Chapter 2: RBI & Monetary Policy

The Reserve Bank of India (RBI) is the central bank of India, established to regulate the country’s currency
and credit systems. It was founded based on the recommendations of the Royal Commission on Indian
Currency and Finance (Hilton-Young Commission). The commission advocated for a central bank to separate
currency control from the government and expand banking facilities, guided by insights from Dr. B. R.
Ambedkar’s book, The Problem of the Rupee: Its Origin and Its Solution.

History of RBI
❖ 1926: Hilton-Young Commission recommended establishing a central bank for India.
❖ 1927: A bill to give effect to the above recommendation was introduced in the Legislative Assembly but
withdrawn due to disagreements among various sections of people.
❖ 1933: The White Paper on Indian Constitutional Reforms recommended the creation of the RBI. A fresh
bill was introduced in the Legislative Assembly.
❖ 1934: The Reserve Bank of India Act was passed and received the Governor General’s assent.
❖ 1935: RBI began operations on April 1 as a private shareholders’ bank with a paid-up capital of ₹5 crore.
❖ 1937: Central Office relocated to Mumbai.
❖ 1942: RBI ceased currency issuance for Burma (Myanmar).
❖ 1947: RBI stopped serving as banker to the Government of Burma.
❖ 1948: RBI ended central banking services for Pakistan.
❖ 1949: RBI was nationalized under the Reserve Bank (Transfer of Public Ownership) Act, 1948.
Organization and Functions of RBI
The RBI’s Central Office, initially in Kolkata, was permanently relocated to Mumbai in 1937. The Governor
and policymakers operate from this office.
Objectives of RBI
As stated in the Preamble of the Reserve Bank of India Act, 1934, the primary objectives of the RBI are:
• Regulating the issuance of banknotes.
• Maintaining reserves to ensure monetary stability in India.
• Formulating and implementing policies to address the complexities of India’s evolving economy.
• Striking a balance between maintaining price stability and promoting economic growth.
Structure of RBI
The RBI's organizational framework consists of a Central Board of Directors, four Local Boards, and a Board
for Financial Supervision (BFS) to ensure efficient governance and oversight.
1. Central Board of Directors
Role: Governs the overall affairs and functions of the RBI, providing general superintendence and strategic
direction.
Appointment: Members are appointed by the Government of India for a term of 4 years, as per the Reserve
Bank of India Act, 1934.
Constitution:
Official Directors: Full-Time Members: 1 Governor and up to 4 Deputy Governors

Non-Official Directors: Government Nominations: 10 Directors from various fields and 2

Government officials.

Representatives of Local Boards: 1 Director from each of the 4 Local Boards.

Functions: Supervising and directing the RBI’s policies and operations.
Current Members:
Governor: Shri Shaktikanta Das
 Deputy Governors: Dr. M.D. Patra
Shri M. Rajeshwar Rao
Shri T. Rabi Sankar
Shri Swaminathan J.

2. Local Boards
Constitution: Established for four regions: Western, Eastern, Northern, and Southern areas. Each board
comprises 5 members appointed by the Central Government for a term of 4 years.
Functions:
• Advising the Central Board on regional and local matters.
• Representing the interests of local cooperative and indigenous banks.
• Performing other functions as delegated by the Central Board.
Note: The four Local Boards are currently non-functional due to a lack of quorum. A Standing Committee
of the Central Board is managing these responsibilities.
3. Board for Financial Supervision (BFS)
Establishment: Constituted in November 1994 as a committee of the Central Board under the Reserve
Bank of India (Board for Financial Supervision) Regulations, 1994.
Purpose: To enhance oversight and strengthen supervision of the financial system.
Functions:
• Supervising commercial banks, financial institutions, and non-banking financial intermediaries.
• Formulating and monitoring supervisory policies.
• Conducting surveillance to ensure financial stability.
Support: The Department of Supervision assists the BFS in its operations by providing secretarial support.
Offices and Establishments of RBI
1. Offices: The Reserve Bank of India operates offices at 33 locations across the country to manage its
functions effectively.
2. Training Establishments: RBI operates five training establishments to enhance staff skills and
knowledge:
o RBI Academy
o College of Agricultural Banking (CAB)
o Reserve Bank of India Staff College (RBSC)
o College of Supervisors (CoS)
In addition, RBI supports an autonomous training institute: Institute for Development and Research in
Banking Technology (IDRBT).
Institutes Funded by RBI
RBI funds and supports several educational and research institutes focused on banking and financial
development:
Centre for Advanced Financial Research Fully funded by RBI to promote research and learning in
and Learning (CAFRAL) advanced financial topics
Indira Gandhi Institute of Development Fully funded by RBI; a research institute dedicated to
Research (IGIDR) development economics and finance
Indian Institute of Bank Management Sponsored by RBI along with other banks and financial
(IIBM) institutions to enhance banking practices
National Institute of Bank Management RBI is an ordinary member along with other financial
(NIBM) institutions to support banking education and research

Subsidiaries of RBI
RBI owns several subsidiaries that play key roles in supporting its operations:
Deposit Insurance and Credit Guarantee Provides deposit insurance to ensure the safety of public
 Corporation of India (DICGC) deposits in banks
Bharatiya Reserve Bank Note Mudran Engaged in printing currency notes for the Reserve Bank
Private Limited (BRBNMPL)
Reserve Bank Information Technology Focuses on cybersecurity and IT systems for the Reserve
Private Limited (ReBIT) Bank and the financial sector
Indian Financial Technology and Allied Provides technology solutions and services for the
Services (IFTAS) banking and financial industry.
Reserve Bank Innovation Hub (RBIH) Promotes innovation in the financial sector by fostering
cutting-edge technology and research.

Functions of RBI
Functions of Reserve Bank can be divided into 3 parts: I. Central Banking Functions, II. Supervisory
Functions, & III. Promotional Functions.
I. Central Banking Functions:
1. Monetary Authority: Formulates, implements, and monitors monetary policy.
Objective: Maintain price stability while fostering economic growth.
2. Controller of Credit: Regulates liquidity in the economy through monetary policies.
Objective: Ensure an adequate flow of credit to productive sectors.
3. Manager of Foreign Exchange: Oversees forex reserves and manages the Foreign Exchange
Management Act (FEMA), 1999. Maintain the value of the Rupee in foreign markets.
Assets: (i) Foreign currency, (ii) Gold, (iii) Special Drawing Rights (SDRs), (iv) Reserve tranche with IMF.
Objective: Facilitate external trade, payments and promote the orderly development and maintenance of
India's foreign exchange market.
4. Issuer of Currency: Issues, exchanges, and destroys currency notes as well as puts into circulation
coins minted by the Government of India.
Objective: Provide the public an adequate supply of currency notes and coins in good quality.
5. Banker to the Government: Performs merchant banking functions for governments. Manages
government funds, including the Consolidated Funds, Contingency Funds, and Public Accounts. Also
manages the public debt and issues new loans on their behalf. Therefore, RBI is called Debt Manager of the
Government.
Objective: Ensure efficient handling of government finances.
6. Banker to Banks: Maintains the banking accounts of all scheduled banks. These banks hold current
accounts with the RBI to maintain SLR and CRR requirements. For special purposes or in need, RBI provides
short-term loans and advances to banks. RBI comes to rescue the banks that are solvent (facing temporary
liquid problems) but have not gone bankrupt. This is why RBI is called Lender of Last Resort (LOLR).
Objective: Protect the interest of depositors and prevent bank failure.
II. Supervisory Functions:
7. Regulator and Supervisor of the Financial System: Prescribes broad parameters of banking
operations within which the country's banking and financial systems function. Also regulates the trade
securities issued by the central and state governments, as well as short-term and highly liquid debt
securities.
• Supervisory Powers: The RBI holds various supervisory powers to develop a sound and effective
banking system, such as:
o Licensing banks,
o Issuing guidelines and circulars to banks,
o Facilitating mergers and acquisitions,
o Conducting audits and inspections,
o Imposing penalties and revoking banking licenses.
Objective: Maintain public confidence in the financial system, protect depositors' interests, and provide
cost-effective banking services to the public.
8. Regulator and Supervisor of Payment and Settlement Systems: Introduces and enhances safe,
efficient payment and settlement systems (e.g., RTGS, NEFT, UPI).
Objective: Build public trust in in payment and settlement systems.
III. Promotional Functions:
9. Developmental Role: Promotes rural and agricultural development. Regularly issues directives to
commercial banks, encouraging them to lend to small-scale industrial companies.
Objective: Support national economic objectives and equitable development.
10. Supporting Financial Institutions: Promotes and supports various financial institutions, such as
NABARD, SIDBI, EXIM Bank, NHB, RRBs, MFIs and NPCI.
Objective: Strengthen India's financial and developmental ecosystem.
Monetary Policy of RBI
RBI is responsible for conducting monetary policy under the RBI Act, 1934. Its primary objective is to
maintain price stability while fostering economic growth.
Monetary Policy Framework
Flexible Inflation Targeting: Introduced via the 2016 amendment to the RBI Act, 1934. The inflation
target is determined by the Central Government in terms of Consumer Price Index (CPI), in consultation
with the RBI under Section 45ZA and is notified in the Official Gazette every five years.
Current Inflation Target (2021–2026): 4% Consumer Price Index (CPI) inflation, with a tolerance band
of 2%–6%.
Failure to Meet Inflation Target: Failure is deemed if average inflation exceeds 6% or falls below 2% for
three consecutive quarters. In case of failure, RBI must submit a report to the Central Government detailing:
Reasons for failure.
Proposed remedial actions.
Timeline to achieve the target.
Operating Framework: Aligns the weighted average call rate (WACR) with the policy repo rate through
proactive liquidity management. Facilitates the transmission of repo rate changes across the financial
system, influencing aggregate demand and economic growth.
Monetary Policy Committee (MPC)
Establishment: Constituted under Section 45ZB of the amended RBI Act, 1934. First MPC formed on
September 29, 2016.
Composition: Six members:
• Governor of RBI: Chairperson (ex officio).
• Deputy Governor of RBI (Monetary Policy): Member (ex officio).
• One officer of RBI nominated by the Central Board: Member (ex officio).
• Three external members appointed by the Central Government.
Decision-Making: Meets at least four times a year (Quorum: Four members). Decisions are made by
majority vote; in case of a tie, the Governor has a casting vote. Each member writes a statement explaining
their vote.
Current Members (as of October 5, 2020):
• Governor of RBI: Chairperson.
• Deputy Governor (Monetary Policy): Member.
• One RBI officer nominated by the Central Board: Member.
• Dr. Nagesh Kumar: Director, Institute for Studies in Industrial Development.
• Shri Saugata Bhattacharya: Economist.
• Prof. Ram Singh: Director, Delhi School of Economics.
Significance of Monetary Policy
• Maintains price stability and controls inflation.
• Facilitates sustainable economic growth.
• Ensures efficient credit flow and liquidity in the economy.
• Strengthens confidence in the financial system.
Instruments of Monetary Policy
The Reserve Bank of India (RBI) uses various tools to regulate liquidity, inflation, and credit flow in the
economy. These instruments are:
• Policy Rates: Repo Rate, Reverse Repo Rate, Standing Deposit Facility (SDF) Rate, Marginal Standing
Facility (MSF) Rate, Bank Rate.
• Reserve Ratios: Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR).
• Liquidity Management Tools: Liquidity Adjustment Facility (LAF), Forex Swaps, Market Stabilization
Scheme (MSS).
• Other Tools: Open Market Operations (OMOs).
Categories of Monetary Instruments:
Direct Indirect
Involves the direct intervention of the central bank Involves influencing market interest rates and
in credit markets. SLR, CRR, Refinance Facilities. money supply through market mechanisms.
Repo/Reverse Repo, MSF Rate, Bank Rate.
Quantitative Credit Control Qualitative Credit Control
Focuses on adjusting the overall quantity of Focuses on the direction of credit flow and its
money in the economy. CRR, Repo/Reverse Repo allocation across different sectors of the economy.
Rate, OMOs. Margin Requirement of Loans, Moral Suasion,
Direct Action, Selective Credit Control.
Expansionary Contractionary
Increases the money supply. Lowering interest Decreases the money supply. Raising interest
rates, buying government securities, reducing rates, selling government securities, increasing
reserve requirements. reserve requirements.

Explanation of Key Instruments

Statutory Liquidity Ratio (SLR): Banks must maintain a minimum percentage of their Net Demand and
Time Liability (NDTL) in unencumbered assets such as government securities, cash, or gold. The NDTL is
calculated based on the last Friday of the second preceding fortnight.
Cash Reserve Ratio (CRR): Banks are required to maintain an average daily balance in cash with the RBI
as a percentage of their NDTL. This helps manage short-term liquidity in the banking system.
Open Market Operations (OMOs): The RBI engages in the outright purchase or sale of government
securities to inject or absorb durable liquidity in the banking system.
Repo Rate: The interest rate at which the RBI provides liquidity to commercial banks under the Liquidity
Adjustment Facility (LAF) against government or approved securities.
Reverse Repo Rate: The interest rate at which the RBI absorbs liquidity from banks under the LAF against
eligible government securities. Following the introduction of the Standing Deposit Facility (SDF), fixed-rate
reverse repo operations are conducted at the RBI's discretion.
Standing Deposit Facility (SDF) Rate: Introduced in April 2022, this is the rate at which the RBI accepts
uncollateralized overnight deposits from LAF participants. It is set 25 basis points below the repo rate and
serves as the floor of the LAF corridor.
Marginal Standing Facility (MSF) Rate: A penalty rate for banks to borrow overnight funds from the RBI
by dipping into their SLR holdings (up to 2%). Positioned 25 basis points above the repo rate, it acts as a
safety valve during liquidity crises.
Bank Rate: The rate at which the RBI buys or rediscounts commercial bills or papers.
Aligned with the MSF rate, it penalizes banks for failing to meet CRR or SLR requirements.
Liquidity Adjustment Facility (LAF): A mechanism by the RBI to inject or absorb liquidity through
overnight or term repo/reverse repo operations at variable or fixed rates, including SDF and MSF.
LAF Corridor: Defined by the MSF (upper bound/ceiling) and SDF (lower bound/floor), with the repo rate
at its center.
Main Liquidity Management Tool: A 14-day variable-rate term repo/reverse repo auction aligned with
the CRR maintenance cycle to address short-term liquidity needs.
Fine-Tuning Operations: These are overnight or longer-term operations to manage unanticipated
liquidity changes during the reserve maintenance period.
Forex Swaps: The RBI conducts foreign currency swaps to influence liquidity and stabilize exchange rates.
Market Stabilisation Scheme (MSS): Introduced in 2004, it aims to withdraw excess liquidity by issuing
market stabilization bonds (MSBs), owned by the Government of India.

Monetary Policy Process

The RBI Monetary Policy Committee (MPC) follows a structured process for formulating and implementing
monetary policy.
Meeting Schedule: The fiscal year schedule is announced in advance, with at least four meetings annually.
Emergency meetings can be convened with 24 hours' notice.
MPC Operations: Reviews surveys and macroeconomic projections, including consumer confidence,
inflation expectations, and credit conditions. Discusses risks and adopts a resolution on the policy repo
rate.
MPC Resolution: Published after every meeting, stating the decision on the repo rate and monetary stance.
Meeting Minutes: Released on the 14th day after each meeting, including: (i) Resolution adopted, (ii)
Voting details of members, (iii) Justifications for votes by individual members.
Monetary Policy Report (Biannual): Includes: (i) Inflation dynamics and near-term projections, (ii)
Economic assessment (real economy, financial markets, fiscal, and external sectors), (iii) Review of
monetary policy procedures and projection performance.
Legal Framework of Reserve Bank of India (RBI)
The RBI operates within a comprehensive legal framework to regulate and supervise India’s financial and
banking sectors. This framework includes acts directly administered by the RBI and other relevant
legislations.
I. Acts Administered by RBI
• Reserve Bank of India Act, 1934: Governs the establishment, functions, and operations of the RBI.
• Public Debt Act, 1944 / Government Securities Act, 2006: Regulates government debt and securities
management.
• Government Securities Regulations, 2007: Provides rules for dealing in government securities.
• Banking Regulation Act, 1949: Regulates banking operations in India.
• Foreign Exchange Management Act (FEMA), 1999: Manages foreign exchange markets and transactions.
• Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)
Act, 2002 (Chapter II): Provides legal framework for asset recovery and securitization.
• Credit Information Companies (Regulation) Act, 2005: Regulates credit information companies.
• Payment and Settlement Systems Act, 2007 (Amended up to 2019): Governs payment systems and
settlement processes.
• Payment and Settlement Systems Regulations, 2008 (Amended up to 2022): Implements the above act.
• Factoring Regulation Act, 2011: Governs factoring transactions to provide liquidity to MSMEs.
II. Other Relevant Acts
• Negotiable Instruments Act, 1881: Deals with promissory notes, bills of exchange, and cheques.
• Bankers' Books Evidence Act, 1891: Governs the admissibility of bank records as evidence in courts.
• State Bank of India Act, 1955: Establishes and regulates the State Bank of India.
• Companies Act, 1956/2013: Regulates the formation, governance, and functioning of companies.
• Securities Contract (Regulation) Act, 1956: Regulates the trading of securities.
• State Bank of India (Subsidiary Banks) Act, 1959: Governs SBI’s subsidiary banks.
• Deposit Insurance and Credit Guarantee Corporation Act, 1961: Provides deposit insurance for bank
depositors.
• Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970 and 1980: Facilitates the
nationalization of banks.
• Regional Rural Banks Act, 1976: Establishes and governs RRBs.
• National Bank for Agriculture and Rural Development (NABARD) Act, 1981: Regulates NABARD.
• National Housing Bank Act, 1987: Governs the NHB.
• Recovery of Debts Due to Banks and Financial Institutions Act, 1993: Provides a framework for debt
recovery.
• Competition Act, 2002: Promotes fair competition in the market.
• Indian Coinage Act, 2011: Regulates the production and circulation of currency and coins.
• Banking Secrecy Act: Ensures the confidentiality of customer transactions.
• The Industrial Development Bank (Transfer of Undertaking and Repeal) Act, 2003: Governs the transfer
and repeal of the IDBI Act.
• The Industrial Finance Corporation (Transfer of Undertaking and Repeal) Act, 1993: Governs the
transfer and repeal of the IFC Act.