Reserve Bank of India (RBI) Overview Established: 1934, based on recommendations of the Hilton Young Commission. Nationalized: 1949. Supervision: Central Board of Directors (20 members): Governor + 4 Deputy Governors. 1 official from Finance Ministry. 10 directors nominated by the government. 4 directors from local boards (nominated by the government). Currency Issuance RBI: Issues currency notes of all denominations except the ₹1 note and coins. Responsible for exchanging and destroying old currency notes. Government of India (Ministry of Finance): Issues coins and ₹1 note (bearing the signature of the Finance Secretary). Governed by the Coinage Act, 1906. Functions of RBI Banker to the Central and State Governments (except Sikkim). Manages public debt for both the Centre and the States. Operates under the Minimum Reserve System (MRS) for issuing currency, backed by gold and foreign securities. Methods to Control Money Supply I. Qualitative Methods (Correct discrepancies in the credit market, control credit flow) Margin Requirement: Specifies a percentage of loan money to be kept as a safety margin. Rationing of Credit: Variable Portfolio Ceiling: Sets fixed credit ceilings for specific sectors. Capital Adequacy Ratio (CAR) or CRAR: High ratio discourages lending to specific sectors. Moral Suasion: Closed-door meetings to persuade banks to follow monetary policy. Publicity: Educating and influencing financial institutions and the public. II. Quantitative Methods (Control cost and quantity of credit) Bank Rate or Discount Policy Rate: Rate at which RBI rediscounts Bills of Exchange or G-Secs held by commercial banks. No collateral required; replaced by Repo Rate as the primary policy tool. Acts as a penal rate for reserve requirement shortfalls. Open Market Operations (OMO): RBI buys/sells government and private securities to control liquidity. Affects the proportion of G-Secs held by RBI, commercial banks, and cooperative banks. Reserve Requirements: Statutory Liquidity Ratio (SLR): Defined under Section 24 of the Banking Regulation Act, 1949. Banks must hold liquid assets (cash, G-Secs, gold, PSU bonds) up to 40% of their liabilities. Cash Reserve Ratio (CRR): Defined under Section 42 of the RBI Act, 1934. Requires banks to maintain a cash reserve with RBI to manage liquidity and inflation. Liquidity Adjustment Facility (LAF): A short-term liquidity control measure introduced based on Narasimham Committee recommendations (1998). Two components: Repo Rate: Rate at which banks borrow from RBI. Reverse Repo Rate: Rate at which RBI borrows from banks (usually 1% lower than Repo Rate). Applies to Scheduled Commercial Banks (SCBs), Primary Dealers, MFs, and Insurance Companies. Marginal Standing Facility (MSF): Allows SCBs with SGL accounts to borrow overnight funds. Key Features: Penal rate: 100 basis points above Repo Rate. Collateral: Dated G-Secs, T-Bills, and State Development Loans (SDLs). Limit: 1% of Net Demand and Time Liabilities (NDTL). Key Monetary Indicators (Current Rates January 2025) IndicatorCurrent RateCash Reserve Ratio (CRR)4.50%Statutory Liquidity Ratio (SLR)18.00%Repo Rate6.50%Reverse Repo Rate3.35%Marginal Standing Facility (MSF) Rate6.75%Bank Rate6.75%RBI rates Market Stabilization Scheme (MSS): A fiscal-cum-monetary tool to absorb excess liquidity caused by capital inflows (e.g., FDI surge). Interest on bonds is paid by the Ministry of Finance. MCLR and Base Rate Evolution of Lending Rates 1991: Narsimhan Committee recommended deregulation of interest rates. Progression: Benchmark Prime Lending Rate (BPLR). 2010: Introduction of Base Rate. 2016: Shift to Marginal Cost of Funds-based Lending Rate (MCLR). 2018: Linkage to Repo Rate for more effective monetary transmission. 1. Base Rate Definition: Minimum rate below which banks cannot lend (except in specific cases). Key Features: Determined by individual banks with discretionary updates. Does not account for the Repo Rate, leading to poor monetary transmission. Exceptions: Differential Interest Scheme (DIS). Loans to bank employees or depositors against their own deposits. 2. MCLR (Marginal Cost of Funds-based Lending Rate) Basis of Calculation: Cost of CRR. Operating Costs. Marginal Cost of Funds (includes Repo Rate and interest on new deposits). Advantage: Enables faster monetary policy transmission compared to the Base Rate. Financial Sector Legislative Reforms Commission (FSLRC) Proposed the Indian Financial Code (IFC) to replace outdated financial laws with a unified legal framework. Debt Management Responsibilities RBI: Manages the market borrowing programs for both the Centre and States. Public debt management for the Union (under obligation to RBI) and States (based on agreements). GoI: Handles external borrowings (limits set by Parliament). Key Initiatives Public Debt Management Cell (PDMC): Established in 2016 under RBI for efficient debt management. Supervisory Functions of RBI Granting banking licenses. Implementing deposit insurance schemes. Conducting periodic reviews of commercial banks and issuing directives. Supervising and controlling Non-Banking Financial Companies (NBFCs). Enforcing the Banking Regulation (Amendment) Act, 2017, which allows RBI to direct banks to initiate insolvency resolution. RBI Dividend Section 47 of the RBI Act, 1934: Mandates surplus transfers from RBI to the Government of India. Five Components of RBI’s Capital Reserves: Contingency Reserve. Asset Revaluation Reserve. Gold and Currency Revaluation Reserve. Investment Revaluation Reserve. Forex Value Account. Narrow and Broad Money Narrow Money (M1) Formula: Currency held by the public + Demand Deposits (DD). Broad Money (M3) Formula: Narrow Money (M1) + Time Deposits (TD). Broad- Narrow+ time deposit with banks + total deposits with post office saving org(excluding national saving certificate) Liquidity Trap Definition: A situation during a recession where lowering interest rates and reserve requirements fails to stimulate demand or economic growth. Key Characteristic: Short-term interest rates approach zero, making monetary policy ineffective. Quantitative Easing (QE) Definition: A monetary policy where the central bank purchases financial instruments not typically accepted in Open Market Operations (OMO). Objective: Inject new money into the economy to boost liquidity and demand. Taper Tantrum Taper: Gradual phasing out of QE to prevent asset bubbles. Taper Tantrum: Market turbulence and adverse reactions triggered by the tapering of QE. Financial Stability and Development Council (FSDC) Background Recommended by the Raghuram Rajan Committee (2008). Members Chairperson: Finance Minister (Chair). Other Members: RBI Governor (Chair of Standing Committee). Finance Secretary. Chief Economic Adviser (CEA). Chairpersons: SEBI, IRDAI, PFRDA. Secretary, Department of Financial Services. Recent Additions: Minister of State for DEA. Secretary, MeitY. Chairperson, IBBI. Revenue Secretary. Functions Ensure financial stability and literacy. Promote financial inclusion. Macro-prudential supervision of the economy. Coordinate between regulatory bodies. Engage with international organizations like FATF and FSB. Financial Stability Board (FSB) Establishment Formed during the 2009 London Summit of the G-20. Successor to the Financial Stability Forum. Details Headquarters: Basel, Switzerland. Hosted and Funded By: Bank for International Settlements (BIS). India’s Representation: Secretary (Economic Affairs). RBI Deputy Governor. SEBI Chairperson. Membership: 24 countries. 6 international organizations. Negative Interest Rate Definition: A situation where the lender pays the borrower for holding their money instead of earning interest.
