Reserve Bank of India

Sub-topics Covered

  1. History of RBI
  2. Functions of RBI
  3. Monetary Policy 
  4. Evolution of Monetary Policy in India – Monetary Targeting framework, Multiple indicator Approach
  5. Inflation Targeting
  6. Monetary Policy Committee
  7. Instruments of Monetary Policy
  8. Current issues regarding Independence of RBI – RBI vs Govt, independence of RBI, Section 7 of the RBI Act
  9. Comparison of RBI and US Federal Reserve
  10. Quick facts
  11. Conclusion

1 . History of RBI

  • The origins of the Reserve Bank of India (RBI) can be traced to 1926, when the Royal Commission on Indian Currency and Finance – also known as the Hilton Young Commission – recommended the creation of a central bank for India to separate the control of currency and credit from the Government and to augment banking facilities throughout the country.
  • The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank, which commenced operations on April 1, 1935.
  • The Bank was constituted to:
  1. Regulate the issue of banknotes
  2. Maintain reserves with a view to securing monetary stability and
  3. To operate the credit and currency system of the country to its advantage.
  • The Bank began its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India, the management of Government accounts and public debt.
  • Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank continued to act as the Central Bank for Burma till Japanese Occupation of Burma and later upto April, 1947
  • After the partition of India, the Reserve Bank served as the central bank of Pakistan upto June 1948 when the State Bank of Pakistan commenced operations.
  • The Bank, which was originally set up as a shareholder’s bank, was nationalised in 1949.

Aims and Objectives (Preamble of RBI Act)

  • To regulate the issue of banknotes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage;
  • That it is essential to have a modern monetary policy framework to meet the challenge of an increasingly complex economy and the primary objective of the monetary policy is to maintain price stability while keeping in mind the 5 objective of growth

2 . Functions of RBI 

  • Thus, the Preamble in the RBI Act, as amended by the Finance Act, 2016, provides that the primary objective of the monetary policy is to maintain price stability, while keeping in mind the objective of growth, and to meet the challenge of an increasingly complex economy.
  • However, the functions which the RBI is undertaking are not confined only within the provisions of the RBI Act, but extend to various areas, such as, regulation and supervision of banks, consumer protection, management of foreign exchange, management of government securities, regulation and supervision of payment systems, etc., for which powers are drawn from various other laws, namely, the Banking Regulation Act, 1949,Foreign Exchange Management Act, 1999, Government Securities Act, 2006,Payment and Settlement Systems Act, 2007, etc


1 . Banking Functions

  • Section 17 of the RBI Act enables RBI to do banking business, such as accepting deposits, without interest, from any person.
  • The other businesses, which the RBI may transact are also mentioned in the said provision.
  • It states that the RBI may transact various businesses such as acceptance of deposits without interest from Central Government and State Governments, purchase, sale and rediscount of Bills of Exchange, short term Loans and Advances to banks, annual Contributions to National Rural CreditFunds, dealing in Derivatives, purchase and sale of Government Securities,purchase and sale of shares of State Bank of India, National Housing Bank, Deposit Insurance and Credit Guarantee Corporation, etc., keeping of deposits with SBI for specific purposes, making and issue of Banknotes, etc .
  • Section 18 facilitates the RBI to act as a ‘Lender of Last Resort’ whereas
  • Section 19 states the list of businesses which the RBI may not transact.
  • Sections 20 and 21 of the RBI Act,the RBI shall have an obligation and right respectively to accept monies for account of the Central Government and to make payments up to the amount standing to the credit of its account, and to carry out its exchange, remittance and other banking operations, including the management of the public debt ofthe Union.
  • In the case of State Governments, the said banking functions may be undertaken by way of an agreement between the RBI and the State Government concerned as provided in Section 21-A of the RBI Act. These agreements madebetween the RBI and the State Governments are statutory as they are required to be laid before the Parliament as soon as they are made

2 . Issue Functions

  • Section 22 of the RBI Act confers the RBI with the sole right toissue bank notes in India

3 . Monetary Policy Functions

  • Chapter III-F of the RBI Act provides for a statutory basis for the Monetary Policy Framework and the Monetary Policy Committee

4. Public Debt Function

  • The Parliament of India enacted the Government Securities Act, 2006 (‘GS Act’) with an objective to consolidate and amend the law relating to Government securities and its management by the Reserve Bank of India .
  • The GS Act applies to Government securities created and issued by the Central Government or State Government .
  • The GS Act prescribes the procedure and modalities to be followed by the RBI in the management of the public debt and also confers various powers on the RBI including the power to determine the title to  Government security if there exists any doubt in the opinion of the RBI .
  • Further,Section 18 of the GS Act provides that no order made by the RBI under this Act shall be called in question by any Court for the reasons stated therein.
  • Prior to the enactment of the GS Act, the said public debt functions of the RBI have been governed under the provisions of the Public Debt Act, 1944.

5 . Foreign Exchange Management

  • The powers and responsibilities with respect to external trades and payments,development and maintenance of foreign exchange market in India are conferredon the RBI under the provisions of the Foreign Exchange Management Act, 199

6 . Banking Regulation and Supervision

  • The power to regulate and supervise banks has been provided under theprovisions of the Banking Regulation Act, 1949 (BR Act, 1949) to the RBI
  • Powers of RBI to formulate banking policy, regulate banking business, protect the interests of banking companies, supervision of banking companies, etc., are scattered across the provisions of the BR Act, 1949

Other Functions

  • Regulation and supervision of NBFC
  • Regulation of Derivatives and Money Market Instruments
  • Payment and Settlement Functions
  • Consumer Protection Functions
  • Financial Inclusion and Development Functions

3 . Monetary Policy


  • MonetaryPolicy refers to the use of monetary instruments under the control of the centralbank to influence variables, such as interest rates, money supply and availabilityof credit, with a view to achieving the objectives of the policy

4 . Evolution of Monetary Policy Framework in India

Monetary Targeting Framework (1980-1998)

  • Under this framework, broad money became the intermediate target while reserve money was one of the main operating instruments for achieving control on broad money growth.
  • Accordingly, monetary (M3) projection was made consistent with the expected real GDP growth and a tolerable level of inflation.
  • Technically, in a simple form, if expected real GDP growth was 6 per cent, the income elasticity of demand for money was 1.5 and a tolerable inflation was 5 percent, the M3 expansion target was set at 14 per cent (M3 growth = 1.5(6) +5 =14 percent).
  • Analysis of the money growth outcomes during the monetary targeting regime indicates that targets were rarely met.
  • The biggest impediment to monetary targeting was lack of control over RBI’s credit to the central government, which accounted for the bulk of reserve money creation
  • With the introduction of LPG policies this framework started becoming less effective

Multiple Indicator Approach (1998-2012)

  • The RBI adopted a ‘multiple indicator approach’ in April 1998 with a greater emphasis on rate channels for monetary policy formulation relative to quantity instruments.
  • Under this approach, a number of quantity variables such as money, credit, output, trade, capital flows and fiscal position as well as rate variables such as rates of return in different markets, inflation rate and exchange rate were analyzed for drawing monetary policy perspectives.
  • The multiple indicator approach was informed by forward looking indicators since the early 2000s drawn from the RBI’s surveys of industrial outlook, credit conditions, capacity utilization, professional forecasters, inflation expectations and consumer confidence.
  • The RBI continued to give indicative projections of key monetary aggregates. The multiple indicator approach seemed to work fairly well from 1998-99 to 2008-09, as reflected in the average real gross domestic product (GDP) growth rate of 7.1 per cent associated with average inflation of about 5.5 per cent in terms of both the wholesale price index (WPI) and the Consumer Price Index (CPI).
  • Subsequently, however, there was a mounting public censure of the efficacy and even the credibility of this framework as persistently high inflation and weakening growth co-existed, i.e., visible signs of stagflation. Use of a large panel of indicators was also not providing a clearly defined nominal anchor for monetary policy. It also left policy analysts unclear about what the RBI looks at while taking policy decisions.
  • Since 2007 several high level Committees in India have highlighted that the RBI must consider switching over to inflation targeting

5 . Flexible Inflation Targeting (Current Policy)

  • Against this backdrop, the RBI constituted an Expert Committee to Revise and Strengthen Monetary Policy Framework on September 12, 2013 to recommend what needed to be done to revise and strengthen the current monetary policy framework with a view to, inter alia, making it transparent and predictable.
  • The Expert Committee submitted its report in Jan 2014. The salient recommendations of the Committee were :
  1. Consumer Price Index (CPI) to be the nominal anchor
  2. The nominal anchor/target to be set at 4 per cent with a band of +/- 2 percent
  3. Inflation to be brought down to 8 per cent by Jan 2015, to 6 per cent by Jan 2016 then adopt the target – the glide path
  4. Monetary Policy decision making be vested in a Monetary PolicyCommittee (MPC)
  5. MPC being accountable for failure to establish and achieve the nominal anchor. The failure defined as the inability to achieve the target of 4 percent (+/- 2 per cent) for 3 successive quarters. Such failure requires MPC to issue a public statement
  • Prior to the amendment to the RBI Act in May 2016, the flexible inflation targeting framework, as recommended by the above-mentioned Committee, was governed by an Agreement between Government of India and Reserve Bank of India on Feb 20, 2015.
  • The amendment of the RBI Act provided the statutory basis for the implementation of the flexible inflation targeting framework.
  • It also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years.
  • Accordingly, in August 2016, the Central Government has notified in the Official Gazette, 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
  • The Central Government notified the following as factors that constitute failure to achieve the inflation target:
  1. the average inflation is more than the upper tolerance level of the inflation target for any three consecutive quarters; or
  2. the average inflation is less than the lower tolerance level for any three consecutive quarters

6 . Monetary Policy Committee

  • Section 45ZB of the amended RBI Act, 1934, also provides for an empowered six-member Monetary Policy Committee (MPC) to be constituted by the Central Government .
  • The Government, accordingly, constituted the six member MPC in September 2016.
  • The Monetary Policy Committee shall consist of:
  1. the Governor of the RBI;
  2. Deputy Governor of the RBI in charge of Monetary Policy;
  3. one officer of the RBI to be nominated by the Central Board; 
  4. three persons to be appointed by the Central Government 
  • The Monetary Policy Committee has been entrusted with the statutory duty to determine the Policy Rate required to achieve the inflation target.
  • The Reserve Bank’s Monetary Policy Department(MPD) assists the MPC in formulating the monetary policy.
  • Under the amended RBI Act, the MPC is required to meet at least four times in a year.
  • The quorum for the meeting of the MPC is four members. Each member of the MPC has one vote, and in the event of an equality of votes, the Governor of the RBI has a second or casting vote.
  • The decision of the Monetary Policy Committee is binding on the RBI and the RBI shall publish a document explaining the steps to be taken by it to implement the decisions of the Monetary Policy Committee

7. Direct and Indirect instruments used for implementing monetary Policy

  • Repo Rate : The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the Liquidity Adjustment Facility (LAF).
  • Reverse Repo Rate : The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF
  • Liquidity Adjustment Facility (LAF) : The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under variable rate repo auctions across the range of tenors. The aim of term-repo is to help develop the inter-bank term-money market, which in turn can set market-based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The RBI also conducts variable interest-rate reverse-repo auctions, as necessitated under market conditions.
  • Marginal Standing Facility (MSF) : A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system
  • Corridor : The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.Bank Rate : It is the rate at which the Reserve Bank is ready to buy or re discount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
  • Cash Reserve Ratio (CRR) : The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand andtime liabilities (NDTL) that the Reserve Bank may notify from time to time in theGazette of India.
  • Statutory Liquidity Ratio (SLR) : The share of NDTL that a bank is required tomaintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability ofresources in the banking system for lending to the private sector.
  • Open Market Operations (OMOs): These include both, outright purchase andsale of government securities, for injection and absorption of durable liquidity,respectively.
  • Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank

8 .Current Issue regarding Independence of RBI 

RBI vs Government

  • The government wants the RBI to help ease the liquidity squeeze gripping non-banking finance companies (NBFCs) and relax the prompt corrective action (PCA) regime for NPA-laden banks.
  • The chasm between the two has been widening ever since RBI issued circular in February which directed banks to acknowledge every loan delayed beyond the 90th day as a non-performing asset (NPA) and provision for it. This alone raised India’s NPAs by nearly 25 per cent to over Rs 10 lakh crore.
  • The turf war came out yet again when the RBI representative put out a dissent note to Inter-Ministerial Committee for finalisation of amendments to the Payment & Settlement Systems Act, 2007.
  • The Committee recommended setting up an independent Payments Regulator outside the ambit of the RBI. RBI saw it as an attack on its powers and an attempt to shrink its authority over the banking space.
  • The Centre’s move to introduce Project Sashakt during the brief didn’t go down well with the RBI. ‘Sashakt’ gave a long rope to non-performing assets providing them between 90-180 additional days before they could be brought before the insolvency and bankruptcy process the RBI is pushing so aggressively. It was considered an extra-constitutional provision to resolve bad assets since the process of dealing with them is already well laid out.
  • Of late the two sides have also disagreed over the liquidity in the system. While the government believes RBI needs to infuse higher liquidity in the banking system to let NBFCs tide over an apparent financial crunch, the RBI believes there is enough liquidity in the system.

Independence of RBI

  • The RBI is not constitutionally independent, as the 1934 act governing its operation gives the government power to direct it.
  • The government appoints the central bank governor and four deputies.“The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest,” the act says.
  • Technically, the government is also permitted by the Act to supersede the central bank if it believes the RBI has failed to carry out its obligations.

Section 7 of the RBI Act

  • It is a provision under which the government can give directions to the RBI to take certain actions “in the public interest”.
  • This provision has been built into the law governing not just the RBI but also regulatory bodies in other sectors.
  • Until now, however, the government has never exercised its powers under Section 7 of the RBI Act.
  • Under Section 7, “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest. Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank
  • This section has never been invoked, not even during the 1991 liberalization nor in the aftermath of the global financial crisis

9 . Comparison of RBI and US Federal Reserve(Central Bank)

  • Members of the Fed are appointed by the President of the US but confirmed by the US Senate; RBI’s Governor and board members are appointed by the government of India.
  • RBI’s Governors and Deputy Governors can be removed by the government of India; Fed’s members cannot be removed by the President or any executive of the government.
  • RBI board members are appointed for a 3-year term; Fed’s members are appointed for a 14 year term to give them a long term horizon of the US economy.
  • RBI is funded by the government of India; Fed draws no funding from the US Congress.
  • Fed’s monetary decisions require no vetting from the President or his executive team; RBI’s do not either, but the government exercises significant control through its own appointees

10 . Quick Facts

  • The Reserve Bank of India was conceptualised in accordance with the guidelines presented by Dr Ambedkar to the Hilton Young Commission (also known as Royal Commission on Indian Currency and Finance) based on his book, The Problem of the Rupee – Its Origin and Its Solution.
  • Executive head of the RBI is Governor
  • First Governor of RBI – Sir Osborne Smith (1935 – 1937).
  • The First Indian Governor of RBI was CD Deshmukh (1943 – 1949).
  • The First women deputy Governor of RBI was KJ Udeshi.
  • The Governor and Deputy Governors hold office for periods not exceeding five years. The term of the governor may be fixed by the government at the time of his appointment. (Urjit Patel and Raghuram Rajan were appointed for three years; though a governor can get five-year tenure). Governor (and also Deputy Governors) is eligible for reappointment or extension
  • It is also known as Mint Street

11 . Conclusion

  • Central bank is a vital financial apex institution of an economy and the  functions of the RBI targets the goal of maintaining economic stability and growth of an economy.
  • Independence in policy decisions is of utmost importance for the long term stability of the economy.
  • Hence government and RBI should work in tandem and talk behind closed doors and resolve their differences for the sustained economic growth of the country.

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