RAMAIAH INSTITUTE OF MANAGEMENT

(POST GRADUATE DIPLOMA IN MANAGEMENT)

ASSIGNMENT ON
Role of Central bank - Comparison
between USA and INDIA

Submitted to: Submitted By:

Prof. Praveen Kumar Hemanth C Reddy (191454)
Batch 2019-21
 Reserve Bank of India
Establishment:

The Reserve Bank of India was established in 1935 under the provisions of the Reserve Bank
of India Act, 1934 in Calcutta, eventually moved permanently to Mumbai. Though originally
privately owned, was nationalized in 1949.

Organisation and Management:

The Reserve Bank’s affairs are governed by a central board of directors. The board is
appointed by the Government of India for a period of four years, under the Reserve Bank of
India Act.

 Full-time officials: Governor and not more than four Deputy Governors. The current
Governor of RBI is Mr. Urjit Pattel.
There are 3 Deputy Governors presently – B P Kanungo, N S Vishwanathan and Viral
V Acharya.
 Nominated by Government: ten Directors from various fields and two government
Officials
 Others: four Directors – one each from four local boards

Main Role and Functions of RBI

 Monetary Authority: Formulates, implements and monitors the monetary policy for
A) maintaining price stability, keeping inflation in check; B) ensuring adequate flow of
credit to productive sectors.
 Regulator and supervisor of the financial system: lays out parameters of banking
operations within which the country’s banking and financial system functions for-
A) maintaining public confidence in the system, B) protecting depositors’ interest ; C)
providing cost-effective banking services to the general public.
 Regulator and supervisor of the payment systems: A) Authorises setting up of
payment systems; B) Lays down standards for working of the payment system; C) lays
down policies for encouraging the movement from paper-based payment systems to
electronic modes of payments. D) Setting up of the regulatory framework of newer
payment methods. E) Enhancement of customer convenience in payment systems. F)
Improving security and efficiency in modes of payment.
 Manager of Foreign Exchange: RBI manages forex under the FEMA- Foreign
Exchange Management Act, 1999. in order to A) facilitate external trade and payment
B) promote the development of foreign exchange market in India.
 Issuer of currency: RBI issues and exchanges currency as well as destroys currency
& coins not fit for circulation to ensure that the public has an adequate quantity of
supplies of currency notes and in good quality.
 Developmental role: RBI performs a wide range of promotional functions to support
national objectives. Under this its setup institutions like NABARD, IDBI, SIDBI, NHB,
etc.
 Banker to the Government: performs merchant banking function for the central and
the state governments; also acts as their banker.
  Banker to banks: An important role and function of RBI is to maintain the banking
accounts of all scheduled banks and acts as the banker of last resort.
 An agent of Government of India in the IMF.

Offices and Training Centres:

1. RBI has 20 regional offices, most of them in state capitals and 11 Sub-offices. So, the
RBI has its offices at 31 locations.
2. Has five training establishments – Two, College of Agricultural Banking and Reserve
Bank of India Staff College are part of the Reserve Bank. Other three are
autonomous, National Institute for Bank Management; Indira Gandhi Institute for
Development Research (IGIDR); Institute for Development and Research in Banking
Technology (IDRBT).

Instruments of Monetary Policy of RBI:

As discussed earlier, RBI executes Monetary Policy for Indian Economy. The RBI formulates,
implements and monitors the monetary policy. The Monetary Policy Committee (MPC) is
entrusted with the task of fixing the benchmark policy interest rate (repo rate) for inflation
targeting.

The main objectives of monitoring monetary policy are:

 Maintaining price stability while keeping in mind the objective of growth

 Inflation control (containing inflation at 4%, with a standard deviation of 2%)
 Control on bank credit
 Interest rate control

The monetary policy (credit policy) of RBI involves the two instruments given in the flow chart
below:

Quantitative Measures

Quantitative measures refer to those measures that affect the variables, which in turn affect the
overall money supply in the economy.
Instruments of quantitative measures:

Bank rate

The rate at which central bank provides loan to commercial banks is called bank rate. This
instrument is a key at the hands of RBI to control the money supply in long term lending. At
present it is 6.25%.

 Increase in the bank rate will make the loans more expensive for the commercial banks;
thereby, pressurizing the banks to increase the rate of lending. The public capacity to
take credit at increased rates will be lower, leading to a fall in the volume of credit
demanded.
  The reverse happens in case of a decrease in the bank rate. This increases the lending
capacity of banks as well as increases public demand for credit and hence will
automatically lead to a rise in the volume of credit flowing in the economy.
 This rate has been aligned to the MSF rate and hence, changes automatically with the
MSF rate changes alongside policy repo rate changes.

Liquidity Adjustment Facility-

Reserve Bank of India’s LAF helps banks to adjust their daily liquidity mismatches. LAF has
two components – repo (repurchase agreement) and reverse repo.

(i) Repo Rate: Repo (Repurchase) rate is the rate at which the RBI lends short-term money to
the banks against securities. When the repo rate increases borrowing from RBI becomes more
expensive. Repo rate is always higher than the reverse repo rate. At present it is 6.00%

(ii) Reverse Repo Rate: It is the exact opposite of repo. In a reverse repo transaction, banks
purchase government securities form RBI and lend money to the banking regulator, thus
earning interest. Reverse repo rate is the rate at which RBI borrows money from banks.The
banks use this tool when they feel that they are stuck with excess funds and are not able to
invest anywhere for reasonable returns. At present it is 5.75%

(iii)Marginal Standing Facility (MSF): was introduced by the Reserve Bank of India (RBI)
in its Monetary Policy (2011-12). The MSF would be a penal rate for banks and the banks can
borrow funds by pledging government securities within the limits of the statutory liquidity ratio
SLR.
The scheme has been introduced by RBI for reducing volatility in the overnight lending rates
in the inter-bank market and to enable smooth monetary transmission in the financial
system. Currently, it is 6.25%

Varying reserve ratios –

The reserve ratio determines the reserve requirements that banks are liable to maintain with
the central bank. These tools are:

(i) Cash Reserve Ratio (CRR)

It refers to the minimum amount of funds in cash (decided by the RBI) that a commercial
bank has to maintain with the Reserve Bank of India, in the form of deposits. An increase in
this ratio will eventually lead to considerable decrease in the money supply. On the contrary,
a fall in CRR will lead to an increase in the money supply. Currently, it is 4%.

(ii) Statuary Liquidity Ratio (SLR)

SLR is concerned with maintaining the minimum percentage (fixed by RBI) of assets in the
form of non-cash with itself. The flow of credit is reduced by increasing this liquidity ratio
and vice-versa. As SLR rises the banks will be restricted to pump money in the economy,
thereby contributing towards a decrease in money supply. The reverse case happens if there is
a fall in SLR, it increases the money supply in the economy. Currently, SLR is 19.5%.

Open Market Operations (OMOs)

These include both, outright purchase and sale of government securities, for both, injection and
absorption of liquidity in the economy.

Market Stabilisation Scheme (MSS)

This instrument was introduced in 2004. Surplus liquidity of a more enduring nature arising
from large capital inflows is absorbed through sale of short-dated government securities and
treasury bills. The cash so mobilised is held in a separate government account with the Reserve
Bank.
 The role of FEDERAL BANK IN USA
The Federal Reserve System, also known as "The Fed," is America's central bank.1 That makes
it the most powerful single actor in the U.S. economy and thus the world. It is so complicated
that some consider it a "secret society" that controls the world's money. They’re right. Central
banks do manage the money supply around the globe. But there is nothing secret about it.

System Structure

To understand how the Fed works, you must know its structure. The Federal Reserve System
has three components. The Board of Governors directs monetary policy. Its seven members are
responsible for setting the discount rate and the reserve requirement for member banks. Staff
economists provide all analyses. They include the monthly Beige Book and the semi-
annual Monetary Report to Congress.

The Federal Open Market Committee (FOMC) oversees open market operations. That includes
setting the target for the fed funds rate, which guides interest rates. The seven board members,
the president of the Federal Reserve Bank of New York, and four of the remaining 11 bank
presidents are members. The FOMC meets eight times a year.

The Federal Reserve Banks work with the board to supervise commercial banks and implement
policy. There is a Fed bank located in each of their 12 districts.2

What the Federal Reserve Does

The Federal Reserve has four functions. Its most critical and visible function is to
manage inflation and maintain stable prices. It sets a 2 percent inflation target for the core
inflation rate.

Why is managing inflation so important? Ongoing inflation is like cancer that destroys any
benefits of growth.

Second, the Fed supervises and regulates many of the nation’s banks to protect consumers.
Third, it maintains the stability of the financial markets and constrains potential crises. Fourth,
it provides banking services to other banks, the U.S. government, and foreign banks.

The Fed performs its functions by conducting monetary policy. The goal of monetary policy
is healthy economic growth. That target is a 2 to 3 percent gross domestic product growth rate.
It also pursues maximum employment. The goal is the natural rate of unemployment of 4.7 to
5.8 percent.

1. Manages Inflation

The Federal Reserve controls inflation by managing credit, the largest component of
the money supply. This is why people say the Fed prints money. The Fed moderates long-term
interest rates through open market operations and the fed funds rate.

When there is no risk of inflation, the Fed makes credit cheap by lowering interest rates. This
increases liquidity and spurs business growth. That ultimately reduces unemployment. The Fed
monitors inflation through the core inflation rate, as measured by the Personal Consumption
Expenditures Price Index. It strips out volatile food and gas prices from the regular inflation
rate. Food and gas prices rise in the summer and fall in the winter. That's too fast for the Fed
to manage.

The Federal Reserve uses expansionary monetary policy when it lowers interest rates. That
expands credit and liquidity. These make the economy grow faster and create jobs. If the
economy grows too much, it triggers inflation. At this point, the Federal Reserve
uses contractionary monetary policy and raises interest rates. High-interest rates make
borrowing expensive. Increased loan costs slow growth and decrease the likelihood of
businesses raising prices. The major players in the fight against inflation are the Federal
Reserve chairs. These are the heads who manage the Fed’s interest rates.

The Fed has many powerful tools. It sets the reserve requirement for the nation's banks. It states
that banks must hold at least 10 percent of their deposits on hand each night. This percentage
is less for smaller banks. The rest can be lent out.

If a bank doesn't have enough cash on hand at the end of the day, it borrows what it needs from
other banks. The funds it borrows is known as the fed funds. Banks charge each other the fed
funds rate on these loans.

The FOMC sets the target for the fed funds rate at its monthly meetings. To keep it near its
target, the Fed uses open market operations to buy or sell securities from its member banks. It
creates the credit out of thin air to buy these securities. This has the same effect as printing
money. That adds to the reserves the banks can lend and results in the lowering of the fed funds
rate. Knowledge of the current fed funds rate is important because this rate is a benchmark in
financial markets.

2. Supervises the Banking System

The Federal Reserve oversees roughly 5,000 bank holding companies, 850 state bank members
of the Federal Reserve Banking System, and any foreign banks operating in the United States.
The Federal Reserve Banking System is a network of 12 Federal Reserve banks that both
supervise and serve as banks for all the commercial banks in their region.3

The 12 banks are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta,
Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. The Reserve Banks
serve the U.S. Treasury by handling its payments, selling government securities, and assisting
with its cash management and investment activities. Reserve banks also conduct valuable
research on economic issues.

The Dodd-Frank Wall Street Reform Act strengthened the Fed's power over banks. If any bank
becomes too big to fail, it can be turned over to Federal Reserve supervision.4 It will require a
higher reserve requirement to protect against any losses.

Dodd-Frank also gave the Fed the mandate to supervise "systematically important institutions."
In 2015, the Fed created the Large Institution Supervision Coordinating Committee.5 It
regulates the 16 largest banks. Most important, it is responsible for the annual stress test of 31
banks.6 These tests determine whether the banks have enough capital to continue making loans
even if the system falls apart as it did in October 2008.
In 2018, President Trump signed a bill that weakened Dodd-Frank. The Economic Growth,
Regulatory Relief, and Consumer Protection Act eased regulations on "small banks."7 These
are banks with assets from $100 billion to $250 billion.8

The rollback means the Fed can't designate these banks as too big to fail.9 They no longer have
to hold as much in assets to protect against a cash crunch. They also may not be subject to the
Fed's "stress tests."1 0 In addition, these smaller banks no longer have to comply with the
Volcker Rule. Now banks with less than $10 billion in assets can, once again, use depositors'
funds for risky investments.

3. Maintains the Stability of the Financial System

The Federal Reserve worked closely with the Treasury Department to prevent global financial
collapse during the financial crisis of 2008. It created many new tools, including the Term
Auction Facility, the Money Market Investor Funding Facility, and Quantitative Easing. For a
blow-by-blow description of everything that happened while it was going on, the article
discussing federal intervention in the 2007 banking crisis gives a clear account.

Two decades earlier, the Federal Reserve intervened in the Long Term Capital Management
Crisis. Federal Reserve actions worsened the Great Depression of 1929 by tightening the
money supply to defend the gold standard.

4. Provides Banking Services

The Fed buys U.S. Treasurys from the federal government. That's called monetizing the debt.
The Fed creates the money it uses to buy the Treasurys. It adds that much money to the money
supply. Over the past 10 years, the Fed has acquired $4 trillion in Treasurys.

The Fed is called the "bankers' bank." That is because each Reserve bank stores currency,
processes checks, and makes loans for its members to meet their reserve requirements when
needed. These loans are made through the discount window and are charged the discount rate,
one that is set at the FOMC meeting. This rate is lower than the fed funds rate and Libor. Most
banks avoid using the discount window because there is a stigma attached. It is assumed the
bank can't get loans from other banks. That's why the Federal Reserve is known as the bank of
last resort.1 1

History

The Panic of 1907 spurred President Woodrow Wilson to create the Federal Reserve System.
He called for a National Monetary Commission to evaluate the best response to prevent
ongoing financial panics, bank failures, and business bankruptcies. Congress passed the
Federal Reserve Act of 1913 on December 23 of that year.

Congress originally designed the Fed to "provide for the establishment of Federal Reserve
banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to
establish a more effective supervision of banking in the United States, and for other
purposes." Since then, Congress has enacted legislation to amend the Fed's powers and
purpose.
Congress created the Fed's board structure to ensure its independence from politics. Board
members serve staggered terms of 14 years each. The president appoints a new one every two
years. The U.S. Senate confirms them. If the staggered schedule is followed, then no president
or congressional party majority can control the board.

This independence is critical. It allows the Fed to focus on long-term economic goals. It can
make all decisions based solely on economic indicators. No president can pressure members to
keep interest rates low and overstimulate the economy.

President Trump is the first president in history to question that independence.1 2 In 2018, he
publicly criticized the Fed for raising interest rates. He said higher rates slow growth and offset
his attempts to spur the economy. When asked to name the single greatest threat to growth, he
blamed the Fed.

This is despite the fact that Trump nominated six of the seven members. The Senate has
confirmed three of them. Trump inherited this rare opportunity to stack the Fed board in his
favor.1 3 The chair position came up for reappointment during his term. Three board positions
were already vacant, including the vice-chair position. Two of them have been vacant since the
financial crisis.1 4

Who Owns the Fed

Technically, member commercial banks own the Federal Reserve. They hold shares of the 12
Federal Reserve banks. But that doesn't give them any power because they don't vote. Instead,
the Board and FOMC make the Fed's decisions. The Fed is independent because those decisions
are based on research. The president, U.S. Treasury Department, and Congress don't ratify its
decisions. But, the board members are selected by the president and approved by Congress.
That gives elected officials control over the Fed's long-term direction but not its day-to-day
operations.

Some elected officials are still suspicious of the Fed and its ownership. They want to abolish it
altogether. Senator Rand Paul wants to control it by auditing it more thoroughly. His father,
former Congressman Ron Paul, wanted to end the Fed.

Role of the Fed Chair

The Federal Reserve Chair sets the direction and tone of both the Federal Reserve Board and
the FOMC. President Trump appointed Board member Jerome Powell to be the chair from
February 5, 2018, to February 5, 2022.1 5 He is continuing the Fed's normalizing policies.

The former chair is Janet Yellen. Her term began on February 3, 2014, and ended on February
3, 2018. Her biggest concern had been unemployment, which is also her academic specialty.
That made her "dovish" rather than “hawkish.” That meant she was more likely to want to
lower interest rates. Ironically, she was the chair when the economy required contractionary
monetary policy.

Ben Bernanke was the chair from 2006 to 2014. He was an expert on the Fed's role during the
Great Depression. That was very fortunate. He knew the steps to take to end the Great
Recession. He kept the economic situation from turning into a depression.
How the Fed Affects You

The press scrutinizes the Federal Reserve for clues on how the economy is performing and
what the FOMC and Board of Governors plan to do about it. The Fed directly affects your
stock and bond mutual funds and your loan rates. By having such an influence on the economy,
the Fed also indirectly affects your home's value and even your chances of being laid off or
rehired.

The Bottom Line

The Federal Reserve is the U.S. central bank. It is independent of governing bodies such as
Congress, Senate, and the Executive Office. It was created to be autonomous and separate from
the political structure.

Three components comprise the Fed’s organization:

 Board of Governors – controls monetary policy and sets the reserve requirements and
discount rates of banks.
 FOMC – sets the fed funds rates and oversees other open market operations.
 Federal Reserve branches – 12 branches that manage the banking system.

Four major functions define the Federal Reserve. These are:

 Managing inflation, its most important objective.

 Regulating and monitoring the banking system.
 Maintaining stability of financial markets.
 Providing banking services for the U.S. government and banks, both domestic and
foreign.