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Hitesh Soni (0854) Suresh Chaudhary (0805)
MS. Khushbu Shah

The Preamble of the Reserve Bank of India describes the basic functions of the R
eserve 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 Reserve Bank of India is the central bank of India, and was established on A
pril 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 Kolka
ta but was permanently moved to Mumbai in 1937. Though originally privately owne
d, the RBI has been fully owned by the Government of India since nationalization
in 1949. Duvvuri Subbarao who succeeded Yaga Venugopal Reddy on September 2, 20
08 is the current Governor of RBI. The Reserve Bank of India was set up on the r
ecommendations of the Hilton Young Commission. The commission submitted its repo
rt in the year 1926, though the bank was not set up for 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 and keeping of reserves with a view to se
curing monetary stability in India and generally to operate the currency and cre
dit system of the country to its advantage. It has 22 regional offices, most of
them in state capitals. RBI was started with a paid up share capital of 5 crore.
on established it took over the function of management of currency from governme
nt of India and power of credit control from imperial bank of india.

Nationalization of RBI:
With a view to have a cordinated regulation of Indian banking Indian Banking Act
was passed in march 1949. To make RBI more powerful the Govt. of India national
ised RBI on January 1, 1949. The general superintendence and direction of the Ba
nk is entrusted to Central Board of Directors of 20 members, the Governor and fo
ur Deputy Governors, one Government official from the Ministry of Finance, ten n
ominated Directors by the Government to give representation to important element
s in the economic life of the country, and four nominated Directors by the Centr
al Government to represent the four local Boards with the headquarters at Mumbai
, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Cent
ral Government appointed for a term of four years to represent territorial and e
conomic interests and the interests of co-operative and indigenous banks.

The Reserve Bank of India was nationalized with effect from 1st January, 1949 on
the basis of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948
. All shares in the capital of the Bank were deemed transferred to the Central G
overnment on payment of a suitable compensation. The image is a newspaper clippi
ng giving the views of Governor CD Deshmukh, prior to nationalization




Bank of Issue Under Section 22 of the Reserve Bank of India Act, the Bank has th
e sole right to issue bank notes of all denominations. The distribution of one r
upee notes and coins and small coins all over the country is undertaken by the R
eserve Bank as agent of the Government. The Reserve Bank has a separate Issue De
partment which is entrusted with the issue of currency notes. The assets and lia
bilities of the Issue Department are kept separate from those of the Banking Dep
artment. Originally, the assets of the Issue Department were to consist of not l
ess than two-fifths of gold coin, gold bullion or sterling securities provided t
he amount of gold was not less than Rs. 40 crores in value. The remaining threefifths of the assets might be held in rupee coins, Government of India rupee sec
urities, eligible bills of exchange and promissory notes payable in India. Due t
o the exigencies of the Second World War and the post-was period, these provisio
ns were considerably modified. Since 1957, the Reserve Bank of India is required
to maintain gold and foreign exchange reserves of Ra. 200 crores, of which at l
east Rs. 115 crores should be in gold. The system as it exists today is known as
the minimum reserve system.
to Government
The second important function of the Reserve Bank of India is to act as Governme
nt banker, agent and adviser. The Reserve Bank is agent of Central Government an
d of all State Governments in India excepting that of Jammu and Kashmir. The Res
erve Bank has the obligation to transact Government business, via. to keep the c
ash balances as deposits free of interest, to receive and to make payme exchange
remittances and other banking operations. The Reserve Bank of India helps the G
overnment - both the Union and the States to float new loans and to manage publi
c debt. The Bank makes ways and means advances to the Governments for 90 days. I
t makes loans and advances to the States and local authorities. It acts as advis
er to the Government on all monetary and banking matters. Bankers' Bank and Lend
er of the Last Resort The Reserve Bank of India acts as the bankers' bank. Accor
ding to the provisions of the Banking Companies Act of 1949, every scheduled ban
k was required to maintain with the Reserve Bank a cash balance equivalent to 5%
of its demand liabilites and 2 per cent of its time liabilities in India. By an
amendment of 1962, the distinction between demand and time liabilities was abol
ished and banks have been asked to keep cash reserves equal to 3 per cent of the
ir aggregate deposit liabilities. The minimum cash requirements can be changed b
y the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the basis of el
igible 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 Rese
rve Bank becomes not only the banker's bank but also the lender of the last reso
rt. 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 gr
oups or persons on the basis of certain types of securities. Since 1956, selecti
ve controls of credit are increasingly being used by the Reserve Bank. The Reser
ve Bank of India is armed with many more powers to control the Indian money mark
et. Every bank has to get a licence from the Reserve Bank of India to do banking
business within India, the licence can be cancelled by the Reserve Bank of cert
ain stipulated conditions are not fulfilled. Every bank will have to get the per
mission 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 an
d liabilities. This power of the Bank to call for information is also intended t
o give it effective control of the credit system. The Reserve Bank has also the
power to inspect the accounts of any commercial bank. As supereme banking author
ity in the country, the Reserve Bank of India, therefore, has the following powe
rs: (a) It holds the cash reserves of all the scheduled banks. (b) It controls t
he credit operations of banks through quantitative and qualitative controls. (c)
It controls the banking system through the system of licensing, inspection and
calling for information. (d) It acts as the lender of the last resort by providi
ng rediscount facilities to scheduled banks. Custodian of Foreign Reserves The R
eserve Bank of India has the responsibility to maintain the official rate of exc
hange. According to the Reserve Bank of India Act of 1934, the Bank was required
to buy and sell at fixed rates any amount of sterling in lots of not less than
Rs. 10,000. The rate of exchange fixed was Re. 1 = sh. 6d. Since 1935 the Bank w
as able to maintain the exchange rate fixed at lsh.6d. though there were periods
of extreme pressure in favour of or against

the rupee. After India became a member of the International Monetary Fund in 194
6, the Reserve Bank has the responsibility of maintaining fixed exchange rates w
ith all other member countries of the I.M.F. Besides maintaining the rate of exc
hange of the rupee, the Reserve Bank has to act as the custodian of India's rese
rve of international currencies. The vast sterling balances were acquired and ma
naged by the Bank. Further, the RBI has the responsibility of administering the
exchange controls of the country. Supervisory functions In addition to its tradi
tional central banking functions, the Reserve bank has certain nonmonetary funct
ions of the nature of supervision of banks and promotion of sound banking in Ind
ia. 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, a
nd liquidation. The RBI is authorised to carry out periodical inspections of the
banks and to call for returns and necessary information from them. The national
isation of 14 major Indian scheduled banks in July 1969 has imposed new responsi
bilities on the RBI for directing the growth of banking and credit policies towa
rds more rapid development of the economy and realisation of certain desired soc
ial 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 imp
rove the methods of their operation. Promotional functions With economic growth
assuming a new urgency since Independence, the range of the Reserve Bank's funct
ions has steadily widened. The Bank now performs a varietyof developmental and p
romotional functions, which, at one time, were regarded as outside the normal sc
ope of central banking. The Reserve Bank was asked to promote banking habit, ext
end banking facilities to rural and semi-urban areas, and establish and promote
new specialised financing agencies. Accordingly, the Reserve Bank has helped in
the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporat
ion in 1962, the Unit Trust of India in 1964, the Industrial Development Bank of
India also in 1964, the Agricultural Refinance Corporation of India 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 a
nd to mobilise savings, and to provide industrial finance as well as agricultura
l finance. As far back as 1935, the Reserve Bank of India set up the Agricultura
l 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 fro
m the villages and to route its short term credit to agriculture. The RBI has se
t up the Agricultural Refinance and Development Corporation to provide long-term
finance to farmers.

Classification of RBIs functions

The monetary functions also known as the central banking functions of the RBI ar
e related to control and regulation of money and credit, i.e., issue of currency
, control of bank credit, control of foreign exchange operations, banker to the
Government and to the money market. Monetary functions of the RBI are significan
t as they control and regulate the volume of money and credit in the country. Eq
ually important, however, are the non-monetary functions of the RBI in the conte
xt of India's economic backwardness. The supervisory function of the RBI may be
regarded as a nonmonetary function (though many consider this a monetary functio
n). The promotion of sound banking in India is an important goal of the RBI, the
RBI has been given wide and drastic powers, under the Banking Regulation Act of
1949 - these powers relate to licencing of banks, branch expansion, liquidity o
f their assets, management and methods of working, inspection, amalgamation, rec
onstruction and liquidation. Under the RBI's supervision and inspection, the wor
king of banks has greatly improved. Commercial banks have developed into financi
ally and operationally sound and viable units. The RBI's powers of supervision h
ave now been extended to non-banking financial intermediaries. Since independenc
e, particularly after its nationalisation 1949, the RBI has followed the promoti
onal functions vigorously and has been responsible for strong financial support
to industrial and agricultural development in the country.


The objectives of bank regulation, and the emphasis, varies between jurisdiction
. The most common objectives are: 1. Prudential -- to reduce the level of risk b
ank creditors are exposed to (i.e. to protect depositors) 2. Systemic risk reduc
tion -- to reduce the risk of disruption resulting from adverse trading conditio
ns for banks causing multiple or major bank failures 3. Avoid misuse of banks -to reduce the risk of banks being used for criminal purposes, e.g. laundering t
he proceeds of crime 4. To protect banking confidentiality 5. Credit allocation
-- to direct credit to favored sectors
General principles of bank regulation
Banking regulations can vary widely across nations and jurisdictions. This secti
on of the article describes general principles of bank regulation throughout the
Minimum requirements
Requirements are imposed on banks in order to promote the objectives of the regu
lator. The most important minimum requirement in banking regulation is maintaini
ng minimum capital ratios.
Supervisory review
Banks are required to be issued with a bank license by the regulator in order to
carry on business as a bank, and the regulator supervises licenced banks for co
mpliance with the requirements and responds to breaches of the requirements thro
ugh obtaining undertakings, giving directions, imposing penalties or revoking th
e bank's licence.

Market discipline
The regulator requires banks to publicly disclose financial and other informatio
n, and depositors and other creditors are able to use this information to assess
the level of risk and to make investment decisions. As a result of this, the ba
nk is subject to market discipline and the regulator can also use market pricing
information as an indicator of the bank's financial health.
Instruments and requirements of bank regulation
Capital requirement
The capital requirement sets a framework on how banks must handle their capital
in relation to their assets. Internationally, the Bank for International Settlem
ents' Basel Committee on Banking Supervision influences each country's capital r
equirements. In 1988, the Committee decided to introduce a capital measurement s
ystem commonly referred to as the Basel Capital Accords. The latest capital adeq
uacy framework is commonly known as Basel II. This updated framework is intended
to be more risk sensitive than the original one, but is also a lot more complex
Reserve requirement
The reserve requirement sets the minimum reserves each bank must hold to demand
deposits and banknotes. This type of regulation has lost the role it once had, a
s the emphasis has moved toward capital adequacy, and in many countries there is
no minimum reserve ratio. The purpose of minimum reserve ratios is liquidity ra
ther than safety. An example of a country with a contemporary minimum reserve ra
tio is Hong Kong, where banks are required to maintain 25% of their liabilities
that are due on demand or within 1 month as qualifying liquefiable assets. Reser
ve requirements have also been used in the past to control the stock of banknote
s and/or bank deposits. Required reserves have at times been gold coin, central
bank banknotes or deposits, and foreign currency.
Corporate governance
Corporate governance requirements are intended to encourage the bank to be well
managed, and is an indirect way of achieving other objectives. Requirements may

1. To be a body corporate (i.e. not an individual, a partnership, trust or other

unincorporated entity) 2. To be incorporated locally, and/or to be incorporated
under as a particular type of body corporate, rather than being incorporated in
a foreign jurisdiction. 3. To have a minimum number of directors 4. To have an
organizational structure that includes various offices and officers, e.g. corpor
ate secretary, treasurer/CFO, auditor, Asset Liability Management Committee, Pri
vacy Officer etc. Also the officers for those offices may need to be approved pe
rsons, or from an approved class of persons. 5. To have a constitution or articl
es of association that is approved, or contains or does not contain particular c
lauses, e.g. clauses that enable directors to act other than in the best interes
ts of the company (e.g. in the interests of a parent company) may not be allowed
Financial reporting and disclosure requirements
1. Prepare annual financial statements according to a financial reporting standa
rd, have them audited, and to register or publish them 2. Prepare more frequent
financial disclosures, e.g. Quarterly Disclosure Statements 3. Have directors of
the bank attest to the accuracy of such financial disclosures 4. Prepare and ha
ve registered prospectuses detailing the terms of securities it issues (e.g. dep
osits), and the relevant facts that will enable investors to better assess the l
evel and type of financial risks in investing in those securities.
Credit rating requirement
Banks may be required to obtain and maintain a current credit rating from an app
roved credit rating agency, and to disclose it to investors and prospective inve
stors. Also, banks may be required to maintain a minimum credit rating.
Large exposures restrictions
Banks may be restricted from having imprudently large exposures to individual co
unterparties or groups of connected counterparties. This may be expressed as a p
roportion of the bank's assets or equity, and different limits may apply dependi
ng on the security held and/or the credit rating of the counterparty.
Related party exposure restrictions
Banks may be restricted from incurring exposures to related parties such as the
bank's parent company or directors. Typically the restrictions may include:
Exposures to related parties must be in the normal course of business and on nor
mal terms and conditions 11

Exposures to related parties must be in the best interests of the bank Exposures
to related parties must be not more than limited amounts or proportions of the
bank's assets or equity.
One of the more pleasant aspects of the latest quarterly Monetary Policy Review
is the attempt by the Reserve Bank of India to be as predictable as possible, or
at least less disruptive than it has been before. The notion that some elements
of a tighter money policy would be announced was pretty much to be expected. Wh
ile raising repo rates by 25 basis points and leaving other indicators of liquid
ity unchanged, the RBI Governor, Dr Y. V. Reddy, has tried to play both policema
n and purveyor of optimism, the former by raising marginally the cost of capital
for banks through the repo rate hike, and the latter by selectively pushing up
the provisioning norms for certain categories of borrowers hoping thereby to cat
ch inflation by the scruff and pull it back within the 5.5 per cent limit. Lest
the markets think the RBI is a killjoy, in its combat against inflation, the Gov
ernor has raised the bar on growth expectations jettisoning his earlier forecast
and the prognosis of North Block for a 9 per cent GDP target for this waning fi
scal. He has tried therefore to be all things to all men, in the bargain creatin
g a dilemma that may not augur well for the economy in the medium to long term.
The basic problem is that the RBI cannot hope to both fight inflation and propel
growth to the levels it wants with the measures it has so far set in motion. Co
ntrols on credit expansion for select categories with inflation potential capita
l markets and commercial real-estate through higher provisioning may choke deman
d only if it is sensitive to the cost of credit. But in a booming economy, highe
r costs can be transmitted down the line; witness the rising housing loan rates.
In many a high-flying sector banks may, therefore, still find takers for expens
ive credit. Regardless of the RBI's marginal increase in repo rates, the percept
ion of a tighter money regime will push up interest rates all around, thus contr
ibuting to the price rise instead of combating it. Given the nature of inflation
, currently at a two-year high, the task of fighting it lies with New Delhi. The
Government must put together a gamut of measures to remove the supply bottlenec
ks that are causing the price rise. The RBI admits that the growth in agricultur
e has "not been sanguine" with the declining output in major cereals pushing up
prices. Focusing its Monetary Policy weapons on "credit quality" and, therefore,
the health of the banking system, the RBI has prudently left this initiative to
New Delhi.


The central bank makes efforts to control the expansion or contraction of credit
in order to keep it at the required level with a view to achieving the followin
g ends. 1. To save Gold Reserves: The central bank adopts various measures of cr
edit control to safe guard the gold reserves against internal and external drain
s. 2. To achieve stability in the Price level: Frequently changes in prices adve
rsely affect the economy. Inflationary and deflationary trends need to be preven
ted. This can be achieved by adopting a judicious of credit control. 3. To achie
ve stability in the Foreign Exchange Rate: Another objective of credit control i
s to achieve the stability of foreign exchange rate. If the foreign exchange rat
e is stabilized, it indicates the stable economic conditions of the country. 4.
To meet Business Needs: According to Burgess, one of the important objectives of
credit control is the Adjustment of the volume of credit to the volume of Busine
ss credit is needed to meet the requirements of trade an industry. So by controll
ing credit central bank can meet the requirements of business.

METHOD OF CREDIT CONTROL There are two method of credit control: Quantitative met
hod 1. Bank Rate Policy 2. Open Market Operations 3. Change in Reserve Ratios 4.
Credit Rationing
Qualitative method 1. Direct Action 2. Moral persuasion 3. Legislation 4. Public
Quantitative method
1. Bank Rate Policy: Bank rate is the rate of interest which is charged by the c
entral bank on rediscounting the first class bills of exchange and advancing loa
ns against approved securities. This facility is provided to other banks. It is
also known as Discount Rate Policy. 2. Open Market Operations: The term Open Mark
et Operations in the wider sense means purchase or sale by a central bank of any
kind of paper in which it deals, like government securities or any other public
securities or trade bills etc. in practice, S.P.B.PATEL ENGG. COLLEGE(MBA PROGRA

however the term is applied to purchase or sale of government securities, shortterm as well as long-term, at the initiative of the central bank, as a deliberat
e credit policy. 3. Change in Reserve Ratios: Every commercial bank is required
to deposit with the central bank a certain part of its total deposits. When the
central bank wants to expand credit it decreases the reserve ratio as required f
or the commercial banks. And when the central bank wants to contract credit the
reserve ratio requirement is increased. 4. Credit Rationing: Credit rationing me
ans restrictions placed by the central bank on demands for accommodation made up
on it during times of monetary stringency and declining gold reserves. This meth
od of controlling credit can be justified only as a measure to meet exceptional
emergencies because it is open to serious abuse. 5. CRR(Cash Reserve Ratio):Cash
reserve Ratio (CRR) is the amount of Cash(liquid cash like gold)that the banks
have to keep with RBI. This Ratio is basically to secure solvency of the bank an
d to drain out the excessive money from the banks. If RBI decides to increase th
e percent of this, the available amount with the banks comes down and if RBI red
uce the CRR then available amount with Banks increased and they are able to lend
more.RBI has reduced this ratio three times and reduced it from 9 % to 5.5% in
last one month or so. 6. Repo Rate:Repo rate is the rate at which our banks borr
ow rupees from RBI. This facility is for short term measure and to fill gaps bet
ween demand and supply of money in a bank .when a bank is short of funds they th
ey borrow from bank at repo rate and if bank has a surplus fund then the deposit
the funds with RBI and earn at Reverse repo rate .So reverse Repo rate is the r
ate which is paid by RBI to banks on Deposit of funds with RBI.A reduction in th
e repo rate will help banks to get money at a cheaper rate. When the repo rate i
ncreases borrowing from RBI becomes more expensive.To borrow from RBi bank have
to submit liquid bonds /Govt Bonds as collateral security ,so this facility is a
short term gap filling facility and bank does not use this facility to Lend mor
e to their customers.present rate is 7.5% and reverse repo rate is 6%. 7. SLR((S
tatutory Liquidity Ratio) is the amount a commercial bank needs to maintain in t
he form of cash, or gold or govt. approved securities (Bonds) before providing c
redit to its customers. SLR rate is determined and maintained by the RBI (Reserv
e Bank of India) in order to control the expansion of bank credit.Generally this
mandatory ration is complied by investing in Govt bonds.present rate of SLR is
24 %.But Banks average is 27.5 % ,the reason behind it is that in deficit budget
ing Govt landing is more so they borrow money from banks by selling their bonds
to banks.so banks have invested more than required percentage and use these exce
ss bonds as collateral security ( over and above SLR )to avail short term Funds
from the RBI at Repo rate.

Qualitative method
1. Direct Action: The central bank may take direct action against commercial ban
ks that violate the rules, orders or advice of the central bank. This punishment
is very severe of a commercial bank. 2. Moral persuasion: It is another method
by which central bank may get credit supply expanded or contracted. By moral pre
ssure it may prohibit or dissuade commercial banks to deal in speculative busine
ss. 3. Legislation: The central bank may also adopt necessary legislation for ex
panding or contracting credit money in the market. 4. Publicity: The central ban
k may resort to massive advertising campaign in the news papers, magazines and j
ournals depicting the poor economic conditions of the country suggesting commerc
ial banks and other financial institutions to control credit either by expansion
or by contraction.

M.Y. Khan Indian financial system Sudhir shah-Indian economy
Website www.rbi.org.in