THESIS ON

“RBI as Watchdog of Indian Economic Scenario”

INDEX
Table of Contents
PROLOGUE..................................................................................................................................2
INTRODUCTION...........................................................................................................................3
Origins of the Reserve Bank of India................................................................................6
History........................................................................................................................................7
Objectives of the Reserve Bank of India............................................................................10
Functions of the Reserve Bank of India.........................................................................11
Traditional Functions of RBI..............................................................................................12
Developmental / Promotional Functions of RBI...........................................................14
Supervisory Functions of RBI...........................................................................................16
Reserve Bank of India's Credit Policy.................................................................................17
Policy rates and Reserve ratios............................................................................................24
 Bank Rate:....................................................................................................................24
 Cash Reserve Ratio (CRR):.....................................................................................25
 Statutory Liquidity Ratio (SLR):.............................................................................25
RBI on Forex Reserves............................................................................................................27
Adequacy of reserves..............................................................................................................28
RBI on corporate debt restructuring...................................................................................29
RBI on Banking..........................................................................................................................31
Branch Authorisation Policy..............................................................................................31
Operations of Foreign Banks in India.............................................................................32
Securitisation Guidelines of the RBI...................................................................................33
EPILOGUE...................................................................................................................................34
WEBLIOGRAPHY......................................................................................................................35

1
PROLOGUE

The Reserve Bank of India (RBI) was established on 1 April 1935 during

the British Raj in accordance with the provisions of the Reserve Bank of India Act,
1934 and plays an important part in the development strategy of the government. It is a
member bank of the Asian Clearing Union. Central banks are a relatively recent
innovation and most central banks, as we know them today, were established around
the early twentieth century.

The Reserve Bank of India was set up on the basis of the recommendations of
the Hilton Young Commission. The Reserve Bank of India Act, 1934 (II of 1934)
provides the statutory basis of the functioning of the Bank, which commenced
operations on April 1, 1935.

Government the functions so far being performed by the Controller of Currency

and from the Imperial Bank of India, the management of Government accounts and
public debt. The existing currency offices at Calcutta, Bombay, Madras, Rangoon,
Karachi, Lahore and Cawnpore (Kanpur) became branches of the Issue Department.
Offices of the Banking Department were established in Calcutta, Bombay, Madras,
Delhi and Rangoon.

With liberalization, the Bank's focus has shifted back to core central banking
functions like Monetary Policy, Bank Supervision and Regulation, and Overseeing the
Payments System and onto developing the financial markets.

2
INTRODUCTION

The Reserve Bank of India (RBI) is the central bank of the country. The Reserve
Bank of India was established on April 1, 1935 in accordance with the provisions of
the Reserve Bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Calcutta
but was permanently moved to Mumbai in 1937. The Central Office is where the
Governor sits and where policies are formulated. Though originally privately owned,
since nationalization in 1949, the Reserve Bank is fully owned by the Government of
India.

It was established in April 1935 with a share capital of Rs. 5 crores on the basis
of the recommendations of the Hilton Young Commission. The share capital was
divided into shares of Rs. 100 each fully paid which was entirely owned by private
shareholders in the beginning. The Government held shares of nominal value of Rs.
2, 20,000.

Reserve Bank of India was nationalized in the year 1949. The general
superintendence and direction of the Bank is entrusted to Central Board of Directors
of 20 members, the Governor and four Deputy Governors, one Government official
from the Ministry of Finance, ten nominated Directors by the Government to give
representation to important elements in the economic life of the country, and four
nominated Directors by the Central Government to represent the four local Boards with
the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of
five members each Central Government appointed for a term of four years to represent
territorial and economic interests and the interests of co-operative and indigenous
banks.

3
Preamble

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

"...to regulate the issue of Bank Notes and 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 Bank was constituted for the need of following:

 To regulate the issue of banknotes

 To maintain reserves with a view to securing monetary stability and

 To operate the credit and currency system of the country to its advantage.

The Reserve Bank of India (RBI) is the central banking institution of India and
controls the monetary policy of the rupee as well as US$300.21 billion (2010) of
currency reserves. The institution was established on 1 April 1935 during the British Raj
in accordance with the provisions of the Reserve Bank of India Act, 1934 and plays an
important part in the development strategy of the government. It is a member bank of
the Asian Clearing Union.

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

4
four basic functions of management, viz., planning, organizing, directing and controlling
in laying a strong foundation for the functioning of commercial banks.

The selection of the Bank's common seal to be used as the emblem of the Bank
on currency notes, cheques and publications, was an issue that had to be taken
up at an early stage of the Bank's formation.

The Government's general ideas on the seal were as follows:

1. The seal should emphasize the Governmental status of the Bank, but not too
closely;
2. It should have something Indian in the design;

3. It should be simple, artistic and heraldically correct; and

4. The design should be such that it could be used without substantial alteration
for letter heading, etc.

5
Origins of the Reserve Bank of India

1926: The Royal Commission on Indian Currency and Finance recommended creation
of a central bank for India.

1927: A bill to give effect to the above recommendation was introduced in the
Legislative Assembly, but was later withdrawn due to lack of agreement among
various sections of people.

1933: The White Paper on Indian Constitutional Reforms recommended the creation of
a Reserve Bank. A fresh bill was introduced in the Legislative Assembly.

1934: The Bill was passed and received the Governor General's assent

1935: The Reserve Bank commenced operations as India's central bank on April 1 as a
private shareholders' bank with a paid up capital of rupees five crores (rupees
fifty million).

1942: The Reserve Bank ceased to be the currency issuing authority of Burma (now
Myanmar).

1947: The Reserve Bank stopped acting as banker to the Government of Burma.

1948: The Reserve Bank stopped rendering central banking services to Pakistan.

1949: The Government of India nationalized the Reserve Bank under the Reserve Bank
(Transfer of Public Ownership) Act, 1948.

6
History

1935—1950

The central bank was founded in 1935 to respond to economic troubles after the
First World War. The Reserve Bank of India was set up on the recommendations of the
Hilton-Young Commission. The commission submitted its report in the year 1926,
though the bank was not set up for another nine years. The Preamble of the Reserve
Bank of India describes the basic functions of the Reserve Bank as to regulate the issue
of bank notes, to keep reserves with a view to securing monetary stability in India and
generally to operate the currency and credit system in the best interests of the country.
The Central Office of the Reserve Bank was initially established in Kolkata, Bengal, but
was permanently moved to Mumbai in 1937. The Reserve Bank continued to act as the
central bank for Myanmar till Japanese occupation of Burma and later up to April 1947,
though Burma seceded from the Indian Union in 1937. After partition, the Reserve Bank
served as the central bank for Pakistan until June 1948 when the State Bank of
Pakistan commenced operations. Though originally set up as a shareholders’ bank, the
RBI has been fully owned by the Government of India since its nationalization in 1949.

1950—1960

Between 1950 and 1960, the Indian government developed a centrally planned
economic policy and focused on the agricultural sector. The administration nationalized
commercial banks and established, based on the Banking Companies Act, 1949 (later
called Banking Regulation Act) a central bank regulation as part of the RBI.
Furthermore, the central bank was ordered to support the economic plan with loans.

1960—1969

7
 As a result of bank crashes, the reserve bank was requested to establish and
monitor a deposit insurance system. It should restore the trust in the national bank
system and was initialized on 7 December 1961. The Indian government founded funds
to promote the economy and used the slogan Developing Banking. The Government of
India restructured the national bank market and nationalized a lot of institutes. As a
result, the RBI had to play the central part of control and support of this public banking
sector.

1969—1985

Between 1969 and 1980, the Indian government nationalized 6 more commercial
banks, following 14 major commercial banks being nationalized in 1969(As mentioned
in RBI website). The regulation of the economy and especially the financial sector was
reinforced by the Government of India in the 1970s and 1980s. The central bank
became the central player and increased its policies for a lot of tasks like interests,
reserve ratio and visible deposits. The measures aimed at better economic
development and had a huge effect on the company policy of the institutes. The banks
lent money in selected sectors, like agri-business and small trade companies.

The branch was forced to establish two new offices in the country for every newly
established office in a town. The oil crises in 1973 resulted in increasing inflation, and
the RBI restricted monetary policy to reduce the effects.

1985—1991

A lot of committees analyzed the Indian economy between 1985 and 1991. Their
results had an effect on the RBI. The Board for Industrial and Financial Reconstruction,
the Indira Gandhi Institute of Development Research and the Security & Exchange
Board of India investigated the national economy as a whole, and the security and
exchange board proposed better methods for more effective markets and the protection
of investor interests. The Indian financial market was a leading example for so-called
"financial repression" (Mackinnon and Shaw). The Discount and Finance House of India
began its operations on the monetary market in April 1988; the National Housing Bank,

8
founded in July 1988, was forced to invest in the property market and a new financial
law improved the versatility of direct deposit by more security measures and
liberalization.

1991—2000

The national economy came down in July 1991 and the Indian rupee was
devalued. The currency lost 18% relative to the US dollar, and the Narasimham
Committee advised restructuring the financial sector by a temporal reduced reserve
ratio as well as the statutory liquidity ratio. New guidelines were published in 1993 to
establish a private banking sector. This turning point should reinforce the market and
was often called neo-liberal. The central bank deregulated bank interests and some
sectors of the financial market like the trust and property markets. This first phase was a
success and the central government forced a diversity liberalisation to diversify owner
structures in 1998.

The National Stock Exchange of India took the trade on in June 1994 and the
RBI allowed nationalized banks in July to interact with the capital market to reinforce
their capital base. The central bank founded a subsidiary company—the Bharatiya
Reserve Bank Note Mudran Limited—in February 1995 to produce banknotes.

Since 2000

The Foreign Exchange Management Act from 1999 came into force in June
2000. It should improve the foreign exchange market, international investments in India
and transactions. The RBI promoted the development of the financial market in the last
years, allowed online banking in 2001 and established a new payment system in 2004 -
2005 (National Electronic Fund Transfer). The Security Printing & Minting Corporation of
India Ltd., a merger of nine institutions, was founded in 2006 and produces banknotes
and coins.

The national economy's growth rate came down to 5.8% in the last quarter of
2008 - 2009 and the central bank promotes the economic development.

9
Objectives of the Reserve Bank of India

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.

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.

10
Functions of the Reserve Bank of India

The Reserve Bank of India performs all the typical functions of a good Central Bank. In
addition, it carries out a variety of developmental and promotional functions attuned to
the course of economic planning in the country:

Issuing currency notes, i.e., to act as a currency authority.

 Serving as banker to the Government.

 Acting as bankers’ bank and supervisor.

 Monetary regulation and management.

 Exchange management and control.

 Collection of data and their publication.

 Miscellaneous developmental and promotional functions and activities.

 Agricultural Finance.

 Industrial Finance

 Export Finance.

 Institutional promotion.

11
 As a central bank, the Reserve Bank has significant powers and duties to
perform. For smooth and speedy progress of the Indian Financial System, it has to
perform some important tasks. Among others it includes maintaining monetary and
financial stability, to develop and maintain stable payment system, to promote and
develop financial infrastructure and to regulate or control the financial institutions.

For simplification, the functions of the Reserve Bank are classified into the
traditional functions, the development functions and supervisory functions.

Traditional Functions of RBI

Traditional functions are those functions which every central bank of each nation
performs all over the world. Basically these functions are in line with the objectives with
which the bank is set up. It includes fundamental functions of the Central Bank. They
comprise the following tasks.

a. Issue of Currency Notes :

The RBI has the sole right or authority or monopoly of issuing currency
notes except one rupee note and coins of smaller denomination. These currency
notes are legal tender issued by the RBI. Currently it is in denominations of Rs. 2, 5,
10, 20, 50, 100, 500, and 1,000. The RBI has powers not only to issue and withdraw
but even to exchange these currency notes for other denominations. It issues these
notes against the security of gold bullion, foreign securities, rupee coins, exchange
bills and promissory notes and government of India bonds.

12
b. Banker to other Banks:

The RBI being an apex monitory institution has obligatory powers to guide,
help and direct other commercial banks in the country. The RBI can control the
volumes of banks reserves and allow other banks to create credit in that proportion.
Every commercial bank has to maintain a part of their reserves with its parent's viz.
the RBI. Similarly in need or in urgency these banks approach the RBI for fund. Thus
it is called as the lender of the last resort.

c. Banker to the Government:

The RBI being the apex monitory body has to work as an agent of the
central and state governments. It performs various banking function such as to
accept deposits, taxes and make payments on behalf of the government. It works as
a representative of the government even at the international level. It maintains
government accounts, provides financial advice to the government. It manages
government public debts and maintains foreign exchange reserves on behalf of the
government. It provides overdraft facility to the government when it faces financial
crunch.

d. Exchange Rate Management:

It is an essential function of the RBI. In order to maintain stability in the

external value of rupee, it has to prepare domestic policies in that direction. Also it
needs to prepare and implement the foreign exchange rate policy which will help in
attaining the exchange rate stability. In order to maintain the exchange rate stability
it has to bring demand and supply of the foreign currency (U.S Dollar) close to each
other.

e. Credit Control Function:

13
 Commercial bank in the country creates credit according to the demand in
the economy. But if this credit creation is unchecked or unregulated then it leads the
economy into inflationary cycles. On the other credit creation is below the required
limit then it harms the growth of the economy. As a central bank of the nation the
RBI has to look for growth with price stability. Thus it regulates the credit creation
capacity of commercial banks by using various credit control tools.

f. Supervisory Function:

The RBI has been endowed with vast powers for supervising the banking
system in the country. It has powers to issue license for setting up new banks, to
open new braches, to decide minimum reserves, to inspect functioning of
commercial banks in India and abroad, and to guide and direct the commercial
banks in India. It can have periodical inspections an audit of the commercial banks in
India

Developmental / Promotional Functions of RBI

Along with the routine traditional functions, central banks especially in the developing
country like India have to perform numerous functions. These functions are country
specific functions and can change according to the requirements of that country. The
RBI has been performing as a promoter of the financial system since its inception.
Some of the major development functions of the RBI are maintained below.

g. Development of the Financial System:

The financial system comprises the financial institutions, financial markets and
financial instruments. The sound and efficient financial system is a precondition of
the rapid economic development of the nation. The RBI has encouraged
establishment of main banking and non-banking institutions to cater to the credit
requirements of diverse sectors of the economy.

h. Development of Agriculture :

14
 In an agrarian economy like ours, the RBI has to provide special attention for the
credit need of agriculture and allied activities. It has successfully rendered service in
this direction by increasing the flow of credit to this sector. It has earlier the
Agriculture Refinance and Development Corporation (ARDC) to look after the credit,
National Bank for Agriculture and Rural Development (NABARD) and Regional Rural
Banks (RRBs).

i. Provision of Industrial Finance :

Rapid industrial growth is the key to faster economic development. In this regard,
the adequate and timely availability of credit to small, medium and large industry is
very significant. In this regard the RBI has always been instrumental in setting up
special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc.

j. Provisions of Training :

The RBI has always tried to provide essential training to the staff of the banking
industry. The RBI has set up the bankers' training colleges at several places.
National Institute of Bank Management i.e NIBM, Bankers Staff College i.e BSC and
College of Agriculture Banking i.e CAB are few to mention.

k. Publication of the Reports :

The Reserve Bank has its separate publication division. This division collects and
publishes data on several sectors of the economy. The reports and bulletins are
regularly published by the RBI. It includes RBI weekly reports, RBI Annual Report,
Report on Trend and Progress of Commercial Banks India., etc. This information is
made available to the public also at cheaper rates.

l. Promotion of Banking Habits :

15
 As an apex organization, the RBI always tries to promote the banking habits in the
country. It institutionalizes savings and takes measures for an expansion of the
banking network. It has set up many institutions such as the Deposit Insurance
Corporation-1962, UTI-1964, IDBI-1964, NABARD-1982, NHB-1988, etc. These
organizations develop and promote banking habits among the people. During
economic reforms it has taken many initiatives for encouraging and promoting
banking in India.

m. Promotion of Export through Refinance :

The RBI always tries to encourage the facilities for providing finance for foreign trade
especially exports from India. The Export-Import Bank of India (EXIM Bank India)
and the Export Credit Guarantee Corporation of India (ECGC) are supported by
refinancing their lending for export purpose.

Supervisory Functions of RBI

The reserve bank also performs many supervisory functions. It has authority to regulate
and administer the entire banking and financial system. Some of its supervisory
functions are given below.

n. Granting license to banks :

The RBI grants license to banks for carrying its business. License is also given for
opening extension counters, new branches, even to close down existing branches.

o. Bank Inspection :

The RBI grants license to banks working as per the directives and in a prudent
manner without undue risk. In addition to this it can ask for periodical information
from banks on various components of assets and liabilities.

16
 p. Control over NBFIs :

The Non-Bank Financial Institutions are not influenced by the working of a monitory
policy. However RBI has a right to issue directives to the NBFIs from time to time
regarding their functioning. Through periodic inspection, it can control the NBFIs.

q. Implementation of the Deposit Insurance Scheme :

The RBI has set up the Deposit Insurance Guarantee Corporation in order to protect
the deposits of small depositors. All bank deposits below Rs. One lakh are insured
with this corporation. The RBI work to implement the Deposit Insurance Scheme in
case of a bank failure.

Reserve Bank of India's Credit Policy

The Reserve Bank of India has a credit policy which aims at pursuing higher growth with
price stability. Higher economic growth means to produce more quantity of goods and
services in different sectors of an economy; Price stability however does not mean no
change in the general price level but to control the inflation. The credit policy aims at
increasing finance for the agriculture and industrial activities. When credit policy is
implemented, the role of other commercial banks is very important. Commercial banks
flow of credit to different sectors of the economy depends on the actual cost of credit
and arability of funds in the economy.

1. Monetary authority

The Reserve Bank of India is the main monetary authority of the country and beside
that the central bank acts as the bank of the national and state governments. It

17
formulates, implements and monitors the monetary policy as well as it has to ensure
an adequate flow of credit to productive sectors. Objectives are maintaining price
stability and ensuring adequate flow of credit to productive sectors. The national
economy depends on the public sector and the central bank promotes an expansive
monetary policy to push the private sector since the financial market reforms of the
1990s.

The institution is also the regulator and supervisor of the financial system and
prescribes broad parameters of banking operations within which the country's
banking and financial system functions. Objectives are to maintain public confidence
in the system, protect depositors' interest and provide cost-effective banking
services to the public. The Banking Ombudsman Scheme has been formulated by
the Reserve Bank of India (RBI) for effective addressing of complaints by bank
customers. The RBI controls the monetary supply, monitors economic indicators like
the gross domestic product and has to decide the design of the rupee banknotes as
well as coins.

2. Manager of exchange control

The central bank manages to reach the goals of the Foreign Exchange Management
Act, 1999. Objective: to facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in India.

3. Issuer of currency

The bank issues and exchanges or destroys currency and coins not fit for circulation.
The objectives are giving the public adequate supply of currency of good quality and
to provide loans to commercial banks to maintain or improve the GDP. The basic
objectives of RBI are to issue bank notes, to maintain the currency and credit system
of the country to utilize it in its best advantage, and to maintain the reserves. RBI
maintains the economic structure of the country so that it can achieve the objective

18
of price stability as well as economic development, because both objectives are
diverse in themselves.

4. Minimum Reserve System - Principle of Currency Note Issue

RBI can issue currency notes as much as the country requires, provided it has to
make a security deposit of Rs. 200 crores, out of which Rs. 115 crores must be in
gold and Rs. 85 crores must be FOREX Reserves. This principle of currency notes
issue is known as the 'Minimum Reserve System'.

5. Developmental role

The central bank has to perform a wide range of promotional functions to support
national objectives and industries. The RBI faces a lot of inter-sectoral and local
inflation-related problems. Some of this problems are results of the dominant part of
the public sector.

6. Related functions

The RBI is also a banker to the government and performs merchant banking function
for the central and the state governments. It also acts as their banker. The National
Housing Bank (NHB) was established in 1988 to promote private real estate
acquisition. The institution maintains banking accounts of all scheduled banks, too.

There is now an international consensus about the need to focus the tasks of a
central bank upon central banking. RBI is far out of touch with such a principle,
owing to the sprawling mandate described above. The recent financial turmoil world-
over, has however, vindicated the Reserve Bank's role in maintaining financial
stability in India.

7. Bank Issue

19
Under Section 22 of the Reserve Bank of India Act, the bank has the sole sight to
issue bank notes of all denominations. The notice issued by the Reserve bank has
the following advantages:

 It brings uniformity to note issue.

 It is easier to control credit when there is a single agency of note issue.

 It keeps the public faith in the paper currency alive.

 It helps in the stabilization of the internal and external value of the currency
and Credit can be regulated according to the needs of the business.

The system of note issue as it exists today is known as the minimum reserve
system. The currency notes issued by the Bank arid legal tender everywhere in India
without any limit. At present, the Bank issues notes in the following denominations:
Rs. 2, 5, 10, 20, 50 100, and 500. The responsibility of the Bank is not only to put
currency into, or withdraw it from, the circulation but also to exchange notes and
coins of one denomination into those of other denominations as demanded by the
public. All affairs of the Bank relating to note issue are conducted through its Issue
Department.

8. Banker, Agent and Financial Advisor to the State

As a banker agent and financial advisor to the State, the Reserve Bank performs the
following functions:

 It keeps the banking accounts of the government.

 It advances short-term loans to the government and raises loans from the
public.

 It purchases and sells through bills and currencies on behalf to the

government.

20
  It receives and makes payment on behalf of the government.

 It manages public debt and

 It advises the government on economic matters like deficit financing price

stability, management of public debts. etc.

9. Banker to the Banks:

It acts as a guardian for the commercial banks. Commercial banks are required to
keep a certain proportion of cash reserves with the Reserve bank. In lieu of this, the
Reserve bank provide them various facilities like advancing loans, underwriting
securities etc. The RBI controls the volume of reserves of commercial banks and
thereby determines the deposits/credit creating ability of the banks. The banks hold
a part or all of their reserves with the RBI. Similarly, in times of their needs, the
banks borrow funds from the RBI. It is, therefore, called the bank of last resort or the
lender of last resort.

10. As Banker to Banks, the Reserve Bank focuses on

 Enabling smooth, swift and seamless clearing and settlement of inter-bank

obligations.

 Providing an efficient means of funds transfer for banks.

 Enabling banks to maintain their accounts with the Reserve Bank for statutory
reserve requirements and maintenance of transaction balances.

 Acting as a lender of last resort.

11. Custodian of Foreign Exchange Reserves

21
 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.

12. Lender of the Last Resort

At one time, it was supposed to be the most important function of the Reserve Bank.
When Commercial banks fail to meet obligations of their depositors the Reserve Bank
22
comes to their rescue as the lender of the last resort, the Reserve Bank assumes the
responsibility of meeting directly or indirectly all legitimate demands for accommodation
by the Commercial Banks under emergency conditions.

13. Banks of Central Clearance, Settlement and Transfer

The commercial banks are not required to settle the payments of their mutual
transactions in cash, It is easier to effect clearance and settlement of claims among
them by making entries in their accounts maintained with the Reserve Bank, The
Reserve Bank also provides the facility for transfer to money free of charge to
member banks.

14. Controller of Credit

In modern times credit control is considered as the most crucial and important
functional of a Reserve Bank. The Reserve Bank regulates and controls the volume
and direction of credit by using quantitative and qualitative controls. Quantitative
controls include the bank rate policy, the open market operations, and the variable
reserve ratio. Qualitative or selective credit control, on the other hand includes
rationing of credit, margin requirements, direct action, moral suasion publicity, etc.
Besides the above mentioned traditional functions, the Reserve Bank also performs
some promotional and supervisory functions. The Reserve Bank promotes the
development of agriculture and industry promotes rural credit, etc. The Reserve
Bank also acts as an agent for the international institutions as I.M.F., I.B.R.D., etc.

15. 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 supervisory functions of the RBI have helped a great
deal in improving the methods of their operation. The Reserve Bank Act, 1934, and
Banking Regulation Act, 1949 have given the RBI wide powers of:

23
  Supervision and control over commercial and cooperative banks, relating to
licensing and establishments.
 Branch expansion.

 Liquidity of their assets.

 Management and methods of working, amalgamation reconstruction and

liquidations.

 The RBI is authorized to carry out periodical inspections off the banks and to
call for returns and necessary information from them.

Policy rates and Reserve ratios

24
Policy rates, Reserve ratios, lending, and deposit rates as on 06/09/2011

Bank Rate 6.0%

Repo Rate 8%

Reverse Repo Rate 7%

Cash Reserve Ratio (CRR) 6.0%

.
Statutory Liquidity Ratio (SLR) 24.0%

Base Rate 9.50%/10.25%

Savings Bank Rate 4%

Deposit Rate 8.50%–9.25%

 Bank Rate:

RBI lends to the commercial banks through its discount window to help the banks
meet depositor’s demands and reserve requirements. The interest rate the RBI
charges the banks for this purpose is called bank rate. If the RBI wants to increase
the liquidity and money supply in the market, it will decrease the bank rate and if it
wants to reduce the liquidity and money supply in the system, it will increase the
bank rate. As of 5 May, 2011 the bank rate was 6%.

 Cash Reserve Ratio (CRR):

Every commercial bank has to keep certain minimum cash reserves with RBI.
RBI can vary this rate between 3% and 15%. RBI uses this tool to increase or
decrease the reserve requirement depending on whether it wants to affect a
decrease or an increase in the money supply. An increase in Cash Reserve Ratio
(CRR) will make it mandatory on the part of the banks to hold a large proportion of
their deposits in the form of deposits with the RBI. This will reduce the size of their

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 deposits and they will lend less. This will in turn decrease the money supply. The
current rate is 6%.

 Statutory Liquidity Ratio (SLR):

Apart from the CRR, banks are required to maintain liquid assets in the form of
gold, cash and approved securities. Higher liquidity ratio forces commercial banks to
maintain a larger proportion of their resources in liquid form and thus reduces their
capacity to grant loans and advances, thus it is an anti-inflationary impact. A higher
liquidity ratio diverts the bank funds from loans and advances to investment in
government and approved securities.

In well-developed economies, central banks use open market operations--buying

and selling of eligible securities by central bank in the money market--to influence
the volume of cash reserves with commercial banks and thus influence the volume
of loans and advances they can make to the commercial and industrial sectors. In
the open money market, government securities are traded at market related rates of
interest. The RBI is resorting more to open market operations in the more recent
years.

Generally RBI uses three kinds of selective credit controls:

 Minimum margins for lending against specific securities.

 Ceiling on the amounts of credit for certain purposes.

 Discriminatory rate of interest charged on certain types of advances.

Direct credit controls in India are of three types:

 Part of the interest rate structure i.e. on small savings and provident funds, are
administratively set.
 Banks are mandatorily required to keep 24% of their deposits in the form of
government securities.

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 Banks are required to lend to the priority sectors to the extent of 40% of their
advances.

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RBI on Forex Reserves

Foreign exchange reserves play an irreplaceable role in many emerging economies.

The central, or reserve, bank creates and then uses domestic money to buy foreign
exchange. If a central bank creates more domestic money, it can buy more foreign
exchange. It does not have to pump iron to build reserves. It does not have to sweat it
out. It has to merely pump domestic money into the domestic economy and coolly build
foreign exchange reserves. The creation of foreign exchange reserves is wholly a white-
collar job.

The Reserve Bank of India (RBI) undertook a review of the main policy and
operational matters relating to management of the reserves, including transparency and
disclosure and decided to compile and make public half-yearly reports on management
of foreign exchange reserves for bringing about more transparency and also for
enhancing the level of disclosure in this regard. These reports are being prepared with
reference to positions as of 31st March and 30th September each year, with a time lag
of about 3 months. The reports talk about the report is a compilation of quantitative
information with regard to external reserves, such as, level of foreign exchange
reserves, sources of accretion to foreign exchange reserves, external liabilities vis-à-vis
foreign exchange reserves, prepayment/repayment of external debt, Financial
Transaction Plan (FTP) of IMF, adequacy of reserves, etc.

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Adequacy of reserves

Adequacy of reserves has emerged as an important parameter in gauging its

ability to absorb external shocks. With the changing profile of capital flows, the
traditional approach of assessing reserve adequacy in terms of import cover has been
broadened to include a number of parameters which take into account the size,
composition and risk profiles of various types of capital flows as well as the types of
external shocks to which the economy is vulnerable. The High Level Committee on
Balance of Payments, which was chaired by Dr. C. Rangarajan, erstwhile Governor of
Reserve Bank of India, had suggested that, while determining the adequacy of
reserves, due attention should be paid to payment obligations, in addition to the
traditional measure of import cover of 3 to 4 months.  

In 1997, the Report of Committee on Capital Account Convertibility under the

chairmanship of Shri S.S.Tarapore suggested four alternative measures of adequacy of
reserves which, in addition to trade- based indicators, also included money-based and
debt-based indicators. Similar views have been held by the Committee on Fuller Capital
Account Convertibility (Chairman: Shri S.S.Tarapore, July 2006). In the recent period,
assessment of reserve adequacy has been influenced by the introduction of new
measures. One such measure requires that the usable foreign exchange reserves
should exceed scheduled amortisation of foreign currency debts (assuming no rollovers)
during the following year. The other one is based on a “Liquidity at Risk” rule that takes
into account the foreseeable risks that a country could face. The import cover for
reserves was 12.4 months at end-March 2007. The ratio of short-term debt to foreign
exchange reserves declined from 146.5 per cent at end-March 1991 to 5.3 per cent as
at end-March 2005, but increased slightly to 5.7 per cent as at end-March 2006 and
further to 6.0 per cent at end-March 2007. However, this ratio increased moderately to
36.9 per cent as at end-March 2005 and further to 43.4 per cent as at end-March 2006
and decreased to 38.2 per cent as at end March 2007.

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RBI on corporate debt restructuring

The objective of the Corporate Debt Restructuring (CDR) framework is to ensure

timely and transparent mechanism for restructuring of the corporate debts of viable
entities facing problems, outside the purview of BIFR, DRT and other legal proceedings,
for the benefit of all concerned. In particular, the framework will aim at preserving viable
corporates that are affected by certain internal and external factors and minimize the
losses to the creditors and other stakeholders through an orderly and coordinated
restructuring programme.

A Special Group was constituted in September 2004 with Smt.S.Gopinath,

Deputy Governor, Reserve Bank of India to undertake a review of the Scheme. The
Special Group had suggested certain changes / improvements in the existing Scheme
for enhancing its scope and making it more efficient. Based on the recommendations
made by the Special Group revised draft guidelines on Corporate Debt Restructuring
were prepared and circulated among banks for comments. On the basis of the feedback
received the draft guidelines have been reviewed and the revised guidelines on CDR
mechanism

The major modifications made in the existing CDR mechanism relate to

(a) Extension of the scheme to entities with outstanding exposure of Rs.10 crore or
more

(b) Requirement of support of 60% of creditors by number in addition to the support of

75% of creditors by value with a view to make the decision making more equitable

(c) Discretion to the core group in dealing with wilful defaulters in certain cases other
than cases involving frauds or diversion of funds with malafide intentions.

(d) Linking the restoration of asset classification prevailing on the date of reference to
the CDR Cell to implementation of the CDR package within four months from the
date of approval of the package.

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(e) Restricting the regulatory concession in asset classification and provisioning to the
first restructuring where the package also has to meet norms relating to turn-around
period and minimum sacrifice and funds infusion by promoters.

(f) Convergence in the methodology for computation of economic sacrifice among banks
and FIs

(g) Limiting RBI’s role to providing broad guidelines for CDR mechanism

(h) Enhancing disclosures in the balance sheet for providing greater transparency

(i) Pro-rata sharing of additional finance requirement by both term lenders and working
capital lenders

(j) Allowing OTS as a part of the CDR mechanism to make the exit option more flexible
and

(k) Regulatory treatment of non-SLR instruments acquired while funding interest or in

lieu of outstanding principal and valuation of such instruments.

RBI on Banking

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Though the RBI, as part of its monetary management mandate, had, from the very
beginning, been vested with the powers, under the RBI Act, 1934, to regulate the
volume and cost of bank credit in the economy through the instruments of general credit
control, it was not until 1949 that a comprehensive enactment, applicable only to the
banking sector, came into existence. The Banking Regulation Act from March 1966. The
Act vested in the Reserve Bank the responsibility relating to licensing of banks, branch
expansion, and liquidity of their assets, management and methods of working,
amalgamation, reconstruction and liquidation. Important changes in several provisions
of the Act were made from time to time, designed to enlarge or amplify the
responsibilities of the RBI or to impart flexibility to the relative provisions, commensurate
with the imperatives of the banking sector developments.

Branch Authorisation Policy

 The RBI announced a new Branch Authorisation Policy in September 2005 under
which certain changes were brought about in the authorisation process adopted by the
RBI for the bank branches in the country. As against the earlier system, where the
banks approached the RBI, piece meal, through out the year for branch authorisation,
the revised system provides for a holistic and streamlined approach for the purpose, by
granting a bank-wise, annual aggregated authorisation, in consultation and interaction
with each applicant bank. The objective is to ensure that the banks take an integrated
view of their branch- network needs, including branch relocations, mergers, conversions
and closures as well as setting up of the ATMs, over a one-year time horizon, in tune
with their own business strategy, and then approach the RBI for consolidated annual
authorisations accordingly.

Operations of Foreign Banks in India

At present, there are 29 foreign banks operating in India with a network of 273 branches
and 871 off-site ATMs. Among some circles, a doubt is sometimes expressed as to

32
whether the regulatory environment in India is liberal in regard to the functioning of the
foreign banks and whether the regulatory approach towards foreign participation in the
Indian banking system is consistent with liberalized environment. Undoubtedly, the facts
indicate that regulatory regime followed by the Reserve Bank in respect of foreign banks
is non-discriminatory, and is, in fact, very liberal by global standards. Here are a few
facts which bear out the contention; .

No restrictions have been placed on establishment of non-banking financial

subsidiaries in India by the foreign banks or of their group companies. Deposit
insurance cover is uniformly available to all foreign banks at a non-discriminatory rate of
premium. In many other countries there is a discriminatory regime. This has been
advantageous to the foreign bank branches as the entire home-country business is
generally routed through these branches.

Substantial FII business is also handled exclusively by the foreign banks. In fact,
some Indian banks contend that certain amount of positive discrimination exists in
favour of foreign banks by way of lower Priority Sector lending requirement at 32 per
cent of the adjusted net bank credit as against a level of 40 per cent required for the
Indian banks. Notably, in terms of our WTO commitment, licences for new foreign banks
may be denied when the share of foreign banks’ assets in India, including both on- as
well as off-balance-sheet items, in the total assets (including both on- and off-balance-
sheet items) of the banking system exceeds 15 per cent. However, we have
autonomously not invoked this limitation so far to deny licences to the new foreign
banks even though the actual share of foreign banks in the total assets of the banking
system, including both on- and off-balance-sheet items (on Notional Principal basis),
has been far above the limit. This share of foreign banks stood at 49 per cent, as at
end-January 2007, as mentioned in the India’s Trade Policy Review, 2007

Securitisation Guidelines of the RBI

33
 The RBI had first issued the draft guidelines for securitisation of standard assets
in April 2005, for public comments and after an extensive consultative process; the final
guidelines were issued in February 2006, in order to facilitate an orderly development of
this market. In certain quarters, however, a view has been expressed that these
guidelines, tend to negate the benefits envisaged in the very concept of securitisation,
and thus, are hindering the growth of securitisation market in the country. Let me
attempt to briefly present today the international perspective vis-à-vis RBI guidelines
and the thinking and rationale underlying our formulation.

The independence of the Reserve Bank holds the key to effective monetary
control. An independent Reserve Bank can hold out threat of a high rate of interest on
Government borrowing if the Government indulges in fiscal excesses. As the high rate
interests retard the rate of economic growth and adversely affect the chances of the
politicians’ re-election they behave more responsibly than they otherwise would.

EPILOGUE
34
In the immediate future, the Reserve Bank’s priority is to ensure that adequate rupee
and forex liquidity are maintained in domestic markets to prevent excessive volatility in
interest rates and exchange rates. Rupee liquidity is being provided through the Repo
window of the Liquidity Adjustment Facility (LAF). As of now, the banking system does
not face any liquidity pressures as evident from the low level of dependence on liquidity
injections under the LAF. In any case the banking system currently has an adequate
stock of Statutory Liquidity Ratio (SLR) securities, which are eligible for Repo
transactions. Further, the capacity of the LAF to inject liquidity has recently been
augmented by the introduction of the Marginal Standing Facility (MSF), which allows
banks to draw down SLR securities up to a further one per cent of their Net Demand
and Time Liabilities (NDTL) in order to meet liquidity requirements. This will help
stabilize the call rate within the LAF corridor, which is currently 7-9 per cent.

As regards forex liquidity, in anticipation of financial market turbulence related to

the US debt ceiling impasse, the Reserve Bank made an assessment of the ability of
the forex reserve portfolio to meet potential forex requirements in the event of significant
capital outflows. This exercise indicated that there were sufficient liquid reserves to
meet the demand for forex even in stress scenarios.

The Reserve Bank is closely monitoring all key indicators and will continuously assess
the impact of global developments on Rupee and forex liquidity and macroeconomic
stability.

WEBLIOGRAPHY

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 Web

 http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/69367.pdf

 http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIAM_230609.pd f

 http://www.rbi.org.in/Commonman/English/History/Scripts/anecdote3.aspx

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