• Reserve Bank of India (RBI) is the central bank and the supreme monetary authority of India. 
  • RBI was established in April 1935 with its central office at Calcutta under the RBI Act, 1934. Now it has its headquarters in Mumbai and four local boards at Kolkata, Delhi, Chennai, Mumbai. 
  • RBI was established with 5 crore as its capital, as a private shareholders banks.
  • RBI was nationalised on 1 January 1949. 
  • Financial year of RBI is from July 1 to June 30. 

Functions of the RBI 

  • It acts as a central bank of India. 
  • It acts as a banker to central and state governments. 
  • It is the supreme mental authority of country. 
  • It announces the annual policy statement (Earlier known as monetary and credit policy) to take care monetary, credit and other policy aspects of the economy. It announces the policy in April (slack season) and reviews it in October (busy season). 
  • It acts as an advisor to the government. 
  • It acts as a banker's bank and a supervisor. 
  • RBI acts as the controller of money supply and credit. 
  • It manages the foreign exchanges. 
  • RBI collects and publishes all monetary and banking data. 
  • RBI promotes commercial banking, Rural (Agriculture) credit, Industrial Finance and Export Finances, etc. 
  • RBI issues currency. 
  • RBI acts as central clearing house for inter-bank transaction.

Monetary Control 

RBI controls money supply in the market through following operations: 

  • Bank rate policy 
  • Open market operation 
  • Cash reserve ratio 
  • Statutory liquidity ratio 
  • Liquidity adjustment facility, operating through repo and reverse repo 
  • Selective credit controls
  • Moral persuasion

Bank Rate 

  • It has been defined as the standard rate at which RBI is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase under RBI Act. 
  • But, practically bank rate is the rate of which RBI extends advances to the commercial banks, April 1997 onwards. Bank rate is the reference rate for general refinance provided by the RBI. 
  • Bank rate is generally raised during a period of inflation this known as Dear Money Policy and it is lowered at the time of recession which is known as Cheap Money Policy.

Open Market Operation (OMO) 

  • As defined by RBI under OMO, RBI purchases and sells the variety of assets such as foreign exchange, gold, government securities, and even company shares. However, in practice OMO are confined to purchase and sale of government securities only. RBI generally conducts these operations through bank's financial institutions. 
  • Government securities may be short term securities and long term securities Treasury bills of 91 days and 364 days are the short term securities. Government can issue securities of 3 years, 5 years or more, up to 30 years. 
  • If RBI purchases the securities, the interest rate will come down as more money will come into market.
  • If RBI sells securities, the interest rate will go up as money supply will be reduced.

Cash Reserve Ratio (CRR)

  • Scheduled commercial banks are required to keep certain percentage of their total deposit, (net demand and time liability) in the form of cash re-serves with RBI. RBI can vary the cash ratio between 3% and 15% of total demand and time liabilities.
    Note: With effect from November 2001, the banks are paid interest at bank rate on the total eligible balances with the RBI.

Statutory Liquidity Ratio (SLR)

  • It is the ratio of total deposits of a commercial bank which it has to keep with itself in the form of liquid assets. Liquid assets may consist of cash in hand reserves with RBI. Excess, government securities and other encumbered securities, gold. etc.
  • SLR was the first time imposed in 1949 at 20%. It was 38.5% in 1991. As per the recommendation of Narsimhan Committee, the SLR has been brought down to 25% of net demand and time liability of the bank. Banking Regulation Act 1949 stipulates 25% as the minimum SLR rate.

Repo and Reverse Repo

  • Repo rates are the short term interest at which banks can park their funds with the RBI.
  • With effective from 29 October 2004, RBI has switched over to International usage of the terms repo and reverse repo. As per this, absorption of liquidity by the RBI is termed as reverse repo and injection of liquidity is termed as repo.