RBI ( Reserve Bank of India)
It was set up in 1935 by virtue of the RBI act, 1934. It was set up as a private bank but was nationalized on January 1, 1949.
The Banking Regulation Act was also passed in 1949. RBI acts as a government bank for both central and state governments. RBI acts as an agent of the government in respect of India’s membership of the IMF and manages the borrowing programme of the government.
Performs several developmental and promotional programme of the government and implements India’s monetary policies.
However in the union budget 2007-2008 the government has proposed the setting up of an independent, Debt Management Office (DMO) in line with the practice in other countries so that hereafter the government’s borrowings programme will be managed by DMO, not by RBI.
RBI has promoted several apex organizations in India (SBI, UTI, IDBI, NABARD, NHB). RBI is the sole authority to issue currency in the country.
It issues two rupee notes and above while One Rupee & subsidiary coins are issued by the Ministry of Finance but distributed by the RBI on behalf of the government.
It issues currency on the basis of the Minimum Reserve System (MRS). To maintain the adequate supply of money in the economy the RBI prints the money as per the Minimum Reserve System.
Under the Minimum Reserve System, the RBI has to keep a minimum reserve of Rs 200 crore comprising of gold coin, gold bullion, and foreign securities/currencies.
Out of the total Rs 200 crores, Rs 115 crore worth gold either in the form of gold coins or gold bullion and 85 crores in the form of foreign securities/ currencies.
Against the backing, RBI can issue an unlimited amount of Currency in the country, as it issues according to the projections of GDP.
The currency we are using is Token Currency which has zero internal value and the face value is much higher as it is promised by the government and is also known as Fiat currency.
It is the Governments Bank and it is the Bankers Bank. It is the guardian of the money market. ( Money market comprises of all financial institutions that deal with short term funds whereas capital markets are in Long term funds).
The Indian money market can be divided into Organized and Unorganized. The unorganized money market consists of indigenous money lenders. The organized money market is Banks.
Banks are divided into Commercial Banks, Regional Banks, and State, Co-operative Banks.
RBI is the sole custodian of foreign exchange reserves of the country. It manages these reserves on a day-to-day basis. That is no bank in the country can do the transaction in foreign currency without having a license from the RBI.
At the end of every day, the dealer has to report to the RBI, up to 90-92 the exchange rate was determined by RBI, now it is not. It is the controller of credit given by the bank to various sectors of the economy.
It controls credits by adopting the following two sets of measures, one is Quantitative measure and another one is Qualitative measures also selective measures.
Quantitative measures are measures aimed at controlling and regulating the overall quantum or volume of credit (i.e Loans) given by commercial banks to various sectors of the economy while Qualitative measures are those aimed at controlling not only the Quantum but also the purpose for which the loans are given by banks to various sectors of the economy.
Eg: Rice Production, Milk Production.
Quantitative measures of Rbi
Bank Rate(BR), Cash Reserve Ration also Variable Reserve Ration (CRR), Open Market Operation (OMO), Statutory Liquidity Ration (SLR)
It is the rate of interest at which the central bank of a country such as RBI provides refinance or discounting facilities to commercial banks, State governments, Central Government, NBFC, etc.
In other words, it is the rate of interest at which RBI provides financial accommodation to commercial banks.
The rate of interest is by March 2019 is 6.5% and now stands at 6.25%. When this rate is raised it is called Dear Money Policy. When this rate is lowered it is called the Cheap Money Policy.
This rate may generally be raised during a period of inflation. It may be lowered during the period of Recession (Dear is costly).
Cash Reserve Ratio(CRR)
It is the ratio of the total deposits of a bank which it needs to keep with the central bank if a country at any given point in time.
This ratio is at present is 5%. Generally, it may be raised in the time of inflation and lowered in the time of recession.
When it is raised it is called a policy of Credit Squeeze or Tight Money Policy and when it is lowered it is called Liberal Credit Policy.
CRR is announced twice a year, once is the end of April and by the end of October.
Busy Season -> Harvesting-> October to April-> Raise CRR
Lean Season->Sowing->May to October->Lower CRR
3. Statutory Liquidity Rate(SLR)
SLR is the ratio of the total deposits of the bank in India which it has to maintain in the form of liquid funds i.e in the form of Cash in Hand and Government securities.
The present SLR is 21.50% that includes Liabilities-Deposits; Assets-Loans given by banks. “Government securities are called ‘Guilt Edged Security: Least Risk’ “. Even the bonds of Tata and Reliance etc are Guilt Edges Securities.
Short-term Securities are called as T-Bills (Max of 1 year). Long Term securities are called Dated Bills(Greater than 1 year).
According to the Banking Regulation Act 1949, CRR to be 3% to 15% and SLR to be 25% to 40%.
4. Open Market Operations (OMO)
The open market operation is conducted by the central bank of any country under which from time to time it may buy government securities from commercial banks or sell securities to commercial banks.
Generally, it may sell securities during a period of Inflation and it may buy securities during a period of Recession
Repo means Repurchase options/ Auction exercised by the RBI in India since 1992 for the first time, to even out short-term fluctuations in the money market.
Hence, Repo is essentially a short-term operation conducted to manage the supply and demand for liquidity in a short period under the RBI’s liquidity Adjustment Facility programme.
Repo means that Reserve Bank repurchases some government securities for a very short period(7-day repo, 14-day repo, etc) from commercial banks and thus injects liquidity into the system.
In other words, it is lending to commercial banks and this repo rate at present is 4.40%.
RBI sells short-dated securities and borrows money from Commercial Banks so as to Absorb Liquidity which is excess in the market for a short period. The Reverse repo rate at present is 6%.
Qualitative measures of rbi
- Rationing of Credit
- Regulation of Credit for consumption Purposes.
- Variation of Margin Requirements
- Moral Suasion
- Direct Action
1. Rationing of Credit
Under this method, the RBI directs banks to give credit in accordance with the importance of various sectors in the economy from time to time.
For eg. It has directed banks that they must give 40% of their total credit at any time to the priority sector as identified by the RBI which consists of sectors like Agriculture, Small Scale, Road and Water Transport, Retail Trade, Low-cost Housing, Poverty alleviation, Employment Generation, etc.
18% of total credit has to go to Agriculture etc.
2. Regulation of Credit for Consumption Purpose
Under the measure of RBI which direct banks to restrict credit for the purchase of consumer durables like TV, Fridge, etc, and instead give more credit for productive purpose as too much of consumer credit fuel inflation.
3. Variation of Margin Requirement
Under this method, the RBI directs banks from time to time to vary (raise or lower) margins on loans given by banks particularly for sensitive and essential commodities in order to prevent speculation, hoarding, black marketing, etc.
RBI has often done it for food grains and other essential commodities by directing banks to raise margins. Eg: Wheat Trader, Cement Manufacturers.
4. Moral Suasion and Direct Action
Under this method, RBI urges commercial banks to help in controlling the supply of money in the economy.
This post is written on the topic ‘RBI or Reserve Bank of India’ and its operations such as Quantitative and Qualitative measures etc for Upsc, Tnpsc and other state service exams.