RBI and the Banking System

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

The Reserve Bank of India (RBI) is India’s central bank — responsible for monetary policy, banking regulation, currency management, and financial stability. The Indian banking system is one of the world’s largest, with a mix of public sector banks (PSBs), private sector banks, foreign banks, cooperative banks, and regional rural banks (RRBs). Understanding the RBI’s structure, functions, and policy tools is essential for the RBI Grade B examination.

Key Facts for RBI Grade B:

• The RBI was established on 1 April 1935 under the Reserve Bank of India Act, 1934.
• The RBI is fully owned by the Government of India — though it operates independently.
• The Monetary Policy Committee (MPC) sets the repo rate — 3 external members + 3 RBI members.
• India’s banking system comprises ~1.5 lakh bank branches — the world’s largest branch network.
• NPAs (Non-Performing Assets) are a major concern — gross NPA ratio peaked at ~11% (2018) before declining to ~3-4% by 2024.
• The prompt corrective action (PCA) framework is used by RBI to regulate weak banks.

⚡ Exam tip: The RBI’s monetary policy tools, the distinction between different types of banks, NPA management, and recent RBI reforms are high-yield topics.

---

🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

The Reserve Bank of India — Structure

Establishment

RBI Act, 1934:

• The RBI was established as the central bank of India
• Nationalised in 1949 — transferred to government ownership
• Initially privately owned — shares were transferred to the government in 1949

Governor and Leadership:

• Governor: Appointed by the Government of India (typically for 3-year terms)
• Current Governor (2024): Shaktikanta Das
• Deputy Governors: 4 (in charge of different functions)

Key Functions of the RBI:

1. Monetary Policy: Control inflation and stabilise the economy
2. Banker to the Government: Manage government accounts, borrowing, payments
3. Banker to Banks: Lender of last resort; provides liquidity
4. Currency Issuer: Sole authority to issue currency (coins, notes)
5. Regulation of Banks: License, supervise, and set standards for banks
6. Foreign Exchange Management: Manage the Rupee, forex reserves
7. Financial Stability: Ensure the financial system is stable

---

Monetary Policy Framework

The Monetary Policy Committee (MPC)

Established: 2016 (under the RBI Act, 1934 amendment) Composition: 6 members

• 3 members from RBI (Governor as ex-officio chairman, one Deputy Governor, one official)
• 3 external members — appointed by the Government of India

Function: Sets the repo rate by majority voting Meetings: Bi-monthly (every 2 months) — 6 meetings per year Outcome: Published in the Monetary Policy Statement

Policy Rates

Rate	Meaning	Current (mid-2024)
Repo Rate	Rate at which RBI lends to banks	6.5%
Reverse Repo Rate	Rate at which RBI borrows from banks	3.35%
CRR (Cash Reserve Ratio)	Cash banks must hold with RBI	4.5%
SLR (Statutory Liquidity Ratio)	Government securities banks must hold	18%
MSF (Marginal Standing Facility)	Emergency lending to banks	6.75%
Bank Rate	Old repo-equivalent rate	6.75%

How Monetary Policy Works

When Inflation is High (RBI raises rates):

RBI raises Repo Rate
        ↓
Banks' cost of borrowing from RBI rises
        ↓
Banks raise lending rates (MCLR, PLR)
        ↓
Borrowing becomes expensive
        ↓
Consumer and business spending falls
        ↓
Demand cools → Inflation falls

When Growth is Low (RBI cuts rates):

RBI cuts Repo Rate
        ↓
Cheaper for banks to borrow
        ↓
Cheaper loans → more borrowing
        ↓
Spending increases → growth recovers

The Transmission Problem:

• In India, RBI rate cuts don’t always translate to lower lending rates quickly
• Banks may not pass on rate cuts due to:
  • High NPA levels
  • Competitive pressures
  • Asset-liability mismatches

---

Types of Banks in India

1. Public Sector Banks (PSBs)

• Owned by the Government of India (majority shareholding)
• Largest banks by assets and network
• Major PSBs: State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BoB), Canara Bank, Union Bank of India, etc.

State Bank of India (SBI):

• Largest bank in India — ~25% market share
• Former Imperial Bank of India — nationalised in 1955
• Over 24,000 branches in India and abroad

Capital Infusion:

• The government has repeatedly recapitalised weak PSBs
• PSBs recapitalisation: ₹2.11 lakh crore (2019-2021) — to meet Basel III capital requirements

2. Private Sector Banks

• Owned by private shareholders — not government
• Generally more agile, technology-focused
• Major private banks: HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank, Yes Bank

HDFC Bank:

• Largest private sector bank by assets
• Strong retail focus, technology leadership

Yes Bank Crisis (2020):

• Yes Bank faced a massive crisis in 2020 — RBI superseded the board
• RBI placed Yes Bank under moratorium — withdrawals capped at ₹50,000
• YES Bank was reconstructed — RBI drew up a reconstruction scheme
• SBI took a majority stake in Yes Bank

3. Foreign Banks

• Operate in India under the Banking Regulation Act, 1949
• Examples: Citibank, HSBC, Standard Chartered, Deutsche Bank
• Operate through branches or subsidiaries
• Priority sector lending requirements also apply to foreign banks operating in India

4. Small Finance Banks (SFBs)

• Licensed by RBI in 2015-2016
• Focus on financial inclusion — serve the unbanked, small businesses
• Examples: AU Small Finance Bank, Ujjivan SFB, Equitas SFB
• Deposits insured by DICGC (Deposit Insurance and Credit Guarantee Corporation)

5. Payments Banks

• Limited scope banks — can accept deposits (max ₹1 lakh per account) but cannot lend
• Focus on digital payments and mobile banking
• Examples: Paytm Payments Bank, Airtel Payments Bank, India Post Payments Bank
• Regulated by RBI — cannot invest in risky assets

6. Regional Rural Banks (RRBs)

• Created in 1975 to serve rural areas
• Sponsored by PSBs (e.g., SBI, PNB) + state governments
• Limited banking services — focused on agricultural loans, small business
• Examples: Baroda Rajasthan Gramin Bank (sponsored by BoB), Rajasthan Marudhara Gramin Bank (sponsored by SBI)

---

Banking Regulation — NPA Management

Non-Performing Assets (NPAs)

An NPA is a loan where:

• Interest or principal is overdue for 90+ days
• The borrower is unlikely to pay (substandard, doubtful, or loss assets)

NPA Classification:

Classification	Description
Substandard	NPA for < 12 months; doubts about recovery
Doubtful	NPA for > 12 months; very low recovery prospects
Loss Asset	Uncollectable — written off by bank/RBI

NPA Trends in India

Year	Gross NPA (%)
2015	~5%
2018 (peak)	~11%
2020 (COVID)	~8%
2024	~3-4%

Why NPAs Increased:

1. Economic slowdown (2016-2018)
2. IBC (Insolvency and Bankruptcy Code) — forced recognition of stressed assets
3. Infrastructure projects delayed — IL&FS, DHFL, Essar Steel
4. Focus on recovery — banks had to recognise all bad loans

Prompt Corrective Action (PCA) Framework

The PCA Framework (revised 2021) allows RBI to:

• Restrict dividends by weak banks
• Stop lending in high-risk areas
• Cap branch expansion for undercapitalised banks
• Compulsorily merge banks if capital falls below critical levels

Banks placed under PCA had high NPAs or low capital ratios.

---

Deposit Insurance — DICGC

Deposit Insurance and Credit Guarantee Corporation (DICGC):

• Established: 1961
• Insurance limit: ₹5 lakh per depositor (raised from ₹1 lakh in 2020)
• Covers: Savings, current, fixed deposits
• Does NOT cover: Inter-bank deposits, deposits of foreign governments, deposits of primary dealers

---

🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Basel III Framework

Basel III is the global standard for bank capital adequacy and liquidity:

Key Requirements:

1. Minimum Capital Adequacy Ratio (CAR):

   • Total CAR: Minimum 11.5% (including capital conservation buffer)
   • For Indian banks: higher for systemically important banks

2. Capital Conservation Buffer (CCB):

   • Additional 2.5% of CET1 capital
   • Can be used in times of stress

3. Liquidity Coverage Ratio (LCR):

   • Banks must hold high-quality liquid assets (HQLA) equal to 30-day net cash outflows
   • Ensures banks can survive a 30-day stress scenario
   • Minimum LCR: 100%

4. Net Stable Funding Ratio (NSFR):

   • Requires banks to have stable funding sources for long-term assets
   • NSFR ≥ 100%

Why Basel III Matters:

• Makes banks safer and more resilient to shocks
• Reduces the risk of bank failures (like the 2008 financial crisis)
• Indian banks are implementing Basel III — full implementation by 2024-25

RBI’s Balance Sheet

The RBI’s balance sheet reveals its policies and priorities:

Liabilities:

• Currency notes in circulation (~₹35 lakh crore)
• Bank deposits (government, bank reserves)
• RBI’s capital and reserves

Assets:

• Foreign currency assets (forex reserves)
• Government securities (domestic)
• Loans and advances (to banks, governments)

Key Feature: The RBI’s Reserve Bank India Fund (RBIF) — where excess reserves can be transferred to the government (after building adequate provisions).

Recent Reforms and Issues

1. RBI’s Surplus Transfer to Government:

• In 2019-2020, RBI transferred ₹1.76 lakh crore to the government
• In 2023-2024: RBI transferred ₹2.11 lakh crore
• This has been controversial — concerns about central bank independence

2. Digital Banking and FinTech:

• RBI has issued several guidelines on digital lending
• FinTech regulations — RBI released the FinTech Sandbox guidelines (2022)
• Account Aggregator framework — allowing individuals to share financial data across institutions

3. Central Bank Digital Currency (CBDC):

• RBI launched e₹ (Digital Rupee) — pilot in 2022
• Issued by RBI — a digital form of the rupee
• Different from UPI — CBDC is direct central bank liability

Practice Questions for RBI Grade B

1. What is the repo rate? How does a change in the repo rate affect the economy?
2. What is the difference between PSBs, private banks, and foreign banks in India?
3. What are NPAs? How has the RBI addressed the NPA problem?
4. What is Basel III? What are its key requirements?
5. What is the difference between the repo rate and the MSF (Marginal Standing Facility) rate?

Common Mistakes to Avoid

• Confusing CRR with SLR — CRR is cash kept with RBI; SLR is government securities held by banks.
• Thinking all banks are regulated by SEBI — only securities market participants; banks are regulated by RBI.
• Confusing PCA with bankruptcy — PCA is a corrective framework, not a winding-up process.

---

Content adapted based on your selected roadmap duration. Switch tiers using the selector above.