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What role of RBI is known as ‘lender of last resort’? Business Economics

According to the current trends, as many as 16% of the total questions from the Finance section are asked from RBI and monetary policy. Read it at length, as it is important for both Prelims and the Main exam. RBI has to manage the risk and liquidity of the bank, or there is a high possibility that the bank may collapse.

Hence, a thorough knowledge of the structure and functions of RBI will help you in understanding it better. Further, over the years, questions from the RBI functions, structure, or the latest announcements/ notifications/guidelines that RBI announces are asked in the exam. The most important function of RBI is the issuance of currency notes and coins, except the one rupee note and coin which are issued by the Ministry of Finance. However, the agency of distribution of all notes and coins issued by the Government of India is the Reserve Bank of India. The questions posted on the site are solely user generated, Doubtnut has no ownership or control over the nature and content of those questions. Doubtnut is not responsible for any discrepancies concerning the duplicity of content over those questions.

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RBI regulates the interest rate on NRI deposits, export credits , and a few other categories. However, the interest rate on most of the categories of deposit and lending have been deregulated so the banks are responsible for determining such rates. The legal provision regarding the management of foreign exchange reserves is mentioned in RBI Act 1934. Every bank has to maintain an account with the banker of banks i.e. the RBI.

That means RBI comes to rescue the banks that are solvent but have not gone bankrupt. RBI provides this facility to protect the interest of depositors and to prevent the possible failure of the bank. RBI is a common banker for the different banks that enables the settlement of interbank transfers of funds. The affairs of RBI are governed by a central board of directors. The role of _____________ is to be ready to lend to banks at all times and so it is said to be the lender of last resort. This is an extremely topic to prepare for because not only is it the exam conducting body for RBI Grade B Exam but also your potential employer.

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To understand this process, we can look at the example of XYZ bank. Suppose the X branch faces a cash deficit, but the Z branch has a cash surplus. When nobody extends credit to a particular bank then RBI acts as a lender of last resort.

  • This banker of banks can revise these policies whenever the situation demands.
  • The debt management policy mainly aims at minimizing the cost of borrowing and smoothening the maturity structure of debt.
  • RBI is authorized to issue various guidelines for bank directors and has the power to appoint additional directors to the board of a banking company.
  • So various tools are undertaken by RBI to manage the liquidity such as the creation of the ALCO committee.
  • When the commercial banks have used all their resources to meet their financial needs, they resort to the central bank of the country in times of liquidity crisis.

This role of the central bank saves the commercial bank from bankruptcy. Thus, the RBI plays the role of guarantor for the commercial banks and maintains a sound banking system in the economy. Since RBI is the one that administers these rates, it is also the one that decides them, which makes it imperative for all the other banks to follow the same. Some of these rates include the policy rates, bank rates, marginal standing facility rates, repo rates, and reverse repo rates. The percentage of the reserves of the other banks that the RBI keeps with itself is also decided by RBI. This includes the statutory liquidity ratio , and the cash reserve ratio .

So now, the RBI is responsible to oversee the foreign exchange market in India. RBI supervises and regulates the Foreign Exchange Market through the provision of the FEMA Act 1999. One of the most important functions of RBI is the formulation and execution of Monetary Policy and securing monetary stability in India It functions the currency and credit system to its advantage.

This in turn, reduces the prices of assets and impacts business operations. Another of the important functions of RBI is maintaining a reserve of foreign currencies that enables the RBI to deal with any crisis situation. Mobile-based solution for small business owners and their customers to enable recording of credit/payment transactions digitally across the country.

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Some of the other rates decided by RBI are the foreign exchange rates, lending rates, and deposit rates. None of the banks has the authority to charge a rate lower than the ones fixed by the RBI. This banker of banks plays a key role in facilitating the money market and call market rates. There are different rates that RBI administers for all the banks. The RBI decides the rates, and that is mandatory for every bank to follow. The rates can be the policy rates which include bank rate, the repo rate, the reverse repo rate, and marginal standing facility rate.

This means that RBI will provide loans to the bank at the prevailing rates. Also, RBI will take adequate steps to manage the liquidity of the bank and make sure they don’t prove to be insolvent. This helps in protecting the interest of the consumers and saves the bank from failure or collapse. Cash pooling refers to the process in which all the transactions move to the parent branch or company.

As per RBI’s regulation, Banks needed to maintain certain reserves in the form of CRR and SLR. Priority sector guidelines don’t provide a preferential interest rate for loans to the sector. The Reserve Bank of India , is the Central Bank of the country which is responsible for the regulation and function of the Indian Banking System. RBI issues rules for the administration of Non-Performing Assets of banks. A framework is laid out where the NPAs are identified consistently and grouped in the required manner.

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It might resort to severe action in case the number of NPAs is large, in which case, the RBI starts its investigation immediately. Fulfil its responsibility as a Banker to both, the state governments as well as the central government. 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. If you’ve any difficulty in preparing for these topics, you can consider joining our detailed course on RBI Grade B Mains.

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However, soon after, in 1937, it was permanently shifted to Mumbai. The organization also aims to maintain macroeconomic stability, financial stability, and a modern monetary policy framework in order to address the challenges posed by an increasingly complex economy. The process of cash pooling includes the transfer of all transactions to the parent branch. The cash collected in the parent branch is then transferred to the other branches based on the surplus or deficit.

As a result, the central bank acts as a guarantor for commercial banks, ensuring that the financial system remains sound and healthy. When the commercial banks have used all their resources to meet their financial needs, they resort to the central bank of the country in times of liquidity crisis. As a lender of last resort, the central bank gives them financial accommodation. This is done either by redeeming their eligible securities or bills of exchange. This saves the bank from any possible case of failure and avoids a breakdown. This is because when a commercial bank faces a financial crisis and fails to obtain funds from other sources, then the central bank provides them with financial assistance in the form of credit.

The reason behind maintaining this reserve is to make sure there is a reasonable amount of liquidity maintained in the banks. In addition to the CRR, the SLR or the Statutory Liquidity Ratio is what role of rbi is known as lender of last resort another reserve that the banks have to maintain with the RBI. A certain amount of reserves are held by the bank in the form of cash, bonds, securities, or gold after being approved by the RBI.