Indian Economy: Money, Banking, and RBI
The financial system is the backbone of any modern economy. For civil services aspirants, understanding the evolution of money, the banking structure in India, and the pivotal role of the Reserve Bank of India (RBI) is crucial.
1. Evolution and Functions of Money
Money is anything that is generally accepted as a medium of exchange, a measure of value, a store of value, and a standard of deferred payment.
- Barter System: Exchange of goods for goods. Faced issues like double coincidence of wants.
- Fiat Money: Money issued by order (fiat) of the government (e.g., currency notes and coins). It is legal tender.
- Fiduciary Money: Accepted as money based on the trust between the issuer and the payee (e.g., Cheques, Demand Drafts).
- Money Supply (M1, M2, M3, M4): Measures the total volume of money held by the public at a particular point in time. M3 is widely used as a measure of the money supply (Broad Money).
2. The Banking System in India
Banks are financial intermediaries that accept deposits from the public and lend them out.
Classification of Banks:
- Scheduled Banks: Included in the 2nd Schedule of the RBI Act, 1934. They must maintain a certain minimum CRR with RBI.
- Commercial Banks: Operate on a profit basis. Include Public Sector Banks (e.g., SBI), Private Sector Banks (e.g., HDFC), and Foreign Banks.
- Regional Rural Banks (RRBs): Established in 1975 to provide credit to agriculture and rural sectors. Ownership ratio: Central Govt (50%), State Govt (15%), Sponsor Bank (35%).
- Co-operative Banks: Operate on a “no profit, no loss” basis. Regulated by RBI and State Governments.
- Non-Banking Financial Companies (NBFCs): Provide banking services but do not hold a banking license. They cannot accept demand deposits (savings/current accounts).
3. The Reserve Bank of India (RBI)
Established on April 1, 1935, under the RBI Act, 1934, on the recommendation of the Hilton Young Commission. Nationalized in 1949.
Key Functions:
- Issuer of Currency: Sole authority to issue currency notes (except One Rupee note, issued by the Ministry of Finance).
- Banker to the Government: Manages accounts of the Central and State governments.
- Banker’s Bank and Lender of Last Resort: Provides loans to commercial banks in times of need.
- Controller of Credit (Monetary Policy): The most important function. Uses qualitative and quantitative tools to control inflation and stimulate growth.
- Custodian of Foreign Exchange Reserves: Manages the FOREX reserves and exchange rate of the Rupee.
4. Monetary Policy Tools
The Monetary Policy Committee (MPC) determines the policy interest rate required to achieve the inflation target.
Quantitative Tools (Directs the volume of credit):
- Cash Reserve Ratio (CRR): The percentage of net demand and time liabilities (NDTL) that banks must keep as cash with the RBI.
- Statutory Liquidity Ratio (SLR): The percentage of NDTL that banks must maintain in safe, liquid assets (gold, govt securities) with themselves.
- Repo Rate: The rate at which RBI lends short-term money to commercial banks against government securities.
- Reverse Repo Rate: The rate at which RBI borrows money from commercial banks.
- Open Market Operations (OMO): Buying and selling of government securities in the open market by the RBI.
Qualitative Tools (Directs the flow of credit):
- Margin requirements, Moral suasion, Direct action.
Conclusion
The dynamics of money supply and banking operations, guided by the RBI’s Monetary Policy, are central to macroeconomic stability. Familiarity with these concepts helps in analyzing issues like inflation, NPA crisis, and economic slowdowns.