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Origin and Scope of RBI in Indian Banking System

RBI plays a very important role yet is very less talked about because of its closed-off nature functioning. In this article, the author has discussed the role, functions and contributions of RBI in detail.

By: Muskan Nagdawne, Third Year Law Student at Symbiosis Law School, Pune.

Introduction

The RBI has always been a very important functional body to India and most valuable in the financial sector. Especially with the massive economic decline due to the global pandemic, RBI has been put into so much pressure to prevent the country from going into bankruptcy. RBI plays a very important role yet is very less talked about because of its closed-off nature functioning. Therefore, the author believes it was important to study and understand its functions and contributions to our country. 

Origin of RBI

RBI has evolved as an important institution over a rich history of over 100 years. The formation of the RBI system has its roots in the “HILTON YOUNG COMMISSION” which was a commission designed for the purpose of enquiry in 1926 by British Colonizers mainly situated in the Eastern and Central provinces of Africa controlled by the British rule.

Post-independence, India had faced with immediate challenges of population and unification, therefore affection the socio-economic conditions of India and to unify and stabilize this, the government had created various “FIVE YEAR PLANS” which were economic plans highlighting the national agendas of India. There promised ideas of development which the RBI was audited to support with loans. RBI acquired a controlling interest in the Imperial Bank of India in 1955 which was the oldest and largest commercial bank of India. 

Roles of RBI

RBI played a special role in the agricultural development by way of restructuring small and big banks for the purpose of accumulating finances and for this, RBI was the body in charge for controlling these said banks into structuring. 

The Preamble to the RBI Act describes the basic objective as 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 system of the country to its advantage.  

Functions

Duties and responsibilities of RBI flow from The Reserve Bank of India Act, 1934 (RBI Act). However, the range of functions, which the RBI is undertaking is not only covered under the RBI Act but is also covered under various other statutes such as the Banking Regulation Act 1949 and the Companies Act 2013, Foreign Exchange Management Act, 1999, Government Securities Act, 2006, Payment and Settlement Systems Act, 2007 etc. Thus, the legal backing for the functions of RBI is spread over a number of statutes.

The basic three operations of RBI:

  1. Issuance of currencySection 22 of RBI Act 1934, RBI has the authority to issue bank notes or currency notes. Section 23 states that the bank notes will be issued by “Department” of RBI.
  2. Banker to Government-Under Section 20 RBI has the authority to transact business for the Central Government and under Section 21 for the State Government.
  3. Banker’s Bank- RBI works like the central bank where the commercial banks are account holders. It is the duty of RBI to control the credit through the CRR Bank rate and open market operations.

RBI is also the:

  1. Controller of Banks- It issues license to entities intending to do banking business and controls over its business and managements.
  2. Controller of Credit- Under section 21 and 35A of the RBI Act, RBI can fix bank rates and exercise selective control change CRR and direct credit guidelines.
  3. Statutory Reserves- Statutory Liquidity Ratio (SLR) and CRR are determined by RBI maintained by banks in order to control the expansion of bank credit.
  4. Collector of Information- about the borrowers enjoying credit facility of Rupees 10 lacs and above and Rupees 5 lacs and below under section 45A to F.
  5. Maintenance of External Values- Maintain internal and external value of Rupee. Maintain foreign reserves and regulates FEMA.

 Provisions under Reserve Bank of India Act, 1934

Section 17 of the Act defines the manner in which the RBI (the central bank of India) can conduct business.

Section 18 deals with emergency loans to banks.

Section 19 describes the kinds of business the RBI cannot do such as trade, buying shares, make loans or advances, allow interest on deposits and currency accounts.

Section 26 of Act describes the legal tender character of Indian bank notes.

Section 28 allows the RBI to form rules regarding the exchange of damaged and imperfect notes.

Section 31 states that in India, only the RBI or the central government can issue and accept promissory notes that are payable on demand. However, cheques, that are payable on demand, can be issued by anyone.

Section 42(1) says that every scheduled bank must have an average daily balance with the RBI. The amount of the deposit shall be more that a certain percentage of its net time and demand liabilities in India.

Section 42C says that RBI has the power to add or delete the name of any bank from 2nd schedule of RBI Act 1934.

Conclusion

The RBI is successful in promoting development and stability throughout its challenging times. However, the author would like to point out some personal suggestions which the RBI or the Banking Institutions can be more mindful about, especially with the constant changing times.

  • Given that RBI does not only finance the Financial Institutions but also the Non-Financial institutions like building infrastructure for educational, marketing and research institutes that can provide massive employment and will help the country generate more income.

The RBI may invest more on institutions which aims at promoting employment, development and harmony amongst the public and not necessarily on infrastructures that creates biasness and division between different communities.

  • With the onset of the Global Pandemic, people have quickly shifted to e-banking, but having realized that the banking regulations are immature and vulnerable, e-banking is very easily prone to scams. There can be more uniformed and sophisticated banking apps that are solely approved by the RBI only. 
  • Small or rural based banks are more vulnerable to huge scams, proved by the history too, like the PNB scam. These banks need more strict rules and regulations in order to prevent such mishaps. It is such scams that makes the country poorer and widens the economic gap between the rich and the poor.  
  • Lastly, with privatization of “bad banks” I personally feel that RBI should have a more microscopic vigilance over the policies that are implemented by the Government, often times in order for the government to generate revenue the Government sells the public assets and in order to do that indirectly, the Government will implement policies that will gradually degrade the efficiency and productivity of those banks, Hence, turning them to “bad banks”. I personally feel that, for a developing country like India the Government should not privatize public assets as it takes away employment from people and the possibility that it will generate more income instead than to that of the total revenue the Government will generate by selling those assets.

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