Project Report on the Constitution of the Reserve Bank of India:

The origin of the Reserve Bank of India in 1935 was the culmination of a long series of

efforts. The earliest effort to set up a central bank dates back to January 1773 when Warren

Hastings, the Governor of Bengal, recommended the establishment of a “General Bank in

Bengal and Bihar”. The next attempt was made in 1807-08 when Robert Richards, a member

of the Bombay Government submitted a scheme for a “General Bank”. But the Governor-

General was not impressed.

The name of John Maynard Keynes also figures in the events leading to the establishment of

the RBI. As a member of the Royal Commission on Indian Finance and Currency of 1931,

Keynes submitted a memorandum entitled “Proposals for the Establishment of a State Bank

in India”. The State Bank proposed by Keynes was to perform both central banking and

commercial banking functions. However, the scheme could not be implemented due to the

outbreak of the First World War.

The first major step was taken in 1921 when the three Presidency Banks were amalgamated

to form the Imperial Bank of India. It was primarily a commercial bank but it also performed

certain central banking functions, such as acting as banker to the Government and to some

extent as bankers’ bank. But the regulation of note issue and management of foreign

exchange were the direct responsibility of the Central Government.

In 1926, the Hilton Young Commission recommended that the dichotomy of functions and

division of responsibility should be ended. It suggested the establishment of a central bank to

be called the “Reserve Bank of India”. Accordingly, the Gold Standard and Reserve Bank of

India Bill was introduced in the Legislative Assembly in January 1927 but was dropped on

account of sharp differences of opinion on the bank’s ownership and the composition of its

Board of Directors.

1
The Indian Constitutional Reforms in 1933 made it obligatory that the transfer of

responsibility from the British Government in India to Indian hands was dependent on the

establishment of a Reserve Bank free from political influence and its successful operation.

These events led to the introduction of a fresh bill in the Indian Legislative Assembly on 8

September, 1933; which was passed by it on 22 December, 1933 and by the Council of States

on 16 February, 1934. It received the Governor-General’s assent on 6 March, 1934. The

Reserve Bank of India was constituted in accordance with the provisions of the Act

containing 58 Sections and was inaugurated on 1 April, 1935.

The RBI was constituted as a shareholders’ bank with a fully paid-up capital of Rs.5 crores

divided into shares of Rs.100 each. Of these 5 lakh shares, 2200 shares were subscribed by

the Directors of the Bank and the remaining by private shareholders.

In view of the need for close integration between the Bank’s policies and those of the

Government, the question of State ownership of the Bank was raised from time to time. But it

was only after Independence that the decision to nationalize the Bank was taken.

In terms of the Reserve Bank (Transfer to Public Ownership) Act, 1948, its entire paid-up

capital was transferred to the Central Government on 1 January 1949 when it became a State-

owned institution.

2. Project Report on the Organisational Structure and Management of RBI:

The organisational structure of the RBI consists of the Central Board and the Local Boards.

The RBI is managed by the Central Board of Directors comprising 20 members. There is one

Governor who is the executive head of the Bank. He is assisted by four Deputy Governors.

They are appointed by the Government of India for a period of five years. Four Directors are

nominated by the Central Government, one each from the four Local Boards situated at

2
“Mumbai, Kolkata, Chennai and Delhi. In addition, the Central Government nominates ten

Directors who are experts from various fields.

They are appointed for four years. The 20th member of the Board is one Government official

who is usually the Secretary, Ministry of Finance nominated by the Central Government. The

government official and the four Deputy Governors do not have the right to vote at the

meetings of the Board.

All powers of the Bank are vested in the Central Board of Directors. It must hold at least six

meetings in a year and at-least one in three months. However, the Governor is empowered to

call a meeting of the Board whenever he likes. The Governor and Deputy Governors are

whole-time paid officers of the Bank while the other Directors are part-time officers who

receive T.A. and other allowances prescribed for them when they attend the meetings of the

Board.

There are four Local Boards with headquarters at Mumbai, Kolkata, Chennai and Delhi

representing the Western, Eastern, Southern and Northern regions respectively. The Central

Government nominates five members on each Local Board for a four-year term. The

Chairman is elected from among the members and the Manager of the RBI office in a region

acts as the ex-officio Secretary of the Local Board.

The RBI is managed by the Central Board of Directors with the Governor as its Chairman.

The Governor is the chief executive of the Bank who exercises wide powers of supervision

and issues directions on behalf of the Board. He is assisted by four Deputy Governors and

four Executive Directors.

The Head Office of the RBI at Mumbai, which has sixteen departments such as the Banking,

Issue, Currency Management, Exchange Control, Industrial Credit, Agricultural Credit, etc.

3
The bank has 15 offices and 2 branches in different parts of the country. Where the RBI has

no office or branch, the State Bank of India and its 7 associates act as its agents or sub-agents.

3. Objectives of Reserve Bank of India:

The broad objectives of the Reserve Bank of India as spelt out in the preamble to the RBI

Act, 1934 are “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”.

What was implied in the objectives stated was more concretely stated in the First Five-Year

Plan: “It would have to take on a direct and active role, firstly, in creating and helping to

create the machinery needed for financing developmental activities all over the country, and

secondly, ensuring that the finance available flows in the directions intended”.

Thus the main objectives of the RBI have been:

1. To promote monetisation and monetary integration of the economy.

2. To manage currency and regulate foreign exchange.

3. To institutionalise savings through promotion of banking habit.

4. To build up a sound and adequate banking and credit structure.

5. To evolve a well-differentiated structure of institutions purveying credit for agriculture and

allied activities.

6. To set up or promote several specialised financial institutions at the all-India level and

regional levels to widen facilities for term finance to industry.

4
7. To lend support to planning authorities and governments in their efforts to accelerate the

pace of economic development with stability and social justice.

4. Functions of Reserve Bank of India:

The Reserve Bank of India performs all the traditional functions of a central bank. At the

same time, it also undertakes active promotional and developmental functions.

Thus we divide the functions of the RBI into two parts:

(1) Traditional Functions, and

(2) Promotional and Developmental Functions.

These are discussed as under:

1. Traditional Functions:

The RBI performs the following traditional functions:

(1) Issue of Currency:

The RBI acts as the currency authority. As such, it has the monopoly of issuing currency of

all denominations except one rupee notes and coins, and small coins which are issued by the

Ministry of Finance of the Government of India. At present, the RBI is issuing notes of the

denominations of Rs.10,20, 50,100. and 500.

These notes are printed and issued by its Issue Department. Rs.1,2 and 5 coins, and small

coins issued by the Ministry of Finance are also distributed by the Issue Department. For the

distribution of notes and coins of ah denominations to the public and banks, the Issue

Department maintains currency chests at its 15 offices and 2 branches and elsewhere keeps

them with the State Bank of India, and its 7 associates, some public sector banks, and State

Government treasuries and sub-treasuries.

5
The RBI issues currency on the basis of minimum of Rs.200 crores of gold and foreign

exchange reserves, of which at least Rs.115 crores worth of gold must be there.

(2) Banker to Government:

The RBI acts as banker to the Central Government and the State Governments.

As such, it renders the following services to them:

(i) It maintains and operates the cash balances of the Central and State Governments in the

current account deposit on which it pays no interest.

(ii) It receives and makes payments on behalf of the Central and State Governments.

(iii) It carries out exchange, remittance and other banking operations on behalf of these

Governments.

(iv) It buys and sells Government securities in the market.

(v) It manages the public debt by issuing Government loans and paying interest and principal.

(vi) It also sells treasury bills through tender on behalf of the Government.

(vii) It makes ways and means advances to the Central and State Governments by purchasing

treasury bills from them for a period not exceeding 91 days.

(viii) It advises the Governments on all banking and financial matters, such as financing of

five year plans and resource mobilisation, balance of payments, etc.

(ix) It acts as the agent of the Central and State Governments in their dealings with the

International Monetary Fund, the World Bank, International Financial Corporation, IDA,

Exim Bank, and other financial institutions.

6
(3) Bankers’ Bank:

Firstly, The RBI acts as banker to the scheduled commercial banks in India. As such, it keeps

a part of the cash reserves of these banks and provides them with remittance facilities. Under

the Banking Regulation Act, 1949, every bank is required to keep between 3% to 15% of the

total of its time and demand liabilities with the RBI as cash reserve ratio which is interest-

free.

The CRR which was reduced to 14 per cent effective 15 May, 1993 was again raised to 15

per cent effective 6 August, 1994. Besides, every bank is required to maintain with the RBI

between 25% to 40% of its net time and demand liabilities as the Statutory Liquidity Ratio

(SLR). It had been reduced from 34.75 per cent to 33.75 per cent effective 16 May 1994. The

incremental SLR continues to be 25 per cent. Secondly, the RBI supervises, regulates and

controls the working of banks in India.

These powers relate to issue of licence for opening and branch expansion, calling of returns/

statements, inspection of books and accounts, issue of directions concerning terms and

conditions of advances, giving approval for the appointment of chairman and directors, and to

acquire or approve the merger of any bank. Thirdly, the RBI acts as a clearing house for

banks.

It has clearing houses at its 17 offices/branches and at other places the State Bank of India

and its associates provide clearing and remittance facilities on its behalf. Fourthly, the RBI

provides refinance facilities to commercial banks for export credit, against 364-Day Treasury

Bills, stand-by refinance limits against the collateral of approved securities (that is for those

banks having excess SLR) and discretionary refinance including li9mits under the facility to

draw without prior approval from the RBI.

7
(4) Exchange Management and Control:

The RBI manages and controls the country’s foreign exchange reserves and external value of

the rupee. Under the Foreign Exchange Regulation Act, 1973, the RBI controls the receipts

and payments of foreign currencies. Foreign currencies coming into India are required to be

sold and exchanged for the rupee either direct to the RBI or to major commercial banks

authorised by it.

Similarly, foreign currencies are allowed to persons travelling abroad and to importers by the

RBI as per rules laid down by it. All such transactions of foreign currencies are made at rates

fixed by the RBI from time to time.

The RBI determines the external value of the rupee in relation to the weighted basket of

India’s major trading partners with pound-sterling as the intervention currency. Since the

exchange value of these currencies keeps on changing in the international market, the RBI

also changes the exchange rate of the rupee in relation to other currencies such as dollar,

mark, yen, sterling etc. Effective 1 March, 1994, the RBI introduced full convertibility of

rupee to the entire current account transactions.

(5) Control of Credit:

The RBI controls the money supply and credit to ensure price stability and meet the varying

economic conditions of the country. It estimates the credit needs of the economy in relation to

the targets laid down in the five-year plans and ensures the supply of credit to different

sectors. For this purpose, it uses various credit control measures such as variations in interest

rates, open market operations, changes in CRR and SLR, selective credit controls, etc.

(6) Collection and Publication of Data and Reports:

8
The RBI has a Division of Reports, Reviews, and Publications under its Department of

Economic Analysis and Policy which collects data on economic matters such as money,

credit, finance, agricultural and industrial production, balance of payments, prices, etc. and

publishes them in various publications.

Some of its important publications are the Reserve Bank of India Bulletin (monthly) and its

Weekly Statistical Supplements, Annual Report on Currency and Finance, and Report on

Trend and Progress on Banking in India, etc. Besides, it brings out Occasional Papers by its

experts, and conducts surveys and publishes reports on them.

(7) Training Facilities:

The RBI has set up a number of training colleges and centres to provide training to the

banking personnel at different levels.

They are:

(i) Bankers Training College (BTC):

The BTC is located at Mumbai. It provides training to senior officers of the Bank in the areas

of application of statistical methods, negotiating skills, counseling import-export financing.

Service Area Approach, etc.

(ii) Reserve Bank Staff College (RBSC):

The RBSC is located at Chennai. It conducts training programmes for officers of the Bank on

areas of investment and fund management, financial services, housing finance, customer

service, etc. Officials of foreign banks also participate.

(iii) College of Agricultural Banking (CAB):

The CAB is located at Pune-and it caters to the training needs of personnel of co-operative

banks, commercial banks, regional rural banks, NABARD, RBI, Deposit Insurance and

9
Credit Guarantee Corporation, Government officials, and also officials from South Asian and

African countries. It conducts training programmes in the field of agricultural finance, rural

banking and allied subjects.

(iv) Zonal Training Centres (ZTCs):

The ZTCs are situated in Mumbai, Kolkata, Chennai and New Delhi. They provide training

to class III and class IV staff of the Bank. These centres also conduct training programmes on

computer and customer service. The RBI has also introduced training in commercial banking

for the banks’ officers at these Zonal centres.

(v) Indira Gandhi Institute of Development Research:

This was set up by the RBI in 1987. It conducts research on projects and arranges workshop,

conferences and seminars.

(vi) Training in Computer Technology:

The RBI set up the Department of Computer Technology in 1995 for efficient and quick use

of new technologies. This Department provides incentives to the Bank’s staff to acquire

qualifications in computer technology.

2. Promotional and Developmental Functions:

The RBI has been taking a direct and active role, first, in creating or helping to create the

machinery needed for financing development activities all over the country, and secondly,

ensuring that the finance available flows in socially desired directions.

In order to achieve these two objectives the RBI has been financing agriculture, industry and

exports. It has also been instrumental in the development and regulation of the banking

system and the bill market. We refer to these activities of the RBI briefly. They are discussed

in detail in subsequent sections.

10
(1) Agricultural Finance:

The RBI has been extending advice and financial assistance to the co-operative credit

institutions for the development of agriculture and allied rural activities since its inception in

1935. For this purpose it set up an Agricultural Credit Department and separate funds for

providing medium-term and long-term finance. Since 1982, the functions of this Department

and those of the funds have been passed on to the National Bank for Agriculture and Rural

Development (NABARD).

(2) Industrial Finance:

The RBI set up an Industrial Credit Department in 1957 to advise and help the bank in

providing financial assistance to industries and in setting up financial institutions like State

Financial Institutions, IFCI, IDBI, ICICI, etc. It also established the National Industrial Credit

(Long-Term Operations) Fund in 1964 to provide financial assistance to large scale

industries.

(3) Export Credit:

The RBI provides concessional credit, refinance facilities and guarantee to commercial banks

for exporters. It has also set up the Export-Import Bank of India to finance export trade.

(4) Credit to Priority Sector and Weaker Sections:

Under its Differential Rate of Interest Scheme, the RBI provides concessional finance to

priority sectors and weaker sections of the society at 4 per cent interest rate.

(5) Bill Market Scheme:

The RBI has been instrumental in developing a well-organised bill market scheme in order to

provide rediscounting facilities to commercial banks from the Bank and other financial

institutions.

11
(6) Development and Regulation of Banking System:

The RBI has played an important role in the development and promotion of banking in the

country. It has spread banking to the remotest corners of India through its Lead Bank

Scheme, SAA, and Regional Rural Banks. It has helped in promoting development banking

by establishing such financial institutions as IDBI, IFCI, ICICI, SIDBI, etc. Further, the RBI

has strengthened the banking system in India and placed it on a sound footing through a

judicious policy of regulation and control of banks.

3. Other Functions:

The RBI also performs the following banking functions also:

(a) It issues demand drafts made payable at its own offices or agencies, and makes, issues and

circulates bank post-bills.

(b) It can borrow money from a scheduled bank in India or from central banks in other

countries.

(c) It is authorised to open an account or make an agency agreement with central banks in

other countries and act as their agent and invest funds in their shares.

(d) It purchases and sells gold and bullion.

4. Prohibitory Functions:

The RBI Act prohibits the Bank to perform certain functions so that it may not compete with

other banks and may keep its assets in liquid form to meet any eventuality.

Some of its prohibited functions are:

(a) It cannot participate in any business, trade or industry,

12
(b) It cannot buy its own shares or those of any other banking company or of any corporation.

Nor can it give loan on the security of shares,

(c) It cannot give loans against immovable property,

(d) It cannot purchase immovable property except for its offices,

(e) It cannot accept bills not payable on demand,

(f) It cannot give interest on deposits held by it.

5. Project Report on the Roles of the RBI:

A. Role in Agricultural Finance:

Since its inception in 1935, the Reserve Bank of India hag teen entrusted with the task of

formulating agricultural credit policy, developing an infrastructure for implementing it,

giving advice on these matters to the State and Central Governments, and providing credit for

agricultural and allied activities.

The RBI has been performing these tasks in the following ways:

(i) Agricultural Credit Department (ACD):

Along with the RBI, a separate Agricultural Credit Department was set up in 1935 to study

the problems of agricultural credit, to develop co-operative credit movement, and to provide

necessary advice, guidance and financial assistance.

Its main functions were:

(a) To maintain an expert staff to study all problems of agricultural credit and provide

consultation to the Central and State Governments, State Co-operative Banks, and other

banking organisations; and

13
(b) To co-ordinate the operations of the RBI relating to agricultural credit with those State

Co-operative Banks and other organisations engaged in the supply of agricultural credit.

The ACD was engaged in the collection of statistics and research in rural credit. It was only

with the beginning of the planning era that this Department became more active and it was

entrusted with an additional function: to finance the processing marketing and other

agricultural operations through State Co-operative Banks and other agencies of rural credit.

The ACD has been merged with NABARD effective July, 1982.

(ii) All India Rural Credit Survey Committee:

The RBI appointed an All India Rural Credit Survey Committee in 1951 which submitted its

report in 1954. The Committee observed that the contribution of co-operatives in providing

rural finance was only 3 per cent in total rural credit. It, therefore, made a number of

recommendations for strengthening co-operative credit movement and to provide more funds

for agricultural and allied activities.

On the recommendations of the Committee, the Reserve Bank made the following

changes to develop co-operative credit movement and to provide agricultural finance:

(1) Integrated Scheme of Rural Credit:

The RBI Act was amended to implement the integrated scheme of rural credit.

The main features of the scheme were:

(a) State partnership in co-operative credit institutions between credit societies with

marketing and processing activities; and

(b) Administration through adequately trained and efficient personnel responsive to the needs

of the rural population.

14
The RBI was required to play an active role in the development of co-operative credit,

coordinating credit with marketing, processing end ware housing activities, and training of

co-operative personnel. As a result of the implementation of this scheme, it was revealed by

the All India Rural Debt and investment Survey conducted by the RBI (1961-62) that the

share of co-operatives in rural credit increased from 3.1 per cent in 1951-52 to 25.8 per cent

in 1961-62.

(2) State Bank of India:

It was on the recommendations of the Committee that the imperial Bank of India was

nationalised in 1955 and renamed the State Bank of India. The RBI became its major

shareholder. The SBI has been entrusted with the task of financing agricultural operations.

(3) Agricultural Credit Board (ACB):

Though the Committee recommended the formation of a Statutory Agricultural Credit Board,

the RBI constituted a Standing Advisory Committee on Agricultural Credit in 1956. Later-on

it was changed into the Standing Advisory Committee on Rural and Co-operative Credit.

It was again reconstituted in 1970 as the Agricultural Credit Board. It formulated policies

relating to agricultural finance and co-ordinated the activities of co-operative credit

institutions-, the RBI, and commercial banks in providing refinance facilities. The NABARD

has taken over the activities of the Board since July 1982.

(4) Rural Credit Funds:

On the recommendations of the Committee, the RBI established in February 1956 the

National Agricultural Credit (Long-Term Operations) Fund to grant long-term loans to State

Governments and Land Development Banks to enable them to subscribe to the share capital

of co-operative banks and cooperative societies.

15
The RBI also established the National Agricultural (Stabilisation) Fund in June 1956 for

converting short term agricultural loans into medium term loans by the State Co-operative

Banks to enable cooperative societies to repay loans in case of default by borrowers as a

result of drought, famines or other natural calamities.

These funds have been transferred to the NABARD since July 1982 and renamed as National

Rural Credit (Long Term Operations) Fund and National Rural Credit (Stabilisation) Fund.

(iii) Establishment of Other Organisations:

With a view to provide larger credit facilities to the rural sector, the RBI has also been

instrumental in the establishment of the following organisations:

(1) Nationalisation of Banks:

In 1969,14 scheduled banks were nationalised and 6 more commercial banks were

nationalised in 1980 in order to spread a network of their branches in rural areas so as to

provide larger credit facilities for agricultural and allied activities.

(2) Agricultural Refinance and Development Corporation (ARDC):

The RBI set up the Agricultural Refinance Corporation in July, 1963 which was subsequently

renamed as Agricultural Refinance and Development Corporation. The main objectives of the

Corporation were to provide medium and long term refinance to Central Land Mortgage

Banks, State Co-operative Banks and commercial banks; and to subscribe to the debentures

of Central Land Mortgage Banks and State Co-operative Banks. Since its inception in 1963 to

June 1982, it sanctioned 19,601 schemes and disbursed Rs.2,808 crores. With the

establishment of the NABARD in July 1982, the ARDC was merged with it.

(3) Regional Rural Banks (RRBs):

16
The RBI was instrumental in establishing RRBs in 1975. The RBI issues licences to

sponsoring commercial banks for opening branches of RRBs which are routed through the

NABARD after July 1982. The RBI has vested the work of financing and supervision of the

RRBs to the NABARD. The principal objective of the RRBs is to grant loans and advances to

the weaker sections of the rural population and to co-operatives.

(4) National Bank for Agriculture and Rural Development (NABARD):

The NABARD was established in July 1982 as an apex rural development bank by merging

ACD of the RBI, ARDC, and the NRC (LTO) Fund and NRC (Stabilisation) Fund of the

RBI. The RBI lends to the NABARD under the General Line of Credit (GLC) for short

periods, and also contributes annually to the NRC (LTO) Fund and NRC (Stabilisation) Fund

of the NABARD. The National Bank provides credit, refinance and institutional building

facilities to integrated rural development. The RBI sanctioned Rs.3,750 crores to NAB ARE»

in 1992-93 under general line of credit.

(5) Service Area Approach (SAA):

The RBI introduced the SAA scheme from April 1989 whereby the service area of the branch

of a commercial hank, a co-operative bank, and a RRB covers 15 to 25 villages. Every branch

in the service area prepares a credit plan relating to agricultural and allied activities for the

target groups and for lending to the priority sector categories of borrowers in particular.

(iv) Help to Co-operatives:

The RBI inspects and audits the accounts of co-operative societies. It provides cheap

remittance facilities to them. It renders them advice about making adjustments of their loans

and assets. It also runs the College of Agricultural Banking at Pune where it conducts training

programmes in the field of agricultural finance, rural banking and allied subjects for the

personnel of co-operative and other banks.

17
(v) Financial Assistance:

The RBI dos not provide direct finance to agriculturists but through the State Co-operative

Banks and NABARD. It provides short-term, medium-term and long-term financial

assistance to meet the needs of rural and allied activities.

(1) Short-Term Advances:

The RBI grants short term loans and advances to State Co-operative Banks for the purpose of

general banking business against the pledge of Government and other approved securities.

The RBI also lends to NABARD under the GLC for short term lending operations for

agricultural and other purposes.

The NABARD, in turn, makes short-term advances to State Co-operative Banks for

agricultural operations, marketing of crops, purchase and distribution of chemical fertilisers,

financing of cottage and small scale industries, working capital requirements of co-operative

sugar factories, etc. Short term advances of the RBI/NABARD to the State Co-operative

Banks amounted to Rs,7,358 crores in 2002-03.

(2) Medium-Term Advances:

Medium term loans and advances are granted by the RBI to the State Cooperative Banks for

the purpose of general banking business against the pledge of Government and other

approved securities for a period of 15 months to 5 years at an interest rate below the bank

rate.

The NABARD also gives medium term loans from NRC (Stabilisation) Fund for conversion

of short term into medium term loans, and from the NRC (LTO) Fund for approved

agricultural purposes and purchase of shares in co- Operative processing societies by farmer

18
members of FACs, The medium term loans and advances by RBI/NABARD to the State Co-

operative Banks amounted to Rs.493 crores in 2002-03.

(3) Long-Term Advances:

The RBI provides long term advances for agricultural and allied activities to the State

Governments to enable them to contribute to the share capital of co-operatives and the NRC

(LTO) Fund and NRC (Stabilisation) Fund. During 1990-91, the RBI contributed Rs.375

crores to the NRC (LTO) Fund and Rs.10 crores to the NRC (Stabilisation) Fund. The

RBI/NABARD sanctioned long-term credit limits amounting to Rs.61 crores to State

Governments for contribution to the share capital of co-operative credit institutions during

2002-03.

Conclusion:

The Reserve Bank’s role in rural finance is confined to the following areas: advisory, training

supervision, strengthening of rural credit institutions, formulating rural credit policy and

providing refinance facilities. The RBI has been successful in creating a number of

institutions like the RRBs, NABARD, etc., and strengthening of co-operative banking in rural

areas in order to provide credit facilities for agricultural and allied activities.’

B. Role in Industrial Finance:

The Reserve Bank has been playing an important role in providing finance indirectly to large,

medium and small scale industries. Towards this end, it has been instrumental in setting up a

number of financial corporations at the Centre and in the States. The RBI provides long term

loans as well as medium/short term credit facilities to these financial institutions.

(i) RBI Assistance to Financial Institutions:

To provide credit facilities to industries, the RBI has helped in the establishment of the

following financial institutions:

19
(1) Industrial Finance Corporation of India (IFCI):

The IFCI was set up in 1948 by the RBI with the objective of providing medium and long-

term financial assistance to the industrial sector. The RBI subscribed 40 per cent of the issued

capital of the Corporation. It also subscribed to the debentures of the Corporation. In 1964, it

was made a subsidiary of the Industrial Development Bank of India.

The RBI provides medium/short term credit limits to the IFCI against the security of eligible

usance bills rediscounted by it. During 1990-91, the RBI sanctioned Rs.60 crores as credit

limits to the Corporation. No amount had been sanctioned after this.

(2) National Industrial Credit (Long Term Operations) Fund:

The RBI created the NIC (LTO) Fund in 1964 for providing long term credit limits to the

leading financial institutions such as IDBI, IRBI, etc.

(3) Industrial Development Bank of India (IDBI):

The RBI established in 1964 ‘the IDBI as the principal financial institution for industrial

finance in the country. It is a wholly owned subsidiary of the RBI. It provides direct

assistance to medium and large industrial concerns by purchasing/underwriting their shares

and debentures. It also provides refinance facilities to other term

lending institutions in the large, medium and small scale sectors. During 1992-93, the RBI

sanctioned a special refinance facility of Rs.400 crores to IDBI. It did not sanction any

amount after this.

(4) Industrial Credit and Investment Corporation of India (ICICI):

The ICICI was established in 1955 as a public limited company at the initiative of the World

Bank. The RBI played an indirect role in its formation. The ICICI provides assistance for

industrial development and investment, by way of rupee and foreign currency loans,

20
underwriting and direct participation to shares, debentures and guarantees. The RBI provides

medium/ short term credit limits to the ICICI against the security of eligible usance bills

rediscounted by it. It sanctioned Rs.33 crores to the ICICI as credit limits for the year 1990-

91. No amount was sanctioned after this.

(5) Industrial Reconstruction Bank of India (IRBI):

The IRBI was established in 1985 after reconstituting the erstwhile Industrial Reconstruction

Corporation of India. It is the principal credit and reconstruction agency for rehabilitation of

sick and closed industrial units. It assists industrial concerns by grant of term loans and

advances, underwriting of stocks, shares, bonds and debentures, and guarantees for

loans/deferred payments. During 1990-91, the RBI sanctioned Rs.35 crores to the IRBI as

long-term assistance from the NIC (LTO) Fund. No amount had been sanctioned after this.

(6) State Financial Corporations (SFCs):

SFCs are the state-level development banks set up under the SFCs Act, 1951 for the

development of medium and small scale industries in their respective States. At present there

are 18 SFCs which provide financial assistance to industries by way of term loans, direct

subscription to equity/ debentures, discounting of bills of exchange and guarantees. Most of

the IDBI schemes for assistance to small and medium sectors are operated through SFCs.

During 1999-2000, the RBI sanctioned fresh adhoc borrowing limits aggregating to Rs.152.5

crores to 15 SFCs.

(7) Small Industries Development Bank of India (SIDBI):

The SIDBI was set up as a wholly-owned subsidiary of IDBI on 2 April, 1990. It aims at

ensuring larger flow of financial and non-financial assistance to small scale industrial sector.

Its major activities relate to refinance of loans and advances, discounting and rediscounting of

bills, extension of seed capital/ soft loans, granting direct assistance and refinancing of loans,

21
providing services like factoring leasing etc., and extending financial support to Small

Industries Development Corporations. During 1995-96, the RBI sanctioned long-term credit

assistance to SIDBI amounting to Rs. 224 crores. It made no sanction after this.

(8) Export-Import Bank of India (Exim Bank):

The Exim Bank was set up in January 1982 as a statutory corporation of the Central

Government. It provides financial assistance to promote Indian exports through direct

financial assistance, overseas investment, finance, term finance for export production and

export development, pre-shipment credit, buyers’ credit, lines of credit, relending facility,

export bills rediscounting, refinance to commercial banks, finance for computer software

exports, finance for export marketing and bulk import finance to commercial banks.

It also extends non-fund facility to Indian exporters in the form of guarantees. The lending

programme of the Exim Bank covers various stages of export such as from the development

of export markets to expansion of production capacity for exports production for exports and

post-shipment financing.

Its focus is on export of manufactured goods, project exports, exports of technology services,

export of manufactured goods and export of computer software. The RBI sanctioned Rs.120

crores as long-term assistance to the Exim Bank out of NIC (LTO) Fund in 1990-91. It made

no sanction after this.

(9) National Housing Bank (NHB):

The NHB was set up in 1988 to meet the requirements of housing finance. Its paid-up capital

of Rs.250 crores is fully subscribed by the RBI. The bank is providing assistance through

Home Loan Account Scheme, liberalised lending by commercial banks and refinance

facilities.

22
Refinance is for land development and shelter programmes of public/private agencies and co-

operatives. During 1992- 93 the RBI sanctioned a loan of Rs.one crore to NHB out of the

National Housing Credit (Long-Term Operations) Fund set up by the RBI. No amount was

sanctioned after this.

(ii) Credit Guarantee Schemes:

The RBI established in 1971 the Credit Guarantee Corporation of India in order to encourage

greater flow of bank credit to small borrowers. In 1978, this Corporation was merged with the

Deposit Insurance Corporation and renamed as Deposit Insurance and Credit Guarantee

Corporation (DICGC).

Thus Corporation guarantees support for the entire priority sector advances by banks and

other approved financial institutions to small borrowers and small scale industries. At present,

the DICGC is operating three credit guarantee schemes. The RBI does not lend to the

Corporation and has simply helped in its formation.

(iii) Industrial Credit Department:

Earlier, the RBI had established the Industrial Credit Department in 1957 to solve the

problems of industrial finance. It was this Department which administered the Credit

Guarantee Scheme for SSI introduced in July 1960. With the formation of DICGC, this

department was wound up by the RBI in 1981.

(iv) Credit Monitoring Arrangement (CMA):

The RBI introduced the CMA in place of the Credit Authorisation Scheme (CAS) in October

1988 whereby it delegated authority to banks to sanction credit proposals of large borrowers

and thereafter submit the same for post-sanction scrutiny to the RBI. These credit limits relate

to working capital (of Rs. 5 crores and above), term finance (of Rs. 2 crores and above), sale

23
of machinery on deferred payments, etc. in case of large scale industries. The CMA has made

possible prompt and easy availability of credit to large industries with post- sanction by the

RBI.

From 1992-93, the working capital credit limit has been raised from Rs.5crores to Rs. 10

crores. The CMA has also been extended to the export sector, The RBI has advised banks to

meet the additional credit needs of exporters in full even if sanction of additional credit

exceeds maximum permissible bank finance (MPBF), provided exporters have firm orders or

confirmed letters of credit.

This facility has been extended to exports by small scale industries where the working capital

limit from banks is less than Rs. 1 crore, provided their exports are not less than 25 per cent

of their total turnover during the previous accounting year. Further, this facility has been

given to companies/organisations engaged in the marketing/trading of the products of village,

tiny and small scale industrial units.

Conclusion:

The RBI has done a remarkable job in creating a number of financial institutions and

evolving credit guarantee schemes to help finance large, medium and small industries, and

small borrowers. It provides direct long-term assistance from the NIC (LTO) Fund and

medium/short-term assistance to financial institutions.

It also changes its credit policy from time to time to help the industrial sector to get larger

financial assistance from banks.

C. Role in the Development of Bill Market Scheme:

The RBI pioneered the development of the bill market scheme for trade and industry in 1952.

Its aim was to induce banks to provide finance against bills of exchange and promissory notes

24
for 90 days. The scheduled commercial banks were allowed to convert a part of their

advances, loans, cash credits or overdrafts into usance promissory notes for 90 days for

lodging as collateral (security) for advances from the RBI. Since this scheme was primarily

meant to accommodate the banks, it did not help in developing a bill market.

In November 1970, the RBI introduced the Bill Rediscounting Scheme with several new

features. Under this scheme, all licensed scheduled commercial banks were made eligible to

rediscount with the RBI genuine trade bills arising out of sale or despatch of goods. But this

did not lead to the development of bill culture as preference for cash credit type of financing

continued in the country.

Several difficulties were cited by trade and industry in developing the bill market:

(a) Non-availability of stamp paper of required denomination,

(b) The need to affix stamp on each bill and payment of stamp duty,

(c) Reluctance of industry, trade and Government Departments to accept bills,

(d) Absence of specialised credit information agencies,

(e) Absence of any active secondary market for bills as rediscounting is permitted only with

the apex level financial institutions, and

(f) Administrative work involved in handling invoices/documents of title to goods.

The Committee to Review the working of the Monetary System (1985) and the Working

Group on the Money Market (1986) set up by the RBI made a number of recommendations

which have since been accepted and implemented by the RBI as under:

25
1. The RBI has developed the treasury bills or Government Securities market in 14-day

Treasury Bills, 91-day Treasury Bills, 182-day Treasury Bills and 364-day Treasury Bills.

2. In order to augment the facilities for rediscounting and to provide liquidity to the bills, the

RBI has been progressively permitting a larger number of financial institutions eligible for

rediscounting bills. Apart from all scheduled commercial banks and selected urban co-

operative banks, 21 other financial institutions like LIC, UTI, GIC, NABARD, all

development banks; all mutual funds, etc., are included in the scheme.

3. The RBI has set up the Discount and Finance House of India (DFHI) as a major financial

institution to rediscount commercial bills, treasury bills and Government dated securities

which it has been doing since its inception on 15 April 1988.

4. In May 1994, the RBI set up the Securities Trading Corporation of India (STCI) to develop

secondary market in Government securities and Treasury bills. The STCI undertakes ready

forward transactions in Treasury Bills and Government dated securities. From March 1996, it

has become a primary dealer in Government securities.

5. Besides, the DFHI and the STCI, the RBI has granted permission to ICICI Securities, SBI

Gilts Ltd., PNB Gilts Ltd. and Gilt Securities Trading Corporation Ltd. to operate as primary

dealers in Government securities. The RBI also provides liquidity support to them in the form

of reverse Repos in Government dated securities and 91-Day Treasury Bills.

6. Up to September 1988 under the bill rediscounting procedure, the bills had to be endorsed

and lodged with the rediscounting banks or institutions. But preference for cash-credit type of

financing continued because certain administrative difficulties, were faced by banks in

following this procedure.

26
In October, 1988, the RBI introduced the scheme of derivative usance promissory note for the

purpose of rediscounting of bills whereby banks could draw a derivative usance promissory

note for suitable sums with maturity up to 90 days on the basis of bona-fide commercial or

trade bills discounted at their branches. Since August, 1989, the derivative promissory note

has been exempted from stamp duty. Thus a major administrative constraint in the use of the

bill system has been removed.

7. To encourage the development of bill finance and bill culture, the RBI had fixed a discount

rate equivalent to an effective interest rate of 15.5 per cent. Further, to stimulate the supply of

funds in the rediscount market, the RBI had fixed the ceiling on rediscount rate at 12.5 per

cent. But this rediscount rate was not applicable when banks and financial houses

rediscounted bills with DFHI which could fix its own discount rates for bills. With effect

from 1 May, 1989, the bill rediscounting rate has been totally freed.

8. The Working Group on the Money Market (1986) made recommendations for developing

bill financing in relation to cash credit system and developing the bill culture. In pursuance of

the recommendations, the RBT advised banks to fix for the Credit Authorisation Scheme

(CAS) now covered by the Credit Monitoring Scheme since October 1988, to attain a ratio of

bill acceptance to their inland credit purchases of 25 per cent and a bill discounting limit of

the same order.

9. To secure finance from banks against bills accepted by the large scale units for prompt

payment to small scale units, the RBI has introduced a Drawee Bill Scheme.

10. The RBI advised commercial banks in July, 1992 that:

(a) They should be cautious in discounting bills drawn by finance companies set up by large

industrial houses on other group companies;

27
(b) They should not rediscount the bills discounted by non-bank financial companies and thus

desist from providing any rediscount facility to finance companies; and

(c) They should ensure that the overall credit limit provided to finance companies and to hire-

purchase and equipment leasing companies should not exceed three times the net worth of

such companies.

11. Recognising the need to derive the benefit of internationally competitive rates, the RBI

decided to allow with effect from 7 April, 1993 authorised dealers in India to rediscount

export bills abroad at rates linked to international interest rates.

Defects:

Despite these measures, the RBI has failed to develop bill finance and bill culture in the

country. Bill financing hardly covers about 4 per cent of the total credit covered by banks

today.

There are many reasons for this:

(a) The Government, public sector undertakings, and large industries do not accept bills as a

basis for financing business,

(b) The bill market is primarily confined to derivative usance promissory notes rather than to

genuine trade bills,

(c) Indigenous bills of exchange, known as hundis, which finance a large segment of

commerce and trade in India are not recognised by the RBI. For a faster growth of bill

financing and bill culture, the RBI should try to remove these drawbacks of the bill market.

28
6. Project Report on Exchange Control Management by RBI:

The RBI manages and controls the country’s foreign exchange reserves and the external value

of the rupee. Foreign exchange is managed and controlled in order to overcome the deficit in

balance of payments. The RBI controls and manages the inflow and outflow of foreign

currencies under the Foreign Exchange Regulation Act, 1973 and Foreign Exchange

Regulation (Amendment) Act, 1993.

Foreign currencies coming into India are required to be sold and exchanged for the rupee

either direct to the RBI or to its authorised dealers. Its authorised dealers include certain

commercial banks, hotels, firms, shops, etc. which deal in foreign currencies and foreign

travellers’ cheques. They are also authorised to lend and borrow foreign currency among

themselves in the inter-bank market locally.

The actual lending limit for each authorised dealer is fixed by the RBI depending upon the

size of its operations and other relevant factors. Authorised dealers are permitted to maintain

with overseas branches and correspondents, balances in foreign currencies at levels which are

commensurate with normal needs of their business, such as payments towards imports or

maturing deliveries under forward contracts. They are also permitted to transfer foreign

currency funds rendered surplus over normal anticipated needs of their business on a day-to-

day basis to special interest bearing accounts.

The blanket foreign exchange permits are issued to exporters in lump sums. Exporters are

allowed to receive export proceeds through normal banking channels. The payments for

imports against foreign currency loans / credits extended by foreign governments / financial

institutions are made either under the Direct Payment Method, also known as Letter of

Commitment Method or Reimbursement Method.

29
Since 1991 significant changes have been made in the exchange rate system by the RBI. In

July, 1991, the rupee was devalued by about 20 per cent with respect to US dollar in two

stages. Simultaneously, the Exim Scrip Scheme was introduced under which certain imports

were permitted only against export entitlement.

This was followed by partial convertibility of rupee in 60:40 ratio with effect from 1 March,

1992. This was the Liberalised Exchange Rate Management System (LERMS). Under this

system, all foreign exchange receipts on current account transactions (i.e. exports, remittances

etc.) were required to be surrendered to the authorised dealers (ADs) in full.

The rate of exchange for these transactions was the free market rate quoted by the ADs. The

ADs, in turn, surrendered to the RBI 40 per cent of their purchase of foreign currencies at the

exchange rate announced by the RBI. They were free to sell the balance of 60 per cent of

foreign exchange in the free market. All importers of goods and services and persons

travelling abroad bought foreign exchange at market- determined rates from the ADs subject

to liberalised exchange control rules.

The RBI issued instructions to authorised dealers to sell foreign exchange without prior

approval for business visits overseas sponsored by firms/companies/ organisations, visits by

self-employed professionals and by journalists on short-term assignments, for medical

treatment abroad, persons proceeding abroad for employment/emigration and on the

hospitality of the overseas organisation, to exporters by way of agency commission and

settlement of quality claims, for sundry personal and commercial remittances, etc. In all such

cases, except exporters, the sale of foreign exchange limit had been raised between $ 100 to $

500.

30
Under LERMS, the Reserve Bank provides foreign exchange at the official exchange

rate in the following cases:

(a) For import of crude, diesel and kerosene by the Indian Oil Corporation,

(b) For import of fertilisers by MMTC.

(c) For discharge of financing arrangements like payments under Banker’s Acceptance

Facility and Suppliers’ Credit in respect of items (a) and (b) above by IOC and MMTC

respectively,

(d) For import of goods by Ministries and Departments of Government of India on a

certification from the Financial Adviser/Internal Finance Wing of the Ministry concerned that

the import of such goods is as per authorisation of the Foreign Exchange Budget of the

Department of Economic Affairs,

(e) For import of Life-saving Drugs and Equipment.

(f) For meeting 40 per cent of foreign exchange requirements of Advance Licences, Imprest

Licence and import for replenishment of raw materials for Gem and Jewelry exports.

With effect from 2 March, 1993, the dual exchange rate system was replaced by the Unified

Exchange Rate System (UERS) under which the 60:40 ratio was extended to 100 per cent

conversion. The UERS was introduced to rectify the anomaly of the LERMS under which

exporters and other earners of foreign exchange indirectly subsidized certain imports. Under

this system, the exchange rate was fully determined by market forces of relative demand and

supply.

The RBI had been announcing its buying and selling rates at the ongoing market rates for

transactions with ADs. This system permitted 100 per cent conversion of the rupee for all

31
exports and imports of goods. But the official RBI exchange rate continued for the

conversion of items not permitted under the UERS. These included more than half-a-dozen

invisible items of current account and all capital account payments. Further, various exchange

control norms of the RBI remained in operation with a few relaxations.

As a result of the operation of the UERS, the exchange rate remained more or less steady at

the level of Rs.31.37 per dollar. With stability in the exchange rate and the large inflow of

resources following liberalisation of foreign investment policy and removal of industrial and

trade restrictions, there had been substantial improvement in the current account deficit. This

led to the current account convertibility of the rupee effective 1 March, 1994.

The RBI announced further relaxations in the exchange control regulations on a number of

invisible items as part of the current account convertibility of the rupee. The final step

towards current account convertibility was taken in August 1994 by further liberalisation of

invisibles payments and acceptance of the obligations under Article VIII of the IMF. Under

it, India is committed to forsake the use of exchange restrictions on current international

transactions.

There is no officially fixed exchange rate of the rupee. Instead, the rate is determined by the

demand and supply conditions in the foreign exchange market. The RBI intervenes to

maintain orderly market conditions and to curb excessive speculation in foreign exchange.

Foreign exchange is released by authorised dealers (ADs) for various purposes like foreign

travel, medical treatment, gifts, services, studies, etc. Release of foreign exchange by ADs for

the above purposes was initially governed by limits laid down by the RBI.

Beyond the specified limits foreign exchange could be obtained after seeking prior approval

of the RBI. Effective July 1995, the RBI has permitted ADs to provide exchange facilities to

32
their customers for the above mentioned purposes beyond the indicative limit without its

prior approval, provided they are satisfied about the bonafides of the application. But, they

are required to report such transactions to the RBI.

The process of liberalisation towards current account convertibility has been continued by

delegating more powers to ADs.

(1) They have been permitted to export their surplus stocks of foreign currency notes and

coins for realisation of proceeds to private money changers abroad, in addition to their

overseas branches and correspondents.

(2) They have been permitted to allow EEFC (Exchange Earners Foreign Currency) account

holders to utilise funds held in such accounts for making remittances in foreign exchange

connected with their trade and business related transactions which are of current account

nature.

(3) The RBI has set up Inter-Bank Forex Clearing House where foreign exchange

transactions by ADs are cleared.

(4) The RBI has set up a Market Intelligence Cell to study and closely monitor the

developments in the Indian foreign exchange market. The Cell receives from the ADs on a

daily basis information on forex transactions which are critically analysed and followed up.

7. Project Report on the Methods of Credit Control by RBI:

To achieve these objectives, the RBI follows the following methods of credit control:
(i) Open Market Operations:

Open market operations refer to the sale and purchase of gold related securities and other

securities, bills and bonds of Government by the RBI from and to the public and financial

institutions. To control inflation and tackle the problem of excess liquidity due to foreign

33
exchange inflows, the RBI sells Government securities. As a result, there is reduction in the

cash balances of banks and other deposits of banks held by the RBI.

The opposite happens when the RBI purchases securities from the open market. In

Government securities, there were adhoc Treasury Bills which were replaced by Ways and

Means Advances from April 1997. They are meant to serve as a means of meeting temporary

mismatches between the receipts and expenditure of the Central Government rather than a

source of financing fiscal deficit.

This has provided more flexibility to the RBI in operating its monetary policy. Besides, to

control fluctuations in call money market rates repos/reverse repo auctions, first on daily

basis then with 3-7 day maturity, were introduced under full-fledged liquidity, Adjustment

Facility (LAF) effective August 2000. Besides, weekly auctions of 14-day Treasury Bills and

28-days Treasury Bills; fortnightly auctions of 182-day Treasury Bills; and monthly auctions

of 364-day Treasury Bills were started from 1997-98.

The RBI has been resorting to open market operations in order to reduce the lending power of

commercial banks because its sale of securities have normally exceeded its purchases. But the

effectiveness of open market operations as an instrument of credit control in India is limited

by a number of factors.

First, except for the gilt- edged market in India, there is the absence of other first class

securities.

Second, the market for Government securities is a ‘captive’ market over which the RBI has

almost a monopoly and some institutional investors like LIC, UTI, GIC, and commercial

banks, etc. are required to invest in them.

34
Third, open market operation: are being used as an instrument of debt-management rather

than to influence the cost and availability of credit. As such, open market operations have not

been a success in India.

(ii) Bank Rate Policy:

The bank rate is the’ rate fixed by the central bank at which it rediscounts first class bills of

exchange and government securities held by commercial banks. But in India, the bank rate

policy is limited to give advances to commercial banks against first class bills of exchange by

the RBI.

The latter include Government securities and genuine trade bills. Under the Bill

Rediscounting Scheme introduced in November 1970, all licensed scheduled commercial

banks are eligible to rediscount with the RBI genuine trade bills arising out of sale or

despatch of goods.

The objectives of the RBI’s bank rate policy are to influence the availability and cost of

credit. The RBI has been unsuccessful in achieving these objectives. From its establishment

in 1935 up to 14 November. 1951, the bank rate was stable at 3 per cent.

It was cheap monetary policy which led to an unlimited expansion of credit. Consequently,

speculative activities received encouragement and the deficit in balance of payments

increased. For the first time, the bank rate was raised to 3.5 per cent in November 1951.

It was raised to 4 per cent in May 1957, to 4.5 per cent in January, 1963; to 5 per cent in

September, 1964; to 6 per cent in January, 1971 and to 7 per cent in May 1973. With an

unprecedented rise in prices, the RBI resorted to a policy of dear money in July 1974 and

raised the bank rate to 9 per cent in 1977, to 10 per cent in July 1981, to 11 per cent in July

1991 and to 12 per cent in October 1991.

35
To overcome recession in the economy, the RBI started following cheap money policy by

reducing the bank rate to 11 per cent in April 1997 and subsequently by stages to 6 per cent

on April 29,2003. Thus the bank rate had not been used as an instrument of credit control till

1973. It is only in the 1980s and 1990s that its proper use has been made in the form of cheap

or dear monetary policy.

(iii) Interest Rate Policy:

Interest rate adjustment is a flexible and potent tool of credit policy. It reinforces

restrictive/liberal impact of credit policy. In order to supplement the bank rate policy, the RBI

has been following the policy of changing the interest rate structure for different sectors of

the economy in the light of evolving economic trends.

(a) Deposit Rates:

Since November 1975, the RBI has been following the policy of administered interest rates.

This policy has the twin objectives of mobilising savings and providing funds for productive

activities in the priority sectors of the economy at concessional rates of interest.

The interest rates on all saving instruments including bank deposits are sometimes reduced to

prevent banks from getting locked into longer period maturities. At other times, they are

raised to assist the banks in deposit mobilisation and to offer a better rate of savings. Up to 21

April, 1992, the term deposit rates of scheduled commercial banks were prescribed in three

slabs of maturities and rates.

Effective 22 April, 1992, the banks were given freedom to determine the term deposits of

three maturity slabs of their choice, subject to a choice of interest rate ‘not exceeding 13 per

cent. With the fall in inflation rate, the ceiling rate was gradually reduced to ‘not exceeding

10 per cent’ by 2 September 1993. When the inflation rate started rising, the ceiling rate was

36
gradually raised to ‘not exceeding 12 per cent’ effective 18 April, 1995 for 46 days to 3 years

and above.

To augment the resources of banks and to impart greater flexibility to term deposit rate

structure, the banks have been allowed freedom to fix their own interest rates on domestic

term deposits of all categories. The minimum period of term deposits has been gradually

reduced from 46 days to 30 days; and subsequently to 15 days. Effective May 2001, the

banks had been permitted to pay higher interest rates to senior citizens on their term deposits

by 0.5 to 1.0 per cent.

The savings deposit rate has been lowered from to 4.0 per cent to 3.0 per cent effective March

1,2003. Term deposit rates on NRE accounts were also rationalised in accordance with the

domestic rates. With a view to maintaining the differential between the interest rates on term

deposits and NRE Rupee term deposits, banks were permitted to offer differential rates of

interest on NRE deposits on size-group basis subject to the overall ceiling rate effective 27

April, 2000. Effective 4 April, 1996, interest rates on NRE term deposits of over two years

had been freed for banks.

(b) Lending Rates:

The lending rate structure prescribed for banks since their nationalisation in 1969 had been

cumbersome and complicated. It was characterised by a multiplicity of rates relating, to

numerous criteria, such as size of loan, priority of a sector, location of activity, specific

programmes, income of borrowers, etc. In September 1990, the RBI rationalised the lending

rate structure of commercial banks. It is linked to the size of loan granted by the commercial

banks.

37
When the inflation rates were high, upward revisions were made in the lending rates of

commercial banks. The first upward revision was made on 13 April, 1991, when the

minimum rate on advances above Rs.2 lakh was raised from 16 per cent to 17 per cent

effective 13 April, 1991 and gradually to 20 per cent on 9 October, 1991.

As the inflation rate declined and the macroeconomic situation improved, the lending rate

was reduced gradually from 20 per cent to 14 per cent effective 1 March, 1994. Effective 18

October, 1994, the prescription of a minimum lending rate has been abolished and banks have

been given freedom to fix the prime lending rate (PLR) for all advances above Rs.2 lakh.

Each bank is required to declare its PLR and made uniformly applicable to all its branches.

In keeping with its policy of rationalisation of the lending rate structure according to the size

of credit limit, the RBI reduced the number of categories from six to three by April 1993. The

three categories with interest rates effective 18 October, 1994 were – (a) Up to Rs.25,000 at

12 per cent (fixed); (b) Over Rs.25,000 and up to Rs.2 lakh at 13 per cent (fixed); and (c)

Over Rs.2 lakh freed.

Under the DIR (Differential Interest Rate) scheme, term loans are provided to small and

water transport operators, professionals and self-employed in the priority sector at the

concessional rate of 4 per cent by both the commercial banks and urban co-operative banks.

They are required to lend 40 per cent of their total advances to the priority sector.

Along with the above measures, interest rates on export credit are reviewed from time to time

with a view to providing an incentive to exporters for repatriating the proceeds as well as

discouraging them from delaying repatriation of export proceeds.

On pre-shipment export credit, banks have been allowed to charge 10 per cent interest up to

180 days and 13 per cent beyond 180 days to 270 days since 1 April, 1999. On post-shipment

38
export credit upto 90 days, the interest rate has been 10 per cent since 1 April, 1999, beyond

90 days to 6 months, and beyond six months the banks are free to charge interest rates

decided by them.

(iv) Changes in Variable Reserve Ratio:

The variable reserve ratio is a very effective instrument of monetary control with the RBI.

In India, the variable reserve ratio is of the following types:

(a) Cash Reserve Ratio (CRR):

Since the establishment of RBI till 1956, the commercial banks were required to keep 2 per

cent of their time deposits and 5 per cent of their demand deposits with the RBI in the form of

reserves. Thus this tool of monetary policy was not used for more than 20 years in India.

With the RBI Amendment Act, 1956, the RBI was empowered to raise the time deposits of

commercial banks from 2 to 8 per cent and the demand deposits from 5 to 20 per cent. By the

RBI Amendment Act, 1962 the distinction between time and demand deposits was abolished

and the provision was made to keep the CRR between 3 to 15 per cent. After this, the RBI

had been making changes in the CRR in keeping with the monetary and economic conditions.

Effective 1 July, 1989, instead of separate ratios for different types of liabilities, there is a

uniform CRR of 15 per cent of the entire net demand and time liabilities (NDTL) of banks,

including FCNR and NRE accounts. The CRR was reduced to 14 per cent effective 15 May,

1993 and again raised to 15 per cent effective 6 August, 1994.

This was to meet monetary pressure arising from large capital inflows. For the same reason,

the CRR on FCNR accounts was raised to 15 per cent and on NRNR deposits to 7.5 per cent.

When these conditions reversed and money growth slowed, the CRR was reduced from 15

39
per cent to 14 per cent effective 9 December 1995 and that on FCRR and NRNR deposited

removed.

To augment the lendable resources of banks, the CRR was further reduced from 14 per cent

to 13 per cent effective 11 May, 1996, and to 12 per cent effective 6 July, 1996 and in

subsequent years gradually to 8 per cent on 1 April, 2000 and to7.5 per cent on 14 May,

2001.

The reduction in CRR to 7.5 per cent has been done to enable banks to reduce their PLR and

to release more liquidity into the monetary system. As a policy measure, the variations in

CRR has been more successful in controlling credit than open market operations and bank

rate policy.

(b) Statutory Liquidity Ratio (SLR):

Another important tool of monetary policy with the RBI is the Statutory Liquidity Ratio

(SLR) which supplements the CRR. Under the Banking Regulation Act, 1949, the

commercial banks are required to keep 20 per cent of their net demand and time liabilities

(NDTL) deposits with them in the form of liquidity ratio.

In this liquidity ratio are included excess reserves, current account balances of the

commercial banks with the RBI and other banks, gold and unencumbered approved

securities. But whenever the RBI raised the CRR, the commercial banks would make this

unsuccessful by increasing their liquidity power through the sale of government securities. In

order to overcome this weakness, the SLR was raised to 25 per cent by the Banking

Amendment Act of 1962.

But the cash reserves kept with the RBI were not included in this ratio. In order to contain the

liquidity growth in the banking system and consequent monetary expansion, the SLR was

40
raised to 30 per cent in November, 1972. Since then it had been revised upward regularly so

that with effect from 22 September, 1990 it had been 38.5 per cent.

To make more funds available for commercial bank lending, the base SLR on NDTL was

reduced gradually and by the end of 1996, it was brought down to 25 per cent as per the

recommendations of the Narasimhan Committee.

The incremental SLR is 25 per cent. This refers to the ratio, the banks are required to keep if

there NDTL increase over the base SLR. The advantages of SLR are that by implementing it

along with CRR, it controls the liquidity of banks and thereby limits their power to make

advances to trade and industry. Thus the quantitative monetary policy is successful in

reducing inflationary pressures. Second, more financial resources are available to the

government for its use.

(v) Selective Credit Controls:

Selective credit controls are meant to regulate and control the supply of credit. They aim at

channelising the flow of bank credit from speculative and other undesirable purposes to

socially desirable and economically useful uses. Thus they help in curtailing the rise in prices

of commodities.

The method of selective credit controls was introduced in India by the RBI in May 1956.

Under this:

(i) It fixes minimum margins for advances against securities for banks. These margins are

from 20 to 100 per cent;

(ii) It fixes ceilings on maximum advances against stocks of certain commodities to traders;

(iii) It fixes minimum discriminatory rates of interest for certain kinds of advances by banks;

41
(iv) It prohibits advances for financing hoarding of certain commodities; and

(v) Prohibits the discounting of bills of exchange relating to the sale of some selected

commodities.

Selective credit controls relate to such commodities as cotton, wheat, paddy/ rice, pulses,

oilseeds, vegetable oils, sugar, gur and khandsari, man-made fibres and cloth. The rate of

interest charged on advances by banks against the security of such commodities is higher than

on other securities.

If the RBI wants to control speculation on the prices of such commodities, it raises the

minimum margins. In case it wants to liberalise credit facilities for them, it lowers the

minimum margins. It does so in keeping with changing market conditions.

For instance, to curb inflationary pressures, the RBI had fixed the ceiling of 45 per cent on

the incremental net non-food credit deposit ratio for banks from October 1989. Further,

restrictions had been placed on loans for purchase of consumer durables and other non-

priority sector personal loans. The minimum margin for loans against shares and

debentures/bonds was fixed at 75 per cent.

When in early 1992, the inflation rate started declining, the banks were advised to support the

revival of productive activity. At the same time, effective 22 April, 1992, all restrictions on

credit or purchase of consumer durables, other non-priority sector personal loans and

stipulation on net non-food credit-deposit ratio were removed.

Effective 21 October, 1996, selective credit controls on pulses, coarse grains, oil seeds,

vanaspati, sugar, gur, khandsari, cotton, kapas had been abolished, except buffer stocks.

Banks were given freedom to fix margins on advances against sensitive commodities, except

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unreleased stocks of sugar for which 15 per cent margin had been fixed. Effective 2

December, 1996, the banks were granted freedom to advance loans against shares/debentures

with the maximum limit of Rs. 10 lakh. It has since been raised to Rs.20 lakh.

Credit Monitoring Arrangement (CMA):

With effect from 10 October 1988, the RBI dispensed with the Credit Authorisation Scheme

(CAS) and introduced the Credit Monitoring Arrangement (CMA) for bank lending for

working capital purposes. Under the revised scheme effective 30 October, 1996 all sanctions/

renewals of credit limits to borrowers enjoying fund-based working capital limits of Rs. 10

crores and above and term loans in excess of Rs. 5 crores were required to be reported by the

banks to the RBI for post-sanction scrutiny.

All sanctions/renewals of credit limits were required to be reported to the RBI. In this way,

the RBI regulated the sanctioning of loans by banks through CMA. The CMA was

discontinued from 8 December, 1997.

In recent years, the Reserve Bank has announced several steps to facilitate the flow of credit

to the commercial sector, particularly for exports, information technology, infrastructure,

agriculture, small scale industries, etc.

The coverage of the priority sector credit has been widened considerably. Bank credit to

NBFCs (non-bank financial companies) for on-lending to small road and water transport

operators, software industry having credit limit up to Rs.1 crore, to the food and agro-based

sector, to NBFCs and financial institutions for on-lending to the tiny sector, and to both

public and private sector undertaking for financing infrastructure projects is now being

treated as priority sector lending. Besides, bank lending to sensitive sectors comprising

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capital market, real estate (housing) and commodities is regulated in keeping with the trends

in the economy.

Their Effectiveness:

Selective credit controls have been more effective in controlling credit than the quantitative

methods. They have been instrumental in channelising the flow of credit from speculative and

other undesirable purposes to socially desirable and economically useful purposes.

They have helped in restricting the demand for money by laying down certain conditions for

borrowers by fixing minimum margin requirements and other limits. Thus they have been

successful in regulating credit for different uses in various sectors of the economy according

to plan priorities.

Despite all these successes, selective credit controls have failed to control the demand for and

supply of money in the country. They have, therefore, failed to control inflationary pressures.

With the introduction of commercial paper by the large organised sector, the RBI’s control

over credit through the CMA had become less effective. Now large industries can raise

money directly from the market at cheaper rates than bank credit.

Moreover, trade and industry can get funds from non-bank financial institutions, mutual

fund’s, etc. which have made selective credit controls less effective. Above all, selective

credit controls alone are not effective in controlling credit. They must be combined with

general (or quantitative) control measures like bank rate, open market operation, CRR, SLR,

etc.

(vi) Direct Action:

The Banking Companies Act, 1949 empowers the RBI to caution or prohibit banks generally

or any individual bank in particular, from entering into any particular transaction or class of

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transactions. The RBI has also the power to inspect any bank and its books accounts. On a

report from the RBI, the Central Government may prohibit any bank from receiving fresh

deposits or direct the RBI to order for the winding up of the bank or its merger with some

other bank.

(vii) Moral Suasion:

Besides, the above noted quantitative and qualitative measures of credit control, the RBI also

follows the method of moral suasion. By this method of persuasion, suggestion and advice,

the RBI asks the banks to follow its declared monetary policy from time to time.

By sending circular letters or calling meetings of directors of banks, it persuades them not to

give credit for speculative activities and/or to give more credit facilities to priority sectors of

the economy. Before the nationalisation of 20 banks in India, the method of moral suasion

was not successful but now all banks follow the RBI guidelines. As a matter of fact, the RBI

is so powerful that no bank dares to ignore its circulars and suggestions.

8. Project Report on the Achievements of the Reserve Bank of India:

Some of the principal achievements of the RBI are as follows:

(i) Regulator of Credit:

The bank has been successfully regulating credit in the economy to meet the requirements of

trade, industry and agriculture during periods of recession and inflation. For this purpose, it

followed a cheap money policy in the early phase of development planning and after that a

policy of controlled monetary expansion to meet the requirements of a growing economy.

(ii) Banker to the Government:

As banker to the Government, the RBI has been admirably managing the public debt. It has

successfully floated loans on behalf of the Central and State Governments at low interest

rates. It has also provided ways and means advances to the State Governments through the

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sale of treasury bills. It has been rendering advice to the Government on economic matters in

general and on financial matters in particular.

(iii) Development of Sound Banking System:

Another achievement of the Bank has been that it has developed and promoted sound banking

practices in the country. In exercise of the powers vested in it by the Banking Regulation Act,

it has been keeping a constant vigil over the banks, trying to remove their defects, and

strengthening them. Consequently, this has inspired public confidence in the banking system

as a whole.

(iv) Institutionalisation of Savings:

The RBI has been successfully promoting the institutionalisation of savings by promoting

banking habits, by large scale extension of banking facilities in rural and urban areas, and

promoting and establishing new specialised financial agencies.

(v) In the Field of Co-Operative Credit:

The RBI has successfully promoted co-operative credit. It has Strengthened co-operatives by

setting up NRC (LTO) Fund and NRC (Stabilisation) Fund and NABARD which now

administers these Funds. It also finances the State Co-operative Banks. It has been due to the

efforts of the RBI that the co-operative movement has been placed on a sound footing.

(vi) In the Field of Rural Credit:

The Bank has been admirably engaged in the task of promoting rural credit since its

inception. It runs a separate department to render advice to the Government on rural credit.

By adopting the multi-agency approach (viz. the commercial banks, the co-operative banks,

the RRBs, and NABARD), it has been successful in providing credit for the development of

agriculture, trade, commerce, industry, and other productive activities in the rural areas.

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(vii) In the Sphere of Industrial Finance:

In the sphere of industrial credit, the RBI has played a pioneering role by promoting a wide

range of institutions for providing medium and long term credit such as IDBI, IFCI, ICICI,

IFC, UTI, etc. It also provides medium/short term credit limits to these institutions by

rediscounting their usance bills and long-term assistance from the NIC (LTO) Fund.

(viii) In the Field of Export Finance:

Another achievement of the bank has been in providing credit facilities to exporters. It has

been providing concessional credit, refinance facilities, and guarantee to commercial banks

for exporters. It has been instrumental in establishing the Export-Import Bank to provide

credit and other facilities to exporters.

(ix) Guardian of Banking System:

As the guardian of banking system, the RBI has been providing deposit insurance and credit

guarantee facilities to the banks. For this purpose it has set up the Deposit Insurance and

Credit Guarantee Corporation (DICGC).

(x) Promotion of Social Banking:

The RBI has played a vital role in the promotion of social banking in the country. It has

progressively directed the banking system since 1969 towards national social economic

objectives, including rural development and uplift of the weaker sections of the society. It has

converted banks in India as instruments of social uplift instead of simply profit-making

institutions.

(xi) Change in the Pattern of Lending:

The Reserve Bank has been successful in changing the pattern of bank lending.

Firstly, banks have been directed to lend 40 per cent of their total advances to the priority

sectors.

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Secondly, they have been asked to ensure that 60 per cent of their deposits raised from rural

and semi-urban centres are deployed as credit in those very areas.

Thirdly, under the DRI scheme, the public sector banks have to ensure that one per cent of

the previous year’s advance is earmarked each year to be lent to certain specified weaker

sections at a low rate of interest of 4 per cent.

(xii) Development of Bill Market:

The RBI has been successful to a considerable extent in developing bill market in India. For

this purpose, it has set up the Discount and Finance House of India (DFHI) and the Securities

Trading Corporation of India (STCI) as major financial institutions to rediscount commercial

bills. It has introduced a number of schemes such as 364-Day Treasury Bills, primary dealers

in securities, etc.

(xiii) Providing Information and Research:

The Reserve Bank has been doing an excellent job in providing information and data on the

different sectors of the economy through its weekly and monthly journals and annual reports.

Its Department of Economic Analysis and Policy conducts highly useful surveys and carries

on research on economic matters and publishes reports on them.

(xiv) Clearing House Facilities:

The Bank has been successfully rendering clearing house facilities at its 15 branches and 2

offices and at other places in the country through the SBI and its associates. It has introduced

Electronic Clearing System. This has helped in the use of cheques and inter-bank

transactions.

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(xv) Exchange Management and Control:

Another achievement of the RBI has been its admirable management and control of the

foreign exchange. It has gradually and successfully led the Indian economy to current account

convertibility of the rupee.

(xvi) Representation at International Fora:

The Bank has been successfully representing the country at the international monetary forum

such as the IMF and the World Bank.

(xvii) Human Resource Development:

One of the principal achievements of the RBI has been the setting up of a number of training

centres and colleges to impart training to the staff of co-operative banks, commercial banks,

RRBs, NABARD etc. Thus it has played a major role in human resource development in the

field of banking.

(xviii) Computerisation:

To modernise the functioning of the RBI, its Department of Information Technology (DIT)

has introduced advanced computer technology for inter-office communication and Internet

technology for information collection and sharing. It has also encouraged computerisation of

branches of commercial.

9. Project Report on the Failures of the Reserve Bank of India:

Despite the above achievements, there are certain fields in which the RBI has not been able to

function successfully.

They are as under:

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(i) Failure to Control Unorganised Money Market:

The Bank has not been able to control the unorganised sector of the money market. The

indigenous bankers function independently of the policies of the RBI. The latter has failed to

bring them under its control and supervision.

(ii) Multiplicity of Interest Rates:

As there is a large unorganised monetary sector which is not under the RBI, there is no

uniformity in the bank rate and other money market rates. Even the money market rates

charged by banks and non-bank financial intermediaries differ widely.

(iii) Failure to Check Inflationary Pressures:

Despite following the policy of controlled monetary expansion, the RBI has failed to control

and contain inflationary pressure within the economy.

(iv) Falling Profitability of Banks:

The RBI’s policy of credit squeeze has led to the decline in the profitability of banks. With

total deposits of banks blocked by reserves up to about 54 per cent, only 46 per cent are left

with them for lending. Out of this 40 per cent is required to be given to the priority sector.

On the other hand, the deposits of banks are on the decline due to the growing number of

alternative saving instruments. AU these measures by RBI have led to decline in the

profitability of banks.

(v) Failure to Develop Bill Culture:

Despite its best efforts, the RBI has failed to develop an organised bill market to provide

rediscounting facilities to banks. In fact, it has not been able to develop bill culture so that

commerce, trade and industry may deal in bills of exchange. Further, it has not done anything

to systematize and recognise hundis as bills of exchange.

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(vi) Failure to Provide Sufficient Rural Credit:

No doubt, the RBI has done a lot in providing rural credit through multiple agencies, but it is

insufficient keeping in view the credit needs of the rural population. Consequently, it has not

been able to free the ruralites from the hold of the indigenous bankers and moneylenders.

(vii) Failure to Develop Exchange Banks:

The Bank has failed to develop Indian exchange banks with the result that foreign banks

operating in the country continue to pocket a major portion of the foreign exchange business.

The State Bank of India and a few public sector banks which deal in foreign exchange

business and have their offices in foreign countries have not been able to achieve much in this

direction because of the lack of clear policy guidelines by the RBI.

(viii) Deterioration of Customer Service:

Since the nationalisation of 20 banks, the customer service in these banks has deteriorated.

The RBI has recently adopted a few measures in this direction, but customer service in public

sector still lags behind private and foreign banks.

(ix) Failure to Control Black Money:

The RBI has failed to check the growth of black money in the country. In fact, its credit

squeeze policy has encouraged black money because traders and businessmen are able to get

credit from the black money.

Conclusion:

Despite these failures, the RBI has ushered-in a new era of social banking. It has carried

banking to the remotest corners of the country. It has created sound credit and monetary

policies in keeping with the development efforts of the country.

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It has brought stability to the banking system. It has been instrumental in providing credit

facilities to agriculturists, industrialists, exporters, and to ordinary persons engaged in

different vocations. It is thus one of the prime movers in the development process.

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