RESERVE BANK OF INDIA ( RBI,SBI PO & IBOS PO, Clerk Exam Oriented)
RESERVE BANK OF INDIA
Several attempts were made from time to time to set up a Central Bank in India prior to 1934. But unfortunately these attempts failed to bear any fruit. In 1921, the Government of India established the Imperial Bank of India to serve as the Central Bank of the country. But the Imperial Bank did not achieve any appreciable success in its functioning as the Central Bank of the country. In 1925, the Hilton Young Commission was asked by the Government to express its views on the subject. The commission made out a forceful case for the establishment of a brand new Central Bank in the country. According to the Commission, it was not desirable to keep the control of currency and credit in the hands of two separate agencies. The Government of India controlled currency while the Imperial Bank regulated credit prior to the establishment of the Reserve Bank of India in April 1st, 1935. The Hilton Young Commission did not consider this double control on currency and credit as a desirable feature of the Indian monetary system. It
was on this account that the Commission recommended the transfer of the control of currency and credit to a new Central Bank to be set up in the country. It was on this account that the Commission recommended the establishment of the Reserve Bank of India as the Central Bank of the country. The Government of India while accepting the recommendations of the Commission brought forward a Bill before the Central Legislature. But the Bill could not be passed on account of differences amongst the members of the legislature. The Government of India, therefore, postponed the idea of a new Central Bank for sometime. In 1929, the Central Banking Enquiry Committee again made a forceful plea for the establishment of the Reserve Bank. Consequently, the Reserve Bank of India Act was passed in 1934, and the Reserve Bank started functioning from 1st April, 1935.
The Reserve Bank of India is the king pin of the Indian money market. It issues notes, buys and sells government securities, regulates the volume, direction and cost of credit, manages foreign exchange and acts as banker to the government and banking institutions.
The Reserve Bank is playing an active role in the development activities by helping the establishment and working of specialized institutions, providing term finance to agriculture, industry, housing and foreign trade. In spite of many criticisms, it has successfully controlled commercial banks in India and has helped in evolving a strong banking system. A study of the Reserve Bank of India will be useful, not only for the examination, but also for understanding the working of the supreme monetary and banking authority in the country.
5.1 Capital
Originally, the Reserve Bank was constituted as a shareholders bank, based on the model of leading foreign central banks of those days. The bank�s fully paid-up share capital was Rs. 5 crores divided into shares of Rs. 100 each. Of this, Rs. 4,97,80,000 were subscribed by the private shareholders and Rs. 2,20,000 were subscribed by the Central Government for disposal of 2,200 shares at part to the Directors of the Bank (including members of the Local Boards) seeking the minimum share qualification. The share capital of the bank has remained unchanged until today. The Reserve Bank also had a Reserve Fund of Rs. 150 crores in 1982. It was nationalised in January 1949 and since then it is functioning as the State-owned bank and acting as the premier institution in India�s banking structure.
Every commercial bank has to keep certain minimum cash reserves with RBI. Consequent upon amendment to sub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate, [Before the enactment of this amendment, in terms of Section 42(1) of the RBI Act, the Reserve Bank could prescribe CRR for scheduled banks between 5% and 20% of total of their demand and time liabilities]. RBI uses this tool to increase or decrease the reserve requirement depending on whether it wants to effect a decrease or an increase in the money supply. An increase in Cash Reserve Ratio (CRR) will make it mandatory on the part of the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This will reduce the size of their deposits and they will lend less. This will in turn decrease the money supply. The current rate is 4.00%.. -25 basis points cut in Cash Reserve Ratio(CRR) on 17 September 2012, It will release Rs 17,000 crore into the system/Market. The RBI lowered the CRR by 25 basis points to 4.25% on 30 October 2012, a move it said would inject about 175 billion rupees into the banking system in order to pre-empt potentially tightening liquidity. The latest CRR is 4%
5.2 Organization
As per the Reserve Bank of India Act, the organisational structure of the Reserve Bank comprises:
(A) Central Board
(B) Local Boards
5.2.1. (A) Central Board
The Central Board of Directors is the leading governing body of the bank. It is entrusted with the responsibility of general superintendence and direction of the affairs and business of the Reserve Bank.
The Central Board of Directors consists of 20 members as follows:
1. One Governor and four Deputy Governors: They are appointed by the Government of India for a period of five years. Their salaries, allowances and other perquisites are determined by the Central Board of Directors in consultation with the Government of India.
2. Four Directors Nominated from the Local Boards: There are four local Boards of Directors in addition to the Central Board of Directors. They are located at Mumbai, Kolkata, Chennai and New Delhi. The Government of India nominates one member each from these local Boards. The tenure of these directors is also for a period of five years.
3. Ten other Directors: The ten other directors of the Central Board of Directors are also nominated by the Government of India. Their tenure is four years.
4. One Government Official: The Government of India also appoints one Government Official to attend the meetings of the Central Board of Directors. This official can continue for any number of years with the consent of the Government, but he does not enjoy the right to vote in the meetings of the Central Board. The Central Board of Directors exercises all the powers of the bank. The Central Board should meet at least six times in each year and at least once in three months. Usually, the Central Board keeps a meeting in March every year at New Delhi so as to discuss the budget with the Finance Minister after its presentation in parliament. Similarly, it keeps a meeting in August at Mumbai in order to pass the Bank�s annual report and accounts.
For all practical purposes, however, the committee set-up by the Central Board looks after the bank�s current affairs. The committee consists of the Governor, the Deputy Governors and such other Directors as may be present. The committee meets once a week. Two sub-committees have also been appointed to assist the committee of the Central Board. Of these, one is called the Building Sub-Committee which deals with matters relating to building projects. The other is called the Staff Sub-Committee which is concerned with staff and other matters.
The Governor is the highest official of the Reserve Bank. There are four Deputy Governors to help and advise him. Each Deputy Governor is allotted a particular job to do, and he is fully held responsible for the proper execution of the job.
5.2.2. (B) Local Boards
The Reserve Bank of India is divided into four regions : the Western, the Eastern, the Northern and the Southern regions. For each of these regions, there is a Local Board, with headquarters in Mumbai, Kolkata, New Delhi and Chennai.
Each Local Board consists of five members appointed by the Central Government for four years. They represent territorial and economic interests and the interests of co-operative and indigenous banks in their respective areas. In each Local Board, a chairman is elected from amongst their members. Managers in-charge of the Reserve Bank�s offices in Mumbai, Kolkata, Chennai and New Delhi are ex-officio Secretaries of the respective Local Boards at these places.
The Local Boards carry out the functions of advising the Central Board of Directors on such matters of local importance as may be generally or specifically referred to them or performing such duties which may be assigned to them. Generally, a Local Board deals with the management of regional commercial transactions.
5.3 Offices of the Bank
The headquarters of the Reserve Bank is located at Mumbai. But for the efficient performance of its functions, the Bank has opened local offices at New Delhi, Kolkata, Chennai, Bangalore, Kanpur, Ahmedabad, Hyderabad, Patna and Nagpur. The Bank can open its office at any other place with the prior consent of the Central Government. The State Bank of India acts as the agent of the Reserve Bank at those places where the latter does not maintain its own offices. The regional offices of the exchange control department of the Reserve Bank are located at New Delhi, Kanpur, Kolkata and Chennai.
The Reserve Bank has three training establishments viz.,
(a) Bankers Training College, Mumbai,
(b) College of Agricultural Banking, Pune and
(c) Reserve Bank Staff College, Chennai.
5.4 Departments of the Reserve Bank
To carry out its functions/operations smoothly and efficiently, the Reserve Bank of India has the following departments:
1. Issue Department.
2. Banking Department.
3. Department of Banking Development.
4. Department of Banking Operations.
5. Agricultural Credit Department.
6. Exchange Control Department.
7. Industrial Finance Department.
8. Non-Banking Companies Department.
9. Legal Department.
10. Department of Research and Statistics.
11. Department of Government and Bank Accounts.
12. Department of Currency Management.
13. Department of Expenditure of Budgetary Control.
14. Rural Planning and Credit Department.
15. Credit Planning Cell.
16. Department of Economic Analysis and Policy.
17. Inspection Department.
18. Department of Administration and Personnel.
19. Premises Department.
20. Management Services Department.
21. Reserve Bank of India Service Board.
22. Central Records and Documentation Centre.
23. Secretary�s Department.
24. Training Establishments.
There are also Zonal Training Centres situated in Mumbai, Kolkata, Chennai and New Delhi for conducting induction, functional and short-term preparatory courses for the clerical staff.
5.5. Functions of the Reserve Bank
According to the preamble of the Reserve Bank of India Act, the main functions of the bank is �to regulate the issue of bank notes and the 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.� The various functions performed by the RBI can be conveniently classified in three parts as follows:
5.5.1. A. Traditional Central Banking Functions
The Reserve Bank of India discharges all those functions which are performed by a central bank. Among these the more important functions are as follows:
1. Monopoly of Note Issue: Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denomination. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank 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, originally, the assets of the Issue Department were to consist of not less than two fifths of gold coin, gold bullion or sterling securities provided the amount of gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might be held in rupee coins, Government of India rupee securities, eligible bills of exchange and promissory notes payable in India. Due to the exigencies of the second World War and the post-war period, these provisions were considerably modified 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.
2. Banker to the Government: The Reserve Bank of India serves as a banker to the Central Government and the State Governments. It is its obligatory function as a central bank. It provides a full range of banking services to these Governments, such as:
(a) Maintaining and operating of deposit accounts of the Central and State Government.
(b) Receipts and collection of payments to the Central and State Government.
(c) Making payments on behalf of the Central and State Government.
(d) Transfer of funds and remittance facilities of the Central and State Governments.
(e) Managing the public debt and issue of new loans and Treasury Bills of the Central Government.
(f) Providing ways and means advances to the Central and State governments to bridge the interval between expenditure and flow of receipts of revenue. Such advances are to be repaid by the government within three months from the date of borrowed.
(g) Advising the Central/State governments on financial matters, such as the quantum, timing and terms of issue of new loans. For ensuring the success of government loan operations, the RBI plays an active role in the gilt-edged market.
(h) The bank also tenders advice to the government on policies concerning banking and financial issues, planning as resource mobilization. The Government of India consults the Reserve Bank on certain aspects of formulation of the country�s Five Year Plans, such as financing pattern, mobilisation of resources, institutional arrangements regarding banking and credit matters. The government also seeks the bank�s advice on policies regarding international finance, foreign trade and foreign exchange of the country.
The Reserve Bank has constituted a sound research and statistical organisation to carry out its advisory functions effectively. The Reserve Bank represents the Government of India as member of the International Monetary Fund and World Bank.
3. Banker�s Bank: The Reserve Bank has the right of controlling the activities of the banks in the country. All the commercial banks, co-operative banks and foreign banks in the country have to open accounts with the bank and are required to keep a certain portion of their deposits as reserves with the Reserve Bank. Cash reserves are not to be less than 3% of the demand and time liabilities of the bank. The Reserve Bank has the power to increase this ratio upto 15%. Through this, Reserve Bank is able to regulate and control the credit created by the commercial banks. In addition to this, the scheduled banks are also required to submit to the Reserve Bank a number of returns every Friday.
4. Lender of the Last Resort: The scheduled banks can borrow from the Reserve Bank on the basis of eligible securities. They can also get the bills of exchange rediscounted. The Reserve Bank acts as the clearing house of all the banks. It adjusts the debits and credits of various banks by merely passing the book entries. The Bank also provides free remittance facilities to the banks. Thus, it acts as the banker�s bank. The Reserve Bank also acts as the lender of the last resort and an emergency bank. It grants short-term loans to scheduled commercial banks against eligible securities in time of need. Similarly, it rediscounts the eligible bills of exchange brought by the commercial banks.
5. National Clearing House: The Reserve Bank acts as the national clearing house and helps the member banks to settle their mutual indebtedness without physically transferring cash from place to place. The Reserve Bank is managing many clearing houses in the country with the help of which cheques worth crores of rupees are cleared every year. The ultimate balances are settled by the banks throught cheques on the Reserve Bank.
6. Credit Control: The Reserve Bank of India is the controller of credit, i.e., it has the power to influence the volume of credit created by bank in India. It can do so through changing the bank rate or through open market operation. According to the Banking Regulation Act of 1949, the Reserve Bank of India 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 Reserve Bank.
The Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get a license from the Reserve Bank of India to do banking business within India. The license can be cancelled by the Reserve Bank if certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the bank to call for information is also intended to give it effective control of the credit system. The Reserve Bank 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:
(a) It holds the cash reserves of all the scheduled bank.
(b) It controls the credit operation of banks through quantitative and qualitative controls.
(c) It controls the banking system through the system of licensing, inspection and calling for information.
(d) It acts as the lender of the last resort by providing rediscount facilities to scheduled banks.
7. Custodian of Foreign Exchange Reserves: The Reserve Bank has the responsibility of maintaining the external value of the rupee. There is centralisation of the entire foreign exchange reserves of the country with the Reserve Bank to avoid fluctuations in the exchange rate.
The RBI has the authority to enter into foreign exchange transactions both on its own account and on behalf of government. The bank is also empowered to buy and sell foreign exchange from and to scheduled banks in amounts of not less than the equivalent of Rs. 1 lakh.
As the custodian of the nation�s foreign exchange reserves, the RBI also administers exchange controls of the country, and enforces the provision of the Foreign Exchange Regulation Act, 1973.
8. Collection of Data and Publications: The Reserve Bank of India collects statistical data and economic information through its research departments. It compiles data on the working of commercial and co-operative banks, on balance of payments, company and government finances, security markets, price tends, and credit measures. The bank is the principal source of certain financial statistics and banking data. It publishes a monthly bulletin, with weekly statistical supplements and annual reports which present a good deal of periodical reviews and comments pertaining to general economic, financial, and banking developments, including the bank�s monetary policies and measures, adopted for the qualitative and quantitative monetary management.
The followings are the regular publications of the Bank:
(a) Reserve Bank of India Bulletin (monthly) and its weekly statistical supplements.
(b) Report of the Central Board of Directors (Annual).
(c) Report on Trend and progress of Banking in India (Annual).
(d) Report on Currency and Finance (Annual).
(e) Review of the Co-operative Movement in India (Published once in two years).
(f) Banking Statistics (Basic Statistical Returns).
(g) Statistical Tables Relating to Banks in India.
(h) Statistical Statements Relating to the Co-operative Movement in India.
(i) Adboc Export Committee�s Reports and Monographs.
(j) Results of surveys conducted by the bank, such as the survey of India, Foreign Liabilities and Assets, All-India Debt and Investment Survey 1971-72, etc.
(k) History of the Reserve Bank of India (1935-51).
(l) Functions and Working of the Reserve Bank of India.
(m) Banking and Monetary Statistics of India and its Supplements.
(n) Reserve Bank of India Occasional Paper (Bi-annual).
5.5.2 B. Promotional Functions
The scope of the functions performed by the Reserve Bank has further widened after the introduction of economic planning in the country. The bank now performs a variety of promotional and developmental functions. The bank�s responsibilities include, apart from monetary functions, the institutionalization of savings through the promotion of banking habit and the expansion of banking system territorially and functionally. The RBI has to provide facilities for agricultural and industrial finance.
(a) Reserve Bank of India and Agricultural Credit: The bank�s responsibility in this field has been occasioned by the predominantly agricultural basis of the Indian economy and the urgent need to expand and coordinate the credit facilities available to the rural sector. The RBI has set up a separate agricultural department to maintain an expert staff to study all questions of agricultural credit and coordinate the operation of the bank with other agencies providing agricultural finance. The RBI does not provide finance directly to the agriculturists, but through agencies like cooperative banks, land development banks, commercial bank etc. After the establishment of the National Bank for Agriculture and Rural Development (NABARD) on July 12, 1982, all the functions of the RBI relating to rural credit have been transferred to this new agency.
(b) Reserve Bank of India and Industrial Finance: The Reserve Bank of India has taken initiative in setting up statutory corporations at the all-India and regional levels to function as specialised institutions for term lending. The first of these institutions was the Industrial Finance Corporation of India set up in 1948. Followed by the State Finance Corporations in each of the state from 1953 onwards. The RBI has
also helped in the establishment of other financial institutions such as the Industrial Development Bank of India, the Industrial Reconstruction Bank of India, Small Industries Development Bank of India, Unit Trust of India, etc. For the promotion of foreign trade the Reserve Bank has established the Export and Import Bank of India. Similarly, for the development of the housing industry the RBI has established
the National Housing Bank.
Furthermore, the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the Reserve Bank, operates credit guarantee schemes with the objective of providing cover against defaults in repayment of loans made to small borrowers, including small-scale industrial borrowers, in order that credit flow to them is enlarged.
C. Supervisory Functions
Over the years, extensive powers have been conferred on the Reserve Bank of India for supervision and control of banking institutions. The Banking Regulation Act 1949, provides wide powers to the Reserve Bank to regulate and control the activities of Banks to safeguard the interests of depositors. Amendment Act passed in 1963, and effective from February 1, 1964, provided further powers to the Reserve Bank, particularly to restrain control exercised by particular groups of persons over the affairs of bank and to restrict loans and advances as well as guarantees given by the bank to or on behalf of any one company, firm, association of persons, and gave greater control to the Reserve Bank over the appointment and removal of bank�s executive personnel.
The various aspects of the supervisory/regulatory functions exercised by the Reserve Bank may be briefly mentioned as under:
1. Licensing of Banks: There is a statutory provision that a company starting banking business in India has first to obtain a licence from the Reserve Bank. If the Reserve Bank is dissatisfied on account of the defective features of the proposed company, it can refuse to grant the licence. The bank is also empowered to cancel the license of a bank when it will cease to carry on banking business in India.
2. Approval of Capital, Reserves and Liquid Assets of Bank: The Reserve Bank examines whether the minimum requirements of capital, reserve and liquid assets are fulfilled by the banks and approves them.
3. Branch Licensing Policy: The Reserve Bank exercises its control over expansion of branches by the banks through its branch licensing policy. n September 1978, the RBI formulated a comprehensive branch licensing policy with a view to accelerate the pace of expansion of bank offices in the rural areas. This
was meant to correct regional imbalance of the banking coverage in the country.
4. Inspection of Banks: The Reserve Bank is empowered to conduct inspection of banks. The inspection may relate to various aspects such as the bank�s organisational structure, branch expansion, mobilisation of deposits, investments, credit portfolio management, credit appraisal profit planning, manpower planning, as well as assessment of the performance of banks in developmental areas such as deployment of credit to the priority sectors, etc. The bank may conduct investigation whenever there are complain about major irregularities or frauds by certain banks. The inspections are basically meant to improve the working of the banks and safeguard the interests of depositors and thereby develop a sound banking system in the country.
5. Control Over Management: The Reserve Bank also looks into the management side of the banks. The appointments, re-appointment or termination of appointment of the chairman and chief executive officer of a private sector bank is to be approved by the Reserve Bank. The bank�s approval is also required for the remuneration, perquisites and post retirement benefits given by a bank to its chairman and chief
executive officer.
The Boards of the public sector banks are to be constituted by the Central Government in consultation with the Reserve Bank.
6. Control Over Methods: The Reserve Bank exercises strict control over the methods of operation of the banks to ensure that no improver investment and injudicious advances made by them.
7. Audit: Banks are required to get their balance sheets and profits and loss accounts duly audited by the auditors approved by the Reserve Bank. In the case of the SBI, the auditors are appointed by the Reserve Bank.
8. Credit Information Service: The Reserve Bank is empowered to collect information about credit facilities granted by individual bank and supply the relevant information in a consolidated manner to the bank and other financial institutions seeking such information.
9. Control Over Amalgamation and Liquidation: The banks have to obtain the sanction of the Reserve Bank for any voluntary amalgamation. The Reserve Bank in consultation with the central government can also suggest compulsory reconstruction or amalgamation of a bank. It also supervises banks in liquidation. The liquidation have to submit to the Reserve Bank returns showing their positions. The Reserve Bank keeps a watch on the progress of liquidation proceedings and the expenses of liquidation.
10. Deposit Insurance: To protect the interest of depositors, banks are required to insure their deposits with the Deposit Insurance Corporation. The Reserve Bank of India has promoted such a corporation in 1962, which has been renamed in 1978 as the Deposit Insurance and Credit Guarantee Corporation.
11. Training and Banking Education: The RBI has played an active role in making institutional arrangement for providing training and banking education to the bank personnel, with a view to improve their efficiency.
In brief, the Reserve Bank of India is performing both traditional central banking functions and developmental functions for the steady growth of the Indian economy.
5.6 CREDIT CONTROL
Commercial banks grant loans and advances to merchants and manufacturers. They create credit or bank deposits in the process of granting loans. In modern times, bank deposits re regarded as money. They are as good as cash. They can be used for the purchase of goods or in payment of debts. But excessive creation of credit by commercial bank leads to inflation. Inflation has serious social and economic consequence. For instance, people with fixed incomes, workers and salaried persons suffer greatly on account of rising prices. So, a Central Bank must control the credit created by commercial banks in order to maintain the value of money at a stable level. Similarly, excessive contraction of credit leads to deflation. Deflation leads to unemployment and suffering among workers. Under such circumstances the central bank should encourage credit creation. Hence it is essential that the creation of credit is kept within reasonable limits by the central bank. The central bank has to control and regulate the availability of credit, the cost of cost and the use of credit flow in the economy. Credit control is an important function of the central bank. The central bank is in a position to control credit in its capacity as the bank of issue and the custodian of the cash reserves of the commercial bank.
5.7 Weapons of Credit Control
Various weapons or methods or instruments are available to the Reserve Bank of India to control credit creation or contraction by commercial banks. These methods are divided into two categories:
(A) Quantitative or general methods or instruments.
(B) Qualitative or selective methods or instruments.
5.7.1 A. Quantitative or General Methods
These are traditional methods of credit control. These methods have only a quantitative effect on the supply of credit. They are used for either increasing or reducing the volume of credit. They cannot control credit for its quality. The important quantitative methods or instruments of credit control are as follows:
1. Bank Rate: The bank rate is the rate of interest at which the Reserve Bank of India makes advances to the commercial banks against approved securities or rediscounts the eligible bills of exchange and other commercial papers. The Reserve Bank of India Act, 1934 defines the bank rate as �the standard rate at which it (the Bank) is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the Act.� The change in the bank rate leads to changes in the market rates of interest i.e., short-term as well as long-term interest rates. If bank rate is raised rates of interest in the money market including the lending rates of commercial banks also rise. So the cost of credit rises. The demand for bank loans generally falls and so the demand for goods will also fall. Thus inflation can be checked or controlled by raising bank rate. Similarly, deflation (i.e., state of falling prices) can be checked by lowering the bank rate. So the bank rate acts as a �pace-setter� in the money market. The Reserve Bank of India has changed the bank rate from time to time to meet the changing conditions of the economy. The bank rate was raised for the first time, from 3 per cent to 3� per cent, in November 1951, with a view to checking an undue expansion of bank credit. The bank rate was further raised to 4 per cent on May 16, 1959. In February 1965, the bank rate was further raised to 6 per cent. In March 1968, however, the bank rate was reduced to 5 per cent with a view to stimulating recovery from the industrial recession of 1967. In January 1971, the bank rate was, however raised to 6 percent as an anti-inflationary device. Subsequently, the bank rates was raised to 10 per cent in July 1981 and to 12 per cent in October 1991. The bank rate was, however, reduced to 10 per cent in June 1997. The increases in the bank rate were adopted to reduce bank credit and control inflationary pressures. The Reserve Bank of India has made only a modest use of this instrument.
2. Open Market Operations: Open market operations consist of buying and selling of government securities by the Reserve Bank. Open market operations have a direct effect on the availability and cost of credit. When the central bank purchases securities from the banks, it increases their cash reserve position and hence, their credit creation capacity. On the other hand, when the central bank sells securities to the banks, it reduces their cash reserves and the credit creation capacity. The Reserve Bank of India did not rely much on open market operations to control credit. It was not used for influencing the availability of credit. Due to under-developed security market, the open market operations of the Reserve Bank are restricted to Government securities. These operations have also been used as a tool of public debt management. They assist the Indian government to raise borrowings. During 1951-52 the sale of securities was more. But in 1961 the purchases were more. This proves that it is not used to credit restraint only.
In India, the open market operations of the Reserve Bank has not been so effective because of the following reasons:
(a) Open market operations are restricted to government securities.
(b) Gift-edged market is narrow.
(c) Most of the open market operations are in the nature of �switch operations� (i.e., purchasing one loan against the other).
3. Cash-Reserve Requirement (CRR): The central bank of a country can change the cash-reserve requirement of the commercial banks in order to affect their credit creation capacity. An increase in the cash-reserve ratio reduces the excess reserves of the banks and a decrease in the cash-reserve ratio increases their excess reserves. The variability in cash-reserve ratios directly affects the availability and cost of credit. Originally, the Reserve Bank of India Act, 1934 required the commercial banks to keep with the Reserve Bank a minimum cash reserve of 5% of their demand liabilities and 2% of time liabilities. The amendment of the Act in 1962 removes the distinction between demand and time deposits and authorises the Reserve Bank to change cash reserve ratio between 3 and 15%. The method of variable cash-reserve ratio is the most direct, immediate and the most effective method to credit control. The Reserve Bank of India used the technique of variable cash reserve ratio for the first time in June, 1973. It raised the cash reserve ratio from 3 to 5% in June 1973. The cash-reserve ratio was further raised to 7% in September 1973. Since then, the Reserve Bank has raised or reduced the cash reserve ratio many times.
Recently, the cash reserve ratio was raised to 11% effective from July 30, 1988 and to 15% with effect from July 1989. The present cash-reserve ratio is 4%. This method is mainly intended to control and stabilize the prices of commodities, stocks and shares and prevent speculation and hoarding. The Reserve Bank used the CRR as a drastic measure to curb credit expansion.
4. Statutory Liquidity Ratio (SLR): Under the Banking Regulation Act, 1949, banks are required to maintain liquid assets in the form of cash, gold and unencumbered approved securities equal to not less than 25% of their total demand and time deposits. This minimum statutory liquidity ratio is in addition to the statutory cash-reserve ratio. Maintenance of adequate liquid assets is a basic principle of sound
banking. The Reserve Bank has been empowered to change the minimum liquidity ratio. Accordingly, the liquidity ratio was raised from 25% to 30% in November 1972, to 32% in 1973, to 35% in October 1981, to 38% in January 1988, and to 38.5% in September 1990. There are two reasons for raising the statutory liquidity requirements or ratio by the Reserve Bank of India.
They are:
(a) It reduces commercial bank�s capacity to create credit and thus helps to check inflationary pressures.
(b) It makes larger resources available to the government.
5.7.2 B. Qualitative Selective Methods
Selective credit controls are qualitative credit control measures undertaken by the central ank to divert the flow of credit from speculative and unproductive activities to productive and more urgent activities. Selective credit controls are better than the quantitative credit controls in many respects. They encourage credit to essential industries and at the same time discourage credit to non-essential industries. Similarly, they encourage productive activities and at the same time discourage speculative activities. In a developing economy like India, qualitative credit controls are mainly intended for the following purposes:
(a) To prevent anti-social use of credit like speculative hoarding of stock.
(b) To divert credit from unproductive activities to productive activities.
(c) To divert credit from non-essential to essential industries.
(d) To encourage credit for certain sectors like priority sector.
5.8 METHODS OF SELECTIVE CREDIT CONTROLS ADOPTED BY RESERVE BANK
The Banking Regulation Act, 1949, granted wide powers to the Reserve Bank of India to adopt selective methods of credit control. The Act empowered the Reserve Bank to issue directions to the banks regarding their advances. These directives may relate to the following:
(a) The purpose for which advances may or may not be made.
(b) The margins to be maintained on secured loans.
(c) The maximum amount of advances to any firm or company, and
(d) The rate of interest to be charged.
The Reserve Bank of India has undertaken the following selective credit controls to check speculative and inflationary pressures and extend credit to productive activities.
1. Variation of Margin Requirements: The �margin� is the difference between the �loan value� and the �market value� of securities offered by borrowers against secured loans. By fixing the margin requirements on secured loans, the central bank does not permit the commercial banks to lend to their customers the full value of the securities offered by them, but only a part of their market value. For example, if the central bank prescribes the margin requirements at 40%, that means that the commercial banks can lend only 60% of the market value of the securities of the customers. If the margin is raised to 50%; the banks can lend only 50% of the market value of the securities to the customers. Thus, by changing the margin requirements, the amount of loan made by the banks can be changed in accordance with the policy of the central government. If the central bank raises the margin requirements, the amount of bank advances against securities will be automatically reduced. As a result the bank credit will be diverted from the field of speculative activities to the other fields of productive investments. If, on the contrary, the central bank lowers down the margin requirements, the amount of bank advances to the customers against securities can be automatically increased. Thus by altering margin requirements
from time to time, the central bank keeps on changing the volume of bank loans to the borrowers. This method is an effective way of checking the flow of credit to less productive and less desirable uses in the economy
The Reserve Bank of India has been increasingly using this method in recent years to control bank advances against essential commodities like food-grains, oil-seeds, sugar etc. The main object is to prevent speculative dealings in such commodities. In 1957, the margin against loans on food-grains was increased to 40% and again to 60% in 1970. In March, 1977, the minimum margin was fixed at 85% on advances against stocks of groundnut oil, castor oil etc. This was done to check undue rise in the price of oil-seeds and vanaspathi. The margin requirements were also increased in the case of pulses, sugar, vanaspathi and oil-seeds in subsequent years. During 1984-85 the maximum margins on bank advances against stocks of food-grains was 45% in the case of mills and 60% in the case of others. Reserve Bank has been using this method flexibly according to the needs of the situation. The margin requirements
was increased when the prices are going up and decreased when the credit flow has to be increased.
2. Credit Authorization Scheme (CAS): Credit Authorization Scheme is a type of selective credit control introduced by the Reserve Bank in November, 1965. Under the scheme, the commercial banks had to obtain Reserve Bank�s authorization before sanctioning any fresh credit of Rs. 1 crore or more to any single party. The limit was later gradually raised to Rs. 6 crores in 1986, in respect of borrowers in private as well as public sector. Under this scheme, the Reserve Bank requires the commercial banks
to collect, examine and supply detailed information regarding the borrowing concerns. The main purpose of this scheme is to keep a close watch on the flow of credit to the borrowers. This scheme requires that the banks should lend to the large borrowing concerns on the basis of credit appraisal and actual requirements of the borrowers. But this scheme was abolished in 1982. Though the scheme has been abolished, the Reserve Bank, however, insists that the banks have to get its approval once the loans have been sanctioned by them to big borrowers. The Reserve Bank would monitor and scrutinize all sanctions of bank loans exceeding Rs. 5 crores to any single party for working capital requirements, and Rs. 2 crores in the case of term loans. This post-sanction scheme has been called �Credit Monitoring Arrangement (CMA).�
3. Control of Bank Advances: This is also used as selective control method. The Reserve Bank has fixed from time to time maximum limits for some kinds of loans and advances. In May 1956, the Reserve Bank issued a directive asking all the commercial banks in the country to restrict their advances against paddy and rice. This directive was issued to check speculative hoarding of paddy and rice. In September 1956, these restrictions were applied to cover food-grains, pulses and cotton textiles. In 1970, the maximum limit for loans against shares and debentures was fixed to Rs. 5 lakhs. This was done to prevent speculation in shares with the help of bank loans.
4. Differential Interest Rates: In 1966, the Reserve Bank announced the policy of �Selective Liberalisation of Credit.� According to this policy, the Reserve Bank encouraged credit to defence industries, export industries and food-grains for procurement by government agencies. The Reserve Bank agreed to provide refinance at the bank rate in respect of advances to the above industries. At the same time it made credit dearer for other purposes.
5. Credit Squeeze Policy: Since 1973, the Reserve Bank has adopted a �Credit squeeze policy� or dear money policy as an anti-inflationary measure. This policy aims at curbing overall loan able resources of banks and also enhancing the cost or credit of borrowers from banks.
6. Moral Suasion: This method involves advice, request and persuasion with the commercial banks to co-operate with the central bank in implementing its credit policies. The Reserve Bank has also been using moral suasion as a selective credit control measure from 1956. It has been sending periodic letters to the commercial banks to use restraint over their credit policies in general and in respect of certain
commodities and unsecured loans in particular. In June 1957, the banks were advised to reduce advances against agricultural commodities. Regular meetings and discussions are also held by the Reserve Bank with commercial banks to impress upon them the need for their co-operation in the effective implementation of the monetary policy.
Selective credit controls are flexible. They can be tightened, relaxed, withdrawn and re-imposed according to price situation in the market. For influencing the purpose and direction of credit. The Reserve Bank has been using various selective credit controls. It should be noted that qualitative methods are not competitive but complementary to quantitative methods of credit control. Both methods should be employed to control credit created by commercial banks.
5.8 MONETARY POLICY OF THE RESERVE BANK OF INDIA
Monetary policy, generally refers to those policy measures of the central bank which are adopted to control and regulate the volume of currency and credit in a country. According to Paul Einzig, an ideal monetary policy may be defined �as an effort to reduce to a minimum the disadvantages and increase the advantages resulting from the existence and operation of a monetary system.� Broadly speaking, by monetary policy is meant the policy pursued by the central bank of a country for administering and controlling country�s money supply including currency and demand deposits and managing the foreign exchange rates:
Reserve Bank of India and Monetary Controls
The main objective of monetary policy pursued by the Reserve Bank of India is that of �controlled monetary expansion.� In order to achieve this objective the Reserve Bank has at its disposal various instruments, the important among these are as follows:
1. Quantitative requirements, and
2. Qualitative or selective controls.
In a developing country like India, the most important objective of monetary policy should be that of �controlled monetary expansion.� Controlled monetary expansion implies two things:
(a) Expansion in the supply of money, and
(b) Restraint on the secondary expansion of credit.
(a) Expansion in the Supply of Money
In a developing country like India, money supply has to be expanded sufficiently to match the growth of real national income. Although it is difficult to say what relation the rate of increase in money supply should bear to the rate of growth in national income, more generally, the rate of increase in money supply should be somewhat higher than the projected rate of growth of real national income for two reasons.
(i) As incomes grow the demand for money as one of the components of savings tends to increase.
(ii) Increase in money supply is also necessitated by gradual reduction of non-monetized sector of the economy.
In India, the rate of increase in money supply has been far in excess of the rate of growth in real national income. It has resulted, to a large extent, in the creation of consistent inflationary pressures in the economy.
(b) Restraint on the Secondary Expansion of Credit: Government budgetary deficits for financing a part of the investment outlays constitute an important source of monetary expansion in India. It is, therefore essential to restrain the secondary expansion of credit. While exercising restraints, care should be taken that the legitimate requirements of agriculture, industry and trade are not adversely affected. The Reserve Bank has also to channelize credit into the vital sectors of the economy, specially the priority sectors.
In order to achieve the twin goals, it is essential to formulate a monetary policy which may regulate the flow of credit to desired sectors. So far as the choice of instruments of the monetary policy is concerned, the Reserve Bank of India has a very limited scope in this respect. The Reserve Bank has at its disposal both quantitative (traditional) and qualitative (selective) methods to control credit. In the past, the Reserve Bank has employed bank rate, open market operations, variable reserves ratio and selective credit controls as the instruments to restrain the secondary expansion of credit.
The progress of the various methods of credit control, contemplated by the Reserve Bank of India suggests that the objective of monetary policy i.e., �controlled monetary expansion� has been realized to a limited extent. While the supply of money has increased in a greater proportion than the national income, the restraints on the expansion of credit have been rather weak and ineffective. In spite of the various methods employed by the Reserve Bank to contain the inflationary pressures, the general price level has been showing a rising trend. It leads up to this inevitable conclusion that there is something wrong with the monetary policy pursued by the Reserve Bank of India in the recent post. The policy should be that of �controlled contraction� rather than �controlled expansion.�
However, if we take into account the nature of the Indian economy and the needs of developmental finance, it would be a folly on our part to adopt a monetary policy of �controlled contraction�. India is a developing economy, and for the overall development of the various sectors like agriculture, industry, trade, commerce, transport, and foreign trade, availability of huge financial resources is essential. With the concept of developmental planning gaining momentum, the availability of monetary resources in sufficient quantity becomes all the more essential. With limited supply of money the Indian economy will not be able to achieve the objective of self-sustained economic growth.
Therefore, the RBI will have to continue with the policy of controlled expansion. The only change that the RBI has to introduce is that it will have to implement the various restraints on the expansion of credit more vigorously and with great authority.
5.9 Limitations of Monetary Policy
A major failure of the monetary policy in India lies on the price front. The monetary authorities have not been in a position to curb an inflationary rise in price which has often taken violent jumps at intervals. A number of causes account for this failure.
(a) Monetary policy, to be effective, should be able to regulate supply and cost of credit. The Reserve Bank tries to do by controlling the activities of commercial banks and to some extent of co-operative banks. But the proportion of total credit provided by non-banking institutions and other agencies is much higher. The impulses generated by the Reserve Bank have thus a limited impact.
(b) In relation to commercial banks the task of the Reserve Bank is rendered difficult by the limitations inherent in the various instruments of monetary control.
(c) In part the freedom to curtain Reserve Bank accommodation for banks is also constrained by the fact that the device of offering preferential facilities has been used for encouraging banks to lend to such sectors with so many windows opened for refinance as an adjunct to efforts to change the long-term pattern of bank finance, it becomes difficult for the Reserve Bank to close these special windows just when the banks may find it necessary or tempting to use these special facilities.
(d) There is a special consideration that hitherto neglected sectors should be shielded as far as possible from credit curbs. This makes the task of the monetary policy more difficult.
(e) The type of the policy the Reserve Bank has pursued so far requires the presence of a sound statistical and monitoring system. Any defects in this system make it difficult to bring about a speedy and appropriate turn around in credit trends.
5.10 ROLE OF RBI IN ECONOMIC DEVELOPMENT
The Reserve Bank is India�s central bank. It occupies a pivotal position in the monetary and banking structure of our country. It is the apex monetary institution in the country. It supervises, regulates, controls and develops the monetary and financial system of the country. It performs all the typical functions of a good central bank. It also performs a number of developmental and promotional functions. It also assists the government in its economic planning. The bank�s credit planning is devised and co-ordinated with the Five year plans. It assists the government in the great task of nation building.
Contribution to Economic Development
Since its inception in 1935, the Reserve Bank of India has functioned with great success, not only as the apex financial institution in the country but also as the promoter of economic development. With the introduction of planning in India since 1951, the Reserve Bank formulated a new monetary policy to aid and speed up economic development. The Reserve Bank has undertaken several new functions to promote economic development in the country. The major contributions of the Reserve Bank to economic development are as follows:
1. Promotion of Commercial Banking: A well-developed banking system is a pre-condition for economic development. The Reserve Bank has taken several steps to strengthen the banking system. The Banking Regulation Act, 1949 has given the Reserve Bank vast powers of supervision and control of commercial banks in the country. The Reserve Bank has been using these powers:
(a) To strengthen the commercial banking structure through liquidation and amalgamation of banks, and through improvement in their operational standards
(b) To extend the banking facilities in the semi-urban and rural areas, and
(c) To promote the allocation of credit in favour of priority sectors, such as agriculture, small-scale industries, exports etc.
The Reserve Bank is also making valuable contribution to the development of banking system by extending training facilities, to the supervisory staff of the banks through its �Banker�s training colleges.
2. Promotion of Rural Credit: Defective rural credit system and deficient rural credit facilities are one of the major causes of backwardness of Indian agriculture. In view of this, the Reserve Bank, ever since its establishment, has been assigned the responsibility of reforming rural credit system and making provision of adequate institutional finance for agriculture and other rural activities. The Reserve Bank has taken the following steps to promote rural credit:
(a) It has set up Agricultural Credit Department to expand and co-ordinate credit facilities to the rural areas.
(b) It has been taking all necessary measures to strengthen the co-operative credit system with a view to meet the financial needs of the rural people.
(c) In 1956, the Reserve Bank set-up two funds. Namely, the National Agriculture Credit (long-term operations) Fund, and the National Agricultural Credit (stabilisation) Fund, for providing medium-term and long-term loans to the state co-operative banks.
(d) Regional rural banks have been established to promote agricultural credit.
(e) Some commercial bank have been nationalised mainly to expand bank credit facilities in rural areas.
(f) The National Bank for Agriculture and Rural Development has been established in 1982 as the apex institution for agricultural finance.
(g) The Reserve Bank has helped the establishment of many warehouses in the country.
As a result of the efforts made by the Reserve Bank, the institutional finance for agriculture has been increasing considerably over the years. The agricultural output has increased by leaps and bounds. Probably no other central bank in the world is doing so much to help, develop and finance agricultural credit.
3.Promotion of Co-operative Credit: Promotion of co-operative credit movement is also the special function of the Reserve Bank. On the recommendations of the Rural Credit Survey Committee, the Reserve Bank has taken a number of measures to strengthen the structure of co-operative credit institutions throughout the country. The Reserve Bank provides financial assistance to the agriculturists through the co-operative institutions. The Reserve Bank has, thus, infused a new life into the co-operative credit movement of the country.
4. Promotion of Industrial Finance: Credit or finance is the pillar to industrial development. The Reserve Bank has been playing an active role in the field of industrial finance also. In 1957, it has set up a separate Industrial Finance Department which has rendered useful service in extending financial and organisational assistance to the institutions providing long-term finance. It made commendable efforts for broadening the domestic capital market for providing the medium and long-term finance to the industrial sector. In this regard the Reserve Bank took initiative in the establishment of a number of statutory corporations for the purpose of providing finance, especially medium and long-term finance, to industries; Industrial Development Bank of India, Industrial Finance Corporation of India, State Finance
Corporations, State Industrial Development Corporations and the Industrial Credit and Investment Corporation of India are some of important corporations established in the country with the initiative of the Reserve Bank. The Reserve Bank has contributed to the share capital of these institutions and providing short-term advances also to some of them. The role of these corporations in providing financial
help to industries is commendable. The Reserve Bank has played an active role in the establishment of the Unit Trust of India. The Unit Trust of India mobilises the savings of people belonging to middle and lower income groups and uses these funds for investment in industries. By mobilising the small savings of the people, the Unit Trust has been promoting capital formation which is the most important determinant of economic development. The Reserve Bank also has been encouraging commercial banks to provide credit to the small-scale industries. It has been encouraging credit for small industries through its �Credit Guarantee Scheme.� Small-scale industries have been recognised as a priority sector. The Reserve Bank has also been, acting as a �developmental agency� for planning, promoting and developing industries to fill in the gaps in the industrial structure of the country.
5. Promotion of Export Credit: �Export or Perish� has become a slogan for the developing economies, including India. In recent years, India is keen on expanding exports. Growth of exports needs liberal and adequate export credit. The Reserve Bank has undertaken a number of measures for increasing credit to the export sector.
For promoting export financing by the banks, the Reserve Bank has introduced certain export credit schemes. The Export Bills Credit Scheme, and the Pre-shipment Credit Scheme are the two important schemes introduced by the Reserve Bank. The Reserve Bank has been stipulating concessional interest rates on various types of export credit granted by commercial banks. The Reserve Bank has been instrumental in the establishment of Export-Import Bank. The Exim Bank is to provide financial assistance to exporters and importers. The Reserve Bank has authority to grant loans and advances to the Exim Bank, under certain conditions.
6. Regulation of Credit: The Reserve Bank has been extensively using various credit control weapons to regulate the cost of credit, the amount of credit, and the purpose of credit. For regulating the cost and amount of credit the Reserve Bank has been using the quantitative weapons. For influencing the purpose and direction of credit, it has been using various selective credit controls. By regulating credit, the Reserve Bank has been able
(a) To promote economic growth in the country.
(b) To check inflationary trends in the country.
(c) To prevent the financial resources from being used for speculative purposes.
(d) To make financial resources available for productive purposes keeping in view the priorities of the plans, and
(e) To encourage savings in the country.
7. Credit to Weaker Sections: The Reserve Bank has taken certain measures to encourage adequate and cheaper credit to the weaker sections of the society. The �Differential Rate of Interest Scheme� was started in 1972. Under this scheme, concessional credit is provided to economically and socially backward persons engaged in productive activities. The Reserve Bank has been encouraging the commercial banks to give liberal credit to the weaker sections and for self employment schemes.
The Insurance and Credit Guarantee Corporation of India gives guarantee for loans given to weaker sections.
8. Development of Bill Market: The Reserve Bank introduced the �Bill Market Scheme� in 1952, with a view to extend loans to the commercial banks against their demand promissory notes. The scheme, however, was not based on the genuine trade bills. In 1970, the Reserve Bank introduced �New Bill Market Scheme� which covered the genuine trade bills representing sale or despatch of goods. The bill market scheme has helped a lot in developing the bill market in the country. The bill market scheme has increased the liquidity of the money market in India.
9. Exchange Controls: The Reserve Bank has been able to maintain the stability of the exchange value of the �Rupee� even under heavy strains and pressure. It has also managed �exchange controls� successfully.
Inspite of the limitations under which it has to function in a developing country like India, the over all performance of the Reserve Bank is quite satisfactory. It has been able to develop the financial structure of the country consistent with the national socio-economic objectives and priorities. It has discharged its promotional and developmental functions satisfactorily and acted as the leader in economic development of the country.
Conclusion
From the above discussion, it is made clear that the Reserve Bank of India is the kingpin of the Indian money market. It issues notes, buys and sells government securities, regulates the volume, direction and cost of credit, manages foreign exchange and acts as banker to the government and banking institutions. The RBI is playing an active role in the development activities by helping the establishment and working of specialised institutions, providing term finance to agriculture, industry housing and foreign trade.
