Brief History
The Reserve Bank of India is the central bank of the country. Central banks are a relatively recent
innovation and most central banks, as we know them today, were established around the early twentieth
century.
The Reserve Bank of India was set up on the basis of the recommendations of the Hilton Young
Commission. 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
* Regulate the issue of banknotes
* Maintain reserves with a view to securing monetary stability and
* 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. The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi,
Lahore and Cawnpore (Kanpur) became branches of the Issue Department. Offices of the Banking
Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon.
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.
An interesting feature of the Reserve Bank of India was that at its very inception, the Bank was seen as
playing a special role in the context of development, especially Agriculture. When India commenced its
plan endeavours, the development role of the Bank came into focus, especially in the sixties when the
Reserve Bank, in many ways, pioneered the concept and practise of using finance to catalyse
development. The Bank was also instrumental in institutional development and helped set up insitutions
like the Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India, the Industrial
Development Bank of India, the National Bank of Agriculture and Rural Development, the Discount and
Finance House of India etc. to build the financial infrastructure of the country.
With liberalisation, the Bank's focus has shifted back to core central banking functions like Monetary
Policy, Bank Supervision and Regulation, and Overseeing the Payments System and onto developing the
financial markets.
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Major functions of the RBI are as follows:
1. Issue of Bank Notes:
The Reserve Bank of India has the sole right to issue currency notes except one rupee notes which are
issued by the Ministry of Finance. Currency notes issued by the Reserve Bank are declared unlimited legal
tender throughout the country.
This concentration of notes issue function with the Reserve Bank has a number of advantages: (i) it brings
uniformity in notes issue; (ii) it makes possible effective state supervision; (iii) it is easier to control and
regulate credit in accordance with the requirements in the economy; and (iv) it keeps faith of the public
in the paper currency.
2. Banker to Government:
As banker to the government the Reserve Bank manages the banking needs of the government. It has to-
maintain and operate the government’s deposit accounts. It collects receipts of funds and makes
payments on behalf of the government. It represents the Government of India as the member of the IMF
and the World Bank.
3. Custodian of Cash Reserves of Commercial Banks:
The commercial banks hold deposits in the Reserve Bank and the latter has the custody of the cash
reserves of the commercial banks.
4. Custodian of Country’s Foreign Currency Reserves:
The Reserve Bank has the custody of the country’s reserves of international currency, and this enables the
Reserve Bank to deal with crisis connected with adverse balance of payments position.
5. Lender of Last Resort:
The commercial banks approach the Reserve Bank in times of emergency to tide over financial difficulties,
and the Reserve bank comes to their rescue though it might charge a higher rate of interest.
6. Central Clearance and Accounts Settlement:
Since commercial banks have their surplus cash reserves deposited in the Reserve Bank, it is easier to deal
with each other and settle the claim of each on the other through book keeping entries in the books of
the Reserve Bank. The clearing of accounts has now become an essential function of the Reserve Bank.
7. Controller of Credit:
Since credit money forms the most important part of supply of money, and since the supply of money has
important implications for economic stability, the importance of control of credit becomes obvious. Credit
is controlled by the Reserve Bank in accordance with the economic priorities of the government.
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MONETARY POLICY
Monetary policy refers to the use of monetary instruments under the control of the central bank to
regulate magnitudes such as interest rates, money supply and availability of credit with a view to achieving
the ultimate objective of economic policy.
The Monetary Policy Process
The Monetary Policy Committee (MPC) constituted by the Central Government under Section 45ZB
determines the policy interest rate required to achieve the inflation target.
The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary
policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to
the process for arriving at the decision on the policy repo rate.
The Financial Market Committee (FMC) meets daily to review the liquidity conditions so as to ensure that
the operating target of monetary policy (weighted average lending rate) is kept close to the policy repo
rate.
Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments
under its control to achieve the goals specified in the Act.
The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This
responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
The goal(s) of monetary policy
The primary objective of monetary policy is to maintain price stability while keeping in mind the
objective of growth. Price stability is a necessary precondition to sustainable growth.
In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for
the implementation of the flexible inflation targeting framework.
The amended RBI Act 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, 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:(a) the average inflation is more than the upper tolerance level of the inflation target for any
three consecutive quarters; or (b) the average inflation is less than the lower tolerance level for any
three consecutive quarters.
Prior to the amendment in the RBI Act in May 2016, the flexible inflation targeting framework was
governed by an Agreement on Monetary Policy Framework between the Government and the Reserve
Bank of India of February 20, 2015.
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The Monetary Policy Framework
The amended RBI Act explicitly provides the legislative mandate to the Reserve Bank to operate the
monetary policy framework of the country.
The framework aims at setting the policy (repo) rate based on an assessment of the current and
evolving macroeconomic situation; and modulation of liquidity conditions to anchor money market
rates at or around the repo rate. Repo rate changes transmit through the money market to the entire
the financial system, which, in turn, influences aggregate demand – a key determinant of inflation and
growth.
Once the repo rate is announced, the operating framework designed by the Reserve Bank envisages
liquidity management on a day-to-day basis through appropriate actions, which aim at anchoring the
operating target – the weighted average call rate (WACR) – around the repo rate.
The operating framework is fine-tuned and revised depending on the evolving financial market and
monetary conditions, while ensuring consistency with the monetary policy stance. The liquidity
management framework was last revised significantly in April 2016.
The Monetary Policy Process
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 by notification in the Official
Gazette. Accordingly, the Central Government in September 2016 constituted the MPC as under:
1. Governor of the Reserve Bank of India – Chairperson, ex officio;
2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member, ex officio;
3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio;
4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
5. Professor Pami Dua, Director, Delhi School of Economics – Member; and
6. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad – Member.
(Members referred to at 4 to 6 above, will hold office for a period of four years or until further orders,
whichever is earlier.)
The MPC determines the policy interest rate required to achieve the inflation target. The first meeting
of the MPC was held on October 3 and 4, 2016 in the run up to the Fourth Bi-monthly Monetary Policy
Statement, 2016-17.
The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary
policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute
to the process for arriving at the decision on the policy repo rate.
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The Financial Markets Operations Department (FMOD) operationalizes the monetary policy, mainly
through day-to-day liquidity management operations. The Financial Markets Committee (FMC) meets
daily to review the liquidity conditions so as to ensure that the operating target of the weighted average
call money rate (WACR).
Before the constitution of the MPC, a Technical Advisory Committee (TAC) on monetary policy with
experts from monetary economics, central banking, financial markets and public finance advised the
Reserve Bank on the stance of monetary policy. However, its role was only advisory in nature. With the
formation of MPC, the TAC on Monetary Policy ceased to exist.
Instruments of Monetary Policy
There are several direct and indirect instruments that are 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 fine-tuning
variable rate repo auctions of 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 Reserve Bank also conducts variable interest
rate reverse repo auctions, as necessitated under the 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 rediscount 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 and time liabilities (NDTL) that the Reserve
Bank may notify from time to time in the Gazette of India.
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Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid
assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence
the availability of resources in the banking system for lending to the private sector.
Open Market Operations (OMOs): These include both, outright purchase and sale of government
securities, for injection and absorption of durable liquidity, respectively.
Market Stabilization 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 mobilized is held in a separate
government account with the Reserve Bank.
For current operative policy rates, please see "Current Rates" section on the home page.
Open and Transparent Monetary Policy Making
Under the amended RBI Act, the monetary policy making is as under:
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 has a
second or casting vote.
The resolution adopted by the MPC is published after conclusion of every meeting of the MPC in
accordance with the provisions of Chapter III F of the Reserve Bank of India Act, 1934.
On the 14th day, the minutes of the proceedings of the MPC are published which include:
a. the resolution adopted by the MPC;
b. the vote of each member on the resolution, ascribed to such member; and
c. the statement of each member on the resolution adopted.
Once in every six months, the Reserve Bank is required to publish a document called the Monetary
Policy Report to explain:
a. the sources of inflation; and
b. the forecast of inflation for 6-18 months ahead.
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