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Meaning: Function of RBI

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RBI

Meaning
Reserve Bank of India (RBI) is the Central Bank of India. RBI was established on 1 April 1935
by the RBI Act 1934. Key functions of RBI are, banker's bank, the custodian of foreign
reserve, controller of credit and to manage printing and supply of currency notes in the
country

Function of RBI
1.Issue of Notes —The Reserve Bank has a monopoly for printing the currency notes in the
country. It has the sole right to issue currency notes of various denominations except one rupee
note (which is issued by the Ministry of Finance).

The Reserve Bank has adopted the Minimum Reserve System for issuing/printing the
currency notes. Since 1957, it maintains gold and foreign exchange reserves of Rs. 200 Cr. of
which at least Rs. 115 cr. should be in gold and remaining in the foreign currencies.

2. Banker to the Government–The second important function of the Reserve Bank is to act as
the Banker, Agent and Adviser to the Government of India and states. It performs all the
banking functions of the State and Central Government and it also tenders useful advice to the
government on matters related to economic and monetary policy. It also manages the public
debt of the government.

3. Banker’s Bank:- The Reserve Bank performs the same functions for the other commercial
banks as the other banks ordinarily perform for their customers. RBI lends money to all the
commercial banks of the country.  

4. Controller of the Credit:- The RBI undertakes the responsibility of controlling credit created
by commercial banks. RBI uses two methods to control the extra flow of money in the economy.
These methods are quantitative and qualitative techniques to control and regulate the credit flow
in the country.  When RBI observes that the economy has sufficient money supply and it
may cause an inflationary situation in the country then it squeezes the money supply
through its tight monetary policy and vice versa.

5. Custodian of Foreign Reserves:-For the purpose of keeping the foreign exchange rates
stable, the Reserve Bank buys and sells foreign currencies and also protects the country's
foreign exchange funds. RBI sells the foreign currency in the foreign exchange market when its
supply decreases in the economy and vice-versa. Currently, India has a Foreign Exchange
Reserve of around US$ 487 bn.
6. Other Functions:-The Reserve Bank performs a number of other developmental works.
These works include the function of clearinghouse arranging credit for agriculture (which has
been transferred to NABARD) collecting and publishing the economic data, buying and selling of
Government securities (gilt edge, treasury bills etc)and trade bills, giving loans to the
Government buying and selling of valuable commodities etc. It also acts as the representative of
the Government in the International Monetary Fund (I.M.F.) and represents the membership
of India.

Credit Control

Credit control is a tool used by Reserve Bank of India , a major weapon of


the monetary policy  used to control the demand and supply of money i.e liquidity in
the economy. Central Bank i.e RBI regulates the credit that the commercial
banks grant. Such a method is used by RBI to bring Economic Development with
Stability in the nation. It means that banks will not only control inflationary trends in
the economy but also boost economic growth which would in the long run lead to
increase in real national income stability. In the view of its functions such as issuing
notes and custodian of cash reserves, credit is not being controlled by RBI as it
would lead to Social and Economic instability in the country .

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 stir up the overall growth of the "priority sector" i.e. those sectors of the economy which
are recognized by the government as "prioritized" depending upon their economic condition
or government interest. These sectors broadly totals to around 15 in number.[1]
 To keep a check over the channelization of credit so that it is not delivered for undesirable
purposes.
 To achieve the objective of controlling inflation as well as deflation.
 To boost the economy by accelerating the flow of adequate volume of bank credit to
different sectors.
 To help the economy develop.

Objectives of credit control


The broad objectives of credit control policy in India have been as follows:

 To ensure an adequate level of liquidity enough for attaining high economic growth


rate along with maximum utilisation of resource without generating high inflationary
pressure.
 To attain stability in the rate of exchange and money market of the country.
 To meet the financial requirement during a slump in the economy and in the normal
times as well.
 To control business cycle and meet business needs.

Methods of credit control


There are two methods that the RBI uses to control the money supply in the economy.
They are:

 Qualitative method
 Quantitative method
During inflation, Reserve Bank of India tightens its policies to regulate the money
supply, whereas during deflation it allows the commercial bank to pump money in the
economy.
Qualitative method
By Quality we mean the uses through which bank credit is directed.
For example- the bank may feel that spectators or 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 disparity is a matter of qualitative credit control.
Qualitative methods control the manner of cash channelisation 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.
Tools used under this method are-
Marginal requirement
Marginal requirement of loan current value of security offered for ban-value of loans
granted. The marginal requirement is increased for those business activities, the flow of
whose credit is to be restricted in the economy.
For Example:- A person mortgages his property worth ₹ 1,00,000 against loan. The
bank will give loan of ₹ 80,000. The marginal requirement here is 20%
Rationing of credit
Under this method there is a maximum limit to loans and advances that can be made,
which the commercial banks cannot exceed. RBI fixes ceiling for specific categories.
Such rationing is used for situations when credit flow is to be checked, particularly for
speculative activities. Minimum of "capital: total assets" (ratio between capital and total
asset) can also be prescribed by Reserve Bank of India.
Publicity
RBI uses media for the publicity of its views on the current market condition and its
directions that will be required to be implemented by the commercial banks to control
the unrest. Though this method is not very successful in developing nations due to
existence of high rate of financial illiteracy making it difficult for people to understand
such policies and its implications.
Direct Action
Under the Banking Regulation Act, the Central Bank is authorised to take strict action against
any of the commercial banks that refuses to abide by the directions given by it. There can be a
restriction on advancing of loans imposed by Reserve Bank of India on such banks.
For e.g. – RBI had put up certain restrictions on the working of the Metropolitan co-operative
banks. Also the 'Bank of Karad' had to come to an end in 1992.[2]
Moral Suasion
This method is also known as "moral persuasion" as the method that the Reserve Bank
of India, being the apex bank uses here, is that of persuading the commercial banks to
follow its directions/orders on the flow of credit. It can also be a part of meetings
between RBI and Commercial Banks. RBI persuades the commercial bank to follow
their policies. RBI puts a pressure on the commercial banks to put a ceiling on credit
flow during inflation and be liberal in lending during deflation.

Quantitative method
By quantitative credit control we mean the control of the total quantity of credit.
For Example- consider that the Central Bank, on the basis of its calculations, considers
that Rs. 50,000 is the maximum safe limit for the expansion of credit. But the actual
credit at that given point of time is Rs. 55,000(say). Thus it then becomes necessary for
the central bank to bring it down to 50,000 by tightening its policies. Similarly if the
actual credit is less, say 45,000, then the apex bank regulates its policies in favor of
pumping credit into the economy.
Different tools used under this method are-
Bank rate
Bank rate is also known as the discount rate. It is the official minimum rate at which the
central bank of the country is ready to re discount approved bills of exchange or lend on
approved securities.
Section 49 of the Reserve Bank of India Act 1934, defines Bank Rate as "the standard
rate at which it (RBI) is prepared to buy or re-discount bills of exchange or
other commercial paper eligible for purchase under this Act".
When the commercial bank for instance, has lent or invested all its available funds and
has little or no cash over and above the prescribed minimum, it may ask the central
bank for funds. It may either re-discount some of its bills with the central bank or it may
borrow from the central bank against the collateral of its own promissory notes.
In either case, the central bank accommodates the commercial bank and increases the
latter's cash reserves. This Rate is increased during the times of inflation when the
money supply in the economy has to be controlled.
At any time there are various rates of interest ruling in the market, like the deposit rate,
lending rate of commercial banks, market discount rate and so on. But, since the central
bank is the leader of the money market and the lender of the last resort, all other rates
are closely related to the bank rate. The changes in the bank rate are, therefore,
followed by changes in all other rates as the money market.
The graph on the right hand side shows variations in the bank rate since 1935–2011.
Working of the bank rate
Changes in bank rate are introduced with a view to controlling the price levels and
business activity, by changing the demand for loans. Its working is based upon the
principle that changes in the bank rate results in changed interest rate in the market.
Suppose a country is facing inflationary pressure. The central bank, in such situations,
will increase the bank rate thereby resulting to a hiked lending rate. This increase will
discourage borrowing. It will also lead to a fall in the business activity due to following
reasons:

 Employment of some factors of production will have to be reduced by the business


people.
 The manufacturers and stock exchange dealers will have to liquidate their stocks,
which they held through bank loans, to pay off their loans.
The effect of rise in bank rate by the Central Bank is depicted pictorially in the diagram
above. Hence, we can conclude that hike in bank rate leads to fall in price level and a
fall in the bank rate leads to an increase in price level i.e. they share an inverse
relationship.

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