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Bachelor of Business Administration Submitted byMr.Vishal Sharma B.B.A. 5th (sem)

ALPINE INSTITUTE OF MGT. & TECH, Nandaki Chawki, Premnagar, Dehradun (U.K.) 2011


Before I get into the depth of the thing, I would like to add a few heartfelt words for the people who at various stages of the project development helped me by their valuable guidance.

First and foremost I would like to pay my sincere gratitude which I owe to Mr. Suneel Chauhan (HOD), and Ms. Priya Sharma (project guide), for their valued help and guidance which they gave me when I needed it the most. It was only due to their sincere help and efforts that I was able to end up with this project.

Last but not the least; I would like to pay our gratitude to my PARENTS, without their help and blessing I cant take a single step in right direction..

Vishal Sharma

SL No. 1234567891011121314TITLES Introduction History Central Board of Directors Governors Supportive Bodies Offices & Branches Main Functions Related Functions RBI Function of R B I Role of R B I Objectives of R B I R B I Action Case Study on FEMA

The banking section will navigate through all the aspects of the Banking System in India. It will discuss upon the matters with the birth of the banking concept in the country to new players adding their names in the industry in coming few years. The banker of all banks, Reserve Bank of India (RBI), the Indian Banks Association (IBA) and top 20 banks like IDBI, HSBC, ICICI, ABN AMRO, etc. has been well defined under three separate heads with one page dedicated to each bank. However, in the introduction part of the entire banking cosmos, the past has been well explained under three different heads namely:

History of Banking in India Nationalisation of Banks in India Scheduled Commercial Banks in India

The first deals with the history part since the dawn of banking system in India. Government took major step in the 1969 to put the banking sector into systems and it nationalised 14 private banks in the mentioned year. This has been elaborated in Nationalisationof Banks in India. The last but not the least explains about the scheduled and unscheduled banks in India. Section 42 (6) (a) of RBI Act 1934 lays down the condition of scheduled commercial banks. The description along with a list of scheduled commercial banks are given on this page.

History of Banking in India

Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reason of India's growth process. The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalisation of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money have become the order of the day. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below:

Early phase from 1786 to 1969 of Indian Banks Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector Reforms.

New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991.

To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III. Phase I The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in india as the Central Banking Authority. During those days public has lesser confidence in the banks. As an aftermath deposit mobilisation was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders. Phase II Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalised Imperial Bank of India with extensive banking facilities on a large scale specially in rural and semi-urban areas. It formed State Bank of india to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July, 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalised. Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country:

1949 : Enactment of Banking Regulation Act.

1955 : Nationalisation of State Bank of India. 1959 : Nationalisation of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalisation of 14 major banks. 1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalisation of seven banks with deposits over 200 crore.

After the nationalisation of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions. Phase III This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalisation of banking practices. The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.

The Reserve Bank of India (RBI), is the central banking institution of India and controls the monetary policy of the rupee as well as US$300.21 billion (2010) of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934. The share capital was divided into shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the beginning. Reserve Bank of India plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. Reserve Bank of India was nationalised in the

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

Seal of RBI Headquarters

The RBI headquarters in Mumbai Mumbai, Maharashtra 18.93337N 72.836201ECoordinates: 18.93337N 72.836201E 1 April 1935 Duvvuri Subbarao India Indian Rupee INR

Coordinates Established Governor Central bank of Currency ISO 4217 Code Reserves Base deposit rate Website

US$300.21 billion (2010 7.00% rbi.org.in


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

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

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

Between 1969 and 1980, the Indian government nationalized 6 more commercial banks, following 14 major commercial banks being nationalized in 1969(As mentioned in RBI website). The regulation of the economy and especially the financial sector was reinforced by the Government of India in the 1970s and 1980s. The central bank became the central player and increased its policies for a lot of tasks like interests, reserve ratio and visible deposits The measures aimed at better economic development and had a huge effect on the company policy of the institutes. The banks lent money in selected sectors, like agri-business and small trade companies. The branch was forced to establish two new offices in the country for every newly established office in a town.The oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce the effects.

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

The national economy came down in July 1991 and the Indian rupee was devalued The currency lost 18% relative to the US dollar, and the Narsimahmam Committee advised restructuring the financial sector by a temporal reduced reserve ratio as well as the statutory liquidity ratio. New guidelines were published in 1993 to establish a private banking sector. This turning point should reinforce the market and was often called neo-liberal The central bank deregulated bank interests and some sectors of the financial market like the trust and property markets. This first phase was a success and the central government forced a diversity liberalization to diversify owner structures in 1998. The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed nationalized banks in July to interact with the capital market to reinforce their capital base. The central bank founded a subsidiary companythe Bharatiya Reserve Bank Note Mudran Limitedin February 1995 to produce banknotes.

Since 2000
The Foreign Exchange Management Act from 1999 came into force in June 2000. It should improve the foreign exchange market, international investments in India and transactions. The RBI promoted the development of the financial market in the last years, allowed online banking in 2001 and established a new payment system in 2004 - 2005 (National Electronic Fund Transfer). The Security Printing & Minting Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and produces banknotes and coins. The national economy's growth rate came down to 5.8% in the last quarter of 2008 2009 and the central bank promotes the economic development.

Central Board of Directors

The Central Board of Directors is the main committee of the central bank. The Government of India appoints the directors for a four-year term. The Board consists of a governor, four deputy governors, four directors to represent the regional boards, and ten other directors from various fields.

The central bank till now was governed by 21 governors. The 22nd, Current Governor of Reserve Bank of India is Dr Subbarao

Supportive bodies
The Reserve Bank of India has four regional representations: North in New Delhi, South in Chennai, East in Kolkata and West in Mumbai. The representations are formed by five members, appointed for four years by the central government and serve - beside the advice of the Central Board of Directors - as a forum for regional banks and to deal with delegated tasks from the central board. The institution has 22 regional offices. The Board of Financial Supervision (BFS), formed in November 1994, serves as a CCBD committee to control the financial institutions. It has four members, appointed for two years, and takes measures to strength the role of statutory auditors in the financial sector, external monitoring and internal controlling systems. The Tarapore committee was set up by the Reserve Bank of India under the chairmanship of former RBI deputy governor S S Tarapore to "lay the road map" to capital account convertibility. The five-member committee recommended a three-year time frame for complete convertibility by 1999-2000. On 1 July 2006, in an attempt to enhance the quality of customer service and strengthen the grievance redressal mechanism, the Reserve Bank of India constituted a new department Customer Service Department (CSD).

Offices and branches

The Reserve Bank of India has 4 regional offices,15 branches and 5 sub-offices. It has 22 branch offices at most state capitals and at a few major cities in India. Few of them are located in Ahmedabad, Bangalore, Bhopal, Bhubaneswar, Chandigarh, Chennai, Delhi, Guwahati, Hyde rabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow, Mumbai, Nagpur, Patna, andThiruvananthapuram. Besides it has sub-offices at Agartala, Dehradun, Gangtok, Kochi, Panaji, Raipur, Ranchi, Shimla and Srinagar. The bank has also two training colleges for its officers, viz. Reserve Bank Staff College at Chennai and College of Agricultural Banking at Pune. There are also four Zonal Training Centresat Belapur, Chennai, Kolkata and New Delhi.

Main functions

Reserve Bank of India regional office, Delhi entrance with the Yakshini sculpture depicting "Prosperity through agriculture"

The RBI Regional Office in Delhi.


regional offices of GPO (in white) and RBI (in sandstone) at Dalhousie Square, Kolkata.

Bank of Issue
Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes. The assets and liabilities of the Issue Department are kept separate from those of the Banking Department. Originally, the assets of the Issue Department were to consist of not less than twofifths of gold coin, gold bullion or sterling securities provided the amount of gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might be held in rupee coins, Government of India rupee securities, eligible bills of exchange and promissory notes payable in India. Due to the exigencies of the Second World War and the post-was period, these provisions were considerably modified. Since 1957, the Reserve Bank of India is required to maintain gold and foreign exchange reserves of Rs. 200 crores, of which at least Rs. 115 crores should be in gold. The system as it exists today is known as the minimum reserve system.

Monetary authority
The Reserve Bank of India is the main monetary authority of the country and beside that the central bank acts as the bank of the national and state governments. It formulates implements and monitors the monetary policy as well as it has to ensure an adequate flow of credit to productive sectors. Objectives are maintaining price stability and ensuring adequate flow of credit to productive sectors. The national economy depends on the public sector and the central bank promotes an expansive monetary policy to push the private sector since the financial market reforms of the 1990s. The institution is also the regulator and supervisor of the financial system and prescribes broad parameters of banking operations within which the country's banking and financial system functions. Objectives are to maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. The Banking Ombudsman Scheme has been formulated by the Reserve Bank of India (RBI) for effective addressing of complaints by bank customers. The RBI controls the monetary supply, monitors economic indicators like the gross domestic product and has to decide the design of the rupee banknotes as well as coins.

Manager of exchange control

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

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

Minimum Reserve System - Principle of Currency Note Issue

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

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

Related functions
The RBI is also a banker to the government and performs merchant banking function for the central and the state governments. It also acts as their banker. The National Housing Bank(NHB) was established in 1988 to promote private real estate acquisition. The institution maintains banking accounts of all scheduled banks, too. There is now an international consensus about the need to focus the tasks of a central bank upon central banking. RBI is far out of touch with such a principle, owing to the sprawling mandate described above.

Policy rates and Reserve ratios

Policy rates, Reserve ratios, lending, and deposit rates as of 14 September, 2011

Bank Rate


Repo Rate


Reverse Repo Rate


Cash Reserve Ratio (CRR)


Statutory Liquidity Ratio (SLR)


Base Rate


Reserve Bank Rate


Deposit Rate


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

Cash Reserve Ratio (CRR): Every commercial bank has to keep certain minimum cash
reserves with RBI. RBI can vary this rate between 3% and 15%. RBI uses this tool to increase or decrease the reserve requirement depending on whether it wants to affect a decrease or an increase in the money supply. An increase in Cash Reserve Ratio (CRR) will make it mandatory on the part of the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This will reduce the size of their deposits and they will lend less. This will in turn decrease the money supply. The current rate is 6%.

Statutory Liquidity Ratio (SLR): Apart from the CRR, banks are required to maintain
liquid assets in the form of gold, cash and approved securities. Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and thus reduces their capacity to grant loans and advances, thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities. In well-developed economies, central banks use open market operations--buying and selling of eligible securities by central bank in the money market--to influence the volume of cash reserves with commercial banks and thus influence the volume of loans and advances they can make to the commercial and industrial sectors. In the open money market, government securities are traded at market related rates of interest. The RBI is resorting more to open market operations in the more recent years. Generally RBI uses three kinds of selective credit controls: 1. Minimum margins for lending against specific securities. 2. Ceiling on the amounts of credit for certain purposes. 3. Discriminatory rate of interest charged on certain types of advances. Direct credit controls in India are of three types: 1. Part of the interest rate structure i.e. on small savings and provident funds, are administratively set. 2. Banks are mandatorily required to keep 24% of their deposits in the form of government securities. 3. Banks are required to lend to the priority sectors to the extent of 40% of their advances.

Reserve Bank of India (RBI)

The central bank of the country is the Reserve Bank of India (RBI). It was established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the begining. The Government held shares of nominal value of Rs. 2,20,000. Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New

Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks. The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank. The Bank was constituted for the need of following:

To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its advantage.

Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank the Reserve Bank of India.

Bank of Issue
Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes. The assets and liabilities of the Issue Department are kept separate from those of the Banking Department. Originally, the assets of the Issue Department were to consist of not less than twofifths of gold coin, gold bullion or sterling securities provided the amount of gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might be held in rupee coins, Government of India rupee securities, eligible bills of exchange and promissory notes payable in India. Due to the exigencies of the Second World War and the post-was period, these provisions 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 least Rs. 115 crores should be in gold. The system as it exists today is known as the minimum reserve system.

Banker to Government
The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the Government and to carry out their exchange remittances and other banking operations. The Reserve Bank of India helps the Government - both the Union and the States to float new loans and to manage public debt. The

Bank makes ways and means advances to the Governments for 90 days. It makes loans and advances to the States and local authorities. It acts as adviser to the Government on all monetary and banking matters.

Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to the provisions of the Banking Companies Act of 1949, every scheduled bank 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 abolished and banks have been asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities. The minimum cash requirements can be changed by the Reserve Bank of India. The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible 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 Reserve Bank becomes not only the banker's bank but also the lender of the last resort.

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 groups or persons on the basis of certain types of securities. Since 1956, selective controls of credit are increasingly being used by the Reserve Bank. The Reserve Bank of India is armed with many more powers to control the Indian money market. 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 certain stipulated conditions are not fulfilled. Every bank will have to get the permission 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 and liabilities. This power of the Bank to call for information is also intended to 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 authority in the country, the Reserve Bank of India, therefore, has the following powers: (a) It holds the cash reserves of all the scheduled banks. (b) It controls the 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 providing rediscount facilities to scheduled banks.

Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rate of exchange. 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 was 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 1946, the Reserve Bank has the responsibility of maintaining fixed exchange rates with all other member countries of the I.M.F. Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies. The vast sterling balances were acquired and managed by the Bank. Further, the RBI has the responsibility of administering the exchange controls of the country.

Supervisory functions
In addition to its traditional central banking functions, the Reserve bank has certain nonmonetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of supervision and control over commercial and co-operative banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction, and liquidation. The RBI is authorised to carry out periodical inspections of the banks and to call for returns and necessary information from them. The nationalisation of 14 major Indian scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing the growth of banking and credit policies towards more rapid development of the economy and realisation of certain desired social 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 improve the methods of their operation.

Promotional functions
With economic growth assuming a new urgency since Independence, the range of the Reserve Bank's functions has steadily widened. The Bank now performs a varietyof developmental and promotional functions, which, at one time, were regarded as outside the normal scope of central banking. The Reserve Bank was asked to promote banking habit, extend 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 Corporation 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 and to mobilise savings, and to provide industrial finance as well as agricultural finance. As far back as 1935, the Reserve Bank of India set up the Agricultural 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 from the villages and to route its short term credit to agriculture. The RBI has set 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 are 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 significant as they control and regulate the volume of money and credit in the country. Equally important, however, are the non-monetary functions of the RBI in the context of India's economic backwardness. The supervisory function of the RBI may be regarded as a nonmonetary function (though many consider this a monetary function). 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 of their assets, management and methods of working, inspection, amalgamation, reconstruction and liquidation. Under the RBI's supervision and inspection, the working of banks has greatly improved. Commercial banks have developed into financially and operationally sound and viable units. The RBI's powers of supervision have now been extended to non-banking financial intermediaries. Since independence, particularly after its nationalisation 1949, the RBI has followed the promotional functions vigorously and has been responsible for strong financial support to industrial and agricultural development in the country.

Role of RBI (Reserve Bank of India) in Payment Systems

The Reserve Bank of India participates in the payment systems as a user of the system, as the service provider for various components of the systems and is also the regulator of the systems in many instances. As a user, the RBI submits instruments for clearing in the cheque-based clearing operations. RBI also participates as a user in the Electronic Clearing Service (ECS)and

EFT systems for making its own internal payments to its employees, vendor payments

etc. Similarly, RBI transactions in Repo / Reverse Repo under LAF, Open Market
Operations etc., would also be settled through the respective components of payment systems. As a provider of payment system services, the RBI has taken many initiatives as can be seen under the evolution of payment systems in the country in the development and operationalisation of the systems. Under this, the clearing houses and ECS systems are managed by the Reserve Bank of India at 16 and 15 centres respectively and EFT systems are completely managed by RBI at the 15 centres. The CFMS, NDS/SSS and RTGS systems have been fully developed, operationalised and maintained by RBI. Besides the above, RBI (through IDRBT) has also provided the communication back bone to the financial system in the country in the form of Indian Financial Network (INFINET). By way of being the central bank, the RBI derives regulatory powers in certain jurisdictions of payment systems. However, specific oversight powers for payment systems for RBI is sought to be obtained through appropriate legislation in the form of the Payment Systems Legislation and the setting of Board for Payment and Settlement Systems.

Organizational Framework
Moving from a technology-based solution towards issues of Payment and Settlement Systems, the Reserve Bank of India has adopted a holistic approach, in which Information Technology is an integral component. In order to usher in and establish a modern, robust payments and settlement system consistent with international best practices, the Reserve Bank has adopted a three-pronged strategy of Consolidation of existing Payment Systems, Development of Payment Systems and Integration of the Payment and Settlement System. In order to drive this Payment System reforms process an institutional framework and structure has been created within the Reserve Bank. The base layer of this structure consisted of the Payment Systems Group, which included an exclusive team of inter-disciplinary professionals representing IT, Banking Operations, Supervision, Legal, Economics, Government & Bank Accounts, and Foreign Exchange operations. The Group focused on the System Design of an integrated payments system, Payment Instruments, Electronic Banking systems, clearing and settlement arrangements, technological infrastructure, legal issues, Monetary Policy implications, Change management and responsibilities of banks. The Group was disbanded in December 2002. The next tier in the institutional framework is the Payment Systems Advisory Committee which is a permanent body and oversees the operations of the Payment Systems Group and reviews the developments in the area of Payment Systems. The apex layer in the institutional structure is the National Payments Council. The council lays down the broad policy framework and guidelines for the implementation of a sound and efficient payments and settlement system for the country. The NPC is chaired by the Deputy Governor in charge of the Department of Information Technology and represented by the Executive Directorin-Charge of the Department of Information Technology, Chairman of the Indian Banks Association, Joint Secretary, Banking Division, Ministry of Finance, Chairmen and Managing Directors of two Public Sector banks, one Private bank, a Nonbanking financial company, Securities Exchange Board of India and the National Stock Exchange. The National Payments

Council is assisted by five permanent Task Forces, each of which is headed by a member of the National Payments Council and comprises of a few experts appointed by the Chairman from different disciplines / institutions. It is assisted by the respective Head of the Department concerned within the Reserve Bank. These are the:

Task Force on Monetary Policy and related issues; Task Force on Payment and Settlement Systems Oversight; Task Force on Legal Issues; Task Force on Technology Related Issues; Task Force on Systems and Procedures related issues.

Role of Reserve Bank of India (RBI) in Indian Economy

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

It brings uniformity to note issue. It is easier to control credit when there is a single agency of note issue. It keeps the public faith in the paper currency alive. It helps in the stabilization of the internal and external value of the currency and Credit can be regulated according to the needs of the business. The system of note issue as it exists today is known as the minimum reserve system. The currency notes issued by the Bank arid legal tender everywhere in India without any limit. At present, the Bank issues notes in the following denominations: Rs. 2, 5, 10, 20, 50 100, and 500. The responsibility of the Bank is not only to put currency into, or withdraw it from, the circulation but also to exchange notes and coins of one denomination into those of other denominations as demanded by the public. All affairs of the Bank relating to note issue are conducted through its Issue Department.

Banker, Agent and Financial Advisor to the State:

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

It keeps the banking accounts of the government. It advances short-term loans to the government and raises loans from the public. It purchases and sells through bills and currencies on behalf to the government. It receives and makes payment on behalf of the government. It manages public debt and

It advises the government on economic matters like deficit financing price stability, management of public debts. etc.

Banker to the Banks:

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

Custodian of Foreign Exchange Reserves:

It is the responsibility of the Reserve bank to stabilize the external value of the national currency. The Reserve Bank keeps golds and foreign currencies as reserves against note issue and also meets adverse balance of payments with other counties. It also manages foreign currency in accordance with the controls imposed by the government. As far as the external sector is concerned, the task of the RBI has the following dimensions:

To administer the foreign Exchange Control; To choose ,the exchange rate system and fix or manages the exchange rate between the rupee and other currencies; To manage exchange reserves; To interact or negotiate with the monetary authorities of the Sterling Area, Asian Clearing Union, and other countries, and with International financial institutions such as the IMF, World Bank, and Asian Development Bank. The RBI is the custodian of the countrys foreign exchange reserves, id it is vested with the responsibility of managing the investment and utilization of the reserves in the most advantageous manner. The RBI achieves this through buying and selling of foreign exchange market, from and to schedule banks, which, are the authorized dealers in the Indian, foreign exchange market. The Bank manages the investment of reserves in gold counts abroad and the shares and securities issued by foreign governments and international banks or financial institutions.

Lender of the Last Resort:

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

Banks of Central Clearance, Settlement and Transfer:

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

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

Supervisory Functions:
In addition to its traditional central banking functions, the Reserve Bank has certain nonmonetary functions of the nature of supervision of banks and promotion of sound banking in India. The supervisory functions of the RBI have helped a great deal in improving the methods of their operation. The Reserve Bank Act, 1934, and Banking Regulation Act, 1949 have given the RBI wide powers of:

Supervision and control over commercial and cooperative banks, relating to licensing and establishments. Branch expansion. Liquidity of their assets. Management and methods of working, amalgamation reconstruction and liquidations. The RBI is authorized to carry out periodical inspections off the banks and to call for returns and necessary information from them.

Promotional Role
A striking feature of the Reserve Bank of India Act was that it made agricultural credit the Banks special responsibility. This reflected the realisation that the countrys central bank should make special efforts to develop, under its direction and guidance, a system of institutional credit for a major sector of the economy, namely, agriculture, which then accounted for more than 50 per cent of the national income. However, major advances in agricultural finance materialised only after Indias independence. Over the years, the Reserve Bank has helped to evolve a suitable institutional infrastructure for providing credit in rural areas. Another important function of the Bank is the regulation of banking. All the scheduled banks are required to keep with the Reserve Bank a consolidated 3 per cent of their total deposits, and the

Reserve Bank has power to increase this percentage up to 15. These banks must have capital and reserves of not less than Rs.5 lakhs. The accumulation of these balances with the Reserve Bank places it in a position to use them freely in emergencies to support the scheduled banks themselves in times of need as the lender of last resort. To a certain extent, it is also possible for the Reserve Bank to influence the credit policy of scheduled banks by means of an open market operations policy, that is, by the purchase and sale of securities or bills in the market. The Reserve bank has another instrument of control in the form of the bank rate, which it publishes from time to time. Further, the Bank has been given the following special powers to control banking companies under the Banking Companies Act, 1949:

The power to issue licenses to banks operating in India. The power to have supervision and inspection of banks. The power to control the opening of new branches. The power to examine and sanction schemes of arrangement and amalgamation. The power to recommend the liquidation of weak banking companies. The power to receive and scrutinize prescribed returns, and to call for any other information relating to the banking business. The power to caution or prohibit banking companies generally or any banking company in particular from entering into any particular transaction or transactions. The power to control the lending policy of, and advances by banking companies or any particular bank in the public interest and to give directions as to the purpose for which advances mayor may not be made, the margins to be maintained in respect of secured advances and the interest to be charged on advances.

Indias apex bank: The Reserve Bank of India(RBI), its objectives and functions
The Reserve Bank of India (RBI) is the apex financial institution of the countrys financial system entrusted with the task of control, supervision, promotion, development and planning. RBI is the queen bee of the Indian financial system which influences the commercial banks management in more than one way. The RBI influences the management of commercial banks through its various policies, directions and regulations. Its role in bank management is quite unique. In fact, the RBI performs the four basic functions of management, viz., planning, organising, directing and controlling in laying a strong foundation for the functioning of commercial banks.

Objectives of the Reserve Bank of India

The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of the Reserve Bank as: to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage. Prior to the establishment of the Reserve Bank, the Indian financial system was totally inadequate on account of the inherent weakness of the dual control of currency by the Central Government and of credit by the Imperial Bank of India. The Hilton-Young Commission, therefore, recommended that the dichotomy of functions and division of responsibility for control of currency and credit and the divergent policies in this respect must be ended by setting-up of a central bank called the Reserve Bank of India which would regulate the financial policy and develop banking facilities throughout the country. Hence, the Bank was established with this primary object in view. Another objective of the Reserve Bank has been to remain free from political influence and be in successful operation for maintaining financial stability and credit. The fundamental object of the Reserve Bank of India is to discharge purely central banking functions in the Indian money market, i.e., to act as the note- issuing authority, bankers bank and banker to government, and to promote the growth of the economy within the framework of the general economic policy of the Government, consistent with the need of maintenance of price stability. A significant object of the Reserve -Bank of India has also been to assist the planned process of development of the Indian economy. Besides the traditional central banking functions, with the launching of the five-year plans in the country, the Reserve Bank of India has been moving ahead in performing a host of developmental and promotional functions, which are normally beyond the purview of a traditional Central Bank.

Functions of the Reserve Bank of India

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

Issuing currency notes, Le., to act as a currency authority. Serving as banker to the Government. Acting as bankers bank and supervisor. Monetary regulation and management. Exchange management and control. Collection of data and their publication. Miscellaneous developmental and promotional functions and activities. Agricultural Finance. Industrial Finance Export Finance. Institutional promotion.

RBIs Role in Risk Management and Settlement of Transactions in the Foreign Exchange Market

Foreign Exchange Market Share

The Indian Foreign Exchange (Forex) market is characterized by constant changes and rapid innovations in trading methods and products. While the innovative products and ways of trading create new possibilities for profit, they also pose various kinds of risks to the market. Central banks all over the world, therefore, have become increasingly concerned of the scale of foreign exchange settlement risk and the importance of risk mitigation measures. Behind this growing awareness are several events in the past in which foreign exchange settlement risk might have resulted in systemic risk in global financial markets, including the failure of Bankhaus Herstatt in 1974 and the closure of BCCI SA in 1991. The foreign exchange settlement risk arises because the delivery of the two currencies involved in a trade usually occurs in two different countries, which, in many cases are located in different time zones. This risk is of particular concern to the central banks given the large values involved in settling foreign exchange transactions and the resulting potential for systemic risk. Most of the banks in the EMEs use some form of methodology for measuring the foreign exchange settlement exposure. Many of these banks use the single day method, in which the exposure is measured as being equal to all foreign exchange receipts that are due on the day. Some institutions use a multiple day approach for measuring risk. Most of the banks in EMEs use some form of individual counterparty limit to manage their exposures. These limits are often applied to the global operations of the institution. These limits are sometimes monitored by banks on a regular basis. In certain cases, there are separate limits for foreign exchange

settlement exposures, while in other cases, limits for aggregate settlement exposures are created through a range of instruments. Bilateral obligation netting, in jurisdictions where it is legally certain, is an important way for trade counterparties to mitigate the foreign exchange settlement risk. This process allows trade counterparties to offset their gross settlement obligations to each other in the currencies they have traded and settle these obligations with the payment of a single net amount in each currency. Several emerging markets in recent years have implemented domestic real time gross settlement (RTGS) systems for the settlement of high value and time critical payments to settle the domestic leg of foreign exchange transactions. Apart from risk reduction, these initiatives enable participants to actively manage the time at which they irrevocably pay way when selling the domestic currency, and reconcile final receipt when purchasing the domestic currency. Participants, therefore, are able to reduce the duration of the foreign exchange settlement risk. Recognizing the systemic impact of foreign exchange settlement risk, an important element in the infrastructure for the efficient functioning of the Indian foreign exchange market has been the clearing and settlement of inter-bank USD-INR transactions. In pursuance of the recommendations of the Sodhani Committee, the Reserve Bank had set up the Clearing Corporation of India Ltd. (CCIL) in 2001 to mitigate risks in the Indian financial markets. The CCIL commenced settlement of foreign exchange operations for inter-bank USD-INR spot and forward trades from November 8, 2002 and for inter-bank USD-INR cash and tom trades from February 5, 2004. The CCIL undertakes settlement of foreign exchange trades on a multilateral net basis through a process of notation and all spot, cash and tom transactions are guaranteed for settlement from the trade date. Every eligible foreign exchange contract entered between members gets notated or replaced by two new contracts between the CCIL and each of the two parties, respectively. Following the multilateral netting procedure, the net amount payable to, or receivable from, the CCIL in each currency is arrived at, member-wise. The Rupee leg is settled through the members current accounts with the Reserve Bank and the USD leg through CCILs account with the settlement bank at New York. The CCIL sets limits for each member bank on the basis of certain parameters such as members credit rating, net worth, asset value and management quality. The CCIL settled over 900,000 deals for a gross volume of US $ 1,180 billion in 2005-06. The CCIL has consistently endeavoured the entire gamut of foreign exchange transactions under its purview. Intermediation, by the CCIL thus, provides its members the benefits of risk mitigation, improved efficiency, lower operational cost and easier reconciliation of accounts with correspondents. An issue related to the guaranteed settlement of transactions by the CCIL has been the extension of this facility to all forward trades as well. Member banks currently encounter problems in terms of huge outstanding foreign exchange exposures in their books and this comes in the way of their doing more trades in the market. Risks on such huge outstanding trades were found to be very high and so were the capital requirements for supporting such trades. Hence, many member banks have expressed their desire in several fora that the CCIL should extend its guarantee to these forward trades from the trade date itself which could lead to significant increase in the liquidity and depth in the forward market. The risks that banks today carry in their books on account of large outstanding forward positions will also be

significantly reduced (Gopinath, 2005). This has also been one of the recommendations of the Committee on Fuller Capital Account Convertibility. Apart from managing the foreign exchange settlement risk, participants also need to manage market risk, liquidity risk, credit risk and operational risk efficiently to avoid future losses. As per the guidelines framed by the Reserve Bank for banks to aligns and exposure in derivative markets as market makers, the boards of directors of ADs (category-I) are required to frame an appropriate policy and fix suitable limits for operations in the foreign exchange market. The net overnight open exchange position and the aggregate gap limits need to be approved by the Reserve Bank. The open position is generally measured separately for each foreign currency consisting of the net spot position, the net forward position, and the net options position. Various limits for exposure, viz., overnight, daylight, stop loss, gap limit, credit limit, value at risk (VaR), etc., for foreign exchange transactions by banks are fixed. Within the contour of these limits, front office of the treasury of ADs transacts in the foreign exchange market for customers and own proprietary requirements. These exposures are accounted, confirmed and settled by back office, while mid-office evaluates the profit and monitors adherence to risk limits on a continuous basis. In the case of market risk, most banks use a combination of measurement techniques including and managed by most banks on an aggregate counter-party basis so as to include all exposures in the underlying spot and derivative markets. Some banks also monitor country risk through cross-border country risk exposure limits. Liquidity risk is generally estimated by monitoring asset liability profile in various currencies in various buckets and monitoring currency-wise gaps in various buckets. Banks also track balances to be maintained on a daily basis in Nostro accounts, remittances and committed foreign currency term loans while monitoring liquidity risk. To sum up, the foreign exchange market structure in India has undergone substantial transformation from the early 1990s. The market participants have become diversified and there are several instruments available to manage their risks. Sources of supply and demand in the foreign exchange market have also changed in line with the shifts in the relative importance in balance of payments from current to capital account. There has also been considerable improvement in the market infrastructure in terms of trading platforms and settlement mechanisms. Trading in Indian foreign exchange market is largely concentrated in the spot segment even as volumes in the derivatives segment are on the rise. Some of the issues that need attention to further improve the activity in the derivatives segment include flexibility in the use of various instruments, enhancing the knowledge and understanding the nature of risk involved in transacting the derivative products, reviewing the role of underlying in booking forward contracts and guaranteed settlements of forwards. Besides, market players would need to acquire the necessary expertise to use different kinds of instruments and manage the risks involved.

Interest Rate Administration by Reserve Bank of India (RBI) during Global Recession/Subprime Crisis
The subprime crises triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States ,lead to major adverse consequences for banks and financial markets around the globe. Administered interest rates are one of the major measures for controlling the money supply in an economy. Bank rate, repo rate and reverse repo rate are administered by The Reserve Bank of India. The records show high fluctuation in the interest rates in the past in India. The Reserve Bank of India (RBI) made drastic cuts in interest rates during the recession period to make sure that the banks and individuals get the benefit of higher credit availability. The Government of India had the stimulus package for the India Inc., where as the Banking sector has been successfully managed by RBI measures.

Meaning of Interest Rates/Policy rates: Interest rates can be defined from different
perspectives, for an Individual an interest rate is the price a borrower pays for the use of money, they do not own. For an Organization, Interest is a fee paid on borrowed funds/assets. It is the price paid for the use of borrowed money or, money earned by deposited funds. For General Banking, An interest rate is the amount received in relation to an amount loaned. An interest rate is the amount received in relation to an amount loaned, generally expressed as a ratio of rupees received per hundred rupees lent. Interest rates can be classified as specific interest rates and interest rates in general. Specific interest rates area interest rates on a particular financial instrument market, these rates are driven by market forces (i.e. Demand and supply). General interest rates, such as bank rate are administered

interest rates i.e. re set by some established group ( bank rate is administered by central bank of a country, RBI in India ).

Bank Rate,Repo and Reverse Repo Rate: Every central bank functions as a controller of
credit in an economy. One of the measures to control credit is by the way of monitoring the bank rate, repo rate and reverse repo rate. Bank rate is the rate at which the central bank (R in INDIA) lends to commercial banks and acts an important benchmark in determination of interest rates charged by banks from the ultimate borrowers. In brief, raising bank rates by raising bank rate, central bank raises the cost of borrowing. This forces the commercial banks to raise in turn the rate of interest from the public and vice versa. Changes in bank rate are generally referred in terms of basis points. A basis point (often denoted as bp) is a unit relating to interest rates that is equal to 1/100th of a percentage point per annum. It is frequently but not exclusively used to express differences in interest rates of less than 1% pa. It avoids the ambiguity between relative and absolute discussions about rates. For example, a 1% increase from a 10% interest rate could refer to an increase either from 10% to 10.1% (relative), or from 10% to 11%. Similar, are the repo and reverse repo rates. Whenever the banks have any shortage of funds they can borrow it either from Reserve Bank of India (RBI) or from other banks. The repo rate is the rate at which the banks borrow these excess funds. The borrowing bank mortgages its government securities to carry out this loan transaction. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from the various commercial banks. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to attractive interest rates. It can cause the money to be drawn out of the banking system.

RBI Actions During Global Recession/Subprime Crisis

Since September 2008, RBI has taken multiple actions in order to ensure that the economy does not suffer a massive downturn. The RBI has cut the repo rate by 400 basis points from 9% to 5%, reverse repo rate by 250 basis points from 6% to 3.5% and the CRR by 400 basis points from a high of 9% to the current 5%. Where as the Statutory Liquidity Ratio (SLR) was reduced from 25% to 24%. The RBI has also reprimanded the Banks which have been slow in passing on the benefits of the lower interest rate onto the borrower. It clearly pointed out that the interest rate cuts by the public sector banks have been in the range of 1.25%-2.25%, 1%-1.25% for private banks and 1% for foreign banks. The slackness in passing on benefits to the consumers can be seen in a comparison between reactions of banks to RBI policies in 2004 and 2008. Towards the beginning of 2004 the RBI key policy rates were at approximately similar levels although private banks were charging about 7.5-8% during that time and are currently charging approximately 10-11% for home loans.

The RBI has adopted a comparatively more conservative target of 6%, as compared to the Governments 7% GDP growth target for the current fiscal, in light of the global downturn resulting in moderation of growth and muted inflationary pressures that are being experienced currently by the Indian economy. The policy announced a cut in repo and reverse repo by 25 bps in order to encourage lowering of lending rates, increased lending and stimulate aggregate demand within the economy in order to mitigate downside risks. After the additional 25 bps cut, currently the repo rate has lowered down to 4.75% and reverse repo rate to 3.25%.There is also a clear indication that the central bank will continue to monitor the economic performance as downside risks continue to persist in the economy and necessary action will be undertaken as deemed favorable which translates to possibly more rate cuts in the short term.

2006 2007 2008 2009 5.25 6.00 6.00 4.00 5.50 6.00 6.00 4.00 5.50 6.00 6.00 3.50 5.50 6.00 6.00 3.25 5.50 6.00 6.00 3.25

5.50 6.00 6.00 3.25 5.75 6.00 6.00 3.25 6.00 6.00 6.00 3.25 6.00 6.00 6.00 3.25 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 5.00

26-oct-05 24-jan-06 9-jun-06 25-jul-06 31-oct-06 23-dec-06 6-jan-07 31-jan-07 17-feb-07 3-mar-07 30-mar-07 14-apr-07 28-apr-07 4-aug-07 10-nov-07 26-apr-08

5.25 5.50 5.75 6.00 6 6 6 6 6 6 6 6 6 6 6 6

Reverse repo
6.25 6.50 6.75 7.00 7.25 7.25 7.25 7.50 7.5 7.5 7.75 7.75 7.75 7.75 7.75 7.75

10-may-08 24-may-08 11-jun-08 25-jun-08 5-jul-08 19-jul-08 30-jul-08 30-aug-08 11-oct-08 20-oct-08 25-oct-08 3-nov-08 8-nov-08 8-dec-08 January 05,2009 January 17,2009 March 05,2009 April 21,2009

6 6 6 6 6 6 6 6 6 6 6 6 6 5.00 4.00 4 3.50 3.25

7.75 7.75 8.00 8.50 8.5 8.5 9.00 9 9 8.00 8 7.50 7.5 6.50 5.50 5.5 5.00 4.75

Impact of RBIs Actions

Lowering of the interest rates would first impact the deposit rates offered by banks as they bring down their cost of funds and then pass on the benefits to the borrowers by lowering lending rates. The impact of lower deposit rates will make fixed income instruments less attractive in the short to medium term. The sharp recent correction in real estate prices that has led to rationalization in property prices has now made real estate a relatively more attractive option. As the fixed deposit rates continue to fall real estate as an asset class will start attracting more investments and become a more preferred investment vehicle. The cut in both reverse repo and repo is expected to induce banks to reduce their lending rates as seen with the immediate cut in lending rates by certain private banks of 50 bps. This reduction in turn will add more spending power of the borrowers as existing loans get cheaper resulting in increased discretionary income which will start to draw the consumer to spend again and help in boosting demand. The new loans generation will also be done at a lower rate which will in turn increase the borrowers affordability. As developers procure additional loans at a lower rate they would be able to pass this benefit on to the end user with lower capital values. The lower lending rates will also result in lower EMI payment resulting in higher affordability, as the interest rates continue to soften in the short to medium term. As per the policy the credit to housing by banks has reduced from 12% on Feb. 15, 2008 to 7.5% on Feb. 27, 2009 from the previous year. Showing the abating demand which has impacted real estate prices resulting in a correction of 20-30% across India from the peak levels established in 2008. On the commercial real estate front, developers who were facing a liquidity crunch will be able to abate the stringent cash flows as there is already sufficient liquidity in the banking system and as the lending rate reduces, the cost of funds for the developers would decrease leading to improved cash flows. This in turn would help many in completing their unfinished projects and meet their expected deadlines. Although fears in the system remain that adequate lending might not occur to the real estate sector due to risk aversion that has developed by banks to control rising NPAs. The only dampener to the lower interest rates would be the government borrowings which the RBI has assured will be carried out smoothly with sufficient liquidity in the system being provided. During the first half of the current fiscal year, planned open market operations (OMO) purchases and Market Stabilization Scheme (MSS) are expected to add further liquidity of approximately INR 1,20,000 crore in the financial sector during in the short term. This expected liquidity along with the rate cuts lead to the long term yields falling after the policy announcement and analysts are expecting the long term yield to drop below 6% in the short term. The dropping of long term yields and increasing liquidity is expected to keep the cost of funds relatively low for the banks amounting to lower lending rates in the short to medium term. A regime of similar components namely low lending rates, ample liquidity was found during the year 2003-04 which led to the start of the real estate Bull Run. Thus we find that the seeds for the next growth cycle being sowed in the current downturn. As experienced in 2002-03 the real estate market remained subdued due to lower economic growth, India is again expected to witness moderate growth during the current financial year

which will translate to suppressed real estate prices. International agencies such as the IMF and World Bank etc are pegging revival of the economy in the first half of 2010 and momentum is likely to be gained only in the second half of calendar year 2010. Due to the economic uncertainty with forecast ranging from 5%-7% one cannot presently foresee the start of the next real estate bull run, however, the market is likely to bottom out during the first half of the next financial year, making it apt for the investor to invest in properties at a discounted prices during the year with a long term investment horizon.

Case Study on FEMA: RBI slapped Rs.125 crore on Reliance Infrastructure

The Reserve Bank of India (RBI) has asked the Anil Dhirubhai Ambani Group firm, Reliance Infrastructure (earlier, Reliance Energy), to pay just under Rs 125 crore as compounding fees for parking its foreign loan proceeds worth $300 million with its mutual fund in India for 315 days, and then repatriating the money abroad to a joint venture company. These actions, according to an RBI order, violated various provisions of the Foreign Exchange Management Act (FEMA). In its order, RBI said Reliance Energy raised a $360-million ECB on July 25, 2006, for investment in infrastructure projects in India. The ECB proceeds were drawn down on November 15, 2006, and temporarily parked overseas in liquid assets. On April 26, 2007, Reliance Energy repatriated the ECB proceeds worth $300 million to India while the balance remained abroad in liquid assets. It then invested these funds in Reliance Mutual Fund Growth Option and Reliance Floating Rate Fund Growth Option on April 26, 2007. On the following day, i.e., on April 27 2007, the entire money was withdrawn and invested in Reliance Fixed Horizon Fund III Annual Plan series V. On March 5, 2008, Reliance Energy repatriated $500 million (which included the ECB proceeds repatriated on April 26, 2007, and invested in capital market instruments) for investment in capital of an overseas joint venture called Gourock Ventures based in British Virgin Islands. RBI said, under FEMA guidelines issued in 2000, a borrower is required to keep ECB funds parked abroad till the actual requirement in India. Further, the central bank said a borrower cannot utilise the funds for any other purpose. The conduct of the applicant was in contravention of the ECB guidelines and the same are sought to be compounded, the RBI order signed by its chief general manager Salim Gangadharan said. During the personal hearing on June 16, 2008, Reliance Energy, represented by group managing director Gautam Doshi and Price waterhouse Coopers executive director Sanjay Kapadia, admitted the contravention and sough compounding. The company said due to unforeseen circumstances, its Dadri power project was delayed. Therefore, the ECB proceeds of $300 million were bought to India and was parked in liquid debt mutual fund schemes, it added.

Rejecting Reliance Energys contention, RBI said it took the company 315 days to realise that the ECB proceeds are not required for its intended purpose and to repatriate the same for alternate use of investment in an overseas joint venture on March 5, 2008. Reliance also contended that they invested the ECB proceeds in debt mutual fund schemes to ensure immediate availability of funds for utilization in India. I do not find any merit in this contention also as the applicant has not approached RBI either for utilizing the proceeds not provided for in the ECB guidelines, or its repatriation abroad for investment in the capital of the JV, the RBI official said in the order. In its defense, the company said the exchange rate gain on account of remittance on March 5 2008, would be a notional interim rate gain as such exchange rate gain is not crystallized. But RBI does not think so. They have also stated that in terms of accounting standard 11 (AS 11), all foreign exchange loans have to be restated and the difference between current exchange rate and the rate at which the same were remitted to India, has to be shown as foreign exchange loss/gain in profit and loss accounts. However, in a scenario where the proceeds of the ECB are parked overseas, the exchange rate gains or losses are neutralized as the gains or losses restating of the liability side are offset with corresponding exchange losses or gains in the asset. In this case, the exchange gain had indeed been realized and that too the additional exchange gain had accrued to the company through an unlawful act under FEMA, the order said. It said as the company has made additional income of Rs 124 crore, it is liable to pay a fine of Rs 124.68 crore. On August this year, the company submitted another fresh application for compounding and requested for withdrawal of the present application dated April 17, 2008, to include contravention committed in respect of an another transaction of ECB worth $150 million. But RBI said the company will have to make separate application for every transaction and two transactions are different and independent and cannot be clubbed together.