Banking Regulation: An Overview

Banking Regulation: An Overview

Dear bankers,

As we all know that Banking regulation is very most important topic for JAIIB Exam. JAIIB exam conducted twice in a year. So, here we are providing the Banking Regulation overview from (Unit-2), Indian Financial system (Module A), Principle & Practice of Banking JAIIB Paper-1.

Banking Regulation

  • The Reserve Bank of India (RBI) is India’s central bank, also known as the banker’s bank. The RBI controls monetary and other banking policies of the Indian government. The Reserve Bank of India (RBI) was established on April 1, 1935, in accordance with the Reserve Bank of India Act, 1934. The Reserve Bank is permanently situated in Mumbai since 1937.

Establishment of Reserve Bank of India

The Reserve Bank is fully owned and operated by the Government of India.

The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as:

  • Regulating the issue of Banknotes
  • Securing monetary stability in India
  • Modernising the monetary policy framework to meet economic challenges

The Reserve Bank’s operations are governed by a central board of directors, RBI is on the whole operated with a 21-member central board of directors appointed by the Government of India in accordance with the Reserve Bank of India Act.

The Central board of directors comprise of:

  • Official Directors – The governor who is appointed/nominated for a period of four years along with four Deputy Governors
  • Non-Official Directors – Ten Directors from various fields and two government Official

Organisation Structure


Legal Framework

The Reserve Bank of India comes under the purview of the following Acts:

  • Reserve Bank of India Act, 1934
  • Public Debt Act, 1944
  • Government Securities Regulations, 2007
  • Banking Regulation Act, 1949
  • Foreign Exchange Management Act, 1999
  • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
  • Credit Information Companies(Regulation) Act, 2005
  • Payment and Settlement Systems Act, 2007


The primary objectives of RBI are to supervise and undertake initiatives for the financial sector consisting of commercial banks, financial institutions and non-banking financial companies (NBFCs).

Some key initiatives are:

  1. Restructuring bank inspections
  2. Fortifying the role of statutory auditors in the banking system

Major Functions of RBI

Monetary Authority 

  • Formulating and implementing the national monetary policy.
  • Maintaining price stability across all sectors while also keeping the objective of growth.

Direct Instruments:

  • Cash Reserve Ratio (CRR): Section 42(I) of RBI Act 1934, cash reserve ratio (CRR) is the amount of funds that all scheduled Commercial Banks (SCBs) are required to maintain with RBI.

The cash reserve is either stored in the bank’s vault or is sent to the RBI. Banks do not get any interest on the money that is with the RBI under the CRR requirements.

Under Section 42 of RBI Act 1934

  • Maximum-20%
  • Minimum– 3%
  • Statutory Liquidity Ratio (SLR): The Reserve Bank of India or RBI mandates that banks store a proportion of their deposits in the form of cash so that the same can be given to the bank’s customers if the need arises. The percentage of cash required to be kept in reserves, vis-a-vis a bank’s total deposits, is called the Cash Reserve Ratio.
  • Minimum- 0%
  • Maximum– 40%

Indirect Instruments:

  • Liquidity Adjustment Facility (LAF): A liquidity adjustment facility (LAF) is a tool used in monetary policy, primarily by the Reserve Bank of India (RBI), that allows banks to borrow money through repurchase agreements (repos) or for banks to make loans to the RBI through reverse repo agreements
  •  Repo/Reverse Repo Rate: Repo or repurchase rate is the benchmark interest rate at which the RBI lends money to all other banks for a short-term. When the repo rate increases.  Reverse Repo Rate (RRR) Reverse Repo rate is the short-term borrowing rate at which RBI borrows money from other banks. The Reserve Bank of India uses this method to reduce inflation when there is excess money in the banking system. borrowing from RBI becomes more expensive and hence customers or the public bear the outcome of high-interest rates
  •  Open Market Operation (OMO): Open market operations is a tool that the RBI uses to smoothen liquidity conditions through the year and regulate money supply in the economy. Open market operations is the sale and purchase of government securities and treasury bills by RBI or the central bank of the country. Sinace 2012, RBI has been using this instrument as a pure LAF, liquidity instrument.
  •  Marginal Standing Facility (MSF): Marginal Standing Facility is a new Liquidity Adjustment Facility (LAF) window created by Reserve Bank of India in its credit policy of May 2011. MSF is the rate at which the banks are able to borrow overnight funds from RBI against the approved government securities.
  • Bank Rate: A bank rate is the interest rate at which a nation’s central bank lends money to domestic banks, often in the form of very short-term loans. Managing the bank rate is a method by which central banks affect economic activity.

Regulatory and Supervisory 

  • Set parameters for banks and financial operations within which banking and financial systems function.
  • Protect investors interest and provide economic and cost-effective banking to the public.

Foreign Exchange Management

  • Oversees the Foreign Exchange Management Act, 1999.
  • Facilitate external trade and development of foreign exchange market in India.

Currency Issuer

  • Issues, exchanges or destroys currency and not fit for circulation.
  • Provides the public adequately with currency notes and coins and in good quality.

Developmental role

  • Promotes and performs promotional functions to support national banking and financial objectives.

Related Functions

  • Provides banking solutions to the central and the state governments and also acts as their banker.
  • Chief Banker to all banks: maintains banking accounts of all scheduled banks.

Banker to Banks

  • Enables smooth and swift clearing and settlements of inter-bank transactions.
  • Provides efficient means of funds transfer for all banks.
  • Enables banks to maintain their accounts with RBI for statutory reserve requirements and maintenance of transaction balances.

Regulatory restrictions on lending

In terms Banking Regulation Act, 1949, RBI provides a framework of the rules, regulations, and instructions with regard to bank lending. Accordingly it has issued following directions to scheduled commercial banks on statutory and other restrictions on loans and advances.

  • A bank cannot grant any loans and advances on the security of its own shares.
  • Enter into any commitment for granting any loan or advance to or on behalf of- (a) any of its Directors,(b) any firm in which any of its Directors is interested as Partner, Manager, Employee or Guarantor.
  • Under section 19 of Banking Regulation Act 1949, a bank cannot hold shares in a company as (a) pledgee or mortgagee in excess 30 percent of paid up of that company or 30 percent of bank’s paid capital and reserves whichever is less. (b) in the management of which Managing Director or Manager of the bank is interested.
  • Bank’s aggregate investment in shares, certificate of deposits, bonds etc. shall not exceed the 40 percent of banks owned funds as at the end of previous year.
  • A bank cannot grant credit facilities against Certificate of deposits, Term deposits issued by other banks or money market mutual funds.
  • Banks shall adhere to selective credit control directives of RBI while releasing loans against sensitive commodities.
  • Banks should not sanction a new or additional facility to borrowers appearing in RBI’s list of Wilful defaulters for a period of 5 years from the date of publication of the list by RBI.
  • There are certain restrictions on Grant of Loans & Advances or award contracts to Officers and Relatives of Officers of Banks. No officer or any Committee comprising, inter alia, an officer as member, shall, while exercising powers of sanction of any credit facility, sanction any credit facility to his/her relative. Such a facility shall ordinarily be sanctioned only by the next higher sanctioning authority. Credit facilities sanctioned to senior officers of the financing bank should be reported to the Board.

Inclusion of Urban Co operative banks in the Second Schedule to the Reserve Bank of India Act 1934

  • The Reserve Bank today allowed urban cooperative banks (UCBs) with total deposits of over Rs 750 crore to graduate to scheduled bank category.
  • If UCBs fulfill certain listed criteria, it will eligible for inclusion in the second schedule, RBI said in a notification.
  • All the public sector banks, private sector banks, foreign banks, regional rural banks are part of the second schedule.
  • As per the government’s notification, with effect from April 01, 2013, only those primary co-operative banks whose demand and time liabilities are not less than Rs 750 crore would be treated as a ‘financial institution’ for the purpose Sub-Clause (iii) of clause (a) of Sub-section (6) of section 42 of RBI Act 1934, i.e, for the purpose of inclusion of UCBs in the Second Schedule of the Reserve Bank of India Act, 1934.
  • UCBs desirous of seeking inclusion in the schedule should fulfill certain other criteria including continuous net profit for the previous three years, capital adequacy ratio of 12 per cent and gross non-performing assets of less than 5 per cent.
  • Besides, the bank needs to comply with Cash Reserve Ratio and Statutory Liquidity Ratio requirements and there should be major regulatory and supervisory concerns.
  • Such UCBs can submit their application along with relevant documents to the Regional Office concerned of Urban Banks Department.

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