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RBI as Banker of Government

For Central and State Governments

Since its inception, the Reserve Bank of India has undertaken the traditional central banking function of managing the government’s banking transactions. The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and the management of its public debt. The Government also deposits its cash balances with the Reserve Bank. The Reserve Bank may also, by agreement, act as the banker and debt manager to State Governments. Currently, the Reserve Bank acts as banker to all the State Governments in India (including Union Territory of Puducherry), except Sikkim. For Sikkim, it has limited agreement for management of its public debt.

The Reserve Bank has well defined obligations and provides several banking services to the governments. As a banker to the Government, the Reserve Bank receives and pays money on behalf of the various Government departments. The Reserve Bank also undertakes to float loans and manage them on behalf of the Governments. It provides Ways and Means Advances – a short-term interest bearing advance – to the Governments, to meet temporary mismatches in their receipts and payments. Besides, like a portfolio manager, it also arranges for investments of surplus cash balances of the Governments. The Reserve Bank acts as adviser to Government, whenever called upon to do so, on monetary and banking related matters. The Central Government and State Governments may make rules for the receipt, custody and disbursement of money from the consolidated fund, contingency fund, and public account. These rules are legally binding on the Reserve Bank as accounts for these funds are with the Reserve Bank .

The banking functions for the governments are carried out by the Public Accounts Departments at the offices/branches of the Reserve Bank. As it has offices and sub-offices in 29 locations, the Reserve Bank appoints other banks to act as its agents for undertaking the banking business on behalf of the governments. The Reserve Bank pays agency bank charges to the banks for undertaking the government business on its behalf. As of now, management of public debt, including floatation of new loans, is done by the Internal Debt Management Department at the Central Office and Public Debt Office at offices/branches of the Reserve Bank. Final compilation of Government accounts, of the Centre and the States, is done at Nagpur office of the Reserve Bank which has a Central Accounts Section.

Banking of Individual Ministries

RBI used to handle banking of individual ministries in past. Currently, every ministry has been given a public sector bank to manage its operations. But still RBI functions for the ministries for which it is nominated to do so.

 

Central Accounts Section

Central Accounts Section, Nagpur : (i) maintains principal accounts of central and state governments, (ii) grants ways and means advances to central and state governments, (iii) invests surplus funds of central and state governments, and (iv) clears all remittance transactions for central and state governments departments under RBIRFS.

Banks that conduct Government Business in India

The Reserve Bank of India (RBI) has decided to allow all private sector banks to undertake Central and state government business, which is still a forte of public sector banks and three large private players, ICICI Bank, HDFC Bank and Axis Bank.

Banks earn a fee while working as an agent of the central bank for collecting revenues as well as disbursing the payments under various schemes. At present, the three private banks are allowed to undertake government business in a limited way but RBI now said all the private lenders will be treated at par with their public sector counterparts.

“It has been decided that all private sector banks will now be considered eligible to handle any Central or state government business (where RBI pays agency commission) at par with public sector banks,” RBI said in a notification.

According to the regulator the move is aimed to enhance the quality of customer service in Government business through more competition, improving customer convenience by increasing the number of customer service outlets and broad basing the revenue collection and payments mechanism of governments.

RBI said those banks interested to handle government business need to be appointed as agents of RBI. For this purpose, it said government may work out the arrangement with the bank and send the proposal to the Controller General of Accounts (CGA) for examination. The CGA, in turn, will forward the recommendation the central bank and then RBI will formally appoint a bank as an agency bank.

RBI works as Debt Manager of Government

The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and the management of its public debt. . The Government also deposits its cash balances with the Reserve Bank. The Reserve Bank may also, by agreement, act as the banker and debt manager to State Governments. Currently, the Reserve Bank acts as banker to all the State Governments in India (including Union Territory of Puducherry), except Sikkim. For Sikkim, it has limited agreement for management of its public debt.

Ways and means advances (WMA)

Whenever there is a temporary mismatch in the cash flow of the receipts and payments of the State Governments, RBI provides them Ways and Means Advances (WMA). This also comes under debt management works of RBI.

RBI as banker to other banks

Statuary Reserves

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 banks or clearing money market transactions between two banks, buying and selling securities and foreign currencies.

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 transactions with each other occurring 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 called e-Kuber. 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 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.

Lender of the Last Resort (LORL)

As a Banker to Banks, the Reserve Bank also acts as the ‘lender of the 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 the 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.

Role of RBI in the management of foreign exchange reserves

For a long time, foreign exchange in India was treated as a controlled commodity because of its limited availability. The early stages of foreign exchange management in the country focussed on control of foreign exchange by regulating the demand due to its limited supply. Exchange control was introduced in India under the Defence of India Rules on September 3, 1939 on a temporary basis. The statutory power for exchange control was provided by the Foreign Exchange Regulation Act (FERA) of 1947, which was subsequently replaced by a more comprehensive Foreign Exchange Regulation Act, 1973. This Act empowered the Reserve Bank, and in certain cases the Central Government, to control and regulate dealings in foreign exchange payments outside India, export and import of currency notes and bullion, transfer of securities between residents and non-residents, acquisition of foreign securities, and acquisition of immovable property in and outside India, among other transactions.

Extensive relaxations in the rules governing foreign exchange were initiated, prompted by the liberalisation measures introduced since 1991 and the Act was amended as a new Foreign Exchange Regulation (Amendment) Act 1993. Significant developments in the external sector, such as, substantial increase in foreign exchange reserves, growth in foreign trade, rationalisation of tariffs, current account convertibility, liberalisation of Indian investments abroad, increased access to external commercial borrowings by Indian corporates and participation of foreign institutional investors in Indian stock market, resulted in a changed environment. Keeping in view the changed environment, the Foreign Exchange Management Act (FEMA) was enacted in 1999 to replace FERA. FEMA became effective from June 1, 2000.

LERMS

An acronym for liberalization Exchange Management System that was introduced from March 1, 1992 under which the rupee was made partially convertible.

The objective was to encourage exporters and induce a greater inflow of remittances through proper channels as well as bring about greater efficiency in import substitution. Under the system, percent of eligible foreign exchange receipts such as exports earnings or remittances was to be converted at the market rate and the balance 40% at the official rate of exchange. Importers could obtain their requirements of foreign exchange from authorized dealers at the market rate. Because of certain weaknesses, this system was replaced by a unified exchange rate in March 1993. This unification was recommended as an important step towards full convertibility by the committee on balance of payments under the chairmanship of C Ragranajan. Under the unified rate system all foreign exchange transactions through authorized dealers out at market determined rate exchange.

Under the LERMS, Exporters of goods and services and those who are recipients of remittances from abroad could sell the bulk of their foreign exchange receipts at market determined rates. Similarly, those who need to import goods and services or undertake travel abroad could buy foreign exchange to meet such needs, at market determined rates from the authorised dealers, subject to their transactions being eligible under the liberalised exchange control system. However, in respect of certain specified priority imports and transactions, provisions were made in the scheme for making available foreign exchange at the official rate by the Reserve Bank of India.

By this scheme, partial convertibility of the rupee was introduced. 40% of the foreign exchange received on current account receipts, whether through export of goods or services alone needed to be converted at the official rate, while take remaining 60% was convertible at market determined rates. The imports of materials other than petroleum, oil products, fertilizers, defence and life saving drugs and equipment always had to be effected against market determined rates.

All receipts of foreign exchange were required to be surrendered to authorised dealers as was the practice hitherto. The rate of exchange for the transactions was to be the free market rate quoted by authorised dealers except for 40% of the proceeds which would be based on the official rate fixed by the Reserve Bank of India. The authorised dealers were required to surrender 40% of their purchases of foreign exchange to the RBI at official rate. The remaining 60% could be retained by them for sale in free market for all permissible transactions. The Exporters were also given a choice to retain a maximum of 15% of the export earnings in foreign exchange itself, which could be utilised by them for their own personal needs.

Although the Minister of Finance had indicated during his presentation of the 1992-93 Budget that full convertibility of the rupee would be introduced in a span of 3 or 4 years, full convertibility was announced much earlier and in fact it is the highlight of the 1993-94 Budget.

There is, however, a subtle difference in the full convertibility of the rupee introduced in India and the concept of full convertibility prevailing in developed countries like the U.K., U.S.A. etc. In developed countries, full convertibility means that their currency is freely convertible anywhere in the world. Their home currency can be converted into foreign currency without any restriction. One does not have to disclose even the purpose of such conversion. For instance, U.S. Dollars can be changed into Sterling Pounds in New York, Japanese Yen could be exchanged to Deutsche Marks in Frankfurt, Australian Dollars can be converted into Candian Dollars in Adelaide etc., The exchange rate is controlled by the position of supply and demand in the market.

The full convertibility announced in the Union Budget of 1993-94, however, allows convertibility only in the current account, which means the amount received by way of sale proceeds of exports, paid for imports and the remittance by NRIs etc., alone are convertible at market determined rates.

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