Role of RBI

7.
Role of RBI
To increase the constancy of Financial Institutions and Markets Government intervenes in the
interest rates and money supply in the Money Markets. Government has several ways to control
income and interest rates which can be divided into two broad groups such as
Fiscal policy
Monetary policy
The government to adjust the exchange rate intervenes with the foreign exchange markets; there
may be a result on the financial base and the supply of money. When the currency is falling, foreign
currencies should be sold and the currency should be bought to steady its price. The use of deposits
of the national currency to do this suggest that the prepared deposits of the banking sector must be
reduced, causing the financial base to fall, affecting the supply of money. Equally by selling the
national currency to decrease its rate, the monetary base will increase. Securities may be sold on the
open market in an effort to dampen the effects of inflows of the national currency, but this would
imply a raise in interest rates and cause the currency to rise further still. A number of institutions can
affect the supply of money but the greatest impact on the money supply is had by the Reserve bank
and the commercial banks.
Role of RBI in Money Market:
 Firstly the central bank(RBI) could do this by setting a necessary reserve ratio, which would
restrict the ability of the commercial banks to increase the money supply by loaning out
money. If this condition were above the ratio the commercial banks would have wished to
have then the banks will have to create fewer deposits and make fewer loans then they
could otherwise have profitably done. If the central bank imposed this requirement in order
to reduce the money supply, the commercial banks will probably be unable to borrow from
the central bank in order to increase their cash reserves if they wished to make further
loans. They might try to attract further deposits from customers by raising their interest
rates but the central bank may retaliate by increasing the necessary reserve ratio.
 The central bank(RBI) can influence the supply of money through special deposits. These are
deposits at the central bank which the banking sector is required to lodge. These are then
frozen, thus preventing the sector from accessing them even though interest is paid at the
average Treasury bill rate. Making these special deposits reduces the level of the
'commercial banks' operational deposits which forces them to cut back on lending.
 The supply of money can also be prohibited by the central bank(RBI) by adjusting its interest
rate which it charges when the commercial banks wish to borrow money (the discount rate).
Banks generally have a ratio of cash to deposits which they consider to be the minimum safe
level. If command for cash is such that their reserves fall below this level they will able to
borrow money from the central bank at its discount rate. If market rates were 8% and the
discount rate were also 8%, then the banks might decrease their cash reserves to their
minimum ratio knowing that if demand exceeds supply they will be able to borrow at 8%.
The central bank, even if, may raise its discount rate to a value above the market level, in
order to encourage banks not to reduce thei cash reserves to the minimum during excess
loans. By raising the discount value to such a level, the commercial banks are given an
incentive to hold more reserves thus reducing the money multiplier and the money supply
 Another way the money supply can be affected by the central bank is through its operation
of the interest rate. By raising or lowering interest rates the demand for money is
respectively reduced or increased. If it sets them at a certain level it can clear the market at
level by supplying sufficient money to match the demand. Alternatively it could fix the
money supply at a convinced rate and let the market clear the interest rates at the balance.
Trying to fix the money supply is not easy so central banks regularly set the interest rate and
provide the amount of money the market demands.
 The central bank(RBI) may also involve the money supply through operating on the open
market. This allows it to influence the money supply through the financial base. It may
choose to either buy or sell securities in the marketplace which will either inject o remove
money respectively. Thus the monetary base will be affected causing the money supply to
modify.

Role of RBI

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7.

Role of RBI in Money Market:

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