DR.

RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY, LUCKNOW
2014-2015

ECONOMICS
[FINAL DRAFT]
ON
RESERVE BANK OF INDIA AND ITS OPERATIONS
SUBMITTED FOR THE PROJECT WORK UNDERTAKEN IN THE
PARTIAL FULFILLMENT OF B.A. LL.B. (HONS.) 5 YEARS
INTEGRATED COURSE OF DR. RAM MANOHAR LOHIYA NLU,
LUCKNOW.

UNDER THE GUIDANCE OF: SUBMITTED BY:

Dr. MITALI TIWARI SHREYA JASORIA

Dr. R.M.N.L.U. ROLL NO. -129

3rd SEMESTER

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 ACKNOWLEDGEMENT
Apart from the efforts of me, the success of this project depends largely on the
encouragement and guidelines of many others. I take this opportunity to express my gratitude
to the people who have been instrumental in the successful completion of this project. I
would like to show my greatest appreciation to Asst. Prof. Mitali Tiwari. I can't say thank
you enough for your tremendous support and help. I feel motivated and encouraged every
time I attend your class. Your willingness to motivate me contributed tremendously to my
project. I also would like to thank you for showing me some example that related to the topic
of my project. Without your encouragement and guidance this project would not have
materialized. Besides, I would like to thank the authority of Dr. Ram Manohar Lohiya
National Law University for providing us with a good environment and facilities to
complete this project. Finally, an honourable mention goes to my family and friends for their
understandings and supports on me in completing this project. Without helps of the particular
that mentioned above, I would face many difficulties in completing this project.

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 TABLE OF CONTENTS Page No.
1. Introduction & Plan of study 4
2. Definition & Subsidiaries of RBI 7
3. Functions of Reserve Bank of India 11
4. Developmental Role of Reserve Bank of India & Report of
Committee to review the working of Monetary System 22

5. Current Focus & Future Prospects of RBI 26

7. Conclusion 27

8. References 28

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CHAPTER 1 - INTRODUCTION & PLAN OF STUDY:
BACKGORUND OF STUDY:

Banking, in its crude form, is an age-old phenomenon. It was in existence even in ancient
times, too. It is the business of providing financial services to consumers and businesses.
They are the single source of institutional finance in the country. In every country there is one
organization which works as the central bank. The function of the central bank of a country is
to control and monitor the banking and financial system of the country. In India, the Reserve
Bank of India (RBI) is the Central Bank.

RESEARCH PROBLEM:
A country possesses two important policies for its development process: Monetary Policy and
Fiscal Policy. While the Government controls the fiscal policy, the Reserve Bank of India is
the apex institution of the monetary sector of the country. It is the prime controller of the
monetary market of the country. In the contemporary world, one of the most serious
economic problems being faced by the developing countries like India is of Inflation. It is a
matter of great concern whether the policies framed by the RBI are efficient enough to fight
this problem of Inflation and find opportunities for the development of the economy of the
country.

OBJECTIVE OF STUDY:
The objective of the study is to:

 Have a detailed analysis of the structure and the functions of the Reserve Bank of
India.
 Determine the importance of this bank in the contemporary India as it occupies a
dominant place in the economy, being the controller of money market.

RESERACH METHODOLOGY:
The method which will be followed for this study would be purely Doctrinal in nature. This
study would be a descriptive and analytical one describing the relevance of Reserve Bank of
India and analysing its influence in the contemporary world. The project is completed with
the help of use of books, articles and other web sources.

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ANALYSIS:
Various books on the Reserve Bank of India have been gone through alongwith the official
website of RBI to learn the working of RBI since its formation in 1935 and after
independence from 1950, its policies, their implementation and effectiveness in the monetary
market of India. The role of RBI in the development process has been analysed thoroughly.

CHAPTERIZATION:

RBI & ITS SUSIDIARIES:

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 meaning and the definition of
commercial banks have been explained under this chapter of the project.

FUNCTIONS OF RESERVE BANK OF INDIA:

The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank
of India as:

“...to regulate the issue of Bank Notes and keeping the 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.”

These functions have been discussed in detail under this head of the project work.

DEVELOPMENTAL ROLE OF RESERVE BANK OF INDIA:

The Reserve Bank is one of the few central banks that have taken an active and direct role in
supporting developmental activities in their country. The Reserve Bank’s developmental role
includes ensuring credit to productive sectors of the economy, creating institutions to build
financial infrastructure, and expanding access to affordable financial services.

CURRENT FOCUS & FUTURE PROSPECTS OF RBI:

Some of the important issues on which the Reserve Bank of India is currently focusing such
as, on supervision of financial institutions, consolidated accounting, legal issues in bank
frauds, divergence in assessments of non-performing assets and supervisory rating model for

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banks have been discussed under this chapter. Reserve Bank of India plays a very important
role in the monetary sector of the economy. It affects the other sectors such as Industrial,
Agricultural & Services sector as well. In such circumstances it becomes essential to be
aware of the current scenario and future prospects of this bank.

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CHAPTER 2 - RBI & ITS SUBSIDIARIES:
Central Bank is the symbol of financial sovereignty and stability of the country. A Central
Bank is an institution responsible for safeguarding the financial stability of a country.
(Dewett, 2005). The Reserve Bank of India is the central bank of India, and was established
on Aril 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.

The origins of the Reserve Bank of India can be traced to 1926, when the Royal Commission
on Indian Currency and Finance – also known as the Hilton-Young Commission –
recommended the creation of a central bank for India to separate the control of currency and
credit from the Government and to augment banking facilities throughout the country.

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 establishment it took over the function of management of currency
from government of India and power of credit control from Imperial Bank of India. Starting
as a private shareholders’ bank, the Reserve Bank was nationalised in 1949. It then assumed
the responsibility to meet the aspirations of a newly independent country and its people. The
Reserve Bank’s nationalisation aimed at achieving coordination between the policies of the
government and those of the central bank.
“RESERVE BANK OF INDIA: TRADITION & CHANGE”
YEAR HIGHLIGHTS
1926 The Hilton Yung Commission recommends
establishment of a Central bank for India.
1934 RBI Act passed.
1935 RBI commences operations at Calcutta
(Kolkata) as a Shareholder’s Bank.
1937 RBI’s Central Office moves to Bombay

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 (Mumbai).
1949 RBI Nationalised.
1950 India embarks on planned economic
development. The Reserve Bank becomes
active agent and participant.
1966 Cooperative banks come under RBI
regulation.

1969 Nationalisation of 14 major commercial

banks (six more were nationalised in 1980).
1973 RBI strengthens exchange controls by
amending Foreign Exchange Regulation Act
(FERA).
1974 Introduction of priority sector lending targets.
1975 Regional Rural Banks set up.
1985 Financial market reforms begin with
Sukhamoy Chakravarty and Vaghul
Committee Reports.
1991 Balance of payment crisis; pledges gold to
shore up reserves. Rupee devalued.
1993 Exchange rate becomes market determined.
1994 Board for Financial Supervision set up.

1997 Regulation of Non-Banking Finance

Companies strengthened.
1998 Multiple indicator approach for monetary
policy adopted.
2000 Foreign Exchange Management Act replaces
FERA.
2002 Clearing Corporation of India Limited
(CCIL) commences clearing and settlement
in government securities.
2003 Fiscal Responsibility and Budget

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 Management Act enacted.
2004 Transition to a full-fledged daily liquidity
adjustment facility (LAF) completed. Market
Stabilisation Scheme (MSS) introduced to
Sterilise capital flows.
2004 Real Time Gross Settlement System
commences.
2005 Focus on financial inclusion and increasing
the outreach of the banking sector.

` 2006 RBI empowered to regulate money, forex, G-

sec and gold related securities market.
2007 RBI empowered to regulate Payment System.
2008/9 Pro-active efforts to minimise impact of
global Financial crisis.
2010 Year-long Platinum Jubilee celebrations.
2011 Positioning RBI as a knowledge institution.

SUBSIDIARIES OF RBI:

The Reserve Bank has following fully owned subsidiaries:

DEPOSIT INSURANCE & CREDIT GUARANTEE CORPORATION (DICGC):

With a view to integrating the functions of deposit insurance and credit guarantee, the
Deposit Insurance Corporation and Credit Guarantee Corporation of India were merged and
the present Deposit Insurance and Credit Guarantee Corporation (DICGC) came into
existence on July 15, 1978. Deposit Insurance and Credit Guarantee Corporation (DICGC),
established under the DICGC Act 1961, is one of the wholly owned subsidiaries of the
Reserve Bank. The DICGC insures all deposits (such as savings, fixed, current, and recurring
deposits) with eligible banks except the following:
(i) Deposits of foreign Governments;
(ii) Deposits of Central/State Governments;
(iii) Inter-bank deposits;

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(iv) Deposits of the State Land Development Banks with the State cooperative bank;
(v) Any amount due on account of any deposit received outside India;
(vi) Any amount, which has been specifically exempted by the corporation with the previous
approval of Reserve Bank of India.
Every eligible bank depositor is insured upto a maximum of Rs.1,00,000 (Rupees One Lakh)
for both principal and interest amount held by him.
NATIONAL HOUNSING BANK (NHB):
National Housing Bank was set up on July 9, 1988 under the National Housing Bank Act,
1987 as a wholly-owned subsidiary of the Reserve Bank to act as an apex level institution for
housing. NHB has been established to achieve, among other things, the following objectives:
(i) To promote a sound, healthy, viable and cost effective housing finance system to all
segments of the population and to integrate the housing finance system with the overall
financial system.
(ii) To promote a network of dedicated housing finance institutions to adequately serve
various regions and different income groups.
(iii) To augment resources for the sector and channelise them for housing.
(iv) To make housing credit more affordable.
(v) To regulate the activities of housing finance companies based on regulatory and
supervisory authority derived under the Act.
BHARTIYA RESERVE BANK NOTE MUDRAN PRIVATE LIMITED (BRBNMPL):
The Reserve Bank established BRBNMPL in February 1995 as a wholly-owned subsidiary to
augment the production of bank notes in India and to enable bridging of the gap between
supply and demand for bank notes in the country. The BRBNMPL has been registered as a
Public Limited Company under the Companies Act, 1956 with its Registered and Corporate
Office situated at Bengaluru. The company manages two Presses, one at Mysore in Karnataka
and the other at Salboni in West Bengal.
NATIONAL BANK FOR AGRICULTURE & RURAL DEVELOPMENT (NABARD):
National Bank of Agriculture and Rural Development (NABARD) is one of the subsidiaries
where the majority stake is held by the Reserve Bank. NABARD is an apex Development
Bank with a mandate for facilitating credit flow for promotion and development of
agriculture, small-scale industries, cottage and village industries, handicrafts and other rural
crafts. It also has the mandate to support all other allied economic activities in rural areas,
promote integrated and sustainable rural development and secure prosperity of rural areas.

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CHAPTER 3 - FUNCTIONS OF RESEVE BANK OF INDIA:
The functions of Reserve Bank of India comprise monetary management, foreign exchange
and reserves management, government debt management, financial regulation and
supervision, apart from currency management and acting as banker to the banks and to the
Government. In addition, from the beginning, the Reserve Bank has played an active
developmental role, particularly for the agriculture and rural sectors. Over the years, these
functions have evolved in tandem with national and global developments. Some important
functions of the Reserve Bank of India have been discussed below:

1. MONETARY MANAGEMENT:
DIFFERENT METHODS ADOPTED FOR MONETARY MANAGEMENT TILL
DATE
Year Method Adopted by RBI
1935 Proportional Reserve System.
1954 Minimum reserve System.
1973-76 Minimum and maximum lending rates for
bank loans purchased.
1985 Flexibility monetary targeting with feedback.
1998 Multiple indicator approach adopted.

One of the most important functions of central banks is formulation and execution of
monetary policy. In the Indian context, the basic functions of theReserve Bank of India as
enunciated in the Preamble to the RBI Act, 1934 are:
“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 currencyand credit system of the
country to its advantage.” Thus, the Reserve Bank’s mandate for monetary policy flows from
its monetary stability objective.
“Monetary policy refers to the use of instruments under the control of the central bank to
regulate the availability, cost and use of money and credit.”
GOAL: The main reason for controlling monetary market is for achieving specific economic
objectives:
a). Low and Stable Inflation
b). Promoting Growth

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OBJECTIVES: The main objectives of Monetary Policy in India are:
i). Maintaining price stability
ii). Ensuring adequate flow of credit to the productive sectors of the economy to support
economic growth
iii). Financial stability
The relative emphasis on the objectives varies from time to time, depending on evolving
macro economic developments. The operating framework of RBI is based on a multiple
indicator approach. It monitors and analyses the movement of a number of indicators
including interest rates, inflation rate, money supply, credit, exchange rate, trade, capital
flows and fiscal position, along with trends in output as it develops its policy perspectives.
TOOLS: There are several direct and indirect instruments that are used in the formulation
and implementation of monetary policy.
 Direct Instruments:
Cash Reserve Ratio (CRR): The share of net demand and time liabilities that banks must
maintain as cash balance with the Reserve Bank.
Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities that banks
must maintain in safe and liquid assets, such as government securities, cash and gold.
Refinance facilities: Sector-specific refinance facilities (e.g., against lending to export
sector) provided to banks.
 Indirect Instruments:
Liquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity on
a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption)
auction operations, using government securities as collateral.
Repo/Reverse Repo Rate: These rates under the Liquidity Adjustment Facility (LAF)
determine the corridor for short-term money market interest rates. In turn, this is expected to
trigger movement in other segments of the financial market and the real economy.
Open Market Operations (OMO): Outright sales/purchases of government securities, in
addition to LAF, as a tool to determine the level of liquidity over the medium term.
Marginal Standing Facility (MSF): was instituted under which scheduled commercial banks
can borrow over night at their discretion up to one per cent of their respective NDTL at 100
basis points above the repo rate to provide a safety valve against unanticipated liquidity
shocks

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Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers. It also signals the medium-term stance of monetary
policy.
Market Stabilisation Scheme (MSS): This instrument for monetary management was
introduced in 2004. Liquidity of a more enduring nature arising from large capital flows is
absorbed through sale of short-dated government securities and treasury bills. The mobilised
cash is held in a separate government account with the Reserve Bank.

2. ISSUER OF CURRENCY:
DEVELOPMENTS MADE BY RBI AS “ISSUER OF CURRENCY”
Year Development Made
1935 Currency Function moves from Controller of
Currency to RBI.
1957 Decimalization of Coinage.
1995 RBI sets up its printing press.
2000 Currency processing mechanised.
2005 Machine-readable security features
introduced.

Management of currency is one of the core central banking functions of the Reserve Bank for
which it derives the necessary statutory powers from Section 22 of the RBI Act, 1934. Along
with the Government of India, the Reserve Bank is responsible for the design, production and
overall management of the nation’s currency, with the goal of ensuring an adequate supply of
clean and genuine notes. In consultation with the Government, the Reserve Bank routinely
addresses security issues and targets ways to enhance security features to reduce the risk of
counterfeiting or forgery of currency notes.
The Paper Currency Act of 1861 conferred upon the Government of India the monopoly of
note issues, thus ending the practice of private and presidency banks issuing currency.
Between 1861 and 1935, the Government of India managed the issue of paper currency. In
1935, when the Reserve Bank began operations, it took over the function of note issue from
the Office of the Controller of Currency, Government of India.
TOOLS: Four printing presses print and supply banknotes. These are at Dewas in Madhya
Pradesh, Nasik in Maharashtra, Mysore in Karnataka, and Salboni in West Bengal. The

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presses in Madhya Pradesh and Maharashtra are owned by the Security Printing and Minting
Corporation of India (SPMCIL), a wholly owned company of the Government of India. The
presses in Karnataka and West Bengal are owned by the Bharatiya Reserve Bank Note
Mudran Private Limited (BRBNMPL), a wholly owned subsidiary of the Reserve Bank.
Coins are minted by the Government of India. The Reserve Bank is the agent of the
Government for distribution, issue and handling of coins. Four mints are in operation:
Mumbai in Maharashtra, Noida in Uttar Pradesh, Kolkata, and Hyderabad.
RBI’s Anti-counterfeiting Measures:
 Continual upgrades of banknote security features.
 Public awareness campaigns to educate citizens to help prevent circulation of forged
or counterfeit notes.
 Installation of note sorting machines.
FEW INITIATIVES:
RBI has taken several initiatives to improve customer service with regard to banknotes. Some
of them are:
1. Giving incentive to banks for adjudication of cut notes and mopping up of soiled notes.
2. Transferring currency exchange facility to bank branches.
3. Permitting banks to engage the services of Business Correspondents and Cash-In-Transit
companies for distribution of notes and coins and ensure last mile connectivity.
4. Withdrawal of old series of banknotes (issued before 2005) keeping in view the standard
international practice.
5. Creating ‘Paisa bolta hai’ – an educative micro site, which includes a film for public
awareness about banknotes.

3. BANKER AND DEBT MANAGER TO GOVERNMENT:

Managing the government’s banking transactions is a key RBI role. Like individuals,
businesses and banks, governments need a banker to carry out their financial transactions in
an efficient and effective manner, including the raising of resources from the public. As a
banker to the central government, the Reserve Bank maintains its accounts, receives money
into and makes payments out of these accounts and facilitates the transfer of government
funds.
Year Event Happened
1935 RBI becomes Banker and Debt Manager to

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 Government.
1944 Public Debt Act passed.
1997 Ad-hoc treasury bills abolished ending
automatic monetization.
2003 Fiscal Responsibility and Budget
Management Act passed.
2007 Government Securities Act replaces Public
Debt Act of 1944.

RBI’s APPROACH: The role as banker and debt manager to government includes several
distinct functions:
1. Undertaking banking transactions for the central and state governments to facilitate
receipts and payments and maintaining their accounts.
2. Managing the governments’ domestic debt with the objective of raising the required
amount of public debt in a cost-effective and timely manner.
3. Developing the market for government securities to enable the government to raise debt at
a reasonable cost, provide benchmarks for raising resources by other entities and facilitate
transmission of monetary policy actions.
TOOLS: At the end of each day, our electronic system automatically consolidates all of the
government’s transactions to determine the net final position. If the balance in the
government’s account shows a negative position, we extend a short-term, interest-bearing
advance, called a Ways and Means Advance—WMA—the limit or amount for which is set at
the beginning of each financial year in April.
RBI as the Governments’ Debt Manager:
In this role, RBI sets policies, in consultation with the government and determines the
operational aspects of raising money to help the government finance its requirements:
 Determine the size, tenure and nature (fixed or floating rate) of the loan.
 Define the issuing process including holding of auctions.
 Inform the public and potential investors about upcoming government loan auctions.
The Reserve Bank also undertakes market development efforts, including enhanced
secondary market trading and settlement mechanisms, authorisation of primary dealers and
improved transparency of issuing process to increase investor confidence, with the objective
of broadening and deepening the government securities market.

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4. BANKER TO BANKS:
Year Changes Occurred
1935 Currency Functions moves from Controller
of Currency to RBI.
1957 Decimalization of Coinage
1995 RBI sets up its printing press.
2000 Currency processing mechanized.
2005 Machine-readable security features
introduced.

Like individual consumers, businesses and organisations of all kinds, banks need their own
mechanism to transfer funds and settle inter-bank transactions—such as borrowing from and
lending to other banks—and customer transactions. As the banker to banks, the Reserve Bank
fulfils this role. In effect, all banks operating in the country have accounts with the Reserve
Bank, just as individuals and businesses have account with their banks.
RBI’s APPROACH: As the banker to banks, RBI focuses on:
1. Enabling smooth, swift and seamless clearing and settlement of inter-bank obligations.
2. Providing an efficient means of funds transfer for banks.
3. Enabling banks to maintain their accounts with us for purpose of statutory reserve
requirements and maintain transaction balances.
4. Acting as lender of the last resort.
TOOLS: The Reserve Bank provides products and services for the nation’s banks similar to
what banks offer their own customers. Here’s a look at how it helps:
1. Non-interest earning current accounts: Banks hold accounts with the Reserve Bank
based on certain terms and conditions, such as, maintenance of minimum balances. They can
hold accounts at each of our regional offices. Banks draw on these accounts to settle their
obligations arising from inter-bank settlement systems. Banks can electronically transfer
payments to other banks from this account, using the Real Time Gross Settlement System
(RTGS).
2. Deposit Accounts Department: This department’s computerised central monitoring
system helps banks manage their funds position in real time to maintain the optimum balance
between surplus and deficit centres.

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3. Remittance facilities: Banks and government departments can use these facilities to
transfer funds.
4. Lender of the last resort: The Reserve Bank provides liquidity to banks unable to raise
short term liquid resources from the inter-bank market. Like other central banks, the Reserve
Bank considers this a critical function because it protects the interests of depositors, which in
turn, has a stabilising impact on the financial system and on the economy as a whole.
5. Loans and advances: The Reserve Bank provides short-term loans and advances to banks
/financial institutions, when necessary, to facilitate lending for specified purposes.

5. FINANCIAL REGULATION AND SUPERVISION:

Banks are fundamental to the nation’s financial system. The central bank has a critical role to
play in ensuring the safety and soundness of the banking system—and in maintaining
financial stability and public confidence in this system. As the regulator and supervisor of the
banking system, the Reserve Bank protects the interests of depositors, ensures a framework
for orderly development and conduct of banking operations conducive to customer interests
and maintains overall financial stability through preventive and corrective measures.
RBI’s APPROACH: The Reserve Bank regulates and supervises the nation’s financial
system. Different departments of the Reserve Bank oversee the various entities that comprise
India’s financial infrastructure. RBI oversees:
1. Commercial banks and all-India development financial institutions: Regulated by the
Department of Banking Operations and Development, supervised by the Department of
Banking Supervision
2. Urban co-operative banks: Regulated and supervised by the Urban Banks Department.
3. Regional Rural Banks (RRB), District Central Cooperative Banks and State Co-
operative Banks: Regulated by the Rural Planning and Credit Department and supervised by
NABARD.
4. Non-Banking Financial Companies (NBFC): Regulated and supervised by the
Department of Non-Banking Supervision.
TOOLS: The Reserve Bank makes use of several supervisory tools:
1. On-site inspections.
2. Off-site surveillance, making use of required reporting by the regulated entities.
3. Thematic inspections, scrutiny and periodic meetings.
The RBI’s Regulatory Role:

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As the nation’s financial regulator, the Reserve Bank handles a range of activities, including:
 Licensing
 Prescribing capital requirements
 Monitoring governance
 Setting prudential regulations to ensure solvency and liquidity of the banks
 Prescribing lending to certain priority sectors of the economy
 Regulating interest rates in specific areas
 Setting appropriate regulatory norms related to income recognition, asset
classification, provisioning, investment valuation, exposure limits and the like
 Initiating new regulation

6. MANAGER OF FOREIGN EXCHANGE:

Year Developments Made
1939 Exchange Control introduced in India under
Defence of India Rules.
1966 Indian Rupee devalued.
1975 Rupee linked to banker of currencies.
1993 Exchange rate becomes market-determined.
2000 Foreign Exchange Management Act (FEMA)
replaces Foreign Exchange Regulation Act
(FERA).

With the transition to a market-based system for determining the external value of the Indian
rupee, the foreign exchange market in India gained importance in the early reform period. In
recent years, with increasing integration of the Indian economy with the global economy
arising from greater trade and capital flows, the foreign exchange market has evolved as a
key segment of the Indian financial market.
RBI’s APPROACH: The Reserve Bank plays a key role in the regulation and development
of the foreign exchange market and assumes three broad roles relating to foreign exchange:
1. Regulating transactions related to the external sector and facilitating the development of
the foreign exchange market.
2. Ensuring smooth conduct and orderly conditions in the domestic foreign exchange market.
3. Managing the foreign currency assets and gold reserves of the country.

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TOOLS: The Reserve Bank is responsible for administration of the Foreign Exchange
Management Act, 1999 and regulates the market by issuing licences to banks and other select
institutions to act as Authorised Dealers in foreign exchange. The Foreign Exchange
Department (FED) is responsible for the regulation and development of the market.
On a given day, the foreign exchange rate reflects the demand for and supply of foreign
exchange arising from trade and capital transactions. The RBI’s Financial Markets
Department (FMD) participates in the foreign exchange market by undertaking sales /
purchases of foreign currency to ease volatility in periods of excess demand for/supply of
foreign currency.
The Department of External Investments and Operations (DEIO) invests the country’s
foreign exchange reserves built up by purchase of foreign currency from the market. In
investing its foreign assets, the Reserve Bank is guided by three principles: safety, liquidity
and return.

7. MAINTAINING FINANCIAL STABILITY:

Pursuit of financial stability has emerged as a key critical policy objective for the central
banks in the wake of the recent global financial crisis. Central banks have a critical role to
play in achieving this objective. Though financial stability is not an explicit objective of the
Reserve Bank in terms of the Reserve Bank of India Act, 1935, it has been an explicit
objective of the Reserve Bank since the early 2000s.
RBI’s APPROACH: In 2009, the Reserve Bank set up a dedicated Financial Stability Unit
mainly to, put in place a system of continuous monitoring of the macro financial system. The
department’s remit includes:
1. Conduct of macro-prudential surveillance of the financial system on an ongoing basis.
2. Developing models for assessing financial stability in going forward.
3. Preparation of half yearly financial stability reports.
4. Development of a database of key variables which could impact financial stability, in co-
ordination with the supervisory wings of the Reserve Bank.
5. Development of a time series of a core set of financial indicators.
6. Conduct of systemic stress tests to assess resilience.
TOOLS: The Reserve Bank makes use of a variety of tools and techniques to assess the build
up of systemic risks in the economy and to provide critical inputs in this respect to its policy
making departments. The tools include:

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1. Financial Stress Indicator - a contemporaneous indicator of conditions in financial
markets and in the banking sector;
2. A Systemic Liquidity Indicator for assessing stresses in availability of systemic liquidity;
3. A Fiscal Stress Indicator for assessing build up of risks from the fiscal;
4. A Network Model of the bilateral exposures in the financial system – for assessing the
interconnectedness in the system;
5. A Banking Stability Indicator for assessing risk factors having a bearing on the stability
of the banking sector; and
6. A series of Banking Stability Measures for assessing the systemic importance of
individual banks.

8. REGULATOR AND SUPERVISOR OF PAYMENT AND

SETTLEMENT SYSTEMS:
Payment and settlement systems play an important role in improving overall economic
efficiency. They consist of all the diverse arrangements that we use to systematically transfer
money—currency, paper instruments such as cheques, and various electronic channels.
RBI’s APPROACH: The Payment and Settlement Systems Act of 2007 (PSS Act) gives the
Reserve Bank oversight authority, including regulation and supervision, for the payment and
settlement systems in the country. In this role, we focus on the development and functioning
of safe, secure and efficient payment and settlement mechanisms.
TOOLS: The Reserve Bank has a two-tiered structure. The first tier provides the basic
framework for our payment systems. The second tier focuses on supervision of this
framework. As part of the basic framework, the Reserve Bank’s network of secure systems
handles various types of payment and settlement activities. Most operate on the security
platform of the Indian Financial Network (INFINET), using digital signatures for further
security of transactions. Here is an overview of the various systems used:
1. Retail payment systems: Facilitating cheque clearing, electronic funds transfer, through
National
Electronic Funds Transfer (NEFT), settlement of card payments and bulk payments, such as
electronic clearing services. Operated through local clearing houses throughout the country.
2. Large value systems: Facilitating settlement of inter-bank transactions from financial
markets. These include:
- Real Time Gross Settlement System (RTGS): for funds transfers

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- Securities Settlement System: for the government securities market
- Foreign Exchange Clearing: for transactions involving foreign currency
3. Department of Payment and Settlement Systems: The Reserve Bank’s payment and
settlement systems regulatory arm.
4. Department of Information Technology: Tech support for the payment systems and for
the Reserve Bank’s internal IT systems.

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CHAPTER 4 - DEVELOPMENTAL ROLE OF RESERVE
BANK OF INDIA:
The Reserve Bank is one of the few central banks that have taken an active and direct role in
supporting developmental activities in their country. The Reserve Bank’s developmental role
includes ensuring credit to productive sectors of the economy, creating institutions to build
financial infrastructure, and expanding access to affordable financial services. Over the years,
its developmental role has extended to institution building for facilitating the availability of
diversified financial services within the country. The Reserve Bank today also plays an active
role in encouraging efficient customer service throughout the banking industry, as well as
extension of banking service to all, through the thrust on financial inclusion.
RBI’s APPROACH:
Over the years, the Reserve Bank has added new institutions as the economy has evolved.
Some of the institutions established by the RBI include:
1. Deposit Insurance and Credit Guarantee Corporation (1962), to provide protection to bank
depositors and guarantee cover to credit facilities extended to certain categories of small
borrowers.
2. Unit Trust of India (1964), the first mutual fund of the country.
3. Industrial Development Bank of India (1964), a development finance institution for
industry.
4. National Bank for Agriculture and Rural Development (1982), for promoting rural and
agricultural credit.
5. Discount and Finance House of India (1988), a money market intermediary and a primary
dealer in government securities.
6. National Housing Bank (1989), an apex financial institution for promoting and regulating
housing finance.
7. Securities and Trading Corporation of India (1994), a primary dealer of Government
Securities.
TOOLS:
The Reserve Bank continues its developmental role, while specifically focussing on financial
inclusion. Key tools in this on-going effort include:
1. Directed credit for lending to priority sector and weaker sections: The goal here is to
facilitate/ enhance credit flow to employment intensive sectors such as agriculture, micro and
small enterprises (MSE), as well as for affordable housing and education loans.

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2. Lead Bank Scheme: A commercial bank is designated as a lead bank in each district in
the country and this bank is responsible for ensuring banking development in the district
through coordinated efforts between banks and government officials. The Reserve Bank has
assigned a Lead District Manager for each district who acts as a catalytic force for promoting
financial inclusion and smooth working between government and banks.
3. Sector specific refinance: The Reserve Bank makes available refinance to banks against
their credit to the export sector. In exceptional circumstances, it can provide refinance against
lending to other sectors.
4. Strengthening and supporting small local banks: This includes regional rural banks and
cooperative banks
5. Financial inclusion: Expanding access to finance and promoting financial literacy are a
part of our outreach efforts.
Financial Inclusion and Literacy: Expanding Access; Encouraging
Education
Expanding access to and knowledge about finance is a fundamental aspect of the Reserve
Bank’s operations. These efforts are critical to ensuring that the benefits of a growing and
healthy economy reach all segments of the population. Our work here includes:
1. Encouraging provision of affordable financial services like zero-balance, no-frills bank
accounts, access to payments and remittance facilities, savings, loans and insurance services.
2. Expanding banking outreach through use of technology, such as banking by cell phone,
smart cards and the like.
3. Encouraging bank branch expansion in parts of the country with few banking facilities.
4. Facilitating use of specified persons to act as agents to perform banking functions in hard-
to reach parts of the country.
Our work to promote financial literacy focuses on educating people about responsible
financial management. Efforts here include:
 Information and knowledge-sharing: User-friendly website includes easy-understand
tips and guidance in multiple languages; brochures, advertisements and other marketing
materials educate the public about banking services.
 Credit counselling: The Reserve Bank encourages commercial banks to set up financial
literacy and credit counselling centres, to help people develop better financial planning
skills.

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REPORT OF COMMITTEE TO REVIEW THE WORKING OF THE
MONETARY SYSTEM:
The Committee to review the working of the Monetary System headed by S. Chakravarty
was constituted in the early 1980s. The Committee submitted its report to the RBI in April
1985. In its terms of reference this committee was required to provide a review of the
monetary system and recommended measures for making monetary policy more effective.
The Committee dealt particularly with the objectives of monetary policy; coordination
between monetary policy and fiscal policy; regulation of money supply; maintenance of price
stability; interest rate policy and utilisation of credit. Its main recommendations are as
follows:

1. The Committee has stressed the need to pursue price stability as the primary objective of
the monetary policy. However, it suggested that this objective should not come in conflict
with other socio-economic goals embodies in the Five Year Plans. The Committee pointed
out that the major factor that contributed to the colossal increase in the money supply had
been the RBI’s credit to the government. The Committee thus recommended that an
appropriate framework for the regulation of the RBI’s credit to the government should be
evolved.

2. The official concept of budgetary deficit did not allow in the past to clearly know the
monetary impact of fiscal operations. The committee, therefore, suggested a change in the
definition of budgetary deficit. The budgetary deficit of the Central Government was
measured in terms of an increase in the treasury bills. In the opinion of this Committee, this
overstated the extent of the monetary impact of fiscal operations because no distinction was
made between the absorption of treasury bills and the increase in the holdings of the treasury
bills by the RBI.

3. The Committee was of the view that banks should have greater freedom in determining
their lending rates. This would prevent unnecessary use of credit which presently is possible
due to relatively low rates. Further the committee strongly felt that concessional interest rates
as a redistributive device should be used in a very selective manner.

4. The Committee did not favour the continuance of cash credit as the predominant form of
bank credit. In its opinion, certain measures should be undertaken to encourage loans and bill

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finance forms of bank credit. It also stressed the importance of credit delivery system in the
area of priority sector lending.

5. The Committee was of the view that the money market in India should be restructured.
In its opinion, in the restructured monetary system the treasury bills market, the call money
market, the commercial bills market and the inter-corporate funds market should play an
important role in the allocation of short term resources. The Committee also recommended
that the RBI should take all measures which are necessary to develop an efficient money
market in this country. (Chakravarty Report, 1985)

The major recommendations of the Chakravarty Committee were accepted and have been
implemented. The Committee had stressed the need for developing aggregate monetary
targets to ensure orderly monetary growth. The government has thus carried out an
exercise to evolve such targets in consultation with the RBI. The government has also
accepted in principle that increase in entire RBI credit to the government should be reflected
in the budget in addition to the narrowly defined figure of the budget deficit. Keeping in view
the recommendations of the Committee the yield on long-term government securities were
increased and the maturities educed. Moreover, now treasury bills of 364 days maturity are
being issued by RBI. These instruments with flexible rates now enable banks to manage their
liquidity better and help in evolving an active secondary market in short-term instruments.
(Puri, 2007)

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CHAPTER 5 - CURRENT FOCUS & FUTURE PROSPECTS
OF RBI:
The Reserve Bank looks at both short term and longer term issues related to liquidity
management. In the longer term, it monitors the developments in global financial markets,
capital flows, the government’s fiscal position and inflationary pressures, with an eye toward
encouraging strong and sustainable economic growth.
Focus continues on ensuring availability of clean notes and on strengthening the security
features of bank notes. Given the volumes involved and costs incurred in the printing,
transport, storage and removal of unfit/ soiled notes, the Reserve Bank is evaluating ways to
extend the life of bank notes - particularly in lower denominations. RBI is, for instance,
considering issue of Rs.10 banknotes in plastic.
Going forward, RBI will continue to enhance efficient and user-friendly conduct of banking
transactions for central and state governments while ensuring cost-effective cash and debt
management by deepening and widening of the market for government securities.
Challenges going forward include implementing core banking solutions for RBIs’ customers
and enhancing the safety and efficiency of the payments and settlement system in the
country.
In the regulatory and supervisory arena, there are several challenges going forward.
1. For commercial banks: Focus is on implementing Basel III norms, which will require
improved capital planning and risk management skills.
2. For urban cooperative banks: Focus is on profitability, professional management and
technology enhancement.
3. For NBFCs: Focus is on identifying the interconnections and the roles these institutions
should play as the financial system deepens.
4. For regional rural banks: Focus is on enhancing capability through IT and HR for
serving the rural areas.
5. For rural cooperative banks: Focus is on ensuring that they meet minimum prudential
standards.
The challenge now is to liberalise and develop the foreign exchange market, with an eye
toward ushering in greater market efficiency while ensuring financial stability in an
increasingly global financial market environment. With current account convertibility
achieved in 1994, the key focus is now on capital account management.

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According to the Financial Stability Report, RBI is launching a Systemic Risk Survey to
more formally elicit market views on the possible sources of risk to systemic stability of the
country - both, domestic and global.
The development role of the Reserve Bank will continue to evolve, along with the Indian
economy. Through the outreach efforts and emphasis on customer service, the Reserve Bank
will continue to make efforts to fill the gaps to promote inclusive economic growth and
stability. RBI is proactively identifying and addressing issues that help mitigate the risks for
large value systems. Efforts on the retail payment system side will focus on operational
efficiencies, cost effectiveness, innovation and risk management

CONCLUSION:
“Building on the firm foundation of our rich tradition, the Reserve Bank is also
changing with the times.”
The Reserve Bank’s mandate—yesterday, today and tomorrow—is to set a monetary and
financial course that will sustain the nation’s economic growth and health during global
downturns, periods of volatility and global upturns alike.
Its actions prior to and during the recent period of global financial upheaval exemplify these
commitments. It has demonstrated willingness to take pro-active measures to preserve gains
and to ensure that progress is sustainable. The Reserve Bank responses during extraordinary
times are aimed at maintaining financial stability including maintaining sufficient rupee and
foreign exchange liquidity to ensure that credit continues to flow to businesses and
consumers and financial markets remain stable.
It also continues to address the challenge of ensuring that the national financial and monetary
policy-making contributes to positive, sustainable and inclusive growth across the income
spectrum. The Reserve Bank’s willingness to use conventional and unconventional measures
has helped buffer the nation from severe crises.

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REFERENCES:

 Datt, Ruddar, and K.P.H. Sundharam. (2008). Indian Economy. New Delhi:
S.Chand & Company Ltd.
 Misra and Puri. (2007). Indian Economy. Delhi: Himalaya Publishing House.
 Dewett, K.K. (2008). Modern Economic Theory. New Delhi: S.Chand & Company
Ltd.
 Agarwal, A.N. (2006). Indian Economy: Problems of Development and Planning.
Delhi: New Age International Publishers.
 Myeni, S.R. (2002). Indian Economics. Allahabad: Allahabad Law Agency.
 Samuelson, Paul A., and William D. Nordhaus. (2005). Economics. New Delhi:
Tata Mac Graw Hill Publishing Company Ltd.
 Raj, Felix J. (2008). Indian Economy: Economic Ideas, Development and
Financial Reforms. New Delhi: Deep & Deep Publications Pvt. Ltd.
 Bhattacharya, Hrisikes. (2011). Banking Strategy, Credit Appraisal and Lending
Decisions: A Risk Return Framework. New Delhi: Oxford University Press.
 Hall, Robert E. & Lieberman, Marc. (2006). USA: Thomson South Western.
 Bauer, P.T. (2011). Indian Economic Policy and Development. New York:
Routledge Taylor & Francis Group.
 www.rbi.org.in accessed on 23rd September 2014.
 Retreived from RBI website:
http://www.rbi.org.in/commonman/English/scripts/organisation.aspx on 24th
September 2014.
 S. Chakravarty Report, 1985: A review on the working of the Monetary System.

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