Central bank

The essentials

The central bank is the apex institution of the monetary and banking system. In India it is the Reserve Bank of India (RBI), set up in 1935. It does not deal with the general public for profit; it manages currency and credit in the interest of the whole economy.

Functions of the RBI

• Bank of issue: it has the sole right to issue currency notes (one-rupee notes and coins are issued by the Government of India).
• Banker to the government: it manages government accounts, receipts, payments and public debt, and advises on financial matters.
• Banker's bank and supervisor: commercial banks keep reserves with it; it regulates and supervises them.
• Lender of last resort: it lends to banks facing a shortage of funds in an emergency.
• Controller of credit: it regulates the money supply and credit to maintain price stability and support growth.
• Custodian of foreign exchange reserves.

Tools of monetary control

• Quantitative tools: repo rate (rate at which the RBI lends short-term to banks), reverse repo rate (rate at which it borrows from banks), bank rate (long-term lending rate), cash reserve ratio (CRR, share of deposits kept with the RBI), statutory liquidity ratio (SLR, share of deposits kept in liquid assets like government securities), and open market operations (buying and selling government securities).
• Qualitative tools: margin requirements, moral suasion and selective credit controls.

Exam tips

To fight inflation the RBI reduces credit: raise repo rate, CRR or SLR, or sell securities. To fight deflation it does the reverse.

Common mistakes

• Mixing up repo and reverse repo.
• Thinking that buying securities in the open market takes money out; buying puts money into the system.