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How Reserve Bank of India (RBI) Manages the Monetary System of the Country?

15-FEB-2016 13:29

    Brief History

    The Reserve Bank of India (RBI) was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. RBI is the top monetary authority in the country, it prints currency notes (except one rupee note) and distributes them through commercial banks in the country. So R.B.I. decides the supply of money in the whole economy.

    The Bank was constituted to

      * Ensure the printing and distribution of currency in the economy

      * To work as banker’s bank

      * To work as the custodian of foreign currency and guide the central and state government in the financial matters.

    Preamble of the RBI

    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."

    Organisation Structure: Central Board of Directors

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    Main Functions of R.B.I.

    1. Issue of Notes: The Reserve Bank has the monopoly of note issue in the country. It has the sole right to issue currency notes of various denominations except one rupee note. The Reserve Bank acts as the only source of legal tender money because the one rupee note issued by Ministry of Finance is also circulated through it. The Reserve Bank has adopted the Minimum Reserve System for the note issue. Since 1957, it maintains gold and foreign exchange reserves of ~ 200 crore, of which at least ~ 115 crore should be in gold.
    2. Banker to the Government: The second important function of the Reserve Bank is to act as the Banker, Agent and Adviser to the Government. It performs all the banking functions of the State and Central Government and it also tenders useful.
    3. Banker's Bank The Reserve Bank performs the same function for
      the other banks as the other banks ordinarily perform for their customers. It is not only a banker to the commercial banks, but it is the lender of the last resort.
    4. Controller of Credit: The Reserve Bank undertakes the responsibility of controlling credit created
      by the commercial banks. To achieve this objective it makes extensive use of quantitative and qualitative techniques to control and regulate the credit effectively in the country.
    5. Custodian of Foreign Reserves: For the purpose of keeping the foreign exchange rates stable the Reserve Bank buys and sell the foreign currencies and also protect the country's foreign exchange funds.
    6. Other Functions: The bank performs a number of other developmental works. These works include the function of clearing house arranging credit for agriculture (which has been transferred to NABARD) collecting and publishing the economic data, buying and selling of Government securities and trade bills, giving loans to the Government buying and selling of valuable commodities etc. It also acts as the representative of Government in I.M.F. and represents the membership of India.

    Read More Monetary Policy: An overview

    How Reserve Bank Manages the Monetary Markets of the Country?

    There are two types of instruments used by the RBI to control the monetary market of the country:

    A. Quantitative Measures:

    (i) Open market operations

    (ii) Discount rate or Bank rate

    (iii) Cash Reserve Ratio

    (i) Open Market Operations (OMOs): Under this method the RBI sales and purchases the government securities & treasury bills in the open market. When RBI wants to reduce inflation or reduce money supply in the market,it sales the government securities & treasury bills to the financial institutions and vice versa.

    (ii) Discount Rate or Bank Rate: It is the rate at which RBI lends money to the commercial banks. When RBI wants to reduce the money supply in the market to control the inflation it increases the bank rate so that borrowing could become expensive for all the borrowers (Institutions.)

    (iii) Cash Reserve Ratio: It is the money which is deposited by the commercial banks in the RBI. When RBI observes that due to excess money supply the inflation has increased in the economy, so to check this inflation, RBI increases the CRR so that commercial banks are left with less money to land the borrowers.

    B. Qualitative or Selective Credit Control Measures:

    (i) Credit Rationing

    (ii) Change in Lending Margin

    (iii) Moral Sausion

    (i) Credit Rationing: Under this method (in the scenario of higher inflation) credit is given to only those sectors which are very crucial for the economy (productive lending). Another measure is charge of interest on the loans after a limit is hiked to check money supply.

    (ii) Change in Lending Margin: Under this method the banks provide loans only upto a certain percentage of the value of the mortgaged property. The gap between a mortgaged property and loaned amount is called the lending margin.

    (iii) Moral Suasion: The moral suasion is the method of persuading and convincing the commercial banks to advance credit in accordance the directive of the RBI. More or less under this method RBI urges to commercial banks to co-operate in managing the money supply in the economy.

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