Reserve Bank of India

Reserve Bank of India

RBI seal RBI headquarters in Mumbai

Headquarters Mumbai, Maharashtra

Established 1 April 1935

Governor DuvvuriSubbarao

Currency Indian rupee ( )₹

ISO 4217 Code INR

Reserves US$30,210 crore (US$302.1 billion)[1][Note 1]

Base borrowing

rate8.00%

Introduction of bank

A bank is a financial institution and a financial intermediary that accepts deposits and

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channels those deposits into lending activities, either directly or through capital markets. A

bank connects customers that have capital deficits to customers with capital surpluses.

Due to their critical status within the financial system and the economy generally, banks

are highly regulated in most countries. Most banks operate under a system known

asfractional reserve banking where they hold only a small reserve of the funds deposited and

lend out the rest for profit. They are generally subject to minimum capital

requirements which are based on an international set of capital standards, known as the Basel

Accords.

The oldest bank still in existence is Monte deiPaschi di Siena, headquartered in Siena, Italy,

which has been operating continuously since 1472.

History of Banking in India

Without a sound and effective banking system in India it cannot have a healthy economy.

The banking system of India should not only be hassle free but it should be able to meet new

challenges posed by the technology and any other external and internal factors.

For the past three decades India's banking system has several outstanding achievements to its

credit. The most striking is its extensive reach. It is no longer confined to only metropolitans

or cosmopolitans in India. In fact, Indian banking system has reached even to the remote

corners of the country. This is one of the main reason of India's growth process.2

The government's regular policy for Indian bank since 1969 has paid rich dividends with the

nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft

or for withdrawing his own money. Today, he has a choice. Gone are days when the most

efficient bank transferred money from one branch to other in two days. Now it is simple as

instant messaging or dial a pizza. Money have become the order of the day.

The first bank in India, though conservative, was established in 1786. From 1786 till today,

the journey of Indian Banking System can be segregated into three distinct phases.

They are as mentioned below:

Early phase from 1786 to 1969 of Indian Banks

Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector

Reforms.

New phase of Indian Banking System with the advent of Indian Financial & Banking

Sector Reforms after 1991.

To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase

III.

Phase -I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and

Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay

(1840) and Bank of Madras (1843) as independent units and called it Presidency Banks.

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These three banks were amalgamated in 1920 and Imperial Bank of India was established

which started as private shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab

National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913,

Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank

of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failures

between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline

the functioning and activities of commercial banks, the Government of India came up with

The Banking Companies Act, 1949 which was later changed to Banking Regulation Act

1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested

with extensive powers for the supervision of banking in india as the Central Banking

Authority.

During those days public has lesser confidence in the banks. As an aftermath deposit

mobilisation was slow. Abreast of it the savings bank facility provided by the Postal

department was comparatively safer. Moreover, funds were largely given to traders.

Phase-II

Government took major steps in this Indian Banking Sector Reform after independence. In

1955, it nationalised Imperial Bank of India with extensive banking facilities on a large scale

specially in rural and semi-urban areas. It formed State Bank of india to act as the principal

agent of RBI and to handle banking transactions of the Union and State Governments all

over the country.

Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th

July, 1969, major process of nationalisation was carried out. It was the effort of the then

Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country

wasnationalised.

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Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with

seven more banks. This step brought 80% of the banking segment in India under

Government ownership. 

The following are the steps taken by the Government of India to Regulate Banking

Institutions in the Country:

1949 : Enactment of Banking Regulation Act.

1955 :Nationalisation of State Bank of India.

1959 :Nationalisation of SBI subsidiaries.

1961 :Insurance cover extended to deposits.

1969 :Nationalisation of 14 major banks.

1971 :Creation of credit guarantee corporation.

1975 :Creation of regional rural banks.

1980 :Nationalisation of seven banks with deposits over 200 crore.

After the nationalisation of banks, the branches of the public sector bank India rose to

approximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and

immense confidence about the sustainability of these institutions.

Phase-III

This phase has introduced many more products and facilities in the banking sector in its

reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set

up by his name which worked for the liberalisation of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put to

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give a satisfactory service to customers. Phone banking and net banking is introduced. The

entire system became more convenient and swift. Time is given more importance than

money.

The financial system of India has shown a great deal of resilience. It is sheltered from any

crisis triggered by any external macroeconomics shock as other East Asian Countries

suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the

capital account is not yet fully convertible, and banks and their customers have limited

foreign exchange exposure.

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Introduction of Reserve Bank of India (RBI)

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The central bank of the country is the Reserve Bank of India (RBI). It was established in

April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the

Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully

paid which was entirely owned by private shareholders in the begining. The Government

held shares of nominal value of Rs. 2,20,000.

Reserve Bank of India was nationalised in the year 1949. The general superintendence and

direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor

and four Deputy Governors, one Government official from the Ministry of Finance, ten

nominated Directors by the Government to give representation to important elements in the

economic life of the country, and four nominated Directors by the Central Government to

represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New

Delhi. Local Boards consist of five members each Central Government appointed for a term

of four years to represent territorial and economic interests and the interests of co-operative

and indigenous banks.

The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of

1934) provides the statutory basis of the functioning of the Bank.

The Bank was constituted for the need of following:

To regulate the issue of banknotes

To maintain reserves with a view to securing monetary stability and

To operate the credit and currency system of the country to its advantage.

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History

1935—1950

Old building of Reserve Bank of India (Mumbai)

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The central bank was founded in 1935 to respond to economic troubles after the firstworld

war.  The Reserve Bank of India was set up on the recommendations of the Hilton-Young

Commission. The commission submitted its report in the year 1926, though the bank was not

set up for another nine years. The Preamble of the Reserve Bank of India describes the basic

functions of the Reserve Bank as to regulate the issue of bank notes, to keep reserves with a

view to securing monetary stability in India and generally to operate the currency and credit

system in the best interests of the country. The Central Office of the Reserve Bank was

initially established in Kolkata, Bengal, but was permanently moved to Mumbai in 1937. The

Reserve Bank continued to act as the central bank for Myanmar till Japanese occupation

of Burma and later up to April 1947, though Burma seceded from the Indian Union in 1937.

After partition, the Reserve Bank served as the central bank for Pakistanuntil June 1948

when the State Bank of Pakistan commenced operations. Though originally set up as a

shareholders’ bank, the RBI has been fully owned by the government of India since its

nationalization in 1949

1950—1960

Between 1950 and 1960, the Indian government developed a centrally planned economic

policy and focused on the agricultural sector. The administration nationalized commercial

banks and established, based on the Banking Companies Act, 1949 (later called Banking

Regulation Act) a central bank regulation as part of the RBI. Furthermore, the central bank

was ordered to support the economic plan with loans.

1960—1969

As a result of bank crashes, the reserve bank was requested to establish and monitor a deposit

insurance system. It should restore the trust in the national bank system and was initialized

on 7 December 1961. The Indian government founded funds to promote the economy and

used the slogan Developing Banking. The Government of India restructured the national

bank market and nationalized a lot of institutes. As a result, the RBI had to play the central

part of control and support of this public banking sector.

1969—1985

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Between 1969 and 1980, the Indian government nationalized 6 more commercial banks,

following 14 major commercial banks being nationalized in 1969(As mentioned in RBI

website). The regulation of the economy and especially the financial sector was reinforced by

the Government of India in the 1970s and 1980s. The central bank became the central player

and increased its policies for a lot of tasks like interests, reserve ratio and visible

deposits The measures aimed at better economic development and had a huge effect on the

company policy of the institutes. The banks lent money in selected sectors, like agri-business

and small trade companies.

The branch was forced to establish two new offices in the country for every newly

established office in a town.The oil crises in 1973 resulted in increasing inflation, and the

RBI restricted monetary policy to reduce the effects.

1985—1991

A lot of committees analysed the Indian economy between 1985 and 1991. Their results had

an effect on the RBI. The Board for Industrial and Financial Reconstruction, the Indira

Gandhi Institute of Development Research and the Security & Exchange Board of

India investigated the national economy as a whole, and the security and exchange board

proposed better methods for more effective markets and the protection of investor interests.

The Indian financial market was a leading example for so-called "financial repression"

(Mackinnon and Shaw). The Discount and Finance House of India began its operations on

the monetary market in April 1988; the National Housing Bank, founded in July 1988, was

forced to invest in the property market and a new financial law improved the versatility of

direct deposit by more security measures and liberalisation.

1991—2000

The national economy came down in July 1991 and the Indian rupee was devalued The

currency lost 18% relative to the US dollar, and the Narsimahmam Committee advised

restructuring the financial sector by a temporal reduced reserve ratio as well as the statutory

liquidity ratio. New guidelines were published in 1993 to establish a private banking sector.

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This turning point should reinforce the market and was often called neo-liberal The central

bank deregulated bank interests and some sectors of the financial market like the trust and

property markets.  This first phase was a success and the central government forced a

diversity liberalization to diversify owner structures in 1998.

The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed

nationalized banks in July to interact with the capital market to reinforce their capital base.

The central bank founded a subsidiary company—the Bharatiya Reserve Bank Note Mudran

Limited—in February 1995 to produce banknotes.

Since 2000

The Foreign Exchange Management Act from 1999 came into force in June 2000. It should

improve the foreign exchange market, international investments in India and transactions.

The RBI promoted the development of the financial market in the last years, allowed online

banking in 2001 and established a new payment system in 2004 - 2005 (National Electronic

Fund Transfer). The Security Printing & Minting Corporation of India Ltd., a merger of nine

institutions, was founded in 2006 and produces banknotes and coins.

The national economy's growth rate came down to 5.8% in the last quarter of 2008 – 2009

and the central bank promotes the economic development.

Offices and branches of RBI

The Reserve Bank of India has 4 zonal offices.[26] It has 19 regional offices at most state

capitals and at a few major cities in India. Few of them are located in Ahmedabad,

Bangalore, Bhopal, Bhubaneswar, Chandigarh, Chennai, Delhi, Guwahati, Hyderabad,

Jaipur, Jammu, Kanpur, Kolkata, Luckhnow,Mumbai, Nagpur, Patna, and

Thiruvananthapuram. Besides it has 09 sub-offices at Agartala, Dehradun, Gangtok, Kochi,

Panaji, Raipur, Ranchi, Shimla and Srinagar.

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The bank has also two training colleges for its officers, viz. Reserve Bank Staff College at

Chennai and College of Agricultural Banking at Pune. There are also four Zonal Training

Centres at Belapur, Chennai, Kolkata and New Delhi.

Structure of Reserve Bank of India

Central Board of Directors

The Central Board of Directors is the main committee of the central bank. The Government

of India appoints the directors for a four-year term. The Board consists of a governor, four

deputy governors, four directors to represent the regional boards, and ten other directors from

various fields.

Governors

The central bank till now was governed by 21 governors. The 22nd, Current Governor of

Reserve Bank of India is DrSubbarao

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Supportive bodies

The Reserve Bank of India has four regional representations: North in New Delhi, South in

Chennai, East in Kolkata and West in Mumbai. The representations are formed by five

members, appointed for four years by the central government and serve - beside the advice of

the Central Board of Directors - as a forum for regional banks and to deal with delegated

tasks from the central board.  The institution has 22 regional offices.

The Board of Financial Supervision (BFS), formed in November 1994, serves as a CCBD

committee to control the financial institutions. It has four members, appointed for two years,

and takes measures to strength the role of statutory auditors in the financial sector, external

monitoring and internal controlling systems.

The Tarapore committee was set up by the Reserve Bank of India under the chairmanship of

former RBI deputy governor S STarapore to "lay the road map" to capital account

convertibility. The five-member committee recommended a three-year time frame for

complete convertibility by 1999-2000.

On 1 July 2006, in an attempt to enhance the quality of customer service and strengthen the

grievance redressal mechanism, the Reserve Bank of India constituted a new department —

Customer Service Department (CSD).

Offices and branches

The Reserve Bank of India has 4 regional offices,15 branches and 5 sub-offices.  It has 22

branch offices at most state capitals and at a few major cities in India. Few of them are

located

in Ahmedabad, Bangalore, Bhopal, Bhubaneswar, Chandigarh, Chennai, Delhi, Guwahati, H

yderabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow, Mumbai, Nagpur, Patna,

andThiruvananthapuram. Besides it has sub-offices

at Agartala, Dehradun, Gangtok, Kochi, Panaji, Raipur, Ranchi, Shimla and Srinagar.

The bank has also two training colleges for its officers, viz. Reserve Bank Staff College at

Chennai and College of Agricultural Banking at Pune. There are also four Zonal Training

Centresat Belapur, Chennai, Kolkata and 

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Measures Taken by RBI towards Corporate Governance

Reserve Bank Of India has taken various steps further in corporate governance in the

Indian Banking system.These can broadly be classified into following three categories

1)Tranferancy

2)Off-site surveillance

3)Prompt corrective action tranperancy

Transparency & accounting standards in india hav been enhanced to align with international

best practices.However,there are many gaps in the disclosures in india vis-à-vis the

international standards,particularly in the area of risk management strategies and risk

parameter, risk concentration performance measures, component of capital structure

etc.Hence, the disclosure standards need to be further broad based in consonance with

improvement in the capability of market players to analyse the information objectively.

The off-site surveillance mechanism is also active in monitoring the movement of

assets, its impact on capital adequacy and overall efficiency and adequacy of

managerial practices in bank.RBI also brings out the periodic data on “Peer Group

Comparison” on critical ratios to mattain peer pressure ofm better performance and

governance.

Prompt Corrective Action has been adopted by RBI as part of core principles of

effective banking supervision. As against a single trigger point based on capital

adequacy normaly adopted by many countries, Reserve Bank in keeping with indian

coundition hav set two or more trigger points namely Non-performing Assets (NPA)

and Return On Assets (ROA) as proxies for asset quality and profitability15

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Functions of Reserve Bank of India  

The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank

the Reserve Bank of India. 

1.Bank of Issue:

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank

notes of all denominations. The distribution of one rupee notes and coins and small coins all

over the country is undertaken by the Reserve Bank as agent of the Government. The

Reserve Bank has a separate Issue Department which is entrusted with the issue of currency

notes. The assets and liabilities of the Issue Department are kept separate from those of the

Banking Department. Originally, the assets of the Issue Department were to consist of not

less than two-fifths of gold coin, gold bullion or sterling securities provided the amount of

gold was not less than Rs. 40 crores in value. The remaining three-fifths of the assets might

be held in rupee coins, Government of India rupee securities, eligible bills of exchange and

promissory notes payable in India. Due to the exigencies of the Second World War and the

post-was period, these provisions were considerably modified. Since 1957, the Reserve Bank

of India is required to maintain gold and foreign exchange reserves of Ra. 200 crores, of

which at least Rs. 115 crores should be in gold. The system as it exists today is known as the

minimum reserve system. 

2.Banker to Government :

The second important function of the Reserve Bank of India is to act as Government banker,

agent and adviser. The Reserve Bank is agent of Central Government and of all State

Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the

obligation to transact Government business, via. to keep the cash balances as deposits free of

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interest, to receive and to make payments on behalf of the Government and to carry out their

exchange remittances and other banking operations. The Reserve Bank of India helps the

Government - both the Union and the States to float new loans and to manage public debt.

The Bank makes ways and means advances to the Governments for 90 days. It makes loans

and advances to the States and local authorities. It acts as adviser to the Government on all

monetary and banking matters.

3.Bankers' Bank and Lender of the Last Resort:

The Reserve Bank of India acts as the bankers' bank. According to the provisions of the

Banking Companies Act of 1949, every scheduled bank was required to maintain with the

Reserve Bank a cash balance equivalent to 5% of its demand liabilites and 2 per cent of its

time liabilities in India. By an amendment of 1962, the distinction between demand and time

liabilities was abolished and banks have been asked to keep cash reserves equal to 3 per cent

of their aggregate deposit liabilities. The minimum cash requirements can be changed by the

Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible

securities or get financial accommodation in times of need or stringency by rediscounting

bills of exchange. Since commercial banks can always expect the Reserve Bank of India to

come to their help in times of banking crisis the Reserve Bank becomes not only the banker's

bank but also the lender of the last resort.

4.Controller of Credit:

The Reserve Bank of India is the controller of credit i.e. it has the power to influence the

volume of credit created by banks in India. It can do so through changing the Bank rate or

through open market operations. According to the Banking Regulation Act of 1949, the

Reserve Bank of India can ask any particular bank or the whole banking system not to lend

to particular groups or persons on the basis of certain types of securities. Since 1956,

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selective controls of credit are increasingly being used by the Reserve Bank.

The Reserve Bank of India is armed with many more powers to control the Indian money

market. Every bank has to get a licence from the Reserve Bank of India to do banking

business within India, the licence can be cancelled by the Reserve Bank of certain stipulated

conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank

before it can open a new branch. Each scheduled bank must send a weekly return to the

Reserve Bank showing, in detail, its assets and liabilities. This power of the Bank to call for

information is also intended to give it effective control of the credit system. The Reserve

Bank has also the power to inspect the accounts of any commercial bank. 

As supereme banking authority in the country, the Reserve Bank of India, therefore, has the

following powers:

(a) It holds the cash reserves of all the scheduled banks. 

(b) It controls the credit operations of banks through quantitative and qualitative controls.  

(c) It controls the banking system through the system of licensing, inspection and calling for

information. 

(d) It acts as the lender of the last resort by providing rediscount facilities to scheduled

banks.

5. Custodian of Foreign Reserves :

The Reserve Bank of India has the responsibility to maintain the official rate of exchange.

According to the Reserve Bank of India Act of 1934, the Bank was required to buy and sell

at fixed rates any amount of sterling in lots of not less than Rs. 10,000. The rate of exchange

fixed was Re. 1 = sh. 6d. Since 1935 the Bank was able to maintain the exchange rate fixed

at lsh.6d. though there were periods of extreme pressure in favour of or against the rupee.

After India became a member of the International Monetary Fund in 1946, the Reserve Bank

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has the responsibility of maintaining fixed exchange rates with all other member countries of

the I.M.F. Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act

as the custodian of India's reserve of international currencies. The vast sterling balances were

acquired and managed by the Bank. Further, the RBI has the responsibility of administering

the exchange controls of the country.

6. Supervisory functions :

In addition to its traditional central banking functions, the Reserve bank has certain non-

monetary functions of the nature of supervision of banks and promotion of sound banking in

India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the

RBI wide powers of supervision and control over commercial and co-operative banks,

relating to licensing and establishments, branch expansion, liquidity of their assets,

management and methods of working, amalgamation, reconstruction, and liquidation. The

RBI is authorised to carry out periodical inspections of the banks and to call for returns and

necessary information from them. The nationalisation of 14 major Indian scheduled banks in

July 1969 has imposed new responsibilities on the RBI for directing the growth of banking

and credit policies towards more rapid development of the economy and realisation of certain

desired social objectives. The supervisory functions of the RBI have helped a great deal in

improving the standard of banking in India to develop on sound lines and to improve the

methods of their operation.

7.Promotional functions:

With economic growth assuming a new urgency since Independence, the range of the

Reserve Bank's functions has steadily widened. The Bank now performs a varietyof

developmental and promotional functions, which, at one time, were regarded as outside the

normal scope of central banking. The Reserve Bank was asked to promote banking habit,

extend banking facilities to rural and semi-urban areas, and establish and promote new

specialised financing agencies. Accordingly, the Reserve Bank has helped in the setting up of

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the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962, the Unit Trust of

India in 1964, the Industrial Development Bank of India also in 1964, the Agricultural

Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of

India in 1972. These institutions were set up directly or indirectly by the Reserve Bank to

promote saving habit and to mobilise savings, and to provide industrial finance as well as

agricultural finance. As far back as 1935, the Reserve Bank of India set up the Agricultural

Credit Department to provide agricultural credit. But only since 1951 the Bank's role in this

field has become extremely important. The Bank has developed the co-operative credit

movement to encourage saving, to eliminate moneylenders from the villages and to route its

short term credit to agriculture. The RBI has set up the Agricultural Refinance and

Development Corporation to provide long-term finance to farmers.

Policy rates and Reserve ratios

Bank Rate: Policy rates, Reserve ratios, lending, and deposit rates

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RBI lends to the commercial banks

through its discount window to

help the banks meet depositor’s

demands and reserve requirements.

The interest rate the RBI charges the

banks for this purpose is called bank rate.

If the RBI wants to increase the liquidity

and money supply in the market,

it will decrease the bank rate and

if it wants to reduce the liquidity

and money supply in the system,

it will increase the bank rate.

As of 5 May, 2011 the bank rate was 6%.

Cash Reserve Ratio   (CRR) :

Every commercial bank has to keep certain minimum cash reserves with RBI. RBI can vary

this rate between 3% and 15%. RBI uses this tool to increase or decrease the reserve

requirement depending on whether it wants to affect a decrease or an increase in the money

supply. An increase in Cash Reserve Ratio (CRR) will make it mandatory on the part of the

banks to hold a large proportion of their deposits in the form of deposits with the RBI. This

will reduce the size of their deposits and they will lend less. This will in turn decrease the

money supply. The current rate is 6%.

Statutory Liquidity Ratio   (SLR) :

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Bank Rate 6.0%

Repo Rate 8.25%

Reverse Repo Rate 7.25%

Cash Reserve Ratio

(CRR)6.0%

Statutory Liquidity

Ratio (SLR)24.0%

Base Rate9.50%–

10.75%

Reserve Bank Rate 4%

Deposit Rate8.50%–

9.50%

Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash

and approved securities. Higher liquidity ratio forces commercial banks to maintain a larger

proportion of their resources in liquid form and thus reduces their capacity to grant loans and

advances, thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds

from loans and advances to investment in government and approved securities.

In well-developed economies, central banks use open market operations--buying and selling

of eligible securities by central bank in the money market--to influence the volume of cash

reserves with commercial banks and thus influence the volume of loans and advances they

can make to the commercial and industrial sectors. In the open money market, government

securities are traded at market related rates of interest. The RBI is resorting more to open

market operations in the more recent years.

Generally RBI uses three kinds of selective credit controls:

1. Minimum margins for lending against specific securities.

2. Ceiling on the amounts of credit for certain purposes.

3. Discriminatory rate of interest charged on certain types of advances.

Direct credit controls in India are of three types:

1. Part of the interest rate structure i.e. on small savings and provident funds, are

administratively set.

2. Banks are mandatorily required to keep 24% of their deposits in the form of

government securities.

3. Banks are required to lend to the priority sectors to the extent of 40% of their

advances.

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Guidelines by RBI regarding Entry of private Bank

Introduction :

Initially all the banks in India were private banks, which were founded in the pre-

independence era to supply to the banking needs of the people. In 1921, three major banks

i.e. Banks of Bengal, Bank of Bombay, and Bank of Madras, merged to form Imperial Bank

of India. In 1935, the Reserve Bank of India (RBI) was established and it took over the

central banking responsibilities from the Imperial Bank of India, transferring commercial

banking functions completely to IBI. In 1955, after the declaration of first-five year plan,

Imperial Bank of India was subsequently transformed into State Bank of India (SBI).

Following this, occurred the nationalization of major banks in India on 19 July 1969. The

Government of India issued an ordinance and nationalized the 14 largest commercial banks

of India, including Punjab National Bank (PNB), Allahabad Bank, Canara Bank, Central

Bank of India, etc. Thus, public sector banks revived to take up leading role in the banking

structure. In 1980, the GOI nationalized 6 more commercial banks, with control over 91% of

banking business ofIndia.

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In 1994, the Reserve Bank Of India issued a policy of liberalization to license limited

number of private banks, which came to be known as New Generation tech-savvy banks.

Global Trust Bank was, thus, the first private bank after liberalization; it was later

amalgamated with Oriental Bank of Commerce (OBC). Then Housing Development Finance

Corporation Limited (HDFC) became the first (still existing) to receive an 'in principle'

approval from the Reserve Bank of India (RBI) to set up a bank in the private sector.

At present, Private Banks in India include leading banks like ICICI Banks, ING Vysya Bank,

Jammu & Kashmir Bank, Karnataka Bank, Kotak Mahindra Bank, SBI Commercial and

International Bank, etc. Undoubtedly, being tech-savvy and full of expertise, private banks

have played a major role in the development of Indian banking industry. They have made

banking more efficient and customer friendly. In the process they have jolted public sector

banks out of complacency and forced them to become more competitive

The guidelines for licensing of new banks in the private sector were issued by the Reserve

Bank of India (RBI) on January 22, 1993. Out of various applications received, RBI had

granted licenses to 10 banks. After a review of the experience gained on the functioning of

the new banks in the private sector, in consultation with the Government, it has now been

decided to revise the licensing guidelines.

The revised guidelines for entry of new banks in private sector are given below. The

guidelines are indicative and any other relevant factor or circumstances would be kept in

view while considering an application. With the issue of revised guidelines, applications

pending with RBI would be treated as lapsed.

Guidelines

1. The initial minimum paid-up capital for a new bank shall be Rs.200 crore. The initial

capital will be raised to Rs.300 crore within three years of commencement of business.

The overall capital structure of the proposed bank including the authorised capital shall

be approved by the RBI.

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2. The promoters’ contribution shall be a minimum of 40 per cent of the paid-up capital

of the bank at any point of time. The initial capital, other than the promoters’

contribution, could be raised through public issue or private placement. In case the

promoters’ contribution to the initial capital is in excess of the minimum proportion of

40 per cent, they shall stretch their excess share after one year of the bank’s

operations. (This would require specific approval of the RBI). Promoters’ contribution

of 40% of the initial capital shall be locked in for a period of five years from the date

of licensing of the bank.

3. While augmenting capital to Rs.300 crore within three years of commencement of

business, the promoters will have to bring in additional capital, which would be at

least 40 per cent of the fresh capital raised. The remaining portion could be raised

through public issue or private placement. The promoters’ contribution of a minimum

of 40% of additional capital will also be locked in for a minimum period of 5 years

from the date of receipt of capital by the bank.

4. The new bank should not be promoted by a large industrial house. However,

individual companies, directly or indirectly connected with large industrial houses may

be permitted to participate in the equity of a new private sector bank up to a maximum

of 10 per cent but will not have controlling interest in the bank. The 10 per cent limit

would apply to all inter- connected companies belonging to the concerned large

industrial houses. In taking a view on whether the companies, either as promoters or

investors, belong to a large industrial house or to a company connected to a large

industrial house, the decision of the RBI will be final.

5. The proposed bank shall maintain an arms length relationship with business entities in

the promoter group and the individual company/ies investing upto 10% of the equity

as stipulated above. It shall not extend any credit facilities to the promoters and

company/ies investing up to 10 per cent of the equity. The relationship between

business entities in the promoter group and the proposed bank shall be of a similar

nature as between two independent and unconnected entities. In taking view on

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whether a company belongs to a particular Promoter Group or not, the decision of RBI

shall be final.

Guideline Regarding the Conversion of NBFCs into private sector

banks :

A non-banking financial company (NBFC) is a company registered under the Companies

Act, 1956 and is engaged in the business of loans and advances, acquisition of

shares/stock/bonds/debentures/securities issued by government or local authority or other

securities of like marketable nature, leasing, hire-purchase, insurance business, chit business,

but does not include any institution whose principal business is that of agriculture activity,

industrial activity, sale/purchase/construction of immovable property.

1. An NBFC with a good track record desiring conversion into a bank should satisfy the

following criteria :

2. The NBFC should have a minimum net worth of Rs.200 crore in its latest balance

sheet which will stand increased to Rs.300 crore within three years from the date of

conversion.

3. The NBFC should not have been promoted by a large Industrial House or

owned/controlled by public authorities, including Local, State or Central

Governments.

4. The NBFC should have acquired a credit rating of not less than AAA rating (or its

equivalent) in the previous year.

5. The NBFC should have an impeccable track record in compliance with RBI

regulations/directions and in repayment of public deposits and no default should have

been reported.

6. The NBFC desiring conversion into bank should have capital adequacy of not less

than 12 per cent and net NPAs of not more than 5 per cent.

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7. The NBFC on conversion to a bank will have to comply with Capital Adequacy Ratio

and all other requirements such as lending to priority sector, promoters’ contribution,

lock-in period for promoters’ stake, dilution of promoters’ stake beyond the

minimum, NRI and foreign equity participation, arms length relationship, etc. as

applicable to banks.

Other Requirements

1. The bank shall be required to maintain a minimum capital adequacy ratio of 10 per

cent on a continuous basis from the commencement of its operations.

2. The promoters, their group companies and the proposed bank shall accept the system

of consolidated supervision by the Reserve Bank of India.

3. The new bank shall not be allowed to set up a subsidiary or mutual fund for at least

three years from the date of commencement of business.

4. The headquarters of the proposed new bank could be in any location in India as

decided by the promoters.

5. The new bank shall make full use of modern infrastructural facilities in office

equipments, computer, telecommunications etc. in order to provide cost-effective

customer service. It should have a high powered Customer Grievances Cell to handle

customer complaints.

6. The new bank will be governed by the provisions of the Banking Regulation Act,

1949, Reserve Bank of India Act, 1934, other relevant Statutes and the Directives,

Prudential regulations and other Guidelines/Instructions issued by RBI and the

regulations of SEBI regarding public issues and other guidelines applicable to listed

banking companies.

Procedure for Applications

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1. In terms of Rule 11 of the Banking Regulation (Companies) Rules, 1949 applications

shall be submitted in the prescribed form (Form III). In addition, the applications

should furnish a project report covering business potential and viability of the

proposed bank, the business focus, the product lines, proposed regional or locational

spread, level of information technology capability and any other information that they

consider relevant.

2. The project report should give as much concrete details as feasible, based on adequate

ground level information and avoid unrealistic or unduly ambitious projections.

Applications should also be supported by detailed information on the background of

promoters, their expertise, track record of business and financial worth, details of

promoters’ direct and indirect interests in various companies/industries, details of

credit/other facilities availed by the promoters/ promoter company(ies)/other Group

company(ies) with banks/financial institutions, and details of proposed participation

by foreign banks/NRI/OCBs.

3. Applications for setting up new banks in the private sector, along with other details as

mentioned above, should reach the following address before March 31,2010

Procedure for RBI decisions

1. In view of the increasing emphasis on stringent prudential norms, transparency,

disclosure requirements and modern technology, the new banks need to have strength

and efficiency to work profitably in a highly competitive environment. As a number of

banks are already functioning, licences will be issued on a very selective basis to those

who conform to the above requirements and who are likely to conform to the best

international and domestic standards of customer service and efficiency. Preference

will however be given to promoters with expertise of financing priority areas and in

setting up banks specialising in the financing of rural and agro based industries.

2. The number of licences to be issued in the next three years may be restricted to two or

three of the best acceptable proposals. This number would also include permission

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granted to any NBFC for conversion into bank. {If the number of acceptable proposals

of the highest standards are more than three, this limit may be relaxed on

recommendation of the Advisory Committee (see below). In that case the period for

issuing new licences may be stretched to four or five years}.

3. At the first stage, the applications will be screened by RBI to ensure prima facie

eligibility of the applicants. Thereafter, the applications will be referred to a high-level

Advisory Committee to be set up by RBI comprising

4. The Committee will set up its own procedures for screening the applications. The

Committee will reserve the right to call for more information as well as have

discussions with any applicant/s and seek clarification on any issue as required by it.

The Committee will submit its recommendations to RBI for consideration within three

months after the last date of receipt of applications by RBI (i.e. 30 June 2010). The

decision to issue an in-principle approval for setting up of a bank will be taken by RBI.

RBI’s decision will be final.

5. The validity of the in-principle approval issued by RBI will be one year from the date

of granting in-principle approval and would thereafter lapse automatically.

6. After issue of the in-principle approval for setting up of a bank in the private sector, if

any adverse features are noticed subsequently regarding the promoters or the

companies/firms with which the promoters are associated and the group in which they

have interest, the Reserve Bank of India may impose additional conditions and if

warranted, it may withdraw the in-principle approval.

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Guidelines regarding Entry of New Foreign Bank

Introduction :

The foreign banks in India are slowly but steadily creating a niche for themselves. With the

globalization hitting the world, the concept of banking has changed substantially over the last

couple of years. Some of the foreign banks have successfully introduced latest technologies

in the banking practices in India. This has made the banking business in the country more

smooth and interesting for the customers.

The concept of foreign banks in India has changed the prevailing banking scenario in the

country. The banking industry is now more competitive and customer-friendly than before.

The foreign banks have brought forth some innovations and changes in the banking industry

of the country.

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According to the new rules set by Reserve Bank of India in the new budget, some decisions

regarding foreign banks in India have been taken. The steps taken by the central monetary

authority provide some extent of liberty to the foreign banks and they are hopeful to grow

unshackled. The foreign banks in India are now allowed to set up local subsidiaries in the

country. The policy also states that the foreign banks are not allowed to acquire any Indian

bank unless the Indian bank is listed as a weak bank by the RBI.

Road map for expention of foreign bank in India :

The year 2009 was supposed to be an inflexion point would for foreign banks, the year they

be given greater operational freedom to increase their presence in India. That was the plan in

February 2005, when the banking regulator, the Reserve Bank of India (RBI), unveiled a

road map for foreign banks, a year after the Ministry of Commerce and Industry had revised

the guidelines on foreign direct investment (FDI) in the banking sector

Foreign banks have brought latest technology and latest banking practices in India. They

have helped made Indian Banking system more competitive and efficient. Government has

come up with a road map for expansion of foreign banks in India.

The road map has two phases. :

Phase I:(March 2005 to March 2009)

1. New banks – first time presence

Foreign banks wishing to establish presence in India for the first time could either

choose to operate through branch presence or set up a 100% wholly owned subsidiary

(WOS), following the one-mode presence criterion.

2. Existing banks – Branch expansion policy

For new and existing foreign banks, it is proposed to go beyond the existing WTO

commitment of 12 branches in a year. The number of branches permitted each year has

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already been higher than the WTO commitments. A more liberal policy for underbanked

areas will be followed. Branch licensing procedure will continue to be as per current practice.

3. Conversion of existing branches to Wholly Owned Subsidiaries :

In the first phase, foreign banks already operating in India will be allowed to convert their

existing branches to WOS while following the one-mode presence criterion. The WOS will

be treated on par with the existing branches of foreign banks for branch expansion in India.

The Reserve Bank may prescribe market access and national treatment limitation consistent

with WTO, as also other appropriate limitations to the operations of WOS consistent with

international practices and the country's requirements.

Phase II : (April 2009)

1. According Full National Treatment to Wholly Owned Subsidiaries of Foreign

Banks :

In the second phase, the removal of limitations on the operations of the WOS and

treating them on par with domestic banks to the extent appropriate will be designed and

implemented after reviewing the experience with Phase I and after due consultations with all

stakeholders in the banking sector.

2. Dilution of Stake in Wholly Owned Subsidiaries :

In this phase, the WOS of foreign banks on completion of a minimum prescribed

period of operation will be allowed to list and dilute their stake so that at least 26 per cent of

the paid up capital of the subsidiary is held by resident Indians at all times consistent with

para 1(b) of the Press Note 2 of March 5, 2004. The dilution may be either by way of Initial

Public Offer or as an offer for Sale.

3. Mergers and Acquisition of any Private Sector Bank in India :

In the second phase, after a review is made with regard to the extent of penetration of

foreign investment in Indian banks and functioning of foreign banks, foreign banks may be

33

permitted, subject to regulatory approvals and such conditions as may be prescribed, to enter

into merger and acquisition transactions with any private sector bank in India subject to the

overall investment limit of 74 percent.

Format of Application by a Foreign Bank to Reserve Bank of India :

I. General Information

Name of the applicant bank:

Place and date of incorporation;

Address of Head Office:

II. Ownership & Management

List of names and addresses of directors and their qualifications and principal

business.34

Details of shareholders holding 10 per cent or more of voting stock and their principal

business

Name of the Chief Executive Officer

Name & designation of senior official at Head quarters that will be responsible for the

bank's operations in India

III. Structure

Organizational chart showing subsidiaries and associated companies

Countries in which the bank and its subsidiaries operate

No. of domestic and overseas branc

IV. Financial Position

Highlights of financial position of the bank based on last three years financial

statements

Capital adequacy ratio as per BIS standards indicating Tier - I and Tier - II capital

separately

Ranking in home country and global ranking

Credit ratings by international credit rating agencies

V. Supervisory Arrangements

Details of supervisory arrangements to which the bank is subject in its country of

origin.

Home country regulations on entry of foreign banks

VI. Details of existing relationship with India

Details of correspondent banking relationships with Indian banks and the aggregate

amount of lines of creditor other limits extended to them.

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Details of foreign currency loans extended to Indian companies and other types of

business transacted such as underwriting of equity/ debt issues of Indian companies

etc.

VII. Details of proposed branch operations in India

Location of branch:

Details of proposed initial capitalisation :

Number of expatriate officials proposed to be posted in India

Purpose of opening the branch in India the benefits to the different sectors in the

Indian community and activities proposed to be undertaken.

Business Plan.

VIII .Documents to be enclosed

Copies of Memorandum Articles of Association or similar documents

Last three years financial statements

Certificate from supervisory authority that the applicant bank is duly authorised as a

bank, is of good standing and it is under their consolidated supervision.

Copy of the approval/authorisation given by the home country supervisor/ regulator

permitting to open a branch in India.

Approval letter from the Bank's Board.

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Guidelines By RBI :

New rules announced by the Reserve Bank of India for the foreign banks in India in this

budget has put up great hopes among foreign banks which allow them to grow unfettered.

Now foreign banks in India are permitted to set up local subsidiaries. The policy conveys that

foreign banks in India may not acquire Indian ones (except for weak banks identified by the

RBI, on its terms) and their Indian subsidiaries will not be able to open branches freely.

1. Foreign banks applying to the RBI for setting up a WOS in India must satisfy RBI

that they are subject to adequate prudential supervision in their home country. In

considering the standard of supervision exercised by the home country regulator, the

RBI will have regard to the Basel standards.

2. The setting up of a wholly-owned banking subsidiary in India should have the

approval of the home country regulator.

3. Other factors that will be taken into account while considering the application are

given below:

a) Economic and political relations between India and the country of

incorporation of the foreign bank

b) Financial soundness of the foreign bank

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c) Ownership pattern of the foreign bank

d) International and home country ranking of the foreign bank

e) Rating of the foreign bank by international rating agencies

f) International presence of the foreign bank.

4. The minimum start-up capital requirement for a WOS would be Rs. 3 billion and the

WOS shall be required to maintain a capital adequacy ratio of 10 % or as may be

prescribed from time to time on a continuous basis, from the commencement of its

operations.

5. The parent foreign bank will continue to hold 100 per cent equity in the Indian

subsidiary for a minimum prescribed period of operation.

6. The composition of the Board of directors should meet the following requirements:

a) Not less than 50 per cent of the directors should be Indian nationals resident in

India.

b) Not less than 50 per cent of the Directors should be non-executive directors.

c) A minimum of one-third of the directors should be totally independent of the

management of the subsidiary in India, its parent or associates.

d) The directors shall conform to the ‘Fit and Proper’ criteria as laid down in

RBI’s extant guidelines dated June 25, 2004.

e) RBI’s approval for the directors may be obtained as per the procedure adopted

in the case of the erstwhile Local Advisory Boards of foreign bank branches.

Accounting, Prudential Norms and other requirements :

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1. The WOS will be subject to the licensing requirements and conditions, broadly

consistent with those for new private sector banks

2. The WOS will be treated on par with the existing branches of foreign banks for branch

expansion. The Reserve Bank may also prescribe market access and national treatment

limitation consistent with WTO as also other appropriate limitations to the operations

of WOS, consistent with international practices and the country’s requirements.

3. The banking subsidiary will be governed by the provisions of the Companies Act,

1956, Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, other relevant

statutes and the directives, prudential regulations and other guidelines/instructions

issued by RBI and other regulators from time to time.

Case Study on FEMA

RBI slapped Rs.125 crore on Reliance Infrastructure

The Reserve Bank of India (RBI) has asked the Anil DhirubhaiAmbani Group firm, Reliance

Infrastructure (earlier, Reliance Energy), to pay just under Rs 125 crore as compounding fees

for parking its foreign loan proceeds worth $300 million with its mutual fund in India for 315

days, and then repatriating the money abroad to a joint venture company. These actions, 39

according to an RBI order, violated various provisions of the Foreign Exchange Management

Act (FEMA).

In its order, RBI said Reliance Energy raised a $360-million ECB on July 25, 2006, for

investment in infrastructure projects in India. The ECB proceeds were drawn down on

November 15, 2006, and temporarily parked overseas in liquid assets. On April 26, 2007,

Reliance Energy repatriated the ECB proceeds worth $300 million to India while the balance

remained abroad in liquid assets.

It then invested these funds in Reliance Mutual Fund Growth Option and Reliance Floating

Rate Fund Growth Option on April 26, 2007. On the following day, i.e., on April 27 2007,

the entire money was withdrawn and invested in Reliance Fixed Horizon Fund III Annual

Plan series V. On March 5, 2008, Reliance Energy repatriated $500 million (which included

the ECB proceeds repatriated on April 26, 2007, and invested in capital market instruments)

for investment in capital of an overseas joint venture called Gourock Ventures based in

British Virgin Islands.

RBI said, under FEMA guidelines issued in 2000, a borrower is required to keep ECB funds

parked abroad till the actual requirement in India. Further, the central bank said a borrower

cannot utilise the funds for any other purpose.

“The conduct of the applicant was in contravention of the ECB guidelines and the same are

sought to be compounded,” the RBI order signed by its chief general manager

SalimGangadharan said.

During the personal hearing on June 16, 2008, Reliance Energy, represented by group

managing director GautamDoshi and Price waterhouseCoopers executive director Sanjay

Kapadia, admitted the contravention and sough compounding. The company said due to

unforeseen circumstances, its Dadri power project was delayed. Therefore, the ECB proceeds

of $300 million were bought to India and was parked in liquid debt mutual fund schemes, it

added.

Rejecting Reliance Energy’s contention, RBI said it took the company 315 days to realise

that the ECB proceeds are not required for its intended purpose and to repatriate the same for

alternate use of investment in an overseas joint venture on March 5, 2008.

Reliance also contended that they invested the ECB proceeds in debt mutual fund schemes to

ensure immediate availability of funds for utilization in India.40

“I do not find any merit in this contention also as the applicant has not approached RBI either

for utilizing the proceeds not provided for in the ECB guidelines, or its repatriation abroad

for investment in the capital of the JV,” the RBI official said in the order.

In its defense, the company said the exchange rate gain on account of remittance on March 5

2008, would be a notional interim rate gain as such exchange rate gain is not crystallized.

But RBI does not think so. “They have also stated that in terms of accounting standard 11

(AS 11), all foreign exchange loans have to be restated and the difference between current

exchange rate and the rate at which the same were remitted to India, has to be shown as

foreign exchange loss/gain in profit and loss accounts.

However, in a scenario where the proceeds of the ECB are parked overseas, the exchange

rate gains or losses are neutralized as the gains or losses restating of the liability side are

offset with corresponding exchange losses or gains in the asset. In this case, the exchange

gain had indeed been realized and that too the additional exchange gain had accrued to the

company through an unlawful act under FEMA,” the order said.

It said as the company has made additional income of Rs 124 crore, it is liable to pay a fine

of Rs 124.68 crore. On August this year, the company submitted another fresh application for

compounding and requested for withdrawal of the present application dated April 17, 2008,

to include contravention committed in respect of an another transaction of ECB worth $150

million. But RBI said the company will have to make separate application for every

transaction and two transactions are different and independent and cannot be clubbed

together.

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