RBI Act: Securing Monetary Stability

The Reserve Bank of India (RBI) is the financial institution at the apex of the country’s financial system, with management, supervision, promotion, development and planning mandates. It influences the operations of commercial banks in multiple ways.

The RBI influences the operations of commercial banks through various policies, directives and regulations, and its role in banking is unique.

RBI carries out its four primary functions of management—planning, organising, directing and controlling, providing a strong foundation for commercial banking functions under the regulation of RBI Act.

In 1921, the British government established the Imperial Bank of India as the Central Bank of India. Unfortunately, Imperial Bank has neither formed a good track record nor been successful as a central bank.

So the government sought the establishment of a new central bank, and the Reserve Bank of India was established on 1 April 1935 and nationalised in January 1949.

Reserve Bank of India Act

The RBI Act contains definitions of so-called scheduled banks, prescribed in the second schedule of the law. These banks have paid up capital and reserves above Rs 5 lakh.

The RBI Act has various sections, but the most controversial one is Section 7. This section has been used only once by the central government but limits the autonomy of the RBI.

As per Section 7, Central Government can regulate the functioning of the RBI through its RBI Board, and the RBI is not an autonomous body.

Section 17 of the RBI Act defines how the RBI conducts its business.

• RBI can accept interest-free deposits from central and state governments.
• It can buy and discount bills of exchange from commercial banks, purchase foreign exchange from banks, and sell it to them.
• It can provide grants to banks and state financial corporations and advances to the central and state governments.
• It is authorised to buy or sell government securities completely for its enforcement.

Apart from the RBI Act, 1934, the Reserve Bank also comes under the purview of various other legislations like:

• Public Debt Act, 1944
• Government Securities Regulations, 2007
• Banking Regulation Act, 1949
• Foreign Exchange Management Act, 1999
• SARFAESI Act, 2002
• Credit Information Companies(Regulation) Act, 2005
• Payment and Settlement Systems Act, 2007

Objectives of RBI act

The primary purpose of the RBI Act is to oversee and implement initiatives in the financial sector, which includes commercial banks, financial institutions and non-bank financial companies (NBFCs). RBI was established keeping in mind the following objectives:-

• Regulation of banknote issuance
• Ensuring currency stability in India
• Modernising the monetary policy framework to overcome economic challenges

Establishment of RBI

The Reserve Bank’s headquarters were initially located in Calcutta but moved permanently to Mumbai in 1934. The central office is the seat of the governor of RBI and is where policy is formulated.

The Reserve Bank has been owned and operated by the Government of India since its nationalisation in 1949.

RBI manages the monetary and other banking policies of the Government of India.

Central Board (21 members) governs the operations of the Reserve Bank. Under the RBI Act, the Government of India appoints the Central Board members.

Role and Functions of RBI

Roles of RBI

Monetary authority

• The RBI Formulates and implements the national monetary policy
• It also maintains price stability across the market with sustainable growth

Regulatory and supervisory

• RBI prescribes financial parameters within which banking and economic systems of banks function
• It also works toward protecting investors’ interests and providing ease of access to banking to the public.

Foreign exchange management

• It also acts as per the provisions of the Foreign Exchange Management Act, 1999 and,
• It facilitates external trade and aids the development of the foreign exchange market.

Currency issuer

• RBI is completely authorised as per RBI Act to Issue, exchange or destroy currency not appropriate for circulation
• It is assigned to publish and provide adequate currency notes and coins in circulation.

Developmental role

RBI promotes and supports national banking and financial objectives undertaken by the banks

Chief banker to all banks

• RBI is authorised to act as the chief banker of all the scheduled banks as per the RBI Act.
• It maintains all banking accounts and provides central and state governments with banking solutions.
• It is also entitled to act as the banker of central and state governments.

Functions of RBI

The issuer of banknotes

As per the RBI Act, the reserve bank of India’s function is to issue currency notes and coins; an exception is the one rupee note and coin issued by the Ministry of Finance.

The Reserve Bank of India distributes all the notes and coins issued by it or the Government of India. The currency notes will bear the signature of the RBI governor on them.

Banker to the Government

Another primary function is that it manages the banking needs of the government, including maintaining and operating the Government’s deposit accounts, collecting the receipts of funds, and undertaking transactions on behalf of the Government of India.

Custodian of cash reserves of commercial banks

It acts as a custodian of the cash reserves throughout all the banks in the country. All Commercial banks must maintain their cash reserves at a rate the RBI decides in its monetary policy.

Custodian of foreign exchange reserve

RBI maintains the foreign cash reserves that enable the RBI to deal with any crisis.

Lender of the last resort

It acts as a parent to all commercial banks in India. Thus, becoming the lender of the last resort for all banks when they are in a crisis. RBI aids the banks by lending money, although at a higher rate of interest, to aid them in passing the financial liabilities.

Controller of credit

RBI Act authorises RBI to control the credit created by the commercial banks in India per the economic priorities.

It does so by announcing monetary policies at regular intervals. The monetary policy includes the management of interest rates and money supply.

The central bank of India twists the money supply to achieve objectives such as liquidity, inflation, and consumption.

Power of RBI

RBI Powers: The Reserve Bank incorporates broad powers to regulate and supervise various banks in India under the RBI Act and the Banking Regulation Act. Below is a summary of the essential rights of RBI.

Under the Banking Regulation Act, the RBI has the following powers:

Section 10BB- Authority of the Reserve Bank to appoint a full-time chairman of the Board of Directors or a Managing Director of a banking company

In the event of a vacancy in the position of full-time chairman or managing director of a banking corporation, the Reserve Bank may nominate one if it believes that the continuation of such a vacancy is likely to affect the interests of the banking corporation adversely. A person appointed as chairman or managing director of a banking company.

Section 21- Reserve Bank Authority to control advance payments from banking companies

The Reserve Bank has the power to set policies and direct banking companies to comply with them.

Section 22- Licensing of banks

All banks must obtain a license from the RBI, and the RBI has the power to issue a license only after the “entry test” has been met.

Section 27– The power to call for other returns and information

As per this section, RBI can direct a banking company to furnish returns with statements and information concerning the business or affairs of the banking company as it may consider expedient to obtain for this Act.

Apart from this, the RBI can call for information every half-year regarding the banking company’s investments and the classification of its advances in the industry, commerce and agriculture.

Section 29A– Power concerning associate enterprises:

The RBI may direct a banking company to annex to its financial statements or furnish to it separately, within such time or intervals, necessary information concerning the business or affairs of any associate enterprise of the banking company.

It can search and inspect any associate enterprise of a banking company and its books of account jointly with the Board or authority regulating such associate enterprise.

Section 30– Power to order Special audit

In the public interest or the interest of the banking company or its depositors, the RBI may direct a special audit of the banking company’s accounts at any time by order.

Section 35 – Audit of banking companies

The Reserve Bank can inspect each bank and its books and accounts, and a copy of such inspection report shall be provided to the banking companies.

Section 35A – Reserve bank authority to give directions

In the interest of the public interest or banking policy, the RBI has the power to issue, amend or revoke instructions at its sole discretion. Banks or banking companies are obliged to comply with these instructions.

SECTION 36 – Other powers and functions of RBI

• The RBI may warn or prohibit banking companies from participating in particular transactions or classes of transactions.
• At the entities’ request and per Section 44A provisions, RBI assists in merging such banking entities.
• Assisting banking entities with loans or advances as defined in Section 18 of the RBI Act
• Make changes to management.
• The RBI also has the power to remove officers and other officers (Section 36AA), appoint additional directors (Section 36AB), and issue orders relating to imminent assets (Section 35AB).
• It may remove directors (Section 36ACA), replace directors of multistate credit unions (Section 36AAA), and impose penalties (Section 47).

RBI Policies

The Reserve Bank of India creates the monetary policy concerning national financial issues. The policy includes measures to regulate the money supply, availability, and cost of credit in the economy.

This policy also monitors user credit allocation and lending and borrowing rates. Monetary policy is crucial in stimulating economic growth in developing countries like India.

Various instruments of monetary policy include changes in bank rates, other interest rates, selective credit management, foreign exchange supplies, changes in reserves, and open market operations.

Objectives of Monetary Policy

The main objectives of monetary policy are to achieve economic growth, exchange rate stability, etc.

Promoting Savings and Investments: Monetary policy controls domestic interest rates and inflation, affecting people’s savings and investments.

Higher interest rates lead to more significant investment and savings opportunities, thereby maintaining healthy cash flow within the economy.

Controlling imports and exports: Monetary policy helps export-oriented companies substitute imports and increase exports by allowing industries to obtain credit at low-interest rates. It will contribute to the improvement of the international balance of payments.

Managing the Business Cycle: The two main phases of the business cycle are boom and bust.

Monetary policy is a tool that can control the booms and busts of the business cycle by managing credit and the money supply. And money supply can control market inflation. On the other hand, when the money supply goes up, so does the economy’s demand.

Regulation of Aggregate Demand: Monetary policy can manage demand in the economy, so it can get utilised by monetary authorities to maintain a balance between supply and demand for goods and services. As credit expands and interest rates fall, more people will be able to buy goods and services on credit, leading to increased demand. On the other hand, if authorities want to reduce the need, they can reduce credit and raise interest rates.

Job Creation: Monetary policy can lower interest rates, making it easier for small and medium-sized enterprises (SMEs) to secure loans to expand their businesses. It can lead to more employment opportunities.

Supporting infrastructure expansion: Monetary policy enables subsidised financing for domestic infrastructure expansion.

Increased Lending to Priority Sectors: As part of monetary policy, additional funds are available at lower interest rates for developing priority sectors such as small industries, agriculture, and creating social classes.

Banking Sector Management and Development: Reserve Bank of India manages the entire banking sector. While RBI aims to make banking facilities ubiquitous across the country, other banks using monetary policy are also encouraged to open branches in rural areas wherever needed for agricultural development.

In addition, the government has also established regional rural banks and cooperative banks to help farmers get the financial support they need in the shortest possible time.

Flexible Inflation Targeting Framework (FITF)

India introduced the Flexible Inflation Targeting Framework (FITF) after the 2016 amendments to RBI Act 1934.

Conclusion

The reserve bank of India is the financial custodian keeping the cash reserves and its record in the country.

The Reserve Bank of India took many steps toward updating the country’s secure and sustainable payment system. The RBI works a lot to ensure effective compliance with the RBI Act by the banking and non-banking financial companies.

The RBI Act effectively works on achieving monetary growth in the country simultaneously with making a balance of payment in the domestic market relating to foreign exchange.

RBI incorporates the power to formulate monetary policies to bring financial stability and growth and impose sanctions for its non-compliance.