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July 4, 2013

Banking System Basics | History and Study of RBI |

What is Banking

A bank is financial institution that provides banking and other financial services to their customers such as accepting deposits and providing loans. A banking system is referred to as system provided by the bank which offers cash management services for customers, reporting the transactions of their accounts and portfolios, throughout the day.
The bank safeguards the money and valuables and provide loans, credit, and payment services, such as checking accounts, money orders and cashier’s cheques. The banks also offer investment and insurance products.
Need of the Banks
    1. 1. To provide security to the savings of customers.
      2. To control the supply of money and credit.
      3. To encourage public confidence in the working of the financial system, increase saving speedily and efficiently.
      4. To avoid focus of financial powers in the hands of a few individuals and institutions.
      5. To set equal norms and conditions to all types of customers.

    History of Banking System in India

    The first Bank in India, called The General Bank of India was established in the year 1786. The East India Company established The Bank of Bengal/Calcutta(1809), Bank of Bombay(1840) and Bank of Madras(1843). These three banks units are also known as Presidency Banks. The next bank was Bank of Hindustan which was established in 1870. The Allahabad Bank was established in 1865, was the first bank completely run by Indians. Punjab National Bank Ltd. was set up in 1894, with its 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 was set up. The Imperial Bank came into existence on the 27th January, 1921 by the Imperial Bank of India Act of 1920, where all Presidency Banks amalgamated. The Imperial Bank was the biggest bank until 1935. On 1 April 1935, the Reserve Bank of India was established under the reserve bank of India act.

    Reserve Bank of India

    RBI is the central bank of India. Its head quarters is in Mumbai. It was originally constituted as a shareholder’s bank with a capital of Rs.5 crores. The entire share capital was contributed private shareholders with the exception of the nominal value of Rs 2.2 lakh subscribed by the central bank. It was set up on the recommendations of the Hilton Young Commission. Initially it was located in Kolkata. It moved to Mumbai in 1937. After independence, the reserve bank of India was nationalized.

    Functions of the reserve bank

    1. Note issue – Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations.
    2. Banker to government – The second important function of the reserve bank of India is to act as government banker, agent and adviser. RBI carries out banking operations (e.g. to receive and make payments, carry cash reserves) for all governments except J&K—acts as advisor to govt on all monetary and banking matters.
    3. Custodian of foreign exchange reserve – 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.
    4. Banker’s bank and Lender of last resort – 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. Banks have been asked to keep cash reserves equal to 3 percent of their aggregate deposit liabilities.
    5. 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.
    6. Bank of settlement and clearance – As the reserve bank keeps the cash balance of all commercial banks it is easy for the bank to act as settlement bank or clearing house for other banks.
    7. Information and research functions – The reserve bank undertakes collection and dissemination of information and conducts research in this field. The bank issues several periodical publications, which attempt to explain and assess the significance of economic developments in the country.

    Some Important Milestones

    1. 1. 1935- The Reserve Bank of India is established on April 1, and starts functioning.
      2. 1947- The Reserve Bank of India goes national, as India gains independence.
      3. 1949- The Reserve Bank of India is nationalized.
      4. 2004- RBI puts in a modern payment and settlement system, strives to further strengthen the financial sector.
  • Structure of RBI

    Some Important Terms used by RBI

    1. Bank Rate: Rate of rediscount at which the RBI discounts the first class bills of exchange brought by the banks.
      Repo Rate: Injection of liquidity by the RBI is termed as ” Repo Rate” . This was introduced in Dec. 1992 and Reverse Repo Rate in Nov. 1996. RBI buys Govt. Securities for a short period usually a fortnight, with an agreement to sell it later. Thus repo rate is a short-term money market instrument to stabilize short term liquidity in the economy.
      Reverse Repo Rate: Repo Rate is the rate at which the RBI lends to commercial banks where as the Reverse Repo Rate is the rate at which the RBI borrows from the commercial banks against securities for a very short period. Repo and Reverse Repo rates are used as policy instruments for day-to-day liquidity management under the liquidity adjustment facility.
      Cash Reserve Ratio (CRR): It refers to the percentage of net demand and time deposits which the scheduled commercial banks have to keep with RBI at zero interest Rate as per RBI act 1934.
      Statutory Liquidity Ratio (SLR): It refers to the percentage of net demand and time deposits which the scheduled commercial banks have to keep with themselves. i.e. by purchasing Govt. Securities or in the form of cash or gold as per Banking Regulation Act 1949, Sec 24. SLR is a mechanism used by Commercial Banks for providing credit to the Govt.
      Public Debt: When the government is unable to meet its public expenditure through public revenue, its resort to public debt, public debt can be raised with in the country or out side the country.
      Public Revenue: It is the income of government through various sources like taxes, fees, profits of the state enterprise and grants.
      Public Expenditure: It is the expenditure of the public authority on various socio-economic and political activities. Expenditure may be spending on administration of law and order development of industries etc.
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