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Reserve Bank of India

The RBI was established in 1935

under the RBI Act, 1934. The
Preamble of the RBI act 1934,
describes its basic functions 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. The RBI thus not only
performs its traditional monetary

Definitions of a Central Bank

H.A.Shaw (1918) defined a central bank
as the bank whose main function is
control of credit.
Hawtrey defines it as A central Bank is
that which is the lender of the last
How is the Central Bank different from
the commercial banks?

Functions of RBI
Monetary functions
Note Issuing Authority
Banker to the Government
Bankers bank
Lender of the last resort
Custodian of foreign exchange reserves
Credit Control

Note Issuing Authority: The issue of paper

money is the most important function of a
Central Bank. The issue department issues
bank notes. The central bank regulates the
credit and currency according to the
economic situation of the country. In the
method of note issue, the Central Bank is
required to keep a certain amount or a fixed
proportion of gold and foreign securities
against the total notes issued. Having this
monopoly of note issue, RBI gains some
advantages such as : ensuring uniformity of
the notes issued, a proper control over
supply of money, creating public confidence,

Banker to the Government: As a banker,

to the government the Central bank manages
the banking needs of the government,
sometimes advancing loans to government.
It also gives advice to the government on
important monetary and economics issues
like budgetary policy, devaluation, etc.
Bankers Bank: Just as individuals and
corporates have account with banks; all
banks operating within the nation have
accounts with RBI. Commercial banks are
required to keep a certain percentage of cash
reserves with the Central bank.

Lender of the Last Resort: The Central

bank acts as a lender of last resort. In times of
need the Central bank lends to banks by
giving accommodation in the form of loans
and advances against securities, re-discounts
Custodian of Foreign Exchange Reserves:
The Central Bank keeps and manages the
foreign exchange reserves of the country. It
fixes the exchange rate of the domestic
currency in terms of foreign currencies.
Credit Control: Central bank controls the
credit creation power of the commercial banks
in order to fight the inflationary and
deflationary pressures within the economy;
using quantitative and qualitative methods.

Non-monetary Functions
Collection and Publication of Data
RBI has a separate department of Statistics for
statistical information and conducting research
related to banks and financial sector of the
Regulatory and Supervisory Functions
As per the RBI Act and Banking Regulation Act;
RBI has extensive powers of regulation and
supervision over commercial and cooperative
banks to check malpractices and protecting
investors interests. It grants licenses, carries out
inspection, auditing, etc.

RBI promotes saving and banking
habits. The development of rural credit
and cooperative credit movement has
been given due importance by RBI. It
has also set of number of training
categories of bank personnel.

Quantitative: Bank Rate Policy (BRP),
Open Market Operations (OMO) and
Variable Reserve Ratio (VRR).
Requirements, Regulation of Consumer
Credit, Credit Rationing, Direct Action,
Moral Suasion and Publicity.

How the quantitative tool of BANK

Operation/Variable Reserve Ratio is
used by RBI to control Inflationary
trends in the economy?
How the quantitative tool of BANK
RATE Policy is used by RBI to control
deflation in the economy?

Limitations of
The success of BRP depends upon the extent

to which the other market rates move in line

with the bank rate.
If banks have excess cash reserves and are
not in the habit of rediscounting or borrowing
from central bank; then also BRP will not be
Lack of well developed security market leads
to failure of OMO.
Excessive cash reserves leads to VRR
implementation failure. So, also NBFIs are not
affected by variation in reserve requirements.

Limitations of Qualitative

It is difficult to ensure if the purpose for which

loan is granted is used for the same or not
which makes site visits a must for the banks.
Even if banks ensure the loan amount is
properly used, they have no control over the
additional income created by the original
Some commercial banks for the purpose of
earning profits may advance loans for
purposes other than laid down by Central

Few Questions:
During the periods of depression, the
Central Bank ______the securities in
the open market.
When the bank rate is reduced, the
interest rate will ________
When the Central bank raises the
reserve ratio, the amount of money
available with the bank ______
During inflation, Central bank
______the bank rate.



Principles of Lending
There are broadly 6 principles
lending which are as follow:
1.Principle of Liquidity
2.Principle of Profitability
3.Principle of Safety and Security
4.Principle of Purpose or Suitability
5.Diversification of Risks
6.Principle of Social Responsibility