RAM MANOHAR LOHIYA NATIONAL LAW

UNIVERSITY

2017-2018
Final draft of:
Banking and Insurance law:
Role of RBI in Indian Economy.

Submitted to:- Submitted by:-

Dr. Aparna Singh Ayushi Verma
Asst.professor Section -A
Rmlnlu Enrollment no.-35
Semester
VI

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ACKNOWLEDGMENT:

I would like to express my heartfelt gratitude to my teacher and

mentor Dr. Aparna Singh (assistant professor), a special thanks to
the Vice Chancellor of Dr. Ram Manohar Lohiya National Law
University, Mr. Gurdeep Singh for providing me with this
opportunity. I also greatly acknowledge the help and guidance
provided to me by Prof. C.M. Jariwala (Dean Academics).
Thanks and appreciation to my family members for their
constant support, to the library staff and other members of this
institution and lastly to my friends for their help.

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TABLE OF CONTENTS:

• Introduction

• Nationalization of RBI

• Role of RBI in India

• Classification of RBI’s functions

• Credit Control

• Conclusion

• Bibliography

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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.

Duvvuri Subbarao who succeeded Yaga Venugopal Reddy on September 2,

2008 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.

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NATIONALIZATION OF RBI:

 With a view to have a cordinated regulation of Indian banking Indian

Banking Act was passed in march 1949. To make RBI more powerful the
Govt. of India nationalised 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. 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

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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.

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

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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.

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.

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

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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 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 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.

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 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.

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

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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.

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

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requirements through obtaining undertakings, giving directions, imposing
penalties or revoking the bank's licence.

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.

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.

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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.

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.

OBJECTIVE OF CREDIT CONTROL:

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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:

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

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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. 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.

5. 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

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institutions to control credit either by expansion or by contraction.

CONCLUSION

I would like to conclude that, the RBI was established in 1935. It was
nationalised in 1949. The RBI plays role of regulator of the banking system
in India. The Banking Regulation Act 1949 and the RBI Act 1953 has given
the RBI the power to regulate the banking system.

The RBI formulates monetary policy twice a year. It reviews the policy
every quarter as well.

The RBI has been assigned the role of controlling and supervising the bank
system in India. The RBI is responsible for controlling the overall operations
of all banks in India. Section 22 of the RBI Act gives authority to the RBI to
issue currency notes. The RBI also takes action to control circulation of fake
currency.

Under the Banking Regulation Act 1949, the RBI has been given powers to
grant licenses to commence new banking operations. The RBI also grants
licenses to open new branches for existing banks.

Apart from the above, the RBI publishes periodical review and data related
to banking. The RBI plays a very important role in every aspect related to
banking and finance. Finally the control of NBFCs and others in the
financial world is also assigned with RBI.

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BIBLIOGRAPHY:

BOOKS:

 M.Y. Khan –Indian financial system

 Sudhir shah-Indian economy

Website:

www.rbi.org.in

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