BRIEF HISTORY OF RBI

The Reserve Bank, as the central bank of the country, started its operations as a private shareholder’s bank. RBI replaced the Imperial Bank of India and started issuing the currency notes and acting as the banker to the government. Imperial Bank of India was allowed to act as the agent of the RBI. RBI covered all over undivided India. To have close integration between policies of the Reserve Bank and those of the Government, it was decided to nationalize the Reserve Bank immediately after the independence of the country. From 1st January 1949, the Reserve Bank began functioning as a State-owned and State-controlled Central Bank. To streamline the functioning of commercial banks, the Government of India enacted the Banking Companies Act,1949 which was later changed as the Banking Regulation Act 1949. RBI acts as a regulator of banks, banker to the Government, and banker’s banks. It controls the financial system in the country through various measures.

STRUCTURE OF THE RBI

The Reserve Bank of India is a central bank and was established on 1^st April 1935 by the provisions of the Reserve Bank of India Act 1934. RBI works as a central bank where commercial banks are account holders. The central office of RBI is located in Mumbai since its inception. It was inaugurated with a share capital of Rs. 5 Crores divided into shares of Rs. 100 each fully paid up. RBI was Nationalised on 1^st January 1949 based on the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. RBI is fully owned by the Government of India. The Reserve Bank of India has 20 regional offices, most of them in state capitals and 11 Sub-offices.

RBI is governed by a central board (headed by a governor) appointed by the central government of India. The general superintendence and direction of the bank are entrusted to the central board consisting of:

1. One Governor;
2. Not more than four Deputy Governors;
3. Two Governmental officials from the Ministry of Finance;
4. Ten nominated directors from various fields by the government to give representation to important elements in the economic life of the country, and
5. The four-nominated director by the Central Government to represent the four local boards with the headquarters at Mumbai, Kolkata, Chennai, and New Delhi.

The local Board consists of five members each central government-appointed for a term of four years to represent territorial and economic interests and the interests of cooperative and indigenous banks.

OBJECTIVES OF RBI

The main objectives of RBI may be stated as follows in specific terms:

• To maintain monetary stability such that the business and economic life of the country can deliver the welfare gains of a mixed economy;
• To maintain the financial stability and ensure sound financial institutions so that economic units can conduct their business with confidence;
• To maintain stable payment systems, so that financial transactions can be safely and efficiently executed;
• To ensure that credit allocation by the financial system broadly reflects the national economic priorities and social concerns;
• To regulate the overall volume of money and credit in the economy to ensure a reasonable degree of price stability;
• To promote the development of financial markets and systems to enable itself to operate/regulate efficiently.

ROLE OF RESERVE BANK OF INDIA

Chapter III of the RBI Act, 1934 describes the role and functions of RBI. These functions are as under:

1. Monetary policy
2. Issuer of currency
3. Transact government business
4. Banker to banks
5. Regulator and supervisor of the financial system
6. Manager of Foreign Exchange
7. Supervisory Functions
8. Developmental role
9. Other Control and Supervisory Roles

1. Monetary policy:

Monitory policy refers to the use of instruments under the control of the Central Bank to regulate the availability, cost, and use of money to maintain price stability, inflation, and credit. The Central Government may, by notification in the Official Gazette, constitute a Committee to be called the Monetary Policy Committee of the Bank. The Monetary Policy Committee shall determine the Policy Rate required to achieve the inflation target. The Central Government shall, in consultation with the Bank, determine the inflation target in terms of the Consumer Price Index, once every five years. The Central Government shall, upon such determination, notify the inflation target in the Official Gazette.

The primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth; The decision of the Monetary Policy Committee shall be binding on the Bank. RBI uses several direct and indirect instruments in the formulation and implementation of monetary policy.

DIRECT INSTRUMENTS

a) Cash Reserve Ratio (CRR):

Cash Reserve Ratio is a certain percentage of bank deposits that banks are required to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent.

Maintenance of CRR daily:

To provide flexibility to banks in choosing an optimum strategy of holding reserves depending upon their intra fortnight cash flows, all SCBs are required to maintain minimum CRR balances up to 95 percent of the average daily required reserves for a reporting fortnight on all days of the fortnight with effect from the fortnight beginning September 21, 2013.

All SCBs are required to submit to Reserve Bank a provisional Return in Form ‘A’ within 7 days from the expiry of the relevant fortnight which is used for preparing press communique. The final Form ‘A’ Return is required to be submitted to RBI within 20 days from expiry of the relevant fortnight.

The Reserve Bank does not pay any interest on the CRR balances maintained by SCBs with effect from the fortnight beginning March 31, 2007. 

Penalties:

From the fortnight beginning June 24, 2006, penal interest is charged as under in cases of default in maintenance of CRR by SCBs:

• In case of default in maintenance of CRR requirement daily which is currently 95 percent of the total CRR requirement, penal interest will be recovered for that day at the rate of three percent per annum above the Bank Rate on the amount by which the amount maintained falls short of the prescribed minimum on that day and if the shortfall continues on the next succeeding day/s, penal interest will be recovered at the rate of five percent per annum above the Bank Rate.
• In cases of default in maintenance of CRR on an average basis during a fortnight, penal interest will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank of India Act, 1934.

SCBs are required to furnish the such as date, amount, percentage, the reason for default in maintenance of requisite CRR, and action taken to avoid recurrence of such default.

b) Statutory Liquidity Ratio (SLR):

All commercial banks in the country have to maintain a stipulated proportion of their net demand and time liabilities in the form of liquid assets like cash, gold, and unencumbered securities. Treasury bills, dated securities issued under market borrowing program and market stabilization schemes (MSS), etc also form part of the SLR. Banks have to report to the RBI every alternate Friday their SLR maintenance and pay penalties for failing to maintain SLR as mandated.  The value of such assets of an SCB shall not be less than such percentage not exceeding 40 percent of its total DTL in India as on the last Friday of the second preceding fortnight as the Reserve Bank may, by notification in the Official Gazette, specify from time to time.

Penalties:

If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to RBI in respect of that default, the penal interest for that day at the rate of three percent per annum above the Bank Rate on the shortfall and if the default continues the next succeeding working day, the penal interest may be increased to a rate of five percent per annum above the Bank Rate for the concerned days of default on the shortfall.

INDIRECT INSTRUMENTS

• Liquidity Adjustment Facility:

A liquidity adjustment facility (LAF) is a tool used in monetary policy that allows banks to borrow money through repurchase agreements. This arrangement allows banks to respond to liquidity pressures and is used by governments to assure basic stability in the financial markets. LAF is used to aid banks in adjusting the day-to-day mismatches in liquidity. LAF helps banks to quickly borrow money in case of any emergency or for adjusting their SLR/CRR requirements. LAF consists of repo and reverses repo operations.

• Repo Rate and Reverse Repo Rate:

Repo or repurchase option is collateralised lending i.e. banks borrow money from the Reserve bank of India to meet short-term needs by selling securities to RBI with an agreement to repurchase the same at a predetermined rate and date. The rate charged by RBI for this transaction is called the repo rate. Repo operations, therefore, inject liquidity into the system. Reverse repo operation is when RBI borrows money from banks by lending securities. The interest rate paid by RBI in this case is called the reverse repo rate.

• Open Market Operations (OMO):

Open market operations refer to the buying and selling of government securities in the open market to expand or contract the amount of money in the banking system. Securities’ purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy.

•  Marginal Standing Facility (MSF):

RBI announced that the MSF scheme has become effective from 9^th May 2011. Marginal Standing Facility is a liquidity support arrangement provided by RBI to commercial banks if the latter doesn’t have the required eligible securities above the SLR limit. Under MSF, a bank can borrow one-day loans from the RBI, even if it doesn’t have any eligible securities excess of its SLR requirement (maintains only the SLR). This means that the bank can’t borrow under the repo facility. MSF, being a penal rate, is always fixed above the repo rate. The MSF would be the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility by pledging government securities, where the rates are lower in comparison with the MSF. 

• Bank Rate:

A bank rate is the interest rate at which a nation’s central bank lends money to domestic banks, often in the form of very short-term loans. Managing the bank rate is a method by which central banks affect economic activity.

2. Issuer of currency:

RBI shall have the sole right to issue banknotes in India. Banknotes shall be of the denominational values of 2, 5, 10, 20, 50, 100, 500, 1000, 5000, and 10000 rupees or such other denominational values, not exceeding ten thousand rupees, as the Central Government may, on the recommendation of the Central Board, specify in this behalf. Every banknote shall be legal tender at any place in India in payment or on account for the amount expressed therein and shall be guaranteed by the Central Government.

3. Transact government business:

The Reserve Bank shall undertake to accept monies for the account of the Central Government and to make payments up to the amount standing to the credit of its account, and to carry out its exchange, remittance, and other banking operations, including the management of the public debt of the Union.

4. Banker to banks:

An important role and function of RBI are to maintain the banking accounts of all scheduled banks and act as the banker of last resort. RBI works as a central bank where commercial banks are account holders.  The RBI must control the credit through the CRR, bank rate, and open market operations.

5. Regulator and supervisor of the financial system:

RBI prescribes broad parameters of banking operations within which the country’s banking and financial system functions. Their main objective is to maintain public confidence in the system, protect depositors’ interests and provide cost-effective banking services to the public.

6. Manager of foreign exchange:

The manager of the exchange control department manages the foreign exchange, according to the foreign exchange management act, 1999. The manager’s main objective is to facilitate external trade and payment and promote orderly development and maintenance of the foreign exchange market in India. The RBI plays a crucial role in foreign exchange transactions. It does due diligence on every foreign transaction, including the inflow and outflow of foreign exchange. It takes steps to stop the fall in the value of the Indian Rupee. The RBI also takes the necessary steps to control the current account deficit. They also give support to promote export and the RBI provides a variety of options for NRIs.

7. Supervisory Functions:

In addition to its traditional central banking functions, the Reserve Bank performs 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 inspections 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 retaliation of certain desired social objectives.

8. Developmental Role:

Being the banker of the Government of India, the RBI is responsible for the implementation of the government’s policies related to agriculture and rural development. The RBI also ensures the flow of credit to other priority sectors as well. Section 54 of the RBI gives stress on giving specialized support for rural development. Priority sector lending is also in the key focus area of the RBI.

9. Other Control and Supervisory Roles:

The other control and supervisory roles of the Reserve Bank of India are done through the following:

• Issue of Licence:

Under the Banking Regulation Act 1949, the RBI has been given powers to grant licenses to commence new banking operations. The RBI also grants licenses to open new branches for existing banks. Under the licensing policy, the RBI provides banking services in areas that do not have this facility.

• Directed credit for lending to Priority Sector and Weaker Sections:

RBI issues guidelines for lending to Priority Sector and Weaker Sections advances. Banks have to follow the guidelines and have to achieve Priority Sector and Weaker Sections advance targets.

• Prudential Norms:

The RBI issues guidelines for credit control and management. The RBI is a member of the Banking Committee on Banking Supervision (BCBS). As such, they are responsible for the implementation of international standards of capital adequacy norms and asset classification.

• Corporate Governance:

The RBI has the power to control the appointment of the chairman and directors of banks in India. The RBI has powers to appoint additional directors in banks as well.

• KYC Norms:

To curb money laundering and prevent the use of the banking system for financial crimes, The RBI has “Know Your Customer” guidelines. Every bank has to ensure KYC norms are applied before allowing someone to open an account and monitor transactions in the accounts.

• Transparency Norms:

This means that every bank has to disclose their charges for providing services and customers have the right to know these charges.

• Risk Management:

The RBI provides guidelines to banks for taking the steps that are necessary to mitigate risk. They do this through risk management in Basel Norms.

• Audit and Inspection:

The procedure of audit and inspection is controlled by the RBI through the off-site and on-site monitoring systems. An on-site inspection is done by the RBI based on “CAMELS”. Capital adequacy; Asset quality; Management; Earning; Liquidity; System and control.

• Publish periodicals:

Apart from the above, the RBI publishes periodical reviews and data related to banking. The RBI plays a very important role in every aspect related to banking and finance.

REGULATORY RESTRICTIONS ON LENDING

RBI provides a framework of the rules and regulations issued to Scheduled Commercial Banks on statutory and other restrictions on loans and advances. Banks should implement these instructions and adopt adequate safeguards to ensure that the banking activities undertaken by them are run on sound, prudent and profitable lines.

• Loans against own Shares:

A bank cannot grant any loans and advances on the security of its shares.

• Loans to the Directors:

BR Act also lays down the restrictions on loans and advances to the directors and the firms in which they hold a substantial interest.

• Restrictions on Holding Shares in Companies:

While granting loans and advances against shares, statutory provisions contained in Sections 19(2) and 19(3) of the Banking Regulation Act, 1949 should be strictly observed.

• Restrictions on Credit to Companies for Buy-back of their Securities:

In terms of provisions of the Companies Act, 2013, companies are permitted to purchase their shares or other specified securities out of their free reserves, or securities premium account, or the proceeds of any shares or other specified securities, subject to compliance with various conditions specified therein. Therefore, banks should not provide loans to companies for buy-back of shares/securities.

• Lending to directors and their relatives on a reciprocal basis:

There have been instances where certain banks have developed an informal understanding or mutual/reciprocal arrangement among themselves for extending credit facilities to each other’s directors, their relatives, etc.

• Restrictions on Grant of Loans & Advances to Officers and Relatives of Senior Officers of Banks:

The statutory regulations and/or the rules and conditions of service applicable to officers or employees of public sector banks indicate, to a certain extent, the precautions to be observed while sanctioning credit facilities to such officers and employees and their relatives.

• advances against FDRs or other term deposits of other banks.

The banks should desist from sanctioning advances against FDRs or other term deposits of other banks.

• Loans against Certificate of Deposits (CDs):

Banks may lend against CDs and buy back their CDs, until further notice, only in respect of CDs held by mutual funds, subject to the provisions of paragraph 44(2) of the SEBI (Mutual Funds) Regulations, 1996.

• advance for subscription to Indian Depository Receipts (IDRs).
• No bank should grant any loan/advance for subscription to Indian Depository Receipts (IDRs).
• No additional facilities to wilful defaulters.No additional facilities should be granted by any bank/FI to the listed wilful defaulters.

CONTROL OVER MANAGEMENT

Power of Reserve Bank to remove managerial and other persons from office (Section 36AA):

Where the Reserve Bank is satisfied that it is necessary so to do, the Reserve Bank may, for reasons to be recorded in writing, by order, remove from office, with effect from such date as may be specified in the order, any Chairman, Director, Chief Executive Officer (by whatever name called) or other officer or employee of the banking company. Such person, within 30 days from the date of communication to him of the order, prefers an appeal to the Central Government. The decision of the Central Government on such appeal, and subject thereto, the order made by the Reserve Bank, shall be final and shall not be called into question in any court. Where an order has been made for removal, the Reserve Bank may, by order in writing, appoint a suitable person in place of the Chairman or Director or Chief Executive Officer or other officer or employee who has been removed from his office, with effect from such date as may be specified in the order.

Any person appointed as Chairman, Director or Chief Executive Officer or other officer or employee under this section, shall hold office during the pleasure of the Reserve Bank and subject thereto for a period not exceeding 3 years or such further periods not exceeding three years at a time as the Reserve Bank may specify;

Power of Reserve Bank to appoint additional Directors (Section 36AB):

If the Reserve Bank is of opinion that in the interest of banking policy or the public interest or the interests of the banking company or its depositors it is necessary so to do, it may, from time to time by order in writing, appoint, with effect from such date as may be specified in the order, one or more persons to hold office as additional directors of the banking company.

Any person appointed as additional Director in pursuance of this section shall hold office during the pleasure of the Reserve Bank and subject thereto for a period not exceeding 3 years or such further periods not exceeding 3 years at a time as the Reserve Bank may specify and shall not be required to hold qualification-shares in the banking company.