Reserve Bank of India (RBI) may control money supply in the market through following operations:
- Bank Rate Policy
- Open Market Operations (OMO)
- Cash Reserve Ratio (SRR)
- Statutory Liquidity Ratio
- Liquidity Adjustment Facility operating through Repo and Reserve Repo.
- Selective Credit Controls
- Moral Suasion
- Bank Rate 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 at which RBI extends credit to other commercial banks. From April 1997 onwards, Bank Rate is the reference rate for general refinance provided by the RBI.
- Bank rate is also called discount rate.
- Bank rate is also called discount rate.
- Bank rate is generally raised during a period of inflation, which is known as Dear Money Policy. It is lowered at the time of recession which is known as Cheap Money Policy.
- Reference Bank Rate of some countries
- USA is Feds Funds Rate
- Germany is Frankfurt Inter Bank Offered Rate (FIBOR)
- Japan is Tokyo Inter Bank Offered Rate (TIBOR)
- UK is London Inter Bank Offered Rate (LIBOR)
Open Market Operations (OMO)
- As defined by RBI, under Operations Market operations OMO, RBI purchase and sells the variety of assets such as foreign exchange, gold, government securities and even company shares. However, in practie OMO, RBI purchase 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 conduct these operations through banks and financial institutions.
- Government securities may be short term or long term securities. Treasury Bills of 91 days and 364 days are the short term securities. Government can issue dated securities of 3 years, 5 years or more upto 30 years.
- If RBI purchases the securities interest rate will come down and more money will come into market. If RBI sells securities, interest rate will go up as money supply will be jreduced.
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 reserves with RBI.
- Credit Squeeze or Tight Money Policy means increase in CRR. Liberal Money Policy means decrease in CRR.
Statutory Liquid Ratio (SLR)
- Statutory Liquid Rate (SLR) is the ratio of total deposits of commercial banks which it has to keep with itself in the form of liquid assets. Liquid assets may consist of cash in hand, gold, reserves with RBI, excess reserves, government securities and other encumbered securities, etc.
- SLR was for the first time imposed in 1949 at 20%. It was 38.5% in 1991. As per the recommendations 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.
- Since 1997, the SLR is at 25% level.
Repo and Reserve Repo
- With effect from Oct 29, 2004, RBI has switched over to international usage of the terms Repo and reverse Repo. As per these terms absorptions of liquidity by the RBI is termed as Reserve Repo and injection of liquidity is termed as Repo (earlier these were having the meaning reverse of this).
Capital Adequacy Ratio (CAR)
- Capital Adequacy Ratio (CAR) is the ratio of capital funds (Share Capital + general Reserves) to risk weighted assets. This is required, so that banks can countermand the problem if so arised due to the generation of non-performing assets.
- RBI has stipulated CAR at 9%, although at present most of the banks have CAR more than 9%.
Prime Lending Rate (PLR)
- Prime Lending Rate (PLR) is the rate of interest which is charged by a commercial bank may set its own PLR level. This is more or less a benchmark for the interst rate of the concerned bank. Normally, banks charge interest more than PLR to other borrowers.
Tier I Capital of Banks
- Tier I capital consist of paid up capital, statutory reserves and other disclosed free reserves, if any. Equity investments in subsidiaries, intangible assets and losses should be reduced from Tier 1 capital.
Tier II Capital of Banks
- Tier I capital consists of undisclosed reserves and cumulative perpetual preference shares, discounted value of revaluation reserves, general provision and loss reserves, hybrid debt capital instruments and subordinated debt instruments. As per the banking norms, tier II capital can’t be more than 50% of the Tier I capital.
- The provision of banking and related services through more and more use of information technology without direct recourse to the bank by the customers is known as Virtual Banking.