Page 125 - DMGT401Business Environment

Business Environment

Notes 4. Cash Reserve Ratio (CRR)
5. Statutory Liquidity Ratio (SLR)
6. Direct Credit Allocation and Credit Rationing
7. Selective Credit Controls (SCC)
8. Credit Authorisation Scheme (CAS)
9. Fixation of Inventory and Credit Norms

10. Credit Planning
11. Moral Suasion
12. Liquidity Adjustment Facility (LAF)
1. Open Market Operations: Open market operations involve the sale and purchase of
government securities by the RBI to influence the volume of cash reserve with commercial
banks and thus influence the volume of loans and advances they can make to the industrial
and commercial sectors. The environment for open market operations is quite favourable
because the government securities market is fairly developed in the country. At present,
the RBI is authorised to conduct purchase and sale operations in government securities,
treasury bills and other approved securities.
The RBI is also empowered to buy and sell short-term commercial bills. Through the sale
of securities the RBI withdraws a part of the deposit resources of the banking sector,
thereby reducing resources available with the banks for lending. This reduces the supply
of money, which in turn reduces inflation. The opposite happens when the RBI purchases
securities. The stock of securities with the seller banks is reduced and the cash with them
expands. This augments the credit-creating capacity of banks, reducing the interest rates
and increasing the level of investment. Some monetary economists and bankers assert
that the bank rate policy and open market operations are complementary measures in the
realm of monetary management.
Open Market Operations have both monetary policy and fiscal policy goals. Their multiple
objectives include: (a) To control the amount of and changes in bank credit and monetary
supply through controlling the reserve base of banks, (b) To make bank rate policy more
effective, (c) To maintain stability in government securities market, (d) To support
government borrowing programme, (e) To smoothen the seasonal flow of funds in the
bank credit market.
2. Bank Rate: The bank rate is also known as discount rate. It is the rate at which the central
bank discounts, or more accurately rediscounts, eligible bills.
In a broader sense it refers to the minimum rate at which the central bank provides
financial accommodation to commercial banks in the discharge of its function as the
lender of the last resort. The bank rate is the basic cost of refinance and rediscounting
facilities. Section 49 of the RBI Act, 1934 defines it as the standard rate at which the Bank is
prepared to buy or rediscount bills of exchange or other eligible commercial paper. The
technique of bank rate and discretionary control of refinance are used to regulate the cost
and availability of refinance, and to change the volume of lendable resources of banks and
other financial institutions.
If monetary policy is effective, then change in bank rate affects the prime-lending rate.
Any increment in bank rate means that now the RBI will charge higher interest rate from
banks against the advances, so it results in the increment in the interest rate charged by
commercial banks. This results in low level of investment and low level of inflation. To
control inflation, bank rate was increased to 12% from 10% in 1991.

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