The RBI and credit controlThe RBI has been assigned the task of controllingthe inflationary pressures in the economy.Credit control measures by the RBI :Quantitative and qualitativeQuantitative methods: regulate only thequantity of credit and not the use of which it isput to.
1) Bank Rate:• The bank rate is the rate at which the Reserve bank advances to the member banks against approved securities or rediscounts the eligible bills of exchange and other papers.
• The bank rate is considered as a pace-setter in the money market: changes in the bank rate influence the entire interest rate structure (both short term and long term interest rates)• Rise in bank rate – dear money policy that increases the cost of borrowing• Fall in bank rate – cheap money policy reducing the cost of borrowing• Current Bank Rate• 9.00% (w.e.f. close of business of 17/04/2012)• Decreased from 9.50% to 9.00% which was continuing since 13/02/2012•
NET LIQUIDITY RATIO:In order to check excessive borrowings from the RBI bycommercial banks, the Net liquidity ratio was introduced inSeptember, 1964A commercial bank can borrow from the RBI at the bank rateonly if it maintains a minimum net liquidity ratio to its totaldemand and time liabilities – if the NLR falls below theminimum ratio fixed by the RBI, the commercial banks will haveto pay a penal rate of interest.Net liquidity of borrowing banks = a) cash in hand and balanceswith the RBI b) balances in currency accounts with other banksc) investments in government and other securities MINUSborrowing from the RBI, SBI and IDBINLR was abandoned in 1975
• OPEN MARKET OPERATIONS : Refers to the purchase or sale of Govt. securities.• The RBI seeks to influence the excess reserves position of the banks by purchasing and selling of government securities, commercial papers, etc.• When the central bank purchases securities from the banks – it increases their cash reserve position and hence their credit creation capacity.
• When the central bank sells securities to the banks – it reduces their cash reserve position and credit creation capacity.• RBI can only trade with Government securities.• The purchase or sale of securities tends to increase or decrease the quantity of money in circulation as well as the cash reserves of the commercial banks immediately and directly.
• When there is money stringency in the money market – the RBI will purchase securities• In the event of inflation – too much money circulation, the RBI sells securities in the market.• Open market operations in India are not quite effective.
• Cash reserve ratio (CRR) – refers to keeping a portion of net demand and time liabilities (NDTL) of banks with the central banks (In India it’s Reserve Bank of India, RBI). Central bank fixes this percentage of NDTL. Central bank can change this percentage as a monetary measure to control the availability of funds in the economy i.e. to inject liquidity or to suck liquidity. RBI doesn’t pay any interest on such funds held with it.
• CRR is used to affect the credit creation policy of commercial banks.• An increase in the cash reserve ratio – reduces the excess reserve of the banks.• A decrease in CRR – increases the excess reserve of the banks• Cash Reserve Ratio (CRR)4.50% (wef 22/09/2012) -announced on 17/09/2012Decreased from 4.75%which was continuing since 10/03/2012
• Statutory liquidity ratio (SLR) : Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). RBI is empowered to increase this ratio up to 40%. An increase in SLR also restrict the bank’s leverage position to pump more money into the economy.
• The minimum SLR is in addition to the CRR.• Reasons for raising SLR:• 1) It reduces commercial banks’ capacity to create credit and thus helps to check inflationary pressures• 2) It makes larger resources available to the government.• Current Statutory Liquidity Ratio (SLR)• 23%(w.e.f. 11/08/2012) (announced on 31/07/2012)Decreased from 24% which was continuing since 18/12/2010•
• Repos• The RBI introduced repurchase auctions (Repos) since December, 1992 with regards to dated Central Government securities.• When banking systems experiences liquidity shortages and the rate of interest is increasing – the RBI will purchase Government securities from Banks – payment is made to banks – improves liquidity and expands credit.
• Since November, 1996 RBI introduced Reverse Repos to sell Govt. securities through auction at fixed cut-off rates of interest. It will provide short term avenues to banks to park their surplus funds, where there is considerable liquidity and call rate has a tendency to decline.
• Selective credit controls• Selective methods of credit control regulate the use of credit by discriminating between essential and non-essential purposes.• * The central bank may prohibit or caution banks against particular type of securities.• May prescribe margins against secured advances.
• May regulate hire-purchases and installment transactions.• It can stipulate the rates of interest on different types of bank advances.• All the above are used to ensure that resources flow into essential lines – prevents speculation and hoarding of commodities.
• The RBI can issue directives to banks in respect of :• 1) Their lending policies – the purpose for which advances may or may not be granted.• 2) The margins to be maintained on secured advances• 3) The rate of interest charged.
• Moral persuasion and direct action• When commercial banks pursue an unsound credit policy or borrow excessively, the RBI may refuse to grant loans or rediscount bills.• The RBI may charge penal rate of interests – direct action• Moral persuasion involves persuading the banks not to ask for further loans.
• RBI and economic development • 1) RBI and commercial banks• A) The RBI is vesting with the great responsibility of developing commercial banks in India.• b) In the past the RBI used these powers to ensure safety of depositors’ money.• C) Recently the RBI is guiding commercial banks effectively in investing their funds for productive purposes. D) The RBI has shown great initiative in creating and expanding banking facilities to rural areas – the Deposit Insurance Scheme was initiated by the RBI
• 2) RBI and Monetary stability• * Since 1956 as volume of investment has increased rapidly and prices have been rising continuously in India• * As deficit financing is resorted to by our planners, inflation set in – The RBI has made frequent use of Bank rate policy and other quantitative measures – selective credit controls also have been in use effectively.
• 3) RBI and agricultural credit• * Though the RBI does not directly lend to agriculturists, its operations are through the State cooperative banks and the State government.• Since 1950 the RBI has operated two funds : The national agricultural credit (Long term operations fund) and The National agricultural credit (stabilization) fund.• The RBI uses National agricultural credit to grant long and medium term loans to state government.
• Through the National agricultural credit, it grants loans to state co-operative banks to enable them to convert their short term loans into medium term loans.• The RBI inspects the working of cooperative banks• It rediscounts agricultural bills maturing within 15 months at concessional rates.• The RBI has an agricultural credit board
• Co-ordination of the activities of the state government, co-operative banks and committees to study problems relating to rural credit is undertaken by the RBI• The RBI has set up the Agricultural refinance corporation and owns a part of its capital – this corporation undertakes term financing and refinancing activities (Now NABARD looks after these functions)
• RBI and Industrial finance• The RBI along with the government has taken initiative in setting up some institutions for term financing of industries.• The RBI owns part of the capital of the Industrial Finance Corporation and that of the State Financial Corporations – it lends funds to them.
• It opened a Department of Industrial finance to look after the Bank’s activities in the Industrial field.• It took initiatives to set up the Unit Trust of India.• The IDBI which is the king-pin of our development banks is a subsidiary of the RBI• The credit guarantee scheme intended to help the small scale industries is managed by the RBI
• The RBI and foreign trade• The RBI has taken several steps to promote exports – to bridge the gap in our trade balance.• RBI has sponsored many schemes under which term loans are given to exporters.• RBI rediscounts export bills of a longer use at concessional rates.