The Reserve Bank functions through its all-powerful monetary policy committee, headed by the governor. Its primary responsibilities include regulating banks, managing the government’s finances, ensuring currency stability, and ensuring credit availability for businesses & individuals to help the economy to grow. The RBI needs to perform these tasks with the major goal of keeping inflation under control. To sum up, the RBI needs to ensure that the country’s economy continues to grow. But at the same time, prices of general goods and services stay within the reach of common citizens.
The central bank’s overall mandate includes complex tasks associated with ensuring the smooth functioning of the economy, though they can be summed up under the following headlines.
Functions of the Reserve Bank of India
1) Regulator of the Banking System
A healthy banking system is a prerequisite for any economy to grow. RBI ensures the proper functioning of the banking system and regulates them through the power vested in it under the Banking Regulation Act, 1949.
The purpose is to protect the interest of depositors while ensuring that money flow is smoothly circulated in the economy. And, it reaches every section of society via banks in the form of credit.
Improved credit circulation, in turn, helps in sustaining businesses, employment, and generating demand in the overall economy.
Banking Regulation Act, 1949, gives RBI the power to license banks, regulate their operations, supervise the shareholding and appointment of the board, conduct audits, prepare lending guidelines, manage stressed assets, and even impose necessary restrictions and penalties if banks are found deviating from its objectives.
2) Banker of the Government
The RBI acts as a banker to the central and state governments. Thereby, it processes all the banking related transactions of the government.
The RBI also provides short-term credit to them and adds a source of revenue for the central government in the form of a dividend. It is also in charge of managing the government’s debt by overseeing new issues of government loans. It also manages its borrowing program by issuing government securities in the domestic as well as the international markets.
The RBI’s responsibilities also include finding buyers for these government securities through the money market. It designs the quantum of securities and interest rates as per the currently prevailing liquidity and ensures that new issues of government securities are received well in the market.
3) Maintaining Liquidity to Ensure Credit Availability
Liquidity means the availability of cash in the system. Liquidity management is crucial for credit to trickle down to corporates, MSMEs, other small entrepreneurs, and consumers.
There are pros and cons of liquidity in the system. Surplus liquidity can push the commodity prices up, increasing inflation. A deficit, on the other hand, can push back demand, adversely impacting the business sentiments, and thereby negatively impacting the growth. The RBI needs to maintain the fine balance between growth and inflation through effective liquidity management.
Open Market Operation (OMO) is the most effective tool at RBI’s disposal for effective liquidity management. OMO is an activity that the central bank uses to buy or sell government securities in the open market.
When there is excess liquidity in the market, RBI sells government securities to banks. Hence, excess liquidity with banks gets transferred to RBI. On the opposite side, RBI purchases securities from the market when liquidity conditions are tight. When RBI pays for those securities, liquidity gets released in the market.
Apart from that, the RBI also controls the flow of liquidity in banks by using several other tools like Liquidity Adjustment Facility, Repo Rate, and Reverse Repo Rates.
4) Managing Inflation
Growing inflation is a major concern for emerging economies like India as they aspire for growth. Inflation elevates the prices of essential items, which directly impacts the poor class. Growing inflation is a prime reason for growing income inequality in the country.
The Reserve Bank of India is the authority assigned with the task of controlling inflation. It has various tools at its disposal for that. It includes monetary measures like changing interest rates, repo rates, cash reserve ratio, buying dollars, regulating money supply, and availability of credit. These measures reduce the market’s money supply, lowering demand and lowering prices even further.
However, containing inflation could also impact the growth, which a growing economy like India cannot afford. Hence, the RBI needs to maintain a fine balance between growth and inflation. RBI’s current mandate is to maintain inflation in the range of 4%, + or -2%.
5) Other Functions
The Reserve Bank is the sole authority to print currency notes in the country. It has the right to issue or withdraw currency notes, except one rupee note, which is issued by the Ministry of Finance.
The RBI also manages the foreign exchange rates and protects the country’s foreign exchange reserve. It keeps the country competitive in international trade and ensures timely payments to foreign trade partners. RBI sells the foreign currency in the foreign exchange market to keep the value of the rupee at par with other major currencies.
RBI, as mentioned at the beginning, plays a crucial role in smoothly running the economic engine of the country. Its major task involves maintaining the right amount of liquidity in the system. This, in turn, would help in ensuring the fine balance between growth and inflation.