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Central banks

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  • 1. Pratiksha
  • 2.  In every country there is one bank which acts as the leader of the money market, supervising, controlling and regulating the activities of commercial banks and other financial institutions.  According to the statutes of Bank of International Settlements, “the bank of the country to which has been entrusted the duty of regulating the volume of currency and credit in that country”
  • 3. Objectives of Central Bank Promote financial institutions Maintain internal value of currency Preserve the external value of currency Ensure price stability Promote economic growth
  • 4.  Monopoly of Note Issue  Custodian of Foreign Exchange Reserve  Banker to the Government   Public Debt functions Advisor to the Govt on economic reforms  Banker to the Banks  Controller of Credit  Promoter of Economic Development
  • 5.  Custodian  Lender of cash reserves of last resort  Clearing agent
  • 6.  It means the regulation of the creation and contraction of credit in the economy.  Objectives      of Credit control Stability of Internal Price-level Checking Booms and Depressions Promotion of Economic Development Stability of the Money Market Stability in Exchange Rates
  • 7.  Quantitative controls are designed to regulate the volume of credit created by the banking system. These measures work through influencing the demand and supply of credit.  Qualititative measures, on the other hand, are designed to regulate the flow of credit in specific uses.
  • 8. Quantitative Methods Qualitative or Selective Methods Bank Rate Policy Issue of directives Variation in Reserve ratios Restriction of purpose Open market Operations Margin requirements Credit rationing Rate of interest Moral persuasion
  • 9.  Bank rate refers to the official minimum lending rate of interest of the central bank.  It is the rate at which the central bank advances loans to the commercial banks by rediscounting the approved first class bills of exchange of the banks.  Hence, bank rate is also called as the discount rate.
  • 10.  Theory of Bank Rate- affects the supply of credit.  Working   of Bank Rate Inflationary scenario Deflationary scenario  The Process of Bank Rate Influence  Limitations for Bank Rate
  • 11.  Open market operations refer to the purchase and sale of securities by the central bank.  In its broader sense, the term includes the purchase and sale of both government and private securities.  But, in its narrow connotation, open market operations embrace the purchase and sale of government securities only
  • 12.  Theory of Open Market Operations  Objectives      of Open Market Operations To eliminate the effects of exports and imports to gold under the gold standard. To impose a check on the export of capital. To remove the shortage of money in the money market. To make bank rate more effective. To prevent a „run on the bank‟.
  • 13.  Conditions      for OPM Institutional Framework Legal Framework Maintenance of a Definite Cash Reserve Ratio Non-operation of Extraneous Factors Non-existence of Direct Access of Commercial Banks to the Central Bank  Limitations for OPM
  • 14.  Variable Reserve Ratio refers to the percentage of the deposits of the commercial banks to be maintained with the central bank, being subject to variations by the central bank.  In other words, altering the reserve requirements of the commercial banks is called variable reserve ratio.
  • 15.  Theory  of VRR The theory underlying the mechanism of variable reserve ratio is that by varying the reserve requirements of the banks, the central bank is in a position to influence the size of credit multiplier of the banks and therefore the supply of credit in the economy.  Working of Variable Reserve Ratio  Limitations of VRR
  • 16. o   Distinguish between essential and nonessential uses of bank credit. Only non-essential uses are brought under the scope of central bank controls. Affect not only the lenders but also the borrowers.         Features of Selective Measures Divert the flow of credit Regulate a particular sector of the economy Regulate the supply of consumer credit. Stabilise the prices of inflation sensitive goods. Stabilise the value of securities. Correct an unfavourable BoP Bring under the control of the central bank Exercise control upon the lending operations of the commercial banks. Objectives
  • 17.  Margin Requirements  Regulation of Consumer Credit   They limited the amount of credit that might be granted for the purchase of any article listed in the regulations; and They limited the time that might be agreed upon for repaying the obligation  Rationing   of Credit Fixes a limit upon its rediscounting facilities for any particular bank. Fixes the quota of every affiliated bank for financial accommodation from the central bank.
  • 18.  Control  through Directives With direct power of controlling bank advances either by statute or by mutual consent between the central bank and commercial banks.  Moral Suasion  Direct Action  Publicity
  • 19.       The selective controls embrace the commercial banks only and hence the nonbanking financial institutions are not covered by these controls. It is very difficult to control the ultimate use of credit by the borrowers. It is rather difficult to draw a line of distinction between the productive and unproductive uses of credit. It is quite possible that the banks themselves through manipulations advance loans for unproductive purposes. Selective controls do not have much scope under a system of unit banking. Development of alternative methods of business financing has reduced the importance of selective controls.
  • 20.  Quantitative or general methods or instruments. Bank rate  Open Market Operations  Cash Reserve Ratio (CRR)  Statutory Liquidity Ratio (SLR)   Qualitative or selective methods or instruments.       Variation of Margin Requirements Credit Authorization Scheme (CAS) & Credit Monitoring Arrangement (CAM) Control of Bank Advances Differential Interest Rates Credit Squeeze Policy Moral suasion
  • 21.  The main objective of monetary policy pursued by the Reserve Bank of India is that of „controlled monetary expansion.‟  Objectives of Monetary policy are:  Expansion in the supply of money, and As incomes grow the demand for money as one of the components of savings tends to increase.  Increase in money supply is also necessitated by gradual reduction of non-monetised sector of the economy.   Restraint on the secondary expansion of credit.  While exercising restraints, care should be taken that the legitimate requirements of agriculture, industry and trade are not adversely affected
  • 22.  Recent changes in the Monetary Policy of RBI past 3 months.  Impact of the RBI‟s monetary policy on the economy  Impact of the Monetary policy on the performance of the Banks