CHAPTER-ISYNOPSIS

1.1. IntroductionCombining the monetary and supervisory functions of a central bank is best attributed to its concern for the systemic stability of the financial system and the protection of the payments system. It is also argued that banking supervisory informationmay improve the accuracy of macroeconomic forecasts and thus help the central bank to conduct monetary policy more effectively. The central banks involvement in supervision does not necessarily weaken its stance on monetary policy as a central banks inflation performance and its role in supervision are two, more or less, separate issues. On the other hand, the combination of control of monetary policy and the role of Lender of Last Resort (LoLR) at the central bank has been criticised on the grounds that it raises inflationary concerns. A central bank committed to price stability will sterilise the injection of liquidity necessary for the stability of the system in the event of crisis so that there is no undesired increase in the money supply. If the LoLR function and supervision are combined, an intervention as LoLR may give rise to confusion in the expectations of the private sector regarding the central banks monetary policy stance. Concerns have also been expressed that a conflict of interest may arise between the reputation of the central bank as guarantor of currency and financial stability. For example, concern for the reputation of the central bank as supervisor may encourage an excessive use of the LoLR facility so that bank crises do not put its supervisory capacity in question. It has been argued that the reputation of the central bank is more likely to suffer, than to benefit, from bank supervision.1.2. Objective of ResearchThe objective of research is 1. To analyse the conflicting roles of the RBI as public debt manager and bank supervisor.2. To understand the monetary functions of the RBI.

1.3. Research QuestionWhether the experience of fiscal dominance over monetary policy would have been different if there had been separation of debt management from monetary management in India? 1.5 Method of Research Method of research is doctrinal in nature. Secondary sources including books, articles from journals and newspaper articles are relied upon.1.6. Survey of LiteratureThe various articles from the internet have been referenced for the Research work. The various case laws relating to research questions are examined. 1.7. Chapterization SchemeThe project is divided five chapters. The first chapter forms the introduction which gives the research question, brief introduction to the research, the methodology of the research, the survey of literature, bibliographical information etc upon the project. The second chapter gives an account of the development role of the RBI since its inception, chapter III gives an account of the relationship of the RBI with the government. Chapter IV gives an account of 1.8. Bibliography Books: ML Tannan, Tannans Banking Law and Practice in India, 22nd Edition, 2008, LexisNexis Butterworths Wadhwa.RK Gupta, Banking Law and Practice in India, 2nd Edition, 2012, Universal Law Publications.Mark Hapgood QC, Pagets Law of Banking, 13th ed., 2007, LexisNexis ButterworthsS.N. Gupta, The Banking Law, Universal Publishing Co., 1st ed., 2010, New DelhiAvtar Singh, Banking and Negotiable Instruments, 2011, Eastern Book Co., Lucknow.Dr. M. Sumathy, Banking Industry in India, 2011, Regal Publications, New Delhi.Butterworths Banking Law Handbook, 7th ed., 2008, LexisNexis.

Articles:Financial Regulation and Supervision, RBI Publications, Available At: http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/69297.pdf Accessed On: 1/12/2012.Report of the Working Group on Conflicts of Interest in the Financial Sector, RBI Publications, Available At: http://rbidocs.rbi.org.in/rdocs/Content/PDFs/68210.pdf Accessed on: 1/12/2012.Regulatory and Supervisory Challenges in Banking, RBI Publications, Available At: http://rbi.org.in/scripts/publicationsview.aspx?id=10497 Accessed on: 1/12/2012.Dr. Rakesh Mohan, Evolution of Central Banking in India, Deputy Governor at the seminar organized by the London School of Ecnonomics and the National Institute of Bank Management at Mumbai on January 24, 2006.

CHAPTER IIDEVELOPMENT ROLE OF THE RBI As in many developing countries, the central bank is seen as a key institution in bringing about development and growth in the economy. In the initial years of the RBI before independence, the banking network was thinly spread and segmented. Foreign banks served foreign firms, the British army and the civil service. Domestic/Indian banks were linked to domestic business groups and managing agencies, and primarily did business with their own groups. The coverage of institutional lending in rural areas was poor despite the cooperative movement. Overall financial intermediation was weak. In an agrarian economy, where more than three-fourth of the population lived in the rural areas and contributed more than half of GDP, a constant and natural concern was agricultural credit. Therefore, almost every few years a committee was constituted to examine the rural credit mechanism. There has perhaps been one committee every two or three years for over a hundred years.[footnoteRef:2] A clear objective of the development role of the RBI was to raise the savings ratio to enable the higher investment necessary for growth, in the absence of efficient financial intermediation and of a well developed capital market. The view was that the poor were not capable of saving and, given the small proportion of the population that was well off, the only way to kick start the savings and investment process in the country was for government to perform both functions. [2: Mark Hapgood QC, Pagets Law of Banking, 13th ed., LexisNexis Butterworths, 2007, 349]

Thus the RBI was seen to have a legitimate role to assist the government in starting up several specialized financial institutions in the agricultural and industrial sectors, and to widen the facilities for term finance and for facilitating the institutionalisation of savings. Although the Reserve Bank was actively involved in setting up many of these institutions, the general practice has been to hive them off as they came of age, or if a perception arose of potential conflict of interest. There can be little doubt that the establishment of these institutions has helped financial development in the country. It can be argued, of course, that similar institutional development could have taken place through private sector efforts or by the Government. The availability of financial sector expertise in the Reserve Bank, however, was instrumental in these tasks being performed over time by the Reserve Bank. [footnoteRef:3] [3: Dr. Rakesh Mohan, Evolution of Central Banking in India, Deputy Governor at the seminar organized by the London School of Ecnonomics and the National Institute of Bank Management at Mumbai on January 24, 2006. ]

CHAPTER IIIRELATIONSHIP OF RBI WITH THE GOVERNMENT The RBI is a banker to the Central Government statutorily and to the State Governments by virtue of specific agreements with each of them.3.1. Monetary and Fiscal Role of the RBIIt is common for central banks in developing countries to act as debt managers of their respective governments. Central Banks have typically financed governments through monetisation as and when the need arose for expansionary fiscal policy which has been often in developing countries. The Indian experience has been no different and expansionary fiscal policy was indeed financed by resort to automatic monetization, accompanied by financial repression and effective loss of central bank autonomy with respect to monetary policy.[footnoteRef:4] [4: Regulatory and Supervisory Challenges in Banking, RBI Publications, Available At: http://rbi.org.in/scripts/publicationsview.aspx?id=10497 Accessed on: 1/12/2012. ]

3.2. Before Liberalization (1991)In 1951, with the onset of economic planning, the functions of the RBI became more diversified. As the central bank of a typical developing country emancipated from centuries old colonial rule, the RBI had to participate in the nation building process. Fiscal policy assumed the responsibility of triggering a process of economic growth through large public investment, facilitated by accommodative monetary and conducive debt management policies. The RBI played a crucial role in bridging the resource gap of the Government in plan financing by monetising government debt and maintaining interest rates at artificially low levels for government securities to reduce the cost of government borrowing.[footnoteRef:5] [5: Report of the Working Group on Conflicts of Interest in the Financial Sector, RBI Publications, Available At: http://rbidocs.rbi.org.in/rdocs/Content/PDFs/68210.pdf Accessed on: 1/12/2012. ]

The provisions of the Reserve Bank of India Act, 1934 authorizes the RBI to grant advances to the Government, repayable not later than three months from the date of advance. These advances, in principle, were to bridge the temporary mismatches in the Governments receipt and expenditure and were mainly intended as tools for Governments cash management. However, in practice, the tool of short-term financing became a permanent source of funds for the Government through automatic creation ofad hocTreasury bills whenever Governments balances with the RBI fell below the minimum stipulated balance. This automatic monetization led to the RBIs loss of control over creation of reserve money. In addition, the RBI also created additionalad hocTreasury bills whenever funds were required by the Government. As there was unbridled expansion of fiscal deficits and the Government was not in a position to redeem thead hocTreasury bills, the RBI was saddled with a large volume of these bills constituting a substantial component of monetized deficit. This process continued from the 1950s to the 1990s.By the end of the 1980s a fiscal-monetary-inflation nexus was increasingly becoming evident whereby excessive monetary expansion on account of monetization of fiscal deficit fuelled inflation. The RBI endeavoured to restrict the monetary impact of budgetary imbalances by raising the required reserve ratios to be maintained by banks. As the growth of pre-empted resources was inadequate to meet the Governments requirement, it had to perforce borrow funds from outside the captive market through postal savings and provident funds, by offering substantial fiscal incentives and at administered low rates of interest. Thus, the economy was pushed into financial repression.[footnoteRef:6] [6: Financial Regulation and Supervision, RBI Publications, Available At: http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/69297.pdf Accessed On: 1/12/2012. ]

3.3. Post LiberalizationThere was a significant change in thinking regarding overall economic policy during the early 1990s. There were arguments for a reduced role of the Government in the economy which resulted in a conscious view in favour of fiscal stabilisation and reduction of fiscal deficits aimed at eliminating the dominance of fiscal policy over monetary policy through the prior practice of fiscal deficits being financed by automatic monetization. It is this overall economic policy transformation that has provided greater autonomy to monetary policy making in the 1990s.[footnoteRef:7] [7: ML Tannan, Tannans Banking Law and Practice in India, 22nd Edition, 2008, LexisNexis Butterworths Wadhwa, 226. ]

In pursuance of the financial sector reforms undertaken in 1991, despite the proactive fiscal compression and efforts made by the RBI in moderating money supply during the early part of the 1990s, the continuance of thead hocTreasury bills implied that there could not be an immediate check on the monetized deficit. In order to check this unbridled automatic monetization of fiscal deficits, the First Supplemental Agreement between the RBI and the Government of India on September 9, 1994 set out a system of limits for creation ofad hocTreasury bills during the three-year period ending March 1997. In pursuance of the Second Supplemental Agreement between the RBI and the Government of India on March 6, 1997, thead hocTreasury bills were completely phased out by converting the outstanding amount into special undated securities and were replaced by a system of Way and Means Advances. The participation by the RBI in primary auctions of the Government has also been discontinued with effect from April 1, 2006 under the provisions of Fiscal Responsibility and Budget Management Act, 2003 (FRBM). Other related measures that have been initiated since 1991 are deregulation of interest rates and lowering of statutory ratios.The Indian economy has made considerable progress in developing its financial markets, especially the government securities market since 1991. Furthermore, fiscal dominance in monetary policy formulation has significantly reduced in recent years. With the onset of a fiscal consolidation process, withdrawal of the RBI from the primary market of Government securities and expected legislative changes permitting a reduction in the statutory minimum Statutory Liquidity Ratio, fiscal dominance would be further diluted.All of these changes took place despite the continuation of debt management by the Reserve Bank. Thus, one can argue that effective separation of monetary policy from debt management is more a consequence of overall economic policy thinking rather than adherence to a particular view on institutional arrangements.[footnoteRef:8] [8: RK Gupta, Banking Law and Practice in India, 2nd Edition, 2012, Universal Law Publications, 317.]

The core issue of the conflict of interest between monetary policy and public debt management lies in the fact that while the objective of minimizing market borrowing cost for the Government generates pressures for keeping interest rates low, compulsions of monetary policy amidst rising inflation expectations may necessitate a tighter monetary policy stance. Therefore, the argument in favour of separating debt management from monetary policy rests on the availability of effective autonomy of the central bank, so that it is able to conduct a completely independent monetary policy even in the face of an expansionary fiscal stance of the government.[footnoteRef:9] [9: Mark Hapgood QC, Pagets Law of Banking, 13th ed., 2007, LexisNexis Butterworths, 442.]

However, if this is a realistic possibility rests to be seen. If there is an understanding amongst policy makers that expansionary fiscal policy that is financed by monetization leads to undesirable results would such a policy be pursued? The Indian experience has itself shown that as such realisation took place in the 1990s the policy response was to arrive at policy conventions between the Government and the Reserve Bank that enabled the practice of independent monetary policy, despite debt management continuing to be housed in the RBI.3.4. Regulation and SupervisionThis issue arose in India primarily because of the predominant Government ownership of banks after nationalization of banks in 1969 and 1980. By the 1990s, more than 90 per cent of banking assets were in banks owned by the Government. In this institutional setting there was a perception given that banks cannot fail and that depositors are effectively fully protected.Moreover, all management appointments in banks rested with the Government, and hence the norms of corporate governance in public sector banks. Furthermore, in the presence of administered deposit and lending rates, credit allocation and other banking decisions that rested with the government, regulation and supervision of banks also effectively became subservient to the Government during the 1970s and 1980s.[footnoteRef:10] [10: S.N. Gupta, The Banking Law, Universal Publishing Co., 1st ed., 2010, New Delhi, 537.]

It was only after the change in banking policy in 1991, which emphasized competition along with interest rate deregulation and elimination of credit allocation that banking regulation and supervision by the Reserve Bank could became effective.[footnoteRef:11] [11: Id at 539. ]

The primary justification for financial regulation and supervision by regulatory authorities is to prevent systemic risk, avoid financial crises, protect depositors interest and reduce asymmetry of information between depositors and financial institutions. The business of banking has a number of attributes that have the potential to generate instability as banks are much more leveraged than other firms due to their capacity to garner public deposits. Therefore, the need for establishing an agency to regulate and supervise the banking activity arose from frequent bank failures in various countries with ramifications for the whole economy. The central banks had started to focus their attention on ensuring financial stability and avoiding a financial crisis, since the late nineteenth century.[footnoteRef:12] [12: Avtar Singh, Banking and Negotiable Instruments, 2011, Eastern Book Co., Lucknow, 442. ]

The basic objective of bank supervision is to ensure that banks are financially sound, well managed and that they do not pose a threat to the interest of their depositors. The emphasis of supervision has been shifting in the recent period from the traditional Capital, Assets, Management, Earnings, Liquidity and Interest Rate Sensitivity (CAMELS) approach to a more risk-based approach. Basel II, which encompasses the risk analysis, uses a three-pillar concept minimum capital requirements, supervisory review and market discipline to ensure financial stability.[footnoteRef:13] [13: S.N. Gupta, The Banking Law, Universal Publishing Co., 1st ed., 2010, New Delhi, 547. ]

Central banks have traditionally regulated and supervised financial institutions, including commercial banks. However, since central banks are also regulators and influence the behaviour of market participants, supervision conducted by central banks may pose a moral hazard problem. Therefore, the idea of a separate supervisory authority has gathered some momentum in recent years. In addition, as a practicing central banker, I can envisage situations of conflict between monetary policy, and regulation and supervision, especially in situations of economic and financial stress. To illustrate a case of conflict, the mounting inflationary pressures in a country may require interest rates to rise sharply but then banks would be potentially exposed to write-downs of their asset valuations.[footnoteRef:14] [14: Dr. M. Sumathy, Banking Industry in India, 2011, Regal Publications, New Delhi. 291. ]

The changing role of financial regulation and supervision of the RBI can be characterised by less stress on micro regulation but more focus on prudential supervision, and on risk assessment and containment. The Indian approach to banking sector reforms has been gradual and different from many other emerging market economies, where financial sector reforms resulted in privatization of erstwhile public sector financial intermediaries.

CHAPTER IVINTERNATIONAL PERSPECTIVE ON SEPARATION OF SUPERVISION FROM CENTRAL BANKSThe question of where authority for the supervision of banks and other financial institutions should reside has become the subject of intense debate. In many countries, responsibility for banking supervision rests with the central bank, while supervision over other financial institutions is typically vested with other agencies. However, in recent years, there are several cases of countries moving away from this model. Although the early central banks were established primarily to finance commerce, foster growth of the financial systems and to bring uniformity in the note issue, central banks in several countries in the 20th century, notably the US, were founded to restore confidence in the banking systems after repeated bank failures. As the incidence of banking crises started increasing, the statutory regulation of banks was considered necessary for the protection of depositors, reduction in asymmetry of information and for ensuring sound development of banking. In the 19th century, central banks had started focusing their attention on ensuring financial stability and their role had increasingly come to eliminate financial crises. The Bank of England used to adjust the discount rate to avoid the effects of crises and this technique was used by other European central banks as well. In the United States, a series of banking crises between 1836 and 1914 had led to the establishment of the Federal Reserve System. The experience of the Great Depression had a profound effect on banking regulation in several countries and commercial banks were progressively brought under the regulation of central banks. Thus, the prevention of systemic risk manifested by crises became the basic reason for central banks involvement with financial regulation and supervision.[footnoteRef:15] [15: Dr. Rakesh Mohan, Evolution of Central Banking in India, Deputy Governor at the seminar organized by the London School of Ecnonomics and the National Institute of Bank Management at Mumbai on January 24, 2006.]

The experience of some other countries in delegating the responsibility of bank regulation was totally different. Despite the occurrence of banking crises and the need for central banks intervention in resolving the crises, some countries established a separate regulatory authority outside the central bank to supervise the banking system, often several years before or after the creation of the central bank. The Canadian Government established the Office of the Inspector General of Banks in 1925 after the collapse of the Home Bank. The Bank of Canada was created nine years later. Canadas experience was not unique. A number of other countries, including Chile, Mexico, Peru, and the Scandinavian countries developed central banks and bank regulators completely separately. Thus, the experiences of countries in creating an appropriate structure and entrusting the responsibility of bank regulation and supervision vary considerably, although the basic motive has been to maintain systemic stability.[footnoteRef:16] [16: Financial Regulation and Supervision, RBI Publications, Available At: http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/69297.pdf Accessed On: 1/12/2012.]

The most strongly emphasised argument in favour of assigning supervisory responsibility to the central bank is that as a bank supervisor, the central bank will have firsthand knowledge of the condition and performance of banks. The central banks supervisory role makes it easier to get advance information from banks. This, in turn, can help it identify and respond to the emergence of a systemic problem in a timely manner. Furthermore, to the extent that the central bank acts as a lender of the last resort, it may be desirable that some regulatory and supervisory functions remain with central bank in order to limit moral hazard incentives and to have an intimate knowledge of the condition of banks, which can be acquired only through its participation in the supervisory process. This argument assumes that it is not possible for a third party, responsible for bank supervision, to transfer information effectively to the LoLR, particularly during financial instability. However, such a conflict of interest may also exist even when central bank is not the regulator and supervisor for banks as the central bank will always endeavour to maintain the stability of the financial system. The conflict could become particularly acute during an economic downturn in that the central bank may be tempted to pursue a too-loose monetary policy to avoid adverse effects on bank earnings and credit quality, and/or encourage banks to extend credit more liberally than warranted based on credit quality conditions to complement an expansionary monetary policy.In recent years, there has been a trend of passing over banking regulation from the central banks to other agencies. Under this arrangement, central banks are assigned the task of monetary policy and also remain lenders of last resort. This phenomenon has occurred in a few countries, notably Great Britain, Japan and South Korea. Countries which belong to the European Monetary Union (EMU) havede factoadopted this system since monetary policy is now carried out at the federal level (the European Central Bank), while banking supervision is undertaken at the national level.CHAPTER VRESERVE BANK OF INDIA: MONETARY POLICY AND INSTRUMENTSThe objectives of the monetary policy are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. Stability for the national currency (after looking at prevailing economic conditions), growth in employment and income are also looked into. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications. The common objective of any kind of monetary policy is the stability in the economy and price stability. It depends on the prevailing conditions of the countrys economy, as what economic policy will be pursued by the RBI, which is the controlling authority of India through its various instruments. In case of inflationary situation, excess aggregate demand, contractionary policy is followed, interest rates are being raised and reserve requirements are being increased to ensure that there is no excess money or demand in the economy leading to demand pull inflation. In case of deflationary situation or depression, or when there is situation of cyclical unemployment in the country, expansionary policy is to be followed by the economy, in which interest rates are kept low to make credit cheap so as to increase the demand in the economy for the goods and services.[footnoteRef:17] [17: Report of the Working Group on Conflicts of Interest in the Financial Sector, RBI Publications, Available At: http://rbidocs.rbi.org.in/rdocs/Content/PDFs/68210.pdf Accessed on: 1/12/2012.]

Monetary policy instruments: quantitative & qualitativePrincipal instruments of monetary policy or credit control of the central bank of a country are broadly classified as: (a) Qualitative Instruments and (b) Quantitative Instruments. Qualitative Instruments affects the quantum of money, whereas Qualitative Instruments focus on the particular areas which are effected by the problems discussed above. Quantitative Instruments refers to those instruments of monetary policy which affect overall money supply/credit in the economy. These instruments do not direct or restrict the flow of credit to some specific sectors of the economy. Few recognized and most used quantitative instruments are as follows:a) Interest Rates: The bank rate is the minimum rate at which the central bank of a country as a lender of last resort is prepared to give credits to the commercial banks.[footnoteRef:18] The increase in bank rate increases the rate of interest and credit becomes dear. Accordingly, the demand for credit is reduced and thus money power or purchasing power is reduced. This course of action is under contractionary policy to handle inflation. On the other hand, decrease in the bank rate lowers the market rate of interest charged by the commercial banks from their borrowers. Credit becomes cheap and money becomes easily available to spend and thus demand in the economy for goods and services increases and controls deflationary situation. Bank rate is the minimum rate. The related interest rates which are controlled by the RBI is Repo Rate and Reverse Repo Rate. [18: Instruments of Monetary Policy, Reserve Bank of India, accessed March 21, 2011.]

Repo Rate is the current rate, not the minimum rate.[footnoteRef:19] Funds are taken by the commercial banks on the Repo Rate for overnight and fortnight requirements to maintain mandatory cash reserves. The effect and operation of Repo Rate is same as Bank Rate in regard the monetary policy. Effect of Repo Rate is generally not shifted to the public in general, it is absorbed, but as it is dependent on Bank Rate, and Bank Rate is shifted to public through primary function of advancing loan of the commercial banks. [19: Ibid.]

Reverse Repo Rate is the another form of interest rate, this is the rate at which central bank pays interest to the money deposited in the central bank by the commercial banks.[footnoteRef:20] If RBI decides to pay more interest, commercial banks would deposit more money with central bank, which will decrease the availability of money for the credit to public by commercial banks, resulting in decreasing money supply. [20: Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), Master Circular, Reserve Bank of India, 2011, accessed 18th March, 2011.]

b) Liquidity Rates: It is humbly submitted that liquidity rates are of two types, Statutory Liquidity Ratio and Cash Reserve Ratio. Cash Reserve Ratio (CRR) refers to the minimum percentage of a banks total deposits required to be kept with central bank.[footnoteRef:21] Commercial banks have to keep with the central bank a certain percentage of their deposits in the form of cash reserves as a matter of law. For example: If the minimum reserve ratio is 10 per cent and total deposits of HDFC bank is ` 1000 Crores, it will have to keep `100 crores with RBI bank. Now, HDFC is left with ` 900 Crores to avail for the credit and to invest. If CRR increases by 5% or decreases by 5%, it will decrease and increase the availability of credit by ` 50 Crores. There is inverse relationship between these two. The maximum and minimum limits of CRR is 15 % and 3 % respectively. [21: Ibid.]

Statutory Liquidity Ratio (SLR): Every bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets.[footnoteRef:22] With a view to reducing the flow of credit in the market, the central bank increases this liquidity ratio. However, in case of expansion of credit, the liquidity ratio is reduced. Success of CRR and SLR again depends on the amount of excess reserves with the commercial banks. CRR and SLR would be rendered meaningless if banks are used to keeping high excess reserves. [22: Ibid.]

c) Open Market Operations: Open market operations refer to the sale and purchase of securities in the open market by the central bank.[footnoteRef:23] By selling the securities (like NSC bonds), the central bank withdraws cash balances from within the economy. And, by buying the securities, the central bank contributes to cash balances in the economy. [23: Supra Note 1, p. 82.]

Cash Balances are high powered money on the basis of which commercial banks create credit. Thus, through open market operations, if cash balances are increased, flow of credit will increase many times more, and if cash balances are reduced, the flow of credit will decrease many times more. Open Market Operations affects the quantity of money supply also by increasing and decreasing VM (Velocity of Money), which is multiplier while calculating money supply. The above discussed were the quantitative measures of monetary policy. Sometimes, just controlling the money supply or increasing supply does not result in price stability. The problem with the monetary supply is that they cannot achieve price stability, if the inflation is in one particular sector or part of the economy. It cannot do anything if one bank is not following the guidelines, sometimes there have to be harsh actions taken by central bank. a) Margin Requirements: The margin requirement of loan refers to the difference between the current value of the security offered for loans and the value of loans granted.[footnoteRef:24] Suppose, a person mortgages an article worth ` 100 with bank and bank gives him loan of ` 70. In this case, 30 % is the margin requirement. If the margin requirement is increased, it will decrease the availability of credit to a person. If the margin requirement is decrease, it will enable this person to get more loan for his assets value worth ` 100. [24: Ibid. p. 82.]

b) Rationing of Credit: Rationing of credit refers to fixation of credit quotas for different business activities.[footnoteRef:25] Rationing of credit is introduced when the flow of credit is to be checked particularly for speculative activities in the economy. The central bank fixes credit quota for different business activities. The commercial banks cannot exceed the quota limits while granting loans. [25: Ibid. p. 83.]

For example: Vehicle loans are safe for banks, whereas agricultural loans are considered unsafe by banks. If there is no rationing of credit, A commercial bank, if lets say Bank has ` 100 Crores to provide for loans. They would provide loans for safe avenues, and it would create money deficit in Agriculture Sector, which will create imbalance. Thus there are two types of quotas to be fixed, one is Minimum and another is maximum, for agriculture there will be minimum and for vehicle loans, there will be maximum quota to be fixed by RBI. c) Direct Action and Moral Suasion: The central bank may initiate direct action against the member banks in case these do not comply with its directives.[footnoteRef:26] Direct action includes derecoginition of a commercial bank as a member of the countrys bank system. Sometimes, the central bank makes the member banks agree through persuasion or pressure to follow its directives with a view to controlling the flow of credit. [26: Supra Note 4, p.145.]

This is hardly taken action due to fear of backlash from union of commercial banks. But certainly moral suasion is pursued.Factors affecting monetary policy:It is not necessary that whatever the monetary policy will be formulated by government or RBI will have the desired result, it may not have the desired result. It is dependent on other factors, such as non-institutionalized or scheduled financing sector, structure of businesses and mechanism use, and existence of investment market. Bank Rate is dependent on the commercial banks upon the central bank for loans is one of the factor, if commercial bank have their own surplus funds which they can utilize for high credit needs, their dependence will be effected by this. It is important to note that in India there is structure of financing created by Sahukars etc, which reaches to more public, even in remote areas of the sector. The interest rates followed by this structure of financing is totally unrelated. Open market operations are dependant on how the large sector companies are doing in the market. When money through NSCs goes to RBI, it is presumed to go out of the circular flow of economy, but when money is invested in PSUs they are considered safe as well as in the market. If the PSUs and Maha Navratnas Companies are performing good in the economy, the open market operations would not be launched by the RBI.

CHAPTER VCONCLUSIONIn theory, separation between the two functions would perhaps enhance the efficiency in monetary policy formulation and debt management, but the debate in the Indian context needs to recognize certain key dynamics of the fiscal-monetary nexus. First, in India, the joint policy initiatives by the Government and the RBI have facilitated good co-ordination between public debt management and monetary policy formulation. Wheres commitment to fiscal discipline and reduction in monetized deficit have imparted considerable autonomy to the operation of monetary policy, the proactive debt management by the RBI also facilitated the conduct of monetary policy, especially through the use of indirect instruments. In fact, the substantial stock of Government securities held by the RBI enabled it to sterilize the monetary impact of capital flows through open market operations since the late 1990s. In recent years, with the reversal in the interest rate cycle, the RBI was able to prescribe higher risk weights on assets to protect the balance sheet of the banks. This step certainly ensured financial stability for the economy. Second, the RBIs experience in managing public debt over the years has equipped it with the requisite technical capacity of efficiently fulfilling the twin responsibilities of debt and monetary management in tune with requirements of the Government and market conditions. The RBI has been making efforts to develop the money and government securities market since 1988 and has gained valuable experience and knowledge about related markets. This may have been difficult to accomplish if the debt management function had been effectively separate. With all of these changes taking place in the monetary fiscal environment in the near future, there will be great need for a continued high degree of coordination in debt management between RBI and the Government. In fact, in the U.S., even though debt management is formally done by the Treasury, the close co-operation that actually exists between the Federal Reserve Bank of New York and the Treasury is not very different in function from the relationship between the RBI and the Government in its debt management function.The evaluation of our experience therefore supports the position that a pragmatic view needs to be taken on this issue keeping in mind the specific institutional context of a particular country in mind.17