Monetary Policy of the Reserve Bank of India!

1. Bank Rate Policy:

The bank rate or the discount rate has been used by the R.B.I, when banks turned to it as lender of last resort. From its very inception until November 1951, the bank rate was kept unchanged at 3%.

However, since then, it has been raised from time to time. It was raised to 11% on July 3, 1991 and to 12% in October 1991, for cubing imports and reducing aggregate de­mand.

It was gradually reduced 6.5% in October 2001, the lowest rate since May 1973. However, the bank rate has not proved to be very effective as an instrument for controlling the amount of bank borrowing. The reason is that, just by varying the bank rate, the R.B.I, cannot alter the interest rate differential between the lending rates of banks and the cost of borrowed reserves—the factor which determines the profitability to banks from borrow­ing.

2. Open Market Operations:


The R.B.I. Act has empowered the Bank to buy and sell short- term commercial bills. But this provision has served very little purpose, largely due to the absence of organised bill market in the country. Moreover, the bulk of government securities in India are held by institutional investors, notably commercial banks and insurance companies. Consequently, dealings of the R.B.I, in regard to open market operations are largely confined to them.

The R.B.I, over the years has tried to raise resource for both developmental and defence pur­poses by selling government securities. Conse­quently, a fiscal bias has emerged in open market operations. In other words, the monetary aspect of O.M.Os has receded to the background. This be­comes clear from the fact that over the last two decades O.M.Os. have been doing well to prevent unchecked expansion of liquidity through gov­ernment borrowing. The growing volume of pub­lic debt reduced cash in the hands of the public.

3. Cash Reserve Ratio:

This method, i.e., changing cash reserve ratio (CRR) which refers to the ratio of cash holding to total liabilities of a bank has been used by the R.B.I, for the first time in 1960 when there sharp increase in commodity prices. But this instrument was used for a short period.

In 1962 the R.B.I, fixed reserve requirements at 3% for both demand and time liabilities (depos­its). This technique of credit control has been very frequently used in recent years with a view to sta­bilising prices. It was raised to 5% in June 1970. Since this measure had failed to yield necessary results, the cash reserve ratio was raised again to 7% in September 1973. Due to huge growth of liquidity in the economy over time, the ratio was raised to 15% in July 1989. However, the Govern­ment to reduced the CRR to 5.5% in October 2001. This was supposed to increase the flow of bank credit by Rs. 8,000 crores.

4. Statutory Liquidity Ratio:


In 1960, the Reserve Bank attempted to control credit expan­sion by fixing up additional cash reserve require­ments. But this measure was not truly effective. The main reason for this was that the commercial banks satisfied the reserve requirements by mak­ing necessary portfolio adjustments without alter­ing their liquidity position. The banks sold the government securities to raise their cash reserve ratio and thus their capacity to create credit re­mained unchanged.

The policy of the commercial banks clearly revealed the limitation of the tech­nique of variable cash reserve ratio. In 1962 the Government, therefore, made necessary amend­ments to the Banking Regulation Act, 1949. Origi­nally, the commercial banks were under the legal obligation to maintain a liquidity ratio of 20% against their demand and time liabilities. It was raised to 38.5% in April 1990.

It was gradually raised from time to time for two reasons:

(i) reducing commercial banks’ abil­ity to create credit and, through it, easing infla­tionary pressures and


(ii) making larger resources available to the Government for developmental purposes.

However, following the recommenda­tions of the Narasinham Committee, SLR on in­crement in net demand and time liabilities has been reduced to 25% in March 2001.

5. Selective Credit Control:

The R.B I. has used this method for regulating the flow of credit to specific branches of economic activity and, thus, check- the misuse of borrowing facilities.

Commercial banks have been prohibited from extending credit for speculative hoarding of es­sential commodities by traders. This is the main thrust of selective credit control.

In the second half of the 1950s the Reserve Bank discovered that the commercial banks made huge advances to traders against the hoarding of essential commodities which pushed up their prices. So it imposed selective credit controls on those commodities.

In fact, S.C.C. were first intro­duced in early 1956 as part of the R.B.I.’s policy of ‘controlled expansion’. At present, the follow­ing commodities are covered food-grains, major “oilseeds and vegetable oils, cotton and kapas, sugar, gur and khandsari, cotton yam, man-made fibres and yarn and fabrics made out of man-made fibres (including stock-in-process).

The techniques of SCC used in India are the following:

(a) Fixation of minimum margins for lend­ing against securities. The margins vary widely (from 20% for certain basic varieties of cotton to 85% for stocks of major vegetable oils);

(b) Fixation of maximum advances to indi­vidual borrowers against stocks of certain com­modities;


(c) Fixation of minimum differential rates’ of interest prescribed for different types of loans;

(d) Total prohibition of advances for financing hoarding of sensitive commodities (i.e., com­modities subject to speculative pressures); and

(e) Prohibition of the discounting of bills covering the sale of certain sensitive items.

In March 1960, in order to reduce specula­tive pressure in the stock market, margin require­ments in respect of loans against the security of ordinary shares were fixed at 50%. For the last 30 years, the R.B.I, has extensively relied on the tech­nique of margin requirements to check the hoard­ing of essential commodities for it causes artificial scarcities in the market and raises prices.


Since 1973-74 much stricter selective controls have been imposed. They now cover advance against six broad groups of commodities, viz., food-grains, oilseeds, sugar, cotton, vegetable oil and cotton textiles. The rate of interest on advances against the security of these commodities is generally kept higher than on loans against securities not cov­ered under selective controls.

The Credit Authorisation Scheme introduced in 1965 by the Reserve bank regulates not only the volume but also the terms on which credit flows to the different large borrowers, in order that credit is directed to genuine productive pur­poses, that credit is in accord with the needs of the borrower and there is no unique channeling of credit to any single borrower or groups of borrow­ers.

The minimum limit for prior authorisation for borrowers in the private sector was originally fixed at Rs. 1 crore. Since then it has been raised several times. It was last raised to Rs. 6 crores from April 4, 1986. Since July 1987, the Credit Au­thorisation Scheme has been liberalised for pro­viding greater access to credit to meet genuine demands in productive sectors without the prior sanction of the R.B.I. No doubt, CAC is a king of SCC.

Apart from the usual techniques for S.C.C., the R.B.I, has been empowered to give directions to banks in general or even some particular banks as to the purpose for which loans should not be given. At the same time, the Government takes sufficient precautions that the credit for produc­tion, movement of commodities, and exports is not denied as it may have serious repercussions on the performance of the economy.


The focus of SCC is mainly on credit to trad­ers for financing inventories, to ensure that the R.B.I, is to see from time to time that credit for production and movement of commodities for ex­ports is not adversely affected by such controls. For making SCC effective, the R.B.I, has made frequent changes in its SCC directives in the con­text of changing market conditions.

While mak­ing an overall assessment of SCC, Prof. Suraj B. Gupta writes: “No definite information is available about the degree of success or failure of the SCC. How­ever, there is a general presumption that they do put mode-rate speculative pressures on the prices of sensitive commodities to some extent.”

However, in spite of the wide powers enjoyed by it, the R.B.I’s control over the supply of credit is limited. The main reason seems to be the struc­ture of the economy itself, or, more specifically, the underdeveloped nature of the Indian money market. In fact, the un-organised sector, which in­cludes indigenous banks and moneylenders as the constituents is completely outside the control of the R.B.I. Whatever success the Reserve Bank has achieved in the past is mainly on account of its strict control over the organised segment of the money market.