Unit – 2: Reserve Bank of India
Short Questions and Answers (1/2 Marks each)
1. In which year the RBI act was passed?
Ans: The RBI act was passed in 1934.
2. In which year RBI came into existence or established?
Ans: The RBI came into existence on April 1935.
3. In which year the RBI nationalized or becomes a state owned institution?
Ans: The RBI was nationalized under the Reserve Bank (Transfer to public ownership) Act 1948, on January 1, 1949.
4. How many members are there in the Central Board of the director of the RBI?
Ans: There are 20 members in the Central Board of Directors.
5. How many local Boards are there in the organizations structures of RBI?
Ans: Four local boards located at Kolkata, Mumbai, New Delhi and Chennai.
6. Who appointed the Governor and the deputy governor of RBI?
Ans: The Central Government.
7. Who is the chairman of the Central Board?
Ans: The Government is the chairman of the Central Board.
8. Expand SLR and CRR.
Ans: SLR: Statutory Liquidity Ratio and CRR: Cash Reserve Ratio.
9. Which department of the RBI is responsible for issuing currency notes?
10. What is the minimum reserve kept by the RBI to issue currency notes?
Ans: Minimum reserves of Rs. 200 crore to issue note out of 200 crore Rs. 115 crore is kept in gold coins and bullion.
11. In which year the RBI adopted the minimum reserves system of note issue?
Ans: In 1956.
12. What types of currency notes issued by the RBI?
Ans: The RBI issue currency notes of Rs. 2, Rs. 5, Rs. 10, Rs. 20, Rs. 50, Rs. 100, Rs. 500 Rs. 1000 denominations. The One Rupee notes are issued by the Minister of Finance, Government of India.
13. What are the principles of issuing notes?
Ans: The three principles of issuing notes are Uniformity, Elasticity and Security.
14. The RBI was originally set up a private bank/Public Sector Bank.
Ans: Private Bank
15. Which principle is followed to constitute various departments in RBI?
Ans: ‘Functional specialisation’
16. Mention the Development and Promotional functions of the Central Banks.
Ans: The Development and Promotional functions of the Central Banks are:
a) To make provision for adequate credit facilities to industry, agriculture and other sectors.
b) To make banking services development oriented.
c) To maintain internal price and exchange rate stability.
d) To protect the market for Govt. securities.
17. What are prohibitive functions of RBI?
Ans: The prohibitive functions of RBI are:-
1) It can neither participate non-provide any direct financial assistance to any industry, trade or business.
2) It cannot purchase its own shares.
3) It cannot purchase shares of any banking company or of any corporation.
4) It cannot give loans on the security of its owners and immovable property.
5) It cannot give interest on deposits held by it.
6) It cannot accept draw bills not payable on demand.
18. Explain the clearing house functions of RBI?
Ans: The clearing house functions of RBI are:-
a) For settlement of banking transactions.
b) To helps in economizing the uses of cash by banks.
c) Look-over the liquidity position of the bank.
Long Answer Type Questions (Marks: 3/5/8)
Q.1. What do you mean by a Central Bank? Explain the nature of central bank.
Ans: Central Bank: The central bank is the supreme monetary institution of any country. It is established, owned, controlled and financed by the govt. of the country. The design and control of the country’s monetary policy is its main responsibility. India’s central bank is called the Reserve Bank of India.
In the words of R.S. Sayers, “It is a bank which controls the commercial banks in such a way as to promote the general monetary policy of the country.”
The nature of Central Bank is as follows:
a) It is the head of all the banks of India. It is the supreme monetary institution of the country.
b) They always work for national welfare of a country. They do not aim at earning profits.
c) It is established, owned, controlled and financed by the govt. of the country.
d) It does not compete with other financial institutions in the market.
e) The RBI acts as the banker, agent and advisor to the Government of India and State governments.
Q.2. Why is the establishment of Central Bank necessary in a country? Or What are the objectives of RBI?
Ans: The Central Bank plays a vital role in economic development of a country. It controls the whole monetary and banking system of a country. It acts as a lender of the money market and supervises controls and regulates the activities of all commercial banks and other financial institutions. A Central Bank is necessary in a country because of the following reasons:
a) To maintain monetary stability in the country.
b) To regulate the overall volume of credit money in the economy so as to maintain price stability.
c) To maintain financial stability and ensure sound financial institutions.
d) To issue currency notes in a country.
e) To meet the financial requirements of the sectors of the economy.
f) To successfully implement the monetary policies of the govt. of the country.
g) To promotion of the foreign trade of the country through various policies.
h) To promote the development of financial market and systems.
Q.3. List out various departments of RBI.
Ans: DEPARTMENTS OF THE RBI: To ensure smooth and efficient functioning of the Bank the RBI has been divided and sub-divided into various department which are as follows:
1. Issue department: The issue department is concerned with the proper and efficient management of the note issue.
2. Banking department: The banking department is responsible for providing the banking services to the Government and to the banks.
3. Exchange control department: The exchange control department is concerned with the purchase and sale of foreign exchange and maintaining stability in foreign exchange rates.
4. Department of banking operations and development: This department is entrusted with the responsibility of the supervision, control and development of the banking system in the country.
5. Agricultural credit department: This department looks into the problems of agricultural sector. It provides facilities of rural credit to state governments and state cooperative societies.
6. Department of non-banking companies: This department administers and controls as well as regulates working of non banking financial companies.
7. Legal department: It renders legal advice on various matters referred to it by the bank.
8. Inspection department: It carries out internal inspection of the offices and department of the banks.
9. Premises department: It is mainly concerned with the construction and maintenance of buildings for the Bank’s office, training institutions and staff quarters.
10. Reserve Bank and India service board: It is concerned with conducting of examination/interviews for the selections and promotion of staff in the RBI.
11. Department of accounts and expenditure: It maintains various records relating to the receipts and expenditure of RBI.
12. External investment and operations: It undertakes investment into the securities of corporate sector or Government.
Q.4. Explain central banking functions of RBI or traditional functions?
Ans: The functions of RBI are:
1. Note Issue: The reserves bank of India is the sole authority for the issue of currency in India other than one rupee coins/notes and subsidiary coins. The RBI has adopted the minimum reserves system of note issue to issue currency notes in the country. Under this system the RBI maintains a minimum reserve of Rs. 200 crore of which Rs. 115 crore is in gold and the rest in securities. The issue department of RBI has the responsibility to issue paper money; the issue of currency into circulation and its withdrawal from circulation take place through the banking department of the Bank.
2. Bankers to Government :- The RBI acts as banker to the Central and State Government as a bankers as a adviser as a agent into there capacities :-
a) As a bankers.
b) As an agent.
c) As an advisor.
As a Government banker the RBI performs the following functions:-
a) It maintains and operates deposit account of the central and state governments.
b) It receives and collects payment on behalf of the Central and state governments.
c) It makes payments on behalf of the central and state governments.
d) It provides short term advances to government for which are called ways and means advances etc.
As a Government agent the RBI perform the followings functions:-
1) Collect tax and other payments on behalf of the government.
2) Raise loan from the public and thus manages public debts.
3) Transfer funds and provide remittances facilities to the government etc.
As an adviser the RBI acts as an advising the Government on all financial matters such as loan separations investment, agricultural and industrial finance, banking planning etc. It also advices to promote the attainment of the national economic goals.
3. Bankers Bank: The Central Bank is a banker to all the other banks. It is the supreme bank of all the banks. As the supreme bank it performs various functions. Some of the functions are:
a) Custodian of cash reserve of the bank: The Central Bank acts as the custodian of cash reserve of the banks. Every Commercial bank has to keep a certain portion of their deposits and time and demand liabilities to the Central Bank in the form of cash reserves. The Central Bank maintains this cash reserve as the custodian and grants money to the commercial bank in times of emergency.
b) Lender of the last resort: The Central Bank is the Lender of the last resort of the commercial banks. When the other banks shortage of funds, then they can approach to the Central Bank for financial assistance. The Central Bank lends money to them by discounting their bills. This enables the Central Bank to establish control over the banking system of the country. The RBI is ultimate source of money and credit provide fund to money market participate thus the RBI act as lender of last resort for the commercial banks.
c) Clearing agent: In India the central clearing functions is managed by the RBI or the SBI is authorized to manage clearing house functions every day. Each commercial bank receives a number of cheques for collection from other banks on account of their customers. One bank may have to pay certain amount to another bank again the RBI will transfer fund from debtor to creditors account. Since all banks have their accounts with the RBI, the RBI can easily settle the claims of various banks each other with least use of cash.
4. Control of credit :- As a central bank, the RBI take the responsibility to control of credit in order to economic development and price stability in the country under credit control policy different method are used to control the volume of credit in the economy. Important of them are General Credit Control and Selective Credit Control.
5. Custodian of gold and foreign exchange reserves: - The RBI act as a custodian of gold and foreign exchange reserves for both on its own and on behalf of the Government.
Q.5. Explain the function of Bank as the issuer of Currency Notes. (3 marks for each method)
Ans: The first function or the primary function of money is to issue paper currency. The Central Bank has the sole power to issue paper currency. The notes are legal tender money. In India, the RBI issue currency notes of all types except One Rupee note which are issued by the Ministry of Finance, Govt. of India. But the notes are issued following some methods. The Central Banks follows different methods or system according to the currency or banking regulations to issue notes. These systems are:
a) Simple Deposit system.
b) Fixed fiduciary system.
c) Proportional reserve system.
d) Minimum reserve system.
e) Maximum reserve system.
The simple deposit system is also knows as full reserve system. Under this system, the Central Bank is required to keep 100% of metal, either gold or silver or both as reserve for every note issued. The notes so issue becomes representative paper money. The advantage of this system is that it enjoys a public confidence and there is no danger of over issue of currency notes. But it is very costly and money supply cannot be increase as and when required.
The system of fixed fiduciary was first introduced in England in 1844. Under this system, the Central Bank issue currency notes up to a certain limit against reserves of Govt. securities. The notes issued beyond the limit set by the law have to be fully banked by metallic reserves. Though the system inspires public confidence and ensures convertibility of currency notes without any danger of over issue, yet the system is uneconomical and un-elastic as it requires sufficient gold reserves and the supply of money cannot be increased easily at time of emergency.
The proportional system of issuing currency is very simple and elastic. According to this system, the notes issued by Central Bank are banked by both metallic reserves and securities. A certain percentage (25 to 40%) of the total notes issued has to be backed by gold or silver reserves and the remaining by Govt. securities. The system guarantees the convertibility of paper money and is economical to use.
The minimum reserve system is a system in which the Central Bank is authorized to issue notes up to any limit by keeping a certain minimum reserve of gold and foreign securities. In India, the RBI is required to keep the minimum reserve of Rs. 200/- crore out of which Rs. 115/- crore should be kept in gold. The system is very elastic and economical for developing countries as it requires only a small and fixed amount of gold reserve. However, it lacks in public confidence due to non-convertibility of notes.
The system in which the Central Bank is authorized to issue notes up to a certain limit without any gold reserves is known as Maximum Reserve System. Under this system, the Central Bank is given power to determine the maximum limit and also the power to reserve the limit from time to time according to the needs of the economy. This system is elastic and economical to use. But it involves the danger of over issue of notes and lacks public confidence.
Q.6. Briefly discuss the supervisory power of RBI?
Ans: The supervisory powers of RBI are:
a) Licensing of Banks: The RBI grants license to banks or establishing their place of business in India. The RBI is empowered to council the license of a banks if it violets any provision of the law or cases to carry on banking business.
b) Approval of capital reserves and liquid assets of banks: The RBI ensures that each and every bank has the minimum requirement of capital reserves and liquid assets.
c) Inspection of Banks : The RBI inspects and makes enquiries in respect of varies matters like loans and advances, deposits, investments, profit planning, man power planning, branch expansion organizational structure and the others banking services.
d) Controls over management and methods: The RBI exercises control over the management of the banks in matters like constitution of the board of the public sector banks appointment remuneration etc.
e) Audit: The banks are required to get their balance sheet and profit and profit and loss account duly audited by the auditors approved by the reserves bank.
f) Control over amalgamation and liquidation: The RBI control over amalgamation and liquidation of the banks in certain cases.
g) Implementing the deposit insurance scheme: The RBI has implemented the deposit insurance scheme for the benefit of the banks depositors.
Q.7. What do you mean by Credit Control? What are its objectives?
Ans: The regulation of credit creation capacity of the commercial banks and other banking institutions by the Central Bank to achieve some definite objectives is known as Credit Control. The objectives of the Central Bank for Credit Control of the other banks are:
a) To establish stability in the internal price level by adjusting the supply of credit.
b) To maintain stability in the foreign exchange rates by eliminating fluctuations in the exchange rates.
c) To eliminate cyclical fluctuations in the production, employment and prices of goods.
d) To stabilize money market of the economy.
e) To achieve full employment of resources and accelerate economic growth with stability.
Q.8. What are the principle methods or instruments of Credit Control used by the Central Bank?
Ans: The principle methods or instruments of Credit Control used by the Central Bank are:
1) Quantitative or General Methods
2) Qualitative or Selective methods
1) Quantitative or General Methods: These are the traditional or general methods of credit control. These methods one used by Central Bank to expand or contract the total volume of credit in the economy neglecting the purpose for which it is used. These methods are :-
a) Variation in the bank rate
b) Open Market operations:
c) Variation in cash reserve ratio:
d) Variation in the statutory liquidity ratio:
e) ‘Repo’ Transactions:
a) Variation in the bank rate: Bank rate or discount rate is the rate at which the Central Bank of a country makes advances to the banks against approved securities or rediscounts the eligible bills. The purpose of change in the rate is to make the credit cheaper or expensive depending upon whether the purpose is to expand or control credit. An increase in bank rate result, in increase in lending rate of commercial banks lending to contraction of credit while a decrease in bank rate leads to decrease in lending rates of commercial banks lending to expansion of credit.
b) Open Market operations: Open market operations means deliberate and direct buying and selling of securities and bills in the market by the Central Bank. The open market operations of the RBI are mostly confined to government securities. In order to increase money supply in the market, the RBI purchases securities in the open market. On the other hand, in order to contract credit, the RBI starts selling the securities in the open market.
c) Cash reserve ratio: Every scheduled bank in India is required to maintain a minimum percentage of their deposits with the RBI. Larger the reserve, lesser is the power of the banks to create credit and smaller the reserves, greater is the power of the banks to create credit.
d) Statutory liquidity ratio: Statutory liquidity ratio is another reserve requirement used by the RBI to control money supply. In India, besides maintaining the cash reserve, every bank has to maintain a statutory reserve of liquid assets in terms of cash, gold or unencumbered securities. This is termed as statutory liquidity ratio. In increase in the liquidity ratio implies a transfer of banking funds to Government and corresponding reduction in credit available to the borrowers.
e) ‘Repo’ Transactions: ‘Repo’ stands for repurchase. Repo or repurchase transactions are undertaken by the Central Bank in the money market to manipulate short term interest rates and to manage liquidity levels. In case the RBI desire to inject fresh funds in the economy it conducts ‘Repo’ transactions. On the other hand, to absorb liquidity the RBI ‘Reserve Repo’ transactions. The securities eligible for carrying out this operation are selected by the RBI. It includes government promissory notes, treasury bills and public sector bonds.
3) Qualitative or Selective Methods: These are basically the selective and general methods of credit control. These methods are used for controlling the use and direction of credit. They have nothing to do with the control of the total volume of credit in economy. These methods are :
b) Margin Requirement
c) Consumer Credit Regulations
e) Credit Rationing
f) Moral Suasion.
g) Direct Action.
a) Directions: Sec. 21 of the Banking Regulation Act gives wide power to the RBI for controlling granting of advances by an individual bank or by banking as a whole. The RBI can give directors to any particular bank or all banks in general in regard to the purposes for which advances may or may not be made, the maximum amount of advance to any individual, firm or company etc.
b) Margin requirement: Margin means the difference between the market price of security and loan amount. Changing margin requirement is another credit control method followed by the RBI. This system was introduced in 1956. By requiring higher margin while accepting a commodity as a security, the RBI can decrease the flow of credit to particular sector or vice versa.
c) Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Under this method the down payment, installment amount, loan duration, etc is fixed in advance. This can help in checking the credit use and then inflation in a country.
d) Publicity: This is yet another method of selective credit control. Through it Central Bank (RBI) publishes various reports stating what is good and what is bad in the system. This published information can help commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins, the information is made public and banks can use it for attaining goals of monetary policy.
e) Credit Rationing: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors.
f) Moral suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes.
g) Direct action: Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates.
Q.9. Write a brief note on Organisation Structure and Management of RBI.
Ans: The Reserve Bank was set up as corporate body. The organizational structure of the Reserve Bank is provided by the Reserve Bank of India Act, 1934. It comprises of the: (a) Central Board and (b) Local Boards.
Central Board: The Central Board of Directors is the supreme governing body of the Bank. It consists of 20 members. The members include the following:
1) A Governor and not more than four Deputy Governors to be appointed by the Central Government.
2) Four Directors to be nominated by the Central Government, one each from the four local boards.
3) Ten Directors to be nominated by the Central Government. They are experts from the fields of business, industry, finance and co-operation.
4) One Government Official (Secretary, Ministry of Finance) to be nominated by the Central Government.
The power of the Board vests with the Governor who is the Chief Executive Officer of the Bank. The Governor has the responsibility of directing the affairs and business of the Bank. The Governor and Deputy Governors hold office for a period of 5years and are eligible for the reappointment. The Governor in his work is assisted by four Deputy Governors and four Executive Directors. The executive directors are not the members of the Central Board but attend Board meetings by invitation. They are subordinate to Deputy Governors.
Local Boards: Apart from Central Board of Directors, four Local Boards are constituted representing each area specified in the first schedule to the Act. There is a Local Board in Eastern, Western, Northern and Southern regions of the country with headquarters at Kolkata, Mumbai, New-Delhi and Chennai.
Local Board consists of five members, each appointed by the Central Government. In each Local Board, a Chairman is elected from amongst the members. The members of the Local Board hold office for a period of four years and are eligible for reappointment.