Following article on”RBI and it's credit control” is part of our series on general awareness:
The Reserve Bank of India was established in 1935 as a central bank of India to supersede the control and regulation of Indian banking sector. With the passage of time the domain of RBI has increased from mere a regulator of banking sector to an agent of development of not just banking sector but of overall development through the manipulation of monetary policy instruments. The major objective of monetary policy is to ensure equal growth and develop of all the sectors, apart from controlling the inflation and creating employment. However RBI is often blamed for concentrating more on the inflation and neglecting the growth factor which may be true also as RBI thorough its tools can affect the money supply directly which in turns affect the inflationary pull while the growth depends on many other factors over which RBI has no say. For instance if investment rate in the economy is low due to negative sentiments, decrease in rate of interest many times doesn’t transform the bad sentiments into good sentiments.
RBI manipulates the money supply with the help of following tools:
1.Bank Rate: Bank rate is the rate at which RBI lend money to the commercial banks if they are short of liquidity. If liquidity in the market is high, inflationary forces are strengthened. In such a situation RBI increases the bank rate, making the availability of funds for the banks expensive and pushes the interest rates upwards. This helps in squeezing the money supply in the market and thereby curbing the inflationary forces. This instrument is not often used by the RBI to affect the money supply as it will make borrowing expensive only when commercial banks are short of cash which rarely happens in India. However, Banks have been borrowing more than Rs.1 lakh crore from the RBI since mid-December, 2011, which touched a peak of Rs.1.5 lakh crore in the recent weeks. The bank rate as on 28 January 2012 is 6 percent.
2.Cash Reserve Ratio (CRR): The cash Reserve ratio is that part of the total deposits with the commercial banks which banks have to keep with the Reserve Bank of India. If RBI increases the CRR, it means that commercial banks had to park more funds with the RBI and are with fewer funds available to lend further to the customers. On the vice versa, if RBI looks for increase in the credit growth, it decreases the CRR which increases the fund availability of funds with the commercial banks for further lending. This instrument is often used by RBI as it directly affects the credit creation capacity of the banks. Last time, RBI reduced the CRR by 0.5 per cent to 5.5 per cent on January 25, 2012, signaling the reversal of the rate hike cycle after nearly two years, and to give a push to growth. The CRR cut by 0.5 basis points releases Rs.32,000 crore of funds from central bank’s reserves to the commercial banks, which had been reeling under a shortage of funds for over a couple of months.
3.Statutory Liquidity Ratio (SLR): SLR is that proportion of deposits that banks need to invest in cash, gold, government debt and other approved securities. It also affects the credit creation capacity of commercial banks in similar manner as that of CRR. This instrument is most seldom used by the RBI to effect the credit creation. It has not been changed since December 2010 and remained unchanged at 24 percent since then.
4.Liquidity Adjustment Facility (LAF): Liquidity adjustment facilities are used to aid banks in resolving any short-term cash shortages during periods of economic instability or from any other form of stress caused by forces beyond their control. Various banks will use eligible securities as collateral through a repo agreement and will use the funds to alleviate their short-term requirements, thus remaining stable.
Liquidity Adjustment Facility (LAF) was introduced by RBI in June, 2000. The funds under LAF are used by the banks for their day-to-day mismatches in liquidity. Minimum bidding size for investment in LAF are Rs.5 crores or in the multiples of Rs5 crores. The Central Government’s dated securities and treasury bills are eligible as the instrument of transfers and these are auctioned under the repo and reverse repo. Repo is the credit injection process where RBI purchases securities from the commercial banks and the rate of interest announced by RBI on these securities is the repo rate. Reverse repo is the credit absorption process where RBI sells the securities to the Commercial banks and adsorbs the additional liquidity from the market. The current repo and reverse repo rates are 8.5 and 7.5 percent respectively.
5.Marginal Standing Facility (MSF): Marginal Standing Facility (MSF): Marginal Standing Facility (MSF) is a new scheme announced by the Reserve Bank of India (RBI) in its Monetary Policy (2011-12). It came into effect from 9th May 2011. MSF scheme is provided by RBI where the banks can borrow overnight up to 1 per cent of their net demand and time liabilities (NDTL) i.e. 1 per cent of the aggregate deposits and other liabilities of the banks. The rate of interest for the amount accessed through this facility is fixed at 100 basis points (i.e. 1 per cent) above the repo rate for all scheduled commercial banks. The MSF would be the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility by pledging through government securities, which has lower rate of interest in comparison with the MSF. The MSF would be a penal rate for banks and the banks can borrow funds by pledging government securities within the limits of the statutory liquidity ratio. The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system. Banks can borrow through MSF on all working days except Saturdays, between 3.30 and 4 30 p.m. in Mumbai where RBI has its headquarters. The minimum amount which can be accessed through MSF is Rs.1 crore and in multiples of Rs.1 crore. The current marginal standing facility rate is 9.5 percent.
With the help of above mentioned instruments RBI regulates the money supply and credit growth in the economy. RBI increases the interest rates to curb the inflationary pressures and reduces the rates to stimulate the growth. RBI criticized for not only more focusing on the inflation rather than on growth but also pursuing wrong policies as in India, inflations not only because of demand side factors but also because of factors affecting the supply of goods like poor infrastructure which increases the costs of goods and increasing the interest increases the cost of investment in infrastructure. In the past also inflation rate has shown little response to the RBI policy but more to the supply of agriculture goods and price of crude oil in International Market. Though inflation is a sensitive issue in India and therefore always under the RBI radar but CRR cut introduced on 25 January 2012 indicates that growth also remains on the radar of RBI.
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