The Reserve Bank of India: origin, functions and balance sheet

Detail

1. Origin: from a shareholders' bank to a public institution

• Background: Before 1935 India had no single central bank. The government issued currency. The Imperial Bank of India did some banking work for the government.
• Hilton Young Commission (1926): also called the Royal Commission on Indian Currency. It recommended a central bank to be called the "Reserve Bank of India" [2].
• Indian Central Banking Enquiry Committee (1931): it took up the idea of a central bank again [2].
• RBI Act, 1934: passed on 5 March 1934 as Act II of 1934. It is the statutory basis of the RBI, meaning the RBI exists because this law created it [2].
• Start of operations: 1 April 1935.
• It began as a shareholders' bank, owned by private shareholders and not by the government.
• Sir Osborne Smith was the first Governor [3].

• The head office was first in Calcutta. It moved permanently to Bombay in 1937.

• Role in Burma: from 1937 the RBI also worked as banker and currency manager for Burma (Myanmar), which had been separated from British India [3].

• Nationalisation: 1 January 1949.
• Done under the RBI (Transfer to Public Ownership) Act, 1948 [4].
• From then on the Government of India has owned the RBI fully.

• Sir Benegal Rama Rau became Governor on 1 July 1949 [3].

• NCERT simplification to watch:

• Class 7 says the RBI has worked as "banker of banks" since 1949.
• In fact it did central-banking work from 1935.
• 1949 only changed who owned it, not what it did.

2. What a central bank is

• Central bank: the top (apex) money institution of a country. It:
• issues currency;
• controls money supply (the total money in the economy, meaning currency held by people plus their bank deposits);
• acts as banker to the government and to banks;

• holds the country's foreign exchange (forex) reserves.

• Unlike a commercial bank, it does not work to make profit. Its main goals are stable prices, a stable financial system and support for growth.

3. Functions of the RBI

3.1 Currency issue monopoly

• Monopoly of note issue: only the RBI may issue banknotes.
• Government of India issues coins and ₹1 notes. The RBI puts these into circulation too.
• Promise to pay: every RBI note carries the Governor's signed promise to pay the bearer.
• Fiat money: money that has value because the government says so, not because of any gold or silver behind it.
• Legal tender: money that nobody in India can refuse as payment of a debt.

• Under Section 26 of the RBI Act, 1934, RBI banknotes, including the digital e₹, are legal tender anywhere in India and are a liability of the RBI [5].

• Currency management: the RBI decides how many notes are printed, sends them across the country through its currency chests, and takes back soiled notes.

3.2 Banker to the government

• For the Centre: a duty under the RBI Act.
• For states: done by agreement with each state.
• Ways and Means Advances (WMA): short-term loans, like an overdraft, that the RBI gives governments when spending runs ahead of receipts for a few days or weeks.

• These are for timing gaps only. They are not long-term funding.

• Public debt management: the RBI sells government securities (G-secs), which are bonds through which the government borrows. It also pays interest on them and repays them when they fall due.

3.3 Banker to banks

• Banks keep accounts and reserves with the RBI (for example, the Cash Reserve Ratio (CRR), the share of deposits banks must keep with the RBI).
• The RBI settles interbank payments, meaning it moves money between banks' RBI accounts.
• It lends to banks, for example through the repo window.

3.4 Lender of last resort

• Lender of last resort: the RBI lends to a sound bank in a liquidity crisis (a sudden cash shortage) when no one else will lend to it.
• Why it matters:
• depositors fear a bank may fail, so they rush to withdraw (a bank run);
• even a healthy bank cannot pay everyone at once;
• RBI lending stops the panic, so it does not spread to other banks.

3.5 Custodian of forex reserves

• The RBI holds and manages India's foreign currency assets and gold.
• It uses them to steady the rupee's exchange rate and to pay for imports in a crisis.

3.6 Bank supervision (Class 10 view)

• The RBI checks that banks keep enough cash balance.
• It makes sure banks lend to small cultivators, small industries and small borrowers, not only to big firms.
• Banks must report how much they lend, to whom and at what interest rate.

3.7 Payment systems and development

• Payment-system regulator: the RBI runs or oversees the systems through which money moves:
• RTGS (Real Time Gross Settlement): large payments settled one by one, instantly;
• NEFT (National Electronic Funds Transfer): payments settled in batches;

• UPI (Unified Payments Interface): run by NPCI under RBI oversight.

• Developmental role: promoting financial inclusion, meaning bringing poor and rural people into formal banking.

3.8 Symbol

• Statues of a yaksha and yakshi stand at the RBI's Delhi office.
• In mythology they guard Kubera's treasure. In the same way, the RBI guards the nation's currency and acts as banker to banks.

4. RBI's balance sheet and surplus

4.1 What is on the balance sheet

• Liabilities (what the RBI owes):
• currency in circulation, since every note is an RBI liability [5];
• deposits of banks and governments;

• reserves and buffers such as the CRB.

• Assets (what the RBI owns):

• foreign currency assets and gold;
• G-secs;
• loans to banks and governments.

4.2 Sources of income

• Interest earned on forex assets and G-secs.
• Income from liquidity operations (lending to banks through repo and similar windows).
• Seigniorage: the profit from issuing currency.
• A note costs very little to print, but it lets the RBI buy interest-earning assets worth its full face value.

• Illustrative example: the RBI issues ₹100 crore of new notes and uses them to buy ₹100 crore of G-secs at 7%. It earns about ₹7 crore a year, minus the small printing cost. That gain is seigniorage.

• Surplus: income minus expenses and provisions. Under the RBI Act it is transferred to the Central Government. It is often called the "RBI dividend".

4.3 Economic Capital Framework (ECF)

• Economic Capital Framework: the RBI's method for deciding how much risk capital it must keep before it transfers the surplus.
• Contingent Risk Buffer (CRB): a reserve kept for sudden shocks, such as losses on forex or bonds, or a financial crisis. It is expressed as a % of the RBI's balance sheet.
• Chain of cause and effect:
• higher CRB → more income kept by the RBI → smaller surplus for the government;

• lower CRB → less income kept → bigger surplus for the government.

• Formula (simplified):

• Required CRB = CRB % × size of the RBI balance sheet

• Surplus transferred = net income − (top-up needed to reach the required CRB)

• Worked example (illustrative numbers):

• Balance sheet = ₹70 lakh crore; the board chooses a CRB of 6.5%.
• Required CRB = 0.065 × 70 = ₹4.55 lakh crore.
• Existing CRB = ₹4.0 lakh crore, so the top-up needed = ₹0.55 lakh crore.
• Net income = ₹3.4 lakh crore, so surplus = 3.4 − 0.55 = ₹2.85 lakh crore.

4.4 Committees and transfers

• Bimal Jalan Committee (2019):
• fixed a CRB range of 5.5–6.5% of the balance sheet;

• a record ₹1.76 lakh crore was transferred in 2019.

• 2025 review of the ECF:

• the CRB band was widened to 4.5–7.5%;

• ₹2.69 lakh crore was transferred for 2024-25.

• Latest transfer (for 2025-26, decided around May 2026): could not be confirmed from a whitelisted official source. Check the RBI press release on "transfer of surplus to the Central Government".

5. Central Bank Digital Currency (e₹)

5.1 Definition and legal basis

• Central Bank Digital Currency (CBDC): legal tender in digital form.
• It is a direct liability of the RBI, the same as a paper note.
• It exchanges one-to-one with cash, so ₹1 of e₹ equals ₹1 of cash.

• It carries the RBI's guarantee and finality of settlement (once paid, the payment cannot be reversed) [5].

• It extends the RBI's note-issue monopoly into digital form.

• Legal change: the Finance Act 2022 amended the RBI Act so that "bank note" includes a digital form.
• Concept Note: released by the RBI in October 2022 [6].
• e₹ is not the same as UPI:
• UPI moves bank-deposit money, which is a liability of a commercial bank;
• e₹ is itself central-bank money.

5.2 Two types

Feature	Wholesale (e₹-W)	Retail (e₹-R)
Users	Banks and financial institutions	Individuals and businesses
Use	Interbank settlement	Everyday payments (P2P, P2M)
Pilot start	1 Nov 2022	1 Dec 2022
First use case	Settling secondary-market G-sec trades	Payments within a closed user group of customers and merchants

• Retail e₹ features:
• Token-based: e₹-R is a digital token that represents legal tender [7], like a digital version of a note in your wallet.
• It is held in bank-provided digital wallets. 19 banks offer retail e₹ wallets, including SBI, ICICI Bank, HDFC Bank and Axis Bank [5].

• It works with UPI QR codes. Offline and programmable features were added later.

• Retail pilot coverage: the first phase ran in Mumbai, New Delhi, Bengaluru and Bhubaneswar, and later Chandigarh [7].

5.3 Why issue a CBDC: motives

• Printing, storing and moving cash is costly. e₹ lowers the cost of cash.
• Programmability: money can be set to be spent only for a certain purpose, for example a subsidy.
• Faster and cheaper cross-border payments.
• It gives a sovereign alternative to private cryptocurrencies.

5.4 Risks

• Bank disintermediation:
• people move deposits out of banks into e₹;
• banks then have less money to lend;
• credit creation weakens.

• This is why e₹ pays no interest on wallet balances [5].

• Privacy: a digital record of payments could expose users' transactions.

Prelims Hooks

• The Hilton Young Commission (1926), also called the Royal Commission on Indian Currency, recommended the RBI. The RBI Act was passed on 5 March 1934 [2].
• The RBI began work on 1 April 1935 as a shareholders' bank. Its first Governor was Sir Osborne Smith [3]. HQ: Calcutta, then Bombay (1937).
• Nationalised on 1 January 1949 under the RBI (Transfer to Public Ownership) Act, 1948 [4]. Trap: the RBI did central-banking work from 1935, not from 1949.
• Notes → RBI. Coins and ₹1 note → Government of India.
• Section 26, RBI Act: RBI notes, including e₹, are legal tender and a liability of the RBI [5].
• Ways and Means Advances are short-term overdrafts, not long-term loans. They are given to the Centre by law and to states by agreement.
• ECF CRB bands: Jalan (2019) = 5.5–6.5%. 2025 review = 4.5–7.5%.
• e₹ pilots: Wholesale on 1 Nov 2022 (G-sec secondary market). Retail on 1 Dec 2022.
• e₹ pays no interest, to avoid pulling deposits out of banks [5].
• Seigniorage is the profit from issuing currency and is a key source of RBI income.

Mains Points

• RBI surplus and fiscal policy (GS-III):
• large transfers (₹1.76 lakh crore in 2019; ₹2.69 lakh crore for 2024-25) help the government meet its fiscal deficit target without extra borrowing;
• but a lower CRB leaves a thinner cushion for future shocks;

• there is a debate between central-bank independence and the government's revenue needs, which the rule-based ECF tries to settle.

• Lender of last resort vs moral hazard:

• RBI support stops bank runs and contagion;
• but if banks expect a rescue, they may take bigger risks;

• so strong supervision (cash balances, reporting of loans) must go with it.

• CBDC trade-offs:

• benefits: cheaper cash management, programmable welfare transfers, cross-border efficiency, a sovereign answer to crypto;
• costs: bank disintermediation and privacy;

• the RBI's design (no interest, bank-run wallets) keeps banks as the middlemen.

• Nationalisation to multi-role regulator (GS-II/III):

• the RBI moved from a private shareholders' bank (1935) to public ownership (1949);
• it now regulates banking, payments (UPI/RTGS/NEFT) and digital currency, and plays a developmental role (financial inclusion);
• this shows the state's use of the central bank as a tool of planned development.