All About Reserve Bank Of India RBI & Its Functions

All About Reserve Bank Of India(RBI) & Its Functions

INTRODUCTION

Reserve Bank of India (RBI) is India's central bank and executes multiple functions which include overseeing monetary policy, issuing currency, managing foreign exchange, working as a bank of government and as banker of scheduled commercial banks, etc. The main feature of RBI is to work for overall economic growth of the country.

In year 1935, the Reserve Bank of India was established with the provision of Reserve Bank of India Act, 1934.

In year 1949, RBI was nationalized and since then is fully owned by Government of India (GoI). The preamble of the Reserve Bank of India describes it main functions 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."

Main Functions of RBI

Monetary Authority

Monetary authority or monetary policy is referred to the use of instruments under RBI control to regulate availability, cost and user of money and credit. The central bank does this to maintain pricing stability, low & stable inflation but also promote economic growth of country.

Issuer of Currency

Reserve bank of India is the solitary body who is authorized to issue currency in India. The coins are minted by GoI, while the RBI works as an agent of GoI for the distribution and handling of coins. RBI also works to prevent forging and faking of currency by regularly upgrading security features of currency. 

Banker and Debt Manager to Government

RBI serves the purpose of carrying out financial transaction effectively for Government of India (Gol). RBI works as banker to Government of India and also maintains its accounts, receive payments into & make payments out of these accounts. 

Banker to Banks

Furthermore, RBI works as an effective banker to all the scheduled commercial banks and all the banks in India maintain its accounts with RBI. This helps them in clearing and settling interbank transactions and customer transactions smoothly and swiftly. 

Regulator of the Banking System

RBI has the accountability and charge of regulating the nation's financial system. As a regulator and supervisor of Indian banking system, RBI safeguards and guarantees the financial stability and public confidence in banking system. 

Manager of Foreign Exchange

RBI pays a pivotal role in regulating and managing key segment of foreign exchange market and also a role to play in regulating and managing this segment. It is because there is increased integration of the Indian economy with the global economy with has arisen from the greater trade and capital flows. 

Regulator and Supervisor of the Payment and Settlement Systems

The payment and settlement systems play a significant role in improving overall economic efficiency. As per the Payment and Settlement Systems Act of 2007 (PSS Act), the Reserve Bank of India has oversight authority, which includes regulation and supervision, for the payment and settlement systems in the country. 

Developmental Role

RBI plays critical role in building country's financial structure. The most important tools in this endeavor include Priority sector lending such as Agriculture, micro and small enterprise (MSE), housing and education.  

Monetary Policy

Monetary Policy is referred to the process which is employed by Central bank of the country to control availability and cost of currency. In this way, it helps in keeping Inflation and Deflation low and stable. The central bank accomplishes this by using various tools which can be broadly categorized in two parts as Quantitative & Qualitative tools.

Quantitative Tools

Quantitative tools are referred to reserve ratios, Open market operation and various interest rates.

Reserve Ratio

Reserve ratios can be defined as the share of net demand and time liabilities (NDTL) which banks have to keep separately ensuring that they have sufficient cash to cover customer withdrawals. There are two types of reserve ratios.

Statutory Liquidity Ratio (SLR)

Statutory Liquidity Ratio (SLR) can be defined as the share of net demand and time liabilities that banks must maintain in safe and liquid assets, such as government securities, cash and gold. On 3 June, 2014, RBI has cut the SLR by 50 basis points to 22.5%. For instance, if a bank has Rupees 200 Crore of NDTL then it has to keep Rs. 45 Crore in liquid assets. 

Cash Reserve Ratio (CRR)

Cash reserve Ratio (CRR) can be defined as the amount of funds that the banks are required to park with the RBI. If the central bank decides to increase the CRR, the available amount with the banks will be falling down. 

Open Market Operation (OMO)

Open market operation is the active process of buying and selling of government securities in open market which helps in controlling the supply of money in banking system. Whenever there is superfluous supply of money, the central bank sells government securities and in this way it sucks out excess liquidity. Likewise, when liquidity is constricted, RBI will buy government securities and in that way injects money supply.

Policy Rates

Policy rates are defined as various interest rates which RBI uses to control money supply in India. Repo Rate is often referred to as fundamental policy rate in India as all the other rates can be derived from repo rate.

Bank Rate

The bank rate is the interest rate when banks want to borrow long term funds from RBI. The current rate is set at 9 per cent and bank rate is not used to control money supply these days.

Liquidity Adjustment Facility (LAF)

In year 2000, Liquidity Adjustment facility was introduced. It is a facility which is provided by the Reserve Bank of India. This facility helps in scheduling commercial banks to avail of liquidity in case of need or to park excess funds with the RBI on an overnight basis against the collateral of Government securities. RBI agree to take application for a minimum amount of Rs.5 crore and in multiples of Rs. 5 crore thereafter. 

Repo Rate

Repo Rate is a rate at which the RBI lends money to commercial banks. Repo rate is an instrument of monetary policy. If banks run short of funds they can borrow from the RBI. To restrain and curtail inflation, RBI increases Repo rate which will make borrowing costly for banks. 

Reverse Repo Rate

Reverse Repo rate is the rate at which the RBI borrows money from the commercial banks. As their money is in safe hands with a good interest, Banks are always happy to lend money to the RBI. As the name suggest, reverse repo rate is just the opposite of repo rate. 

IMPACT OF THESE RATES ON THE BANKS

The Monetary Policy Department of RBI has the power to formulate and also to implement the Reserve Bank’s monetary policy. Its main objectives comprises of price stability, ensuring adequate flow of credit to productive sectors of the economy to support economic growth, and maintaining financial stability. According to the prevailing macroeconomic conditions and outlook, the relative emphasis is placed on a particular objective at a particular point in time, as per the policy statements of RBI. 

The core activities of the this Department include formulating monetary policy measures, which include policies on CRR, SLR, repo and reverse repo rates under the LAF, export credit refinance, market stabilization scheme (MSS) and open market operations (OMOs). It also formulates policy on interest rates of the banking sector. The activities also include monitoring maintenance of CRR and SLR and also monitoring, analyzing and dissemination of data on interest rates in the banking sector.

Repo Rate, Reverse Repo Rate, Cash Reserve ratio (CRR) and the Statutory Liquidity Ratio (SLR) are considered to be the independent variables. The dependent variable is the interest rate offered by banks. From the correlation and regression analysis, it has been understood that the repo rate is found to be the most influencing factor, among the five factors, on banks to determine their interest rates. 

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