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Central bank and its functions

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Central bank and its functions

  1. 1. CENTRAL BANK ANDITS FUNCTIONS
  2. 2. Acknowledgement The success and final outcome of this project required alotof guidance and assistance from many people and Iam extremely privileged to have got this all along the completion of myproject. Allthat I have done is onlydue to such supervision and assistance and I would not forget to thank them. I would like to express myspecial thanks of gratitude to myteacher Mrs. Lavita who gave me the golden opportunity to do this wonderful project on the topic Central Bank and its Functions, which also helped me in doing a lotofResearch and icame to know aboutso many new things Iam really thankful to them. Secondly Iwould also liketo thank myparents and
  3. 3. friends who helped me alotin finalizing this project within the limited time frame.
  4. 4. Central Bank A CentralBank, Reserve Bank, or Monetary Authority is an institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency, which usually serves as the state's legal tender. Central banks also act as a "lender of last resort” to the banking sector during times of financial crisis. Most central banks usually also have supervisory and regulatory powers to ensure the solvency of member institutions, prevent bank runs, and prevent reckless or fraudulent behavior by member banks. Central banks in most developed nations are institutionally designed to be independent from political interference. Still, limited control by the executive and legislative bodies usually exists. “A Central Bank is the bank in any country to which has been entrusted the duty of regulating the volume of currency and credit in that country” -Bank of International Settlement. Bank of England was the world’s first effective central bank that was established in 1694. As per the resolution passed in Brussels Financial Conference, 1920, all the countries should establish a central bank for interest of world cooperation. Thus, since 1920, central banks are formed in almost every country of the world. In India, RBI operates as a central bank. Most central banks are governed by a board consisting of its member banks. The country's chief elected official appoints the director. The national legislative body approves him or her. That keeps the central bank aligned with the nation's long-term policy goals. At the same time, it's free of political influence in its day-to-day operations. The Bank of England first established that model. Conspiracy theories to the contrary, that's also who owns the U.S. Federal Reserve. ReserveBankofIndia Reserve Bank is the Central Bank of India Established in “1st April 1935” under the “RESERVE BANK OF INDIA ACT”. Its head quarter is in Mumbai
  5. 5. (Maharashtra). Its present governor is Urjit Ravindra Patel . It has 22 Regional Offices, most of them in State capitals. It was set up on the recommendations of the “Hilton Young Commission”. It was started as Share-Holders Bank with a paid up capital of 5 crores. Initially it was located in Kolkata. It moved to Mumbai in 1937. Initially it was Privately Owned. Since Nationalization in 1949, the Reserve Bank is fully owned by the Government of India. PREAMBLE The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as :- “…To regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." Objectives Of R.B.I  To manage the monetary and credit system of the country.  To stabilizes internal and external value of rupee.  For balanced and systematic developmentof banking in the country.  For the developmentof organized money market in the country.  For properarrangement of agriculture finance.  For properarrangement of industrial finance.  For propermanagement of public debts  To establish monetary relations with other countries of the world and international financial institutions.  For centralization of cash reserves of commercialbanks.  To maintain balance between the demand and supply of currency. FUNCTIONSOF RBI  Issue of currency  Development role  Banker to government
  6. 6.  Banker to bank  Role of RBI in inflation control  Formulate monetary policy  Manager of foreign reserve  Clearing house functions  Regulations of banking system  Issue and management of public debts  Development of financial institutions  Cash reserve  Counseling services  Acts as Lender of last resort Issue of Currency: To ensure adequate quantity of supplies of currency notes and coins of good quality the RBI issues new currency and destroys currency and coins not fit for circulation. It has to keep in forms of gold and foreign securities as per statutory rules against notes & coins issued. DevelopmentalRole: To develop the quality of banking system in India RBI performs a wide range of promotional functions to support national objectives. To establish financial institutions of national importance, for e.g: NABARD,IDBI etc. BankertotheGovernment: RBI Performs all banking function for the central and the state governments and also acts as their banker excepting that of Jammu and Kashmir. It makes loans and advances to the States and local authorities. It acts as adviser to the Government on all monetary and banking matters. Bankertobanks:
  7. 7. Maintains banking accounts of all scheduled banks. RBI also regulates the opening /installation of ATM Fresh currency notes for ATMs are supplied by RBI. RBI regulates the opening of branches by banks. It ensures that all the N.B.F.S follow the Know Your Customer guidelines. The Reserve Bank of India also regulates the trade of gold. Currently 17 Indian banks are involved in the trade of gold in India. RBI has invited applications from more banks for direct import of gold to curb illegal trade in gold and increase competition in the market. Collection and publication of data. It issues guidelines and directives for the commercial banks. RoleofRBIininflationcontrol Inflation arises when the demand increases and there is a shortage of supply.There are two policies in the hands of the RBI.Namely; Monetary Policy: It includes the interest rates. When the bank increases the interest rates than there is reduction in the borrowers and people try to save more as the rate of interest has increased. Fiscal Policy: It is related to direct taxes and government spending. When direct taxes increased and government spending increased than the disposable Income of the people reduces and hence the demand reduces. Formulatemonetarypolicy Maintain price stability and ensuring adequate flow of credit in the economy. It formulates implements and monitors the monetary policy. Instruments: qualitative & quantitative. Quantitative Measures: Quantitative Measures “BANK RATE ” also called “Discount Rate”. It also includes “Repo Rate ”. “Open Market Operations” buying and selling of government securities. “Variable Reserve Ratio” it includes C.R.R and S.L.R. BANK RATE : It’s the interest rate that is charged by a country’s central bank on loans and advances to control money supply in the economy and the banking sector. Cash Reserve Ratio (CRR): It is the amount of Cash(liquid cash like gold)that the banks have to keep with RBI. SLR (Statutory Liquidity Ratio) : It is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers.
  8. 8. Qualitative Measures 1. Direct Action: The central bank may take direct action against commercial banks that violate the rules, orders or advice of the central bank. 2. Moral persuasion: It is another method by which central bank may get credit supply expanded or contracted. 3. Legislation: The central bank may also adopt necessary legislation for expanding or contracting credit money in the market. 4. Publicity: The central bank may resort to massive advertising campaign in the news papers, magazines and journals depicting the poor economic conditions of the country suggesting commercial banks and other financial institutions to control credit either by expansion or by contraction. Managerof ForeignExchange : To facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. It acts as a custodian and Manages the Foreign Exchange Management Act, (FEMA) 1999. RBI buys and sells foreign currency to maintain the exchange rate of Indian Rupee v/s foreign currencies like the US Dollar, Euro, Pound and Japanese yen. ClearingHouseFunctions: The RBI operates clearing houses to settle banking transactions. The RBI manages 14 major clearing houses of the country situated in different major cities. The State Bank of India and its associates look after clearing houses function in other parts of the country as an agent of RBI. Regulation Of BankingSystem: The prime duty of the reserve Bank is to regulate the banking system of our country in such a way that the people of the country can trust in the banking Up to perform its duty. The Reserve Bank has following powers in this regard:  Licensing : According to the section 22 of the Banking Regulation Act, every bank has to obtain license from the Reserve Bank. The Reserve Bank issues such license only to those banks which fulfill condition of the bank.
  9. 9.  Management : Section 10 of the Banking Regulation Act embowered the Reserve Bank to change manager or director of any bank if it considers it necessary or desirable.  Branch Expansion : Section 23 requires every bank to take prior permission from Reserve Bank to open new places of business in India.  Power of inspection of Bank: Under Section 35, the Reserve Bank may inspect any bank and its books and accounts either at its own initiative or at the instance of the Central Government. Issueandmanagement of publicdebts: Central bank manage issue of debts, payment of interest and retirement. Pay annual interest and return the principal amount on maturity. Developmentof FinancialInstitutions: Central bank is responsible to develop financial institution which play vital role in industrial, agriculture and capital development of economy. It also facilitates the establishment and running of money market and stock exchange. Cashreserve : Every bank is bound to deposited a certain percentage of all its deposits with the central bank. In this manner central bank finds itself in better position to control credit money. Counselingservices: The central bank offers advice and counseling services in the light of experts and advice commercial banks to formulates and readjust their polices. ActsasLenderoflast resort: The commercial banks approach the Central Bank for its financial needs as it is the lender of the last resort or the ultimate source of finance. It lends to the commercial banks by rediscounting the eligible bills. The rediscounting facilities given by the Central Bank impart elasticity and liquidity to the entire credit
  10. 10. structure of the country. It helps the commercial banks in a big way to prevent them from bank failures. Moreover, a commercial bank is not entitled to financial accommodation simply because it has eligible paper or approved securities. Unless it is conducting its business ac- cording to sound banking principles, the Central Bank refuses accommodation. The Central Bank is also regarded as performing the function of last resort when it grants accommodation to the government in times of monetary stringency. Methods of issuing currency 1. Minimum reserve system 2. Fixed fiduciary system 3. Proportional reserve system 4. Simple deposit method I. MINIMUM RESERVE SYSTEM Certain level of gold reserve is fixed against which any amount of currency can be issued. Advantages: • Facilitates saving of gold • Flexible and allow contraction and expansion of money supply. Limitations: • This system cause inflation • It may lose public confidence for over-issue of the currency. II. FIXED FIDUCIARY SYSTEM Currency is issued up to a certain amount without any reserve of gold. Currency is needed more than the fixed level it must be backed by gold penny for penny. This method was adopted by Japan and Norway.
  11. 11. Merits • It is safe system • Inflation is well controlled • It enjoys public confidence to the highest. Demerits : • The system is inelastic • It adversely affects industrial growth. • It lacks frugality because it requires much gold • It is a costly system III. PROPORTIONAL RESERVE SYSTEM This system call for a proportionate gold and silver reserve to the total issue of currency. Due to its strong benefits it has become internationally accepted currency- issuing system. Counties depositedreserve ratio: o U.S 40% o France 35% o Germany 40% o Russia 25% o Pakistan 30% o India 40% Advantages: • It is flexible. • It is helpful in industrial growth. • Gold and silver are required in comparatively small amount. Disadvantages: • Inflation to some extent is possible • Keynes declared it an extravagant and wasteful system • Government have tendency to violate the system.
  12. 12. IV. SIMPLE DEPOSIT SYSTEM This systemrequiresahundredpercentgoldreserve forthe issue of currency. Pros : • It is safe • Inflation is not possible Cons : • It is inelastic and cannot be changed to the requirement. • It restricts business and industrial growth. • A large amount of gold and silver is needed. • Costly and wasteful. • Risk of deflation. • It is impracticable Limitations oftheworkingofRBI 1. Lack of a well organized and well integrated money market. 2. Stability in the internal and external value of the rupee has not been maintained. 3. The Reserve Bank of India is not as yet a Completely Autonomous Institution. 4. The unorganized money market of India is still out of the control of RBI. RepoRateandReverseRepoRate: Repo rate: Repo rate is the rate at which the Reserve Bank of India lends the banks for a very short period. The central bank can make necessary changes in the
  13. 13. repo rate according to the present economic situation. It can also be used as a tool of credit control by RBI. Reverse Repo Rate: It is the rate at which Reserve Bank of India borrows from the banks. Generally there is 1% gap between the Repo rate and Reverse Repo rate. (Reverse repo rate is always lower than repo rate). RelationshipbetweenthecentralBank andCommercialBanks The Central Bank is the head of the financial system. All financial institutions including commercial banks are regulated and monitored by the Central Bank. All commercial banks must keep an account with the Central Bank. These balances are used for cheque clearing purposes between banks. Payments for cheques between banks are set off at the Central Bank’s clearing house. The Central Bank can also demand commercial banks to deposit a certain percentage of their total deposits with the central bank in order to control the money supply. The Central Bank dictates the interest rate that commercial banks can offer by setting the bank rate. This is the interest rate set by the Central Bank and the rate at which commercial banks and the Central Bank do business, e.g. loans offered by the Central Bank to commercial bank. Shaktikanta Das
  14. 14. Shaktikanta Das (born 26 February 1957) is a retired 1980 batch Indian Administrative Service (IAS) officer of Tamil Nadu cadre. Currently serving as the 25th governor of the Reserve Bank of India (RBI), he was earlier a member of the Fifteenth Finance Commission and India's Sherpa to the G20. During his career as an IAS officer, Das served in various capacities for Indian and Tamil Nadu governments, including as Economic Affairs Secretary, Revenue Secretary, Fertilizers Secretary. Das was appointed Governor of the Reserve Bank of India by the ACC on 11 December 2018 for a period of three years, replacing Urjit Patel who had resigned the day before. Das' appointment as RBI governor received mostly positive responses, with DBS Bank's head of markets for India at Singapore, Ashish Vaidya, saying that previous governors of the RBI with an IAS background, such as Y. Venugopal Reddy and Duvvuri Subbarao, had been successful and that Das' "cordial relations with the government [...] [would] likely help policy negotiations."S. S. Mundra, a former deputy governor of the RBI, said Das was a "good and balanced choice" for RBI governorship and had "a good understanding of the whole of the financial sector both from the ministry and also in his interactions with the RBI." A former Governor of the Reserve Bank of India C. Rangarajan, said Das had "experience in economic affairs" and would "make a good governor". Gaurav Shah, a senior vice president at Geojit Financial Services, said "a name like Shaktikanta Das carries track record, experience, credentials, credibility and respect along with him. Das assumed charge as RBI governor on 12 December 2018.Reactions of the markets to Das' appointment was positive, with BSE SENSEX gaining 629 points and NIFTY 50 increasing by 188 points. As RBI governor, Das serves as the ex-officio chairperson of the Monetary Policy Committee of the central bank.

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