Chapter 5

RBI-Functions
Chapter Contents..
D
Central Bank : Introduction, O Commercial Bank : Introduction D Reserve Bank of
India : Introduction, Functions of Reserve Bank of India, D Failures of Reserve Bank of
India

O CENTRAL BANK :INTRODUCTION

Central Bank is the supreme financial institution that regulates the banking and monetary
system of the country. It is formed to bring monetary stability, issue notes and maintain the
value of a country's currency in the international market. It administers the currency arnd credit
system of the nation. In India, the Reserve Bank of India plays the role of a central bank, which
came into existence, after passing an act in parliament in 1934. The bank is headquartered in
Mumbai, Maharashtra.
The following are the main features of the Central Bank
It is authorized to issue currency notes except coins and notes of small magnitude.
Ithas the power to control, direct and supervise the commercial banks.
It also helps them at the time of need.
It employs various measures to control the credit operations of the commercial banks.
It is the banker and advisor to the government of the country.
It acts as a manager of foreign exchange reserves.
It collects and publishes the information relating to banking and financial sector.
It oversees the credit and monetary policy of the nation.

D cOMMERCIAL BANK : INTRODUCTION

The entities that provide banking and financial services to a large number of stakeholders
are known as Commercial Banks. They act as amediator between the borrowers and savers. The
5.2

Commercial Banks receive deposits

economic cycle goes on smoothly.

from
this
In
the general public and
way, the
individuals and organizations. In earlier times, people used to
banking system
lends it on

deposit
was
high
mobilization of savings takes RplinBateIce,-rFeusntctio
felt.money in
to he
post andofic t
for saving purposes,
establishment whencan
where they
requirement of
the deposit the The people want
their savings and withdraw it at the time of need.
ofa Commercial Bank are:
The essential functions
deposits from the general public, firms, institutions and organization.
It accepts
it gives the facility to withdraw
various rates on different deposits.
money on demand. Banks pay interest on
Pdeposurithtse a
organization in the form of
It lends money to public, institutions, and long term and
charges interest on the
short term loans for a particular period and the customer amount \ent
Moreover, it provides overdraft and cash credit facilities to
bills of exchange and
It performs agency functions like collections of promissory notes,
trading of shares and debentures, payment to third parties on standing
the customer, etc. instructions of

It provides the facility of safe keeping of valuables like jewelry and documents
It collects, transfers and makes payment of funds on behalf of the customer.
It provides the facility of ATM card, Debit Card, Credit C Card, Cheques, etc., to is
account holders.

Basis Central Bank Commercial Bank

Meaning The bank, which monitors, regulates The financial institution which
and controls the financial system of receives the deposits from people
the economy is known as Central and advances them money is
Bank. known as Commercial Bank.
Motive The main purpose of Central Bank is In contrast Commercial Bank, which
public welfare and economic runs for-profit motive.
develop-ment.
Regulated The Central Bank of India ie. the The Commercial Bank are regulated
Reserve Bank of India is governed by the Banking Regulation Act,
by RBI Act,1934. 1949.
Act as Central Bank is the banker to banks, Commercial Bank is the banker to
government, and financial the citizens.
institution.
have
Authority The Central Bank is the supremne The commercial bank does not
monetary authority of the country. such authority and powers.
RBI-Functions 5.3

Type of The Central Bank is a publicly The Commercial Bank can be

Institutions oWned institution. publicly or privately owned
institution.
Dealing The Central Bank does not deal with The Commercial Bank does.
the general public.
Purpose The Central Bank does not exist for The Commercial bank operates for
making a profit. making a profit for its owners.
Issue Notes The Central Bank has got the The commercial bank does not have
authority to print and issue the such authority.
notes.

Presence There is only one Central Bank in The Commercial Banks are many
every country, which serve the whole country.
Source The Central Bank is the fundamental The commercial bank does not
source of money supply in the perform such function.
economy.
Policies A Central Bank devises new policiesA Commercial Bank has no such
and rules which have to befollowed authority of making policies or
by the other banks. rules.

Accept A Central Bank does not make Commercial Banks are solely made
Deposits profits out of the deposits. for earning profits through people's
deposits.
The Central Bank is the leading public financial institution that governs the entire banking
system in the country. It has full control over all the commercial banks in the country. The
Central Barnk regulates the flow of money in the economy. The apex bank adopts various
measures like Cash Reserve Ratio, Statutory Liquidity Ratio, Bank Rate, Repo Rate, Reverse
Repo Rate, etc. to control the supply of money.

O RESERVE BANK OF INDIA-INTRODUCTION

The Reserve Bank of India (RBI) is the Central Bank of the country. It was established on the
recommendations of Hilton Young Commission. It has been established as a body corporate
under the Reserve Bank of India Act, 1934 which came into effect from Ist April, 1935. The
Reserve Bank of India was started as share-holders bank with a paid-up capital of 5 crores was
divided in 5 lakhs shares of 100 each. On establishment it took over the function of
management of currency from the Government of India and power of eredit control from the
Imperial Bank of India.
 5.4

DFUNCTIONS OF RESERVE BANK OF INDIA

The main function of Reserve Bank of India is to regulate the monetary system of t
in such a way that the balance of economic growth of the country is the
RBI-Fncton
economic stability. achieved
calongoiutnty
Accordingtothe Preamble of RBI Act, 1934, "The main functions of the bank are to
the issue of bank notes and keeping of reserve with view to securing monetary
stability in Inrdiegauiat,
generally to operate the currency and credit system of the country to its advantage. and
Functions of Reserve Bank of India may be broadly classified intotwo
() Traditional Functions
categories.
() Development Functions.
I. Traditional Functions

The traditional functions of RBIare further divided into three types

(A) Central Banking Functions.
(B) General Banking Functions.
(©) Prohibitory Functions.

(A) Central Banking Functions :

Reserve Bank of India is the central bank of India. Its Central Banking functions av
underSection 22 of the RBI Act, 1934 has given the monopoly of note issue to the Resem
Bank. Under Section 22(1), the issue of notes has been entrusted to
the Issue Department of
Reserve Bank. India follow minimum reserve system of note issue.
Amendment Act 1957 the RBI should maintain a minimum reserve of 200 crore According to RR
of gold coins
gold bullion and foreign securities of which the value of gold and bullion
115 crore.
should not be less than
1. Issue of Paper Currency : RBI is the sole body who is
authorized to issue currency in
India. RBI performs as an agent of Government of India for distributing and handling
of coins while coins and one rupee notes are minted by
Government of India. Reserve
Bank of India also works to prevent counterfeiting of currency by
security features of currency.
regularly upgrading
RBI is authroised to issue notes upto value of ten thousands and coin upto one
thousands. RBI issues notes of the denomination of 5, 10, 20, 50,7 100,? 500 and
? 2000at present. New notes of 500 and 2000 have been issued on Nov.8, 2016. Ihe
old Mahatma Gandhi series note of 500 and 1000 are considered illegal. All bartk
notes are legal tender all over the country. The supply of notes into the circulation b
solely injected by the RBI and the withdrawal of notes also handled only by the RB.
RBI-Functions 5.5

2. Regulation of Credit : Regulation of credit refers to control over the credit policy of the
commercial banks. As the central bank, RBI controls the creation of credit by the
commercial Banks. According to the Reserve Bank of India Act, the RBI can adopt
different methods of credit control such as Bank rate, open market operation, change in
CRR and selective methods to control the credit of commercial bank.
3. Banker's Bank:The Reserve Bank of India acts as the bank of all the Banks in the
country.The scheduled banks are required to maintain with the Reserve Bank as cash
balance certain percentage of their time and demand liabilities. It acts as a lender of last
resort to them. The scheduled banks can borrow money from the Reserve Bank on the
basis of eligible securities or get financial accommodation at the times of need or
stringency by rediscounting their bills of exchange. So RBI gives loans to the
commercial bank during time of emergerncy.
4. Banker of the Government: The Reserve Bank of India acts as the Banker to
Government. It accepts money for the account of Union and State Governments in
India, makes payment on their behalf, carries out their exchange remittance and other
banking operations and manages the public debt. It makes ways arnd means advances
to the Government for 90 days. It advises the Government on all monetary and banking
matters.

5. Regulation of Foreign Exchange : The Reserve Bank has been entrusted with the
responsibility of maintaining the external value of the rupee and for this purpose the
bank holds most of the foreign exchange reserves. Since India is a member of
International Monetary Fund, the Reserve Bank has to maintain fixed exchange rates
with all other member countries of the Fund. It sells and buys foreign exchange to and
from authorised persons at rates fixed by the Government.
6. Other Functions : The RBI performs the following other functions besides the above
discussed specific functions
(a) Export Assistance : RBI grants loans to the exporters directly or indirectly to
promote foreign trade of India.
(b) Clearing House Facilities : The RBI also functions as Clearing House. Inter-banking
obligations are easily settled through this house.
(c) Change of Currency :RBI changes big notes into small ones and small notes into
coins.

(d) Transfer of Currency : The bank also facilitates the transfer of currency.
(e) Publication of Information : Reserve Bank publishes data on various aspects such as
money, credit, finance, agriculture and industrial output.
() Control over Nationalised Banks : The RBI has wide powers of supervision and
control over commercial co-operative and regional banks.
 5.6

(g) Thainingin Banking: RBI

talented bankers
has opened

Bankers Training College.

following
RBI-FuncptiroondsuCe
various training centres
to
()
Gi) College of Agricultural Banking, Pune.
(ii) Reserve Bank Staff College, Chennai.
(iv) National Institute of Bank Management.

B. General Banking Functions

Section 20, 21, 21A of the RBI Act 1934 has made provisions for the RBI to act as an
banker and adviser to the Government of India. agent.
Reserve Bank also performs certain general banking functions. These functions
follows are as
1. Accepting Deposits: RBI accepts deposits from Central
Governments and privateiindividual without paying of any interest on Government, State
2. Bills Discounting: Reserve Banks buys, sells and rediscounts the 90
these deposits.
Bills, Promissory Notes etc. days duration
3. Advancing Loans : Reserve Bank of India gives loans to the Central
Governments for the period of 90 days. and State
4. Deal in Foreign Securities : RBI also deals in all such foreign securities
encashable within 10 years from the date of purchase. which are
5. Deal in Costly Metals : Reserve Bank deals in the sale and
purchase of gold, silyer ac
well as the coins of these metals.
6. Deal with other Countries' Banks: RBI establishes business
relations with the banks of
other member countries being a member of IMF.

C. Prohibitory Functions of RBI

Reserve Bank of India Act prohibits this bank from performing certain functions. The
prohibitory functions of the RBI are
1. The bank cannot participate in trade, commerce, or industrial activities of the
country;
2. RBI cannot purchase its own shares or shares of any other bank or a
company. It also
cannot grant loan on such shares.
3. It cannot give any loan against the security of any immovable property. It also
cannot
purchase immovable property beyond its needs.
4. RBI cannot pay any interest on its deposits.
5. Bank cannot advance loans without
securities.
RBI-Functions 5.7

IL. Developmental Functions of RBI

Reserve Bank of India also performs certain developmental functions to promote the
economic growth of the country.
These developmental functions are as followS-
1. Promotion of Agricultural Finance : RBI has an Agricultural Credit department to
conduct research regarding various problems of agricultural credit. RBI also advises
the Central Government, state governments and co-operative societies on the various
aspect of agricultural growth. In the Reserve Bank of ndia Act itself, it is recognised
that it has special responsibility for providing institutional credit to agriculture and
allied activities. A major step in the direction was setting up of the Agricultural
Refinance and Development Corporation, a subsidiary of the RBI. Establishing
Regional Rural Banks and inclusion of agriculture in the priority sector are other major
steps. Another major development in this directions was the establishing of the
National Bank for Agriculture and Rural Development (NABARD) in 1982, which took
over the Agricultural Refinance and Development Corporation.
2. Promotion of Industrial Finance :Reserve Bank provides significant financial help for
the industrial development of the country. The commercial banks can take care of the
working capital requirements of the industrial units. But industrial growth cannot be
possible in the absence of medium and long term finance. The setting up of Industrial
Development Bank of India (IDBI), Industrial Finance Corporation of India (IFC), State
Finance Corporations (SFC), Small Scale Industrial Development Corporations etc. to
meet the long-term and medium term financial needs of industries are the important
steps taken by RBI.
3. Promotion of Finance for Exports : Reserve Bank of India has been playing important
role through refinance to banks against export credit to encourage exports. Export
finance is provided through various schemes eg. the Bill Market Scheme, Export Bills
Credit Schemes, Shipment Credit Scheme, Duty Drawback Credit Scheme.
The Government of India established Export-Import Bank (EXIM) as an apex bank for
financing the foreign trade. The main objective of this bank is to provide financial
facilities toexport import trade.
4. Promotion of Banking: The Reserve Bank of India has undertaken several measures to
promote the banking structure of the country. The main steps undertaken by RBI in
this direction are
0) Strengthening of Banking Structure : The Reserve Bank has strengthened the banking
structure of the country by eliminated the large number of weak, unsound or
improperly managed banks.
(ii) Extension of Banking Facilities : The banking facilities have been extended
throughout the country, especially in small towns and rural areas so as to improve
the geographical coverage of banks.
5.8

(ii) Improvement of Functional Coverage : The

functional coverage in
priority sectors such as agriculture, small scale industries
Rural Banks.
etc. RBI-Functlon
fa vour ot he
has been
by setting up Regional
(iv) Insurance of Deposits : The Deposit Insurance and
Credit
Guarantee et ndet
has been set up to provide protection to depositors and
institutions.
guarantee cards Cotorporeaiigoe
(v) Development of Bill Market : The RBI has introduced several schemes with aview t
encouraging the growth of a bill market in India.
5. Framing Monetary Policy : The another very important function of
India is the framing of monetary policy for the country. Reserve Bank
O MONETARY POLICY OF RESERVE BANK OF INDIA
One of the important functions of Reserve Bank as a central bank of the
formulate and administer the monetary policy of the country. country
Monetary policy refers to that policy through which the central bank of the
controls- country
) the supply of money,
(ii) the availability of money, and
(ii) cost of money ie. rate of interest, in order to achieve a set of objectives orien.
towards the growth and stability of the country.
The monetary policy is defined as discretionary action undertaken by the authorities desianed
to influence
() the supply of money,
(ii) cost of money or rate of interest, and
(i) the availability of money". -D.C. Rowan

Therefore, monetary policy refers to the use of official instruments under the control of the
Reserve Bank of India to regulate the availability, cost and use of money and credit with the aim
of achieving optimum levels of output and employment, price stability, balance of payments
equilibrium or any goals set by government.
Objectives of Monetary Policy
The main objectives of the monetary policy of the Reserve Bank are
) Controlled Expansion of Money Supply : Expansion of money supply was needed a
meet the increased demand of funds for the development process. Reserve Bank
reorganised the need for expansion of credit and money supply for carrying out ue
rapid development and diversification of the economy. At the same time, the cont
over the expansion of money supply was needed to restrain the inflationary forces u
 5.9
RBI-Functions

the economy. Therefore, expansion of money supply was needed to finance the
development process and control of money supply was deemed essential to check the
inflation or rise in prices. Thus, controlled expansion of money supply was essential for
growth with stability, which can be achieved through monetary policy of Reserve
Bank.
6) funds
Sectoralto Allocation of Funds :Another objective of monetary policy was to allocate
predetermined sectors. The Reserve Bank has determined the allocation of
funds to various sectors as also the rates at which these are made available. This
allocation is made according to the priorities laid down in the plans and requirements
of day to day development.

SI5 QUESTIONS F
A. Objective Type Questions
1. All currency notes beyond the denomination of 1 are issued by :
(a) State Bank of India
(b) Ministry of Finance, Government of India
(c) Reserve Bank of India
(d) Regional Rural Banks Ans. (c)
2. When did RBI Commence its operations :
(a) 30th April, 1939 (b) 1st June, 1932
(c) 1st April, 1935 (d) 25th May, 1937 Ans. (c)
3. RBI was nationalised in :
(a) 1948 (b) 1947
(c) 1950 (d) 1949 Ans. (a)
4. RBI acts as :
(a) Bankers' banks
(b) Bankers' government
(c) Custodian of foreign currency reserves
(d) All of above. Ans. (d)
5. RBI has been established under the provisions of :
(a) Banking Regulation Act, 1949
(b) Reserve Bank of India Act, 1934
(c) Banking Companies Act, 1968
(d) None of above Ans. (b)
6. RBI was started with a paid-up capital of :
(a) 50 crore (b) ?5 crore
(c) 15 crore (d) 500 crore Ans. (b)
7. Which is the Central Bank of India :
(a) RBI (b) SBI
(c) RRBs (d) Central Bank Ans. (a)
RBI-Functlons 5.11

D (2 MARKS)
6. RBI was nationalized in year.
7. What are the Central Banking Functions of RBI?
8. Reserve bank has zonal offices regional offices.
O(2MARKS)
9. What is RBI?
10. Write two functions of RBI, (Berhampur University, 2021)
11. What is meant by central bank? (MPC Autonomous College, 2021)
12. What are the Central Banking Functions of RBI?
(Bhadrak Autonomous College)
13. What do you mean by spreads? (Ravenshaw University, 2021-22)
14. What do you mean by lender of the last resort?
(Ravenshaw University, 2021-22)
15. What do you mean by bank rate? (Utkal University, 2022)

D(MARKS 3)
16. Write a short note on IFCI. (Berhampur University, 2021)
17. What are the Central Banking Functions of RBI?
(Bhadrak Autonomous College)
18. Why is RBI called the lender of last resort? (Sambalpur University, 2021)
19. Explain bank rate as a tool for credit control.
(Ravenshaw University, 2021-22)
20. Reserve Bank of India (RBI). (F.M. Autonomous College)
21. Discuss the various functions of Reserve Bank of India.
(Ravenshaw University, 2021-22)
22. Discuss the regulatory functions of Reserve Bank of India. (Utkal University, 2022)

O(7 MARKS)
23. Discuss the role of Reserve Bank of India in Economic development of the country.
(MPC Autonomous College)