The central bank and the Reserve Bank of India: evolution, organisation and functions

1. Evolution of central banking

Central banks were not designed; they grew out of commercial banks that came to hold a special position with the State.

• Riksbank of Sweden (1668) is the oldest surviving central bank.
• Bank of England (1694) was founded to lend to the Crown. The Bank Charter Act, 1844 gave it the dominant right of note issue in England, and through the crises of the nineteenth century it learnt to act as lender of last resort, a role Walter Bagehot described in Lombard Street (1873): lend freely, against good security, at a high rate.
• Twentieth century. The US Federal Reserve (1913) and, after the Brussels Conference of 1920 recommended that every country should have one, central banks across the world, including the RBI (1935).
• Nationalisation. After 1945 most central banks were taken into State ownership: the Bank of England in 1946, the RBI from 1 January 1949.

2. Characteristics, objectives, and the central bank and the State

A central bank is the apex monetary institution of a country. Its characteristics:

• it has the monopoly, or the dominant right, of note issue;
• it is banker, agent and adviser to the government;
• it is the banker's bank, holding their reserves and acting as lender of last resort;
• it is the custodian of foreign exchange reserves;
• it controls credit and the money supply;
• it does not compete with commercial banks and does not work for profit as its object; s.47 of the RBI Act sends its surplus profits to the Central Government.

Economic objectives: price stability, a stable exchange rate, a sound banking system and adequate credit for growth. Social objectives, which the Indian central bank has carried from the start: rural credit (s.54 of the RBI Act requires the RBI to maintain expert staff to study agricultural credit), directed credit to priority sectors, financial inclusion and consumer protection.

The relation with the State is one of autonomy within accountability. Under s.7(1) the Central Government may give directions to the RBI after consulting the Governor; under s.30 it may supersede the Central Board if the RBI fails in its obligations. The Government appoints the Governor and all directors. Since 2016, however, monetary policy is fixed by the Monetary Policy Committee against an inflation target the Government notifies (ss.45ZA, 45ZB), and the RBI must report to Government if it misses the target (s.45ZN). The relationship is therefore statutory, and the RBI is not an independent authority in the strict sense.

3. The RBI: establishment and capital

• Establishment (s.3). A bank called the Reserve Bank of India is constituted to take over the management of the currency from the Central Government and to carry on the business of banking under the Act. It is a body corporate with perpetual succession and a common seal, and may sue and be sued.
• Capital (s.4). Five crores of rupees. Originally held by private shareholders, it has been wholly owned by the Central Government since the Reserve Bank (Transfer to Public Ownership) Act, 1948.
• Offices (s.6). Central office at Mumbai, with offices, branches and agencies elsewhere.

4. Organisational structure

Management (s.7). Subject to the Central Government's directions, the general superintendence and direction of the RBI's affairs vests in the Central Board of Directors. The Governor, and in his absence a Deputy Governor he nominates, also has powers of general superintendence and direction unless the Board's regulations provide otherwise.

The Central Board (s.8) consists of:

• the Governor and not more than four Deputy Governors, appointed by the Central Government, who devote their whole time to the RBI;
• four directors nominated by the Central Government, one from each of the four Local Boards;
• ten directors nominated by the Central Government; and
• one Government official nominated by the Central Government.

The Governor and Deputy Governors hold office for up to five years and are eligible for reappointment. The ten directors nominated under clause (c) hold office for four years, for not more than two terms. Deputy Governors and the Government official may attend Board meetings and take part in deliberations but do not vote (s.8(3)), except that a Deputy Governor authorised by an absent Governor may vote for him.

Local Boards (s.9). There is one Local Board for each of four areas — western, eastern, northern and southern, at Mumbai, Kolkata, New Delhi and Chennai — each of five members appointed by the Central Government to represent territorial and economic interests and the interests of co-operative and indigenous banks. They advise the Central Board and perform duties delegated to them.

Disqualification of directors is in s.10 and removal in s.11. Below the Board, the RBI works through departments (regulation, supervision, monetary policy, currency management, foreign exchange, consumer education and protection) headed by Executive Directors, and through subsidiaries such as the DICGC and the Bharatiya Reserve Bank Note Mudran.

5. Functions

Issue of currency. The RBI has the sole right to issue bank notes in India (s.22). Explained in the next note.

Banker to government. The RBI must accept money for the Central Government, make payments on its behalf and carry out its exchange, remittance and other banking operations, including management of the public debt (s.20). The Central Government must entrust all its money, remittance and banking transactions in India to the RBI and deposit its cash balances with it free of interest (s.21). With a State the same arrangement rests on agreement (s.21A); The RBI also makes ways and means advances to governments, repayable within three months (s.17(5)) and advises them on financial matters.

Banker's bank.

• Every scheduled bank must keep with the RBI a cash reserve of a percentage of its demand and time liabilities that the RBI notifies (s.42).
• The RBI rediscounts eligible bills and makes advances to banks against approved securities (s.17(2), (4)) and may make direct discounts and advances in an emergency (s.18): this is the lender of last resort function.
• It runs the clearing and settlement systems and regulates payment systems under the Payment and Settlement Systems Act, 2007.

Regulator and supervisor of banks under the Banking Regulation Act (licensing, inspection, directions: see the Unit I note) and of non-banking financial companies under Chapter IIIB of the RBI Act (separate note).

Custodian of foreign exchange and manager of the exchange rate under s.40 and the Foreign Exchange Management Act, 1999.

Developmental and promotional role: agricultural credit (s.54), the creation of institutions such as NABARD, IDBI and the DICGC, financial inclusion, and consumer protection through the Integrated Ombudsman Scheme.

What the RBI may not do is in s.19: it may not trade or hold a direct interest in a commercial undertaking, buy shares of banks or companies, lend on the security of immovable property, or allow interest on deposits except as permitted.

How this is examined

As essays: “Explain the management and functions of the Reserve Bank of India” (June 2025) and “Discuss briefly the functions of RBI” (February 2025). As short notes: “Management of RBI” (February 2025) and “Central Bank” (August 2024). For management, the composition under s.8 must be exact. For functions, use the six heads in section 5 and give a statutory provision for each, then add one line on autonomy and the Monetary Policy Committee.