RBI and its Functions

RBI and its Functions

RBI has to facilitate the flow of an adequate volume of bank credit to industry, agriculture and trade to meet their genuine needs. At the same time, to keep inflationary pressures under check, it has to restrain undue credit expansion and also ensure that credit is not diverted for undesirable purposes. As the central monetary authority, the Reserve Bank’s chief function is to ensure the availability of credit to the extent that is appropriate to sustain the tempo of development and promote the maintenance of internal price stability. The Reserve Bank is empowered under the Banking Regulation Act to issue directions to control loans and advances by banking companies. Reserve Bank at its discretion may issue directions to all banking companies or to any particular banking company, The Reserve Bank may determine the policy in respect of banks’ loans and advances and issue directions fromtime to time. The instruments of credit control are of two types as under: 

(a) General or Quantitative 

(b) Selective or Qualitative

Quantitative/General Credit Control 

Under the General Credit Control, the instruments often employed by RBI are discussed below: 1. Bank Rate Policy

 The Bank rate has been defined in Section 49 of RBI Act as “ the standard rate at which it (RBI) is prepared to buy or rediscount bills of exchange or other commercial paper eligible to purchase under this Act. By varying the rate, the RBI can to a certain extent regulate the commercial bank credit and the general credit situation of the country. The impact of this tool has not been very great because of the fact that RBI does not have a mechanism to control the unorganized sector. 2. Reserve Requirements 

The Reserve Bank of India is vested with the powers to vary the CRR and SLR as explained above. By varying reserve requirements, the RBI restricts/frees the flow of funds by way of credit to different sectors of the economy. When SLR or CRR is increased by RBI, It reduces commercial banks’ capacity to create credit and thus helps to check inflationary pressures 

3. Open Market Operations 

Open market operations are a flexible instrument of credit control by means of which the Reserve Bank on its own initiative alters the liquidity position of the bank by dealing directly in the market instead of using its influence indirectly by varying the cost of credit. Open market operations can be carried out by purchases and sales, by Central Bank, of a variety of assets such as government securities (G-sec), commercial bills of exchange, Foreign exchange, gold and even company shares. In practice, however, RBI confines to the purchase and sale purchase of government securities including treasury bills. When the RBI purchases government securities from the banks, the latest deposits with it tend to increase adding to the cash reserves of banks and hence their capacity to expand credit increase. Conversely, when the RBI sells securities to the banks, their deposits with RBI would get reduced, contracting the credit base. The net result would be a contraction of credit and a reduction in money supply

Repo Rate and Reverse Repo Rate:

 Repos: The RBI introduced repurchase auctions (Repos) since December,1992 with regards to dated Central Government securities. When banking systems experiences liquidity shortages and the rate of interest is increasing, the RBI will purchase Government securities from Banks, payment is made to banks and it improves liquidity and expands credit. 

Reverse Repos : Since November, 1996 RBI introduced Reverse Repos to sell Govt. securities through auction at fixed cut-off rates of interest. It provides short term avenues to banks to park their surplus funds, where there is considerable liquidity and call rate has a tendency to decline. These two rates are, now-a- days, commonly applied for reducing money supply or increasing it. 

4. Moral Suasion 

Moral Suasion indicates the advice and exhortations given by the Reserve Bank to the banks and other players in the financial system, with a view to regulate and control the flow of credit, generally, or to any one particular segment of the economy. This may be attempted through periodical discussions/communications. With a substantial share of banking business being in the public sector, this tool has proved effective. 

5. Direct Action 

This technique indicates the denial of the Reserve Bank to extend facilities to the banks which do not follow sound banking principles or where the Reserve Bank feels the capital structure of the bank is very weak. This is not attempted frequently but is used in rare cases involving continual and wilful violations of policies of the Reserve Bank/Govt. of India.

Selective Credit Control 

Under the Selective Credit Control, the authority of the Reserve Bank is exercised by virtue of the provisions of Section 21 and 35 A of Banking Regulation Act. The Reserve Bank may give directions to banks generally or to any bank or a group of banks in particular on different aspects of granting credit, namely, –

 (a) the purposes for which advances may or may not be made 

(b) the margins to be maintained in respect of secured advances 

(c) the maximum amount of advances or other financial accommodation which may be made by a bank to or the maximum amount of guarantees which may be given by a bank on behalf of any one company, firm, association of persons or individuals, having regard to the bank’s financial position such as paid-up capital, reserves nd deposits and other relevant considerations, and 

(d) the rate of interest and other terms of conditions subject to which advances or other financial accommodation may be granted or guarantees may be given. 

While the first two instruments control the quantum of credit, the third instrument works as a leverage on the cost of credit. Selective Credit Control is imposed to manage the balance between the supply and demand of the essential commodities. The main purpose of the Selective Credit Control is to restrict the speculative hoarding of essential commodities using bank credit. Some of the main restrictions on loans and advances are: 

(i) As per the provisions of the Banking Regulation Act, no banking company in India can grant loans or advances against the security of its own shares

 (ii) No banking company can hold shares in a company

 (a) as pledge or mortgagee in excess of the limit of 30 per cent of the Paid up capital of that company or 30 percent of the Bank’s Paid-up capital andReserves, whichever is less. No banking company can commit to grant or grant loans or advances to or on behalf of any of its directors (iii) Further restrictions on the loans and advance to the director as a partner, guarantor of any loans and advances 

(iv) No banking company can grant loans against

 (a) Fixed Deposits of other Banks 

(b) Certificate of Deposits The restrictions on different types of loans and advance may be imposed from time to time by the Reserve Bank of India according to the requirement of the situation as well.

RBI as a Controller  of  Foreign  Exchange 

RBI has got the powers under Foreign Exchange Management Act, 1999 (FEMA) to prohibit, restrict and regulate the following: 

(a) transfer or issue of any foreign security by a resident of India and by a person residing outside India 

(b) transfer or issue of any security or foreign security by any branch, office or agency in India owned by a person outside India 

(c) any borrowing or lending in foreign exchange 

(d) any borrowing or lending in rupees between a resident in India and a person outside India 

(e) deposits between residents in India and residents outside India

 (f) export, import or holding of currency or currency notes

 (g) transfer of immovable property outside India other than a lease not exceeding five years by a person resident in India 

(h) acquisition or transfer of immovable property in India other than a lease by a person resident outside India 

(i) giving guarantee or surety in respect of any debt obligation or other viability incurred by person resident in India to a person outside India and vice-versa. The Reserve Bank does not deal in foreign exchange directly with the public. It gives license to certain Scheduled Commercial Banks and other entities to deal in foreign exchange and those are known as authorized dealers (ADs) in foreign exchange

Cash – Currency  Management

The currency ( bank notes) of our country is issued by the Reserve Bank of India. The Reserve Bank has the sole right to issue and manage currency in India under Section 22 of the RBI Act. RBI may issue notes of different denominations as decided by the Central Government, based on the recommendations made by the Central Board of the bank from time to time. Such notes should be legal tender at any place in India. The Reserve Bank handles the currency management function through its Department of Currency Management in Mumbai. The aggregate value of gold coins, bullion and foreign securities held by RBI should not be below the prescribed limit at any time. The Reserve Bank currency management is handled through two departments viz., the Issue Department and the Banking Department. The issue department should ensure that the aggregate value of the currency notes and bank notes in circulation from time to time should be equivalent to the eligible assets( gold coins, bullion and foreign securities) held by RBI 

Currency Chests 

The Reserve Bank of India has made adequate arrangements for the issue of currency notes and distribution of coins and currency notes across India. One of the distribution channel used by the Reserve Bank is Currency Chests. Reserve Bank has authorized selected branches of banks to establish currency chests. In these currency chests, bank notes and coins are stocked/stored on behalf of the Reserve Bank. Currency chests which are managed by banks, store soiled and re-issuable notes and also fresh currency notes. The banks review the currency notes (which are in their view not fit for circulation and forward them to RBI for further action. After reexamining them, RBI if necessary, re circulate them, other wise arranges to destroy them, as per their procedures. The issue department co-ordinates with printing presses and mints for its regular supply of notes and coins. It also ensures that notes/coins are distributed through different channels such as Reserve Bank counters, banks, post offices, co-operative banks. 

Currency Printing and Coin Minting 

The Government of India on the advice of the Reserve Bank of India decides on the various denominations for printing the notes. The Reserve Bank coordinates with the Government in designing the bank notes. Printing of currency notes are handled by the Security Printing and Minting Corporation of India Limited (SPMCIL) and The Bharatiya Reserve Bank Note Mudran Pvt Ltd (BRBNMPL) in their different printing presses setup at Nashik, Devas, Mysore. SPMCIL has mints for coin production at Mumbai, Noida, Hyderabad. The Reserve Bank acts as agent for the Central Government for issue, distribution, withdrawing of the coins. Reserve Bank of India’s concern is on the level of forged notes penetrated into the circulation. The Reserve Bank has been regularly educating the public, banks and others through press releases and display of “Know Your Bank Note”. Reserve Bank from time to time circulate information on the security features of the currency notes. Banks are advised to install the required ultra violet machines and counterfeit note detecting machines. Reserve Bank provides training to banks and government treasury offices and issues detailed guidelines on how to detect and take further necessary steps including impounding of such notes.