The Reserve Bank of India (RBI) 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.
History of Reserve Bank of India (RBI)
In 1921, the Imperial Bank of India was established to perform as 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 the Reserve Bank of India (RBI)
The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of the Reserve Bank as: “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.”
Prior to the establishment of the Reserve Bank, the Indian financial system was totally inadequate on account of the inherent weakness of the dual control of currency by the Central Government and of credit by the Imperial Bank of India.
The Hilton-Young Commission, therefore, recommended that the dichotomy of functions and division of responsibility for control of currency and credit and the divergent policies in this respect must be ended by setting-up of a central bank – called the Reserve Bank of India – which would regulate the financial policy and develop banking facilities throughout the country. Hence, the Bank was established with this primary object in view.
Another objective of the Reserve Bank has been to remain free from political influence and be in successful operation for maintaining financial stability and credit. The fundamental object of the Reserve Bank of India is to discharge purely central banking functions in the Indian money market, i.e., to act as the note- issuing authority, bankers’ bank and banker to government, and to promote the growth of the economy within the framework of the general economic policy of the Government, consistent with the need of maintenance of price stability.
A significant object of the Reserve -Bank of India has also been to assist the planned process of development of the Indian economy. Besides the traditional central banking functions, with the launching of the five-year plans in the country, the Reserve Bank of India has been moving ahead in performing a host of developmental and promotional functions, which are normally beyond the purview of a traditional Central Bank.
Functions of the Reserve Bank of India (RBI)
As per the RBI Act 1934 it performs 3 types of functions as that of any other central bank. They are,
- Banking Functions
- Supervisory Functions and
- 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 external value of rupee.
1. Banking Functions:
1. Bank of Issue:
Under section 22 of the Reserve Bank of India Act, the bank has the sole 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.
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.
Originally, 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 rupees 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 known,-as the minimum reserve system.
2. 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 agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir.
The Reserve Bank has the obligation 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.
The Reserve Bank of India 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.
3. Bankers’ Bank and Lender of the Last Resort:
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.
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 percent 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 Reserve Bank of India 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 Reserve Bank of India 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.
4. 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 through changing the Bank rate or through open market operations.
According to the Banking Regulation Act of 1949, the Reserve Bank of India 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 Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get licence from the Reserve Bank of India to do banking business within India. The licence can be cancelled by the Reserve Bank if certain stipulated conditions are not fulfilled. Every bank will have to 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 power of the Reserve Bank to call for information is also intended to give it effective control of the credit system. The Reserve Bank has also the power to inspect the accounts of any commercial bank.
As 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 control.
- 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 re-discount facilities to scheduled banks.
5. 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 adverse balance of payments with other counties. It also manages foreign currency in accordance with the controls imposed by the government.
As far as the external sector is concerned, the task of the RBI has the following dimensions:
- To administer the foreign Exchange Control;
- To choose ,the exchange rate system and fix or manages the exchange rate between the rupee and other currencies;
- To manage exchange reserves;
- To interact or negotiate with the monetary authorities of the Sterling Area, Asian Clearing Union, and other countries, and with International financial institutions such as the IMF, World Bank, and Asian Development Bank.
The RBI is the custodian of the country’s foreign exchange reserves, id it is vested with the responsibility of managing the investment and utilization of the reserves in the most advantageous manner. The RBI achieves this through buying and selling of foreign exchange market, from and to schedule banks, which, are the authorized dealers in the Indian foreign exchange market. The Bank manages the investment of reserves in gold counts abroad and the shares and securities issued by foreign governments and international banks or financial institutions.
2. 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 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, liquidity of their assets, management and methods of working, amalgamation, reconstruction and liquidation.
The RBI is authorized to carry out 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 more rapid development of the economy and realization of certain desired social objectives.
The supervisory functions of the RBI 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.
3. 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.
These institutions were set up directly or indirectly by the Reserve Bank to promote saving habit and to mobilize 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 important.
The Bank has developed the co-operative credit movement to encourage saving, to eliminate 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 provide long-term finance to farmers.