01 Reserve Bank of India as a Banking Regulator
RESERVE BANK OF India was set up in 1935 under the Reserve Bank
of India Act. 1934 and is the monetary authority and central bank
of the country with responsibilities to overview, develop and
regulate the financial system.
CENTRAL BANKING FUNCTIONS
1. Reserve Bank. as Note-Issuing Authority Section 38 of the RBI
ActThe currency of our country consists of one-rupee notes and
coins (including subsidiary coins) issued by the Government of
India and bank notes issued by RBI. As required by - Government
puts into circulation one-rupee coins and notes through RBI only.
RBI has the sole right to issue bank notes in India. The notes
issued by RBI and the one-rupee notes and coins issued by the
Government are unlimited legal tender. RBI also bears the
responsibility of exchanging notes and coins into those of other
denominations as required by the public.
2. Reserve Bank as Banker to Government Section 20 and 21 of RBI
Act,RBI acts as banker to the Central and State Governments to
transact government business including the management of the public
debt of the Central Government. Section 21 requires the Central
Government to entrust RBI all its money, remittance, exchange and
banking transactions in India and, in particular deposit free of
interest all its cash balances with RBI. RBI performs similar
functions on behalf of the State Governments also. The Bank has
entered into agreements with the Central and State Governments for
carrying on these functions. For conducting ordinary banking
business of the Central Government, RBI is not entitled to any
remuneration; it holds cash balances of the Government free of
interest. For the management of public debt, RBI is entitled to
charge a commission. RBI is also required to maintain currency
chests of its Issue Department at places prescribed by the
Government and to maintain sufficient notes and coins therein.
Reserve Bank of India has also been entrusted with the task of
managing the public debt of the Central and State Governments. It
undertakes auctions for the treasury bills and Government dated
securities are issued by it on behalf of the Government. It is
entitled to charge a commission for managing public debt. It may
also purchase and sell securities of Central and State
Governments.
RBI is also authorized to make to the Central and State
Governments ways and means advances which are repayable within 3
months from the date of making the advance. RBI also acts as
adviser to the Government on important economic and financial
matters.
3. Reserve Bank as Bankers' Bank (2nd Schedule to the RBI Act,
1934)RBI is the banker to the banks-that is, to all commercial.
cooperative and Regional Rural Banks (RRBs).
A 'Scheduled Bank' means a' bank included in the Second Schedule
to the Reserve Bank of India Act, 1934. The Reserve Bank is
empowered to include in the Second Schedule the name of a bank
which carries on the business of banking in India and which
satisfies the conditions laid down in Section 42(b).
(i) It must have a paid up capital and reserves of an aggregate
value of not less than Rs.5Iakh; (ii) It must satisfy the Reserve
Bank that its affairs are not being conducted in a manner
detrimental to the interests of its depositors; and (iii) must have
any of the following structure: (i)Commercial banks-Indian and
foreign. (ii) Public Sector Banks, (iii) State Cooperative Banks,
(iv) Urban Cooperative Banks, and (v) Regional Rural Banks.
The status of "Scheduled Bank" confers certain privileges e.g ..
they become eligible for availing of the facilities of
accommodation from RBI. A scheduled bank. on the other hand. has to
fulfill the obligation to maintain statutory reserves with RBI.
4. Reserve Bank as Lender of the Last Resort As the banker to
the banks. RBI acts as the lender of the last resort and grants
accommodation to the scheduled banks in the following manner:
(a) Re-discounting or purchase of eligible bills (Section 17(2)
and (3)(b) Loans and Advances. Section 17(4) enables the RBI to
grant loans and advances to the scheduled banks. repayable on
demand or on the expiry of fixed periods not exceeding 90 days
against the security of the following: (i) Stocks. funds and
securities (other than immovable property) in which a trustee is
authorised to invest trust money. (ii) Gold or silver or documents
of title to the same. (iii) Such bills of exchange and promissory
notes as are eligible for purchase or re- discount by the RBI
(stated above) or those guaranteed by the State Government as to
repayment of the principal and interest. (iv) Promissory notes of
any scheduled bank or State Cooperative Bank supported by documents
of title to goods (such documents having been transferred. assigned
or pledged to any other bank as securtty for a loan or advance made
of bona fide commercial or trade transactions or for the purpose of
financing agricultural operations or the marketing of crops).
Section 17(3-A) enables the banks to secure accommodation from
the RBI on easier terms in connection with export finance provided
by them. The RBI may make loans and advances to any scheduled bank
against the promissory note of the latter repayable on demand or on
the expiry of a fixed period not exceeding 180 days.
Emergency Advances The commercial banks and cooperative banks
may be granted emergency advances by RBI under Section 18 on such
special occasions when RBI is satisfied that the grant of such
loans Is necessary for the purpose of regulating credit in the
interests of Indian trade and commerce, industry and agriculture.
Such emergency advances may be given notwithstanding any limitation
contained in Section 17 and 18.
5. As Controller of Credit Reserve Bank of India exercises
control over the credit granted by the commercial banks through
various powers conferred upon it for this purpose. The methods of
credit control are as follows:
(a) Statutory Cash Reserve Ratio (CRR). Under Section 42 of RBI
Act. 1934. everyscheduled bank is under an obligation to keep a
cash reserve with RBI called the Statutory Cash Reserve Ratio
(CRR). Every scheduled bank is required to maintain with RBI an
average daily balance equal to -a prescribed percentage of its
demand and time liabilities Average daily balance means the average
of balances held at the close of business on each day of a
fortnight. Liabilities of a scheduled bank exclude its paid-up
capital an reserves and inter bank liabilities. Section 42(3) of
RBI Act. 1934 prescribes penalties for not complying with the above
mentioned requirements. Currently prescribed CRR is 4%
(b) Statutory Liquidity Requirement (SLR,-) (under Section 24 of
RBI Act., apart from statutory cash reserve which the scheduled
banks have to keep with RBI. All banks have to main tam liquid
assets at also in the form of cash, gold and unencumbered approved
securities. Curent SLR is 23%
Reserve Bank of India gradually revised this requirement during
1970's and 1980's till it reached the highest level of 38.5 per
cent in January 1988. RBI had stepped up the liquidity ratio for
three reasons :
(a) A higher liquidity requirement forces scheduled banks to
maintain- a larger proportion of their resources in liquid form and
thus reduces their capacity to grant loans and advances to business
and industry. Thus it is anti-inflationary in its impact; and (b) A
higher liquidity ratio diverts banks' funds from loans and advances
granted to industry and trade to investment in government and other
approved securities. (c) The higher liquidity ratio is a method of
raising funds for the Government and for the public sector
financial institutions at a rate lower than the market rate of
interest.
It may be mentioned here that the effect of stepping up cash
reserve ratio (CRR) and the statutory liquidity requirement (SLR)
is the same, viz., they force banks to keep large volume of funds
in liquid form, reduce their capacity to extend credit to business
and industry and thus act as anti-inflationary measures. , (c)
Selective Credit Controls. Under Section 21 of the Banking
Regulation Act, 1949, RBI has been vested with wide powers to
control advances by individual banks or by the banking system as a
whole and to issue directives for : (i) The purpose for which
advances may or may not be made; (ii)The margins to be maintained
on secured loans; (iii)The maximum amount of advances to any firm
or company; and (iv) The rate of interest to be charged by banks
and other terms and conditions for granting advances.
Advances against (a) food grains, (b) cotton and kappas, (c)
oilseeds and oil, (d) vanaspati, (e) sugar. khandsari and gur. and
(f) cotton textiles. Including yarn. were subject to selective
controls. Under the system of selective credit controls. whose need
for credit may not be so urgent or larger flow of credit to whom is
likely to aggravate the price situation. RBI does not allow
granting of clean credit facilities to any borrower subject to
selective credit controls. RBI makes certain exemptions also from
the selective credit controls-for example. State agencies such as
the Food Corporation of India (FCI) and State Trading Corporation
(STC) are exempted. Banks generally conform to the selective
control directives issued by RBI.
(d) Bank Rate Policy. Bank rate is the rate at which Reserve
Bank of India grants loans to the commercial banks and re-discounts
the bills of exchange. By changing the Bank rate.
Reserve Bank of India varies the cost of funds which the banks
may borrow from Reserve
Bank of India. In turn they also increase their lending rates.
At present Bank rate is 8. 25%.
(e) Liquidity Adjustment Facility. Reserve Bank of India has
introduced the Liquidity Adjustment facility to provide short term
liquidity to the banks and also to absorb excess Liquidity from the
banking system. Under this facility fixed rate repo auctions are
conducted on a daily basis. Commercial banks which are in need of
funds for a very short period bid for funds under this scheme.
Funds are made available to them by way of purchase of approved
securities by the Reserve Bank. This is subject to a commitment by
the borrowing bank to repurchase the same security after the
specified period is over. say one. three or seven days at the price
specified by the Reserve Bank. This is called Repo transaction. The
repo rate is fixed by Reserve Bank of India. When the commercial
banks possess excess liquidity and the Reserve Bank feels the
necessity of absorbing such Liquidity, it conducts reverse repo
auctions. under which Reserve Bank sells the approved securities to
the banks with the commitment to repurchase the same after a
specified period. This is called Reverse Repo. Its rate is also
fixed by Reserve Bank of India.
6. To Undertake Transactions in Foreign Exchange Section 40 of
Reserve Bank of India Act authorities the Reserve Bank of India to
undertake transactions in foreign exchange. The Bank sells to and
buys from any authorized dealer in foreign exchange. foreign
currencies on conditions prescribed by the Government. The
authorised dealers-are those who are entitled to buy or sell
foreign exchange under the Foreign Exchange Management Act. 1999.
Moreover. Reserve Bank of India holds India's reserves (currently
approx. USD285 Bn) of international currencies and administers
the-exchange control system in the country.
7. Collection and Furnishing of Credit Information Reserve Bank
of India is empowered to collect credit information from Banking
companies and to furnish such information in a consolidated form to
any banking company applying for the same along with the prescribed
fee.
Section 17 of the Reserve Bank of India Act. 1934 has been
amended in 2006 to include the following business which may be
undertaken by Reserve Bank of India: (a) Dealing in derivatives.
and, with the approval of the Central Government, in any other
financial instrument. " (b) Lending or borrowing of securities of
the Central Government or a State Government or of such securities
of a local authority as may be specified by the Central Government,
or foreign securities. (c) Dealing in repo or reverse repo (without
any limitation on lending or borrowing of funds).
The newly inserted Section 45W authorises the Reserve Bank to
determine the policy relating to interest rates or interest rate
products and may give directions in that behalf to all agencies or
any of them. dealing in securities, money market instruments,
foreign exchange, derivatives or other instruments of like nature
as the bank may specify from time to time. But such directions
shall not relate to the procedure for execution or settlement of
the trades in respect of the transactions of the Stock
Exchanges
REGULATORY AND SUPERVISORY FUNCTIONS Banking Regulation Act
1949Reserve Bank of India Act and the Banking Regulation Act confer
wide powers on Reserve Bank of India to regulate and supervise the
affairs of banking institutions in India. Important powers of the
Reserve Bank of India are as follows :
1. Licensing of Banking Companies. Section 22 of Banking
Regulation Act, 1949 requires every banking company to hold a
licence from the Reserve Bank to carry on the business of banking
in India. The Reserve Bank is empowered to conduct an inspection of
the books of the banking company for this purpose, and to issue a
licence if it is satisfied that the necessary conditions are
fulfilled.
2. Permission for Opening Branches. Section 23 requires every
banking company to take Reserve Bank's prior permission for opening
a new place of business in India or to change the location of an
existing place of business in India or outside. The Reserve Bank
takes into account the financial position, the history, the general
character of management and adequacy of its capital structure and
earning prospects and the fact whether public inter~st will be
served or not, before granting permission.
3. Power to Inspect Banking Companies under Section 35, the
Reserve Bank may, either at its own initiative or at the instance
of the Central Government, inspect any banking company and its
books and accounts. If on the basis of the inspection report
submitted by the Reserve Bank, the Central Government is of the
opinion that the affairs of the banking company are being conducted
to the detriment of interests of its depositors. it may by order in
writing prohibit the banking company from receiving fresh deposits,
or direct the Reserve Bank to apply for the winding up of the
banking company.
4. Power to Issue Directions. Section 35.A confers powers on the
Reserve Bank to issue directions to a banking company or companies
in the public interest or in the interest of banking policy or to
prevent the affairs of the banking company being conducted in a
manner detrimental to the interests of the depositors. Section 36
confers powers on the Reserve Bank to caution or prohibit banking
companies against entering into any particular transaction and
generally give advice to any banking company. It may pass orders
requiring the banks to carry out the specified instructions.
5. Control over Top Management. Reserve Bank's prior approval is
necessary for appointment or re-appointment or termination of
appointment of a chairman, managing director, manager or chief
executive officer. Section 36-AA empowers the bank to remove from
office any chairman, director, chief executive officer or other
officer or employee of a bank, if it considers it necessary or
desirable. The Bank may appoint any other suitable person in place
of the person removed by it. The Reserve Bank can appoint one or
more additional directors on the Board of Directors of banks, if it
considers it necessary in the interest of banking policy or in the
public interest in the interests of the bank or its depositors.
BANKING REGULATIONS ACT 1949 Summary of some important sections is
provided hereunder. The section no. is given at the end of each
item. For details, kindly refer the bare Act.1) Banking means
accepting for the purpose of lending or investment of deposits of
money from public repayable on demand or otherwise and withdraw
able by cheque, drafts order or otherwise (5 (i) (b)).2) Banking
company means any company which transacts the business of banking
(5(i)(c)3) Transact banking business in India (5 (i) (e).4) Demand
liabilities are the liabilities which must be met on demand and
time liabilities means liabilities which are not demand liabilities
(5(i)(f)5) Secured loan or advances means a loan or advance made on
the security of asset the market value of which is not at any time
less than the amount of such loan or advances and unsecured loan or
advances means a loan or advance not secured (5(i)(h).6) Defines
allied business activities a banking company may be engaged in like
borrowing, lockers, letter of credit, traveller cheques, mortgages
etc (6(1).7) States that no company shall engage in any form of
business other than those referred in Section 6(1) (6(2).8) For
banking companies carrying on banking business in India to use at
least one word bank, banking, banking company in its name (7).9)
Restrictions on business of certain kinds such as trading of goods
etc. (8)10) Prohibits banks from holding any immovable property
howsoever acquired except as acquired for its own use for a period
exceeding 7 years from acquisition of the property. RBI may extend
this period by five years (9)11) Paid up capital, reserves and
rules relating to these (11 & 12)12) Banks not to pay any
commission, brokerage, discount etc. more than 2.5% of paid up
value of one share (13)13) Prohibits a banking company from
creating a charge upon any unpaid capital of the company. (14)
Section 14(A) prohibits a banking company from creating a floating
charge on the undertaking or any property of the company without
the RBI permission.14) Prohibits payment of dividend by any bank
until all of its capitalized expenses have been completely written
off (15)15) To create reserve fund and 20% of the profits should be
transferred to this fund before any dividend is declared (17
(1))16) Permits banks to form subsidiary company for certain
purposes (19)17) No banking company shall hold shares in any
company, whether as pledgee, mortgagee or absolute owners of any
amount exceeding 30% of its own paid up share capital + reserves or
30% of the paid up share capital of that company whichever is less.
(19(2).18) Restrictions on banks to grant loan to person interested
in management of the bank (20)19) Every bank has to publish its
balance sheet as on March 31st (29).Balance sheet is to be got
audited from qualified auditors (30 (i))Publish balance sheet and
auditors report within 3 months from the end of period to which
they refer. RBI may extend the period by further three month
(31)Prevents banks from producing any confidential information to
any authority under Industrial Disputes Act. (34A)20) Amendments
carried in the Act during 1983 empowers Central Govt to frame rules
specifying the period for which a bank shall preserve its books
(45-y), nomination facilities (45ZA to ZF) and return a paid
instrument to a customer by keeping a true copy (45Z).21) Certain
returns are required to be sent to RBI by banks such a monthly
return of liquid assets and liabilities (24-3), quarterly return of
assets and liabilities in India (25) return o unclaimed deposits
i.e 10 years and above (26) and monthly return of assets and
liabilities (27-1)Board for Financial Supervision It comprises of
four directors of the central Board of Directors of the Reserve
Bank of India. The Board is entrusted with the supervision of
commercial banks, selected financial institutions and non-banking
finance companies. The focus of supervisory strategy is on the
following aspects: (a) Off-site surveillance system. (b) On-site
inspection. (c) Monitoring asset quality, capital adequacy and
other prudential norms of banks. (d) Extending the task of
supervision to strengthen internal control, management information
system and fraud monitoring procedures within the above mentioned
institutions.
01 B Review Questions on Banking Regulator :
1. What do you under stand by a Scheduled bank?a. A bank which
is in the schedule VI of the Companies Act -1956b. A bank that
qualifies to be included in 2nd Schedule of RBI Act-1935 c. A bank
that qualifies to be included in 2nd Schedule of Banking Regulation
Act 1949d. All of the abovee. None of the above
2. Which is not condition that need not be satisfied by a bank
to become a scheduled bank? (i) It must have a paid up capital and
reserves of aggregate value of not less than Rs.5Iakh; (ii) It must
satisfy the Reserve Bank that its affairs are not being conducted
in a manner detrimental to the interests of its depositors; and
(iii) must have any of the following structure: Commercial
banks-Indian and foreign, Public Sector Banks, State Cooperative
Banks, Urban Cooperative Banks, Regional Rural Banks. iv) all of
the above v) none of the above3. What is the necessity of
exercising control over credit created by banks.
4. What is the ceiling on shares a bank can hold in any company
whether as pledgee, mortgagee or absolute owner?5. What do you
understand by Cash Reserve Ratio? Why is it maintained? What is
current CRR?
6. What do you understand by Statutory Liquidity Requirement?
What purpose does it serve? What is current SLR?
7. Describe the Liquidity Adjustment facility provided by
Reserve Bank of India. What is Repo and reverse repo
transaction?7
