Role of the Reserve Bank of India

Introduction

The Reserve Bank of India (RBI) was established by the Reserve Bank of India Act, 1934. Set up on the recommendation of the Hilton Young Commission, it took over the functions of management of government accounts, monetary functions including public debt, from the Imperial Bank of India and the Controller of Currency. The RBI was included under Schedule VII, Entry 38 of List I (Union List) of the Constitution of India upon its enactment. Today, it acts as the principal regulatory body for the commercial and non-commercial banks working in India.

The RBI, other than being mandated by the RBI Act of 1934, derives its functions and authority from:

• Public Debt Act, 1944 (Act No. 18 of 1944),
• Banking Regulation Act, 1949 (Act 10 No. of 1949),
• Foreign Exchange Management Act, 1999 (Act No. 42 of 1999),
• Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Act No.54 of 2002),
• Credit Information Companies (Regulation) Act, 2005 (Act No. 30 of 2005),
• Payment and Settlement Systems Act, 2007 (Act No. 51 of 2007)
• Government Securities Regulations, 2007 (made in exercise of powers granted to the RBI vide Section 32 of the Government Securities Act, 2006 [Act No. 38 of 2006]).

Functions of the RBI

1. The Preamble to the Act states that the RBI has been established to “regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency any credit system of the country to its advantage.”[1]
2. Consolidating all the powers conferred on the RBI from the above-stated legislations, the functions of the central bank can be categorized as below:
   1. Monetary function,
   2. Supervisory and regulatory role,
   3. Forex management,
   4. Developmental role,
   5. Issuer and regulator of the Indian currency, and
   6. Banker of banks.
3. Monetary and credit policy functions
   1. Its chief aim is maintaining the price stability for all sectors in the Indian market in consonance with its growth objective, simultaneously maintaining full employment and balance of payments.[2]

It releases its statutory ‘Annual Report’ stating the progress of the Indian economy in the preceding year, and also projects the growth of the financial sector prospectively.

It also publishes the statutory ‘Report on Trend and Progress of Banking in India’ that analyses the efficacy and implementation of the policies of the preceding year.

• Until the establishment of its subset, the Monetary Policy Committee (MPC)[3] in 2016, the RBI was entrusted with the responsibility of controlling monetary policy.
• It works to keep the inflationary tendencies of the complex economy in check.
• It fixes an interest rate for the ‘repo’ (repurchase) rate and the reverse ‘repo’ rate. Repo rate is the interest at which RBI lends securities to the banks, whereas reverse repo rate (RRR) is the interest at which the RBI borrows securities from the banks.[4]

The RBI increases the repo rate in order to suck out increased liquidity in the economy, whereas it decreases the repo rate to increase the money flow in the economy. Currently, the repo rate was revised and reduced by the RBI to 4% (in contrast to the previous 4.4%) whereas the reverse repo rate has been pegged at 3.35% (from the previous 3.75%) to surge money circulation in the economy.[5]

• It also fixes the ‘bank rate’ (the rate at which the RBI rediscounts bills of commercial banks or gives them advance in return of approved securities).[6] The RBI reduces the bank rate when it has to surge cash creation in the economy (as the banks issue more due to cheaper rates), whereas it increases the bank rate to control credit expansion in the economy (as higher rates of interest deter banks from borrowing more).
• It also controls the money stock by performing open-market operations. It sells the securities to private individuals and commercial banks to reduce the existing money supply in the market, example during inflation, whereas it buys more securities to infuse more cash at the times of contraction, recession, or depression.
• Supervisory and regulatory role
  • As the central bank of the State of India, it oversees smooth, transparent, and profitable working of all commercial and non-commercial banks. It gathers and publishes data of economic progress district-wise, region-wise, and state-wise in the annual journal called ‘Basic Statistical Returns.’
• It actively frames cost-effective economic banking schemes for welfare of the public and securing the interest of the investors.
• As a supervisory body, it also conducts on-site inspections (annually) and off-site surveillance system to monitor closely the financial health of the banks on the basis of their liquidity position, assets held, earnings, capital, etc.[7]
• It is also the ‘licensing authority’ that grants approval or denies to companies desirous of commencing banking or non-banking operations[8] in India. It is also capable of canceling such licence issued in consonance with law.

With regards to its supremacy in this decision-making, the Madras High Court held that ‘the RBI has been established with a view to foster the banking business and not for impeding its growth, that its functions are non-political and genuine, and it has been entrusted with the financial system of the country. Therefore, it could ‘weed out’ the institutions running on unsound lines or detrimental to the public interest.’[9]

• Forex Management (Section 40)
  • The RBI is the custodian of India’s foreign exchange reserves (whose reports are published in its balance sheet) under the Foreign Exchange Management Act, 1999.[10] Further, only the RBI holds the authority to allow a person to deal in the foreign exchange and securities.[11]
• It releases the half-yearly report on such management, which is termed as the ‘Report on Foreign Exchange Reserves.’
• It ensures smooth functioning of foreign trade and maintains the forex trade market in India by revaluating and devaluating the rupee.
• Developmental role
  • The RBI keeps formulating fiscal policies to ensure that nation’s fiscal objectives are met, and also checks constantly that the banks are in a sound working condition.
• The RBI promotes ‘financial inclusion’ policy and observes if the aim is being met. For example, in the furtherance of the same, Basic Savings Bank Deposit (BSBD) (generally called ‘no frills accounts’) regulations were relaxed and made more flexible, allowing the banks to expand banking facilities to basic account holders free-of-charge.
• The RBI propagates financial inclusion also by creating ‘financial literacy,’ that is, by press releases, SMSs, social media handles, and business television channels. “Depositor Education and Awareness” fund has been created for this purpose.
• It has advanced the Indian monetary system from paper-based instruments to electronic means by the introduction of Unified Payment Interface (UPI), prepaid payment instruments (e-wallets and KYC compliance), point-of-sale terminals, ATM-based transfers, National Electronic Funds Transfer (NEFT), Real Time Gross Settlement (RTGS), Electronic Fund Transfer (EFT) etc.
• Issuer of the Indian currency (Section 22 & 23)
  • The RBI, through its Issue Department, is responsible for the issuance of bank notes in return of bank notes, coins, bullions, or securities.[12]
• The RBI is responsible for the printing of various denomination currencies under its seal of authority, thereby giving money the recognition of legal tender,[13] while it also destroys the currency unfit for circulation.
• The RBI regulates, maintains the efficacy, and ensures the proper transparency of all the payment systems across the country. It documented the ‘Report on Currency and Finance 2009-12’ in 2013, stating in it its monetary policy coordination, institutional arrangements, and analysis of its balance sheets.
• It also detects and impounds the circulation of the counterfeit currency in the market.[14]
• Banker’s role
  • The central bank issues funds as a lending body to the commercial and non-commercial banks operating in India at various rates, which is why it is called as “banker of banks.” Chapter III of the RBI Act, 1934, deals with the functions of RBI as India’s central bank.
• It acts as a consultative body regarding financial matters for the commercial and non-commercial banks operating in India.
• It maintains a register of all the banking operations undertaken by all scheduled commercial banks. These reports are published by the RBI in the ‘Statistical Tables Relating to Banks in India.’
• It performs lending operations for the Central Government.[15] Further, in relation to the central government, it executes exchanges and remittances, and also manages its public debt as well as banking functions.
• It acts as a banker for the state governments[16] also by selling and purchasing government securities and provides them with banking solutions.[17] These statistics of the financial and analytical data are reported in the ‘State Finances: A Study of Budgets’ that highlights the fiscal position of the state governments.

Conclusion

1. The RBI has always had a crucial role to play. Presently although it is the central bank of the State of India, but in the past, it has also served as the central bank for the States of Myanmar (until 1947) and Islamic Republic of Pakistan (until 1948).
2. It is largely an autonomous body that not only performs the functions of a central monetary body, but also promotes capital formation, acts to boost the economic growth, promotes monetisation and decides the monetary policy.
3. However, differences in approaches, analysis, judgments, and instrumentalities between the central government and the RBI has often caused a deadlock.[18]
4. In emerging economies, it is best to have autonomy of the central bank based on convention instead of a statute.[19]
5. The RBI performs a lot of functions that are not mandated in the legislations. Even flexible framework for inflation targeting was not a statutory function until the amendment of May 2016.[20] It also executes its duties via traditional moral suasion, where commercial and non-commercial banks cede to the orders, violation of which may lead to unfavorable sanctions.

[1] Preamble, The Reserve Bank of India, 1934 (As amended by the Finance (No.2) Act, 2019).

[2] Mandeep Kour Bansal, “Role of Reserve Bank of India in Indian Economy,” 7(1), International Journal of Business Administration and Management, 45 (2017).
[3] Monetary Policy Committee is a six-member committee consisting of the Governor of RBI as its ex-officio Chairperson, brought into being by Section 45ZB of the RBI Act, 1934. Its three members are nominated by the RBI, whereas the other three are nominated by the Government of India.
[4] Explanation, Section (12AB), The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).
[5] RBI cuts repo rate again, down to 4%, The Hindu, Editorial, May 23, 2020.
[6] Both bank rate and repo rate are instruments to control liquidity in the market. Bank rate is used when the money is lent for long-term whereas repo rate is used when the money is lent for short-term.
[7] Government of India, Report: Reserve Bank of India: Functions and Working (Reserve Bank of India, available at: Source Link (Accessed on May 20, 2020).
[8] Section 45-IA, The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).
[9] Sajjan Bank Pvt. Ltd. v. Reserve Bank of India, Madras, (1959) 2 MLJ 455.
[10] Section 3, The Foreign Exchange Management Act, 1999 (Act No. 42 of 1999).
[11] Section 10, The Foreign Exchange Management Act, 1999 (Act No. 42 of 1999).
[12] Section 23, The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).
[13] Section 24, The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).
[14] Master Circular 2018-19, Department of Currency Management, available at: Source Link. Last accessed: May 23, 2020).
[15] Section 17(11), The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).
[16] Ibid.
[17] Sections 21A & 21B, The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).
[18] Evolving role of the Reserve Bank of India: Recent Developments, available at: Source Link (Accessed on: May 20, 2020).
[19] L M Bhole, Jitendra Mahakud, Financial Institutions and Markets: Structure, Growth & Innovations, 6^th Ed., (McGraw-Hill Education, 2017).
[20] Section 45ZA, The Reserve Bank of India Act, 1934 (As amended by the Finance (No.2) Act, 2019).