What are the main Functions of Reserve Bank of India?

A. Traditional Functions

B. Monopoly of Note Issue.

1. Banker to the Government Agent and adviser to the Government

2. Banker to the Banks. Acts as the clearing

3. House of the country Lender of last resort Controller of credit and fore Custodian of foreign

4. Exchange reserves maintaining the external value of domestic currency.

5. Ensures the internal value of currency.

6. Publishers the Economics Statistics and other.

7. The following are the important functions of RBI. They can be explained with the help of the following chart:

Functions of Reserve Bank of India

1. Information. Fights against economic crisis and ensures economic and price stability in the country

2. Promotional Functions

3. Promotional of banking habit and expansion of banking systems. Provides refinance for export promotion. Expansion of facilities for the provision of agricultural credit through NABARD

4. Extension of facilities for the Small Scale Industries.

5. Helping the co-operative sector.

6. Prescription of minimum statutory requirements. Innovations in banking business.

C. Supervisory Functions

1. Granting license to banks.

2. Inspect and make enquiry or determine position in respect of matters under various sections of RBI and Banking Regulation Act.

3. Implementation of Deposit Insurance Scheme.

4. Periodical review of review of the work of commercial banks.

5. Giving directives to commercial banks.

6. Control the non- banking finance cor­porations.

7. Ensuring the health of financial system through on-site and off-site verifications.

Let us discuss the important functions one by one in detail.

A. Traditional Functions

The RBI functions on the traditional lines regarding the following activities.

1. Monopoly of Note Issue

In terms of Section 22 of the Reserve Bank of India Act, the RBI has been given the statutory function of note issue on a monopoly basis. The note issue in India was originally based upon "Proportional Reserve System".

When it became difficult to maintain the re­serve proportionately, it was replaced by "Minimum Reserve System ". According to the RBI Amendment Act of 1957, the bank should now maintain a minimum reserve of Rs.200 crore worth of gold coins, gold bullion and foreign securities of which the value of gold coin and bullion should be not less than Rs.115 crore.

The Government of India issues rupee coins in the denomination of Rs.1, 2, and 5 topublic. These coins are required to be circulated to public only through Reserve Bank un­der Section 38 of the RBI Act. The RBI presently issues notes of denominations Rs.10 and above.

RBI manages circulation of money through currency chests. Originally RBI issued currency notes of Rs.2 and above. However, due to higher cost of printing small denomina­tion notes these denominations are now coincides and issued by Government.

The value of currency with public as on June 1991 was only to the extent of Rs.53048 crore. However, this value went up to Rs.145182 crore in June 1998 and further to Rs.169382 crore in March, 1999.

Currency Chests Currency Chests are receptacles in which stocks of issuable and new notes are stored along with rupee coins. Currency Chests are repositories run by RBI, SBI, subsidiaries of SBI, public sector banks, Government Treasuries and Sub treasuries.

Cur­rency Chests help in expansion and contraction of currency in the country. The advantages for a bank having currency chest are:

(i) The bank can draw funds whenever it is required for its use and deposit funds when found surplus.

(ii) Exchange old and mutilated notes for new notes and coins

(iii) Enjoy remittance facilities

(iv) Cash remitted to currency chests by banks can be taken into account for mainte­nance of CRR.

The currency chests maintained by public sector and few private sector banks are the property of RBI. The value of currency held in the chest belongs to RBI. There are as many as 4150 currency chests with banks in India.

2. Banker to the Government

The RBI acts as banker to the Government under Section 20 of RBI Act. Section 21 provides that Government should entrust its money remittance, exchange and banking transactions in India to RBI. Under Section 21A RBI has to conduct similar transactions for State Governments also.

RBI earns no income by conducting those functions but earns com­missions for managing the government's public debt. Where RBI has no branch, SBI or its subsidiaries are appointed as agents and sub-agents under Section 45 of the RBI Act. Agency Banks receive commission on all transactions conducted on turnover basis.

The RBI extends ' ways and means ' advances to Central and State Governments.

Ways and Means Advances:

"Ways and Means Advances" (WMA) is not a commercial bank credit. It is a system under which the RBI provides credit to Central and State Gov­ernments for meeting temporary shortfall in government revenues as compared to the monthly expenditures.

In other words, this facility is provided to meet temporary mis­matches between revenue collections and revenue expenditures of governments. The maxi­mum volume and period of such advances are governed by agreements between RBI and the concerned government. To the State Governments, this facility is extended under three categories known as

1. Normal WMA

2. Special WMA and

3. as an overdraft facility.

It also acts as adviser to Government on economic and financial matters. In brief, as a banker to the Government the RBI renders the following functions:

(a) Collects taxes and makes payments on behalf of the Government

(b) Accepts deposits from the Government

(c) Collects cheques and drafts deposited in the Government accounts.

(d) Provides short-term loans to the Government

(e) Provides foreign exchange resources to the Government.

(f) Keep the accounts of various Government Department.

(g) Maintains currency chests in treasuries at some importance places for the conve­nience of the government.

(h) Advises governments on their borrowing programmes.

(i) Maintains and operates Central Government's IMF accounts.

3. Agent and Adviser of the Government

The RBI acts, as the financial agent and adviser to the Government. It renders the fol­lowing functions:

(a) As an agent to the Government, it accepts loans and manages public debts on behalf of the Government.

(b) It issues Government bonds, treasury bills, etc.

(c) Acts as the financial adviser to the Government in all important economic and financial matters.

4. Banker to the Banks

The RBI acts as banker to all scheduled banks. Commercial banks including foreign banks, co-operative banks and RRBs are eligible to be included in the second schedule of RBI Act subject to fulfilling conditions laid down under Section 42 (6) of RBI Act.

RBI has powers to delete a bank from the second schedule if the bank concerned fails to fulfill the laid down conditions such as erosion in paid up capital below the prescribed limits and the banks' activities became detrimental to the interest of depositors, etc.

All banks in India, should keep certain percentage of their demand and time liabilities as reserves with the RBI. This is known as Cash Reserve Ratio or CRR. At end November 1999, it is 3 per cent for RRBs and co-operative banks; 9 per cent for commercial banks.

They also maintain Current Account with RBI for various banking transactions. This centralization of reserves and accounts enables the RBI to achieve the following:

(a) Regulation of money supply credit.

(b) Acts as custodian of cash reserves of commercial banks.

(c) Strengthen the banking system of the country

(d) Exercises effective control over banks in Liquidity Management.

(e) Ensures timely financial assistance to the Banks in difficulties.

(f) Gives directions to the Banks in their lending policies in the public interest.

(g) Ensures elasticity in the credit structure of the country.

(h) Quick transfer of funds between member banks.

5. Acts as National Clearing House

In India RBI acts as the clearing house for settlement of banking transactions. This function of clearing house enables the other banks to settle their interbank claims easily. Further it facilitates the settlement economically.

Where the RBI has no offices of its own, the function of clearing house is carried out in the premises of the State Bank of India. The entire clearing house operations carried on by RBI are computerized. The inter-bank cheque clearing settlement is done twice a day.

There is a separate route for clearing high value cheques of Rs.1.00 lakh and above. Cheques drawn on banks in metropolitan cities are cleared on the same day.

The RBI carries out this function through a cell known as National Clearing Cell. In 1998, there were in all 860 clearing houses in operation of which 14 were run by RBI, 578 by SBI and others by public sector banks.

The RBI acts as a lender of last resort or emergency fund provider to the other member banks. As such, if the commercial banks are not able to get financial assistance from any other sources, then as a last resort, they can approach the RBI for the necessary financial assistance.

In such situations, the RBI provides credit facilities to the commercial banks on eligible securities including genuine trade bills which are usually made available at Bank Rate.

RBI rediscounts bills under Section 17 (2) and 17 (3) and grants advances against secu­rities under Section 17 (4) of RBI Act. However, many of these transactions are practically carried out through separate agencies like DHFI, Securities Trading Corporation of India, primary dealers.

The RBI now mainly provides refinance facilities as direct assistance. Rediscounting of bills fall under the following categories:

(i) Commercial Bill:

A bill arising out of bonfire commercial or trade transaction drawn and payable in India and mature within 90 days from the date of pur­chase or discount is eligible for rediscount.

(ii) Bills for Financing Agricultural Operations:

A bill issued for purpose of financ­ing seasonal agricultural operations or the marketing of crops and maturing within 15 months from the date of purchase or rediscount.

(iii) Bills for Financing Cottage and Small Scale Industries:

Bills drawn or is­sued for the purpose of financing the production and marketing of products of cottage and small industries approved by RBI and mature within 12 months from the date of discount.

Refinance under agricultural and small scale industries activities are now provided by NABARD by obtaining financial assistance from RBI. Bill for holding or trading in Government securities: Such a bill should mature within 90 days from the date of purchase or rediscounting and be drawn and payable in India,

(iv) Foreign bills:

Bonfire bill arising out of export of goods from India and which mature within 180 days from the date of shipment of goods are eligible. As lender of last resort the RBI facilitates the following:

(a) Provides financial assistance to commercial banks at the time of financial needs.

(b) It helps the commercial banks in maintaining liquidity of their financial resources.

(c) Enables the commercial banks to carry out their activities with minimum cash reserves.

(d) As a lender of last resort, the RBI can exercise full control over the commercial banks.

7. Acts as the Controller of Credit

The RBI controls the credit creation by commercial banks. For this, the RBI uses both quantitative and qualitative methods. The important methods used by RBI are,

(i) Bank Rate Policy

(ii) Open Market Operation

(iii) Variation of Cash Reserve Ratio

(iv) Fixing Margin Requirements

(v) Moral Suasion

(vi) Issue of Directives

(vii) Direct Action

By controlling credit, the RBI achieves the following:

(a) Maintains the desired level of circulation of money in the economy.

(b) Maintains the stability in the price level prevailing in the economy.

(c) Controls the effects of trade cycles

(d) Controls the fluctuations in the foreign exchange rate

(e) Channelize credit to the productive sectors of the economy

8. Custodian of Foreign Exchange Reserves

The RBI acts as the custodian of foreign exchange reserves. Adequate reserves may help maintain foreign exchange rates. In order to minimize the undue fluctuations in the rates it may buy and sell foreign currencies depending upon the situations.

Its purchase and sale of foreign currencies from the market is done like commercial banks. However, the objective of the RBI will not be profit booking.

It may buy the foreign currency to build up adequate reserves or to arrest unwarranted rise in the value of rupee which may be due to sudden inflow of foreign currencies into India. It may also buy and sell foreign currencies in international market to switch the portfolio of investments de­nominated in different international currencies depending upon circumstances and needs.

The value of India's Foreign Exchange reserves held by RBI as on June 1998 amounted to Rs.115001 crore. This amount comprises of gold Rs.12826 crore, foreign currency assets and value of IMF currency, viz., SDR (Special Drawing Rights).

These reserves are increased to Rs. 1, 38,005 crore in March 1999. The value of foreign currency assets of RBI, which form the largest portion in India's Foreign Currency reserves, is subject to changes even on daily basis depending upon ruling exchange rates, inflow and outflow of currencies, interven­tion policy of the RBI, etc.

9. Exchange Control

When a country faces Balance of Payment of problems usually when its foreign ex­change payments exceed foreign exchange receipts it controls the whole gamut of fore (foreign exchange) transactions and regulates payment system for its advantage.

Ever since the beginning of Second World War in 1939 India faced shortage of forex for its develop­ment and growth. A Foreign Exchange Regulation Act was originally put in operation from March 1947 and later a new act known as Foreign Exchange Regulation Act (FERA) 1973 was introduced from 1st January 1974.

Under this Act, RBI is empowered to regulate foreign exchange outgo and inflow, for example, we cannot buy everything we need from abroad and pay for it in forex.

Trade side imports, i.e., merchandise imports are regulated by Director General Foreign Trade in the Ministry of Commerce. Payment for invisible transactions like tourism, foreign visit, dividend/interest payment, etc. is regulated by RBI.

Similarly, all forex received or earned by residents in India, like exporters and rela­tives of NRIs [Non-resident Indian] should be surrendered to banks having license from RBI to deal in forex. However, since 1992, the receivers of forex are permitted to retain certain part of this forex in a separate foreign currency account if they so desire. Such account is known as Exchange Earners' Foreign Currency Account or EEFC Account.

Fur­ther, since 1994 many controls exercised by RBI on forex payments were relaxed. These days the RBI regulates forex transactions only to a minimum level and soon the Act, FERA may be replaced by a new Foreign Exchange Management Act.

While the purchase and sale of forex, maintenance of foreign exchange reserves/gold, are handled in the Depart­ment of External Investment and operations the control and regulations of various other forex transactions are handled in the Exchange Control Department of Reserve Bank of India.

The RBI by its operation of credit control and price stability maintains the internal value of domestic currency and ensures its stability

External Value of Rupee

In terms of preamble to RBI Act, the Bank is also required to maintain external, value of the Rupee. It, however, depends upon many factors like inflation levels, interest rates Balance of payments situation, etc., ruling in different countries on which RBI does not have control. Earlier, till 1993 the RBI uses to prescribe the Exchange Rate of Rupee.

The external value of rupee is now determined by market forces. RBI by virtue of its position as the Central Bank of the country and custodian of large forex reserves can influence the level of External Value in the short run.

Publishes the Economic Statistics and Other Information

The RBI collects statistics on economic and financial matters. It publishes periodically an analytical account of the operations of joint stock and co-operative banks. It presents the genuine financial position of the government and companies.

The publications like the report on currency and finance, the report on the trend and progress of banking in India, the review of co-operative movement present a critical account and a balanced review of banking developments commercial, economic and financial conditions of the country.

Fights against Economic Crisis

The RBI aims at economic stability in the country whenever, there is a danger to the economic stability, it takes immediate measures to put the economy on proper course by effective policy changes and implementation thereof.

Promotional Functions

These are non-monetary functions. They include the following:

1. Promotion of Banking Habits

The RBI institutionalizes saving through the promotion of banking habit and expan­sion of the banking system territorially and functionally.

Accordingly RBI has set up De­posit Insurance Corporation in 1962, Unit Trust of India in 1964, the IDBI in 1964, the Agri­cultural Refinance Corporation in 1963, Industrial Reconstruction Corporation of India in 1972, NABARD in 1982 and the National Housing Bank in 1988, etc.

It has helped to bring into existence several industrial finance corporations such as Industrial Finance Corpora­tion of India, Industrial Credit and Investment Corporation of India for industrialization of the country. Similarly sector specific corporations took care of development in their respec­tive spheres of activity.

2. Provides Refinance for Export Promotion

The RBI takes the initiative for widening facilities for the provision of finance for for­eign trade particularly of exports.

The Export Credit and Guarantee Corporation (ECGC) and Exam Banks render useful functions on this line. To encourage exports the RBI is providing refinance facilities for export credit given by commercial banks. Further the rate of interest on export credits con­tinues to be prescribed by RBI at a lower rate.

The ECGC provides an insurance cover on Export receivables. EXIM Bank extends long term finance to project exporters and foreign currency credit for promotion of Indian exports. Students should know that many of these institutions were part of Reserve Bank earlier although they are currently functioning as separate financial institutions.

3. Facilities for Agriculture

The RBI extends indirect financial facilities to agriculture regularly. Through NABARD it provides short-term and long-term financial facilities to agriculture and allied activities. It established NABARD for the overall administration of agricultural and rural credit. Indian agriculture would have starved of a cheap credit but for the institutionalization of rural credit by RBI.

The Reserve Bank was extending financial assistance to the rural sector mainly through contributions to the National Rural Credit Funds being operated by NABARD. RBI pres­ently makes only a symbolic contribution of Rs.1.00 crore.

It, however, extends cheap indi­rect financial assistance to the agricultural sector by providing large sums of money through General Line of Credit to NABARD. The loans and advances extended to NABARD by RBI and outstanding as on June 1999 amounted to Rs.5073 crore.

4. Facilities to Small Scale Industries

The RBI takes active steps to increase the supply of credit to small industries. It gives directives to the commercial banks regarding the extension of credit facilities to small scale industries. It encourages commercial banks to provide guarantee services to SSI sector. Banks advances to SSI sector are classified under priority sector advances.

SSI sector contributes to a very great extent to employment opportunities and for Indian Exports. Keeping this in view, RBI has directed commercial banks to open specialized SSI bank branches to provide adequate financial and technical assistance to SSI branches. There are around 30 lakh SSI units operating in India. Meeting their financial needs is one of the prime concerns of RBI.

5. Helps Co-operative Sector

RBI extends indirect financing to State Co-operative Banks thereby connects the co­operative sector with the main banking system of the country. The finance is mostly, is routed through NABARD. This way the financial needs of agricultural sector are taken care of by RBI.

6. Prescription of Minimum Statutory Requirements for Banks

The RBI prescribes the minimum statutory requirements such as, paid up capital, re­serves, cash reserves, liquid assets, etc. RBI prescribes reserves requirements both under Banking Regulation Act and RBI Act to ensure different objectives.

For example, SLR pre­scription is done to ensure liquidity position of the bank. CRR prescription is done to have effective monetary control and money supply. Statutory Reserves Appropriation is done to ensure sound banking system, etc.

It also asks banks to set aside provisions against pos­sible bad loans. With these functions, it exercises control over the monetary and banking systems of the country to ensure growth, price stability and sound banking practices.

C. Supervisory Functions

The Reserve Bank of India performs the following supervisory functions. By these functions it controls and administers the entire financial and banking systems of the country.

1. Granting License to Banks

The RBI grants license to the banks, which like to commence their business in India. Licenses are also required to open new branches or closure of branches. With this power

RBI can ensure avoidance of unnecessary competitions among banks in particular location evenly growth of banks in different regions, adequate banking facility to various regions, etc. This power also helps RBI to weed out undesirable people from starting banking business.

2. Function of Inspection and Enquiry

RBI inspects and makes enquiry in respect of various matters covered under Banking Regulations Act and RBI Act. The inspection of commercial banks and financial institu­tions are conducted in terms of the provisions contained in Banking Regulation Act.

These refer to their banking operations like loans and advances, deposits, investment functions and other banking services. Under such inspection RBI ensures that the banks and finan­cial institutions carry on their operations in a prudential manner, without taking undue risk but aiming at profit maximization within the existing rules and regulations.

This type of inspection is carried on periodically once a year or two covering all branches of banks. Banks are obliged to take remedial measures on the lapses / deficiencies pointed out dur­ing inspection. In addition RBI also calls for periodical information concerning certain assets and liabilities of the banks to verify that the banks continue to remain in good health.

This type of inspection / verification is known as off- site inspection. The RBI team visiting bank offices to conduct verification of books and records is known as on- site inspection. RBI inspects banks under RBI Act only when there is a threat to close down a bank for mismanagement and there is a need to verify the fulfillment of conditions for the status of 'scheduled bank'.

RBI presently conducts inspection of commercial banks, Development Financial Institutions like IDBI, NABARD, etc. Urban Co- operative Banks and non banking financial companies like Lease Financing Companies, Loan Companies.

3. Implementing the Deposit Insurance Scheme

RBI Implements the Deposit Insurance Scheme for the benefit of bank depositors. This supervisory function has improved the standard of banking in India due to this confidence building exercise. Under this system, deposits up to Rs.1.00 lakh with the bank branch are guaranteed for payment. Deposits with the banking system alone are covered under the scheme.

For this purpose banking system include accounts maintained with commercial banks, co- operative banks and RRBs. Fixed Deposits with other financial institutions like ICICI, IDBI, etc. and those with financial companies are not covered under the scheme. ICICI is since merged with ICICI Bank Ltd. and IDBI is getting converted into a bank.

4. Periodical Review of the Working of the Commercial Banks

The RBI periodically reviews the work done by commercial banks. It takes suitable steps to enhance the efficiency of the banks and make various policy changes and imple­ment programmes for the well-being of the nation and for improving the banking system as a whole.

5. Controls the Non-Banking Financial Corporations

RBI issues necessary directions to the Non-Banking financial corporations and con­ducts inspections through which it exercises control over such institutions. Deposit taking NBFCs require permission from RBI for their operations.