RESERVE BANK OF INDIA (RBI)
The Central Bank of India was created in 1935 by the Reserve Bank of India Act, 1934. Later, it was nationalized on January 1, 1949 and is fully owned by the Government of India. It is headquartered in Mumbai and is headed by a Governor, who is assisted by four deputy governors. Some major functions of the RBI are:
• Formulation and implementation of monetary policy
• Controller and Regulator of banking business
• Issue and management of currency
• Banker to the government and banks
• Lender of the last resort
• Custodian of foreign exchange and supervision of FEMA
Under the monetary policy, the RBI maintains the optimum level of money supply in the country. Any excess of money supply may lead to inflationary conditions while its shortage may suck out the availability of funds to the business and industry, causing a slowdown in the economy. Either situation is bad for the economy, which presents a big challenge to the RBI. It has to maintain a level of money supply which neither leads to inflation nor adversely affects the growth momentum of the economy. The RBI tries to meet this challenge by tinkering with six key policy rates, called quantitative measures.
These measures aim to control the money supply directly as they affect the banking system as a whole. Two of them, the CRR and the SLR are also called Statutory Measures as they are provided by two separate laws. Both of these ratios are kept as a proportion of total deposits of the banks. In banking parlance, the total deposits are called ‘Demand and Time Liabilities’ (DTL) or Net Demand and Time Liabilities (NDTL).
STATUTORY LIQUIDITY RATIO (SLR)
Under the Banking Regulation Act, 1949, all banks are required to maintain a certain portion (23% at present) of their total deposits as liquid assets i.e. government securities, gold or cash. However, as a common practice, most banks block their SLR funds in the form of government.
CASH RESERVE RATIO (CRR)
As per the RBI Act 1934, all banks are required to maintain a certain portion of their total deposits as cash with the RBI (4% at present).
LIQUIDITY ADJUSTMENT FACILITY (LAF)
The tern liquidity here refers to the availability of funds with the banks. Whenever the banks need funds, they can borrow from the RBI under the repo facility and in case of surplus funds, they can deposit them with RBI under the revere repo facility. Repo, reverse repo and MSF put together form LAF.
A Repo is a Repurchase Agreement. Repo rate is the rate of interest the RBI charges (7.5% at present) from the Banks for short term lending against SLR securities. The Banks can borrow a minimum of Rs. 5 crore under this arrangement and further in multiples of Rs. 5 crore.
REVERSE REPO RATE
Reverse Repo rate is the rate of interest (6.5% at present) the RBI pays to the Banks on their short term deposits maintained with it. As a rule, the Reverse Repo Rate is fixed at 100 basis points (1 %) below the repo rate.
MARGINAL STANDING FACILITY (MSF)
It is a new overnight borrowing facility for the banks granted by the RBI. The facility is available from 3.30 pm to 4.30 pm for a minimum Rs. 1c crore and thereafter in multiples of Rs. 1 crore. Recently its duration was increased to 7 -14 days.
The rate of interest at which the RBI is ready to give loan to the banks is called the Bank Rate. Here the loan is given against the rediscounting of bills and can be given for a longer period, say a few months. The Bank Rate is aligned to the MSF i.e. it is same as MSF rate.
OPEN MARKET OPERATIONS (OMO)
Under this system, the RBI buys or sells securities in the open market to increase or decrease the money supply respectively, in the market.
MARKET STABLISATION SCHEME (MSS)
To protect the domestic money supply levels from the impact of heavy inflow of FDI, THE RBI resorts to MSS by selling the government securities held by it, sucking the liquidity from the market.
All these policy rates are inversely linked to the money supply i.e. as any one or more of these rates is/are increased, it will lead to a decrease in money supply and vice versa.
These are selective measures designed to regulate bank credit for specific purposes. Such measures may include changing marginal requirements for various loans, selective credit control, directives to curb or encourage particulars loan or moral persuasion to the banks.
MEASURES OF MONEY SUPPLY
The RBI classifies money supply in India into four categories:
• MO- Reserve Money: currency in circulation + deposits with RBI
• M1 – Narrow Money: MO + demand deposits with banking system
• M2 – M1 + term deposits with maturity up to one year + Certificates of Deposits issued by banks
• M3 – Broad Money: M2 + other term deposits of bank
The size of M3 in India is estimated at Rs. 85 to 90 trillion.