RBI and Monetary Policy: Functions, MPC and Credit Control

The correct answer is A, the Hilton Young Commission. This body, formally the Royal Commission on Indian Currency and Finance, reported in 1926 and recommended the creation of a central bank separated from the government. Its recommendation led to the Reserve Bank of India Act, 1934, under which the Bank began work on 1 April 1935.

Option B, the Chamberlain Commission of 1913 and 1914, also examined Indian currency and finance and had John Maynard Keynes as a member, but the central bank it discussed was not set up, which makes it the standard distractor. Option C, the Fowler Committee of 1898, dealt with the gold standard question in India. Option D, the Narasimham Committee, belongs to the era of reform after 1991 and made recommendations on the banking sector, long after the Reserve Bank existed.

The correct answer is B, 1 January 1949. The Bank began as a shareholders' institution, and the Reserve Bank (Transfer to Public Ownership) Act, 1948 transferred its shares to the central government with effect from the first day of 1949, since when it has been fully owned by the Government of India.

Option A, 1 April 1935, is the date the Bank began operations under the Act of 1934, not the date of nationalisation, and mixing the two is the commonest error in this question. Option C is the date of independence and has no connection with the ownership of the Bank. Option D, 19 July 1969, is the date on which fourteen major commercial banks were nationalised, a separate event; six more were nationalised in 1980.

The correct answer is B. In a repurchase agreement a bank sells government securities to the Reserve Bank and agrees to buy them back the next day at a fixed price; the difference is the interest, and the rate is the repo rate. It is the policy rate announced by the Monetary Policy Committee, so a change in it moves the whole structure of short term interest rates.

Option A describes the reverse repo rate, under which banks lend their surplus to the central bank, and the standing deposit facility now performs the same absorbing role. Option C describes a lending rate to customers, such as the benchmark rate to which a bank links its loans, which is set by the bank and not by the Reserve Bank. Option D describes government borrowing through the sale of dated securities, which the Bank manages as debt manager but which is not the repo rate.

The correct answer is C, six. Three of them come from the Reserve Bank, the Governor as chairperson, the Deputy Governor in charge of monetary policy and an officer of the Bank nominated by the Central Board, and three are appointed by the central government from among persons of ability and integrity with knowledge of economics, banking or finance.

Option A, four, is the quorum for a meeting rather than the strength of the Committee, which is why it is offered here. Option B and option D are simply wrong numbers, though seven tempts candidates who count the Governor twice, once as chairperson and once as a member. Decisions are taken by a majority of members present and voting, and if the votes are equally divided the Governor has a second or casting vote, which is possible only with an even number of members.

The correct answer is A, the Finance Act, 2016. It amended the Reserve Bank of India Act, 1934 to insert the provisions on the inflation target and on the Monetary Policy Committee, so that the policy rate is now set by a committee and not by the Governor alone, and the framework of flexible inflation targeting became law.

Option B, the Banking Regulation Act, 1949, gives the Bank its powers to license, regulate and supervise banks and prescribes the statutory liquidity ratio, but it does not deal with the Committee. Option C, the Fiscal Responsibility and Budget Management Act, 2003, sets targets for the fiscal deficit and government debt, which is fiscal and not monetary policy, and it is the usual trap here. Option D, the Foreign Exchange Management Act, 1999, replaced the older foreign exchange law and governs transactions in foreign exchange.

The correct answer is A, Section 42 of the Reserve Bank of India Act, 1934. It requires every scheduled bank to keep with the Reserve Bank a cash balance calculated on its net demand and time liabilities, and this proportion is the cash reserve ratio. Since the amendment of 2006 the Bank may set the ratio without any statutory floor or ceiling.

Option B, Section 24 of the Banking Regulation Act, 1949, prescribes the statutory liquidity ratio, the share of liabilities that a bank must hold in cash, gold and approved securities with itself, and the pairing of the two sections is the favourite trap in banking papers. Option C, Section 22 of the Reserve Bank of India Act, gives the Bank the sole right of note issue. Option D governs dealings in foreign exchange and has nothing to do with reserve requirements.

The correct answer is B, margin requirements. A margin requirement is the part of the value of a security that the borrower must fund from his own resources; by raising it for loans against a particular commodity the Bank can discourage credit flowing into speculation in that commodity without touching the total supply of credit. That is why it is called a qualitative or selective instrument.

Option A, open market operations, changes the quantity of money by the purchase or sale of government securities. Option C, the cash reserve ratio, changes the quantity of funds a bank can lend. Option D, the repo rate, changes the price of credit for the whole economy. All three act on the volume of credit and are therefore quantitative, while moral suasion, rationing of credit, consumer credit regulation and direct action join margin requirements on the qualitative side.

The correct answer is B, the Finance Secretary. The one rupee note is not a Reserve Bank note at all: it is issued by the Government of India through the Ministry of Finance, is a legal tender note of the government and carries the signature of the Finance Secretary. All coins are likewise minted and issued by the government.

Option A is wrong for the one rupee note, though the Governor does sign every note of two rupees and above, which the Bank issues under Section 22 of its Act; the distinction is the whole point of the question. Option C is wrong because the Finance Minister signs no currency note. Option D is wrong because a Deputy Governor signs no currency note either, although Deputy Governors sign other instruments of the Bank and sit on the Monetary Policy Committee.

The correct answer is A. Under the minimum reserve system adopted in 1957 the Bank keeps assets of at least two hundred crore rupees against the notes it issues, of which gold must be worth at least one hundred and fifteen crore rupees and the rest is held in foreign securities. The system replaced the proportional reserve system, under which a fixed proportion of the notes in circulation had to be backed by gold and sterling, and it freed note issue from that limit.

Option B inverts the figures, taking the gold component as the total. Option C is wrong because the whole reserve is not in gold; only the smaller part is. Option D uses figures that belong to no stage of the system and is offered to catch a candidate who remembers only that the number is large.

The correct answer is A. A higher repo rate raises the cost at which banks borrow from the Reserve Bank, so they raise their own lending rates. Loans become dearer, households and firms borrow and spend less, the growth of credit and of money supply slows, and the pressure of demand on prices eases. This is called a dear money or contractionary policy.

Option B states the effect of a cut in the repo rate, the easy money policy used to support growth when inflation is low. Option C is wrong because the fiscal deficit is decided by the government's own taxing and spending; indeed dearer credit raises the government's interest bill. Option D is wrong because the statutory liquidity ratio is a separate instrument under the Banking Regulation Act and does not move automatically with the policy rate.