2.2 Central Bank

Pivotal financial institution: oversee monetary and financial system of the country

RBI
- introduced
  - in reponse to economic turmoil
  - 1935
- roles
  - monetary policy formulation
  - financial inclusion, inflation control
- Historical evolution
  - response to Hilton young comission
  - 1934: est
  - 1935: establishment
  - 1949: nationalized
- Org struct
  - Governed by central board of directors
    - Overseen by the Governor
      - under him are 4 deputy governors
  - Zonal offices
    - Delhi, Mumbai, Kolkata & Chennai
  - Regional offices within the country

Nature¶

Monetary Authority
- Fomulation and implementation of monetary policy
  - 3 things
  - e.g. to curb inflation in 2022
  - Inflation rises => reduces liquidity (increase cost of borrowing, reduce spending and demand)
- tools:
  - repo rate
  - reverse repo rate
  - open market operations
Regulator & supervisor of FS
- ensures stability and efficiency
- monitors: comm banks, NFBC, FIs
- 2020: Yes bank liquidity crisis:
  - restricted the bank
  - restriction on withdrawals
  - revived the banks
- Ensures they are following good practices
Issuer of Currency
- Exclusive right to issue currency notes
- except one-rupee coins and notes issued by the Ministry of Finance
- Adequate supply of clean currency
- 2016 demonetization
  - withdrew: 500 and 1000 notes
  - intro 500 and 2000 notes
  - curb black money
Government Banker and Debt Manager
- Manage account
- facility borrowing
- facilitates: Handles public debt
- e.g.
  - G-secs
  - issues bonds and tbills
  - financial advisor
Foreign exhcange manager
- forex reserves
- ensures smooth functioning
- sets policies
- manages exchange rate volatility
- e.g.
  - 2013 Indian rupee under pressure
  - Selling forex reserves
  - raised interest rates
- FEMA
  - regulates foreign exchange deals
Developmental role
- supporting national growth, financial literacy, promote inclusive banking
- e.g. PMJDY
- Guided banks
- simplified the process of opening accounts
Custodian of Forex reserves
- Gold, foreign currencies, SDRs (special drawing rights)
- ensures it can meet its international payment obligations
  - e.g. COVID-19 2020: forex reserves to stabilize rupee when there was an economic slowdown and for investments declined
- Buffer against external shocks (forex reserves)
  - maintain confidence in the economy
Lender of last resort
- when comm banks face illiquidity
- 2008 global financial crisis: lack of cashflow
- ensures bank do not fail due to fail due to temp liquidyt shortages
Promote financial inclusion
- enchaned digital banking services
- E.g.
  - Mobile banking and wallets
  - Priority Sector Lending (PSL) norms
    - weaker section of society
    - agro
Bankers to banks
- e.g. Banks maintain a cash reserve (Cash reserve ratio)
  - ensure sufficient liquidity
  - acts as a settlement agent between banks like clearing cheques

Functions of RBI¶

Monetary policy formulation & implementation
- econ stability
  - manage inflation
  - control liquidity
  - fostering growth
- Monetary Policy: Central bank controls money supply and ensures price stability and liquidity
  - How much and at what cost should the money be?
Monetary policy
- Objectives
  - Price stability
    - Inflation: higher cost of living
    - Deflation: hurt businesses & investments
    - Striking a balance
  - Economic growth
    - Enough money available for lending
    - get credit at reasonable rates
- Challenge (to balance)
  - Inflation down => hurts growth (loans are expensive)
  - boost growth => loans become cheaper => inflation up
- Instruments
  - CRR
    - % of banks total deposits to be held in the reserves
    - decrease liquidity => increase CCR
      - less money to lend => lower liuidity
    - increase liquidity => lower CCR
      - more money to lend
    - ~ 3.4%
  - SLR
    - Banks must maintain a certain % of their deposits in the form of liquid assets and govt-approved securities
    - in addition to CRR
    - higher SLR: more funds locked up and vice versa
    - Helps control credit growth and ensure investment in safe assets
  - Repo rate & reverse repo rate
    - Repo rate: rate at which RBI lends money to the comm banks when they are short in funds
    - increase => expensive borrowing => passed on to borrowers as increased interest rates
    - Reverse repo rate: Rate at which RBI borrows money from comm banks
      - increase in reverse repo rate => park more money with the CB. Reducing the amount of money that can be lent
    - They both signal about the cost of operations
  - Open Market Operations (OMO)
    - To increase liquidity: buy g-secs. putting more money into the banking system
    - sell g-secs, take money out of the circulations
    - More flexible than CRR and SLR (can be used more frequently) & (affects money supply in a more subtle and immediate manner)
  - Bank Rate
    - RBI lends money to comm banks in the long term without colletaral
    - Influence cost of borrowing and interest rates for customers
    - repo rates: short terms
Inflation mangement and currency Regulation
- Inflation management
  - NPC (Monetary Policy Committee)
    - inflation target: 4% \(\pm\) 2%
    - rise: tighten monetary policy
    - fall: loosen MP
- Currency Regulation
  - intervene to stabilize the rupee
  - ensure there is enough foreign currency available to pay during imports and clearing internaltional obligations
Currency Issuance & Management
- Sole issuer
- control supply of bank notes
- prevent counterfeit: design and distribute
- Currency Printing:
  - ensure adequate suply
- Currency in circulation
  - introduce new series with ehanced security
Banker to the government
- Facilitate financial transaction
- borrowing
- Public debt management
- government accounts
Banking Regulation & Supervision
- Licensing of banks
- Banking inspection
  - comply
  - ensure adequate capital
  - manage norm
- Prudential norms
  - Asset classification
  - Capital Adequacy
  - Provision for NPAs
- Consumer protection
  - Banking Ombudsman Scheme: Consumer grievances related to banking services
Foreign Exchange Management
- FEMA
  - regulate the inflow and outflow
- stabilize the value of Indian Rupee
- Forex reserves (buffer against external shocks)
- Exchange rate management
Development Role and Financial Inclusion
- PMJDY
- Microfinance & Priority Sector Lending
  - Mandates SME, housing, agriculture.
  - Promote Microfinance Institutions (MFIs)
- Digital Financial Services
  - UPI
  - IMPS
Payment & Settlement Systems
- RTGS (Real-time Gross Settlement)
- NPCI (National Payments Corporation of India)
- NEFT (National Electronic Funds Transfer)
Monetary Policy & Inflation Control
- Manage inflation
  - balance between price rise and growth
  - liquidity management
- Inflation targeting
  - Central bank targets \(4\pm 2\%\)
- Inflation vs Growth Trade-off
Impact of RBI on the Indian Economy
- Control of Inflation
- Financial Sector Stability
  - Internal and external shocks
- Promoting Growth
  - lowering interest rates
- Digital Payments Revolution

Roles of RBI¶

Financial Stability
- Regulation & Supervision
  - Licensing: grants for new banks and FIs
    - Sound financial practices
  - Prudential Norms
    - enough reserves to deal with potential losse
  - Supervision
    - Monitors banks through inspection and audits
  - Stress testing
    - How banks would handle adverse econ situations
- Managing Systemic Risk
  - Macroprudential Policies
    - Safeguard the entire financial institutions
  - Systematic Liquidity Management
    - Repo rate, reserve repo, OMO
    - prevent financial crisis
- Crisis Management
  - Lender of Last Resort to prevent broader financial crisis
  - Resolution Frameworks
    - Mechanisms for resolving stressed assets
    - minimize impact (of mergers and acquisitions or restructuring, say) on the Financial system
- Ensuring Payment System stability
  - Oversee payment systems (NEFT, RTGS)
  - Ensure smooth secure and without interruptions
  - Monitoring digital transactions
    - prevent fraud and cyberatttacks
Inflation Control
- Basics
  - spearheaded by MPC
  - Inflation Targeting \(4\% \pm 2\%\)
  - Primary measure of inflation: CPI
- MP tools
  - Repo Rate
  - Reverse Repo Rate
  - CRR (Must be kept in reserve)
  - OMO (Buying or seeing g-secs)
- Inflation Forecasting & monitoring
  - Data Analysis
  - Inflation Forecasting Models (to predict future and adjust monetary policy preemptly)
- Communication with the public
  - announcement
  - intentions
  - transparency to anchor expectations
- Managing supply-side shocks
  - ensure timely supply in case of
    - Rising fuel prices
    - food shortages
Balancing Financial Stability & Inflation Control
- COVID-19: lowering interest => inflation when back to stability
- Sound regulation
- proactive monetary policy framework
- supervision of FIs from both internal and external shocks.