RBI AND MONETARY

POLICY

Mufaddal Nullwala - MIM - 131

MIM - 2nd Yr. 3rd SemSubj- Business Environment.Prof- Dr. Anil Pandey.Batch - 2015-2018.

RESERVE BANK OF INDIA(RBI)

- India’s central banking institution.- Controls monetary policy of Indian

rupee.- Commenced operation on 1st April 1935.- Nationalised on 1st January 1949.- Head quarter in Mumbai.- Regional headquarter at Mumbai,

Chennai, Kolkata and New Delhi.

RBI STRUCTURE21 Members

GOVERNOR

4 DEPUTY GOVERNORS

2 FINANCE MINISTRY REPRESENTATIVE

10 GOVERNMENT NOMINATED MEMBERS

4 LOCAL HEADQUARTER DIRECTOR

FUNCTIONS OF RBI

1. Issue of Bank Notes2. Banker to Government3. Custodian of Cash Reserves of Commercial Banks4. Custodian of Country’s Foreign Currency Reserves5. Lender of Last Resort6. Central Clearance and Accounts Settlement7. Controller of Credit

FUNCTIONS OF RBI

Controller of CreditThe 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.

Controller of money market The Reserve Bank of India is armed with many more powers to control the Indian money market

Custodian of foreign exchange reservesBesides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies.

A) TRADITIONAL FUNCTIONS

1. Monopoly of currency notes issue2. Banker to the Government(both the central and state)3. Agent and advisor to the Government4. Banker’s Bank5. Acts as the clearing house of the country6. Lender of the last resort (B R P)7. Custodian of the foreign exchange reserves8. Maintaining the external value of domestic currency9. Controller of forex and credit (Credit Policy)10. Ensures the internal value of the currency11. Publishes the Economic statistical data12. Fight against economic crisis and ensures stability of Economy.

B) PROMOTIONAL FUNCTIONS

1. Promotion of banking habit and expansion of banking systems.

2. Provides refinance for export promotion. (E P C G)

3. Expansion of the facilities for the provision of the agricultural credit through NABARD.

4. Extension of the facilities for the small scale industries.

5. Helping the Co-operative sectors.

6. Prescribe the minimum statutory requirement. (SLR)

7. Innovating the new banking business transactions.

C) SUPERVISORY FUNCTIONS

1. Granting license to Banks.2. Inspecting and making enquiry or determining position in respect of matters under various sections of RBI and Banking regulations.3. Periodical review of the work of the commercial banks.4. Giving directives to commercial banks.5. Control the non-banking finance corporations.6. Ensuring the health of financial system through on-site and off-site verification.

ECONOMIC POLICIES FOR STABILIZATION

Economic Policy Fiscal Policy Monetary Policy

MONETARY POLICY OVERVIEW

The monetary authority, typically the central bank of a country, is vested with the responsibility of conducting monetary policy. Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.

OBJECTIVES OF MONETARY POLICY:

• Maximum feasible output.• High rate of growth.• Fuller employment.• Price stability.• Greater equality in the distribution of income

and wealth.• Healthy balance in balance of payments(BOP).

INSTRUMENTS / TOOLS OF MONETARY POLICY:

• Cash Reserve Ratio (CRR)• Statutory Liquidity Ratio (SLR)• Refinance facilities• Liquidity Adjustment Facility (LAF)• Marginal Standing Facility (MSF)• Open Market Operations (OMOs)• Bank Rate

1. 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

2. STATUTORY LIQUIDITY RATIO (SLR)

• Statutory Liquidity Requirement ( SLR).• 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.

21 %

3. REFINANCE FACILITIES

• Sector-specific refinance facilities aim at achieving sector specific objectives through provision of liquidity at a cost linked to the policy repo rate.

• The Reserve Bank has, however, been progressively de-emphasising sector specific policies as they interfere with the transmission mechanism.

4. LIQUIDITY ADJUSTMENT FACILITY (LAF)

• Consists of overnight and term repo/reverse repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected in the LAF through term-repos.

6. MARGINAL STANDING FACILITY (MSF)

• A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their SLR portfolio up to a limit (currently two per cent of their net demand and time liabilities deposits) at a penal rate of interest (currently 100 basis points above the repo rate).

• This provides a safety valve against unanticipated liquidity shocks to the banking system. MSF rate and reverse repo rate determine the corridor for the daily movement in short term money market interest rates.

7. OPEN MARKET OPERATIONS (OMOS)

• 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, Reduces the capital available for lending and interest rate goes up.

• RBI buys securities: Increases the money supply available with banks, so interest rate moves down and business activities like new investments, capacity expansion goes up.

8. BANK RATE- Bank rate is the minimum rate at which the central bank provides loans to the commercial banks.- It is also called the discount rate.

ORIts 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 : 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. Bankers lending rates get adjusted to deposit rates. Rise in deposit rate

turns borrowers into depositors. 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.

6. 75%

OTHER METHODS1. REPO - RATE

6.25 %

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.`

OTHER METHODS2. REVERSE REPO - RATE

5.75 %

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 repo-rate means absorption of liquidity.

MONETARY POLICY TO CONTROL RECESSION PROBLEM: RECESSION MEASURES

• Central Banks buy securities through OMO.• Lowers Bank Rate.• Reduces CRR

• Money Supply Increases• Interest Rate Falls• Investment Increases

• Aggregate Demand Increases

• Aggregate Output increases

MONETARY POLICY TO CONTROL INFLATION PROBLEM

• Central Banks sells securities through OMO.• Increases Bank Rate.• Raises CRR

• Money Supply Decreases• Interest Rate Rises• Investment Declines

• Aggregate Demand Declines

• Price Level Falls

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