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The Reserve Bank of India: history, organisation and functions

RBI and monetary policy · Part 1 / 2 · Fact-checked on 22 October 2026 · how we check

Written with AI from the sources listed at the bottom of this page, then fact-checked by a separate AI.

Why India's central bank was set up and when it was nationalised, how its Central Board is formed, and each of its functions with the law behind it: currency issue and the minimum reserve system, banker to governments (ways and means advances), banker and regulator of banks, foreign exchange under FEMA, payment systems, its developmental role, and the transfer of its surplus to the Centre.

Every modern economy has one institution standing behind its money and its banks. In India it is the Reserve Bank of India (RBI), the country's central bank. The previous chapter showed what money is and how banks create it; this chapter turns to the body that oversees the whole system. Part 1 covers the RBI itself: why it was created, who runs it, and the jobs the law gives it, from issuing notes to keeping the government's accounts. Part 2 covers its most closely watched job, monetary policy, and the instruments it uses. Each function here is tied to the Act that gives it, because Prelims questions often turn on exactly that link.

The case for a separate central bank came from the Royal Commission on Indian Currency and Finance of 1926, usually called the Hilton Young Commission. Control over money was then divided: the government issued currency, while the Imperial Bank of India did some banking work for it. The Commission wanted one body to manage both. The Central Legislature passed the Reserve Bank of India Act in 1934, and the RBI opened on 1 April 1935 as a shareholders' bank owned by private investors, with its central office in Calcutta; the office moved to Bombay in 1937. After independence the government wanted the central bank to serve national policy rather than private owners, so the Reserve Bank (Transfer to Public Ownership) Act, 1948 nationalised it from 1 January 1949. Its first Governor was Sir Osborne Smith; C.D. Deshmukh became the first Indian Governor in 1943.

Under section 8 of the RBI Act, the RBI is governed by a Central Board of Directors: the Governor and not more than four Deputy Governors, who are full-time officials, plus directors nominated by the Central Government. Four of these come from the RBI's Local Boards (Mumbai, Kolkata, New Delhi and Chennai), ten are experts from fields such as banking, industry, agriculture and economics, and two are government officials. The Central Government appoints the Governor and Deputy Governors for terms of up to five years, with reappointment allowed. Section 7 lets the government, after consulting the Governor, give the RBI directions in the public interest; it is a reserve power, not a means of daily control. Bank supervision is guided by the Board for Financial Supervision, formed in 1994 as a committee of the Central Board. The RBI's accounting year, once July–June, now runs April–March; 2020-21 was a nine-month transition year.

Managing the currency is the RBI's oldest function. Section 22 of the RBI Act gives it the sole right to issue bank notes in India; coins and the ₹1 note come from the Government. Section 23 keeps note issue in a separate Issue Department, apart from the Banking Department, so that the assets backing the notes are accounted for on their own. Under the old proportional reserve system those assets had to equal a fixed share of the notes in circulation. An amendment of 1956 brought in the minimum reserve system: the RBI must hold gold and foreign exchange worth at least ₹200 crore, of which at least ₹115 crore must be gold, and above that floor note issue follows the economy's needs rather than the size of the gold stock. The RBI decides how many notes of each denomination are needed, has them printed, distributes them through currency chests kept by banks and withdraws soiled notes. Since 2022 the RBI Act also covers notes in digital form, which allowed the digital rupee (e₹) pilots that began in November and December 2022.

The RBI is also banker to the governments. Sections 20 and 21 of the RBI Act require it to receive and pay money for the Central Government and to manage its public debt; section 21A lets it do the same for the states by agreement. It keeps their accounts, sells their treasury bills and dated securities, and services their debt. When spending runs ahead of receipts for a few weeks, it lends through ways and means advances (WMA), temporary advances that section 17(5) requires to be repaid within three months; borrowing above the agreed limit becomes a costlier overdraft. WMA replaced a riskier practice. Until 1997 the Centre covered its deficits with ad hoc treasury bills that the RBI absorbed by creating new money, an automatic monetisation of the deficit that fed inflation. Agreements of 1994 and 1997 ended ad hoc bills from 1 April 1997, and section 5 of the FRBM Act, 2003 barred the RBI from buying the Centre's securities in primary issues from 2006-07, except on special grounds that the Act lists, such as a national calamity.

Banks, in turn, bank with the RBI. Every scheduled bank keeps its cash reserve balance with the RBI and settles payments with other banks through that account. When a sound bank suddenly runs short of cash, say because frightened depositors all withdraw at once, the RBI can lend to it as the lender of last resort, so that a passing shortage does not sink a solvent bank and spread panic to others. Under the Banking Regulation Act, 1949 the RBI is also the main regulator and supervisor of banks: it issues licences, approves the appointment of chief executives, sets capital norms, inspects banks, and can restrict a weak bank's business or arrange its merger. The Banking Regulation (Amendment) Act, 2020 brought urban and multi-state cooperative banks under much fuller RBI regulation. Non-banking financial companies come under Chapter IIIB of the RBI Act, whose section 45IA requires them to register with the RBI before doing business.

The RBI manages foreign exchange under the Foreign Exchange Management Act, 1999 (FEMA), which replaced the Foreign Exchange Regulation Act, 1973 (FERA). FERA treated foreign exchange offences as crimes and assumed that every transaction was banned unless permitted; FEMA treats most violations as civil matters and aims to make external trade and payments easier. Under FEMA the RBI, in consultation with the government, frames the rules for current and capital account transactions and authorises dealers in foreign currency. It is also custodian of India's foreign exchange reserves, made up of foreign currency assets, gold, Special Drawing Rights and the reserve tranche position with the International Monetary Fund. The rupee's exchange rate is market-determined, but the RBI buys or sells dollars to smooth sharp swings. If foreign investors pull money out quickly and the rupee falls steeply, the RBI can sell dollars from its reserves to calm the market, without holding the rupee at any fixed level.

Money also needs safe ways to move between accounts. The Payment and Settlement Systems Act, 2007 makes the RBI the regulator of payment systems, with a Board for Regulation and Supervision of Payment and Settlement Systems overseeing the work. The RBI itself runs the two large interbank systems: Real Time Gross Settlement (RTGS), which settles each high-value payment individually the moment it is made, and National Electronic Funds Transfer (NEFT), which settles in batches. NEFT became available round the clock in December 2019 and RTGS in December 2020. For retail payments, the RBI and the Indian Banks' Association promoted the National Payments Corporation of India (NPCI) in 2008, a not-for-profit company that runs RuPay cards, the Immediate Payment Service (IMPS) and the Unified Payments Interface (UPI), launched in 2016. So the RBI licenses operators and writes the rules, while NPCI and the banks run the everyday retail systems.

The RBI was also given a developmental role, because independent India lacked institutions willing to lend to farmers, small industry and long-term projects. It helped build several: the Industrial Development Bank of India, set up in 1964 as an RBI subsidiary; the Unit Trust of India, which began work the same year; the National Bank for Agriculture and Rural Development (NABARD), which took over the RBI's agricultural and rural credit work in 1982; and the National Housing Bank, set up in 1988. Under the Lead Bank Scheme of 1969, one bank in each district leads credit planning there. The same spirit continues in financial inclusion and financial literacy drives. For customers, the Reserve Bank – Integrated Ombudsman Scheme, launched on 12 November 2021, gives one place to complain about banks, non-banking financial companies and payment system participants, replacing three separate schemes with a single 'one nation, one ombudsman' arrangement.

The RBI earns mainly from interest on the government securities and foreign assets it holds. After meeting its costs and providing for reserves and contingencies, section 47 of the RBI Act requires it to pay the balance of its profits to the Central Government. How large a cushion to keep is debated, since sharp moves in the rupee or in bond prices can cause the RBI losses. The Expert Committee to Review the Extant Economic Capital Framework, chaired by Bimal Jalan, reported in 2019 and recommended a Contingent Risk Buffer of 5.5 to 6.5 per cent of the RBI's balance sheet; on that basis ₹1.76 lakh crore was transferred to the government in August 2019. In May 2025 the Central Board widened the buffer range to 4.5 to 7.5 per cent, kept the buffer at 7.5 per cent and approved a transfer of ₹2.69 lakh crore for 2024-25. In the Union Budget this surplus is a non-tax revenue receipt.

Put together, the RBI wears many hats: issuer of currency, banker to governments, banker and regulator of banks, manager of foreign exchange, overseer of payments and builder of institutions. The table lists the main functions with the law behind each. Some roles pull against each other. As manager of government debt the RBI would like borrowing to stay cheap, but price stability may require higher interest rates; as regulator it wants banks safe, but as lender of last resort it may have to support them in a crisis. Such tensions are one reason why the law since 2016 gives monetary policy a clear primary objective and a committee to set the policy rate, the subject of Part 2. For each function in this part, ask which Act gives the power and whether the RBI acts alone or together with the government.

Exam traps

• The RBI began on 1 April 1935 under the RBI Act, 1934 and was nationalised on 1 January 1949; 1969 is the nationalisation of 14 commercial banks, not of the RBI.
• The RBI issues all bank notes except the ₹1 note; the ₹1 note and all coins are issued by the Government of India.
• The minimum reserve system is a fixed floor (₹200 crore of gold and foreign exchange, at least ₹115 crore of it gold), not a percentage of notes issued; the percentage rule was the older proportional reserve system.
• Ways and means advances cover temporary mismatches and must be repaid within three months; they are not a way to finance the deficit. Ad hoc treasury bills, which did finance it, ended on 1 April 1997.
• The Governor and Deputy Governors (at most four) are appointed by the Central Government for terms of up to five years, with reappointment allowed.
• FEMA, 1999 replaced FERA, 1973; under FEMA most violations are civil, not criminal.
• NPCI (2008) is a not-for-profit company promoted by the RBI and the Indian Banks' Association; it runs UPI, while the RBI itself runs RTGS and NEFT.
• The Bimal Jalan Committee (2019) dealt with the RBI's economic capital framework and surplus transfer, not with monetary policy or inflation targeting.

Recap

• Hilton Young Commission (1926) → RBI Act, 1934 → RBI opens 1 April 1935 as a shareholders' bank; office to Bombay 1937; nationalised 1 January 1949.
• Central Board (s.8): Governor, up to four Deputy Governors, nominated directors from four Local Boards and other fields, two government officials; terms up to five years.
• Section 7 lets the government direct the RBI in the public interest after consulting the Governor; accounting year now April–March.
• Currency: sole issuer of notes (s.22), Issue Department (s.23), minimum reserve system since 1956 (₹200 crore, ₹115 crore gold); digital rupee pilots from 2022.
• Banker to governments (ss.20, 21, 21A); ways and means advances repayable in three months (s.17(5)); ad hoc treasury bills ended 1997; FRBM s.5 bar on primary purchases.
• Banker to banks and lender of last resort; regulates banks (BR Act 1949, cooperative banks more fully since 2020) and NBFCs (s.45IA).
• Forex under FEMA 1999 (civil, replaced FERA 1973); custodian of reserves; payments under the 2007 Act, RTGS and NEFT run by the RBI, UPI by NPCI.
• Developmental role: IDBI and UTI (1964), NABARD (1982), NHB (1988), Lead Bank Scheme (1969); Integrated Ombudsman Scheme (2021).
• Surplus to the Centre under s.47; Jalan Committee (2019) buffer 5.5–6.5%; range widened to 4.5–7.5% in 2025.

Practice questions

Sources

• Reserve Bank of India Act, 1934 (Preamble; ss.7, 8, 17, 20, 21, 21A, 22, 23, 33, 42, 45IA and 47, as amended, including by the Finance Acts of 2016 and 2022) — https://www.indiacode.nic.in
• Reserve Bank (Transfer to Public Ownership) Act, 1948 — https://www.indiacode.nic.in
• Banking Regulation Act, 1949 (as amended by the Banking Regulation (Amendment) Act, 2020); Foreign Exchange Management Act, 1999; Payment and Settlement Systems Act, 2007 — https://www.indiacode.nic.in
• Fiscal Responsibility and Budget Management Act, 2003 (s.5) — https://www.indiacode.nic.in
• Reserve Bank of India: history of the Reserve Bank and 'About us' pages (Central Board, Local Boards, functions); Report of the Expert Committee to Review the Extant Economic Capital Framework (Bimal Jalan, 2019); press releases on surplus transfer (August 2019, May 2025), the Reserve Bank – Integrated Ombudsman Scheme (November 2021), the digital rupee pilots (2022) and 24x7 NEFT and RTGS (2019, 2020) — https://www.rbi.org.in