CONTENTS

EXECUTIVE SUMMARY OBJECTIVE OF STUDY QUALITATIVE CREDIT CONTROL Objective of Credit Control Need For Credit Control Method Of Credit Control OVERVIEW OF RBI Nationalization of RBI Management And Structure ROLE OF RBI IN INDIAN FINANACIAL SYSTEM Role of RBI in inflation control MONETARY POLICY Monetary Regulation Function Operation of Monetary Policy Quantitative method of credit Control Qualitative method of credit Control UNDERSTANDING THE CONCEPT AND THE RELEVANCE OF CREDIT POLICY Role Of RBI Channels Of Management

RBIS ANNEXURE REGARDING QUALITATIVE METHOD OF CREDIT CONTROL FIRST QUARTER REVIEW 2012-2013 CONCLUSION BIBLIOGARPHY

EXECUTIVE SUMMARY
This project highlights all the information regarding the RBIs monetary policies and their instruments. I have focused mainly on qualitative credit method of RBI although I have mentioned other method also as I thought necessity of my project. First I had given what exactly is credit control, need & objective for credit control. The following project also contains RBIS annexure regarding qualitative credit method for banks and RBIs 1st Quarter Review of Monetary Policy 2012-2013. There is introduction given below on what exactly is Selective Credit control: Qualitative Method By Quality we mean the uses to which bank credit is directed. For example- the Bank may feel that spectators or the big capitalists are getting a disproportionately large share in the total credit, causing various disturbances and inequality in the economy, while the small-scale industries, consumer goods industries and agriculture are starved of credit. Correcting this type of discrepancy is a matter of Qualitative Credit Control. Qualitative Method controls the manner of channelizing of cash and credit in the economy. It is a selective method of control as it restricts credit for certain section where as expands for the other known as the priority sector depending on the situation.

OBJECTIVE OF STUDY
To know exactly what is the qualitative credit method To study how RBI control the banks regarding credit supply and formulation of credit control method To study the need and objective of qualititave credit control method. To understand the monetary policies and their instruments

QUALITATIVE CREDIT CONTROL

One of the more pleasant aspects of the latest quarterly Monetary Policy Review is the attempt by the Reserve Bank of India to be as predictable as possible, or at least less disruptive than it has been before. The notion that some elements of a tighter money policy would be announced was pretty much to be expected. While raising repo rates by 25 basis points and leaving other indicators of liquidity unchanged, the RBI Governor, Dr Y. V. Reddy, has tried to play both policeman and purveyor of optimism, the former by raising marginally the cost of capital for banks through the repo rate hike, and the latter by selectively pushing up the provisioning norms for certain categories of borrowers hoping thereby to catch inflation by the scruff and pull it back within the 5.5 per cent limit. Lest the markets think the RBI is a killjoy, in its combat against inflation, the Governor has raised the bar on growth expectations jettisoning his earlier forecast and the prognosis of North Block for a 9 per cent GDP target for this waning fiscal. He has tried therefore to be all things to all men, in the bargain creating a dilemma that may not augur well for the economy in the medium to long term. The basic problem is that the RBI cannot hope to both fight inflation and propel growth to the levels it wants with the measures it has so far set in motion. Controls on credit expansion for select categories with inflation potential capital markets and commercial real-estate through higher provisioning may choke demand only if it is sensitive to the cost of credit. But in a booming economy, higher costs can be transmitted down the line; witness the rising housing loan rates. In many a high-flying sector banks may, therefore, still find takers for expensive credit. Regardless of the RBI's marginal increase in repo rates, the perception of a tighter money regime will push up interest rates all around, thus contributing to the price rise instead of combating it. Given the nature of inflation, currently at a two-year high, the task of fighting it lies with New Delhi. The Government must put together a gamut of measures to remove the supply bottlenecks that are causing the price rise. The RBI admits that the growth in agriculture has "not been sanguine" with the declining output in major cereals pushing up prices. Focusing its Monetary Policy weapons on "credit quality" and, therefore, the health of the banking system, the RBI has prudently left this initiative to New Delhi.

OBJECTIVE OF CREDIT CONTROL

The central bank makes efforts to control the expansion or contraction of credit in order to keep it at the required level with a view to achieving the following ends. 1. To save Gold Reserves: The central bank adopts various measures of credit control to safe guard the gold reserves against internal and external drains. 2. To achieve stability in the Price level: Frequently changes in prices adversely affect the economy. Inflationary and deflationary trends need to be prevented. This can be achieved by adopting a judicious of credit control. 3. To achieve stability in the Foreign Exchange Rate: Another objective of credit control is to achieve the stability of foreign exchange rate. If the foreign exchange rate is stabilized, it indicates the stable economic conditions of the country. 4. To meet Business Needs: According to Burgess, one of the important objectives of credit control is the Adjustment of the volume of credit to the volume of Business credit is needed to meet the requirements of trade an industry. So by controlling credit central bank can meet the requirements of business.

NEED FOR CREDIT CONTROL

Controlling credit in the Economy is amongst the most important functions of the Reserve Bank of India. The basic and important needs of Credit Control in the economy are

To encourage the overall growth of the priority sector i.e. those sectors of the economy which is recognized by the government as prioritized depending upon their economic condition or government interest. These sectors broadly totals to around 15 in number. To keep a check over the channelization of credit so that credit is not delivered for undesirable purposes. To achieve the objective of controlling Inflation as well as Deflation. To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors. To develop the economy.

METHOD OF CREDIT CONTROL

There are two method of credit control:

1. Bank Rate Policy 2. Open Market Operations 3. Change in Reserve Ratios 4. Credit Rationing

1. Direct Action 2. Moral persuasion 3. Legislation 4. Publicity

OVERVIEW OF RBI
The Reserve Bank of India is the central bank of India, and 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 Kolkata but was permanently moved to Mumbai in 1937. Though originally privately owned, the RBI has been fully owned by the Government of India since nationalization in 1949. Duvvuri Subbarao who succeeded Yaga Venugopal Reddy on September 2, 2008 is the current Governor of RBI. The Reserve Bank of India was set up on the recommendations of the Hilton Young Commission. The commission submitted its report in the year 1926, though the bank was not set up for nine years. 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. It has 22 regional offices, most of them in state capitals. RBI was started with a paid up share capital of 5 crore.on established it took over the function of management of currency from government of India and power of credit control from imperial bank of india. Preamble 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.

Nationalization of RBI:
With a view to have a cordinated regulation of Indian banking Indian Banking Act was passed in march 1949. To make RBI more powerful the Govt. of India nationalised RBI on January 1, 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks The Reserve Bank of India was nationalized with effect from 1st January, 1949 on the basis of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. All shares in the capital of the Bank were deemed transferred to the Central Government on payment of a suitable compensation. The image is a newspaper clipping giving the views of Governor CD Deshmukh, prior to nationalization.

MANAGEMENT AND STRUCTURE

The Governor is the Reserve Banks chief executive. The Governor supervises and directs the affairs and business of the Reserve Bank. The management team also includes Deputy Governors and Executive Directors.

Anand Sinha,Dy.Governor

Dr.Subrin Gokaran,Dy. Governor

Dr.Kc Chakraborty,Dy.Governor

H.R.Khan,Dy. Governor

Dr. D. Subbaroa,Gov ernor

EXECUTIVE DIRECTORS: 1.Shri V.K.Sharma 2.Shri V.S.Das 3. Shri G. Gopalakrishna 4. Shri D. K. Mohanty 5.Shri S. Karuppasamy 6.Shri R. Gandhi 7.Shri P. Vijaya Bhaskar 8.Shri B. Mahapatra 9.Shri G. Padmanabhan

ROLE OF RBI IN INDIAN FINANCIAL SYSTEM

The reserve Bank of India is the central bank of India. Therefore, it performs all those functions which are essentially being performed by the central bank of a country. The important functions of the reserve Bank of India are as follows: Issue of Notes: The reserve Bank of India enjoys monopoly in the issue of currency notes as central Bank of the country. All the currency notes except one rupee note are issued by RBI. One rupee note and all coins of small magnitude are issued by the Government of India and are circulated through the Reserve Bank of India. The RBI Act permits RBI to issue notes in the denominations of rupees 2,5,10,20,50,100,500,1000,5000,10,000. Although the RBI had issued all these denominations, but at present notes of all denominations except 5,000 and 10,000 are being issued in circulation. The RBI has established a separate department for this purpose known as issuing department. The basis of note issue is minimum Reserve system. The RBI has been issuing currency notes on the principle of banking system, in which cent per gold/precious metals reserves are not required. In this system RBI have to maintain a minimum reserve of Rs. 200 crore as security against note issue. In which a minimum reserve of Rs. 115 crore has been maintain in gold and remaining Rs. 85 crore reserve in foreign securities. The value of gold reserve held by the issue department has not been less than Rs. 85 crore at the time of an emergency.

Banker, Agent and advisor to the Government: The reserve bank of India acts as the banker, agent and advisor to the Government of India. RBI as banker: It accepts payments for the account of the union and state governments and also makes payments on behalf of the Government. On behalf of the Government, RBI carries remittances, managing foreign exchange reserves and public debts and other banking operation. It also makes way and means advances to the central and state Government repayable within three months. The reserve bank of India carries out agency functions of the Government as the commercial banks carries out on behalf of their customers. RBI as Agent: The state Bank of India works as an agent of the RBI where its offices do not exist. The RBI does not charge any fee for its operation from the Central and state Governments. It also does not pay any interest on the deposits of the central and state Government accounts. The reserve Bank,

as the agent of the Government, issues Government securities to the public and collects money on behalf of the Government. It also manages public debts to the central and state Governments. The RBI pays interest on the securities and redeemed at the time of maturity and also maintains accounts of this effect. The RBI also issues treasury bills of Government for three months.

RBI as advisor: The RBI is also authorized to make to the central and state Government, ways and means advances which are repayable in three months. It not only advises Govt. on all monetary and banking issues but also on a wide range of economic issues including those in the field of planning and resource mobilization. It also manages foreign exchange reserves to meet the important requirement. Thus, RBI acts as the custodian public debts. It also advises Govt. in the matters of agriculture credit, cooperation, banking and credit and investment of funds. WAMA: The issue, management and administration of the public debt of the Government is a major function of the RBI for which it charges a commission. The objective of the debt management policy is to raise resources from the market at the minimum cost, while containing the refinance risk and maintaining consistency with the monetary policy objectives, to bridge temporary mismatches in the cash flows (i.e. temporary gaps between receipts and payments), the RBI provides Ways and Means Advances (WAMAs). The maximum maturity period of these advances is three months. The WAMAs to the state Governments are of three types: Normal advances, that is advances without any collateral security; Secured advances, which are secured against the pledge of central Governments securities and Special advances granted by the RBI at its discretion.

In addition to WAMAs, the state government make heavy use of overdrafts from the RBI, in excess of the credit limits (WAMAs) granted by the RBI. Overdrafts are, in a way, unauthorized WAMAs drawn by the state governments, on the RBI. In fact, the management of these overdrafts is on of the major responsibilities of the RBI these days. The interest charged by the RBI on the WAMAs is related to a graduated scale of interest

based on its duration. Overdrafts upto 7 days are charged at the bank rate and an interest of 3 per cent above the bank rate is charged from the 8th day onwards.

Bankers Bank: As an apex bank the RBI acts as banker of the banks and lender of the last resort. Under the RBI Act, the bank has been vested with extensive powers of supervision and control over all scheduled commercial and cooperative banks. Once the name of a bank is incorporated in the second schedule of the RBI Act, it becomes entitled to refinance facility from the RBI. Under the act, every schedule bank is required to keep with the RBI a cash balance of 5% of its total demand and time liabilities as cash reserve ratio. Now, CRR has reduced from 5% to 4.75 with effect from 16 November, 2002. The cash reserve ratio may be between 3 to 15% as decided by the Reserve Bank. This provision is also applicable on non-scheduled banks. This provision of cash reserve enables the Reserve Bank to control credit which is created by commercial banks. In case of need of funds, commercial banks can borrow funds from Reserve Bank on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting their bills of exchange. Therefore, commercial banks always look upon the Reserve Bank at the Time of financial crisis Custodian of Foreign Exchange Reserves: One of the important functions performed by the Reserve Bank is that of external value of the rupee. Apart from adopting appropriate monetary polices for the economic stability in the country and thereby exchange stability in the long-term, the Reserve Bank has to ensure that the normal short-term fluctuations in trade do not affect the exchange rate.

. Regulation of Banking System: The prime duty of the reserve Bank is to regulate the banking system of our country in such a way that the people of the country can trust in the banking Up to perform its duty. The Reserve Bank has following powers in this regard: Licensing:

According to the section 22 of the Banking Regulation Act, every bank has to obtain license from the Reserve Bank. The Reserve Bank issues such license only to those banks which fulfill

condition of the bank should be strong. The RBI is also empowered to cancel the license granted to a bank works against the interests of the depositors. Management:

Section 10 of the Banking Regulation Act embowered the Reserve Bank to change manager or director of any bank if it considers it necessary or desirable. Branch Expansion:

Section 23 requires every bank to take prior permission from Reserve Bank to open new places of business in India or ro change the location of an existing place of business in India or abroad. Power of inspection of Bank:

Under Section 35, the Reserve Bank may inspect any bank and its books and its books and accounts either at its own initiative or at the instance of the Central Government. If, on the basis of the inspection report submitted by the Reserve Bank Central Government is of the opinion that the affairs of the bank are being conducted to the detriment of the interests of depositors, it may direct to the Reserve Bank to apply for the winding up of such bank. Power to issue Directions:

Section 35(A) of IBR Act confers powers to RBI to issue direction or to prevent the affairs of the being conducted in manner detriment to the interests of the depositors or in a manner prejudicial to the interests of the bank or to secure proper management of the bank. Section 36 confers powers on the RBI to caution or prohibit banks against entering into any particular transaction and generally give advice to any bank. It may pass orders requiring the bank to carry out the specified instructions. In order to develop a strong banking structure in the country the RBI promotes amalgamation or merger of weak banks so that they can develop as a strong bank. Section 38 of the Act empowered RBI to request to High Court to windup the bank which has no hopes of improvement. Clearing House Functions The RBI operates clearing houses to settle banking transactions. The RBI manages 14 major clearing houses of the country situated in different major cities. The State Bank of India and its associates look after clearing houses function in other parts of the country as an agent of RBI.

Credit Control Credit control is a very important function of RBI as the Central Bank of India. For smooth functioning of the economy RBI control credit through quantitative and qualitative methods. Thus, the RBI exercise control over the credit granted by the commercial bank. The reserve Bank is the most appropriate body to control the creation of credit in view if its functions as the bank of note issue and the custodian of cash reserves of the member banks.

Other Functions The RBI performs following other functions: Agriculture Credit:

All matters relating to agriculture credit are looked after by RBI before the establishment of NABARD in 1982. Now all functions relating to agriculture and rural development are performed by NABARD.

Industrial Finance:

The RBI has contributed in the share capital of industrial finance institutions such as Industrial Finance Corporation of India, Industrial Development Bank of India, State Finance Corporations etc. Thus RBI indirectly contributes in the field of industrial finance. Publication of Data:

The RBI publishes statistics regarding money, price, finance etc, in its periodicals. This provides valuable information for Govt., business and industries. This information is helpful to take decisions. The important publications of RBI are the Reserve Bank of India Annual Report, currency and finance, trends and progress of Banking etc. At present, there are more than 100 publications of RBI. Banking Education and Training:

The RBI has been organizing various educations and training programs for bank employees and officers. Banker Training College Mumbai has been setup by RBI for the training of Bank officers. Other important training institutes such as College of Agriculture Banking (Pune), Reserve Bank staff Training College (Chennai) etc. had been setup by the RBI. RBI had also setup regional training centers at Mumbai, Kolkata, Chennai and Delhi. Remitting Facility:

Reserve Bank provides remitting facilities to the central Government, state Government and semi-Government institutions free of cost. It also provides this facility to cooperative banks free of cost. Conversion of currency:

The RBI converts spoiled currency in to fresh currency. It also provides facilities to convert currency notes into small denominating coins. To accept Deposits:

The RBI accept deposits from Central and state Governments institution and individual persons without paying interest.

Transactions with international institutions:

All international economic transactions are being made through RBI. RBI opens its accounts in the central bank of member countries of IMF. It also deals with IMF, World Bank and other international financial institutions. Transactions in precious metals:

In order to fulfill its obligations, RBI buys and sells precious metals, gold coins etc. RBI can borrow funds by mortgaging these precious metals. Expansion of banking facilities:

RBI has played an important role in expansion of banking facilities in the rural areas of the country. At the end of June, 2001, there are 65,931 bank branches are situated in country, out of which more than half of the branches are situated in rural areas. At the end of 2000, on an average there were only one bank branches at a population of 5,000 in the country. Supply of Development Finance:

The RBI provides development finance for the different parts of the economy. It leads economic development of the country as a whole. RBI Financial Fraud monitoring: The system of internal control and follow-up in respect of cases of large frauds of Rs.1 crore and above reported to the RBI is reviewed periodically. The emphasis on house keeping aspects has helped in detecting large frauds and instituting fraud prevention measures.

Banks are cautioned about the details of individuals/companies/firms/ proprietary concerns involved in perpetration of frauds, furnishing details of their directors/partners /guarantors/associates. In addition, modus operandi of new types of frauds is also circulated 15 among banks and financial institutions, to put them on guard. RBI also conducts special scrutiny in respect of large value frauds at the branch/controlling office level to find out lapses contributing to the frauds. All cases of frauds involving large amounts are analyzed to identify the contributory factors and taken up with the banks concerned for remedial measures. The aspects relating to recovery, staff accountability and improvement in internal controls are also pursued with the banks which are advised in the process to report the fraud cases to Police/CBI, if not already done. Detailed instructions have been issued by Reserve Bank of India towards streamlining fraud prevention and control/monitoring system. Role of RBI in Inflation Control Inflation arises when the demand increases and there is a shortage of supply. So by anyways if government is able to reduce the money in the hands of the people it will be able to reduce the demand as the purchasing power of the people will reduce. There are two policies in the hands of the RBI. Monetary Policy: It includes the interest rates. When the bank increases the interest rates than there is reduction in the borrowers and people try to save more as the rate of interest has increased. Fiscal Policy: It is related to direct taxes and government spending. When direct taxes increased and government spending increased than the disposable income of the people reduces and hence the demand reduces.

1949-1975: Since 1949, India ran into trade deficits that increased in magnitude in the 1960s. The Government of India had a budget deficit problem and therefore could not borrow money from abroad or from the private sector, which itself had a negative savings rate. As a result, the government issued bonds to the RBI, which increased the money supply, leading to inflation. In 1966, foreign aid, which was hitherto a key factor in preventing devaluation of the rupee, was finally cut off and India was told it had to liberalize its restrictions on trade before foreign aid would again materialize. The response was the politically unpopular step of devaluation accompanied by liberalization.

The Indo-Pakistani War of 1965 led the US and other countries friendly towards Pakistan to withdraw foreign aid to India, which further necessitated devaluation. Defense spending in 1965/1966 was 24.06% of total expenditure, the highest in the period from 1965 to 1989. This, accompanied by the drought of 1965/1966, led to a severe devaluation of the rupee. Current GDP per capita grew 33% in the Sixties reaching a peak growth of 142% in the Seventies, decelerating sharply back to 41% in the Eighties and 20% in the Nineties. Some other excuses that were generally offered were - War with China in 1962 and with Pakistan in 1965 and 1971; a flood of refugees from East Pakistan in 1971; droughts in 1965, 1966, 1971, and 1972; currency devaluation in 1966; and the first world oil crisis, in 1973-1974, all jolted the economy. 1991 Economic crisis: In 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having balance of payments problems since 1985, and by the end of 1990, it found itself in serious economic trouble. The government was close to default and its foreign exchange reserves had dried up to the point that India could barely finance three weeks worth of imports. As in 1966, India faced high inflation and large government budget deficits. This led the government to devalue the rupee. At the end of 1999, the Indian Rupee was devalued considerably.

Revaluation In the period 20002007, the Rupee stopped declining and stabilized ranging between 1 USD = INR 4448. In recent times, the Indian Rupee had begun to gain value and by 2007 traded around 39 Rs to 1 US dollar, on sustained foreign investment flows into the country. This posed problems for major exporters and BPO firms located in the country. The trend has reversed lately with the 2008 financial crisis.

The changes in the relative value of the rupee has reflected that of most currencies, eg the British Pound, which had gained value against the dollar and then has lost value again with the recession of 2008. RBI takes measures to control inflation in 2008 Inflation has soared to 8.75 per cent for the week ended May 31. It is set to cross the 9 per cent mark when the official data is released on June 20, which reflect the impact of hike in fuel prices, according to analysts. As part of inflation control measures, the Reserve Bank of India had last week increased the repo rate to 8 per cent, prompting the banks to consider a rise in lending rates for consumers and industries. The continuous rise in inflation has forced the banks to increase interest rates which analyst feel could further add to the cost factor. However, the monetary measures are aimed at cooling the high demand which is pushing up prices. Most of the banks have the prime lending rates pegged at around 13 %. Besides raising the shortterm lending rate (repo rate), RBI had also sucked over Rs 27,000 crore out of the economy by increasing the Cash Reserve Ratio by 0.75 per cent in three phases.

MONETARY POLICY
India is the management of a nation's money supply to achieve economic goals by a central bank or currency board. Monetary policy objectives can include control of inflation, control of exchange rates, or even simply economic stability. Monetary policy is contrasted with fiscal policy, which aims to achieve economic goals through taxation and government expenditure. The Federal Reserve, or Fed, handles monetary policy in the United States. The Fed controls the money supply through open market operations, and also sets interest rates between banks and reserve requirements. Tight monetary policy, also called contractionary monetary policy, tends to curb inflation by contracting the money supply. Easy monetary policy, also called expansionary monetary policy, tends to encourage growth by expanding the money supply. These factors include - money supply, interest rates and the inflation. In banking and economic terms money supply is referred to as M3 - which indicates the level (stock) of legal currency in the economy. Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it. These would be banks, financial institutions, non-banking financial institutions, Nidhis and primary dealers (money markets) and dealers in the foreign exchange (forex) market

When is the Monetary Policy announced?

Historically, the Monetary Policy is announced twice a year - a slack season policy (AprilSeptember) and a busy season policy (October-March) in accordance with agricultural cycles. These cycles also coincide with the halves of the financial year. Initially, the Reserve Bank of India announced all its monetary measures twice a year in the Monetary and Credit Policy. The Monetary Policy has become dynamic in nature as RBI reserves its right to alter it from time to time, depending on the state of the economy

Monetary regulations
The main function of the Reserve Bank of India, as of all the central banks, is to formulate and administer monetary policy. Monetary policy refers to the use of instruments with the purview of the central bank to influence the level of aggregate demand for goods and services. Monetary policy is the twin objective of price and growth. As part of the monetary policy, money supply is sought to be influenced because it will have effect on output and prices. With the economic and the financial liberalisation and deregulation measures initiated since early 1990s, the framework of the monetary policy formulation and implementation has been undergoing significant changes, indirect tools gaining prominence over direct instruments along with a series of steps for the development and integrity of financial markets. The Reserve Bank of India thus seeks to influence the level of money through a continuation of measures that include interest rates as well as open market operations and other measures that alter the Bank reserves

MONETARY POLICY FUNCTIONS

Monetary policy functions form the core of central banking functions and constitute the key functions of almost all the central banks. Of these functions, currency management and maintenance of external value of currency were the predominant concerns of central banks in the early years of central banking .the explicit concern for price stability is of relatively later origin.

. 1) Maintaining internal value of the currency

Instituting a medium of exchange is one of the oldest functions assigned to central banks. Arising from the core function is the monetary policy function of keeping inflation low in order to maintain the value of the medium of exchange over time. This function is still very relevant to modern central banks as can be seen from the widespread adoption of inflation targeting framework.

Domestic policy objectives have been centered on price stability goals for years and even today have remained the main pre-occupation of central banks. There have been often a conflict between functions of central bank; for instance, maintaining the value of currency conflicted with its functions of being a banker to the government, especially in developing country. These central banks have to manage a very level of public debts and often used inflation tax that undermined their price stability objective. There is increasing realizing that printing more money does not help in raising growth rates. In fact, a stable price level has become a pre-requisite of growth and trade. Accordingly, the maintenance of price stability through the conduct of monetary policy has become the prime objective of central bank. In a market economy, the central may have the option of using market-based instruments for conduct of monetary policy. It may choose intermediate targets such as interest rates, exchange rates and monetary aggregates.

2) Maintaining external value of the currency Central banks in many economies consider exchange rate management as a crucial function. Exchange rate management was the core concern of the traditional central banks even in the 17 th century. During the gold standards, the exchange rate was determined more or less automatically by the mechanism of specie flow. It ensured that the value of the currency rose with an increase in gold reserves and decreased with a decrease in the reserves. The role of central bank in managing the exchange rate cannot be underplayed. The rationale underlying the management of the exchange rate by the central bank has varied over time. There are various patterns to the

management of the exchange rate. Some central banks keep exchange rates depressed while others target it a particular point or within a range

OPERATIONS OF MONETARY POLICY

Instruments
The RBI has multiple instruments at its command such as repo and reverse repo rates, cash reserve ratio (CRR), statutory liquidity ratio, open market operations, including the market stabilization schemes (MSS) and the liquidity adjustment facility (LAF), special market operations, and sector- specific liquidity facilities. In addition, the RBI also uses other operational tools to modulate flow of credit to certain sectors consistent with financial stability. The availability of multiple instruments and flexible use of these instruments in the implementation of monetary policy has enabled the RBI to modulate the liquidity and interest rate conditions admit uncertain global macroeconomics conditions. The important function of RBI is to control money and credit in the country. The instruments of monetary policy operated by the RBI may be classified into two categories (i) (ii) Quantitative measures which affect the total money supply and credit Qualitative or the selective measures which affect the allocation of bank credit among competing uses and users

Quantitative credit control

1) Bank rate: As the lender of the last resort, the RBI helps the commercial banks in temporary need of cash when other sources of raising cash are exhausted. The RBI provides credit to banks by rediscounting eligible bills of exchange and by making advances against eligible securities such as government securities. The lending rate for these advances by the RBI is called the BANK RATE which is a traditional weapon to control money supply. An increase in the bank rate would discourage commercial banks to borrow from the RBI and a corresponding increase in the lending rate of commercial banks to general public would decrease public borrowings from the bank.

2) Reserve requirements: Reserve requirements are used by RBI to control the credit creation capacity of banks. Every commercial bank needs to maintain a certain proportion of its assets in the form of reserves dash reserve ratio (CRR) and statutory liquidity ratio (SLR) are the two reserve requirements imposed by the RBI. When the TBI changes the reserve requirements, its influences that capacity of banks to lend and create credit. During inflation the reserve requirements are raised and during recession they are lowered.

a) CASH RESERVE RATIO (CRR):Scheduled banks in India are required to hold cash reserves, called cash reserve ratio (CRR), with the RBI. Increase/decrease in CRR is used by the RBI as an instrument of monetary control, particularly to mop up excess increase in the supply of money this power was given to RBI in 1956.

b) STATUTORY LIQUIDITY RATIO:

Apart from the CRR, the banks in India are also subject to statutory liquidity requirement. Under this requirement, commercial banks along with other financial institutions are required under law to invest prescribed minimum proportions of their total assets/liabilities in government securities and other approved securities. The underlying philosophy of this provision is to allocate total bank credit between the government and the rest of the economy. The assurance of a certain minimum share of bank credit to the government affects the borrowings of the government from the RBI and hence serves as a tool of quantitative monetary control. The SLR provisions have created a captive market for government securities which increases automatically with the growth in the liabilities of the banks. Moreover, it has kept the cost of the debt to the government low in view of the generally low rate of interest on government securities.

3) Open market operations: The RBI can enter the money market for the purpose or sale of government securities on its own account. Every open market purchase of the RBI increase primary money by equal amount while every sale decreases it. As regards their advantages, open market operations are highly flexible. Easily reversible in time, their effect on money supply is immediate, and they do not carry announcement effect as in the case of changes in the bank rate. Open market operations, consider very effective in developed countries, are not of much importance in India in view of captive nature of the market for government bonds. For example, the treasure bill market is limited largely to the RBI itself and scheduled commercial banks which are required under law to invest minimum proportion of their total liabilities in government securities. The private dealers In government securities are few and far between.

4) Repo And Reverse Repo Rates:

The bank rate as a credit control policy instrument is losing its importance in recent years. At present, the repo and the reverse repo rates are becoming important in

determining interest rate trends. Repo (sale and repurchase agreement) is a swap deal involving the immediate sale of securities and simultaneous purchase of those securities at a future date, at a predetermined price. Such swap deals take place between the RBI on one hand, and banks and other financial institutions, on the other

b) SELECTIVE OR QUALITATIVE METHODS

The RBI has the power to direct banks to meet their obligation through selective methods of credit control. These methods affect particular sections of the economy as the influence distribution and direction of credit. The following are some of the selective methods followed by RBI:-

1) Margin requirements: A loan is sanctioned against a collateral security. Margin is that proportion of value of the security against which loan is not given higher the margin, lesser will be the loan sanctioned in India, bank loans are often used for speculative and unproductive purposes. To prevent this, the RBI has relied on the method of minimum requirements.

2) Discriminatory rates of interest:Under this method, different rates of interest are charged for different use of credit. RBI has relied on this method to direct resources to priority sector, export promotion and prevent speculative use of bank finance. This method has been used along with margin requirements in to prevent hoarding essential agricultural commodities. 3) Ceiling on credit:- Under this scheme, the RBI imposes limits on the amount of credit to different sectors. 4) Direct action:- RBI may use strict disciplinary actions against banks that fail to follow its directives. These may be in the form of cancellation of licenses , refusal of rediscounting facility and imposition of penalty. These methods are very harsh and are therefore rarely carried out by RBI. 5) Moral suasion:- though moral suasion (discussions, suggestions and advise), the RBI can influence the investment and credit policies of the commercial banks. For example, it can ask the commercial banks to invest a larger proportion, than required, of their assets

in government securities. Similarly, it canadvice them regarding the allocation of credit to the private sector.

Operating Procedures of Monetary Policy

Now two new initiatives are one structural and the other on policy review and communication.

(i)

Liquidity adjustment facility(LAF):LAF, introduced in June 2000, allows the RBI to manage market liquidity on a daily basis and also transmit interest rate signals to the market. The LAF, initially recommended by the committee on banking sector reforms, was introduced in the stages in consonance with the level of market development and technological advances in payment and settlement systems. The first challenge was to combine the various sources of liquidity available from the RBI into a single comprehensive window, with a common price. An interim liquidity adjustment facility (ILAF), introduced in April 1999 as a mechanism for liquidity management through a repo operation, export credit refinance facilities and collateralized lending facilities support by open market operations at set rates of interest, was upgraded into a full- fledge LAF. Most of the alternative provision of primary liquidity has been gradually phased out and even though export credit refinance is still available, it is linked to the repo rate since March 2004. Accordingly, the LAF has now emerged as the principal operating instrument of monetary policy.

(ii)

Market stabilization scheme:

Pursuant to the recommendations of the Internal Working Group on LAF as well as the Internal Working Group on Instruments for Sterilisation, a market Stabilisation Scheme (MSS) was introduced in April 2004. The issurance of securities under the MSS enables the Reserve Bank to improve liquidity management in the system\, to

maintain stability in the foreign exchange market and to conduct monetary policy in accordance with the stated objectives.

Monetary policy tools

Monetary base Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total amount of money circulating in the economy. A central bank can use open market operations to change the monetary base. The central bank would buy/sell bonds in exchange for hard currency. When the central bank disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the monetary base. Reserve requirements The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve changes the availability of loanable funds. This acts as a change in the money supply. Central banks typically do not change the reserve requirements often because it creates very volatile changes in the money supply due to the lending multiplier. Discount window lending Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. By calling in existing loans or extending new loans, the monetary authority can directly change the size of the money supply. Interest rates

The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates. Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market. One cannot set independent targets for both the monetary base and the interest rate because they are both modified by a single tool open market operations; one must choose which one to control. Currency board A currency board is a monetary arrangement that pegs the monetary base of one country to another, the anchor nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is backed by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign currency must be held in reserves with the currency board. This limits the possibility for the local monetary authority to inflate or pursue other objectives. The principal rationales behind a currency board are three-fold: 1. To import monetary credibility of the anchor nation; 2. To maintain a fixed exchange rate with the anchor nation; 3. To establish credibility with the exchange rate (the currency board arrangement is the hardest form of fixed exchange rates outside of dollarization)

UNDERSTANDING THE CONCEPT AND THE RELEVANCE OF THE CREDIT POLICY

Definition The regulation of the money supply and interest rates by a central bank, such as the Reserve Bank of India and Federal Reserve Board in the U.S., in order to control inflation and stabilize currency. Monetary policy is one the ways the government can impact the economy. By impacting the effective cost of money, the Federal Reserve can affect the amount of money that is spent by consumers and businesses. It regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. Role of Reserve Bank of India: Relevance of Monetary and Credit Policy Historically, the Monetary Policy is announced twice a year - a slack season policy (AprilSeptember) and a busy season policy (October-March) in accordance with agricultural cycles. These cycles also coincide with the halves of the financial year. However, with the share of credit to agriculture coming down and credit towards the industry being granted whole year around, the RBI since 1998-99 has moved in for just one policy in April-end. However a review of the policy does take place later in the year. The monetary and credit policy is half yearly affair of the Reserve Bank of India Traditionally, RBI, in this monetary and credit policy, announces structural and monetary measures to improve the functioning of the banking system and also functioning of the economy as whole. There are some key sets of indicators to ensure stability in the economy. These include money supply, interest rates, and inflation, amongst others. The RBI uses various tools to regulate or influence these indicators. The policy also provides a platform for the RBI to announce norms for financial

entities including banks, financial institutions (FIs), non-banking financial companies (NFBCs), nidhis, primary dealers (PDs) in the money market, authorized dealers in the foreign exchange markets, which are regulated by the apex bank. The monetary authority uses various instruments to control the supply of money. These instruments are known as instruments of credit control. These instruments can be divided into two categories; quantitative and qualitative credit control, viz, bank rate policy, open market operation and changes in statutory reserve requirements. These methods are used to control the quantum methods of credit control are also known as selective credit control methods. These include credit rationing, direct action, changes in margin requirements moral suasion etc. The credit policy gives indication about the economy and the banking system in the country and it also provides an opportunity for the RBI to spell out on overview on the economy. The RBI now prefers to announce monetary measures as and when the situation demands. Channels of Management: There are four main ?channels?, which the RBI looks at:

Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates).

Interest rate channel. Exchange rate channel (linked to the currency). Asset price.

RBIS ANNEXURE-3 REGARDING SELECTIVE CREDIT CONTROL

Other Operational Stipulations 1. Banks should not allow the customers dealing in Selective Credit Control commodities any credit facilities which would directly or indirectly defeat the purpose of the directive. Advances against book debts/receivables and collateral securities like LIC policies, shares and stocks and real estate should not be considered in favour of such borrowers. 2. Although advances against security of or by way of purchase of demand documentary bills drawn in connection with the movement of the Selective Credit Control commodities are exempted, the bank should ensure that the bills offered have arisen out of actual movement of goods by verifying the relative invoices as also the receipts issued by transport operators, etc. 3. Usance bills arising out of sale of Selective Credit Control commodities should not be discounted except to the extent specifically permitted in the directives issued. 4. Clean Telegraphic Transfer Purchase facility may be allowed to a reasonable extent on certain conditions specified in the directives. 5. Priority sector advances are also covered by/under Selective Credit Control directives. 6. Where credit limits have been sanctioned against the security of more than one commodity and/or any other type of security, the credit limits against each commodity should be segregated and the restrictions contained in the directives made applicable to each of such segregated limit. 7. Banks are free to determine the rate of interest in respect of advances covered under Selective Credit Control directives. 8. Banks could grant loans to borrowers dealing in Selective Credit Control commodities, provided the term loans are used for the purpose of acquiring block assets like plant & machinery and normal appraisal and other criteria are followed by the banks. 9. Reserve Bank of India authorises limits to the Food Corporation of India and State Governments for procurement of foodgrains; at prices fixed by the Government of India, for the Central Pool and for the distribution of the same under the Public Distribution System (PDS). As the limits are authorised without margin, credit cannot be drawn against credit sales, book debts, Government subsidies, etc. 10. Banks should refer to the directives on Selective Credit Control measures issued by RBI from time to time.

FIRST QUARTER REVIEW OF MONETARY POLICY 2012-13

Monetary Measures On the basis of the current assessment and in line with policy stance outlined in Section III, the Reserve Bank announces the following policy measures. Repo Rate It has been decided to:

reduce the repo rate under the liquidity adjustment facility (LAF) by 50 basis points from 8.5 per cent to 8.0 per cent with immediate effect.

Reverse Repo Rate The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, stands adjusted to 7.0 per cent with immediate effect. Marginal Standing Facility . In order to provide greater liquidity cushion, it has been decided to:

raise the borrowing limit of scheduled commercial banks under the marginal standing facility (MSF) from 1 per cent to 2 per cent of their net demand and time liabilities (NDTL) outstanding at the end of second preceding fortnight with immediate effect.

Banks can continue to access the MSF even if they have excess statutory liquidity ratio (SLR) holdings, as hitherto. The MSF rate, determined with a spread of 100 basis points above the repo rate, stands adjusted to 9.0 per cent with immediate effect. Bank Rate The Bank Rate stands adjusted to 9.0 per cent with immediate effect. Cash Reserve Ratio The cash reserve ratio (CRR) of scheduled banks has been retained at 4.75 per cent of their NDTL.

The First Quarter Review of Monetary Policy for 2012-13 is scheduled on Tuesday, July 31, 2012. Developmental and Regulatory Policies . This part of the Statement reviews the progress in various developmental and regulatory policy measures announced by the Reserve Bank in the recent policy statements and also sets out new measures. . Financial institutions and markets continue to operate in an uncertain global environment. Efforts are underway globally to reform the regulatory and supervisory frameworks; augment capital and liquidity buffers; improve risk management practices; adopt prudential compensation models; institute sound information technology (IT) governance and security systems; and bring about transparency in operations as well as reporting. These and a host of other measures are intended to enhance the resilience and risk bearing capacity of financial institutions and markets so as to safeguard the financial system from recurrent crises. . In India, reforms have continued with a view to building a robust and resilient financial system. More stringent capital and liquidity measures for commercial banks have been implemented and steps have been taken to build provision buffers. Basel III capital and liquidity standards for banks are in the process of being prescribed. New prudential compensation practices have been adopted. Various institutional mechanisms and tools for monitoring systemic risks have been put in place. Efforts are being made to develop effective macroprudential supervision. Apart from commercial banks, measures have been taken to strengthen urban co-operative banks (UCBs), non-banking financial companies (NBFCs) and micro-finance institutions (MFIs). Alongside reforms in various segments of financial system, the focus on financial inclusion continues. The Reserve Bank has also engaged with banks to improve customer service. I. Financial Stability Assessment of Financial Stability . The fourth Financial Stability Report (FSR) was released in December 2011. According to the assessment made in the report, the domestic financial system remained robust, though risks to stability increased in the recent period. That the financial system remained robust was evidenced by a series of macro-financial stress tests, which assessed the resilience of the banking system to adverse macroeconomic developments. Stress tests also revealed that banks capital adequacy remained above regulatory requirements, even under severe stress scenarios. The Reserve Bank instituted a systemic risk survey (SRS) to supplement its assessment of systemic risks through wider consultation. The findings of the SRS also reaffirmed the stability of the system. Over half the respondents were confident or very confident about the stability

of the Indian financial system. However, according to the survey, deterioration in asset quality was identified as one of the major risks faced by banks. II. Financial Markets Working Group on G-Sec and Interest Rate Derivatives Market As announced in the Second Quarter Review (SQR) of October 2011, a Working Group (Chairman: Shri R. Gandhi) was constituted to examine ways to enhance liquidity in the G-Sec and interest rate derivatives markets. The Working Group is in the process of finalising its draft report, which will be placed on the Reserve Banks website by end-May 2012 for wider feedback. Based on the feedback/comments received from market participants, the Group will finalise its report. Introduction of a Web-based System for Access to NDS-Auction and NDS-OM To facilitate direct participation of retail and mid-segment investors in G-Sec auctions, the Reserve Bank has allowed web-based access to negotiated dealing system (NDS)-auction system developed by the Clearing Corporation of India Ltd. (CCIL). The system allows gilt account holders to directly place their bids in the auction system through a primary members portal, as against the earlier practice wherein the primary member used to combine bids of all constituents and bid in the market on their behalf. A similar web-based access to NDS-order matching (OM) system for secondary market transaction is under development and is expected to be implemented by end-June 2012. III. Credit Delivery and Financial Inclusion Financial Inclusion Plan for Banks It was indicated in the Monetary Policy Statement of May 2011 that all public and private sector banks had prepared and submitted their board approved three-year financial inclusion plans (FIPs). These contained self-set targets in respect of opening of rural brick and mortar branches; deployment of business correspondents (BCs); coverage of unbanked villages with population above 2,000 as also other unbanked villages with population below 2,000 through branches/BCs/other modes; opening of no-frills accounts; kisan credit cards (KCCs) and general credit cards (GCCs) issued; and other specific products designed by them to cater to the financially excluded segments.

CONCLUSION
By the above Project we can frame out the following conclusions, which are as given below: These are directed towards the particular use of credit and not its total volume. These are generally meant to regulate credit for specific purposes. Qualitative measures consist of consumer credit regulation, issue of directives ,rationing of credit, moral suasion etc. Credit policy is amended from time to time to suit the needs of economy.

BIBLIOGRAPHY Books
Monetary, banking and financial development in India -Nitin basin. RBI functions and working - shri m Jesudasan. RBI volume 3.

Business economics. Net

www.google.com www.scribd.com www.wikipedia.org www.rbi.com