CENTRAL BANKING

ESSENTIAL FEATURES OF CENTRAL BANK

It stands as the lender of money, issue notes and

coins, supervises, controls and regulates the activities of the banking system and acts as the banker to the government. Discretionary control over the monetary system of the country. It acts as the leader of the money market and in that capacity it supervises , controls and regulates the activities of the commercial banks. Called central bank ? Central bank is an institution whose main function is to help, control and stabilize the monetary and

Need for central bank

Direction & regulation Issue of currency notes

Foreign exchange reserve

Banker to the government Bankers Bank

Control of credit

OBJECTIVES OF CENTRAL BANKS

1. To abolish weak currency system 2. Maintain value of currency 3. Appropriate credit policy 4. To act as Bankers Bank ( control over the cash

reserves of the commercial banks) (RBI acts as a central bank, it provides loans and advances to medium and small scale banks.) 5. Control over Banking System ( issue licenses, inspect books)

Functions of central bank

Monopoly Power of note issue Bankers Bank ( C.B. acts a custodian of cash

reserves) Repo Rate: Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the Rate will help banks to get money at a cheaper rate. When the Repo rate increases borrowing from RBI becomes more expensive. Reverse Repo Rate: Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates.

Functions of central bank

Controller Of credit ( To ensure price stability the

supply of bank credit is to be regulated) ( keep the supply of bank credit in limit) Banker to the government Custodian of Foreign Exchange Reserve Promotional and developmental function Regulator of domestic financial institutions

RESERVE BANK OF INDIA

The Reserve Bank of India 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. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India. It has to regulate the issue of bank notes and the keeping of reserves with a view of securing monetary

ROLE of rbi
1. 2.

3.
4. 5.

6.
7. 8. 9. 10. 11.

Flexible Monetary Policy Success in Notes Issue Governments Banker Maintaining Stable interest Rate Advisor to the Government Arrangement of public debt Control over banks Maintaining stable exchange rate system ( relation with IMF) Agricultural Development Industrial finance Regulating money market and government

Where RBI has failed ?

No control over inflation No uniformity in interest rates

No link with indigenous banking

Banking problems Failure in Agricultural Finance

FUNCTIONS OF RBI
The functions are classified into three heads,viz.,

A) Traditional functions B) Promotional functions and C) Supervisory functions

TRADITIONAL FUNCTIONS
1.Monopoly of currency notes issue 2.Banker to the Government(both the central and state) 3.Agent and advisor to the Government 4.Banker to the bankers 5.Acts as the clearing house of the country 6.Lender of the last resort 7.Custodian of the foreign exchange reserves 8.Maintaining the external value of domestic currency 9.Controller of forex and credit 10.Ensures the internal value of the currency 11.Publishes the Economic statistical data 12.Fight against economic crisis and ensures stability of Indian economy.

Promotional functions
1.Promotion of banking habit and expansion of banking systems. 2.Provides refinance for export promotion 3.Expansion of the facilities for the provision of the agricultural credit through NABARD 4.Extension of the facilities for the small scale industries 5.Helping the Co-operative sectors. 6.Prescribe the minimum statutory requirement. 7.Innovating the new banking business transactions.

Supervisory functions
1. 2.

3.

4.
5. 6. 7.

Granting license to Banks. Inspects and makes enquiry or determine position in respect of matters under various sections of RBI and Banking regulations Implements Deposit insurance scheme Periodical review of the work of the commercial banks Giving directives to commercial banks Control the non-banking finance corporation Ensuring the health of financial system through onsite and off-site verification.

MONEY CREATOR
Monetary policy means a regulatory policy of RBI Control over the supply of money for the realization

of general economic goals. In developing economies there has to be a continuous expansion of money supply and bank credit and the central bank has the duty to see that legitimate credit requirements are met. Monetary authority is a part of economic policy which a country tries to implement to attain certain objectives. A. Rapid economic growth B. Stable prices

MONEY CREATOR
C.B has the responsibility to manage

Monetary magnitudes 2. Credit flows 3. Interest rates Monetary policy acts through the cost and availability of credit and money. Now the demand for credit is not seasonal Indian economy is globalized Integration Policy announcements are made throughout the year
1.

What is Monetary Policy?

The term monetary policy refers to actions

taken by central banks to affect monetary magnitudes or other financial conditions. Monetary Policy operates on monetary magnitudes or variables such as money supply, interest rates and availability of credit. Monetary Policy ultimately operates through its influence on expenditure flows in the economy. In other words affects liquidity and by affecting liquidity, and thus credit, it affects total demand in the economy.

Why monetary policy is needed

Accelerate economic development Reasonable price stability

Institutional set up
Influencing the cost, volume and direction of credit Sectoral & overall development

Controlled expansion of bank credit

Disinflation without deflation Credit expansion takes place the right way

Increase productivity of investment

Independent objective: Promotion of Exports

Why monetary policy is needed

RBIs monetary policy should have the national,

social and economic objectives. Price stability & economic growth- Two basic objectives Money supply & volume of credit Money supply does not change on its own Variations in the bank credit is the major factor which influences economic activity.

Aims of Monetary policy

MP is a part of general economic policy of the

govt. Thus MP contributes to the achievement of the goals of economic policy. Objective of MP may be: 1. Full employment 2. Stable exchange rate 3. Healthy BoP 4. Economic growth 5. Reasonable Price Stability 6. Greater equality in distribution of income & wealth 7. Financial stability

Techniques of Monetary Control

1.

2.

Open Market Operations: Sales and purchases of government securities Affects reserve position of the banks Least used technique by the bank Sale or purchase Treasury bills in the open market Bank Rate: Financial assistance in the form of rediscounting of bills of exchange and promissory notes Loans and advances If the bank rate is reduced the finance will be more and if it is increased there will be less demand for finance.

Techniques of Monetary Control

3. Direct Regulation of Interest Rates:
RBI can control the monetary policy by regulating market

rates of interest directly. 4. Cash Reserve Ratio 5. Statutory Liquidity Ratio Statutory Liquidity Ratio or SLR refers to the amount that all banks require to maintain in cash or in the form of Gold or approved securities. Approved securities means, bond and shares of different companies. The objectives of SLR are: To restrict the expansion of bank credit. To augment the investment of the banks in Government securities. To ensure solvency of banks

Techniques of Monetary Control

Difference between SLR & CRR: What SLR does is it restricts the banks leverage in

pumping more money into the economy. CRR, or Cash Reserve Ratio, is the portion of deposits that the banks have to maintain with the RBI. Higher the ratio, the lower is the amount that banks will be able to use for lending and investment. The other difference is that to meet SLR, banks can use cash, gold or approved securities whereas with CRR it has to be only cash. CRR is maintained in cash form with RBI, whereas SLR is maintained in liquid form with banks

Techniques of Monetary Control

6. Credit rationing: Credit rationing a situation in which lenders are unwilling to advance additional funds to borrowers at the prevailing market . 7.Moral suasion: RBI usually writes letters and holds discussions with the banks about the trends in the economy in general and in money, credit and finance in particular. The RBI also informs the measures to be taken from taken from time to time in the light of national objectives.

Techniques of Monetary Control

8.Selective Credit Control: Seasonal nature and inflation have made selective credit controls most actively used technique of monetary control in India. These controls are used to reduce the supply of credit in certain directions and to encourage credit in certain directions. Fixation of margin requirements 9. Credit Authorization Scheme: Regulate credit to control inflation Enforce financial discipline on large borrowers End use credit is genuine Applicable to all banks

Techniques of Monetary Control

10. Fixation of credit norms: Issuing guidelines to banks in order to exercise monetary control Micro level inventory norms New methods of bank lending Reduce dependence of industrial borrowers on bank financing 11. Credit Planning: Regulating the expansion of funds at the desired level and direct flows of funds to desired sectors, areas and purposes. Realistic annual credit budget incorporating estimates of volume and growth of deposits of other resources and demand for credit Submitted to RBI

CREDIT REGULATOR
Credit creation Bank is the factory of credit Credit creation- Expansion of bank deposits Take deposits from public and repay on demand Deposits are lent out to the businessmen for certain

periods. On the basis of small reserves banks can create a huge superstructure of credit known as credit creation by banks. Deposit is created out of loan ?

Process of credit creation

Receive deposits from public 2. Keep certain portion of these deposits in cash 3. Remaining amount is lended
1.

LIMITATIONS ON CREDIT CREATION BY BANKS: 1. Cash deposit 2. Ratio of reserve to deposits 3. Desire of people to hold cash 4. Business conditions 5. Credit control

Supervision of banking sector

RBI has power to supervise and control commercial

and co-operative banks RBI issues licenses Prescribe minimum requirements regarding paid up capital and reserves Cash and other reserves, inspect the working habits of other banks Conduct ad hoc investigations from time to time into complaints, irregularities and frauds in the banks Control appointment, reappointment and termination of the chairman and chief executive officers of the private sector banks.