OVERVIEW OF THE RESERVE
BANK OF INDIA ACT, 1934
MODULE -IV
INTRODUCTION
• The Reserve Bank of India (RBI), as the central banking
institution of India, is the backbone of the Indian financial
system.
• It is under the supervision of the Union Ministry of Finance.
• The Reserve Bank of India Act, 1934 is the primary legislation
that establishes the framework and governing principles for the
Reserve Bank of India (RBI).
• The Act outlines the functions, powers, and responsibilities of
the RBI, as well as its relationship with the government and the
banking system.
OBJECTIVE OF RBI ACT
• To regulate the issue of Bank notes and the keeping of reserves
with a view to securing monetary stability in India
• To operate the currency and credit system of the country to its
advantage;
• To have a modern monetary policy framework to meet the
challenge of an increasingly complex economy;
• To maintain price stability while keeping in mind the objective of
growth;
• To regulate the monetary policy framework in India
ESTABLISHMENT AND INCORPORATION OF
RESERVE BANK – SECTION 3
• Section 3 of the RBI Act states that a bank to be called the
Reserve Bank of India.
• RBI 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 the Act.
• RBI is a body corporate having perpetual succession and a
common seal, and can sue and be sued.
ORGANIZATIONAL STRUCTURE & MANAGEMENT OF
RBI –
BROAD FUNCTIONS OF RBI
• Issue and Management of Currency and
Distribution of Coins
• Banker to the Government
• Banker to the Banks
• Lender of Last Resort
• Loans and Advances
ISSUE AND MANAGEMENT OF CURRENCY AND DISTRIBUTION OF
COINS
• The currency of our country consists of One-rupee notes and
coins (including lower denominations thereof) as well as Bank
notes issued by RBI.
• Issuance of bank notes (currency) is one of the original
central banking functions for which the RBI was established.
• In terms of section 22, of the RBI Act, 1934, RBI has the sole
right to issue bank notes in India.
• Such bank notes are issued by a department of RBI known as
Issue Department, which is a separate and wholly distinct
department from the Banking Department which is
responsible for banking business of the RBI.
• However, the design, form and material of bank notes are
to be approved by the Central Government on the basis of
recommendations of Central Board of the RBI.
• Every bank note shall be a legal tender at any place in India.
• On recommendation of the Central Board, the Central
Government may declare any series of bank notes of any
denomination to be not a legal tender.
• The RBI has the power to recommend to Central Government
various denominations of bank notes.
• The issue department keeps its assets, which forms the
backing for note issuance, distinctly separate from that of the
assets of the banking department. (like gold, foreign
securities etc.)
• Within RBI, the ‘Department of Currency Management
(‘DCM’)’ has the responsibility of administering the
functions of currency management.
• Currency management basically relates to the issue
of notes and coins and retrieval of unfit notes from
circulation.
• All branches of banks in all parts of the country are
mandated to provide the customer services related to
Issuing fresh/good quality notes and coins of all
denominations on demand in exchange of soiled/
mutilated/ defective notes.
BANKER TO THE GOVERNMENT
• In terms of section 20 of RBI Act, 1934, RBI has an
obligation to Act as a banker to the central government.
• Under this obligation RBI has:
To accept monies for account of the Central Government,
To make payments up to the amount standing to the credit
of Central Government,
To carry out its exchange, remittance and other banking
operations, including the management of the public debt of
the Union of India.
• For carrying out its duties as banker to the Government of
India, it is not paid any remuneration, RBI is entitled for a
commission for managing public debt functions.
• The Government transaction work also includes
maintaining currency chests at places specified by the
Central Government.
• RBI also provides investment services by deploying
temporary surplus cash balances in Government accounts.
• RBI also advises the Government on monetary and banking
issues when requested to do so.
• Also manages Consolidated Fund of India, contingency
fund and public accounts as these accounts are
maintained by RBI.
BANKER TO THE BANKS
• This is a special relationship that is created due to statutory requirements under the
RBI Act.
• Once the name of a bank is included in the Second Schedule, that Bank is eligible to
be called as a Scheduled Bank.
• Among other conditions, it is bound to maintain the stipulated Cash reserves under
section 42 in an account with RBI.
• The Scheduled Bank status to any bank also confers privileges such as availing
financial accommodation from RBI under specified conditions.
• Reserve Bank also provides means of transfer and settlement of funds between
banks on account of clearing, remittances, lending and borrowing through such
accounts.
• Thus, RBI provides a platform for inter-bank financial transactions.
• Such accounts of banks are maintained by ‘Deposit Accounts Department’ of RBI.
• Intra-bank funds transfers also takes place through an RBI portal known as e-
Kuber.
LENDER OF LAST RESORT
• When ‘banks’ exhaust all other means for raising funds for their operations, they
fall back on RBI as a source for finance as provided under the RBI Act.
• Hence, RBI is known as ‘Lender of last resort’.
• RBI grants financial accommodation to banks - “sale, purchase and rediscount
of eligible bills” as well as loans and to advances banks.
• Rediscount of bills with RBI by banks are confined to the following categories:
i. Bonafide Commercial bills
ii. Bills related to financing agriculture operations or marketing of
crops
iii. Bills that are associated with Cottage and Small-Scale
Industries
iv. Bills representing holding or trading in Government Securities
v. A foreign bill
LOANS AND ADVANCES
• RBI Act, empowers Reserve Bank to grant loans among others to, Scheduled
Banks, State Co-operative Banks, and State Financial Corporations loans and
advances, repayable on demand or on the expiry of fixed periods not exceeding
ninety days.
• Such loans and advances are granted against the securities of:
Stocks, funds and other (than immovable property) securities, in which there is an
authorization to a trustee to invest monies
Gold or silver or documents of title to these
Promissory Notes or Bills of Exchange eligible for purchase or rediscount by RBI or
guaranteed by State Government regarding repayment of principal and interest due on
them
Promissory notes of any scheduled bank or State Co-operative Bank which are
supported by documents of title to goods (which have been already transferred,
assigned or pledged to any other bank as a security for any advance or loan made of
bonafide commercial or trade transactions or those in respect of financing agricultural
operations or marketing of crops).
EMERGENCY ADVANCES
• RBI, grants emergency advances to specified banks on special
occasions as envisaged in Section 18 of the said Act in the interest of
regulating credit to trade, commerce, agriculture and industries.
• This special provision is available despite any restrictions stated
under Section 17 and Section 18 to RBI and extend such financial
accommodation to banks on such bills which are not financeable by
RBI, otherwise.
• Further under Section 18 RBI can make an advance to a State
Cooperative Bank or to a cooperative society based on the
recommendations of a State Cooperative Bank.
• Such advance is repayable on demand, or on the expiry of fixed period
generally not exceeding 90 days under the terms and conditions
specified by RBI.
WHAT IS CREDIT CONTROL FUNCTION OF RBI?
• Credit control is a monetary policy tool used by the Reserve Bank of
India (RBI) to control the demand and supply of money, or liquidity, in
the economy.
• The Reserve Bank of India (RBI) supervises the credit granted by
commercial banks.
• The following are the broad aims of India’s credit control policy:
To maintain an acceptable amount of liquidity in order to achieve a
high rate of economic growth while maximizing resource use without
causing severe inflationary pressure.
To achieve stability in the country’s currency rate and money market.
To meet financial obligations during a downturn in the economy as
well as in regular times.
Controlling the business cycle and meeting the needs of the company
CASH RESERVE RATIO (CRR)
• It is the ratio of bank deposits that commercial bank has to
keep with the central bank.
• At the time of inflation the RBI increases the rate of CRR,
similarly at the time of deflation RBI decreases the rate of
CRR.
• Statutory Liquidity Ratio (SLR): Every bank required to
maintain a fixed percentage of its assets in the form of
cash or other liquid assets called SLR.
• At the time of inflation the RBI increases the SLR, similarly
at the time of deflation RBI decreases the rate of SLR.
FUNCTIONS OF THE RESERVE BANK –
A. Purpose of RBI:
a. To regulate the issue of banknotes;
b. To regulate keeping of reserves with a view to securing monetary stability in India;
c. To operate the currency and credit system of the country to its advantage;
d. To maintain price stability while keeping in mind the objective of growth;
e. To look after the monetary policy framework in India.
B. Functions of RBI –
a. Banking Functions
b. Issue bank notes
c. Monetary Policy Functions
d. Public Debt Functions
e. Foreign Exchange Management
f. Banking Regulation & Supervision
g. Regulation and Supervision of NBFCs
h. Regulation & Supervision of Co-operative banks
i. Regulation of Money Market Instruments
j. Payment and Settlement Functions
k. Consumer Protection Functions
l. Financial Inclusion and Development Functions
FOREIGN EXCHANGE MANAGEMENT
• Powers and responsibilities w.r.t. external
trades and payments, developments and
maintenance of foreign exchange market in
India have been conferred on RBI under the
provisions of Foreign Exchange Management
Act, 1999 (FEMA)
• The RBI, as the custodian of the country’s
Foreign Exchange reserves, is vested with the
responsibility of managing their investment.
BANKING FUNCTIONS –
• CBD exercises all the powers and functions and does all acts for RBI.
• RBI may transact various businesses such as –
a. Acceptance of deposits without good interest from Central
Government and State Governments,
b. Purchase, sale and rediscount of Bills of Exchange, short term Loans
and Advances to banks,
c. Annual Contributions to National Rural Credit Funds
d. Dealing in Derivatives,
e. Purchase and sale of Government Securities,
f. Purchase and sale of shares of State Bank of India, National Housing
Bank, Deposit Insurance and Credit Guarantee Corporation, etc.,
g. Keeping of deposits with SBI for specific purposes, making and issue
of Banknotes, etc.
– RBI also act as ‘Lender of Last Resort’.
– RBI also act as banker to Central Government and State Governments.
RBI CANNOT TRANSACT FOLLOWING BUSINESS –
• 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 immovable property 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.
• Engage in trade or have a direct interest in any commercial,
industrial or other undertaking except such interest as it may in any
way acquire in the course of the satisfaction of any of its claims
REGULATION AND SUPERVISION OF NBFCS –
• The regulation and supervision of non-banking financial
companies is one of the critical functions that the RBI has been
entrusted with.
• Every NBFC is mandatorily required to be registered with RBI
under section Section 45-IA of RBI Act, 1934.
• RBI has powers to regulate or prohibit issue of prospectus or
advertisements soliciting deposits of money by non-banking
financial companies,
• RBI has power to determine policy and issue directions to non-
banking financial companies.
• RBI has power to call for information and issue directions to non-
banking financial companies
• The RBI has powers to inspect NBFC .
RIGHT TO ISSUE BANK NOTES –
• Along with the Government of India, the Reserve Bank is responsible for
the design, production and overall management of the nation’s currency,
with the goal of ensuring an adequate supply of clean and genuine notes.
• In consultation with the Government, the Reserve Bank routinely
addresses security issues and targets ways to enhance security features
to reduce the risk of counterfeiting or forgery of currency notes.
• The Paper Currency Act of 1861 conferred upon the Government of India
the monopoly of issuing note, thus ending the practice of private and
presidency banks issuing currency.
• Between 1861 and 1935, the Government of India managed the issue of
paper currency.
• In 1935, when the Reserve Bank began operations, it took over the
function of note issue from the Office of the Controller of Currency,
Government of India.
RESERVE BANK AS BANKER TO BANKS –
• The Reserve Bank to fulfill this function, opens current accounts of banks with
itself, enabling these banks to maintain cash reserves as well as to carry out
inter-bank transactions through these accounts.
• Inter-bank accounts can also be settled by transfer of money through electronic
fund transfer system, such as, the Real Time Gross Settlement System.
• Reserve Bank has also introduced the Centralised Funds Management System
(CFMS) to facilitate centralized funds enquiry and transfer of funds across
Deposit Accounts Department (DADs).
• This helps banks in their fund management as they can access information on
their balances maintained across different DADs from a single location.
• As Banker to Banks, the Reserve Bank provides short-term loans and advances
to select banks, when necessary, to facilitate lending to specific sectors and for
specific purposes.
• The Reserve Bank also acts as the ‘lender of last resort’ because it provides
emergency liquidity to solvent banks that cannot obtain funds from other
sources, preventing bank failures and maintaining financial stability
BANKER TO THE CENTRAL GOVERNMENT &
STATE GOVERNMENT
• Reserve bank acts as banker to the Central Government and
all the State Government in India.
• As a banker to the government, the Reserve Bank receives
and pays money on behalf of the various Government
departments.
• RBI also undertakes to float loans and manage them on
behalf of the governments.
• The Banking functions for the governments are carried out
by the Public Account Departments at the offices/branches
of the Reserve Bank, while management of the public debt..
MONETARY POLICY
• Monetary policy refers to the policy of the central bank w.r.t. the use
of the monetary instruments under its control to achieve the goals
specified in the act.
• The Reserve Bank of India is vested with responsibility of adopting
and implementing monetary policy.
• The responsibility is explicitly mandated under the RBI Act, 1934.
• Objective: of monetary policy is to maintain price stability while
keeping in mind the objective of growth.
• Price Stability is a necessary pre-condition to sustainable growth.