Chapter – 3 Reserve Bank of India – Structure and Functions



Every country has its own central bank which controls and handles the monetary affairs of the country. For instance central bank of USA is called the Federal Reserve Bank, the central bank of UK is Bank of England and the central bank in China is known as the People’s Bank of China and so on.

The Reserve Bank of India (RBI) is the central bank of the country. It was established on April 1, 1935 under the Reserve Bank of India Act, 1934.

The basis of the establishment of RBI was the recommendations given by a Committee called ‘Hilton Young Commission’ established by the then British Government in India.

It started as a private bank with private shareholding as was in vogue in most foreign central banks of the world operating at that point of time.

When RBI was established, its capital was fixed at Rupees 5 crore i.e. Rupees 50 million).

When the RBI was established, it took over the functions of currency issue from the Government of India and the power of credit control from the then Imperial Bank of India.

Initially RBI had its headquarter in Calcutta (now Kolkata) but soon shifted its headquarter to Bombay (now Mumbai) in 1937.

However from January 1, 1949, RBI was nationalized by the Government through an Act called Transfer of Public Ownership Act, 1948.

The RBI Act covers whole of India in terms of supervision, control and guidance/directions to financial institutions in India.


Reserve Bank of India is operating as a corporate body. It has its common seal and is an on-going concern with perpetual succession.

The organizational structure of RBI is through the Central Board of Directors (CBD). The Transfer of Public Ownership Act provides for the constitution of CBD and Local Board by the Central Government. The CBD has of 20 members (as on date). Besides these members, RBI has one Governor, four Deputy Governors appointed by the Central Government. Their tenure in office is 5 years for Governor and 4 years for Deputy Governors. Also in the organizational structure are Executive Directors.

Presently Mr. Raghuraj Ranjan is the 23rd Governor of Reserve Bank of India, who took over the charge from Dr. Y.V. Reddy. To start with the first person appointed as the Governor of RBI was Sir Osborne Smith.

The RBI Act provides that CBD conducts one meeting every quarter and at least 6 meetings in a year.

RBI at present has 22 Regional Offices located mostly in the State Capitals /UTs. The jurisdiction of RBI as per the RBI Act of 1934 extends to all the States and Union Territories.

The Local Boards have been formed in four major centers of the country, viz. Mumbai, Kolkata, New Delhi and Chennai.

The general control, superintendence and directions regarding the working of banks in India remain with the Central Board of Director through its Governor and Deputy Governors and other executives.

One Director each from Local Boards is nominated to the CBD by the Central Government. Nearly 10 Directors are nominated by GOI besides one Central Government official.

Reserve Bank of India besides being named as ‘bank’ does not fall in the category of commercial banks because it does not do the business of banking as defined in the Banking Regulation Act i.e. accepting deposits and lend money to people as done by commercial banks.

RBI controls the changes in the stock of market because firstly, such changes exert a powerful influence on prices, secondly, greatly influence output and distribution of income and wealth, which in turn influence employment and lastly it helps in balancing income and wealth distribution.


RBI normally declares the monetary policy twice a year. These policies are called busy season policy (declared in October every year) and slack season policy (declared in April every year).The objective behind such monetary policy is to:

• ensure price stability of commodities in the country

• ensure balanced credit expansion

• ensure growth of long term investments in the economy

• ensure proper balance of exports and imports.

• Encourage food procurement operations

• Ensure proper distribution of credit to all sectors of the economy.

In order to achieve these objectives RBI resorts to various methods / techniques, like:-

• Open Market Operations

• Interest Rates management on loans and advances by banks

• Bank Rate Mechanism

• Maintaining proper SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio)

• Credit Rationing through Selective Credit Control (now withdrawn)

• Moral Suasion

• Exchange Control Mechanism


• Reserve Bank of India as a central monetary authority of India, like in any other Central Bank of any country, is empowered to guide, monitor, regulate, control and promote the past, present and future of the financial system of the country

• RBI is performing such functions since 1935 after its inception as empowered by the Reserve Bank of India Act, 1934 and Banking Regulation Act, 1949.

• As a Central Bank of the country, the RBI performs a wide range of functions. Among various functions important are:

• Acts as the currency authority

• Controls money supply and credit

• Manages foreign exchange Serves as a banker to the government

• Builds up and strengthens the country’s financial infrastructure

• Acts as the banker of commercial banks

• Supervises banks.

Reserve Bank of India performs various functions to manage the monetary system of the country. These functions include:

1. Reserve Bank of India under the RBI Act, Section 22 is solely responsible for the issuance of currency notes excluding rupee one note which issued by Finance Secretary of the Government of India. RBI regulates the issuance of the notes in India mainly to bring confudence among people of genuineness, quality and credibility of money issued besidesbringing in uniformity in issuance of notes. Due to single authority there is effective control on ow of credit in and out of the market.

2. RBI acts as banker to commercial banks.

3. RBI conducts banking and financial operations of the Government of India and advises on various financial and economic issues.While handling the Government business, RBI maintains government accounts, advises on monetary matters including financial aspects, besides carrying out Government business as and when required.

4. It provides financial accommodation to cooperative banking sector for financing special sectors of the economy like agriculture etc.

5. Bank performs the function of controller of exchange value of rupee vs. US dollar.

6. As a guide and controller of banking and financial sector, RBI appoints CEOs of Banks and put its members of the Boards of the Bank to ensure proper Governance and sound banking practices.

7. As a developmental function, RBI promotes various specialized institutions. It has promoted IDBI (Industrial Development Bank of India), NABARD (National Bank for Agriculture & Rural Development), Small Industrial Development Bank of India (SIDBI), Deposit Insurance & Credit Guarantee Trust for Small and Medium Enterprises (DI & CGTSME) / Export Credit Guarantee Corporation of India (ECGC) etc.

8. RBI issues monetary policy twice a year to provide guidance to flow of credit and safety measures to the banking and financial sector. It issuesbusy season policy in October every year and slack season policy in May-June. This sets the tone for the money market as well as financial activities.

9. For good governance, RBI resorts to moral suasion on banking and financial sector.

10. It disseminates fiancial data on banking, economy and other aspects of monetary aspects.

11. RBI is sole authority to handle overall monetary and credit policy in the country.

12. To regulate the flow of credit in the economy RBI also resorts to selling and purchasing of short term or even long term securities.

13. RBI provides ‘ways and means’ credit facility to the Government of India and State Governments in order to overcome tight money position between payment and receipt of the client. The period of such ‘ways and means’credit is maximum 90 days (3 months) Such power to lend money to governments is given under section 17 (5) of Reserve Bank of India Act, 1934.

14. RBI also acts as a lender of the last resort, which means meeting the genuine financial requirements of commercial banks.

15. Management of raising of finance by the Government and issuance of new loans/advances on behalf of the Government of India / State Government is handled by the Public Debt Office of the Reserve Bank of India.

16. It regulates the credit flow in the market by using credit control instruments like bank rate, open market operations and power to vary reserve ratios like cash reserve ratio (CRR) and statutory liquidity ratio (SLR). These two ratios are most important tools for maintaining liquidity in the financial system, particularly banking system.

17. Bank Rate, CRR and SLR are some of the quantitative steps that RBI can take from time to time to control flow of money and to control inflation.

1. Statutory Liquidity Ratio (SLR)

• Reserve Bank of India exercises direct control over the liquidity of the banking system. RBI is the only authority to effect changes in the liquidity position of banks based on demand and time liabilities.

• As per Section 5 (f) of the Banking Regulation Act, 1949 ‘demand liabilities’ means those liabilities that are to be met on demand.

• Banks are also required to maintain a portion of their deposit liabilities in the form of liquid assets i.e. bonds etc. This is called Statutory Liquidity Ratio. As on 15.6.2014 the SLR fixed by RBI is 22.5 per cent reduced by 0.5 per cent from 23 per cent.

• Liquid assets to be maintained are in the form of cash, gold and unencumbered approved securities as per section 24 of the Banking Regulation Act, 1949.

• As and when RBI increases the SLR, reduces the funds supply in the market, thus reducing the lendable resources with commercial banks. Vice versa when SLR is reduced it will increase the funds with banks for onward lending.

2. Cash Reserve Ratio (CRR)

• Banks are required to deposit with reserve bank of India an amount equal to the percentage of deposits with respective bank in the ratio prescribed by RBI from time to time. This is called Cash Reserve Ratio (CRR).

• This is mainly done to provide stability to the economy. In simple words CRR is the proportion of funds banks have to deposit with the Reserve Bank of India. It change from time to time is part of economic policy to control inflation etc. Any change in CRR percentage means either increased availability of funds with the banks or reduced funds available in the market.

• Unchanged CRR means no additional funds available for banks to lend.

3. Bank Rate

It means the rate of interest at which RBI buys or rediscounts the bills of exchange including commercial papers etc. as permissible under RBI Act, 1934. As per the need of the hour, RBI raises the Bank Rate in order to squeeze the credit expansion whereas it reduces the Bank Rate when it needs to allow more flow of credit in the economy.

4. Repo Rate

Repo Rate is the rate at which banks borrow from the Reserve Bank of India (RBI). A lower repo rate means bank’s borrowing cost will go down which could prompt banks to cut lending rates.

5. Reverse Repo Rate

Reverse repo rate means the rate of interest at Which RBI borrows from the banks.

Objectives of Monetary Policy

(a) Ensures price stability

(b) Controls expansion of bank credit

(c) Promotion and development of fixed investments

(d) Controls inventory build up by some individuals

(e) Export promotion

(f) Ensures proper food procurement operations.

(g) Uniform credit distribution among various sectors of the economy and society.

Techniques Used by RBI to Manage and Control Monetary System

1. Open market Operations

2. Bank Rate Mechanism

3. Discretionary control of refinance and rediscounting

4. Interest Rate (Repo rate and reverse repo rate) control

5. CRR and SLR mechanism

6. Credit rationing

7. Credit reporting 8. Selective Credit Control when need arises

9. Credit reporting system to RBI

10. Inventory and credit norms

11. Moral suasion


• Any person, group of persons or company who/which wishes to start a banking company in India is required to take prior permission / licence from the Reserve Bank of India vide section 22 of the Banking Regulation Act, 1949.

• Before granting licence, RBI gets itself satisfied on various terms like:

Location of bank
Availability of sufficient capital. As of now minimum capital for opening a new bank is Rupees 500 crore. This may vary from time to time. Initially, minimum capital required for opening a new bank was only Rupees 5 lakhs. The minimum capital to be decided by RBI is as per the Banking Regulation Act, section11.
Ensure that bank will serve the cause of people (depositors).
Ensure that bank will not work detrimental to the interest of the country
Banks are required to transfer from their annual profits, minimum 20 per cent to the reserves.
A bank opened as public sector undertaking is not required to any permission or licence from RBI
Bank Holiday

A bank holiday in India is a public holiday which is declared specially for the Banks and other Financial Institutions. Not all public holidays are classified as Bank Holidays. Bank Holidays are declared by Central/State Governments/ Union Territory under the Negotiable Instruments (NI) Act, 1881.


• As a part of their function to control the business of banking in India and ensure the availability and access of banking facilities to all citizens of the country, RBI exercises the power to control opening/expansion of new branches in the country. Banking Regulation Act, section 23 makes it obligatory for the bank to take prior permission from RBI to open any new branch.

• RBI before granting the permission to open new branch in an area in India gets itself satisfied on some of the following important aspects:

availability of banking infrastructure already existing in the area.
ensures that bank has strong and sound financials (capital, profits etc.) to support opening of new office/branch.
ensure that business development is possible in the area.
does general good to the public (depositors and borrowers) at large.


• Capital Account Convertibility (CAC) is basically associated with change of ownership in foreign/domestic financial assets and liabilities at market determined rate of exchange.

Interest on Savings Accounts

A committee formed to review the government’s savings scheme under the leadership of Shyamala Gopinath, former deputy governor of the Reserve Bank of India who retired on 20 June 2011, has recommended that the interest paid on savings instruments under the scheme, except post office savings accounts, be reviewed annually and benchmarked to government securities of similar maturity periods.

To protect investors from large volatility, the rates will not be changed by more than 1 percentage point.

Rate for senior citizens’ savings scheme will be 1 percentage point higher than comparable government securities. National Savings Certificates (NSCs) will give 0.5 percentage pointhigher than benchmark securities and other schemes, including PPF, will offer 0.25 percentage point above the benchmark.

Benefits of CAC to Indian Economy

• There is availability of larger capital stock to supplement domestic resources that will help growth.

• Reduction in cost of capital and improved access to international financial markets

•CAC enhances the effectiveness of fiscal policy by reducing real interest rates applicable to public sector borrowings.

• Can bring about an optimal combination of taxes through reduction of the inflation and in the rates of other taxes to international levels that has beneficial effect on tax revenues.


• Securities and Exchange Board of India is a regulatory body controlling investments in the market.

• Many countries of the world have similar type of controllers for making the investment market more efficient, stable, transparent and of high quality.

• SEBI was established under the Securities Exchange Board of India Act of 1992 and came into operation on April, 12.1992.

• Main function of the SEBI as provided in the preamble of the Act is “to protect the interest of the investors in securities and promote the development of, and regulate the securities market and for matters connected therewith or incidental thereto”.

• SEBI is headed by a Chairman in Mr. U.K. Sinha and assisted by three Whole Time Members (WTM). They are Mr. Prashant Saran, Mr. Rajeev Kumar Agarwal and Mr. S. Raman. These members in turn are assisted by Executive Directors who control different departments and various functions.

• First member looks after the corporate finance, special enforcement cell, investigation department, economic & analysis, HRD while Mr. Rajeev Kumar looks market regulations, integrated surveillance, legal affairs, general services, affairs of the SEBI’s Regional Offices. Mr S Raman on the other hand looks after the investment management, enforcement, adjudication, RTI and Appellate Authority, IT department, etc.

• SEBI hears the complaints of investors and has constituted a Appellate Tribunal to hear the complaints against the decisions of the first level authorities. The Securities Appellate Tribunal (SAT) has a Presiding Officer in Hon’bl Justice J.P. Devadhar(as of now) with two members in Mr. Jog Singh and Mr. A.S. Lamba.

Participatory notes

Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. In many ways, this is similar to an informal ADR process, where brokerages hold on to stocks for foreign investors.


• Government of India appointed a Committee called by the name Malhotra Committee to look into various aspects of the life and non-life insurance in India.

• Malhotra Committee Report was submitted in 1994, January 7. Based on the recommendations of Malhotra Committee, IRDA was established and incorporated as a statutory body by an act of Parliament of India.

• IRDA was incorporated under the Insurance Regulatory and Development Authority Act, 1999. This Act was cleared by the Central Government.

• IRDA has its headquarter at Hyderabad (Andhra Pradesh). Till 2001 it operated from Delhi.

• As far as organizational structure of the IRDA is concerned, it has 10 members appointed by the Central Government. The 10 member team is headed by the Chairman. At present its Chairman is T.S. Vijayan. Of the other members, four members (at present R.K.Nair, M. Ram Prasad, S. Roy Chowdhary and DD Singh) are whole time members whereas Mr. Anup Wadhawan, S.B. Mathur, Prof. V.K. Gupta as CA and Subodh Krumar Agarwal are four part time members.

• Main purpose and function of IRDA is to protect the insurance policy holders’ interest. It also regulates the opening of new insurance companies in the country for which it provides registration certification to the interested insurance companies which wantto start insurance business in India. It also has a role in allowing balanced and orderly growth of insurance industry.

• In cases where it finds irregularities in the functioning of the insurance business where policy holders’ interest is at stake, it may not renew or modify the registration certificate or even cancel or suspend the operations.

• Insurance Repository Facility : Central Government recently announced a setting up of a system called Insurance Repository. It is a type of facility whereby the policy holder (s) can buy and keep policy of insurance in electronic format. In this way paper document could be avoided and so the cost. Such policies kept in electronic format are called “electronic policies” or “e Policies

• Various Functions of IRDA: Among the many functions that IRDA performs, some important ones are:

In order to watch the interest of policy holders’,

IRDA makes out rules and regulations. IRDA sets standard of code of conduct for surveyors and assessors of losses.

Takes up inspections, audit and conduct of insurers, insurance intermediaries and others having any connection with insurance business. Helps regulate the investment of insurance company funds. Recommends margin for maintaining of solvency / liquidity of insurance company.

Adjudicates disputes among various parties to insurance business like insurers, non-insurance intermediaries and insurance intermediaries.

IRDA sets business targets in terms of percentage of total insurance business for rural, other social sectors etc.

Sets premium income of the insurer.

Unit Linked Insurance Plan (ULIP):

A Unit Linked Insurance Plan (ULIP) is a product offered by insurance companies that unlike a pure insurance policy gives investors the benefits of both insurance and investment under a single integrated plan.The first ULIP was launched in India in 1971 by Unit Trust of India (UTI). With the Government of India opening up the insurance sector to foreign investors in 2001 and the subsequent issue of major guidelines for ULIPs by the Insurance Regulatory and Development Authority (IRDA) in 2005, several insurance companies forayed into the ULIP business leading to an over abundance of ULIP schemes being launched to serve the investment needs of those looking to invest in an investment cum insurance product.


• Among the many tools that RBI uses to control the flow of credit / money in the economy,“open money market operations” is one of them

• As the name indicates open market operation, it means sale and purchase of financial instruments is done by the RBI in the open market.

• RBI in order to expand or contract the money in the economy, sells or purchases the eligible short term or long term government securities or bills of exchange or foreign exchange etc.

• In the Open Market Operations, RBI while selling the securities tries to withdraw the money from the economy (market) whereas when it purchases the securities in the open market it expands the money in the economy or market.

• Open Market Operations are used to control and reduce market money fluctuations.

• The concept behind open market operation is that any sale or purchase of approved securities by the Reserve Bank of India as the Central Bank of the country tends to either squeeze the money in the market or increases the supply of money.

• This method is effective in controlling money supply. Increase in money supply by purchasing the securities will help banks to lend more money in various sectors of the economy.

Hot Money:

Money that flows regularly between financial markets as investors attempt to ensure they get the highest short-term interest rates possible. Hot money will flow from low interest rate yielding countries into higher interest rates countries by investors looking to make the highest return. These financial transfers could affect the exchange rate if the sum is high enough and can therefore impact the balance of payments.

Banks usually attract “hot money” by offering relatively short-term certificates of deposit that have above-average interest rates. As soon as the institution reduces interest rates or another institution offers higher rates, investors with “hot money” withdraw their funds and move them to another institution with higher rates.


• Mutual Fund is a fund created by pooling customers’ funds held for trading for higher income with low risk. In other words Mutual Fund is a link between investors who save money and capital market. As an investor, he brings liquidity into the financial system besides promoting good corporate governance with investor protection.

• Mutual Fund is constituted as a ‘Trust’. Its functions include mobilizing public funds, identifying capital markets for investment such funds on behalf of investor.

• For holding and managing the public funds, Mutual Fund is required to act efficiently and professionally for the benefit of the investor, besides, holding the portfolio as Trustee of investor.

• Based on the period of the units and the amount raised, Fund can be classified as ‘open ended fund’, ‘close ended fund’ , income oriented fund’, and Trust oriented fund’.

• In the open ended fund there is no ceiling on the amount to be raised. Here unit holders are assured of certain return in the form of dividends, appreciation in capital and safety of funds.

• Close ended Fund is characterized by maximum amount to be raised or pooled, fixed period and stocks are listed in stock markets in order to have quick liquidity. Here the unit price is normally less than the Net Asset Value (NAV).

• Net Asset Value (NAV) is the value of each unit or share. In other words it is the total value of asset (Fund) divided by the total number of units/share outstanding. It also means value of asset (Fund) minus liabilities.

• Suppose a Mutual Fund Scheme has investment at Market Value to the tune of Rupees 700 crore. The liabilities are Rupees 50 lakh whereas outstanding units are 28 crore. The Net Asset Value (NAV) will be 24.98.

• India’s first Mutual Fund came up as Unit Trust of India on February,1. 1964. It is first statutory Mutual Fund organization in India. The first commercial bank to start the business of Mutual Fund in India was State Bank of India.

• With the amendments in the Banking Regulation Act, 1949, banks can do the business of Mutual Fund.

• Where the investor wants regular income from his /her investment, the Fund invests money so pooled in fixed income bearing securities. Such Funds are called “IncomeOriented Fund”.

• SEBI controls, supervises and guides the functioning of the Mutual Funds for better governance.

• Normally the lock-in-period of repurchase of the units by Mutual Fund is 3 years.

• Mutual Funds sometimes charge a fee from unit holder only at the time of redemption of the units. Such transactions and mode of collection of fee is called Back-ended-load Redemption Scheme.

• Mutual Funds are required to be operated by a separate organization called Asset Management Company (AMC) formed under the Indian Companies Act of 1956 which requires the approval of SEBI.

• Mutual Fund is useful to investors in various ways. For instance, small investors can be party to Fund, there is diversification of risk and are largely safe since it is managed by experienced professionals. Professionally managed Mutual Fund investment means having investment management skills and doing continuous research in available investment options.

• The first diversified equity investment scheme in India was ‘Master Shares’.

• While investing money in Mutual Fund, as an investor he/she has the right: to inspect his documents of investment, to have access to information, and in the beneficial ownership of the asset of the scheme.

• A high portfolio turnover means that the fund is active in the market, transaction cost is high and there might be some risk involved.

• In Mutual Fund, “Load” means expenses charged to the fund.

Sovereign Wealth Funds: A sovereign wealth fund (SWF) is a state-owned investment fund investing in real and financial assets such as stocks, bonds, real estate, precious metals, or in alternative investments such as private equity fund or hedge funds. Sovereign wealth funds invest globally. Most SWFs are funded by revenues from commodity exports or from foreign-exchange reserves held by the central bank. Some sovereign wealth funds may be held by a central bank, which accumulates the funds in the course of its management of a nation’s banking system; this type of fund is usually of major economic and fiscal importance. Other sovereign wealth funds are simply the state savings that are invested by various entities for the purposes of investment return, and that may not have a significant role in fiscal management.