Central University of South Bihar

School of Law and Governance

Constitutional law of India

PROJECT TOPIC: ROLES AND FUNCTIONS OF RESERVE BANK OF INDIA

SUBMITTED BY: SUBMITTED TO:

SHUBHAM SINGH DR. ABODH KUMAR

SECTION: B ASSISTSANT PROFESSOR
B.A.LL.B. (2ND SEM) CENTRE FOR ECONOMIC STUDIES AND
CUSB1913125100 POLICIES
SCHOOL OF LAW AND GOVERNANCE CUSB, GAYA
CUSB, GAYA
p

It is a matter of pleasure for me to work on a practical

project like “ROLES AND FUNCTIONS OF RBI” .This

project has added value to my theoretical knowledge. I

would like to admit my sincere thanks to DR. ABODH

KUMAR for providing me such an opportunity to prepare

this project on the beautiful topic. I would like to thank my

professor also for providing his valuable guidance and for

taking keen interest in my project.

Secondly, I would also like to thank my parents and friends

who helped me a lot in finalizing this project within the

limited time frame. I am highly indebted to Central

University of South Bihar for their guidance and constant

supervision as well as for providing necessary information

regarding the project and also for their support in

completing the project.

SHUBHAM SINGH
Establishment
The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of the Reserve Bank of India Act, 1934

The Central Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and
where policies are formulated.

Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully
owned by the Government of India.

Preamble :
The Preamble of the Reserve Bank of India describes the
basic functions of the Reserve Bank as:
"...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."
Central Board
The Reserve Bank's affairs are governed by a central board of directors. The board is
appointed by the Government of India in keeping with the Reserve Bank of India Act.

 Appointed/nominated for a period of four years

 Constitution:
o Official Directors
 Full-time : Governor and not more than four Deputy Governors
o Non-Official Directors
 Nominated by Government: ten Directors from various fields and
one government Official
 Others: four Directors - one each from four local boards
An overview :
The Reserve Bank of India is an apex financial institution of a country.
It is needed to regulate and control the monetary system of an economy.
The need for a central bank in India was felt during 18 th century. The
earliest attempts to set up a central bank dates back to 1773 when Warren
Hastings recommended to establish the “General Bank of Bengal and Bihar”
as Central Bank of India. In 1913 Lord Keynes also recommended to set up a
Central Bank. Later on in 9121, by amalgamating three presidency Banks
(Presidency Bank of Bengal, Presidency Bank of Madras and Presidency
Bank of Bombay), Imperial Bank of India was set up. Though Imperial Bank
of India performed certain central banking function, but the right of Note
issue was not given to Imperial Bank of India and Government of India
performed the function of credit control. The establishment of a Central
Bank that would issue notes and at the same time function as banker to the
Government was recommended in 1926 by the Royal Commission in Indian
Currency and Finance (known as the Hilton Young Commission). In 1931,
Central Banking inquiry Committee also recommended for setting up of a
Central Bank in India.

In 1933, the “Round Table Conference” also suggested to set up a

Central bank free from political influence. As a result of all these
recommendations and suggestions, a fresh bill was passed by the assembly
on December 22, 1933 and got Governor General Ascent on March 6,
1934. Thus, the Reserve Bank of India started working since, 1st April, 1935
in accordance with the provision of the Reserve Bank of India Act, 1934.

OBJECTIVES OF RBI
• To regulate the financial policy and develop banking facilities through the country.
• To remain free from political influence and be in successful operation for maintaining
financial stability and credit.
• To act as the note issuing authority, bankers’ bank and banker to government and to
promote the growth of the economy within the framework of the general economic policy of
the government, consistent with the need of maintenance of price stability.
• To assist the planned process of development of the Indian economy.
 ROLE OF RESERVE BANK OF INDIA

(1) Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right
to issue bank notes of all denominations. The distribution of one rupee notes
and coins and small coins all over the country is undertaken by the Reserve
Bank as agent of the Government. The Reserve Bank has a separate Issue
Department which is entrusted with the issue of currency notes. The assets and
liabilities of the Issue Department are kept separate from those of the Banking
Department. Originally, the assets of the Issue Department were to consist of
not less than two-fifths of gold coin, gold bullion or sterling securities provided
the amount of gold was not less than Rs.40 crores in value. The remaining
three-fifths of the assets might be held in rupee coins, Government of India
rupee securities, eligible bills of exchange and promissory notes payable in
India. Due to the exigencies of the Second World War and the post-war period,
these provisions were considerably modified. Since 1957, the Reserve Bank of
India is required to maintain gold and foreign exchange reserves of Rs. 200
crores, of which at least Rs.115 crores should be in gold. The system as it exists
today is known as the minimum reserve system.

(2) Banker to Government

The second important function of the Reserve Bank of India is to act as

Government banker, agent and adviser. The Reserve Bank is agent of Central
Government and of all State Governments in India excepting that of Jammu
and Kashmir. The Reserve Bank has the obligation to transact Government
business, via to keep the cash balances as deposits free of interest, to receive
and to make payment exchange remittances and other banking operations. The
Reserve Bank of India helps the Government - both the Union and the States
to float new loans and to manage public debt. The Bank makes ways and
means advances to the Governments for 90 days. It makes loans and advances
to the States and local authorities. It acts as adviser to the Government on all
monetary and banking matters.

(3) Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to the
provisions of the Banking Companies Act of 1949, every scheduled bank was
required to maintain with the Reserve Bank a cash balance equivalent to 5% of
its demand liabilities and 2 per cent of its time liabilities in India. By an
amendment of 1962, the distinction between demand and time liabilities was
abolished and banks have been asked to keep cash reserves equal to 3 per cent
of their aggregate deposit liabilities. The minimum cash requirements can be
changed by the Reserve Bank of India.
The scheduled banks can borrow from the Reserve Bank of India on the basis
of eligible securities or get financial accommodation in times of need or
stringency by rediscounting bills of exchange. Since commercial banks can
always expect the Reserve Bank of India to come to their help in times of
banking crisis the Reserve Bank becomes not only the banker's bank but also
the lender of the last resort.

(4) Controller of Credit

The Reserve Bank of India is the controller of credit i.e. it has the power to
influence the volume of credit created by banks in India. It can do so through
changing the Bank rate or through open market operations. According to the
Banking Regulation Act of 1949, the Reserve Bank of India can ask any
particular bank or the whole banking system not to lend to particular groups or
persons on the basis of certain types of securities. Since 1956, selective
controls of credit are increasingly being used by the Reserve Bank.

The Reserve Bank of India is armed with many more powers to control the
Indian money market. Every bank has to get a license from the Reserve Bank
of India to do banking business within India, the license can be cancelled by
the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank
will have to get the permission of the Reserve Bank before it can open a new
branch. Each scheduled bank must send a weekly return to the Reserve Bank
showing, in detail, its assets and liabilities. This power of the Bank to call for
information is also intended to give it effective control of the credit system.
The Reserve Bank has also the power to inspect the accounts of any
commercial bank.
As supreme banking authority in the country, the Reserve Bank of India,
therefore, has the following powers:

 It holds the cash reserves of all the scheduled banks.

 It controls the credit operations of banks through quantitative and qualitative

controls.

 It controls the banking system through the system of licensing,

inspection and calling for information.

 It acts as the lender of the last resort by providing rediscount facilities to

scheduled banks.

(5) Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rate
of exchange. According to the Reserve Bank of India Act of 1934, the Bank
was required to buy and sell at fixed rates any amount of sterling in lots of not
less than Rs.10,000. The rate of exchange fixed was Re. 1 = sh. 6d. Since
1935 the Bank was able to maintain the exchange rate fixed at l=sh.6d though
there were periods of extreme pressure in favour of or against the rupee. After
India became a member of the International Monetary Fund in 1946, the
Reserve Bank has the responsibility of maintaining fixed exchange rates with
all other member countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to
act as the custodian of India's reserve of international currencies. The vast
sterling balances were acquired and managed by the Bank. Further, the RBI
has the responsibility of administering the exchange controls of the country.
 (6) Supervisory functions

In addition to its traditional central banking functions, the Reserve bank has
certain non-monetary functions of the nature of supervision of banks and
promotion of sound banking in India. The Reserve Bank Act, 1934, and the
Banking Regulation Act, 1949 have given the RBI wide powers of supervision
and control over commercial and co-operative banks, relating to licensing and
establishments, branch expansion, liquidity of their assets, management and
methods of working, amalgamation, reconstruction, and liquidation. The RBI
is authorized to carry out periodical inspections of the banks and to call for
returns and necessary information from them. The nationalization of 14 major
Indian scheduled banks in July 1969 has imposed new responsibilities on the
RBI for directing the growth of banking and credit policies towards more rapid
development of the economy and realization of certain desired social
objectives. The supervisory functions of the RBI have helped a great deal in
improving the standard of banking in India to develop on sound lines and to
improve the methods of their operation.

(7) Promotional functions

With economic growth assuming a new urgency since Independence, the range of
the Reserve Bank's functions has steadily widened. The Bank now performs a
variety of developmental and promotional functions, which, at one time, were
regarded as outside the normal scope of central banking. The Reserve Bank was
asked to promote banking habit, extend banking facilities to rural and semi-urban
areas, and establish and promote new specialized financing agencies. Accordingly,
the Reserve Bank has helped in the setting up of the IFCI and the SFC; it set up the
Deposit Insurance Corporation in 1962, the Unit Trust of India in 1964, the
Industrial Development Bank of India also in 1964, the Agricultural Refinance
Corporation of India in 1963 and the Industrial Reconstruction Corporation of
India in 1972. These institutions were set up directly or indirectly by the Reserve
Bank to promote saving habit and to mobilize savings, and to provide industrial
finance as well as agricultural finance. As far back as 1935, the Reserve Bank of
India set up the Agricultural Credit Department to provide agricultural credit. But
only since 1951 the Bank's role in this field has become extremely important. The
Bank has developed the co-operative credit movement to encourage saving, to
eliminate moneylenders from the villages and to route its short term credit to
agriculture. The RBI has set up the Agricultural Refinance and Development
Corporation to provide long-term finance to farmers.
 Classification of RBIs functions

The monetary functions also known as the central banking functions of the
RBI are related to control and regulation of money and credit, i.e., issue of
currency, control of bank credit, control of foreign exchange operations,
banker to the Government and to the money market. Monetary functions of the
RBI are significant as they control and regulate the volume of money and
credit in the country.

Equally important, however, are the non-monetary functions of the RBI in the
context of India's economic backwardness. The supervisory function of the RBI
may be regarded as a non-monetary function (though many consider this a
monetary function). The promotion of sound banking in India is an important goal
of the RBI, the RBI has been given wide and drastic powers, under the Banking
Regulation Act of 1949 - these powers relate to licencing of banks, branch
expansion, liquidity of their assets, management and methods of working,
inspection, amalgamation, reconstruction and liquidation. Under the RBI's
supervision and inspection, the working of banks has greatly improved.
Commercial banks have developed into financially and operationally sound and
viable units. The RBI's powers of supervision have now been extended to non-
banking financial intermediaries. Since independence, particularly after its
nationalization 1949, the RBI has followed the promotional functions vigorously
and has been responsible for strong financial support to industrial and agricultural
development in the country.
 REGULATION OF BANKING SYSTEM

Objective
The objective of bank regulation, and the emphasis, varies between
jurisdictions. The most common objectives are:

1. Prudential -- to reduce the level of risk bank creditors are

exposed to (i.e. to protect depositors)
2. Systemic risk reduction -- to reduce the risk of disruption resulting
from adverse trading conditions for banks causing multiple or major
bank failures
3. Avoid misuse of banks -- to reduce the risk of banks being used
for criminal purposes, e.g. laundering the proceeds of crime
4. To protect banking confidentiality
5. Credit allocation -- to direct credit to favored sectors

General principles of bank regulation

Banking regulations can vary widely across nations and jurisdictions. This
section of the article describes general principles of bank regulation
throughout the world.

Minimum requirements
Requirements are imposed on banks in order to promote the objectives of the
regulator. The most important minimum requirement in banking regulation
is maintaining minimum capital ratios.
Supervisory review

Banks are required to be issued with a bank license by the regulator in order to
carry on business as a bank, and the regulator supervises licenced banks for
compliance with the requirements and responds to breaches of the requirements
through obtaining undertakings, giving directions, imposing penalties or
revoking the bank's licence.

Market discipline
The regulator requires banks to publicly disclose financial and other
information, and depositors and other creditors are able to use this
information to assess the level of risk and to make investment decisions. As
a result of this, the bank is subject to market discipline and the regulator can
also use market pricing information as an indicator of the bank's financial
health.

Instruments and requirements of bank regulation

Capital requirement
The capital requirement sets a framework on how banks must handle
their capital in relation to their assets. Internationally, the Bank for
International Settlements' Basel Committee on Banking Supervision
influences each country's capital requirements. In 1988, the Committee
decided to introduce a capital measurement system commonly referred to
as the Basel Capital Accords. The latest capital adequacy framework is
commonly known as Basel II. This updated framework is intended to be
more risk sensitive than the original one, but is also a lot more complex.

Reserve requirement
The reserve requirement sets the minimum reserves each bank must hold
to demand deposits and banknotes. This type of regulation has lost the
role it once had, as the emphasis has moved toward capital adequacy, and
in many countries there is no minimum reserve ratio. The purpose of
minimum reserve ratios is liquidity rather than safety. An example of a
country with a contemporary minimum reserve ratio is Hong Kong,
where banks are required to maintain 25% of their liabilities that are due
on demand or within 1 month as qualifying liquefiable assets.

Reserve requirements have also been used in the past to control the stock
of banknotes and/or bank deposits. Required reserves have at times been
gold coin, central bank banknotes or deposits, and foreign currency.

Corporate governance
Corporate governance requirements are intended to encourage the
bank to be well managed, and is an indirect way of achieving other
objectives. Requirements may include:

1. To be a body corporate (i.e. not an individual, a partnership,

trust or other unincorporated entity)

2. To be incorporated locally, and/or to be incorporated under as a

particular type of body corporate, rather than being incorporated in a
foreign jurisdiction.

3. To have a minimum number of directors

 4. To have an organizational structure that includes various offices and
officers, e.g. corporate secretary, treasurer/CFO, auditor, Asset
Liability Management Committee, Privacy Officer etc. Also the
officers for those offices may need to be approved persons, or from an
approved class of persons.

5. To have a constitution or articles of association that is approved, or

contains or does not contain particular clauses, e.g. clauses that
enable directors to act other than in the best interests of the
company (e.g. in the interests of a parent company) may not be
allowed.

Financial reporting and disclosure requirements

1. Prepare annual financial statements according to a financial
reporting standard, have them audited, and to register or publish
them
2. Prepare more frequent financial disclosures, e.g. Quarterly Disclosure
Statements
3. Have directors of the bank attest to the accuracy of such financial
disclosures
4. Prepare and have registered prospectuses detailing the terms of
securities it issues (e.g. deposits), and the relevant facts that will
enable investors to better assess the level and type of financial risks
in investing in those securities.

Credit rating requirement

Banks may be required to obtain and maintain a current credit rating from
an approved credit rating agency, and to disclose it to investors and
prospective investors. Also, banks may be required to maintain a minimum
credit rating.
Large exposures restrictions
Banks may be restricted from having imprudently large exposures to
individual counterparties or groups of connected counterparties. This may
be expressed as a proportion of the bank's assets or equity, and different
limits may apply depending on the security held and/or the credit rating of
the counterparty.

Related party exposure restrictions

Banks may be restricted from incurring exposures to related parties such
as the bank's parent company or directors. Typically the restrictions may
include:

 Exposures to related parties must be in the normal course of business

and on normal terms and conditions
 Exposures to related parties must be in the best interests of the bank
 Exposures to related parties must be not more than limited
amounts or proportions of the bank's assets or equity.
 CREDIT CONTROL

One of the more pleasant aspects of the latest quarterly Monetary Policy
Review is the attempt by the Reserve Bank of India to be as predictable as
possible, or at least less disruptive than it has been before. The notion that
some elements of a tighter money policy would be announced was pretty
much to be expected. While raising repo rates by 25 basis points and leaving
other indicators of liquidity unchanged, the RBI Governor, Dr. Y. V. Reddy,
has tried to play both policeman and purveyor of optimism, the former by
raising marginally the cost of capital for banks through the repo rate hike,
and the latter by selectively pushing up the provisioning norms for certain
categories of borrowers hoping thereby to catch inflation by the scruff and
pull it back within the 5.5 per cent limit.

Lest the markets think the RBI is a killjoy, in its combat against inflation,
the Governor has raised the bar on growth expectations jettisoning his earlier
forecast and the prognosis of North Block for a 9 per cent GDP target for
this waning fiscal. He has tried therefore to be all things to all men, in the
bargain creating a dilemma that may not augur well for the economy in the
medium to long term. The basic problem is that the RBI cannot hope to both
fight inflation and propel growth to the levels it wants with the measures it
has so far set in motion. Controls on credit expansion for select categories
with inflation potential — capital markets and commercial real-estate —
through higher provisioning may choke demand only if it is sensitive to the
cost of credit. But in a booming economy, higher costs can be transmitted
down the line; witness the rising housing loan rates. In many a high-flying
sector banks may, therefore, still find takers for expensive credit. Regardless
of the RBI's marginal increase in repo rates, the perception of a tighter
money regime will push up interest rates all around, thus contributing to the
price rise instead of combating it.
Given the nature of inflation, currently at a two-year high, the task of fighting it
lies with New Delhi. The Government must put together a gamut of measures to
remove the supply bottlenecks that are causing the price rise. The RBI admits
that the growth in agriculture has "not been sanguine" with the declining output
in major cereals pushing up prices. Focusing its Monetary Policy weapons on
"credit quality" and, therefore, the health of the banking system, the RBI has
prudently left this initiative to New Delhi.

OBJECTIVE OF CREDIT CONTROL

The central bank makes efforts to control the expansion or contraction of

credit in order to keep it at the required level with a view to achieving the
following ends.

 To save Gold Reserves: The central bank adopts various measures of

credit control to safe guard the gold reserves against internal and
external drains.

 To achieve stability in the Price level: Frequently changes in prices

adversely affect the economy. Inflationary and deflationary trends need
to be prevented. This can be achieved by adopting a judicious of credit
control.

 To achieve stability in the Foreign Exchange Rate: Another objective

of credit control is to achieve the stability of foreign exchange rate. If
the foreign exchange rate is stabilized, it indicates the stable economic
conditions of the country.

 To meet Business Needs: According to Burgess, one of the important

objectives of credit control is the “Adjustment of the volume of credit
to the volume of Business” credit is needed to meet the requirements
of trade an industry. So by controlling credit central bank can meet
the requirements of business.
METHOD OF CREDIT CONTROL

There are two method of credit control:-

Quantitative method
1. Bank Rate Policy
2. Open Market Operations
3. Change in Reserve Ratios
4. Credit Rationing
5. CRR
6. Repo Rate
7. SLR

Qualitative method
1. Direct Action
2. Moral persuasion
3. Legislation
4. Publicity

Quantitative method

1. Bank Rate Policy: Bank rate is the rate of interest which is charged by
the central bank on rediscounting the first class bills of exchange and
advancing loans against approved securities. This facility is provided to
other banks. It is also known as Discount Rate Policy.

2.Open Market Operations: The term “Open Market Operations” in the

wider sense means purchase or sale by a central bank of any kind of paper
in which it deals, like government securities or any other public securities
or trade bills etc. in practice, however the term is applied to purchase or
sale of government securities, short-term as well as long-term, at the
initiative of the central bank, as a deliberate credit policy.

3. Change in Reserve Ratios: Every commercial bank is required to

deposit with the central bank a certain part of its total deposits. When the
central bank wants to expand credit it decreases the reserve ratio as
required for the commercial banks. And when the central bank wants to
contract credit the reserve ratio requirement is increased.

4. Credit Rationing: Credit rationing means restrictions placed by the

central bank on demands for accommodation made upon it during times
of monetary stringency and declining gold reserves. This method of
controlling credit can be justified only as a measure to meet exceptional
emergencies because it is open to serious abuse.

5. CRR(Cash Reserve Ratio): Cash reserve Ratio (CRR) is the amount of

Cash(liquid cash like gold) that the banks have to keep with RBI. This Ratio
is basically to secure solvency of the bank and to drain out the excessive
money from the banks. If RBI decides to increase the percent of this, the
available amount with the banks comes down and if RBI reduces the CRR
then available amount with Banks increased and they are able to lend more.
RBI has reduced this ratio three times and reduced it from 9 % to 5.5% in
last one month or so.

6. Repo Rate: Repo rate is the rate at which our banks borrow rupees from
RBI. This facility is for short term measure and to fill gaps between demand
and supply of money in a bank .when a bank is short of funds they borrow
from bank at repo rate and if bank has a surplus fund then the deposit the
funds with RBI and earn at Reverse repo rate. So reverse Repo rate is the
 rate which is paid by RBI to banks on Deposit of funds with RBI. A
reduction in the repo rate will help banks to get money at a cheaper rate.

7. SLR(Statutory Liquidity Ratio): is the amount a commercial bank needs to

maintain in the form of cash, or gold or govt. approved securities (Bonds) before
providing credit to its customers. SLR rate is determined and maintained by the
RBI (Reserve Bank of India) in order to control the expansion of bank credit.
Generally this mandatory ration is compiled by investing in Govt. bonds present
rate of SLR is 24 %.But Banks average is 27.5 % , the reason behind it is that in
deficit budgeting Govt. landing is more so they borrow money from banks by
selling their bonds to banks.so banks have invested more than required percentage
and use these excess bonds as collateral security ( over and above SLR )to avail
short term Funds from the RBI at Repo rate.

Qualitative method

1. Direct Action: The central bank may take direct action against
commercial banks that violate the rules, orders or advice of the
central bank. This punishment is very severe of a commercial
bank.

2. Moral persuasion: It is another method by which central

bank may get credit supply expanded or contracted. By moral
pressure it may prohibit or dissuade commercial banks to deal
in speculative business.
 3. Legislation: The central bank may also adopt necessary
legislation for expanding or contracting credit money in the
market.

4. Publicity: The central bank may resort to massive advertising

campaign in the newspapers, magazines and journals depicting the
poor economic conditions of the country suggesting commercial
banks and other financial institutions to control credit either by
expansion or by contraction.

“Troublesome to acquire, troublesome to protect, troublesome if lost,

troublesome if spent; money is nothing but trouble, from beginning to end.”

- Panchatantra, 200 BC
 CONCLUSION
India’s financial system has undergone development as part of the economic
reform process that began in 1990. This has resulted in the expansion of both the
banking sector and the stock market. However, India’s banking sector remains
relatively small compared with those of most East Asian economies, and there
appears to be scope for further expansion. Individual banks are also small by
international standards. Furthermore, the corporate bond market is still immature
and has not yet started to develop on a significant scale.
The main role of RBI is related to the Indian economy, and the banks are an
instrument to help RBI make changes according to different macroeconomic facets
of the Indian economy.
There are 3 ultimate goals of a central bank, including RBI: -
 Growth - higher the better, but should be sustainable
 Inflation - under
 Unemployment - at the natural rate of unemployment

To achieve these 'Ultimate Goals', RBI changes/adjusts its intermediate goals

according to current levels of growth, inflation, unemployment and fiscal policies
(i.e. the policy of the ruling government). These intermediate goals are -
 Money Supply
 Interest Rate
 Credit
 Exchange Rate

All of these intermediate goals, which contribute to achieve the ultimate goals, are
to be controlled by the central bank. Now, to control these 'Intermediate Goals',
RBI has some short term ways which can lead to achieving the intermediate goals
of RBI. These ways are called 'Instruments of Monetary Policy’. Hence RBI is a
FACILITATOR of the Indian banking system and not a REGULATOR.
 Bibliography

BOOKS:
M.Y. Khan –Indian financial system
Sudhir Shah-Indian economy

WEBSITE:
www.rbi.org.in