Module 3: Central Bank

RBI AS CENTRAL BANK

1. The Reserve Bank of India was set up on the basis of the recommendations of the Hilton Young
Commission.

2. The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory basis of the functioning
of the Bank, which commenced operations on April 1, 1935.

3. It began its operations by taking over from the Government the functions of the Controller of
Currency and the Imperial Bank of India, the management of Government accounts and public
debt.

4. After the partition of India, the Reserve Bank served as the central bank of Pakistan upto June
1948 when the State Bank of Pakistan commenced operations.

5. It started originally as a shareholders bank with a paid up capital of 5 crores.

 CHRONOLOGY
1914-Chamberlain Commission recommended that three Presidency Banks be merged into a Central
Bank

1926- Royal Commission on Indian Currency and Finance (Hilton Young Commission)

1927- Bill introduced in Legislative assembly, but could not be passed.

1931- Central Banking Enquiry Commission

1934- The Reserve Bank of India Act

1935- April 1, RBI becomes operational

1948- The Reserve Bank (Transfer of Public Ownership) Act, 1948

1949- January 1, nationalisation of RBI brought into effect.

 RBI and ITS OFFICES
RBI has four zonal offices

- Chennai

- Mumbai

- Delhi

- Kolkata

It has 19 regional offices:

Ahmedabad,
Bangalore,Bhopal,Bhubaneshwar,Chandigarh,Chennai,Delhi,Guwahti,Hyderabad,Jaipur,Jammu,Kanpur
, Kochi, Kolkata, Lucknow, Mumbai, Nagpur, Patna and Thiruvananthapuram
 STRUCTURE OF RBI
1. Body corporate, having perpetual succession and a common seal, and can sue and be sued by its
name.

2. 1 Central Board- 20 Members

3. 4 Local Boards

4. Offices- 1 head office, 19 regional and 9 sub-offices

5. Fully owned subsidiaries: Deposit Insurance and Credit Guarantee Corporation of India(DICGC),

Bharatiya Reserve Bank Note Mudran Private Limited(BRBNMPL)

 It has several Departments, they are:

1. Market

1. - Internal Debt Management Department

2. - Department of External Investments and Operations

3. - Monetary Policy Department

4. - Financial Markets Department

 2. Regulation, Supervise and financial stability

1. - Department of Banking Operations and Development

2. - Department of Non-Banking Supervision

3. - Urban Banks Department

4. - Department of Banking Supervision

5. - Foreign Exchange Department

6. - Rural Planning and Credit Department

 3. Research

- Department of Economic and Policy Research

- Department of Statistics and Information Management

4. Services

- Department of Government and Bank Accounts

- Deposit Accounts Department

- Department of Currency Management

- Department of Payment and Settlement System

- Customer Service Department

5. Support

- Human Resource Management Department

- Department of Communication

- Department of Expenditure and Budgetary Control

- Department of Information Technology

- Premises Department

- Secretary’s Department

- Rajbhasha Department

- Inspection Department

- Legal Department
 IMPORTANT FUNCTIONS OF RBI
The Bank was constituted to:

1. Regulate the issue of banknotes

2. Maintain reserves with a view to securing monetary stability and

3. To operate the credit and currency system of the country to its advantage.

Preamble, the Reserve Bank of India Act, 1934 states the purpose 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.’
 The main functions of RBI can be understood by the following points:

1. Issuer of currency

1. Section 22 of RBI Act 1934 gives RBI the sole authority to issue currency in India under
the signature of the Governor.

2. The responsibility for managing the currency in circulation is vested in the RBI and for
this they have established 14 offices for the Issue department, for other places they
have currency chest.

3. Currency chests are branches of selected banks authorized by the RBI to stock rupee
notes and coins, it provide remittance facilities to banks and the public.

4. However credit cannot be extended to an unlimited extent, that would lead to price
instability.
 2. Banker to Government

1. Section 20 provides that RBI shall undertake to accept money from account of the
Central Government and to make payment up to the amount standing to the credit
of its account and it carry out its other banking operations.

2. RBI is not just a banker to GOI but also to State Governments.

3. It also manages the public debts of the Government.

4. Section 21 and 21 A gives RBI the right to transact the Government business of
Central Government and also State Government on agreement.

5. In case there is no branch or office in any place RBI can appoint SBI or the National
Bank as its agent under section 45.
3. Banker to Banks

RBI maintains banking accounts of all Scheduled Banks. It acts as a banker to the
banks.

In case of difficulties RBI acts as a lender as a last resort to the Scheduled

Commercial Banks under section 17. Section 17 (4) provides that RBI can grant
loans and advances to the banks.

“the making to local authorities, scheduled banks, State cooperative banks and State
Financial Corporations of loans and advances, repayable on demand or on the expiry of
fixed periods not exceeding ninety days, against the security of …….”
 4. Organizer of Banking System

1. It is concerned largely with the organization of a sound and healthy commercial

banking system and ensure effective co-ordination.

2. Banking Regulations Act, 1949 gives immense power to the RBI to supervise and
control the banks in India.

3. Can control licensing and branch licensing u/s 22 and 23

4. Inspection of books and accounts and to give directions u/s 35 35 A

5. Moratorium of business u/s 37

 5. Control over Management of Banks

Banking Regulations Act, 1949 gives RBI

Section 35B - Amendments of provisions relating to appointments of Managing Directors, etc., to be

subject to previous approval of the Reserve Bank.

6. Promoter of Financial Institutions (Promotional Role)

RBI took several measures for planned economic development of the countries:

1. - RBI established the Bill Market Scheme in 1952 and again in 1970

2. - Established financial corporation to provide credit to Agricultural and Industrial sector

3. - Promoted RRBs

4. - Establishment of EXIM Bank

7. Financial Supervision over Banks

RBI performs supervisory functions under the guidance of Board of Financial Supervision (BFS). Some
of the initiatives are:

- Restructuring of the system of banking inspection

- Introduction of Off-site Surveillance

- Strengthen the role of statutory auditors

Till 1993, regulatory as well as supervisory functions over commercial banks were performed by the
Department of Banking Operations and Development (DBOD).

The Board for Financial Supervision (BFS) was set up in November 1994 under the aegis of the Reserve
Bank of India, a new Department of Banking Supervision (DBS).
 8. Credit Control

It exercises control over money and credit through appropriate monitory and credit policies
from time to time. It can exercise selective credit control in order to control inflation and
deflation in money supply.

These credit control measures are divided into:

Selective Credit Control Method

Section 21 gives RBI to power to control the advances granted by commercial banks.

Power of RBI to control advances by banking companies by policy on Rate of interest ,

Purpose of advances, the Margins to be maintained in respect of secured advances, Maximum
amount of advances or other financial accommodation to a single borrower
- Quantitative Methods

There are essentially three measures:

Bank Rates

Open Market Operations

Variable Cash Reserve requirements

Bank rate u/s 49

‘Publication of bank rate. The Bank shall make public from time to time the standard rate at
which it is prepared to buy or re-discount bills of exchange or other commercial paper
eligible for purchase under this Act’

The rate of interest charged by the central bank on the loans they have extended
to commercial banks and other financial institutions is called “Bank Rate”.

In this case, there is no repurchasing agreement signed, no securities sold or

collateral involved.

Banks borrow funds from the central bank and lend the money to their customers
at a higher interest rate, thus, making profits
Whenever the RBI wants to reduce credit, the bank rate is raised and bank rate is
reduced in case the volume of bank credit goes up.

Current bank rate is 6.75%

Open Market Operations u/s 17

Open market operations are conducted by the RBI by way of sale or purchase of
government securities to adjust money supply conditions.

Securities purchases inject money into the banking system and stimulate growth,
while sales of securities do the opposite and contract the economy.

This affects the cash base of the commercial banks, and thus controls it.
Variable Reserve Requirement

All commercial banks are required to keep a certain amount of deposit with the RBI,
who time and again regulates the minimum reserve.

If RBI wants to contract credit from the market, then it would increase the
percentage of reserve to be maintained by the banks and would decrease it in case
there is shortage of credit in the market.

The two ways RBI does this is via

- Cash Reserve Ratio

- Statutory Liquidity Ratio

 Cash Reserve Ratio

An average daily balance of the total of the demand and time liabilities in India, as the
Reserve Bank may from time to time, having regard to the needs of securing the monetary
stability in the country, notify in the Gazette of India (Section 42, The Reserve Bank of India
Act, 1934).

“Every bank included in the Second Schedule shall maintain with the Bank an average daily balance the
amount of which shall not be less than such per cent. of the total of the demand and time liabilities in
India of such bank as shown in the return referred to in sub-section (2), as the Bank may from time to
time, having regard to the needs of securing the monetary stability in the country, notify in the Gazette of
India:

Provided that the Bank may, by notification in the Gazette of India, increase the said rate to such higher
rate as may be specified in the notification so however that the rate shall not be more than 6[twenty per
cent of the total of the demand and time liabilities.”

Current CRR rate is 4%

 Statutory Liquidity Ratio

‘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 20 percent of the total of its demand and time
liabilities in India.’ (Section 24, the Banking Regulation Act, 1949)

Current SLR rate 19.5%

 Repo Rate
The interest at which banks borrow funds from RBI by selling their
securities and bonds is called Repo Rate.
A repurchasing agreement is signed by both the parties stating that the
securities will be repurchased on a given date at a predetermined
price.
For example: If the repo rate fixed by the RBI is 10% p.a and the
amount borrowed by a bank from RBI is Rs 10,000, the interest rate to
be paid by the bank to RBI is Rs 1,000.
Current Repo rate is 6.50%
 Reverse Repo Rate

It is the interest rate offered by RBI to banks who deposit into its
treasury. If banks generate excess funds, deposit it with RBI.

The rate of interest earned by the depositing bank is called reverse

repo rate.

For example: If the reverse repo rate fixed by RBI is 5% p.a and the
amount deposited by commercial banks into RBI’s account is Rs.
10,000, the interest rate by the depositing bank is Rs 500 p.a.

Current Reverse Repo Rate is 6.25%

 Marginal Standing Facility (MSF)

Under the Marginal Standing Facility (MSF), banks avail funds from the RBI on overnight
basis against their excess statutory liquidity ratio (SLR) holdings.

MSF was introduced by the RBI in its monetary policy for 2011-12.

MSF is related with SLR. If a bank has securities holding of just 19.5 % i.e. mandatory SLR
holding. The bank can’t borrow using the repo facility.

But as per the MSF, the bank can borrow 1 % of its liabilities from the RBI. Sometimes the
RBI increases the limit of borrowings to 2%.

But in the case of repo, the bank has to mortgage the securities with the RBI.

In MSF the rate of interest is higher, 2017- 0.25% more than repo rate.
 RBI Regulates the Money Market

The call money market is the market where overnight loans can be taken by banks.

Banks which need liquidity borrow from the ones who have excess liquidity in the call
market.

It is functional from Monday to Friday, 9 to 5

Banks can access CMM to meet their reserve requirements (CRR and SLR) or to cover a
sudden shortfall in cash on any particular day.

Call Money Market is a market oriented mechanism to meet the liquidity requirements
of banks.

Money market is a section of the financial market where financial instruments with high
liquidity and short-term maturities are traded.
They consists of negotiable instruments like treasury bills, commercial papers, certificates of
deposit.
It is used by many participants, including companies, to raise funds by selling commercial
papers in the market.
Money market is considered a safe place to invest due to the high liquidity of securities.
Call Money, Notice Money, Term Money
Participants: Scheduled Commercial banks but not including RRBs, Co-operative banks, except
Land Development Banks and Primary Dealers (market makers of G Sec).
RBI regulates it via:
- The Reserve Bank of India Act, 1934 , S. 45-W, w.e.f. 9.1.2007.
- The RBI Master Circular on Call/notice Money Market
RBI & Credit InformationCHAPTER IIIA
Section 45A-45G (inserted in 1962)
45A (C): Credit information means any information relating to–

(i) the amounts and the nature of loans or advances and other credit facilities granted by a
banking company to any borrower or class of borrowers;

(ii) the nature of security taken from any borrower or class of borrowers for credit facilities
granted to him or to such class;

(iii) the guarantee furnished by a banking company for any of its customers or any class of its
customers;

(iv) the means, antecedents, history of financial transactions and the credit worthiness of any
borrower or class of borrowers;

(v) any other information which the Reserve Bank may consider to be relevant for the more
orderly regulation of credit or credit policy.
Power of Reserve Bank to collect credit information

RBI has the power to collect credit information from banks u/s 45 B

45B. Power of bank to collect credit information

The bank may-

(a) collect, in such manner as it may think fit, credit information from banking companies; and

(b) furnish such information to any banking company in accordance with the provisions of
section 45D.
 Procedure for furnishing credit information
to banking companies Section 45D
On request of a banking company,

The RBI shall, as soon as may be, furnish the applicant with such credit information
relating to the matters specified in the application, as may be in its possession:

Provided that the information so furnished shall not disclose the names of the
banking companies which have submitted such information to the Bank.

RBI may levy on each application such fees, not exceeding twenty-five rupees, as it
may deem fit for furnishing credit information
 Confidentiality Of Information 45 E

The information provided by the RBI under section 45 C and D is confidential and must not be published as per
section 45E.

But second clause provide certain exceptions, they are:

- Disclosure by any banking company, with the previous permission of the RBI.

- The publication by the Bank, if it considers necessary in the public interest so to do (without disclosing name of
bank or borrowers).

- The disclosure or publication by the banking company or by the Bank of any credit information to any other
banking company or in accordance with the practice and usage customary among bankers or as permitted or
required under any other law.

- The disclosures of any credit information under the Credit Information Companies (Regulation) Act, 2005.

*Credit Information Bureau Limited is India’s first Credit Information Company founded in August 2000. CIBIL
collects and maintains records of an individual’s payments pertaining to loans and credit cards.
No court, tribunal or other authority shall compel the Bank or any banking company
to produce or to give inspection of any statement submitted by that banking
company under section 45C or to disclose any credit information furnished by the
Bank to that banking company under section 45D.

45F. Certain claims for compensation barred.

No person shall have any right, whether in contract or otherwise, to any

compensation for any loss incurred by reason of the operation of any of the
provisions of this Chapter.
 NON-BANKING INSTITUTIONS
RECEIVING DEPOSITS AND
FINANCIAL INSTITUTIONSCHAPTER
IIIBSections 45H-45N
 WHAT IS A NBFC?

A Non-Banking Financial Company (NBFC) is a company registered under the

Companies Act, 1956 which is engaged in the business of

- loans and advances,

- acquisition of shares/stocks/bonds/debentures/securities issued by Government or

local authority

- marketable securities of a like nature, leasing, hire-purchase, insurance business,

chit business but does not include any institution whose principal business is that of
agriculture activity, industrial activity, purchase or sale of any goods or providing any
services and sale/purchase/construction of immovable property.
A non-banking institution which is a company and has principal business of receiving deposits under
any scheme or arrangement in one lump sum or in installments by way of contributions or in any
other manner, is also a non-banking financial company (Residuary non-banking company).

Difference between banks and NBFC

NBFCs lend and make investments, but there are certain differences between banks and NBFC, they
are:

1. NBFC cannot accept demand deposits

2. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on
itself.

3. Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available
to depositors of NBFCs, unlike in case of banks

Source: https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92
Earlier the RBI Amendment Act 1997 made it compulsory for NBFCs to have a minimum capital
requirement of 25 lakhs

Later the requirement was increased to 2 crores, but the already registered were allowed to
operate on 25 lakhs minimum capital

Revised Regulatory framework of RBI in 2014 put a deadline as 31 st March, 2017 for all NBFCs to
reach 2 crores.

“There are still a large number of NBFC that have not been able to reach that level, and RBI is
cancelling their registrations.”*

*https://www.livemint.com/Industry/3aPlbk7FcRyaSosCT65v0H/RBI-cancels-licences-of-368-
NBFCs-in-first-half-of-2018.html
 45J. Bank to regulate or prohibit issue of prospectus
or advertisementsoliciting deposits of money.
The Bank may, if it consider necessary in the public interest so to do, by general or special order,—

(a) regulate or prohibit the issue by any non-banking institution of any prospectus or advertisement
soliciting deposits of money from the public, and

(b) specify the conditions subject to which any such prospectus or advertisement, if not prohibited,
may be issued.

The RBI regulates NBFCs for three reasons, they are depositor protection, the fact that many NBFCs
rely on banks to finance their liabilities, and also to regulate the interface between customers and
NBFCs.

In 2015 RBI cancelled license of 56 NBFC- 2018 368 NBFC licenses were cancelled.
 45JA. Power of Bank to determine policy and issue directions.

Will regulate if RBI is satisfied that it is in public interest.

Bank may give directions to NBFCs as to–

- The purpose for which advances or other fund based or non-fund

based accommodation may not be made.

- The maximum amount of advances or other financial accommodation

or investment in shares and other securities which may be made by
NBFCs to any person or a company or to a group of companies.
Section 45K & 45L: Power of RBI to call information from NBFc and Financial
Institutions and give them direction.

Section 45M: Duty of NBFc to give information.

Section 45MB: RBI can prevent NBFc from accepting deposits if they fail to
comply with RBI directions.

‘prohibiting from accepting deposit has been issued, not to sell, transfer, create
charge or mortgage or deal in any manner with its property and assets without
prior written permission of the Bank for such period not exceeding six months from
the date of the order.’

Section 45MC: Winding up application.

 PROHIBITION OF ACCEPTANCE OF
DEPOSITS BY UNINCORPORATED BODIES
Ch 3 Section 45S
No person, being an individual or a firm or an
unincorporated association of individuals shall, accept any
deposit except receipt of money by an individual by way of
loan from any of his relatives or to the receipt of money by
a firm by way of loan from the relative or relatives of any
of the partners.