Role Of RBI in Indian

Economy

~By~

M.Shashank Reddy
P.Adithya
K.Sai Gokul
K.Satyanaryana
B.Surya Tej
 A REPORT

ON

ROLE OF RBI IN INDIAN ECONOMY

BY

M.SHASHANK REDDY P.ADITHYA

2008B3AA606H 2008B3A3499H

K SAI GOKUL

2008B3A7375H

B.SURYA TEJ K.SATYANARAYANA

2008B3A4431H 2008B3A2321H

UNDER THE SUPERVISION OF

Dr. MEERA LAL

Professor, Department of Economics

BIRLA INSTITUTE OF TECHNOLOGY & SCIENCE, PILANI - HYDERABAD CAMPUS

March, 2011
 A REPORT

ON

ROLE OF RBI IN INDIAN ECONOMY

Submitted in partial fulfillment of the

MONEY BANKING AND FINANCIAL MARKETS (ECON C362) COURSE

BY

M.SHASHANK REDDY P.ADITHYA

2008B3AA606H 2008B3A3499H

K SAI GOKUL

2008B3A7375H

B.SURYA TEJ K.SATYANARAYANA

2008B3A4431H 2008B3A2321H

UNDER THE SUPERVISION OF

Dr. MEERA LAL

Professor, Department of Economics

BIRLA INSTITUTE OF TECHNOLOGY & SCIENCE, PILANI - HYDERABAD CAMPUS

March, 2011
 Acknowledgements

We are extremely thankful to Dr. MEERA LAL, Professor, Department of Economics, BITS, Pilani -

Hyderabad Campus, for providing us with an opportunity to work on an excellent project. It was indeed

a great pleasure and experience to work on a real time title like “the role of RBI in indian economy”.
 Abstract

Since 1935, RBI has stood at the center of India‟s financial system, with a fundamental
commitment to maintaining the nation‟s monetary and financial stability. From ensuring stability
of interest and exchange rates to providing liquidity and an adequate supply of currency and
credit for the real sector; from ensuring bank penetration and safety of depositors‟ funds to
promoting and developing financial institutions and markets, the Reserve Bank plays a crucial
role in the economy. RBI‟s decisions touch the daily life of all Indians and help chart the
country‟s current and future economic and financial course. Over the years, RBI‟s specific roles
and functions have evolved. However, there have been certain constants, such as the integrity
and professionalism with which the Reserve Bank discharges its mandate.
 Contents
ACKNOWLEDGEMENTS .......................................................................................................................... 4

1. INTRODUCTION .................................................................................................................................... 7

1.1 Research Methodology…………………………………………………………………………………................................10

2. MONETARY AUTHORITY………………………………………………………………………………………………………11

2.1 Direct Instruments ............................................................................................................................ 11

2.2 Indirect Instruments .......................................................................................................................... 12

2.3 Open and Transparent Monetary Policy-Making………………………………………………………………………..12

3. ISSUER OF CURRENCY ...................................................................................................................... 13

3.1 Tools Used By RBI in the Issuing Process…………………………………………………………………………………….14

3.2 RBI’s Anti-counterfeiting Measures……………………………………………………………………………………………..14

4. BANKER AND DEBT MANAGER TO GOVERNMENT…………………………………………..15

4.1 Role in brief………………………………………………………………………………………15

4.2 Conflict theory……………………………………………………………………………………16
5.BANKERS TO BANKS ……………………………………………………………………………..20
5.1 Role in Brief………………………………………………………………………………...........20
6. REGULATOR OF BANKING SYSTEM…………………………………………………………..22
6.1 Recent Developments of the Regulatory status of the RBI……………………………………………………..23
7. CLEARING HOUSES…………………………………………………………………………………………………………………………25
8. MANAGER OF FOREIGN EXCHANGE……………………………………………………………………………………………….27
9. REGULATOR AND SUPERVISER OF PAYMENT AND SETTLEMENT SYSTEMS…………………………………….30
9.1.Tools……………………………………………………………………………………………………………………………………….30
10.DEVELOPMENTAL ROLE ……………………………………………………………………………………………………………….31
10.1.The Developmental Outlook………………………………………………………………………………………………….31
11.OTHER ROLES………………………………………………………………………………………………………………………………32
12.CONCLUSION………………………………………………………………………………………………………………………………34

REFERENCES ........................................................................................................................................... 37
 1.Introduction
The RBI was established under the Reserve Bank of India Act, 1934 on April 1, 1935 as
a private shareholders' bank, but since its nationalisation in 1949, is fully owned by the
Government of India.The RBI is placed under the Entry 38 of List 1 of Schedule VII of
the Constitution of India, which is the Union List.
The Preamble to the RBI Act describes the basic objective 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". Thus, there is no explicit mandate for price-stability or formal inflation
targeting. The twin objectives of monetary policy in India have evolved over the years as
those of maintaining price stability and ensuring adequate flow of credit to facilitate
the growth process. The relative emphasis between the twin objectives is modulated as
per the prevailing circumstances and is articulated in the policy statements.
Consideration of macroeconomic and financial stability is also subsumed in the
articulation of policy. The RBI is also entrusted with the management of foreign
exchange reserves, which are reflected in its balance sheet. While RBI is essentially a
monetary authority, its founding statute mandates it to be the manager of public debt of
the Government of India and banker to the Government. In terms of Section 20 of the
RBI Act 1934, RBI has the obligation to undertake the receipts and payments of the
Central Government and to carry out the exchange, remittance and other banking
operations, including the management of the public debt of the Union.
Role of RBI during Liberalisation :

After decades of resistance to international economic integration, India has recently made
significant progress in liberalizing trade and access to foreign investment, beginning in 1993.
These policy changes reflect widespread concern that Indians past inward orientation inhibited
economic growth, especially in comparison with the developing countries of East Asia. The
acceptance of economic liberalization and reform has allowed the relaxation of restrictions on
foreign direct investment and inward portfolio capital flows. India retains tight controls on
outward portfolio capital flows, restricting the access of residents to foreign capital markets
and domestic markets in foreign currency-denominated securities. The relaxation of these
controls and further liberalization of the capital account remain controversial policy issues for
India. The RBI was the backbone of the entire process.
All of this has been achieved without experiencing a serious macro-economic crisis or severe
inflation over an extended period. Most importantly, the real economy has clearly prospered.
The rate of growth of GDP has increased steadily over the past two decades, culminating in an
unprecedented 9 percent growth per year in the four year period just before the global
financial crisis. Poverty too, has declined steadily, though this is an area where much more
remains to be done.

The Reserve Bank of India has played a major role in this transformation. It has been a lead
player in banking and financial sector reforms and has acted as a confidential adviser to the
Government on many other issues relevant to the complex task of macroeconomic
management in an increasingly open and liberalized economic environment. Indeed, it is one of
our great institutions of which we can all be truly proud.

The past two years have been difficult years for governments and central banks all over the
world. Excessive credit expansion and asset price inflation both fuelled by so-called “financial
innovations” of dubious value, and a lax regulatory environment led to an accumulation of risk
that was not adequately understood and ultimately produced a severe crisis.

India was relatively insulated from these developments because our financial system was much
less integrated with the global system. However, the RBI deserves credit for having been
prescient about the dangers posed by property bubbles. When the crisis exploded in September
2008, the RBI rapidly reversed its earlier tightening of credit to meet the new and changed
circumstances. The CRR and the repo and reverse repo rates were rapidly lowered in a series of
quick steps. Some initiatives were also taken to enhance access to bank credit by Non-Banking
Finance Companies. Signs of panic withdrawals from some private sector banks in the initial
weeks of the crisis were met with strong reassurances by both the Government and the RBI
that our banks were sound and would be fully supported.
Ensuring that the Indian financial system remained stable in these very difficult times was a
major achievement in financial and economic management. I would like to compliment
Governor Subbarao and his team at the RBI for the role they played in this period.

With the crisis now nearly over, we need to reflect on the challenges that confront us in the
years that lie ahead.

The industrialized countries are almost certainly entering a period of slower growth. India on
the other hand is emerging stronger, with a good prospect of better performance in future. Our
domestic savings rate has increased to around 35 percent and our domestic investment rates
are around 37 percent of our GDP. We have a highly entrepreneurial private sector which has
demonstrated that it can compete in global markets, not just in software but in areas of
traditional manufacturing also. We have a critical mass of human resources with good quality
higher education, which definitely places us at an advantage in today’s world. We are
geographically located in a continent which is gaining in economic importance and looks like
being a major driver of the world economy in the years that lie ahead.

RBI Actions During Global Recession/Subprime Crisis

Since September 2008, RBI has taken multiple actions in order to ensure that the economy does
not suffer a massive downturn. The RBI has cut the repo rate by 400 basis points from 9% to
5%, reverse repo rate by 250 basis points from 6% to 3.5% and the CRR by 400 basis points from
a high of 9% to the current 5%. Where as the Statutory Liquidity Ratio (SLR) was reduced from
25% to 24%. The RBI has also reprimanded the Banks which have been slow in passing on the
benefits of the lower interest rate onto the borrower. It clearly pointed out that the interest
rate cuts by the public sector banks have been in the range of 1.25%-2.25%, 1%-1.25% for
private banks and 1% for foreign banks. The slackness in passing on benefits to the consumers
can be seen in a comparison between reactions of banks to RBI policies in 2004 and 2008.
Towards the beginning of 2004 the RBI key policy rates were at approximately similar levels
although private banks were charging about 7.5-8% during that time and are currently charging
approximately 10-11% for home loans.
The RBI has adopted a comparatively more conservative target of 6%, as compared to the
Government’s 7% GDP growth target for the current fiscal, in light of the global downturn
resulting in moderation of growth and muted inflationary pressures that are being experienced
currently by the Indian economy. The policy announced a cut in repo and reverse repo by 25
bps in order to encourage lowering of lending rates, increased lending and stimulate aggregate
demand within the economy in order to mitigate downside risks. After the additional 25 bps
cut, currently the repo rate has lowered down to 4.75% and reverse repo rate to 3.25%.There is
also a clear indication that the central bank will continue to monitor the economic performance
as downside risks continue to persist in the economy and necessary action will be undertaken
as deemed favorable which translates to possibly more rate cuts in the short term.

Research methodology:

We used both intensive and extensive data available in various forms viz. print,web etc.

The intensive data used is from the source RBI website as given in the references.

The extensive data used is from various books, journals and speeches.
 2.Monetary Authority: A

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. The main objectives of monetary
policy in India are:

 Maintaining price stability

 Ensuring adequate flow of credit to the productive sectors of the economy to support
economic growth
 Financial stability

The RBI 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 the policy accordingly.

The Reserve Bank’s Monetary Policy Department formulates monetary policy. The Financial
Markets Department handles day-to-day liquidity management operations. There are several
direct and indirect instruments that are used in the formulation and implementation of
monetary policy.

2.1. 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.

2.2. 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.
 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.
 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.
 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.
 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.

2.3. Open and Transparent Monetary Policy-Making:

The Reserve Bank explains the relative importance of its objectives in a given context in a
transparent manner, emphasizes a consultative approach in policy formulation as well as
autonomy in policy operations and harmony with other elements of macroeconomic policies.
The monetary policy formulation is aided by advice and input from:

 Technical Advisory Committee on Monetary Policy

  Pre-policy consultations with bankers, economists, market participants, chambers of
commerce and industry and other stakeholders
 Regular discussions with credit heads of banks
 Feedback from banks and financial institutions
 Internal analysis

The Reserve Bank’s Annual Policy Statements, announced in April, are followed by three
quarterly reviews, in July, October and January. A detailed background report “ Review of
Macroeconomic and Monetary Developments” is released the day before the policy review.
Faced with multiple tasks and a complex mandate, the Reserve Bank emphasizes clear and
structured communication for effective functioning.

3. Issuer of Currency A

The Reserve Bank is the nation’s sole note issuing authority. Along with the Government of
India, it is responsible for the design and production and overall management of the nation’s
currency, with the goal of ensuring an adequate supply of clean and genuine notes. The Reserve
Bank also makes sure there is an adequate supply of coins, produced by the government. In
consultation with the government, we routinely address security issues and target ways to
enhance security features to reduce the risk of counterfeiting or forgery.

The Reserve Bank has a separate Issue Department which is entrusted with the issue of
currency notes. The assets and liabilities of the Issue Department are kept separate from those
of the Banking Department. Originally, the assets of the Issue Department were to consist of
not less than two-fifths of gold coin, gold bullion or sterling securities provided the amount of
gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might be
held in rupee coins, Government of India rupee securities, eligible bills of exchange and
promissory notes payable in India. Due to the exigencies of the Second World War and the
post-war period, these provisions were considerably modified. Since 1957, the Reserve Bank of
India is required to maintain gold and foreign exchange reserves of Ra. 200 crores, of which at
least Rs. 115 crores should be in gold. The system as it exists today is known as the minimum
reserve system.

3.1.Tools Used By RBI in the Issuing Process:

Four printing presses actively print notes: Dewas in Madhya Pradesh, Nasik in Maharashtra,
Mysore in Karnataka, and Salboni in West Bengal. The 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 set up by BRBNMPL, a wholly owned subsidiary of the Reserve Bank. Coins are minted by
the Government of India. RBI is the agent of the Government for distribution, issue and
handling of coins. Four mints are in operation: Mumbai, Noida in Uttar Pradesh, Kolkata, and
Hyderabad.

3.2. RBI’s Anti-counterfeiting Measures:

 Continual upgrades of bank note security features

 Public awareness campaigns to educate citizens to help prevent circulation of forged or
counterfeit notes
 Installation of note sorting machines
 4. BANKER AND DEBT MANAGER TO GOVERNMENTB
4.1. Role in brief:

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. Also act as the banker to
those state governments that have entered into an agreement.

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.
As the Governments’ Debt Manager
In this role, RBI set policies, in consultation with the government and determine the
operational aspects of raising money to help the government finance its requirements:
1. Determine the size, tenure and nature (fixed or floating rate) of the loan.
2. Define the issuing process including holding of auctions.
3. 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.
4.2. CONFLICT THEORY

The United Forum of Reserve Bank Officers & Employees, the body of four unions of workers,
employees and officers of the Reserve Bank of India, in a statement, has questioned the “conflict
theory' being touted by the Government in support of its decision to separate the management of
public debt from the country's central bank. The argument that there is a conflict of interest
between the RBI's role as a monetary authority and as manager of public debt is unacceptable,
says the statement quoting US economist Mr. James Tobin, who has observed that there is no
neat way to distinguish monetary policy from debt management. “It is not merely that monetary
action and debt management interact; they are one and indivisible; debt management lies at the
heart of monetary control,” Mr. Tobin has been quoted as saying. The Union Government has
decided to establish a debt management office (DMO) to manage public borrowings of Central
and State governments and enact for that purpose a National Treasury Management Act which
will divest the RBI of its debt management function. This would have become operational by
now but for the global economic meltdown plunging many countries in serious economic crisis
and the RBI's cautious approach in view of the Union Government's huge borrowing
programmer of Rs4.5lakhcrore in the current fiscal. The Government's contention is that as a
manager of public debt, the RBI arranges to sell the Government bonds cheap to reduce the
interest burden on the Government whereas as monetary authority it should tighten the interest
rates to contain inflation. Hence, the conflict arises. It is, therefore, suggested that the RBI should
exclusively focus on price stability whereas under the proposed DMO, the pricing of bonds
should be market-determined. Otherwise, there would be distortions in the market. There are
other reasons why the United Forum is opposed to the separation of debt management from the
RBI. Going by the market logic, the new authority for the issue and management of public debt
will opt for debt instruments of only those States whose financial position is in a good shape.
Which means the States with not-so-satisfactory financial position will be in a fix. They will be
required to offer higher interest rates to push their instruments, thus putting further strain on their
finances. More important, various State Governments will come to the market offering varying
rates of interest. The RBI's interest rate management will go awry, it is felt. Also, once DMO
starts operation, the kind of support provided by the RBI to various State Governments by way
of guarantees and extension of overdraft facilities will not be there. The argument that the
Government bonds are underpriced does not hold good. For the past couple of years, debt
instruments are being auctioned in the market, bids are invited and depending on the response,
the interest rates fixed. The sale of some bonds was withheld recently as the bids were
unacceptable to the RBI. In other words, the market already has a role, though in a limited way.
There are instances where some countries that opted for market mechanism had subsequently
reverted to public debt management under their respective central banks. The United Forum has
already communicated these views to the RBI Governor and the Union Finance Minister.

RECENT EXAMPLE:

SRINAGAR, Jan 22 2011: The Reserve Bank of India, Central Bank, has entered into a
supplementary agreement under Section 21A of the Reserve Bank of India Act, 1934 with the
Jammu and Kashmir government to carry banking business of the state government. Experts here
oppose the agreements and term it long run „economic subjugation‟. The agreement shall be
effective from April 1, 2011. “The Reserve Bank of India shall carry on the general banking
business of the government of Jammu and Kashmir and act as the sole agent for investment of
government‟s funds,” a handout of the RBI said. According to the sources it was on the
recommendation of the state government, that the Reserve Bank of India has entered into an
agreement with J&K Bank Ltd. whereby J&K Bank —state‟s premier financial institution—
would act as an agent of the Reserve Bank of India, for conduct of general banking business of
the state government. The RBI in a statement said, “The Reserve Bank of India has already been
acting as a debt manager to the government of Jammu & Kashmir pursuant to an agreement
entered into with the state government under Section 21 A of the Reserve Bank of India Act,
1934, with effect from September 1, 1972.” However, contradicting its own statement, the RBI
website said that the state government transactions are carried out by RBI in terms of the
agreement entered into with the state governments in terms of Section 21 A of the Act. “As of
now, such agreements exist between RBI and all the state governments except with the
Governments of Jammu and Kashmir and Sikkim,” it mentions. The Chairman and Chief
Executive Officer of Jammu and Kashmir Bank, Mushtaq Ahmad told Kashmir Times that The
J&K Bank acts as an agent of RBI for conduction of general banking business of the state
government and for other related matters. When asked if they have any communication from the
state government, Mushtaq Ahmad said, “As of now we haven‟t received any formal
communication from the state government about the same.” Noted economist of the state,
Professor Nissar Ali told Kashmir Times that the existing system was the unique route available
to J&K government only. “It used to provide comfortable position to the state to get overdraft
from J&K bank and to bridge the mismatches on account of funds as it takes time for the state to
receive funding from New Delhi,” he added. At present J&K Bank provides an overdraft of
about Rs 2300 crores to the J&K government. Prof Ali believes that the present move would put
the state government in a tight position in the long run, as “ours is a resource deficient sate, so
revenue flow is too little”. According to Prof Ali, the agreement for J&K Bank would mean an
immediate short run problem. “The bank is in pressing need to look for the ways to deploy Rs
2000 crores in one go,” Prof Ali added. The agreement, according to well informed exerts on the
matter said that it would push the state toward „total dependence‟ on New Delhi and terms it
„economic suppression‟.

Is it necessary? (Interpretation of this role)

The Reserve Bank of India is enjoying its new found job of constantly monitoring the economy.
It wants to review the economy not just every quarter but mid-course as well. This is a comfort
factor, as the economy is being constantly monitored and watched. According to its mid-quarter
monetary policy review, which is best called economic review, in the current month, the bank is
happy that growth tempo is persisting while inflation is moving southwards. Its only concern is
that the inflationary pressure persists even as inflation is moving down. There is cause for
concern on manufactured product prices. The other thing is that the RBI is keen that the growth
tempo is maintained, and, accordingly, a bit concerned about the liquidity pressure. In its own
admission, the economy is having some problem of liquidity deficit. Accordingly, the Bank, in
its review, has taken some measures to pump in necessary liquidity into the system. SLR of the
scheduled commercial banks has been reduced from 25% to 24% with effect from December 18,
2010. Besides that, it has decided to conduct open market operations / auctions for purchase of
government securities for an aggregate amount of Rs.48, 000 crore in the next one month. The
idea is that when the economy is showing signs of 9% growth (the second quarter GDP growth
being 8.9%) there should be no constraint of liquidity and banks should be able to lend, not
generously but, adequately. Given this assessment of the RBI, the industry can heave a sigh of
relief that in the coming months of the current fiscal, there may not be any hike in the lending
rate; at least there is no reason for lending rate to go up. The reality, however, may be slightly
different from the expectation. There is a general consensus in the banking community that
deposit rates have to go up, currently being in 0 to negative range in real terms. Banks have to
boost their deposit mobilization, as otherwise they may be losing their deposit market to
competition from the capital market. Thus, there is an implicit pressure on them to increase their
deposit rate. Question is can lending rate remain untouched, when deposit rates have to be
moved up? The banks are the best judge on this question. It is they who have to decide what to
do about the lending rate. Currently, they need not wait for any signal from RBI as they have
sufficient flexibility to take their own decisions. Inflation is not always the right criteria for them
to decide on the lending rate. Even as the RBI has not signaled increase in lending rate, and
would prefer maintaining status quo, we may see some increase in the lending rate. There may
not be much publicity, but banks would probably negotiate a rate which the clients will take. I
have a feeling that somewhere down the line the RBI is making a mistake on its assessment of
the inflationary situation. It is right in saying that the inflationary pressure persists, but there is
much more than that. First, international commodity prices are once again moving up. More
importantly, the movement in oil price is giving rise to a fresh concern as to the level it may go
up to. Is the world economy facing another threat of steady upward movement in commodity
prices? There is no clear answer to this as yet, but, one should be more careful. Second is the
much talked about issue of recovery? The global economic recovery is both slow and uncertain
as yet, but healthy recovery is not likely to come without its many-sided negative effects. For
instance, if recovery means strong demand for commodities, then recovery means increase in
inflationary pressure and actual rise in inflation. If that happens, then the recovery process may
itself suffer as the first victim. There is some kind of Catch 22 situation here and there is
something that they need to do to snap the link between recovery and inflation. Third, as I have
just said, currently the recovery itself is uncertain. This, we can very well understand if we look
at the situation in the USA and EU. In USA, the Obama administration is injecting second
stimulus in the form of sale of treasury bonds and tax reforms which are meant to boost demand.
On the other end, the US economy is at a critical end with respect to size and proportion of the
budget deficit and its rising debt problem. These two problems, many are arguing, run the risk of
a currency crisis. Thus, the US economy is at that precipice where it can slip from financial
crisis and jump into currency crisis, due to the stimulus packages. The European Union, as we
all know, is also facing the prospect of great instability in its single currency due to mounting
burden of government debts in some of its peripherals economies. I need not go into further
details, but want to say that the world economy is facing the prospect of another phase of rising
inflation. The problem is already raising its head in many of the emerging market economies as
well. In addition to the inflationary pressure, there is the problem of unemployment. Recovery
so far has not helped the unemployment problem in any way. In other words, the world
economy continues to be in crisis. Place Indian economy in the backdrop of this and see where it
stands. In the current year, we would, in all probability achieve 9% growth, but let us not forget
that this is on the back of good performance of agricultural sector. If the world economic
prospect is uncertain, the manufacturing sector is not likely to give a steady and stable growth.
The unsteadiness in performance of the industrial sector has been already observed in the last
couple of months. For the first time, perhaps, one can say that in spite of what we can call
recovery of growth, the economy is not out of the woods as yet. Nothing is stable and lasting,
when everything is not. The patient has been having recovery, but has not recuperated fully yet.

Finally we can say, RBI plays a critical role managing the issuance of public debt. Part of this
role includes informing potential investors about upcoming debt auctions through notices such as
these.

5. BANKER TO BANKS B
5.1. Role in brief:
Like individual consumers, businesses and organizations 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
fulfills this role. In effect, all banks operating in the country have accounts with the Reserve
Bank, just as individuals and businesses have accounts with their banks.

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.

The Reserve Bank provides similar products and services for the nation‟s banks to what banks
offer their own customers.

1. Non-interest earning current accounts: Bank should 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 Account 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. Remittance facilities: Banks and government
departments can use these facilities to transfer funds.
3. 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.
4. Loans and advances: The Reserve Bank provides short-term loans and advances to
banks / financial institutions, when necessary, to facilitate lending for specified purposes.

RECENT EXAMPLE:
Mumbai March 17, 2011: Banks asked the Reserve Bank of India (RBI) for preservation of
priority sector status for the micro lending sector, irrespective of the individual conduct of
borrowing microfinance institutions (MFIs). "Bankers' main reservation is nothing should
happen by which some act or conduct or misconduct of MFIs should result in the priority sector
status being withdrawn," Indian Banks Association Chief Executive K Ramakrishnan told PTI
here. Top bankers, including Corporation Bank CMD Ramnath Pradeep, HDFC Bank MD
Aditya Puri, Axis Bank CEO Shikha Sharma and Dhanlaxmi Bank CEO & MD Amitabh
Chaturvedi, met RBI Deputy Governor KC Chakrabarty to voice their concerns regarding the
recommendations of the Malegam Committee on MFIs, before they are ratified into guidelines
on April 1. Ramakrishnan said even though the Malegam Committee has suggested the
continuance of priority sector status for loans to the MFI sector, there are some conditions
wherein the status can be cancelled due to the misconduct of borrowing MFI like using coercion,
charging higher interest rate, etc. “If the MFIs don't do certain things vis-a-vis borrowers, don't
penalize me in terms of regulation by taking out sector (from priority sector)," he said. He added
the RBI was appreciative of the reservations expressed by the bankers. Another banker said on
the condition of anonymity the RBI is keen to implement the Malegam Committee
recommendations from April 1 itself. The banker said if the Reserve Bank becomes the single
regulator for the MFI sector, "it will be a great positive". All commercial banks are mandated to
lend a certain amount to priority sectors, which mainly includes advances to boost the rural
economy and encourage smaller enterprises. As the MFIs lend to micro enterprises in rural areas,
loans given to them are also qualified as priority sector lending. The Malegam Committee was
constituted after certain problems in the MFI sector which came to the fore after suicides by
some borrowers of MFIs in the largest market of Andhra Pradesh, allegedly due to coercive
tactics used by collection agents. AP has since come out with a legislation to regulate the MFIs,
while the RBI constituted the Malegam committee, which has given a slew of recommendations,
including the suggestion to allow RBI to regulate the sector, capping maximum lending limit to
an individual at Rs 25,000 and interest rates at 24% per annum.
Interpretation of this role:
All major banks bank with the RBI. Banking accounts of all scheduled banks in India is
maintained by the RBI. RBI provides insurance on deposits for up to Rs 1 lakh in scheduled
banks. If cash withdrawn from scheduled banks, cash withdrawal tax is applicable. Smaller co-
operative banks do not usually fall under the category of scheduled banks. The bank interest rates
increase or decrease according to the RBI lending rates. Every scheduled bank was required to
maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilities and 2%
of its time liabilities in India, according to the provisions of the Banking Companies Act of 1949.
The distinction between demand and time liabilities was abolished by an amendment of 1962,
and cash reserves equal to 3% of their aggregate deposit liabilities have to be kept by the banks
as has been asked for by the RBI. The Reserve Bank of India can change the minimum cash
requirements of other banks. On the basis of eligible securities the scheduled banks can borrow
money from the Reserve Bank of India. At times of need or stringency by re-discounting bills of
exchange, the banks can get financial accommodation from the RBI. Reserve Bank becomes not
only the banker‟s bank but also the lender of the last resort since in times of banking crisis the
Reserve Bank of India is expected to come to the help of commercial banks.
6. Regulator of Banking System C
An important duty of the Reserve Bank is to regulate the banking system of our nation in such a
way that the banking system is reliable and efficient so as to serve the country’s citizens well.
The Reserve Bank is vested with the following powers in order to regulate the banks:-

I. Licensing:
According to the section 22 of the Banking Regulation Act, every bank has to obtain
license from the Reserve Bank. The RBI is empowered to revoke the license granted
to a bank works against the interests of the depositors.
II.Management:
Section 10 of the Banking Regulation Act enabled the Reserve Bank to change the
higher order managerial officials of any bank if it considers it necessary or desirable.
III.Branch Expansion:
Section 23 requires demands every bank to take prior permission from the reserve
bank to open new places of business in India or to change the location of an existing
place of business in India or abroad.
IV.Inspection of bank:
Under section 35, the reserve bank may inspect any bank and its books and accounts
either at its own initiative or at instance of the central government. If the inspection
reveals a trial of fraud or disorientations, the reserve bank may be directed to wind
up the bank.
Issue Directions and continuous monitoring:
Section 35(A) of IBR Act confers powers to RBI to issue direction or to prevent the
affairs of the being conducted in manner detriment to the interests of the
 depositors or in a manner prejudicial to the interests of the bank or to secure proper
management of the bank. Section 36 confers powers on the RBI to caution or
prohibit banks against entering into any particular transaction and generally give
advice to any bank. It may pass orders requiring the bank to carry out the specified
instructions. In order to develop a string banning structure in the country the RBI
promotes amalgamation or merger of weak banks so that they can develop as a
strong bank. Section 38 of the Act, empowered BI to request to High Court to
windup the bank which has no scope of improvement.

6.1. Recent Developments of the Regulatory status of the RBI:

Presently, the RBI Governor heads an informal High Level Coordination Committee (HLCC) on
financial and capital markets, which consists of all the regulators and finance ministry officials.
But the RBI's role as the banking regulator, and the resultant inevitable conflict of interest,
often detracts from the effectiveness of the HLCC. In any case, the HLCC is not vested with any
statutory powers to pass binding directions to its members or enforce discipline among
members.

There have been calls to divest the RBI off its banking regulatory powers and then make it the
super-regulator. Already there is widespread opinion that the RBI's role as debt manager for
the Union Government conflicts with the effective conduct of monetary policy. The need for
the setting up of a separate Debt Management Office (DBO) has however been repeatedly
rejected by the RBI.

If a super-regulator to co-ordinate among all financial sector regulators is created, the RBI
should assume that role. Further, in light of the sub-prime crisis and the systemic ramifications
of widespread bank failures, it may also be appropriate to retain the banking regulatory role
with the RBI. Here are four strong reasons in support of the RBI as the super-regulator

1. As Ben Bernanke, Chairman, Federal Reserve recently pointed out, the central banks' bank
regulatory powers significantly enhances its ability to carry out its conventional central banking
functions - its ability to effectively address actual and potential financial crises depends critically
on the information, expertise, and powers that it gains by virtue of being both a bank
supervisor and a central bank

2. The twin functions of consolidated supervision of individual banks and assessing macro
prudential systemic risks require expertise that only the RBI possesses. Any effort to replicate
the same in another agency will not only be near impossible, but also very costly. Further, only
the RBI has the requisite market credibility to exercise this role.

3. The RBI needs to manage both the monetary policy and the external sector, a challenge that
requires effectively addressing the Impossible Trinity (middle solutions of open but managed
capital account and flexible exchange rate but with management of volatility). The RBI's relative
recent success with this (in contrast with the failures elsewhere) can be attributed to its ability
(and willingness!) to judiciously deploy the full spectrum of banking and financial market
regulatory instruments.

4. As Paul Volcker (Ex-Chairman, Federal Reserve) points out, recent events have conclusively
proved that "monetary policy and the structure and condition of the banking and financial
system are irretrievably intertwined". Separating the two activities will hamper both functions
and render the respective regulators ineffectual.

The after lessons of the Global Recession of 2008 which originated from US also pointed to the
importance of the regulation of the banks and financial institutions by the central bank. And the
recent issues of the Micro financial Institutions (MFI) have also raised the alarm of a more
tightening regulation for the Non-banking Financial Corporations. And Hence RBI now has a
tougher role in controlling and coordinating the financial and banking activities of these
financial institutions.
 7. Clearing House FunctionsC

The RBI operates clearing houses to settle banking transactions. The RBI manages 14 major
clearing houses of the country situated in different major cities. The State Bank of India and its
associates look after clearing houses function in other parts of the country as an agent of RBI.

Clearing House Functions

A clearing house is a financial institution that provides clearing and settlement services for
financial and commodities derivatives and securities transactions. These transactions may be
executed on a futures exchange or securities exchange, as well as off-exchange in the over-the-
counter (OTC) market. A clearing house stands between two clearing firms (also known as
member firms or clearing participants) and its purpose is to reduce the risk of one (or more)
clearing firm failing to honor its trade settlement obligations. A clearing house reduces the
settlement risks by netting offsetting transactions between multiple counterparties, by requiring
collateral deposits (a.k.a. margin deposits), by providing independent valuation of trades and
collateral, by monitoring the credit worthiness of the clearing firms, and in many cases, by
providing a guarantee fund that can be used to cover losses that exceed a defaulting clearing
firm's collateral on deposit.

Once a trade has been executed by two counterparties either on an exchange, or in the OTC
markets, the trade can be handed over to a clearing house which then steps between the two
original traders' clearing firms and assumes the legal counterparty risk for the trade. This process
of transferring the trade title to the clearing house is called novation. It can take fractions of
seconds in highly liquid futures markets; or days, or even weeks in some OTC markets.

As the clearing house concentrates the risk of settlement failures into itself and is able to isolate
the effects of a failure of a market participant, it also needs to be properly managed and well-
capitalized in order to ensure its survival in the event of a significant adverse event, such as a
large clearing firm defaulting or a market crash.
 8.RBI’s role in Foreign Exchange Market:D

Foreign exchange market in India gained its importance during the early stages of the reform
period. This is because, the external value of one rupee was now determined by market forces.

Also in the recent years the there is a substantial increase in the integration of Indian economy
with global economy due to an increase in trade and capital flows . Thus foreign exchange
market has evolved as a key segment of Indian financial market.

RBI plays an key role in the regulation and development of international foreign exchange
market. It assumes the following broad rules relating to foreign exchange.

1. Regulating transactions relating to external sector and facilitating the development of

foreign exchange market.
2. Ensuring the smooth conduct and orderly conditions in the domestic foreign exchange
market.
3. Managing the foreign currency assets and gold reserves of the country.

In addition to the above, the Reserve Bank of India has the responsibility to maintain the official
rate of exchange.

Exchange rate refers to the value of one currency with respect to currency of the other country.
This rate is a variable due to many external forces.

According to the Reserve Bank of India Act of 1934, the Bank was required to buy and sell at
fixed rates any amount of sterling in lots of not less than Rs. 10,000. The rate of exchange fixed
was Re. 1 . Since 1935 the Bank was able to maintain the exchange rate fixed at Re. 1 , though
there were periods of extreme pressure in favour of or against the rupee. India became a member
of the International Monetary Fund in the year 1946. After that the Reserve Bank had
undertaken the responsibility of maintaining fixed exchange rates with all other member
countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the
custodian of India's reserve of international currencies. The vast sterling balances were acquired
and managed by the Bank. Further, the RBI has the responsibility of administering the exchange
controls of the country.

The reserve bank is responsible for the administration of the foreign exchange management
act,1999 and regulates the market by issuing the licences to banks and other selected institutions
to act as Authorised dealers in foreign exchange. Foreign exchange department is responsible for
the regulation and development of the market.

On a given day foreign exchange rate reflects the demand for and supply of foreign exchange
arising from trade and capital transactions. The RBI‟s financial markets department participates
in the foreign exchange market by undertaking sales or purchases of foreign currency to ease
volatility in the periods of excess demand or supply of foreign currency.

The department of external investments and operations 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 the three principles: safety, liquidity and return.
9.Regulator and Supervisor of Payment and Settlement SystemsE

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.

The 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.

9.1.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 NET
work(INFINET), using digital signatures for further security of transactions. Here is an overview
of the various systems used:
� 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 clearinghouses throughout the
country.
� Large value systems: Facilitating settlement of inter-bank transactions from financial
markets. These include:
- Real Time Gross Settlement System (RTGS):for funds transfers
- Securities Settlement System: for the government securities market
- Foreign Exchange Clearing: for transactions involving foreign currency
Department of Payment and Settlement Systems:
It is the Reserve Bank‟s payment and settlement systems regulatory arm.
�Department of Information Technology:
It is the technical support for the payment systems and for the Reserve Bank‟s internal IT
systems.
Looking Ahead
Going forward, we are 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.

10.Developmental RoleE
This role is, perhaps, the most unheralded aspect of our activities, yet it remains among the most
critical. This includes ensuring that credit is available to the productive sectors of the economy,
establishing institutions designed to build the country‟s financial infrastructure, expanding access
to affordable financial services and promoting financial education and literacy.

Over the years, the Reserve Bank has added new institutions as the economy has evolved. Some
of the institutions established by the RBI include:
 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
 Unit Trust of India (1964), the first mutual fund of the country
 Industrial Development Bank of India (1964), a development finance institution for
industry
 National Bank of Agriculture and Rural Development (1982), for promoting rural and
agricultural credit
  Discount and Finance House of India (1988), a money market intermediary and a
primary dealer in government securities
 National Housing Bank (1989), an apex financial institution for promoting and
regulating housing finance
 Securities and Trading Corporation of India (1994),a primary dealer

10.1.The Developmental Outlook :

The Reserve Bank continues its developmental role, while specifically focusing on financial
inclusion. Key tools in this on-going effort include:
� 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.
� 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.
� 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..
� Strengthening and supporting small local banks: This includes regional rural banks and
cooperative banks
� Financial inclusion: Expanding access to finance and promoting financial literacy are a part
of our outreach efforts.
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.
 11. Other FunctionsC
Apart from the above mentioned roles, the RBI performs the following other functions:
i.)Agriculture Credit:

All matters relating to agriculture credit are looked after by RBI before the establishment of
NABARD in 1982. Now all functions relating to agriculture and rural development are
performed by NABARD.

ii)Industrial Finance:

The RBI has contributed in the share capital of industrial finance institutions such as Industrial
Finance Corporation of India, Industrial Development Bank of India, State Finance Corporations
etc. Thus RBI indirectly contributes in the field of industrial finance.

iii)Publication of Data:

The RBI publishes statistics regarding money, price, finance etc, in its periodicals. This provides
valuable information for Govt., business and industries. This information is helpful to take
decisions. The important publications of RBI are the Reserve Bank of India Annual Report,
currency and finance, trends and progress of Banking etc. At present, there are more than 100
publications of RBI.

iv)Banking Education and Training:

The RBI has been organizing various educations and training programs for bank employees and
officers. Banker Training College Mumbai has been setup by RBI for the training of Bank
officers. Other important training institutes such as ³College of Agriculture Banking (Pune),
Reserve Bank staff Training College (Chennai) etc. had been setup by the RBI. RBI had also
setup regional training centers at Mumbai, Kolkata, Chennai and Delhi.
v)Remitting Facility:

Reserve Bank provides remitting facilities to the central Government, state Government and
semi-Government institutions free of cost. It also provides this facility to cooperative banks free
of cost.

vi)Conversion of currency:

The RBI converts spoiled currency in to fresh currency. It also provides facilities to
convert currency notes into small denominating coins.

vii)To accept Deposits:

The RBI accept deposits from Central and state Governments institution and individual
persons without paying interest.

viii)Transactions with international institutions:

All international economic transactions are being made through RBI. RBI opens its accounts in
the central bank of member countries of IMF. It also deals with IMF, World Bank and other
international financial institutions.

ix)Transactions in precious metals:

In order to fulfill its obligations, RBI buys and sells precious metals, gold coins etc. RBI
can borrow funds by mortgaging these precious metals.

x)Expansion of banking facilities:

RBI has played an important role in expansion of banking facilities in the rural areas of the
country. At the end of June, 2001, there are 65,931 bank branches are situated in country, out of
which more than half of the branches are situated in rural areas. At the end of 2000, on an
average there were only one bank branches at a population of 5,000 in the country.
xi)Supply of Development Finance:

The RBI provides development finance for the different parts of the economy. It leads
economic development of the country as a whole

12.Conclusion:
To highlight some recent developments and discuss certain issues of contemporary relevance
relating to the evolving role of RBI.

First, compared with several countries which introduced rapid reforms in central banking law
and governance in the last about two decades, the Indian experience reflects an evolution or
adaptation of central banking to new economic realities. These changes were brought about both
through some legislative measures and changes in operating procedures.

Second, this evolution has inter alia contributed to imparting some autonomy to the central bank,
de facto, particularly in the areas of monetary management and financial regulation.

Third, in sharp contrast to the situation before 1991, since then, apart from a transparent
communications policy and a broad based consultative approach to policy making, Governors‟
speeches and appearances on the electronic media and the press have been substantial, having
significant influence on markets and opinions. In the process, the RBI has gained reputational
bonus and public credibility.

Fourth, thanks to related developments in the last 15 years, financial and external sectors in India
have also become relatively more efficient and resilient.

Fifth, while the effectiveness of monetary policy has improved significantly to meet the evolving
demands, some constraints are persisting, which impact the choice and effectiveness of our
policy framework.
To conclude, the role of RBI has been redefined through gradual evolution and adaptation, along
with some statutory changes, and not through any radical restructuring. Further, while assessing
the autonomy of the RBI, one should recognise that RBI is not a pure monetary authority but is
responsible for several other functions also, as a central bank. The developments in the recent
past lead one to the conclusion that, de facto, there has been enhancement of the autonomy of the
RBI.As regards monetary policy framework, the objectives remained the same but the
framework has been changed from time to time in a gradual fashion in response to the evolving
circumstances. Contextually, there are three important issues in the conduct of monetary policy
viz., the assessment of potential output, the measurement of unemployment and appropriate
measure of inflation. While the policy tries to cope with these issues, a combination of
instruments is necessarily used in a flexible manner to meet these complexities. Every effort has
been made to improve the transmission channels especially through the financial markets, and
through regulatory and institutional reforms. In addition, there are some constraints in the
conduct of monetary policy, in particular, the fiscal impact, predominant public ownership,
prevalence of administered interest rate, etc. While these challenges and dilemmas persist in the
Indian context, every effort is made by the RBI to meet the broader objectives set forth, from
time to time.
 References:

1.“Financial Institutions and Markets”,L.M.Bhole,J.Mahakud.Fifth Edition.Print.2009

2.“Banking and Finance”.V.K.Vasishth,H.R.Swami,B.P.Gupta.2003.1e

3.“Indian Financial System” ,M Y Khan,5e.

4.“RBI‟s role in brief”. www.rbi.org.in .Web.

5.Reddy, Y. V. (2006). “Economic Reforms and Changing Role of the Reserve

Bank of India”,Radhakrishna R., et al “India in a Globalising World: Some
Aspects of Macroeconomy, Agriculture and Poverty, Essays in Honour of C.H.
Hanumantha Rao, Academic Foundation,New Delhi.

6.http://en.wikipedia.org/wiki/Clearing_house_finance.Web. 18th march 2011

7. http://en.wikipedia.org/wiki/RBI.Web.18th march 2011

LEGEND:
A – M.Shashank Reddy
B – P.Adithya
C – K.Sai Gokul
D – K.Satyanarayana
E – B.Surya Tej