The Reserve Bank of India
Evolution , Organization
Role and Functions
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The Reserve Bank of India
• The Reserve Bank of India is a regulator for Financial Institutions which
deal with public money. Regulator is required because:
• There might be unfair or dishonest people .
• Some might be taking unduly high risk putting public money in jeopardy.
R.B.I.
Regulation and
Supervision
Banks/NBFCs
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Organization and Management of
The Reserve Bank of India
• Structure of RBI
• The organization of RBI can be divided into two parts:
• 1) Central Board of Directors. 2) Local Boards
• Central Board of Directors : The organization and management of RBI is
vested on the Central Board of Directors.
• It is responsible for the management of RBI . Central Board of Directors
consist of 20 members.
• It is constituted as follows.
• a)One Governor: it is the highest authority of RBI. He is appointed by the
Government of India for a term of 5 years. He can be re-appointed for
another term.
• b)Four Deputy Governors: Four deputy Governors are nominated by
Central Govt. for a term of 5 years
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Governor and Deputy Governors
• The Governor: appointment and term in office
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The Governor and Deputy Governors hold office for periods not exceeding
five years. The term of the governor may be fixed by the government at
the time of his appointment. (Urjit Patel and Raghuram Rajan were
appointed for three years; though a governor can get five-year tenure).
Governor (and also Deputy Governors) is eligible for reappointment or
extension.
• Section 8 (4) of the RBI Act explains the term of the Governor and Deputy
Governors. “The Governor and a Deputy Governor shall hold office for
such term not exceeding five years as the [Central Government] may fix
when appointing them, and shall be eligible for re-appointment.”
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Organization of R.B.I.
• c)Fifteen Directors :Other fifteen members of the Central Board are
appointed by the Central Government. Out of these , four directors , one
each from the four local Boards are nominated by the Government
separately by the Central Government.
• Ten directors nominated by the Central Government are among the
experts of commerce, industries, finance, economics and cooperation.
• The finance secretary of the Government of India is also nominated as
Govt. officer in the board.
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Organization of R.B.I.
(Local Boards)
• Local Boards :
• Besides the central board, there are local boards for four regional areas of
the country with their head-quarters at Mumbai, Kolkata, Chennai, and
New Delhi.
• Local Boards consist of five members each, appointed by the central
Government for a term of 4 years.
• They represent territorial and economic interests and the interests of cooperatives and indigenous banks.
• The function of the local boards is to advise the central board on general
and specific issues referred to them and to perform duties which the
central board delegates.
• There are 20 departments of R.B.I.
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Functions of R.B.I.
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The main functions of R.B.I. are to
1) maintain monetary stability.
2) ensure stability of financial institutions.
3) promote development of financial markets.
4) ensure credit allocation as per national priorities.
5) ensure reasonable degree of price stability.
6) ensure reasonable degree of currency stability
This is enable business and manufacturing units to conduct their business
with confidence and to enable them to deliver gains of economic
development to welfare of society.
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Roles of RBI
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The major roles of the Reserve Bank of India are:
1) Currency Issuing Authority
2) Bankers to the Government and Bankers to the Banks
3) Developmental and Promotional
4) Regulatory
1) Currency Issuing Authority: RBI has sole authority to issue currency
notes other than one rupee notes and coins of all denominations.
• One rupee notes and coins as well as coins of smaller denominations are
issued by the Government of India.
• These are put to circulation only through RBI.
• Thus putting currency into circulation and to withdraw and to exchange it
is the responsibility of RBI.
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Role of RBI
(Note Issuing Authority)
• All affairs regarding note issue are conducted through Issue Department of
RBI. BBI has 15 issue offices and 4127 currency chests. Currency Chests
have stock of new and issuable notes , which supply/exchange currency
with the banks.
R.B.I.
Issue Department
Issue Offices
Currency
Chests
Currency
Chests
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Role of RBI
(Bankers to the Government)
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2) Bankers to the Government and Banker to the Bank:
RBI is the banker to Central as well as State Governments.
It provides the Government all banking facilities such as accepting deposits ,
receipts, payments and management of Public Debt.
RBI receives Government Deposit free of Interest and The Government does
not pay any remuneration to RBI for the services. However for Bank charges
commission for management of public debt.
Deficit or surplus in the account of Central Government account is managed
by issuance or cancellation of treasury bills.
Ways and Means Advances: In order to meet temporary gap in receipts and
payments of State Governments RBI makes temporary advances to the States
subject to limits. These are called ways and means advances.
These are of three types:
1) Normal ways and means advances (which are without security)
2) Secured advances (against Central Government Securities)
3) Special Advances (at discretion)
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Role of RBI
(Banker’s Bank Developmental & Promotional role)
• Banker’s Bank:
• RBI is a Central Bank of the country.
• In case of need commercial and cooperative banks borrow funds from RBI.
It is a lender of last resort to the banks.
• RBI controls reserves of the banks and there by controls credit creation
capacity of the banks.
• 3) Developmental and Promotional Role:
• RBI has been rendering developmental and promotional role which will
strengthen banking and financial system in the country . It controls
interest rates and supply of credit to various sectors of economy.
Promotion of growth and control of inflation are prime objectives of it’s
and credit policy. RBI directs flow of credit to Agriculture and Industry so
as to boost up production and growth.
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Role of RBI
(Developmental & Promotional role)
• Promotion of Financial System:
• i) Money Market :R.B.I. is continuously working for integration of
organized and unorganized sectors by improving spread of banking in rural
areas . It is making efforts to reduce role of private money lenders in an
the economy.
• ii) Agriculture Sector : RBI makes efforts to direct and increase flow of
credit to Agriculture sector . In addition to this, it making efforts to
strengthen cooperative banking system in India. NABARD prepares various
schemes for development and financing of agriculture.
• iii) Industrial Finance : The role of the bank in developing institutional
structure is important. Industrial Development Bank of India (IDBI) and
Small Industries Bank of India (SIDBI) have been promoted by RBI to
promote financing to industries and Small Industries respectively.
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Role of RBI
(Developmental & Promotional role)
• iv) Credit Delivery: RBI has evolved joint financing by the different banks or
financial institutions. This has resulted in pooling of resources as well as
expertise and has improved geographical reach. It has also issued
guidelines for transfer or take over of the accounts by the bank . Thus
banking business is growing in healthy manner.
• v) Formulation of Prudential Norms: RBI has formulated norms for
identifying credit accounts, as performing assets and to classify them
depending on the quality of assets. Provisioning norms are decided as per
asset quality.
• This is necessary to preserve and enhance the stability of banking system.
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Separate office for management of public debt
• There is thinking amongst central bankers that central banks should focus
solely on inflation and
• management of public debt for the government should be undertaken by
separate agency.
• The work of RBI is to control inflation and there is inherent conflict
between managing debt and controlling inflation at the same time.
• For efficiently managing debt interest rates are required to be kept low as
it will reduce cost of borrowing. Low interest rates will fuel inflation.
• On the other hand, interest rates required to be kept high to control
inflation which will increase cost of borrowing.
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Role of RBI
(Regulator)
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Regulator: RBI regulates money and credit . RBI regulates money supply
through
a) Interest rates (viz. repo rates, bank rate): Increase in interest rates will
reduce money supply and decrease in rates will increase money supply.
b) Open Market Operations: It is a widely used technique by monetary
authorities. It involves purchase and sale of Government securities in open
market. Purchase of securities by RBI increases money supply and sale of
securities decrease money supply.
c) CRR & SLR: Increase in CRR/SLR reduces money supply and decrease results
into increase in money supply.
d) Control of Discount of Refinance: Increase in refinance limit will increase
money supply and decrease will reduce money supply.
e) Liquidity Adjustment facility. Increase in limit will increase money supply
and decrease will reduce money supply.
RBI regulates credit by putting restrictions on lending to unproductive sectors ,
sensitive sectors like real estate, stock market securities and directing it to
priority sectors.
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Role of RBI
(Regulator)
• Open Market Operations by RBI
Securities
Purchase of
Securities
Money
Securities
Sale of
Securities
Money
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Effects of Open Market Operations
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When R.B.I. buys bonds in the market and infuses liquidity in the system:
The consequences are:
1) It reduces interest rates.
2) Thus fresh bonds can be issued at lower rates and the government can
thus borrow at reasonable costs.
3) It enables the corporates to borrow at favorable interest rates.
4) It prevents rupee from strengthening unnecessarily and protects the
interests of exporters.
5) It may lead to increase in inflation
It helps regulate interest rates and foreign exchange rates.
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Managing recession through monetary policy
• Central banks across the world have been managing recession through
• 1) Interest rate policies: (Lowering interest rates, thereby increasing
money supply and increasing demand in the economy)
• 2) Quantitative easing. : Increasing money supply and creating demand.
• 3) Negative interest rates
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Quantitative easing
• Quantitative easing is an unconventional monetary policy tool which was
used by the Central bank of the USA (Federal reserve) to boost the
economy after the financial crisis of 2007-08.
• The federal reserve had to resort to quantitative easing because the
conventional monetary policy tools used to control money supply had
become ineffective.
• The main tool of conventional monetary policy in the USA is the federal
funds rate. The Federal funds rate is the rate at which banks lend
overnight to each other. It is the interbank rate.
• In India, the key policy rate is repo rate.
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Quantitative easing
• In the aftermath of the financial crisis, the United States started reducing
its federal funds rate to increase the money supply in the economy.
• It was intended to boost the economy and lower the unemployment rate.
• By December 2008, interest rates had reached to 0%.
• It became impossible to cut interest rates further and hence quantitative
easing was used.
• In quantitative easing, Federal reserve bank buys Government bonds and
other financial assets from commercial banks to inject cash into the
economy.
• Japan was the first country to use Quantitative easing.
• From where does the Fed get money to buy bonds?
• The money is created electronically and credited in the reserves accounts
of the banks.
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How does Quantitative easing work?
• When Fed buys bonds from the bank, it increases its reserves.
• Banks have to keep a certain percentage of deposits as reserves with the
Fed.
• Increasing the reserves lets banks lend more money as now it has extra
reserves parked with the Fed.
• How does Quantitative easing work?
• Quantitative easing is the buying of Government bonds from the banks.
• It has the following effects:
• The price of the bonds increases as its demand increases.
• Interest rates reduce.
• Bank has more money kept as reserves than it is required.
• It can lend this money to consumers and businesses. Hence, money supply
in the economy increases.
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Quantitative easing-Tapering
• The quantitative easing was done in three phases or rounds. QE1, QE2 and
QE3 refers to the first, second and the third round of quantitative easing
respectively.
• In the first phase of quantitative easing called QE1 (Nov 2008 to August
2010), Fed bought $1.7 trillion worth of financial assets.
• Under QE2 ( Nov 2010 to June 2011), Fed purchased a total of $ 600 billion
of assets from the bank.
• Under QE3 (September 2012- October 2014), Fed was buying $85 billion
worth of financial assets a month from the banks.
• What is tapering?
• Tapering is nothing but the gradual reduction in this bond/ asset-buying
program of the Fed. QE3 did not have a definite end date. Fed had
announced that quantitative easing (or bond-buying) will continue till the
economy shows signs of recovery and unemployment rate reduces
substantially.
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Quantitative easing –Impact on India
• Most of the capital inflows in India after 2008 were a result of quantitative
easing. QE put lots of money in the hands of investors and they preferred
to invest it in emerging nations like India because these countries
remained resilient even in the face of the economic crisis.
• But, when Fed had announced tapering for the first time in June 2013, it
led to a flight of this capital from India. This was because tapering implied
that US economy is slowly recovering and investors decided to shift their
capital from risky emerging market economies like India to the United
States.
• Between June and August, Foreign Institutional Investors (FIIs) pulled out
230 billion rupees from the stock markets. This selling pressure led to a
decline in Sensex and the value of the rupee was also hit.
• The Rupee lost 27% in 3 months.
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Quantitative easing in India
• QE is a relatively simple process in developed economies as they have a
very strong bond market.
• But the problem with QE is that the Central Bank doesn't know when to
apply brakes to it.
• The fact of just stopping the QE creates panic in the markets ,which is
evident nowadays when all the economies are anticipating a rate hike by
Federal Reserve.
• So inflation is only a monetary phenomena for the developed economies
and it can be controlled through monetary policy.
• In case of Indian economy inflation is not purely a monetary phenomena
but majorly linked to supply constraints.
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Quantitative easing in India
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Policy rates in India are not the freely transmitted as in case of developed
economies.
• So changes in policy rates come with a major lag and may not in most of
the cases affect the base rates of banks.
• This makes QE tough to have an effect on the economy because it is likely
to fuel inflation in India.
• In India, the inflation, if not controlled, will be far more tough to deal
with.
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Negative interest rates
• Quantitative easing is undertaken when lowering of interest rates is
ineffective.
• This is being undertaken in the US. (Appears successful)
• Japan was the first country in the world to undertake Quantitative easing.
• However QE has not been able to revive economy of Japan.
• After failure of QE Japan has undertaken policy of negative interest rates
which is reviving demand.
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Numericals for practice-options-1
• 1) A has purchased call option (American) for 200 shares of company X on
20.05.17 at Rs250. maturing on 31.08.17. On the date of purchase share
was quoted at highest price of 260.Commission charged was Rs5 per share.
• On 02.08.17 share price increased to 270 and thereafter it raised to 275 on
15.08.17.After 15th August share price was fluctuating between 260 and
265 till 31.08.17. On 31.08.17 share was quoted at 260
• Option was exercised on 02.08.17.
• a)Calculate profit earned by purchaser of option.
• b)Calculate loss incurred by option writer.
• c)What would have been the best date for exercising option?
• d)What would have been the profit/loss to option buyer, had it been
European option?
• e)Calculate profit by option seller, if option is not exercised by A
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Solution to numerical-options-1
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Solution to numerical-1
a) Profit if option is exercised on 02.08.17
(270 -250 ) = 20 is Gross profit per share:
Net profit is (20-5) : Rs15 per share. Total profit = 200 X 15 = 3,000.
b) Loss by option writer is Rs3,000. (as he will have buy from market at
270 and sell at 250 incurring loss of Rs20 per share.
His net loss will be Rs15 per share(net of commission) . Thus total net loss
will be Rs3000.
c) Best date is 15/08/17, price being highest.
d) European option is exercised on last date i.e. on 31.08.17, when price is
260. Thus net profit is (260-250)-5=Rs5 per share.
Total profit is Rs1000.
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Numericals for practice-options-2
• 2) A has purchased put option (American) for 300 shares of company Y on
01.07.17 at Rs1200. maturing on 30.09.17. On the date of purchase share
was quoted at highest price Rs1150.Commission charged was Rs5
• Between 01.07.17 to 30.09.17 share price share price was fluctuating
between Rs980 and Rs.1210. On 14.08.17 it was Rs980 and Rs1210 on
30.09.17
• a)Calculate profit/loss earned by purchaser of option and option writer if
option is exercised on 14.08.17
• b)If option is not exercised till 29.09.17, what would have been the best
date for exercising option thereafter?
• c) What is profit/loss to the purchaser if option is exercised when price
was Rs1055.
• d)In case option is European what is profit or loss to the purchaser ?
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Solution to numericals-options-2
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1) If option is exercised on 14.08.17, market price was Rs980. Thus
Profit gross per share is Rs(1200-980 ) = 220
Profit net of commission per share is Rs220-5= 215
Total profit = (215 X 300 ) = Rs64,500.
2) No best date.
3) Profit per share = (1200 -1055)-5 = 145 – 5 = 140 per share
Total profit = (140 X 300) = 42,000
4) Loss to purchaser Rs5 per share i.e. Rs1500 as option will not be
exercised.
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Numericals-T-Bills
• Ex:1: Calculation of Yield on Treasury Bills:
• SBI Guilt Ltd bought 91 days-T-bill on Oct 12 ,2016 which maturing on Jan
11, 2017. SBI Guilt purchased the bill on 01.12.2016 for Rs99.2475 with
Rs100 face value . Find Yield to maturity. (6.75%)
• Ex:2: SBI Guilds bought 181 days T-bill on 01.03.2017 which were issued
on Jan 30th ,2017 the purchase price was 98.1655. Find the yield to
maturity. (4.5173%)
• Ex: 3: Calculation of Yield on Treasury Bills:
• Bank ‘A’ purchased 91 days-T-bills on May 12 ,2017 which matured on
July 6, 2017 The .rate quoted by was 98.8480 for Rs100 face value . Find
Yield to maturity. (7.7342%)
• Ex:4: Bank ‘X’ bought 364 days T-bills on 30th Jan ,2017. The rate quoted
by was 95.1355. Find the yield to maturity. (5.1273%)
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Numerical on Repo
• Ex: 1: Bank X has entered into repo for 14 days with bank Y for
100 crores. The security chosen is 12.0 % G-Sec2017. The
repo rate is 6%. The agreed price is Rs.101.10, last coupon
was paid 20 days ago. Find repurchase price.
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Solution to Numerical on Repo
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Ex: 1: Bank X has entered into repo for 14 days with bank Y for 100 crores. The
security chosen is 12.0 % G-Sec2017. The repo rate is 6%. The agreed price is
Rs.101.10, last coupon was paid 20 days ago. Find repurchase price.
Calculation for first leg: ( X will receive the amount equal to value of securities
it has parted to Y)
Selling Price:
(100,00,00,000 X 1.011)= 101,10,00,000
Accrued Interest (30 days)
1,00,00,000
Loan Amount received
102,10,00,000
At second leg of Transaction: ( X will have to pay Y )
Amount of loan:
102,10,00,000
Interest on loan at repo rate
(102,10,00,000) X 6 X14/(100X365)
23,49,698
Less Interest on securities Y has received (for 44 days)
100,00,00,000x24 X12 /(365X100)
78,90,411.
X will have to pay
101,54.59,287
Repurchase price will be
101.55
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