Role of RBI: Functions & Objectives
What is the role of RBI?
The RBI is the central bank of India. It was established in 1935 under a special act of the parliament. It is responsible for determining the country's monetary policy. The main role of the RBI is to maintain financial stability and to ensure adequate liquidity in the economy. The following are the main functions that the RBI performs dutifully:-
1) Monetary management:- One of the major functions of the RBI is the formulation and smooth execution of the monetary policy. Monetary policy makes use of various policy instruments that influence the cost and availability of money in the economy. The objective remains to promote economic growth and ensure stability of prices. It ensures a smooth flow of credit to the productive sectors of the economy.
2) Issuer of Currency:- The management and issuance of currency is a vital central banking function. The RBI is responsible for the design, production, distribution and the overall management of the nation’s currency. It works to ensure a sufficient supply of clean and genuine notes across the state. It works to reduce the risks of counterfeit. Counterfeited notes are often used for terrorist financing which have various ill-effects.
3) Banker and debt manager of the government:- The RBI manages the government’s banking transactions. The Government of India also deposits its cash balances with the Reserve Bank. It can also act as a banker to any state government. It appoints other banks to act as its agents for carrying out the transactions on behalf of the government. It also manages public debt and issues new loans on behalf of the Central and state governments.
4) Banker to banks:- The settlement of inter-bank transactions is also the function of the RBI. This is usually done through the mechanism of a “clearing house” where banks present cheques and other such tools for clearing. The Central bank acts as the common banker among all the various banks.
5) Lender of the last resort:- When a commercial bank fails to obtain funds from the available sources then the Central Bank issues loans to it as a “lender of the last resort”. It can come to the rescue of any bank by supplying it with the needed liquidity when no other institution is willing to extend credit to it.
6) Financial regulation and supervision:- The RBI’s regulatory and supervisory functions are quite broad. It strives to maintain overall financial stability through various policy measures. It aims to achieve orderly development and conduct of banking operations, liquidity and solvency of banks.
7) Keeps a check on the growth of inflation:- The RBI maintains an inflation target of 4% with a +/- 2% tolerance band and deems it to be appropriate for the next five years. Whenever the RBI lowers the interest rates, people get to borrow loans from the commercial banks at a reduced rate. This in turn places more money in the hands of the general public, which boosts their purchasing power and demand for stocks. This heightened demand raises the prices of goods and in turn causes inflation. Similarly, when the banks increase the interest rates, the amount of borrowing from the banks decreases. People have less purchasing power and the demand for stocks decreases. The RBI controls inflation in this manner.
8) Acts as the custodian of foreign exchange reserves:- The Central Bank also functions as the custodian of the nation’s foreign exchange reserves. It focuses on the maintenance of market’s confidence in monetary and exchange rate policies. It helps to reduce the costs at which the foreign exchange resources are available to market participants.
9) Foreign exchange management:- The RBI oversees the foreign exchange market. It has also permitted foreign investment in almost all sectors.
10) Over-sees market operations:- The Central Bank operationalises its monetary policy through its operations in government securities, foreign exchange and money markets. It also carries out regulation and development of money market instruments such as, term money market, repo market, etc.
11) Developmental role:- The RBI takes an active role in supporting and enhancing developmental activities in the country. It ensures that the productive sectors of the economy get enough credit and creates institutions to build financial infrastructure. It also works to guarantee banking services to all.
It is understood that RBI has a significant role in the country’s economy. But there are some defined objectives of the RBI. They are:
Each of the above objectives are explained in the upcoming units.