Money, Banking and the RBI

Functions of money

Medium of exchange, measure of value, store of value and standard of deferred payment.

Money supply measures (RBI)

• M1 (narrow money) = currency with the public + demand deposits with banks + other deposits with RBI.
• M3 (broad money) = M1 + time deposits with banks. M3 is the most commonly used measure.

Reserve Bank of India

• Established on 1 April 1935 under the RBI Act, 1934; nationalised in 1949.
• Functions: issuer of currency (except ₹1 notes and coins, issued by the Government), banker to the Government, banker's bank, custodian of forex reserves, regulator of banks.

Monetary policy tools

• Repo rate: rate at which RBI lends short-term funds to banks.
• Reverse repo / SDF: rate at which RBI absorbs surplus liquidity.
• CRR: share of deposits banks must keep with RBI as cash.
• SLR: share of deposits banks must hold in liquid assets (cash, gold, approved securities).
• Open Market Operations (OMO): buying/selling government securities.

Raising CRR or repo rate reduces liquidity (tight policy); cutting them increases it.

Monetary Policy Committee (MPC)

Six members (3 from RBI incl. Governor, 3 external). Flexible inflation target: CPI inflation 4% ± 2%.

Prelims pointers

1. Bank nationalisation: 14 banks in 1969, 6 more in 1980.
2. Distinguish quantitative tools (CRR, SLR, repo, OMO) from qualitative ones (margin requirements, moral suasion).

Analogy

The RBI works like the main valve of a city's water supply. Banks are the pipes to homes. Raising the repo rate or CRR tightens the valve — less money flows to borrowers and prices cool down. Cutting them opens the valve, pushing more money through the pipes to boost growth.