UNIVETSITY OF MUMBAI

RAYAT SHIKSHAN SANSTHAS

KARMAVEER BHAURAO PATIL COLLEGE
VASHI, NAVI MUMBAI 400703
A PROJECT REPORT ON
TYPES OF AUDIT ADOPT BY SBI BANK
SUBMITTED BY
BHAVESH PATIL
PROF. LATIKA DAS
IN PARTIAL FULFILLMENT FOR THE COURCE OF
BACHELOR OF COMMERCE (BANKING &
INSURANCE)
SEMESTER V
ACADEMIC YEAR 2016-2017

1
 ACKNOWLEDGEMENT

Would like to extend my sincere gratitude to all those people

who helped me in the successful completion of my project
entitled CENTRAL BANK first and foremost I wish to take
this opportunity of express my deep sense of gratitude to Prof
LATIKA DAS for her valuable guidance in this endeavor. She
has been a constant source of inspiration and I sincerely thank
her for suggestions and help to preparation this project
I am grateful to our coordinators Prof. Harsha Goyal and H.O.D
Prof. Archana Salunkhe for giving me valuable information
regarding project.
Special thanks to my parents who have always stood by me I
also wish to thank my friends for their constant support and
assignment to make this project worth presentation before you.

2
 RAYAT SHIKSHAN SANSTHAS

KARMAVEER BHAURAO PATIL COLLEGE

VASHI, NAVI MUMBAI 400703

CERTIFICATE

This is to certify that BHAVESH V. PATIL student of B.com

(Banking & Insurance) SEMESTER V has complete his project
on TYPES OF AUDIT ADOPT BY SBI BANK And has
submitted the project under the guidance of Prof. Archana
Salunkhe in the partial fulfillment of B.com(Banking &
Insurance) course of university of Mumbai the academic year
2016-2017.

.. .
Project Guide Coordinator Principal

University Examiner

3
 DECLARATION

I BHAVESH V PATIL student of KAMARVEER

BAHURAO PATIL COLLEGE, VASHI studying in
T.Y.B.COM (BANKING & INSURANCE) (SEMESTER V)
hereby declare that I have completed project report on TYPES
OF AUDIT ADOPT BY SBI BANK and has not been
submitted to any other university or institute for the award of
any degree, diploma etc. The information is submitted to me is
true and original to the best of my knowledge.

Date:
Place: Vashi

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 INDEX
Chapter Sub Topic Topic Name Page no.
No.

CH.1 INTRODUCTION TO THE STUDY 6-7

1.1 Introduction 8
1.2 Objectives of the study 8-9
1.3 Importance of the study 10
1.4 Scope of study 11-13
1.5 Methodology research

CH.2 Central bank

2.1 Introduction of Central Bank 15
2.2 History 16-22
2.3 Purpose & Structure 23

CH.3 3.1 The Role & Function of Central Bank in 25-31

economy

33-61
CH.4 4.1 Central Bank role in nature

CH.5 5.1 Conclusion 63

5.2 Suggestion 63
5.3 bibliography 64

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 CHAPTER 1

INTRODUCTION TO STUDY

6
 INTORDUCTION TO THE STUDY

1.1 INTRODUCTION
A central bank, reserve bank, or monetary authority is an institution that manages a
state's currency, money supply, and interest rates. Central banks also usually
oversee the commercial banking system of their respective countries. In contrast to
a commercial bank, a central bank possesses a monopoly on increasing the
monetary base in the state, and usually also prints the national currency, which
usually serves as the state's legal tender.

The primary function of a central bank is to control the nation's money supply
(monetary policy), through active duties such as managing interest rates, setting the
reserve requirement, and acting as a lender of last resort to the banking sector
during times of bank insolvency or financial crisis. Central banks usually also have
supervisory powers, intended to prevent bank runs and to reduce the risk that
commercial banks and other financial institutions engage in reckless or fraudulent
behavior. Central banks in most developed nations are institutionally designed to
be independent from political interference. Still, limited control by the executive
and legislative bodies usually exists.

7
1.2 OBJECTIVE OF THE STUDY
To study the behavior of the Central bank.
To study the function of Central Bank.
To study the history of the bank.
To study the importance in the nature.
To study the advantages & disadvantages.

1.3 IMPORTANCE TO THE STUDY

The central bank in a developing country aims at the promotion and maintenance
of a rising level of production, employment and real income in the country. The
central banks in the majority of underdeveloped countries have been given wide
powers to promote the growth of such economies. They, therefore, perform the
following functions towards this end.

One of the aims of a central bank in an underdeveloped country is to improve its

currency and credit system. More banks and financial institutions are required to be
set up to provide larger credit facilities and to divert voluntary savings into
productive channels. Financial institutions are localized in big cities in
underdeveloped countries and provide credit facilities to estates, plantations, big
industrial and commercial houses.

In order to remedy this, the central bank should extend branch banking to rural
areas to make credit available to peasants, small businessmen and traders. In
underdeveloped countries, the commercial banks provide only short-term loans.
Credit facilities in rural areas are mostly non-existent. The only source is the
village moneylender who charges exorbitant interest rates.

The hold of the village moneylender in rural areas can be slackened if new
institutional arrangements are made by the central bank in providing short-term,
medium term and long-term credit at lower interest rates to the cultivators. A
network of co-operative credit societies with apex banks financed by the central
bank can help solve the problem.

8
Business Objectives:

Central banks are crucial to the functioning of any economy. Virtually every
country has one. In 1900, there were 18, but today there are more than 170 central
banks throughout the world. The earliest central banks, such as the Bank of
England, started as commercial banks that did some business with the government,
which, over time, took on more and more functions of a central bank. Other central
banks, such as the European Central Bank and the United States Federal Reserve
were created as central banks right from the start.

Central banks act as both the government's bank, which was their original purpose,
and as the bankers' bank, providing services to commercial banks, such as check
clearing, electronic payment systems, and providing liquidity when necessary.
However, what distinguishes central banks from other banks is their primary
objective of maximizing economic efficiency through monetary policy, by
increasing or decreasing the supply money or interest rates and overseeing the
financial system to maintain soundness of financial institutions and markets.
Central banks are not beholden to owners nor do they seek profits. Any profits
made by central banks are generally turned over to their government.

Central banks became necessary to help manage the economy without

interference from politicians since financial problems can easily destroy the
economy and problems in one area or country can easily spread, as demonstrated
in the recent Credit Crisis of 2008 2009.

The economic objectives of most central banks are to maintain financial stability in
the economy, while maximizing growth and employment. Stability is important
because financial instability is a systemic risk that affects the economy as a whole
and cannot be diversified away. For instance, booms and busts in the past, most
often brought about by individual banks, have caused the entire economy to
expand and contract. Such events characterized the history of the United States
before the creation of the Federal Reserve in 1913.

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1.4 SCOPE OF THE STUDY

Central banking, the function of central banks, consists essentially of the exercise
of the public duty of influencingby regulation, persuasion, or market
operationthe behavior of banks and other financial intermediaries in a country.
Although they have antecedents as private institutions in the economic
development of a few countries, central banks are now primarily public institutions
for implementing economic policies of governments. They are appropriate to the
Western-type economies; in the communist countries, where economic activity is
more comprehensively organized by governments, there is little scope for central
banking, although institutions described as central banks exist. In true central
banking the public interest is universally paramount, although for historical and
other reasons there is some clinging to vestigial private forms and some insistence
on a peculiar independence from the central machinery of government.

The activity of central banking emerged gradually from attempts by bankers to

protect themselves by organized action and attempts by governments to ensure that
monetary conditions serve the purposes of financial policy (at first) and general
economic policy (later); this twofold origin is reflected in the formal organization
of central banks as banks and in their ultimate subjection to the sovereign power in
the state. Before 1900, the development of central banking was almost entirely
empirical. Ideas on the subject sprang largely from the efforts of the Bank of
England to deal with practical problems; there were also important experiences in
the United States before 1836 and in Europe at times during the nineteenth century.
Although some aspects were discussed in official inquiries, in English pamphlet
literature (W. Bagehots Lombard Street, 1873, being the classic example), and in
European controversy on the issue of bank notes, systematic thought on central
banking in recognizably modern form can be dated from the United States
controversy and public inquiry from which the Federal Reserve System emerged in
1913.

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1.5 METHODOLOGY RESEARCH

Problem of the Study:

The Statement of the problem is A STUDY ON GOVERNANCE PRACTICES

IN CO-OPERATIVE BANKS.

Objectives of the Study:

The main aim of the study is to analyze the present status of Governance in Urban
Cooperative Banks (UCBs). The specific objectives of the study are:

1. To study and understand the concept and genesis of Cooperative Banks in India
in general and Gujarat in particular.

2. To understand and analyze the importance of Governance in Banks in general

and Cooperative banks in particular.

3. To evaluate the Compliance level of Governance in Urban Cooperative banks

and to evaluate their performance.

4. To identify and discuss various challenges faced by UCBs to implement

governance mechanism.

5. To suggest various means through which Governance practices can be improved

so as to increase the efficiency of Cooperative Banks.

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1.5.1 TYPES OF RESEARCH

PRIMARY DATA: This data is collected from direct questionnaire. The

source of the data collection is primary data

SECONDARY DATA: Secondary data is collected from magazines,

newspaper, etc. The source of data collection social networking sites,
books, newspapers etc.

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1.5.2 METHOD OF DATA COLLECTION
Why is research important?

What should the central bank research cover (topics and Synergies)?

Monetary policy

Financial stability (macro prudential)

Supervision (micro prudential)

Consumer Protection, Financial Literacy

Financial sector development

Broader development

Research helps to:

Support the development of policy strategies and the decision-making process;

Better communicate the policies to the public;

Produce public good by contributing to the general knowledge that benefits the
society as a whole;

Improve credibility of policymakers and their policies.

1.5.3 SAMPLING

SAMPLING SIZE: It indicates that number of people to the surveyed.

Through sample gives more reliable result. The total number of sample size is 100.

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 CHAPTER 2

PROFILE OF THE ORGANISATION

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2.1 INTRODUCTION
Central Bank of India, a government-owned bank, is one of the oldest and largest
commercial banks in India. It is based in Mumbai which is the financial capital of
India and capital city of state of Maharashtra.[1] The bank has 4700 branches,
5000 ATM's and 4 extension counters across 27 Indian states and three Union
Territories. At present, Central Bank of India has overseas office at Nairobi, Hong
Kong and a joint venture with Bank of India, Bank of Baroda, and the Zambian
government. The Zambian government holds 40 per cent stake and each of the
banks has 20 per cent. Recently it has also opened a representative office at
Nairobi in Kenya.

Central bank of India is one of 19 Public Sector banks in India to get

recapitalization finance from the government over the next 24 months.

Central Bank of India has approached the Reserve Bank of India (RBI) for
permission to open representative offices in five more locations - Singapore,
Dubai, Doha and London.

As on 31 March 2015, the bank's reserves and surplus stood at 283030 million.
Its total business at the end of the last fiscal amounted to 45, 05,390(approx)
million.

15
2.2 HISTORY
It was established on 21 December 1911 by Sir Sorabji Pochkhanawala with Sir
Pherozeshah Mehta as Chairman,[4] and claims to have been the first commercial
Indian bank completely owned and managed by Indians.

By 1918 it had established a branch in Hyderabad. A branch in nearby

Secunderabad followed in 1925.

In 1923, it acquired the Tata Industrial Bank in the wake of the failure of the
Alliance Bank of Simla. The Tata bank, established in 1917, had opened a branch
in Madras in 1920 that became the Central Bank of India, Madras.

Central Bank of India was instrumental in the creation of the first Indian exchange
bank, the Central Exchange Bank of India, which opened in London in 1936.
However, Barclays Bank acquired Central Exchange Bank of India in 1938.

Also before World War II, Central Bank of India established a branch in Rangoon.
The branch's operations concentrated on business between Burma and India, and
especially money transmission via telegraphic transfer. Profits derived primarily
from foreign exchange and margins. The bank also lent against land, produce, and
other assets, mostly to Indian businesses.

In 1963, the revolutionary government in Burma nationalized Central Bank of

India's operations there, which became People's Bank No. 1.

In 1969, the Indian Government nationalized the bank on 19 July, together with 13
others

In the 1980s the managers of the London branches of Central Bank of India,
Punjab National Bank, and Union Bank of India were caught up in a fraud in
which they made dubious loans to the Bangladeshi jute trader Rajender Singh
Sethia. The regulatory authorities in England and India forced all three Indian
banks to close their London branches.

Central Bank of India was one of the first banks in India to issue credit cards in the
year 1980 in collaboration with MasterCard. Central Bank of India announces that
the financial results for the year ended 2013-Total Business Rs. 402000 Cr. Net
Profit-Rs. 1015 Cr.

16
On 1 August 2013, Central Bank of India appoints new CMD Rajiv Rishi, who
was previously ED of Indian Bank and General Manager of OBC and Raj Kumar
Goyal as the new ED of the bank. On 1 November of the same year, the bank open
its second representative office in Hong Kong.

YEAR EVENTS 1969 - The Bank was brought into existence by an Ordinance on 19th July, for
taking over the Undertaking of the Central Bank of India, Ltd. In terms of the Ordinance, the
Undertaking of "The Central Bank of India, Ltd." was transferred to and vested in the new Bank.
The Ordinance was replaced by the Banking Companies Act, 1969. The Act was declared null
and void by the Supreme Court on 10th February, 1970. An Ordinance was thereupon
promulgated which was later replaced by the Banking Companies Act, 1970 which was made
effective retrospectively from 19th July, 1969.

1970 - 83 offices were opened in the Lead Districts bringing the total number of offices in such
districts to 139 as at 31st December. A total of 817 branches were opened by the Bank in 47
districts since nationalisation.

1982 - Rs 2,50,00,000 was subscribed by Government.

1984 - One more regional rural bank was opened. Another 3 RRBs were set up in 1985, raising
the number of RRBs sponsored by the Bank to 23 covering 37 districts.

1985 - Rs 41.74 crores subscribed for by Government.

1995 - Rs 1256.46 crores subscribed for by Government.

1996 - Rs 500 crores subscribed for by Government.

1997 - The Bank acted as lead managers/co-managers in a few public/Rights issue besides taking
up underwriting commitments in a couple of issues. The bank also acted as bankers to 20 Mega
Bond Issue of lead financial institutions.

17
- The Bank took a number of steps to canvass new export accounts and to reduce response time
in meeting the credit requirements of the existing customers of the bank. The bank fully
computerised its International business branch at three major international business branches at
Mumbai, Calcutta and New Delhi.

- Centbank Financial & Custodial Services Ltd., Centbank Home Finance Ltd., are subsidiaries
the bank.

- Indo Zambia Bank Ltd.: is a joint venture of the bank along with Bank of Baroda, Bank of
India and Government of the Republic of Zambia.

1998 - As at 31st March, the total number of branches were 3079 and the total number of
extension counters increased from 229 to 232 from the previous year.

- Under the Lead Bank Scheme, the Bank was allotted 39 districts in six states.

2000 - Dalbir Singh has been appointed the chairman and managing director of Central of India
for five years, from 17th July to 30th June, 2005.

- Central Bank of India has received the Asian Bankers' Award 2000 for its business journal
`Focus' under the category for marketing, public relation or brand management.

- Central Bank of India has introduced 7-day banking services in select computerised branches in
Chennai which includes the branches at Adyar, Mylapore, Pallavaram, T Nagar, Kodambakkam,
and Washermanpet and Mogappair.

2001 - The Bank has launched its voluntary retirement scheme (VRS) for a period of 15 days
commencing on February 22 to March 8, 2001.

18
- Central Bank of India has set up a first-of-its-kind customer information desk at Delhi's Vikas
Sadan.

- Central Bank of India will launch a private placement of tier-2 bonds to raise up to Rs 200
crore.

- The state-run Central Bank of India (Central Bank) is planning to raise Rs 250 crore for
bolstering its Tier-II capital, via private placement.

2003

- Central Bank of India (CBI), along with Canara Bank, Indian Overseas Bank (IOB), UCO Bank
and Union Bank of India (UBI) have formed an alliance to launch `Cash Online' ATM network

2004

- Central Bank of India ties up with New India Assurance Company Ltd for distribution of non-
life insurance covers

-Central Bank unveils new trading system on NDS

2005

-Central Bank of India has amalgamated three sponsored regional rural banks (RRBs) in
Maharashtra with effect from September 12. The newly formed bank is called the Vidharbha
Kshetriya Gramin Bank and will be headquartered in Akola.

19
2006

-The Andhra Pradesh State Financial Corporation (APSFC) has entered into a memorandum of
understanding with Central Bank of India to ensure integrated and speedy flow of credit to
industrial customers and provide easy facility of working capital to all the assisted units in State.

2008

- Central Bank of India has appointed Shri. M S Johar as part-time non-official Director under
the Chartered Accountant category on the Board of the Bank for a period of 3 years w.e.f.
January 02, 2008.

- Central Bank of India has rolled out Visa Platinum and Visa Gold cards having domestic and
international acceptance. The cards will offer facilities such as revolving credit, reward points,
balance transfer facility and SMS alerts. Central Bank has a debit and credit card base of around
four lakh customers.

- Central Bank Of India has informed that Shri J. Noble, Deputy General Manager of the Bank,
has been appointed as Compliance Officer of the Bank in place Shri S.R. Shukla.

2009

- Central Bank of India will be focusing on car financing in a big way and to achieve this
objective, the bank on Sept 25 tied up with Hyundai Motor India Ltd. Under this arrangement,
Central Bank of India will provide loans for purchase of Hyundai vehicles.

- Central Bank of India has informed that Major (Retd) Ved Prakash has been appointed as
Director on the Bank's Board.

20
2010

-Setting up of a branch at Margram village in Murshidabad district, West Bengal.

-It will take a decision in the current fiscal to enter insurance business.

-Central Bank FY10 net up 83% at Rs 1,162 cr

-Central Bank of India has launched a new facility named- CentFast2India in order remit funds
online from United States to India.

-Central Bank introduces pre-paid cards

2011

-Central bank of India launched Cent Double scheme that is designed to offer double the money
deposited by the depositor, in seven-and-a-half year.

-Central Bank of India announced its opening and closing date for the Rs 2,500 crore rights issue
as of March 24 and April 7 respectively.

-Central Bank of India Issues Rights in the Ratio of 3:5

2012

21
-Central Bank of India has won the prestigious GOLDEN PEACOCK HR EXCELLENCE
AWARD

-Central Bank of India provided water storage tanks to the villages of Satara district

-Central Bank of India launched "Go Green" Campaign for customers.

- "Central Bank of India in Association with Angel Broking Launch CENT-e-TRADE" The
Three-in-One Online Share Trading Facility.

-Central Bank of India - Cent Sanskriti extends helping hand to disabled persons.

2013

-Board recommended a Final Dividend of Rs. 25%.

2014

-CBI received Rajbhasha shield from NARAKAS

-CBI & Tata Motors Ltd signs MOU for commercial Vehicle finance

-CBI Received National Award for Excellence in MSME Lending

22
2.3 Purpose and Structure
The central bank makes sure regular banks have adequate money to pay their
customers. This is often referred to as reserves. Although rare in the United States,
sometimes too many customers will withdraw their savings from a particular bank
and it will run out of money; the Federal Reserve can step in and loan the bank
money to satisfy and pay its customers in times of distress.

The central bank is also responsible for ensuring that banks are treating customers
fairly and charging appropriate interest rates on loans. The consumer rights and
protection you get when you use a ATM machine, credit or debit card, or when you
get a car loan, are all regulations the Federal Reserve creates and monitors.

23
 CHAPTER 3

THE ROLE AND FUNCTION OF

CENTRAL BANK IN ECONOMY

24
A central bank has been defined in terms of its functions. According to Vera
Smith, The primary definition of central banking is a banking system in which a
single bank has either complete control or a residuary monopoly of note issue.
W.A. Shaw defines a central bank as a bank which control credit.

To Hawtrey, a central bank is that which the lender of the last resort is. According
to A.C.L. Day, a central bank is to help control and stabilize the monetary and
banking system.

According to Sayers, the central bank is the organ of government that undertakes
the major financial operations of the government and by its conduct of these
operations and by other means, influences the behavior of financial institutions so
as to support the economic policy of the Government. Sayers refers only to the
nature of the central bank as the governments bank. All these definitions are
narrow because they refer only to one particular function of a central bank.

On the other hand, Samuelsons definition is wide. According to him, a central

bank is a bank of bankers. Its duty is to control the monetary base. and through
control of this high-powered money to control the communitys supply of
money. But the broadest definition has been given by De Kock.

In his words, a central bank is a bank which constitutes the apex of the monetary
and banking structure of its country and which performs as best as it can in the
national economic interest, the following functions:

(i) The regulation of currency in accordance with the requirements of business and
the general public for which purpose it is granted either the sole right of note issue
or at least a partial monopoly thereof,

(ii) The performance of general banking and agency for the state,

(iii) The custody of the cash reserves of the commercial banks,

(iv) The custody and management of the nations reserves of international

currency,

25
(v) The granting of accommodation in the form of re-discounts and collateral
advances to commercial banks, bill brokers and dealers, or other financial
institutions and the general acceptance of the responsibility of lender of the last
resort,

(vi) The settlement of clearance balances between the banks,

(vii) The control of credit in accordance with the needs of business and with a
view to carrying out the broad monetary policy adopted by the state. De Kocks
definition is too long to be called a definition. For, a definition must be brief.

Functions of a Central Bank:

A central bank performs the following functions, as given by De Kock and
accepted by the majority of economists.

1. Regulator of Currency:
The central bank is the bank of issue. It has the monopoly of note issue. Notes
issued by it circulate as legal tender money. It has its issue department which
issues notes and coins to commercial banks. Coins are manufactured in the
government mint but they are put into circulation through the central bank.

Central banks have been following different methods of note issue in different
countries. The central bank is required by law to keep a certain amount of gold and
foreign securities against the issue of notes. In some countries, the amount of gold
and foreign securities bears a fixed proportion, between 25 to 40 per cent of the
total notes issued.

In other countries, a minimum fixed amount of gold and foreign currencies is

required to be kept against note issue by the central bank. This system is operative
in India whereby the Reserve Bank of India is required to keep Rs 115 crores in
gold and Rs 85 crores in foreign securities. There is no limit to the issue of notes
after keeping this minimum amount of Rs 200 crores in gold and foreign securities.

26
The monopoly of issuing notes vested in the central bank ensures uniformity in the
notes issued which helps in facilitating exchange and trade within the country. It
brings stability in the monetary system and creates confidence among the public.
The central bank can restrict or expand the supply of cash according to the
requirements of the economy. Thus it provides elasticity to the monetary system.
By having a monopoly of note issue, the central bank also controls the banking
system by being the ultimate source of cash. Last but not the least, by entrusting
the monopoly of note issue to the central bank, the government is able to earn
profits from printing notes whose cost is very low as compared with their face
value.

2. Banker, Fiscal Agent and Adviser to the Government:

Central banks everywhere act as bankers, fiscal agents and advisers to their
respective governments. As banker to the government, the central bank keeps the
deposits of the central and state governments and makes payments on behalf of
governments. But it does not pay interest on governments deposits. It buys and
sells foreign currencies on behalf of the government.

It keeps the stock of gold of the government. Thus it is the custodian of

government money and wealth. As a fiscal agent, the central bank makes short-
term loans to the government for a period not exceeding 90 days. It floats loans,
pays interest on them, and finally repays them on behalf of the government. Thus it
manages the entire public debt. The central bank also advises the government on
such economic and money matters as controlling inflation or deflation, devaluation
or revaluation of the currency, deficit financing, balance of payments, etc. As
pointed out by De Kock, Central banks everywhere operate as bankers to the state
not only because it may be more convenient and economical to the state, but also
because of the intimate connection between public finance and monetary affairs.

27
3. Custodian of Cash Reserves of Commercial Banks:
Commercial banks are required by law to keep reserves equal to a certain
percentage of both time and demand deposits liabilities with the central banks. It is
on the basis of these reserves that the central bank transfers funds from one bank to
another to facilitate the clearing of cheques.

Thus the central bank acts as the custodian of the cash reserves of commercial
banks and helps in facilitating their transactions. There are many advantages of
keeping the cash reserves of the commercial banks with the central bank, according
to De Kock.

In the first place, the centralization of cash reserves in the central bank is a source
of great strength to the banking system of a country. Secondly, centralized cash
reserves can serve as the basis of a large and more elastic credit structure than if
the same amount were scattered among the individual banks.

Thirdly, centralized cash reserves can be utilized fully and most effectively during
periods of seasonal strains and in financial crises or emergencies. Fourthly, by
varying these cash reserves the central bank can control the credit creation by
commercial banks. Lastly, the central bank can provide additional funds on a
temporary and short term basis to commercial banks to overcome their financial
difficulties.

4. Custody and Management of Foreign Exchange Reserves:

The central bank keeps and manages the foreign exchange reserves of the country.
It is an official reservoir of gold and foreign currencies. It sells gold at fixed prices
to the monetary authorities of other countries. It also buys and sells foreign
currencies at international prices. Further, it fixes the exchange rates of the
domestic currency in terms of foreign currencies.

28
It holds these rates within narrow limits in keeping with its obligations as a
member of the International Monetary Fund and tries to bring stability in foreign
exchange rates. Further, it manages exchange control operations by supplying
foreign currencies to importers and persons visiting foreign countries on business,
studies, etc. in keeping with the rules laid down by the government.

5. Lender of the Last Resort:

De Kock regards this function as a sine qua non of central banking. By granting
accommodation in the form of re-discounts and collateral advances to commercial
banks, bill brokers and dealers, or other financial institutions, the central bank acts
as the lender of the last resort.

The central bank lends to such institutions in order to help them in times of stress
so as to save the financial structure of the country from collapse. It acts as lender of
the last resort through discount house on the basis of treasury bills, government
securities and bonds at the front door.

The other method is to give temporary accommodation to the commercial banks or

discount houses directly through the back door. The difference between the two
methods is that lending at the front door is at the bank rate and in the second case
at the market rate. Thus the central bank as lender of the last resort is a big source
of cash and also influences prices and market rates.

6. Clearing House for Transfer and Settlement:

As bankers bank, the central bank acts as a clearing house for transfer and
settlement of mutual claims of commercial banks. Since the central bank holds
reserves of commercial banks, it transfers funds from one bank to other banks to
facilitate clearing of cheques. This is done by making transfer entries in their
accounts on the principle of book-keeping. To transfer and settle claims of one
bank upon others, the central bank operates a separate department in big cities and
trade centers. This department is known as the clearing house and it renders the
service free to commercial banks.

29
When the central bank acts as a clearing agency, it is time-saving and convenient
for the commercial banks to settle their claims at one place. It also economizes the
use of money. It is not only a means of economizing cash and capital but is also a
means of testing at any time the degree of liquidity which the community is
maintaining.

7. Controller of Credit:
The most important function of the central bank is to control the credit creation
power of commercial bank in order to control inflationary and deflationary
pressures within this economy. For this purpose, it adopts quantitative methods and
qualitative methods. Quantitative methods aim at controlling the cost and quantity
of credit by adopting bank rate policy, open market operations, and by variations in
reserve ratios of commercial banks.

Qualitative methods control the use and direction of credit. These involve selective
credit controls and direct action. By adopting such methods, the central bank tries
to influence and control credit creation by commercial banks in order to stabilize
economic activity in the country.

Besides the above noted functions, the central banks in a number of developing
countries have been entrusted with the responsibility of developing a strong
banking system to meet the expanding requirements of agriculture, industry, trade
and commerce.

Accordingly, the central banks possess some additional powers of supervision and
control over the commercial banks. They are the issuing of licenses; the regulation
of branch expansion; to see that every bank maintains the minimum paid up capital
and reserves as provided by law; inspecting or auditing the accounts of banks; to
approve the appointment of chairmen and directors of such banks in accordance
with the rules and qualifications; to control and recommend merger of weak banks
30
in order to avoid their failures and to protect the interest of depositors; to
recommend nationalization of certain banks to the government in public interest; to
publish periodical reports relating to different aspects of monetary and economic
policies for the benefit of banks and the public; and to engage in research and train
banking personnel etc..

31
 CHAPTER 4

CENTRAL BANK ROLE IN

NATURE

32
4.1 INTRODUCTION

Central banks were established in many European countries during the 19th
century. The War of the Second Coalition led to the creation of the Banque de
France in 1800, in an effort to improve the public financing of the war.
Although central banks today are generally associated with fiat money, the 19th
and early 20th centuries central banks in most of Europe and Japan developed
under the international gold standard, elsewhere free banking or currency
boards were more usual at this time. Problems with collapses of banks during
downturns, however, led to wider support for central banks in those nations which
did not as yet possess them, most notably in Australia.
On 23 December 1913 the U.S. Congress created the US Federal Reserve through
the passing of The Federal Reserve Act in the Senate and its signing by
President Woodrow Wilson on the same day. Australia established its first central
bank in 1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New
Zealand in the aftermath of the Great Depression in 1934. By 1935, the only
significant independent nation that did not possess a central bank was Brazil,
which subsequently developed a precursor thereto in 1945 and the present Central
Bank of Brazil twenty years later. After gaining independence, African and Asian
countries also established central banks or monetary unions.
The People's Bank of China evolved its role as a central bank starting in about
1979 with the introduction of market reforms, which accelerated in 1989 when the
country adopted a generally capitalist approach to its export economy. Evolving
further partly in response to the European Central Bank, the People's Bank of
China had by 2000 become a modern central bank. The most recent bank model
was introduced together with the euro, and involves coordination of the European
national banks, which continue to manage their respective economies separately in
all respects other than currency exchange and base interest rates.

33
Functions of a central bank may include:

Implementing monetary policies. Setting the official interest rate used to manage
both inflation and the country's exchange rate and ensuring that this rate takes
effect via a variety of policy mechanisms controlling the nation's entire money
supply the Government's banker and the bankers' bank ("lender of last resort")
managing the country's foreign exchange and gold reserves and the Government's
stock register regulating and supervising the banking industry

Currency insurance

At the most basic level, monetary policy involves establishing what form of
currency the country may have, whether a fiat currency, gold-backed currency
(disallowed for countries in the International Monetary Fund), currency board or a
currency union. When a country has its own national currency, this involves the
issue of some form of standardized currency, which is essentially a form of
promissory note: a promise to exchange the note for "money" under certain
circumstances. Historically, this was often a promise to exchange the money for
precious metals in some fixed amount. Now, when many currencies are fiat money,
the "promise to pay" consists of the promise to accept that currency to pay for
taxes.

A central bank may use another country's currency either directly in a currency
union, or indirectly on a currency board. In the latter case, exemplified by the
Bulgarian National Bank, Hong Kong and Latvia, the local currency is backed at a
fixed rate by the central bank's holdings of a foreign currency. Similar to
commercial banks, central banks hold assets (government bonds, foreign exchange,
gold, and other financial assets) and incur liabilities (currency outstanding).
Central banks create money by issuing interest-free currency notes and selling
them to the public (government) in exchange for interest-bearing assets such as
government bonds. When a central bank wishes to purchase more bonds than their
34
respective national governments make available, they may purchase private bonds
or assets denominated in foreign currencies.

The European Central Bank remits its interest income to the central banks of the
member countries of the European Union. The US Federal Reserve remits all its
profits to the U.S. Treasury. This income, derived from the power to issue
currency, is referred to as seignior age, and usually belongs to the national
government. The state-sanctioned power to create currency is called the Right of
Issuance. Throughout history there have been disagreements over this power, since
whoever controls the creation of currency controls the seignior age income. The
expression "monetary policy" may also refer more narrowly to the interest-rate
targets and other active measures undertaken by the monetary authority.

35
High employment
Frictional unemployment is the time period between jobs when a worker is
searching for, or transitioning from one job to another. Unemployment beyond
frictional unemployment is classified as unintended unemployment.

For example, structural unemployment is a form of unemployment resulting from a

mismatch between demand in the labour market and the skills and locations of the
workers seeking employment. Macroeconomic policy generally aims to reduce
unintended unemployment.

Keynes labeled any jobs that would be created by a rise in wage-goods (i.e., a
decrease in real-wages) as involuntary unemployment:

Men are involuntarily unemployed if, in the event of a small rise in the price of
wage-goods relatively to the money-wage, both the aggregate supply of labour
willing to work for the current money-wage and the aggregate demand for it at that
wage would be greater than the existing volume of employment.

36
Price stability

Inflation is defined either as the devaluation of a currency or equivalently the rise

of prices relative to a currency.

Since inflation lowers real wages, Keynesians view inflation as the solution to
involuntary unemployment. However, "unanticipated" inflation leads to lender
losses as the real interest rate will be lower than expected. Thus, Keynesian
monetary policy aims for a steady rate of inflation. A publication from the Austrian
School, The Case against the Fed, argues that the efforts of the central banks to
control inflation have been counterproductive.

Economic growth
Economic growth can be enhanced by investment in capital, such as more or better
machinery. A low interest rate implies that firms can loan money to invest in their
capital stock and pay less interest for it. Lowering the interest is therefore
considered to encourage economic growth and is often used to alleviate times of
low economic growth. On the other hand, raising the interest rate is often used in
times of high economic growth as a contra-cyclical device to keep the economy
from overheating and avoid market bubbles.

Further goals of monetary policy are stability of interest rates, of the financial
market, and of the foreign exchange market. Goals frequently cannot be separated
from each other and often conflict. Costs must therefore be carefully weighed
before policy implementation.

37
Policy instruments
The main monetary policy instruments available to central banks are open market
operation, bank reserve requirement, interest rate policy, re-lending and re-
discount (including using the term repurchase market), and credit policy (often
coordinated with trade policy). While capital adequacy is important, it is defined
and regulated by the Bank for International Settlements, and central banks in
practice generally do not apply stricter rules.

To enable open market operations, a central bank must hold foreign exchange
reserves (usually in the form of government bonds) and official gold reserves. It
will often have some influence over any official or mandated exchange rates: Some
exchange rates are managed, some are market based (free float) and many are
somewhere in between ("managed float" or "dirty float").

38
Interest rates
By far the most visible and obvious power of many modern central banks is to
influence market interest rates; contrary to popular belief, they rarely "set" rates to
a fixed number. Although the mechanism differs from country to country, most use
a similar mechanism based on a central bank's ability to create as much fiat money
as required.

The mechanism to move the market towards a 'target rate' (whichever specific rate
is used) is generally to lend money or borrow money in theoretically unlimited
quantities, until the targeted market rate is sufficiently close to the target. Central
banks may do so by lending money to and borrowing money from (taking deposits
from) a limited number of qualified banks, or by purchasing and selling bonds. As
an example of how this functions, the Bank of Canada sets a target overnight rate,
and a band of plus or minus 0.25%. Qualified banks borrow from each other within
this band, but never above or below, because the central bank will always lend to
them at the top of the band, and take deposits at the bottom of the band; in
principle, the capacity to borrow and lend at the extremes of the band are
unlimited.[18] Other central banks use similar mechanisms.

The target rates are generally short-term rates. The actual rate that borrowers and
lenders receive on the market will depend on (perceived) credit risk, maturity and
other factors. For example, a central bank might set a target rate for overnight
lending of 4.5%, but rates for (equivalent risk) five-year bonds might be 5%,
4.75%, or, in cases of inverted yield curves, even below the short-term rate. Many
central banks have one primary "headline" rate that is quoted as the "central bank
rate". In practice, they will have other tools and rates that are used, but only one
that is rigorously targeted and enforced.

"The rate at which the central bank lends money can indeed be chosen at will by
the central bank; this is the rate that makes the financial headlines." Henry C.K.
Liu.[19] Liu explains further that "the U.S. central-bank lending rate is known as
39
the Fed funds rate. The Fed sets a target for the Fed funds rate, which its Open
Market Committee tries to match by lending or borrowing in the money market ...
a fiat money system set by command of the central bank. The Fed is the head of
the central-bank because the U.S. dollar is the key reserve currency for
international trade. The global money market is a USA dollar market. All other
currencies markets revolve around the U.S. dollar market." Accordingly, the U.S.
situation is not typical of central banks in general.

Typically a central bank controls certain types of short-term interest rates. These
influence the stock- and bond markets as well as mortgage and other interest rates.
The European Central Bank for example announces its interest rate at the meeting
of its Governing Council; in the case of the U.S. Federal Reserve, the Federal
Reserve Board of Governors. Both the Federal Reserve and the ECB are composed
of one or more central bodies that are responsible for the main decisions about
interest rates and the size and type of open market operations, and several branches
to execute its policies. In the case of the Federal Reserve, they are the local Federal
Reserve Banks; for the ECB they are the national central banks.

A typical central bank has several interest rates or monetary policy tools it can set
to influence markets.

Marginal lending rate (currently 0.30% in the Euro zone [20]) a fixed rate for
institutions to borrow money from the central bank. (In the USA this is called the
discount rate).

Main refinancing rate (0.05% in the Euro zone [20]) the publicly visible interest
rate the central bank announces. It is also known as minimum bid rate and serves
as a bidding floor for refinancing loans. (In the USA this is called the federal funds
rate).

40
Deposit rate, generally consisting of interest on reserves and sometimes also
interest on excess reserves (-0.20% in the Euro zone [20]) the rates parties
receive for deposits at the central bank.

These rates directly affect the rates in the money market, the market for short term
loans

Open market operations

Through open market operations, a central bank influences the money supply in an
economy. Each time it buys securities (such as a government bond or treasury bill),
it in effect creates money. The central bank exchanges money for the security,
increasing the money supply while lowering the supply of the specific security.
Conversely, selling of securities by the central bank reduces the money supply.

Open market operations usually take the form of:

Buying or selling securities ("direct operations") to achieve an interest rate target in

the interbank market .Temporary lending of money for collateral securities
("Reverse Operations" or "repurchase operations", otherwise known as the "repo"
market). These operations are carried out on a regular basis, where fixed maturity
loans (of one week and one month for the ECB) are auctioned off.

Foreign exchange operations such as foreign exchange swaps. All of these

interventions can also influence the foreign exchange market and thus the
exchange rate. For example, the People's Bank of China and the Bank of Japan
have on occasion bought several hundred billions of U.S. Treasuries, presumably
in order to stop the decline of the U.S. dollar versus the renminbi and the yen.

41
Capital requirements
All banks are required to hold a certain percentage of their assets as capital, a rate
which may be established by the central bank or the banking supervisor. For
international banks, including the 55 member central banks of the Bank for
International Settlements, the threshold is 8% (see the Basel Capital Accords) of
risk-adjusted assets, whereby certain assets (such as government bonds) are
considered to have lower risk and are either partially or fully excluded from total
assets for the purposes of calculating capital adequacy. Partly due to concerns
about asset inflation and repurchase agreements, capital requirements may be
considered more effective than reserve requirements in preventing indefinite
lending: when at the threshold, a bank cannot extend another loan without
acquiring further capital on its balance sheet.

Reserve requirements
Historically, bank reserves have formed only a small fraction of deposits, a system
called fractional reserve banking. Banks would hold only a small percentage of
their assets in the form of cash reserves as insurance against bank runs. Over time
this process has been regulated and insured by central banks. Such legal reserve
requirements were introduced in the 19th century as an attempt to reduce the risk
of banks overextending themselves and suffering from bank runs, as this could lead
to knock-on effects on other overextended banks. See also money multiplier.

As the early 20th century gold standard was undermined by inflation and the late
20th century fiat dollar hegemony evolved, and as banks proliferated and engaged
in more complex transactions and were able to profit from dealings globally on a
moment's notice, these practices became mandatory, if only to ensure that there
was some limit on the ballooning of money supply. Such limits have become
harder to enforce. The People's Bank of China retains (and uses) more powers over
reserves because the yuan that it manages is a non-convertible currency.

42
Loan activity by banks plays a fundamental role in determining the money supply.
The central-bank money after aggregate settlement "final money" can take only
one of two forms:

physical cash, which is rarely used in wholesale financial markets,

central-bank money which is rarely used by the people

The currency component of the money supply is far smaller than the deposit
component. Currency, bank reserves and institutional loan agreements together
make up the monetary base, called M1, M2 and M3. The Federal Reserve Bank
stopped publishing M3 and counting it as part of the money supply in 2006.

Exchange requirements
To influence the money supply, some central banks may require that some or all
foreign exchange receipts (generally from exports) be exchanged for the local
currency. The rate that is used to purchase local currency may be market-based or
arbitrarily set by the bank. This tool is generally used in countries with non-
convertible currencies or partially convertible currencies. The recipient of the local
currency may be allowed to freely dispose of the funds, required to hold the funds
with the central bank for some period of time, or allowed to use the funds subject
to certain restrictions. In other cases, the ability to hold or use the foreign exchange
may be otherwise limited.
In this method, money supply is increased by the central bank when it purchases
the foreign currency by issuing (selling) the local currency. The central bank may
subsequently reduce the money supply by various means, including selling bonds
or foreign exchange interventions.

43
Margin requirements and other tools

In some countries, central banks may have other tools that work indirectly to limit
lending practices and otherwise restrict or regulate capital markets. For example, a
central bank may regulate margin lending, whereby individuals or companies may
borrow against pledged securities. The margin requirement establishes a minimum
ratio of the value of the securities to the amount borrowed.
Central banks often have requirements for the quality of assets that may be held by
financial institutions; these requirements may act as a limit on the amount of risk
and leverage created by the financial system. These requirements may be direct,
such as requiring certain assets to bear certain minimum credit ratings, or indirect,
by the central bank lending to counterparties only when security of a certain
quality is pledged as collateral.

Limits on policy effects

Although the perception by the public may be that the "central bank" controls
some or all interest rates and currency rates, economic theory (and substantial
empirical evidence) shows that it is impossible to do both at once in an open
economy. Robert Mundell's "impossible trinity" is the most famous formulation of
these limited powers, and postulates that it is impossible to target monetary policy
(broadly, interest rates), the exchange rate (through a fixed rate) and maintain free
capital movement. Since most Western economies are now considered "open" with
free capital movement, this essentially means that central banks may target interest
rates or exchange rates with credibility, but not both at once.

In the most famous case of policy failure, Black Wednesday, George Soros
arbitraged the pound sterling's relationship to the ECU and (after making $2 billion
himself and forcing the UK to spend over $8bn defending the pound) forced it to
abandon its policy. Since then he has been a harsh critic of clumsy bank policies
and argued that no one should be able to do what he did.[citation needed]
44
The most complex relationships are those between the yuan and the US dollar, and
between the euro and its neighbours. (The situation in Cuba is so exceptional as to
require the Cuban peso to be dealt with simply as an exception, since the United
States forbids direct trade with Cuba.)

US dollars were ubiquitous in Cuba's economy after its legalization in 1991, but
were officially removed from circulation in 2004 and replaced by the convertible
peso.

Banking supervision and other activities

In some countries a central bank, through its subsidiaries, controls and monitors
the banking sector. In other countries banking supervision is carried out by a
government department such as the UK Treasury, or by an independent
government agency, for example, UK's Financial Conduct Authority. It examines
the banks' balance sheets and behaviour and policies toward
consumers.[clarification needed] Apart from refinancing, it also provides banks
with services such as transfer of funds, bank notes and coins or foreign currency.
Thus it is often described as the "bank of banks".

Many countries will monitor and control the banking sector through several
different agencies and for different purposes. the Bank regulation in the United
States for example is highly fragmented with 3 federal agencies, the Federal
Deposit Insurance Corporation, the Federal Reserve Board, or Office of the
Comptroller of the Currency and numerous others on the state and the private
level. There is usually significant cooperation between the agencies. For example,
money center banks, deposit-taking institutions, and other types of financial

45
institutions may be subject to different (and occasionally overlapping) regulation.
Some types of banking regulation may be delegated to other levels of government,
such as state or provincial governments.

Any cartel of banks is particularly closely watched and controlled. Most countries
control bank mergers and are wary of concentration in this industry due to the
danger of groupthink and runaway lending bubbles based on a single point of
failure, the credit culture of the few large banks.

46
Independence
Governments generally have some degree of influence over even "independent"
central banks; the aim of independence is primarily to prevent short-term
interference. For example, the Board of Governors of the U.S. Federal Reserve are
nominated by the President of the U.S. and confirmed by the Senate, publishes
verbatim transcripts, and balance sheets are audited by the Government
Accountability Office.
In the 2000s there has been a trend towards increasing the independence of central
banks as a way of improving long-term economic performance. While a large
volume of economic research has been done to define the relationship between
central bank independence and economic performance, the results are ambiguous.
Advocates of central bank independence argue that a central bank which is too
susceptible to political direction or pressure may encourage economic cycles
("boom and bust"), as politicians may be tempted to boost economic activity in
advance of an election, to the detriment of the long-term health of the economy and
the country. In this context, independence is usually defined as the central bank's
operational and management independence from the government.
The literature on central bank independence has defined a number of types of
independence.

Legal independence

The independence of the central bank is enshrined in law. This type of

independence is limited in a democratic state; in almost all cases the central bank is
accountable at some level to government officials, either through a government
minister or directly to a legislature. Even defining degrees of legal independence
has proven to be a challenge since legislation typically provides only a framework
within which the government and the central bank work out their relationship.

47
Goal independence

The central bank has the right to set its own policy goals, whether inflation
targeting, control of the money supply, or maintaining a fixed exchange rate. While
this type of independence is more common, many central banks prefer to announce
their policy goals in partnership with the appropriate government departments.
This increases the transparency of the policy setting process and thereby increases
the credibility of the goals chosen by providing assurance that they will not be
changed without notice. In addition, the setting of common goals by the central
bank and the government helps to avoid situations where monetary and fiscal
policy are in conflict; a policy combination that is clearly sub-optimal.

Operational independence

The central bank has the independence to determine the best way of achieving its
policy goals, including the types of instruments used and the timing of their use.
This is the most common form of central bank independence. The granting of
independence to the Bank of England in 1997 was, in fact, the granting of
operational independence; the inflation target continued to be announced in the
Chancellor's annual budget speech to Parliament.

Management independence

The central bank has the authority to run its own operations (appointing staff,
setting budgets, and so on.) without excessive involvement of the government. The
other forms of independence are not possible unless the central bank has a
significant degree of management independence. One of the most common
statistical indicators used in the literature as a proxy for central bank independence
is the "turn-over-rate" of central bank governors. If a government is in the habit of
appointing and replacing the governor frequently, it clearly has the capacity to
micro-manage the central bank through its choice of governors.

It is argued that an independent central bank can run a more credible monetary
policy, making market expectations more responsive to signals from the central
bank.[by whom?] Both the Bank of England (1997) and the European Central
Bank have been made independent and follow a set of published inflation targets

48
so that markets know what to expect. Even the People's Bank of China has been
accorded great latitude, though in the People's Republic of China the official role
of the bank remains that of a national bank rather than a central bank, underlined
by the official refusal to "unpeg" the yuan or to revalue it "under pressure". The
People's Bank of China's independence can thus be read more as independence
from the USA, which rules the financial markets, rather than from the Communist
Party of China which rules the country. The fact that the Communist Party is not
elected also relieves the pressure to please people, increasing its independence.

The Central Bank (Reserve Bank of India) is the organ of government that
undertakes the major financial operations of the government and by its conduct of
these operations & other means, influences the behavior of financial institutions so
as to support the economic policy of the Government. A central bank is a bank of
bankers. Its duty is to control the monetary base and thorough control of high-
powered money in order to control the communitys supply of money.

The Reserve Bank of India Act of 1934 entrust following important functions of a
central bank i.e. Reserve Bank of India.

Bank of Note 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 currency notes printed and issued by the central bank become unlimited legal tender
throughout the country. However, the monopoly of central bank to issue the currency notes may
be partial in certain countries. For example, in India, one rupee notes are issued by the Ministry
of Finance and all other notes are issued by the Reserve Bank of India.

49
The main advantages of giving the monopoly right of note issue to the central bank are given
below:

(i) It brings uniformity in the monetary system of note issue and note circulation.

(ii) The central bank can exercise better control over the money supply in the country. It
increases public confidence in the monetary system of the country.

(iii) Monetary management of the paper currency becomes easier. Being the supreme bank of
the country, the central bank has full information about the monetary requirements of the
economy and, therefore, can change the quantity of currency accordingly.

(iv) It enables the central bank to exercise control over the creation of credit by the commercial
banks.

(v) The central bank also earns profit from the issue of paper currency.

(vi) Granting of monopoly right of note issue to the central bank avoids the political interference
in the matter of note issue.

50
Banker, Agent and Adviser to the 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.

(a) It maintains the accounts of the central as well as state government; it receives
deposits from government; it makes short-term advances to the government; it
collects cheques and drafts deposited in the government account; it provides
foreign exchange resources to the government for repaying external debt or
purchasing foreign goods or making other payments,

(b) As an Agent to the government, the central bank collects taxes and other
payments on behalf of the government. It raises loans from the public and thus
manages public debt. It also represents the government in the international
financial institutions and conferences,

(c) As a financial adviser to the lent, the central bank gives advice to the
government on economic, monetary, financial and fiscal matters such as deficit
financing, devaluation, trade policy, foreign exchange policy, etc.

51
The central bank acts as the bankers bank in three capacities:

a) Custodian of the cash preserves of the commercial banks;

(b) As the lender of the last resort; and

(c) As clearing agent. In this way, the central bank acts as a friend, philosopher and
guide to the commercial banks

As a Custodian of the cash reserves of the commercial banks the central bank
maintains the cash reserves of the commercial banks. Every commercial bank has
to keep a certain percentage of its cash balances as deposits with the central banks.
These cash reserves can be utilized by the commercial banks in times of
emergency.

The centralization of cash reserves in the central bank has the

following advantages:

(i) Centralized cash reserves inspire confidence of the public in the banking system
of the country.

(ii) Centralized cash reserves provide the basis of a larger and more elastic credit
structure than if these amounts were scattered among the individual banks.

52
(iii) Centralized reserves can be used to the fullest possible extent and in the most
effective manner during the periods of seasonal strains and financial emergencies.

(iv) Centralized reserves enable the central bank to provide financial

accommodation to the commercial banks which are in temporary difficulties. In
fact the central bank functions as the lender of the last resort on the basis of the
centralized cash reserves.

(v) The system of centralized cash reserves enables the central bank to influence
the creation of credit by the commercial banks by increasing or decreasing the cash
reserves through the technique of variable cash-reserve ratio.

Lender of Last Resort

As the supreme bank of the country and the bankers bank, the central bank acts as
the lender of the last resort. In other words, in case the commercial banks are not
able to meet their financial requirements from other sources, they can, as a last
resort, approach the central bank for financial accommodation. The central bank
provides financial accommodation to the commercial banks by re-discounting their
eligible securities and exchange bills.

The main advantages of the central banks functioning as the lender of the last
resort are:

(i) It increases the elasticity and liquidity of the whole credit structure of the
economy.

53
 (ii) It enables the commercial banks to carry on their activities even with their
limited cash reserves.

(iii) It provides financial help to the commercial banks in times of emergency.

(iv) It enables the central bank to exercise its control over banking system of the
country.

Clearing Agent
As the custodian of the cash reserves of the commercial banks, the central bank acts
as the clearing house for these banks. Since all banks have their accounts with the
central bank, the central bank can easily settle the claims of various banks against
each other with least use of cash.

The clearing house function of the central bank has the following advantages:

(i) It makes the use of cash by banks while settling their claims and counter-claims.

(ii) It reduces the withdrawals of cash and these enable the commercial banks to
create credit on a large scale.

(iii) It keeps the central bank fully informed about the liquidity position of the
commercial banks.

54
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.

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.

55
56
Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rate of
exchange. According to the Reserve Bank of India Act of 1934, the Bank was
required to buy and sell at fixed rates any amount of sterling in lots of not less than
Rs. 10,000. After India became a member of the International Monetary Fund in
1946, the Reserve Bank has the responsibility of maintaining fixed exchange rates
with all other member countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as
the custodian of Indias reserve of international currencies. The vast sterling balances
were acquired and managed by the Bank. Further, the RBI has the responsibility of
administering the exchange controls of the country.

Under the RBIs supervision and inspection, the working of banks has greatly
improved. Commercial banks have developed into financially and operationally
sound and viable units. The RBIs powers of supervision have now been extended to
non-banking financial intermediaries. Since independence, particularly after its
nationalization 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.

57
CRR Ratio:
Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of
customers, which commercial banks have to hold as reserves either in cash or as
deposits with the central bank. CRR is set according to the guidelines of the central
bank of a country.

To understand this, we have to understand the concept of Ordinary Money and High
Powered Money.

Ordinary Money (M) is defined as the sum of Currency and Demand Deposits in
banks held by public

So, M = C + DD

High Powered Money (H) is money produced by RBI and Government (coins), held
by public and banks. It is also called Reserve Money. It is the sum of (i) Currency
held by public and (ii) Cash Reserves of Banks.

So, H=C+R

So comparing the two equations, the difference is DD and R, currency being the
common factor. This difference arises from the presence of banks as producers of
demand deposits, to produce which they have to maintain R, which is a part of H,
produced by only RBI and not banks.

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 CRR
4.5

3.5

2.5

2 CRR

1.5

0.5

0
Curency DD

SLR

The chief role of SLR is to govern the allocation of total bank credit between the
government and the commercial sector,. There are two ways in which it plays this
role:

By affecting the borrowings of the government from the RBI

By affecting the freedom of the banks to sell government securities or borrow

against them from the RBI

In both ways the creation of H is affected and thereby variations in the money supply

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Under this statutory liquidity requirement, each bank is required statutorily to
maintain a prescribed minimum proportion of its daily total demand and time
liabilities in the form of designated liquid assets.

The liquid assets consist of

Excess reserves

Unencumbered government and other approved securities

Current account balances with other banks

This SLR is defined as:

SLR = (ER + I + CB)/L

ER = Excess Reserves

I = Investment in unencumbered government and other approved securities

CB = Current account balances with other banks

L = Total demand and time liabilities

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 Series 1
5
4.5
4
3.5
3
2.5
Series 1
2
1.5
1
0.5
0
ER I CB L

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 CHAPTER 5

CONCLUSION, SUGGESTION AND

BIBLIGRAPHY

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5.1 CONCLUSION

Every authority concerned with Co-operative sector will have to play its part in
ensuring that the aspirations of the Urban Co-operative Banking sector are nurtured
in a manner that depositor interest and the public interest at large is protected. The
role of RBI could, thus, be to frame a regulatory and supervisory regime that is multi-
layered to capture the heterogeneity of the sector and implement policies that would
provide adequate elbowroom for the sector to grow in a non-disruptive manner. The
State and Central Governments could recognize that the UCBs are not just co-
operative societies but they are essentially banking entities whose management
structure is that of a co-operative. They should recognize the systemic impact that
inefficient functioning of the entities in the sector could have. Consequently, it would
be in the interest of the sector if they support, facilitate and empower the RBI to put
in place mechanisms and systems that would enable these UCBs to perform their
banking functions in a manner that is in the overall interest of the depositor and the
public at large.

5.2 SUGGESTION
Standalone, shorter monetary policy statement: The current statements are way too
long, possibly because they attempt to cover too many things, from monetary policy
measures to financial development initiatives.

There is a pressing need for a standalone monetary policy statement; non-monetary

policy measures can be issued as a separate statement.

Single policy interest rate: The monetary policy statement should focus on a single
policy interest rate (in India's case, the reverse repo rate). By giving importance of a
potential monetary signal in the repo rate and the bank rate, the RBI only causes
confusion.

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.5.3 BIBLIOGRAPHY

BOOK PREFERRED:

T.Y.B.com (Banking & Insurance)

Study of Central Banking in India
Central Bank journal

RESEARCH ENGINES:

Google
Wikipedia
Scribd

WEBSITES:

http://www.google.co.in
http://www.scribd.com
http://www.centralbank.com
http://www.wikipedia.com

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