Functions of the Reserve Bank of India – AHSEC Class 12 Finance Chapter 2

Here is a comprehensive study note for the AHSEC Class 12 Finance textbook, focusing on Chapter 2: Functions of the Reserve Bank of India.

Chapter 2:

Functions of the Reserve Bank of India

Summary Note

This chapter details the various roles and responsibilities performed by the Reserve Bank of India as the country’s central bank. These functions are broadly categorized into traditional, supervisory, and promotional functions.

• A. Traditional Functions: These are the core and conventional functions of a central bank.
  1. Issue of Currency Notes: The RBI has the sole authority to issue all currency notes in India except the one-rupee note and coins, which are issued by the Government of India. To issue notes, the RBI must maintain a minimum reserve of ₹200 crores in gold and foreign securities under the Minimum Reserve System (since 1957).
  2. Banker’s Bank: The RBI acts as the bank for all other banks in the country. It holds a part of their cash reserves (CRR), provides financial assistance to them through loans and rediscounting of bills, and supervises their operations to ensure stability in the banking system.
  3. Government’s Banker, Agent, and Advisor: The RBI manages the banking transactions of the Central and State Governments, such as accepting deposits, making payments, and managing public debt. It also represents the Government of India in international financial institutions like the IMF and World Bank and advises the government on financial and economic matters.
  4. Custodian of Foreign Exchange Reserves: The RBI is the custodian of the nation’s foreign exchange reserves. It manages these reserves to maintain the stability of the rupee’s external value and administers the country’s exchange control regulations.
  5. Lender of Last Resort: When commercial banks are unable to secure funds from any other source during a financial emergency, they can approach the RBI as a last resort for financial assistance. The RBI provides credit against eligible securities to prevent bank failures and financial crises.
  6. Clearing House Functions: The RBI facilitates the settlement of inter-bank claims and transactions. It acts as a central clearing house, enabling banks to settle their mutual obligations easily and economically.
  7. Controller of Money Supply and Credit: This is one of the most crucial functions. The RBI regulates the volume of money and credit in the economy to achieve price stability and promote economic growth, using various quantitative and qualitative credit control techniques.
• B. Supervisory Functions: The RBI supervises and controls the banking system to ensure its sound operation. This includes issuing licenses for new banks and branches, prescribing capital and reserve requirements, inspecting the working of banks, and controlling the appointment of top management in private banks.
• C. Promotional Functions: The RBI also undertakes developmental and promotional activities to strengthen the country’s financial infrastructure. This includes promoting banking habits among the public, expanding the banking system, and developing specialized institutions for agricultural credit (like NABARD), industrial finance, and export promotion.
• Prohibited Functions: Under Section 19 of the RBI Act, 1934, the RBI is prohibited from performing certain commercial banking functions. It cannot engage in trade, purchase shares of any company, grant loans on the security of shares or immovable property, or pay interest on deposits.
• System of Note Issue: The RBI has adopted two systems for issuing currency notes.
  1. Proportionate Reserve System (1935-1956): Required a certain percentage (25-40%) of total notes issued to be backed by gold and convertible securities.
  2. Minimum Reserve System (1957-Present): Requires the RBI to maintain a minimum reserve of ₹200 crores, of which at least ₹115 crores must be in gold. This system allows for greater flexibility in currency issuance to meet the needs of a growing economy.

Complete Textual Question Answers

Here are the answers to all the questions given at the end of Chapter 2.

A. Very Short Answer Questions (1 Mark each)

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 from its inception in 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 1957.

B. Short Answer Questions (2 Marks each)

1. Write two functions of the RBI.
   Ans: Two important functions of the RBI are:
   i. Issue of Currency Notes: The RBI has the sole authority to issue currency notes in India (except the one-rupee note).
   ii. Banker’s Bank: The RBI acts as the bank for other banks, holding their cash reserves and acting as the lender of last resort.
2. What is Minimum Reserve System of Note Issue?
   Ans: The Minimum Reserve System (MRS) is a principle of currency issuance where the central bank is required to maintain a fixed minimum amount of gold and foreign securities as a reserve. Since 1957, the RBI has been following this system, maintaining a minimum reserve of ₹200 crores (₹115 crores in gold and ₹85 crores in foreign securities) to issue any amount of currency notes as per the country’s needs.
3. Write two supervisory functions of the RBI.
   Ans: Two supervisory functions of the RBI are:
   i. It issues licences for setting up new banks and for establishing new branches for existing banks.
   ii. It inspects the working of scheduled banks to ensure their sound operations and compliance with regulations.
4. Write two promotional functions of the RBI.
   Ans: Two promotional functions of the RBI are:
   i. It promotes banking habits among the people by ensuring a safe and reliable banking system.
   ii. It helps in the expansion of the banking system by licensing new branches, especially in unbanked areas.
5. Write two prohibited functions of the RBI.
   Ans: Two functions prohibited for the RBI under Section 19 of the RBI Act are:
   i. It cannot undertake or enter into any trade or business.
   ii. It cannot grant loans on the security of shares and immovable property.
6. What is Proportionate Reserve System?
   Ans: The Proportionate Reserve System is a system of note issue where the central bank has to maintain a certain percentage (e.g., 25% to 40%) of the total currency issued in the form of gold and convertible securities. The remaining portion of the note issue is covered by government securities. This system was followed by the RBI from 1935 to 1956.

C. Long Answer Questions (Type-I) (5 Marks each)

1. Write any two traditional functions of the RBI.
   Ans: Two important traditional functions of the RBI are:
   • (i) Issue of Currency Notes: The RBI has the sole authority to issue, circulate, and manage currency notes in India, except for the one-rupee note and all coins, which are issued by the Government of India. This monopoly ensures uniformity in the nation’s currency and allows the RBI to control the money supply. The RBI follows the Minimum Reserve System, maintaining a reserve of ₹200 crores in gold and foreign exchange as security against the notes issued.
   • (ii) Government’s Banker: The RBI acts as the banker, agent, and advisor to the Central and State Governments. As a banker, it carries out all banking business for the government, such as maintaining their accounts, receiving money, and making payments. As an agent, it manages public debt. As an advisor, it provides counsel to the government on all financial and monetary matters, helping to frame economic policies.
2. Briefly state the promotional and supervisory functions of the RBI.
   Ans:
   • Promotional Functions: Besides its traditional roles, the RBI performs several functions to promote economic development. It works to promote banking habits among the public, helps in the expansion of the banking system into rural and unbanked areas, and provides refinance facilities for export promotion. Through institutions like NABARD, it ensures the flow of credit to agriculture and small-scale industries. It also encourages innovations in the banking business and helps develop the cooperative sector.
   • Supervisory Functions: The RBI has extensive powers to supervise and control the banking system under the Banking Regulation Act, 1949. It issues licences for new banks and branches, prescribes minimum requirements for capital and reserves, and conducts inspections of banks to ensure their financial soundness. It also controls the appointment and termination of chief executives of private banks and can compel the amalgamation or merger of weak banks to protect depositors’ interests.

D. Long Answer Questions (Type-2) (8 Marks each)

1. Discuss the traditional functions of the RBI.
   Ans: (For this answer, you can elaborate on the 7 traditional functions mentioned in the summary: Issue of Currency Notes, Banker’s Bank, Government’s Banker, Custodian of Foreign Exchange Reserves, Lender of Last Resort, Clearing House Functions, and Controller of Money Supply and Credit. Explain each function in detail as covered in the chapter.)
2. Discuss the functions of the RBI.
   Ans: (This is a comprehensive question. For the answer, you should discuss all three categories of functions in detail. Start with the Traditional Functions, then explain the Supervisory Functions, and finally, the Promotional Functions, as outlined in the summary and the chapter text.)

Previous Year AHSEC Question Answers (2015-2025)

Short Questions (1-2 Marks)

• Mention any two traditional functions of RBI. (AHSEC 2015, 2019)
  Ans: Two traditional functions of RBI are (i) Issue of Currency Notes and (ii) Banker to the Government.
• What is the Minimum Reserve System of note issue? (AHSEC 2016, 2020)
  Ans: The Minimum Reserve System requires the RBI to maintain a minimum reserve of ₹200 crores in gold and foreign securities (with at least ₹115 crores in gold) against which it can issue any amount of currency notes according to the needs of the economy.
• Write two promotional functions of RBI. (AHSEC 2017)
  Ans: Two promotional functions of RBI are (i) Promotion of banking habit among the people and (ii) Promotion of agriculture through institutions like NABARD.
• Mention two prohibited functions of RBI. (AHSEC 2018)
  Ans: Two prohibited functions of RBI are (i) It cannot engage in any trade or business, and (ii) It cannot give interest on deposits held by it.

Long Questions (5-8 Marks)

• Discuss any four traditional functions of the Reserve Bank of India. (AHSEC 2018, 2022)
  Ans: (For this answer, select any four traditional functions from the list in the summary—e.g., Issue of Currency, Banker’s Bank, Lender of Last Resort, Controller of Credit—and explain each one in detail.)
• Explain the promotional and supervisory functions of RBI. (AHSEC 2021)
  Ans: (This answer is the same as the textual Long Answer Question C.2. Please refer to that answer above.)

10 Most Important Questions in English

1. What is the ‘Lender of Last Resort’ function of the RBI?
   Ans: It is the function where the RBI provides financial assistance to commercial banks when they are unable to get help from any other source, thus saving them from crisis.
2. Explain the RBI’s role as a ‘Banker’s Bank’.
   Ans: As a ‘Banker’s Bank’, the RBI holds a portion of the cash reserves of commercial banks, provides them with loans and advances, and acts as a clearing house for inter-bank transactions.
3. What is the system of note issue currently followed by the RBI?
   Ans: The RBI currently follows the ‘Minimum Reserve System’ for note issue.
4. Why is the RBI called the custodian of foreign exchange reserves?
   Ans: The RBI is called the custodian of foreign exchange reserves because it holds and manages the country’s reserves of foreign currencies to maintain the stability of the rupee and manage foreign trade payments.
5. Mention two supervisory functions of the RBI.
   Ans: Two supervisory functions are (i) issuing licenses for new banks and branches, and (ii) conducting inspections of commercial banks.
6. State two differences between the Proportionate Reserve System and the Minimum Reserve System.
   Ans: (i) In the Proportionate system, reserves are a percentage of notes issued, while in the Minimum system, the reserve is a fixed absolute amount. (ii) The Proportionate system offers less flexibility in currency expansion compared to the more elastic Minimum Reserve System.
7. How does the RBI act as a banker to the government?
   Ans: The RBI acts as a banker to the government by maintaining its accounts, accepting deposits, making payments on its behalf, and managing its public debt.
8. What is the composition of the ₹200 crore minimum reserve that RBI has to maintain?
   Ans: The RBI has to maintain a minimum of ₹115 crores in the form of gold and the remaining ₹85 crores in the form of foreign securities.
9. Why can’t the RBI perform commercial banking functions?
   Ans: The RBI is prohibited from performing commercial banking functions (like accepting deposits from the public or providing unsecured loans) to avoid a conflict of interest with its primary role as the regulator and supervisor of the banking system.
10. How does the RBI promote agricultural credit?
    Ans: The RBI promotes agricultural credit by establishing and supporting specialized institutions like NABARD, and by directing commercial banks to provide credit to the agricultural sector as a part of priority sector lending.