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THE RESERVE BANK OF INDIA

CENTRAL BANKING

The central bank of country as the name signifies, is the central monetary institution
that regulates the supply, availability and cost of money in the interest of the general
public. The central controls and directs other banking institutions and renders services
to them.

RESERVE BANK OF INDIA

The establishment of a central bank for India was the result of a well thought out plan
after several discussions. According to the white paper, the transfer of responsibility at
the centre from British to Indian hands was made dependent on the condition that a
Reserve Bank, free of political influence, be established. Accordingly, a new bill was
introduced in the Indian Legislative Assembly on8th September 1933 and was passed
on 6th march 1934. The reserve bank of India (RBI) commenced business on the 1 st of
April 1935.

The central office of the Reserve Bank is in Mumbai. The central office is where the
Reserve Bank Governor whop along his team (Board members) is formulating policies.

STRUCTURE OF THE BANK

Originally, the Reserve Bank of India was set up as a shareholders’ bank with a share
capital of Rs. 5 crore divided into 5 lakh fully paid-up shares of Rs. 100 each. The entire
share capital was owned by private shareholders with the exception of Rs. 2,20,000
which was reserved for allotment to the Government.

For the successful operation of the Bank, the country is divided into four regions, viz.
Mumbai, Kolkata, Chennai and New Delhi. RBI is governed by a Central Board and
four Local Boards each for the four regions of the country.

NATIONALIZATION FO THE BANK

Close integration between the policies of the Reserve Bank and the Government was
found to be essential; therefore the question of its nationalization was discussed from
time to time. However, the decision in this regard was taken only after the attainment
of Independence. Finally, the Reserve Bank of India [Transfer of Public Ownership]
Act, 1948 was passed and as per provisions of the Act, the entire share capital of the
Bank was acquired by the Government of India with effect from 1st January 1949.

MANAGEMENT
The management of the Bank is vested in the hands of a Central Board of Directors and
four local boards. The Central Board consists of 20 members. It consists of the
following:

1. One Governor and four Deputy Governors appointed by the Central


Government for a term not exceeding five years.
2. Four directors nominated by the Central Government, one from each of the four
local boards.
3. Ten directors nominated by the Central Government to represent business,
industry and cooperation.
4. One official nominated by the Government of India [Secretary, Ministry of
Finance, Government of India.]

The Board is expected to meet at least six times in a year and at least once in each
quarter. The directors are appointed for a period of four years and the appointments are
made in such a manner that two directors retire every year. The Governor is the
chairman of the Central Board of Directors and the Chief Executive Authority of the
Bank.

FUNCTIONS OF THE RESERVE BANK OF INDIA

The RBI performs all the functions; a typical central bank is expected to do. The
Preamble of the RBI Act, 1934 defines the main functions of the Bank as “to regulate
the issue of bank notes and the keeping of reserve with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country
to its advantage.”

The functions of the Reserve Bank of India may be classified into:


▪ Monetary Functions
▪ Non-monetary Functions

Monetary Functions: The monetary functions of the Reserve Bank are related to
control and regulation of money and credit. They are:

▪ Note issue
▪ Banker to the Government
▪ Bankers’ Bank and lender of last resort
▪ Custodian of foreign reserves
▪ Controller of credit

These are described in detail below:

Note Issue
The Reserve Bank of India has the sole authority to issue currency in the country. All
currencies (except one rupee coins, one rupee notes and other smaller coins) are issued
by the Reserve Bank of India. Since the bank has the monopoly to issue currency, it
controls the supply of currency in India.

Banker to the Government


It acts as the Banker, agent and advisor to the government. As per the provisions of
Section 20, 21, and 21A of the RBI Act, the Bank has the legal right and obligation to
transact the business of both central and State Governments. As banker to the
Government the Bank discharges the following functions:

1. Keeping the cash balances of the Government as deposits free of interest.


2. Receiving and making payments on behalf of the Government.
3. Carrying out the Governments exchange remittances and other banking
operations.
4. Helping both Central and State Governments float new loans and manage public
debt.
5. Making ways and means advances to the states and local authorities.
6. Acting as advisor to the Government on all monetary and banking matters.

Bankers Bank and lender of last resort:


This means that if the commercial banks are not able to secure financial accommodation
from other sources, then as a last resort, they can approach the RBI for the necessary
credit facilities. It holds the cash balances of the commercial banks as it controls the
banking and credit system through its position as bankers’ bank.

Custodian of Foreign reserves:


RBI as a central bank of the country has a responsibility to maintain the rate of
exchange. If there are fluctuations in foreign exchange rates, the RBI, in order to
minimize them may have to buy and sell foreign currencies in the market. In terms of
the powers conferred by the act, the bank has licensed several banks as authorised
dealers in foreign exchange.

Controller of Credit:
This is the most important function performed by the Central Bank. The RBI has all the
instruments of credit control which are ordinarily available to the central banks, at its
disposal.

Methods of Credit control: The various methods which are employed by the central
bank to control the creation of credit by the commercial banks are classified under two
heads:

a. Quantitative Methods
b. Qualitative Methods

a. Quantitative Methods:

i. Bank Rate: Bank rate may be defined as the minimum official rate at
which the Central bank as a bank of rediscount rediscounts the bills of
exchange brought to it by commercial banks. The Section 49 of the RBI
Act defines bank rate as “the standard rate which is prepared to buy or
rediscounts bills of exchange or other commercial papers eligible for
purchase under this Act. RBI tries to control credit through bank rate
policy. There is an intimate relationship between bank rates and other
interest rates prevailing in the market. If there is any change made by the
RBI in its bank rate, it will lead to corresponding changes in the other
interest rates of the market, thereby making credit either dearer or cheaper
as the case may be. Bank rate has certain limitations, which are as follows:

✓ The commercial banks are able to get other refinance facilities; therefore
they do not wish to go to the Reserve Bank for rediscounting their
eligible securities at bank rate.
✓ The bill market in India is not developed; therefore the sub-markets of
Indian money market are not influenced by the bank rate.

ii. Open Market Operations: In India, Open Market Operations refer to the
purchase and sale of govt. securities by the RBI from / to the Public and
banks on its own account. The RBI does not use open market operations
as a means of credit control instead these operations have been employed
to assist the govt. in its borrowing programmes. The open market
operations are also used to provide seasonal finance to commercial banks
by purchase of securities from them.

iii. Variable Reserve Ratio: As per section 42 of RBI “every bank included
in the second schedule shall maintain with the bank an average daily
balance, the amount of which shall not be less be 3% of the total demand
and total liability in India of such bank.”

According to section 24 of the Banking Regulation Act, 1949, “every


banking company shall maintain in India in cash, gold, or unencumbered
approved securities, valued at a price not exceeding the current market
price, an amount which shall not at the close of business on any day be
less than 25% of the total of its time and demand liabilities in India. The
Reserve to be maintained under section 42 of RBI act is known as Cash
Reserve Ratio [CRR] and the reserve to be maintained under section 24
of the banking regulation act is known as statutory liquidity ratio [SLR].

❖ Cash Reserve Ratio: By changing the CRR, the cash reserves of the
commercial banks can be directly changed affecting thereby their ability
to create credit in the economy.

❖ Statutory Liquidity Ratio: It is another method of influencing the


lending policies of commercial banks. All commercial banks have to
maintain liquid assets in the form of cash, gold, and govt. securities
equal to not less than 25% of their total demand and time deposit
liabilities.

b. Qualitative Methods:

The objective of qualitative methods is to divert the flow of credit into particular
uses or channels in the economy, so it encourage the flow of credit into those
uses or channels which help the growth of the economy. The following three
kinds of qualitative credit control methods are generally exercised by the banks:

i. Minimum Margins for lending against specific securities.


ii. Ceiling on the amounts of credit for certain purposes.
iii. Control through the directives by the central bank.

▪ Non-Monetary Functions: The RBI has certain non-monetary


functions:
1. Supervisory Function: The RBI Act, 1934 and the Banking Regulation
Act, 1979 have given the RBI wide powers of supervision and control over
commercial and co-operative banks. Every bank has to obtain a license from
the Reserve Bank for carrying on banking business. RBI is also authorised
to carry out periodical inspection of the banks and call for periodical returns.

2. Promotional Functions: The Bank now performs a variety of


developmental and promotional functions which are regarded as outside the
normal central banking functions. In order to promote banking habits,
extend banking facilities to rural and semi-urban areas, and establish and
promote new financing agencies it has helped in setting up following
institutions:

✓ Industrial Finance Corporation of India [IFCI] and State Financial


Corporation of India [SFCs]
✓ Industrial Development Bank of India [IDBI]
✓ The Unit Trust of India [UTI]

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