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Reserve Bank of India(RBI)

RBI 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 originally established in Calcutta but later was permanently moved to Mumbai in 1937. The Central Office is where the Governor of RBI sits and where policies are formulated. However originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India.

Brief History

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

The Bank was constituted to:

  • Regulate the issue of banknotes
  • Maintain reserves with a view to securing monetary stability and
  • Operate the credit and currency system of the country to its advantage.

The Bank started its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India, the management of Government accounts and public debt. The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Kanpur became branches of the Issue Department. Offices of the Banking Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon. Burma separated from the Indian Union in 1937 but the Reserve Bank continued to act as the Central Bank for Burma till Japanese Occupation of Burma and later upto April, 1947. After the partition of India, the Reserve Bank served as the central bank of Pakistan upto June 1948 when the State Bank of Pakistan started operations. The Bank, which was at first set up as a shareholder's bank, was nationalized in 1949.

An interesting feature of the RBI was that at its very inception, the Bank was seen as playing a special role in the context of development, especially Agriculture. When India started its plan endeavours, the development role of the Bank came into focus, especially in the sixties when the Reserve Bank, in many ways, pioneered the concept and practise of using finance to catalyse development. The Bank was also influential in institutional development and helped set up institutions like the Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India, the Industrial Development Bank of India, the National Bank of Agriculture and Rural Development, the Discount and Finance House of India etc. to build the financial infrastructure of the country. With liberalization, the bank's focus has shifted back to core central banking functions such as Monetary Policy, Bank Supervision and Regulation, and Overseeing the Payments System and onto developing the financial markets.

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."

Structure

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:Official Directors
  • Full-time : Governor and not more than four Deputy Governors Non-Official Directors
  • Nominated by Government: ten Directors from various fields and one government Official
  • Others: four Directors - one each from four local boards

Functions: General superintendence and direction of the Bank's affairs

Local Boards

  • One each for the four regions of the country in Mumbai, Calcutta, Chennai and New Delhi
  • Membership: consist of five members each appointed by the Central Government for a term of four years.

Functions

To give advice to the Central Board on local matters and to represent territorial and economic interests of local cooperative and indigenous banks; to perform such other functions as delegated by Central Board from time to time.

Board for Financial Supervision (BFS)

The Board was constituted in November 1994 as a committee of the Central Board of Directors of the RBI.

Objective

The main objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies.

Constitution

The Board is constituted by co-opting four Directors from the Central Board as members for a term of 2 years and is chaired by the Governor. The Deputy Governors of the Reserve Bank are ex-officio members. One Deputy Governor, usually, the Deputy Governor in charge of banking regulation and supervision, is nominated as the Vice-Chairman of the Board.

BFS meetings

The Board is required to meet normally once every month. It considers inspection reports and other supervisory issues placed before it by the supervisory departments. BFS through the Audit Sub-Committee also intend at upgrading the quality of the statutory audit and internal audit functions in banks and financial institutions. The audit sub-committee consists Deputy Governor as the chairman and two Directors of the Central Board as members.

The BFS oversees the functioning of Department of Banking Supervision (DBS), Department of Non-Banking Supervision (DNBS) and Financial Institutions Division (FID) and gives directions on the regulatory and supervisory issues.

BFS Functions

Some of the initiatives taken by BFS include:

  • Restructuring of the system of bank inspections
  • Introduction of off-site surveillance,
  • Strengthening of the role of statutory auditors and
  • Strengthening of the internal defenses of supervised institutions.

The Audit Sub-committee of Board for Financial Supervision (BFS) has reviewed the current system of concurrent audit, norms of empanelment and appointment of statutory auditors, the quality and coverage of statutory audit reports, and the significant issue of greater transparency and disclosure in the published accounts of supervised institutions.

Current Focus

  • Supervision of financial institutions
  • Consolidated accounting
  • Legal issues in bank frauds
  • Divergence in assessments of non-performing assets and
  • Supervisory rating model for banks.

Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the significant functions of a central bank the Reserve Bank of India.

Classification of RBIs functions

The monetary functions also referred to 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 important 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 can be regarded as a non-monetary function (though many consider this a monetary function). The promotion of sound banking in India is an significant goal of the RBI, the RBI has been given wide and drastic powers, under the Banking Regulation Act of 1949 - these powers relate to licensing 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 significantly 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, principally after its nationalisation 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.

Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Reserve Bank only has the 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. RBI has a separate Issue Department which is entrusted with the issue of currency notes. The assets and liabilities of the Issue Department are kept apart from those of the Banking Department. Initially, 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 called as the minimum reserve system.

Banker to Government

The second vital 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 excluding that of Jammu and Kashmir. The Reserve Bank has the compulsion to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the Government and to carry out their exchange remittances and other banking operations. RBI 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.

Bankers' Bank and Lender of the Last Resort

RBI 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 RBI 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 RBI 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.

Controller of Credit

The RBI 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 RBI 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 RBI 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 must 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 authority 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 authority to inspect the accounts of any commercial bank.

As a 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.

Custodian of Foreign Reserves

The RBI 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 lsh.6d. Though there were periods of extreme pressure in favor of or against the rupee. After India became a member of the International Monetary Fund (IMF) 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 Reserve Bank of India has the responsibility of administering the exchange controls of the country.

Supervisory functions

Other than the 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 authority 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 Reserve Bank of India is authorized to carry out periodical inspections of the banks and to call for returns and more rapid development of the economy and realization of certain desired social objectives. The supervisory functions of the Reserve Bank of India 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.

Promotional functions

With economic growth assuming a new urgency since Independence, the range of the Reserve Bank's functions has progressively widened. The Reserve 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 set up and promote new specialised financing agencies. Accordingly, the Reserve Bank has helped in the establishing 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 established directly or indirectly by the Reserve Bank to promote saving habit and to mobilise 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 vital. The Bank has developed the co-operative credit movement to encourage saving, to get rid of 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 offer long-term finance to farmers.

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