Establishment and Management of the Reserve Bank of India

The Reserve Bank of India is the institution around which the whole of Indian banking law is arranged. It issues the currency, banks for the Government, regulates and supervises every other bank, and sets monetary policy. Before any of its powers can be understood, it is necessary to know how the Bank is constituted, who controls it, and what the Central Government may lawfully require of it. This note deals with those questions under the opening chapters of the Reserve Bank of India Act, 1934.

Figure 1: How the Reserve Bank came to be what it is

1. Origin and Purpose

• The Hilton Young Commission: the Royal Commission on Indian Currency and Finance, which reported in 1926, recommended a central bank separate from the Government and from the Imperial Bank.
• The statute: the Reserve Bank of India Act, 1934 was enacted after an earlier bill had failed, and the Bank commenced operations on 1 April 1935, with its central office at Calcutta, moved to Bombay in 1937.
• Ownership: the Bank began as a shareholders' bank. The Reserve Bank of India (Transfer to Public Ownership) Act, 1948 vested the whole of its share capital in the Central Government with effect from 1 January 1949.
• First Governors: Sir Osborne Smith was the first Governor; C.D. Deshmukh was the first Indian to hold the office.

The preamble

The preamble is the key to the Bank's purpose. It states that the Bank is constituted to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India, and generally to operate the currency and credit system of the country to its advantage. The Finance Act, 2016 added a further recital describing the modern monetary policy framework needed to meet the challenge of an increasingly complex economy, whose primary objective is to maintain price stability while keeping in mind the objective of growth. The two recitals together explain why the Bank is both a currency authority and a monetary authority.

2. Establishment and Capital

• Corporate character: the Bank is a body corporate created by statute. It is not a department of Government, and it holds its own property, makes its own contracts and sues in its own name.
• Capital (Section 4): the capital of the Bank is five crores of rupees, a figure unchanged since 1934 and now wholly held by the Central Government.
• Offices (Section 6): the Bank must establish offices in Mumbai, Kolkata, Delhi and Chennai, may establish branches or agencies anywhere else in India, and may do so outside India only with the previous sanction of the Central Government.
• Status in law: as an authority discharging public functions under a statute, the Bank is State within Article 12, and its actions are subject to the writ jurisdiction under Articles 226 and 32.

3. Management: Section 7

What Section 7 does and does not permit

• A power of direction, not of command in detail: the Central Government may direct the Bank, but only in the public interest and only after consultation with the Governor. Consultation is a condition precedent, not a formality.
• Subordination of the Board: the Central Board's general superintendence is expressly subject to directions under sub-section (1), so a valid direction prevails over the Board's own view.
• The Governor's executive power: sub-section (3) gives the Governor the same powers of general superintendence, save as the regulations otherwise provide, which is the legal source of the Governor's day-to-day authority.
• Use in practice: the power under sub-section (1) is understood never to have been formally exercised, although it has been referred to publicly during disagreements between the Government and the Bank. Its value lies in its existence rather than its use.

4. The Central Board

Figure 2: Composition of the Central Board under Section 8(1)

• Composition (Section 8(1)): a Governor and not more than four Deputy Governors appointed by the Central Government; four Directors nominated by the Central Government, one from each of the four Local Boards; ten Directors nominated by the Central Government; and two Government officials nominated by the Central Government, in practice the Secretaries of the Departments of Economic Affairs and Financial Services. The Board therefore has at most twenty one members.
• Term of the Governor and Deputy Governors: such term not exceeding five years as the Central Government may fix at the time of appointment, and they are eligible for reappointment. They must devote their whole time to the affairs of the Bank.
• Term of nominated Directors: four years and thereafter until a successor is appointed, with eligibility for renomination but not for more than two terms, that is eight years in the aggregate, whether continuously or intermittently.
• The Government officials: hold office during the pleasure of the Central Government.
• Validity of proceedings: an act of the Board is not invalid merely because of a vacancy in, or a defect in the constitution of, the Board.

Disqualification and removal

• Section 10 disqualifies from being a Director or a member of a Local Board a salaried Government official, a person who is or has been adjudicated an insolvent or has suspended payment or compounded with his creditors, a person of unsound mind, an officer or employee of any bank, and a Director of a banking company or of a cooperative bank. The bars relating to Government officials, bank employees and bank directors do not apply to the Governor, the Deputy Governors or the Government officials nominated under clause (d).
• Section 11 provides for removal by the Central Government and for vacation of office on absence from three consecutive meetings without leave.
• Section 30: if the Bank fails to carry out any of the obligations imposed on it by the Act, the Central Government may, by notification, supersede the Central Board and entrust the Bank's affairs to an agency it thinks fit, with a report to be laid before Parliament.

5. Local Boards and Committees

• Section 9: there are four Local Boards, one each for the Western, Eastern, Northern and Southern areas, with headquarters at Mumbai, Kolkata, New Delhi and Chennai respectively.
• Membership: five members for each Local Board, appointed by the Central Government for a term of four years, and for not more than two terms, to represent, as far as possible, territorial and economic interests and the interests of cooperative and indigenous banks.
• Function: a Local Board advises the Central Board on matters referred to it and performs the duties the Central Board delegates.
• Committee of the Central Board: the Board works largely through committees constituted under the regulations, including the Committee of the Central Board, which meets weekly, and board-level committees on audit, risk, inspection and human resources.

6. Autonomy and Accountability

The Reserve Bank is often described as autonomous, but its autonomy is functional rather than constitutional. Every element of it rests on ordinary legislation that Parliament may alter. What the Act provides is a set of arrangements that make interference visible: a direction under Section 7(1) must be preceded by consultation and must rest on the public interest; supersession under Section 30 must be reported to Parliament; and the monetary policy framework in Chapter IIIF gives the Bank a statutory mandate that it is answerable for in its own name.

• Appointments: the Governor, the Deputy Governors and every Director are appointed or nominated by the Central Government, which is the most significant structural limit on independence.
• No fixed statutory term: the Act prescribes only a maximum of five years, so the actual term is fixed by the Government at the time of appointment, and short terms have been given.
• Financial relationship: the Bank transfers its surplus to the Central Government, and the size of that transfer and of the Bank's reserves has itself been a matter of public controversy.
• Accountability: under Section 53 the Bank sends the Central Government weekly accounts, its audited annual accounts and the Central Board's report on its working, and the Government publishes the annual accounts and report in the Gazette of India. The Governor also appears before parliamentary committees.

7. Quick Revision

8. Frequently Asked Questions

When was the Reserve Bank of India established and nationalised?

It was constituted under the Reserve Bank of India Act, 1934 and commenced operations on 1 April 1935. It was nationalised by the Reserve Bank of India (Transfer to Public Ownership) Act, 1948, with effect from 1 January 1949, when its entire share capital passed to the Central Government.

What does Section 7 of the RBI Act provide?

Section 7(1) allows the Central Government to give the Bank directions it considers necessary in the public interest, but only after consultation with the Governor. Section 7(2) entrusts the general superintendence of the Bank to the Central Board, subject to any such directions. Section 7(3) gives the Governor the same powers of general superintendence save as the regulations provide.

Who constitutes the Central Board of the Reserve Bank?

Under Section 8(1): the Governor and not more than four Deputy Governors; four Directors, one nominated from each Local Board; ten Directors nominated by the Central Government; and two Government officials. All are appointed or nominated by the Central Government, giving a maximum strength of twenty one.

Is the Reserve Bank independent of the Government?

Only to a limited and statutory extent. The Bank has instrument independence, in that it chooses the policy rate and the tools by which it pursues the target. It does not have goal independence, because the Central Government notifies the inflation target under Section 45ZA. The Government also appoints every member of the Board, may give directions under Section 7(1) and may supersede the Board under Section 30.

Can the Central Government remove the Governor of the Reserve Bank?

Yes. The Governor holds office for such term not exceeding five years as the Central Government fixes, and Section 11 empowers the Central Government to remove from office any Governor, Deputy Governor or Director. There is no security of tenure comparable to that of a judge, which is why the length of the term fixed at appointment matters so much in practice.

9. Related Topics and Provisions

• Note issue and currency management
• The Reserve Bank as banker to the Government and to banks
• Monetary policy and the Monetary Policy Committee
• Instruments of monetary control
• Inspection and the power to issue directions (Sections 35 and 35A)
• Constitutional and legislative framework of banking