The Reserve Bank of India under the RBI Act, 1934: Complete Notes

The Reserve Bank is the currency authority, the Government's banker, the bankers' bank and the monetary authority, and it regulates both banks and a great deal of finance that lies outside banking. This note brings together the law on each of those roles: how the Bank is constituted and who may direct it, how currency is issued and withdrawn, what the Bank may and may not do as a banker, how monetary policy is now decided by a statutory committee against a statutory target, the instruments through which that decision is given effect, and the Bank's authority over non-banking financial companies and payment systems.

Six turning points in the law of the Reserve Bank

Figure 1: Six turning points in the law of the Reserve Bank

1. Establishment and Management

Origin: recommended by the Hilton Young Commission (1926), constituted by the RBI Act, 1934, commenced 1 April 1935, nationalised 1 January 1949 by the Transfer to Public Ownership Act, 1948.
Preamble: to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability, and, after the Finance Act, 2016, to maintain price stability while keeping in mind the objective of growth.
Corporate status: a body corporate with perpetual succession (Section 3) and a capital of ₹5 crore (Section 4) wholly held by the Central Government. It is State within Article 12.
Section 7: the Central Government may give directions in the public interest after consultation with the Governor (sub-section 1); subject to those directions the Central Board has general superintendence (sub-section 2); the Governor has the same powers save as the regulations provide (sub-section 3). Sub-section (1) is understood never to have been formally invoked.
Central Board (Section 8): the Governor, up to four Deputy Governors, four Directors one from each Local Board, ten nominated Directors and two Government officials, at most twenty one. The Governor serves a term not exceeding five years, renewable; nominated Directors serve four years and not more than two terms.
Local Boards (Section 9): four, at Mumbai, Kolkata, New Delhi and Chennai, of five members each.
Supersession (Section 30): the Central Government may supersede the Central Board for failure to carry out obligations, reporting the order to Parliament.

2. Note Issue and Currency

Sole right (Section 22): the Bank alone issues bank notes; the one rupee note and coins come from the Central Government under the Coinage Act, 2011 but circulate through the Bank. Section 31 bars anyone else from issuing instruments payable to bearer on demand.
Issue Department (Section 23): wholly separated from the Banking Department. Its liabilities are the notes in circulation (Section 34); its assets (Section 33) must at least equal them.
Minimum reserve system: adopted in 1956 and, in its present form since 1957, requiring gold and foreign securities of at least ₹200 crore, of which gold at least ₹115 crore. It replaced the proportional reserve system of forty per cent.
Denominations and form: up to ₹10,000 (Section 24), with design and material approved by the Central Government on the Board's recommendation (Section 25).
Legal tender (Section 26(1)): every note is legal tender for the amount expressed in it and is guaranteed by the Central Government. Coin legal tender is capped at ₹1,000 for coins of a rupee and above, and ₹10 for fifty paise coins.
Demonetisation (Section 26(2)): on the recommendation of the Central Board, the Central Government may by notification declare that any series of notes of any denomination shall cease to be legal tender.
Withdrawal is not demonetisation: the ₹2000 note was withdrawn from circulation in May 2023 but remains legal tender.

📖 Vivek Narayan Sharma v. Union of India, (2023) 3 SCC 1

Facts: The notification of 8 November 2016 under Section 26(2) withdrew legal tender status from all ₹500 and ₹1,000 notes. It was challenged on the ground that the provision permits only a particular series to be demonetised, that it amounted to excessive delegation, that the Bank had not applied an independent mind, and that the measure was disproportionate.

Held: A Constitution Bench upheld the notification four to one on 2 January 2023. The word "any" was read purposively to include all series; the requirement of a recommendation of the Central Board was a sufficient safeguard against excessive delegation; and the measure satisfied proportionality, having a legitimate aim, a rational nexus and a reasonable fifty two day exchange window.

Ratio: Section 26(2) supports the demonetisation of all notes of a denomination, provided the Board's recommendation precedes the notification and the measure is proportionate. Nagarathna J. dissented, holding that demonetising all notes of a denomination requires legislation by Parliament and that the Board had not applied an independent mind.

3. The Bank as a Banker

The four roles of the Reserve Bank

Figure 2: The four roles of the Reserve Bank

What it may do (Section 17): accept deposits without interest, and since the Finance Act, 2018 interest-bearing deposits under the standing deposit facility (17(1A)); rediscount eligible commercial, agricultural and small industry paper; make advances to scheduled banks against eligible security (17(4)); make ways and means advances to Governments repayable within three months (17(5)); deal in Government securities, gold and foreign exchange; manage the public debt.
What it may do in a crisis (Section 18): on a special occasion, and notwithstanding Section 17, discount paper that is otherwise ineligible and lend to a State cooperative bank, a cooperative society or any other person for up to ninety days on such terms and conditions as the Bank considers sufficient. This is the lender of last resort power, answering to the rule that a central bank should lend freely, at a penal rate, against good collateral.
What it may not do (Section 19): save as Sections 17, 18, 42 and 45 authorise, trade, allow interest on deposits, make loans or advances, lend on the security of immovable property or of shares, or draw bills payable otherwise than on demand.
Banker to the Government: Section 20 obliges the Bank to accept Government money and manage the Union's public debt; Section 21 obliges the Government to entrust its banking to the Bank and deposit its balances free of interest; Section 21A brings in the States by agreement.
End of automatic monetisation: ad hoc treasury bills were phased out between 1994 and 1997, and the FRBM Act, 2003 restricts Government borrowing from the Bank and its subscription to primary issues, while leaving the secondary market open.
Banker to banks: scheduled banks keep the cash reserve ratio with the Bank under Section 42(1), and Section 42(6) governs inclusion in and removal from the Second Schedule.

4. Monetary Policy and the Committee

The framework: Chapter IIIF, inserted by the Finance Act, 2016, following the Urjit Patel Committee (2014) and the Monetary Policy Framework Agreement (February 2015).
The target (Section 45ZA): the Central Government, in consultation with the Bank, notifies the inflation target in terms of the consumer price index once in five years, with upper and lower tolerance levels. The current target is four per cent with a band of two to six, notified on 25 March 2026 for 1 April 2026 to 31 March 2031.
The Committee (Section 45ZB): six members. From the Bank, the Governor as chairperson, the Deputy Governor in charge of monetary policy and one officer nominated by the Central Board. From outside, three persons appointed by the Central Government through a Search cum Selection Committee headed by the Cabinet Secretary, for four years and without re-appointment. The decision binds the Bank.
Meetings (Section 45ZI): at least four a year, six in practice; quorum four including the Governor or the Deputy Governor member; one vote each, majority of those present and voting, with a casting vote for the Governor; reasons recorded by every member.
Transparency: minutes published on the fourteenth day (Section 45ZL) with each member's vote and statement, and a Monetary Policy Report every six months (Section 45ZM).
Failure (Section 45ZN): where inflation stays outside the band for three consecutive quarters, above or below, the Bank must report to the Central Government the reasons, the remedial actions and the estimated time to return to target. First engaged in 2022.
Goal and instruments: the Government sets the goal; the Committee chooses the instruments. India has instrument independence, not goal independence.

5. Instruments of Monetary Control

The instruments and where they come from

Figure 3: The instruments and where they come from

Cash reserve ratio: Section 42(1) of the RBI Act, held with the Reserve Bank, earns nothing, with no statutory floor or ceiling since 2007. Penal interest at three and then five per cent above the bank rate under Section 42(3).
Statutory liquidity ratio: Section 24 of the Banking Regulation Act, held by the bank itself in cash, gold or unencumbered approved securities, earns interest, and may not exceed forty per cent, with the same scale of penal interest.
Policy rates: the repo rate is the single policy rate; the standing deposit facility (from April 2022) is the floor and the marginal standing facility the ceiling of the corridor; the bank rate (Section 49) is aligned to the latter and supplies the reference for penal interest.
Open market operations: Section 17(8) permits outright purchase and sale of Government securities, affecting durable liquidity.
Selective credit control: Section 21 of the Banking Regulation Act lets the Bank prescribe the purposes of advances, the margins, the maximum amount to a borrower, the maximum guarantees and the rate of interest.
Persuasion and direction: moral suasion, and directions under Section 35A enforceable through Sections 46 and 47A.
Transmission: improved by the requirement from 1 October 2019 that new floating rate retail and small business loans be linked to an external benchmark, after the failure of the prime lending rate, base rate and marginal cost of funds based lending rate.

6. Beyond Banking

Non-banking financial companies: governed by Chapter IIIB of the RBI Act. Section 45-I defines them, with the fifty per cent principal business test; Section 45-IA requires registration and a net owned fund of ₹25 lakh or such higher amount not exceeding ₹100 crore as the Bank specifies by category, rising to ₹10 crore by 31 March 2027 for investment and credit companies, microfinance institutions and factors; Section 45-IB requires liquid assets of five to twenty five per cent of deposits and Section 45-IC a twenty per cent transfer to a reserve fund.
Scale based regulation: from 1 October 2022, companies are sorted into base, middle, upper and top layers, with regulation intensifying up the scale. All deposit taking companies are at least in the middle layer; the top layer is ordinarily empty.
Payment systems: the Payment and Settlement Systems Act, 2007 makes the Reserve Bank the designated authority (Section 3), acting since May 2025 through the Payments Regulatory Board, bars operation without authorisation (Sections 4 and 7), permits standards (Section 10) and directions (Sections 17 and 18), and confers settlement finality that survives a participant's insolvency (Section 23).
Infrastructure: real time gross settlement and National Electronic Funds Transfer run round the clock; the National Payments Corporation of India operates the Unified Payments Interface and related systems; the Finance Act, 2022 brought digital currency within the definition of a bank note.

7. How the Functions Hold Together

The functions are not a list but a structure. The Bank can be the lender of last resort only because Section 19 keeps its assets short and liquid. It can conduct open market operations only because it manages the public debt and the market in Government securities. It can enforce the cash reserve ratio only because scheduled banks must keep accounts with it, and that same account is what makes settlement finality possible. The inflation target gives a legal objective to powers that previously had none, and Section 45ZN attaches a consequence to failure. Each power supports the others, which is why a change in one, such as removing debt management from the Bank, is never a simple administrative reallocation.

⚠ Key point

The Reserve Bank, constituted by the RBI Act, 1934 and nationalised in 1949, is a body corporate with a capital of ₹5 crore, managed by a Central Board of at most twenty one under Section 8, subject to Central Government directions under Section 7(1). It has the sole right of note issue (Section 22) backed by the minimum reserve system (Section 33), and may demonetise a series on the Board's recommendation (Section 26(2)), upheld in Vivek Narayan Sharma (2023). It is banker to the Government (Sections 20, 21, 21A), banker to banks (Section 42) and lender of last resort (Sections 17(4) and 18), while Section 19 forbids trading, interest on deposits outside the standing deposit facility, and lending on immovable property. Chapter IIIF gives it a statutory inflation target of four per cent within a two to six band and a six member Monetary Policy Committee whose decision binds it, with minutes on the fourteenth day and a failure report under Section 45ZN. Its instruments are the cash reserve ratio (Section 42), the statutory liquidity ratio (Section 24, BR Act, maximum forty per cent), the repo rate and the corridor, open market operations (Section 17(8)) and selective credit control (Section 21, BR Act). It also regulates non-banking financial companies under Chapter IIIB and payment systems under the Act of 2007.

8. Quick Revision

✦ Points worth fixing

Seven directs, eight constitutes, nine localises, thirty supersedes. The management sections in order.

Twenty two issues, twenty three separates, twenty six makes legal tender and takes it away.

Two hundred and one fifteen crore is the minimum reserve, unchanged since 1957.

Seventeen may, eighteen in a crisis, nineteen may not.

Twenty obliges the Bank, twenty one obliges the Government, twenty one A brings in the States.

Four per cent, two to six, five years. The inflation target in three numbers.

Three from the Bank, three from the Government, four is the quorum.

Fourteenth day minutes, six monthly report, three quarters is failure.

With the Bank and barren, with yourself and earning. Cash reserve ratio against statutory liquidity ratio.

Forty per cent is the only statutory limit left, and it belongs to the statutory liquidity ratio.

Any means all. The majority in Vivek Narayan Sharma.

9. Frequently Asked Questions

What are the main functions of the Reserve Bank of India?

Issuing currency (Section 22), acting as banker to the Central and State Governments (Sections 20, 21 and 21A) and managing their public debt, acting as banker to banks and lender of last resort (Sections 17(4) and 18), formulating monetary policy through the Monetary Policy Committee under Chapter IIIF, and regulating and supervising banks, non-banking financial companies and payment systems.

Can the Government direct the Reserve Bank?

Yes, but within limits. Section 7(1) allows the Central Government to give directions it considers necessary in the public interest, and only after consultation with the Governor. The Central Board's superintendence is expressly subject to such directions. The power is understood never to have been formally exercised, although it has been referred to in public disagreements.

What is the composition of the Monetary Policy Committee?

Six members: the Governor as chairperson ex officio, the Deputy Governor in charge of monetary policy ex officio, one officer of the Bank nominated by the Central Board ex officio, and three persons appointed by the Central Government for a non-renewable term of four years. The quorum is four, decisions are by majority, and the Governor has a casting vote.

What is the difference between the cash reserve ratio and the statutory liquidity ratio?

The cash reserve ratio arises under Section 42(1) of the RBI Act, is kept in cash with the Reserve Bank and earns nothing, with no statutory limit. The statutory liquidity ratio arises under Section 24 of the Banking Regulation Act, is kept by the bank itself in cash, gold or unencumbered approved securities, earns interest, and may not exceed forty per cent.

Was the 2016 demonetisation held to be legal?

Yes. In Vivek Narayan Sharma v. Union of India, (2023) 3 SCC 1 a Constitution Bench upheld it by four to one, reading "any series" in Section 26(2) to include all series, treating the recommendation of the Central Board as an adequate safeguard against excessive delegation, and finding the measure proportionate. Nagarathna J. dissented.

Why does the Reserve Bank regulate entities that are not banks?

Because financial risk moved outside the banking licence. Non-banking financial companies fund themselves from banks and markets, so their failure spreads, and payment systems carry the settlement of the whole economy. Chapter IIIB of the RBI Act and the Payment and Settlement Systems Act, 2007 extend the Bank's authority to both, by function rather than by the form of the entity.

10. Related Topics and Provisions

Licensing of banking companies (Section 22)
Inspection and the power to issue directions (Sections 35 and 35A)
Control over management and supersession of the board
Reconstruction and amalgamation of banks (Section 45)
Priority sector lending
Deposit insurance