RBI: monetary regulation, credit control, currency issue, exchange control and bank rate

1. Why the RBI regulates money and credit

Banks create credit: every loan becomes a deposit somewhere, which supports further loans. If credit grows faster than output, prices rise; if it contracts, output falls. The RBI's task is to keep the supply and the cost of credit in line with price stability while keeping in mind the objective of growth. Since the amendments of 2016 the RBI Act itself builds monetary policy around a statutory inflation target, set out below.

2. The monetary policy framework

• Inflation target (s.45ZA). The Central Government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index once every five years and notifies it. The target notified in 2016 and renewed in 2021 was 4 per cent, with an upper tolerance of 6 and a lower of 2.
• Monetary Policy Committee (s.45ZB). Six members: the Governor (chairperson), the Deputy Governor in charge of monetary policy, one RBI officer nominated by the Central Board, and three persons appointed by the Central Government. It determines the policy rate (the repo rate) needed to meet the target, and its decision binds the RBI. It meets at least four times a year (s.45Z-I).
• Accountability (s.45ZN). If the target is missed, the RBI must report to the Government the reasons, the remedial action and the time within which the target will be met.

3. Quantitative (general) credit control

These act on the total volume and cost of credit in the whole system.

• Bank rate (s.49 RBI Act). The RBI must make public the standard rate at which it is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the Act. A higher bank rate raises the cost of borrowing from the RBI and therefore lending rates generally. The bank rate is also the reference rate for penal interest when a bank defaults on CRR or SLR (ss.42(3) RBI Act, 24(4) BR Act). In practice it is now aligned with the marginal standing facility rate, and the repo rate is the signal that matters.
• Repo and the liquidity facilities. The repo rate is the rate at which the RBI lends to banks overnight against government securities. Banks may park surplus funds with the RBI under the Standing Deposit Facility (s.17(1A), inserted in 2018) and borrow in emergencies under the marginal standing facility. Together these form the “corridor” within which the overnight rate moves.
• Cash Reserve Ratio (s.42 RBI Act). Every scheduled bank must keep with the RBI an average daily balance of not less than the percentage of its net demand and time liabilities that the RBI notifies, having regard to monetary stability. Raising the CRR withdraws lendable funds; there is no longer a statutory floor or ceiling. The Banking Laws (Amendment) Act, 2025 redefined the reporting “fortnight” in s.42 as the first to fifteenth and sixteenth to last day of each month.
• Statutory Liquidity Ratio (s.24 BR Act). Every bank must maintain in India cash, gold and unencumbered approved securities of a value not less than the percentage of its demand and time liabilities the RBI notifies, up to 40 per cent. It locks part of bank funds into government securities.
• Open market operations (s.17(8) RBI Act). The RBI buys and sells government securities in the market. Selling absorbs liquidity; buying injects it.

4. Qualitative (selective) credit control

These direct credit towards or away from particular uses without changing the total.

• Section 21 BR Act. The RBI may determine the policy on advances by banks and give directions as to the purposes for which advances may or may not be made, the margins to be kept on secured advances, the maximum amount of advances to any one borrower, and the rate of interest. Raising the margin on loans against foodgrains or shares in a speculative period is the classic use.
• Directions under s.35A BR Act, binding on all banks or one bank.
• Priority sector lending targets: a positive form of selective control requiring banks to lend a fixed share of credit to agriculture, small enterprises, weaker sections and similar sectors.
• Credit rationing and consumer credit regulation: ceilings on certain kinds of lending, and risk weights for consumer loans and credit cards.
• Moral suasion: persuasion through meetings and letters, which works because banks know that statutory directions can follow.
• Direct action: refusal of refinance, penalties, and the use of ss.35A and 36 against a bank that disregards policy.

5. Monopoly of currency issue

• Sole right (s.22). The RBI has the sole right to issue bank notes in India. One-rupee notes and coins are issued by the Central Government under the Coinage Act, 2011 and distributed by the RBI (s.38).
• Issue Department (s.23), kept separate from the Banking Department. Its assets must equal its liabilities, and under the minimum reserve system (s.33(2)) at least ₹200 crore must be held in gold and foreign securities, of which at least ₹115 crore in gold.
• Denominations (s.24) up to ₹10,000 on the Central Board's recommendation; legal tender (s.26(1)) at any place in India, guaranteed by the Central Government. Section 22A, inserted in 2022, excludes certain sections for notes in digital form, the legal basis of the e-rupee.
• Demonetisation (s.26(2)). On the Central Board's recommendation the Central Government may declare that any series of notes of any denomination shall cease to be legal tender. The notification of 8 November 2016 withdrawing ₹500 and ₹1,000 notes was upheld by a 4:1 majority in Vivek Narayan Sharma v. Union of India, 2023 INSC 2, (2023) 3 SCC 1. The majority read “any series” to permit all series of a denomination and found the decision-making process not vitiated. Nagarathna J. dissented, holding that so wide a withdrawal had to be made by legislation, not by notification.
• Under s.31 no one other than the RBI or the Central Government may issue a bill, hundi or note payable to bearer on demand, which protects the monopoly.

6. Exchange control

Exchange control means regulation of dealings in foreign currency and of payments to and from abroad, to protect the reserves and the external value of the rupee.

• FERA era. The Foreign Exchange Regulation Act, 1947 and then the Foreign Exchange Regulation Act, 1973 made almost every foreign exchange transaction an offence unless permitted, with criminal penalties.
• FEMA, 1999. The Foreign Exchange Management Act, 1999 replaced FERA with a civil regime whose object is to facilitate external trade and payments and promote the orderly development of the foreign exchange market. Current account transactions are free subject to reasonable restrictions; capital account transactions need permission under regulations the RBI makes. Dealings are permitted only through authorised persons (banks and money changers) whom the RBI authorises (s.10 FEMA) and to whom it gives directions (s.11). Contraventions are punished by penalty, adjudicated by officers of the Enforcement Directorate, with appeal to the Appellate Tribunal.
• RBI Act. The RBI holds the country's foreign exchange reserves and buys and sells foreign exchange with authorised persons (s.40), which is how it intervenes to steady the rupee.

How this is examined

“Explain on credit control of RBI” (January 2026) is the usual essay, sometimes framed as the “regulation of the monetary mechanism.” Write the two heads, quantitative and qualitative, each method with its section, and a paragraph on the MPC. Short notes: “Foreign exchange control” (January 2026), and bank rate or monopoly of note issue. For exchange control, the contrast between FERA (criminal) and FEMA (civil, facilitative) is what earns the marks.