1

UNIT I
Introduction to banking RBI: Evolution of central bank – Banking Regulations Act, 1949 –
Organizational structure of RBI – Functions of RBI and Commercial Banks – Credit Creations of
RBI – Credit Control Measures – Monetary Policy and its objectives - Relationship between RBI
and Commercial Banks.

CENTRAL BANKING

An institution charged with the responsibility of managing the expansion and contraction
of the volume of money in the interest of general public welfare.

- Prof Kent

One which constitute the apex of the monetary and banking structure of its country

- Prof .M.H. De Kock

EVOLUTION OF CENTRAL BANK IN INDIA

Commenced operation on 1st April 1935 as per the Reserve Bank of India Act, 1934 (II of
1934) and Nationalize on 1st January 1949.

 To regulate the issue of banknotes

 To maintain reserves with a view to securing monetary stability and
 To operate the credit and currency system of the country to its advantage.

BANKING REGULATION ACT, 1949

1. Act to have overriding effect (Section 5A)

2. Restriction on use of word „Bank‟,Banker or Banking (Section 7)
3. Not engage in trading activities (Section 8)
4. Holding an immovable Property (Section 9)
5. Payment of Brokerage or commission (Section 13)
6. Charge on Floating Assests (Section 14)
7. Payment of Dividend (Section 15)
8. Appointment & Voting rights of Directors (Section 16)
9. Creation of Reserve (Section 17)
10. Maintenance of Cash Reserve (Section 18)
11. Business activities of Subsidiary (Section 19)
12. Regulation of loans & Advances by RBI (Section 20)
13. Power of RBI to Regulate advances (Section 21)
14. Removal of Managerial Personnel by RBI (Section 36)

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 2

ORGANIZATIONAL STRUCTURE OF RBI

Reserve Bank of India is the Central Bank of India, which was established on the recommendation
of Hilton Young Commission on 1st April, 1935 and was nationalised in 1949. RBI is wholly owned by
government in India. Reserve Bank‟s Head Office is located in Mumbai.

As per the RBI Act, the organizational structure of the bank consists of the Central Board and the
Local Board

1. THE CENTRAL BOARD

The central board comprises 20 members as follows:

a. One governor who is the chairman of the central board appointed by the central governor
for a period of five years.
b. Four Directors nominated by the central government from each of the four local boards,
four deputy governors appointed by the central government.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 3

c. Four Directors nominated by the central government from each of the four local boards.
Ten directors nominated by the central government representing various field from
Industry,finance and co-operations.
d. One government official nominated by the central government usually the secretary,
Ministry of Finance.

2. LOCAL BOARD

The RBI has four local boards in tour regions-the Western, the Eastern the Northern and the
southern parts of India. These local boards are headquartered at Mumbai, Kollkata, New Delhi
and Chennai respectively. The Central government nominates five members on each local board
for tenure of four years. The chairman of each local board is elected from among members.

FUNCTIONS OF RBI

Major functions of the RBI are as follows:

1. Issue of Bank Notes:

The Reserve Bank of India has the sole right to issue currency notes except one rupee notes
which are issued by the Ministry of Finance. Currency notes issued by the Reserve Bank are
declared unlimited legal tender throughout the country.

This concentration of notes issue function with the Reserve Bank has a number of advantages: (i)
it brings uniformity in notes issue; (ii) it makes possible effective state supervision; (iii) it is
easier to control and regulate credit in accordance with the requirements in the economy; and (iv)
it keeps faith of the public in the paper currency.

2. Banker to Government:

As banker to the government the Reserve Bank manages the banking needs of the government. It
has to-maintain and operate the government‟s deposit accounts. It collects receipts of funds and
makes payments on behalf of the government. It represents the Government of India as the
member of the IMF and the World Bank.

3. Custodian of Cash Reserves of Commercial Banks:

The commercial banks hold deposits in the Reserve Bank and the latter has the custody of the
cash reserves of the commercial banks.

4. Custodian of Country’s Foreign Currency Reserves:

The Reserve Bank has the custody of the country‟s reserves of international currency, and this
enables the Reserve Bank to deal with crisis connected with adverse balance of payments
position.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 4

5. Lender of Last Resort:

The commercial banks approach the Reserve Bank in times of emergency to tide over financial
difficulties, and the Reserve bank comes to their rescue though it might charge a higher rate of
interest.

6. Central Clearance and Accounts Settlement:

Since commercial banks have their surplus cash reserves deposited in the Reserve Bank, it is
easier to deal with each other and settle the claim of each on the other through book keeping
entries in the books of the Reserve Bank. The clearing of accounts has now become an essential
function of the Reserve Bank.

7. Controller of Credit:

Since credit money forms the most important part of supply of money, and since the supply of
money has important implications for economic stability, the importance of control of credit
becomes obvious. Credit is controlled by the Reserve Bank in accordance with the economic
priorities of the government.

FUNCTIONS OF COMMERCIAL BANK

According to Culbertson,“Commercial Banks are the institutions that make short make short
term bans to business and in the process create money.”

(A) PRIMARY FUNCTIONS:

Refer to the basic functions of commercial banks that include the following:

1. Accepting Deposits:

Commercial banks are mainly dependent on public deposits. There are two types of deposits,
which are discussed as follows:

(i) Demand Deposits:

Refer to kind of deposits that can be easily withdrawn by individuals without any prior notice to
the bank. In other words, the owners of these deposits are allowed to withdraw money anytime
by simply writing a check. These deposits are the part of money supply as they are used as a
means for the payment of goods and services as well as debts. Receiving these deposits is the
main function of commercial banks.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 5

(ii) Time Deposits:

Refer to deposits that are for certain period of time. Banks pay higher interest on rime deposits.
These deposits can be withdrawn only after a specific time period is completed by providing a
written notice to the bank.

2. Advancing Loans:

It refers to one of the important functions of commercial banks. The public deposits are used by
commercial banks for the purpose of granting loans to individuals and businesses. Commercial
banks grant loans in the form of overdraft, cash credit, and discounting bills of exchange.

(B) SECONDARY FUNCTIONS:

Refer to crucial functions of commercial banks. The secondary functions can be classified under
three heads, namely, agency functions, general utility functions, and other functions.

These functions are explained as follows:

1. Agency Functions:

Implies that commercial banks act as agents of customers by performing various functions,
which are as follows:

(i) Collecting Checks:

Refer to one of the important functions of commercial banks. The banks collect checks and bills
of exchange on the behalf of their customers through clearing house facilities provided by the
central bank.

(ii) Collecting Income:

Constitute another major function of commercial banks. Commercial banks collect dividends,
pension, salaries, rents, and interests on investments on behalf of their customers. A credit
voucher is sent to customers for information when any income is collected by the bank.

(iii) Paying Expenses:

Implies that commercial banks make the payments of various obligations of customers, such as
telephone bills, insurance premium, school fees, and rents. Similar to credit voucher, a debit
voucher is sent to customers for information when expenses are paid by the bank.

2. General Utility Functions:

Include the following functions:

(i) Providing Locker Facilities:

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 6

Implies that commercial banks provide locker facilities to its customers for safe keeping of
jewellery, shares, debentures, and other valuable items. This minimizes the risk of loss due to
theft at homes.

(ii) Issuing Traveler’s Checks:

Implies that banks issue traveler‟s checks to individuals for traveling outside the country.
Traveler‟s checks are the safe and easy way to protect money while traveling.

(iii) Dealing in Foreign Exchange:

Implies that commercial banks help in providing foreign exchange to businessmen dealing in
exports and imports. However, commercial banks need to take the permission of the central bank
for dealing in foreign exchange.

(iv) Transferring Funds:

Refers to transferring of funds from one bank to another. Funds are transferred by means of draft,
telephonic transfer, and electronic transfer.

(C) OTHER FUNCTIONS:

Include the following:

1. Creating Money:

It refers to one of the important functions of commercial banks that help in increasing money
supply. For instance, a bank lends Rs. 5 lakh to an individual and opens a demand deposit in the
name of that individual.

Bank makes a credit entry of Rs. 5 lakh in that account. This leads to creation of demand
deposits in that account. The point to be noted here is that there is no payment in cash. Thus,
without printing additional money, the supply of money is increased.

2. Electronic Banking:

Include services, such as debit cards, credit cards, and Internet banking.

CREDIT CREATION OF RBI

Credit control is an important tool used by Reserve Bank of India, a major weapon of the
monetary policy used to control the demand and supply of money (liquidity) in the economy.
Central Bank administers control over the credit that the commercial banks grant. Such a method
is used by RBI to bring "Economic Development with Stability". It means that banks will not
only control inflationary trends in the economy but also boost economic growth which would

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 7

ultimately lead to increase in real national income stability. In view of its functions such as
issuing notes and custodian of cash reserves, credit not bNeed for credit control.

Controlling credit in the economy is amongst the most important functions of the Reserve Bank
of India. The basic and important needs of credit control in the economy are-

 To encourage the overall growth of the "priority sector" i.e. those sectors of the economy
which is recognized by the government as "prioritized" depending upon their economic
condition or government interest. These sectors broadly totals to around 15 in number.[1]

 To keep a check over the channelization of credit so that credit is not delivered for
undesirable purposes.

 To achieve the objective of controlling inflation as well as deflation.

 To boost the economy by facilitating the flow of adequate volume of bank credit to
different sectors.

 To develop the economy.

Objectives of credit control

Credit control policy is just an arm of economic policy which comes under the purview
of Reserve Bank of India, hence, its main objective being the attainment of high growth rate
while maintaining the reasonable stability of the internal purchasing power of money. The broad
objectives of credit control policy in India have been-

 Ensure an adequate level of liquidity enough to attain high economic growth rate along
with maximum utilization of resource but without generating high inflationary pressure.

 Attain stability in the exchange rate and money market of the country.

 Meeting the financial requirement during a slump in the economy and in the normal times
as well.

 Control business cycle and meet business needs.

CREDIT CONTROL MEASURES

CREDIT CREATION OF RBI

Some of the methods employed by the RBI to control credit creation are:

I. QUANTITATIVE METHOD
II. QUALITATIVE METHOD.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 8

The various methods employed by the RBI to control credit creation power of the commercial
banks can be classified in two groups, viz., quantitative controls and qualitative controls.
Quantitative controls are designed to regulate the volume of credit created by the banking system
qualitative measures or selective methods are designed to regulate the flow of credit in specific
uses.

Quantitative or traditional methods of credit control include banks rate policy, open market
operations and variable reserve ratio. Qualitative or selective methods of credit control include
regulation of margin requirement, credit rationing, regulation of consumer credit and direct
action.

I. QUANTITATIVE METHOD:

(i) Bank Rate:

The bank rate, also known as the discount rate, is the rate payable by commercial banks on the
loans from or rediscounts of the Central Bank. A change in bank rate affects other market rates
of interest. An increase in bank rate leads to an increase in other rates of interest and conversely,
a decrease in bank rate results in a fall in other rates of interest.

A deliberate manipulation of the bank rate by the Central Bank to influence the flow of credit
created by the commercial banks is known as bank rate policy. It does so by affecting the
demand for credit the cost of the credit and the availability of the credit.

An increase in bank rate results in an increase in the cost of credit; this is expected to lead to a
contraction in demand for credit. In as much as bank credit is an important component of
aggregate money supply in the economy, a contraction in demand for credit consequent on an
increase in the cost of credit restricts the total availability of money in the economy, and hence
may prove an anti-inflationary measure of control.

Likewise, a fall in the bank rate causes other rates of interest to come down. The cost of credit
falls, i. e., and credit becomes cheaper. Cheap credit may induce a higher demand both for
investment and consumption purposes. More money, through increased flow of credit, comes
into circulation.

A fall in bank rate may, thus, prove an anti-deflationary instrument of control. The effectiveness
of bank rate as an instrument of control is, however, restricted primarily by the fact that both in
inflationary and recessionary conditions, the cost of credit may not be a very significant factor
influencing the investment decisions of the firms.

(ii) Open Market Operations:

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 9

Open market operations refer to the sale and purchase of securities by the Central bank to the
commercial banks. A sale of securities by the Central Bank, i.e., the purchase of securities by the
commercial banks, results in a fall in the total cash reserves of the latter.

A fall in the total cash reserves is leads to a cut in the credit creation power of the commercial
banks. With reduced cash reserves at their command the commercial banks can only create lower
volume of credit. Thus, a sale of securities by the Central Bank serves as an anti-inflationary
measure of control.

Likewise, a purchase of securities by the Central Bank results in more cash flowing to the
commercials banks. With increased cash in their hands, the commercial banks can create more
credit, and make more finance available. Thus, purchase of securities may work as an anti-
deflationary measure of control.

The Reserve Bank of India has frequently resorted to the sale of government securities to which
the commercial banks have been generously contributing. Thus, open market operations in India
have served, on the one hand as an instrument to make available more budgetary resources and
on the other as an instrument to siphon off the excess liquidity in the system.

(iii) Variable Reserve Ratios:

Variable reserve ratios refer to that proportion of bank deposits that the commercial banks are
required to keep in the form of cash to ensure liquidity for the credit created by them.

A rise in the cash reserve ratio results in a fall in the value of the deposit multiplier. Conversely,
a fall in the cash reserve ratio leads to a rise in the value of the deposit multiplier.

A fall in the value of deposit multiplier amounts to a contraction in the availability of credit, and,
thus, it may serve as an anti-inflationary measure.

A rise in the value of deposit multiplier, on the other hand, amounts to the fact that the
commercial banks can create more credit, and make available more finance for consumption and
investment expenditure. A fall in the reserve ratios may, thus, work as anti-deflationary method
of monetary control.

The Reserve Bank of India is empowered to change the reserve requirements of the commercial
banks.

The Reserve Bank employs two types of reserve ratio for this purpose, viz. the Statutory
Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR).

The statutory liquidity ratio refers to that proportion of aggregate deposits which the commercial
banks are required to keep with themselves in a liquid form. The commercial banks generally
make use of this money to purchase the government securities. Thus, the statutory liquidity ratio,

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 10

on the one hand is used to siphon off the excess liquidity of the banking system, and on the other
it is used to mobilise revenue for the government.

The Reserve Bank of India is empowered to raise this ratio up to 40 per cent of aggregate
deposits of commercial banks. Presently, this ratio stands at 25 per cent.

The cash reserve ratio refers to that proportion of the aggregate deposits which the commercial
banks are required to keep with the Reserve Bank of India. Presently, this ratio stands at 9
percent.

II. QUALITATIVE METHOD:

The qualitative or selective methods of credit control are adopted by the Central Bank in its
pursuit of economic stabilisation and as part of credit management.

(i) Margin Requirements:

Changes in margin requirements are designed to influence the flow of credit against specific
commodities. The commercial banks generally advance loans to their customers against some
security or securities offered by the borrower and acceptable to banks.

More generally, the commercial banks do not lend up to the full amount of the security but lend
an amount less than its value. The margin requirements against specific securities are determined
by the Central Bank. A change in margin requirements will influence the flow of credit.

A rise in the margin requirement results in a contraction in the borrowing value of the security
and similarly, a fall in the margin requirement results in expansion in the borrowing value of the
security.

(ii) Credit Rationing:

Rationing of credit is a method by which the Central Bank seeks to limit the maximum amount
of loans and advances and, also in certain cases, fix ceiling for specific categories of loans and
advances.

(iii) Regulation of Consumer Credit:

Regulation of consumer credit is designed to check the flow of credit for consumer durable
goods. This can be done by regulating the total volume of credit that may be extended for
purchasing specific durable goods and regulating the number of installments through which such
loan can be spread. Central Bank uses this method to restrict or liberalise loan conditions
accordingly to stabilise the economy.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 11

(iv) Moral Suasion:

Moral suasion and credit monitoring arrangement are other methods of credit control. The policy
of moral suasion will succeed only if the Central Bank is strong enough to influence the
commercial banks.

In India, from 1949 onwards, the Reserve Bank has been successful in using the method of moral
suasion to bring the commercial banks to fall in line with its policies regarding credit. Publicity
is another method, whereby the Reserve Bank marks direct appeal to the public and publishes
data which will have sobering effect on other banks and the commercial circles.

EFFECTIVENESS OF CREDIT CONTROL MEASURES:

The effectiveness of credit control measures in an economy depends upon a number of factors.
First, there should exist a well-organised money market. Second, a large proportion of money in
circulation should form part of the organised money market. Finally, the money and capital
markets should be extensive in coverage and elastic in nature.

Extensiveness enlarges the scope of credit control measures and elasticity lends it adjustability to
the changed conditions. In most of the developed economies a favourable environment in terms
of the factors discussed before exists, in the developing economies, on the contrary, economic
conditions are such as to limit the effectiveness of the credit control measures.

MONETARY POLICY AND ITS OBJECTIVES

Monetary policy is how central banks manage liquidity to create economic growth. Liquidity is
how much there is in the money supply. That includes credit, cash, checks and money
market mutual funds. The most important of these is credit. It includes loans, bonds and
mortgages.

OBJECTIVES OF MONETARY POLICY:

The monetary policy in developed economies has to serve the function of stabilization and
maintaining proper equilibrium in the economic system. But in case of underdeveloped
countries, the monetary policy has to be more dynamic so as to meet the requirements of an
expanding economy by creating suitable conditions for economic progress. It is now widely
recognized that monetary policy can be a powerful tool of economic transformation.

As the objective of monetary policy varies from country to country and from time to time, a brief
description of the same has been as following:

(i) Neutrality of money

(ii) Stability of exchange rates

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 12

(iii) Price stability

(iv) Full Employment

(v) Economic Growth

(vi) Equilibrium in the Balance of Payments.

1. Neutrality of Money:

Economists like Wicksteed, Hayek and Robertson are the chief exponents of neutral money.
They hold the view that monetary authority should aim at neutrality of money in the economy.
Any monetary change is the root cause of all economic fluctuations. According to neutralists, the
monetary change causes distortion and disturbances in the proper operation of the economic
system of the country.

They are of the confirmed view that if somehow neutral monetary policy is followed, there will
be no cyclical fluctuations, no trade cycle, no inflation and no deflation in the economy. Under
this system, money is kept stable by the monetary authority. Thus the main aim of the monetary
authority is not to deviate from the neutrality of money. It means that quantity of money should
be perfectly stable. It is not expected to influence or discourage consumption and production in
the economy.

2. Exchange Stability:

Exchange stability was the traditional objective of monetary authority. This was the main
objective under Gold Standard among different countries. When there was disequilibrium in the
balance of payments of the country, it was automatically corrected by movements. It was
popularly known, “Expand Currency and Credit when gold is coming in; contract currency and
credit when gold is going out.” This system will correct the disequilibrium in the balance of
payments and exchange stability will be maintained.

It must be noted that if there is instability in the exchange rates, it would result in outflow or
inflow of gold resulting in unfavorable balance of payments. Therefore, stable exchange rates
play a key role in international trade. Thus, it is clear from this fact that: the main objective of
monetary policy is to maintain stability in the external equilibrium of the country. In other
words, they should try to eliminate those adverse forces which tend to bring instability in
exchange rates.

(i) It leads to violent fluctuations resulting in encouragement to speculative activities in the

market.

(ii) Heavy fluctuations lead to loss of confidence on the part of domestic and foreign capitalists
resulting in adverse impact in capital outflow which may also result in capital formation and
growth.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 13

(iii) Fluctuations in exchange rates bring repercussions in the internal price level.

3. Price Stability:

The objective of price stability has been highlighted during the twenties and thirties of the
present century. In fact, economists like CrustarCassels and Keynes suggested price stabilization
as a main objective of monetary policy. Price stability is considered the most genuine objective
of monetary policy. Stable prices repose public confidence because cyclical fluctuations are
totally eliminated.

It promotes business activity and ensures equitable distribution of income and wealth. As a
consequence, there is general wave of prosperity and welfare in the community. Price stability
also impedes economic progress as there is no incentive left with the business community to
increase production of qualitative goods.

It discourages exports and encourages imports. But it is admitted that price stability does not
mean „price rigidity‟ or price stagnation‟. A mild increase in the price level provides a tonic for
economic growth. It keeps all virtues of a stable price.

4. Full Employment:

During world depression, the problem of unemployment had increased rapidly. It was regarded
as socially dangerous, economically wasteful and morally deplorable. Thus, full employment
assumed as the main goal of monetary policy. In recent times, it is argued that the achievement
of full employment automatically includes prices and exchange stability.

However, with the publication of Keynes‟ General Theory of Employment, Interest and Money
in 1936, the objective of full employment gained full support as the chief objective of monetary
policy. Prof. Crowther is of the view that the main objective of monetary policy of a country is to
bring about equilibrium between saving and investment at full employment level.

Similarly, Prof. Halm has also favoured Keynes‟ view. Prof. Gardner Ackley regards that the
concept of full employment is „slippery‟. Classical economists believed in the existence of full
employment which is the normal feature of an economy. Full employment, thus, exists when all
those who are ready to work at the existing wage rate get work. Voluntary, frictional and
seasonal unemployed are also called employed.

According to their version, full employment means absence of involuntary unemployment.

Therefore, it implies not only employment of all types of labourers but also includes the
employment of all economic resources. It is not an end in itself rather a pre-condition for
maximum social and economic welfare.

Keynes equation of income, Y = C + I throws light as to how full employment can be secured
with monetary policy. He argues that to increase income, output and employment, it is necessary

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 14

to increase consumption expenditure and investment expenditure simultaneously. This indirectly

solves the problem of unemployment in the economy. Since the consumption function is more or
less stable in the short period, the monetary policy should aim at raising investment expenditure.

As monetary policy is the government policy regarding currency and credit, in this way,
government measures of currency and credit can easily overcome the problem of trade
fluctuations in the economy. On the other side, when the economy is facing the problem of
depression and unemployment, private investment can be stimulated by adopting „cheap money
policy‟ by the monetary authority.

Therefore, this policy will serve as an effective and ideal stimulant to private investment as there
is pessimism all round in the economy. Further, the objective of full-employment must be
integrated with other objectives, like price and exchange stabilization.

The advanced countries like U.S.A. and U.K. are normally working at full employment level as
their main concern is how to maintain full employment and avoid fluctuations in the level of
employment and production. While, on the contrary, the main problem in underdeveloped
country is as to how to achieve full employment.

Therefore, in such economies, monetary policy can be designed to meet with the problem of
under employment and disguised unemployment and by further creating new opportunities for
employment. The most suitable and favourable monetary policy should be followed to promote
full-employment through increased investment, which in turn having multiplier and acceleration
effects.

After achieving the objective of full-employment, monetary policy should aim at exchange and
price stability. In short, the policy of full employment has the far-reaching beneficial effects.

(a) Keeping in view the present situation of unemployment and disguised unemployment
particularly in more growing populated countries, the said objective of monetary policy is most
suitable.

(b) On humanitarian grounds, the policy can go a long way to solve the acute problem of
unemployment.

(c) It is useful tool to provide economic and social welfare of the community.

(d) To a greater extent, this policy solves the problem of business fluctuations.

5. Economic Growth:

In recent years, economic growth is the basic issue to be discussed among economists and
statesmen throughout the world. Prof. Meier defined “Economic growth as the process whereby
the real per capita income of a country increases over a long period of time.” It implies an

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 15

increase in the total physical or real output, production of goods for the satisfaction of human
wants.

In other words, it means utilization of all the productive natural, human and capital resources in
such a manner as to ensure a sustained increase in national and per capita income over time.

Therefore, monetary policy promotes sustained and continuous economic growth by maintaining
equilibrium between the total demand for money and total production capacity and further
creating favourable conditions for saving and investment. For bringing equality between demand
and supply, flexible monetary policy is the best course.

In other words, monetary authority should follow an easy or tight monetary policy to suit the
requirements of growth. Again, monetary policy in a growing economy, has to satisfy the
growing demand for money. Thus, it is the responsibility of the monetary authority to circulate
the proper quantity and quality of money.

6. Equilibrium in the Balance of Payments:

Equilibrium in the balance of payments is another objective of monetary policy which emerged
significant in the post war years. This is simply due to the problem of international liquidity on
account of the growth of world trade at a more faster speed than the world liquidity.

It was felt that increasing of deficit in the balance of payments reduces, the ability of an economy
to achieve other objectives. As a result, many less developed countries have to curtail their
imports which adversely effects development activities. Therefore, monetary authority makes
efforts that equilibrium should be maintained in the balance of payments.

RELATIONSHIP BETWEEN RBI AND COMMERCIAL BANKS.

BASIS FOR CENTRAL BANK COMMERCIAL BANK

COMPARISON

Meaning The bank which looks after the The establishment, which provides
monetary system of the country banking services to the public is
is known as Central Bank. known as Commercial Bank.

What is it? It is a banker to the banks and It is the banker to the citizens of the
the government of the country. nation.

Governing Statute Reserve Bank of India Act, Banking Regulation Act, 1949.
1934.

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE

 16

Ownership Public Public or Private

Profit motive It does not exist for making It exist for making profit for its
profit for its owners owners.

Monetary Authority It is the supreme monetary No such authority.

authority with wide powers.

Objective Public welfare and economic Earning Profits

development.

Money supply Ultimate source of money No such function is performed by it.

supply in the economy.

Right to print and Yes No

issue currency notes

Deals with General Public Banks and Governments

How many banks are Only one Many

there?

PROF. R.VENKATESH, SREE SARASWATHI THYAGARAJA COLLEGE