RBI/central banks and its functions

Introduction

A Central Bank, Reserve Bank, or Monetary Authority

is an institution that manages a State’s Currency, money
supply, and interest rates. Central banks also usually
oversee the commercial banking system of their
country. In contrast to a commercial bank, a central
bank possesses a monopoly on increasing the monetary
base in the state and usually also prints the national
currency, which usually serves as the State’s legal
tender.
The main function of a central bank is to control the
Nation’s money supply(monetary policy), through
active duties such as managing interest rates, setting the
reserve requirement, and acting as a lender of last resort
to the banking sector during times of bank’s insolvency
or financial crisis. A central bank usually also has
supervisory powers, intended to prevent bank runs and
to reduce the risk that commercial banks and other
financial institutions engage in reckless or fraudulent
behaviour. Central banks in most developed nations are
institutionally designed to be independent of political
interference. Still, limited control by the executive and
legislative bodies usually exists.
RBI/central banks and its functions

Brief history

 It was set up on the recommendation of the

HILTON YOUNG COMMISSION.
 It was started as a Share-holders Bank with a paid-
up capital of Rs.5 Crores.
 It was established on April 1, 1935.
 Initially, it was located in Kolkata.
 It moved to Mumbai in the year 1937.
 Initially, it was privately owned.
 It was the first bank to be nationalized in 1949.
 It has 22 Regional offices, most of these in-state
Capitals.
 Since its nationalization in 1949, Reserve Bank is
fully owned by the Government of India.

Preamble

The Preamble of the Reserve Bank of India describes

the basic functions of the Reserve Bank as:
RBI/central banks and its functions

“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
systems of the country to its advantage; to have a
modern monetary policy framework to meet the
challenge of an increasingly complex economy, to
maintain price stability while keeping in mind the
objective of growth.”

Objectives of RBI

The Objectives of the Central Bank of India are 

 To help ensure the monetary, stability of the

country.
 To assist in regulating the financial system of the

country.
 To formulate, implement and monitor the monetary

policy.
 To maintain liquidity in the country.

 To ensure an adequate flow of credits.

 Prescribes parameters for banking in the country.

 Maintain public confidence in the system.

 To manage the foreign management Act.

 To facilitate external trade.

 Issue and exchange currency.

RBI/central banks and its functions

 Maintain the supply of currency.

 Own and operate the depository and exchange for
government bonds.
 Banker to the government.
 To stabilize the internal and external value of the
rupee.
 To centralize the cash reserves of commercial
banks.
 To establish monetary relations with other
countries of the world and international financial
institutions.

Meaning and definition

“Central Bank is an ‘apex’ body that controls, operates,

regulates, and direct the entire banking and monetary
structure of the country.”
It is known as the apex (supreme) body as it occupies
the topmost position in the monetary and banking
system of the country. All the financially developed
countries have their central bank. India’s RBI was
established on April 1, 1935, under the Reserve Bank of
RBI/central banks and its functions

India Act passes in 1934. Central Bank is known by

different names in different countries. In India, it is the
Reserve Bank of India (RBI), in the UK as Bank of
England and in the USA, it is known as Federal Reserve
System.

Functions of central bank

 Issue of currency
 Banker to the Government
 Bankers bank and supervisor
 Money supply and credit control
 Custodian of foreign reserve
As the Central Bank of the country, The Reserve Bank
of India performs the following functions:

 Currency issue
The central bank has the sole authority for the issue of
currency in the country. In India, RBI has the sole right
of issuing paper currency notes (except one rupee notes
and coins, which are issued by the Ministry of Finance).
All the currency issued by the Central Bank is its
monetary liability i.e. Central Bank is obliged to back
RBI/central banks and its functions

the currency with assets of equal value, to enhance the

public confidence in paper currency.
Assets usually consist of gold coins, gold bullions,
foreign securities, and domestic government's local
currency securities.
 Advantages of sole authority of note issue with
RBI
1. It leads to uniformity in note circulation.
2. It gives the Central Bank power to influence the
money supply because currency with the public is a
part of the money supply.
3. It enables the Government to have supervision and
control over the Central Bank concerning the issue
of notes.
4. It ensures public faith in the currency system.
5. It helps in the stabilization of the internal and
external value of the currency.
Central Government is also authorized to borrow
money from the Central Bank. Whom government
incurs a deficit in its budget, It borrows from Central
Bank by selling its treasury bills. When Central Bank
acquires these securities, it issues new currency. This is
known as ‘monetizing the Govt’s Debt’ or ‘Deficit
Financing’.

 Banker to the government

RBI/central banks and its functions

The Reserve Bank of India acts as a Banker, Agent, and

Financial Advisor to the Central Government and all
State Governments [except that of Jammu and
Kashmir].
As a banker, it carries out all banking business of the
Government.
1. It maintains a current account for keeping its cash
balances.
2. It accepts receipts and makes payments for the
government and carries out the exchange,
remittance, and other banking operations.
3. It also gives loans and advances to the government
for temporary periods. The government borrows
money by selling treasury bills to the Central Bank.
As an agent, the Central Bank also has the
responsibility of managing the public debt.
As a financial advisor, the Central Bank advises the
Government from time to time on economic, financial,
and monetary matters.

 Bankers bank and supervisor

As the banker to banks, the Central Bank functions in
three capacities:
1. Custodian of Cash Reserves: Commercial Banks
are required to keep a certain proportion of their
deposits (known as Cash Reserve Ratio or CRR)
with the Central Bank. In this way, Central Bank
RBI/central banks and its functions

acts as a custodian of cash reserves of commercial

banks.
2. Lender of Last Resort When Commercial Banks
fails to meet their financial requirements from other
sources, they approach the Central bank to give
loans and advances as lender of the last resort.
Central Bank assists these banks through
discounting of approves securities and bills of
exchange.
3. Clearing House All Commercial Banks have their
account with the Central Bank. Therefore, The
Central Bank can easily settle claims of various
economical banks against each other, by making
debit and credit entries in their accounts.
As a supervisor, Central Bank regulates and controls the
Commercial Banks. The regulation of Banks may be
related to their licensing, branch expansion, the
liquidity of assets, management, merging, winding up,
etc. The control is exercised by periodic inspection of
banks and the return filed by them.

 The controller of money supply and credit

Due to economic fluctuations, the Central Bank i.e. RBI
controls the money supply and credit in the best interest
of the economy as RBI has the sole monopoly in
currency issue, it can control credit and supply of
RBI/central banks and its functions

money. For this, RBI makes use of the following

methods of credit control:
1. Repo [Repurchase] Rate: ‘Repo rate is the rate at
which the Central Bank of a country lends money
to Commercial banks to meet their short-term
needs.’ The Central bank advances loans against
approved securities or eligible bills of exchange.
An increase in repo rate increases the cost of
borrowings from the Central Bank. It forces the
commercial banks to increase their lending rates,
which discourages borrowers from taking loans. It
reduces the ability of Commercial Banks to create
credit. A decrease in the repo rate will have the
opposite effect.
2. Bank Rate (or Discount Rate) ‘Bank rate is the rate
at which the Central Bank of a country lends
money to Commercial Banks to meet their long-
term needs.’ RBI has been actively using Bank rate
to control credit. Bank rate has the same effect as
that of Repo rate, i.e. an increase in Bank rate
increases the cost of borrowings from the Central
bank, which leads to an increase in lending rates by
Commercial banks. It discourages borrowers from
taking loans, which reduces the ability of
Commercial Banks to create credit. Reverse Repo
Rate is the exact opposite of the Repo Rate. It is the
rate at which RBI borrows from Commercial
RBI/central banks and its functions

Banks. RBI makes use of this tool when it feels

there is excess money supply in the banking
system. An increase in Reverse Repo Rates induces
the banks to transfer more funds to RBI due to
attractive interest rates.
3. Open Market Operations: “Open Market
Operations (OMO) refers to buying and selling of
Government securities by the Central Bank from/to
the public and Commercial Banks.” It does not
matter whether the securities are bought or sold to
the public or banks because ultimately the amounts
will be deposited in or transferred from some bank.
 Sale of Securities by Central Bank reduces the
reserves of Commercial banks. It adversely affects
the bank’s ability to create credit and therefore
decreases the money supply in the economy.
 Purchase of Securities by Central Bank increases
the reserves and raises the Bank’s ability to give
credit.
4. Legal Reserve Requirements (Variable Reserve
Ratio Method) : Commercial Banks are required to
maintain reserves on two accounts:
a. Cash Reserve Ratio (CRR): It refers to the
minimum percentage of net demand and time
liabilities, to be kept by Commercial Banks
with the Central bank.’ An increase in CRR
reduces the excess reserves of Commercial
Banks and limits credit creating power.
RBI/central banks and its functions

(ii) Statutory Liquidity Ratio (SLR) ‘It refers to the

minimum percentage of net demand and time
liabilities which Commercial Banks are required to
maintain themselves.’ SLR is maintained in the form
of designated liquid assets such as excess reserves,
and other securities or current account balances with
other banks. An increase in SLR reduces the ability of
banks to give credit and vice-versa.
5. Margin Requirements: ‘Margin is the difference
between the amount of loan and market value of
the security offered by the borrower against the
loan.’ An increase in margin reduces the borrowing
capacity and money supply. A fall in margin
encourages people to borrow more. RBI may
prescribe differed margins for different types of
borrowers against other instruments of credit
control are Moral Suasion and Selective Credit
Controls. RBI uses the above-mentioned methods
to control credit in the economy. The security of
the same commodity. The margin is necessary
because if a bank gives a loan equal to the full
value of the security, the bank will suffer a loss in
case fall in the price of the security.

Custodian of foreign exchange reserves

RBI/central banks and its functions

The Central Bank also acts as the custodian of the

country’s stock of gold and reserves of foreign
exchange. This function enables the Central bank to
exercise reasonable control over foreign exchange.
According to regulations of foreign exchange, all
foreign exchange transactions must be routed through
RBI. The centralization of foreign exchange
transactions with RBI serves two objectives:
1. It helps the bank in stabilizing the external value of
the currency.
2. It helps in pursuing a coordinated policy towards
the balance of payments situations of the country.

Promotional functions of RBI

Various promotional functions are performed by the

Reserve Bank of India are given below:
1. _Promotion of Banking Habit: _The RBI helps in
mobilizing the savings of the people for
investment. It expanded the banking system
throughout institutions like UTI, IDBI, IRCI,
NABARD, etc. Thereby it promoted banking habit
among the people.
RBI/central banks and its functions

2. _Providing Refinance for Exports: _The RBI is

providing refinance for export promotion. The
Export Credit and Guarantee Corporation [ECGC]
and Export-Import Bank were established initially
by RBI to finance the foreign trade of India.
3. _Providing Credit to Agriculture: _RBI makes
institutional arrangements for rural or agricultural
finance. For e.g.: the bank has set up special
agricultural credit cells. It has promoted regional
rural banks with the help of Commercial Banks. It
has also promoted NABARD.
4. _Providing Credit to Small Scale Industrial Unit:
_Commercial Banks lend loans to small-scale
industrial units as per the directives issued by the
RBI time to time. The RBI encourages Commercial
Banks to render guarantee services also to the
small-scale industrial sector. RBI directed
Commercial Banks to open specialized branches to
provide adequate financial and technical assistance
to small-scale industrial branches.
5. _Providing Indirect Finance to Cooperative Sector:
The RBI has directed NABARD to give loans to
state cooperative Banks, which in turn lend loans to
cooperative sector. Hence, the Reserve Bank of
India provides indirect finance to cooperative
sector in India.
6. _Exercising Control over Monetary and Banking
System of the Country: The RBI is vested with
RBI/central banks and its functions

enormous and extensive powers regarding

supervision and control over Commercial Banks,
Cooperative Banks and also Non-Banking
Institution Institutions receiving deposits. The
Banking Regulation Act prescribes extensive
requirements reserves, cash reserves, and liquid
assets. Every scheduled bank is required to furnish
to the Reserve Bank a weekly statement showing
the principal items of its liability and assets in
India.

Achievements of RBI [central bank]

1. Flexible Monetary Policy: The RBI has adopted a

flexible monetary policy. It has introduced changes
in monetary regulations of the Indian money
market. The pressure of seasonal demand has been
adequately met.
2. _Stable Structure of Interest Rates: _ the interest
rate policy of RBI has resulted in a relatively stable
structure of interest rates in the economy. The Bank
rate remained unchanged at a low level of 3 percent
up to 1951.
RBI/central banks and its functions

3. Modern Banking and Credit Structure: The Reserve

Bank has succeeded in building up a sound modern
banking and credit structure. The Bank enjoyed
vast supervisory powers which enabled it to guide
the development of banking on sound lines.
Training of Bank personnel has improved their
efficiency. The geographical and fundamental
coverage of banking has also increased
substantially.
4. Cheap Remittance Facilities: The Reserve bank has
introduced very cheap remittance facilities. These
have been widely used by Commercial Banks, the
Government, and Cooperative Banks.
5. _Successful Management of Public Debt: _ The
RBI has successfully managed public debt. It has
floated loans for the Govt. at low rates of interest.
It has helped in raising the funds for the expansion
of the public sector in the economy.
6. _Exchange Stability: _ The RBI has maintained the
exchange value of the rupee at a relatively higher
rate than would have prevailed in the market. It has
made judicious use of exchange control measures
to keep the demand for foreign exchange within the
limits of available supplies.
Failures of RBI

1. Lack of Adjustment in Money Market: RBI has

virtually failed in regulating or controlling the
activities of rural money lenders and other
RBI/central banks and its functions

indigenous bankers. These bankers just do not

come within the scope of the Reserve Bank.
2. Lack of Uniformity in the Rate of Interest: Because
of the lack of control on different sectors of the
money market, different rates of interest continue
to prevail outside the organized sector of the
money market, ROI is exorbitantly higher than the
Bank Rate.
3. Lack of Bill Market: RBI prepared a plan for the
development of Bill Market in 1952. But to date,
there is no Independent and Organised widespread
bill market in India.
4. Insufficient Availability of Agricultural Credit:
Despite the fact that a lot of steps have been
initiated by RBI to provide enough agricultural
credit, its requirement as it is still being dominated
by rural money lenders and other indigenous
bankers.
5. Insufficient Banking Facility: Most of the banking
activity is concentrated in urban areas. People in
small villages and sub-urban areas still deprived of
the banking facility.
6. Instability in the Internal Value of Rupee: It has
been the biggest failure of RBI because of ever-
increasing circulation of money, prices have been
rising almost non-stop.
RBI/central banks and its functions

Conclusion
Banking Systems have been with us for as long as
people have been using the money. Banks and Financial
Institutions provide security for individuals, businesses,
and governments. In general, what banks do is pretty
easy to figure out. For the average person, Banks accept
deposits, lend loans and provides a safe place for money
and valuables and act as a payment agent between
merchants and banks.
History has power banks to be vulnerable to many risks,
however, including credit, liquidity, market, operating
interest rate, and legal risk, many global crises have
been resulting of such vulnerabilities and this has led to
the strict regulations of state and national banks.
However, Central Bank is the backbone of all Banking
sector without which there would be absolutely no
banking sector involved. This, Central Bank is an
RBI/central banks and its functions

essential part of an economy and helps to grow

resources of an economy.

ACKNOWLEDGEMENT
I would like to express my special thanks of gratitude to
my teacher Mr. XYZ as well as our principal Mrs. XYZ
who gave me the golden opportunity to do this project
on the topic Central Bank – RESERVE BANK OF
INDIA. This also helped me in doing a lot of research
and I came to know about so many things. My project
has been successful only because of her guidance

Certificate
RBI/central banks and its functions

This is to certify that XYZ of Class XII – D of XYZ has

completed his/her project under my guidance and
supervision. She has taken proper care and shown
utmost sincerity in the completion of this project. I
certify that this project is up to my expectations and as
per guidelines issued by CBSE.
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