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RBI Act 1934: Important

Provisions

Jiji T Mathew
Legal Framework
Umbrella Acts
1. Reserve Bank of India Act, 1934:governs the Reserve
Bank functions
2. Banking Regulation Act, 1949: governs the financial
sector
Acts governing specific functions
1. Public Debt Act, 1944/Government Securities Act
(Proposed): Governs government debt market
2. Securities Contract (Regulation) Act, 1956: Regulates
government securities market
3. Indian Coinage Act, 1906:Governs currency and coins
4. /Foreign Exchange Management Act, 1999 (which
replaced Foreign Exchange Regulation Act, 1973) :
Governs trade and foreign exchange market
Acts governing Banking Operations
1. Companies Act, 1956:Governs banks as companies
2. Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970/1980: Relates to nationalisation
of banks
3. Bankers' Books Evidence Act
4. Banking Secrecy Act
5. Negotiable Instruments Act, 1881
Acts governing Individual Institutions
1. State Bank of India Act, 1954
2. The Industrial Development Bank (Transfer of
Undertaking and Repeal) Act, 2003
3. The Industrial Finance Corporation (Transfer of
Undertaking and Repeal) Act, 1993
4. National Bank for Agriculture and Rural Development Act
5. National Housing Bank Act
6. Deposit Insurance and Credit Guarantee Corporation Act
The origin of RBI
• The Royal Commission on Indian Currency and
Finance (1926)-known as the Hilton-Young
Commission- recommended the creation of a
central bank in India to separate the control of
currency and credit from the government and to
augment banking facilities throughout the
country.
• Reserve Bank of India was set up in 1935, under
RBI act of 1934, as the banker to the central
government
• RBI was nationalized in 1949.
RBI Act 1934
• Specifies the institutional or legal/de jure
relationship among the monetary authority-
central bank-, government, banking sector
and the public.
• The Act relates to
– Organizational structure of the CB
– Functions of the CB
– Objectives for the assigned functions and Policy
– Independence, Accountability & Transparency
Rationale of central Bank: Why do we need a Central
Bank?
First Central Banks (CB), Swedish Riksbank (1668) and Bank of
England (1694) was established to provide the government with
finance in needy times at favorable terms.
• Need for a specialized and professional institution different from
the elected government
• Need for Development,Regulation and Supervision of Financial
System.
• Need for efficiently oversee, guide and regulate the market in
midst of globalized financial Markets and financial Innovations
• To facilitate the smooth functioning of the payments and
settlements mechanism
• Finally to formulate and conduct the monetary and exchange rate
policy and financial policy with a view to create orderly
conditions in the financial market and Goods market.
Evolution of central banks in the world
• Evolution of central banking is a 20th century
phenomenon with only a dozen or so CBs till 1873
• Only Swedish Rikz bank and Bank of England till 1800
• Now that figure is around 160
• German CB was set up in 1875 for the need to restore
and maintain a stable currency.
• Federal Reserve Board came into established in 1914
for the provision of nation-wise payment and
depository system.
• Reserve Bank of India set up in 1935, under RBI act of
1934, and was nationalized in 1948.
RBI ACT contains:
115 pages; 59 sections; 79 amendments as on Feb 28, 2009.
• 5 Chapters
I. Preliminary: title, commencement , definitions
II. Incorporation, Capital, Management and Business
III. Central banking Functions
(IIIA) Collection and Furnishing of Credit information
(IIIB) Provisions relating to Non-Banking Institutions
and Financial Institutions
(IIIC) Prohibition of Acceptance of Deposits by
unincorporated Bodies
(IIID) Regulation of transactions in Derivatives, Money
Market Instruments, Securities, Etc.
IV. General Provisions
V. Penalties
The Preamble of RBI Act states that RBI is
constituted “to regulate the issue of Bank notes and
the 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”.
This can be interpreted as a statement on Objectives
of monetary policy , which implies that RBI’s main
objectives of monetary policy are Price stability
and Economic growth.
This is an example of Implicit and unclear
statement of objectives, without stating the
priorities and targets assigned the objectives of
the of monetary policy
Example 2-Statement on Objectives of monetary policy
from ESCB
• "The primary objective of the ESCB shall be to maintain
price stability". And: "without prejudice to the objective
of price stability, the ESCB shall support the general
economic policies in the Community with a view to
contributing to the achievement of the objectives of the
Community as laid down in Article 2."
• The objectives of the Union (Article 2 of the Treaty on
European Union) are a high level of employment and
sustainable and non-inflationary growth.
• The ECB Governing Council has defined price stability
as an annual increase in the Harmonised Index of
Consumer Prices (HICP) in the euro area of below 2 %.

This is an example of Explicit and clear statement of


objectives, priorities and targets for Monetary Policy
Example 2-Statement on Objectives of monetary policy
from FRB
• The goals of monetary policy are spelled out in the
Federal Reserve Act, which specifies that the Board of
Governors and the Federal Open Market Committee
should seek “to promote effectively the goals of
maximum employment, stable prices, and moderate
long-term interest rates.” Stable prices in the long run are
a precondition for maximum sustainable output growth
and employment as well as moderate long-term interest
rates.
 This is an explicit statement of the multiple objectives of
Monetary policy but there is no clarity in the priorities
among the objectives and the targets are not stated
either explicitly on implicitly.
 Statement of Reserve Bank of New Zealand
• Section 8 in the RBN Act 1989 declares that the RBN’s
main function is “to formulate and implement monetary
policy directed to the economic objective of achieving and
maintaining stability in the general level of prices”.
• Inflation target of 0-3% for CPI is mentioned in the PTA
Statement of Bank of England
• [1]The BoE Act, 1998, Chapter 2, section 11(2), states, “in
relation to monetary policy, the objectives of the BoE shall
be- (a) to maintain price stability, and (b) subject to that, to
support the economic policy of Her Majesty's Government,
including its objectives for growth and employment.”
• Currently the inflation target is 2.5% as measured by the
Retail Price Index excluding mortgage interest rates.
 These are examples of Explicit and clear statement of
objectives, its priorities and targets for Monetary Policy
Chapter II: Incorporation, Capital, Management
and Business (Section 3-19)
• Reserve Bank of India shall be constituted for the purposes
of taking over the management of the currency from the
Central Government and of carrying on the business of
banking in accordance with the provisions of this Act
(section 3.1).
• The capital of the Bank shall be five crores of rupees( S 4)
• Management (Section 7): the general superintendence and
direction of the affairs and business of the Bank is entrusted
to a Central Board of Directors, subject to directions of
the Central Government.
Composition of the Central Board & Term of Office of
Directors (S:8)

• Central Board of Directors


– Constituted of 21 members-including a governor and not more
than 4 Deputy Governors, 4 directors from the local boards, two
government officiall, 10 directors nominated by the government.
– Nominated and appointed by the government for a term of not
more than 5 years for Governor and deputy governors and 4
years for other directors and are eligible for reappointment.
– Meets at least six times in a year and at least once in a quarter
– Minutes and voting patterns of the meetings are not published
– Consensus approach to decision-making
• Committee of Central Board
– Constituted of governor, 4 deputy governors and few other
directors
– Meets once in a week
• The Local Boards: composition
• The local Boards, one each for the four regions of the
country in Mumbai, Calcutta, Chennai and New Delhi,
consist of five members each appointed by the Central
Government for a term of four years.
• The members of the Local Board shall elect from amongst
themselves one person to be the chairman of the Board.
• The functions of local boards are: to advise the Central
Board on local matters; to represent territorial and
economic interests of local cooperative and indigenous
banks; and to perform such other functions as delegated
by Central Board from time to time.
RBI is authorised to conduct following Business
transactions.
• the accepting of money on deposit without interest from and
the collection of money for Central Government, State
Governments, local authorities, banks.
• the purchase, sale and rediscount of bills of exchange and
promissory notes submitted by commercial banks,
cooperative banks, Financial Institutions, primary dealers.
• Loans and advances to banks and financial institutions
against collaterals of stocks, securities, funds, loans etc.
• Making Investments in bonds, shares of SBI, domestic
financial institutions like NHB, NABARD, SIDBI, EXIM
bank, world bank, IMF, ADB, foreign central banks etc.
• the purchase and sale of gold or silver coins and gold and
silver bullion and foreign exchange and the opening of a
gold account with the principal currency authority of any
foreign country or the BIS or any international or regional
bank or financial institution.
RBI is not authorised to conduct following
Business transactions:
• engage in trade or otherwise have a direct interest in any
commercial, industrial, or other undertaking
• purchase the shares of any banking company or of any
other company, or grant loans upon the security of any
such shares;
• advance money on mortgage of, or otherwise on the
security of, immovable property or documents of title
relating thereto, or become the owner of immovable
property, except so far as is necessary for its own business
premises and residences for its officers and servants;
• make loans or advances
• draw or accept bills payable otherwise than on demand;
• allow interest on deposits or current accounts.
Chapter III: Central banking
Functions (Sections 20-45)
• Banker to the government
– Keeping and Managing the Government account at
the CB
– Lending to the Government
– Public Debt Management
• Intervention in the Secondary market for
Government Securities
• RBI’s Intervention in Primary market is
prohibited
RBI as a Public debt manager

• RBI Act- Managing debt of Central Govt. (mandatory)


and State Govts. (voluntary)
• Timing,size,pricing,form of issue;direct impact on cost
• Marketing
• Cost is Market Determined and Timing is Constrained
by Govt Need
• So RBI Follows a Strategy of 100% Underwriting by
Primary Dealers (PDs)
• To ensure Govt. is able to borrow even under volatile
conditions and to promote Deep and Liquid Market to
Minimize Long Term Borrowing Cost
• FRBM Act
FRBM ACT provisions

• Fiscal deficit targeted at 3% of the GDP


• Revenue Deficit targeted at 0% of the
GDP
• Prohibition of CB lending to the
government
• Prohibition of CB intervention in the
primary market for Government Securities
Ways and Means Advances
• The RBI is authorized to provide WMA to Central
and State Governments in terms of Section 17(5)
of the RBI Act.

• Until 1994-95, the needs of Government were


accommodated through automatic monetisation by
issuing ad hoc treasury Bills at 4.6 per cent.

• Considering the ill effects of automatic


monetisation of Government deficit, the RBI and
the Government agreed mutually in September
1994 to restrict the issue of ad hocs for the year-
end and also within the year and for scrapping the
issue of ad hoc treasury bills from 1 April 1997.
Ways and Means Advances
• The limit for WMA will be Rs.20,000 crore for the first half of the
year (April to September) and Rs. 6,000 crore for the second half of
the year (October to March). When 75 percent of the limit of WMA
is utilised by Government, the Reserve Bank may trigger fresh
floatation of market loans.
• The Reserve Bank would retain the flexibility to revise the limits at
any time, in consultation with the Government of India, taking into
consideration the transitional issues and prevailing circumstances.
• The interest rate on WMA/overdraft will be as under:
• a) Ways and Means Advances Repo Rate b) Overdraft Two percent
above the Repo Rate.The minimum balance required to be
maintained by the Government of India with the Reserve Bank of
India will not be less than Rs.100 crore on Fridays, on the date of
closure of Government of India's financial year and on June 30, i.e,
closure of the annual accounts of the Reserve Bank of India and not
less than Rs.10 crore on other days.
• As per the provisions of the Agreement dated March 26, 1997
between the Government of India and the Reserve Bank of India,
overdrafts beyond ten consecutive working days will not be allowed
• Monopoly in Issue of notes or Currency
– Role of Issue Department, Assets and liabilities
• The issue of bank notes is conducted by the Bank in
an Issue Department which shall be separated and kept
wholly distinct from the Banking Department.
– Minimum Reserve System: The issue of Indian currency
has to be backed by a minimum of 200 crores of
reserves, of which Rs/ 115 crores in Gold and the rest in
the form of foreign currency and government securities.
– Remainder of liabilities has to be backed by rupee coins,
GoI rupee securities, Promissory notes, Bills of excahnge
etc.
– Currency denomination
• RBI is authorized to issue Coins up to 1000 Rs and
notes up to 10000 Rs .
As per Indian Coinage Act-
– Rupee coin (1 and above) can be used to pay /settle
for any sum
– Paise 50 can be used to pay /settle any sum not
exceeding Ten Rupees
– In case of smaller coins below 50 paise, any sum
not exceeding One Rupee
Powers of Central Government to supersede Central
Board (Section 30)

• If in the opinion of the Central Government the Bank fails


to carry out any of the obligations imposed on it by or
under this Act , the Central Government] may, by
notification in the Gazette of India, declare the Central
Board to be superseded, and thereafter the general
superintendence and direction of the affairs of the Bank
shall be entrusted to another agency.
• Full report of the circumstances leading to such action and
of the action taken to be laid before Parliament at the
earliest possible opportunity and in any case within three
months from the issue of the notification superseding the
Board.
• Banker to the commercial banks
– CRR ,Discount Loans at repo Rate and standing lending
Facility, Liquidity adjustment facility, Interest rate corridor of
Statutory ceiling & floor for CRR & was abolished
– Lender of Last Resort
• Custodian of forex reserves
• Operating the Payments and Settlement System (Board for
Payments and settlements)
– Clearing of Cheques and electronic fund Transfers via RTGS
and NEFT
• Prudential Regulation and supervision of Banks (Board for
Financial supervision)
– Issuing licenses and regulations to domestic and foreign banks
for operations, expansion, Mergers & Acquisitions
– Facilitating Risk Management via Implementation of Basel II
and International financial standards and codes
Distribution of Regulatory Supervisory
Responsibilities
• Commercial banks and all-India development financial
institutions: Regulated by the Department of Banking
Operations and Development, supervised by the
Department of Banking Supervision
• Urban co-operative banks: Regulated and supervised by
the Urban Banks Department
• Regional Rural Banks (RRB), District Central
Cooperative Banks and State Co-operative Bank:
Regulated by the Rural Planning and Credit Department
and supervised by NABARD
• Non-Banking Financial Companies (NBFC): Regulated
and supervised by the Department of Non-Banking
Supervision
Legal and Institutional Characterisitcs of the RBI
Extent of CB Autonomy from the government
Term of Office of Governor 5 Years
Appointment of Governor By the government
Procedures of dismissal Full discretion for the govt.
Freedom to set the Instruments Yes
Freedom to set the goals of monetary Partial
policy
Prohibition of unlimited Central Bank Yes
lending to the government
Prohibition of Central Bank buying Yes
government securities in the primary
market
Maturity of CB loans 1-day to three months
In case of Policy conflicts Govt prevails over CB
International practices in CB Transparency/ Accountability
Extent of Communication/Transparency in Monetary Policy
Indicators of Communication/Transparency RBI FED ECB BOE
Explicit statement of objectives in Act No No Yes Yes
Formal prioritization/ranking of objectives No No Yes Yes
Explicit statement of targets/limits for Yes No Yes Yes
objectives
Explicit Statement of institutional No Yes Yes Yes
arrangements
Existence of a Statutory Monetary Policy No Yes Yes Yes
Committee
Minutes of monetary policy meeting No Yes Yes Yes
published.
Voting patterns in the meeting published. No Yes Yes Yes
Parliamentary hearings of CB Governor No Yes Yes Yes
Policy decision Making Structure at RBI
• Central Board of Directors
– General Superintendence and Direction
• Committee of Central Board
• Financial Markets Committee
– Daily decision-making on market intervention
• Technical Advisory Committee on Monetary Policy
• Technical Advisory Committee (TAC) on Money,
Foreign Exchange and Government Securities Markets
Certain Decision-making practices at
RBI which is outside RBI Act., have
evolved on the basis of conventions
and traditions and in confirmation with
the global best practices in this regard.

This is discussed in the next section.


Detailed Structure
• Financial Markets Committee (FMC)

• Decisions on day-to-day money market operations,


including management of liquidity, are taken by an
Internal FMC)
• FMC is constituted of senior officials of the Bank
responsible for monetary policy and related operations in
money, government securities and foreign exchange
markets.
• The Deputy Governor, Executive Director (s) and heads of
four departments in charge of monetary policy and related
market operations meet every morning as financial
markets open for trading.
• MMC also meet more than once during a day, if such a
need arises.
• Minutes of meetings are not published
Detailed Structure
Technical Advisory Committee on Monetary Policy
• 12 members of which five are external experts,
governor, 4 deputy governors, and 2 members of the
Central board.
• Tenure is 2 years
• Meets at least once in Quarter
• Reviews macro economic and monetary developments
and advice on the stance of monetary policy
• Its views will be discussed in the following meeting of
the committee of the Central Board of the RBI
• Minutes of the meetings are not published
Detailed Structure

Technical Advisory Committee (TAC) on Money,


Foreign Exchange and Government Securities Markets
• Composed of academicians and financial market
experts, including those from depositories and credit
rating agencies
• provides support to the consultative process.
• meets once a quarter
• discusses proposals on instruments and institutional
practices relating to financial markets.
• Minutes of meetings are not published
Monetary Policy Formulation In India

• No Legal autonomy and accountability for the CB

• Decision-making is not by a Monetary Policy


Committee
• Existing Committees are advisory in nature
• But there is a wide ranging consultative process
Consultative Process for Monetary Policy
INTERNAL
• Staff Analysis & Projections are cornerstone of the
policy-making
• Relevant Departments make formal projections on
inflation & output
• Inter-Departmental group then makes a joint
assessment
• These are debated in Monetary Policy Strategy
Committee meetings held at least once a month
• Projections on several other parameters – money
supply, credit, etc. are also discussed.
• Deliberation in Central Board
Consultative Process for Monetary Policy
EXTERNAL
• Technical Advisory Committee (TAC) on Monetary
Policy
• MPD of RBI arranges discussions between the top
management of the RBI and the select commercial banks
, industry associations, bodies representing markets and
the significant industry groups (IBA, FIMMDA, FEDAI,
CII etc)
• MPD also holds monthly meetings with select major
banks and financial institutions, which provide a
consultative platform for issues concerning monetary,
credit, regulatory and supervisory policies of the Bank.
• Expert Opinions from academics through rigorous
studies under DRG framework
• Consultation with Government of India.
RBIs Policy Announcements

RBI communicates its Monetary Policy and


Financial Policy through its Annual, mid Quarter &
Quarterly Policy statements
• Earlier Busy Season & Slack Season Reviews
• Later Annual Policy & Mid-term Review
• A Quarterly Policy Framework from 2005

• From September, 2010, onwards RBI provides 4


additional mid Quarter official policy reviews, in
addition to 4 existing Quarterly statements.
Structure of the Annual Policy Statements
Part-A: Annual Statement on Monetary Policy for the
Year
I. Review of Macroeconomic and Monetary
Developments during 2011-12
 Assessment of Domestic, External Sector, Global Economy

II. Stance of Monetary Policy for 2012-13


Economic and Monetary Projections & policy Stance

III. Monetary Measures


 Bank Rate, Reverse Repo/ Repo Rate, CRR)
Structure of the Annual Policy Statements
Part B: Annual Statement on Developmental and
Regulatory Policies for the Year 2012-13
I. Interest Rate Prescriptions
II. Financial Markets
III. Credit Delivery Mechanisms & Other Banking Services
IV. Prudential Measures
V. Institutional Developments
Features of the Annual, mid-quarter and Quarterly
Policy Statements
 Structure of the Annual Policy & Second Quarter Review
is the same. They contain both Part A & B
 Structure of the First & Third Quarter Review is the same
& does not include Part B as they limit themselves to
review of Monetary Policy Statement.
 Mid-Quarter review includes only a short review of
monetary and macro developments, including the policy
measures.
 An analytic review of the Macroeconomic & Monetary
Developments is issued a day in advance as a supplement
to Part I for each of the four quarterly policies.
CBs Interaction with Markets After the Policy

• Governor listens to Chairmen/CEOs of banks for their


reaction as part of Annual & mid-term policies
• Governor addresses Press Conference after the Quarterly
Policy Announcements
• Separate press briefings by Governor, DG(s)
• Comments by public, media, experts are given high
importance as a feedback mechanism
• Formal meetings with banks/industry forums are also
used to explain & get feedback
• Notifications of policy announcements often take into
the feedback.
• Internal Staff analysis on measures also form an
important input in follow-up action.