The Reserve Bank of India is India’s central bank as we know it and it is wholly owned by the Government of India. It was established on April 1 1935, before our independence. The Central Office of RBI is located in Mumbai, Maharashtra.
Functions of RBI
The RBI formulates implements and monitors India’s monetary policies, which helped maintain price stability, ensure adequate flow of credit to productive sectors, and financial stability.
The RBI issues currency and coins, and exchanges or destroys currency notes and coins unfit for circulation.
The RBI acts as a banker and debt manager to Government of India by performing merchant banking functions for central and state governments, acting as their banker, and determining how best to raise money in debt markets to help the government fnance its requirements.
The RBI acts as a banker to banks by enabling, clearing and settlement of inter-bank transactions, maintains bank account for statutory reserve requirement and act as a lender of last resort.
The RBI also manages foreign exchange. It regulates transaction related to the external sector, enables development of the foreign exchange market (forex), ensures smooth functioning of the domestic forex market, and manages India’s foreign currency assets and gold reserves.
Monetary Policies of RBI
The primary objective of monetary policies is to maintain price stability while keeping in mind the objective of growth.
The amended RBI Act also provides for the inflation target to be set by the Government of India once in every five years.
The Central Government has set 4% Consumer Price Index (CPI) inflation as the target period from August 5, 2016 to March 31st, 2021 with the upper tolerance limit of 6% and the lower tolerance limit of 2%.
Instruments of Monetary Policies
- Repo rate
- Reverse Repo rate
- Bank rate
- Cash Reserve Ratio (CRR)
- Statutory Liquidity Ratio (SLR)
- Open Market Operations (OMO)
Repurchase Options or in short Repo Rate is the rate at which the Reserve Bank of India lends money to commercial banks in the event of any shortfall of funds.
Repo Rate is to borrow money for short term. The banks have to pay this interest rate. The loan is collateralized.
Reverse Repo Rate
If a bank has surplus money, they can park this excess liquidity with Reserve Bank of India and central bank will pay an interest interest on this. This interest rate is called Reverse Repo Rate.
It can be said that Reverse Repo Rate is the opposite of Repo Rate. Because in Repo Rate Reserve Bank of India was giving a loan to bank.
When banks want to borrow long term funds from RBI, it is the interest rate which RBI charges from them.
It is for non-collateralized loan. No collateral has to be given by the normal bank to RBI.
Cash Reserve Ratio
The ratio specifies minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves, either in cash or as deposits with the Central bank.
Banks get no interest on cash reserve, thus they want CRR to be as less as possible.
It acts as a safety net for commercial banks.
Statutory Liquidity Ratio
The share of net demand and time liabilities that banks must maintain in safe and liquid assets, such as government securities, cash and gold, is SLR.
Banks get interest on their investment in such liquid assets.
It also acts as a safety net for the commercial banks.
Open Market Operations
Open market operation is the activity of buying and selling of government securities in open market to control the supply of money in banking system.
When there is excess supply of money, RBI sells government securities thereby taking away access liquidity.
Similarly when the economy needs more liquidity, RBI buys government securities and infuses more money supply into the economy.
In addition to these measures, the Reserve Bank of India also uses many qualitative tools to regulate credit flow and cost of credit to the economy and specific sectors within it.
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