Indian Financial System - Central Banking - 2 - Notes - Finance, Study notes of Business Administration

Download Indian Financial System - Central Banking - 2 - Notes - Finance and more Study notes Business Administration in PDF only on Docsity! 4.3 Reserve bank of India The Reserve Bank of India (RBI) is the apex financial institution of the country's financial system entrusted with the task of control, supervision, promotion, development and planning. RBI is the queen bee of the Indian financial system which influences the commercial banks' management in more than one way. The RBI influences the management of commercial banks through its various policies, directions and regulations. Its role in bank management is quite unique. In fact, the RBI performs the four basic functions of management, viz., planning, organising, directing and controlling in laying a strong foundation for the functioning of commercial bank From Private Ownership to State Ownership Originally, the Reserve Bank was constituted as a shareholders' bank, based on the model of leading foreign central banks of those days. The bank's fully-paid share capital was Rs.5 crores dividend into shares of Rs.100 each. Of this, Rs.4,97,80,000 were subscribed by the private shareholders and Rs.2,20,000 were subscribed by the Central Government for disposal of 2,200 shares at par to the Directors of Bank (including members of the Local Boards) seeking the minimum share qualification. The share capital of the bank has remained unchanged until today . Objectives of the Reserve Bank of India The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of the Reserve Bank as: "to regulate the issue of Bank notes and the 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." Prior to the establishment of the Reserve Bank, the Indian financial system was totally inadequate on account of the inherent weakness of the dual control of currency by the Central Government and of credit by the Imperial Bank of India. The Hilton-Young Commission, therefore, recommended that the dichotomy of functions and division of responsibility for control of currency and credit and the divergent policies in this respect must be ended by setting-up of a central bank - called the Reserve Bank of India - which would regulate the financial policy and develop banking facilities throughout the country. Hence, the Bank was established with this primary object in view. Another objective of the Reserve Bank has been to remain free from political influence and be in successful operation for maintaining financial stability and credit. Banker to the Banks: It acts as a guardian for the commercial banks. Commercial banks are required to keep a certain proportion of cash reserves with the Reserve bank. In lieu of this, the Reserve bank 0 them various facilities like advancing loans, underwriting securities etc., The RBI controls the volume of reserves of commercial banks and thereby determines the deposits/credit creating ability of the banks. The banks hold a part or all of their reserves with the RBI. Similarly, in times of their needs, the banks borrow funds from the RBI. It is, therefore, called the bank of last resort or the lender of last resort. Custodian of Foreign Exchange Reserves It is the responsibility of the Reserve bank to stabilize the external value of the national currency. The Reserve Bank keeps golds and foreign currencies as reserves against note issue and also meets adverse balance of payments with other counties. It also manages foreign currency in accordance with the controls imposed by the government. As far as the external sector is concerned, the task of the RBI has the the following dimensions: (a) to administer the foreign Exchange Control; I) to choose ,the exchange rate system and fix or manages the exchange rate between the rupee and other currencies; (c) to manage exchange reserves; (d) to interact or negotiate with the monetary authorities of the Sterling Area, Asian Clearing Union, and other countries, and with International financial institutions such as the IMF, World Bank, and Asian Development Bank. The RBI is the custodian of the country's foreign exchange reserves, id it is vested with the responsibility of managing the investment and utilization of the reserves in the most advantageous manner. The RBI achieves this through buying and selling of foreign exchange market, from and to schedule banks, which, are the authorized dealers in the Indian, foreign exchange market. The Bank manages the investment of reserves in gold counts abroad' and the shares and securities issued by foreign governments and international banks or financial institutions. Lender of the Last Resort At one time, it was supposed to be the most important function of the Reserve Bank. When Commercial banks fail to meet obligations of their depositors the Reserve Bank comes [b their rescue As the lender of the last resort, the Reserve Bank assumes the responsibility of meeting directlyor indirectly all legitimate demands for accommodation by the Commercial Banks under emergency conditions. Banks of Central Clearance, Settlement and Transfer The commercial banks are not required to settle the payments of their mutual 1000nsactions in cash, It is easier to effect clearance and settlement of claims among them by making entries in their accounts maintained with the Reserve Bank, The Reserve Bank also provides the facility for transfer to money free of charge to member banks. Controller of Credit In modern times credit control is considered as the most crucial and important functional of a Reserve Bank. The Reserve Bank regulates and controls the volume and direction of credit by using quantitative and qualitative controls. Quantitative controls include the bank rate policy, the open market operations, and the variable reserve ratio. Qualitative or selective credit control, on the other hand includes rationing of credit, margin requirements, direct action, moral suasion publicity, etc. Besides the above mentioned traditional functions, the Reserve Bank also performs some promotional and supervisory functions. The Reserve Bank promotes the development of agriculture and industry promotes rural credit, etc. The Reserve Bank also acts as an agent for the international institutions as I.M.F., I.B.R.D., etc. 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 supervisory functions of the RBI have helped a great deal in improving the methods of their operation. The Reserve Bank Act, 1934, and I Banking Regulation Act, 1949 have given the RBI wide powers of: (i) Supervision and control over commercial and cooperative banks, relating to licensing and establishments. (ii) Branch expansion. (iii) Liquidity of their assets. (iv) Management and methods of working, amalgamation reconstruction and liquidations; (v) The RBI is authorized to carry out periodical inspections off the banks and to call for returns and necessary information from them. Promotional Role A striking feature of the Reserve Bank of India Act was that it made agricultural credit the Bank's special responsibility. This reflected the realisation that the country's central bank should make special efforts to develop, under its direction and guidance, a system of institutional credit for a major sector of the economy, namely, agriculture, which then accounted for more than 50 per cent of the national income. However, major advances in agricultural finance materialised only after India's independence. Over the years, the Reserve Bank has helped to evolve a suitable institutional infrastructure for providing credit in rural areas. Another important function of the Bank is the regulation of banking. All the scheduled banks are required to keep with the Reserve Bank a consolidated 3 per cent of their total deposits, and the Reserve Bank