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Banking in India - Part 2 (RBI)

Bankers Corner

Reserve Bank of India

  • The Reserve Bank of India was established on the basis of Hilton Young Commission recommendations on 1st April, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.
  • The RBI is the apex Bank or Central Bank of the country. It is entrusted with the control, supervision, promotion, development and planning of the financial system.
  • The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937.
  • The RBI’s main function is to control the monetary base and through this route influence the supply of money, depending on the economic conditions of the nation. Its objectives are to maintain price stability and ensure an adequate flow of credit to the productive sectors. The RBI commenced its operations with effect from 1 April 1935, with a share capital of rupees 5 crores. It was later nationalized in January 1949. It became a member of Bank of International Settlements (BIS) in September 1996.
  • The RBI is not only the Central Bank of India; it is also the principal regulatory authority in the Indian money market. It derives its powers from two principal enactments, namely the Reserve Bank of India Act, 1934, and the Banking Regulation Act, 1949.
  • RBI continued to serve as the Central Bank to Burma (Myanmar), until Japanese occupation of Myanmar in April, 1947.
  • RBI also continued to serve as Central Bank to Pakistan, until June, 1948.
  • RBI was nationalised in 1949 and its first Indian Governor was CD Deshmukh.
  • RBI is the representative of the government in IMF.

Functions of RBI

The RBI regulates and supervises commercial banks and non-banking finance companies in the money market. It has two distinct roles to play: monetary control and bank supervision. As the nation's financial regulator, the RBI handles a range of activities or functions which are discussed below:

  • Monetary Management: One of the most important functions of the RBI is formulation and execution of monetary policy. It formulates, implements and monitors monetary policy to achieve the basic objectives of monetary stability. Over time, the objectives of monetary policy in India have evolved to include maintaining price stability, ensuring adequate flow of credit to productive sectors of the economy for supporting economic growth, and achieving financial stability.
  • Banker and Debt Manager to Government: The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and the management of its public debt. The Government also deposits its cash balances with the Reserve Bank. The Reserve Bank may also, by agreement, act as the banker to a State Government. Currently, the Reserve Bank acts as banker to all the State Governments in India, except Jammu & Kashmir and Sikkim. It has limited agreements for the management of the public debt of these two State Governments.

The Reserve Bank manages the public debt and issues new loans on behalf of the Central and State Governments. It involves issue and retirement of rupee loans, interest payment on the loan and operational matters about debt certificates and their registration.

  • Issuer of Currency: Management of currency is one of the core central banking functions of the Reserve Bank. Along with the Government of India, the Reserve Bank is responsible for the design, production and overall management of the nation’s currency. The Paper Currency Act of 1861 conferred upon the Government of India the monopoly of note issues but in 1935, when the Reserve Bank began operations, it took over the function of note issue from the Office of the Controller of Currency, Government of India. RBI issues all the currency notes except one rupee notes. One rupee notes and coins are issued by the Government of India but put into circulation by the RBI.
  • Banker to Banks: Banks are required to maintain a portion of their demand and time liabilities as cash reserves with the Reserve Bank, thus necessitating a need for maintaining accounts with the Bank. As a Banker to Banks, the Reserve Bank also acts as the ‘lender of last resort’. It can come to the rescue of a bank that is solvent but faces temporary liquidity problems by supplying it with much-needed liquidity when no one else is willing to extend credit to that bank.
  • Financial Regulation and Supervision: The Reserve Bank’s regulatory and supervisory domain extends not only to the Indian banking system but also to the development financial institutions (DFIs), non-banking financial companies (NBFCs), primary dealers, credit information companies and select segments of the financial markets. In respect of banks, the Reserve Bank derives its powers from the provisions of the Banking Regulation Act, 1949, while the other entities and markets are regulated and supervised under the provisions of the Reserve Bank of India Act, 1934. The credit information companies are regulated under the provisions of Credit Information Companies (Regulation) Act, 2005. As the regulator and the supervisor of the banking system, the Reserve Bank has a critical role to play in ensuring the system’s safety and soundness on an ongoing basis. The objective of this function is to protect the interest of depositors through an effective prudential regulatory framework for orderly development and conduct of banking operations and to maintain overall financial stability through various policy measures. India’s financial system includes commercial banks, regional rural banks, local area banks, cooperative banks, financial institutions and non-banking financial companies
  • Foreign Exchange Reserves Management: To keep the foreign exchange rates stable, the RBI buys and sells foreign currencies. It maintains and protects the country's foreign exchange funds.
  • Controller of Credit: The RBI is the controller of credit. It has the regulatory power to influence the amount of credit created by the banks, by changing the bank rate, repo rate, reverse repo rate and through open market operations. Recently, repo and reverse repo rates are used, rather than the bank rate, which has become a conventional tool.

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