DR.

RAM MANOHAR LOHIYA NATIONAL LAW

UNIVERSITY, LUCKNOW

SUBJECT: FINANCIAL MARKET REGULATION

Session: 2019 - 2020

FINAL DRAFT

ON

“Role of RBI in Indian Economy”

SUBMITTED TO: SUBMITTED BY:

Dr. Manoj Kumar Shubham Singh Rawat

Assistant Professor (Law) B.A. LL.B. (Hons.)

RMLNLU Sec. B; Enroll. No.-134

 ACKNOWLEDGEMENT

I express my gratitude and deep regards to my teacher Dr. Manoj Kumar for giving me such a challenging
topic and also for his exemplary guidance, monitoring and constant encouragement throughout the course of
this project.

I also take this opportunity to express a deep sense of gratitude to my seniors in the college for their cordial
support, valuable information and guidance, which helped me in completing this task through various
stages.

I am obliged to the staff members of the Madhu Limaye Library, for the timely and valuable information
provided by them in their respective fields. I am grateful for their cooperation during the period of my
assignment.

Lastly, I thank almighty, my family and friends for their constant encouragement without which this
assignment would not have been possible.

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 TABLE OF CONTENTS

1. INTRODUCTION…………………………………………………………………......................4

2. NATIONALIZATION OF RBI………………………………………………………………….5

3. ROLE OF RBI……………………………………………………………………………………5

4. CLASSIFICATION OF RBI’S FUNCTION…………………………………………………….9

5. REGULATION OF BANKING SYSTEM………………………………………………………9

6. INSTRUMENTS & REQUIREMENTS OF BANK REGULATION………………………….10

7. CREDIT CONTROL & ITS METHOD………………………………………………………...11

8. CONCLUSION…………………………………………………………………………………14

9. BIBLIOGRAPHY………………………………………………………………………………15

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INTRODUCTION

The Reserve Bank of India is the central bank of India, and was established on April 1, 1935 in
accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the
Reserve Bank was initially established in Kolkata but was permanently moved to Mumbai in
1937. Though originally privately owned, the RBI has been fully owned by the Government of
India since nationalization in 1949.
Shaktikanta Das is the current Governor of RBI.
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 nine years.
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as
to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country to its
advantage. It has 22 regional offices, most of them in state capitals.
RBI was started with a paid up share capital of 5 crore and when established it took over the
function of management of currency from Government of India and power of credit control
from Imperial bank of India.

Preamble

The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank
as:
"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country to its
advantage."

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Nationalization of RBI:
 With a view to have a coordinated regulation of Indian banking, The Indian Banking Act
was passed in March, 1949. To make RBI more powerful the Govt. of India nationalized
RBI on January 1, 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 was nationalized with effect from 1st January, 1949 on the
basis of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. All shares
in the capital of the Bank were deemed transferred to the Central Government on payment
of a suitable compensation.

ROLE OF 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 two-fifths 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. 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
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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 except that of Jammu and Kashmir. The Reserve Bank has the obligation
to transact Government business, via. keep the cash balances as deposits free of interest, to
receive and to make payment 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 an 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 liabilities 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

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market. Every bank has to get a license from the Reserve Bank of India to do banking business

within India, the license can be cancelled by the Reserve Bank of India if 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 supreme 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 non-
monetary 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
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 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 authorized to
carry out periodical inspections of the banks and to call for returns and necessary information
from them. The nationalization 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 realization 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 variety of 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 specialized 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 mobilize 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.

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Classification of RBI’s 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 non-
monetary 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 licensing 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 nationalization
in 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.

REGULATION OF BANKING SYSTEM

The objectives of bank regulation, and the emphasis, varies between jurisdictions. The most
common objectives are:
1. Prudential -- to reduce the level of risk bank creditors are exposed to (i.e. to protect
depositors).
2. Systemic risk reduction -- to reduce the risk of disruption resulting from adverse
trading conditions for banks causing multiple or major bank failures.
3. Avoid misuse of banks -- to reduce the risk of banks being used for criminal
purposes, e.g. laundering the proceeds of crime.
4. To protect banking confidentiality.
5. Credit allocation -- to direct credit to favored sectors.
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Instruments and Requirements of Bank Regulation

Capital requirement
The capital requirement sets a framework on how banks must handle their capital in relation
to their assets. Internationally, the Bank for International Settlements' Basel Committee on
Banking Supervision influences each country's capital requirements. In 1988, the Committee
decided to introduce a capital measurement system commonly referred to as the Basel Capital
Accords. The latest capital adequacy framework is commonly known as Basel II. This
updated framework is intended to be more risk sensitive than the original one, but is also a lot
more complex.

Reserve requirement
The reserve requirement sets the minimum reserves each bank must hold to demand deposits
and banknotes. This type of regulation has lost the role it once had, as the emphasis has moved
toward capital adequacy, and in many countries there is no minimum reserve ratio. The
purpose of minimum reserve ratios is liquidity rather than safety. An example of a country
with a contemporary minimum reserve ratio is Hong Kong, where banks are required to
maintain 25% of their liabilities that are due on demand or within 1 month as qualifying
liquefiable assets.
Reserve requirements have also been used in the past to control the stock of banknotes and/or
bank deposits. Required reserves have at times been gold coin, central bank banknotes or
deposits, and foreign currency.

Corporate governance
Corporate governance requirements are intended to encourage the bank to be well
managed, and is an indirect way of achieving other objectives. Requirements may
include:
1. To be a body corporate (i.e. not an individual, a partnership, trust or other
unincorporated entity).
2. To be incorporated locally, and/or to be incorporated under as a particular type of body
corporate, rather than being incorporated in a foreign jurisdiction.
3. To have a minimum number of directors.
4. To have an organizational structure that includes various offices and officers, e.g.
 corporate secretary, treasurer/CFO, auditor, Asset Liability Management Committee,

Privacy Officer etc. Also the officers for those offices may need to be approved persons,
or from an approved class of persons.
5. To have a constitution or articles of association that is approved, or contains or does not
contain particular clauses, e.g. clauses that enable directors to act other than in the best
interests of the company (e.g. in the interests of a parent company) may not be allowed.

CREDIT CONTROL
The central bank makes efforts to control the expansion or contraction of credit in order to keep
it at the required level with a view to achieving the following ends:

 To save Gold Reserves: The central bank adopts various measures of credit control to
safe guard the gold reserves against internal and external drains.
 To achieve stability in the Price level: Frequently changes in prices adversely affect the
economy. Inflationary and deflationary trends needs to be prevented. This can be
achieved by adopting a judicious of credit control.
 To achieve stability in the Foreign Exchange Rate: Another objective of credit control is
to achieve the stability of foreign exchange rate. If the foreign exchange rate is
stabilized, it indicates the stable economic conditions of the country.
 To meet Business Needs: According to Burgess, one of the important objectives of credit
control is the “Adjustment of the volume of credit to the volume of Business” credit is
needed to meet the requirements of trade and industry. So by controlling credit, central
bank can meet the requirements of business.

METHOD OF CREDIT CONTROL

There are two methods of Credit Control:-

1. Quantitative Method
2. Qualitative Method
Quantitative method

1. Bank Rate Policy: Bank rate is the rate of interest which is charged by the central
bank on rediscounting the first class bills of exchange and advancing loans against
approved securities. This facility is provided to other banks. It is also known as
Discount Rate Policy.
2. Open Market Operations: The term “Open Market Operations” in the wider sense
means purchase or sale by a central bank of any kind of paper in which it deals,
like government securities or any other public securities or trade bills etc. in
practice, however the term is applied to purchase or sale of government securities,
short-term as well as long-term, at the initiative of the central bank, as a deliberate
credit policy.
3. Change in Reserve Ratios: Every commercial bank is required to deposit with the
central bank a certain part of its total deposits. When the central bank wants to
expand credit it decreases the reserve ratio as required for the commercial banks.
And when the central bank wants to contract credit the reserve ratio requirement is
increased.
4. Credit Rationing: Credit rationing means restrictions placed by the central bank
on demands for accommodation made upon it during times of monetary stringency
and declining gold reserves. This method of controlling credit can be justified only
as a measure to meet exceptional emergencies because it is open to serious abuse.
5. CRR (Cash Reserve Ratio): The amount of Cash (liquid cash like gold) that the
banks have to keep with RBI. This Ratio is basically to secure solvency of the bank
and to drain out the excessive money from the banks. If RBI decides to increase the
percent of this, the available amount with the banks comes down and if RBI reduce
the CRR then available amount with Banks increases and they are able to lend
more. RBI has reduced this ratio three times and reduced it from 9% to 4% in last
one month or so.
6. Repo Rate: Repo rate is the rate at which our banks borrow rupees from RBI. This
facility is for short term measure and to fill gaps between demand and supply of
money in a bank. When a bank is short of funds then they borrow from bank at
repo rate and if bank has a surplus fund then they deposit the funds with RBI and
earn at Reverse repo rate. So reverse Repo rate is the rate which is paid by RBI to
banks on Deposit of funds with RBI. A reduction in the repo rate will help banks to
 get the money at a cheaper rate. When the repo rate increases, borrowing from RBI
becomes more expensive. To borrow from RBI bank have to submit liquid
bonds /Govt. Bonds as collateral security, so this facility is a short term gap filling
facility and bank does not use this facility to lend more to their customers. Present
repo rate is 5.15 % and reverse repo rate is 4.9 %.
7. SLR (Statutory Liquidity Ratio) is the amount a commercial bank needs to
maintain in the form of cash, or gold or govt. approved securities (Bonds) before
providing credit to its customers. SLR rate is determined and maintained by the
RBI (Reserve Bank of India) in order to control the expansion of bank credit.
Generally this mandatory ration is compiled by investing in Govt. bonds. Present
rate of SLR is 18.75 %. But Banks average is 27.5 %, the reason behind it is that in
deficit budgeting Govt. lending is more so they borrow money from banks by
selling their bonds to banks, so banks have invested more than required percentage
and use these excess bonds as collateral security (over and above SLR) to avail
short term funds from the RBI at repo rate.

Qualitative method
1. Direct Action: The central bank may take direct action against commercial banks that
violate the rules, orders or advice of the central bank. This punishment is very severe of a
commercial bank.

2. Moral persuasion: It is another method by which central bank may get credit supply
expanded or contracted. By moral pressure it may prohibit or dissuade commercial banks
to deal in speculative business.

3. Legislation: The central bank may also adopt necessary legislation for expanding or
contracting credit money in the market.

4. Publicity: The central bank may resort to massive advertising campaign in the
newspapers, magazines and journals depicting the poor economic conditions of the
country suggesting commercial banks and other financial institutions to control credit
either by expansion or by contraction.
 CONCLUSION

The role of RBI as central bank of India is immense and would enhance in the coming years. On July 6,
2005 a new department, named financial market department in reserve bank of India was constituted for
surveillance on financial markets. This newly constituted department will separate the activities of debt
management and monetary operations in future. This department will also perform the duties of developing
and monitoring the instruments of the money market and also monitoring the government securities and
foreign money markets. So it can be concluded that as soon as our country is growing the role of RBI is
going to be very crucial in the upcoming years.
The Payment and Settlement Systems Act of 2007 (PSS Act) gives the Reserve Bank oversight authority,
including regulation and supervision, for the payment and settlement systems in the country. In this role, the
RBI focuses on the development and functioning of safe, secure and efficient payment and settlement
mechanisms. Two payment systems National Electronic Fund Transfer (NEFT) and Real Time Gross
Settlement (RTGS) allow individuals, companies and firms to transfer funds from one bank to another.
These facilities can only be used for transferring money within the country.

Recently Section 7 of the RBI Act has come into spotlight amid the war and loggerheads between the
Central government and the Reserve Bank of India (RBI). The provision in the RBI Act empowers the
government to issue directions to the RBI. Although the government has invoked Section 7 of RBI Act
which has never been used before. Exercising powers under this section, the government has sent several
letters to the then RBI governor Urjit Patel in recent weeks on issues ranging from liquidity for non-banking
financial companies (NBFCs), capital requirement for weak banks and lending to micro, small and medium
enterprises (MSME’s). Therefore with surplus amount of reserves and supplies with it, the importance and
role of RBI would become more important in the coming days, provided Sec. 7 of RBI Act is not interfered
upon by the government with this prestigious independent institution because the whole country’s economy
and future is at stake just for gaining some good/ old political scores.
 BIBLIOGRAPHY

This project was made due to the resources mentioned herein:

Books:-
 M.Y. Khan - Indian Financial System
 Sudhir Shah - Indian Economy

External Web links:-

 https://craytheon.com/charts/rbi_base_rate_repo_reverse_rate_crr_slr.php
 https://www.sanasecurities.com/role-of-rbi-in-indian-economy/
 https://www.jagranjosh.com/general-knowledge/what-are-the-main-functions-of-reserve-bank-of-
india-1488794634-1
 https://www.mbauniverse.com/content/rbi-monetary-authority-india-role-credit-control-tools-how-
it-impacts-indian-economy
 https://www.jstor.org/stable/4417290?seq=1#metadata_info_tab_contents