CENTRAL BANK

It is essential for every country to have a central bank The banking system of a country without central bank at the top is like a human body without head

RESERVE BANK OF INDIA

(CENTRAL BANK OF INDIA)

History The Reserve Bank of India was set up on the basis of the recommendations of the Hilton Young Commission. The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank, which commenced operations on Apri 1, 1935.

FUNCTION OF CENTRAL BANK

Bank of Issue Banker to Government Bankers' Bank and Lender of the Last Resort Controller of Credit Custodian of Foreign Reserves Supervisory functions Promotional functions

QUANTITATIVE TOOLS
1)BANK RATE (current rate:-6%) Rate at which Central bank rediscounts the security presented by financial institute. Demand Rate of Bank Rate situation For fund Interest inflation

deflation

contd.
2)Open market operation. buying and selling of securities by central bank in the money market to influence the volume of cash reserve with commercial banks. Central bank Buyer Seller financial institute seller buyer situation depression inflation liquidity injection absorption

contd.
3) Cash reserve ratio (current rate:-5%) Commercial bank keep certain minimum cash reserve with R.B.I. CRR 25% Commercial bank 100 - 25 75

contd.
S.L.R (statutory liquidity requirement)

(current rate:-25%)
Bank are forced to invest in certain government security. Situation S.L.R Bank Inflation 30% 100-30=70 Depreciation 20% 100-20=80

QUALITATIVE MEASURE
CREDIT MARGIN CEILING ON CREDIT RATIONING OF CREDIT

FUNCTIONS OF CENTRAL BANK

MONOPOLY OF NOTE ISSUE GOVERNMENT BANBER BANKERS BANK LENDER OF LAST RESORT CONTROL OF CREDIT MAINTENANCE OF EXCHANGE RATE CUSTODIAN OF NATIONAL RESERVE PROVISION OF CLEARING HOUSE FACILITIES DEVELOPMENTAL FUNCTIONS

MONOPOLY OF NOTE ISSUE

Note issue is the sole privilege of the central bank In India, the Reserve Bank of India (RBI) which is the central bank is required to keep a minimum reserve of Rs 200 crores, of which not less than Rs 115 crores must be gold.

BANKERS BANK
All banks in the country are bound either by law or convention to keep a certain proportion of their total deposits as reserve with central bank. They also keep their spare cash with central bank on which they draw as and when needed. Under the Banking Regulation Act of 1949, the RBI has been empowered with the right to supervise and control the activities of various scheduled commercial banks. These powers are related to give licensing, branch expansion, management of banks, inspection, liquidity of assets.

LENDER OF LAST RESORT

The other banks in the country depend upon the Central Bank in times of emergency. This may be in the form of a loan on the security or rediscount of bills of exchange. In India, the scheduled banks have to keep in deposit as reserve as reserve with Reserve Bank of India not less than 3% of their total deposit liabilities.

CONTROL OF CREDIT
The most important function of a Central Bank is to control the credit. The central bank ensures price stability and avoids inflationary and deflationary tendencies by raising or lowering bank rate, by purchase or sale of securities in the open market

MAINTAINING EXCHANGE RATE

A stable exchange rate is necessary to maintain or promote a countrys foreign trade and to encourage foreign investments, which is necessary for economic growth. In order to maintain a stable rate of exchange, central bank buys and sells foreign currencies at rates fixed by it.

CUSTODIAN OF NATIONAL RESERVE

It is central bank which serves as the custodian of nations reserves of gold and international currency

PROVISION OF CLEARING HOUSE FACILITIES

Performs the duty of a Clearing House for cheques. It settles the account of commercial banks and enables them to settle their dues. Central bank does not come in competition with other banks. That is why it does not pay interest on the money kept with it. It is a government owned and whatever be the profits , they go to government treasury.

DEVELOPMENT FUNCTION
RBI concentrates on the economic development of under developed countries. The main task of central banks in such countries is to bring about a rapid expansion of banking facilities and also to make adequate funds available to finance development programs.

CONTROL OF CREDIT
OBJECTIVES OF CREDIT CONTROL 1. To safe guard its gold reserve against internal and external drains 2. To maintain stability of internal prices 3. To achieve stability of foreign exchange rate 4. To eliminate fluctuations in production and employment and 5. To assist in economic growth

METHODS OF CREDIT CONTROL

1.Quantitative 2.qualitative

QUANTITATIVE CONTROLS
1. BANK RATE Policy 2. OPEN MARKET OPERATIONS 3. VARYING RESERVE REQUIREMENTS

QUALITATIVE CONTROLS
1. 2. 3. 4. 5. Fixation of margin requirement Regulation of consumer credit. Rationing of credit Moral Suasion Direct action

BANK RATE policy

Bank rates and other rates in the market have a close relationship. Let us see how central bank can control credit by manipulating bank rate. If central bank want to control credit, it will raise the bank rate? Borrowing then will be discouraged Those who hold stock with borrowed money will unload their stock due to high interest payable and consequently they will pay back the loan. Thus raising interest will contract the credit. Conversely a fall in bank rate will lower interest rate which will stimulate industrial activity, and expand credit

Bank Rate Policy

The bank rate can be interpreted in 2 ways .in the narrow sense ,the bank rate may be defined as the minimum official rate at which the central bank rediscounts first class bills of exchange brought by the discount houses and commercial banks. In broad sense, the bank rate may be defined as the varying of the terms and conditions under which the market can have temporary access to the central bank either in the form of rediscounts or through secured advances. The central bank ,thus tries to control credit by influencing both the cost as well as the availability of credit . The cost of credit is influenced by changing the bank rate. By changing the eligibility rules, the central bank can influence the availability of credit .

 The bank rate acts as the pacesetter for the entire interest rate structure in the country. If there is any change made by the central bank in its bank rate, it will lead to corresponding changes in the other interest rates of the market, thereby making credit either dearer or cheaper as the case may be. The changes in the market rates of interest ,consequent upon the changes in the bank rate, affect the willingness of businessmen and industrialists to borrow and invest .this will in turn affect the level of economic activity and the level of prices in the economy.

Open Market Operations

Open market operations as a method of credit control developed by only after the first world war. The term open market used in 2 senses. In the narrow sense ,open market operations imply the purchase and sale by the central bank of govt. securities in the money market. In the broader sense ,this term implies the purchase and sale by the govt. securities but also of other eligible papers like bills and securities of private concerns.

 Open market operations (purchase and sale of securities in the open market) by the central bank directly results in an increase or decrease in the cash reserves of the commercial banks leading thereby to an increase or decrease in their ability to create credit. The policy of open market operations , thus brings about an immediate change in the total volume of credit created by the commercial banks. This influences the level of business activity , employment and the internal price level.

OPEN MARKET OPERATIONS

Means purchase or sale of securities/ bills by central bank SAY SALE BY CENTRAL BANK it receives payment in the form of cheque on a commercial bank and cash is reduced in the commercial bank to this extend. With reduction in cash the commercial banks have to reduce lending SAY PURCHASE BY CENTRAL BANKS It pays through cheque and the cash balance in the central bank lying in the account of commercial bank will be increased. This will increse the lending

VARYING RESERVE REQUIREMENTS

CRR Stands for Cash Reserve Ratio A CRR is the % of bank Reserve to Deposit and Notes, CRR is the amount of Funds that the banks have to keep with RBI . By changing the cash reserve ratio, the cash reserves of the commercial banks can be directly changed ,affecting thereby their ability to create credit in the economy. If RBI decides to increase the % of this, the available amount with the banks comes down .RBI increases CRR rate to pull out the excessive money from the banks CRR is used as tool in Monetary Policy, which influence Countrys Economy, Borrowing and Interest Rates across the country. SLR stands for Statutory Liquidity Reserve/Ratio Statutary Liquidity Reserve/Ratio(SLR) is percentage of deposits the bank has to maintain in form of gold, cash or other approved securities. It regulates the credit growth in India. By varying the the SLR ,the RBI can control the expansion and contraction of credit. Every financial institute is required to maintain a Statutory Liquidity reserve (SLR) of 25% (including CRR) on all its liabilities.

VARYING RESERVE REQUIREMENTS

The central bank can vary reserve ratio when it wants to control credit. In 1960, the RBI required scheduled banks to maintain with it additional reserve equivalent to 25% of their increase in Deposits and later increased to 50%. The raising of reserve requirements is an anti- inflationary measure

Qualitative methods
The objective of Qualitative or selective credit control is to control and regulate the total volume of credit in the economy without bothering about the uses or the channels into which it flows. Types of selective credit controls 1. Fixation of margin requirement 2. Regulation of consumer credit. 3. Rationing of credit 4. Moral Suasion 5. Direct action

Fixation of margin requirement

The method of fixing margin requirements on secured loans granted by commercial banks was first used in the USA under securities act of 1934. The margin is the difference between the loan value and the market value of securities offered by borrowers against secured loans. By prescribing the margin requirements on secured loans, the central bank does not permit the commercial banks to lend to their customers the full value of securities offered by them ,but only a part of their market value. For example ,if the central bank prescribes the margin requirements at 40% that means that the commercial bank can lend only 60% of the market value of the securities of the customers. Now if the margin is raised to 50% the banks can lend only 50 % of the market value of the securities of the customers. Thus by changing the margin requirements, the amount of loan made by the banks can be changed in accordance with the policy of the central bank. Thus by altering the margin requirments from time to time the central bank keeps on changing the volume of bank advances to the borrowers.

Regulation of consumer credit

Another method of selective credit control is that of regulating credit for the purchase of durable consumer goods. According to this system ,a certain percentage of the price of the durable consumer goods is paid by the consumers in downright cash. The remaining part of the price of the goods is financed by bank credit which is repayable by the consumer in installments spread over a specified period of time. This method controls excessive consumer demand for durable goods in the following ways By extending or curtailing the applicability of the method of consumer credit. By changing the minimum down payment By changing the maturity period of consumer credit By changing the cost of consumer credit

Control through directives by the central bank

Directives are issued to the commercial banks in order to realize the following objectives To control the lending poliices of commercial banks To divert credit from less urgent uses to more urgent uses or from the less productive uses to more productive uses. To prohibit lending for certain purposes altogether. To fix maximum limits of credit for certain purposes.

CREDIT RATIONING
The term rationing of credit implies 2 things. 1st it means that central banks fixes a limit upon its rediscounting facilities for any particular bank. 2nd it means that the central bank fixes quota of every affiliated bank for the financial accommodation from the central bank.

Moral suasion
The method of moral suasion is still another method frequently employed by the central bank to exercise control on the commercial banks . This method involves advice ,request and persuasion with the commercial bank to cooperate with the central bank in implementing its credit policies.

DIRECT ACTION
The method of direct action is most extensively used by the central banks to implement their credit policies. The method of direct action implies the use of coercive measures against those commercial banks whose credit policies do not conform to the declared objectives of the central bank. This method also involves the issuing of general instructions by the central bank to all the commercial banks. It may also take the form of special instructions by the central bank issued to the erring banks. Method of direct action is used only as a last resort when other methods fail to yield the desired result.