|Headquarters||Mumbai, Maharashtra, India|
|Established||1 April 1935|
|Ownership||100% state ownership|
|Central bank of||India|
|Currency||Indian rupee (₹ )|
|Reserves||₹3,612,641 crore (US$510 billion)|
|Interest on reserves||3.35% (market determined)|
The Reserve Bank of India (RBI) is India's central bank, which controls the issue and supply of the Indian rupee. RBI is the regulator of the entire Banking in India. RBI plays an important part in the Development Strategy of the Government of India.
RBI regulates commercial banks and non-banking finance companies working in India. It serves as the leader of the banking system and the money market. It regulates money supply and credit in the country. The RBI carries out India's monetary policy and exercises supervision and control over banks and non-banking finance companies in India. RBI was set up in 1935 under the Reserve Bank of India Act,1934.
Until the Monetary Policy Committee was established in 2016, it also controlled monetary policy in India. It commenced its operations on 1 April 1935 in accordance with the Reserve Bank of India Act, 1934. The original share capital was divided into shares of 100 each fully paid . Following India's independence on 15 August 1947, the RBI was nationalised on 1 January 1949.
It is a member bank of the Asian Clearing Union. The general superintendence and direction of the RBI is entrusted with the 21-member central board of directors: the governor; four deputy governors; two finance ministry representatives (usually the Economic Affairs Secretary and the Financial Services Secretary); ten government-nominated directors to represent important elements of India's economy; and four directors to represent local boards headquartered at Bombay, Calcutta, Madras and the capital New Delhi. Each of these local boards consists of five members who represent regional interests, the interests of co-operative and indigenous banks.
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 till August 2016. A central bank is known by different names in different countries. The functions of a central bank may vary from country to country and are autonomous or body and perform or through another agency vital monetary functions in the country. 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.
The bank is also active in promoting financial inclusion policy and is a leading member of the Alliance for Financial Inclusion (AFI). The bank is often referred to by the name 'Mint Street'. RBI is also known as banker's bank.
The preamble of the Reserve Bank of India describes the basic functions of the reserve bank as:
"to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth."
The Reserve Bank of India was established following the Reserve Bank of India Act of 1934. Though privately owned initially, it was nationalised in 1949 and since then fully owned by the Government of India (GoI).
The Reserve Bank of India was founded on 1 April 1935 to respond to economic troubles after the First World War. The Reserve Bank of India was conceptualised based on the guidelines presented to the Central Legislative Assembly which passed these guidelines as the RBI Act 1934. The bank was set up based on the recommendations of the 1926 Royal Commission on Indian Currency and Finance, also known as the Hilton–Young Commission. The original choice for the seal of RBI was the East India Company Double Mohur, with the sketch of the Lion and Palm Tree. However, it was decided to replace the lion with the tiger, the national animal of India. The Preamble of the RBI describes its basic functions to regulate the issue of bank notes, keep reserves to secure monetary stability in India, and generally to operate the currency and credit system in the best interests of the country. The Central Office of the RBI was established in Calcutta (now Kolkata) but was moved to Bombay (now Mumbai) in 1937. The RBI also acted as Burma's (now Myanmar) central bank until April 1947 (except during the years of Japanese occupation (1942–45)), even though Burma seceded from the Indian Union in 1937. After the Partition of India in August 1947, the bank served as the central bank for Pakistan until June 1948 when the State Bank of Pakistan commenced operations. Though set up as a shareholders' bank, the RBI has been fully owned by the Government of India since its nationalisation in 1949. RBI has monopoly of note issue.
In the 1950s, the Indian government, under its first Prime Minister Jawaharlal Nehru, developed a centrally planned economic policy that focused on the agricultural sector. The administration nationalised commercial banks and established, based on the Banking Companies Act, 1949 (later called the Banking Regulation Act), a central bank regulation as part of the RBI. Furthermore, the central bank was ordered to support economic plan with loans.
As a result of bank crashes, the RBI was requested to establish and monitor a deposit insurance system. Meant to restore the trust in the national bank system, it was initialised on 7 December 1961. The Indian government founded funds to promote the economy, and used the slogan "Developing Banking". The government of India restructured the national bank market and nationalised a lot of institutes. As a result, the RBI had to play the central part in controlling and supporting this public banking sector.
In 1969, the Indira Gandhi-headed government nationalised 14 major commercial banks. Upon Indira Gandhi's return to power in 1980, a further six banks were nationalised. The regulation of the economy and especially the financial sector was reinforced by the Government of India in the 1970s and 1980s. The central bank became the central player and increased its policies a lot for various tasks like interests, reserve ratio and visible deposits. These measures aimed at better economic development and had a huge effect on the company policy of the institutes. The banks lend money in selected sectors, like agricultural business and small trade companies. The Banking Commission was established on Wednesday, 29 January 1969, to analyse banking costs, effects of legislations and banking procedures, including non-banking financial intermediaries and indigenous banking on Government of India economy; with Mr. R.G. Saraiya as the chairman.
The branch was forced to establish two new offices in the country for every newly established office in a town. The oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce the effects.
A lot of committees analysed the Indian economy between 1985 and 1991. Their results had an effect on the RBI. The Board for Industrial and Financial Reconstruction, the Indira Gandhi Institute of Development Research and the Security & Exchange Board of India investigated the national economy as a whole, and the security and exchange board proposed better methods for more effective markets and the protection of investor interests. The Indian financial market was a leading example for so-called "financial repression" (Mckinnon and Shaw). The Discount and Finance House of India began its operations in the monetary market in April 1988; the National Housing Bank, founded in July 1988, was forced to invest in the property market and a new financial law improved the versatility of direct deposit by more security measures and liberalisation.
The national economy contracted in July 1991 as the Indian rupee was devalued. The currency lost 18% of its value relative to the US dollar, and the Narsimham Committee advised restructuring the financial sector by a temporal reduced reserve ratio as well as the statutory liquidity ratio. New guidelines were published in 1993 to establish a private banking sector. This turning point was meant to reinforce the market and was often called neo-liberal. The central bank deregulated bank interests and some sectors of the financial market like the trust and property markets. This first phase was a success and the central government forced a diversity liberalisation to diversify owner structures in 1998.
The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed nationalised banks in July to interact with the capital market to reinforce their capital base. The central bank founded a subsidiary company—the Bharatiya Reserve Bank Note Mudran Private Limited—on 3 February 1995 to produce banknotes.
The Foreign Exchange Management Act, 1999 came into force in June 2000. It should improve the item in 2004–2005 (National Electronic Fund Transfer). The Security Printing & Minting Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and produces banknotes and coins.
In 2016, the Government of India amended the RBI Act to establish the Monetary Policy Committee (MPC) to set. This limited the role of the RBI in setting interest rates, as the MPC membership is evenly divided between members of the RBI (including the RBI governor) and independent members appointed by the government. However, in the event of a tie, the vote of the RBI governor is decisive.
In April 2018, the RBI announced that "entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling virtual currencies,” including Bitcoin. While the RBI later clarified that it "has not prohibited" virtual currencies, a three-judge panel of the Supreme Court of India issued a ruling on 4 March 2020 that the RBI had failed to show "at least some semblance of any damage suffered by its regulated entities" through the handling of virtual currencies to justify its decision. The court challenge was filed by the Internet and Mobile Association of India, whose members include some cryptocurrency exchanges whose businesses suffered following the RBI's 2018 order.
The central board of directors is the main committee of the central bank. The Government of India appoints the directors for a four-year term. The board consists of a governor, and not more than four deputy governors; four directors to represent the regional boards; two – usually the Economic Affairs Secretary and the Financial Services Secretary — from the Ministry of Finance and ten other directors from various fields. The Reserve Bank – under Raghuram Rajan's governorship – wanted to create a post of a chief operating officer (COO), in the rank of deputy governor and wanted to re-allocate work between the five of them (four deputy governor and COO).
Two of the four deputy governors are traditionally from RBI ranks and are selected from the bank's executive directors. One is nominated from among the chairpersons of public sector banks and the other is an economist. An Indian Administrative Service officer can also be appointed as deputy governor of RBI and later as the governor of RBI as with the case of Y. Venugopal Reddy and Duvvuri Subbarao. Other persons forming part of the central board of directors of the RBI are Dr. Nachiket Mor, Y. C. Deveshwar, Prof Damodar Acharya, Ajay Tyagi and Anjuly Duggal.
Uma Shankar, chief general manager (CGM) in charge of the Reserve Bank of India's financial inclusion and development department has taken over as executive director (ED) in the central bank.
Sudha Balakrishnan, a former vice-president at National Securities Depository Limited, assumed charge as the first chief financial officer (CFO) of the Reserve Bank on 15 May 2018; she was given the rank of an executive director.
Branches and support bodies
The RBI has four regional representations: North in New Delhi, South in Chennai, East in Kolkata and West in Mumbai. The representations are formed by five members, appointed for four years by the central government and with the advice of the central board of directors serve as a forum for regional banks and to deal with delegated tasks from the Central Board.
It has two training colleges for its officers, viz. Reserve Bank Staff College, Chennai and College of Agricultural Banking, Pune. There are three autonomous institutions run by RBI namely National Institute of Bank Management (NIBM), Indira Gandhi Institute of Development Research (IGIDR), Institute for Development and Research in Banking Technology (IDRBT). There are also four zonal training centres at Mumbai, Chennai, Kolkata, and New Delhi.
The Board of Financial Supervision (BFS), formed in November 1994, serves as a CCBD committee to control the financial institutions. It has four members, appointed for two years, and takes measures to strength the role of statutory auditors in the financial sector, external monitoring, and internal controlling systems. The Tarapore committee was set up by the Reserve Bank of India under the chairmanship of former RBI deputy governor S. S. Tarapore to "lay the road map" to capital account convertibility. The five-member committee recommended a three-year time frame for complete convertibility by 1999–2000.
On 8 December 2017, Surekha Marandi, Executive Director (ED) of Reserve Bank of India, said RBI will open an office in the north-eastern state of Arunachal Pradesh
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The central bank of any country executes many functions such as overseeing monetary policy, issuing currency, managing foreign exchange, working as a bank for government and as a banker of scheduled commercial banks. It also works for overall economic growth of the country. The preamble of the Reserve Bank of India describes its main functions as:
..to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.
The primary objective of RBI is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions, and non-banking finance companies.
The board is constituted by co-opting four directors from the Central Board as members for a term of two years and is chaired by the governor. The deputy governors of the reserve bank are ex-officio members. One deputy governor, usually the deputy governor in charge of banking regulation and supervision, is nominated as the vice-chairman of the board. The board is required to meet normally once every month. It considers inspection reports and other supervisory issues placed before it by the supervisory departments.
BFS through the Audit Sub-Committee also aims at upgrading the quality of the statutory audit and internal audit functions in banks and financial institutions. The audit sub-committee includes deputy governor as the chairman and two directors of the Central Board as members. The BFS oversees the functioning of the Department of Banking Supervision (DBS), the Department of Non-Banking Supervision (DNBS) and the Financial Institutions Division (FID) and gives directions on the regulatory and supervisory issues.
Regulator and supervisor of the financial system
The institution is also the regulator and supervisor of the financial system and prescribes broad parameters of banking operations within which the country's banking and financial system functions. Its objectives are to maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. The Banking Ombudsman Scheme has been formulated by the Reserve Bank of India (RBI) for effective addressing of complaints by bank customers. The RBI controls the monetary supply, monitors economic indicators like the gross domestic product and has to decide the design of the rupee banknotes as well as coins.
Regulator and supervisor of the payment and settlement systems
Payment and settlement systems play an important role in improving overall economic efficiency. The Payment and Settlement Systems Act of 2007 (PSS Act) gives the Reserve Bank oversight authority, including regulation and supervision, for the payment and settlement systems in the country. In this role, the RBI focuses on the development and functioning of safe, secure and efficient payment and settlement mechanisms. Two payment systems National Electronic Fund Transfer (NEFT) and Real-Time Gross Settlement (RTGS) allow individuals, companies and firms to transfer funds from one bank to another. These facilities can only be used for transferring money within the country.
NEFT operates on a deferred net settlement (DNS) basis and settles transactions in batches. The settlement takes place for all transactions received until a particular cut-off time. It operates in hourly batches – there are twelve settlements from 8 am to 7 pm on weekdays and six between 8 am and 1 pm on Saturdays. Any transaction initiated after the designated time would have to wait until the next settlement time. In RTGS, transactions are processed continuously, all through the business hours. RBI's settlement time is 9 am to 4:30 pm on weekdays and 9 am to 2 pm on Saturdays.
Banker and debt manager to government
Just as individuals need a bank to carry out their financial transactions effectively and efficiently. Government also need a bank to carry out their financial transactions. The RBI serves this purpose for the Government of India (GoI). As a banker to the Government of India, the RBI maintains its accounts, receive payments into and make payments out of these accounts. The RBI also helps the GoI to raise money from the public via issuing bonds and government-approved securities. In Sep 2019, a decision at RBI directors meet was taken to change the RBI financial accounting year to March–April to align itself with the central government calendar instead of the current June–July year.
Managing foreign exchange
The central bank manages to reach different goals of the Foreign Exchange Management Act, 1999. Their objective is to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.
With the increasing integration of the Indian economy with the global economy arising from greater trade and capital flows, the foreign exchange market has evolved as a key segment of the Indian financial market and the RBI has an important role to play in regulating and managing this segment. The RBI manages forex and gold reserves of the nation.
On a given day, the foreign exchange rate reflects the demand for and supply of foreign exchange arising from trade and capital transactions. The RBI's Financial Markets Department (FMD) participates in the foreign exchange market by undertaking sales/purchases of foreign currency to ease volatility in periods of excess demand for/supply of foreign currency.
Issue of currency
Other than the Government of India, the Reserve Bank of India is the sole body authorised to issue banknotes in India.
The bank also destroys banknotes when they are not fit for circulation. All the money issued by the central bank is its monetary liability, i.e., the central bank is obliged to back the currency with assets of equal value, to enhance public confidence in paper currency. The objectives are to issue banknotes and give the public adequate supply of the same, to maintain the currency and credit system of the country to utilise it in its best advantage, and to maintain the reserves.
The RBI maintains the economic structure of the country so that it can achieve the objective of price stability as well as economic development because both objectives are diverse in themselves.
For the printing of notes, RBI uses four facilities:
- The Security Printing and Minting Corporation of India Limited (SPMCIL), a wholly owned company of the Government of India, has printing presses at Nashik, Maharashtra and Dewas, Madhya Pradesh.
- The Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL), owned by the RBI, has printing facilities in Mysore, Karnataka and Salboni, West Bengal.
Whilst coins are minted by, and ₹ 1 notes are issued by the Government of India (GoI), the RBI works as an agent of GoI for the distribution and handling of coins. RBI also works to prevent counterfeiting of currency by regularly upgrading security features of currency.
The RBI is authorised to issue notes with face values of up to ₹ 10,000 and coins up to ₹ 1,000 rupees.
Earlier ₹ 1,000 notes have been discarded by the RBI.
Reserve Bank of India also works as a central bank where commercial banks are account holders and can deposit money. RBI maintains banking accounts of all scheduled banks. Commercial banks create credit. It is the duty of the RBI to control the credit through the CRR, repo rate and open market operations. As banker's bank, the RBI facilitates the clearing of cheques between the commercial banks and helps the inter-bank transfer of funds. It can grant financial accommodation to schedule banks. It acts as the lender of the last resort by providing emergency advances to the banks.
Regulator of the Banking System
RBI has the responsibility of regulating the nation's financial system. As a regulator and supervisor of the Indian banking system it ensures financial stability & public confidence in the banking system. RBI uses methods like On-site inspections, off-site surveillance, scrutiny & periodic meetings to supervise new bank licences, setting capital requirements and regulating interest rates in specific areas. RBI is currently focused on implementing norms.
Detection of fake currency
To curb the counterfeit money problem in India, RBI has launched a website to raise awareness among masses about fake banknotes in the market. www.paisaboltahai.rbi.org.in provides information about identifying fake currency.
On 22 January 2014; RBI gave a press release stating that after 31 March 2014, it will completely withdraw from circulation of all banknotes issued prior to 2005. From 1 April 2014, the public will be required to approach banks for exchanging these notes. Banks will provide exchange facility for these notes until further communication. The reserve bank has also clarified that the notes issued before 2005 will continue to be legal tender. This would mean that banks are required to exchange the notes for their customers as well as for non-customers. From 1 July 2014, however, to exchange more than 15 pieces of '500 and '1000 notes, non-customers will have to furnish proof of identity and residence as well as show aadhar to the bank branch in which he/she wants to exchange the notes.
This move from the reserve bank is expected to unearth black money held in cash. As the new currency notes have added increased security features, they would help in curbing the menace of fake currency.
The central bank has to perform a wide range of promotional functions to support national objectives and industries. The RBI faces a lot of inter-sectoral and local inflation-related problems. Some of these problems are results of the dominant part of the public sector.
Key tools in this effort include Priority Sector Lending such as agriculture, micro and small enterprises (MSE), housing and education. RBI work towards strengthening and supporting small local banks and encourage banks to open branches in rural areas to include large section of society in banking net.
The RBI is also a banker to the government and performs merchant banking function for the central and the state governments. It also acts as their banker. The National Housing Bank (NHB) was established in 1988 to promote private real estate acquisition. The institution maintains banking accounts of all scheduled banks, too. RBI on 7 August 2012 said that Indian banking system is resilient enough to face the stress caused by the drought-like situation because of poor monsoon this year.
Custodian to foreign exchange
The Reserve Bank has custody of the country's reserves of international currency, and this enables the Reserve Bank to deal with crisis connected with adverse balance of payments position.
On 8 November 2016, the Government of India announced the demonetisation of all ₹ 500 and ₹ 1,000 banknotes of the Mahatma Gandhi Series on the recommendation of the Reserve Bank of India (RBI). The government claimed that the action would curtail the shadow economy and crack down on the use of illicit and counterfeit cash to fund illegal activity and terrorism.
The Reserve Bank of India laid down a detailed procedure for the exchange of the demonetised banknotes with new ₹ 500 and ₹ 2,000 banknotes of the Mahatma Gandhi New Series and ₹ 100 banknotes of the preceding Mahatma Gandhi Series. The key points were:
- Citizens had until 30 December 2016 to tender their old banknotes at any office of the RBI or any bank branch and credit the value into their respective bank accounts.
- Cash withdrawals from bank accounts were restricted to ₹10,000 (US$140) per day and ₹20,000 (US$280) per week per account from 10 to 13 November 2016. This limit was increased to ₹24,000 (US$340) per week from 14 November.
- For immediate cash needs, the old banknotes could be exchanged for the new ₹500 and ₹2,000 banknotes as well as ₹100 banknotes over the counter of bank branches by filling up a requisition form along with a valid ID proof. It was announced that this facility would be available until 30 December 2016.
- Initially, the limit was fixed at ₹4,000 (US$56) per person from 8 to 13 November 2016.
- This limit was increased to ₹4,500 (US$63) per person from 14 to 17 November 2016.
- The limit was reduced to ₹2,000 (US$28) per person from 18 November 2016.
- All exchange of banknotes was abruptly stopped from 25 November 2016.
- Initially, all ATMs were dispensing banknotes of only ₹ 50 and ₹100 denominations and cash withdrawals from ATMs were restricted to ₹2,000 (US$28) per day. From 14 November onwards, ATMs were recalibrated to dispense new ₹500 and ₹2,000 notes and to allow a maximum withdrawal of ₹2,500 (US$35) per day, while other ATMs dispensing banknotes of only ₹50 and ₹100 denominations will allow a maximum withdrawal of ₹2,000 (US$28) per day.
However, exceptions were given to petrol, CNG and gas stations, government hospitals, railway and airline booking counters, state-government recognised dairies and ration stores, and crematoriums to accept the old ���500 and ₹1,000 banknotes until 11 November 2016, which was later extended to 14 November 2016 and once again to 24 November 2016. International airports were also instructed to facilitate an exchange of notes amounting to a total value of ₹5,000 (US$70) for foreign tourists and outbound passengers.
Under the revised guidelines issued on 17 November 2016, families were allowed to withdraw ₹250,000 (US$3,500) for wedding expenses from one account provided it was KYC compliant. The rules were also changed for farmers who are permitted to withdraw ₹25,000 (US$350) per week from their accounts against crop loan.
Cash crunch and effects
The scarcity of cash due to demonetisation led to chaos, and most people holding old banknotes faced difficulties exchanging them due to endless lines outside banks and ATMs across India, which became a daily routine for millions of people waiting to deposit or exchange the ₹500 and ₹1,000 banknotes since 9 November. ATMs were running out of cash after a few hours of being functional, and around half the ATMs in the country were non-functional. Sporadic violence was reported in New Delhi, but there were no reports of any grievous injury, people attacked bank premises and ATMs, and a ration shop was looted in Madhya Pradesh after the shop owner refused to accept ₹500 banknotes.
Policy rates and reserve ratios
|Policy repo rate||4.00%|
|Reverse repo rate||3.35%|
|Marginal standing facility rate||4.25%|
|Cash reserve ratio (CRR)||3.0%|
|Statutory liquidity ratio (SLR)||18.00%|
|Lending and deposit rates|
|Marginal Cost of funds-based overnight Lending Rate (MCLR)||7.80%–8.30%|
|Savings deposit rate||3.25%–3.50%|
|Term deposit rate for > 1 year||6.25%–7.00%|
Repo (repurchase) rate also known as the benchmark interest rate is the rate at which the RBI lends money to the commercial banks for a short-term (a maximum of 90 days). When the repo rate increases, borrowing from RBI becomes more expensive. If 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. If the repo rate is increased, banks can't carry out their business at a profit whereas the very opposite happens when the repo rate is cut down. Generally, repo rates are cut down whenever the country needs to progress in banking and economy.
If banks want to borrow money (for short term, usually overnight) from RBI then banks have to charge this interest rate. Banks have to pledge government securities as collateral. This kind of deal happens through a re-purchase agreement. If a bank wants to borrow, it has to provide government securities at least worth ₹ 100 crore (could be more because of margin requirement which is 5%–10% of loan amount) and agree to repurchase them at ₹106.5 crore (US$15 million) at the end of borrowing period. So the bank has paid ₹6.5 crore (US$910,000) as interest. This is the reason it is called repo rate.
The government securities which are provided by banks as collateral can not come from SLR quota (otherwise the SLR will go below 19.5% of NDTL and attract penalties).
To curb inflation, the RBI increases repo rate which will make borrowing costs for banks. Banks will pass this increased cost to their customers which make borrowing costly in the whole economy. Fewer people will apply for loans and aggregate demand will be reduced. This will result in inflation coming down. The RBI does the opposite to fight deflation. When the RBI reduces the repo rate, banks are not legally required to reduce their own base rate.
The present repo rate is 4%.
Reverse repo rate (RRR)
As the name suggest, reverse repo rate is just the opposite of repo rate. Reverse repo rate is the short term borrowing rate at which RBI borrows money from banks. The reserve bank 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 banks will get a higher rate of interest from RBI. As a result, banks prefer to lend their money to RBI which is always safe instead of lending it to others (people, companies, etc.) which is always risky.
Repo rate signifies the rate at which liquidity is injected into the banking system by RBI, whereas reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks. Currently, reverse repo rate is pegged to be 0.25% (or 25 bps) below the repo rate.
Statutory liquidity ratio (SLR)
Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash and approved securities. 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, thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities.
In well-developed economies, central banks use open market operations—buying and selling of 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 commercial and industrial sectors. In the open money market, government securities are traded at market-related rates of interest. The RBI is resorting increasing to open market operations in recent years. Generally, the RBI uses
- Minimum margins for lending against specific securities.
- A ceiling on the amounts of credit for certain purposes.
- The discriminatory rate of interest charged on certain types of advances.
Direct credit controls in India are of three types:
- Part of the interest rate structure, i.e., on small savings and provident funds, are administratively set.
- Banks are mandatory required to keep 19.50% of their NDTL (net demand and time liabilities) in the form of liquid assets.
- Banks are required to lend to the priority sectors to the extent of 40% of their advances.
The share of net demand and time liabilities that banks must maintain in safe and liquid assets, such as government securities, cash, and gold. Here it would be pertinent to mention the gold swap of July 2014. The present SLR is 18.75%.
Bank rate is defined in Section 49 of the RBI Act of 1934 as the 'standard rate at which RBI is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase'. When banks want to borrow long term funds from the RBI, it is the interest rate which the RBI charges to them. It is currently set to 5.40%. The bank rate is not used to control money supply, but penal rates continue to be linked to the bank rate. If a bank fails to meet SLR or CRR requirements then the RBI will impose a penalty of 300 basis points above bank rate.
Liquidity adjustment facility (LAF)
Liquidity adjustment facility was introduced in 2000. LAF is a facility provided by the Reserve Bank of India to scheduled commercial banks to avail of liquidity in case of need or to park excess funds with the RBI on an overnight basis against the collateral of government securities.
RBI accepts applications for a minimum amount of ₹5 crore (US$700,000) and in multiples of ₹ 5 crore thereafter.
Cash reserve ratio (CRR)
CRR refers to the ratio of bank's cash reserve balances with RBI with reference to the bank's net demand and time liabilities to ensure the liquidity and solvency of the scheduled banks. The share of net demand and time liabilities that banks must maintain as cash with the RBI. The RBI has set CRR at 4%. A 1% change in CRR affects the economy by ₹1,000,000 crore (US$140 billion). An increase draw this amount from the economy, while a decrease injects this amount into the economy. So if a bank has ₹200 crore (US$28 million) of NDTL then it has to keep ₹8 crore (US$1.1 million) in cash with RBI. RBI pays no interest on CRR.
Let's assume the economy is showing inflationary trends and the RBI wants to control this situation by adjusting SLR and CRR. If the RBI increases SLR to 50% and CRR to 20% then bank will be left only with ₹60 crore (US$8.4 million) for operations. Now it will be very difficult for the bank to maintain profitability with such a small amount of capital. The bank will be left with no choice but to raise its interest rate which will make borrowing by its customers more costly. This will in turn reduce the overall demand and hence prices will eventually come down.
Open market operation (OMO)
Open market operation is the activity of buying and selling of government securities in open market to control the supply of money in banking system. When there is excess supply of money, central bank sells government securities thereby sucking out excess liquidity. Similarly, when liquidity is tight, RBI will buy government securities and thereby inject money supply into the economy.
On 23 March 2020, Reserve Bank of India infuse Rs 1 lakh crore through term repo auction, a massive OMOs (open market operations) purchase of government securities. The Reserve Bank is monitoring the financial market conditions and liquidity situation in the economy as COVID-19 pandemic in India fears of a recession.
Marginal standing facility (MSF)
This scheme was introduced in May 2011 and all the scheduled commercial bank can participate in this scheme. Banks can borrow up to 2.5% percent of their respective net demand and time liabilities. The RBI receives application under this facility for a minimum amount of Rs. 1 crore and in multiples of Rs. 1 crore thereafter.
The important difference from repo rate is that bank can pledge government securities from its SLR quota (up to one percent). So even if SLR goes below 20.5% by pledging SLR quota securities under MSF, the bank will not have to pay any penalty. The MSF rate is set to 100 basis points above bank rate and currently is at 5.65% as of 7 August 2019.
Loan-to-value (LTV) is the ratio of loan amount to the actual value of asset purchased.
The RBI regulates this ratio so as to control the amount a bank can lend to its customers. For example, an individual wants to buy a car using borrowed money and the car's value is ₹10 lakh (US$14,000). If the LTV is set to 70% he can borrow a maximum of ₹7 lakh (US$9,800).
The RBI can decrease or increase to curb inflation or deflation respectively.
Selective credit control
Under this measure, the RBI can specifically instruct banks not to give loans to traders of certain commodities e.g. sugar, edible oil, etc.
This prevents the speculation/hoarding of commodities using money borrowed from banks.
Under this measure, the RBI try to persuade banks through meetings, conferences, media statements to do specific things under certain economic trends. For example, when the RBI reduces repo rate, it asks banks to reduce their base rate as well. Another example of this measure is to ask banks to reduce their non-performing assets.
Limitations of monetary policy
In developing countries like India, monetary policy fails to show immediate or no results because the following factors:
- People do not employ alternative investment options. A large section of society still depends on saving accounts, fixed deposits, Public Provident Fund for investment. Commercial banks have large deposits. RBI is not the main or even prominent money supplier for these banks. So whatever monetary action central bank takes has little or late impact on the economy.
- Many people in rural areas are out of the banking net and whatever the RBI does, has no impact on their financial activities.
- Monsoon uncertainty adversely affects food production and thereby cause food inflation. Monetary policy has no impact on food inflation.
RTGS and NEFT transactions' charges removal
Regulation of variable pay of bank management
In November, RBI introduced a set of draft guidelines to regulate the variable pay of CEOs and top management at private banks. The new rules are in line with the Sound Compensation Practices issued by the Financial Stability Board in April 2009. The rules will apply to CEOs, wholetime directors, and material risk takers at private banks, small finance banks and domestic executives of foreign banks. As per the new rules at least 50% of the pay should be based on individual, unit, business and firm wide performance evaluation which will be capped at 300% of the fixed pay. In case of variable pay above 200% then at least 50% of this amount should be via non-cash instruments. Share linked instruments are included as part of variable pay. Guaranteed bonus should not be part of the compensation package except in case of joining bonus. The RBI also has put clauses in place to clawback/malus in case of deteriorating performance. The bank shall identify a representative set of conditions when the recovery clause for clawback /malus can be invoked.
A report titled "Trend and Progress of Banking in India" is published annually, as required by the Banking Regulation Act, 1949. The report sums up trends and developments throughout the financial sector. Starting in April 2014, the Reserve Bank of India publishes bi-monthly policy updates.
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