UNIT II

Reserve Bank of India

For the purpose of carrying on the functions of central bank of the country,
Reserve Bank of India was established on April 1, 1935 through Reserve Bank of India
Act, 1935. The main office of RBI was initially established in Kolkata but in the year 1937,
it was permanently moved to Mumbai. The chief of RBI is called as Governor of RBI and
he functions from the main office. Originally the RBI was established as a privately owned
central bank with a share capital of Rs. 5 crores divided into 5 lakh shares of Rs. 100 each.
After independence, the RBI was nationalized and it started functioning as government
owned central bank from January 1, 1949.
Reserve Bank of India has 26 Regional Offices and Branches, a number of training centres,
research institutes and subsidiaries. National Housing Bank (NHB), Deposit Insurance
and Credit Guarantee Corporation (DICGC) and Bharatiya Reserve Bank Note Mudran
Private Ltd., (BRBNMPL) are the fully owned subsidiaries of RBI. RBI also has a major
stake in the National Bank of Agriculture and Rural Development (NABARD).
The management of RBI is governed by a central board of directors which is appointed
by the Government of India in accordance with the provisions of RBI Act, 1935. The board
consists of a governor, four deputy governors, four directors to represent regional board
and ten other directors from various other fields. Till September 30, 2016 RBI was
governed by 22 governors. Dr. Raghuram Rajan was the 22nd governor of RBI and retired
on September 30, 2016. Presently, Mr. Urjit Patel is the governor of RBI.

Objectives of RBI
1. To manage monetary and credit system of the country
2. To stabilize internal and external value of the domestic currency
3. To ensure balanced and systematic development of the banking industry in the country
4. To help organized development of money market in the country
5. To establish friendly monetary relations with other countries of the world
6. To help in the centralization of cash reserves of commercial banks
7. To maintain a balance between demand and supply of currency notes
8. To conduct research and publish data on financial matters

Functions of RBI
The functions of RBI may be classified under three heads viz., traditional functions,
promotional functions and supervisory functions.

Traditional functions
1. Monopoly of note issue: – In terms of section 22 of the RBI Act, the RBI is given
the statutory power to issue notes on a monopoly basis. No other bank or
institution is allowed to issue notes for public circulation. In the earlier days, the
 notes used to be issued on the basis of “Proportional Reserve System” wherein the
notes were issued in proportion to the reserves of gold coins, gold bullion and
foreign securities. However, due to difficulty of maintaining the reserves
proportionately, now the “Minimum Reserve System” is adopted to issue notes.
Under this system, the RBI should maintain a minimum reserve of Rs. 200 crore
worth of gold coins, gold bullion and foreign securities in which gold coin and gold
bullion should not be less than 115 crore. Presently RBI issues notes of Rs. 10
denomination and above. Coins and notes of less than Rs. 10 denomination are
issued by the government of India. The management of circulation of money is
done through currency chests maintained by RBI, SBI, Subsidiaries of SBI, Public
Sector Banks, Government Treasuries and Sub-treasuries. Currency chests refer
to the receptacles in which stocks of issuable and new notes and coins are stored.
2. Banker to the Government: - In terms of section 21 of the RBI Act, the government
should entrust its money remittance, exchange and banking transactions in India
to RBI. In terms of section 21A the state governments should also entrust their
remittance, exchange and banking transactions in the respective states to RBI.
Therefore, RBI acts as a banker to both the central and state governments. RBI
does not earn any income by conducting these functions. However, it earns income
by way of commission for managing the governments’ public debt. By virtue of
section 45 of the RBI Act, wherever RBI has no branch, SBI or its subsidiaries are
required to function as the agents and sub-agents of RBI. These agent or sub-agent
banks would get commission on all transactions conducted on turnover basis.
Being a banker to the governments the RBI extends “Ways and Means Advances
(WMA)” to both central and state governments. “Ways and Means Advances
(WMA)” refers to the credit facility to meet the temporary shortfall in government
revenue as compared to the monthly expenditure. As a banker to the government
RBI renders the following services to the government.
a) Collection of taxes
b) Payment to various parties
c) Accepting of deposits from governments
d) Collection of cheques and drafts
e) Providing of short term loans to the government
f) Maintaining various accounts of the government departments
g) Maintaining of currency chests
h) Advising the government on their borrowing programs
i) Maintaining and operating the central government accounts in International
Monetary Fund (IMF)
3. Agent and Advisor to the Government: - The RBI acts as the financial agent and
adviser to the government and renders the following services
a) Managing the public debts and accepting the loans on behalf of the government
b) Issue of government bonds, treasury bills, etc.
c) Advising the government in all important economic and financial matters of the
country
4. Banker to the Banks: - The RBI acts as banker to all the scheduled banks. All banks
in India are required to keep certain percentage of their demand and time
liabilities as reserves with the RBI. This is known as Cash Reserve Ratio (CRR)
5. Acting as National Clearing House: - The RBI acts as the clearing house for
settlement of banking transactions in India. The function of clearing house is to
settle the interbank claims easily and at low cost. Wherever the RBI does not have
 a clearing house, the function of clearing house is carried out in the premises of
State Bank of India.
6. Acting as Controller of Credit: - One of the primary functions of the commercial
banks is credit creation by automatically creating a deposit account as and when
a loan or advance is sanctioned to the customer. Credit creation has a direct impact
on the economic conditions of the country. Hence the RBI acts as the controller of
credit creation through quantitative and qualitative measures. By acting as the
controller of credit, RBI would strive to achieve the following objectives:
a) Maintaining the desired level of circulation of money
b) Maintaining the stability in the prevailing price level in the economy
c) Controlling the effects of trade cycles
d) Controlling the fluctuations in the foreign exchange rates
e) Channelizing the credit to productive sectors of the economy

The important measures used by RBI for control of credit creation are:
a) Bank Rate Policy
b) Open Market Operations
c) Variation of SLR
d) Variation of CRR
e) Fixation of Margin Requirements
f) Moral Suasion
g) Issue of Directives
h) Direct Action
7. Acting as Custodian of Foreign Exchange Reserves: - The RBI acts as custodian
of foreign exchange reserves. Foreign-exchange reserves (also called forex
reserves or FX reserves or official international reserves or international
reserves), refers to the foreign currency deposits and bonds held by central banks
and monetary authorities. It commonly includes foreign exchange and gold,
special drawing rights (SDRs) and International Monetary Fund (IMF) reserve
positions. Foreign exchange reserves are important indicators of ability to repay
foreign debt and for currency defense, and are used to determine credit ratings of
nations.
8. Foreign Exchange Control: - Foreign exchange control, popularly referred to as
‘exchange control’ refers to the activity of regulating the demand for foreign
exchange for various purposes against the supply constraints. When the
Government finds a shortage of foreign exchange due to the low level of external
reserves on account of deficit in the balance of payments, exchange control
becomes necessary. Exchange control implies a kind of rationing of foreign
exchange for the various categories of demand for it. The Reserve Bank of India
implements exchange control on a statutory basis. The Foreign Exchange
Regulation Act, 1973 empowers the bank to regulate investments as well as
trading, commercial and industrial activities in India of foreign concerns (other
than banking), foreign nationals and non-resident individuals. Moreover, the
holding of immovable property abroad and the trading, commercial and industrial
activities abroad by Indian nationals are also regulated by the Bank under
exchange control. The Reserve Bank manages exchange control in accordance
with the general policy of the Central Government. In India, exchange control is
grossly related to and supplemented by trade control. While trade control is
confined to the physical exchange of goods, exchange control implies supervision
 over the settlement of payments – financial transactions pertaining to the
country’s exports and imports. Comparatively, exchange control is more
comprehensive than trade control, since it covers all exports and imports as well
as invisible and capital transactions of the country’s balance of payments. Under
the present exchange control system, the Reserve Bank does not directly deal with
the public. The bank has authorized foreign exchange departments of commercial
banks to handle the day-to-day transactions of buying and selling foreign
exchange. Further, the bank has given money changer’s licences to certain
established firms, hotels, shops, etc. to deal in foreign currencies and travellers’
cheques to a limited extent.
9. Publication of Economic Statistics and Other Information: - The RBI collects
statistical and other information on economic and financial matters of the country.
The statistics and other information so collected are published periodically in an
analytical manner. It also presents the genuine financial position of the
government and the economic condition of the whole country.
10. Fights against the Economic Crisis: - The RBI aims at the economic stability in
the country. Whenever it feels that there is a danger to the economic stability, it
immediately interferes and takes suitable measures to put the economy on the
right track. For this purpose, it forms and implements various policies and adopts
various quantitative and qualitative measures.

Promotional Functions
1. Promotion of Banking Habits: - The RBI promotes banking habits among the
public through expanding the banking business to various corners of the country
and also by establishing various corporations like Deposit Insurance Corporation,
Unit Trust of India, IDBI, NABARD, Agricultural Refinance Corporation, Industrial
Reconstruction Corporation of India, etc.
2. Providing of Refinance for Export Promotion: - The RBI takes initiative for
widening the facilities for financing of foreign trade. Export Credit and Guarantee
Corporation (ECGC) and EXIM Bank are established for the purpose of expanding
the foreign trade. It also encourages export trade through refinance facilities for
export credit granted by commercial banks. Further, it prescribes rates of interest
on export credits.
3. Promotion of Agriculture: - The RBI promotes agriculture through financial
facilities on a regular basis. For this purpose, it provides refinance facility to
NABARD. Through NABARD it provides short-term and long-term financial
facilities at lower rate of interest to agriculture and allied activities.
4. Promotion of Small Scale Industries: - The RBI takes active steps for the
promotion of SSI through issuing directives to the commercial banks to extend
credit facilities to SSIs. It also encourages commercial banks to provide guarantee
services to SSIs. RBI has classified bank advances to SSI as priority sector advance.
5. Promotion of Co-operative Banks: - The RBI extends indirect financing facilities
to co-operative banks and connects them with the main banking system of the
country.
Supervisory Functions
1. Granting of license to Banks: - The RBI grants license to open new banks. It also
grants license to open new branches or close existing branches. With this function,
the RBI ensures avoidance of unnecessary competition among banks, even growth
of banks in different regions, adequate banking facility in all regions, etc.
2. Inspection and Enquiry: - The RBI inspects and makes enquiry in respect of
various matters covered under Banking Regulation Act, 1949.
3. Deposit Insurance Scheme: - The RBI implements the deposit insurance scheme
for the benefit of small depositors. Under this scheme, deposit of an individual
depositor upto Rs. 1,00,000 is guaranteed for payment. Through this scheme, the
confidence of common people on the banking system is improved.
4. Review of Working: - The RBI periodically reviews the work done by the
commercial banks. It takes suitable measures to enhance the efficiency of the
banks and make various policy changes and implement programs for the well
being of the nation and for improving the banking system as a whole.
5. Control of NBFCs: - The RBI issues necessary directions to the NBFCs and
conducts inspections through which it exercises control over such institutions.
Deposit mobilization by NBFCs requires permission from RBI.