RBI and its functions

Banking Awareness Study Material

RBI and its functions

Reserve Bank of India is the Central Bank of India. It was established on 1 April, 1935 on the recommendation of the Hilton Young Commission. It was nationalized in the year 1949. According to the preamble of the RBI, Act 1934,”The main functions of the bank are to regulate the issuing of bank notes and keeping the 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 head office or the Central office of the RBI is in Mumbai.

Organization and Management of the RBI

RBI is managed by the Central Board of Directors. Presently, this Board consists of 20 members. Besides Governor and 4 Deputy Governors, 4 directors are nominated, each by the Four Local Boards which are in Mumbai, Chennai, Kolkata and New Delhi. Besides, ten directors and 1 government officer are nominated by the Government of India.

• The term of nominated members is 4 years.


• The term of Governor and Deputy Governors is 5 years.

Functions of RBI

These can be classified in 3 ways :

1. Traditional Functions


2. Developmental Functions


3. Regulatory Functions

Traditional Functions

These are as under :

1. Central Banking functions : These include issuing of paper currency ( RBI is India’s sole note issuing authority ), Control over the credit policies of Commercial Banks, serving as Banker of the Banks ( All Commercial Banks have to submit weekly reports to RBI about their transactions ) and Banker to the Government ( maintaining government accounts, providing financial advice to the government ).


2. General Banking Functions :
   • It accepts deposits of the Central Government of India, State Governments, Port-Trust and private individuals without paying any taxes.
   
   
   • It buys sells, buys and rediscounts the Bills, Promissory Notes and Hundies.
   
   
   • It gives loans to the Central and State Governments.
   
   
   • It buys, sells and discounts agricultural bills.
   
   
   • It deals with all the foreign securities.
   
   
   • It deals with the sale and purchase of gold, silver as well as coins made of these metals.
   
   
   • It deals with the banks of other countries and establishes business relations with them
   
   

Developmental Functions

These are :

1. Development of Agriculture


2. Promotions of Industrial Finance


3. Promotion of Export through refinance


4. Development of Bill Market


5. Development and Regulation of Banking System

Regulatory Functions

Control of Credit is the principal function of RBI. The methods of credit control adopted by the RBI are under 2 parts :

1. Quantitative Credit Control


2. Qualitative or Selective Credit Control

Quantitative Credit Control

RBI adopts all those measures that are adopted by the central banks of other countries. These measures are :

1. Bank Rate : Rate of Interest that RBI charges from other Scheduled Banks on the loans given to them is called Bank Rate.


2. Differential Rate of Interest : In October, 1960 the RBI started ‘Differential Rates of Interest’ program. According to this program, if any bank borrows from the RBI beyond its quota fixed for it, it has to pay higher interest rate than the prevailing Bank rate. On December 28, 1974, a new scheme was introduced in which a member bank would be given loan at the prevailing bank rate only if its Net Liquidity Ratio is 39%. In case the Net Liquidity Ratio is less than that , the Bank Rate can be raised to any limit up to 18%.


3. Open Market Operations : It means that the Bank controls the flow of credit through the sale and purchase of government securities in the open market.


4. Cash Reserve Ratio (CRR) : Cash Reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the RBI decides to increase the percent of this, the available amount with the banks comes down. RBI uses this method to drain out the excessive money from the banks.


5. Statutory Liquidity Ratio (SLR) : According to the Indian Banking Act, 1949, a bank is legally bound to keep 20% of its deposits in the form of Liquid Assets. This is kept by the bank itself. Amendment of 1962 to the Indian Banking Act raised this SLR to 25%. It was further raised to 33% in 1974, 34% in 1978, 37.5% in 1987. In 1997 it was reduced to 25%. This method is used to check inflation.


6. Direct Action : According to the 1949 Act, RBI can stop any commercial bank from any type of transaction. In case of defiance of the orders of RBI, the RBI can resort to direct action against the member bank.


7. Credit Authorization Scheme : In 1965, Credit Authorization Scheme was adopted. It aims at regularizing of the credit given by the banks. According to this scheme, before sanctioning a credit limit of Rs. 2 crore or more to any one debtor, every bank will have to get authorization from the RBI.


8. Moral Persuasion : RBI holds meetings with the member banks seeking their cooperation in effectively controlling the monetary system of India.

Qualitative or Selective Credit Control

This refers to the control of specific credit meant for certain specific objectives. Banking Companies Act, 1949 has given RBI many rights of selective control. Some techniques of selective control are as under :

• Change in Margin Requirements on Loans


• Fixing maximum limit of the Loans


• Rationing of Credit