Functions of the RBI: Monetary Policy and Tools

The Reserve Bank of India is the central bank of the country. It was set up on the recommendation of the Hilton Young Commission, the Royal Commission on Indian Currency and Finance of 1926, and began work on 1 April 1935 under the Reserve Bank of India Act, 1934. It started as a shareholders' bank with its central office at Calcutta, moved that office to Bombay in 1937, and was nationalised on 1 January 1949, since when it has been owned wholly by the Government of India. Sir Osborne Smith was its first Governor and C. D. Deshmukh its first Indian Governor. The preamble to the Act describes its purpose as regulating the issue of banknotes, keeping reserves for monetary stability and operating the currency and credit system to the country's advantage.

Monetary authority

The chief function of the Reserve Bank is to formulate and implement monetary policy, so that price stability is maintained while growth is kept in view. Since the amendment of the Act in 2016 this is done through a Monetary Policy Committee of six members: the Governor as chairperson, the Deputy Governor in charge of monetary policy, one officer of the Bank nominated by the Central Board, and three members appointed by the Central Government. Each member has one vote and the Governor has a second or casting vote in the event of a tie. The Committee meets at least four times a year, and the inflation target is set by the Central Government in consultation with the Reserve Bank once every five years. If the target is missed for three consecutive quarters, the Bank must report to the Government explaining why and what it will do.

Issuer of currency

The Reserve Bank has the sole right to issue banknotes in India under Section 22 of its Act. It issues notes of two rupees and above; the one rupee note and all coins are issued by the Government of India through the Ministry of Finance, although the Bank puts them into circulation. Since 1957 note issue has followed the Minimum Reserve System, under which the Bank must hold assets of at least two hundred crore rupees, of which gold must be worth at least one hundred and fifteen crore rupees. The Bank also decides the design of notes with the approval of the Central Government, withdraws soiled and mutilated notes, and runs currency chests with commercial banks so that fresh notes reach every district.

Banker, agent and adviser to the Government

The Reserve Bank keeps the accounts of the Union Government and of the State Governments that have agreements with it, receives and pays money on their behalf, and gives short term accommodation called Ways and Means Advances when receipts and payments do not match. It is also the manager of public debt, issuing Treasury Bills and dated Government securities, paying interest on them and redeeming them, and it advises the Government on banking and financial questions.

Banker to banks and lender of last resort

Every scheduled bank keeps an account with the Reserve Bank, maintains its cash reserve there and settles claims against other banks through it. When a sound bank cannot find funds anywhere else, the Reserve Bank lends to it against eligible securities, which is the classic lender of last resort function and the reason a liquidity problem in one bank need not become a panic in the system.

Regulator and supervisor

Under the Banking Regulation Act, 1949 the Reserve Bank licenses banks, approves their branches, lays down prudential norms on capital, provisioning and exposure, inspects them, and can supersede a board or place a bank under a corrective plan. It also registers and regulates non banking financial companies, regulates co-operative banks along with the state authorities, and acts against unsound practices through its Department of Supervision.

Foreign exchange and payment systems

The Reserve Bank manages the Foreign Exchange Management Act, 1999, holds and invests the country's foreign exchange reserves, and intervenes in the market to keep the rupee orderly rather than to fix its value. Under the Payment and Settlement Systems Act, 2007 it authorises and oversees payment systems, and it runs or oversees Real Time Gross Settlement, the National Electronic Funds Transfer system and the retail systems operated by the National Payments Corporation of India.

Developmental and promotional work

• Priority sector lending rules that direct credit to agriculture, small enterprise, education, housing and weaker sections.
• Financial inclusion through basic savings accounts, business correspondents and the lead bank scheme.
• Consumer protection through the integrated Ombudsman scheme for complaints against regulated entities.
• Research and statistics, including the Annual Report, the Monetary Policy Report and the Financial Stability Report.

Instruments of credit control

Remember that the Reserve Bank does not decide the fiscal deficit or the tax rates, which belong to the Government, and that it is not the regulator of the securities market or of insurance, which belong to other bodies.