RBI Governor changed - How does it matter?

[Karan Gogia]

You must have realized by now that Mr Rajan exit has been seen via different lenses. Lot of rumors are coming in and some looks really promising.

Here my idea for writing this article is not to indulge you in one more rumor but to help you understand how does it matter if Mr X or Mr Y is appointment as RBI Governor. What does RBI or its governor really do? and why it important? To whom it matters?

RBI has following functions to perform.

 

Not sure what exactly these financial jargon means. Stay on with me. I will take it one by one in your language.

Currency Manager - Central bank has a unique power, at the same time a unique responsibility to issue the currency notes. Can any other bank in India print currency??- Ans is NO. So this is the first reason you should know about central bank. Can central bank print any amount of currency as is wish to? Formal answer is NO because it is guided by lot of other variable which i will discuss in my later post in very detail. RBI has a separate department for issuing of currency and its assets and liabilities are kept separate from the other assets and liabilities arise due to other function  of central bank namely the Banking function.

Does central bank earn any profit when it print the money?? - Ans is yes. Then what RBI do with this profit?? Now hold on your breath. This profit goes to government of India. Yes it is government of India who owns the central bank and is entitled to any surplus generated by central bank. This profit is called Seigniorage.

Now Lets take on the 2nd function.

Banker - Central bank is essentially a bank but for whom? for you and me? - Ans is NO. Central bank is a bank for the government and the other banks. To put it in simple words it is very much similar to bank in your corner street where you hold your saving/FD account. You deposit money with the bank and take loans from the bank when required. Same way your bank and your elected government deposit their surplus funds with the Central bank and take loan whenever required. This looks simple???right??- Actually it is not. Just think from the angle that how about you own the bank where you have saving/FD account? What will you do??. This is true for central government which owns central bank and deposit and take loan from the central bank. Now take a deep breath and imagine a situation where you are the creator of the money and there are other banks standing in a queue asking for loans. Got tensed?? This is what commercial bank has to manage and has to see when and how much  money to give.

Managing banking System - Just think you got some money with you or say you don't have any money. Can you open a bank of your own and start taking money from your neighborhood and start grating loan to the people who needs it. - The ans is yes?? but will it be legal - Ans is big NO. Banks has a job of a nature of trustee where it hold people money with a trust(no security) that it will pay back the money as and when demanded. If this system goes unregulated, which was the case a century back then there will bad times all around. Central bank govern all the other banks and make sure that there is no loss of money of any depositor in any circumstances irrespective how bad circumstances would become.

This majorly define the main function of central bank in most simple words. If you have not understood any part or want to know more about central bank or want to give any feedback. Reach me @[email protected].