Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI

RBI & its Functions

Introduction
 Central bank occupies a significant status in the context of monetary and banking system
of a country. Reserve Bank of India is India’s central bank.
 On the recommendation of Hilton Young Commission, it was established on April 1, 1935 .
To begin with, both the Govt. as well as individuals had shares in the Reserve Bank. Its
total capital of 5 crore was divided in 5 lakhs shares of 100 rupees each. After
independence, Reserve bank was nationalized in 1949. Shares of the individuals were
purchased by the Govt.
 Bank's Head Office is located in Mumbai. The bank has 27 regional offices and 4 sub-
offices.
 Reserve Bank performs all the functions of a central bank viz., issue of notes banker to
the state, regulation of banking system in the country, exchange control, etc. It advises
the government on the formulation of monetary policy. It meets the financial needs of
agriculture industry, trade, transport small industry, etc,. in the interest of the economic
development of the country. It helps in alleviating poverty, removing regional inequalities
and unemployment. In short, it performs both banking and development functions.

Role & Functions

The principal function of Reserve Bank of India is to regulate the monetary system of the
country (in accordance with the overall economic policy of the government) in such a way that
the balanced economic growth of the country is achieved along with economic stability.
According to the Preamble of Reserve Bank of India Act, 1934, “The main functions of the
bank are to regulate the issue of bank notes and keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of the
country to its advantage.”

FUNCTIONS MAY BE CLASSIFIED INTO THREE PARTS:

A. Traditional Functions
B. Developmental Functions
C. Regulatory Functions

TRADITIONAL FUNCTIONS
1. Central Banking Functions: Reserve Bank is the Central Bank of India. Its central banking
functions are as under:
a) Issue of Paper Currency: Reserve Bank of India has the monopoly right of Note
Issue. Earlier it issued notes of the denomination of Rs. 1, Rs. 2, Rs. 5, Rs.10, Rs.20, Rs.
50, Rs.100, Rs. 500 and Rs. 1,000. Now it issues notes of the denomination of Rs.10,
Rs.20, Rs. 50, Rs.100, Rs. 500 and Rs.2,000. The bank has its separate department for
note issuing. This is known as Issue Department.
b) Regulation of Credit: Regulation of credit implies control over the credit policy of the
commercial banks. Being the central bank, the Reserve Bank controls the creation of
credit by the commercial banks. This bank can adopt several measures to control
credit creation, viz., changing the bank rate, open market operations, change in the

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 Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI
reserve requirement of commercial banks, etc. Reserve Bank also controls the loan
policy, interest policy and investment policy of the commercial banks.
c) Banker of Banks: Being the central bank, RBI is the bank all the banks in the country.
In this context the Reserve Bank acts as a guide of the commercial banks, besides
controlling and regulating their affairs. During times of emergency, it is lender of the
last resort for the commercial banks. That is, it gives loans to the commercial banks
during times of emergency. RBI has various other rights such as to issue licenses to
the banks, regulate the number and branches of commercial banks, examine the plans
and accord sanctions for the merger of banks, obtain reports from the banks, examine
the credit policy of the banks and give advice and suggestions.
d) Banker of the Government: Reserve Bank is the banker of the Central and State
governments. All banking functions of the government are handled by RBI like
(i) The Reserve Bank keeps cash balances of the Central and State Governments and
makes payment out of these balances on the advice of the government. No interest is
paid to the government on these balances.
(ii) The bank arranges public loans for the governments.
(iii) It sells and purchases government securities.
(iv) It also sells Treasury Bills on behalf of the government by issuing Tenders.
(v) The bank also gives loans to the government. It is called Ways and Means Advances.
These loans are returned within 90 days.
(vi) On the basis of experience of the monetary system, the bank advices the
government on the monetary and economic policies.
(vii) Reserve Bank also has the right to function on behalf of foreign governments.
e) Regulation of Foreign Exchange: Being the Central Bank of the Country, Reserve Bank
of India also regulates exchange rate of rupee in terms of foreign currencies. It tries
to maintain stability of exchange rate. Reserve Bank deals in the currencies of those
countries only which are members of IMF.
f) Other Functions:
i. Export Assistance: RBI gives loans to the export industries. These loans are given
indirectly by refinancing the loans given by export import bank and other banks.
ii. Clearing House Functions: The Reserve Bank also functions as Clearing House.
Inter-banking obligations are conveniently settled through this house.
iii. Change of Currency : The bank changes big notes into small ones and small notes
into coins.
iv. Transfer of Currency : The bank also facilitates the transfer of currency. It also
issues Demand Hundies on its branches.
v. Publication of statistics and other Information: Reserve Bank publishes data on
various parameters, such as money, credit, finance, agricultural and industrial
output. Reports on these data are also periodically published.
vi. Training in Banking: The Reserve Bank has opened various Training Centers to
produce talented bankers: (i) Bankers' Training College, (ii) College of Agricultural
Banking, Pune (iii) Reserve Bank Staff College, Chennai, (iv) National Institute of
Bank Management, (v) Zonal Training Centers.

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 Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI
2. General Banking Functions : RBI is not a commercial bank. Yet, being the Central Bank, it
performs certain general banking functions as well. These functions are as follows:
a) To Accept Deposits: The bank accepts deposits of the Central Govt, State Govt, Port-
Trust and private individuals. But no interest is paid on these deposits.
b) To Deal in Bills: Reserve Bank buys, sells and rediscounts the Bills, Promissory Notes
and Hundies. However, these bills should not be of the duration exceeding 90-days and
should be payable within the country.
c) Lending of Money: Reserve Bank of India gives loans to the central and state
governments. These loans are of the duration of not more than 90-days. The loans are
given against securities, credit notes of the banks and gold or silver.
d) To Deal in Agricultural Bills: RBI buys, sells and discounts agricultural bills. These
bills should be payable in India and should not be of the duration exceeding 15-months.
e) To Deal in Foreign Securities: The bank deals in all such foreign securities which are
encashable within 10 years from the date of purchase.
f) Taking of Loans: Reserve Bank can borrow loan on the security of assets from
scheduled banks. Duration of such loan should not exceed 30 days, nor should it exceed
the total capital of the bank.
g) To Deal in Costly Metals: Reserve Bank deals in the sale and purchase of gold, silver
as well as the coins of these metals.
h) To Deal with the Banks of Others Countries: Being a member of IMF, Reserve Bank
establishes business relations with the central banks of other member countries. It
can open accounts with those banks, act as their agent or handle I.M.F. dealings.
3. Prohibitory Functions Of The Reserve Bank: RBI Act prohibits this bank from
performing certain activities to avoid competition of this bank with its member banks and
to keep its assets fully secure. The prohibitory functions of the bank are :
a) The bank cannot participate in trade, commerce or industrial activity of the country.
It can only control a particular business for some time with a view to realize the loans
b) The bank cannot buy its own shares or that of any other bank or a company. Also it
cannot give loan on the basis of such shares.
c) It cannot give loan against the security of any immovable property. Also it cannot buy
immovable property beyond its needs.
d) The bank can neither stop nor accept such bills which are payable on demand.
e) It cannot pay interest on its deposits.
f) The bank cannot give loans without securities.

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 Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI
DEVELOPMENTAL FUNCTIONS OR ECONOMIC DEVELOPMENT
1. Development Of Agricultural Finance:- Right from the beginning, Reserve Bank of India
has an Agricultural Credit Department. The principal function of this department to
conduct research regarding various problems of agricultural credit. Besides this the bank
advises the central government, state governments and co-operative societies on the
various aspects of agricultural growth. It also helps the central government and state
governments in establishing godowns and warehouses in different parts of the country.
Contribution of the Reserve Bank in the field of agricultural credit is notable. However,
the bank does not fulfill credit needs of the farmers directly. Contribution of the
Reserve Bank to the field of agricultural credit may be described as under:
a) Short term Agricultural Credit: Reserve Bank arranges short-period credit for the
State Cooperative Banks for the sale of agricultural produce and other seasonal
agricultural operations, at 2% less rate of interest than the bank rate. The Bank
offers credit to State Co-operative Banks on the securities or the securities of state
governments.
b) Medium Term Agricultural Credit: Medium term credit is generally offered for a
period ranging between 3 to 5 years. But from 1953 onwards, medium term loans could
be advanced on the securities of the State governments to Agricultural Co-operatives
for agricultural purposes. This type of credit is given for the following purposes (1)
Irrigation, purchase of pump sets, boring of tube well and digging of wells, (2) Land
Reclamation, (3) Purchase of agricultural implements and cattle, (4) 'Gobar' Gas Plants,
(5) Purchase of shares of the Co-operative Sugar Mills.
When crops are damaged due to certain reasons, farmers are not in a position to pay
back their loans to the co-operatives, in turn the co-operatives fail to return their
short-period loans. In such a situation, the co-operatives can seek loans from National
Agricultural Credit Stabilization Fund and get their short term loans converted into
medium term loans.
c) Long Term Credit: National Agricultural Credit (Long Term Operations) Fund caters
to the long period credit requirements of the Central Co-operative Banks. Reserve
Bank used so advance loans to the state governments for the purchase of shares of
Co-operatives. It also used to buy debentures of Land Development Banks. Joint
efforts of the Reserve Bank and the Government of India led to the establishment of
National Bank for Agriculture and Rural Development (NABARD). Authorized capital of
this bank has been fixed to be 500 crore, and it's paid-up capital is 100 crore. Of this,
shares worth ₹ 50 crore have been purchased each by the government of India and
Reserve Bank of India. This bank can raise capital from within the country and abroad,
by selling debentures.
2. Promotion Of Industrial Finance:- Reserve Bank established Industrial Finance
Department in 1957. This department executes all plans of the Reserve Bank regarding
industrial finance. The following observations should bring out the contribution of Reserve
Bank in the field of industrial finance .

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 Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI
a) Establishment of Specialized Institutions: To cope with the growing need of
industrial financial in India. Reserve Bank has established various specialized
institutes. Industrial Finance Corporation of India, Industrial Development Bank of
India State Finance Corporations and Industrial Credit and Investment Corporation
and Small Industries Development Bank of India are some of the notable name in this
regard.
b) National Industrial Credit Long Term Operations) Fund: With a view to satisfy
credit needs of the large scale industries Reserve Bank started National Industrial
Credit Long term Operations Fund in 1964. This Fund was started with ₹10 Crore in
the fine rear, and ₹5 crore were to be added to it annually. This fund is used for
several purposes:
i. To give loan to Industrial Development Bank for the purchase of share and
debentures of Finance Corporation of India and Share Finance Co-operations.
ii. To bus debentures issued by the Development Bank.
c) Credit Guarantee Scheme for Small Scale Industries: From July 1, 1960 onwards,
Reserve Bank has arranged for guaranteeing the credit raised by small scale
industries. Credit Guarantee Organisation of the Reserve Bank looks after this
scheme. Under this scheme 75% of the standing loans of the small industries are
guaranteed by Credit Guarantee Organization.
d) Help to Sick Industrial Units: Sick Industrial Unit Division of the Reserve Bank looks
after this function of the bank. This Division identities sick units of large, medium and
small industries and arranges loans for them from the Nationalized Banks.
3. Promotion Of Export Assistance:- Export Houses get financial assistance from the
Reserve Bank, both directly as well as indirectly by way of ‘Refinance’ of the loans given
by other financial institutes. In 1963, Export Credit Bill Plan was also started. And in
1982 it was with the assistance of Reserve Bank that the government established Export-
Import Bank. This Bank avails of the credit facility from the Reserve Bank.
4. Development Of Bill Market:- Organised bill market is a very important element of
economic growth. Reserve Bank has made concerted efforts for the development of bill
market. In this regard it initiated its first plan in 1952. This plan was made applicable for
all the Scheduled Banks from 1954 onwards. In 1958, Export Bills also came within the
purview of this plan. In 1970, Reserve Bank started New Bill Market Programme. As a
result of development of the Bill Market it can be possible to make the Monetary Policy
more successful.
5. Development And Regulation Of Banking System:- Reserve Bank has very efficiently
developed and regulated the banking system. It is because of the notable efforts of
Reserve Bank that banking system in India has assumed the status of development
banking. Appropriate credit facilities have been arranged for the priority sectors. Under
20-point programme, arrangement has been made to give financial assistance to the poor
strata of the society. Liquidity of the banking system has been maintained to inspire
confidence among the people in the system. Nationalization of 20 big banks of the country
has further facilitated the operations of Reserve Bank.

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 Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI
REGULATORY FUNCTIONS OR MONETARY POLICY OF RESERVE BANK
 Control of credit is the principal function of the Reserve Bank of India. Control of credit
means expansion or contraction of credit.
 Reserve Bank has played a significant role in the expansion of credit. It has followed a
liberal policy to expand credit in the country to meet the financial needs of agriculture,
industry, transport, import, export, etc. Reserve Bank's policy has been liberal in respect
of priority sectors, like small farmers, small industries, petty traders, etc.
 The aim of its monetary policy is to expand credit on a long term basis and to regulate the
pace of its expansion in the short period.
 Main aim of the monetary regulation is to achieve the objective of growth with stability in
order to accelerate the rate of economic development in the country.
 The methods adopted by the Reserve Bank to control credit are studied under two parts:
1. Quantitative Credit Control
2. Qualitative or Selective Credit Control

1. Quantitative Credit Control :-

To control the flow of quantum of credit, Reserve Bank adopts all these measures :-
a) Bank Rate: Rate of interest that the Reserve Bank charges from other scheduled
banks on the loans given to them is called bank rate.
b) Differential Rates Of Interest: In October, 1960 the Reserve Bank started
'Differential Rates of Interest' programme. According to this programme if any bank
borrows from the Reserve Bank beyond the quota fixed for it, it has to pay higher
interest rate than the prevailing Bank Rate. Reserve Bank also decides the rate of
interest to be paid by the banks on different types of deposits and what rate of
interest will be payable by them on loans secured from it. This policy aims at
discouraging the commercial banks from borrowing from RBI.
c) Open Market Operations: Open Market Operations is yet another technique adopted
by the Reserve Bank for Quantitative Credit control. This means that the bank
controls the flow of credit through the sale and purchase of government securities in
the open market.
d) Variable Cash Reserve Ratio: Reserve Bank also controls the Cash Reserve Ratio of
the commercial banks. Initially, all Scheduled Banks had to keep 5% of their Demand
Deposits and 2% of their Time Deposits as cash reserves with Reserve Bank. Presently,
it is 4 % .
e) Statutory Liquidity Ratio: According to the Indian Banking Act, 1949, a bank is legally
bound to keep 20% of its deposits in the form of Liquid Assets. This is kept by the
bank itself. This method is used to check inflation. Presently, it is 18 %.
f) Direct Action: According to the 1949 Act, Reserve Bank can stop any commercial bank
from any type of transaction. In case of defiance of the orders of Reserve Bank, it can
resort to direct action against the member bank. It can stop giving loans and even
recommend the closure of the member bank under pressing circumstances.

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 Anil’s Commerce +3 3rd yr FMIS Unit-1 RBI
g) Credit Authorisation Scheme: In 1965, Credit Authorizations Scheme was adopted. It
aims at regularising of the credit given by the banks. Before sanctioning a credit limit
of 2 crore or more to any one debtor, every bank will have to get authorization from
the Reserve Bank.
h) Moral Persuasion: RBI can also exercise moral influence upon the member banks with a
view to pursuing its monetary policies. From time to time RBI holds meetings with the
member banks seeking their co-operation in effectively controlling the monetary
system of the country. It advises against the expansion of credit, except to priority
sector, i.e., agriculture, small industries, etc. RBI has also counselled the banks to
invest more and more in government securities and increase their liquidity. RBI can
initiate direct action against such banks as disregard its advice. Role of moral
persuasion has increased considerably ever since the nationalization of 20 banks.
2. Selective Credit Control:-
This refers to the control of specific credit meant for certain specific objectives.
Following techniques of selective control are generally adopted:
a) Change in Margin Requirements on Loans: Reserve Bank directs the member banks
to change their margin requirement from time to time. First such direction was given
by the RBI in 1956 regarding rice-trade. In 1957, margin requirement for wheat was
fixed at 40%. In 1958, it was raised to 80 per cent. In 1970 it was reduced to 40%.
Likewise, margin requirement has been varied regarding various commodities from
time to time.
b) Maximum Limit of the Loans: With a view to checking speculation Reserve Bank has
fixed maximum limits of loans by the commercial banks. No scheduled bank is allowed
to grant loan exceeding Rs. 1 crore to any single party without the prior permission of
RBI. This restriction has since been withdrawn.
c) Rationing of Credit: Rationing of credit is yet another technique of selective credit
control. Under this programme, the Reserve Bank fixed credit quota for member
banks as well as their limits for the payment of Bills. Quota system was introduced in
1960. If the member banks seek more loans than their fixed quota, they will have to
pay higher interest charges to the Reserve Bank than the prevailing bank rate.

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