How RBI Controls Other Banks

India’s central bank is the Reserve Bank of India (RBI). Reserve Bank of India monitors, formulates and implements India’s monetary policy. Established in the year 1935, Reserve bank of India was nationalized in the year 1949. Owned fully by the Government of India, Reserve Bank has are 22 regional offices in various state capitals of India with its headquarters located in Mumbai. It has a majority stake in the State Bank of India.

Functions of the Reserve Bank of India

1. The financial system is regulated and supervised by the Reserve Bank of India.

2. The guidelines according to which the banking operations within which the country’s banking and financial system functions are defined by the RBI. By monitoring the functioning of other banks, it tries to protect depositors’ interests and provides cost-effective banking services to the public. If a customer has a problem and the bank does not solve the customer’s problem, Reserve bank of India can approach them through the Banking Ombudsman Scheme.

3. RBI regulates the foreign exchange inflow and outflow, by the Foreign Exchange Management Act, 1999 of RBI. All money transfer out of India, is subject to limits defined by the RBI. The money transfer could be either for personal or for trade purposes.

4. Currency notes and coins of various denominations are issued by The Reserve Bank of India. It destroys damaged currency notes not fit for circulation and also issues and exchanges coins. To prevent circulation of fake currency, the design of the currency is periodically modified.

5. The banker to the Government of India is the RBI. Merchant banking function for the central and the state governments are performed by the RBI. Reserve bank of India is the banker to all Government departments of India. For example, in Mumbai, the tax refunds drawn on the Reserve bank of India are issued by the Income tax department.

6. All major banks bank with the RBI. Banking accounts of all scheduled banks in India is maintained by the RBI. RBI provides insurance on deposits for up to Rs 1 lakh in scheduled banks. If cash withdrawn from scheduled banks, cash withdrawal tax is applicable. Smaller co-operative banks do not usually fall under the category of scheduled banks. According to the RBI lending rates, the bank interest rates increase or decrease.

7. The gold trade is also regulated by the Reserve Bank of India. In India. Currently 17 Indian banks are involved in the trade of gold. In order to curb illegal trade in gold and increase competition in the market, applications have been invited by the RBI from more banks for direct import of gold.

8. Know your customer guidelines has been issued by the RBI for non-banking finance companies (NBFC ) in March 2006. Customer whose outstanding credit is more than Rs 1 lakh or deposit balance with the NBFC is less than Rs 50,000 need not provide all the documents to the bank. The customers will be categorized as low risk, medium risk and high risk. One of the largest NBFC in India is Sahara India.

9. To maintain the exchange rate of Indian Rupee versus foreign currencies like the US Dollar, Euro, Pound sterling, and Japanese yen, RBI buys and sells foreign currencies. Their website provides the trends in exchange rate values for these currencies.

10. RBI sets the maximum interest rate Indian banks can offer on NRI dollar deposits depending on the liquidity in the money markets. Banks can offer an interest rate equal to the London Interbank Offered Rate (LIBOR) from March 2006 onwards. LIBOR is an international benchmark rate on dollar deposits.

11. Percentage of deposits that banks in India should keep with RBI is known as the Cash Reserve Ratio (CRR). The CRR which is currently 5%, also depends on the liquidity in the money markets. The rate at which RBI absorbs funds from banks is the reverse repo rate.

12. The opening /installation of ATM (Automatic Teller Machines) is also regulated by the RBI. It is trying to increase the density of the ATMs in rural areas. The RBI supplies fresh currency notes for ATMs.

13. Transactions related to cheques, drafts and pay orders are settled in clearing houses. There are about 1050 clearing house out of which 567 clearing houses are managed by the The State Bank of India, mainly in the smaller cities and towns.

14. In April of every year the annual monetary policy is announced.

15. Banks like ICICI bank charge Rs 100 for clearing an outstation cheque from metro cities (Mumbai, Delhi, Chennai, Kolkatta), but it costs banks only 50 paisa for clearing through the RBI clearing system. Even though RBI has asked banks to display the service charges on their website, only 5 banks have complied so far.

16. The opening of branches by banks are regulated by RBI and ensures that they follow the Know Your Customer guidelines.

RBI is Bankers’ Bank

The Reserve Bank of India acts as the bankers’ bank. Every scheduled bank was required to maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilities and 2% of its time liabilities in India, according to the provisions of the Banking Companies Act of 1949. The distinction between demand and time liabilities was abolished by an amendment of 1962, and cash reserves equal to 3% of their aggregate deposit liabilities have to be kept by the banks as has been asked for by the RBI. The Reserve Bank of India can change the minimum cash requirements of other banks.

On the basis of eligible securities the scheduled banks can borrow money from the Reserve Bank of India. At times of need or stringency by rediscounting bills of exchange, the banks can get financial accommodation from the RBI. Reserve Bank becomes not only the banker’s bank but also the lender of the last resort since in times of banking crisis the Reserve Bank of India is expected to come to the help of commercial banks.

RBI is Controller of Credit

The Reserve Bank of India has the power to influence the volume of credit created by banks in India which means that it is the controller of credit. This is being done through open market operation or by changing the Bank rate. Reserve Bank of India can ask any particular bank or the whole banking system not to lend financial support to a  particular groups or persons on the basis of certain types of securities according to the Banking Regulation Act of 1949. Selective controls of credit are increasingly being used by the Reserve Bank since 1956.

Indian money market is controlled by the many more powers of the Reserve Bank of India. A license from the Reserve Bank of India to do banking business within India has to be obtained by every bank. On stipulated conditions not being fulfilled, the RBI has powers to cancel the licenses also. Before a new branch of any bank be opened. it has to get the permission of the Reserve Bank. A weekly return showing in detail its assets and liabilities must be sent to the Reserve Bank by every scheduled bank. This power of the RBI to call for information is also intended to give it effective control of the credit system. Another power of the Reserve Bank is the power to inspect the accounts of any commercial bank.

Reserve Bank of India, as the supreme banking authority in the country, therefore, has the following powers:
a) The cash reserves of all the scheduled banks are in the hands of the RBI.
b) Through quantitative and qualitative operations, it controls the credit operations of other banks.
c) Through the system of licensing, inspection and calling for information, the RBI controls the banking system in the country.
d) By providing rediscount facilities to scheduled banks, it acts as the lender of the last resort to other banks.

By all these methods RBI controls the whole financial system of India.