RBI and its Power, Function and Challenges I IASTarget IAS Target

RBI and its Power, Function and Challenges

22 Feb 2020

Category : Economical Issue

Topic: RBI and its Power, Function and Challenges

The Reserve Bank of India (RBI) is India's central bank, which controls all the scheduled banks along with issuing and supplying Indian rupee. That’s why is called the “the regulator of entire Banking” in India. RBI plays a significant role in the Development Strategy of the GoI (Government of India). Until the Monetary Policy Committee was introduced in 2016, it also regulated monetary policy in India. It first commenced its operations on 1 April 1935 as per Reserve Bank of India Act, 1934. Following India's independence on 15 August 1947, the RBI was nationalised on 1 January 1949.

Structure of RBI

Central Board
Central Board of Directors (CBD) governs the affairs of Reserve Bank. CBD is the apex body in the governance structure of the RBI. Aside CBD there are also four local Boards for the Eastern, Western, Northern and Southern regions of the India which take care of Local interests. Central government of India nominates/appoints Central Board directions and local boards’ member as per RBI Act. The structure of the Central Board is cherished under Section 8(1) of the RBI Act, 1934.
The general superintendence and guidance of the RBI is delegated with the 21-member of central board of directors:
  • The Governor;
  • Four Deputy Governors;
  • Two finance ministry representatives
    • The Economic Affairs Secretary
    • The Financial Services Secretary);
  • Ten government-appointed directors to characterize important elements of India's economy; and four directors to represent local boards headquartered at Mumbai, Chennai, Kolkata and New Delhi.

The Central Board is supported by three committees:

  • The Committee of the Central Board (CCB)
  • The Board for Financial Supervision (BFS)
  • The Board for Regulation and Supervision of Payment and Settlement Systems (BPSS)

Key Role and Functions of RBI

Monetary Authority Formulates, implements and monitors the monetary policy for
  • focus on keep maintaining inflation
  • ensuring sufficient flux of credit to productive sectors.
After establishing of Monetary policy committee, RBI stopped performing Monetary function. The MPC was established after MoU (Memorandum of Understanding) between the RBI and the government about the conduct of the new inflation targeting monetary policy framework in February 2015. First meeting of the Monetary policy committee was held on October 4, 2016 after the Government made amendment of the RBI Act as of June 27, 2016. MPC meeting also marked the starting of full-sized implementation of the new inflation targeting monetary policy framework.
RBI: A Regulator and supervisor of the financial system Lays out parameters of banking operations within which the country’s banking and financial system functions for-
  • maintaining public reliance on system,
  • shielding depositors interest;
  • providing cost-effective banking services to the general public.
Regulator of the payment systems
  • Authorizes introducing payment systems;
  • Lays down standards for working of the payment system;
  • Lays down policies for boosting the movement from paper-based payment systems to electronic modes of payments.
  • Establishing regulatory framework of novice payment methods.
  • Increasing customer convenience in payment systems.
  • Enhancing security in modes of payment.
  • Approving License to Banks
  • Inspection of Banks
  • Control Over NBFIs
    The non- bank financial institutions (NBFIs) are not affected by the working of a monitory policy. Reserve bank can issue directives to the NBFIs from time to time regarding their functioning. It has also right to control NBFIs through periodic inspection.
  • Enactment of Deposit Insurance Scheme
    The RBI has introduced the Deposit Insurance Guarantee Corporation for protecting the deposit of small depositors. All bank deposits less than Rs. 1 Lakh are insured with this corporation. RBI works to implement the Deposit Insurance Scheme in case of a bank fiasco.
Manager of Foreign Exchange RBI handles forex under the FEMA- Foreign Exchange Management Act, 1999 for:
  • facilitating external trade and payment as well
  • encourage the development of foreign exchange market in India.
Issuer of currency RBI is the supplier of currencies, but it is also a destroyer of coins & currency not suitable for circulation to ensure that the public has an sufficient amount of supplies of currency notes and in good quality. The RBI has authority to issue currency notes except coins of smaller denomination and one rupee note.
Role of RBI in development RBI executes types of promotional functions to help national objectives. Under this, it established institutions such as SIDBI, IDBI, NABARD, NHB, etc.
  • Growth of the Financial System
    The financial systems include - financial institutions, financial instruments and financial markets. The sound and well-organized financial system is essential for fast economic development of India. RBI strengthens both the banking and non - banking institutions to keep maintained sound and healthy financial system.

  • Agriculture Development
    India is an agricultural economy so RBI always pays attention to agriculture sector by considering credit needs of this sector. National Bank for Agriculture and Rural Development (NABARD) and Regional Rural Banks (RRB) are only for agrarian finance controlled by RBI.

  • Strive to meet Industrial need
    Industrial development plays an important role when it comes to economic development. Industries involve- small industries, medium industries and large industries, all these industries growth are important for economic development of the nation. For this purpose RBI helps the industrial sector too. Reserve bank has played an important role in establishing finance institutions like SIDBI, EXIM, ICICI Limited etc.

  • Training programme
    RBI always strived to provide the proper training to the staff of the banking industry. It has set up training college for bankers at many places. The training institute namely College of Agriculture Banking (CAB), National Institute of Bank Management (NIBM), Bankers Staff College (BSC) and many others.

  • Management of informative Data
    RBI always gathers important statistical data on various topics like inflation, interest rates, deflation, savings, investment, etc. This data is very useful for researchers and policy makers as well.

  • Reports Publication
    RBI has its separate publication division. This division collects and publishes data on various sector of the economy. The bulletins and reports are daily published by the RBI. It involves RBI annual reports, RBI weekly reports, Progress of commercial banks and Reports on Trend. This information is made available to the public also at reasonable costs.

  • Promotion of Banking and merge unbanked into banking system
    RBI always takes effective steps to increase the banking habits among people for economic development of nation. RBI has set up institutions such as Deposit Insurance Corporation UTI 1964, 1962, NABARD 1982, IDBI 1964, NHB 1988 etc. These organizations develop the banking habits among the people.

  • Export Promotion
    RBI always strives to improve the facilities for providing finance for foreign trade mainly exports from India. The Export - Import Bank of India (EXIM) and the Export Credit Guarantee Corporation of India (ECGC) are helped by refinancing their lending for export purpose.
Banker to the Government Performs merchant banking function for the state and the central governments and also acts as their banker.
Banker to banks A vital role of RBI is to maintain the banking accounts of scheduled banks and performs as the banker of former resort.
Agent of Government RBI acts as an agent of Government of India in the IMF.
Exchange Rate Management RBI prepares domestic policies to maintain of the external value of rupee and also prepare and implement the foreign exchange rate policy which will often aid in attaining the exchange rate stability. To keep exchange rates stable, RBI brings in demand and supply of foreign currency (U.S.) dollar close to each other.
Credit Control Function Commercial banks create credit as per the demand of economy. But if this credit creation is unchecked then it leads to the economy into inflationary cycles. Also, if credit creation is below the required limit, it affects the growth of the economy. Being a Central bank of India, RBI has to concentrate on growth with price stability. Consequently, it creates the credit creation capacity of commercial banks by using varied credit control tools.

Tools of Monetary Policy of RBI:

The Monetary Policy Committee (MPC) is the body of the RBI, directed by the Governor and responsible for taking the necessary monetary policy decision about fluctuation of the repo rate. Repo rate is the policy instrument in monetary policy that helps to realize the set inflation target by the RBI. The Monetary policy committee replaces the past arrangement of Technical Advisory Committee.

The main objectives of monitoring monetary policy are:

  • Upholding price stability to increase the economic growth
  • Inflation control (containing inflation at 4 percent, with a standard deviation of 2 percent)
  • Control on bank credit
  • Interest rate control

Quantitative Measures

Quantitative measures refer to those measures that impact on the variables which in result affect the whole money supply in the economy.

Instruments of quantitative measures

Bank Rate Bank rate in India is decided by Reserve Bank of India. It is the rate at which Reserve bank issue loan to commercial banks without keeping any collateral. The RBI, along with this, provides short term loans to its customers (keeping collateral) which is known as a “repo rate”.
Liquidity Adjustment Facility (LAF) A liquidity adjustment facility is an instrument used in monetary policy, mainly by the Reserve Bank of India, that permits banks to borrow money through repurchase/repo agreements or for banks to issue loans to the RBI through reverse repo agreements. This arrangement manages liquidity pressures and assures stability in the financial markets. On the recommendation of Narasimham Committee on Banking Sector Reforms (1998), RBI introduced the Liquidity Adjustment Facility.
Cash Reserve Ratio(CRR) CRR is the amount of funds that the banks have to keep with the central bank. If the RBI decides to boost the CRR, the available amount with the banks cuts down. Through, CRR RBI drains out the excessive money from the system. Scheduled banks are needed to maintain with the central bank an average cash balance, the amount of which will not be above 4% of the total of the time liabilities and net demand.
Reverse Repo Rate It is the rate at which the RBI borrows money from commercial banks. It is a tool of monetary policy. The rate at which the RBI lends money to commercial banks is called repo rate. Whenever banks have any shortage of funds they can borrow money from the RBI.
Statutory Liquidity Ratio (SLR) SLR is used to reserve requirement that the commercial banks in India need to maintain the in the form of forex, gold and government approved securities before offering credit to the customers.
Repo Rate Repo denotes to re-purchasing option, the rate at which central bank of India (RBI) approves loans to other banks. In other words, it is the rate at which banks can buy back the securities that they keep with the RBI. Bank offers loan to the public at a higher rate, frequently 1% higher than REPO rate, at a rate known as Bank Rate. While in Reverse repo rate, RBI borrows from banks at a lower rate.
Marginal standing facility (MSF) Marginal standing facility (MSF) is a kind of window for banks to borrow from the RBI in an emergency situation when inter-bank liquidity dries up fully.
Open market operations Open market operations are the purchase and sale of government securities and treasury bills by RBI. The main objective of OMO is to regulate the money supply in the economy. Reserve bank of India carries out the OMO through commercial banks and does not do outright deal with the public. Whenever the RBI has to increase the money supply in the economy, it purchases all the government securities from the market and it sells government securities to suck out liquidity from the system.
Market Stabilization Scheme (MSS) MSS is considered an important is a monetary policy tool used by the RBI to regulate money supply in the economy. Under Market Stabilization Scheme, if there is an excess money supply in the economy, RBI intervenes by selling Government securities (such as Treasury Bills, Cash Management Bills & Stamps, and dated securities.). This aids to withdraw the excess liquidity from the system.

Market Stabilization Scheme various from Open Market Operations

Open Market Operations (OMO) is buying and selling of Government securities to manage money supply in the economy, as we highlighted above. Thus, it is used to both insert and withdraw liquidity. Further, these securities are a significant part of Government borrowing. MSS is only selling of Government securities to drain out excess liquidity. The money earned through the selling of securities is kept in a separate account known as MSS account. And the amount kept in MSS account is merely used for redemption of securities issues under the MSS. Government can’t use this amount to meet its expenditure needs; it means it is not a part of Government borrowing. Though, interest is paid on securities issued under MSS. Hence, there is only a minimal impact on fiscal deficit due to interest payments. The cost of interest payment is shown separately in the budget.

The Government vs RBI debate on cash transfer

Recent conflicts, between the government and the RBI on RBI cash transfer. The RBI is accountable to the government through various constitutional provisions and regulations. They are not equal power entities. The RBI and the treasury (read Finance Ministry) is historically not good pal in most economies. Both RBI and government have the power and responsibility to manage the economy through their respective fiscal policies. Coordination between the two is required to make the economy successfully handle all the problems.

Transfer of capital reserves to the government

The recent issue of debate is the government demand for the transfer of a part of the capital reserves with the RBI. Reserve Bank is holding a capital reserve of 28% or around 9.5 lakh crores and is highly capitalized central bank in the world. Actually, the logic behind capital reserve is that like commercial banks, the RBI should have sufficient amount to manage its liquidity operations banks (Commercial banks have a minimum CRAR of 9%). The RBI raised capital from its retained profit after sharing the profit with the government. But in the current scenario, the government is demanding full profit transfer and is not letting the RBI to carry other reserves like contingency funds. The government has secured around Rs 50000 crores in 2017-18 form the RBI as profit share. RBI, in its part has installed a ruled based Staggered Surplus Distribution Policy for sharing the profit with the government in a scientific manner.

Linkage between capital reserves and the autonomy of the RBI

More than just a fund transfer, capital for RBI is highly interrelated with its independence and autonomy. When there is large capital, the RBI need no to approach the government in a contingency situation to handle its loans operations to financial institutions like banks. Hence, when the RBI has to independently operate its liquidity interventions, large capital reserves gives it confidence. In the past years, many central banks were recapitalized by governments when the latter lacked funds to issue liquidity to banks. This was especially due to high level of profit transfer by the central banks to the government. Of all issues, the capital reserve transfer is the main area of the debate between the RBI and the government. Presently, RBI's Deputy Governor Viral Acharya strongly defended capital reserves with the RBI as a necessary bulwark to smoothly regulate liquidity operations that the central bank performs.

Emergence of the conflict

In India, the conflict between the two arose so clearly during the time of former Finance Minister P Chidambaram. At that time, the RBI Governor was not ready to alleviate the repo rate as per the wishes of the FM. Since then, the government introduced various steps with or without success to control the regulatory powers of the RBI. Some recent incidents indicate that the India’s government is in a mood to violate the regulatory powers of the RBI. In this angle, there are two features regarding the conflict between the Ministry of Finance and the RBI. First, the conflict is not a recent one and second; the government has been persistently making efforts over the last few years to intervene the powers of the RBI.