RBI FUNCTIONS

&
MONETARY
POLICY
 Introduction
The Reserve Bank of India (RBI) is the Central Bank of the country. It has been established as a
body corporate under the Reserve Bank of India Act, which came into effect from 1st April, 1935.
The Reserve Bank was started as a share-holders bank with a paid-up capital of Rs.5 crores. On
establishment, it took over the function of management of currency from the Government
of India and power of credit control from the then Imperial Bank of India. The Reserve Bank
was nationalized in 1949 soon after the country‟s independence. The basic reasons for
nationalization were as follows:
1) There was a trend towards nationalization of Central Banks of the country in all parts of the
world after the end of the Second World War. Even the Bank of England was nationalized in the
year 1946.
2) The inflationary tendencies started right from the beginning of the Second World War, i.e., 1939.
To control these tendencies effectively, it was thought proper to nationalize the Reserve Bank of
India – the Central Bank of the country, responsible for credit and currency management.
3) The country had embarked upon a Planned Economic Programme after independence.
Nationalization of the Reserve Bank of India was necessary to use it as an effective instrument
for economic development of the country.
The Reserve Bank of India carries on its operations according to the provisions of the Reserve Bank
of India Act, 1934. The act has been amended from time to time.
Features of RBI
1) RBI formulates implements and monitors the monetary policy.
2) RBI maintains public confidence in the system, protect
depositors‟ interest and provide cost-effective banking services
to the public.
3) To facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in
India.
4) To give the public adequate quantity of supplies of currency
notes and coins and in good quality.
Role of Reserve Bank of
India
Since its inception in 1935, the Reserve Bank of India has
functioned with great success, not only as the apex financial
institution in the country but also as the promoter of economic
development. With the introduction of planning in India since
1951, the Reserve Bank formulated a new monetary policy to
aid and speed up economic development. The Reserve Bank
has undertaken several new functions to promote economic
development in the country. The major contributions of the
Reserve Bank to economic development are as follows:
1) Promotion of Commercial Banking: A well-developed banking system is a
precondition for economic development. The Reserve Bank has taken several
steps to strengthen the banking system. The Banking Regulation Act, 1949 has
given the Reserve Bank vast powers of supervision and control of commercial
banks in the country. The Reserve Bank has been using these powers:
i) To strengthen the commercial banking structure through liquidation and
amalgamation of banks and through improvement in their operational
standards,
ii) To extend the banking facilities in the semi-urban and rural areas, and
iii) To promote the allocation of credit in favor of priority sectors, such as
agriculture, smallscale industries, exports, etc.
The Reserve Bank is also making valuable contribution to the development of
banking system by extending training facilities, to the supervisory staff of the
banks through its „Banker‟s training colleges.
2) Promotion of Rural Credit: Defective rural credit system and deficient rural credit facilities are
some of the major causes of the backwardness of Indian agriculture. In view of this, the Reserve Bank,
ever since its establishment, has been assigned the responsibility of reforming the rural credit system
and making provision of adequate institutional finance for agriculture and other rural activities. The
Reserve Bank has taken the following steps to promote rural credit:
i) It has set up the Agricultural Credit Department to expand and co-ordinate credit facilities to rural
areas.
ii) It has been taking all necessary measures to strengthen the cooperative credit system to meet the
financial needs of the rural people.
iii) In 1956, the Reserve Bank set up two funds. Namely, the National Agriculture Credit (long-term
operations) Fund and the National Agricultural Credit (stabilization) Fund, for providing
medium-term and long-term loans to the state cooperative banks.
iv) Regional rural banks have been established to promote agricultural credit.
v) Some commercial banks have been nationalized mainly to expand bank credit facilities in rural areas.
vi) The National Bank for Agriculture and Rural Development has been established in 1982 as the apex
institution for agricultural finance.
vii) The Reserve Bank has helped the establishment of many warehouses in the country.
3) Promotion of Co-operative Credit: Promotion of co-operative credit movement is also the
special function of the Reserve Bank. On the recommendations of the Rural Credit Survey
Committee, the Reserve Bank has taken a number of measures to strengthen the structure of
co-operative credit institutions throughout the country. The Reserve Bank provides financial
assistance to the agriculturists through the co-operative institutions. The Reserve Bank has,
thus, infused a new life into the co-operative credit movement of the country.
4) Promotion of Industrial Finance: Credit or finance is the pillar to industrial development.
The Reserve Bank has been playing an active role in the field of industrial finance also. In 1957,
it has set up a separate Industrial Finance Department which has rendered useful service in
extending financial and organizational assistance to the institutions providing longterm finance.
It made commendable efforts for broadening the domestic capital market for providing the
medium and long-term finance to the industrial sector. In this regard the Reserve Bank took
initiative in the establishment of a number of statutory corporations for the purpose of
providing finance, especially medium and long-term finance, to industries; Industrial
Development Bank of India, Industrial Finance Corporation of India, State Finance Corporations,
State Industrial Development Corporations and the Industrial Credit and Investment Corporation
of India are some of the important corporations established in the country with the initiative of
the Reserve Bank.
5) Promotion of Export Credit: “Export or Perish” has become a slogan for the
developing economies, including India. In recent years, India is keen on expanding
exports. Growth of exports needs liberal and adequate export credit. The Reserve
Bank has undertaken a number of measures for increasing credit to the export sector.
For promoting export financing by the banks, the Reserve Bank has introduced
certain export credit schemes. The Export Bills Credit Scheme and the Pre-
shipment Credit Scheme are the two important schemes introduced by the
Reserve Bank. The Reserve Bank has been stipulating concessional interest rates on
various types of export credit granted by commercial banks. The Reserve Bank has
been instrumental in the establishment of Export-Import Bank. The EXIM Bank is to
provide financial assistance to exporters and importers. The Reserve Bank has
authority to grant loans and advances to the EXIM Bank, under certain conditions.
6) Regulation of Credit: The Reserve Bank has been extensively using various
credit control weapons to regulate the cost of credit, the amount of credit and the
purpose of credit. For regulating the cost and amount of credit the Reserve Bank has
been using the quantitative weapons. For influencing the purpose and direction of
credit, it has been using various selective credit controls. By regulating credit, the
Reserve Bank has been able:
i) To promote economic growth in the country,
ii) To check inflationary trends in the country,
iii) To prevent the financial resources from being used for speculative purposes,
iv) To make financial resources available for productive purposes keeping in view the
priorities of the plans, and
v) To encourage savings in the country
7) Credit to Weaker Sections: The Reserve Bank has taken certain measures to
encourage adequate and cheaper credit to the weaker sections of the society. The
“Differential Rate of Interest Scheme” was started in 1972. Under this scheme,
concessional credit is provided to economically and socially backward persons
engaged in productive activities. The Reserve Bank has been encouraging the
commercial banks to give liberal credit to the weaker sections and for self
employment schemes. The Insurance and Credit Guarantee Corporation of
India gives guarantee for loans given to weaker sections.
8) Development of Bill Market: The Reserve Bank introduced the “Bill Market
Scheme” in 1952, with a view to extend loans to the commercial banks against their
demand promissory notes. The scheme, however, was not based on the genuine
trade bills. In 1970, the Reserve Bank introduced “New Bill Market Scheme” which
covered the genuine trade bills representing sale or dispatch of goods. The bill
market scheme has helped a lot in developing the bill market in the country. The bill
market scheme has increased the liquidity of the money market in India
9) Exchange Controls: The Reserve Bank has been able to
maintain the stability of the exchange value of the “Rupee” even
under heavy strains and pressure. It has also managed
“exchange controls” successfully. Inspite of the limitations under
which it has to function in a developing country like India, the
over all performance of the Reserve Bank is quite satisfactory. It
has been able to develop the financial structure of the country
consistent with the national socio-economic objectives and
priorities. It has discharged its promotional and developmental
functions satisfactorily and acted as the leader in economic
development of the country.
Functions of Reserve Banks
of India
The Reserve Bank of India is the Central Bank of India and therefore, it
performs all those functions which a central bank is required to perform in a
country. The function of central banks are broadly the same all over the world,
but the scope and content of policy objectives vary from country to country and
from period to period depending upon a number of factors like development
and the structure of the economy, goals to which the government is committed
and the general economic situation.
The functions performed by the Reserve Bank can be classified into three
categories:
1) Central banking functions.
2) Supervisory functions.
3) Promotional functions.
A. Traditional functions/Central
banking functions.
The RBI was established on the model of the Bank of England. It was, therefore,
enacted with the task of performing all those functions which the Bank of England
had been performing. These functions, which are usually known as traditional
functions of a central bank are:
◦ 1) To issue currency notes.
◦ 2) To act as a banker to the government
◦ 3) To act as a banker’s bank
◦ 4) To control and supervise banks
◦ 5) To maintain and control the foreign exchange
◦ 6) To control credit
 Supervisory Functions
In order to promote and develop a sound and efficient system of banking in India, the
Reserve Bank has been given several supervisory powers over different banking
institutions. These powers relate to licensing and establishment, branch expansion,
liquidity of assets, management, working, amalgamation, reconstruction and liquidation of
commercial and co-operative banks. The Reserve Bank carries out periodical inspections
of these banks and calls for such information, which it considers necessary for effective
performance of its functions. The various powers vested in the R.B.I. are as follows:
1) Obtain License
2) Coverage of Bank Operations
3) Liquidation of Weak Banks
4) Branch Expansion
5) Issue Directions On Credit Control:
6) Training of Bank Personnel
7) Spreading Banking Habits
 Promotional Functions
The Reserve Bank of India as a Central Bank of the country has assumed greater responsibilities
as developmental and promotional agency as compared to a merely monetary authority. It not
only controls the credit and currency in the economy or maintains internal/external value of the
rupee for ensuring price stability but also acts as a promoter of financial institutions, required
for meeting specific financial requirements of the developing economy. At the time of
establishment of the Reserve Bank of India in the Year 1935, the country lacked a well-
developed money market and a well-developed commercial banking system. Moreover, it was
industrially a backward country. After independence, the country embarked upon a well-
organized and planned economic development. The process is still continuing. All this made
necessary for the Reserve Bank of India to pursue appropriate monetary and credit policy and
take all necessary steps required for a fast growth and development of all sectors of the
economy, keeping in view the guidelines and policies formulated by the Government.
The promotional steps taken by the RBI in this direction can be summarized as
follows:
1) Established the Bill Market Scheme: It established the Bill Market Scheme in 1952.
2) Development of Specialized Financial Institutions
3) Promote Regional Rural Banks
4) Promote National Housing Bank
5) Establishment of Export Import Bank of India
6) Promotes Research
 Monetary Policy
Monetary policy refers to use of different instruments under the control of the central bank
to regulate the supply of money and credit with the aim of achieving optimum levels of
output and employment, price stability, balance of payments equilibrium or any other
objectives decided by the State. At present the main objective of monetary policy in India is
believed to be the promotion of economic growth coupled with a high level of employment
and price stability. It has induced economic growth by facilitating an adequate volume of
credit to industry, trade and agriculture. This obviously necessitated the RBI to follow
policies that led to the expansion of credit.
However, such a policy could lead to inflation. Therefore, the RBI has been following a
cautious policy in credit expansion. To keep inflationary pressures under control, it has to
restrain credit expansion and prevent the flow of credit to socially undesirable activities like
speculation and hoarding. Thus, the RBI's function has been to ensure adequate availability
of credit to sustain the tempo of development without adversely affecting the internal price
stability. This policy is often characterized as the policy of controlled expansion.
techniques of credit control
the techniques of credit control are of two types:
i) general or quantitative, and
ii) selective or qualitative.
The techniques of credit control in the first category are the bank rate, open market
operations and reserve requirements. All these three methods affect loanable funds
of the commercial banks, and thereby influence the volume of credit and thus total
money supply. In the case of qualitative or selective credit control, the impact is on
the direction of credit rather than its amount.

Following are the general or quantitative techniques of credit control.

 1. Bank Rate:
The bank rate is the rate of interest at which the central bank makes advances to
commercial banks. The central bank provides financial accommodation to banks against
approved securities or purchases or rediscounts of eligible bills of exchange and other
commercial papers. The purpose of making changes in bank rates is to vary the cost of
securing funds from the central bank. If the bank rate changes, it brings about changes in
the structure of market interest rates, which in turn influences the level of economic
activity. In an inflationary situation when the policy of reducing money supply is to be
pursued, the bank rate is raised with the hope that unwarranted investment activity will be
checked. On the other hand, in a recessionary situation, the bank rate is raised with the
expectation that it will induce investment activity thereby providing impetus to overall
economic activity.
However, the effectiveness of bank rates is rather limited in India. The changes in the bank
rate have very little operative significance. They merely indicate the changes in The
direction of the credit policy of RBI. It is for this reason that changes in the bank rate are
almost always accompanied by some other techniques of credit control.
 2. Open market operations
Open market operations are a technique of credit control by means of which the central bank
changes the liquidity position of banks by operating directly in the market. Open market
operations involve purchase aid sale of government securities, foreign exchange, gold, bills of
exchange and company shares by the central bank. However, in India, open market operations
are generally confined to the buying and selling of government securities, including ‘Treasury
Bills.
Open market operations have two aspects. The first is the buying of securities. When the
central bank purchases securities from banks, the latter's cash reserves increase and this
improves their capacity to create credit. The other aspect is die selling of securities to
commercial banks which results in the decline of their cash reserves. As a consequence, the
banks' credit creation capacity is reduced.
In India, the government securities market is narrow which is a constraint on open market
operations. A sizeable proportion of the government securities is held by some leading financial
institutions and the volume of transactions in them is limited. Further on account of the virtual
absence of a treasury bill market, open market operations of the RBI are entirely in government
bonds. Given the narrow government securities market, an attempt by the RBI to conduct
large-scale operations would unduly disturb security prices.
3. Reserve Requirements:
The Central bank can change the reserve Requirements and can thereby affect the
credit-creating capacity of the commercial banks. It is a direct and effective
instrument of credit control. In India, 'the RIB regulates the liquidity of the banking
system by two complementary methods:
1) cash reserve ratio, and
2) statutory liquidity ratio.
The Commercial banks are statutorily required to maintain a cash reserve with the
RBI equal to a certain percentage of deposits. This cash reserve ratio is prescribed by
the RBI and can be in the range of 3 to 15 per cent of the deposits. Whenever the RBI
wants to put a check on the expansion of credit, it raises the cash reserve ratio.
conversely, when credit expansion is to be induced, the cash reserve ratio is lowered.
 cont..
The effectiveness of changes in the cash reserve ratio is limited by the tendency of
commercial banks to offset their impact by liquidating their government security
holdings. , Therefore, along with a change in the cash reserve ratio, a change in the
statutory liquidity ratio also becomes necessary. In India, until 1962 commercial banks
were required to maintain a: liquidity ratio of 20% against their deposit liabilities. Cash h
hand, cash with the RBI and other banks, gold and unencumbered approved securities
are considered liquid assets. The statutory provision until 1962 enabled commercial
banks to liquidate some government securities whenever the cash reserve ratio was
raised. Hence their capacity to create credit remained intact. The Banking Regulation Act
was thus mended to plug this loophole. Now liquid assets are to be maintained exclusive
of the cash balance maintained in terms of statutorily determined cash reserve ratio. The
statutory liquidity ratio is also determined by the RBI.
Direct Credit Regulation
The regulation of credit by means other than control of bank reserves or the cost of
credit is known as direct credit regulation or qualitative credit control. The widely
used qualitative techniques of credit control are;
(1) selective credit control, and
(ii) moral suasion.
The quantitative or general techniques of credit control operate effectively in well-
organised money markets but are not very effective in countries where money
markets are less developed. Qualitative techniques are more suitable for less
developed money markets as these techniques help regulate the distribution or
direction of bank resources to particular sectors of the economy in accordance with
broad national priorities. In fact, qualitative credit control measures are considered
complementary to general credit control and their effectiveness increases greatly
when these are used together with general credit control.
 1. selective Credit
Regulation:
The RBI exercises selective credit control under the provisions of the Banking Regulation Act.
‘the main techniques of selective control in India are:
i) margin requirements for lending against selected commodities,
ii) ceilings on levels of credit, and
iii) charging of minimum rate of interest on advances against specified commodities.
The first two techniques control the amount of credit, while the other technique operates
through its impact on the cost of credit. These instruments of credit control are operated by the
RBI in such a manner that they meet particular situations or achieve the desired direction of the
flow of credit. The margin against a particular commodity is determined keeping in view the
socially and economically legitimate requirements of bank credit to that sector. Ceiling limits are
fixed in order to restrict the capacity of the lending bank to grant credit against controlled
commodities. The rate of interest mechanism is used to achieve policy objective of increasing or
decreasing the credit flows to particular sectors. It is in fact through this technique that credit is
made available to certain preferred sectors on concessional interest rates.
 2. Moral Suasion:
Moral suasion refers to the advice given by the central bank to commercial banks in
respect of their Bending and other operations with the expectation that it will be
accepted and the latter will operate accordingly. Moral suasion may be quantitative in
content, that is, the quantum of credit that a bank may grant may be fixed. It can also be
qualitative, that is, banks may be advised not to give credit against certain commodities
as their prices may be subject to speculative tendencies. In India, the RBI has found the
technique of moral suasion quite useful. ' Since the nationalisation of major commercial
banks, the effectiveness of moral suasion has increased. An added reason for the
effectiveness of moral suasion in India is that it is backed by the RBI's vast powers of
direct regulation.