For the first time, the world felt the need for a central banking body after the banking crisis of the early twentieth century. Following the global trend, the Reserve Bank of India5 was established in Calcutta on April 1, 1935, in accordance with the provisions of the RBI Act, 1934. (got shifted to Bombay in 1937). Set up as a bank under private ownership, it was given two additional functions: regulating the banking industry and acting as the government’s banker. To better serve the purpose, a global consensus emerged in the mid-1940s in favor of a government-owned central bank, and governments began to take them over.
The Reserve Bank of India was nationalized in 1949 as well. It ceased to be a ‘bank’ in the technical sense after nationalization (as it stopped accepting deposits from the general public). The RBI has been entrusted with a number of complex and difficult responsibilities, which are summarised in its Preamble as follows:
“To regulate the issue of Banknotes 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; 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.”
Functions of RBI
As per the changing needs of the time, the RBI Nationalisation Act of 1949 has been amended several times by the Government and its functions broadened. Its current functions may be summarised objectively in the following way-
- Monetary Authority: It includes monetary policy formulation, implementation, and monitoring. The overall goal is to maintain price stability while pursuing the goal of growth. It now stabilizes the wholesale price index (WPI) and targets the consumer price index under price stability (CPI-C).
- Currency Authority: It entails issuing new currency notes and coins (with the exception of those in the rupee one of its denominations, which are issued by the Ministry of Finance), as well as exchanging or destroying those that are no longer fit for circulation. This function also includes the responsibility for currency and coin distribution (of those ones also which are issued by the Ministry of Finance). The overall goal is to maintain adequate supplies of high-quality currencies and coins.
- Regulator and Supervisor of the Financial System: It includes establishing broad parameters for banking operations within which the banking and financial system can function. This function’s broad goal is to maintain public trust in the system, protect depositors’ interests, and provide cost-effective banking services to the general public.
- Manager of Foreign Exchange: Its broad responsibilities include managing the FEMA (Foreign Exchange Management Act, 1999); maintaining the country’s Forex (foreign exchange) reserves; stabilizing the rupee exchange rate; and representing the Indian government at the IMF and the World Bank (and other international financial agencies of which India is a member). This function’s goals are to facilitate international trade and payments, as well as to promote the country’s foreign exchange market’s orderly development and maintenance.
- Regulator and Supervisor of Payment and Settlement Systems: It has responsibilities such as introducing and upgrading safe and efficient payment systems in the country to meet the needs of the general public. The goal is to maintain public trust in the payment and settlement system.
- Banker of the Governments and Banks (known also as the Related Functions): It performs three categories of functions for the central and state governments: first, performing Merchant Banking6 functions for them; second, acting as their Bankers; and third, maintaining banking accounts for SCBs (scheduled commercial banks) operating in the country, both domestic and foreign, public and private. The broad objectives are to enable governments and banks to mobilize sufficient liquidity for their operations, in which it lends or manages government borrowing plans and provides short- and long-term loans to banks (as Lender of Last Resort).
- Developmental Functions: Unlike most central banks around the world, the RBI was also given some developmental responsibilities. It established developmental banks such as IDBI, SIDBI, NABARD, NEDB (North Eastern Development Bank), Exim Bank, and NHB in order to fulfill this role. The RBI is gradually transferring ownership of these banks to the Government of India (aimed at enhancing regulatory freedom and professionalism of the central bank and enabling the Government to take care of the dynamic requirements of development in a better way).
Regional offices of Reserve Bank of India
The RBI now has 27 regional offices, the majority of which are located in state capitals, and is governed by a central board of directors. The board is formed by the government by appointing or nominating the directors for a four-year term as follows:
- Official Directors: Governor and not more than four Deputy Governors.
- Non-Official Directors: 10 nominated from various fields and 2 government officials. It also includes 4 Directors coming 1 each from the four local boards of RBI (also known as sub-offices, they are situated in Chennai, Kolkata, Mumbai, and N. Delhi).
Deposit Insurance and Credit Guarantee Corporation of India (DICGC), Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL), Reserve Bank Information Technology Private Limited (ReBIT), and Indian Financial Technology and Allied Services are the RBI’s four fully-owned subsidiaries (IFTAS).
New Financial Year
In February 2020, the RBI decided to change its financial year from 2020-21 to April-March in order to align with the government’s financial year (from its existing financial year July-June). As a result, the RBI will abandon nearly eight decades of practice—the financial year used to be January-December before it was changed to July-June in 1940. The Jalan Committee recommended such a change (set up by the RBI on the Economic Capital Framework, 2019).
RBI’s Reserve and Surplus Capital
In 2019-20, there was a lot of discussion about the RBI’s reserve transfer to the government. The RBI established an expert committee on Economic Capital Framework (headed by Bimal Jalan) in 2019 to investigate the issue and advise on how surplus capital should be shared with the government. The RBI transferred 1.76 lakh crore to the government on its advice and made several changes related to the issue:
The committee recommended that realized equity be used to meet all risks/losses because it was primarily built up from retained earnings, while revaluation balances are used only as risk buffers against market risks because they represented unrealized valuation gains and were thus not distributable.
The central bank’s revaluation balance should not be distributed. Only if realized equity exceeds the required amount can the entire net income be transferred to the government. If it falls below the lower bound of requirement, risk provisioning will be made to the extent necessary, with any remaining net income (if any) going to the government.
The committee examined the status, need, and justification of the RBI’s various reserves, risk provisions, and risk buffers, and recommended that they be maintained.
In terms of market risk provisioning, the committee has recommended using the Expected Shortfall (ES) methodology under stressed conditions (rather than the existing Stressed-Value at Risk) to measure the RBI’s market risk, which has gained popularity among central banks and commercial banks in recent years. While central banks appear to be adopting ES at a confidence level of 99 percent (CL), the committee has recommended that, in light of macroeconomic stability requirements, a target of ES of 99.5 percent CL be adopted.
According to the report, realized equity is also needed to protect against credit and operational risk. The Contingent Risk Buffer (CRB) is a risk provisioning made primarily from “retained earnings” that has been recommended to be kept within a range of 6.5 percent to 5.5 percent of the RBI’s balance sheet, with 5.5 percent for monetary and financial stability risks and 1.0 percent for credit and operational risks.
The committee’s recommendations were based on a review of central banks’ financial resilience, cross-country practices, statutory provisions, and the impact of the RBI’s public policy mandate and operating environment on its balance sheet and risks.
Practice Questions for UPSC Prelims
Ques 1: What is the mandate of the KV Kamath Committee formed by the Reserve Bank of India?
(a) Financial parameters for restructuring of loans
(b) Forex Reserve Management
(c) Potential impact of COVID-19 pandemic on MSME credit
(d) Monetary Policy Framework Targets
Answer: Option A
Explanation: The RBI had formed a committee under the chairmanship of former ICICI Bank CEO KV Kamath to make recommendations on the financial parameters to be considered in the restructuring of loans impacted by the COVID-19 pandemic.
Ques 7: The Committee on Financial Sector Reforms was headed by:
(b) Urjit Patel
(c) Raghuram Rajan
(d) Viral Acharya
Answer: Option C
Explanation: The Raghuram Rajan Committee on Financial Sector Reforms was a committee constituted by the Government of India in 2007 for proposing the next generation of financial sector reforms in India.
An Internal Working Group of the Reserve Bank of India (RBI) has recently recommended that corporate houses be given bank licenses. The Raghuram Rajan committee had said that it is premature to allow industrial houses to own banks.
Ques 3: Which of the following is/are the potential impact(s) of the sale of Government securities by the Reserve Bank of India?
- Increase in liquidity in the market.
- Increase in interest rates.
Select the correct answer using the code given below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer: Option B
Explanation: When the RBI feels that there is excess liquidity in the market, it resorts to the sale of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, RBI may buy securities from the market, thereby releasing liquidity into the market.
Quick Questions on Reserve Bank of India for UPSC Preparation
The Reserve Bank of India was set up on 1st April, 1935 on the recommendation of Hilton Young Commission. The Reserve Bank of India Act, 1934 (II of 1934) establishes the legal framework for the Bank’s operations, which began on April 1, 1935.
The Reserve Bank of India which is also known as RBI is the central Indian Bank responsible for managing and monitoring the Indian Banking System.
The RBI i.e. Reserve Bank of India was initially established in Kolkata in 1935. But in the year 1937 RBI was permanently shifted to Mumbai. RBI has more than 31 Regional offices in India.