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RESERVE BANK OF INDIA- SUBSIDIARIES, FUNCTIONS, MONETARY POLICY

Contents
SUBSIDIARIES OF RBI..................................................................................................................... 2
1. Deposit Insurance and Credit Guarantee Corporation (DICGC) ......................... 2
History and introduction ...................................................................................................... 2
Banks covered by Deposit Insurance Scheme............................................................... 2
Types of Deposits Covered ................................................................................................... 3
Insurance coverage ................................................................................................................ 3
2. Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL) ................ 4
3. Reserve Bank Information Technology Private Limited (ReBIT) ...................... 4
4. Indian Financial Technology and Allied Services (IFTAS) .................................... 4
FUNCTIONS OF RBI.......................................................................................................................... 5
Monetary policy ........................................................................................................................... 5
Monetary Policy Making: ...................................................................................................... 7
Monetary policy instruments: ............................................................................................ 8
Monetary Policy Committee: ............................................................................................. 13

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RESERVE BANK OF INDIA- SUBSIDIARIES, FUNCTIONS, MONETARY POLICY

SUBSIDIARIES OF RBI
The Reserve Bank has the following fully-owned subsidiaries:

1. Deposit Insurance and Credit Guarantee Corporation (DICGC)

History and introduction

• The concept of insuring deposits kept with banks received attention for the first time
in the year 1948 after the banking crises in Bengal.

• Deposit Insurance Act, 1961 came into force on January 1, 1962.

• Deposit Insurance Corporation (Amendment) Act was enacted in 1968.

• The Reserve Bank of India also promoted a public limited company on January 14,
1971, named the Credit Guarantee Corporation of India Ltd. (CGCI).

• With a view to integrating the functions of deposit insurance and credit guarantee,
the Deposit Insurance Corporation and Credit Guarantee Corporation of India were
merged and the present Deposit Insurance and Credit Guarantee Corporation
(DICGC) came into existence in 1978.

• Consequently, the title of Deposit Insurance Act, 1961 was changed to 'The Deposit
Insurance and Credit Guarantee Corporation Act, 1961 '. The functions of DICGC are
governed by the provisions of this act.

• Deposit Insurance and Credit Guarantee Corporation (DICGC) is one of the wholly
owned subsidiaries of the Reserve Bank.

• The Head Office of the Corporation is at Mumbai. It has four Departments, viz.
Accounts, Deposit Insurance, Credit Guarantee and Administration.

Banks covered by Deposit Insurance Scheme

(I) All commercial banks including the branches of foreign banks functioning in
India, Local Area Banks and Regional Rural Banks.

(II) Co-operative Banks - All eligible co-operative banks as defined in Section 2(gg) of
the DICGC Act are covered by the Deposit Insurance Scheme. All State, Central and
Primary co-operative banks functioning in the States/Union Territories which have

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amended their Co-operative Societies Act as required under the DICGC Act, 1961, are
treated as eligible banks. At present all Co-operative banks are covered by the Scheme.
The Union Territories of Lakshadweep and Dadra and Nagar Haveli do not have Co-
operative Banks.

Types of Deposits Covered

The DICGC insures all deposits (such as savings, fixed, current, and recurring deposits)
with eligible banks except the following:
(i) Deposits of foreign Governments;
(ii) Deposits of Central/State Governments;
(iii) Inter-bank deposits
(iv) Deposits of the State Land Development Banks with the State co-operative bank;
(v) Any amount due on account of any deposit received outside India;
(vi) Any amount which has been specifically exempted by the corporation with the
previous approval of the RBI.

Insurance coverage

Initially, the insurance cover was limited to 1,500/- only per depositor(s) for deposits
held by him (them) in the "same right and in the same capacity" in all the branches of the
bank taken together. However, the Act also empowers the Corporation to raise this limit
with the prior approval of the Central Government. Accordingly, the insurance limit was
enhanced from time to time as follows:

• 5,000/- with effect from 1st January 1968

• 10,000/- with effect from 1st April 1970
• 20,000/- with effect from 1st January 1976
• 30,000/- with effect from 1st July 1980
• 1,00,000/- with effect from 1st May 1993 onwards.

This limit of 1 lakh has now been increased to Rupees 5 lakhs by Budget 2020-21.

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2. Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL)

• The Reserve Bank established BRBNMPL in 1995 as a wholly-owned subsidiary

to augment the production of bank notes in India and to enable bridging of the
gap between supply and demand for bank notes in the country.

• The BRBNMPL has been registered as a Public Limited Company under the
Companies Act, 1956. The company manages two Presses, one at Mysore in
Karnataka and the other at Salboni in West Bengal.

3. Reserve Bank Information Technology Private Limited (ReBIT)

• It was established in 2016 with the following objectives:

• Deliver and manage IT projects of RBI for a productive and delightful user
experience through collaboration and excellence

• Assist RBI in performing risk-based supervision of regulated entities

through security audits and incident analysis

• Improve cyber resilience of the banking sector through collaboration with

key stakeholders to promote best practices, drive policy research and build
innovative technology solutions

• Safeguard RBI assets by detecting and responding to cyber-threats through

architecting and operating state-of-the-art security infrastructure and
services

4. Indian Financial Technology and Allied Services (IFTAS)

• IFTAS was established to facilitate the smooth functioning of banks, supporting

them to innovate, and to craft unique digital banking experiences.

• It is a wholly owned subsidiary of RBI, mandated to design, deploy & support IT-
related services to RBI, and all Banks and Financial Institutions in the country.

• Its core competencies is to manage & operate the Financial messaging platform
(SFMS) for India's largest and critical payment system, comprising of Real-Time
Gross Settlement and National Electronic Funds Transfer & the underlying
closed user group Payment System network (INFINET) connecting all of India's

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financial institutions.

• IFTAS operates CLOUD (Indian Banking Community Cloud), the only community
cloud in the country, hosting cloud-based solutions (Platform, Core, Channel,
Corporate, etc.) dedicated to the Banking & Financial Community.

FUNCTIONS OF RBI

The functions of the Reserve Bank today can be categorized as follows:

1. Monetary policy
2. Regulation and supervision of the banking and non-banking financial institutions
3. Regulation of money, forex and government securities markets as also certain
financial derivatives
4. Debt and cash management for Central and State Governments Management of
foreign exchange reserves
5. Foreign exchange management—current and capital account management Banker
to banks
6. Banker to the Central and State Governments Oversight of the payment and
settlement systems Currency management
7. Developmental role
8. Research and Statistics

Monetary policy

• Monetary Policy is the actions of RBI that determine the size and rate of growth of
the money supply, which in turn affects interest rates.

• Monetary Policy is maintained through actions such as modifying the interest rate
(repo, reverse repo, bank rate), buying or selling government bonds (OMOs) and
changing the amount of money banks are required to keep in the vault (CRR and
SLR). All the above 3 methods are termed as conventional tools of monetary policy.

• Broadly, there are two types of monetary policy, expansionary and contractionary.
Expansionary monetary policy (easy/cheap monetary policy) increases the money
supply in order to lower unemployment, boost private-sector borrowing and
consumer spending, and stimulate economic growth. Often referred to as "easy
monetary policy," this description applies to many central banks since the 2008
financial crisis, as interest rates have been low and in many cases near zero.

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• Contractionary monetary policy slows the rate of growth in the money supply or
outright decreases the money supply in order to control inflation; while sometimes
necessary, contractionary monetary policy can slow economic growth, increase
unemployment and depress borrowing and spending by consumers and businesses.

• In recent years, conventional monetary policy has become more common. This
category includes quantitative easing, which means purchase of varying financial
assets from commercial banks. In the US, the fed loaded its balance sheet with
trillions of dollars in treasury notes and mortgage backed securities between 2008
and 2013. The bank of England, ECB and Bank of Japan have pursued similar
policies. The effect of quantitative easing is to raise the price of securities, therefore
lowering their yields, as well as to increase total money supply.

Success of monetary policy depends on many factors:

• Operating Target- There was a time when RBI used broad money (M3) as the
policy target. This was replaced with multiple indicators approach in order to
derive policy perspectives from a wide number of indicators. This has now been
replaced with Inflation Targeting wherein Inflation indicator is the primary
target of RBI.

• Monetary Policy Instruments- The Reserve Bank traditionally relied on direct

instruments of monetary control such as Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR). Cash Reserve Ratio indicates the quantum of cash that
banks are required to keep with the Reserve Bank as a proportion of their net
demand and time liabilities. SLR prescribes the amount of money that banks
must invest in securities issued by the government.

• In the late 1990s, the Reserve Bank restructured its operating framework for
monetary policy to rely more on indirect instruments such as Open Market
Operations (OMOs).

• In addition, in the early 2000s, the Reserve Bank instituted Liquidity Adjustment
Facility (LAF) to manage day-to-day liquidity in the banking system. These
facilities enable injection or absorption of liquidity that is consistent with the
prevailing monetary policy stance. The repo rate (at which liquidity is injected)
and reverse repo rate (at which liquidity is absorbed) under the LAF have
emerged as the main instruments for the Reserve Bank’s interest rate signalling
in the Indian economy. The armour of instruments with the Reserve Bank to
manage liquidity was strengthened in April 2004 with the Market Stabilisation
Scheme (MSS). The MSS was specifically introduced to manage excess liquidity

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arising out of huge capital flows coming to India from abroad.

• Monetary Policy Transmission- An important factor that determines the

effectiveness of monetary policy is its transmission – a process through which
changes in the policy achieve the objectives of controlling inflation and achieving
growth.

• In the implementation of monetary policy, a number of transmission channels

have been identified for influencing real sector activity.
o These are
o (a) the quantum channel relating to money supply and credit;
o (b) the interest rate channel;
o (c) the exchange rate channel; and
o (d) the asset price channel.

• How these channels function in an economy depends on its stage of development

and its underlying financial structure. For example, in an open economy one
would expect the exchange rate channel to be important; similarly, in an
economy where banks are the major source of finance as against the capital
market, credit channel could be a major conduit for monetary transmission.
These channels are not mutually exclusive, and there could be considerable
feedback and interaction among them.

Monetary Policy Making:

Objective of Monetary Policy-

To Maintain Equilibrium of Supply and Demand of Money

If Disequilibrium- Deflation or Inflation in the Economy

Too Much Fall in

Supply >
Money Purchasing
Demand of Inflation
chasing too Power of
Money
few goods Money

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Rise in
Supply <
Shorfall of Purchasing
Demand of Deflation
Money Power of
Money
Money

How Can the Government Affect Inflation/ Deflation?

Increase or & removing

decrease supply structural
of goods impediments to
FISCAL POLICY
demanded by demand and
Investing in supply of
different sectors goods/services

Tight money policy/ dear money policy- during inflation, if monetary policy tries to
reduce money supply in the economy, it is called tight money policy
Easy money policy/ cheap money policy- during deflation, if monetary policy tries to
increase money supply in the economy, it is called cheap money policy.

Monetary policy instruments:

Monetary Policy
Instruments

Quantitative Qualitative
Instruments Instruments

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Quantitative Instruments:

1. General and Indirect Reserve Ratios (CRR, SLR)

•Reserve ratios act as cushion for banks

•They disallow banks from lending their entire deposits and protect against bank run
•CRR and SLR are a certain % of net demand and time liabilities and are the basic reserve ratios.
(Demand liabilities are Current account and savings account (CASA) and time liabilities are FD, RD,
cash certificates, staff security deposits)
•To calculate Net demand and time liabilities (NDTL), there is a fortnight lag.
•CRR is kept in cash. Banks cannot lend or invest this money. CRR applies to all kinds of banks
•SLR is money kept in terms of liquid assets like cash, gold, RBI approved securities. SLR is maintained
so that banks have liquid reserves, which can be used in times of need. SLR applies to all kinds of
banks.
•To counter inflation, RBI increases CRR SLR requirements, which reduces money supply in the
economy, as more money is kept as reserve and less money is lent to public. A reduction in money
supply makes it dear and increases interest rates on lending. This also results in less demand of loans
by the public. Therefore, to counter inflation, actions of RBI have a negative impact on Economic
growth because of fall in borrowings by the industry.
•SLR also contributes to fiscal deficit financing, as banks are required to invest in government
securities, and government uses that money to finance fiscal deficit but it has been seen that this
money goes to unproductive areas like subsidy. To counter this situation, SLR has been reduced
despite inflation in Indian economy. Now, extra money with banks will flow in productive sectors of
the economy rather than going towards government financing through government securities.

2. Open Market Operations

•Open Market Operations is the method of controlling/ regulating money supply by RBI through
purchase or sale of government securities to banks
•Under OMOs, there is no compulsion on banks to buy/ sell securities.
•Banks invest in OMOs using idle money
•In times of inflation, RBI will sell government securities in order to reduce money supply in the
economy. (reverse under deflation)

3. Rates (repo, reverse repo, bank rate, MSF, LAF)

•The rate at which long term loan is provided by RBI to banks is called Bank rate
•There is no collateral provided by banks for taking this loan. Bank rate is increased to control
inflation, as higher bank rate means less borrowing by banks from RBI and further less lending to the
public. Less lending to the public would reduce money supply in the economy.
•LAF- LIQUIDITY ADJUSTMENT FACILITY. (Consists of repo rate and reverse repo rate)
•Repo rate- It’s a repurchase agreement where RBI lends to banks for short term, in exchange for
securities. The bank agrees to pay back the loan with interest by repurchasing the securities lent.
Government securities are kept as collateral, however SLR bound securities cannot be placed as
collateral. The minimum borrowing can be 5 crores. Repo rate can also be used by central and state
governments, NBFI (LIC, UTI), all banks.
•Repo rate is also called policy rate as it links all other rates (reverse repo and MSF)
•Reverse repo rate is the rate at which RBI can borrow from banks, central and state governments
or NBFIs. Government securities are kept as collateral in reverse repo as well.

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4. Marginal Standing Facility

• MSF is an emergency facility wherein banks can borrow from RBI by using SLR
QUOTA securities (1% of NDTL), but subject to higher interest rate (repo + 1%).
minimum borrowing can be 1 crore. only scheduled commercial banks can use this
facility. (Scheduled commercial banks are- ‘banks mentioned in RBI act 1934,
minimum paid up capital of 5 lakh, banks which aim to protect interests of
depositors).

5. Term Repo Rates

• TERM REPO RATES (Introduced in 2014): The new ‘term repo’ is provided by the
RBI. The ‘term repo’ window allows RBI to supply funds from time to time, with
banks bidding for the rates at which they will borrow this money.
• The impact of term repos is two-fold. One, it can cause a spike in bank’s costs of
funds. (For example- Banks borrowed an average of ₹31,000 crore daily under the
LAF window in the last two months at the fixed repo rate of 8 per cent. But the 14-
day term repos, which were auctioned at 8.2 per cent in the beginning of March
were priced at 8.8 per cent towards the end of the month, due to the tight liquidity
situation. Thus, by capping the amount borrowed at the repo window, the RBI is
nudging banks to borrow at higher rates). the weighted average cost of funds for
banks may go up by 20-40 basis points.
• The second fallout of the term repos is that banks may have to stop relying on the
RBI for liquidity support at a fixed rate and instead adapt to ‘floating’ rates that RBI
prefers to accept on each auction.

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6. Market Stabilisation Scheme

• The MSS was devised since continuous resort to sterilization by the RBI depleted its
limited stock of Government Securities and impaired the scope for similar interventions
in the future. Under this scheme, the GoI borrows from the RBI (such borrowing being
additional to its normal borrowing requirements) and issues Treasury-Bills/Dated
Securities that are utilized for absorbing excess liquidity from the market. Therefore, the
MSS constitutes an arrangement aiding in liquidity absorption, in keeping with the
overall monetary policy stance of the RBI, alongside tools like the Liquidity Adjustment
Facility (LAF) and Open Market Operations (OMO)
• MSS securities are issued with the objective of providing the RBI with a stock of
securities with which it can intervene in the market for managing liquidity. These
securities are not issued to meet the government's expenditure.
• The MSS scheme was launched in April 2004 to strengthen the RBI's ability to conduct
exchange rate and monetary management. The bills/bonds issued under MSS have all
the attributes of the existing treasury bills and dated securities.
• The securities issued under the MSS scheme are matched by an equivalent cash balance
held by the government with the RBI. As a result, their issuance will have a negligible
impact on the fiscal deficit of the government.

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Qualitative Instruments

1. Loan to Value ratio / Margin requirements

• If a person brings Rs 1 lakh collateral/ security for taking loan, the bank/ NBFC can give
loan equal to LTV ratio as declared by RBI. A 60% LTV means the bank can lend Rs 60,000
loan on Rs 1 lakh. During inflation, LTV ratio is reduced to reduce money supply in the
economy.

2. Consumer credit control/ Down payment

• RBI can reduce down payment requirements for loans to counter deflation and vice-
versa. RBI can also reduce/ increase minimum instalments for loans.

3. Moral suasion

• Moral suasion is done through seminars, conferences etc

4. Direct action

• selective direct action on banks not complying with requirements is referred to as direct
action.

5. Credit Rationing

• Credit rationing refers to the situation where lenders limit the supply of additional credit
to borrowers who demand funds, even if the latter are willing to pay higher interest
rates. "priority sector lending" is a type of credit rationing. Under PSL, certain sectors
need to be given a minimum loan by banks so that there is balanced growth and areas/
sectors having high inflation/ deflation can be targeted.
-

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Monetary Policy Committee:

The Monetary Policy Committee (MPC) is a committee of the Central Bank

in India (Reserve Bank of India), headed by its Governor, which is
entrusted with the task of fixing the benchmark policy interest rate (repo
rate) to contain inflation within the specified target level.

Monetary Policy Committee is defined in Section 2(iii)(cci) of the

Reserve Bank of India Act, 1934 and is constituted under Sub-
section (1) of Section 45ZB of the same Act.

The MPC replaces the current system where the RBI governor,
with the aid and advice of his internal team and a technical
advisory committee, has complete control over monetary policy
decisions. A Committee-based approach will add lot of value and
transparency to monetary policy decisions.

The history of suggestions for setting up MPC is not new and traces back
to 2002 when the Y. V. Reddy Committee recommended for MPC to
decide policy actions. Subsequently, suggestions were made to set up
MPC in 2006 by the Tarapore Committee, in 2007 by the Percy Mistry
Committee, in 2009 by the Raghuram Rajan Committee and then in 2013,
both in the report of the Financial Sector Legislative Reforms
Commission (FSLRC) and the Dr. Urjit R. Patel (URP) Committee.

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Functions of the MPC:

Under the Monetary Policy Framework Agreement, the RBI is

responsible for containing inflation targets at 4% (with a standard
deviation of 2%) in the medium term

Under Section 45ZA(1) of the RBI Act, 1934, the Central

Government determines the inflation target in terms of the
Consumer Price Index, once in every five years in consultation
with the RBI

The newly designed statutory framework would mean that the

RBI would have to give an explanation in the form of a report
to the Central Government, if it failed to reach the specified
inflation targets. It shall, in the report, give reasons for failure,
remedial actions as well as estimated time within which the
inflation target shall be achieved.

RBI is mandated to publish a Monetary Policy Report every 2 months,

explaining the sources of inflation and the forecasts of inflation for the
coming period of six to eighteen months.

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Constitution of the MPC:

The Central Government constitutes the MPC through

a notification in the Official Gazette

The MPC has six members - the RBI Governor

(Chairperson), the RBI Deputy Governor in charge of
monetary policy, one official nominated by the RBI
Board and the remaining three members to represent
the Government of India

The Government of India nominees are appointed

by the Central Government based on the
recommendations of a search cum selection
committee consisting of the cabinet secretary
(Chairperson), the RBI Governor, the secretary of the
Department of Economic Affairs, Ministry of
Finance, and three experts in the field of economics
or banking as nominated by the central government.

The three central government nominees of the MPC

appointed by the search cum selection committee will
hold office for a period of four years and will not be
eligible for re- appointment.

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