It refers to the whole mechanism pertaining to money and, it is conducted through the ‘Monetary Policy’ formulated and controlled by the Central Bank of the country, i.e. RBI in India.

Reserve Bank of India

Established in 1935 with a capital of 5 crore on the recommendation of Hilton Young Committee and nationalised in 1949. It got the membership of the Bank of Internationalised Settlement (BIS) in 1996. It is managed by a team if 20 members headed by the government. Its headquarter at Mumbai and four local boards situated in the 4 metropolitan cities.

Its main functions can be envisaged as follows:
1. Issuing Currency Notes
2. Bankers' Bank and Lender of the Last Resort
3. Government’s Banker, Adviser and Agent
4. Regulator of the Monetary System
5. Regulator of the Banking System
6. Custodian of the Foreign Currency Reserve
7. Regulator of the Exchange Rate System
8. Debt Manager of the Government
9. Measurement of Money Supply
10. Credit Control

(Points need to be discussed)
Last two points are most important for both i.e. Civil Aspirants and RBI.
Money Supply
RBI adopts following measures for the purpose:-
M1 = Currency with Public + Demand (Narrow Deposit with Bank + Other
Money) deposits with RBI.
M2 = M1 + Post Office Saving Deposits.
M3 = M1 + Time Deposits with Banks (Broad Money).
M4 = M3 + Total Deposits with Post Office.
Credit Control By RBI

It is one of the most important function of RBI. Credit means loan and credit creation is the prime objective of the banks. But, if they can cause much harm to the economy like Sub-Prime crisis in USA.

MONETARY SYSTEM

Therefore as a regulator RBI holds exclusive powers to control over them through a variety of monetary tools:-
1. Cash Reserve Ratio
2. Statutory Liquidity Ratio (CRR)
3. Liquidity Adjustment Facility (LAF)
    - REPO Rate
    - Reserve Repo Rate
4. Open Market Operations (OMO)
5. Bank Rate
6. Marginal Standing Facility (MSF)
7. Selective or Qualitative Credit Control
    - Moral Suasion
    - High or Low Rate of Interest for specific sectors of Economy etc.

(Points need to be noted)

CRR: It is that part of total cash deposits in a bank which has to be kept with RBI. At present it is 4.75%. Any increase or decrease in this ratio will liable to be decrease and increase in the liquidity available to the banks. (Discuss) \

SLR: Every bank has to keep certain part of its total liquid assets with itself. At present it is 24%. It is an essential part of Fund Banking. No part of SLR would be available to the Public, but for the government.

REPO RATE: It is that rate of interest at which leads to other banks at short term basis. At present it 8%. Any increase in the Repo Rate will increase the rate of interest for public.

REVERSE REPO RATE: It is that rate of interest at which RBI borrows from other banks with an objective to absorb their surplus liquidity. As per the new guidelines of RBI it would be less tha n 1% of Repo Rate. Now it is 7%.

OMO: It is the process of securities by RBI. In case of more liquidity available in the money market it is sold out by RBI, while in a situation shortage of liquidity it is purchased by RBI in order to inject the liquidity, the participants of sale and purchase are banks, NBFCs and insurance Companies etc.

SELECTIVE CREDIT CONTROL: Such measures are qualitative in nature. It is not mandatory but expected from the banks to be followed and public as well. From time to time relevant guidelines are issued by the RBI.

MSF: It is a new financial product by RBI introduction in May 2011, under which bank can borrow overnight up to 1% of net demand and time liabilities (NDTL). It would be 1% above the Repo Rate. Banks can borrow funds through MSF when there is considerable shortfall of liquidity. This measure has been introduced by RBI liability mismatch more effectively. In such a way MSF will help it curb volatility in the overnight to lending rates in the banking system.

Development of Banking System in India

Its credit goes to European trading companies arriving in India during 18th and 19th century. Following facts should be remembered in this regard:- n Bank of Hindustan was the first bank to be established in India in 1770 based on European banking system.

• In 1806 - Bank of Bengal

• In 1840 - Bank of Bombay

• In 1843 - Bank of Madras

were established and known as Presidency Banks.

• In 1921 it was nationalised and renamed as Imperial Bank of India.

• In 1955 Imperial Bank was also nationalised and renamed as State Bank of India,
  the largest bank at present.

• Oudh Commercial Bank, established in 1881 was the first bank by Indians but also held foreign capital, so the fully Indian bank is Punjab National Bank (1894).

• In 1969 14 major private sector banks and again in 1980 6 other were nationalised. But, New Bank of India later on merged into PNB. Therefore, the total number of nationalised banks, at present is 19.

Following are some important concepts in exam point of view:
» NPA : Non-Performing Assets
» CAR : Capital Adequacy Ratio
» PLR : Prome Lending Rate
» Bank Rate
»  Teasere Rate
» Bank Money / High Power Money
»  Banking Ombudsman
» NBFCs
» Call Money Market
» Quantitative Easing
»  Financial Inclusion
»  LIBOR / MIBOR
»  CAMELS
» MICR
»  ECS
»  RTGS

Courtesy: Mr. LS Mishra

Related Topics:

• Basic Economy

• Fiscal System

• Foreign Investment

• Monetary System

• Capital Market

• Inflation

• National Housing Bank - NHB