RBI FUNCTIONS

 

 

The Reserve Bank of India (RBI) is the central banking institution of India, responsible for regulating the country's monetary and financial system. Its history dates back to the early 20th century:

1. **Establishment:** The Reserve Bank of India was established on April 1, 1935, in accordance with the provisions of the Reserve Bank of India Act, 1934. It was conceptualized and established to serve as the central bank of India, with the primary objective of ensuring monetary stability and financial soundness.
2. **Role in Colonial India:** Prior to the establishment of the RBI, the financial system in India was primarily managed by the Imperial Bank of India, which acted as a quasi-central bank under British colonial rule. However, the need for a formal central banking institution became apparent as India's economy grew and diversified.
3. **Hilton Young Commission:** The idea of establishing a central bank in India gained momentum in the early 20th century. In 1926, the British government appointed the Royal Commission on Indian Currency and Finance, commonly known as the Hilton Young Commission, to study and recommend reforms for India's monetary and financial system.
4. **Recommendations and Legislation:** Based on the recommendations of the Hilton Young Commission, the Reserve Bank of India Act, 1934 was enacted by the British Parliament, paving the way for the establishment of the RBI. The Act conferred statutory powers and responsibilities upon the RBI to regulate currency issuance, manage reserves, and oversee the banking system.
5. **Inauguration:** The Reserve Bank of India officially commenced operations on April 1, 1935, with Sir Osborne Smith serving as its first Governor. The central office of the RBI was initially established in Kolkata (then Calcutta), but it was later moved to Mumbai (then Bombay), which remains its headquarters to this day.
6. **Evolution and Expansion:** Over the decades, the RBI has evolved and expanded its functions to meet the changing needs of India's economy. It has played a pivotal role in promoting monetary stability, fostering financial inclusion, and supporting economic development. The RBI Act has been amended several times to empower the central bank with additional responsibilities and regulatory authority.
7. **Modernization and Reforms:** In recent years, the RBI has undertaken various initiatives to modernize and strengthen India's financial infrastructure. It has implemented reforms to enhance banking supervision, promote digital payments, and improve monetary policy transmission. The RBI's role in managing the impact of global economic challenges and domestic policy objectives remains paramount.
Today, the Reserve Bank of India stands as a key institution in India's financial landscape, overseeing monetary policy, regulating the banking sector, and maintaining financial stability to support sustainable economic growth. Its rich history reflects the evolution of India's economy and its journey towards becoming a dynamic and resilient financial powerhouse.

Here's a more detailed explanation of the Reserve Bank of India's (RBI) initial capital and other related aspects:

1. **Initial Capital and Ownership Structure:**

   - When the RBI was established in 1935, its initial capital was set at ₹5 crores, divided into 5 lakhs shares of ₹100 each. This capital was subscribed by private shareholders, including individuals and institutions, both Indian and foreign.

   - The ownership structure of the RBI at its inception was predominantly private, with private shareholders holding the majority of its shares. The government held a minority stake in the central bank.

2. **Nationalization and Paid-Up Capital:**

   - In 1949, the RBI was nationalized by the Government of India through the Reserve Bank (Transfer to Public Ownership) Act, 1948. This legislation mandated the acquisition of the private shareholders' holdings by the government.

   - Following nationalization, the RBI became fully owned by the Government of India, and the private shareholders were compensated for their holdings. The paid-up capital of the RBI was then consolidated, reflecting the entire authorized capital of ₹5 crores.

3. **Reserve Fund and Financial Stability:**

   - In addition to its capital, the RBI maintains a reserve fund to ensure financial stability and absorb potential losses. The reserve fund consists of retained earnings, surplus profits, and provisions made over the years.

   - The reserve fund serves as a financial cushion, providing the RBI with the flexibility to address contingencies, stabilize financial markets, and fulfill its responsibilities as the central bank.

4. **Dividend Distribution and Government Revenue:**

   - As a central bank, the RBI earns income from various sources, including interest on government securities, foreign exchange operations, and banking services. After meeting operational expenses and maintaining adequate reserves, the RBI distributes surplus profits to the government as dividends.

   - Dividend payments from the RBI contribute to the government's revenue, supporting fiscal policy objectives and public expenditures.

The initial capital, reserve fund, and financial resources of the RBI have played a vital role in facilitating its operations and fulfilling its mandate to regulate the country's monetary and financial system. These resources have enabled the RBI to maintain stability, foster economic growth, and support the government's policy objectives over the years.

ORGANISATION AND MANAGEMENT

The management of the Reserve Bank of India (RBI) is structured to ensure effective governance, operational efficiency, and fulfillment of its statutory responsibilities. Here's an overview of the management structure of the RBI:

1. **Governance Structure:**

   - Central Board of Directors: The Central Board of Directors is the highest governing body of the RBI, responsible for overseeing the affairs and functions of the central bank. It comprises members appointed by the government, including a Governor, Deputy Governors, and non-official directors representing various fields such as economics, finance, and banking.

   - Local Boards: The RBI has four Local Boards located in Mumbai, Kolkata, Chennai, and New Delhi. These boards represent different regions of India and provide regional perspectives and insights to the central bank's operations.

2. **Key Management Positions:**

   - Governor: The Governor is the chief executive officer of the RBI and is responsible for the overall management and administration of the central bank. The Governor chairs the Central Board meetings, represents the RBI in national and international forums, and plays a key role in formulating monetary policy.

   - Deputy Governors: The RBI typically has four Deputy Governors who assist the Governor in managing various functions of the central bank. Each Deputy Governor is assigned specific portfolios such as monetary policy, banking supervision, currency management, and financial markets.

3. **Committees and Departments:**

   - Monetary Policy Committee (MPC): The MPC is responsible for formulating monetary policy decisions, including setting the benchmark interest rates. It consists of six members, including three members from the RBI (Governor and Deputy Governors) and three external members appointed by the government.

   - Various Departments: The RBI has several departments and divisions responsible for different functions such as monetary policy, banking regulation and supervision, currency management, foreign exchange operations, economic research, financial stability, and development initiatives.

4. **Operational Units and Regional Offices:**

   - Operational Units: The RBI's operational units include currency chests, printing presses, and payment and settlement systems such as Real-Time Gross Settlement (RTGS) and National Electronic Funds Transfer (NEFT).

   - Regional Offices: In addition to its central office in Mumbai, the RBI has regional offices located in major cities across India. These regional offices facilitate the implementation of RBI policies and regulations, monitor banking operations, and address regional issues.

5. **Consultative Forums and Stakeholder Engagement:**

   - Advisory Committees: The RBI convenes various advisory committees and forums to seek input and advice from stakeholders, including banks, financial institutions, government agencies, and industry experts. These committees provide valuable insights and recommendations on policy matters and regulatory initiatives.

   - Public Engagement: The RBI engages with the public through outreach programs, public consultations, seminars, and publications to enhance transparency, communication, and public awareness about its functions, policies, and initiatives.

Overall, the management structure of the RBI is designed to ensure effective governance, accountability, and responsiveness to the evolving needs of the Indian economy and financial system. It emphasizes collaboration, expertise, and stakeholder engagement to fulfill the central bank's mandate of maintaining monetary stability, fostering financial inclusion, and promoting sustainable economic growth.

FUNCTIONS:-

The principal function of Reserve Bank India is to regulate the monetary system of country (in accordance with the overall economic policy of the government) in such a way the balanced economic growth of the country is achieved alongwith economic stability. ording to the Preamble of Reserve Bank of India Act, 1934, "The main functions of the bank are gulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India generally to operate the currency and credit system of the country to its advantage."

Functions of the Bank may be classified into three parts:

(A) Traditional Functions

(B) Developmental Functions

(C) Regulatory Functions

A) Traditional Functions of the Reserve Bank

Traditional functions of Reserve Bank may be classified as under:

(1) Central Banking Functions: Reserve Bank is the Central Bank of India. Its central banking functions are as under:

(a) Issue of Paper Currency: Reserve Bank of India has the monopoly right of Note- Issue. Earlier it issued notes of the denomination of ₹ 1,₹2. ₹5. ₹10, ₹20, ₹50. 100,₹ 500 and 1,000. Now it issues notes of the denomination of ₹10, 20, ₹50, ₹100,₹500 and 2,000. The bank has its separate department for note issuing. This is known as Issue Department. In accordance with the Reserve Bank of India Act, this bank is required to maintain 'Reserve Fund' for note-issuing. This is to maintain confidence of the people in the country's currency. Since 1956, note-issuing is based on Minimum Reserve System. Presently, a minimum reserve of 200 crore is to be maintained for issuing-notes upto any limit. This comprises of Gold worth 115 crore and foreign securities worth 85 crore.

(b) Regulation of Credit: Regulation of credit implies control over the credit policy of the commercial banks. Being the central bank, the Reserve Bank controls the creation of credit by the commercial banks According to the Reserve Bank of Indu Act. this bank can adopt several measures to control credit creation, viz., chatsying the bank rate, open market operations, change in the reserve requirement of the commercial banks, etc. Reserve Bank also controls the loan policy, interest policy and investment policy of the commercial banks.

(c) Banker of Banks: Being the central bank, Reserve Bank of India is the bank of all the banks in the country. In this the Reserve Bank acts as a guide all the commercial banks, besides controlling and regulating their affairs. During times of emergency, it is lender of the last resort for the commercial banks. The is, it gives loans to the commercial banks during times of emergency. Banking Companies Act, (1949), has conferred various rights on the Reserve Bank, such as to issue licenses to the banks, regulate the number and branches of commerce banks, examine the plans and accord sanctions for the merger of banks, obtain reports from the banks, examine the credit policy of the banks and give advice and suggestions. With the nationalisation of 14 banks in 1969 and 6 banks in 1980, control over the banking system of the country has further tightened.

(d) Banker of the Government: Reserve Bank is the banker of the Central and State governments. All banking functions of the government are handled by the Reserve Bank of India. Thus: (i) The Reserve Bank keeps cash balances of the Central and State Governments and makes payment out of these balances on the advice of the government. No interest is paid to the government on these balances. The bank arranges public loans for the governments. (iii) It sells and purchases government securities. (iv)It also sells Treasury Bills on behalf of the government by issuing Tenders. (v) The bank also gives loans to the government. It is called Ways and Means Advances. These loans are returned within 90 days. (vi) On the basis of experience of the monetary system, the bank advises the government on the monetary and economic policies. (vii) Reserve Bank also has the right to function on behalf of foreign governments. (viii) The Bank functions for the success of monetary and economic policies of the government.

(e) Regulation of Foreign Exchange: Being the Central Bank of the Country, Reserve Bank of India also regulates exchange rate of rupee in terms of foreign currencies It tries to maintain stability of exchange rate. For this, the Reserve Bank deals foreign exchange only at fixed rates right from the beginning. Earlier, entire business of foreign exchange was done through the medium of sterling. But after India became member of the International Monetary Fund in 1947, Sterling System was given up in favour of the IMF system of exchange. Reserve Bank deals in the currencies of those countries only which are members of IMF. 

(f) Other Functions: Besides the above stated specific functions, the Reserve Bank of India performs the following other functions: 

(i) Export Assistance: Reserve Bank gives loans to the export industries. These loans are given indirectly by refinancing the loans given by Export Import Bank and other banks.

(ii) Clearing House Functions: Being central bank of country, the Reserve Bank also functions as Clearing House. Inter-banking obligations are conveniently settled through this house.

(iii) Change of Currency: The bank changes big notes into small ones and small notes into coins.

(iv) Transfer of Currency: The bank also facilitates the transfer of currency. It also issues Demand Hundies on its branches.

(v) Publication of Statistics and Other Information: Reserve Bank publishes data on various parameters, such as money, credit, finance, agricultural and industrial output. Reports on these data are also periodically published.

(vi) Training in Banking: The Reserve Bank has opened various Training Centres to produce talented bankers: (i) Bankers' Training College, (ii) College of Agricultural Banking. Pune (iii) Reserve Bank Staff College, Chennai, (iv) Institute of Bank Management, (v) Zonal Training Centres.

(2) General Banking Functions: Reserve Bank is not a commercial bank. Yet, being the Central Bank, it performs certain general banking functions as well. These functions. are as follows:

(a) To Accept Deposits: The bank accepts deposits of the Central Government, State Governments, Port-Trust and private individuals. But no interest is paid on these deposits.

(b) To Deal in Bills: Reserve Bank buys, sells and re-discounts the Bills, Promissory Notes and Hundies. However, these bills should not be of the duration exceeding 90-days and should be payable within the country.

(c) Lending of Money: As a central bank, the Reserve Bank of India gives loans to the central and state governments. These loans are of the duration of not more than 90-days. The loans are given against securities, credit notes of the banks and gold or silver.

(d) To Deal in Agricultural Bills: Reserve Bank also buys, sells and discounts agricultural bills. These bills should be payable in India and should not be of the duration exceeding 15-months.

(e) To Deal in Foreign securities The bank deals in all such foreign securities which are encashable within '10' years from the date of purchase.

(f) Taking of Loans: Reserve Bank can borrow loan on the security of assets from scheduled banks. Duration of such loan should not exceed 30 days, nor should it exceed the total capital of the bank.

(g) To Deal in Costly Metals: Reserve Bank deals in the sale and purchase of gold, silver as well as the coins of these metals.

(h) To Deal with the Banks of Others Countries: Being a member of IMF, Reserve Bank establishes business relations with the central banks of other member countries. It can open accounts with those banks, act as their agent or handle I.M.F. dealings.

(3) Prohibitory Functions of the Reserve Bank: Reserve Bank of India Act prohibits this bank from performing certain activities. This is with a view to avoid competition of this bank with its member banks and to keep its assets fully secure. The prohibitory functions of the bank are under:

(a) The bank cannot participate in trade, commerce or industrial activity of the country. It can only control a particular business for some time with a view to realise the loans.

(b) The bank cannot buy its own shares or that of any other bank or a company. Also it cannot give loan on the basis of such shares,

(C) It cannot give loan against the security of any immovable property. Also it cannot buy immovable property beyond its needs.

(d) The bank can neither stop nor accept such bills which are payable on demand.

(e) It cannot pay interest on its deposits.

(1) The bank cannot give loans without securities.

(B) Developmental Functions of the Reserve Bank

Or

Contribution of Reserve Bank in Economic Development

India adopted the strategy of planned development programme with a view to accelerating the rate of growth. In these programmes the contribution of Reserve Bank of India cannot be over-emphasized. Economic progress of a country depends upon the growth and development of its industry, agriculture, trade and commerce, as well as the stability of domestic price level and foreign exchange rate. The Reserve Bank of India has very actively catered to the financial needs of industries over the last 70 years. It has been encouraging exports, also In the field of agriculture, the Reserve Bank of India has been actively engaged in the provision of agricultural credit fertilizers and machinery. Research, Statistics and Publication Division of the Reserve Bank of India has been providing useful information to the planners. It has appreciably contributed to the growth process of the economy. It has indeed succeeded as a central bank of the country. Following points should bring out the contribution of the Reserve Bank of India to the process of economic growth:

(1) Development of Agricultural Finance: Right from the beginning. Reserve Bank of India has an Agricultural Credit Department. The principal function of this department is to conduct research regarding various problems of agricultural credit. Besides this, the bank advises the central government, state governments and co-operative societies on the various aspects of agricultural growth. It also helps the central governments and state governments in establishing godowns and warehouses in different parts of the country. Contribution of the Reserve Bank in the field of agricultural credit is notable. However, the bank does not fulfil credit needs of the farmers directly.

(2) Promotion of Industrial Finance: Reserve Bank provides significant financial assistance for the industrial development of the country. It established Industrial Finance Department in 1957. This department executes all plans of the Reserve Bank regarding industrial finance. The following observations should bring out the contribution of Reserve Bank in the field of industrial finance:

(a) Establishment of Specialized Institutions: To cope with the growing need of industrial finance in India, Reserve Bank has established various specialised institutes. Industrial Finance Corporation of India, Industrial Development Bank of India. State Finance Corporations and Industrial Credit and Investment Corporation and Small Industries Development Bank of India are some of the notable names in this regard.

(b) National Industrial Credit (Long Term Operations) Fund: With a view to satisfy credit needs of the large scale industries, Reserve Bank started National Industrial Credit (Long term Operations) Fund in 1964. This Fund was started with 10 crore in the first year, and 5 crore were to be added to it annually. This fund is used for several purposes:

(i) To give loan to Industrial Development Bank for the purchase of shares and debentures of Finance Corporation of India and State Finance Co-operations.

(ii) To buy debentures issued by the Development Bank.

(c) Credit Guarantee Scheme for Small Scale Industries: From July 1, 1960 onwards, Reserve Bank has arranged for guaranteeing the credit raised by small scale industries. Credit Guarantee Organisation of the Reserve Bank looks after this scheme. Under this scheme 75% of the standing loans of the small industries are guaranteed by Credit Guarantee Organisation.

(d) Help to Sick Industrial Units: Reserve Bank also arranges for financial assistance to the sick industrial units. Sick Industrial Unit Division of the Reserve Bank looks after this function of the bank. This Division identifies sick units of large, medium and small industries and arranges loans for them from the Nationalized Banks.

(3) Promotion of Export Assistance: Export Houses get financial assistance from the Reserve Bank, both directly as well as indirectly by way of 'Refinance' of the loans given by other financial institutes. In 1963, Export Credit Bill Plan was also started. And. in 1982 was with the assistance of Reserve Bank that the government established Export-Import Bank. This Bank avails of the credit facility from the Reserve Bank.

(4) Development of Bill Market: Organised bill market is a very important element of economic growth. Reserve Bank has made concerted efforts for the development of bill market. In this regard it initiated its first plan in 1952. This plan was made applicable for all the Scheduled Banks from 1954 onwards. In 1958, Export Bills also came within the purview of this plan. In 1970, Reserve Bank started New Bill Market Programme. As a result of development of the Bill Market it can be possible to make the Monetary Policy more successful.

(5) Development and of Banking System: Reserve Bank has very efficiently developed and regulated the banking system. It is because of the notable efforts of Reserve Bank that banking system in India has assumed the status of development banking. Also there has been a notable spread of branch banking in rural areas. Appropriate credit facilities have been for the priority sectors. Under 20-point programme, arrangement has been made to give financial assistance to the poor strata of the society. Liquidity of the banking system has been maintained to inspire confidence among the people in the system. Nationalization of 20 big banks of the country has further facilitated the operations of Reserve Bank. Besides, the establishment of Regional Rural Banks has notably contributed to the development of banking system as well as to meet the credit needs of underdeveloped areas. In order to regulate the functions of the banks, in 1993, Department of Supervision was set-up. Since 1994, banks in the private sector have been issued licences.

In Reserve Bank's contribution to the economic development of the country has been very significant.

(C) Regulatory Functions of Reserve Bank

Or

Monetary Policy of Reserve Bank

Control of credit is the function of the Reserve Bank of India. Control of credit means expansion or contraction of credit. Main aim of the monetary regulation is to achieve the objective of growth with stability in order to accelerate the rate of economic development in the country. Reserve Bank has played a significant role in the expansion of credit. It has followed a liberal policy to expand credit in the country to meet the financial needs of agriculture, industry, transport, import, export, etc. Reserve Bank's policy has been liberal in respect of priority sectors, like small farmers, small industries, petty traders, etc. It has helped development of public sector by giving discriminatory support to government securities. Monetary policies after independence has not only encouraged investment for economic development but by increasing the rate of interest has stimulated saving.

Price Stability has sought to be maintained by following a credit control policy keeping in view the production resources of the country. In a developing country like India, problems of investment persist due to constant increase in the volume of investment with increase in income and output, consumption need go on expanding in the same ratio causing rate of saving to fall. Under the circumstances it becomes necessary to regulate the supply of credit, rate of interest and use of credit through appropriate monetary policy. Consequently, Reserve Bank has adopted a policy of controlled credit expansion. The aim of its monetary policy is to expand credit on a long term basis and to regulate the pace of its expansion in the short period.

Reserve Bank of India makes use of all those methods of credit control as are adopted by other central bank in the world. The methods adopted by the Reserve Bank to control credit are studied under two parts:

1. Quantitative credit control

2. Qualitative credit control

1. Quantitative credit control

BANK RATE

Bank Rate is the official minimum rate at which the central bank rediscounts approved bills of exchange or lends on approved securities of commercial banks or member bank. Bank rate is the rate at which the central bank undertakes to discount first cemember bank Bank rate is exchange presented by the commercial banks to get financial accommodation from the central bank. In other words, it is that rate of interest which is charged on loans and advances given by the central bank to commercial banks.

This is most traditional method of controlling the credit.

Assumptions

1. Economy should be elastic. Perfectly elastic economy of the country means with the every increase or decrease of bank rate the economy behaves in pre-expected way i.e. borrowing of commercial bank can be increased or decreased.

2. Direct relationship between bank rate and rate of interest. For successful

implementation of policy with increase or decrease in Bank Rate, rate of interest should

also increase or decrease as the case may be.

3. Sufficient eligible securities with the bank. Another important essential of bank rate policy is well organised capital market and eligible securities so that banks can borrow.

4. Investor's behavior is rational. Investor should be rational and should behave accordingly. If the prices are rising in the market and central bank increases the bank rate, the investor may be optimistic that the prices shall further increase and they start borrowing more.

5. Commercial banks keep cash adequate reserves. Commercial banks maintain reserves, which are adequate for their day-to-day activities. For additional cash resources, they freely approach the central bank.

6. Demand of credit depends on interest rates. The demand of bank credit is dependent upon the prevailing interest rates.

OPEN MARKET:-

The term 'open market operations' refers to the purchase or sale by the central bank of an kind of paper in which it deals. But in England and USA the term is applied only to the sale Government securities. Thus, "Open market operations imply purchase and sale of securities the Central Bank in open market". The purchase or sale is conducted in open market more often through brokers.

Open market operations attempt to increase or decrease the credit in the system by direct influencing the cash reserves with the banking system. This is done by selling or buying the government securities from the open market.

"Open market operations imply the purchase and sale of securities by central bank in the open market".

"Open market operations consist of central bank's purchases or sales of securities in the open market"

ASSUMPTIONS OF OPEN MARKET OPERATIONS

(i) A well organised and developed security market is there in the economy to purchase and sale.

(ii) There is no interference from external factors like policy of govt.

(iii) Commercial banks keep reserves just sufficient to satisfy the legal requirement of CRR and SLR.

CASH RESERVE RATIO:-

Changes in the bank rate and purchase and sale of securities in the open market produce only marginal changes in the cash reserves of the commercial banks and indirectly in the credit creation by banks. But cash reserve ratio is more direct and effective method of exercising credit control.

All the commercial banks are required to maintain a minimum percentage of its deposits with the Reserve Bank. The reserves in excess of the minimum requirements can be utilised by commercial banks to extend credit to its customers. Larger are the reserves, greater is the power of the commercial banks to create credit, smaller are the reserves, lesser is the power of the banks to create credit.

This method was first of all used by Federal Reserve System in 1933. It is also known as Statutory Minimum Reserve. This method was suggested by Keynes.

"Variation in cash reserve ratio implies changes in the minimum percentage of the deposits to be kept reserve funds by the banks with the central bank"

-RA. Young

POLICY OF VARYING CASH RESERVE RATIO

The Varying Cash Reserve Ratio is that policy by which the central bank contracts or expands the credit by increasing or reducing in the cash reserve ratio.

(a) Expansion of Credit. Whenever the Reserve Bank wants to expand credit in the economy, it lowers the cash reserve ratio, so that credit creation power of the banks is enhanced. commercial banks will be required to maintain lesser amount of cash reserves with RBI and excess reserves can be utilised to create credit.

For Example. Let us assume that, a commercial bank has deposits of 200 crore and the CRR (Cash Reserve Ratio) is 10%. It will be required to deposit 20 crore with Reserve Bank as cash reserves. The excess money i.e. (200-20) 180 crore can be utilised by the commercial banks to create credit.

(b) Contraction of Credit. Whenever Reserve Bank wants to contract credit, raises the cash reserve ratio to be followed by commercial banks. These results in increase in cash reserves required to be maintained with RBI and lesser reserves for creation of credit by commercial banks.

Limitations of CRR Policy

This method of credit control is superior to Bank rate and open market operations. It sens to increase or decrease cash reserves of banks by a stroke of the pen. It acts directly on cash reserves and therefore on quantity of credit.

However, this weapon is subject to the following limitations:

1. It affects different banks differently. Banks having higher cash reserves with them are least affected.

2. It cannot be used in small and localised situations.

3. It lacks precision.

4. It forces banks to maintain excess reserves out of fear of increase in CRR. It leads to an increase in interest rates

5. It introduces an element of uncertainty. The banks do not know when CRR will be increased or lowered.

6. Increase in CRR may have adverse effect on the security market because when CRR increases, cash reserves decrease which leads to sale of securities ie. securities decreases.

7. It is not suitable for marginal changes as a very little change will not affect money supply.

8. This method is required to be used very carefully because it has very immediate effect.

9. High CRR may create hurdle in profit earning capacity of commercial banks.

In view of above limitations, the method should be used with caution. It should be employed only in abnormal conditions. CRR should be varied with due notice and in small degrees.

Statutory Liquidity Ratio (SLR)

Under the Banking Companies Regulation Act, banks were required to maintain liquid assets equal to 20% of their total demand and time liabilities. So, when the variable cash reserves ratio was increased, the banks used to dilute the impact by liquidating excess liquid assets. To check this exercise, the Act was amended in 1962 requiring banks to maintain liquid assets equal to 25% of the time and demand liabilities in addition to cash reserves ratio.

According to Statutory Liquidity Ratio, the commercial banks have to keep a certain percentage of their assets in liquid form compulsorily. It involves cash and government securities. It also curtails the power of the commercial banks create credit.

This method was first adopted by Belgium in 1946 and later followed by Italy (1947) and France (1948). Other countries also adopted it from time to time. Central banks in Europe have taken much advantage of it. This system can prove useful to developing countries as well.

The difference between Cash Reserve Ratio and Statutory Liquidity Ratio is that Cash Reserves are to be kept with the Central Bank whereas statutory ratio is maintained by the commercial banks concerned.