RBI as a Regulator | Commerce & Accountancy Optional Notes for UPSC PDF Download

Introduction

• The Reserve Bank of India (RBI), serving as the central bank of the nation, holds the primary regulatory authority within the Indian money market. Its authority stems from two key legislations: the Reserve Bank of India Act, 1934, and the Banking Regulations Act, 1949. The Reserve Bank of India Act, 1934, not only outlines the structure, management, and functions of the RBI but also grants it the power to oversee and regulate commercial banks, non-banking financial companies, and financial institutions.
• Meanwhile, the Banking Regulation Act, 1949, encompasses various provisions governing commercial banks in India, with some of these provisions extending to cooperative banks. Additionally, the State Bank of India, its subsidiary banks, and nationalized banks operate under specific regulatory frameworks dictated by their incorporation status. The subsequent sections of this unit will delve into the regulatory framework in greater detail.

Now, let's explore the primary functions carried out by the Reserve Bank of India. Established on April 1, 1935, under the Reserve Bank of India Act, 1934, the RBI, as the country's central bank, fulfills the following roles:

• Currency Issuance: The RBI is the sole authority responsible for issuing currency notes, excluding one-rupee notes and coins of smaller denominations. Within the RBI, the Issue Department handles all matters related to issuing notes, ensuring that eligible assets of equivalent value back the notes issued.
• Government Banking: Acting as the government's banker, the RBI serves the Central Government under the Reserve Bank of India Act and the State Governments under agreements. In this capacity, the RBI offers services such as deposit acceptance, fund withdrawal, fund management, and debt management on behalf of the government.
• Banker's Bank: Through various credit control measures, the RBI regulates the volume of resources available to commercial banks. This control influences banks' ability to create or restrict credit for industries, trade, and commerce.
• Supervisory Authority: The RBI oversees and regulates commercial banks, granting licenses for new bank establishments and branch openings. It also has the authority to adjust reserve ratios, conduct bank inspections, and approve the appointment of bank chairpersons and chief executive officers.
• Exchange Control: Regulating foreign exchange demands under the Foreign Exchange Management Act, the RBI ensures the maintenance of the Indian rupee's external value.
• Credit Regulation: A crucial function of the RBI is to manage the flow of credit to industries, achieved through mechanisms like the Bank Rate, Reserve Requirements, Open Market Operations, selective credit controls, and moral persuasion.

Regulations over Commercial Banks

The primary provisions of the Banking Regulation Act, 1949, which oversee commercial banks, are outlined as follows:

• Licensing Requirement: Prior to commencing operations in India, every banking company, whether Indian or foreign, must obtain a license from the Reserve Bank of India (RBI). The RBI grants a license if certain conditions are met, ensuring the company's ability to fulfill its obligations to depositors, conduct business in the interest of depositors and the public, maintain a sound management structure, possess adequate capital, and serve the public interest while not disrupting the banking system's stability.
• Branch Operations: Any banking company, whether Indian or foreign, must seek the RBI's approval before opening a new branch in India or abroad or relocating an existing branch within or outside India. The RBI considers factors such as the company's financial status, management quality, capital adequacy, and the public interest before granting permission.
• Permissible and Prohibited Activities: The Act delineates permissible activities for banking companies and prohibits them from engaging in trading activities or assuming trading risks, except those directly related to loan realization or bill collection.
• Subsidiary Establishment: Banking companies may establish subsidiaries to engage in permissible activities, banking operations outside India, or other activities deemed beneficial by the RBI to promote banking in India or serve the public interest.
• Capital Requirements: The Act sets forth minimum paid-up capital and reserves requirements for banks, with revised guidelines issued by the RBI specifying minimum paid-up capital for new private sector banks. Nationalized banks have authorized capital levels, with guidelines for issuing shares to the public and maintaining the Central Government's majority ownership.
• Liquidity Maintenance: Banking companies are mandated to maintain a specified percentage of their net demand and time liabilities as liquid assets in India. The RBI has the authority to adjust this Statutory Liquidity Ratio (SLR) and determine the mode of asset valuation.
• Asset Maintenance: Banking companies must ensure that their assets in India constitute at least 75% of their demand and time liabilities.
• Inspection Authority: The RBI has the power to inspect banking companies and their records, either at its own discretion or at the Central Government's behest. Based on inspection findings, the Central Government may take action if it deems the company's affairs detrimental to depositors' interests.
• Regulatory Directions: The RBI may issue directives to banking companies, either in the public interest or to safeguard depositors' interests or ensure proper management. Banks are obligated to comply with these directives.
• Management of Banks: The composition of the Board of Directors for private sector commercial banks must adhere to the stipulations outlined in the Banking Regulation Act, 1949. Section 10A specifies that the Board of Directors must consist of no less than 51% of individuals meeting the following two criteria:
  • Possession of specialized knowledge or practical experience in fields such as accountancy, agriculture, rural economy, banking, co-operation, economics, finance, law, small-scale industry, or related areas.
  • Absence of substantial interests in, or connections with, companies or firms engaged in trading, commercial, or industrial activities (excluding those associated with small-scale industries or companies registered under Section 25 of the Companies Act).
• The Reserve Bank of India (RBI) is empowered to direct banking companies to reconstitute their boards if they fail to meet the aforementioned requirements. The RBI can also remove directors and appoint suitable replacements. Additionally, an individual cannot serve as a director of two banking companies simultaneously, nor can they hold such a position if they are a director of companies exercising voting rights exceeding 25% of the total voting rights of all shareholders of the banking company.
• Furthermore, the Act mandates that the Chairman of a banking company possess specialized knowledge and practical experience relevant to banking, finance, economics, or business administration. However, they must not hold directorships in companies, partnerships in firms, or substantial interests in any company or firm. If the RBI deems the appointed Chairman unfit for the position, it can request the bank to elect a different person. Failure to comply may result in the RBI's authority to remove the Chairman and appoint a suitable replacement.
• The appointment, reappointment, or termination of a Chairman, Director, or Chief Executive Officer requires the RBI's approval. The RBI can also dismiss top managerial personnel if it deems necessary in the public interest or to prevent detrimental conduct to depositors' interests. Additionally, the RBI has the authority to appoint up to five Additional Directors or one-third of the maximum board strength, whichever is less.
• In the case of nationalized banks, the composition of the Board of Directors follows the provisions of Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, or 1980. This involves appointments from RBI officials, the Central Government, other financial institutions, as well as officers and workers of the bank. Additionally, the Central Government nominates six Directors, and shareholders, excluding the Government, elect two to six directors. These Directors must possess expertise or practical experience in relevant fields, similar to the requirements for private bank Directors. The RBI has the authority to remove any Director elected by shareholders if they fail to meet the specified criteria.
• Nationalized banks are obligated to comply with directives issued by the Central Government concerning matters of policy affecting public interest, following consultations with the RBI Governor.
• Control over Advances: Under Section 21, the Reserve Bank of India (RBI) possesses extensive authority to issue directives to banking companies regarding advances. These directives may pertain to the purposes for which advances may be granted, margins for secured advances, maximum amounts for individual advances, limits on guarantees provided by banks, and interest rates and terms for advances or guarantees. Directives related to advances secured by specific commodities are termed Selective Credit Control Directives, and banking companies are obligated to adhere to them.
• Restrictions on Loans and Advances: Banking companies are prohibited, under Section 20, from sanctioning loans and advances with their own shares as security. Additionally, restrictions are imposed on loans granted by banks to individuals interested in bank management.
• Maintenance of Cash Reserve with Reserve Bank: Section 42 of the Reserve Bank Act, 1934 mandates every scheduled bank to maintain an average daily balance with the Reserve Bank of India, amounting to no less than 3% of the bank's net demand and time liabilities in India. The RBI has the authority to increase this ratio up to 20% of the net demand and time liabilities. Failure to maintain the required cash balance may result in penalties as specified in the Act. This requirement applies to all scheduled banks, commercial banks, state co-operative banks, and Regional Rural Banks.
• As of December 29, 2001, commercial banks are required to maintain a Cash Reserve Ratio (CRR) of 5.5% of their net demand and time liabilities for the second preceding fortnight. This was reduced from 7.5% to 5.5% effective that date and further reduced to 5% as of June 1, 2002. The RBI pays interest on eligible cash reserves based on the Bank Rate (currently 6.5%).

Regulations over Co-operative Bank

• The category of cooperative banks encompasses central and state cooperative banks, as well as urban cooperative banks. These banks operate as organized cooperative societies and are registered and governed by the respective State Governments under their Cooperative Societies Act. Therefore, matters such as registration, administration, recruitment, liquidation, and amalgamation fall under the control of State Governments. However, as these banks undertake banking functions, certain provisions of the Banking Regulation Act, 1949 are also applicable to them. Consequently, the Reserve Bank of India regulates them concerning banking-related matters.
• Supervision and control by the Reserve Bank over urban cooperative banks are comparatively weaker. These banks face dual control, posing a persistent challenge. Nonetheless, the Reserve Bank has established prudential norms concerning income recognition, asset classification, and provisioning for urban cooperative banks. Similar to commercial banks, exposure norms have also been prescribed for urban cooperative banks.

Regulations over Non-Banking Finance Companies 

• Non-Banking Finance Companies (NBFCs) play a vital role in India's financial intermediation landscape. They complement the services offered by traditional banking institutions by catering to borrowers who may not have access to traditional banking services and by mobilizing savings from depositors. NBFCs include hire purchase finance and leasing companies, loan and investment companies, and housing finance companies.
• Given their significant role, a regulatory framework has been established to safeguard the interests of depositors. Chapter III B of the Reserve Bank of India Act, 1934 provides the regulatory framework for NBFCs. Substantial amendments were made to this chapter in January 1997, granting more powers to the Reserve Bank of India to regulate NBFC activities. The provisions of Chapter III B, along with important directives issued by the Reserve Bank of India, are outlined below.

Reserve Bank of India Act, 1934:

The Reserve Bank of India Act grants the following powers under Chapter III B:

• Regulation or prohibition of prospectus issuance: The RBI may regulate or prohibit the issuance of prospectuses or advertisements soliciting deposits from the public by NBFCs. The RBI can also provide directions regarding the particulars to be included in such advertisements.
• Collection of information and issuance of directions: The RBI can direct NBFCs to provide information or particulars regarding the deposits they receive. Additionally, the RBI can issue directions to NBFCs on matters related to deposit receipt. Failure to comply with these directions may result in the prohibition of deposit acceptance by the NBFC.
• Inspection: The RBI has the authority to conduct inspections of NBFCs at any time to verify the accuracy and completeness of information provided to the RBI or to obtain any such information if not submitted.

Directions for NBFCs Accepting Public Deposits (Reserve Bank):

Under Chapter III B, the RBI issued directions to NBFCs regarding the acceptance of public deposits. These directions were revised significantly in January 1998 to incorporate prudential norms. Key features of the RBI Directions include:

• Classification of NBFCs into categories based on their acceptance of public deposits.
• Definition of public deposits and exclusion of certain types of funds from this definition.
• Imposition of ceilings on public deposits for NBFCs based on their Net Owned Funds (NOF).
• Prescription of maximum permissible interest rates on public deposits.
• Submission of annual statutory returns and financial statements to the RBI by NBFCs accepting public deposits.

Prudential Norms for NBFCs:

The RBI issued guidelines in June 1994 prescribing prudential norms for NBFCs. These norms include:

• Income recognition: NBFCs should not record income due but not received within six months.
• Asset classification: NBFCs should classify assets as non-performing if payment is overdue.
• Capital adequacy: Minimum capital adequacy requirements have been stipulated for NBFCs.
• Credit/investment concentration norms: Limits have been set on credit and investment concentrations to mitigate risks.
• Liquid assets: NBFCs must maintain a certain percentage of deposits in liquid assets to ensure liquidity and protect depositors' interests.

Overall, the Reserve Bank of India has established a comprehensive regulatory framework for NBFCs to ensure their stability and protect the interests of depositors.