Reserve Bank of India (RBI)

The central bank of the country is the Reserve Bank of India (RBI). It was established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the begining. The Government held shares of nominal value of Rs. 2,20,000. Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks. The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank. The Bank was constituted for the need of following:

To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its advantage.

Functions

of

Reserve

Bank

of

India

The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank the Reserve Bank of India. Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. 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 twofifths 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-was 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. Banker to Government

The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the Government and to carry out their exchange remittances and other banking operations. The Reserve Bank of India helps the Government - both the

Union and the States to float new loans and to manage public debt. The Bank makes ways and means advances to the Governments for 90 days. It makes loans and advances to the States and local authorities. It acts as adviser to the Government on all monetary and banking matters. Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to the provisions of the Banking Companies Act of 1949, every scheduled bank was required to maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilites and 2 per cent of its time liabilities in India. By an amendment of 1962, the distinction between demand and time liabilities was abolished and banks have been asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities. The minimum cash requirements can be changed by the Reserve Bank of India. The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting bills of exchange. Since commercial banks can always expect the Reserve Bank of India to come to their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but also the lender of the last resort. Controller of Credit

The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. According to the Banking Regulation Act of 1949, the Reserve Bank of India can ask any particular bank or the whole banking system not to lend to particular groups or persons on the basis of certain types of securities. Since 1956, selective controls of credit are increasingly being used by the Reserve Bank. The Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get a licence from the Reserve Bank of India to do banking business within India, the licence can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the Bank to call for information is also intended to give it effective control of the credit system. The Reserve Bank has also the power to inspect the accounts of any commercial bank. As supereme banking authority in the country, the Reserve Bank of India, therefore, has the following powers: (a) It holds the cash reserves of all the scheduled banks. (b) It controls the credit operations of banks through quantitative and qualitative controls.

(c) It controls the banking system through the system of licensing, inspection and calling for information. (d) It acts as the lender of the last resort by providing rediscount facilities to scheduled banks. Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rate of exchange. 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 = sh. 6d. Since 1935 the Bank was able to maintain the exchange rate fixed at lsh.6d. though there were periods of extreme pressure in favour of or against the rupee. After India became a member of the International Monetary Fund in 1946, the Reserve Bank has the

responsibility

of

maintaining

fixed

exchange

rates

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all

other

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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. Supervisory functions

In addition to its traditional central banking functions, the Reserve bank has certain non-monetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of supervision and control over commercial and cooperative banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction, and liquidation. The RBI is authorised to carry out periodical inspections of the banks and to call for returns and necessary information from them. The nationalisation of 14 major Indian scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing the growth of banking and credit policies towards more rapid development of the economy and realisation of certain desired social objectives. The supervisory functions of the RBI have helped a great deal in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation. Promotional functions

With economic growth assuming a new urgency since Independence, the range of the Reserve Bank's functions has steadily widened. The Bank now performs a varietyof developmental and promotional functions, which, at one time, were regarded as outside the normal scope of central banking. The Reserve Bank was asked to promote banking habit, extend banking facilities to rural and semi-urban areas, and establish and promote new specialised financing agencies. Accordingly, the Reserve Bank has helped in the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962, the Unit Trust of India in 1964, the Industrial Development Bank of India also in 1964, the Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of India in 1972. These institutions were set up directly or indirectly by the Reserve Bank to promote saving habit and to mobilise savings, and to provide industrial finance as well as agricultural finance. As far back as 1935, the Reserve Bank of India set up the Agricultural Credit Department to provide agricultural credit. But only since 1951 the Bank's role in this field has become extremely important. The Bank has developed the co-operative credit movement to encourage saving, to eliminate moneylenders from the villages and to route its short term credit to agriculture. The RBI has set up the Agricultural Refinance and Development Corporation to provide long-term finance to farmers. Classification of RBIs functions

The monetary functions also known as the central banking functions of the RBI are related to control and regulation of money and credit, i.e., issue of currency, control of bank credit, control of foreign exchange operations, banker to the Government and to the money market. Monetary functions of the RBI are significant as they control and regulate the volume of money and credit in the country. Equally important, however, are the non-monetary functions of the RBI in the context of India's economic backwardness. The supervisory function of the RBI may be regarded as a non-monetary function (though many consider this a monetary function). The promotion of sound banking in India is an important goal of the RBI, the RBI has been given wide and drastic powers, under the Banking Regulation Act of 1949 - these powers relate to licencing of banks, branch expansion, liquidity of their assets, management and methods of working, inspection, amalgamation, reconstruction and liquidation. Under the RBI's supervision and inspection, the working of banks has greatly improved. Commercial banks have developed into financially and operationally sound and viable units. The RBI's powers of supervision have now been extended to non-banking financial intermediaries. Since independence,

particularly after its nationalisation 1949, the RBI has followed the promotional functions vigorously and has been responsible for strong financial support to industrial and agricultural development in the country.

What is Bank rate? Bank Rate is the rate at which central bank of the country (in India it is RBI) allows finance to commercial banks. Bank Rate is a tool, which central bank uses for short-term purposes. Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate. Thus any revision in the Bank rate indicates that it is likely that interest rates on your deposits are likely to either go up or go down, and it can also indicate an increase or decrease in your EMI.

What is Bank Rate ? (For Non Bankers) : This is the rate at which central bank (RBI)
lends money to other banks or financial institutions. If the bank rate goes up, long-term interest rates also tend to move up, and vice-versa. Thus, it can said that in case bank rate is hiked, in all likelihood banks will hikes their own lending rates to ensure that they continue to make profit.

[Remember Bank Rate is not the same thing as Deposit Rates offered by banks for fixed deposits and recurring deposits. If you are a non banker and have landed on this page while looking at Deposit Rates, please click here to go to correct page i.e. Best Deposit Rates offered by banks for fixed deposits] The Reserve Bank of India (Amendment) Bill, 2006 has been enacted and has come into force with its gazette notification. Consequent upon amendment to sub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate. [Before the enactment of this amendment, in terms of Section 42(1) of the RBI Act, the Reserve Bank could prescribe CRR for scheduled banks between 3 per cent and 20 per cent of total of their demand and time liabilities].
What is CRR? RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves duel purposes i.e.(a) ensures
that a portion of bank deposits is kept with RBI and is totally risk-free, (b) enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money.

What is CRR (For Non Bankers) : CRR means Cash Reserve Ratio. Banks in India are required to hold a certain proportion of their deposits in the form of cash. However, actually Banks dont hold these as cash with themselves, but deposit such case with Reserve Bank of India (RBI) / currency chests, which is considered as equivlanet to holding cash with RBI. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio.

Thus, When a banks deposits increase by Rs100, and if the cash reserve ratio is 6%, the banks will have to hold additional Rs 6 with RBI and Bank will be able to use only Rs 94 for investments and lending / credit purpose. Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use for lending and investment. This power of RBI to reduce the lendable amount by increasing the CRR, makes it an instrument in the hands of a central bank through which it can control the amount that banks lend. Thus, it is a tool used by RBI to control liquidity in the banking system. What is SLR? Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). RBI is empowered to increase this ratio up to 40%. An increase in SLR also restrict the banks leverage position to pump more money into the
economy.

What is SLR ? (For Non Bankers) : SLR stands for Statutory Liquidity Ratio. This term is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved securities to liabilities (deposits) It regulates the credit growth in India. What are Repo rate and Reverse Repo rate? Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive. Therefore, we can say that in case, RBI wants to make it more expensive for the banks to borrow
money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate

Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the
RBI. The banks use this tool when they feel that they are stuck with excess funds and are not able to
invest anywhere for reasonable returns. An increase in the reverse repo rate means that the RBI is ready to borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep more and more surplus funds with RBI.

Thus, we can conclude that Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse repo ratesignifies the rate at which the central bank absorbs liquidity from the banks

The policy announcements on 03/05/2011, indicates that now repo rate has become the only independent variable policy rate, marking a shift from earlier method of calibrating various policy rates separately.

The reverse repo rate -- the rate at which RBI borrows will be kept 100 basis points lower than the repo rate. On the other hand Marginal Standing Facility (MSF) rate will be kept 100 basis points higher than the repo rate.

All commercial banks will be required to make provisions on the net funded country exposures on a graded scale ranging from 0. 25 to 100 per cent under the new country exposure norms that the Reserve Bank of India has put in place.

The central bank has directed banks to switchover to real-time monitoring of country exposures (all categories) by March 31, 2003. RBI has asked banks to take into account indirect country risk exposures too. If a domestic borrower has a substantial economic dependence on a certain country, this will be construed as indirect exposure for the lending bank. The indirect exposure will quantify as 50 per cent of direct exposure. To start with, only in respect of the country, where a bank's net funded exposure is 2 per cent or more of its total assets, the bank is required to make provision for dealing with that country risk exposure. State Bank of India [ Get Quote ], Bank of India and Bank of Baroda [ Get Quote ] which have significant presence outside the country will be required to make the provisionings. The provision for country risk shall be in addition to the provisions required to be held according to the asset classification status of the asset. In the case of 'loss assets' and 'doubtful assets', total provisions taking into account country risk may not exceed 100 per cent of the outstanding, RBI said. The RBI has directed all banks to frame 'country risk management' policies which will also include contingency plans and clear exit strategies that can be activated at times of crisis. The policy should also stipulate rigorous application of the 'know your customer' principle in international activities which should not be compromised by availability of collateral or shortening of maturities. Banks also need to look at both funded and non-funded exposures from their domestic as well as foreign branches while identifying, measuring, monitoring and controlling country risks.

For provisioing purpose, exposures should be computed on a net basis -- gross exposure minus collaterals, guarantees, insurance, etc, it said. In the case of foreign banks operating in India, the scope would be confined to their branches in India. The RBI has also asked banks not to rely solely on rating agencies or other external sources as their only country risk-monitoring tool. "Banks should also incorporate information from the relevant country managers of their foreign branches into their country risk assessments. "However, the rating accorded by a bank to any country should not be better than the rating of that country by an international rating agency," it said. Till such time as banks move over to internal rating systems, they are allowed to use the seven category classification followed by Export Credit Guarantee Corporation of India Ltd for the purpose of classification and making provisions for country risk exposures. The RBI has directed the banks to place the guidelines before their boards at the next meeting. These guidelines will be reviewed after one year.

Definitions of Commercial Banks

While defining the term banks it is taken into account that what type of task is performed by the banks. Some of the famous definitions are given below:

According to Prof. Sayers, "A bank is an institution whose debts are widely accepted in settlement of other people's debts to each other." In this definition Sayers has emphasized the transactions from debts which are raised by a financial institution.

According to the Indian Banking Company Act 1949, "A banking company means any company which transacts the business of banking . Banking means accepting for the purpose of lending of investment of deposits of money from the public, payable on demand or other wise and withdraw able by cheque, draft or otherwise."

Functions of Commercial Banks

Commercial bank being the financial institution performs diverse types of functions. It satisfies the financial needs of the sectors such as agriculture, industry, trade, communication, etc. That means they play very significant role in a

process of economic social needs. The functions performed by banks are changing according to change in time and recently they are becoming customer centric and widening their functions. Generally the functions of commercial banks are divided into two categories viz. primary functions and the secondary functions. The following chart simplifies the functions of banks.

Primary Functions of Commercial Banks

Commercial Banks performs various primary functions some of them are given below 1. Accepting Deposits : Commercial bank accepts various types of deposits from public especially from its clients. It includes saving account deposits, recurring account deposits, fixed deposits, etc. These deposits are payable after a certain time period. 2. Making Advances : The commercial banks provide loans and advances of various forms. It includes an over draft facility, cash credit, bill discounting, etc. They also give demand and demand and term loans to all types of clients against proper security. 3. Credit creation : It is most significant function of the commercial banks. While sanctioning a loan to a customer, a bank does not provide cash to the borrower Instead it opens a deposit account from where the borrower can withdraw. In other words while sanctioning a loan a bank automatically creates deposits. This is known as a credit creation from commercial bank.

Secondary Functions of Commercial Banks

Along with the primary functions each commercial bank has to perform several secondary functions too. It includes many agency functions or general utility functions. The secondary functions of commercial banks can be divided into agency functions and utility functions. A. Agency Functions : Various agency functions of commercial banks are

o o o o o o
B.

To collect and clear cheque, dividends and interest warrant. To make payment of rent, insurance premium, etc. To deal in foreign exchange transactions. To purchase and sell securities. To act as trusty, attorney, correspondent and executor. To accept tax proceeds and tax returns. General Utility Functions : The general utility functions of the commercial banks include To provide safety locker facility to customers. To provide money transfer facility. To issue traveller's cheque. To act as referees. To accept various bills for payment e.g phone bills, gas bills, water bills, etc. To provide merchant banking facility. To provide various cards such as credit cards, debit cards, Smart cards, etc.

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Bank Guarantee: Financial Bank Guarantee is a bond which is not cancelable and ensures the payment of the interest and repayment of the principal amount as per the schedule agreed upon by both the borrower and the lender. A guarantor to this debt security is liable to pay off the liability in case the first party or the issuer of the Financial Bank Guarantee fails to make the payment. 2) Performance Bank Guarantee: The seller issues a Performance Bank Guarantee to ensure or give concrete commitment to the buyer through its bank. This method ensures the buyer the timely execution of an agreement to have the goods exported or delivered or services performed. In case the seller defaults on execution of the terms agreed upon the Performance Bank Guarantee ensures the buyer the payment of the guarantee amount by the issuing bank. Generally the performance Bank guarantee is 10 percent of the total assignment or project value.

The Government of India set up Regional Rural Banks (RRBs) on October 2, 1975. Initially, five RRBs were set up on October 2, 1975 which were sponsored by Syndicate Bank, State Bank of India, Punjab National Bank, United Commercial Bank and United Bank of India. Capital share being 50% by the central government, 15% by the state government and 35% by the scheduled bank. Earlier Reserve Bank of India had laid down ceilings on the rate of interest to be charged by these RRBs. However from August 1996 the

RRBs have been granted freedom to fix rates of interest, which is usually in the range of 14-18% for advances.

Conception, reforms and the progress.

The establishment of regional rural banks was done to overcome basic rural credit problems like availability of cheap institutional credit to help overcome the financial problem of small and medium scale farmers. They came into being under the provisions of an Ordinance promulgated on the 26th September 1975 and the RRB Act, 1976. The ownership of RBI stays with the Government of India, the respective State Government and Sponsor Banks. These three components hold the issued share capital of the regional rural bank in the proportion of 50%, 15% and 35% respectively. The process of formulation of RRBs started on 2nd October 1975. During this process only a single bank was formed namely Prathama Grameen Bank. Statistics show that as on march 2006 , India had 133 RRBs (post-merger) covering 525 districts with a network of 14,494 branches. RRBs came with a pre conceived notion as institutions with keeping only the poor in focus and having local ethos. With the success of RRBs the Government of India in consultation with RBI and NABARD started their reform process through a wide-ranging package which also included their recapitalisation and auditing of their financial statements. As a part of their reforms process they were allowed to have variations in their investment schemes and were allowed to lend extensively. Studies show that the number of regional rural banks who were functioning well and were making a profit were about 166 of the 196 RRBs. RRBs have become quite large covering most parts of the State in many cases. Assam Gramin Vikas Bank, an amalgamated RRB, covers 25 districts, the highest in the country. 40 RRBs covered two districts and 16 RRBs covered a single district each in 2005-06. The entire rural credit system comprises of 37% of all scheduled commercial bank offices and in semi urban regions their share goes upto a 15%. At all India level, RRBs account for 12% of all deposit accounts of

scheduled commercial banks and a meagre 3.5% of deposit amount. Studies regarding the deposit and credit show that the success of regional rural banks is more as compared to that of scheduled commercial banks.
[edit] A bank guarantee and a letter of credit are similar in many ways but they're two different things. Letters of credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if the transaction doesn't go as planned. A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. This ensures the payment will be made as long as the services are performed. A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. This can be used to essentially insure a buyer or seller from loss or damage due to nonperformance by the other party in a contract. For example a letter of credit could be used in the delivery of goods or the completion of a service. The seller may request that the buyer obtain a letter of credit before the transaction occurs. The buyer would purchase this letter of credit from a bank and forward it to the seller's bank. This letter would substitute the bank's credit for that of its client, ensuring correct and timely payment. A bank guarantee might be used when a buyer obtains goods from a seller then runs into cash flow difficulties and can't pay the seller. The bank guarantee would pay an agreed-upon sum to the seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the purchaser the agreed-upon sum. Essentially, the bank guarantee acts as a safety measure for the opposing party in the transaction. These financial instruments are often used in trade financing when suppliers, or vendors, are purchasing and selling goods to and from overseas customers with whom they don't have established business relationships. The instruments are designed to reduce the risk taken by each party.

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