RBI and its functions

The central bank of our country is the Reserve Bank of India (RBI). It was established in 1935 (by the RBI Act, 1934) on the basis of recommendation of Hilton Young commission as a private shareholders’ bank with a paid up capital of rupees five crores. Starting as a private shareholders’ bank, the Reserve Bank of India was nationalised in 1949 and emerged as the central banking body of India.

The functions of the Reserve Bank today can be categorised as follows:

• Monetary and Credit policy
• Foreign exchange management
• Currency management
• Banker to banks & Lender of the last resort
• Banker to the Central and State Governments
• Central clearing house of payment and settlement systems
• Performing developmental and promotional functions

Monetary and Credit Policy

One of the most important functions of central banks is formulation and execution of monetary policy. Over time, the objectives of monetary policy in India have evolved to include maintaining price stability, ensuring adequate flow of credit to productive sectors of the economy for supporting economic growth, and achieving financial stability. The policy by which desired level of money flow and its demand is regulated is known as monetary and credit policy.

The Governor of the Reserve Bank announces the Monetary Policy in April every year for the financial year that ends in the following March. This is followed by three quarterly reviews in July, October and January. However, depending on the evolving situation, the Reserve Bank may announce monetary measures at any point of time. There are many tools by which RBI regulates the desired kind of credit and monetary policy- CRR, SLR, Bank Rate, Repo Rate, Reverse Repo Rate (explained later).

Currency management

Under Section 22 of the RBI Act, the bank has the sole right to issue bank notes of all denomination.

The Indian Currency is called the Indian Rupee and its sub-denomination the Paisa. The printing of Re.1 and Rs.2 denominations has been discontinued. However, notes in these denominations issued earlier are still valid and in circulation. Coins up to 50 paisa are called “small coins” and coins of Rupee one and above are called “Rupee coins”.

The RBI Act requires that the Reserve Bank’s affairs relating to note issue and its general banking business be conducted through two separate departments – the Issue Department and the Banking Department. RBI issues currency on the basis of Minimum Reserve System under which it keeps a minimal backing of 200 crores; out of which 115cr worth of Gold and 85cr worth of securities and Bonds of foreign governments.

Foreign exchange management

The Reserve Bank, as the custodian of the country’s foreign exchange reserves, is vested with the responsibility of managing their investment. The basic parameters of the Reserve Bank’s policies for foreign exchange reserves management are safety, liquidity and returns. While safety and liquidity continue to be the twin-pillars of reserves management, return optimisation has become an embedded strategy within this framework.

Within this framework, the Reserve Bank focuses on:

a) Maintaining market’s confidence in monetary and exchange rate policies.

b) Enhancing RBI intervention in stabilising foreign exchange markets.

c) Limiting external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis, including national disasters or emergencies.

The foreign exchange reserves include foreign currency assets (FCA), Special Drawing Rights (SDRs) and gold. SDRs are held by the Government of India. The foreign currency assets are managed following the principles of portfolio management.

Banker to banks & Lender of the last resort

Banks are required to maintain a portion of their demand and time liabilities as cash reserves with the Reserve Bank, thus necessitating a need for maintaining accounts with the Bank. In order to facilitate a smooth inter-bank transfer of funds, or to make payments and to receive funds on their behalf, banks need a common banker. In order to meet the above objectives, in India, the Reserve Bank provides banks with the facility of opening accounts with itself. This is the ‘Banker to Banks’ function of the Reserve Bank.

As Banker to Banks, the Reserve Bank provides short-term loans and advances to select banks, when necessary, to facilitate lending to specific sectors and for specific purposes. The Reserve Bank also acts as the ‘lender of last resort’. It can come to the rescue of a bank that is solvent but faces temporary liquidity problems by supplying it with much needed liquidity when no one else is willing to extend credit to that bank.

Banker to the Central and State Governments

The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and the management of its public debt. The Reserve Bank may also, by agreement, act as the banker to a State Government. Currently, the Reserve Bank acts as banker to all the State Governments in India, except Jammu & Kashmir and Sikkim.

The Reserve Bank also undertakes to float loans and manage them on behalf of the Governments. It also provides Ways and Means Advances – a short-term interest bearing advance – to the Governments, to meet the temporary mismatches in their receipts and payments. It also acts as adviser to Government, whenever called upon to do so, on monetary and banking related matters.

Central clearing house of payment and settlement systems

The increasing monetisation in the economy, the country’s large geographic expanse, people’s preference for paper-based instruments and rapid changes in technology are among factors that make this task a formidable one.

The various initiatives taken by RBI are:

• Computerisation
• Pre-paid payment instruments
• Cheque Truncation System (CTS)
• Electronic Clearing Service (ECS)
• National Electronic Clearing Service (NECS)
• Electronic Funds Transfer (EFT)
• The Real Time Gross Settlement (RTGS) system

Performing developmental and promotional functions

The Reserve Bank’s developmental role includes ensuring credit to productive sectors of the economy, creating institutions to build financial infrastructure, and expanding access to affordable financial services. It also plays an active role in encouraging efficient customer service throughout the banking industry, as well as extension of banking service to all, through the thrust on financial inclusion. Towards this goal, which has evolved over many years, the Reserve Bank has taken various initiatives like Priority Sector Lending, Lead Bank Scheme, Kisan Credit Cards, Differential Interest Rate Scheme, setting up of various institutions like SIDBI, NABARD.