Scheduled Banks and Reserve Requirements under the RBI Act

Understand Scheduled Banks and Reserve Requirements

Key rules to remember

Minimum cash reserve (Section 42(1))

Required average daily balance ≥ notified % × total demand and time liabilities in India

The percentage is notified by the RBI in the Gazette. The Act no longer fixes a number, so never quote a figure as statutory.

Average daily balance

Sum of closing balances on each day of the fortnight ÷ number of days in the fortnight

A fortnight runs from Saturday to the second following Friday, both days inclusive.

Additional balance cap (Section 42(1A))

Additional balance ≤ notified rate × excess of liabilities over the base date's liabilities; never more than the excess

Applies on top of the balance under Section 42(1).

Penal interest for shortfall (Section 42(3))

First fortnight: Bank Rate + 3% on the shortfall; next fortnight and each later default fortnight: Bank Rate + 5% on the shortfall

Charged on the amount by which the balance falls short of the prescribed minimum.

Penalty for late or no return (Section 42(4))

₹100 for each day the failure continues

Payable to the RBI.

Eligibility for inclusion (Section 42(6))

Paid-up capital and reserves ≥ ₹5,00,000 (real value) + affairs not detrimental to depositors + prescribed type of entity

All three conditions must be met.

How to solve Scheduled Banks and Reserve Requirements questions

1. 1Identify the issue: inclusion or exclusion, cash reserve, returns, or penalty.
2. 2State the rule in plain words, naming Section 42 and the relevant sub-section.
3. 3List the facts that matter: capital and reserves, type of entity, depositor interest, fortnight balances, return dates.
4. 4Apply the test fact by fact. For inclusion, check all three conditions. For reserve, compare the average daily balance with the required amount.
5. 5For a shortfall, work out the amount short, then apply Bank Rate plus 3% for the first fortnight and plus 5% for consecutive defaults.
6. 6Check the escalation. After the five per cent rate applies, a further defaulting fortnight exposes directors and allows a bar on fresh deposits.
7. 7Check any relief: the RBI may not demand penal interest if it accepts sufficient cause, and may grant exemptions under Section 42(7).
8. 8Conclude in one clear line with the consequence.

Quickest way: Four-line Section 42 check

Common mistakes in Scheduled Banks and Reserve Requirements

• Stating the cash reserve as a fixed percentage such as 3%.

  Older textbooks quoted the figure that the Act once contained.

  Fix: Say the RBI notifies the percentage from time to time in the Gazette, having regard to monetary stability.

• Treating the ₹5 lakh test as the only condition for inclusion.

  The number is easy to remember, so the other two limbs are forgotten.

  Fix: Always list all three: capital and reserves, no detriment to depositors, and the type of entity.

• Using nominal capital to test eligibility.

  Students read the balance sheet figure as final.

  Fix: The Act says value means real or exchangeable value. The RBI's determination in a dispute is final.

• Applying the penalty to the whole balance instead of the shortfall.

  The wording on penal interest is read loosely.

  Fix: Penal interest is charged only on the amount by which the balance falls short of the minimum.

• Confusing the penalty for return default with penal interest for reserve default.

  Both sit in Section 42 and both are paid to the RBI.

  Fix: Reserve shortfall: Bank Rate plus 3% or 5% (sub-section 3). Return default: ₹100 per day (sub-section 4).

• Calling the week or month the averaging period.

  Students recall the earlier weekly system.

  Fix: The period is a fortnight, Saturday to the second following Friday, both included.

Worked examples