Reserve Bank of India: functions and role

1. Establishment

The RBI was set up on 1 April 1935 under the Reserve Bank of India Act, 1934, on the recommendation of the Royal Commission on Indian Currency and Finance (Hilton Young Commission, 1926). It began as a shareholders’ bank and was nationalised on 1 January 1949. Its central office moved from Calcutta to Bombay in 1937. The preamble to the Act, as amended in 2016, describes its purpose as regulating the issue of bank notes and keeping reserves to secure monetary stability, operating the currency and credit system to the country’s advantage, and operating the monetary policy framework, with the primary objective of maintaining price stability while keeping in mind the objective of growth.

Organisation. The Central Board of Directors has the Governor, up to four Deputy Governors, directors nominated by the Central Government from the local boards and from various fields, and two government officials. Local boards sit at Mumbai, Kolkata, Chennai and New Delhi.

2. Traditional central banking functions

(1) Bank of issue. Under section 22 the RBI has the sole right to issue bank notes other than the one-rupee note (which, like coins, is issued by the Government of India). Since 1956 it follows the minimum reserve system (section 33): it must hold gold coin and bullion and foreign securities of at least Rs. 200 crore, of which gold is at least Rs. 115 crore. This allows the money supply to grow with the needs of the economy.

(2) Banker to the government. Under sections 20 and 21 the RBI is banker to the Central Government and, by agreement under section 21A, to the State Governments. It keeps their accounts, receives and pays money on their behalf, manages the public debt (issuing and redeeming government securities), gives ways and means advances to cover temporary mismatches, and advises on financial matters.

(3) Bankers’ bank and lender of last resort. Scheduled banks must keep a cash reserve with the RBI (section 42). The RBI rediscounts their bills and lends to them against approved securities (section 17), and in a crisis acts as the lender of last resort so that a temporary shortage of liquidity does not cause bank failure. It provides clearing and settlement.

(4) Controller of credit. The RBI regulates the volume and direction of credit through quantitative tools (repo rate, bank rate, open market operations, CRR, SLR) and qualitative tools (margin requirements, selective credit control, moral suasion). This is its monetary policy role; see the note on methods of credit control.

(5) Custodian of foreign exchange reserves. The RBI holds the country’s foreign exchange and gold reserves, manages the exchange rate of the rupee by buying and selling foreign currency to prevent excessive volatility, and administers the Foreign Exchange Management Act, 1999. It represents India at the IMF.

3. Regulatory and supervisory functions

• Licensing and regulation of banks under the Banking Regulation Act, 1949: licences for new banks and branches (section 22), control over management, mergers and winding up, prudential norms (capital adequacy under Basel norms, asset classification, provisioning).
• Inspection and supervision of banks, through the Board for Financial Supervision (1994).
• Regulation of NBFCs under Chapter IIIB of the RBI Act, and of co-operative banks (strengthened by the Banking Regulation (Amendment) Act, 2020).
• Payment and settlement systems under the Payment and Settlement Systems Act, 2007: RTGS, NEFT, and oversight of the National Payments Corporation of India, which runs UPI.
• Consumer protection through the Integrated Ombudsman Scheme (2021).

4. Promotional and developmental functions

• Agricultural credit: the RBI had an Agricultural Credit Department from its start; it promoted co-operative credit and, in 1982, transferred this work to NABARD.
• Institution building: it helped set up the Industrial Development Bank of India (1964), the Unit Trust of India (1964), the Deposit Insurance Corporation (1962, now DICGC), the Industrial Reconstruction Corporation and the Discount and Finance House of India.
• Priority-sector lending directions to banks.
• Financial inclusion and literacy: no-frills and basic savings bank deposit accounts, business correspondents, financial literacy centres.
• Development of money and government securities markets.
• Data and research: the RBI Bulletin, the Annual Report, the Report on Currency and Finance and the Handbook of Statistics on the Indian Economy.

5. The Monetary Policy Committee

The Finance Act, 2016 amended the RBI Act to give statutory basis to flexible inflation targeting. Under section 45ZA the Central Government, in consultation with the RBI, fixes the inflation target every five years. The target is 4 per cent CPI inflation with a tolerance band of 2 to 6 per cent; it was first set for 2016–21, renewed for 2021–26 and, by a notification of 25 March 2026, retained for 1 April 2026 to 31 March 2031. Under section 45ZB a six-member Monetary Policy Committee (the Governor as chair, a Deputy Governor, one RBI officer, and three members appointed by the Central Government) decides the policy repo rate by majority, with the Governor having a casting vote. If inflation stays outside the band for three consecutive quarters, the RBI must report the reasons and remedial action to the government.

6. Role of the RBI in economic development

For a 6-mark “role of RBI” answer, group the functions under development aims: price stability (monetary policy), a sound banking system (regulation), credit for agriculture, small industry and weaker sections (priority sector, NABARD, SIDBI), external stability (foreign exchange management), financing of plans and government borrowing (public debt management), and modern payments (UPI, RTGS). Add a line of criticism: the RBI’s autonomy depends on its relationship with the government, and section 7 of the Act allows the government to give it directions after consultation.

How this is examined

June/July 2025 (100 marks): “Explain the functions of Reserve Bank of India” (16). January/February 2025: “Explain the various functions of RBI” (10). June/July 2025 (80 marks): “Role of RBI” (6). For the long answer, write sections 1 to 4 with the MPC paragraph; for the short note, section 6.