UNIT 2

Objectives and Functions of Reserve

Bank Of India
RBI
The RBI (Reserve Bank of India) is the apex financial institution of the country’s
financial system entrusted with the task of control, supervision, promotion,
development, and planning. RBI is the queen bee of the Indian financial system
which influences the commercial banks’ management in more than one way. The
RBI influences the management of commercial banks through its various policies,
directions, and regulations. Its role in bank management is quite unique. In fact, the
RBI performs the four basic functions of management, viz., planning, organizing,
directing and controlling in laying a strong foundation for the functioning of
commercial banks. 

In 1921, the Imperial Bank of India was established to perform as the central bank of
India by the British Government. But unfortunately, Imperial Bank failed to show its
performance up to the mark and didn’t achieve any success as the Central Bank.
Then the Government asked the Hilton Young Commission in 1925 to view on this
subject.

The commission submitted their reports saying that one single organization can’t be
able to act as two separate agencies (both credit and currency control). So, it’s
required to set up a brand new central bank. In 1st April 1935, Reserve Bank of India
was set up. In January 1949, RBI was nationalized.

Objectives of Reserve Bank of India

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.

The Reserve Bank of India was established with the main motto of regulating all the
banks in India. The objective was to keep in check the reserves as well as the issue
of bank notes.

So, it was done to secure the monetary stability and thereby to operate the credit
system and currency of the country to its own advantage.

Prior to the RBI, the government of India and the Imperial Bank of India were unable
to control the Indian financial system by keeping it in check.

Therefore, a committee led by the Hilton and young commission in 1935, shifted the
entire financial system to the RBI.
So, the primary target for RBI was to control and regulate the various financial
policies and help in the development of the banking facilities throughout India.

The primary objective for the RBI would be to regulate the various banking functions
for India in the money market. Thus, they focus mainly on issuing new notes.

The RBI was established with the aim of being a banker’s bank and also the bank for
the government. Its task was to promote the economic growth of the country through
various frameworks and economic policies of the government.

Functions of Reserve Bank of India

As per the RBI Act 1934, it performs 3 types of functions as that of any other central
bank.

They are:

1. Banking Functions
2. Supervisory Functions and
3. Promotional Functions.
The main functions of the RBI are to regulate the money supply in the country.
Moreover, it has been directed to take care of agriculture, industry, export promotion
etc. The RBI is also responsible for the maintenance of the external value of rupee.

Banking Functions

 Bank of issue:  The Reserve Bank has a separate Issue Department which is

entrusted with the issue of currency notes. The assets and liabilities of the Issue
Department are kept separate from those other Banking Department.
 Banker to Government: The second important function of the Reserve Bank of
India is to act as Government banker, agent, and adviser. The Reserve Bank is
the agent of Central Government and of all State Governments in India excepting
that of Jammu and Kashmir.
 Banker's Bank: The Reserve Bank of India acts as the banker’s 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 percent of its time liabilities in India.
 Controller of Credit: The Reserve Bank of India 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 by changing the Bank rate or through open market operations.
 Custodian of Foreign Reserve: It is the responsibility of the Reserve bank to
stabilize the external value of the national currency. The Reserve Bank keeps
golds and foreign currencies as reserves against note issue and also meets the
adverse balance of payments with other counties. It also manages foreign
currency in accordance with the controls imposed by the government.
Supervisory Functions

In addition to its traditional central banking functions, the Reserve Bank has certain
non-monetary functions of the nature of supervision of banks and the promotion of
sound banking in India.

The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the
RBI wide powers of supervision and control over commercial and co-operative
banks, relating to licensing and establishments, branch expansion, the liquidity of
their assets, management and methods of working, amalgamation, reconstruction,
and liquidation.

The RBI is authorized to carry out the periodical inspection of the banks and to call
for returns and necessary information from them. The nationalization of 14 major
Indian scheduled banks in July 1969 has imposed new responsibilities on the RBI for
directing the growth of banking and credit policies towards the more rapid
development of the economy and realization of certain desired social objectives.

Promotional Functions

With economic growth assuming a new urgency since independence, the range of
the Reserve Bank’s functions has steadily widened. The 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 establish and promote new specialized financing
agencies. Accordingly, the Reserve Bank has helped in the setting up of
the Industrial Finance Corporation of India and the State Financial Corporations; 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 Indian in 1963 and the Industrial Reconstruction Corporation of India
in 1972.

The Reserve Bank of India (RBI) is India’s central bank, also known as the
banker’s bank.

The RBI controls the monetary and other banking policies of the Indian
government. The Reserve Bank of India (RBI) was established on April 1, 1935, in
accordance with the Reserve Bank of India Act, 1934. The Reserve Bank is
permanently situated in Mumbai since 1937.
Establishment of Reserve Bank of
India
The Reserve Bank is fully owned and operated by the Government of India.

The Preamble of the Reserve Bank of India describes the basic functions of the
Reserve Bank as:

 Regulating the issue of Banknotes

 Securing monetary stability in India

 Modernising the monetary policy framework to meet economic challenges

The Reserve Bank’s operations are governed by a central board of directors, RBI is
on the whole operated with a 21-member central board of directors appointed by
the Government of India in accordance with the Reserve Bank of India Act.

The Central board of directors comprise of:

 Official Directors – The governor who is appointed/nominated for a period of

four years along with four Deputy Governors

 Non-Official Directors – Ten Directors from various fields and two

government Official

Organisation Structure
Objectives
The primary objectives of RBI are to supervise and undertake initiatives for the
financial sector consisting of commercial banks, financial institutions and non-
banking financial companies (NBFCs).

Some key initiatives are:

 Restructuring bank inspections

 Fortifying the role of statutory auditors in the banking system

Legal Framework
The Reserve Bank of India comes under the purview of the following Acts:

 Reserve Bank of India Act, 1934

 Public Debt Act, 1944

 Government Securities Regulations, 2007

 Banking Regulation Act, 1949

 Foreign Exchange Management Act, 1999

 Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, 2002

 Credit Information Companies(Regulation) Act, 2005

 Payment and Settlement Systems Act, 2007

Major Functions of RBI

Monetary Authority 

 Formulating and implementing the national monetary policy.

 Maintaining price stability across all sectors while also keeping the objective
of growth.
Regulatory and Supervisory 

 Set parameters for banks and financial operations within which banking and
financial systems function.

 Protect investors interest and provide economic and cost-effective banking to

the public.

Foreign Exchange Management

 Oversees the Foreign Exchange Management Act, 1999.

 Facilitate external trade and development of foreign exchange market in

India.

Currency Issuer

 Issues, exchanges or destroys currency and not fit for circulation.

 Provides the public adequately with currency notes and coins and in good
quality.

Developmental role

 Promotes and performs promotional functions to support national banking

and financial objectives.

Related Functions

 Provides banking solutions to the central and the state governments and also
acts as their banker.
 Chief Banker to all banks: maintains banking accounts of all scheduled
banks.

RBI Annual publications 

Annual Report – The annual report is a statutory report of the Reserve Bank of
India that is released every year. This report consists of valuation and progress of
the Indian economy. Overview of the economy, the working of the Reserve Bank
during that year and the RBI’s projected vision and agenda for the following year
along with the annual accounts of the Reserve Bank

Report on Trend and Progress of Banking in India – This document is an

assessment of the policies and progress of the financial sector for the preceding
year.

Lectures – The Reserve Bank of India has constituted three annual lectures. Two
of these lectures are conducted by past Governors of the Reserve Bank and one
lecture is by a noted economist.

Report on Currency and Finance – This report is documented and presented by

the staff of Reserve Bank of India bank and focusses on a particular theme and
presents a detailed economic analysis of the issues related to the theme.

Handbook of Statistics on the Indian Economy – This report is an important

initiative by the Reserve Bank to improve data distribution. It is a resourceful
storehouse of major statistical information.

State Finances: A Study of Budgets – The report is an essential source of

segregated state-wise financial data and provides an analytical data-driven
conceptualisation on the fiscal position of state governments across India. These
data inputs are used to analyse specific issues of relevance.

Statistical Tables Relating to Banks in India – This annual publication contains

holistic timeline data with regards to the Scheduled Commercial Banks (SCBs) of
India. The report also covers the information of balance sheets and performance
indicators for each SCB in India. The journal also includes segregated data sources
on some essential factors relating to bank-wise, bank group-wise and state-wise
level of information.

Basic Statistical Returns – This is another data-focused yearly journal which

represents complex information on the number of offices, employees, deposits and
credit of Scheduled Commercial Banks in minute levels of detail such as, region-
wise, state-wise and district-wise information. This information also trickles down
to the population and credit requirements in each bank.

RBI Policies 
Repo Rate 

Repo or repurchase rate is the benchmark interest rate at which the RBI lends
money to all other banks for a short-term. When the repo rate increases, borrowing
from RBI becomes more expensive and hence customers or the public bear the
outcome of high-interest rates.

Reverse Repo Rate (RRR) 

Reverse Repo rate is the short-term borrowing rate at which RBI borrows money
from other banks. The Reserve Bank of India uses this method to reduce inflation
when there is excess money in the banking system.
Cash Reserve Ratio (CRR)

Cash Reserve Ratio is the particular share of any bank’s total deposit that is
mandatory and to be maintained with the Reserve Bank of India in the form of
liquid cash.

Statutory liquidity ratio (SLR)

Leaving aside the cash reserve ratio, banks are required to maintain liquid assets in
the form of gold and approved securities. A higher SLR disables the banks to grant
more loans.

Payment System Initiatives

 The Reserve Bank has taken many steps towards initiating and updating
secure and sustainable methods of payment systems in India to meet public
requirements.

 Currently, payment methods in India consist of paper-based instruments,

electronic instruments and other instruments, such as pre-paid system (e-
wallets), mobile internet banking, ATM-based transactions, Point-of-sale
terminals and online transactions.

Paper-based Payments

 Use of paper-based instruments such as cheques and demand drafts accounts

for nearly 60% of the volume of total non-cash transactions in India. These
forms of payments have been steadily decreasing over a period of time due to
 the electronic modes of payments gaining popularity due to the comparative
convenience, safety and overall efficiency.

 Magnetic Ink Character Recognition (MICR) technology was introduced by

RBI  in the paper-based payment method for speeding up and bringing in
efficiency in the processing of cheques.

 A separate clearing system for paper-based payment method was introduced

for clearing cheques of high-value ranging from rupees one lakh and above. 
Also, the introduction of cheque truncation (CTS) system restricts the
physical movement of cheques and utilises images for enhanced secure
payment processing.

Electronic Payments

The initiatives taken by the Reserve Bank in the domain of electronic payment
systems are immense and vast. The types of electronic forms of payment by the
RBI are as follows:

 Electronic Clearing Service (ECS) – This enables customer bank accounts

to be credited with a specified value and payment on a set date. This makes
EMIs, or other monthly bills hassle free.

 National Electronic Clearing Service (NECS) – This facilitates multiple

advantages to beneficiary accounts with destination branches against a single
debit of the account of the sponsor bank.

 Electronic Funds Transfer (EFT) – This retail funds transfer system was to
enable an account holder of a bank to electronically transfer funds to another
account holder with any other intermediate or participating bank.
 National Electronic Funds Transfer (NEFT) –  A secure system to
facilitate real-time fund transfer between individuals/corporates.

 Real Time Gross Settlement (RTGS) – A funds transfer function in which

transfer of money takes place from one bank to another on a real-time basis
without delaying or netting with any other transaction.

 Clearing Corporation of India Limited (CCIL) – This system is for banks,

financial institutions, non-banking financial companies and primary dealers,
to serve as an industry service mechanism for clearing settlement of trades in
money market, government securities and foreign exchange markets.

 The RBI (Reserve Bank of India) has made changes to the Prepaid Payment
Instruments (PPI) also know as e-wallets. These changes include KYC –
known your customer compliance. KYC is the process of collecting user
details by the service provider and verifying the same with the respective
government bodies.

Collection and Furnishing of credit

information
The Reserve Bank is empowered to collect credit information from banking
companies and to furnish such information in consolidated form to any banking
company applying for the same along with the prescribed fee. The term credit
information means any formation relating to –

(1) the amounts and the nature of loans or advances and other credit facilities
granted by a banking company to any borrower or class of borrowers;
(2) the nature of security taken from any borrower or class of borrowers or credit
facilities granted to him or to such class;
(3) the guarantee furnished by a banking company for any of its customers or any
class of its customers;
(4) the means, antecedents, history of financial transactions and the creditworthiness
of any borrower or class of borrowers; and
(5) any other information which the bank may consider to be relevant for the more
orderly regulation of credit or credit policy.
The term, credit information thus has much wider coverage and significance.

The term banking company includes for this purposes, the scheduled and non-
scheduled banks, the State Bank of India and its subsidiary banks, the nationalized
banks and any other financial institutions notified by the Central Government. The
term borrower is also defined so as to include in case of a company its subsidiaries
also, in case of Hindu undivided family any member if the family or any firm in which
such member is partner; in case of a partnership, any partner or any form in which
he is a partner and in case of an individual of any firm in which such an individual is
a partner.

The credit information is required in respect of big borrowers only. The Reserve
Bank has directed the bask to submit credit information on the prescribed forms. The
credit limits for the purposes of submitting half yearly returns (as on the last Friday of
April and October every year) by banks to Reserve Bank relating to information on
borrowers have been raised in 1984 from Rs 5 lakh and over to Rs 10 lakhs and
over in case of secured advances and from Rs 1 lakh and over to Rs 5 lakhs and
over in respect of unsecured advances.

Section 45-C empowers the Reserve Bank to direct any banking company to submit
to it statements relating to credit information in the specified time and form. Every
banking company shall be bound to comply with such direction.

Under Section 45-D a banking company may make an application to the Reserve
Bank to furnish the applicant with such credit information as may be specified in the
applications in connection with any person. The Reserve Bank shall furnish the credit
information in its possession but it shall not disclose the names of the banking
companies which have submitted such formation to the Bank.

Any credit information submitted by a banking company to the Reserve Bank or by

the Reserve Bank to any banking company shall be treated as confidential and shall
not be published or disclosed except for the following purposes specified in the Act:

(1) Disclosure by any banking company of any formation furnished to the Reserve
bank with the previous permission of the Reserve Bank.
(2) Publication by the Reserve Bank of any information collected by it under this
Section in such consolidated form as it may think fit without disclosing the name of
nay banking company or its borrowers and
(3) The disclosure or publication by the banking company or by the Reserve Bank of
any credit information to any other banking company or in accordance with the
practice and usage customary among bankers or as permitted or required under any
other law.

Credit control
Credit control is an important tool used by Reserve Bank of India, a major weapon of
the monetary policy used to control the demand and supply of money i.e liquidity in the economy.
Central Bank i.e RBI regulates the credit that the commercial banks grant. Such a method is
used by RBI to bring "Economic Development with Stability" in the nation. It means that banks
will not only control inflationary trends in the economy but also boost economic growth which
would in the long run lead to increase in real national income stability. In the view of its functions
such as issuing notes and custodian of cash reserves, credit not being controlled by RBI would
lead to Social and Economic instability in the country.

Need for credit control[edit]

Controlling credit in the economy is amongst the most important functions of the Reserve Bank of
India. The basic and important needs of credit control in the economy are-

 To stir up the overall growth of the "priority sector" i.e. those sectors of the economy which
are recognized by the government as "prioritized" depending upon their economic condition
or government interest. These sectors broadly totals to around 15 in number.[1]
 To keep a check over the channelization of credit so that it is not delivered for undesirable
purposes.
 To achieve the objective of controlling inflation as well as deflation.
 To boost the economy by accelerating the flow of adequate volume of bank credit to different
sectors.
 To help the economy develop.

Objectives of credit control[edit]

The broad objectives of credit control policy in India have been as follows:

 To ensure an adequate level of liquidity enough for attaining high economic growth rate
along with maximum utilisation of resource without generating high inflationary pressure.
 To attain stability in the rate of exchange and money market of the country.
 To meet the financial requirement during a slump in the economy and in the normal times as
well.
 To control business cycle and meet business needs.

Methods of credit control[edit]

There are two methods that the RBI uses to control the money supply in the economy. They are:

 Qualitative method
 Quantitative method
During inflation, Reserve Bank of India tightens its policies to regulate the money supply,
whereas during deflation it allows the commercial bank to pump money in the economy.

Qualitative method[edit]
By Quality we mean the uses through which bank credit is directed.
For example- the bank may feel that spectators or big capitalists are getting a disproportionately
large share in the total credit, causing various disturbances and inequality in the economy, while
the small-scale industries, consumer goods industries and agriculture are starved of credit.
Correcting this type of disparity is a matter of qualitative credit control.
Qualitative methods control the manner of cash channelisation and credit in the economy. It is a
'selective method' of control as it restricts credit for certain section where as expands for the
other known as the 'priority sector' depending on the situation.
Tools used under this method are-
Marginal requirement[edit]
Marginal requirement of loan current value of security offered for ban-value of loans granted. The
marginal requirement is increased for those business activities, the flow of whose credit is to be
restricted in the economy.
For Example:- A person mortgages his property worth ₹ 1,00,000 against loan. The bank will
give loan of ₹ 80,000. The marginal requirement here is 20%
Rationing of credit[edit]
Under this method there is a maximum limit to loans and advances that can be made, which
the commercial banks cannot exceed. RBI fixes ceiling for specific categories. Such rationing is
used for situations when credit flow is to be checked, particularly for speculative activities.
Minimum of "capital: total assets" (ratio between capital and total asset) can also be prescribed
by Reserve Bank of India.
Publicity[edit]
RBI uses media for the publicity of its views on the current market condition and its directions
that will be required to be implemented by the commercial banks to control the unrest. Though
this method is not very successful in developing nations due to existence of high rate of illiteracy
making it difficult for people to understand such policies and its implications.
Direct Action[edit]
Under the Banking Regulation Act, the Central Bank authorises to take strict action against any
of the commercial banks that refuses to abide by the directions given by Reserve Bank of India.
There can be a restriction on advancing of loans imposed by Reserve Bank of India on such
banks.
For e.g. – RBI had put up certain restrictions on the working of the Metropolitan co-operative
banks. Also the 'Bank of Karad' had to come to an end in 1992.[2]
Moral Suasion[edit]
This method is also known as "moral persuasion" as the method that the Reserve Bank of India,
being the apex bank uses here, is that of persuading the commercial banks to follow its
directions/orders on the flow of credit. It can also be a part of meetings between RBI and
Commercial Banks. RBI persuades the commercial bank to follow their policies. RBI puts a
pressure on the commercial banks to put a ceiling on credit flow during inflation and be liberal in
lending during deflation.

Quantitative method[edit]
Graph showing variations in the Bank Rate from 1935–2011 (current year)[3]

By quantitative credit control we mean the control of the total quantity of credit.

For Example- consider that the Central Bank, on the basis of its calculations, considers that Rs.
50,000 is the maximum safe limit for the expansion of credit. But the actual credit at that given
point of time is Rs. 55,000(say). Thus it then becomes necessary for the central bank to bring it
down to 50,000 by tightening its policies. Similarly if the actual credit is less, say 45,000, then the
apex bank regulates its policies in favor of pumping credit into the economy.
Different tools used under this method are-

Chart showing effect of increase in bank rate

Bank rate[edit]
Bank rate is also known as the discount rate. It is the official minimum rate at which the central
bank of the country is ready to re discount approved bills of exchange or lend on approved
securities.
Section 49 of the Reserve Bank of India Act 1934, defines Bank Rate as "the standard rate at
which it (RBI) is prepared to buy or re-discount bills of exchange or other commercial
paper eligible for purchase under this Act".
When the commercial bank for instance, has lent or invested all its available funds and has little
or no cash over and above the prescribed minimum, it may ask the central bank for funds. It may
either re-discount some of its bills with the central bank or it may borrow from the central bank
against the collateral of its own promissory notes.
In either case, the central bank accommodates the commercial bank and increases the latter's
cash reserves. This Rate is increased during the times of inflation when the money supply in the
economy has to be controlled.
At any time there are various rates of interest ruling in the market, like the deposit rate, lending
rate of commercial banks, market discount rate and so on. But, since the central bank is the
leader of the money market and the lender of the last resort, all other rates are closely related to
the bank rate. The changes in the bank rate are, therefore, followed by changes in all other rates
as the money market.
The graph on the right hand side shows variations in the bank rate since 1935–2011.
Working of the bank rate[edit]
Changes in bank rate are introduced with a view to controlling the price levels and business
activity, by changing the demand for loans. Its working is based upon the principle that changes
in the bank rate results in changed interest rate in the market.
Suppose a country is facing inflationary pressure. The central bank, in such situations, will
increase the bank rate thereby resulting to a hiked lending rate. This increase will discourage
borrowing. It will also lead to a fall in the business activity due to following reasons:

 Employment of some factors of production will have to be reduced by the business people.
 The manufacturers and stock exchange dealers will have to liquidate their stocks, which they
held through bank loans, to pay off their loans.
The effect of rise in bank rate by the Central Bank. Hence, we can conclude that hike in bank
rate leads to fall in price level and a fall in the bank rate leads to an increase in price level i.e.
they share an inverse relationship.