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Quick recap: RBI and monetary policy on one page

RBI and monetary policy · Quick recap · Fact-checked on · how we check

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

Both parts of RBI and monetary policy condensed for quick revision: the RBI's history, board and functions with the law behind each, its surplus transfer, the objective of monetary policy, the LAF corridor, OMOs and the MSS, reserve ratios, qualitative tools, transmission and limits, with a one-table overview and eight mixed questions.

The Reserve Bank of India is the country's central bank. Recommended by the Hilton Young Commission (1926) and created by the RBI Act, 1934, it opened on 1 April 1935 as a shareholders' bank, moved its central office from Calcutta to Bombay in 1937 and was nationalised on 1 January 1949. A Central Board under section 8 runs it: the Governor, up to four Deputy Governors, and directors nominated by the Central Government, including four from the Local Boards and two government officials. The Governor is appointed by the Centre for up to five years, and section 7 allows the government to issue directions after consulting the Governor.

Each function rests on a law. The RBI alone issues bank notes (s.22), keeping note issue in a separate Issue Department, and since 1956 it follows the minimum reserve system of ₹200 crore in gold and foreign exchange, at least ₹115 crore of it gold; the ₹1 note and coins come from the Government. As banker to governments it lends through ways and means advances, repayable within three months; ad hoc treasury bills ended in 1997 and the FRBM Act barred primary purchases of the Centre's securities from 2006-07. It is banker to banks and lender of last resort, regulates banks under the Banking Regulation Act, 1949 and NBFCs under section 45IA, manages foreign exchange under FEMA, 1999, and regulates payments under the 2007 Act; NPCI, set up in 2008, runs UPI.

The RBI also built institutions such as IDBI and UTI (1964), NABARD (1982) and the National Housing Bank (1988), and launched the Integrated Ombudsman Scheme in November 2021. Its surplus goes to the Centre under section 47; the Bimal Jalan Committee (2019) set a Contingent Risk Buffer of 5.5 to 6.5 per cent of the balance sheet, and in May 2025 the range was widened to 4.5 to 7.5 per cent. Under the 2016 amendment to its preamble, monetary policy has a primary objective of price stability while keeping growth in mind; the stance (accommodative, neutral or withdrawal of accommodation) signals direction.

The MPC sets the policy repo rate, at which the RBI lends to banks against government securities under the liquidity adjustment facility (2000). A corridor keeps the overnight call rate, the operating target, close to it: the standing deposit facility floor (since 8 April 2022, 25 basis points below repo, no collateral, section 17(2B)) and the marginal standing facility ceiling (2011, 25 basis points above repo). The bank rate (s.49) equals the MSF rate. open market operations buy or sell government securities to add or absorb durable liquidity; operation twist (2019) and G-SAP (2021) were variants. The Market Stabilisation Scheme (2004) sterilises capital inflows, with proceeds kept unspent in a separate account.

CRR and SLR also serve as tools; an incremental CRR of 10 per cent was imposed in August 2023 after the ₹2,000 note withdrawal. Qualitative tools (margin requirements, selective credit controls, moral suasion and direct action) and prudential steps such as the November 2023 rise in risk weights on unsecured consumer credit target particular kinds of lending. Transmission to loans improved as loan pricing moved from BPLR (2003) to the base rate (2010), MCLR (2016) and, from 1 October 2019, external benchmarks reset at least every three months. Monetary policy still struggles with supply shocks, long lags, fiscal dominance and informal credit, so it needs supply-side support from the government.

RBI and monetary policy at a glance
ItemKey factLaw or year
RBI begins / nationalisedShareholders' bank, then wholly government-owned1 April 1935 / 1 January 1949
Note issueRBI alone, except ₹1 note and coins; minimum reserve ₹200 crore (₹115 crore gold)s.22; 1956 amendment
Ways and means advancesTemporary advances to governments, repayable within 3 monthss.17(5); ad hoc bills ended 1997
Surplus transferBalance of profits to the Centre; buffer 5.5–6.5% (2019), range 4.5–7.5% (2025)s.47; Jalan Committee
Objective of monetary policyPrice stability while keeping in mind growthPreamble, amended 2016
LAF corridorSDF floor (repo − 25 bp, no collateral), MSF ceiling (repo + 25 bp); bank rate = MSF2022; 2011; s.49
Market Stabilisation SchemeExtra securities to sterilise inflows; proceeds not spent2004 MoU
External benchmark lendingNew floating retail and MSE loans; reset at least every 3 months1 October 2019

Exam traps

Recap

Practice questions

Q1. The proposal to set up a central bank for India, which led to the Reserve Bank of India Act, 1934, came from which body?

  1. The Hilton Young Commission
  2. The Narasimham Committee
  3. The Gadgil Study Group
  4. The Bimal Jalan Committee
Show answer

Answer: A. The Hilton Young Commission

The Royal Commission on Indian Currency and Finance (1926), known as the Hilton Young Commission, recommended a central bank. The Narasimham Committee (1991) dealt with banking reform, the Gadgil group with district credit planning, and the Jalan Committee (2019) with the RBI's capital framework.

Q2. Consider the following statements:
1. Section 47 of the RBI Act requires the RBI to pay the balance of its profits to the Central Government.
2. The RBI's surplus is shown in the Union Budget as a tax revenue.
Which of the statements given above is/are correct?

  1. 1 only
  2. 2 only
  3. Both 1 and 2
  4. Neither 1 nor 2
Show answer

Answer: A. 1 only

Statement 1 is right. Statement 2 is wrong: the surplus is a non-tax revenue receipt. So '2 only', 'both' and 'neither' are wrong.

Q3. Which one of the following Acts replaced the Foreign Exchange Regulation Act, 1973?

  1. The Payment and Settlement Systems Act, 2007
  2. The Foreign Exchange Management Act, 1999
  3. The FRBM Act, 2003
  4. The Banking Regulation Act, 1949
Show answer

Answer: B. The Foreign Exchange Management Act, 1999

FEMA, 1999 replaced FERA and made most violations civil. The 2007 Act deals with payment systems, the FRBM Act with fiscal discipline, and the Banking Regulation Act (older than FERA) with banks.

Q4. Consider the following statements about the LAF corridor:
1. The standing deposit facility rate is the floor of the corridor.
2. Banks must give government securities as collateral to use the standing deposit facility.
Which of the statements given above is/are correct?

  1. 1 only
  2. 2 only
  3. Both 1 and 2
  4. Neither 1 nor 2
Show answer

Answer: A. 1 only

Statement 1 is right: since April 2022 the SDF, 25 basis points below repo, is the floor. Statement 2 is wrong: banks deposit money under the SDF, and no collateral changes hands. So '2 only', 'both' and 'neither' are wrong.

Q5. When the RBI buys dollars to slow a rupee rise and then absorbs the resulting rupee liquidity by issuing special government securities, the process is called

  1. monetisation of the deficit
  2. sterilisation
  3. operation twist
  4. moral suasion
Show answer

Answer: B. sterilisation

Absorbing the rupees created by forex purchases, for example through the Market Stabilisation Scheme, is sterilisation. Monetisation is the opposite (the central bank financing the deficit with new money); operation twist swaps long- and short-term bonds; moral suasion is persuasion of banks.

Q6. Consider the following statements:
1. Ways and means advances are meant to cover temporary gaps between a government's receipts and payments.
2. The FRBM Act, 2003 generally bars the RBI from subscribing to the Centre's securities in primary issues.
Which of the statements given above is/are correct?

  1. 1 only
  2. 2 only
  3. Both 1 and 2
  4. Neither 1 nor 2
Show answer

Answer: C. Both 1 and 2

Both are right: WMA cover short mismatches and must be repaid within three months, and section 5 of the FRBM Act bars primary subscription from 2006-07 except on special grounds. So '1 only', '2 only' and 'neither' are wrong.

Q7. Which one of the following would reduce the liquidity available to banks?

  1. A cut in the cash reserve ratio
  2. An OMO purchase of government securities
  3. A variable rate reverse repo auction
  4. A buy/sell dollar-rupee swap by the RBI
Show answer

Answer: C. A variable rate reverse repo auction

In a variable rate reverse repo the RBI takes surplus cash from banks, so liquidity falls. A CRR cut, an OMO purchase and a buy/sell swap all put rupees into the system.

Q8. Under the external benchmark system introduced on 1 October 2019, the interest rate on covered loans must be reset at least once every

  1. month
  2. three months
  3. six months
  4. year
Show answer

Answer: B. three months

The RBI's 2019 circular requires a reset at least once in three months, so that changes in the benchmark, such as the repo rate, reach borrowers quickly. One month is not required, and six months or a year would be slower than the rule allows.

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