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Reserve Bank of India & Indian Monetary Policy

2. Central Bank “It is a bank of banker” -- Samuelson “Bank which has monopoly over note issue” -- Vera
Smith “Central bank is the government’s bank” -- Sayers

3. History & Preamble In 1921, three presidency banks (Madras, Bombay and Bengal) were
amalgamated to form the Imperial Bank of India. It was primarily a commercial bank but it discharged
certain central banking functions specifically as the banker to the government. It was set up on the
recommendations of the HILTON YOUNG COMMISSION It was started as Share-Holders Bank with a
paid up capital of 5 Crs It was established on 1st of April 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. Initially it was privately owned but it was the 1st bank to be
Nationalized in 1949 and is now fully owned by the Government of India

4. History & Preamble It has 19 regional offices, most of them in state capitals The First governor was
Sir Osborne A. Smith (1st April 1935 to 30th June 1937) The First Indian Governor was “Sir Chintaman
D. Deshmukh”(11th August 1943 to 30th June 1949) Preamble The preamble of the Reserve Bank of
India describe the basic functions of the Reserve Bank a “…to regulate the issue of Bank Notes and
keeping of reserve with a view to securing monetary stability in India and generally to operate the
currency and credit system of the country to its advantage”

5. Organization Structure Governor (1) Deputy Governor (4) Executive Directors (11) Principal Chief
General Manager Chief General Managers General Managers Deputy General Managers Asstt. General
Managers Managers Asstt Managers Support staff

6. Organization Central Board - The Reserve Bank affairs are governed by a central board of directors.
The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.
Appointed/nominated for a period of four years Official Directors Full-time : Governor and not more
than four Deputy Governors Non-Official Directors Nominated by Government: Ten Directors from
various fields and two government Officials Others: four Directors - One each from four local boards
Local Boards - One each for the four regions of the country in Mumbai, Calcutta, Chennai and New Delhi
Membership: Consist of five members each Appointed by the Central Government For a term of four
years Functions : To advise the Central Board on local matters and to represent territorial and
economic interests of local cooperative and indigenous banks; to perform such other functions as
delegated by Central Board from time to time.

7. Objectives To manage the monetary and credit system of the country. To stabilizes internal and
external value of rupee. For balanced and systematic development of banking in the country. For the
development of organized money market in the country. For proper arrangement of agriculture
finance. For proper arrangement of industrial finance. For proper management of public debts To
establish monetary relations with other countries of the world and international financial institutions.
For centralization of cash reserves of commercial banks. To maintain balance between the demand
and supply of currency.
8. RBI vs Commercial Banks Commercial Bank RBI prime goal is profit maximization objective is
economic development with stability. directly involved with the public i.e. depositors and borrowers
directly related to the commercial banks of the country Multiple in Number in the country Only One in
the country has many branches spread throughout the country and even aboard Has 19 regional offices,
most of them in state capitals and 9 Sub-offices but no branches can collect savings from the general
public in the form of various types of deposits and lend most of them to investors with a view of making
profit. They are thus ‘financial intermediaries’ between savers and investors not allowed to accept
deposits from the public. The commercial banks are subjected to rules and regulations prescribed by RBI
from time to time. RBI supervises and controls the activities of commercial banks in the overall interest
of the country at large The commercial banks do not work in such advisory capacity. RBI is the banker to
the government and also a financial advisor

9. Functions Traditional Functions Issuer of currency notes Banker and Debt Manager To
Government Banker to Banks Credit control Monetary Authority Manager of Foreign Exchange
Promotional Functions Supervisory Functions

10. Traditional Functions Issuer of Currency Notes The RBI has monopoly of issuing currency notes
except one rupee note and coins of smaller denomination. Currently it is in denominations of Rs. 5, 10,
20, 50, 100, 500, and 1,000. It issues these notes against the security of gold bar, foreign securities,
exchange bills and promissory notes and Government of India bonds. The RBI has powers not only to
issue and withdraw but even to exchange these currency notes for other denominations. RBI has
special issue department. Bank notes are printed at four notes presses at Nasik, Dewas, Mysore and
Salboni. This is done to give the public adequate quantity of supplies of currency notes..

11. Traditional Functions Banker and Debt Manager To Government The RBI being the apex monitory
body has to work as an agent of the central and state governments. It performs various banking
function such as to accept deposits, taxes and make payments on behalf of the government. It works
as a representative of the government even at the international level. It maintains government
accounts, provides financial advice to the government. It manages government public debts and
maintains foreign exchange reserves on behalf of the government. It provides overdraft facility to the
government when it faces financial crunch.

12. Traditional Functions Banker’s Bank Every commercial bank has to maintain a part of their reserves
with the RBI. 4% of their total deposits (both demand and time deposits) as cash reserves. Besides this
every bank is required to maintain 21.5% of its total deposits as SLR and must submit weekly statements
of their transactions to RBI. The RBI controls the credit created by commercial banks by varying the
proportion of reserves. It facilitates the clearing & rediscounting of promissory notes, bills of exchange
and cheques and also helps in inter bank transfer of funds. Similarly in need or in urgency these banks
approach the RBI for funds. Thus it is called as the ‘lender of the last resort’.

13. Traditional Functions Credit Control The RBI controls the credit creation by commercial banks. For
this, the RBI uses both quantitative and qualitative methods. By controlling credit, the RBI achieves the
following: Maintains the desired level of circulation of money in the economy. Maintains the stability
in the price level prevailing in the economy. Controls the effects of trade cycles. Controls the
fluctuations in the foreign exchange rate. Channelizes credit to the productive sectors of the economy.

14. Instrument of Credit Control Quantitative or General Methods Qualitative or Selective Methods
Qualitative • Selective Credit Control • Rationing of Credit • Moral Persuasion • Direct Action
Quantitative • Change in Cash Reserve Ratio (CRR) • Statutory Liquidity Ratio(SLR) • Repo and Reverse
Repo Ratio

15. Traditional Functions Monetary Authority Formulates, implements and monitors the monetary
policy Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors
Manager of Foreign Exchange Manages the Foreign Exchange Management Act, 1999. Objective: to
facilitate external trade and payment and promote orderly development and maintenance of foreign
exchange market in India

16. Promotional Functions Along with the routine traditional functions, central banks especially in the
developing country like India have to perform numerous functions. These functions are country specific
functions and can change according to the requirements of that country. Development of the Financial
System: The financial system comprises the financial institutions, financial markets and financial
instruments. The sound and efficient financial system is a precondition of the rapid economic
development of the nation. The RBI has encouraged establishment of main banking and non-banking
institutions to cater to the credit requirements of diverse sectors of the economy. Development of
Agriculture : In an agrarian economy like ours, the RBI has to provide special attention for the credit
need of agriculture and allied activities. It has successfully rendered service in this direction by
increasing the flow of credit to this sector.

17. Promotional Functions Provision of Industrial Finance : In this regard the RBI has always been
instrumental in setting up special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc
for the adequate and timely availability of credit to small, medium and large industry is very significant.
Collection of Data : Being the apex monetary authority of the country, the RBI collects process and
disseminates statistical data on several topics. This data proves to be quite useful for researchers and
policy makers. Publication of the Reports : This RBI collects and publishes data on several sectors of
the economy. The reports and bulletins are regularly published by the RBI. It includes RBI weekly
reports, RBI Annual Report This information is made available to the public also at cheaper rates.
Promotion of Banking Habits : As an apex organization, the RBI always tries to promote the banking
habits in the country. It institutionalizes savings and takes measures for an expansion of the banking
network.

18. Supervisory Functions: The reserve bank also performs many supervisory functions. It has authority
to regulate and administer the entire banking and financial system. Some of its supervisory functions are
given below. Granting license to banks : The RBI grants license to banks for carrying its business.
License is also given for opening extension counters, new branches, even to close down existing
branches. Bank Inspection : The RBI grants license to banks working as per the directives and in a
prudent manner without undue risk. In addition to this it can ask for periodical information from banks
on various components of assets and liabilities. Control over NBFIs : The Non-Bank Financial
Institutions are not influenced by the working of a monitory policy. However RBI has a right to issue
directives to the NBFIs from time to time regarding their functioning. Through periodic inspection, it can
control the NBFIs.

19. Fully owned Subsidiaries National Housing bank (NHB) Deposit Insurance and Credit Guarantee
Corporation of India (DICGC) Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL)

20. RBI Publication of the Reports RBI Bulletin bulletin.rbi.org.in/ RBI Annual Report
annualreport.rbi.org.in/ Weekly Statistical Supplement wss.rbi.org.in Monetary and Credit Policy
cpolicy.rbi.org.in RBI Notifications notifics.rbi.org.in RBI Press Release pr.rbi.org.in RBI Speeches
speeches.rbi.org.in Monetary and credit Information Review mcir.rbi.org.in Report on Trend and
Progress of Banking bankreport.rbi.org.in

21. Monetary Policy in India ABHIJEET V DESHMUKH

22. The Monetary Authority, typically the central bank of a country, is vested with the responsibility of
conducting monetary policy. Monetary policy refers to the use of instruments under the control of the
central bank to regulate the availability, cost and use of money and credit. Monetary Policy helps
manage the amount of money floating in the economy and ensures that all sectors are on the growth
path. Monetary policy is the actions of a central bank, currency board or other regulatory committee
that determine the size and rate of growth of the money supply, which in turn affects interest rates.
Monetary policy is maintained through actions such as modifying the interest rate, buying or selling
government bonds, and changing the amount of money banks are required to keep as reserves. The
Monetary Policy - Definition

23. The Monetary Policy Process The Reserve Bank’s Monetary Policy Department (MPD) assists the
Governor in formulating the monetary policy. Views of all key stakeholders in the economy, advice of
the Technical Advisory Committee (TAC), and analytical work of the Reserve Bank contribute to the
conduct of Monetary Policy. The Financial Markets Committee (FMC) meets daily to review the
consistency between policy rate, money market rates, and liquidity conditions.

24. Goals of Monetary Policy Primarily Price Stability, while keeping in mind the objective of growth.
As per Dr. Urjit Patel Committee Report, the Reserve Bank has formally announced a “glide path” for
disinflation that sets an objective of below 8 per cent CPI inflation by January 2015 and below 6 per cent
CPI inflation by January 2016. The agreement on Monetary Policy Framework between the
Government and the Reserve Bank of India dated February 20, 2015 defines the price stability objective
explicitly in terms of the target for inflation – as measured by the consumer price index-combined (CPI-
C) – in the near to medium-term, i.e., (a) below 6 per cent by January 2016, and (b) 4 per cent (+/-) 2 per
cent for the financial year 2016-17 and all subsequent years. Price stability is a necessary (if not
sufficient) precondition to sustainable growth and financial stability. Financial stability is important for
smooth transmission of monetary policy & therefore, regulatory and financial market policies, including
macro-prudential policies, are often announced along with monetary policy under Part-B of monetary
policy statements
25. Policy Framework The framework aims at setting the policy (repo) rate based on a forward looking
assessment of inflation, growth and other macroeconomic risks, and modulation of liquidity conditions
to anchor money market rates at or around the repo rate. Repo rate changes transmit through the
money market to alter the interest rates in the financial system, which in turn influence aggregate
demand - a key determinant of inflation and growth. Once the repo rate is announced, the operating
framework on a day to day basis is implemented through proactive liquidity management, which aims at
anchoring the operating target – the weighted average call rate (WACR) – around the repo rate.

26. Instruments of Monetary Policy There are several direct and indirect instruments that are used in
the implementation of monetary policy. Cash Reserve Ratio (CRR): The share of net demand and time
liabilities (deposits) that banks must maintain as cash balance with the Reserve Bank. Statutory
Liquidity Ratio (SLR): The share of net demand and time liabilities (deposits) that banks must maintain in
safe and liquid assets, such as, government securities, cash and gold. Changes in SLR often influence the
availability of resources in the banking system for lending to the private sector. Refinance facilities:
Sector-specific refinance facilities aim at achieving sector specific objectives through provision of
liquidity at a cost linked to the policy repo rate. The Reserve Bank has, however, been progressively de-
emphasising / discouraging sector specific policies as they interfere with the transmission mechanism.

27. Instruments of Monetary Policy Term Repos: Since October 2013, the Reserve Bank has introduced
term repos (of different tenors, such as, 7/14/28 days), to inject liquidity over a period that is longer
than overnight. The aim of term repo is to help develop inter-bank money market, which in turn can set
market based benchmarks for pricing of loans and deposits, and through that improve transmission of
monetary policy. Marginal Standing Facility (MSF): A facility under which scheduled commercial banks
can borrow additional amount of overnight money from the Reserve Bank by dipping into their SLR
portfolio up to a limit (currently two per cent of their net demand and time liabilities deposits) at a penal
rate of interest (currently 100 basis points above the repo rate). This provides a safety valve against
unanticipated liquidity shocks to the banking system. MSF rate and reverse repo rate determine the
corridor for the daily movement in short term money market interest rates.

28. Instruments of Monetary Policy Liquidity Adjustment Facility (LAF): Consists of overnight and term
repo/reverse repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity
injected in the LAF through term-repos. Open Market Operations (OMOs): These include both,
outright purchase/sale of government securities (for injection/absorption of liquidity) Bank Rate: It is
the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial
papers. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when
the MSF rate changes alongside policy repo rate changes. Market Stabilization Scheme (MSS): This
instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring
nature arising from large capital inflows is absorbed through sale of short-dated government securities
and treasury bills. The mobilized cash is held in a separate government account with the Reserve Bank.
The instrument thus has features of both, SLR and CRR.

29. Looking Ahead With the agreement on Monetary Policy Framework between the Government and
the Reserve Bank of India dated February 20, 2015, the Reserve Bank has formally adopted a flexible
inflation targeting (FIT) framework. As announced in the Union Budget for 2015-16, decision making
by an empowered Monetary Policy Committee (MPC) would require amendment of the Reserve Bank of
India Act, which the Government intends to do in 2015-16. The recommendations of the Dr. Urjit Patel
Committee Report on all related aspects of monetary policy are being examined and progressively
implemented. In implementing the framework, strengthening the transmission of policy changes to
the ultimate objectives while dealing with uncertainties in terms of unanticipated global and domestic
shocks will remain a major challenge.

30. Open & Transparent Monetary Policy-Making Transparency in monetary policy that makes it more
predictable and effective requires communication to avoid undue apprehensions about monetary policy.
The Reserve Bank explains the rationale of its monetary policy stance in a transparent manner, provides
forward guidance on the near-term likely stance of monetary policy to contain uncertainty arising from
possible noisy market expectations. In Includes Pre-policy consultations with bankers, economists,
market participants, chambers of commerce and industry and other stakeholders Regular discussions
with credit heads of banks Feedback from banks and financial institutions Internal analysis Starting
with the first bi-monthly statement of monetary policy in April 2014, the Reserve Bank has changed the
normal frequency of monetary policy announcements from eight times in a year (i.e., four quarterly and
four mid- quarter) to six times in a year (i.e., bi- monthly).

31. Contractionary / Expansionary Monetary Policy

32. Contractionary Monetary Policy A type of policy that is used as a macroeconomic tool by the
country's central bank or finance ministry to slow down an economy. Contractionary policies are
enacted by a government to reduce the money supply and ultimately the spending in a country. When
both spending and the availability of money are high, prices start to rise - this is known as inflation.
When a country is experiencing higher-than-anticipated inflation, the government might step in with a
contractionary policy to try to slow down the economy. Their goal is to reduce spending by making it
less attractive to acquire loans or by taking currency out of circulation, and thus reduce inflation. The
effectiveness of these policies vary. Increasing the interest / Repo rate at which the RBI lends will also
increase the rates at which banks lend. When rates are higher, it is more expensive for individuals to
obtain loans; this reduces spending. Banks are required to keep a reserve of cash to meet withdrawal
demands. If the reserve requirements are increased, there is less money for banks to lend out. Thus
there is a lower money supply. Central banks can borrow money from institutions or individuals in the
form of Gsec. If the interest paid on these securities is increased, more investors will buy them. This will
take money out of circulation. Central banks can also reduce the amount of money they lend out or call
in existing debts to reduce the money supply.

33. Expansionary Monetary Policy A macroeconomic policy that seeks to expand the money supply to
encourage economic growth or combat inflation (price increases). One form of expansionary policy is
fiscal policy, which comes in the form of tax cuts, rebates and increased government spending.
Expansionary policies can also come from central banks, which focus on increasing the money supply in
the economy. The RBI employs expansionary policies whenever it lowers the benchmark Repo Rate or
when it buys Government Securities in the open market, thereby injecting capital/liquidity directly into
the economy. Expansionary Policy is a useful tool for managing low-growth periods in the business
cycle, but it also comes with risks. First and foremost, economists must know when to expand the
money supply to avoid causing side effects like high inflation. There is also a time lag between when a
policy move is made (whether expansionary or contractionary) and when it works its way through the
economy. This makes up-to-the-minute analysis nearly impossible, even for the most seasoned
economists. And finally, prudent central bankers and legislators must know when to halt money supply
growth or even reverse course and switch to a contractionary policy.

34. Thank You