Money and Banking online Test - 17

The International Monetary Fund (widely known as the IMF) is an international cooperative institution whose main mission is to promote and assist in international monetary stability. With its initial organization coming at the end of World War II, for many years the main goal of the IMF was to oversee a system of stable, fixed exchange rates among the currencies of member nations. Since 1971, the exchange rates of the world's currencies have been allowed to float, with supply and demand market forces determining their value. In 2008, the IMF consisted of 185 member countries, which pay an initial quota subscription to become members. The organization works to achieve and enhance a stable world economy through the promotion of open financial disclosure among member nations, the provision of loans during periods of economic crises, and technical assistance provided through educational and promotional means.

Reserve Bank has granted general permission under Sections 19(1)(d), 19(1)(a) and 29(1)(b) of the Foreign Exchange Regulation Act, 1973 to Indian companies for issue and exports of shares/securities to non-resident investors, and to non-resident investor to acquire shares/securities of Indian companies under various non-resident direct investment schemes.

The Reserve Bank of India is a banker to the commercial banks.

The important measure taken by central bank to keep money supply under control is called monetary policy. The Central Bank increases public confidence in the monetary system of the country. It brings profit to the public exchequer. It brings uniformity in the monetary system .

$$M_1$$ is the money supply that includes physical currency and coin, demand deposits, travelers checks, other demand deposits and negotiable order of withdrawal accounts.

The most liquid portions of the money supply are measured by $$M_1$$ because it contains currency and assets that can be quickly converted to cash.

Deficit financing, practice in which a government spends more money than it receives as revenue, the difference is filled up by borrowing or printing new currency.

The measures of money supply in India are as follow:

1. Reserve Money (M0): It is also known as High-Powered Money, monetary base, base money etc.
   M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI
   It is the monetary base of economy.
2. Narrow Money (M1):
   M1 = Currency with public + Demand deposits with the Banking system (current account, saving account) + Other deposits with RBI
3. M2 = M1 + Savings deposits(Demand deposits)  of post office savings banks
4. Broad Money (M3)
   M3 = M1 + Time deposits with the banking system
5. M4 = M3 + All deposits with post office savings banks

When Cash Reserve Ratio or Bank rate is increased, the commercial banks have  less deposits to lend to the public, as such, the money supply in the economy reduces and it helps in controlling inflation.

The methods of credit control adopted by the 'Central Bank' are: 

1. Quantitative Methods of monetary policy includes those instruments which focus on the overall supply of the money. It includes: 

A. Two Policy Rates: 

Bank rate is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. It is increased at the time of inflation to reduce the money supply in the economy and vice versa. 

Repo rate is the rate charged on the secured loans offered by the Central bank to the commercial banks that includes collateral. It is increased at the time of inflation to reduce the money supply in the economy and vice versa. 

B. Two Policy Ratio:

Statutory Liquidity Ratio (SLR) refers to liquid assets that the commercial banks must hold on daily basis as a percentage of their total deposits. SLR is determined by the central bank and is a legal requirement to be fulfilled by the commercial banks.  It is increased at the time of inflation to reduce the money supply in the economy and vice versa. 

Cash Reserves Ratio (CRR) refers to the proportion  of total deposits of the commercial banks which they must have keep as cash reserves with the central bank. The ratio is fixed by the central bank and is varied from time to time to control the supply of money in the economy depending upon the prevailing situation of inflation or deflation.

C. Open Market Operations: 

Open market operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities in the open market to control the supply of money in the economy. By selling the securities, the central bank soaks liquidity from the economy and by buying the securities, the central bank releases liquidity. 

 

2. Qualitative Methods of monetary policy includes those instruments which focus on the selected sectors of the economy. It includes: 

A. Margin Requirement:

Margin requirement refers to the difference between the current value of the security offered for loan (called collateral) and the value of loan granted. It is a qualitative method of credit control adopted by the central bank in order to stablise the economy from inflation or deflation.

B. Rationing of Credit:

Rationing of credit refers to fixation of credit quotas for different business activities which is introduced when the flow of credit is to be checked particularly for speculative activities in the economy. 

C. Moral Suasion: 

The central bank makes the member bank agree through persuasion or pressure to follow its directives which is generally not ignored by the member banks. The banks are advised to restrict the flow of credit during inflation and be liberal in lending during deflation. 

Bank rate refers to the interest rate at which the central bank (RBI in India) will advance short term loans to commercial banks. Changes in bank rate are reflected in prime lending rates offered by commercial banks, which in turn affect investments such as bank deposits, bond issues, mortgages. This term has largely been replaced by newer terms base rate and prime rate. The borrowing capacity of an individual or company is called credit. Credit will contract when the bank rate is raised.