Banking Basics

 

BANKING BASICS

RBI

Establishment

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated.

Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the Government of India.

RBI Functions:

Monetary Authority:

• Formulates , implements and monitors the monetary policy.
• Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

Regulator and supervisor of the financial system:

• Prescribes broad parameters of banking operations within which the country''s banking and financial system functions.
• Objective: maintain public confidence in the system, protect depositors'' interest and provide cost-effective banking services to the public.
• Regulator and supervisor of the payment systems
• Authorises setting up of payment systems
• Lays down standards for operation of the payment system
• Issues direction, calls for returns/information from payment system operators.

Manager of Foreign Exchange

• Manages the Foreign Exchange Management Act, 1999.
• Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

Issuer of currency:

• Issues and exchanges or destroys currency and coins not fit for circulation.
• Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.

Developmental role

• Performs a wide range of promotional functions to support national objectives.

Related Functions

• Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker.
• Banker to banks: maintains banking accounts of all scheduled banks.

Legal Framework

Umbrella Acts

• Reserve Bank of India Act, 1934 : governs the Reserve Bank functions
• Banking Regulation Act, 1949: governs the financial sector

Acts governing specific functions

• Public Debt Act, 1944/Government Securities Act (Proposed): Governs government debt market
• Securities Contract (Regulation) Act, 1956: Regulates government securities market
• Indian Coinage Act, 1906:Governs currency and coins
• Foreign Exchange Regulation Act, 1973/ Foreign Exchange Management Act, 1999 : Governs trade and foreign exchange market
• Payment and Settlement Systems Act 2007: Regulation and supervision of the payment systems.

Acts governing Banking Operations

• Companies Act, 1956:Governs banks as companies
• Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980: Relates to nationalisation of banks
• Bankers'' Books Evidence Act
• Banking Secrecy Act
• Negotiable Instruments Act, 1881

Acts governing Individual Institutions

• State Bank of India Act, 1954
• The Industrial Development Bank (Transfer of Undertaking and Repeal) Act, 2003
• The Industrial Finance Corporation (Transfer of Undertaking and Repeal) Act, 1993
• National Bank for Agriculture and Rural Development Act
• National Housing Bank Act
• Deposit Insurance and Credit Guarantee Corporation Act

RBI and Monetary Policy

Monetary policy refers to the use of the instruments under the control of the central bank to regulate the availability, cost and the use of money and credit.

The main objectives of Monetary Policy in India are:

·       Maintaining price stability

·       Ensuring adequate flow of credit to the productive sectors of the economy to support economic growth

·       Financial stability

 

There are several direct and indirect instruments that are used in the formulation and implementation of monetary policy.

Direct Instruments:

·       Cash Reserve Ratio(CRR): The share of net demand and time liabilities that banks must maintain as cash balance with the Reserve Bank

·       Statutory Liquidity Ratio (SLR): the share of net demand and time liabilities that banks must maintain in safe and liquid assets as government securities, cash and gold.

·        Refinance Facilities: Sector specific refinance facilities (e.g. lending to export sector) provided to the banks.

Indirect Instruments:

·       Liquid Adjustment Facility (LAF): consists of daily infusions or absorption of liquidity on a repurchase basis, through repo (liquidity absorption) auction operations, using government securities as collateral.

·       Open Market Operations (OMO): outright sales/purchase of government securities, in addition to LAF as a tool to determine the level of liquidity over the medium term

·       Market Stabilisation Scheme (MSS): liquidity of a more enduring nature arising from large capital flow is absorbed through sale of short dated government securities and treasury bills. The mobilised cash is reserved separately  in govt account held with reserve Bank.

·       Repo/ Reverse Repo Rate: these rates under the liquidity adjustment Facility (LAF) determine the corridor for short term money market interest rates.  In return this is expected to trigger movement in other segments of financial markets and the real economy.  

·       Bank Rate: it is the rate at which the reserve Bank is ready to buy and rediscount bills of exchange or other commercial papers. It also signals the medium term stance of monetary policy.