The Reserve Bank of India was instituted in 1935 after the parliament passed the Reserve Bank of India Act 1934. As enunciated in the preamble of the RBI Act 1934, the Reserve Bank is the apex bank of India which has been incorporated to manage and synchronize the monetary and the financial system of India. RBI is responsible for controlling the money supply and the credit flow in the economy. It has been delineated with an exclusive power to issue Indian currency. It not only aims at striking a balance between money supply and credit facilities but it also acts as a supervisor over all the other banking firms operating in India. All the banks are subordinate to the Reserve Bank of India and they are bound by the guidelines and directives issued by RBI for enforcement of its powers and functions.
The RBI Act 1934 focuses on expounding the roles, powers, and functions assigned to the apex bank of India. This act further elucidates the procedures and penalties imposed by the central bank over the subordinate banks. Thus, this act focuses on what shall be the powers of the central bank and how those powers shall be enforced. The present article shall focus on digging into the salient provisions of the RBI Act of 1934. This article will also ponder upon the independence of RBI.
Salient Provisons of the RBI Act 1934
Provisions regarding Incorporation, Capital, Management; and Business
Chapter II of the act i.e. Sections 3 to 19 deals with the provisions relating to incorporation and management of the central bank.
- Nature of the institution – Section 3 elucidates the fact that this bank has been instituted as a corporate body having a separate legal entity with perpetual succession which can sue and can be sued under this name. The capital of the bank is fixed at Rupees 5 crore. And further, it can establish various offices at different places in India or elsewhere with the prior permission of the central government of India.
- Board composition – Section 7 of this act provides for the appointment of a central board of directors to manage the day to day operations of the bank and Section 8 explains the composition of this board. This board is headed by the governor of the bank as may be appointed for a tenure of 5 years by the central government. The central government shall also appoint not more than four deputy governors; four directors from each of the four local boards set up under Section 9 of this act; ten nominated directors by the central government and two nominated government officials. Directors have a tenure of four years and they are eligible for reappointment not exceeding two successive terms. Section 9 provides for the composition of local boards for all the areas included in the First Schedule. The local boards aim at providing aid and advice to the central board.
- Disqualification and removal of members of the board are dealt with under Section 10 and Section 11 of this act respectively.
- Meetings of the board – The central board shall meet at least six times a year and at least once in every quarter. If a member of the central board is absent from three consecutive meetings without the prior permission of the central board, then he may be removed from his office by the central government.
- Business and transactions – Section 17 is one of the most important sections of this act. This section enumerates the various business transactions which the central bank is authorized to do within its ambit. The various transactions namely are:
(i) It has the exclusive authority to issue the Indian currency.
(ii) It acts as a banker to the government where it maintains the cash balance of the government. It can accept deposits, receipts, make payments, and conduct other banking operations on the behalf of the government.
(iii) It can accept money deposits from the government and advance loans to the government when needed.
(iv) it can purchase, sale and rediscount bills of exchange and promissory notes drawn on or payable in India.
(v) it can purchase foreign exchange and sell it to commercial banks.
(vi) it can provide advances to other banks and financial corporations.
(vii) it has the authority to sell and purchase government securities.
(viii) it regulates the money supply by modulating bank rate, the repo rate, reverse repo rate, open market operations, cash reserve ratio, statutory liquidity ratio, selective credit control, and varying margin requirements.
6. Prohibited transactions – Section 19 of this act names the various transaction that this bank cannot undertake such as it cannot directly invest in any commercial or industrial enterprise; it is prohibited to buy shares of any banking company or provide advances on such shares; it does not have the authority to advance money on mortgage of immovable property; make an advance, and allow interest on current accounts.
Powers and Functions of the RBI
Chapter III of this act enunciates the essential functions of the Reserve Bank of India. The various important functions can be enumerated as under:
- As stated in Section 20 and Section 21 of this act, the first and foremost function of the central bank is to act as a banker of the union government and conduct all the banking operations on the behalf of the central government including acceptance of deposits, making of payments, receipts of money and management of public debt. In addition to this, Section 21A provides that this bank may also carry the financial operations of a state upon an agreement between the two.
- Another important role of the central bank is that of a ‘bank of issue’. This bank has been ceded with the sole authority to issue currency upon the recommendation of the union government. However, one rupee note and coins are not issued by this bank. These are issues by the ministry of finance. The task to issue currency is dedicated to the issue department which is completely distinct from the banking department. Also, this bank is not liable to pay stamp duty on the issue of currency notes.
- Section 40 of this act defines the central bank as a guardian of the foreign exchange reserves. The central bank is responsible to maintain the foreign exchange rate. It buys and sells foreign currencies in the market to maintain the value of the currency internally and externally.
- It functions as a banker’s bank and a supervisor. It provides financial aids to its subordinate banks when needed and all the subordinate banks are bound by the directives issued by the reserve bank of India. It is also responsible to conduct periodic inspections of all the banking firms operating in the country.
- This bank acts as the controller of credit and money supply. It uses various quantitative and qualitative measures to achieve a balance between the flow of credit and money supply in the economy.
- The central bank has the authority to collect and furnish credit information from banking companies. As per Section 5 of the Banking Regulation Act, 1949, banking companies include the State Bank of India or any subsidiary bank defined under State Bank of India or any new bank incorporated under Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 or any other financial institution recognized by the union government on this behalf.
RBI vis-a-vis Non-Banking Financial Institutions : Powers and Functions
RBI regulates the operations of the non-banking financial institutions under the Companies (Acceptance of Deposits) Rules, 1975. These institutions are called NBFC i.e. non-banking financial companies. For the management and regulating of these NBFC’s, the central bank issues several directives such as NBFCs (Reserve Bank) Directions, 1977; The miscellaneous Non-Banking Companies (Reserve Bank) Directions, 1977; The residuary Non-Banking Companies (Reserve Bank) Directions, 1987 and; The Housing Finance Companies (National Housing Bank) Directions, 1989. RBI has fixed the upper limit of deposits which can be accepted by these companies which is generally 10% of their net owned fund. RBI directs these companies to maintain a 10% cash reserve ratio. In addition to this, these companies are required to issue periodical returns of their operations to the RBI. It has the power to call from information from such companies and issue directions. The RBI is authorized to conduct timely inspections of these NBFCs as well as hear complaints against these companies. In case the central bank is not satisfied with the functioning of an NBFC, it can initiate a winding-up petition for the same as stated in Section 45MC.
Role with regards to Monetary Policy
The inflation target in terms of the consumer price index is fixed once every five years. RBI is accountable to achieve the inflation target. Inflation target refers to a system wherein the central bank makes sure that the price keeps on rising until a certain range so that the people may buy goods now before they become costly in the coming future. For this, a monetary policy committee is constituted. The bank has to publish the conclusion and the resolution taken after every meeting of the monetary policy committee and a monetary policy report is published once every 6 months. If the central bank fails to achieve the inflation target then it must address the reasons for such failure, remedial measures, and an estimated period within which the target can be achieved.
It aims at protecting and developing equal monetary opportunities for the rural as well as the urban sectors. However, through selective credit control policies, the central bank aims at empowering the flow of monetary resources to the rural and agricultural sectors.
Chapter V, Section 58B of this act provides for the penalties that can be imposed by RBI on various offenders. The penalties imposed are mainly like fines.
This schedule enlists the sub-areas divided under four areas namely western, eastern, northern, and southern areas where the local boards are to be constituted for Section 9 of this act.
There are two types of banks namely scheduled banks and non-scheduled banks. Where scheduled banks are governed by the directives of RBI, the non-scheduled banks are not included in the second schedule of this act and hence are not bound to follow the guidelines issued by RBI. The second schedule includes the list of various scheduled commercial banks in India. There are a total of 225 scheduled banks in India some of which are UCO Bank, Punjab National Bank, Syndicate Bank, State Bank of India, Union Bank of India, RBL Bank Limited, Oriental Bank of Commerce, Vijaya Bank, Standard Chartered Bank, and others
Independence of Reserve Bank of India
The question of the independent status of the central bank of India arises due to the provision laid down in Section 7. It is apparent from a reading of Section 7 that the central government has been granted authority to issue directions to RBI as and when necessary in pursuance of the public interest. Hence, an inference can be drawn that the functioning and management of RBI is not completely independent. Independence in operations of RBI is one of the predominant factors for effective implementation and achievement of its goals. Due to the provision of Section 7, there is always a disputing state prevalent between the bank and the government. This section was never invoked since 2018 but the government of Indian and RBI have been in dispute over certain major issues such as tight credit controls, classification of non-performing assets, and arranging a payment mechanism independent of the central bank. This section all in all proves to be a hindrance in the autonomous status of the central bank of India. Hence, the provision under Section 7 can be deemed to be an extreme measure for curbing differences between the government and the central bank. It will hamper the long-term financial stability of the country.
- RBI Act 1934, available at RESERVE BANK OF INDIA ACT, 1934 (last visited on 12 December 2020)
- RBI Act 1934 (Act of 2019), s.4.
- RBI Act 1934 (Act of 2019),s.6.
- RBI Act 1934 (Act of 2019)
- RBI Act 1934 (Act of 2019), s.13.
- G. Vijayaragavan Iyengar, Introduction to Banking, p.no.155 (Excels Books, New Delhi, 2007).
- Sangeeta Ojha,”New one rupee currency notes:key things to know”, available at https://www.livemint.com/news/india/new-one-rupee-currency-notes-key-things-to-know-11581317431206.html (last visited on 12 December 2020)
- Radha Bahuguna, “Introductory Macro Economics”,(Dhanpat Rai & Co. (P) Ltd., Delhi, 2016).
- Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, s. 3.
- Control of RBI over Non-Banking Financial Companies (last visited on 12 December 2020)
- RBI Act 1934 (Act of 2019)
- RBI Act 1934 (Act of 2019), Second Schedule.
- RBI Act 1934 (Act of 2019)
- “What is section 7 of and why it is been seen as an extreme step against the RBI”, The Economic Times, 31 October 2018, available at ET explaining what is section 7 (last visited on 12 December 2020)
BY PRERNA SINGH | GURU NANAK DEV UNIVERSITY, AMRITSAR.