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RBI Governor argues for Independent Central Bank for Macroeconomic Stability of the Country


In his last public speech as the RBI Governor at St. Stephens College, New Delhi on September 3, 2016, Dr. Raghuram G. Rajan explained why central banking was not as easy as it appeared - just raising or cutting interest rates - and why it needed decisions, sometimes unpopular or hard-to-explain ones, to be made under conditions of extreme uncertainty and argued in favour of having an independent central bank and the role and responsibilities of the central bank governor.

The central bank governor has to make difficult policy choices often in the face of uncertainties after weighing the alternatives as best as one can. He cited the example of 2013, when due to weak macro fundamentals the rupee tumbled and it was necessary to get back the confidence of international investors and how he, who had just taken over as the Governor of the Reserve Bank, had to decide on introducing the FCNR(B) scheme in the midst of uncertainties. That the decision proved to be beneficial for the country, the Reserve Bank and the banks, taught him that "Policy making invariably involves taking measured risks in the face of uncertainty." He then made out a case for India to have a strong and independent central bank so that it could ensure macroeconomic stability.

It is for taking complex decisions - often difficult for the common citizens to understand - that the central banks should be independent and should be able to say 'no' to seemingly attractive proposals, he argued but added that at the same time, it also cannot become free of all constraints. "It has to work under a framework set by the Government," he said. In his view, "Frameworks reduce the space for differences" and it was important that the constitutional authorities clearly outlined the central bank's responsibilities.

He gave two examples - a framework for inflation objective and a risk management framework for RBI that indicated the level of equity the RBI needed, given the risks it faced, to be adopted by the RBI Board. "The RBI did not have the luxury of economic inconsistency," he said, be it interest rates, exchange rate, pushing banks to clean up or paying dividend to the government. In a poor country like India where so many people lived at the margin, the role of the central bank was to ensure that growth did not exceed the country's potential, adopting prudential policies that reduce the risk, and building sufficient buffers that the country was protected against shocks. The Governor also explained the economic rationale of why the RBI cannot pay special dividend to the government - in addition to the entire surplus being paid out for the last three years.

He explained that paying a special dividend over and above the surplus RBI generated, as had been suggested, was legally not possible. And even if it were legally possible, and even if the Board were convinced a higher dividend would not compromise the creditworthiness of the RBI, this not reduce overall market borrowing by the government, defeating the very purpose of special dividend! He instead made out a case for transferring to the government the entire surplus of the RBI, retaining just enough buffers that were consistent with good central bank risk management practice. "Separately, the government could infuse capital into the banks. The two decisions need not be linked," he pointed out and further suggested that the Government should acknowledge its substantial equity position in the RBI and subtract it from its outstanding debt when it announces its net debt position. That would satisfy all concerned without monetary damage.

The Governor also argued for operational freedom of the central bank, "albeit invariably in consultation with the Finance Ministry" in matters relating to macroeconomic stability. "Multiple layers of scrutiny, especially by entities that do not have the technical understanding, will only hamper decision making," he said and suggested that instead, the government-appointed RBI Board, which included ex-officio government officials as well as government appointees, should continue to play its key oversight role. He pointed out in this context that at present all important RBI decisions including budgets, licenses, regulation, and supervision are either approved by the Board or one of its sub-committees and it was, therefore, important to quickly fill the vacancies in the RBI Board so that the full expertise and oversight of the Board could be utilised.

In the interests of macroeconomic stability again, he argued that the Governor’s rank should be commensurate with her position as the most important technocrat in charge of economic policy in the country. On communication, Governor said that in a developing democracy such as India, the RBI Governor also has to continuously make the case for the actions the central bank is taking, including the many structural reforms that were underway. Communication was as much about educating as it was about informing - be it with entrepreneurs and retail borrowers or pensioners or Parliamentarians, he said and added that public understanding could help ease the way for reforms, as well as increase support for policies. "The RBI Governor therefore has to explain again and again...and occasionally also warn about the dangers of certain courses of action or certain tendencies in the economy for growth and macroeconomic stability."

Quantitative Methods of Credit Control

The bank rate, also known as the discount rate, is the rate payable by commercial banks on the loans or rediscount rate of the Reserve Bank.

A change in bank rate affects the other market rates of interest. An increase in bank rate leads to an increase in other rates of interest, and conversely, a decrease in bank rate results in a fall in other rates of interest.

Credit control

A deliberate manipulation of the bank rate by the Reserve Bank to influence the flow of credit created by the commercial banks is known as bank rate policy. It does so by affecting the demand for credit, the cost of the credit and the availability of the credit.

An increase in bank rate results in an increase in the cost of credit, this is expected to lead to a contraction in demand for credit. In as much as bank credit is an important component of aggregate money supply in the economy, a contraction in demand for credit consequent on an increase in the cost of credit restricts the total availability of money in the economy, and hence may prove an anti-inflationary measure of control.

Likewise, a fall in the bank rate causes other rates of interest to come down. The cost of credit falls, i.e., credit becomes cheaper. Cheap credit may induce a higher demand both for investment and consumption purposes. More money through increased flow of credit comes into circulation. A fall in bank rate may, thus, prove an anti-deflationary instrument of control.

The effectiveness of bank rate as an instrument of control is, however, restricted primarily by the fact that both in inflationary and recessionary conditions, the cost of credit may not be a very significant factor influencing the investment decisions of the firms.

Open Market Operations:

Open market operations refer to the sale and purchase of securities by the Reserve Bank to the commercial banks. A sale of securities by the Reserve Bank, i.e., the purchase of securities by the commercial banks, results in a fall in the total cash reserves of the latter.

A fall in the total cash reserves is tantamount to a cut in the credit creation power of the commercial banks. With reduced cash reserves at their command the commercial banks can only create lower volume of credit. Thus, a sale of securities by the Reserve bank serves as an anti- inflationary measure of control.

Likewise, a purchase of securities by the Reserve Bank results in more cash flowing to the commercial banks. With increased cash in their hands the commercial banks can create more credit, and make more finance available. Thus, purchase of securities may work as an anti- deflationary measure of control.

The Reserve Bank of India has frequently resorted to the sale of government securities to which the commercial banks have been generously contributing. Thus, open market operations in India have served, on the one hand as an instrument to make available more budgetary resources and on the other as an instrument to siphon off the excess liquidity in the system.

Variable Reserve Ratios:

Variable reserve ratios refer to that proportion of bank deposits which the commercial banks are required to keep in the form of cash to ensure liquidity for the credit created by them.

The Reserve Bank of India is empowered to change the reserve requirements of the commercial banks. The Reserve Bank employs two types of reserve ratios for this purpose, viz., the Statutory Liquidity Ratio (SLR) arid the Cash Reserve Ratio (CRR).

A rise in the cash reserve ratio results in a fall in the value of the deposit multiplier. Conversely, a fall in the cash reserve ratio leads to a rise in the value of the deposit multiplier. A fall in the value of deposit multiplier amounts to a contraction in the availability of credit, and thus, it may serve as an anti-inflationary measure.

A rise in the value of deposit multiplier, on the other hand, amounts to the fact that the commercial banks can create more credit, and make available more finance for consumption and investment expenditure. A fall in the reserve ratios may, thus, work as anti-deflationary method of monetary control.

The statutory liquidity ratio refers to that proportion of aggregate deposits which the commercial banks are required to keep with themselves in a liquid form. The commercial banks generally make use of this money to purchase the government securities. Thus, the statutory liquidity ratio,

on the one hand, is used to siphon off the excess liquidity of the banking system, and on the other, it is used to mobilise revenue for the government. The Reserve Bank of India is empowered to raise this ratio upto 40 per cent of aggregate deposits of commercial banks.




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What is Bank Rate ? : The standard rate at which RBI is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase by the RBI. This is also a rate at which RBI provides refinance to banks.

Repo (Repurchase Option) rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive.

Reverse Repo Rate is used by the central bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, meaning that the central bank will pay a higher rate of interest to the banks for depositing money with it.


Cash Reserve Ratio: CRR is that proportion of a bank’s Net Demand and Time Liabilities (NDTL) that it has to keep as cash deposits with RBI. This proportion is specified by RBI and could change from time to time. As on Date, the CRR is 4.00 percent.
CRR is governed by the provisions of Section 42 of the Reserve Bank of India Act, 1934.

There is no minimum level of CRR. Similarly, there is no maximum. In theory, CRR can go upto 100%, which would mean RBI impounding the entire NDTL as a cash reserve.
Until the RBI Act was amended in 2007, the minimum value of CRR was statutorily fixed at 3% and the maximum was fixed at 20%. Both these limits (lower and upper) were removed by the amendment which came into effect in early 2007.

Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.

Statutory Liquidity Ratio: SLR is that proportion of a bank’s Net Demand and Time Liabilities (NDTL) that it has to maintain as investments in certain specified assets (cash, precious metals, and govt. approved securities like bonds). SLR is governed by the provisions of Section 24 of the Banking Regulation Act.
There is no minimum stipulation on SLR (earlier there used to be a minimum stipulated SLR of 25% – but this was removed with an amendment to the Banking Regulation Act in 2007).
However, SLR cannot exceed 40%.
Statutory Liquidity Ratio is determined and maintained by the Reserve Bank of India in order to control the expansion of bank credit. The current SLR is 20.5%.(will be 20% w.e.f.24.06.2017)
Net Demand and Time Liability is the sum total of demand and time liability a bank owes. (NDTL )



Demand Liabilities' include all liabilities which are payable on demand and they include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand. Money at Call and Short Notice from outside the Banking System should be shown against liability to others.Time Liabilities are those which are payable otherwise than on demand and they include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held against letters of credit if not payable on demand, deposits held as securities for advances which are not payable on demand and Gold Deposits

What is Marginal Standing Facility ? / Definition of Marginal Standing Facility - RBI :-
RBI announced that MSF scheme ( effective from 09th May, 2011)
Marginal Standing Facility Rate : Under this scheme, Banks are able to borrow upto 2% of their respective Net Demand and Time Liabilities" outstanding at the end of the second preceding fortnight .
The rate of interest on the amount is at present 0.5% higher than REPO rate
What is Marginal Standing Facility -
The Marginal Standing Facility Scheme was introduced on the lines of the existing Liquidity Adjustment Facility – Repo Scheme (LAF – Repo). The salient features of the ORIGINAL Scheme are as under:
1. Effective Date
This facility will be effective from May 9, 2011.
2. Eligibility
All Scheduled Commercial Banks having Current Account and SGL Account with Reserve Bank, Mumbai will be eligible to participate in the MSF Scheme.
3. Tenor and Amount
Under the facility, the eligible entities can avail overnight, up to [2 per cent]* of their respective Net Demand and Time Liabilities (NDTL) outstanding at the end of the second preceding fortnight. But for the intervening holidays, the MSF facility will be for one day except on Fridays when the facility will be for three days or more, maturing on the following working day. In the event, the banks’ SLR holdings fall below the statutory requirement up to one per cent of their NDTL, banks will not have the obligation to seek a specific waiver for default in SLR compliance arising out of use of this facility in terms of notification issued under sub section (2A) of Section 24 of the Banking Regulation Act, 1949.
4. Timing
The Facility will be available on all working days in Mumbai, excluding Saturdays between 3.30 P.M. and 4.30 P.M. [These are subject to change as per RBI announcements]
5. Rate of Interest
The rate of interest on amount availed under this facility at present is 6.5% 
6. Discretion to Reserve Bank
The Reserve Bank will reserve the right to accept or reject partially or fully, the request for funds under this facility.
7. Mechanics of operations
i) The requests will be submitted electronically in the Negotiated Dealing System (NDS). Eligible members facing genuine system problem on any specific day, may submit physical requests in sealed cover in the box provided in the Mumbai Office, Reserve Bank of India, to the Manager, Reserve Bank of India, Securities Section, Public Accounts Department (PAD), Mumbai Office by 4.30 P.M.
ii) The NDS provides for submission of single or multiple applications by the member. However, as far as possible only one request should be submitted by an applicant.
iii) The MSF will be conducted as "Hold-in-Custody" repo, similar to LAF - Repo.
iv) On acceptance of MSF requests, the applicant’s RC SGL Account will be debited by the required quantum of securities and credited to Bank’s RC SGL Account. Accordingly, the applicant’s current account will be credited with the MSF application amount. The transactions will be reversed in the second leg. In case the second leg falls on a holiday, the reversal date will be the next working day.
v) The MSF transactions between Reserve Bank and counter parties which would involve operation of the RC SGL Account would not require separate SGL forms.
vi) Pricing of all securities including Treasury Bills will be at face value for MSF operations by Reserve Bank. Accrued interest as on the date of transaction will be ignored for the purpose of pricing of securities.
7. Minimum request size
Requests will be received for a minimum amount of Rs. One crore and in multiples of Rs. One crore thereafter.
8. Eligible Securities
MSF will be undertaken in all SLR-eligible transferable Government of India (GoI) dated Securities/Treasury Bills and State Development Loans (SDL).
9. Margin Requirement
A margin of five per cent will be applied in respect of GoI dated securities and Treasury Bills. In respect of SDLs, a margin of 10 per cent will be applied. Thus, the amount of securities offered on acceptance of a request for Rs.100 will be Rs.105 (face value) of GoI dated securities and Treasury Bills or Rs.110 (face value) of SDLs.
10. Settlement of Transactions
The settlement of all applications received under the MSF Scheme will take place on the same day after the closure of the window for acceptance of applications.

What is the difference between liquidity adjustment facility-repo rate and marginal standing facility(MSF) rate of RBI?
Under LAF - Repo rate, Banks can borrow from RBI at the Repo -rate by pledging government securities over and above the statutory liquidity requirements.

However, in case of borrowing from the marginal standing facility, banks can borrow funds up to two percentage of their net demand and time liabilities, at the rates announced by RBI and this can be within the statutory liquidity ratio of 21.5%.

The rate of interest payable by banks is less in case of Repo facility than the borrowing availed under MSF i.e. we can say MSF borrowing is costlier for the banks than the borrowing under Repo Rate.


The buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Purchases inject money into the banking system and stimulate growth while sales of securities do the opposite.

Open market operations are the principal tools of monetary policy. (The discount rate and reserve requirements are also used.) The RBI's goal in using this technique is to adjust liquidity in the system.

What is banking and what is the role of banking in an economy?
An organisation which accepts deposits from public repayable on demand or otherwise for the purpose of lending and investment. The banking services these days include issuance of debit and credit cards, providing safe custody of valuable items, lockers, ATM services and online transfer of funds across the country / world.
It is well said that banking plays a silent, yet crucial part in our day-to-day lives. The banks perform financial inter mediation by pooling savings and channelizing them into investments through maturity and risk transformations, thereby keeping the economy’s growth engine revving.
Banking business has done wonders for the world economy. The simple looking method of accepting money deposits from savers and then lending the same money to borrowers, banking activity encourages the flow of money to productive use and investments. This in turn allows the economy to grow. In the absence of banking business, savings would sit idle in our homes, the entrepreneurs would not be in a position to raise the money, ordinary people dreaming for a new car or house would not be able to purchase cars or houses.
What is a bank ? Define a Bank ?
An organisation which accepts deposits from public repayable on demand or otherwise for the purpose of lending and investment.
What is a Banking Company ?
Any company, which transacts the business of banking defined above is termed as Banking company and in INDIA these are regulated by BANKING REGULATION ACT AND RBI ACT.