RBI as lender of last resort : an analytical

study

Project submitted to:Dr. Y. Papa Rao

(Faculty of banking law (Optional 1))

Submitted by: Meha Bhushan

Roll no. : 73
Semester IXth
Section : B

Date of submission: 08/10/2015

Hidayatullah National Law University

Raipur, Chhattisgarh
1

Acknowledgements
First & foremost, I take this opportunity to thank Mr. Y. Papa Rao, Faculty, Banking law, HNLU,
for allotting me this challenging topic to work on. He has been very kind in providing inputs for
this work, by way of suggestions.
I would also like to thank my dear colleagues and friends in the University, who have helped me
with ideas about this work. Last, but not the least I thank the University Administration for
equipping the University with such good library and I.T. facilities, without which, no doubt this
work would not have taken this shape in correct time

Meha Bhushan
Sem. IX

Declaration
I hereby declare that the project work entitled RBI as lender of last resort : an analytical
study submitted to Hidayatullah National Law University, Raipur, is a record of an original
work done by me under the guidance of Dr. Y. Papa Rao and this project work has been
performed on the basis for the award of any Degree or diploma/ associateship/ fellowship and
similar project if any.

Meha Bhushan
Sem. IX

Contents
Page
Acknowledgements

(ii)

Declaration
1.
2.
3.
4.
5.
6.
7.
8.

Introduction
Reserve Bank of India : an overview
Structure of RBI
Function of RBI
Lender of last resort
RBI as lender of last resort
Conclusion
Bibliography

(iii)
(vi)
(viii)
(xii)
(xviii)
(xix)

1. Introduction
Democracy is the worst form of government except all the other forms that have been tried from time
to time.- Winston Churchill 1.

Communication lies at the heart of politics2. Rulers, even in authoritarian states, must
communicate with their people in order to build up at leats a sembalance of legitimacy. In
democratic states, sophisticated and complex processes of communication operate through
activities such as campaigning, polling, focus-group consultation and the general politics of
persuasion. Indeed, democracy itself may be seen as a form of political communication, in that it
involves the ongoing negation of popular consent between government and the people 3.
However, poltical communication is rarely unmediated. Our knowledge and understanding of
politics very seldom comes from politicians directly, but, instead, comes from what we read in
newspapers and magazines, see on television, hear on radio, and, increasingly, find out about
through the new media, especially the internet. The mass media, though, constitute much more
than a channel of communication. They are part of the political process, affecting, and not
merely reflecting, The distribution of power in society at large4. The impact that the mass media
have on democracy is one of the most widely debated aspects of the relationship between the
media and politics. For many, the Free press is one of the key features of democractic
governance. However, how do the free press act as custodians of democracy? And to what extent
mass media in form of free press is helping democracy? Are the key issues which the research
paper seeks to find out.

1.1 Objectives
1 WINSTON CHURCHILL, SPEECH, UK HOUSE OF COMMONS (1947).
2 HEYWOOD ANDREW, POLITICS 231 ( 3d. ed. 2007).
3Ibid.
4 Ibid.
5

The main objective of the study is to examine and understand democracy as a form of
government and its transcendent virtues. The specific objectives are:

To examine and understand democracy as a form of government,

To study the role free press plays in the functioning of a democracy; and

To find out as to what kind of role the press in India plays.

1.2 Research methodology

This research paper is descriptive & analytical in approach. It is largely based on secondary &
electronic sources. Books & other reference as guided by faculty of political science are
primarily helpful for the completion of this project. Books, journals, websites, dictionaries and
articles have been referred.

1.3

Scope and limitation

The scope of study limited to democracy as a form of government and role played by free press
in keeping the democracy a vibrant one. It will cover various roles played by the press in India.

1.4

Organisation of study

The reseach paper is divided into four sections comprising of introduction in first section ,
various topics to be dealt in second , conclusion in third and biblography in fourth.The first
section i.e. introduction deals with throwing light on the topic of research paper and its
importance as to take it as a topic to deal with it; in the same.The second section is of topics
comprising of various topic in reseach paper which will dealt with. The 1 st topic deals with
6

studying democracy as a form of government, 2 nd with role of free press in democracy and 3 rd
with explaaining free press in India.

2. Reserve Bank of India : an overview

The Reserve Bank of India (RBI) is India's central banking and monetary authority. RBI
regulates loans offered by banks and non-banking financial institutions to government entities,
businesses, and consumers and controls the availability of funds in the financial system for
credit.
RBI sets the direction for interest rates and price stability and conducts fund raising activities for
the central and the state governments through the auction of government securities. Reserve
Bank is also responsible for monitoring the foreign exchange flows into the Indian economy,
managing currency exchange rates and supervising how banks and non-banking financal
institutions function.
Establishment
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of
the Reserve Bank of India Act, 1934.
The Central Office of the Reserve Bank was initially established in Calcutta but was permanently
moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are
formulated.
Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully
owned by the Government of India.
Preamble
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as:
"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country to its
advantage."
Banks are required to maintain a portion of their demand and time liabilities as cash reserves
with the Reserve Bank. For this purpose, they need to maintain accounts with the Reserve Bank.
They also need to keep accounts with the Reserve Bank for settling inter-bank obligations, such
as, clearing transactions of individual bank customers who have their accounts with different
7

banks or clearing money market transactions between two banks, buying and selling securities
and foreign currencies.
In order to facilitate a smooth inter-bank transfer of funds, or to make payments and to receive
funds on their behalf, banks need a common banker. By providing the facility of opening
accounts for banks, the Reserve Bank becomes this common banker, known as Banker to
Banks function. The function is performed through the Deposit Accounts Department (DAD) at
the Reserve Banks Regional offices. The Department of Government and Bank Accounts
oversees this function and formulates policy and issues operational instructions to DAD.

3. Structure of RBI
The Reserve Bank of India is wholly owned by the Government of India. The structure of RBI is
as follows:
Central Board of Directors
At the apex is the Central Board of Directors, which is made of official directors and Nonofficial directors.
Official Directors : The Governor and Deputy Governor of RBI are its full time official directors.
There is one Governor appointed and maximum four deputy governors. Governor and Deputy
governors are appointed by Central Government. The tenure of service is maximum of 5 years or
till the age of 62 whichever is earlier.
Non-Official Directors: There are 16 non-official directors in RBI. Out of them, there are 4 Nonofficial Directors represent the local Boards located in Delhi, Chennai, Kolkata and Mumbai
representing 4 regions of India. Rest 10 Non-official directors are nominated by the Reserve
Bank of India. These 10 personalities have expertise in various segments of Indian Economy.
The Central Board of Directors holds minimum 6 meetings every year. Out of which, at least 1
meeting every quarter is held. Though, typically the committee of the central board meets every
week (Wednesday).
Assistive Boards: There are two assistive bodies for Central Board of Directors viz. Board of
Financial Supervision (BFS) and Board for Payment and Settlement Systems (BPSS). Both of
these are chaired by RBI Governor.
Local Boards: There are four local boards of RBI located in Chennai, Kolkata, Mumbai and
New Delhi. These four local boards represent four regions of the country. Members and directors
of local boards are appointed by central government for four-year terms. The local boards
represent regional and economic interests and the interests of co-operative and indigenous banks.
8

Departments: Reserve Bank of India has 33 departments which focus on policy issues in the
Reserve Banks functional areas and internal operations. Regional Offices and Sub-offices There
are 19 regional offices and 9 sub-offices of RBI. Most of the 19 regional offices are located in
state capitals.
Training Centres: The training centres of RBI are as follows: The Reserve Bank Staff College,
Chennai College of Agricultural Banking at Pune Zonal Training Centres, located at regional
offices, train non-executive staff. Apart from that following are RBI funded Research
Institutions: National Institute of Bank Management (NIBM) : Pune, Indira Gandhi Institute of
Development Research (IGIDR) : Mumbai Institute for Development and Research in Banking
Technology (IDRBT) : Hyderabad.
RBIs Subsidiaries: RBI has following subsidiaries Deposit Insurance and Credit Guarantee
Corporation,DICGC National Housing Bank Bharatiya Reserve Bank Note Mudran Private
Limited (BRBNMPL) NABARD

4. Function of RBI
The Reserve Bank of India performs various traditional central banking functions as well as
undertakes different promotional and developmental measures to meet the dynamic
requirements of the country.
The broad objectives of the Reserve Bank are:
(a) Regulating the issue of currency in India;
(b) keeping the foreign exchange reserves of the country;
(c) establishing the monetary stability in the country; and
(d) developing the financial structure of the country on sound lines consistent with the national
socio-economic objectives and policies. Main functions of the Reserve Bank are described
below:

Note Issue:
9

The Reserve Bank has the monopoly of note issue in the country. It has the sole right to issue
currency notes of all denominations except one-rupee notes. One-rupee notes are issued by the
Ministry of Finance of the Government of India. The Reserve Bank acts as the only source of
legal tender because even the one-rupee notes are circulated through it. The Reserve Bank has
a separate Issue Department, which is entrusted with the job of issuing currency notes. The
Reserve Bank has adopted minimum reserve system of note issue. Since 1957, it maintains
gold and foreign exchange reserves of Rs. 200 crore, of which at least Rs. 115 crore should be
in gold.

Banker to Government:
The Reserve Bank acts as the banker, agent and adviser to Government of India:
(a) It maintains and operates government deposits,
(b) It collects and makes payments on behalf of the government,
(c) It helps the government to float new loans and manages the public debt,
(d) It sells for the Central Government treasury bills of 91 days duration,
(e) It makes 'Ways and Means' advances to the Central and State Governments for periods not
exceeding three months,
(f) It provides development finance to the government for carrying out five year plans,
(g) It undertakes foreign exchange transactions on behalf of the Central Government,
(h) It acts as the agent of the Government of India in the latter's dealings with the International
Monetary Fund (IMF), the World Bank, and other international financial institutions, (i) It
advises the government on all financial matters such as loan operations, investments,
agricultural and industrial finance, banking, planning, economic development, etc.

Banker's Bank:
The Reserve Bank acts as the banker's bank in the following respects:
(a) Every Bank is under the statutory obligation to keep a certain minimum of cash reserves
with the Reserve Bank. The purpose of these reserves is to enable the Reserve Bank to extend
financial assistance to the scheduled banks in times of emergency and thus to act as the lender
of the last resort. According to the Banking Regulation Act, 1949, all scheduled banks are
required to maintain with the Reserve Bank minimum cash reserves of 5% of their demand
liabilities and 2% of their time liabilities. The Reserve Bank (Amendment) Act, 1956
empowered the Reserve Bank to raise the cash reserve ratio to 20% in the case of demand
deposits and to 8% in case of time deposits. Due to the difficulty of classifying deposits into
demand and time categories, the amendment to the Banking Regulation Act in September 1972
changed the provision of reserves to 3% of aggregate deposit liabilities, which can be raised to
15% if the Reserve Bank considers it necessary,
10

(b) The Reserve Bank provide financial assistance to the scheduled banks by discounting their
eligible bilk and through loans and advances against approved securities,
(c) Under the Banking Regulation Act,1949 and its various amendments, the Reserve Bank has
been given extensive powers of supervision and control over the banking system. These
regulatory powers relate to the licensing of banks and their branch expansion; liquidity of
assets of the banks; management and methods of working of the banks; amalgamation,
reconstruction and liquidation of banks; inspection of banks; etc.

Custodian of Exchange Reserves:

The Reserve Bank is the custodian of India's foreign exchange reserves. It maintains and
stabilises the external value of the rupee, administers exchange controls and other restrictions
imposed by the government, and manages the foreign exchange reserves. Initially, the stability
of exchange rate was maintained through selling and purchasing sterling at fixed rates. But
after India became a member of the international Monetary Fund (IMF) in 1947, the rupee was
delinked with sterling and became a multilaterally convertible currency. Therefore the Reserve
Bank now sells and buys foreign currencies, and not sterling alone, in order to achieve the
objective of exchange stability. The Reserve Bank fixes the selling and buying rates of foreign
currencies. All Indian remittances to foreign countries and foreign remittances to India are
made through the Reserve Bank.

Controller of Credit:
As the central bank of the country, the Reserve Bank undertakes the responsibility of
controlling credit in order to ensure internal price stability and promote economic growth.
Through this function, the Reserve Bank attempts to achieve price stability in the country and
avoids inflationary and deflationary tendencies in the country. Price stability is essential for
economic development. The Reserve Bank regulates the money supply in accordance with the
changing requirements of the economy. The Reserve Bank makes extensive use of various
quantitative and qualitative techniques to effectively control and regulate credit in the country.

Ordinary Banking Functions:

The Reserve Bank also performs various ordinary banking functions:
(a), It accepts deposits from the central government, state governments and even private
individuals without interest,
(b) It buys, sells and rediscounts the bills of exchange and promissory notes of the scheduled
banks without restrictions,
(c) It grants loans and advances to the central government, state governments, local authorities,
scheduled banks and state cooperative banks, repayable within 90 days,
(d) It buys and sells securities of the Government of India and foreign securities,

11

(e) It buys from and sells to the scheduled banks foreign exchange for a minimum amount of
Rs. 1 lakh,
(f) It can borrow from any scheduled bank in India or from any foreign bank,
(g) It can open an account in the World Bank or in some foreign central bank.
(h) It accepts valuables, securities, etc., for keeping them in safe custody.
(i) It buys and sells gold and silver.

Miscellaneous Functions:
In addition to central banking and ordinary banking functions, the Reserve Bank
performs the following miscellaneous functions:
(a) Banker's Training College has been set up to extend training facilities to supervisory staff of
commercial banks. Arrangements have been made to impart training lo the cooperative
personnel,
(b) The Reserve Bank collects and publishes statistical information relating to banking,
finance, credit, currency, agricultural and industrial production, etc. It also publishes the results
of various studies and review of economic situation of the country in its monthly bulletins and
periodicals.

8. Forbidden Business:
Being the central bank of the country, the Reserve Bank:
(a) Should not compete with member banks and
(b) should keep its assets in liquid form to meet any situation of economic crisis.
Therefore, the Reserve Bank has been forbidden to do certain types of business:
(a) It can neither participate in, nor directly provide financial assistance to any business, trade
or industry,
(b) It can neither buy its own shares not those of other banks or commercial and industrial
undertakings,
(c) It cannot grant unsecured loans and advances,
(d) It cannot give loans against mortgage security,
(e) It cannot give interest on deposits.
(f) It cannot draw or accept bills not payable on demand,
12

(g) It cannot purchase immovable property except for its own offices.

Promotional and Developmental Functions:

Besides the traditional central banking functions, the Reserve Bank also performs a
variety of promotional and developmental functions:
(a) By encouraging the commercial banks to expand their branches in the semi-urban and rural
areas, the Reserve Bank helps (i) to reduce the dependence of the people in these areas on the
defective unorganised sector of indigenous bankers and money lenders, and (ii) to develop the
banking habits of the people
(b) By establishing the Deposit Insurance Corporation, the Reserve Bank helps to develop the
banking system of the country, instills confidence of the depositors and avoids bank failures,
(c) Through the institutions like Unit Trust of India, the (Reserve Bank helps to mobilise
savings in the country,
(d) Since its inception, the Reserve Bank has been mating efforts to promote institutional
agricultural credit by developing cooperative credit institutions.
(e) The Reserve Bank also helps to promote the process of industrialisation in the country by
setting up specialised institutions for industrial finance,
(f) it also undertakes measures for developing bill market in the country
Lender of resort
A lender of last resort is an institution which is willing to offer loans as a last
resort.
Such institution is usually a countrys central bank. In this case, we talk of a
wholesale
lender
of
last
resort.
A central bank offers extension of credit to financial institutions experiencing
financial difficulties which are unable to obtain necessary funds elsewhere.
The main task in front of the lender of last resort is to preserve the stability of the
banking and financial system by protecting individuals deposited funds and
preventing panic-ridden withdrawing from banks with temporary limited liquidity.
For more than century and a half, central banks have been trying to avoid great
depressions by acting as lenders of last resort in times of financial crisis. At first,
this act provides liquidity at a penalty rate. Subsequently trough open market
operations, it lowers interest rates on safe assets. And finally, this process involves
direct
market
support.
Commercial banks usually resort to lenders help only in times of crisis because
such actions indicate financial difficulties. Loans may be granted not only to
commercial banks but also to any other eligible financial institution, even private
companies,
which
is
considered
highly
risky.
13

Different institutions may act as a lender of last resort in different countries. For
instance in the USA, the Federal Reserve serves as a lender of last resort. Its main
purpose is to provide credit to financial institutions that are short of reserves,
prevent their bankruptcy, and avoid negative impact on the economy. As a lender of
last resort, the Federal Reserve encourages member banks to borrow funds from the
so called discount window. The term refers to loans granted to member banks.
The banks may use these loans either to meet reserve requirements or to pay for
large
withdrawals.
In the United Kingdom, the central bank, the Bank of England functions as a lender
of last resort. In New Zealand this role is taken by the Reserve Bank of New
Zealand, its central bank. On a global level, the International Monetary Fund also
serves as an international lender of last resort, taking such role because of the
recent
financial
crisis.
A non-central bank also may act as a lender of last resort. This is an example of a
retail lender of last resort. HSBC Holdings plc, the worlds largest banking group,
illustrates this case. History shows that even a physical person can assume the role
of a lender of last resort. John Pierpont Morgan, an American financier and banker,
has acted as a lender in the beginning of the 20th century.
Cheque cashing stores or credit card operations, dealing with highly risky private
clients, may also assume the role. Sometimes, a so called criminal loan shark may
act as a lender, offering loans at very high rates, which of course maybe illegal.
These are not single cases of lenders of last resort, dealing with the public.
For instance, credit may be granted for the purchase of certain goods which cannot
be
sold
for
cash.
The operations of the lender of last resort are not approved by everybody. There are
wide-spread arguments against, with critics claiming that such operations are
immoral. In their opinion, such practice won't work in the long run. Providing
institutions with financial support appears to be quite tempting as the
consequences of risky actions seem less severe. As a result, an institution tends to
take on more risks than normally. Such extension of credit can, in fact, conceal the
true financial state of an institution, and prolong its failure. Eventually, the body
fails to cure the current financial crises and instead creates new ones.

5. Conclusion
In this paper, I showed the need to seriously study democracy as a form of government
and how free press plays an important role in proper functioning of democracy.
Democracy is a form of government which is by the people and for the people. It
empowers the citizen . Various functions of democracy are sovereignty of the people,
government based upon consent of the governed, majority rule, minority rights, guarantee
of basic human rights etc. Free press includes newspapers ( and, by extension, other
14

media outlets) that are free from censorship and political interference by government and,
usually, are privately owned . It plays ensures proper functioning of democracy like by
fostering public debate and political engagement, acting as a public watchdog to check
abuses of power, redistributing power and political influence and by providing a
mechanism through which democracy can operate. Free press is considered as one of the
pillars holding democracy in a society. Free press in India is also discussed in the paper.
There are various legal rules providing freedom to press. But the theoretical freedom to
press differs from the practical freedom of press. Free press has to face many obstacles
including governmental as well as non- governmental ones. On one hand governmental
restrictions comes in form of legal restrictions and on the other the non-governmental
ones comes in form of monopoly trends and time to time pressure from different
religious, caste and other communal groups etc. It is a basic principle that all people want
things to be benefitting their interest. And hence they try to influence press in different
ways as result of which the information accessible from mainstream press becomes more
and more vulnerable to interests of various groups of society. This trend also reduces the
number of different views that the public is exposed to, and threatens the marketplace of
ideas. The only means to ensure free flow of information is by protecting all forms of
media equally and hence resulting to proper awareness of public about the actual
happenings and thus ensuring proper functioning of democracy.

1. Bibliography
1. HEYWOOD ANDREW, POLITICS, ( 3d. ed. 2007).
2. JUSTICE SAWANT P. B., MASS MEDIA IN CONTEMPORARY SOCIETY, (1t ed.
1997).
3. H DE SMAELE, MASS MEDIA AND POLITICAL COMMUNICATION IN NEW, (2006,
PSYCHOLOGY PRESS).
4. GAUBA O. P., AN INTRODUCTION TO POLITICAL THEORY, ( 5h ed. 2010).
5. RAY AMAL AND BHATTACHARYA MOHIT, POLITICAL THEORY IDEAS AND
INSTITUIONS, ( 8h ed. 1983).
15

16