BBA 1st Year Business Environment FEMA Long Question Answer

(iii) In underdeveloped countries where banking system is not well developed, securities and capital markets are not interdependent.

(iv) The popularity of government bonds and securities with the public also matters a lot. The government debt instruments are not popular because of low rate of return. Central Bank has then to use coerc4ve power measures and force the Commercial Banks to buy the government bonds as is the case in India.

[8JBank Rate Policy

Bank rate is the rate in which the Central Bank rediscount the first class bills of exchange presented by commercial banks.

The RBI act defines, “bank rate” as the, standard rate at which the bank is prepared to buy bills of exchange or other commercial papers, eligible to purchase under this Act.
The Central Bank can change this rate-increase or decrease-depending on what it wants to do, i.e., expand or contract the flow of credit from the Commercial Bank. The bank rate policy was first adopted by the bank of England in 1839.

The working of the discount rate policy is simple. When the Central Bank changes its own discount rate, Commercial Banks change their discount rate too. This is when the Central Bank raises its discount rate, Commercial Banks raises their discount rates too and vice versa. As for example, during inflation RBI increase the bank rate and during deflation RBI decrease the bank rate.

[C] The Cash Reserve Ratio or Satutory Reserve Ratio

It is the percentage of total deposits which commercial banks are required to maintain in the form of cash reserve with the Central Bank.
The main objective is to prevent shortage of cash in meeting the demand of cash depositors.
By changing the CRR, the central bank can change the money supply over night. Central Bank raises the CRR when conditions demand contraction in monetary conditions; and decreases the CRR, when conditions demand expansion of money. Limitations of CRR: (i) Its effectiveness is limited by the existence of unorganized banking sector.

(ii) It proves more handy where open market operation and bank rate policy prove less effective.

(iii) Its effectiveness depends upon the share of the banking credit in the credit market.

(iv) CRR is relatively more effective in the advanced countries with advanced banking system accounting for a major share in the capital market.

Qualitative or Selective Credit Controls

The qualitative or selective credit control measures are resorted to, when RBI intends to control the use of credit. Its impact is uniform on all the sectors of the economy.

The monetary are often faced with the problems of:

(i) Rationing the credit.

(ii) Diverting the flow of credit from the non-priority sectors to the priority ones.

(iii) Curbing speculative tendency based on the availability of bank credit.

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