ROLE OF CENTRAL

BANK
 Central Bank – RBI in India
• Central bank is an apex institute of monitoring and regulating
the entire banking system
• Its role is to foster financial stability and regulate India's Note: Reusable permitted
currency and credit. by google,
Source-
http://rbidocs.rbi.org.in/rdo
cs/AnnualReport/PDFs/0R
• Function– BIAN240810_F.pdf

1. Acts as a banker to the government

2. Lender of the money market (i.e. bankers bank),
3. Issues currency notes, supervises,
4. Controls and Regulates banking activities
Central Bank- Role and History
◦ Founded in 1935, the bank sets monetary policy for the country. It is fully owned by the government of
India and is run by a government-appointed board of directors.
 CB/RBI as ‘currency authority’
◦ Issuer and Regulator of Currency
◦ CB posses the exclusive authority to issue currency in the country.
◦ Notes issued by RBI circulate as legal tender money.
◦ Note- Except one rupees note? Any idea?
◦ ensures uniformity in issue of currency and grant control over money supply
◦ Although government is the technical issuer of currency, the RBI actually distributes the notes and coins into
the marketplace.
◦ Coins are manufactured in the government mint but they are put into circulation through the central bank.
◦ Central bank is required by law to keep a certain amount of gold and foreign securities against the issue of notes.
◦ In some countries, the amount of gold and foreign securities bears a fixed proportion, between 25 to 40 per cent of the total notes
issued.
◦ To RBI, required is Rs 115 crores in gold and Rs 85 crores in foreign securities.
 CB as “Banker to Government”

◦ Custodian of government money and wealth: RBI is in-chargeof all banking

business of central as well as state governments.
◦ As a banker to the government: RBI gives the same banking facilities to the
government which banks give to the general public.
◦ RBI keeps accounts of government, gives them loans, works as agent in matters of
collection of taxes, etc.
◦ It buys and sells foreign currencies on behalf of the government, keeps the stock of
gold of the government.
 CB as “Agent and Adviser to Government”

◦ As an agent of the government, it makes and receives payments on behalf

of the government.
◦ For more detail, refer https://m.rbi.org.in/Scripts/FAQView.aspx?Id=61
◦ As a fiscal agent, the central bank makes short-term loans to the government for a period not exceeding 90 days.
◦ It floats loans, pays interest on them, and finally repays them on behalf of the government. Thus it manages the
entire public debt. 

◦ As an advisor to the government, RBI advises the government on

monetary and economic matters, such as exchange policy, price stability,
economic and money matters as controlling inflation or deflation,
devaluation or revaluation of the currency, deficit financing, balance of
payments, etc.
 CB as “Banker's Bank”
◦ As a Banker’s Bank, RBI proceed with three functions or tasks-
◦ RBI Acts as
1. Custodian of cash reserve: Commercial banks are required by law to keep reserves equal to a certain percentage of
NDTL (Net Demand and Time Liability) with the CB. It is on the basis of these reserves that the CB transfers funds from one bank
to another to facilitate the clearing of cheques.

2. Bank of clearance
3. Lender of last resort: Not only does the RBI set the lending rate between banks, it acts as a banker's
bank. When banks need money, the RBI can lend money to them since it holds some of their reserves.
◦ In addition to supporting other banks, the RBI has the power to inspect and audit other banks.
◦ The RBI also insures deposits made in other banks, up to 5,00,000 rupees (Rs. 5.00 lakh), including
commercial banks.
 CB as Custody and Management of
Foreign Exchange Reserves
◦ It is an official reservoir of gold and foreign currencies.
◦ It sells gold to the monetary authorities of other countries, and also buys and sells foreign currencies at international
prices.
◦ RBI as CB, fixes the exchange rates of the domestic currency in terms of foreign currencies.
 CB as “Controller of Credit”
◦ RBI’s one of the primary task is to control the supply of bank credit or rather
regulate the supply of bank credit in order to control inflationary and
deflationary pressures within this economy.

◦ To control credit, money supply, RBI uses various quantitative and qualitative
instruments
◦ Quantitative instruments: aim at controlling the cost and quantity of credit using
bank rate, CRR, and open market operations.
◦ Qualitative instruments : control the use and direction of credit using margin
requirement, moral suasion
QUANTITATIVE
INSTRUMENTS
 Bank Rate of Interest
◦ -the rate at which the central bank lends money to
the commercial bank.
◦ During Inflation, RBI increases the bank rate of
interest due to which borrowing power of commercial
banks reduces which thereby reduces the supply of
money or credit in the economy.
◦ When Money supply Reduces, it reduces the
purchasing power and thereby curtailing Consumption
and lowering Prices.
 Cash Reserve Ratio (CRR)
◦ CRR refers to a portion of deposits (cash) which banks
have to keep or maintain with the RBI (RBI, 2005).
◦ During Inflation, RBI increases the CRR due to
which commercial banks have to keep a greater
portion of their deposits with the RBI.
Open Market Operations (OMO)
◦ Refers to the Operation of GOI linked with the
buying and selling of securities in the open market
(general public).
◦ To control excess demand (during inflation),
RBI/GOI sells securities in the open market which
leads to transfer of money to RBI.
◦ This reduces effective deposits with the commercial
banks, and thereby, reduces lending capacity of
banks.
◦ Thus money supply is controlled in the economy.
Recent OMO by RBI
Reserve Bank announces OMOs worth Rs 20,000 crore to maintain liquidity
https://
www.business-standard.com/article/finance/rbi-to-buy-sell-omo-worth-rs-20-000-crore-to-maintain-liquidit
y-in-banks-120082500319_1.html
, accessed on 26 Aug, 2020
◦ The RBI on Tuesday (25/Aug/2020) announced that it will “conduct purchase and sale of government
securities worth Rs 20,000 crore as part of Open Market Operation (OMO). The OMO will be conducted
in two tranches on August 27 and September 3.”
 QUALITATIVE
INSTRUMENTS
 Margin Requirements
◦ Banks give loans to customers against some collateral securities.
◦ Banks generally lend an amount less than the value of securities,
called Margin Requirement
◦ During Inflation, RBI fixes a high rate of margin on the securities
kept by the public for loans.
◦ If the margin increases, banks will give less amount of credit on
the securities kept by the public thereby controlling inflation.
 Moral Suasion
◦ RBI sometimes makes use of moral suasion technique
◦ to affect the credit policies of the commercial banks.
◦ Ways- dialog/ formal letters, speeches, debates, discussions, public forum
and or suggestions to banks.
Other Roles of CB
◦ Some additional powers of supervision and control over the commercial banks.
◦ They are the issuing of licences;
◦ the regulation of branch expansion;
◦ to see that every bank maintains the minimum paid up capital and reserves as provided by law;
◦ inspecting or auditing the accounts of banks;
◦ to approve the appointment of chairmen and directors of such banks in accordance with the rules and qualifications;
◦ to control and recommend merger of weak banks in order to avoid their failures and to protect the interest of
depositors;
◦ to recommend nationalisation of certain banks to the government in public interest;
◦ to publish periodical reports relating to different aspects of monetary and economic policies for the benefit of
banks and the public;
◦ and to engage in research and train banking personnel etc..
References
◦ https://
www.yourarticlelibrary.com/banking/central-bank-7-most-important-functions-of-the-central-bank-of-ind
ia/11023
◦ Agarwal V (2010) Macroeconomics Theory and Policy. Pearson Education,
◦ Dwivedi DN (2010) Macroeconomics: Theory and Policy. 3rd edn. Tata McGraw-Hill Education, New
Delhi
◦ Mankiw NG (2020) Principles of Macroeconomics. Cengage Learning,
MCQs
◦ 1. Which of the following are commonly functions of the central bank?
1) Conduct of monetary policy.
2) Lending to the general public.
3) Supervising the stockmarket.
4) Lending to the commercial banking system.

1 and 3
1, 2 and 4
1 and 4
2 and 4
MCQs
2. Which of the following functions of a central bank may potentially conflict with its monetary policy role?
1. Supervisor of the banking system.
2. Banker to the banking system.
3. Manager of the national debt.
4. Banker to the government.
5. Issuer of currency.

A. 1 and 4
B. 2 and 4
C. 1 and 3
D. 1, 2 and 3
 MCQs
3. Which of the following are normally regarded as banks' 'reserves'?
1. Notes and coin in circulation with the public.
2. Operational deposits at the central bank.
3. Treasury bills held by the banking system.
4. The wide monetary base.
5. Notes and coin held by banks.

A. 2, 4 and 5
B. 1, 3 and 5
C. 1 and 4
D. 2 and 4
E. 2 and 5