Get AHSEC Class 12 Finance Chapter 2: Functions of the Reserve Bank of India Important Questions Answers 2025.
In this Post we have provided HS 2nd Year Finance Chapter 2: Functions of the Reserve Bank of India Important Notes with Marked/highlighted previous year questions asked in AHSEC Examination.
AHSEC Class 12 Finance Notes
Chapter 2: Functions of the Reserve Bank of India
1. Explain central banking functions of RBI or traditional functions? [AHSEC 2013, 2015, 2016, 2017, 2018, 2019]
Ans: The functions of RBI are can be classified as:
I. Traditional Functions
II. Supervisory Functions
III. Promotional Functions [AHSEC 2024]
I). TRADITIONAL FUNCTIONS:
1. Note Issue: The RBI possesses the exclusive authority to issue currency in India, excluding one rupee coins and all coins of small magnitude. It employs the minimum reserves system to regulate the issuance of currency notes across the nation. Currency notes of various denominations such as Rs. 10, Rs. 20, Rs. 50, Rs. 100, Rs. 200, Rs. 500 and Rs. 2000 are issued by the RBI. However, One Rupee notes are issued by the Ministry of Finance, Government of India.
2. Government Banker:
A. As a Government banker, the RBI undertakes various functions:
i.Maintaining and managing deposit accounts for both central and state governments.
ii. Handling the receipt and collection of payments on behalf of these governments.
iii. Making payments as required by the central and state governments.
iv. Offering short-term advances to the government, often referred to as ways and means advances
B. In the capacity of a Government agent, the RBI carries out the following tasks:
i.Collecting taxes and other payments on behalf of the government.
ii.Managing the issuance of loans from the public, thereby overseeing public debts.
iii. Facilitating fund transfers and providing remittance services for the government.
C. Acting as an advisor: Acting as an advisor, the RBI offers guidance to the government on a wide range of financial matters. These include advising on issues like loan structuring, investment decisions, agricultural and industrial finance, as well as banking planning. This advisory role extends to supporting the pursuit of national economic objectives.
3. Bankers Bank: The Central Bank is like the boss of all the other banks. It’s the most important bank. If other banks need money, they can borrow it from the Central Bank.
4. Custodian of cash reserve of the bank: The Central Bank takes care of some money for all the other banks. Regular banks have to keep a part of the money people give them in the Central Bank as a safety measure.
5. Lender of the last resort(AHSEC 2017): When regular banks don’t have enough money, they can ask the Central Bank for help. The Central Bank can lend them money to keep things going. This way, the Central Bank makes sure everything in the banking system works well.
6. Clearing Agent (2018): In India, either the RBI or the SBI is responsible for managing the central clearing functions. This means that they oversee the process where banks exchange cheques collected from other banks. If one bank owes money to another bank, the RBI steps in and transfers funds from the owing bank to the receiving bank’s account. Because all banks have accounts with the RBI, they can easily sort out how much they owe or are owed without needing a lot of actual cash. The main role of RBI’s clearing house is to settle transactions between banks.
II) SUPERVISORY FUNCTIONS
The Reserve Bank of India (RBI) carries out various supervisory functions, encompassing the following aspects:
a. Granting Licences: The RBI issues licences for the establishment of new banks and the expansion of existing banks by allowing them to open new branches.
b. Setting Financial Standards: The RBI sets minimum requirements for paid-up capital, reserves and the maintenance of cash reserves and liquid assets for banks.
c. Ensuring Sound Operations: The RBI conducts comprehensive inspections of scheduled banks in India and overseas to ensure their stable and secure functioning. It also conducts ad hoc investigations into complaints, irregularities and frauds related to banking operations
d. Appointments and Oversight: The RBI exercises control over the appointments, re appointments and termination of Chairpersons and Chief Executive Officers (CEOs) of private banks.
e. Merger Approval: The RBI approves or mandates the merger or amalgamation of two banks when deemed necessary
III) PROMOTIONAL FUNCTIONS [AHSEC 2024]: The RBI also plays a role in promoting various aspects of the financial sector through the following functions:
a. Fostering Banking Habits: The RBI encourages the adoption of banking habits among the populace. b. Banking System Expansion: It contributes to the growth and expansion of the banking system.
c. Export Refinancing: The RBI provides refinance facilities to support export promotion.
d. Agricultural Credit Enhancement: Through institutions like NABARD, it aids in expanding agricultural credit facilities.
e. Support for Small-scale Industries: The RBI helps extend financial facilities to small-scale industries.
f. Cooperative Sector Development: It contributes to the development of the cooperative sector.
g. Innovations in Banking: The RBI promotes innovation within the banking industry.
2. What are prohibitive functions of RBI? [AHSEC 2019]
Ans: The Reserve Bank of India (RBI) is restricted from engaging in certain activities outlined in its mandate.
These prohibited functions, as given in Section 19 of the Reserve Bank of India Act, 1934, are:
i. Trade or Business: The RBI is precluded from participating in any trade or business activities, differentiating it from commercial banks.
ii. Share Purchase: It is not authorized to purchase its own shares or invest in the shares of any company. This extends to the prohibition of providing loans using shares and immovable property as collateral.
iii.Interest on Deposits: The RBI is not permitted to offer interest on deposits held by the institution.
iv. Unsecured Loans and Advances: Providing unsecured loans and advances is among the functions that the RBI is restricted from undertaking. Term Bills: The RBI cannot draw and discount term bills, which distinguishes it from typical banking operations.
vi. Immovable Property: The RBI is allowed to purchase immovable property only for the establishment of its own business premises and staff residences, barring other property-related investments.
3. Discuss the system of note issue of the reserve bank of India. [AHSEC 2024]
Ans: The Reserve Bank of India (RBI) has employed different systems for the issuance of currency notes over the years. Initially, the Proportionate Reserve System was adopted, which was in use from 1935 to 1956. Subsequently, from 1957 onwards, the RBI adopted the Minimum Reserve System for note issuance. Let’s delve into these two systems in detail:
Proportionate Reserve System:
Originating in Germany in 1875, the Proportionate Reserve System of note issue was implemented in India during the period from 1935 to 1956. Under this system, the central bank was required to maintain a certain percentage of the total currency notes issued in the form of gold and convertible securities. This percentage typically ranged from 25% to 40%. The remaining portion of the note issue was backed by government securities. This system aimed to ensure both flexibility in the money supply and public confidence in the currency.
The Proportionate Reserve System facilitated a scenario where an inflow of gold could lead to a multiple expansion of the currency. For example, if the stipulated gold reserve percentage was set at 25% of the note issue, then four hundred crores of rupee notes could be issued against one hundred crores of rupees worth of gold. Conversely, if one hundred crores of rupees worth of gold was withdrawn, currency amounting to four hundred crores of rupees would be withdrawn from circulation. However, during times of currency contraction, financial crises could intensify, making this system more suitable for normal economic conditions.
Minimum Reserve System (MRS): [AHSEC 2014, 2016, 2017]
The Minimum Reserve System is a widely adopted framework for note issuance across various countries. Under this system, the central bank is mandated to uphold a minimum reserve comprising of gold and foreign securities to facilitate the issuance of currency notes. As long as this minimum reserve requirement is met, the central bank has the flexibility to print and distribute notes based on the country’s economic needs.
The Reserve Bank of India embraced the Minimum Reserve System in 1957. Within this system, the RBI was required to maintain a minimum reserve of Rs. 200 crores, consisting of both gold and foreign securities. Out of this total reserve, Rs. 115 crores was maintained in gold reserves, while the remaining Rs. 85 crores were held in the form of foreign securities. This shift to the Minimum Reserve System allowed the RBI to exercise greater control over currency issuance and regulation, providing the necessary flexibility to respond to changing economic conditions and financial demands. Thus the Reserve Bank of India transitioned from the Proportionate Reserve System to the Minimum Reserve System in 1957. This shift reflected a strategic adjustment in the approach to currency issuance, enabling the central bank to better manage currency supply and respond effectively to economic dynamics.
A. Very Short Answer Questions:
1. In which year the RBI has adopted the Proportionate Reserve System of Note Issue?
Ans: The RBI adopted the Proportionate Reserve System of Note Issue in the year 1935.
2. In which year the RBI has adopted the Minimum Reserve System of Note Issue?
Ans: The RBI adopted the Minimum Reserve System of Note Issue in the year 1957.
3. What was the initial system of note issue adopted by the RBI called?
Ans: The initial system of note issue adopted by the RBI was called the Proportionate Reserve System.
4. When was the Proportionate Reserve System of note issue introduced in India?
Ans: The Proportionate Reserve System of note issue was introduced in India in the year 1935.
5. Under the Proportionate Reserve System, what assets did the central bank have to maintain a certain percentage of?
Ans: Under the Proportionate Reserve System, the central bank had to maintain a certain percentage of the total note issue in gold and convertible securities.
6. What were the two main types of securities that covered the rest of the note issue under the Proportionate Reserve System?
Ans: The two main types of securities that covered the rest of the note issue under the Proportionate Reserve System were government securities.
7. How did the Proportionate Reserve System ensure both elasticity and public confidence?
Ans: The Proportionate Reserve System ensured both elasticity (flexibility in the money supply) and public confidence in the currency.
8. Explain the concept of multiple expansion of currency under the Proportionate Reserve System.
Ans: The concept of multiple expansion of currency under the Proportionate Reserve System meant that an inflow of gold could lead to the issuance of more currency than the actual value of the gold
9. What potential issue could intensify during currency contraction in the Proportionate Reserve System?
Ans: Financial crisis could intensify during currency contraction in the Proportionate Reserve System.
10. What is the main feature of the Minimum Reserve System of note issue?
Ans: The main feature of the Minimum Reserve System of note issue is that the central bank maintains a minimum reserve of gold and foreign securities for issuing notes.
11. When did the Reserve Bank of India adopt the Minimum Reserve System?
Ans: The Reserve Bank of India adopted the Minimum Reserve System in the year 1957.
12. What is the minimum reserve requirement for the Minimum Reserve System and how is it divided between gold and foreign securities?
Ans: The minimum reserve requirement for the Minimum Reserve System is Rs. 200 crores, with Rs. 115 crores in gold reserves and Rs. 85 crores in foreign securities.
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