Roles of RBI as Banker to Government!

a
The RBI acts as banker to the government the Central as well as state
governments. As such, it transacts all banking business of the govern-
ment, which involves the receipt and payment of money on behalf of the
government and carrying out of its exchange, remittance and other
banking operations. In return, the governments keep their cash balances
on current account deposit with the RBI.

As government’s banker, the RBI provides short-term credit to the

government to meet any shortfalls in its receipts over its disbursements.
It also provides short-term credit to state governments as ways and
means advances. But, some state governments do resort to over-drafts at
times for short periods. The RBI has not been able to stop this practice.

As government’s banker, the RBI is also charged with the responsibility

of managing the public (i.e., the government) debt. In discharge of this
responsibility, the RBI manages all new issues of government loans,
services the public debt outstanding, and nurses the market for govern-
ment securities. The last function is very important for the success of
government’s borrowing programme from the public (including banks),
which has itself become increasingly important for mobilising resources
for financing public-sector projects.

To this end the RBI and the government have taken several measures
which will be only briefly mentioned here. The most important of these
measures is the statutory requirement for investment in government
securities.

Under this requirement, various financial institutions like commercial

banks, the LIC, GIC and subsidiaries, and provident funds are required
by law to invest designated minimum proportions of their total
assets/liabilities in government securities (and other ‘approved securi-
ties’). This provision concerning banks is administered by the RBI and
will be studied more fully in section 19.6 under the ‘Statutory Liquidity
Ratio’ (SLR) as a monetary-credit control measure of the RBI.
The RBI’s other (secondary) responsibilities in this field are to ensure
smooth functioning of the market, to see that government securities of
various maturities are available to potential buyers in adequate amounts,
that the maturity-structure of interest rates on these securities does not
get out of line due to excess supply of some maturities and deficient
supply of others, that the government bond market is not subject to
sudden and large fluctuations, that the liquidity of investments in
government securities is reasonably maintained, and that the new issues
of government loans are well received in the market.

ADVERTISEMENTS:

As manager of the new loans of the Central and State governments, the
RBI advises these governments on the quantum, timing, and terms of
such loans and co-ordinates their borrowing programmes. To ensure
success of new loan operations, it ‘grooms’ or prepares the market for
receiving new loans by acquiring securities nearing maturity. On the one
hand, this puts cash in the hands of investors (mostly financial
institutions) which they can use to subscribe to new loan floatation’s; on
the other hand, this helps lengthen the average maturity of the
government debt outstanding.

Normally, the Bank itself buys large amounts of new loans and later sells
on tap a large variety of new and old issues to cater to the diverse
demands of investors. Overall, the Bank has done a good job of its
function of government debt management. As the country’s central bank,
the RBI also acts as adviser to the government on all banking and
financial matters, including matters concerning international finance,
the financing pattern of five year plans, the mobilisation of resources and
banking legislation, among other things.

2- bankers to bank
As bankers’ bank, the RBI holds a part of the cash reserves
of banks, lends them funds for short periods, and provides
them with centralised clearing and cheap and quick
remittance facilities. In the early stages of the development
of central banking, banks used to keep some of their cash
reserves voluntarily with a leading bank which gradually
took over the role of a central bank. The obvious advantage
to individual banks was that of the facility of centralised
inter-bank clearing it automatically provided.

Reserve-holding banks could settle their daily mutual

clearings by drawing upon or crediting to their individual
accounts with one bank, the central hank. Thus, the mere
entries in the books of the central bank can settle claims
against each other among banks without the actual transfer
of cash.

ADVERTISEMENTS:

The pooling of cash reserves of banks with one bank as the

central bank also led to a great economy of cash reserves for
the banking system as whole, because individual banks
could borrow from the central pool of reserves with the
central bank whenever they fell short of cash.

The conditions are substantially different in India. The RBI

as the country’s central bank is authorised statutorily to
require scheduled commercial bank to deposit with it a
stipulated ratio (lying between 3 per cent and 15 per cent) of
their net total liabilities. This ratio is called Cash Reserve
Ratio (CRR). These reserves of banks with the RBI are held
neither voluntarily nor are available to them for meeting
interbank clearing drains except temporarily over the
reserve period, that is, the period over which the daily
average of the required cash reserves is calculated. Till
March 29, 1985, this reserve period used to be a week. From
that date the length of this period has been doubled to a
fortnight.

The true rationale of the statutory reserve requirement now

is that by varying it within limits the RBI can use it as a tool
of monetary and credit control. To meet any clearing drains,
banks must hold extra reserves over and above their
statutory reserves or raise cash in other ways. The pool of
bank reserves with the RBI, however, does serve as the
common fund out of which the RBI can and does make
advances to banks in temporary need of funds. Normally,
banks are supposed to meet their shortfalls of cash from
sources other than the RBI and go to it only as a matter of
last resort, because the RBI as the central bank is supposed
to function as only ‘the lender of last resort’.

Under the Reserve Bank of India Act, 1934 and the Banking
Regulation Act, 1949 (as amended from time to time), the
RBI enjoys extensive powers of supervision, regulation, and
control over commercial and co-operative banks.

ADVERTISEMENTS:

The Bank’s regulatory functions relating to banks cover

their establishment (i.e. licensing), branch expansion,
liquidity of their assets, management and methods of
working, amalgamation, reconstruction and liquidation.
The control by the Bank is exercised through periodic
inspection of banks and follow-up action and by calling for
returns and other information from them. The objective of
such supervision and control is to ensure the development
of a sound banking system in the country.