CONTENTS

CONTENTS

Foreword

Acknowledgements

Chapters Description

1

Evolution of Central Banking Globally and in India

2

Legal Framework for Reserve Bank Functions

3

Monetary Policy Framework

4

Market Operations

5

Financial Stability

6

Overview of the Indian Financial System

7

Regulation of Commercial Banks

8

Supervision of Commercial Banks

9

Regulation and Supervision of Co-operative Banks in India

10

Regulation and Supervision of Non-Banking Financial

Companies in India

11

Enforcement in RBI

12

Development and Regulation of Financial Markets

13

Payment and Settlement Systems

14

Currency Management

15

Banker to Banks and Governments

16

Public Debt Management

17

Understanding RBI Balance Sheet

18

Foreign Exchange Management

19

Foreign Exchange (Forex) Reserves

20

Consumer Education and Protection

21

Financial Inclusion and Development

22

Development of Institutions

23

Research, Surveys and Data Dissemination

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98 103 122 132 148 157 162 175 184 190 197 207 210

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Foreword

The importance of central banks has increased manifold in the last decade with such institutions taking a proactive lead in responding to situations and circumstances that have a bearing on financial stability, supporting respective economies during the global financial crisis of 2007-08 and more recently in dealing with the scenario emerging out of Covid-19 pandemic.

The role of Reserve Bank of India (RBI) has also evolved with several dimensions added (recent addition as regulator for HFCs, for example), several reforms and reformations, modification and re-designing of functional domains and creation of new Departments/verticals since its establishment on April 1, 1935. It is in this context that Reserve Bank Staff College as the premier Training Institution of RBI, has constantly tried to document the functions and working of RBI in its most current form. Discerning readers and scholars may recall that the last compilation was brought out in the year 2017, which was an update on the previous publications brought out in the year 2010.

What has necessitated this review and update are several factors which include some very rapid developments in central banking activities and reorganization of departments and divisions within RBI in the intervening period. A case in point are the recent additions/modifications to functional domains in the form of creation of Enforcement Department, the new Supervisory and Regulatory verticals etc. Further, the emphasis in the newer version has shifted more to the functional aspects and thus we have removed references to certain regulations which have since been over-written by new ones(manner of resolution of stressed assets, changing norms on Priority Sector Lending etc) so that the content remains sturdy and stable over longer periods of time. Other significant changes that have been covered in the revised version include introduction of new rupee liquidity management tools by RBI, reconstitution of Financial Stability and Development Council (FSDC), amendments in chapter-III of RBI Act covering changes in provisions related to NBFCs, transfer of regulation of Housing Finance Companies to RBI, introduction of new ombudsman schemes, changes in priority sector guidelines, introduction of National Strategy for Financial Education, etc.

The updated version of this book earlier unveiled by Governor, RBI at RBSC, Chennai on January 3, 2020 and was subsequently modified in June 2020 through a vetting process by concerned CO Department(s). To fulfil the obligations under the bank's Rajbhasha Policy, this book has since been translated in Hindi as well. We hope that the new updated version will make for some valuable read and we shall also look forward to suggestions to bring in more features and updates.

R Kesavan

Principal

ii

ACKNOWLEDGEMENT Covering a wide range of fully evolved and currently evolving functions and working of Reserve Bank of India most definitely implies that an intense collaborative effort must be involved in producing Training Material of this order. Accordingly, we wish to acknowledge the sincere efforts of all Members of Faculty and all others (more specifically Rajbhasha Officers from RBSC and RO, Chennai, who worked on the Hindi translation) involved in the process, without whose help we would not have been able to bring out an updated version of the book. 2. The meticulous efforts of Members of Faculty of the Reserve Bank Staff College in updating individual chapters is heartily appreciated. The untiring efforts and hard work rendered by the editorial team, consisting of R Sathish, Satish Chandra Rath, M K Subhashree, Edwin Prabu A and Hema Chatterjee are worthy of special mention. But for their determination, hard work and discipline, this version would not have materialised. Smt R Suma, Rajbhasha Officer (RBSC), Smt Mayalakshmi, Shri Pandarinath and Shri Shyam Sunder, Rajbhasha Officers from RO, RBI, Chennai who contributed significantly to the Hindi version, also deserve our gratitude. 3. Needless to mention, there would be changes and updates in the manner we operate and function as a full service Central Bank and there would always scope to update further and improve the effort. We shall, therefore, look forward to reader's suggestions in this regard which may be mailed to principalrbsc@.in.

R Kesavan Principal

iii

Chapter 1: Evolution of Central Banking Globally and in India

"THERE have been three great inventions since the beginning of time: fire, the wheel and central banking" ? Will Rogers

The evolution of central banks can be traced back to the seventeenth century when Riksbank, the Swedish Central Bank was set up in 1668. The Bank of England was founded in 1694. The Central Bank of the United States, the Federal Reserve established in 1914, was relatively a late entrant to the Central Banking arena. The Reserve Bank of India, India's central bank started operations in 1935. At the turn of the twentieth century there were only eighteen central banks. Today, most of the countries have a central bank.

Central banks are not regular banks. They are unique both in their functions and their objectives. In the beginning, central banks were established with the primary purpose of providing finance to the government to meet their war expenses and to manage their debt. They were initially known as banks of issue with the term central banking coming into existence only in the nineteenth century. They were founded as "special" commercial banks and would evolve into public-sector institutions much later. The "special" nature of these banks was based on government charters, which made them not only the main bankers to the government but also provided them monopoly privileges to issue notes or currency. Central banks also held accounts of other banks even as they engaged in normal commercial banking activities. Given their "special" status and their size, they soon came to serve as banker to banks facilitating transactions between banks as well as providing them banking services.

The eighteenth and nineteenth century witnessed several financial panics. Panics are a serious problem as failure of one bank may lead to failure of others. Banks are susceptible to panics or "runs" as more popularly known, due to the nature of their balance sheets. Their liabilities are short-term and liquid (banks' major liabilities are demand deposits, which means depositors can ask their money back anytime they want and therefore immediately payable) and the assets are long-term and illiquid (in the sense that it is not easy to sell them and convert into cash quickly). Banks engage in this so-called maturity or liquidity transformation to allocate society's available pool of resources effectively between savers and borrowers. The failure of banks and its potential adverse impact on the real economy was and is a serious concern for all policymakers. In 1873, Walter Bagehot, an editor of the Economist magazine, published a book titled "Lombard Street" where he clearly articulated that to avoid panics, central banks should assume the role of "lender of last resort". The doctrine, which came to be known as Bagehot's dictum states that a central bank, in periods of panics or crisis, should lend freely, against quality collateral and at a penal rate of interest. The idea being, a bank that is facing a "run" by its depositors or other lenders can tide over temporary liquidity problem in the stress period, by borrowing from the central bank against collateral. It can pay off the depositors and buy some time before things calm down. Given bank runs are selffulfilling prophecies, if the banks can navigate this period without becoming insolvent, a crisis could be averted. The very fact that the bank was able to meet the withdrawal demands would

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