keep their money with the RBI
Thus, we can conclude that Repo Rate signifies the rate at which liquidity is injected in the banking
system by RBI, whereas Reverse repo rate signifies the rate at which the central bank absorbs
liquidity from the banks.

(b) Qualitative measures

The selective or qualitative credit control is intended to ensure an adequate credit flow to the
desired sectors and preventing excessive credit for less essential economic activities. The RBI
issues directives under Section 21 of the Banking Regulation Act 1949, to regulate the flow of
banks' credit against the security of selected commodities. It is usually applied to control the credit
provided by the banks against certain essential commodities which may otherwise lead to traders
using the credit facilities for hoarding and black marketing and thereby permitting spiraling prices
of these commodities. The selective credit control measures taken by RBI are resorted to
commodities like, wheat, sugar, oilseeds, etc. The important methods of this nature are explained
herein below:
(i) Rationing of credit
This method is used to control the scheduled banks borrowings from the RBI. The RBI shows
differential treatment in giving financial help to its member banks according to the purpose for
which the credit is used.

(ii) Variation of Margin Requirement

Here the term “margin" refers to a portion of the loan amount which cannot be borrowed from bank.
In other words, the margin money is required to be brought in by the borrower from his own
sources. This much percentage of money will not be lent by banks. The RBI lowers the margin to
expand the credit and raises margin to control the credit for stock market operations. The changes in
the minimum margin requirements were effected mainly to discourage speculative hoarding
tendencies and to check the rising prices of agricultural commodities.

(iii) Regulation for consumer credits

The credit facilities provided by the banks to purchase durable consumer goods like cars,
refrigerators, T.V. furniture, etc. is called as consumer credit. If consumer credit is expanded, it
leads to the increase in production of consumer goods in the country.
Such increased sale of consumer goods will affect savings of people and capital formation in the
economy. Hence, RBI may control the consumer credit extended by the commercial banks. These
days RBI does not use such credit control measure as increased consumption lead to more economic
activity.

(iv) Publicity and moral suasion

RBI outlays guidelines to banks of banks countries to disobey the guideline. It may increase bank
rate or cancel licensing. Moral suasion is a means of strengthening mutual confidence an
understanding between the monetary authority and the banks as well as financial institute and,
therefore, is an essential instrument of monetary regulation.
(v) Directaction

When the moral suasion proves ineffective the RBI may have to use direct action on banks. The
RBI is empowered to take certain penal actions against banks which do not follow the line of policy
dictated by it. This method is essentially a corrective measure which may bring about some
psychological pressure on the commercial banks to follow the RBI instructions.
 Conclusion
The efficacy of the emerging operating procedures of monetary policy remains a matter of debate.
There is very little doubt that the RBI is now able to set an informal corridor through two-way day-
to-day liquidity management. The pass-through to the credit market, however, does not appear very
effective because of a variety of factors such as the overhang of high cost deposits, large non-
performing assets and high non-operating expenses in the banking system. As a result, real interest
rates continue to remain high. This underscores the need to further strengthen structural measures to
impart the necessary flexibility to the interest rate structure in the credit markets. The phasing out of
ad hoc Treasury Bills and the enactment of Fiscal Responsibility and Budget Management
legislation are two important milestones in providing safeguards to monetary policy from the
consequences of fiscal expansion and ensuring better monetary-fiscal co-ordination. The RBI’s
vision documents at presently has also required, to be adequately focused on regulation and
supervision of payment systems so as to provide a safe, secure, efficient and sound mechanism
which would match international standards and best practices.