Powers of RBI, Tools for managing liquidity, Government as regulator of banks

1. REGULATORY
FRAMEWORK OF
BANKS:
Dr. Shaifali Mathur
Assistant Professor
Dr. Shaifali Mathur

2. Introduction
• The principal regulatory frame work of Banks in India involves
Legal Framework for Regulation of Banks
Banking Regulation Act 1949
Reserve Bank Of India Act
1934
BR Act 1949 provides a legal framework to regulate and supervise the banking activities. It acts as
an instruction manual, guiding the banks what to do and what not.
RBI Act 1934 empowers RBI to be a guardian of all the banks, issue currency notes and maintain
the financial and economic stability of the country.
Dr. Shaifali Mathur

3. RESERVE BANK OF INDIA ACT, 1934 (AN OVERVIEW)
The RBI Act was enacted with an objective of constituting Reserve Bank of India to
regulate issue of bank notes, to keep reserves to ensure monetary stability, to
operate currency and credit system.
This Act is the basis for constitution, powers, and functions of RBI.
RBI Act deals with Incorporation, Capital, Management, Business of RBI itself,
Central Banking Functions, Collection and furnishing of information, Regulating
Non-Banking Institutions receiving deposits and financial institutions, Prohibition of
Acceptance of deposits by unincorporated bodies, Regulation of transactions in
derivatives, money market instruments, securities etc., Monetary Policy, General
Provisions, Penalties along with Schedule I and II.
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4. Amendments to RBI Act (August 2019)
While presenting the Finance Bill in August 2019, The Finance Minister
proposed the following amendments/ Insertions of Sections to RBI Act 1934 : -
RBI has been given more Powers to regulate NBFCs than before including
seeking additional financial and business information including activities of
group/group of companies.
Empowering RBI to remove directors and Superseding board of directors of
delinquent NBFCs.
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5. Empowering RBI for a Resolution of problematic NBFCs by way of
framing of schemes of amalgamation, reconstruction or splitting in
to separate companies, of NBFCs.
 Empowering RBI to forcibly interfere in legitimate business of
NBFCs in case of emergencies.
 Arming RBI with power of removal/ debarring of Auditors for a
period of three years, at a time from auditing any RBI regulated
entities.
Dr. Shaifali Mathur

6. CONSTITUTION OF RESERVE BANK OF INDIA
• The main purpose for which RBI was constituted has been stated in Chapter II Section 3 (1) and (2)
of the RBI Act as under-
• A bank to be called the Reserve Bank of India shall be constituted for the purposes of taking over
the management of the currency from the Central Government and of carrying on the business of
banking in accordance with the Act.
• The Bank shall be a body corporate by the name of the Reserve Bank of India, having perpetual
succession and a common seal.
• RBI has been constituted as a body corporate (under the then prevailing Companies Act) in 1935,
with a capital of Rs. 5 crores, which is wholly owned by the Government of India from January 1,
1949.
• Prior to 1949 RBI was Private entity owned by public shareholders.
Dr. Shaifali Mathur

7.  Economic Affairs Secretary
 Financial Services Secretary
Governor (1)
Deputy Governors (4)
Finance Ministry Representatives (2)
government-nominated directors (10)
Directors from Local Boards (4)
Each of these local boards consists of
five members who represent regional
interests, the interests of co-operative
and indigenous banks.
Dr. Shaifali Mathur

8. Section 7(1) of RBI Act empowers the Central Government to give directions to the Governor in
the public interest after due consultations.
 The Governor and Deputy Governors hold office for a period of five years,
 The independent director’s tenure is for four years,
 And government officials is at the pleasure of the government.
 A Deputy Governor and Government officials nominated as Director may attend any meeting
of the Central Board and take part in its deliberations but shall not be entitled to vote.
 In the absence of the Governor, and if permitted by Governor in writing, a Deputy Governor
may vote in the meetings of Central Board.
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9.  RBI Act confers powers to disqualify Directors and members of Local Boards, remove and
vacate them from their office under section 10 & section 11.
 The Governor has to convene meeting of Central Board at least six times in a year and at
least once in a quarter.
 If any four Directors request the Governor to convene the meeting of Central Board, the
Governor has to convene a meeting forthwith.
 The Board is authorized to make regulations in regard to the following matters:
 Conduct of the business of the Central Board/Local Boards and the procedure that may be
followed at meetings;
 Delegation of powers and functions to Central Board to Deputy Governors, Directors, or
Officers of the Bank, Local Boards;
 Formation of committees of the Central Board and delegation of functions and powers to
such committees;
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10.  Constitution and management of staff and superannuation funds
 Execution of contracts binding on RBI, Use of the common seal of the Bank;
 Maintenance of accounts and preparation of balance sheets of RBI;
 Remuneration of Directors;
 The relationship of the scheduled banks with the RBI;
 The returns submitted by the scheduled banks to the RBI;
 Conduct and management of clearing houses for scheduled banks;
 Refund of currency notes of the Government of India or bank notes which are lost, stolen,
mutilated or imperfect;
 Any other matter for the efficient conduct of the business of the RBI.
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11. OBJECTIVES OF RBI
 To regulate the issue of Bank notes.
 To keep reserves with a view to securing monetary stability in India.
 To operate the currency and credit system of the country to its advantage.
 To operate the monetary policy for maintaining price stability while keeping
mind objective of growth.
Dr. Shaifali Mathur

12. Banker to
the
Government
Issue and
Management
of Currency
and
distribution of
Coins
Banker to
the Bank
Lender of
Last resort
Controller
of Credit
Loans and
advances
Collection
and
Furnishing
of Credit
Information
Managing
the
External
Value of
Rupee
Functions of RBI
Dr. Shaifali Mathur

13.  In terms of section 22, of the RBI Act, RBI has the sole right to issue bank notes in India. Such bank
are issued by a department of RBI known as Issue Department, which is a separate and wholly distinct
department from the Banking Department which is responsible for banking business of the RBI.
 The design, form and material of bank notes are to be approved by the Central Government on the
of recommendations of Central Board of the RBI.
 On recommendation of the Central Board, the Central Government may declare any series of bank
of any denomination to be not a legal tender. For example on November 8, 2016, the Government of
India announced the demonetization of all Rs.500 and Rs.1,000 banknotes of the Mahatma Gandhi
It also announced the issuance of new Rs.500 and Rs.2,000 banknotes in exchange for the
banknotes. Also RBI has introduced new Rs. 200 notes.
 Within RBI, the Department of Currency Management (‘DCM’) has the responsibility of administering
functions of currency management.
 As on March 2019, the currency management infrastructure consists of a network of 19 issue offices,
3812 currency chests (including sub-treasury offices and a currency chest of the Reserve Bank at
and 3519 small coin depots of commercial, cooperative and regional rural banks (‘RRB’s) spread across
the country.
Dr. Shaifali Mathur

14. (ii) Banker to the Government
Section 20 of RBI Act, RBI has an obligation to Act as a banker to the central government.
 Under this obligation RBI has to accept monies for account of the Central Government, to
payments up to the amount standing to the credit of Central Government, to carry out its
exchange, remittance and other banking operations, including the management of the public
debt of the Union of India.
 Also under section 21 of RBI Act, RBI has a right to transact Government business in India
which include money, remittance, exchange and banking transactions in India; and, the
Government to deposit free of interest all its cash balances with the RBI under mutually
terms.
 For carrying out its duties as banker to the Government of India, it is not paid any
remuneration.
 RBI is entitled for a commission for managing public debt functions.
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15. (iii) Banker to the Banks
 Reserve Bank provides means of transfer and settlement of funds between banks on account
of clearing, remittances, lending and borrowing through such accounts.
 Thus RBI provides a platform for inter-bank financial transactions.
 Such accounts of banks are maintained by Deposit Accounts Department of RBI.
 Intra-bank funds transfers also takes place through an RBI portal known as e-Kuber.
 Scheduled commercial banks are bound to maintain the stipulated Cash reserves under
42 in an account with RBI.
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16. (iv) Lender of last resort
When banks exhaust all other means for raising funds for their operations, they fall back on RBI as a source
for finance as provided under the RBI Act. Hence RBI is known as Lender of last resort.
RBI grants financial accommodation to banks in terms of section 17(2), (3) and 3 (A) “sale, purchase and
rediscount of eligible bills” as well as loans and to advances banks under section 17(4) of RBI Act.
Rediscount of bills with RBI by banks are confined to the following categories :
 Bonafide Commercial bills
 Bills related to financing agriculture operations or marketing of crops:
 Bills that are associated with Cottage and Small Scale Industries
 Bills representing holding or trading in Government Securities
 A foreign bill
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17. (v) Loans and Advances
Section 17(4) of the RBI Act empowers Reserve Bank to grant loans among others to, Scheduled Banks,
Co-operative Banks, and State Financial Corporations loans and advances, repayable on demand or on the
expiry of fixed periods not exceeding ninety days
Such loans and advances are granted against the securities of
 stocks, funds and other (than immovable property) securities
 Gold or silver or documents of title to these
 Promissory Notes or Bills of Exchange eligible for purchase or rediscount by RBI or guaranteed by State
Government regarding repayment of principal and interest due on them
 Promissory notes of any scheduled bank or State Co-operative Bank.
Further by means of Section 17(3-A) of the RBI Act, RBI grants financial accommodation at concessional
on export oriented bills, repayable on demand or a fixed period which mature in not exceeding 180 days
based on declarations from banks.
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18. (V) Controller of Credit
As Bank credit extended by various banks has its own impact on the economy,
of the key functions for which RBI was constituted was to manage the credit for
advantage of the country.
RBI exercises control over the credit extended by banks through specific
instruments on account of wide powers granted to it by RBI Act as well as Banking
Regulation Act, 1949.
Dr. Shaifali Mathur

19. Managing the external value of Rupee (i.e. Managing Foreign Exchange)
Under section 40 of the RBI Act, there is an obligation on the part of RBI to buy or sell foreign
exchange from or to an Authorised Person based on the exchange rate .
 The Authorised Persons are those who are licensed to buy or sell foreign exchange under
Foreign Exchange Management Act, 1999 (FEMA)
The main objective of exchange rate management by RBI is to ensure that exchange rate of
Indian rupee reflects the strong economic fundamentals of the country.
Also,to maintain of external value of Indian Rupee:
 to reduce excess volatility in exchange rates,
 to help maintain an adequate level of foreign exchange reserves,
 to facilitate the development of a healthy foreign exchange market.
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20. Collection and furnishing of Credit Information
Section 45(B) of the RBI Act empowers the RBI to collect credit information regarding
from banks and under Section 45(D) to furnish the same to other banks against request in
writing and payment of a nominal fee.
The term Credit information includes
i. the amounts and the nature of loans or advances and other credit facilities granted,
ii. the nature of security taken from any borrower for credit facilities granted,
iii. the guarantee furnished by a bank for any of its customers,
iv. the means, antecedents, history of financial transactions and the credit worthiness of any
borrower,
v. v. any other information which the Bank may consider to be relevant for the more orderly
regulation of credit or credit policy.
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21. SELECTIVE CREDIT CONTROL (UNDER SECTION 21 AND SECTION 35A OF BANKING REGULATION
ACT)
To control speculative holding of essential commodities by traders who hoard the same with the
help of advances from banks and thereby stem the price rise, RBI under section 21 and section
35A issues directives to banks containing restrictions in financing against selective commodities.
The directives of RBI to banks contain-
i. Purpose for which advances can be made.
ii. The margins to be maintained on secured advances.
iii. The maximum amount of Advances that can be extended to any constituent.
iv. The interest rate to be charged, as well as other terms and conditions for extending
advances.
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22. In the past advances against price sensitive commodities such as food grains, cotton, kappas, oils
seeds(grown indigenously such as ground nut, rapeseed, mustard, cottonseed, linseed and castor seed)
and their respective oils, all imported oils, vanaspati, sugar, kandasari and jaggery (gur) and cotton
textiles including man-made fibres, yarn and fabric made out of man-made and Cotton fibres were
subject to strict guidelines under Selective Credit Control.
Over a period due to Economic liberalization and improvements in economic environment, several of the
aforesaid commodities have been taken out of Selective Credit Control mechanism of RBI. Presently the
following are under Selective Credit Control coverage:
i. Buffer stock of Sugar with Sugar Mills.
ii. ii. Unreleased stocks of sugar with Sugar Mills representing levy sugar as well as free sale sugar.
RBI has specified 0% margin on buffer stocks of sugar and 10% on unreleased sugar with sugar mills
representing levy sugar.
Dr. Shaifali Mathur

23. Dr. Shaifali Mathur
Government as a Regulator of Banks
Directly or indirectly under the RBI Act, 1934 as well as The Banking Regulation Act, 1949, the
Government of India, enjoys extensive powers in the banking domain in India. This is primarily due to the
following:
i. The Government of India is the owner of RBI as it holds the entire share capital of RBI.
ii. Power to appoint Governor and the Board members of the Central Board, as also removing them is
vested in the Government.
iii. Wherever necessary Government has powers to issue special directions to banks in consultation with
RBI.
iv. The Government also enjoys the status of appellate jurisdiction vis-à-vis RBI in the matters of removal
of managerial persons, cancellation of banking licence, refusal of issuance of certificate regarding floating
charge on assets.
v. Besides these, the Government has powers to suspend the operation of the BR Act, 1949 or grant
exemption from the applicability of the provisions of the same on the basis of recommendations of RBI.

24. Dr. Shaifali Mathur
vi. The Government has power to determine the forms of business a banking company can
do under Sec. 6(1) of the BR Act.
vii. Powers to make rules under Sec 52 and 45 Y are also reside with the Government.
viii. The Government also enjoys numerous powers for permitting formation of subsidiary for
some business activities, notifying banks for maintenance of assets under Section 24, with
reference to accounts and balance sheet, direction for inspection of banks, acquire
undertakings, appointment of court liquidator, suspension of business, amalgamation of
banks etc.

25. Dr. Shaifali Mathur