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AHSEC - Class 12: Banking Notes | Reserve Bank of India for Feb' 2021 Exam | 30% Reduced

AHSEC CLASS 12 NOTES FOR 2021 EXAM
SUBJECT: BANKING
Unit – 2: Reserve Bank of India

Short Questions and Answers (1/2 Marks each)

1. In which year the RBI act was passed?

Ans: The RBI act was passed in 1934.

2. In which year RBI came into existence or established?             2012

Ans: The RBI came into existence on April 1935.

3. In which year the RBI nationalized or becomes a state owned institution?

Ans: The RBI was nationalized under the Reserve Bank (Transfer to public ownership) Act 1948, on January 1, 1949.

4. How many members are there in the Central Board of the director of the RBI?             2014, 2014

Ans: There are 20 members in the Central Board of Directors.  Its head office is located in Mumbai.

5. How many local Boards are there in the organizations structures of RBI?

Ans: Four local boards located at Kolkata, Mumbai, New Delhi and Chennai.

6. Who appointed the Governor and the deputy governor of RBI?           2015

Ans: The Central Government for 5 years.

7. Who is the chairman of the Central Board?

Ans: The Government is the chairman of the Central Board.

8. Expand SLR and CRR.                 2013, 2014, 2016, 2019

Ans: SLR: Statutory Liquidity Ratio and CRR: Cash Reserve Ratio.

Statutory Liquidity ratio of the total deposits of a bank which it has to maintain with itself in the form of liquid funds like government securities and cash in hand at any given conditions and point of time. Present SLR is 19.25%.

All the banks operating in a country, beside, cash in hand must maintain statutory cash reserve in the Reserve Bank of India against their time and Demand liabilities which is called cash reserve ratio. The Cash Reserve Ratio (CRR) refers to the portion of total deposits of a commercial bank which it has to keep with the RBI in the form of cash reserves. Present CRR is 4%.

9. Which department of the RBI is responsible for issuing currency notes?

Ans: The issue department of the RBI is responsible for issuing currency notes. 

10. What is the minimum reserve kept by the RBI to issue currency notes?

Ans: Minimum reserves of Rs. 200 crore to issue note out of 200 crore Rs. 115 crore is kept in gold coins and bullion.

11. In which year the RBI adopted the minimum reserves system of note issue?              2015

Ans: In 1956.

12. What types of currency notes issued by the RBI?                      2013

Ans: The RBI issue currency notes of Rs. 2, Rs. 5, Rs. 10, Rs. 20, Rs. 50, Rs. 100, Rs. 200, Rs. 500 Rs. 2000 denominations. The One Rupee notes are issued by the Minister of Finance, Government of India. 

13. What are the principles of issuing notes?

Ans: The three principles of issuing notes are Uniformity, Elasticity and Security.

14. The RBI was originally set up a private bank/Public Sector Bank.

Ans: Private Bank

15. Which principle is followed to constitute various departments in RBI?

Ans: ‘Functional specialisation’

16. What is credit authorization scheme?

Ans: Credit authorization scheme was introduced in 1965 by RBI under which every scheduled bank is required to obtain prior approval of RBI before granting any fresh credit exceeding Rs. 1 crore which was increased to Rs. 2 crores in 1975.

17. How does commercial bank help in execution of Monetary Policy?                 2020

Ans: Commercial bank help in execution of monetary policy by maintaining CRR and SLR. They also follow the RBI guidelines for granting loans and advances.

18. Write a note on RBI’s role in Bank Inspection.            2020

Ans: Inspection of Bank is done by Officers of Reserve Bank of India as per Banking Regulation Act 1949 and some other laws of Government of India. The main job of the Inspecting Officers of RBI is to check the Authenticity of the Audit Report. They also carry some extra work other than carried out by CAs.

Long Answer Type Questions (Marks: 3/5/8)

Q.1. What do you mean by a Central Bank? Explain the nature of central bank.

Ans: Central Bank: The central bank is the supreme monetary institution of any country. It is a national bank which provides banking services to the government and commercial banks. It also helps in implementing monetary policy of the government and issuing currency. It is established, owned, controlled and financed by the govt. of the country.

In the words of R.S. Sayers, “It is a bank which controls the commercial banks in such a way as to promote the general monetary policy of the country.”

India’s central bank is called the Reserve Bank of India. It is the apex monetary institution of India (2017). Reserve Bank of India was established on April 1, 1935 under schedule II of the Reserve Bank of India Act, 1934. Originally it was constituted as private banks with a share capital of Rs. 5 Crores. Entire share capital was owned by the private individuals. After independence, it was decided to nationalize the Reserve Bank of India and it was nationalized under the Reserve Bank (Transfer to public ownership) Act 1948, on January 1, 1949. From January 1, 1949 the RBI started functioning as a state owned and state controlled central bank. The nature of Central Bank is as follows:

a)      It is the head of all the banks of India. It is the supreme monetary institution of the country.

b)      They always work for national welfare of a country. They do not aim at earning profits.

c)       It is established, owned, controlled and financed by the govt. of the country.

d)      It does not compete with other financial institutions in the market.

e)      The RBI acts as the banker, agent and advisor to the Government of India and State governments.

Q.2. Write a brief note on Organisation Structure and Management of RBI.

Ans: The Reserve Bank was set up as corporate body. The organizational structure of the Reserve Bank is provided by the Reserve Bank of India Act, 1934. It comprises of the: (a) Central Board and (b) Local Boards.

Central Board: The Central Board of Directors is the supreme governing body of the Bank. It consists of 20 members. The members include the following:

1)      A Governor and not more than four Deputy Governors to be appointed by the Central Government.

2)      Four Directors to be nominated by the Central Government, one each from the four local boards.

3)      Ten Directors to be nominated by the Central Government. They are experts from the fields of business, industry, finance and co-operation.

4)      One Government Official (Secretary, Ministry of Finance) to be nominated by the Central Government.

The power of the Board vests with the Governor who is the Chief Executive Officer of the Bank. The Governor has the responsibility of directing the affairs and business of the Bank. The Governor and Deputy Governors hold office for a period of 5years and are eligible for the reappointment. The Governor in his work is assisted by four Deputy Governors and four Executive Directors. The executive directors are not the members of the Central Board but attend Board meetings by invitation. They are subordinate to Deputy Governors.

Local Boards: Apart from Central Board of Directors, four Local Boards are constituted representing each area specified in the first schedule to the Act. There is a Local Board in Eastern, Western, Northern and Southern regions of the country with headquarters at Kolkata, Mumbai, New-Delhi and Chennai.

Local Board consists of five members, each appointed by the Central Government. In each Local Board, a Chairman is elected from amongst the members. The members of the Local Board hold office for a period of four years and are eligible for reappointment.

Q.3. Why is the establishment of Central Bank necessary in a country? Or What are the objectives of RBI?

Ans: The Central Bank plays a vital role in economic development of a country. It controls the whole monetary and banking system of a country. It acts as a lender of the money market and supervises controls and regulates the activities of all commercial banks and other financial institutions. A Central Bank is necessary in a country because of the following reasons:

a)      To maintain monetary stability in the country.

b)      To successfully implement the monetary policies of the govt. of the country.

c)       To regulate the overall volume of credit money in the economy so as to maintain price stability.

d)      To maintain financial stability and ensure sound financial institutions.

e)      To issue currency notes in a country.

f)       To meet the financial requirements of the various sectors of the economy.

g)      To promotion of the foreign trade of the country through various policies.

h)      To promote the development of financial market and systems.

i)        To establish monetary relations with other countries of the world and international financial institutions.

j)        To set up government banks.

k)      To manage public debt.

Q.4. List out various departments of RBI.              2012, 2016

Ans: DEPARTMENTS OF THE RBI: To ensure smooth and efficient functioning of the Bank the RBI has been divided and sub-divided into various department which are as follows:

1.       Issue department: The issue department is concerned with the proper and efficient management of the note issue.

2.       Banking department: The banking department is responsible for providing the banking services to the Government and to the banks.

3.       Exchange control department: The exchange control department is concerned with the purchase and sale of foreign exchange and maintaining stability in foreign exchange rates.

4.       Department of banking operations and development: This department is entrusted with the responsibility of the supervision, control and development of the banking system in the country.

5.       Agricultural credit department: This department looks into the problems of agricultural sector. It provides facilities of rural credit to state governments and state cooperative societies.

6.       Department of non-banking companies: This department administers and controls as well as regulates working of non banking financial companies.

7.       Legal department: It renders legal advice on various matters referred to it by the bank.

8.       Inspection department: It carries out internal inspection of the offices and department of the banks.

9.       Premises department: It is mainly concerned with the construction and maintenance of buildings for the Bank’s office, training institutions and staff quarters.

10.   Reserve Bank and India service board: It is concerned with conducting of examination/interviews for the selections and promotion of staff in the RBI.

11.   Department of accounts and expenditure: It maintains various records relating to the receipts and expenditure of RBI.

12.   External investment and operations: It undertakes investment into the securities of corporate sector or Government.

Q.5. Explain central banking functions of RBI or traditional functions?   2013, 2015, 2016, 2017, 2018, 2019

Ans: The functions of RBI are:

1.       Note Issue: The reserves bank of India is the sole authority for the issue of currency in India other than one rupee coins/notes and subsidiary coins. The RBI has adopted the minimum reserves system of note issue to issue currency notes in the country. Under this system the RBI maintains a minimum reserve of Rs. 200 crore of which Rs. 115 crore is in gold and the rest in securities. The issue department of RBI has the responsibility to issue paper money. It is responsible for getting its periodical requirements of notes printed from the currency presses of the Government of India, distribution of currency among the public and withdrawal of unserviceable notes and coins from circulation. The Issue Department deals directly with the public in exchange of currency for coins and vice versa and exchange of notes of one denomination for another.

2.       Bankers to Government: The RBI acts as banker to the Central and State Government as a bankers as a adviser as a agent into their capacities:

a)      As a bankers.

b)      As an agent.

c)       As an advisor.

As a Government banker the RBI performs the following functions:-

a)      It maintains and operates deposit account of the central and state governments.

b)      It receives and collects payment on behalf of the Central and state governments.

c)       It makes payments on behalf of the central and state governments.

d)      It provides short term advances to government for which are called ways and means advances etc.

As a Government agent the RBI perform the followings functions:-

a)      Collect tax and other payments on behalf of the government.

b)      Raise loan from the public and thus manages public debts.

c)       Transfer funds and provide remittances facilities to the government etc.

As an adviser the RBI acts as an advising the Government on all financial matters such as loan separations investment, agricultural and industrial finance, banking planning etc. It also advices to promote the attainment of the national economic goals.

1.       Bankers Bank: The Central Bank is a banker to all the other banks. It is the supreme bank of all the banks. As the supreme bank it performs various functions. Some of the functions are:

a)      Custodian of cash reserve of the bank: The Central Bank acts as the custodian of cash reserve of the banks. Every Commercial bank has to keep a certain portion of their deposits and time and demand liabilities to the Central Bank in the form of cash reserves. The Central Bank maintains this cash reserve as the custodian and grants money to the commercial bank in times of emergency.

b)      Lender of the last resort (2017): The Central Bank is the Lender of the last resort of the commercial banks. When the other banks shortage of funds, then they can approach to the Central Bank for financial assistance. The Central Bank lends money to them by discounting their bills. This enables the Central Bank to establish control over the banking system of the country. The RBI is ultimate source of money and credit provide fund to money market participate thus the RBI act as lender of last resort for the commercial banks.

c)       Clearing agent (2018): In India the central clearing functions is managed by the RBI or the SBI is authorized to manage clearing house functions every day. Each commercial bank receives a number of cheques for collection from other banks on account of their customers. One bank may have to pay certain amount to another bank again the RBI will transfer fund from debtor to creditors account. Since all banks have their accounts with the RBI, the RBI can easily settle the claims of various banks each other with least use of cash. The clearing house functions of RBI are:

Ø  For settlement of banking transactions between two banks.

Ø  To helps in economizing the uses of cash by banks.

Ø  Look-over the liquidity position of the bank.

2.       Control of credit:  As a central bank, the RBI take the responsibility to control of credit in order to economic development and price stability in the country under credit control policy different method are used to control the volume of credit in the economy. Important of them are General Credit Control and Selective Credit Control.

3.       Custodian of gold and foreign exchange reserves: - The RBI act as a custodian of gold and foreign exchange reserves for both on its own and on behalf of the Government.

Q.7. Mention the Development and Promotional functions of the Central Banks.                            2020

Ans: The RBI, as a Central Bank of the Country has assumed greater responsibility as developmental and promotional agency. Its promotional functions and activities have been mainly directed towards building up and strengthening financial infrastructure and filling the institutional gap by setting up new financial institutions and by ensuring the allocation of credit in the socially desired directions. The Development and Promotional functions of the Central Banks are listed below:

a)      To promote and strengthen commercial banking in our country by taking various steps such as putting regulation on banks, setting up of deposit insurance corporation, amalgamation and consolidation of banks.

b)      To promote agricultural and rural credit by setting up and developing key financial institutions like NABARD and RRBS.

c)       To promote short, medium and long term industrial finance by setting up various institutions such as IDBI, SIDBI, SFCs, SSIDC etc.

d)      To promote exports through refinance to banks against export credit.

e)      To maintain internal price and exchange rate stable.

f)       To promote the market for investments in Govt. securities.

g)      To promote housing finance by promoting the national housing bank in 1988 to organise and augment resources for housing.

h)      To promote co-operative banking by providing funds to co-operative banks.

i)        RBI also encourages and promotes research in the areas of banking.

Q.8. What are prohibitive functions of RBI?                        2019

Ans: The prohibitive functions of RBI are:-

1)      It can neither participate non-provide any direct financial assistance to any industry, trade or business.

2)      It cannot purchase its own shares.

3)      It cannot purchase shares of any banking company or of any corporation.

4)      It cannot purchase immovable property except for the establishment of its offices.

5)      It cannot give loans on the security of shares and immovable property.

6)      It cannot give interest on deposits held by it.

7)      It cannot accept draw bills not payable on demand.

Q.9. Briefly discuss the supervisory power of RBI?

Ans: The supervisory powers of RBI are:

a)      Licensing of Banks: The RBI grants license to banks or establishing their place of business in India. The RBI is empowered to council the license of a banks if it violets any provision of the law or cases to carry on banking business.

b)      Approval of capital reserves and liquid assets of banks: The RBI ensures that each and every bank has the minimum requirement of capital reserves and liquid assets.

c)       Inspection of Banks : The RBI inspects and makes enquiries in respect of varies matters like loans and advances, deposits, investments, profit planning, man power planning, branch expansion organizational structure and the others banking services.

d)      Controls over management and methods: The RBI exercises control over the management of the banks in matters like constitution of the board of the public sector banks appointment remuneration etc.

e)      Audit: The banks are required to get their balance sheet and profit and profit and loss account duly audited by the auditors approved by the reserves bank.

f)       Control over amalgamation and liquidation: The RBI control over amalgamation and liquidation of the banks in certain cases.

g)      Implementing the deposit insurance scheme: The RBI has implemented the deposit insurance scheme for the benefit of the banks depositors.

Q.10. What do you mean by Monetary Policy and Credit Control? What are its objectives?

Ans: Monetary policy refers to the use of the official instruments under the control of the central bank to regulate the availability, cost and use of money and credit with the aim of achieving optimum levels of output and employment, price stability and balance of payments equilibrium.

Credit control is the most important function of the RBI. The capacity of the banks to create credit depends on the cash reserves available with banks which increase with rise in the deposits of the banks or vice-versa. The regulation of credit creation capacity of the commercial banks and other banking institutions by the Central Bank to achieve some definite objectives is known as Credit Control. The objectives of the Central Bank for Credit Control of the other banks are:

a)      To establish stability in the internal price level by adjusting the supply of credit.

b)      To maintain stability in the foreign exchange rates by eliminating fluctuations in the exchange rates.

c)       To eliminate cyclical fluctuations in the production, employment and prices of goods.

d)      To stabilize money market of the economy.

e)      To achieve full employment of resources and accelerate economic growth with stability.

f)       To meet the financial requirements of an economy not only during normal times but also during emergency or war.

Q.11. What are the principle methods or instruments of Credit Control used by the Central Bank? 2012, 2014, 2018

Ans: The principle methods or instruments of Credit Control used by the Central Bank are:

1)      Quantitative or General Methods

2)      Qualitative or Selective methods

1)      Quantitative or General Methods: These are the traditional or general methods of credit control. These methods one used by Central Bank to have control over the total volume of credit in the economy neglecting the purpose for which it is used. These methods are:

a)      Variation in the bank rate                     2012, 2015, 2017

b)      Open Market operations:

c)       Variation in cash reserve ratio:

d)      Variation in the statutory liquidity ratio:

e)      ‘Repo’ Transactions:

a)      Variation in the bank rate: Bank rate or discount rate is the rate at which the Central Bank of a country makes advances to the banks against approved securities or rediscounts the eligible bills. The purpose of change in the rate is to make the credit cheaper or expensive depending upon whether the purpose is to expand or control credit. An increase in bank rate result, in increase in lending rate of commercial banks lending to contraction of credit while a decrease in bank rate leads to decrease in lending rates of commercial banks lending to expansion of credit.

b)      Open Market operations: Open market operations means deliberate and direct buying and selling of securities and bills in the market by the Central Bank. The open market operations of the RBI are mostly limited to government securities. In order to increase money supply in the market, the RBI purchases securities in the open market. On the other hand, in order to contract credit, the RBI starts selling the securities in the open market.

c)       Cash reserve ratio: Every scheduled bank in India is required to maintain a minimum percentage of their deposits with the RBI. Larger the reserve, lesser is the power of the banks to create credit and smaller the reserves, greater is the power of the banks to create credit.

d)      Statutory liquidity ratio: Statutory liquidity ratio is another reserve requirement used by the RBI to control money supply. In India, besides maintaining the cash reserve, every bank has to maintain a statutory reserve of liquid assets in terms of cash, gold or unencumbered securities. This is termed as statutory liquidity ratio. In increase in the liquidity ratio implies a transfer of banking funds to Government and corresponding reduction in credit available to the borrowers.

e)      ‘Repo’ Transactions: ‘Repo’ stands for repurchase. Repo or repurchase transactions are undertaken by the Central Bank in the money market to manipulate short term interest rates and to manage liquidity levels. Under repo, buying and selling of securities takes place with the condition that at the end of the specified fixed period the buyer shall sell the securities at the predetermined rate. The difference between the repurchase price and the original sale price will be earning for the lender. An increase in repo rate means the commercial banks will get more interest on their reserve with RBI which leads to shortage of funds in the economy. On the other hand, decrease in repo rate means the commercial banks will earn less return on their balance with RBI which increases withdrawal of funds by commercial banks from RBI and thus increases liquidity.

2)      Qualitative or Selective Methods: These are basically the selective and general methods of credit control. These methods are used for controlling the use and direction of credit. They have nothing to do with the control of the total volume of credit in economy. These methods are :

a)      Directions: Sec. 21 of the Banking Regulation Act gives powers to the RBI for controlling granting of advances by an individual bank or by banking as a whole. The RBI can give directions to any particular bank or all banks in general in regard to the purposes for which advances may or may not be made, the maximum amount of advance to any individual, firm or company etc.     

b)      Margin requirement: Margin means the difference between the market price of security and loan amount. Changing margin requirement is another credit control method followed by the RBI. This system was introduced in 1956. By requiring higher margin while accepting a commodity as a security, the RBI can decrease the flow of credit to particular sector or vice versa.

c)       Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Under this method the down payment, installment amount, loan duration, etc is fixed in advance. This can help in checking the credit use and then inflation in a country.

d)      Publicity: This is yet another method of selective credit control. Through it Central Bank (RBI) publishes various reports stating good sector and bad sectors in the system. This published information can help commercial banks to direct credit supply in the desired good sectors.

e)      Credit Rationing: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors.

f)       Moral suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes. It helps in restraining credit during inflationary periods.

g)      Direct action: Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates.

Q. 12. Distinguish between Central bank and commercial bank.

Ans: There are some fundamental differences between them:

1)      Profit making is not the objective of central banks, although, they do earn profits. But, the principle aim of a commercial bank is to make large amounts of profits.

2)      The central bank is owned and controlled by the Government. But A commercial bank is generally owned, managed and controlled by private citizens.

3)      There is only one central bank in a country. But, there are commercial banks operating in a country on a competitive basis.

4)      The central bank is the only agency in a country entrusted with the power of issuance of notes. But, the commercial banks do not have the power of issuing notes.

5)      The central bank s the lender of the money market. But, the commercial banks are just its sub-ordinates.

Q.13. Write a brief note on achievements and failures of RBI.

Ans: Achievements of RBI

(a) Contribution in economic development: The Reserve Bank fully contributes to the economic development and planning programs of the country. The demand for credit for agriculture industry, trade, foreign exchange etc. is met with the fulfillment of the deficit finance arrangements.

(b) Contribution in agricultural development: The Reserve Bank has made significant contribution in providing short-term, medium and long-term financing through cooperative banks to the agriculture sector. The Reserve Bank has given Rs 2 thousand crore in agricultural sector till date.

(c) Industrial finance: With the establishment of the Industrial Finance Bank such as Industrial Finance Corporation, State Finance Corporation etc, the Reserve Bank has provided adequate finance to the industries by purchasing shares of other institutions.

(d) Flexible Monetary Policy: The Reserve Bank has adopted a flexible monetary policy. It has introduced changes in monetary regulations keeping in view the seasonal character of Indian money market. The pressure of seasonal demand has been adequately met. On account of it the seasonal fluctuations in money rates have been negligible.

(e) Organising Public Debts: RBI is the agent of the government. So he also manages the public debt. The Reserve Bank has achieved tremendous success in this. From time to time, the Reserve Bank has solved financial problems by giving short term loans to the government.

(f) Function of clearing house: The Reserve Bank is doing the job of clearing house in India smoothly. As a result, mutual transactions of different banks are handled instantly with ease.

Failures of RBI

(a) Fails to regulate and control banking system: The Reserve Bank has failed to regulate and control commercial banks and other financial institutions. The Reserve Bank has failed to comply with the banking law, to study the audit report to banks and to control the loan amount transactions.

(b) Lack of Uniformity in the Rate of Interest: Because of the lack of control on different sectors of the money market, different rates of interest continue to prevail. Outside the organised sector of the money market, rates of interest are exorbitantly higher than the bank rate. Reserve Bank has rather miserably failed in this regard.

(c) Lack of statistics: Although the Reserve Bank has many resources and agencies to collect data of different economic items of the country, yet it has not developed a system whose publications can be used as a reliable "bank of statistics".

(d) Lack of Bill Market: Reserve Bank prepared a plan for the development of Bill Market in 1952. But till date there is no independent and organised bill market in India. Bill Market in India does not receive first-rate Discountable Bills.

(e) Inadequate Banking Facilities: Nationalization done from time to time in the country increased the number of banking branches. But there is still lack of banking facilities in rural areas.

(f) High rates of interest: The Reserve Bank has failed to coordinate the various currency markets in the country. There are many types of interest rates are available in the money market. The unorganized sector in rural areas still offers loans at very high rates.

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