RBI Its Board Capital Offices Functions and Role In Development

Advanced 467 Reasoning Puzzles Book SBI PO 2018

Reserve Bank of India

In 1921, the Government of India established the Imperial Bank of India (In 1955 Imperial Bank of India changed to SBI) to serve as the Central Bank of the country. But the Imperial Bank did not achieve any appreciable success in its functioning as the Central Bank of the country.
In 1925, the Hilton Young Commission was asked by the Government to express its views on new central bank. Hilton-Young Commission submitted its report in the year 1926. On the recommendations of Hilton Young Commission Reserve Bank of India (RBI) established on 1 April 1935. The RBI Act was passed by the parliament in 1934 & The RBI started functioning from 1st April 1935.
In 1949, the government of India nationalized the RBI under RBI (Transfer of Public Ownership) Act, 1948. It is responsible for controlling the entire banking system of India. It was a private shareholders institution till January 1949, after which it became a state-owned institution under the Reserve Bank of India Act, 1948.
It is the oldest central bank among the developing countries. As the apex bank, it has been guiding, monitoring, regulating and promoting the Indian financial system.
Initially the headquarter of RBI was in Calcutta (Now Kolkata) but in 1937 it was permanently moved to Mumbai, Maharashtra. The first central bank in the world was Riks Banks of Sweden which was established in 1668. In America, Federal Reserve System & in England, Bank of England operate as central banks.
Chintaman Dwarkanath Deshmukh (C D Deshmukh) was the governor of RBI at the Time of nationalization of RBI in 1949 and the 1st women Deputy Governor of RBI K.J.Udeshi. RBI is not a Commercial Bank. RBI prints currency in 15 Languages. RBI is a member of IMF (International Monetary Fund) & World Bank.

Emblem of RBI - Panther and Palm Tree.

Objectives of RBI

The objectives of the central banking system are given below :-

1. The central bank should work for the national interest of the country.
2. The central bank must aim for the stabilization of the mixed economy.
3. It aims at the stabilization of the price level at average prices.
4. Stabilization of the exchange rate is also essential.
5. It should aim for the promotion of economic activities.


The Reserve Bank was constituted as a shareholders bank. The bank’s fully paid-up share capital was Rs. 5 crores divided into shares of Rs. 100 each. Of this, Rs. 4,97,80,000 were subscribed by the private shareholders and Rs. 2,20,000 were subscribed by the Central Government for disposal of 2,200 shares at part to the Directors of the Bank (including members of the Local Boards) seeking the minimum share qualification.
The share capital of the bank has remained unchanged until today. The Reserve Bank also had a Reserve Fund of Rs. 150 crores in 1982. It was nationalised in January 1949 and since then it is functioning as the State-owned bank and acting as the premier institution in India’s banking structure.


The organisational structure of the Reserve Bank comprises :-

(A) Central Board - The Central Board of Directors is the leading governing body of the bank. It is entrusted with the responsibility of general superintendence and direction of the affairs and business of the Reserve Bank.

The Central Board of Directors consists of 21 members as follows:-

1. One Governor and four Deputy Governors - They are appointed by the Government of India for a period of five years. Their salaries, allowances and other perquisites are determined by the Central Board of Directors in consultation with the Government of India.
Governor – Mr Raghuram Rajan
4 Deputy Governors are H R Khan,Dr Urjit Patel,R Gandhi & S S Mundra

2. Four Directors Nominated from the Local Boards - There are four local Boards of Directors in addition to the Central Board of Directors. They are located at Mumbai, Kolkata, Chennai and New Delhi. The Government of India nominates one member each from these local Boards. The tenure of these directors is also for a period of five years.

3. Ten other Directors - The ten other directors of the Central Board of Directors are also nominated by the Government of India. Their tenure is four years.

4. 2 Representative from Finance Ministry.

The Central Board should meet at least six times in each year and at least once in three months. The Central Board keeps a meeting in March every year at New Delhi so as to discuss the budget with the Finance Minister after its presentation in parliament. Similarly, it keeps a meeting in August at Mumbai in order to pass the Bank’s annual report and accounts.

 (B) Local Boards - The Reserve Bank of India is divided into four regions: the Western, the Eastern, the Northern and the Southern regions. For each of these regions, there is a Local Board, with headquarters in Mumbai, Kolkata, New Delhi and Chennai. Each Local Board consists of five members appointed by the Central Government for four years.
The Local Boards carry out the functions of advising the Central Board of Directors on such matters of local importance as may be generally or specifically referred to them or performing such duties which may be assigned to them. Generally, a Local Board deals with the management of regional commercial transactions.


RBI Has 19 regional offices, most of them in state capitals and 9 Sub-offices.

Training Establishments

RBI has five training establishments
  • Two, namely, College of Agricultural Banking and Reserve Bank of India Staff College are part of the Reserve Bank
  • Others are autonomous, such as, National Institute for Bank Management, Indira Gandhi Institute for Development Research (IGIDR), Institute for Development and Research in Banking Technology (IDRBT)

Functions of the Reserve Bank of India

A. Traditional Central Banking Functions

1. Monopoly of Note Issue - The RBI has the sole right to issue bank notes of all denomination. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which deals with the issue of currency notes. The assets and liabilities of the Issue Department are kept separate from those of the Banking Department, originally, the assets of the Issue Department were to consist of not less than two fifths of gold coin, gold bullion or sterling securities provided the amount of gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might be held in rupee coins, Government of India rupee securities, eligible bills of exchange and promissory notes payable in India. Due to the exigencies of the Second World War and the post-war period, these provisions were considerably modified since 1957, the Reserve Bank of India is required to maintain gold and foreign exchange reserves of Rs. 200 crores, of which at least Rs. 115 crores should be in gold. The system as it exists today is known as the Minimum Reserve System.

Currency Chest - Currency chests are the storehouses at selected commercial bank branches where currency notes and coins are kept on behalf of RBI. These branches are responsible for the further distribution of the currency to other banks and thereby to the general public for use.

2. Banker to the Government - The Reserve Bank of India acts as a banker, agent & financial advisor to the government.

As a banker to the government it provides various services such as:-

  • It keeps and operates the accounts of the Central and State Government.
  • Receipts and collection of payments to the Central and State Government.
  • It makes payments on behalf of the Central and State Government.
  • Transfer of funds and remittance facilities of the Central and State Governments.
  • It manages the public debt and issue of new loans and Treasury Bills of the Central Government.
  • Providing ways and means advances to the Central and State governments to bridge the interval between expenditure and flow of receipts of revenue.
  • It Advises the Central/State governments on financial, economic, monetary matters.
  • RBI plays an active role in the gilt-edged market. Gilt-edged market means the market in which RBI buys and sells government securities and Treasury Bills on the behalf of the government.
  • The bank also advice to the government on banking and financial issues. The Government of India consults the Reserve Bank on certain aspects of formulation of the country’s Five Year Plans, such as financing pattern, mobilisation of resources, institutional arrangements regarding banking and credit matters. The government also seeks the bank’s advice on policies regarding international finance, foreign trade and foreign exchange of the country.
  • The Reserve Bank represents the Government of India as member of the International Monetary Fund and World Bank.
3. Banker’s Bank - The Reserve Bank of India performs the function of a banker to all other banks in the country. All the commercial banks, co-operative banks and foreign banks in the country have to open accounts with the bank and are required to keep a certain portion of their deposits as cash reserves with the Reserve Bank. 

These cash reserves are kept by the commercial bank in two ways:-

  • Part of the cash balances with themselves (In the Form of SLR)
  • Part of the cash balances with RBI (As CRR)
4. Lender of the Last Resort - The RBI acts as lender of last resort for the other banks of the country. It means that if a commercial bank fails to get financial help from anywhere, it approaches the RBI as last resort.
  • Only scheduled banks can borrow from the Reserve Bank against their approved securities.
  • They can also get the bills of exchange rediscounted.
  • The Reserve Bank acts as the clearing house of all the banks. It adjusts the debits and credits of various banks by merely passing the book entries.
  • The Bank also provides free remittance facilities to the banks.
  • It grants short-term loans to scheduled commercial banks against eligible securities in time of need.
5. National Clearing House - The Reserve Bank acts as the national clearing house and helps the member banks to settle their mutual indebtedness without physically transferring cash from place to place.
The Reserve Bank is managing many clearing houses in the country with the help of which cheques worth crores of rupees are cleared every day. The ultimate balances are settled by the banks throught cheques on the Reserve Bank.
Suppose, Bank A receives a cheque of Rs 15000 drawn on Bank B, and Bank B receives a cheque of Rs 10000 drawn on Bank A. According to Clearing House Method, Bank A should issue a cheque of Rs 5000 in favour of Bank B, drawn on RBI. As a result of this transference, a sum of Rs 5000 will be debited to the account of Bank A and Credited to the account of Bank B. There is no need of cash transactions between the banks concerned.

6. Credit Control – The most important function of the RBI is to control the credit activities of the commercial banks. Credit control refers to the increase or decrease in the volume of credit money in accordance with the monetary requirement of the country. More expansion of credit leads to the situation of inflation and vice versa. Detailed note on this Method is given below (How Does the RBI Controls Money Supply or Flow of Credit in the)

7. Custodian of Foreign Exchange Reserves - It is the responsibility of Reserve Bank to keep the external value of rupee stable.
The RBI has the authority to enter into foreign exchange transactions both on its own account and on behalf of government. The bank is also empowered to buy and sell foreign exchange from and to scheduled banks. RBI maintains foreign exchange reserves in order to promote international trade and stabilise exchange rate.
As the custodian of the nation’s foreign exchange reserves, the RBI also administers exchange controls of the country, and enforces the provision of the Foreign Exchange Regulation Act, 1973.
RBI uses Minimum Reserve System. This system allows RBI to keep only a fixed amount of reserve against whatever the amount of note issue. Under this RBI can holds a minimum reserve of Rs 200 crores, out of which Gold should be amount of Rs 115 cr and Remaining Rs 85 cr should be in Foreign currency.

8. Collection of Data and Publications - The Reserve Bank of India collects statistical data and economic information through its research departments. It compiles data on the working of commercial and co-operative banks, on balance of payments, company and government finances, security markets, price trends, and credit measures.
It publishes a monthly bulletin, with weekly statistical supplements and annual reports which present a good deal of periodical reviews and comments pertaining to general economic, financial, and banking developments, including the bank’s monetary policies and measures, adopted for the qualitative and quantitative monetary management.

The followings are the some regular publications of the Bank: -

  • Reserve Bank of India Bulletin (monthly) and its weekly statistical supplements.
  • Report of the Central Board of Directors (Annual).
  • Report on Trend and progress of Banking in India (Annual).
  • Report on Currency and Finance (Annual).
  • Banking Statistics (Basic Statistical Returns).
  • History of the Reserve Bank of India (1935-51).
  • Functions and Working of the Reserve Bank of India.
  • Banking and Monetary Statistics of India and its Supplements.
  • Reserve Bank of India Occasional Paper (Bi-annual).

B. Promotional Functions

  • Reserve Bank of India and Agricultural Credit - Under this every commercial bank has the responsibility to provide basic banking services in the rural areas and also to launch its branches in rural areas. The RBI has set up a separate agricultural department to maintain an expert staff to study all questions of agricultural credit and coordinate the operation of the bank with other agencies providing agricultural finance. The RBI does not provide finance directly to the agriculturists, but through agencies like cooperative banks, land development banks, commercial bank etc. After the establishment of the National Bank for Agriculture and Rural Development (NABARD) on July 12, 1982, all the functions of the RBI relating to rural credit have been transferred to this new agency.
  • Reserve Bank of India and Industrial Finance - The Reserve Bank of India has taken initiative in setting up statutory corporations at the all-India and regional levels to function as specialised institutions for term lending. These institutions are Industrial Finance Corporation of India, State Finance Corporations, Industrial Development Bank of India, the Industrial Reconstruction Bank of India, Small Industries Development Bank of India, Unit Trust of India, etc.
  • RBI and Foreign Trade Finance - For the promotion of foreign trade the Reserve Bank has established the Export and Import Bank of India.
  • RBI and NHB - For the development of the housing industry the RBI has established the National Housing Bank.
  • RBI and DICGC - Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the Reserve Bank, operates credit guarantee schemes with the objective of providing cover against defaults in repayment of loans made to small borrowers, including small-scale industrial borrowers, in order that credit flow to them is enlarged.

C. Supervisory Functions

The RBI also supervises the commercial banks by using these following methods:-

  • Licensing of Banks – It is a statutory provision that if a company (Domestic & Foreign) wants to start banking business in India has first to obtain a licence from the Reserve Bank.
  • Approval of Capital, Reserves and Liquid Assets of Bank - The Reserve Bank examines whether the minimum requirements of capital, reserve and liquid assets are fulfilled by the banks and approves them.
  • Branch Licensing Policy - The Reserve Bank exercises its control over expansion of branches by the banks through its branch licensing policy. In September 1978, the RBI formulated the branch licensing policy with a view to expansion of bank offices in the rural areas
  • Inspection of Banks - The Reserve Bank has right to conduct inspection of banks. The inspection may relate to various aspects such as the bank’s organizational structure, branch expansion, mobilisation of deposits, investments, credit portfolio management, credit appraisal profit planning, manpower planning, etc. The bank may conduct investigation whenever there are complain about major irregularities or frauds by certain banks. The inspections are basically meant to improve the working of the banks and safeguard the interests of depositors.
  • Control Over Management - Under this the appointments, re-appointment or termination of appointment of the chairman and chief executive officer of a private sector bank is to be approved by the Reserve Bank. The bank’s approval is also required for the remuneration, perquisites and post retirement benefits given by a bank to its chairman and chief executive officer. The Boards of the public sector banks are to be constituted by the Central Government in consultation with the Reserve Bank.
  • Control Over Methods - The Reserve Bank exercises strict control over the methods of operation of the banks to ensure that no improver investment and injudicious advances made by them.
  • Audit - Banks are required to get their balance sheets and profits and loss accounts duly audited by the auditors approved by the Reserve Bank. In the case of the SBI, the auditors are appointed by the Reserve Bank.
  • Credit Information Service - The Reserve Bank is empowered to collect information about credit facilities granted by individual bank and supply the relevant information in a consolidated manner to the bank and other financial institutions seeking such information.
  • Control over Amalgamation and Liquidation - The banks have to take the permission of the Reserve Bank for any voluntary amalgamation (It means merger). The Reserve Bank in consultation with the central government can also suggest compulsory reconstruction or amalgamation of a bank. It also supervises banks in liquidation (cash in hand). The liquidation has to submit to the Reserve Bank returns showing their positions. The Reserve Bank keeps a watch on the progress of liquidation proceedings and the expenses of liquidation.
  • Deposit Insurance -To protect the interest of depositors, banks are required to insure their deposits with the Deposit Insurance Corporation. The Reserve Bank of India has promoted such a corporation in 1962, which has been renamed in 1978 as the Deposit Insurance and Credit Guarantee Corporation.
  • Training and Banking Education - The RBI has played an active role in making institutional arrangement for providing training and banking education to the bank personnel, with a view to improve their efficiency.
  • Money Market – RBI regulates the money market in India. It is the market for short term loan less than one year. In this borrowers (merchants, traders, brokers and etc) borrow fund & lenders (Commercial banks, insurance companies, finance companies etc) lend fund for short period of time. It deals in trade bills, promissory notes, govt papers or bills and etc. it does not deal in money or cash.
  • Return of Torn Notes – RBI gets back old and torn notes & issue new ones in their places.

How Does the RBI Controls Money Supply or Flow of Credit in the Economy ?


What are the Principal Instruments of Monetary Policy Of the RBI ?

Various weapons or methods or instruments are available to the Reserve Bank of India to control credit creation or contraction by commercial banks.

These methods are divided into two categories :-

1.  Quantitative or general methods or instruments
2.  Qualitative or selective methods or instruments

(A) Quantitative or general methods or instruments -

These methods have only a quantitative effect on the supply of credit. They are used for either increasing or reducing the volume of credit. They cannot control credit for its quality.

The important quantitative methods or instruments of credit control are as follows:-

1. Bank Rate (Discount Rate Policy) - The bank rate is the minimum rate of interest at which the Reserve Bank of India gives credit  to the commercial banks against approved securities or rediscounts the eligible bills of exchange.

How RBI uses this rate for credit control or expansion of credit or credit supply ?

If RBI increases the bank rate then the rate of interest & credit (loans to people) become dear and the demand for credit/loan expands. On the other hand, If RBI decreases the bank rate then the rate of interest charged by the commercial banks and credit (loans) offered by the commercial banks  become cheap and the demand for credit/loan expands.
The RBI adopts Dear Money Policy when the supply of credit needs to be reduced during the period of inflation and the RBI adopts Cheap Money Policy when the supply of credit needs to be expanded during deflation.

Success of Bank Rate Policy depends on the following factors :-

  • Degree of Dependence of the commercial banks upon the RBI for Loans – If banks have their own surplus funds which they can utilize during periods of high credit needs, their dependence on the RBI is comparatively less.
  • Degree of Sensitivity of Bank’s Demand for funds from the RBI – Depending on the business conditions, commercial banks may not be very sensitive to small variations in bank rate. In such condition, bank rate policy may not be a big success.
  • Overall Supply of Funds in the Market – Bank Rate Policy may not ne success if non-banking sources of funds are of greater importance than the banking sources.
  • Structure of Interest rates in Money Market – If non banking financial institutions in the market vary, their interest rates in accordance with what the RBI expects from the commercial banks, the bank rate policy may not succeed.
2. Open Market Operations - Open market operations refer to buying and selling of government securities by the Reserve Bank in the open market. Open market operations have a direct effect on the availability and cost of credit. When the central bank purchases securities from the banks, it increases their cash reserve position and hence, their credit creation capacity. On the other hand, when the central bank sells securities to the banks, it reduces their cash reserves and the credit creation capacity.
These operations have also been used as a tool of public debt management. They assist the Indian government to raise borrowings.
In countries where debt markets are well developed, the central banks can influence liquidity through open market operations.
  • If RBI wants to decrease liquidity from the market, it will sell securities (or gold, foreign exchange etc.) to the market. When the market buys these assets, liquidity/Cash is transferred from the market to the RBI
  • If a central bank wants to increase liquidity in the market, it will buy back securities (or gold, foreign exchange etc.) from the market. When it pays for the assets acquired, liquidity is released in the market.

In India, the open market operations of the Reserve Bank have not been so effective because of the following reasons:-

  • Open market operations are restricted to government securities only.
  • Gift-edged market is narrow.
  • Most of the open market operations are in the nature of “switch operations” (i.e., purchasing one loan against the other).
3. Cash Reserve Ratio (CRR) – CRR refers to the minimum percentage of a bank’s total deposits required to
be kept with the RBI. It means commercial banks have to keep a percentage (Decide by RBI) of their Net Demand and Time Liabilities (NDTL) with the RBI in the form of cash reserves. For example, if the CRR is 10% and total deposits of a bank is Rs 100 crore, it will have to keep Rs 10 crore with the RBI, if the CRR is raised to 15%, the bank will have to keep Rs 15 crore with the RBI.

Net Demand and Time Liabilities

Demand Liabilities include all liabilities which are payable on demand and they include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/ guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand.
Time Liabilities are those which are payable otherwise than on demand or after a fixed period of time and they include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held against letters of credit if not payable on demand, deposits held as securities for advances which are not payable on demand, India Millennium Deposits and Gold Deposits.

How RBI uses CRR for credit control or control the expansion of credit or control the credit supply ?

If RBI increases the CRR then the funds of a bank is reduced. So it will make less credit to the people it means less fund in the economy. RBI increases the CRR during inflation. Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services.
Under inflation situation, people have more money with them and they purchase more goods and the meantime sellers increase the prices of their goods (as demand is more and less supply) as a result, each unit of currency buys fewer goods. To control this RBI increases CRR → less funds with banks → less credit to people → Less money for expenditure.
If RBI decreases the CRR then the funds of a bank is more. So it will make more credit to the people it means more fund/cash in the economy. RBI decreases the CRR during deflation. Deflation is a decrease in the general level of prices of goods and services in an economy over a period of time. When the general price level decreases, each unit of currency buys more goods and services.
Under deflation situation, people have less money with them and they purchase less goods and the meantime sellers decreases the prices of their goods (as demand is less and more supply) as a result, each unit of currency buys more goods. To control this RBI decreases CRR → more funds with banks → more credit to people → More money for expenditure.
The RBI is empowered to vary the CRR between 3% and 15%.
4. Statutory Liquidity Ratio (SLR) - SLR is the amount a commercial banks needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by RBI in order to control the expansion of the bank credit.

Why RBI uses SLR ?

  • The RBI can ensure the solvency of commercial banks.
  • It is also helpful to control the expansion of the Bank credits. 
  • Through SLR, RBI compels the commercial banks to invest in the government securities like govt. bonds.
If RBI increases the SLR then the funds of a bank is reduced. So it will make less credit to the people, it means less fund in the economy. RBI increases the SLR during inflation and if RBI decreases the SLR then the funds of a bank is increased. So it will make more credit to the people, it means more fund in the economy. RBI decreases the SLR during deflation. (Inflation & Deflation situations are same as in CRR)

5. Liquidity adjustment facility (LAF) - Liquidity adjustment facility (LAF) is a monetary policy tool which allows banks to borrow money through repurchase agreements. LAF is used to control the liquidity in the market. Liquidity Adjustment Facility (LAF) was introduced by RBI during June, 2000 in phases, to ensure smooth transition and keeping pace with technological upgradation.
  • Repo Rate - Whenever the banks have any shortage of funds they can borrow it form RBI. Repo rate is the rate at which commercial banks borrows rupees from RBI. It is the rate at which commercial banks take loans from RBI against their approved securities. Loans are given for 90 days so it is called short term loan. If RBI reduces the Repo Rate, then banks will get fund at reduced rate as a result loan will become cheaper and people will borrow more credit. It is used by the RBI during Deflation but If RBI increases the Repo Rate, then banks will get fund at higher rate as a result loan will become dearer or expensive and people will borrow less credit. It is used by the RBI during inflation.
  • Reverse Repo Rate - This is exact opposite of Repo rate. Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. RBI uses this tool when it feels there is too much money floating in the banking system. Banks are always happy to lend money to RBI since their money is in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this  increased attractive interest rates as a result less credit supply to borrowers and vice versa.
6. Marginal Standing Facility (MSF) - MSF rate is the rate at which banks borrow funds overnight from the Reserve Bank of India (RBI) against approved government securities.
This facility is effective from May 9, 2011. 
Under the Marginal Standing Facility, banks avail funds from the RBI on overnight basis against their excess statutory liquidity ratio (SLR) holdings.
  • Additionally, they can also avail funds on overnight basis below the stipulated SLR up to 1 per cent of their respective Net Demand and Time Liabilities (NDTL) outstanding at the end of second preceding fortnight.
  • Banks borrow money from RBI at MSF rate when there is an acute cash shortage or acute asset liability mismatch. This does not carry any stigma. Minimum amount is 1 crore & in multiple of Rs 1 crore thereafter can be raised.
  • All Scheduled Commercial Banks having Current Account and SGL Account with Reserve Bank, Mumbai will be eligible to participate in the MSF Scheme.    
  • The Facility will be available on all working days in Mumbai, excluding Saturdays between 3.30 P.M. and 4.30 P.M.  The rate of interest on amount availed under this facility will be 100 basis points above the LAF repo rate, or as decided by the Reserve Bank from time to time.
  • MSF will be undertaken in all SLR-eligible transferable Government of India (GoI) dated Securities/Treasury Bills and State Development Loans (SDL).

B) Qualitative or selective methods or instruments

Under Selective Credit Control, credit is provided to selected borrowers for selected purpose, depending upon the use to which the control tries to regulate the quality of credit - the direction towards the credit flows. Selective credit controls are better than the quantitative credit controls in many respects. They encourage credit to essential industries and at the same time discourage credit to non-essential industries. Similarly, they encourage productive activities and at the same time discourage speculative activities. 

The Selective Controls are:-

1. Margin Requirement of loan – It means difference between the current market value of the security offered for loans and the value of loans granted. Suppose a person mortgages (Mortgages means Loan taken by people against their Immoveable property or fixed asset) an article worth Rs 100 with the bank & the bank gives him loan of Rs 80 only. If RBI increases this Margin then the credit grants to the borrower will be less and If RBI decreases this Margin gap then the credit grants to the borrower will be more.

2. Rationing of Credit – it means fixation of credit quotas for different business activities. RBI fixes credit quota limits for different business activities. Banks cannot exceed the quota limits while granting loans.
If RBI increases the loan limit for the different activities then the credit will be more for people and vice-versa.

3. Credit Authorisation Scheme (CAS) - Credit Authorisation Scheme is introduced by the Reserve Bank in November, 1965. Under the scheme, the commercial banks had to obtain Reserve Bank’s authorisation before sanctioning any fresh credit of Rs. 1 crore or more to any single party. The limit was later raised to Rs. 6 crores in 1986, in respect of borrowers in private as well as public sector.
The main purpose of this scheme is to keep a close watch on the flow of credit to the borrowers. This scheme requires that the banks should lend to the large borrowing concerns on the basis of credit appraisal and actual requirements of the borrowers. But this scheme was abolished in 1982. Though the scheme has been abolished, the Reserve
Bank, however, insists that the banks have to get its approval once the loans have been sanctioned by them to big borrowers. The Reserve Bank would monitor and scrutinize all sanctions of bank loans exceeding Rs. 5 crores to any single party for working capital requirements, and Rs. 2 crores in the case of term loans. This post-sanction scheme has been called “Credit Monitoring Arrangement (CMA).”

4. Direct Action – RBI may take direct action against the member banks in case they do not follow its directives or guidelines. Direct Action includes derecognition of a bank as a member of the country’s banking system.

5. Moral Suasion - This method involves advice, request and persuasion with the commercial banks to co-operate with the central bank in implementing its credit policies. The Reserve Bank has also been using moral suasion as a selective credit control measure from 1956. It has been sending periodic letters to the commercial banks to use restraint over their credit policies in general and in respect of certain commodities and unsecured loans in particular.

6. Differential Interest Rates - Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging concessional rates of interest. In 1966, the Reserve Bank announced the policy of “Selective Liberalisation of Credit.” According to this policy, the Reserve Bank encouraged banks to grant credit to Defence industries, export industries and food-grains for procurement by government agencies at Concessional rates.


Different economists have different views on the objectives of monetary policy because they keep on changing from time to time as per the change in business activities and the level of economic development. The main objectives of the monetary policies are as follows:
  • Stability of exchange rates
  • Full employment
  • Price stability
  • Neutrality of money
  • High rate of economic growth
  • Encourages saving and capital formation


Though, the monetary policy is very important for the development of the country, but it has got certain limitation too. These limitations are as follows:
  • Underdeveloped capital and money market
  • No integrated rate of interest structure
  • Illiteracy and social obstacles.
  • Lack of cooperation among the banks
  • Banking habits
  • Existence of black money
  • Government policies


The Reserve Bank is India’s central bank. It is the apex monetary institution in the country. It supervises, regulates, controls and develops the monetary and financial system of the country. It performs a number of developmental and promotional functions. It also assists the government in its economic planning. The bank’s credit planning is devised and co-ordinated with the Five year plans.

The major contributions of the Reserve Bank to economic development are as follows:

1. Promotion of Commercial Banking - Reserve Bank has taken several steps to strengthen the banking system. The Banking Regulation Act, 1949 has given the Reserve Bank vast powers of supervision and control of commercial banks in the country. The Reserve Bank has been using these powers:
  • To strengthen the commercial banking structure through liquidation and amalgamation of banks, and through improvement in their operational standards
  • To extend the banking facilities in the semi-urban and rural areas, and
  • To promote the allocation of credit in favour of priority sectors, such as agriculture, small-scale industries, exports etc.
2. Promotion of Rural Credit - Reserve Bank has been assigned the responsibility of reforming rural credit system and making provision of adequate institutional finance for agriculture and other rural activities. 

The Reserve Bank has taken the following steps to promote rural credit:

  • It has set up Agricultural Credit Department to expand and co-ordinate credit facilities to the rural areas.
  • It has been taking all necessary measures to strengthen the co-operative credit system with a view to meet the financial needs of the rural people.
  • In 1956, the Reserve Bank set-up two funds. Namely, the National Agriculture Credit (long-term operations) Fund, and the National Agricultural Credit (stabilisation) Fund, for providing medium-term and long-term loans to the state co-operative banks.
  • Regional rural banks have been established to promote agricultural credit.
  • Some commercial bank have been nationalised mainly to expand bank credit facilities in rural areas.
  • The National Bank for Agriculture and Rural Development has been established in 1982 as the apex institution for agricultural finance.
3. Promotion of Co-operative Credit - On the recommendations of the Rural Credit Survey Committee, the Reserve Bank has taken a number of measures to strengthen the structure of co-operative credit institutions throughout the country. The Reserve Bank provides financial assistance to the agriculturists through the co-operative institutions.

4. Promotion of Industrial Finance - The Reserve Bank has been playing an active role in the field of industrial finance also. In 1957, it has set up a separate Industrial Finance Department which has rendered useful service in extending financial and organisational assistance to the institutions providing long-term finance.
Reserve Bank took initiative in the establishment of a number of statutory corporations for the purpose of providing finance, especially medium and long-term finance. These are
  • Industrial Development Bank of India
  • Industrial Finance Corporation of India
  • State Finance Corporations
  • State Industrial Development Corporations
  • Industrial Credit and Investment Corporation of India
5. UTI - The Reserve Bank has played an active role in the establishment of the Unit Trust of India. The Unit Trust of India mobilises the savings of people belonging to middle and lower income groups and uses these funds for investment in industries. By mobilising the small savings of the people, the Unit Trust has been promoting capital formation which is the most important determinant of economic development.

6. Promotion of Export Credit - The Reserve Bank has undertaken a number of measures for increasing credit to the export sector. For promoting export financing by the banks, the Reserve Bank has introduced certain export credit schemes. The Export Bills Credit Scheme, and the Pre-shipment Credit Scheme are the two important schemes introduced by the Reserve Bank. The Reserve Bank has been instrumental in the establishment of Export-Import Bank. The Exim Bank is to provide financial assistance to exporters and importers. The Reserve Bank has authority to grant loans and advances to the Exim Bank, under certain conditions.

7. Regulation of Credit - The Reserve Bank has been using various credit control weapons to regulate the cost of credit, the amount of credit, and the purpose of credit. For regulating the cost and amount of credit the Reserve Bank has been using the quantitative weapons. For influencing the purpose and direction of credit, it has been using various selective credit controls. By regulating credit, the Reserve Bank has been able
  • To promote economic growth in the country.
  • To check inflationary trends in the country.
  • To prevent the financial resources from being used for speculative purposes.
  • To make financial resources available for productive purposes keeping in view the priorities of the plans
  • To encourage savings in the country.
8. Credit to Weaker Sections - The Reserve Bank has taken certain measures to encourage adequate and cheaper credit to the weaker sections of the society. The “Differential Rate of Interest Scheme” was started in 1972. Under this scheme, concessional credit is provided to economically and socially backward persons engaged in productive activities. The Insurance and Credit Guarantee Corporation of India gives guarantee for loans given to weaker sections.

9. Development of Bill Market - The Reserve Bank introduced the “Bill Market Scheme” in 1952, with a view to extend loans to the commercial banks against their demand promissory notes. The scheme, however, was not based on the genuine trade bills. In 1970, the Reserve Bank introduced “New Bill Market Scheme” which covered the genuine trade bills representing sale or dispatch of goods. The bill market scheme has helped a lot in developing the bill market in the country. The bill market scheme has increased the liquidity of the money market in India.

10. Exchange Controls - The Reserve Bank has been able to maintain the stability of the exchange value of the “Rupee” even under heavy strains and pressure. It has also managed “exchange controls” successfully. In spite of the limitations under which it has to function in a developing country like India, the overall performance of the Reserve Bank is quite satisfactory.

Why RBI controls credit expansion or credit supply ?

We are just giving a short note, to understand the complete Method Please read above given Monetary Policy Tools.
If people have more money with them, their expenses will also increase and they will purchase more goods and services due to this sellers will increase the prices of the goods and services as a result per unit of currency will purchase less good. This lead to inflation. To control this situation RBI uses above Monetary Policy Tools.
If people have less money with them, their expenses will also decrease and they will purchase less goods and services due to this sellers will decrease the prices of the goods and services as a result per unit of currency will purchase more good. This lead to deflation. To control this situation RBI uses above Monetary Policy Tools.

What do you mean by liquidity in the market?

Liquidity in simple words is the availability of capital or money with the consumers to spend or invest in the form of either cash, credit (loan) or equity (shares).

How does RBI control inflation?

RBI increases its key rates such as Repo rate and bank rate so that the banks have to increase their lending rates. Therefore people borrow less and save more thereby decreasing liquidity in the market.

How does RBI control deflation?

RBI decreases its key rates such as Repo rate and bank rate so that the banks have to decrease their lending rates. Therefore people borrow more and save less thereby increasing liquidity in the market.

Chapter-1 "Bank Meaning and their Functions & Structure"

Chapter-2 "Principles Of Sound Lending & Types Of Banking"