NATIONAL LAW UNIVERSITY, LUCKNOW

Final Draft of

ECONOMICS
On the topic

Methods Of Credit Control By RBI

Submitted by:
VarnitPratap Singh B.A. LLB (Hons.) IIIrd Semester Section- A Roll Number- 147

Submitted to:
Prof. MadhuriSrivastava Visiting Professor (Economics) Dr. Ram ManoharLohiya National Law University, Lucknow

ACKNOWLEDGEMENT
I would like to extend my heartfelt gratitude to Prof. MadhuriSrivastava for providing me with her expert guidance, the staff at the Dr. RMLNLU library and a number of colleagues who have directly or indirectly given pointers to how this project should proceed. Without their valuable assistance this project would not have been possible.

VarnitPratap Singh

CONTENTS

PREAMBLE INTRODUCTION NATIONALIZATION OF RBI ROLE OF RESERVE BANK OF INDIA CLASSIFICATION OF RBIS FUNCTIONS REGULATION OF BANKING SYSTEM CREDIT CONTROL OBJECTIVE OF CREDIT CONTROL METHOD OF CREDIT CONTROL CONCLUSION BIBLIOGRAPHY

Preamble
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as: "...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage."

Introduction
The Reserve Bank of India is the central bank of India, and was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in Kolkata but was permanently moved to Mumbai in 1937. Though originally privately owned, the RBI has been fully owned by the Government of India since nationalization in 1949. DuvvuriSubbarao who succeeded YagaVenugopal Reddy on September 2, 2008 is the current Governor of RBI. The Reserve Bank of India was set up on the recommendations of the Hilton Young Commission. The commission submitted its report in the year 1926, though the bank wasnot set up for nine years. The Preamble of the Reserve Bank of India describes the basic functions of the ReserveBank as to regulate the issue of Bank Notes and keeping of reserves with a view tosecuring monetary stability in India and generally to operate the currency and creditsystem of the country to its advantage. It has 22 regional offices, most of them in state capitals. RBI was started with a paid up share capital of 5 crore.on established it took over thefunction of management of currency from government of India and power of creditcontrol from imperial bank of india.

Objective of the Study

The objective of this project is to study the role and methods of Reserve Bank of India along with the all the functions of Reserve Bank of India and the objective of its credit control. This project also deals with the role of Reserve Bank of India in Indian monetary control.

Nationalization of RBI:
With a view to have a coordinated regulation of Indian banking Indian BankingAct was passed in March 1949. To make RBI more powerful the Govt. of Indianationalised RBI on January 1, 1949. The general superintendence and direction of the Bank is entrusted to CentralBoard of Directors of 20 members, the Governor and four Deputy Governors, oneGovernment official from the Ministry of Finance, ten nominated Directors by theGovernment to give representation to important elements in the economic life ofthe country, and four nominated Directors by the Central Government to representthe four local Boards with the headquarters at Mumbai, Kolkata, Chennai andNew Delhi. Local Boards consist of five members each Central Government appointed for aterm of four years to represent territorial and economic interests and the interestsof co-operative and indigenous banks. The Reserve Bank of India was nationalized with effect from 1st January, 1949 on the basis of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. All shares in the capital of the Bank were deemed transferred to the Central Government on payment of a suitable compensation. The image is a newspaper clipping giving the views of Governor CD Deshmukh, prior to nationalization

ROLE OF RESERVE BANK OF INDIA

Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. 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 is entrusted 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-was period, these provisions were considerably modified. Since 1957, the Reserve Bank of India is required to maintain gold and foreign exchange reserves of Ra. 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.

Banker to Government
The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payme exchange remittances and other banking operations. The Reserve Bank of India helps the Government - both the Union and the States to float new loansand to manage public debt. The Bank makes ways and means advances to the Governments for 90 days. It makes loans and advances to the States and local authorities. It acts as adviser to the Government on all monetary and banking matters.

Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to the provisions of the Banking Companies Act of 1949, every scheduled bank was required to maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilites and 2 per cent of its time liabilities in India. By an amendment of 1962, the distinction between demand and time liabilities was abolished and banks have been asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities. The minimum cash requirements can be changed by the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting bills of exchange. Since commercial banks can always expect the Reserve Bank of India to come to their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but also the lender of the last resort.

Controller of Credit
The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. According to the Banking Regulation Act of 1949, the Reserve Bank of India can ask any particular bank or the whole banking system not to lend to particular groups or persons on the basis of certain types of securities. Since 1956, selective controls of credit are increasingly being used by the Reserve Bank. The Reserve Bank of India is armed with many more powers to control the Indian moneymarket. Every bank has to get a licence from the Reserve Bank of India to do banking business within India, the licence can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the Bank to call for information is also intended to give it effective control of the credit system. The Reserve Bank has also the power to inspect the accounts of any commercial bank. As supreme banking authority in the country, the Reserve Bank of India, therefore, has the following powers: (a) It holds the cash reserves of all the scheduled banks. (b) It controls the credit operations of banks through quantitative and qualitative controls. (c) It controls the banking system through the system of licensing, inspection and calling for information. (d) It acts as the lender of the last resort by providing rediscount facilities to scheduled banks.

Classification of RBIs functions

The monetary functions also known as the central banking functions of the RBI are related tocontrol and regulation of money and credit, i.e., issue of currency, control of bank credit, controlof foreign exchange operations, banker to the Government and to the money market. Monetary functions of the RBI are significant as they control and regulate the volume of money and credit in the country. Equally important, however, are the non-monetary functions of the RBI in the context of India's economic backwardness. The supervisory function of the RBI may be regarded as a nonmonetary function (though many consider this a monetary function). The promotion of sound banking in India is an important goal of the RBI, the RBI has been given wide and drastic powers, under the Banking Regulation Act of 1949 - these powers relate to licencing of banks, branch expansion, liquidity of their assets, management and methods of working, inspection, amalgamation, reconstruction and liquidation. Under the RBI's supervision and inspection, the working of banks has greatly improved. Commercial banks have developed into financially and operationally sound and viable units. The RBI's powers of supervision have now been extended to nonbanking financial intermediaries. Since independence, particularly after its nationalisation 1949, the RBI has followed the promotional functions vigorously and has been responsible for strong financial support to industrial and agricultural development in the country.

REGULATION OF BANKING SYSTEM

Objective

The objectives of bank regulation, and the emphasis, varies between jurisdiction. The most common objectives are: 1. Prudential -- to reduce the level of risk bank creditors are exposed to (i.e. to protect depositors) 2. Systemic risk reduction -- to reduce the risk of disruption resulting from adverse trading conditions for banks causing multiple or major bank failures 3. Avoid misuse of banks -- to reduce the risk of banks being used for criminal purposes, e.g. laundering the proceeds of crime 4. To protect banking confidentiality 5. Credit allocation -- to direct credit to favored sectors

General principles of bank regulation

Banking regulations can vary widely across nations and jurisdictions. This section of the article describes general principles of bank regulation throughout the world.

Minimum requirements Requirements are imposed on banks in order to promote the objectives of the regulator. The most important minimum requirement in banking regulation is maintaining minimum capital ratios.

Supervisory review Banks are required to be issued with a bank license by the regulator in order to carry on business as a bank, and the regulator supervises licenced banks for compliance with the requirements and responds to breaches of the requirements through obtaining undertakings, giving directions, imposing penalties or revoking the bank's licence.

Market discipline The regulator requires banks to publicly disclose financial and other information, and depositors and other creditors are able to use this information to assess the level of risk and to make investment decisions. As a result of this, the bank is subject to market discipline and the regulator can also use market pricing information as an indicator of the bank's financial health.

CREDIT CONTROL
One of the more pleasant aspects of the latest quarterly Monetary Policy Review is the attempt by the Reserve Bank of India to be as predictable as possible, or at least less disruptive than it has been before. The notion that some elements of a tighter money policy would be announced was pretty much to be expected. While raising repo rates by 25 basis points and leaving other indicators of liquidity unchanged, the RBI Governor, Dr Y. V. Reddy, has tried to play both policeman and purveyor of optimism, the former by raising marginally the cost of capital for banks through the repo rate hike, and the latter by selectively pushing up the provisioning norms for certain categories of borrowers hoping thereby to catch inflation by the scruff and pull it back within the 5.5 per cent limit. Lest the markets think the RBI is a killjoy, in its combat against inflation, the Governor has raised the bar on growth expectations jettisoning his earlier forecast and the prognosis of North Block for a 9 per cent GDP target for this waning fiscal. He has tried therefore to be all things to all men, in the bargain creating a dilemma that may not augur well for the economy in the medium to long term. The basic problem is that the RBI cannot hope to both fight inflation and propel growth to the levels it wants with the measures it has so far set in motion. Controls on credit expansion for select categories with inflation potential capital markets and commercial real-estate through higher provisioning may choke demand only if it is sensitive to the cost of credit. But in a booming economy, higher costs can be transmitted down the line; witness the rising housing loan rates. In many a high-flying sector banks may, therefore, still find takers for expensive credit. Regardless of the RBI's marginal increase in repo rates, the perception of a tighter money regime will push up interest rates all around, thus contributing to the price rise instead of combating it.

Given the nature of inflation, currently at a two-year high, the task of fighting it lies with New Delhi. The Government must put together a gamut of measures to remove the supply bottlenecks that are causing the price rise. The RBI admits that the growth in agriculture has "not been sanguine" with the declining output in major cereals pushing up prices. Focusing its Monetary Policy weapons on "credit quality" and, therefore, the health of the banking system, the RBI has prudently left this initiative to New Delhi.

OBJECTIVE OF CREDIT CONTROL

The central bank makes efforts to control the expansion or contraction of credit in order to keep it at the required level with a view to achieving the following ends. 1. To save Gold Reserves: The central bank adopts various measures of credit control to safe guard the gold reserves against internal and external drains. 2. To achieve stability in the Price level: Frequently changes in prices adversely affect the economy. Inflationary and deflationary trends need to be prevented. This can be achieved by adopting a judicious of credit control. 3. To achieve stability in the Foreign Exchange Rate: Another objective of credit control is to achieve the stability of foreign exchange rate. If the foreign exchange rate is stabilized, it indicates the stable economic conditions of the country. 4. To meet Business Needs: According to Burgess, one of the important objectives of credit control is the Adjustment of the volume of credit to the volume of Business credit is needed to meet the requirements of trade an industry. So by controlling credit central bank can meet the requirements of business.

METHOD OF CREDIT CONTROL

There are two method of credit control:-

Quantitative method
1. Bank Rate Policy 2. Open Market Operations 3. Change in Reserve Ratios 4. Credit Rationing

Qualitative method
1. Direct Action 2. Moral persuasion 3. Legislation 4. Publicity

Quantitative method
1. Bank Rate Policy: Bank rate is the rate of interest which is charged by the central bank on rediscounting the first class bills of exchange and advancing

loans against approved securities. This facility is provided to other banks. It is also known as Discount Rate Policy. 2. Open Market Operations: The term Open Market Operations in the wider sense means purchase or sale by a central bank of any kind of paper in which it deals, like government securities or any other public securities or trade bills etc. in practice, however the term is applied to purchase or sale of government securities, short-term as well as long-term, at the initiative of the central bank, as a deliberate credit policy. 3. Change in Reserve Ratios: Every commercial bank is required to deposit with thecentral bank a certain part of its total deposits. When the central bank wants to expand credit it decreases the reserve ratio as required for the commercial banks. And when the central bank wants to contract credit the reserve ratio requirement is increased. 4. Credit Rationing: Credit rationing means restrictions placed by the central bank on demands for accommodation made upon it during times of monetary stringency and declining gold reserves. This method of controlling credit can be justified only as a measure to meet exceptional emergencies because it is open to serious abuse. 5. CRR(Cash Reserve Ratio):Cash reserve Ratio (CRR) is the amount of Cash(liquid cash like gold)that the banks have to keep with RBI. This Ratio is basically to secure solvency of the bank and to drain out the excessive money from the banks. If RBI decides to increase the percent of this, the available amount with the banks comes down and if RBI reduce the CRR then available amount with Banks increased and they are able to lend more.RBI has reduced this ratio three times and reduced it from 9 % to 5.5% in last one month or so. 6. Repo Rate:Repo rate is the rate at which our banks borrow rupees from RBI. This facility is for short term measure and to fill gaps between demand and supply of money in a bank .when a bank is short of funds they they borrow from bank at repo rate and if bank has a surplus fund then the deposit the funds with RBI and earn at Reverse repo rate .So reverse Repo rate is the rate which is paid by RBI to banks on Deposit of funds with RBI.A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. To borrow from RBI bank have to submit liquid bonds /Gov. Bonds as collateral security ,so this facility is a short term gap filling facility and bank does not use this facility to Lend more to their customers.Present rate is 7.5% and reverse repo rate is 6%. 7. SLR((Statutory Liquidity Ratio) is the amount a commercial bank 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 the RBI (Reserve Bank of India) in order to control the expansion of bank credit.Generally this mandatory ration is compiled by investing in Gov.bonds. Present rate of SLR is 24 %.But Banks average is 27.5 % ,the reason behind it is that in deficit budgeting Gov. landing is more so they borrow money from banks by selling their bonds to banks.so banks have invested more than required percentage and use these excess bonds as collateral security ( over and above SLR )to avail short term Funds from the RBI at Repo rate.

Qualitative method
1. Direct Action: The central bank may take direct action against commercialbanks that violate the rules, orders or advice of the central bank. This punishment is very severe of a commercial bank. 2. Moral persuasion: It is another method by which central bank may get credit supply expanded or contracted. By moral pressure it may prohibit or dissuade commercial banks to deal in speculative business. 3. Legislation: The central bank may also adopt necessary legislation for expanding or contracting credit money in the market. 4. Publicity: The central bank may resort to massive advertising campaign in the newspapers, magazines and journals depicting the poor economic conditions of the country suggesting commercial banks and other financial institutions to control credit either by expansion or by contraction.

Conclusion
RBI has powers to supervise and control commercial and co-operative banks with a view to developing an adequate and a sound banking system in the country. The RBI has powers to issue licenses to new banks and branches, prescribe minimum requirements regarding paid up capital and reserve, maintenance of cash and other reserves and inspect the working of banks in India and abroad.

The RBI has also powers to conduct ad-hoc investigations from time to time into complaints, irregularities and frauds in banks. The functions of RBI include issue of currency notes, banker to the government, bankers banks, and exchange control authority audit control and agriculture finance. The monetary policy of RBI is regulatory policy whereby the central bank maintains its control over the supply of money for the realization of general economic goals. RBI is the apex banking institution in India. RBI is an autonomous body promoted by the government of India and is headquartered at Mumbai. The RBI plays a key role in the management of the treasury foreign exchange movements and is also the primary regulator for banking and non-banking financial institutions. The RBI operates a number of government mints that produce currency and coins.

Bibliography:-

BOOKS M.Y. Khan Indian financial system Sudhir shah-Indian economy

Website www.rbi.org.in www.wikipedia.com