A PROJECT ON

RESERVE BANK OF INDIA (LENDER OF LAST RESORT)

SUBMITTED TO
DR.KIRAN KORI
(FACULTY FOR BANKING LAW(OPTIONAL-2)

SUBMITTED BY

HEMANT VERMA

ROLL NO. 58, SEMESTER – IXTH

B.A. LL.B(HONS.)

DATE OF SUBMISSION

25TH OF OCTOBER,2018

HIDAYATULLAH NATIONAL LAW UNIVERSUTY

RAIPUR (C.G.)

1
CONTENTS
ACKNOWLEDGMENTS ................................................................................................................. 3
DECLARATION .............................................................................................................................. 4
RESEARCH METHODOLOGY ....................................................................................................... 5
RESERVE BANK OF INDIA ........................................................................................................... 6
STRUCTURE OF RBI ...................................................................................................................... 7
FUNCTIONS OF RBI ( THE INDIA'S CENTRAL BANK ) LIST .................................................... 8
LENDER OF LAST RESORT(MEANING) .................................................................................... 13
How it works/Example ................................................................................................................ 13
Why it Matters............................................................................................................................. 13
RBI AS LENDER OF LAST RESORT ........................................................................................... 14
CONCLUSION ............................................................................................................................... 16
REFERENCE.................................................................................................................................. 17

2
ACKNOWLEDGMENTS

At the outset, I would like to express my heartfelt gratitude and thank my teacher, Dr. Papa
Rao for putting his trust in me and giving me a project topic such as this and for having the
faith in me to deliver. Sir thank you for an opportunity to help me understand and learn
something new.

My gratitude also goes out to the staff and administration of HNLU for the infrastructure in
the form of our library and IT Lab that was a source of great help for the completion of this
project.

Hemant Verma

3
DECLARATION

I hereby declare that the project work entitled “RBI-Lender of last Resort” submitted to
Hidayatullah National Law University, Raipur, is a record of an original work done by me
under the guidance of Dr. Papa Rao and this project work has not been performed on the
basis for the award of any Degree or diploma/ associate ship /fellowship and similar project if
any.

- Hemant Verma

Semester IX– A

Roll No. 58

4
RESEARCH METHODOLOGY
(a) Problems -
 What exactly is meant by lender of last resort function?
 How does RBI exercise this function?

(b) Rationale of the Project- The rationale behind the project is that there are a lot of
functions which the RBI performs ,but being the leader of all the banks in the country,its
function is also to safeguard the commercial banks from lack of liquidity by granting
loans and advances and thus acting as lender of last resort.
(c) Objectives-
i) To study various functions of RBI
ii) To analyze the role of RBI as lender of last resort

(d) Nature of Research- The nature of research is Doctrinal.

(e) Sources- Secondary Sources and Internet have been used

5
RESERVE BANK OF INDIA
India's central bank is the Reserve Bank of India (RBI). Reserve Bank of India monitors,
formulates and implements India's monetary policy. Established in the year 1935, Reserve
bank of India was nationalized in the year 1949.1 Owned fully by the Government of India,
Reserve Bank has around 22 regional offices in various state capitals of India with its
headquarters located in Mumbai. It has a majority stake in the State Bank of India. 2
It was established in April 1935 with a share capital of Rs. 5 crores on the basis of the
recommendations of the Hilton Young Commission. The Reserve Bank of India Act, 1934
was commenced on April 1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of
the functioning of the Bank. In accordance with the provisions of the RBI Act, 1934 with the
main functions as: 3
(i) Operating monetary policy with the aim of maintaining economic and financial
stability and ensuring adequate financial resources for development purposes
(ii) Meeting the currency requirement of the public;
(iii) Promotion of an efficient financial system;
(iv) Foreign exchange reserve management;
(v) The conduct of banking and financial operations of the government.4

It can be summarised by the preamble 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." 5
Since the onset of the process economic reforms, including the on-going liberalization and
globalization of the economy, the role of the RBI as the Regulator of the financial sector has
grown and diversified. Reserve Bank of India is regulator for all the banks in the country and
as a regulator, apart from commercial banks, also supervises Co-operative banks,
Non Banking Finance companies, Financial Institutions etc. Thus the entire institutional
function of providing finance comes under the regulatory oversight of the RBI

1
M L Tannan, "TANNAN'S BANKING: LAW AND PRACTICE IN INDIA" p 163 (21st Edn, 2005)
2
Id.
3
Id.
4
Id.
5
Reserve Bank of India Act, 1934.

6
STRUCTURE OF RBI

 Central Board of Directors

The Central Board of Directors is the main committee of the Central Bank. The Government
of India appoints the directors for a 4-year term. The Board consists of a Governor, and not
more than 4 Deputy Governors, 16 6 Directors to represent the regional boards, 2 from the
Ministry of Finance and 10 other directors from various fields.

 Governor's

The Governor of RBI is Raghuram Rajan. There are 4 Deputy Governors, Deputy
Governor H R Khan, Dr Urjit Patel, R Gandhi and SS Mundra. Dr. Urjit Patel became Deputy
Governor in January 2013. One of the four Deputy Governors is traditionally from RBI ranks,
and is selected from the Bank's Executive Directors. As for the rest, one is nominated from
among the Chairpersons of Public Sector Bank, and the other is an economist of repute . It is
also often seen that an officer of Indian Administrative Service is appointed Deputy Governor
of RBI and later as the Governor of RBI. The case of Y. Venugopal Reddy, an officer
of Indian Administrative Service batch of 1964 is a noted example for this trend in the RBI.

 Supportive bodies

The Reserve Bank of India has four regional representations: North in New Delhi, South in
Chennai, East in Kolkata and West in Mumbai. The representations are formed by five
members, appointed for four years by the central government and serve—beside the advice of
the Central Board of Directors—as a forum for regional banks and to deal with delegated
tasks from the central board.7The institution has 22 regional offices.

The Board of Financial Supervision (BFS), formed in November 1994, serves as a CCBD
committee to control the financial institutions. It has four members, appointed for two years,
and takes measures to strength the role of statutory auditors in the financial sector, external
monitoring and internal controlling systems.

6
Reserve Bank of India - India's Central Bank. Rbi.org.in. Retrieved on 2014-05-21.
7
About us, Organisation and Functions". RBI. Retrieved 2010-08-20.

7
The Tarapore committee was set up by the Reserve Bank of India under the chairmanship of
former RBI deputy governor S.S.Tarapore to "lay the road map" to capital account
convertibility. The five-member committee recommended a three-year time frame for
complete convertibility by 1999–2000.

On 1 July 2007, in an attempt to enhance the quality of customer service and strengthen the
grievance redressal mechanism, the Reserve Bank of India created a new customer service
department.

 Offices and branches

The Reserve Bank of India has four zonal offices. 8 It has 19 regional offices at most state
capitals and at a few major cities in India. Few of them are located
in Ahmedabad,Bangalore, Bhopal, Bhubaneswar, Chandigarh, Chennai, Delhi, Guwahati, Hy
derabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow, Mumbai, Nagpur, Patna,
andThiruvananthapuram. It also has 10 sub-offices located
in Samana, Dehradun, Gangtok, Kochi, Panaji, Raipur, Ranchi, Shillong, Shimla , Srinagar a
nd Agartala .

The bank has also two training colleges for its officers, viz. Reserve Bank Staff College at
Chennai and College of Agricultural Banking at Pune. There are also four Zonal Training
Centres at Mumbai, Chennai, Kolkata and New Delhi.

FUNCTIONS OF RBI ( THE INDIA'S CENTRAL BANK ) LIST

As a central bank, the Reserve Bank has significant powers and duties to perform. For
smooth and speedy progress of the Indian Financial System, it has to perform some important
tasks. Among others it includes maintaining monetary and financial stability, to develop and
maintain stable payment system, to promote and develop financial infrastructure and to
regulate or control the financial institutions.For simplification, the functions of the Reserve
Bank are classified into the traditional functions, the development functions and supervisory
functions. 9

8
"Reserve Bank of India". Rbi.org.in. Retrieved 2011-09-16
9
Gaurav Akrani, Functions of Reserve Bank of India RBI - RBI Credit Policy Kalyan-city.blogspot.com (2014),
http://kalyan-city.blogspot.com/2010/09/functions-of-reserve-bank-of-india-rbi.html (last visited Oct 8, 2014).

8
Traditional Functions of RBI

Traditional functions are those functions which every central bank of each nation performs all
over the world. Basically these functions are in line with the objectives with which the bank
is set up. It includes fundamental functions of the Central Bank. They comprise the following
tasks.

1. Issue of Currency Notes : The RBI has the sole right or authority or monopoly of
issuing currency notes except one rupee note and coins of smaller denomination.
These currency notes are legal tender issued by the RBI. Currently it is in
denominations of Rs. 2, 5, 10, 20, 50, 100, 500, and 1,000. The RBI has powers not
only to issue and withdraw but even to exchange these currency notes for other
denominations. It issues these notes against the security of gold bullion, foreign
securities, rupee coins, exchange bills and promissory notes and government of India
bonds.

2. Banker to other Banks : The RBI being an apex monitory institution has obligatory
powers to guide, help and direct other commercial banks in the country. The RBI can
control the volumes of banks reserves and allow other banks to create credit in that
proportion. Every commercial bank has to maintain a part of their reserves with its
parent's viz. the RBI. Similarly in need or in urgency these banks approach the RBI
for fund. Thus it is called as the lender of the last resort. The same function will be
discussed in detail later.

3. Banker to the Government : The RBI being the apex monitory body has to work as
an agent of the central and state governments. It performs various banking function
such as to accept deposits, taxes and make payments on behalf of the government. It
works as a representative of the government even at the international level. It
maintains government accounts, provides financial advice to the government. It
manages government public debts and maintains foreign exchange reserves on behalf
of the government. It provides overdraft facility to the government when it faces
financial crunch.

9
 4. Exchange Rate Management : It is an essential function of the RBI. In order to
maintain stability in the external value of rupee, it has to prepare domestic policies in
that direction. Also it needs to prepare and implement the foreign exchange rate
policy which will help in attaining the exchange rate stability. In order to maintain the
exchange rate stability it has to bring demand and supply of the foreign currency (U.S
Dollar) close to each other.

5. Credit Control Function : Commercial bank in the country creates credit according
to the demand in the economy. But if this credit creation is unchecked or unregulated
then it leads the economy into inflationary cycles. On the other credit creation is
below the required limit then it harms the growth of the economy. As a central bank
of the nation the RBI has to look for growth with price stability. Thus it regulates the
credit creation capacity of commercial banks by using various credit control tools.

6. Supervisory Function : The RBI has been endowed with vast powers for supervising
the banking system in the country. It has powers to issue license for setting up new
banks, to open new braches, to decide minimum reserves, to inspect functioning of
commercial banks in India and abroad, and to guide and direct the commercial banks
in India. It can have periodical inspections an audit of the commercial banks in
India.10

Developmental / Promotional Functions of RBI

Along with the routine traditional functions, central banks especially in the developing
country like India have to perform numerous functions. These functions are country specific
functions and can change according to the requirements of that country. The RBI has been
performing as a promoter of the financial system since its inception. Some of the major
development functions of the RBI are maintained below.

10
Id.

10
1. Development of the Financial System : The financial system comprises the financial
institutions, financial markets and financial instruments. The sound and efficient
financial system is a precondition of the rapid economic development of the nation.
The RBI has encouraged establishment of main banking and non-banking institutions
to cater to the credit requirements of diverse sectors of the economy.

2. Development of Agriculture : In an agrarian economy like ours, the RBI has to

provide special attention for the credit need of agriculture and allied activities. It has
successfully rendered service in this direction by increasing the flow of credit to this
sector. It has earlier the Agriculture Refinance and Development Corporation
(ARDC) to look after the credit, National Bank for Agriculture and Rural
Development (NABARD) and Regional Rural Banks (RRBs).

3. Provision of Industrial Finance : Rapid industrial growth is the key to faster

economic development. In this regard, the adequate and timely availability of credit to
small, medium and large industry is very significant. In this regard the RBI has
always been instrumental in setting up special financial institutions such as ICICI Ltd.
IDBI, SIDBI and EXIM BANK etc.

4. Provisions of Training : The RBI has always tried to provide essential training to the
staff of the banking industry. The RBI has set up the bankers' training colleges at
several places. National Institute of Bank Management i.e NIBM, Bankers Staff
College i.e BSC and College of Agriculture Banking i.e CAB are few to mention.

5. Collection of Data : Being the apex monetary authority of the country, the RBI
collects process and disseminates statistical data on several topics. It includes interest
rate, inflation, savings and investments etc. This data proves to be quite useful for
researchers and policy makers.

6. Publication of the Reports : The Reserve Bank has its separate publication division.
This division collects and publishes data on several sectors of the economy. The
reports and bulletins are regularly published by the RBI. It includes RBI weekly
reports, RBI Annual Report, Report on Trend and Progress of Commercial Banks
India., etc. This information is made available to the public also at cheaper rates.

7. Promotion of Banking Habits : As an apex organization, the RBI always tries to

promote the banking habits in the country. It institutionalizes savings and takes

11
 measures for an expansion of the banking network. It has set up many institutions
such as the Deposit Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD-
1982, NHB-1988, etc. These organizations develop and promote banking habits
among the people. During economic reforms it has taken many initiatives for
encouraging and promoting banking in India.

8. Promotion of Export through Refinance : The RBI always tries to encourage the
facilities for providing finance for foreign trade especially exports from India. The
Export-Import Bank of India (EXIM Bank India) and the Export Credit Guarantee
Corporation of India (ECGC) are supported by refinancing their lending for export
purpose.11

Supervisory Functions of RBI

The reserve bank also performs many supervisory functions. It has authority to regulate and
administer the entire banking and financial system. Some of its supervisory functions are
given below.

1. Granting license to banks : The RBI grants license to banks for carrying its business.
License is also given for opening extension counters, new branches, even to close
down existing branches.

2. Bank Inspection : The RBI grants license to banks working as per the directives and
in a prudent manner without undue risk. In addition to this it can ask for periodical
information from banks on various components of assets and liabilities.

3. Control over NBFIs : The Non-Bank Financial Institutions are not influenced by the
working of a monitory policy. However RBI has a right to issue directives to the
NBFIs from time to time regarding their functioning. Through periodic inspection, it
can control the NBFIs.

4. Implementation of the Deposit Insurance Scheme : The RBI has set up the Deposit
Insurance Guarantee Corporation in order to protect the deposits of small depositors.

11
Id.

12
 All bank deposits below Rs. One lakh are insured with this corporation. The RBI
work to implement the Deposit Insurance Scheme in case of a bank failure. 12

LENDER OF LAST RESORT(MEANING)

The term "Lender of Last Resort" refers to financial institutions or individuals that
provide credit and/orliquidity to other financial institutions and/or individuals who have
exhausted their remaining alternatives for credit or liquidity.
How it works/Example
There are generally two types of lenders of last resort: (1) financial institutions that
provide credit to other financial institutions that require credit to remain solvent for their
depositors; (2) institutions or individuals providing credit to individuals, commonly referred
to as retail lending. This latter form can take the appearance of illegal practices widely known
as loan sharking.
Today, the lender of last resort among financial institutions refers to the Federal Reserve
Bank in the U.S or the Bank of England in Great Britain, both of which serve as the central
banks of their respective countries. The credit that they provide to banks serves as a type
of guarantee, preventing public confidence in the banking system from being undermined and
thereby preventing a "run" on the banking system as a whole.
In retail lending, this service is provided to individuals who have no other recourse in
obtaining credit. For example, this can take the form of car or home loans to individuals in
the high risk category. The incentive for the loan providers in these cases is monetary, due to
the high rates of interest demanded for high risk loans.

Historically, the lender of last resort system has been used by various entities to
provide liquidity to the credit markets when it would not otherwise be forthcoming. Two
historical examples of this use are the Great Depression and the Panic of 1907.
Why it Matters
A "run" on the banking system is when depositors line up to withdraw all of
their deposits from the banking system en masse. Most banks do not have this amount
of cash on hand at any one point in time, due to the fractional reserve banking system used in
most of the Western world. The inability to handle a bank run can lead to panic and plunge

12
Id.

13
society into civil breakdown and a state of social unrest. For this reason the lender of last
resort system is viewed as an essential backstop in the banking system.

One criticism of the lender of last resort system is that it allows financial institutions to take
greater risk with their own investments knowing they have an entity that will absorb some of
that risk if the bank fails.
Another criticism is towards the International Monetary Fund (IMF), which provides loans to
countries as a lender of last resort. The criticism leveled here is that countries who borrow
from the IMF are bad creditrisks that are almost not expected to pay off their loans.

RBI AS LENDER OF LAST RESORT

The RBI serves as a banker to the scheduled commercial banks in India. All the Scheduled
Banks keep their Accounts with the RBI for the purpose of maintaining cash reserve as also
for settlement of clearing transactions.

Banks are required to maintain a portion of their demand and time liabilities as cash reserves
with the Reserve Bank, thus necessitating a need for maintaining accounts with the Bank.
Further, banks are in the business of accepting deposits and giving loans. Since different
persons deal with different banks, in order to settle transactions between various customers
maintaining accounts with different banks, these banks have to settle transactions among each
other. Settlement of inter-bank obligations thus assumes importance. To facilitate smooth
operation of this function of banks, an arrangement has to be made to transfer money from
one bank to another. This is usually done through the mechanism of a clearing house where
banks present cheques and other such instruments for clearing. Many banks also engage in
other financial activities, such as, buying and selling securities and foreign currencies. Here
too, they need to exchange funds between themselves. 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. In order to meet the above objectives, in India, the Reserve Bank provides
banks with the facility of opening accounts with itself. This is the ‘Banker to Banks’ function
of the Reserve Bank, which is delivered through the Deposit Accounts Department (DAD) at
the Regional offices. The Department of Government and Bank Accounts oversees this
function and formulates policy and issues operational instructions to DAD. To fulfill this
function, the Reserve Bank opens current accounts of banks withitself, enabling these banks
to maintain cash reserves as well as to carry out inter-bank transactions through these

14
accounts. Inter-bank accounts can also be settled by transfer of money through electronic
fund transfer system, such as, the Real Time Gross Settlement System (RTGS). The Reserve
Bank continuously monitors operations of these accounts to ensure that defaults do not take
place. Among other provisions, the Reserve Bank stipulates minimum balances to be
maintained by banks in these accounts. Since banks need to settle funds with each other at
various places in India, they are allowed to open accounts with different regional offices of
the Reserve Bank. The Reserve Bank also facilitates remittance of funds from a bank’s
surplus account at one location to its deficit account at another. Such transfers are
electronically routed through a computerised system. The computerisation of accounts at the
Reserve Bank has greatly facilitated banks’ monitoring of their funds position in various
accounts across different locations on a real-time basis.

In addition, the Reserve Bank has also introduced the Centralised Funds Management System
(CFMS) to facilitate centralised funds enquiry and transfer of funds across DADs. This helps
banks in their fund management as they can access information on their balances maintained
across different Box 637 DADs from a single location. Currently, 75 banks are using the
system and all DADs are connected to the system. As Banker to Banks, the Reserve Bank
provides short-term loans and advances to select banks, when necessary, to facilitate lending
to specific sectors and for specific purposes. These loans are provided against promissory
notes and other collateral given by the banks. As a Banker to Banks, the Reserve Bank also
acts as the ‘lender of last resort’. It can come to the rescue of a bank that is solvent but faces
temporary liquidity problems by supplying it with much needed liquidity when no one else is
willing to extend credit to that bank. The Reserve Bank extends this facility to protect the
interest of the depositors of the bank and to prevent possible failure of a bank, which in turn
may also affect other banks and institutions and can have an adverse impact on financial
stability and thus on the economy.

The relevant provision of RBI Act which talks about this function are Section 17 and 18 of
the RBI act 1934.In terms of section 17 of the RBI act,1934, Scheduled Banks may have
recourse to RBI for financial assistance in the form of rediscount of eligible bills of exchange
and promissory notes. The act also empowers Reserve Bank to make loans and advances to
scheduled banks against the security of stocks, funds and other eligible trustee securities etc.
repayable on demand or on the expiry of fixed periods not exceeding 180 days. In case a

15
commercial bank is not in a position to raise finances from other sources, then as a last resort
it may approach RBI for necessary financial accommodation. In its capacity of the lender of
last resort the BRI assumes the responsibility of meeting directly or indirectly all the
reasonable demands for credit facilities from commercial banks and other credit institutions
on terms and conditions a may be specified under Section 42 of the RBI Act,1934. The RBI
holds the cash reserves of the commercial and other banks and thus act as custodian of the
ultimate reserves of the country which support its credit and banking system. The RBI acts as
a clearing house for settling their mutual transactions by book entries. 13

According to section 18 of the RBI act 1934, when in the opinion of the RBI a special
occasion has arisen making it necessary or expedient that action should be taken for
regulating credit in the interest of Indian trade, commerce, industry and agriculture the bank
may, notwithstanding any limitations contained in section 17 of the act-

 Purchase, sell or discount any bill of exchange or promissory note, though the same
may not be eligible for purchase or discount under Section 17.
 Make loans and advances to
1. a State cooperative bank.
2. or on the recommendation of a state Cooperative bank, to a co-operative society
registered within the area in which the state co-operative bank operates, or
3.any other person ,
such loans or advances should be payable on demand or on expiry of fixed periods,
not exceeding 90 days, on such terms and conditions as the RBI may consider to be
sufficient.14

CONCLUSION

Thus we see that 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 by rediscounting
bills of exchange. Since commercial banks can always expect the Reserve Bank of India to come to
their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but also the
lender of the last resort. RBI ‘s function as lender of last resort is one of the most important functions

13 nd
Myneni S.R.,Laws of banking,2014(2 Ed.,Asia Alw House)p.41
14
Id.

16
of it as it ensures liquidity in commercial banks and thus saves it big time from embarrassment from
lack of cash .This function is also important because the banks cannot ask its customers to which it
has granted load to return the money without completion of term of loan and thus the RBI helps the
banks in its smooth functioning and can surely be called as bankers bank in its true sense.

REFERENCE

Books

1. Myneni S.R.,Laws of Banking,2014(2nd Ed.,Asia Alw House)

2. Tannan, ML,Tannan’s Banking Law and Practice in India, 23 rd Edition 2010, Lexis
Nexis Butterworths Wadhwa, Nagpur.

3. Varshney P.N., Banking Law and Practice, 13th edition, 2010, Jain Book Agency,
Delhi.

4. Gupta S.N., Banking Law in Theory and Practice, 5th Edition, 2010, Universal Law
Publishing Co. Pvt. Ltd.

5. K.C. Shekhar & Lekshmy Shekhar, Banking-Theory and Practice, 20th edition, 2011,
Jain Book Agency, Delhi.

Articles

 Gaurav Akrani, Functions of Reserve Bank of India RBI - RBI Credit Policy Kalyan-
city.blogspot.com (2014), http://kalyan-city.blogspot.com/2010/09/functions-of-reserve-
bank-of-india-rbi.html (last visited Oct 8, 2014).
 General Knowledge Today, Functions of RBI (2011), http://www.gktoday.in/functions-
of-rbi/ (last visited Oct 8, 2014).
 S. L. N. Simha. History of the Reserve Bank of India, Volume 1: 1935–1951. RBI.
1970. ISBN 81-7596-247-X. (2005 reprint PDF)
 G. Balachandran. The Reserve Bank of India, 1951–1967. Oxford University Press.
1998. ISBN 0-19-564468-9. (PDF)
 Investinganswers.com, Lender of Last Resort Definition & Example | Investing Answers
(2014), http://www.investinganswers.com/financial-dictionary/economics/lender-last-
resort-592 (last visited Oct 8, 2014).

Websites
 Rbi.gov.in

17
 Manupatra.com
 Heinonline.com
 Jstor.com

18