A Project Report On ROLE OF RBI IN INDIAN ECONOMY Submitted In the Partial fulfilment of the Degree of PGDM (International Business)

By Ajay Gupta (01) Under the Guidance of Dr. Neelam Tandon Associate Professor JIMS KALKAJI New Delhi

Submitted to Jagan Nath International Management School Kalka Ji, New Delhi (2012-2014)

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."

OVERVIEW OF RBI
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. Dr. Raghuram Rajan 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 , on established it took over the function of management of currency from government of India and power of credit control from imperial bank of India.

Objectives and Reasons for the Establishment of R.B.I. :

The main objectives for establishment of RBI as the Central Bank of India were as follows: To manage the monetary and credit system of the country To stabilizes internal and external value of rupee For balanced and systematic development of banking in the country For proper arrangement of agriculture finance For proper arrangement of industrial finance For proper arrangement of public debts To establish monetary relations with other countries of the world and international financial institutions. For centralization of cash reserves of commercial banks To maintain balance between the demand and supply of currency According to the Reserve Bank of India Act, the aim of RBI is , to regulate the issue of bank notes and keeping of reserve with a view to secure system of the country to its advantage.

Nationalization of RBI:
passed in march 1949. To make RBI more powerful the Govt. of India nationalised RBI on January 1, 1949. 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. 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. The image is a newspaper clipping giving the views of Governor CD Deshmukh, prior to nationalization

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. 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 payme 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. 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 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 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.

REGULATION OF BANKING SYSTEM

Objective The objectives of bank regulation, and the emphasis, varies between jurisdiction. 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

General principles of bank regulation

Banking regulations can vary widely across nations and jurisdictions. This section of the article describes general principles of bank regulation throughout the world. Minimum requirements Requirements are imposed on banks in order to promote the objectives of the regulator. The most important minimum requirement in banking regulation is maintaining minimum capital ratios. Supervisory review Banks are required to be issued with a bank license by the regulator in order to carry on business as a bank, and the regulator supervises licenced banks for compliance with the requirements and responds to breaches of the requirements through obtaining undertakings, giving directions, imposing penalties or revoking the bank's licence. Market discipline The regulator requires banks to publicly disclose financial and other information, and depositors and other creditors are able to use this information to assess the level of risk and to make investment decisions. As a result of this, the bank is subject to market discipline and the regulator can also use market pricing information as an indicator of the bank's financial health.

Instruments and requirements of bank regulation

Capital requirement The capital requirement sets a framework on how banks must handle their capital in relation to their assets. Internationally, the Bank for International 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.

Financial reporting and disclosure requirements 1. Prepare annual financial statements according to a financial reporting standard, have them audited, and to register or publish them 2. Prepare more frequent financial disclosures, e.g. Quarterly Disclosure Statements 3. Have directors of the bank attest to the accuracy of such financial disclosures 4. Prepare and have registered prospectuses detailing the terms of securities it issues (e.g. deposits), and the relevant facts that will enable investors to better assess the level and type of financial risks in investing in those securities.

Credit rating requirement

Banks may be required to obtain and maintain a current credit rating from an approved credit rating agency, and to disclose it to investors and prospective investors. Also, banks may be required to maintain a minimum credit rating. Large exposures restrictions Banks may be restricted from having imprudently large exposures to individual counterparties or groups of connected counterparties. This may be expressed as a proportion of the bank's assets or equity, and different limits may apply depending on the security held and/or the credit rating of the counterparty. Related party exposure restrictions Banks may be restricted from incurring exposures to related parties such as the bank's parent company or directors. Typically the restrictions may include:

and conditions

related parties must be not more than limited amounts or proportions of the bank's assets or equity.

CREDIT CONTROL
One of the more pleasant aspects of the latest quarterly Monetary Policy Review is the attempt by the Reserve Bank of India to be as predictable as possible, or at least less disruptive than it has been before. The notion that some elements of a tighter money policy would be announced was pretty much to be expected. While raising repo rates by 25 basis points and leaving other indicators of liquidity unchanged, the RBI Governor, Dr Y. V. Reddy, has tried to play both policeman and purveyor of optimism, the former by raising marginally the cost of capital for banks through the repo rate hike, and the latter by selectively pushing up the provisioning norms for certain categories of borrowers hoping thereby to catch inflation by the scruff and pull it back within the 5.5 per cent limit. Lest the markets think the RBI is a killjoy, in its combat against inflation, the Governor has raised the bar on growth expectations jettisoning his earlier forecast and the prognosis of North Block for a 9 per cent GDP target for this waning fiscal. He has tried therefore to be all things to all men, in the bargain creating a dilemma that may not augur well for the economy in the medium to long term. The basic problem is that the RBI cannot hope to both fight inflation and propel growth to the levels it wants with the measures it has so far set in motion. Controls on credit expansion for select categories with inflation potential capital markets and commercial real-estate through higher provisioning may choke demand only if it is sensitive to the cost of credit. But in a booming economy, higher costs can be transmitted

down the line; witness the rising housing loan rates. In many a high-flying sector banks may, therefore, still find takers for expensive credit. Regardless of the RBI's marginal increase in repo rates, the perception of a tighter money regime will push up interest rates all around, thus contributing to the price rise instead of combating it. Given the nature of inflation, currently at a two-year high, the task of fighting it lies with New Delhi. The Government must put together a gamut of measures to remove the supply bottlenecks that are causing the price rise. The RBI admits that the growth in agriculture has "not been sanguine" with the declining output in major cereals pushing up prices. Focusing its Monetary Policy weapons on "credit quality" and, therefore, the health of the banking system, the RBI has prudently left this initiative to New Delhi.

OBJECTIVE OF 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. 1. To save Gold Reserves: The central bank adopts various measures of credit control to safe guard the gold reserves against internal and external drains. 2. To achieve stability in the Price level: Frequently changes in prices adversely affect the economy. Inflationary and deflationary trends need to be prevented. This can be achieved by adopting a judicious of credit control. 3. 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. 4. To meet Business Needs: According to Burgess, one of the important objectives of credit control is the Adjustment of the volume of credit to the volume of Business credit is needed to meet the requirements of trade an industry. So by controlling credit central bank can meet the requirements of business.

METHOD OF CREDIT CONTROL

There are two method of credit control:Quantitative method 1. Bank Rate Policy 2. Open Market Operations 3. Change in Reserve Ratios 4. Credit Rationing Qualitative method 1. Direct Action 2. Moral persuasion 3. Legislation 4. Publicity

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):Cash reserve Ratio (CRR) is the amount of Cash(liquid cash like gold)that the banks have to keep with RBI. This Ratio is basically to secure solvency of the bank 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 increased and they are able to lend more.RBI has reduced this ratio three times and reduced it from 9 % to 5.5% in last one month or so. 6. Repo Rate:Repo rate is the rate at which our banks 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 they they borrow from bank at repo rate and if bank has a surplus fund then the deposit the funds with RBI and earn at Reverse repo rate .So reverse Repo rate is the 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 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 rate is 7.5% and reverse repo rate is 6%.

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 complied by investing in Govt bonds.present rate of SLR is 24 %.But Banks average is 27.5 % ,the reason behind it is that in deficit budgeting Govt landing is more so they borrow money from banks by selling their bonds to banks.so banks have invested more than required percentage and use these 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 news papers, 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.

Bibliography:BOOKS Indian financial system -Indian economy

Website www.rbi.org.in