RBI as Banker of Banks

The Reserve Bank of India (RBI), as the central bank of the country, performs several crucial functions to ensure monetary stability and the smooth functioning of the financial system. Among its key roles is that of the “Banker to Banks.” This function refers to the RBI’s responsibility for maintaining the banking system’s liquidity, solvency, and stability by providing essential financial and operational services to commercial and cooperative banks. In this capacity, the RBI acts much like how a commercial bank serves its customers, but on a higher institutional level, catering exclusively to banks and financial institutions.

Meaning and Concept

When the RBI acts as Banker to Banks, it performs for commercial and cooperative banks the same functions that these banks perform for their customers. In other words, the RBI provides banking services—such as accepting deposits, lending funds, clearing transactions, and maintaining accounts—to other banks operating within India.
This function enables the RBI to regulate the banking sector effectively, maintain liquidity in the system, and ensure the overall stability of the financial structure.
The statutory basis for this function is found in Section 42(1) of the Reserve Bank of India Act, 1934 and Section 18 of the Banking Regulation Act, 1949.

Major Functions of RBI as Banker to Banks

The role of the RBI as Banker to Banks can be explained under the following major heads:

1. Custodian of Cash Reserves

Every scheduled commercial bank in India is required to maintain a portion of its deposits as Cash Reserve Ratio (CRR) with the Reserve Bank of India. These reserves act as a safeguard for depositors and ensure liquidity in the banking system.

• The RBI holds these reserves and allows withdrawals or additions as per regulatory requirements.
• The maintenance of CRR helps the RBI control the money supply and influence credit conditions in the economy.

By acting as a custodian of cash reserves, the RBI ensures that banks maintain adequate liquidity and adhere to statutory reserve requirements.

2. Lender of the Last Resort (LOLR)

When commercial banks face temporary liquidity shortages or financial stress, they can borrow funds from the RBI. This is known as the Lender of the Last Resort function.

• The RBI provides short-term loans or advances to banks against approved securities.
• It prevents financial panic and ensures confidence in the banking system.
• This facility is generally availed during emergencies, such as a sudden withdrawal of deposits or interbank market disruptions.

Through this function, the RBI safeguards the banking sector from insolvency and prevents a chain reaction of bank failures.

3. Clearing House Function

The RBI facilitates the settlement of interbank transactions through its clearing house system. Banks often have to make payments to one another due to cheque clearing, fund transfers, or other obligations.

• The RBI acts as an intermediary, clearing and settling these transactions efficiently.
• With technological advancement, the RBI manages electronic payment systems such as the National Electronic Funds Transfer (NEFT), Real Time Gross Settlement (RTGS), and the Electronic Clearing Service (ECS).

This clearing function reduces the need for banks to maintain large cash balances and ensures faster, safer settlements.

4. Maintenance of Accounts of Banks

The RBI maintains current accounts of all scheduled commercial banks in the country.

• These accounts are used by banks for settling interbank obligations and reserve requirements.
• Transactions such as payment of government dues, clearing settlements, and remittances are carried out through these accounts.

In essence, these accounts serve as the foundation for the interbank payment system, ensuring smooth financial operations among institutions.

5. Controller of Credit and Liquidity

The RBI exercises control over the volume and direction of credit created by commercial banks. Through its monetary policy instruments, it regulates the liquidity available to banks.

• Repo Rate and Reverse Repo Rate: Adjust short-term liquidity by influencing borrowing and lending costs.
• Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR): Affect the lending capacity of banks.
• Open Market Operations (OMO): Control liquidity through the purchase or sale of government securities.

By performing these regulatory functions, the RBI ensures that the banking system remains balanced and that inflationary or deflationary pressures are controlled.

6. Supervisor and Regulator of Banks

As a banker to banks, the RBI also acts as a regulatory authority overseeing the functioning of commercial and cooperative banks.

• It ensures that banks follow prudential norms and maintain financial discipline.
• It conducts periodic inspections and audits to monitor their financial soundness.
• It issues licenses, supervises new branch openings, and enforces compliance with Know Your Customer (KYC) and anti-money laundering regulations.

This supervisory function enhances the overall stability and efficiency of the banking sector.

7. Settlement of Interbank Obligations

The RBI facilitates the settlement of interbank obligations through its centralised payment and settlement systems.

• All major settlements between banks are routed through the RBI.
• The Settlement Guarantee Mechanism (SGM) ensures that even if one bank defaults, the entire system remains stable.

This role reinforces confidence and operational integrity in India’s banking and payment systems.

8. Financial Adviser and Guide

The RBI not only provides banking services to commercial banks but also acts as their adviser in times of financial uncertainty.

• It offers guidance on investment policies, risk management, and credit control.
• It advises banks during periods of financial distress or economic instability.

By offering expert advice, the RBI helps banks align their operations with national economic goals and maintain prudent financial practices.

Importance of RBI as Banker to Banks

The RBI’s role as banker to banks is of immense importance to India’s financial system.

• Ensures Liquidity: Facilitates smooth day-to-day functioning of banks by providing liquidity support.
• Prevents Bank Failures: Acts as a safety net through the lender of last resort mechanism.
• Promotes Stability: Regulates credit and ensures systemic stability.
• Supports Monetary Policy Implementation: Helps transmit policy measures effectively through the banking system.
• Fosters Confidence: Maintains public trust in the integrity and resilience of the financial system.