RESERVE BANK OF INDIA & COMMERCIAL BANKS

• If we want to study fin. inst., we have to study the regulator of financial institutions of the country because fin. markets are characterized by various degrees of imperfection, the need for regulator - prudential or otherwise-even in a liberalized framework cannot be denied.

• The fin. system deals in other people' money and therefore, their confidence, trust & faith in it is crucially important for its smooth functioning.

• Fin. regulation is necessary to generate, maintain and promote this trust.

• The regulation becomes necessary to ensure that investors are protected.

• The rule of the market is that:

• Market should be fair & efficient.

• In this context, it is said that fairness and efficiency are two sides of the same coin.

• If the market is unfair , it is inefficient also.

• In India, RBI is the regulator for commercial banks in particular & Indian financial system in general.

• The RBI was established in 1935 by an Act of Parliament.

ROLE OF RESERVE BANK OF INDIA

• Printing of currency notes.

• Govt’s bank

• Banker’ bank

• Supervising authority

• Exchange control authority

• Promotion of financial system

ISSUE OF CURRENCY

• RBI is the sole authority for issue of currency in India.• Rupee coins/ notes and subsidiary coins are issued by

the Govt. Of India and they are put into circulation through RBI

• One rupee note & coins are legal tender money for unlimited amount, 50 paisa coin for a sum not exceeding 10 rupee and smaller coins for sum not exceeding one rupee.

• The RBI act permits the issue of notes in the denomination of 2,5,10,20,50,100,500,1000,5000 &10000

• At present denomination up to 1000 are being printed. • This is done by issue dept & banking dept.

BANKER TO THE GOVT.

• RBI is the banker to the central Govt. Statutorily & to the State Govt. by virtue of agreements entered into with them.

• RBI accept money on deposits. • Withdrawal of funds by cheque, receipts & collection

of payments to the Govt. and transfer of funds by various means throughout India

• The terms and conditions on which the bank acts as a banker to the Central & State Govt. are set out in separate agreements

• As a banker to the Govt., the bank can make “ways & means advances” (temporary advances made in order to bridge the temporary gap between receipt & payments) to both central & state govt.

• Advances to Central Govt. by issue of adhoc treasury bills.

• State Govt.: BY W & M ADVANCES i.e. NORMAL OR CLEAN ADVANCE WITHOUT COLLETRAL, SECURED ADVANCE: AGAINST PLEDGE OF CENTRAL GOVT SECURITIES.

• Special advance: at the discretion of the bank.

• Rate of int.: Bank rate till 1976. Thereafter graduated rate of int. Based on duration of the advance.

• Apart from “ways & means advances” State Govts. have made heavy use of OD facility from RBI.

• OD means excess of WAYS AND MEANS advance limits granted by RBI. Penal int. 3% ABOVE BANK RATE IF IT EXCEEDS 7 DAYS i.e. FROM 8TH DAY

• Od-overdrawings

BANKER’S BANK

• RBI like all other central banks also act as banker’s bank because it has a very special relation ship with commercial banks & cooperative banks.

• RBI controls volume of reserves of commercial banks and thereby determine the deposits/credit creating ability of the commercial banks.

• In time of need, the commercial banks borrow funds from RBI.

• When CB do not get funds from other sources, it is the duty of RBI to lend them.

• It is , therefore, called the lender of the last resort

SUPERVISING AUTHORITY

• RBI has vast power to supervise and control com. Banks & coop banks with a view to develop an adequate & sound banking system in the country. It has the powers:

• To issue licenses for the establishment of new banks.• To issue licenses for setting of new branches • To prescribe minimum requirement regarding paid up

capital & reserve, transfer to reserve funds and maintenance of CRR & other liquid assets.

• To inspect working of banks in India & abroad in all areas.

• Conduct adhoc investigation into complaints, irregularities & frauds.

• Control methods of operations so that they do not fritter away funds in improper investments & injudicious advances.

• Control appointments & termination of CMD & CEO• Approve or force amalgamation

EXCHANGE CONTROL AUTHORITY

• Maintains stability of the external value of rupee.• Choose exchange rate system and fix or manage the

exchange rate between rupee & other currencies. Manage exchange reserve.

• Interact or negotiate with monetary authorities of other countries, IMF, World bank or Asian Dev. Bank. Administer exchange control in terms of FEMA (1999).

• Objective of exchange control is to regulate the demand for foreign exchange within the limit set by the available supply.

• This is sought to be achieved by conserving foreign exchange

• RBI administer the control through authorized dealers.• With the introduction of floating Exchange Rate

system & the rupee convertibility on trade, current & capital a/c(full convertibility is yet to take place.)

• Role of RBI as the stabilizer of market rupee ex. Rate become more important.

PROMOTION OF FINANCIAL SYSTEM

• RBI is also rendering services which have strengthened the country’s banking & financial system.

• This has helped in mobilizing savings & directing credit flows to desired channels thereby helping to achieve the objective of Eco. Development with social justice.

• RBI continuously worked for integration of its unorganized & organized sector by trying to bring indigenous bankers into the main stream of the banking business.

• In order to improve the quality of finance provided by the money market, it has introduced the bill market scheme.

• With a view to increase the strength and viability of the banking system, it carried out a programme of amalgamation & merger of weak banks with strong banks.

• Lead bank scheme, Deposit Insurance Corporation

• Agriculture Refinance Corp.(NOW NABARD) RRBs have been promoted by RBI.

OBJECTIVE OF RBI

• The objective of monetary policy in India were to accelerate economic development in an environment of reasonable price stability.

• By influencing the cost, volumes and direction of credit, monetary policy has been encouraging sectoral and overall developments.

• The key note of monetary policy is controlled expansion of bank credit and money supply, with special attention to seasonal requirements for credit.

RBI’S TECHNIQUES

• Bank rate

• Open market operation

• Reserve ratio

• Moral persuassion

• Selective & quantitative credit controls

1. BANK RATE

• THE STANDARD RATE OF INTEREST AT WHICH RBI IS PREPARED TO BUY OR REDISCOUNT BILLS OF EXCHANGE OR OTHER COMMERCIAL PAPERS i.e. SECURITIES ELIGIBLE FOR PURCHASE .

• The techniques of bank rate used to regulate the cost and availability of funds as well as volume of lendable resources of banks.

• This was very effective when bill market was not much in use.

• Earlier rate of interest charged by commercial banks were linked with bank rate.

• Later on it was linked with their own PLR

• It was not much effective.

• After 1991, RBI was compelled to regulate the Rate of interest on deposits & advances.

2.RESERVE RATIOSCRR & SLR

• The present banking system is called a “fractional reserve banking system” because the bank needs to keep only a fraction of their deposit liabilities in the form of liquid assets.

• Earlier RBI used to change this mainly for the purpose of ensuring the safety & liquidity of deposits over the year it has become an important & effective tool for directly regulating the lending capacity of banks.

• CRR refers to the cash balances which banks have to maintain with RBI as a certain %age of their demand & time liabilities.

• RBI can impose penal rate in respect of short fall in the prescribed CRR.

STATUTORY LIQUIDITY RATIO

• In addition to CRR, RBI has made active use of SLR.

• Every bank is required to keep prescribed %age of their demand & time liabilities in the form of govt. Securities.

• The objective is to restrict:

• (A) expansion of bank credit

• (B)augment bank’ investment in Govt. securities

• (c) ensure solvency of banks

• Though default do not invite penal interest but do results in restriction on the access to refinance from RBI

3. OPEN MARKET OPERATION

• Open Market Operation is a actively used technique of monetary control in the US, UK and many other countries.

• RBI conduct OMO. RBI can affect volume and cost of bank credit.

• RBI conduct OMO in T-bills,State Govt. securities, Central Govt. Securities.

• But mainly in Central Govt. securities of all maturities.

REPO & REVERSE REPO

• Repo is a money market mechanism which enables collateralized short term borrowing and lending through sale/purchase operation in debt instruments.

• Unlike all deposits and T-bills, repo is not an instrument in the market.

• It is a process wherein number of instruments such as G-sec, PSU bonds & other securities can be used as underlying security to the borrower and lend in the money market.

• Under repo transaction, a holder of securities sells them to an investor with an agreement to repurchase back the same securities for the same amount at a predetermined rate and date.

REPOS

• REPO IS ALSO CALLED READY FORWARD CONTRACT i.e. SELLING ON SPOT(READY) & REPURCHASING SAME ON A FORWARD BASIS.

• Repo is undertaken by RBI for controlling liquidity in the market as also help banks in need of liquidity.

• Reverse repo is the mirror image of repo. • In the reverse repo, securities are acquired with a

simultaneous commitment to resell.• Banks can borrow funds from RBI by doing repo. • This is reverse repo for RBI and is known as “LAF”

(liquidity adjustment facility)

4. SELECTIVE CREDIT CONTROLS

• Most actively used technique in India.• The seasonal nature of Indian economy & the nature of

inflation have made SCC useful.• SCC seek to change the composition of credit.• They are used to reduce the supply of credit in certain

directions.• They have been used particularly to prevent

speculative hoarding of sensitive commodities such as paddy, rice, wheat, pulses, oil seeds, oil& vanaspati, cotton, sugar ,gur etc.

• SCC is used in 3 forms:

• (1) fixation of margin requirement

• (2) separate minimum lending rate on credit under SCC

• (3)fixation of ceiling on flows of credit.

5. MORAL PERSUASION

• This is another most actively and consistently used technique of monetary control.

• It takes the form of writing letter and holding discussion between RBI and banks about trends in the economy in general and money, credit and finance in particular and about the measures which ought to be taken from time to time in the light of national interest

COMMERCIAL BANKS

• Cb are the oldest, biggest and fastest growing financial intermediaries in india.

• They are the most important depositories of public savings and most importnt disbursers of finance.

• C.Banking in india is a unique system, the like of which exists no where in the world. Exam sbi.

• Cb are simple business & commercial concers which provides various types of financial services to customers in return for payments in one form or another, such as interest, discount, fees. Commission and so on. The objective is to make profit

COMMERCIAL BANKING

• Banking business distinguishes from other business concern(financial as well as manufacturing) in the degree to which they have to balance the principle of profit maximisation with certain others principles.

• Social justice, social welfare & promotion of regional balances in development.

• They have to pay much more attention to balancing profitability with liquiditybecause of the nature of their liabilities. Reserve requirements.

• Cb deals with other people’s money which they receive as deposits of various types.

• Difference between cb & fin inst. IS THAT cbs ARE CREATOR OF CREDITS WHEREAS OTHER fis ARE PURVEYER OF CREDITS.

HISTORY OF COMMERCIAL BANKS

• In 1806 bank of bengal,1840 bank of bombay & 1846 bank of madras were formd & they were called presidency banks.

• In 1921 they were amalgated to form imperial bank of india. It functioned as quasi-centrl bank till 1935 when rbi was created.

• In 1954 all india rural credit survey committee submitted its report & suggested:

• Creation of a strong, integrated , state sponsored, state partnered commercial banking institution with an effective mechanism of branches spread all over the country

HISTORY OF CBs

• This resulted in creation of sbi on 1st july 1955.

• 1956-1959 on account of reorganisation of princely states, the associated banks came into existence.

• 1962 deposit insurance corporation of india establised

• 1969, 19th july- 14 banks were nationalised and again in 1980 6 more banks were nationalised. 91% of deposits & 84% of advances in banking was in the nationalised sector.

• In 1969 lead bank scheme was introduced

POST NATIONALISATION

• Increase in number of branches in rural and semi urban areas.

• This was due to licencing policy of rbi—open 4 branches in rural and semi urban area and get one licence for metro/urban centre.

• 1976 –rrbs were established

• 1989– service area approched was introduced

THE CONSOLIDATION PHASE

• THE CONSOLIDATION PHASE STARTED IN LATE 80s AND MORE PARTICULARLY early90s

• In 1985 rbi took steps for consolidation in

• House keeping,

• Customer service,

• Credit management,

• Staff productivity

• Profitability

REFORM & POST REFORM PHASE

• With the submission of report by narsimham committee, financial sector reforms started:

• Deregulation of interest rates

• More competition

• Technological changes

• Prudential guidelines on assets classification

• Income recognition,capital adequacy,autonomy

• During post reform era, the banking system has seen developments with focus on bigger size, new innovative products, extensive use of it & global standards of services.