Index

1. Introduction
a. Central Bank
b. Reserve Bank of India (RBI)
c. History of RBI
d. Preamble of RBI
2. Functions of the Central
Bank (RBI)
3. Monetary Policy –
Advantages & Disadvantages
4. Credit Control
a. Definition
b. Objectives
c. Importance
5. Control of Credit Supply
by the Central Bank (RBI
in India)
a. Quantitative Instruments of
Credit Control
b. Qualitative Instruments of Credit
Control
6. Need & Limitations of
Credit Control
7. Policy Rates & Reserve
Ratios
8. Conclusion
Introduction
Central Bank
A central bank, reserve bank or monetary authority
is the apex institution that manages a state’s
currency, money supply and interest rates. Central
Bank also, usually oversee the commercial banking
system of their country. 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
serves as the state’s legal tender.
The main function of a central bank is to control the
nation’s money supply (through monetary policy)
through active duties such as managing interest
rates, setting the reserve requirements, also acting
as a lender of last resort to the banking sector
during times of a bank’s insolvency or financial
crisis. It also has the supervisory powers intended
to prevent bank runs and to reduce the risk that
commercial banks and other financial institutions
engage in from reckless and fraudulent behavior.
Central Banks in most of the developed nations are
institutionally designed to be independent from
political interference but are still subjected to
limited control by the legislative and the executive.
Reserve Bank of India (RBI)
RBI, the Central Bank of India is the apex monetary
institution which supervises, regulates, controls and
develops the monetary and financial system of the
country. It is the sole agency of note issuing and
controls the supply of money in the economy. It
serves as a banker to the government and
manages forex (foreign exchange) reserves of the
country. The role of RBI has undergone through a
rigorous change over the period of time. Earlier, it
was a common perception that the role of RBI is
confined to credit control depending on the
economic environment of the national as well as
international level. Credit control measures are
Policy Rates (Bank Rate and Repo Rate) and Policy
Ratios (CRR and SLR). RBI raises the different key
rates such as Cash Reserve Ratio, Statutory
Liquidity Ratio, REPO Rate which curb the credit
creating capacity of the banks and reduces the
money circulation in the economy. Until the
Monetary Policy Committee was established in
2016, it also controlled monetary policy in India.
The bank has to simultaneously ensure three
functions - liquidity, profitability as well as the
safety of the fund collected from the depositors.
RBI plays developmental role, promotional role,
supervisory role as well as regulatory role.
History of RBI
The Reserve Bank of India was established
following the Reserve Bank of India Act, 1934.
Initially, it was constituted as a private
shareholders‘ bank with a fully paid up capital of
Rs. 5 crores. Following India's independence on 15
August 1947, the RBI was nationalized on 1 January
1949. The Reserve Bank of India was founded on 1
April 1935 to respond to economic troubles after
the First World War. The
Reserve Bank of India was conceptualised based on
the guidelines presented by the Central Legislative
Assembly which passed these guidelines as the RBI
Act
1934. RBI was conceptualised as per the guidelines,
working style and outlook presented by Dr. B. R.
Ambedkar in his book titled "The Problem of the
Rupee
Its origin and its solution" and presented to the
Hilton Young Commission. The bank was set up
based on the recommendations of the 1926 Royal
Commission
on Indian Currency and Finance, also known as the
Hilton-Young Commission. The original choice for
the seal of RBI was the East India Company Double
Mohur, with the sketch of the Lion and Palm Tree.
However, it
was decided to replace the lion with the tiger, the
national animal of India. The Central Office of the
RBI was established in Calcutta (now Kolkata) but
was moved
to Bombay (now Mumbai) in 1937.
Preamble of RBI
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; to
have a modern monetary policy framework to meet
the challenge of an increasingly complex economy,
to maintain price stability while keeping in mind
the objective of growth."

Functions of the
Central Bank (RBI)
Principal functions of the central bank are as under:

(1) Bank of Issuing Notes: Central bank of a

country has the exclusive right (monopoly right) of
issuing notes. This is called Currency Authority
function of the central bank. The notes issued by
the central bank are an unlimited legal tender.

(2) Banker to the Government: Central bank is a

banker, agent, and financial advisor to the
government.
■ As a banker to the government, it manages
accounts of the government
■As an agent to the government, it buys and sells
securities on behalf of the government.
■As an advisor to the government, it frames
policies to regulate the money market.

(3) Bankers' Bank and Supervisory Role: As a

Bankers' Bank, it has almost the same relation with
other banks in the country as a commercial bank
has with its customers. Three observations need to
be noted in this context:

(i) The central bank accepts deposits from the

commercial banks, and offers them loan.

(ii) The central bank provides 'Clearing House'

facility to the commercial banks. It is a cheque
clearing facility provided at one centre to all the
banks.
(iii) In its supervisory role, the central bank ensures
that the commercial banks show compliance to its
directives, particularly relating to CRR and SLR. The
central bank changes CRR, SLR as and when
required. It ensures that the commercial banks
show compliance to these changes so that the
desired targets are achieved.
(4) Lender of the Last Resort: It means that if a
commercial bank fails to get financial
accommodation from anywhere, it approaches the
central bank as a last resort. Central bank
advances loan to such a bank against approved
securities. By offering loans to the commercial
banks in situations of emergency, the central bank
ensures: (i) that the banking system of the country
does not suffer any set-back, and (ii) that money
market remains stable.

(5) Custodian of Foreign Exchange: Central bank

is the custodian of nation's foreign exchange
reserves. It also exercises 'managed floating to
ensure stability of exchange rate in the
international money market.
Managed floating refers to the sale and purchase of
foreign exchange with a view to achieving stability
of exchange rate for the domestic currency.

(6) Clearing House Function: The central bank is

a banker’s bank that keeps the cash balances of
commercial banks and helps the member banks. It
is also responsible for settling the accounts of
commercial banks. Its function is that of a clearing
house, an organization where the banks can offset
the mutual claims against one another and make a
settlement by paying the difference. For example –
Suppose there are two banks. They draw cheques
on each other. Suppose
bank A has Rs. 10,000 from Bank B and is obligated
to pay Rs. 12,000 to Bank B. At the clearing house,
they can offset the mutual claims, where bank A
pays off Rs. 2,000 to bank B, and the account is
settled. The central bank’s clearinghouse
contributes to the economy through cash, avoiding
hectic communications and inconvenience.

(7) Control of Credit: The principal function of the

central bank is to control the supply of credit in the
economy. It implies increase or decrease in the
supply of money in the economy by regulating the
'creation of credit' by the commercial banks. The
central bank needs to control the supply of money
to cope with the situations of inflation and
deflation. During inflation, the supply of money is
reduced and during deflation, it is increased.

(8) Protection of Depositor’s Interests: The

central bank supervises the functioning of
commercial banks to protect the interest of the
depositors and ensure the development of banking
on sound lines. The banking business has,
therefore, been recognized as a public service
necessitating legislative safeguards to prevent
bank failures. The central bank is authorized to
inspect commercial banks to ensure an efficient
banking system with sufficient financial resources
operating under proper management by the
banking laws and regulations.
MEASURES TO CORRECT
DEFICIENT AND EXCESS
DEMAND: FISCAL AND
MONETARY POLICIES
Economic stability requires that the situations of
excess demand and deficient demand are
corrected as fast as possible. The government does
it through its revenue-expenditure policy (Fiscal
Policy), and the Central Bank (RBI) does it through
its monetary policy. Let us understand how these
policies are used to combat inflationary gap
(related to excess demand) and deflationary gap
(related to deficient demand).

FISCAL POLICY (FISCAL

MEASURES)
Fiscal policy refers to revenue and expenditure
policy of the government. It is also called
Budgetary Policy of the government. It focuses on
the growth and stability of the economy by
correcting the situations of excess demand
(inflationary gap) and deficient demand
(deflationary gap).

Components of Fiscal Policy and the

Way these are Used
Following are the principal components of fiscal
policy
(1)Government Expenditure
It is by changing any or all types of expenditure
that the government seeks to correct the situations
of excess demand or deficient demand in the
economy. When there is excess demand,
government expenditure is reduced, and when
there is deficient demand, government expenditure
is increased. A rise in government expenditure acts
as an 'injection' into the circular flow of income in
the economy. It is required when liquidity needs to
be released to combat deflation. Likewise, a cut in
government expenditure acts like a 'withdrawal'
from the circular flow of income in the economy. It
is required when liquidity needs to be soaked to
combat inflation.

(2)Taxes
Taxes are a compulsory payment made to
government by the household.
By increasing the tax burden on the households,
the government reduces their disposable income.
Accordingly, aggregate demand is reduced or
excess demand is managed. On the other hand, by
lowering the tax burden, the government increases
disposable income of the households. Accordingly,
aggregate demand is raised and deficient demand
is managed.
(3)Public Borrowing/Public Debt
By borrowing from the public, the government
creates public debt. In a situation of deficient
demand, the government reduces its borrowing
from the public. So that people are left with greater
liquidity (or cash balances) and aggregate
expenditure remains high. On the other hand, when
there is a situation of excess demand, the
government steps up public borrowing by offering
attractive rate of interest. This reduces liquidity
with the people. Accordingly, aggregate
expenditure also reduces and excess demand is
managed.

(4)Borrowing from RBI (the Cental

Bank)
Borrowing by the government from the RBI is
another element of fiscal policy. It is increased to
fight deflationary gap, and reduced to fight
inflationary gap. Higher borrowing releases greater
liquidity in the economy, as required to correct
deflationary gap (deficient demand). When
borrowing is reduced, the amount of liquidity in the
economy is also reduced, as desired to correct
inflationary gap (excess demand) in the economy
Monetary Policy
Monetary policy is the policy adopted by the
monetary authority of a nation to control either the
interest rate payable for very short-term borrowing
(borrowing by banks from each other to meet their
short- term needs) or the money supply, often as
an attempt to
reduce inflation or the interest rate, to ensure price
stability and general trust of the value and stability
of the nation's currency.
Advantages :-
 Expansionary monetary policy makes it possible
for more investments come in and consumers
spend more.
 Lowered interest rates also lower mortgage
payment rates.
 It allows the Central Bank to apply quantitative
easing.

Disadvantages :-
 Despite expansionary monetary policy, there is
still no guaranteed economy recovery.
 Cutting interest rates is not a guarantee.
 It will not be useful during global recession.
Credit Control
Definition
Credit control is an important tool used by Reserve
Bank of India, a major weapon of the monetary
policy used to control the demand and supply of
money (liquidity) in the economy. Central Bank
administers control over the credit that the
commercial banks grant. Such a method is used by
RBI to bring "Economic Development with
Stability". It means that banks will not only control
inflationary trends in the economy but also boost
economic growth which would ultimately lead to
increase in real national income stability. In view of
its functions such as issuing notes and custodian of
cash reserves, credit not being controlled by RBI
would lead to Social and Economic instability in the
country.

Objectives
The Primary Objective according to RBI is to control
inflationary tendencies present in the economy to
ensure high economic growth with adequate level
of liquidity and maximum utilization of resources.
• To achieve internal price stability.
• To achieve financial stability.
• To achieve stability in foreign exchange rate.
• To meet the financial requirement during slump
in the economy.
• To maximise income, output and employment in
the economy.
• To eliminate business cycles and meet business
needs.
• To promote economic growth and development of
the country.

Importance
• It helps in achieving the primary objective of
controlling inflation through price stability and
financial stability.
• It helps in boosting the economy by facilitating
adequate flow and volume of bank credit to
different sectors and encourages growth of priority
sectors by providing adequate credit to priority
sectors essential for economic development.
• Encourages judicious delivery of credit by keeping
check on credit granted for undesirable purposes
by commercial banks.
CONTROL OF CREDIT SUPPLY BY
THE CENTRAL BANK (RBI IN
INDIA)
The central bank adopts various measures to
control the supply of money in the economy.
Largely, these measures relate to credit supply by
the commercial banks. These are broadly classified
as:
(A) Quantitative Instruments, and
(B) Qualitative Instruments.

A) Quantitative Instruments of Credit

Control
Quantitative instruments are those instruments of
credit control which focus on the overall supply of
money in the economy. Supply of money is lowered
to tackle inflation, and it is raised Supply Following
is a brief description of these instruments:

(1) Bank Rate: Bank rate refers to the rate of

interest at which the RBI lends money to the
commercial banks. It relates to instant (immediate)
loan requirement of the commercial banks.
The increase (or decrease) in bank rate is often
followed by increase (or decrease) in the market
rate of interest (the interest rate charged by the
commercial banks from
the general public). Accordingly, the cost of credit
(also called the cost of capital) changes in the
market. When bank rate is increased, market rate
of interest is also increased. Accordingly, the cost of
capital increases. This lowers the demand for credit
and therefore, the supply of money tends to fall.
Accordingly, inflation is corrected. On the other
hand, when bank rate is decreased, market rate of
interest is also decreased. Accordingly, the cost of
capital decreases. This increases demand for credit
and therefore, supply of money tends to rise.
Accordingly, deflation is corrected.

(2) Open Market Operations: Open market

operations refer to the sale and purchase of
securities in the open market by the RBI on behalf
of the government. By selling the securities (like,
National Saving Certificates-NSCs) in the open
market, the RBI soaks liquidity (cash) from the
economy. And, by buying the securities, the RBI
releases liquidity.

When liquidity is soaked (as during inflation), cash

reserves of the commercial banks are squeezed.
Implying a cut in their credit creation capacity. On
the other hand, when liquidity is released (as
during recession/deflation), cash reserves of the
banks tend to rise. Implying a rise in credit creation
capacity of the commercial banks.
Thus, inflation is corrected by selling the securities
and soaking liquidity, while deflation is corrected by
buying the securities and releasing liquidity.

(3) Repo Rate: The rate at which the RBI (central

bank) offers short period loans to the commercial
banks by buying the government securities in the
open market is called 'Repo Rate'. In fact, it is a
Repurchase Rate the purchase agreement is signed
by both the parties stating that the securities will
be repurchased by the commercial banks on a
given date at a predetermined price.

In other words, the RBI issues a loan cheque to the

commercial banks by buying from them the
government securities. But, it carries the
agreement of repurchase of securities by the
commercial banks at the predetermined date and
at a predetermined price.

During inflation, the cost of capital is increased by

increasing the repo rate. This lowers the demand
for credit and accordingly, the supply of money in
the economy, as desired. On the other hand, during
deflation, the cost of capital is reduced by reducing
the repo rate. This increases the demand for credit
and accordingly, the supply of money in the
economy, as desired.
(4) Reverse Repo Rate: The rate at which the RBI
(central bank) accepts deposits from the
commercial banks (through government securities)
is called 'Reverse Repo Rate'. It is also called
Reverse Repurchase Rate. In this case, a reverse
repurchase agreement is signed by both the parties
stating that the securities will be repurchased on a
given date at a predetermined price. Reverse repo
rate allows the commercial banks to generate
interest income.

When reverse repo rate is lowered, banks are

discouraged to park their surplus funds with the
RBI. Instead, the banks may use these funds as
CRR-funds with the RBI. This leads to a rise in credit
supply (money supply) by the commercial banks.
Accordingly, supply of money is enhanced in the
economy, as desired to control deflation. On the
other hand, a rise in reverse repo rate may induce
the commercial banks to park more funds with the
RBI to generate interest income. This lowers their
capacity to offer CRR-funds to the RBI for the
creation of credit. Accordingly, supply of money is
reduced in the economy, as desired to control
inflation.

(5) Cash Reserve Ratio (CRR): It refers to the

minimum percentage of a bank's total deposits
required to be kept with the RBI. It is fixed by the
RBI and is varied from time to time to regulate the
supply of money in the economy.
When the supply of money is to be increased, CRR
is lowered, and when the supply of money is to be
reduced, CRR is raised.

(6) Statutory Liquidity Ratio (SLR): Every bank is

required to maintain a fixed percentage of its
assets in the form of liquid assets, called SLR. The
liquid assets include: (i) cash, (ii) gold, and (iii)
unencumbered approved securities. The rate of SLR
(like that of CRR) is fixed by the RBI and is varied
from time to time. To decrease the supply of money
(as during inflation), the central bank increases
SLR. Accordingly, funds available for CRR-deposits
(for the creation of credit) are reduced. Conversely,
SLR is reduced to increase the supply of money (as
during deflation) in the economy. Accordingly, funds
available for CRR-deposits (for the creation of
credit) are increased.
(B) Qualitative Instruments of Credit
Control
Qualitative instruments are those instruments of
credit control which focus on select sectors of the
economy. These instruments are used to increase
or decrease the supply of money to select sectors
of the economy. (These are those sectors which are
the principal source
instability in the economy.) Broadly, the qualitative
instruments are placed in three categories, as
under:

(1) Margin Requirement: The margin requirement

refers to the difference between the current value
of the security offered for loan (called collateral)
and the value of loan granted. Suppose, a person
mortgages his house worth 1 crore with the bank
for a loan of 80 lakh. The margin requirement in
this case would be 20 lakh. The margin requirement
is raised when the supply of money needs to be
reduced. The margin requirement is lowered when
the supply of money is to be increased. Often the
margin requirement is kept high for speculative
(trading) activities.
(2) Rationing of Credit: Rationing of credit refers
to fixation of credit quotas for different business
activities. Rationing of credit is introduced when the
supply of credit is to be checked particularly for
speculative activities in the economy. The RBI fixes
credit quota for different business activities. The
commercial banks cannot exceed the quota limits
while granting loans. This restricts the supply of
money in the economy, and inflation is controlled.
On the other hand, rationing of credit (if already in
practice) is withdrawn to increase the supply of
money. This controls deflation.
3) Moral Suasion: It is like rendering an advice to
the commercial banks by the RBI to follow its
directives. The banks are advised to restrict loans
during inflation, and be liberal in lending during
deflation. Moral suasion is a combination of both
'persuasion' and 'pressure'. The RBI tries to
persuade the commercial banks to follow its
directives, but if persuasion does not work, it uses
the required pressure as an apex bank of the
country. If pressure also does not work, the RBI can
use direct action which includes derecognition of
the concerned bank. As an instrument of monetary
policy, 'moral suasion' works both as a quantitative
instrument as well as a qualitative instrument.
However, often it is classified as a qualitative
instrument

Need for Credit Control

Controlling credit in the economy is amongst the
most important functions of the Reserve Bank of
India. The basic and important needs of credit
control in the
economy are-
 To encourage the overall growth of the "priority
sector" those sectors of the economy which is
recognized by the government as "prioritized"
depending upon their economic condition or
government interest. These sectors broadly
totals to around 15 in number.
  To keep a check over the channelization of
credit so that credit is not delivered for
undesirable purposes.
 To achieve the objective of controlling inflation
as well as deflation.
 To boost the economy by facilitating the flow of
adequate volume of bank credit to different
sectors.
 To develop the economy.

Limitations of Credit Control

Sometimes central bank fails to control the flow of
credit at an optimum level. Those reasons are
described below-
 To be successful in credit control program, full
control over the money market is essential. But
sometimes it is not possible.
 There are different terms of the loan period
credit control method can only affect a short-
term loan.
 The unorganized money market is not suitable
for use of credit control method.
 There is not much co-operation between
commercial banks with the central bank.
 An unstable economy is not suitable to use
credit control method.
 If steps for credit control arc not taken at
primary level, it will not be effective later.
 If the lengthy plan is taken for credit control it
will not work as satisfactorily
Policy Rates &
Reserve Ratios (as of
30 May 2024)
th

Policy Rates
1. Policy Repo Rate – 6.50%
2. Reverse Repo Rate – 3.35%
3. Marginal Standing Facility Rate – 6.75%
4. Bank Rate – 6.75%

Reserve Ratios
1. Cash Reserve Ratio (CRR) – 4.50%
2. Statutory Liquidity Ratio (SLR) – 18.00%

Lending & Deposit Rates

1. Base Rate - 9.10% - 10.25%
2. Marginal Cost of Funds based Lending
Rate (MCLR) - 8.00% - 8.60%
3. Savings Deposit Rate - 2.70% - 3.00%
4. Term Deposit Rate (for less than one
year) – 6.00% - 7.25%

Conclusion
The effectiveness of credit control measures in an
economy depends upon a number of factors. First,
there should exist a well-organised money market.
Second, a large proportion of money in circulation
should form part of the organised money market.
Finally, the money and capital markets should be
extensive in coverage and elastic in nature.

Extensiveness enlarges the scope of credit control

measures and elasticity lends it adjustability to the
changed conditions. In most of the developed
economies a favourable environment in terms of
the factors discussed before exists, in the
developing economies, on the contrary, economic
conditions are such as to limit the effectiveness of
the credit control measures.