B.

Com 2nd semester

Sir RN
Reserve Bank of India (RBI)
Reserve Bank of India (RBI) is the central bank of India entrusted
with a multidimensional role which includes implementation of
monetary policy and maintaining monetary stability in the country.
RBI was established on 1st April 1935 under the Reserve Bank of
India Act, 1934. RBI was set up after the recommendations of Hilton
young Commission which had submitted its report in the year 1926.
Later on, in 1931 the Indian Central banking enquiry committee had
also recommended for the establishment of the central bank in India.
Reserve Bank of India was established as a private shareholders
bank, but it was nationalised after independence in the year 1949
through the Reserve Bank (Transfer of public ownership) act, 1948.
As per the Preamble of Reserve Bank of India, the role and
functions of RBI are described asto 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; to have a modern monetary policy
framework to meet the challenge of an increasingly complex
economy, to maintain price stability while keeping in mind the
objective of growth
Organisational and Management structure of Reserve Bank of
India
The supervision and general affairs of RBI are governed by the central
board of directors. The Government of India appoints the central board
of directors for a tenure of 4 years.
The Central Board of directors consists of full-time officials which
include the Governor and not more than four Deputy Governors.
The government nominates ten directors from different fields and two
government officials. Other four directors one each from the local
boards are also appointed.
The current Reserve Bank of India governor is Dr. Urjit R. Patel. The
current 4 Deputy Governors are Shri M. K. Jain, Shri B.P Kanungo, Dr.
Viral V. Acharya, and Shri N.S. Vishwanathan.
The Deputy Governor and director attend the meetings of the Central
Board, however, they are not entitled to vote.
Role and functions of RBI
Traditional functions.
Traditional role and functions of RBI refer to those functions which
every Central Bank of a country has to perform all over the world.
Traditional functions are mainly the basic and fundamental functions of
RBI
1. Issue currency notes: RBI has the sole authority to issue currency
notes in India. Earlier all currency notes except one rupee note and
coins of smaller denomination were issued by RBI. However, Reserve
Bank of India in New Mahatma Gandhi series has issued notes in the
denominations of Rs 10 and above. Reserve Bank of India has been
given these exclusive powers under the provisions of section 22 of
Reserve Bank of India Act, 1934. This system of issuing currency notes
is known as minimum reserve system. The currency notes issued by
RBI is a legal tender throughout the territory of India without any
limitations. It issues these currency notes against the security of gold
bullion, gold coins, promissory notes, exchange bills and government of
India bonds etc.
2. Banker to other banks: Reserve Bank of India is the apex monetary
body in the country and it controls the volume of bank reserves. It helps
and regulates other banks to create credit in the right proportion. It has
obligatory powers to regulate, guide, help and direct other banks of the
country, and hence it acts as the guardian of commercial banks in India.
Every commercial bank has to maintain a certain part of the Reserves
with RBI. Reserve Bank of India acts as the lender of last resort and
banks can approach RBI when they need funds. Under the Banking
Regulation Act, 1949 RBI has extensive powers to supervise and control
the banking system of the country.
3. Banker, agent and financial advisor of the government: under section
20 of Reserve Bank of India act, it acts as the banker and agent to the
government. Section 21 and 21A gives powers to RBI to conduct
transactions of Central and state governments. It has the duty to make
payments, taxes, and deposits on behalf of the government. It represents
Government of India at International levels. It gives financial advice to
the government and maintains government accounts. It has a
responsibility to manage public debt and maintain the foreign exchange
reserves. It provides overdraft facilities to Central and state governments.
4. Exchange rate management and the custodian of Foreign Exchange
Reserves: Reserve Bank of India has the responsibility to stabilize the
external value of Indian currency. It keeps gold bullions and foreign
currency reserves etc. against currency note issue and has the
responsibility to meet the adverse balance of payment with other
nations. RBI has the responsibility to maintain exchange rate stability
and for this, it has to bring demand and supply of foreign currency
(usually US Dollar) to similar levels. It maintains this stability through
buying and selling of foreign currency etc.
5. RBI as the bank of Central clearance, settlement, and transfer: RBI
provides the facility of clearing house for settling banking transactions.
This allows other banks to settle their interbank claims smoothly and
economically. At places where RBI does not have its own office, this
function is carried out in the premises of State Bank of India. This
facility is provided by Reserve Bank of India through a cell called as
the National Clearing Cell.
6.Credit control function: RBI tries to maintain price stability in the
country which is essential for economic development. It regulates
money supply in the economy according to the changing
circumstances of the economy. It uses various measures such as
qualitative and quantitative techniques to regulate credit in the
economy. It uses quantitative controls such as bank rate policy, cash
reserve ratio, open market operations etc. Qualitative controls include
selective credit control, rationing of credit etc.
Promotional and developmental Role and Functions of RBI
Every Central Bank has to perform numerous promotional and
development functions which vary from country to country.This is
truer in a developing country like India were RBI has been performing
the functions of the promoter of financial system along with several
special functions and non-monetary functions.
1.Promotion of Banking habits and expansion of banking system: It
performs several functions to promote banking habits among different
sections of the society and promotes the territorial and functional
expansion of banking system. For this purpose, RBI has set several
Institutions such as Deposit and Insurance Corporation 1962, the
agricultural refinance Corporation in 1963, the IDBI in 1964, the UTI
in 1964, the Investment Corporation of India in 1972, the NABARD in
1982, and national housing Bank in 1988 etc.
2.Export promotion through refinance facility: RBI promotes export
through the Export Credit and Guarantee Corporation (ECGC) and
EXIM Bank. It provides refinance facility for export credit given by
the scheduled commercial banks. The interest rate charged for this
purpose is comparatively lower. ECGC provides insurance on export
receivables whereas EXIM banks provide long-term finance to project
exporters etc.
3. Development of financial system: RBI promotes and encourages the
development of Financial Institutions, financial markets and the
financial instruments which is necessary for the faster economic
development of the country. It encourages all the banking and non-
banking financial institutions to maintain a sound and healthy financial
system.
4. Support for Industrial finance: RBI supports industrial development
and has taken several initiatives for its promotion. It has played an
important role in the establishment of industrial finance institutions
such as ICICI Limited, IDBI, SIDBI etc. It supports small scale
industries by ensuring increased credit supply. Reserve Bank of India
directed the commercial banks to provide adequate financial and
technical assistance through specialised Small Scale Industries (SSI)
branches.
5. Support to the Cooperative sector: RBI supports the Cooperative
sector by extending indirect finance to the state cooperative banks. It
routes this finance mostly via the NABARD.
6. Support for the agricultural sector: RBI provides financial facilities to
the agricultural sector through NABARD and regional rural banks.
NABARD provides short term and long term credit facilities to the
agricultural sector. RBI provides indirect financial assistance to
NABARD by providing large amount of money through General Line
of Credit at lower rates.
7. Training provision to banking staff: RBI provides training to the staff
of banking industry by setting up banker s training college at many
places. Institutes like National Institute of Bank management (NIBM),
Bank Staff College (BSC) etc. provide training to the Banking staff.
8. Data collection and publication of reports: RBI collects data about
interest rates, inflation, deflation, savings, investment etc. which is
very helpful for researchers and policymakers. It publishes data on
different sectors of the economy through its Publication division. It
publishes weekly reports, annual reports, reports on trend and progress
of commercial bank etc.
Supervisory Role and Functions of RBI
RBI performs certain non-monetary functions for the supervision of
banks and promotion of sound banking system in India. Supervisory
functions ensure improvement in the methods of operation of Banking
in India. It controls and administers the entire financial and banking
system of India through these functions.
1. Giving licence to banks: RBI has the authority to grant licence to the
banks for carrying out business. It provides licence for the opening of new
branches, opening extension counters, and also for closing down existing
branches. Reserve Bank of India through this power avoids unnecessary
competition among different banks at any particular location. It helps RBI to
remove undesirable people from entering into the banking business.
2. Bank inspection and enquiry: RBI has the power to inspect and enquire
banks in various matters under the Banking Regulation Act, and the Reserve
Bank of India act. It can inspect loans and advances, deposits, investment
functions etc. which helps to ensure that financial Institutions and banks
carry out their operations in a proper manner. It carries out periodical
inspection once or twice a year and banks have to take remedial measures
pointed out during an inspection. It also asks for periodical information
regarding certain Assets and liabilities of banks.
3. Implementation of deposit Insurance Scheme: RBI has the responsibility
to implement the deposit Insurance Scheme to ensure the protection of
deposits of small depositors. Under this scheme, deposits below Rs 1 lakh
are insured with the Deposit Insurance Guarantee Corporation set up by
Reserve Bank of India. It implements the deposit Insurance Scheme in
case of failure of any Bank. Deposits made in the accounts of commercial
banks, cooperative banks and RRBs are covered under this scheme. The
fixed deposits with Institutions such as ICICI, IDBI etc are not covered
under this scheme.
4.Control over Non-Banking Financial Institutions: The monetary policy
of RBI does not influence the Non-Banking Financial Institutions.
However, it gives directions to the Non-Banking Financial Institutions and
also conducts enquiry and inspection to exercise control over these
institutions. For example, it requires permission from the Reserve Bank of
India for deposit-taking operations by Non-Banking Financial Institutions.
5. Periodic review of the working of commercial banks: the supervisory
functions of RBI also includes periodic review of the working of
commercial banks. It takes necessary steps to increase the efficiency of the
commercial banks, and for the implementation of policy changes and
schemes for the improvement of the banking system.
Prohibitory Role and Functions of RBI
RBI cannot purchase the shares of any industrial undertaking or even
its own share. It cannot provide direct monetary or financial
assistance to any commercial undertaking or trade etc. RBI does not
have the power to buy any immovable property. RBI does not have
the authority to give loans on the security of property or shares.
Instruments of monetary policy of Reserve Bank of India (RBI)
I. Quantitative measures
It refers to those measures of RBI in which affects the overall money
supply in the economy. Various instruments of quantitative measures
are:
1.Bank Rate: One of the most effective instruments of monetary policy is the
bank rate. A bank rate is essentially the rate at which the RBI lends money to
commercial banks without any security or collateral. It is also the standard rate
at which the RBI will buy or discount bills of exchange and other such
commercial instruments.So now if the RBI were to increase the bank rate, the
commercial banks would also have to increase their lending rates. And this will
help control the supply of money in the market. And the reverse will obviously
increase the supply of money in the market. The present bank rate is 5.40℅
2.Open Market Operations : Open Market Operations is when the RBI
involves itself directly and buys or sells short-term securities in the open
market. This is a direct and effective way to increase or decrease the supply of
money in the market. It also has a direct effect on the ongoing rate of interest in
the market.Let us say the market is in equilibrium. Then the RBI decides to sell
short-term securities in the market. The supply of money in the market will
reduce. And subsequently, the demand for credit facilities would increase. And
so correspondingly the rate of interest would also see a boost.On the other
hand, if RBI was purchasing securities from the open market it would have the
opposite effect. The supply of money to the market would increase. And so, in
turn, the rate of interest would go down since the demand for credit would fall
3. Liquidity adjustment facility: The Liquidity Adjustment Facility
(LAF) is an indirect instrument for monetary control. It controls the flow
of money through repo rates and reverse repo rates. The repo rate is
actually the rate at which commercial banks and other institutes obtain
short-term loans from the Central Bank. And the reverse repo rate is the
rate at which the RBI parks its funds with the commercial banks for short
time periods. So the RBI constantly changes these rates to control the
flow of money in the market according to the economic situations.
(i) Repo rate: Repo repurchase agreement rate is the interest rate at which
the Reserve Bank provides short term loans to commercial banks against
securities. At present, the repo rate is 5.15%
(ii) Reverse repo rate: It is the opposite of Repo, in which banks lend
money to RBI by purchasing government securities and earn interest on
that amount. Presently the reverse repo rate is 4.90%
4.Marginal Standing Facility (MSF): It was introduced in 2011-12
through which the commercial banks can borrow money from RBI by
pledging government securities which are within the limits of the
statutory liquidity ratio (SLR). Presently the Marginal Standing Facility
rate is 5.40%
5.Variable Reserve Requirement: There are two components to this
instrument of monetary policy, namely – The Cash Reserve Ratio (CLR)
and the Statutory Liquidity Ratio (SLR). Let us understand them both.
(i) Cash reserve ratio: Cash Reserve Ratio (CRR) is the portion of
deposits with the commercial banks that it has to deposit to the RBI. So
CRR is the percent of deposits the commercial banks have to keep with
the RBI. The RBI will adjust the said percentage to control the supply of
money available with the bank. And accordingly, the loans given by the
bank will either become cheaper or more expensive. The CRR is a great
tool to control inflation. The current CRR rate is 4%.
(ii)Statutory liquidity ratio (SLR): The Statutory Liquidity Ratio (SLR)
is the percent of total deposits that the commercial banks have to keep
with themselves in form of cash reserves or gold. So increasing the SLR
will mean the banks have fewer funds to give as loans thus controlling
the supply of money in the economy. And the opposite is true as
well.The current SLR rate is 18.5%
6.Market stabilisation scheme (MSS): this instrument is used to
absorb the surplus liquidity from the economy through the sale of short-
dated government securities. The cash collected through this instrument
is held in a separate account with the Reserve Bank. It was introducedin
2004. RBI had raised the ceiling of the market stabilisation scheme after
demonetization in 2016
7.Regulation of consumer credit: During inflation, this method is
followed to control excess spending of the consumers. Generally the
hire purchase facilities or installment methods are used to reduce to the
minimum to curb the expenditure on consumption. On the contrary,
during depression period, more credit facilities are allowed so that
consumer may spend more and more to pull the economy out of
depression.
8.Publicity: Publicity is also another qualitative technique. It means to
force them to follow only that credit policy which is in the interest of
the economy. The publicity generally takes the form of periodicals and
journals. The banks are not kept informed about the type of monetary
policy, the central bank regards goods for the economy. Therefore, the
main aim of this method is to bring the banking community under the
pressure of public opinion.
[CRR 4%, SLR18.50%, Repo rate5.15%, Reverse repo rate4.90%,
Marginal Standing facility rate5.40%, Bank Rate5.40%]
#Effectiveness of Credit Control Measures:
The effectiveness of credit control measures in an economy depends
upon a number of factors. First, there should exist a well-organised
money market. Second, a large proportion of money in circulation
should form part of the organised money market. Finally, the money
and capital markets should be extensive in coverage and elastic in
nature. Extensiveness enlarges the scope of credit control measures and
elasticity lends it adjustability to the changed conditions. In most of the
developed economies a favourable environment in terms of the factors
discussed before exists, in the developing economies, on the contrary,
economic conditions are such as to limit the effectiveness of the credit
control measures.
#Fiscal Policy
A policy set by the finance ministry that deals with matters related to
government expenditure and revenues, is referred to as the fiscal policy.
Revenue matter include matters such as raising of loans, tax policies,
service charge, non-tax matters such as divestment, etc. While
expenditure matters include salaries, pensions, subsidies, funds used for
creating capital assets like bridges, roads, etc.
#Demand Pull Inflation
This is a state when people have excess money to buy goods in the
market. RBI practises easier control on this as it can lead to a fall in
money supply in the economy, which in turn would mean a drop in
the prices.
#Supply Side Inflation
Inflation in the economy owing to constraints in the supply side of
goods in the market. This cannot be controlled by RBI as it does not
control prices of commodities. The government plays an important
role in this case through fiscal policy.
#Monetary Policy Transmission
Borrowers fail to fully benefit from RBI’s repo rate cut due to the following
reasons:
1.Banks are not affected by RBI rate cuts as the Central Bank is not their
primary money supplier.
2.Deposits already made are fixed at the rates when taken and cannot be
reduced; the rate cuts will only reflect in the new deposit rates.
3. PPF, Post Office accounts and other small saving instruments are available
at high administered interest rates and in case of reduction of bank deposit
rates, customers have the choice to move to those funds.
4.Banks do not prefer to lower their rates as high lending rates keep their
profit margins up.
5.India does not have a well-developed corporate bond market, therefore
corporate customers have little choice but to reach out to banks for
borrowing.
#Steps to improve monetary transmission:
1.Both the government and RBI has taken and plans to take some steps
in order to accelerate the transmission of monetary policy.
2. Government intends to bring down the interest rates on small saving
accounts. If the small saving rates are linked to the bank rate, this could
serve as a permanent solution.
3. In order to improve monetary transmission, RBI wants banks to
change the calculation methodology of base rate to marginal cost of
funds from average cost of funds. Despite banks raising the lending
rates immediately after RBI’s rate cuts, the Central Bank is unable to
control inflation due to the following reasons:
1.Financial deficit in the higher government.
2. Issues at the supply side, such as crude oil prices, issues in agri
marketing, etc.
3.Lack of financial inclusion as borrowers still depend on
moneylenders, who are not under RBI’s control.
4.Non-monetised economy in certain rural areas.
#Dear Money Policy or Contractionary Monetary Policy:
Dear money policy is a policy when money become more expensive
with the rise of interest rate. Due to this, the supply of money also
decreases in the economy, therefore it is also referred to as the
contractionary monetary policy. This policy leads to a drop in business
expansions owing to a high cost of credit, as well as a fall in business
expansion. This in turn affects employment as it brings down growth
rates. Therefore, interest rate cuts such as SLR and CRR are preferred
by the government and the corporates.
#RBI’s Role in Business Facilitation
As we know the government plays a huge role in facilitating and
promoting business and trade in the economy. It does so through its
various business organizations. The RBI plays a major role in this
function. Let us see how the RBI helps facilitate business and growth in
the economy.
#Currency Policy
If you remember from the recent demonetizationevent, the RBI played
a major role in that. This is because the RBI is responsible for the
monetization of the economy, i.e. the currency policy.The entire
economy depends on the availability of money in the market. So the
money supply is also critical to the functioning and success of
businesses. And businesses also require foreign currency for
international trade.The RBI is also responsible for the foreign
exchange mechanism of the economy. So the RBI plays a very direct
role in the government’s facilitation of business in the economy.
#The RBI’s Role In Current Scenario
The role of RBI in Indian economy has changed according to the
scenario in the country. In April 2019 the RBI took the monetary
policy decision to lower its borrowing rate to 6%. This was the
second rate cut for 2019 and is expected to have a positive impact on
the borrowing rate across the credit market more substantially. Prior
to April, credit rates in the country have remained relatively high,
despite the central bank’s positioning, which has been limiting
borrowing across the economy. The central bank must also grapple
with a slightly volatile inflation rate that is projected at 2.4% in
2019, 2.9% to 3% in the first half of 2020, and 3.5% to 3.8% in the
latter half of 2020.