INDIAN BANKING SYSTEM (PART-2) RESERVE BANK OF INDIA PART 1

Transcription

1 INDIAN BANKING SYSTEM (PART-2) RESERVE BANK OF INDIA PART INTRODUCTION Hello students! Welcome to the series on Indian Banking system. The topic of this lecture is Reserve Bank of India. The objectives of this lecture are: a) To make you familiar with the history of RBI or Reserve Bank of India. b) To talk about the milestones achieved by RBI and discuss the various objectives of RBI. In the words of De Kock guiding principle for a Central Bank whatever function or group of functions it performs at any particular moment is that it should act only in public interest and without regard to profit as a primary consideration. which means that the Central Bank of the country should act in the interest of public and just the profit should not be the main aim of the Central Bank. The Central Bank of our country is the Reserve Bank of India or RBI. The central office of the Reserve Bank was initially established in Calcutta but was permanently moved in Mumbai in the year The central office is where the Governor sits and where the policies are formulated. RBI was established on April 1 st 1935 in accordance with the provisions of the Reserve Bank of India Act It was set up on the basis of recommendations of the Hilton Young Commission. The RBI performs the functions the Central Bank as well as the departmental and the promotional function. The Reserve Bank of India Act 1934 provides the statutory basis of the functioning of RBI. RBI acts as currency notes issuing authority, banker's bank and the banker of the government. It is also responsible for regulating the supply of credit and money.

2 It not only controls the inflation but helps in establishing and strengthening the financial mechanism in our country. It monitors the system of credit planning and credit deployment as per the national objectives. 2. HISTORY OF RBI Now let us talk about the history of RBI. RBI was established on the recommendations of the Hilton Young Commission. The Commission recommended the creation of a Central Bank to separate the control of the currency and credit from the government and to augment banking facilities throughout the country. The Reserve Bank of India Act 1934, establish the Reserve Bank, as the banker to the Central Government and set in motion a series of action culminating in the start of operations in the year Since then the Reserve Bank's role and functions have undergone numerous changes, as the nature of the Indian economy has changed. RBI was established in the year 1935 with the aim to regulate the issue of bank notes maintains reserves with a view to securing monetary stability and to operate the credit and currency system of the country to its advantage. It began its operations by acting as the controller of currency. Earlier this function was entrusted with the government. And the management of government account and public debt is now the function of RBI. Earlier this function was performed by the Imperial Bank of India. The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Kanpur became branches of the issue department. The offices of the banking department were established in Calcutta, Bombay, Madras, Delhi and Rangoon, at that time. Burma or Myanmar seceded from the Indian Union in the year 1937 but Reserve Bank continued to act as Central Bank for Burma till Japanese occupation of Burma and later up to April After the partition of India the Reserve Bank had served as the Central Bank of Pakistan up to June 1948, when the State Bank of Pakistan commenced operation. The bank which was originally set up as a shareholders' bank was nationalized in the year 1949.The Reserve Bank of India at its inception was seen as playing a special role in the context of agricultural development. 2

3 But when its plan endeavors were commenced the development role of bank came into focus when RBI pioneered the concept and practice of using finance to catalyze development. The bank was also instrumental in institutional development and helped in setting up of institutions like The Deposit Insurance and Credit Guarantee Corporation of India, The Unit Trust of India, the Industrial Development Bank of India, The National Bank of Agriculture and Rural Development, The Discount and Finance House of India etc. to build the financial infrastructure of our country. With liberalization the focus of bank shifted back to core central banking functions like monetary policy, bank supervision and regulation and overseeing the payments system and onto the developing the financial markets. It is worth considering today, RBI bears some resemblance to the original institution although the machine has expanded, along with the deepened, broadened and increased globalized economy. 3. ESTABLISHMENT OF RBI The Reserve Bank of India was established in the year 1935 with the share capital of Rupees Five Crore divided into shares of Rupees Hundred each for the paid up. In the beginning entire Share Capital was owned by the private shareholders. According to Ruddar Datt and K.P.M. Sundharam, the Government of India held shares of nominal value of Rs.2,22,00/-,but in view of public nature of banks function the Reserve Bank of India Act 1934 provided for the appointment of the Central Government of the Governor and two Deputy Governors who were also the directors of the central board. This Act also contained provisions governing the holding of shares and the rate of dividend to be paid to the shareholders. 3

4 The Reserve Bank of India was nationalized in the year The general superintendence and the direction of the RBI are now entrusted to the Central Board of Directors of 20 members consisting of a Governor and four Deputy Governors. Earlier when RBI was established only two Governors were appointed. But now there is a provision for four Deputy Governors. Now there is a provision for the appointment of one Government official from the Ministry of Finance, ten Directors nominated by the Government of India to give representation to important elements in the economic life of India. 4

5 And Four Directors are nominated by the Central Government to represent four local boards. Besides the central board there are four local boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. 5

6 The local board consists of five members each appointed by the Central Government for a term of four years to represent territorial and economic interest and the interest of cooperative and indigenous banks. It is very important for you to understand the structure of RBI. But, we will discuss this structure of RBI at length in the next lecture. 4. MILESTONES ACHIEVED BY RBI Let us have a quick view at the milestones achieved after its establishment. But, before that I would like to quote here the excerpts from telegram sent by the Viceroy to Osborne Smith, the First Governor of Reserve Bank of India 1935 as released by RBI: As Reserve Bank commences operations today I take the opportunity to express my confidence that this great undertaking will contribute largely to the economic wellbeing of India and its people". In the year 2010 the RBI celebrated its Platinum Jubilee. The milestones that RBI achieved during this journey are: In the year 1935, it came into existence, in the year 1949 RBI was nationalized and banking regulation Act was enacted. In the year 1950, India embarked on planned economic development and the Reserve Bank of India became active agent and participant. In the Year 1966, cooperative banks came under RBI regulations. In the year 1969, 14 major commercial banks were nationalized. In the year 1973, RBI strengthened exchange control by amending Foreign Exchange Regulation Act or FERA. In the year 1974, priority sector lending targets were introduced. In the year 1975, Regional Rural Banks were set up. In the year 1980, six major commercial banks were nationalized. 6

7 In the year 1985, financial market reforms began with Sukhamoy Chakravarty and Vaghul Committee Reports. But, in the year 1991 India faced a balance of payment crisis and it pledged Gold to shore up reserves. Rupee was also devalued during this year. In the year 1993, exchange rate became market determined and in the year 1994 board for financial supervision was set up. In the year 1997, Ad hoc treasury bills phased out ending automatic monetization and regulation of non-banking finance company was strengthened. In the year 1998, multiple indicator approach for monetary policy was adapted. In the year 2000, Foreign Exchange management Act replaced FERA. In the year 2002, Clearing Corporation of India Limited or CCIL commenced clearing and settlement in government securities. In the year 2003, fiscal responsibility and budget management Act was enacted. In the year 2004, transition to a full-fledged daily Liquidity Adjustment Facility or LAF was completed and Market Stabilizations Scheme or MSS was introduced to sterilize capital flows. Also real time gross settlement system was commenced in this year. In the year 2005, RBI focused on financial inclusion and increasing the outreach of the banking sector In the year 2006, RBI empowered to regulate money, forex, G-sec and gold related securities market. In the year 2007 RBI empowered to regulated payment system. In the year 2008 and 2009 proactive efforts were made by RBI to minimize impacts of global financial crisis. This was about the journey of RBI from the year of commencement till the year it celebrated its platinum jubilee 7

8 5. ROLE OF RBI DURING RECESSION It is important to mention here the role of Reserve Bank of India during the global financial crisis in the year 2008 and 2009.The Reserve Bank of India used the conventional and unconventional measures to help buffer the nation from severe global financial crisis. The response of RBI to global financial crisis is being summed up as implication of carefully considered and calibrated reduction of interest rate until situation was stabilized, loosen restriction on access to foreign currency creation of a rupee dollar swap facility to manage short term funding requirements, establishment of a refinancing window and special purpose people for non-banking financial companies, expansion of funding sources for umbrella financial institutions to keep credit flowing to small businesses, housing and export houses. Similarly, inflation is the major problem in our country and RBI has all its efforts directed in the way to combat the situation for dealing with inflation as a problem. In January 2011 RBI was prepared to frame its monetary policy taking into account the inflation. However, in a short while thereafter, inflation has re-emerged as the major concern. The wholesale price index for WPI based inflation reversed itself in February There has been a sharp increase in non-food products inflation which has more than offset the fall in the prices of food articles since January 2011.The prices of milk, fish, egg and meat remained high suggesting structural demand and supply mismatch. Fuel prices remained high and prognosis were not given even over the medium term. Talking about the non-food manufactured product inflation an indicator of demand side pressure rose sharply from 4.8% in January 2011 to 6.1% in February 2011 which is well above its medium term trend. The rise in the price of such products is the main reason behind RBI's move to hike its WPI inflation target to 8% for March 2011 from 7%. The latest budget plans to bring down the fiscal deficit sharply by compressing expenditure estimates and anticipating buoyant revenue this should ate the monetary policies in the inflation stands. But certain expenditure items like subsidies may have been underestimated in the budget. The current account deficit is expected to be at a lower than expected level of 2.5% of the GDP. However, the means of financing the current account deficit is a matter of concern. 8

9 It is necessary to take measures to attract these capital flows such as foreign direct investments which was more stable. The dependence on short term volatile portfolio flows should be reduced. The CSOs estimates of 8.6% growth for the current fiscal are in line with the RBI projections. Agricultural production is likely to be sustained at a high level. The Index of Industrial Production or IIP remains volatile while the other indicators such as direct and indirect tax collection, merchandize export growth and bank credit expansion suggest that the growth momentum persists but there is uncertainty over the energy and commodity prices. This may vitiate the investment capital and strengthen the current growth projector as highlighted in the article "Significance of RBI's Policies Statement" by C.R.L. Narsimhan in Hindu dated March 28, According to the RBI about the macro economic consequences of natural disaster in Japan, expenditure on reconstruction may give a boost to the economy. However, if the Thermal Power is going to replace Nuclear Power in Japan, there will be further upward pressure on global petroleum prices. 6. OBJECTIVES OF RBI Let us continue this lecture with the discussion of objectives of Reserve Bank of India or the RBI. According to Reserve Bank of India Act 1934 the objective of Reserve Bank of India or RBI is to regulate the issue of bank notes and the keeping of reserves with a view to securing the monetary stability in India and generally to operate the currency and credit system of the country to its advantage. The formulation, framework and institutional architecture of monetary policy in India have evolved round these objectives. Maintaining price stability ensuring adequate flow of credit to sustain the growth momentum and securing financial stability. The responsibility for ensuring functional stability has entailed the vesting of extensive powers in and operational objectives of the Reserve Bank for regulation and supervision of the financial system and its constituents the money, debt and foreign exchange segments of the financial market in India, and the payment and settlement system. 9

10 The aim of Reserve Bank of India is to develop a robust, efficient and diversified financial system so as to anchor financial stability and to facilitate effective transmission of monetary policy. Reserve Bank pursues operational objectives in the context of its core function of issuance of bank notes and currency management as well as its agency functions such as banker to government both central and state government and management of public debt bankers to the banking system including regulation of bank reserves and the lender of the last resort. The specific features of the Indian economy including its socio-economic characteristics make it necessary for the Reserve Bank of India to operate with multiple objectives. Regulations, supervisions and development of financial system remain within the legitimate ambit of monetary policy. The role of communication policy of RBI lies in articulating the hierarchy of objectives in a given context, in a transparent manner, emphasizing a consultative approach as well as autonomy in policy operations and harmony with other elements of macroeconomic policies. The long term goal of Reserve Bank of India's communication policy was intimately interlinked to its objectives. Faced with multiple tasks and a complex mandate, clear and structured communication is critical for effective functioning as well as enlarging the spheres of traditional policy instruments. The goal of communication policy is to anchor inflation expectation by promoting credibility and understanding of monetary policy, and enabling private stakeholders to map the changing economic circumstances into anticipation of broad policy direction with reasonable accuracy. In order to be realistic the communication policy highlights impediments to achieving stated objectives in a conditional sense. The principle goals of Reserve Bank s communication strategy are: Transparency for strengthening accountability and credibility. Clarity on the Reserve Bank's role and responsibility with regard to its multiple objectives. Managing inherent, complementarities/ contradiction and transition. Managing expectation and promoting two way of flow of information or perceptions. 10

11 Dissemination of information, statistics and research at various frequencies. 7. CONCLUSION We are continuing this lecture with the discussion of objectives of RBI. In simple words RBI is entrusted with monetary stability the management of currency and supervision of the financial as well as the payment system. Hence, its main objectives are: To manage the monetary and credit system of India. To stabilize internal and external value of rupee. To balance and systematically develop the banking sector in India To develop organized money market in India To properly arrange for agricultural and industrial finance. To manage public debt. To establish monetary relations with other countries and international financial institutions. To centralize cash reserves of commercial banks. To maintain balance between the demand and supply of currency. The objective of RBI is to ensure stability of interest and exchange rates to provide liquidity and an adequate supply of currency and credit for real sector. To ensure bank penetration and safety of depositors fund. To promote and develop financial institutions and markets in India. To play a crucial role in growth of Indian economy. With these objectives RBI touches the daily life of Indians and help in the economic development. RBI plays a significant role in raising the standard of living of people and increasing the growth of economy. It does so by keeping a check on inflation, controlling the credit and issuing of currency notes. RBI is the banker of the Government and also the banker of the banks. In the next lecture we will discuss in detail the functions and structure of RBI. Thank you! 11