Reserve Bank of India - Functions and MPC for UPSC

Reserve Bank of India (RBI): Functions, Monetary Policy Committee and Developmental Roles for UPSC

The Reserve Bank of India (RBI) is India’s central bank. Established on 1 April 1935 and nationalised in 1949, it regulates the issue of bank notes, manages currency and credit to secure monetary stability, and formulates modern monetary policy to maintain price stability while supporting economic growth. For civil services aspirants, understanding the RBI’s objectives, its monetary policy framework and its developmental roles is essential for both prelims and mains.

Definition box: What is the RBI?

RBI objectives and constitutional position

Constitutional mandate and preamble

The RBI Act of 1934 created the Reserve Bank of India. Its preamble succinctly captures its dual objectives: currency and monetary stability and economic growth. The bank regulates the issue of bank notes and maintains reserves to ensure monetary stability while operating the currency and credit system to India’s advantage. Following nationalisation in 1949, it became fully owned by the Government of India and is now accountable to Parliament.

Central Board and governance

The RBI is governed by a central board of directors appointed by the Government of India. The board consists of the Governor, up to four Deputy Governors, ten government‑nominated directors from various fields, two government officials and four directors from local boards. This board provides overall policy direction. An important committee of the board is the Board for Financial Supervision (BFS), constituted in 1994 to sharpen supervision and surveillance over banks and non‑banking financial institutions. The BFS exercises integrated supervision over commercial banks, financial institutions and non‑banking financial intermediaries.

Central bank functions at a glance

The RBI’s core functions include:

1. Monetary authority – formulates and implements monetary policy with the objective of maintaining price stability while supporting growth.
2. Regulator and supervisor of the financial system – prescribes broad parameters within which banks and financial institutions operate, to maintain public confidence and protect depositors.
3. Manager of foreign exchange – manages the Foreign Exchange Management Act (FEMA) to facilitate external trade, maintain orderly development of the foreign exchange market and manage forex reserves.
4. Issuer of currency – issues, exchanges and destroys currency notes and circulates coins to ensure adequate quantity and quality of currency.
5. Developmental role – performs promotional and developmental functions to support national objectives such as financial inclusion and MSME credit.
6. Regulator of payment and settlement systems – introduces and upgrades safe and efficient payment systems such as NEFT, RTGS, UPI and digital currency.
7. Banker to government and banks – acts as banker, agent and debt manager for central and state governments and maintains accounts of scheduled banks.

Understanding these functions forms the bedrock for analysing the RBI’s role in monetary policy, banking supervision and economic development.

Monetary policy & Monetary Policy Committee (MPC)

Monetary policy framework

India adopted a flexible inflation‑targeting framework in 2016. Under the Monetary Policy Framework Agreement, the Central Government, in consultation with the RBI, sets the inflation target. The current target, valid from 2021 to 2026, is to maintain consumer price index (CPI) inflation at 4 % with a tolerance band of ± 2 % (i.e., inflation should remain within 2–6 %). This target is reviewed every five years. Studies show that after adopting inflation targeting, average inflation fell to around 4.9 % between 2016‑2025 compared with 6.8 % in the pre‑targeting period.

Monetary Policy Committee (MPC)

The RBI’s policy decisions are taken by the Monetary Policy Committee, a statutory body created in 2016 to improve transparency and accountability. Composition and features:

Recent monetary policy decisions (2025)

At its 55th MPC meeting (June 6 2025), the committee cut the repo rate from 6 % to 5.50 %, lowered the Standing Deposit Facility (SDF) rate to 5.25 % and the Marginal Standing Facility (MSF)/Bank rate to 5.75 %. The policy statement reaffirmed the inflation target of 4 % ± 2 % and projected real GDP growth of 7 % for 2024‑25 and 6.5 % for 2025‑26. It also highlighted the need to support growth as inflation remained within the target band.

The 57th MPC meeting (October 2025) kept the repo rate unchanged at 5.50 %. The RBI revised its GDP growth forecast for FY 2025‑26 upwards to 6.8 %, citing robust services and manufacturing activity, and lowered its CPI inflation forecast to 2.6 % following a decline to 1.6 % in July 2025. The accommodative stance signalled that further rate cuts would depend on inflation dynamics and global factors.

Monetary policy instruments

The RBI uses several quantitative and qualitative tools to influence liquidity and interest rates. Key instruments and current (Oct 2025) parameters are summarised below:

Liquidity management framework

The Liquidity Adjustment Facility (LAF) is the RBI’s primary tool for day‑to‑day liquidity management. It allows banks and primary dealers to borrow money or park surplus funds overnight using repos and reverse repos against government securities. The revised liquidity management framework (September 30 2025) states that:

• The weighted average call rate (WACR) remains the operating target. The corridor comprises the repo rate in the middle, SDF as floor and MSF as ceiling.
• 7‑day variable rate repos and reverse repos are now the main liquidity tools; the earlier 14‑day operations were discontinued. Longer‑term variable rate repos/reverse repos and open market operations continue, along with forex swap auctions.
• The RBI will give at least one day’s notice for variable‑rate operations and maintain a “rule‑based” approach to avoid surprises.
• Banks are required to maintain 90 % of CRR on a daily basis, compared with the earlier fortnightly averaging.

Flexible inflation targeting – debates and developments

India’s inflation targeting framework has helped anchor inflation expectations and enhance policy credibility. However, debates persist on whether the 4 % target should be changed. In August 2025, the RBI published a discussion paper seeking public views for the 2026 review. The paper noted that the current framework has worked well but asked whether the target or the 2‑6 % band should be tweaked and whether the focus should shift from headline to core inflation. The RBI cautioned that ignoring food inflation would neglect the cost‑of‑living concerns of poor households. A September 2025 report indicated that most stakeholders, including the RBI, favoured retaining the 4 % headline inflation target within the 2‑6 % band.

Banking supervision and regulation

Integrated supervision and BFS

The Board for Financial Supervision (BFS), a committee of the RBI’s central board, was established in November 1994 under the Board for Financial Supervision Regulations. The BFS strengthens supervision and surveillance over the financial system; it provides a sharper focus on supervisory policy and skills. It exercises integrated supervision over commercial banks, financial institutions and non‑banking financial intermediaries. The Department of Supervision provides secretarial support to the BFS.

Regulation of banks and NBFCs

Under the Banking Regulation Act, 1949 and other laws, the RBI issues licences, sets prudential norms, conducts inspections and enforces regulations for banks and non‑banking financial companies (NBFCs). Key aspects include:

• Capital adequacy – banks must maintain adequate capital against risk‑weighted assets (CRAR). The RBI gradually implemented Basel III norms to strengthen resilience.
• Asset quality review – launched in 2015 to identify non‑performing assets and clean up bank balance sheets. It is complemented by the Prompt Corrective Action (PCA) framework which imposes restrictions on weak banks.
• Risk‑based supervision – banks are categorised based on risk and supervisory attention is commensurate with potential systemic impact.
• Digital lending guidelines – in 2022, the RBI issued guidelines to regulate digital lending by banks and NBFCs, addressing consumer protection, data privacy and grievance redressal.

Deposit Insurance and Credit Guarantee Corporation (DICGC)

To protect depositors, the RBI’s wholly owned subsidiary DICGC insures deposits in commercial and co‑operative banks. Each depositor is insured up to ₹5 lakh for both principal and interest held in the same right and capacity. Deposits in different banks are insured separately and a depositor’s accounts in the same bank are aggregated for the insurance limit. The insurance covers savings, fixed, current and recurring deposits but excludes government and inter‑bank deposits.

Manager of foreign exchange and issuer of currency

Foreign exchange management and reserves

The RBI administers the Foreign Exchange Management Act (FEMA) 1999 and manages India’s foreign exchange reserves. The objective is to facilitate external trade and promote orderly development of the foreign exchange market. The RBI intervenes in the foreign exchange market to smooth volatility and maintain stability. As of September 12 2025, India’s foreign exchange reserves stood at US $702.966 billion, comprising US $587.014 billion in foreign currency assets and US $92.419 billion in gold. These reserves are sufficient to cover approximately 11 months of imports.

Issuer of currency and the digital rupee

The RBI is the sole authority for issuing currency notes and putting coins minted by the Government of India into circulation. Currency notes are printed by Bharatiya Reserve Bank Note Mudran Pvt. Ltd., a wholly owned subsidiary of the RBI, while coins are issued by the Government of India. The bank monitors currency in circulation, withdraws soiled notes and introduces new series with enhanced security features.

Central Bank Digital Currency (CBDC) – In November 2022 the RBI launched pilot projects for the digital rupee (e₹), a legal tender in digital form. The e₹ provides features of physical cash: it is a claim on the central bank, operates 24×7, can be stored in digital wallets offered by banks, and requires no minimum balance. The pilot aims to test the technology, architecture and use cases before wider rollout. The RBI emphasises that the e₹ will coexist with cash and complement existing digital payment systems.

Developmental role and financial inclusion

Financial inclusion efforts

The RBI performs a broad developmental role by promoting financial inclusion, credit to priority sectors and balanced regional development. A key metric is the Financial Inclusion Index (FI‑Index), which combines indicators of access, usage and quality of financial services. In March 2025 the FI‑Index stood at 67.0, up from 64.2 in March 2024; the improvement reflects progress across the three sub‑indices thanks to financial literacy drives, digital payments and expanded coverage of bank branches. Nearly 56 crore accounts have been opened under the Pradhan Mantri Jan Dhan Yojana, and micro‑credit schemes like Mudra and Stand‑Up India have deepened inclusion.

Priority sector lending and MSME support

The RBI’s Priority Sector Lending (PSL) directions, 2025 require banks to lend a specified portion (40 % for commercial banks) of their adjusted net bank credit to priority sectors such as agriculture, micro and small enterprises, education, housing and renewable energy. Key features:

• Definition of MSME – As per the March 21 2025 notification, an enterprise is classified as micro if investment in plant and machinery does not exceed ₹2.5 crore and turnover does not exceed ₹10 crore; small if investment does not exceed ₹25 crore and turnover does not exceed ₹100 crore; and medium if investment does not exceed ₹125 crore and turnover does not exceed ₹500 crore. All such enterprises must register on the Udyam Registration portal and obtain a Udyam Registration Certificate (URC).
• Udyam Assist Platform – For informal micro enterprises unable to register due to lack of PAN or GSTIN, the Udyam Assist Platform managed by SIDBI issues Udyam Assist Certificates with the assistance of RBI‑regulated entities. Such certificates are treated at par with URCs for PSL classification.
• PSL coverage – All bank loans to MSMEs qualify under priority sector lending provided they meet the definition above. A sub‑target of 7.5 % of adjusted net bank credit is prescribed for micro and small enterprises. Loans to agriculture (including allied activities), education, housing (loans up to ₹50 lakh), renewable energy, social infrastructure and exports also fall under PSL.

Through PSL, the RBI directs credit to employment‑intensive sectors and financially excluded groups, thereby furthering inclusive growth.

Payment Vision 2025 and digital payments

India has witnessed an explosive growth in digital payments. To build on this momentum, the RBI released its Payments Vision 2025 with the theme “E‑Payments for Everyone, Everywhere, Everytime”. The vision rests on five pillars — Integrity, Inclusion, Innovation, Institutionalisation and Internationalisation — and aims to:

• Triple the number of digital payment transactions by 2025;
• Achieve >50 % year‑on‑year growth in Unified Payments Interface (UPI) transactions;
• Achieve 150 % growth in transactions through prepaid payment instruments (PPIs);
• Ensure more than 50 % increase in the number of mobile‑based payment customers.

The RBI promotes several payment systems:

1. Unified Payments Interface (UPI) – A real‑time payment system enabling instant person‑to‑person and person‑to‑merchant transfers using virtual payment addresses or QR codes. UPI transactions crossed 12 billion per month in 2025.
2. National Electronic Funds Transfer (NEFT) – An electronic payment system that operates 24×7 in half‑hourly batches. NEFT allows individuals and firms to transfer funds to any bank account across India. Its advantages include round‑the‑clock availability, near‑real‑time settlement, positive confirmation to remitter and absence of transaction charges.
3. Real‑Time Gross Settlement (RTGS) – A system for large‑value transfers (minimum ₹2 lakh) where funds settle individually and irrevocably in real time. It is available 24×7×365, is safe and secure, and has no upper limit on transaction amount.
4. Immediate Payment Service (IMPS) and Aadhaar Enabled Payment System (AePS) – Provide instant fund transfer using mobile numbers, AADHAAR or bank account numbers.
5. Digital Rupee (e₹) – Central bank digital currency pilot enabling tokenised, secure and offline capable digital cash.

Other developmental initiatives

In addition to payment and credit initiatives, the RBI’s developmental role spans:

• Financial literacy and education – The RBI runs Financial Literacy Centres (FLCs) and produces educational material on banking products, cyber security and consumer rights. It conducts awareness programmes through the RBI Kehta Hai campaign and school‑level courses.
• Priority sector regulation for renewable energy and agriculture – Loan limits for small renewable energy projects and credit to farmers have been enhanced under the PSL Directions 2025.
• Innovation and technology – The RBI established the Reserve Bank Innovation Hub (RBIH) to foster fintech innovation and improve access to financial services. The RBIH is working on building the digital rupee infrastructure and incubating start‑ups.

Comparison of major monetary policy instruments

The table below summarises the key monetary policy tools, their objectives and their impact. Note: long explanations are avoided to keep the table concise; explanations appear in the body above.

UPSC Notes: Prelims vs Mains

Prelims focus

For the Civil Services Prelims, emphasise factual details and one‑line statements:

• RBI establishment & ownership – Set up on 1 April 1935; nationalised in 1949; wholly owned by Government of India.
• Preamble & functions – Main goal: regulate currency, secure monetary stability, maintain price stability while keeping in mind growth; functions include monetary policy, banking supervision, forex management, issue of currency, developmental roles and payment systems.
• MPC composition – Six members: RBI Governor (chair), Deputy Governor (monetary policy), one RBI board nominee, three government‑appointed external experts.
• Inflation targeting – CPI inflation target 4 % ± 2 %, set jointly by Government and RBI, reviewed every 5 years.
• Current policy rates (Oct 2025) – Repo 5.50 %, SDF 5.25 %, MSF/Bank rate 5.75 %, CRR 4.5 %, SLR 18 %.
• Financial inclusion & FI‑Index – FI‑Index 67.0 in March 2025 (improvement due to digital payments and inclusion initiatives).
• Deposit insurance – DICGC insures deposits up to ₹5 lakh per depositor per bank.
• Forex reserves – US $702.966 billion (Sept 12 2025), providing roughly 11 months’ import cover.
• PSL & MSME criteria – Investment & turnover limits: Micro (≤₹2.5 crore, ≤₹10 crore), Small (≤₹25 crore, ≤₹100 crore), Medium (≤₹125 crore, ≤₹500 crore); Udyam registration mandatory.
• Payment systems – NEFT and RTGS operate 24×7; NEFT allows near‑real‑time transfers in half‑hourly batches; RTGS settles high‑value funds individually in real time.

Mains focus

For the Mains examination, frame answers around analysis and critical evaluation:

1. Discuss the effectiveness of the inflation‑targeting framework in India. Evaluate how the framework has helped anchor expectations, the trade‑off between growth and inflation, and challenges such as food price shocks and supply‑side constraints. Mention ongoing debates on revising the 4 % target and tolerance band.
2. Examine the role of the Monetary Policy Committee in enhancing transparency and accountability. Discuss its composition, voting process and publication of minutes; compare with the earlier system where policy decisions were taken by the RBI Governor alone.
3. Analyse the RBI’s liquidity management strategy. Explain the revised framework (WACR as operating target, SDF–Repo–MSF corridor, 7‑day repos, CRR requirements) and assess its effectiveness in ensuring orderly money market conditions.
4. Critically evaluate the RBI’s developmental role. Discuss financial inclusion initiatives (FI‑Index improvement, Jan Dhan accounts), priority sector lending, MSME support, Payments Vision 2025, digital rupee and financial literacy. Highlight achievements and remaining challenges such as credit penetration in rural areas and digital divide.
5. Discuss the RBI’s regulatory challenges in the era of fintech and digital lending. Evaluate guidelines on digital lending, data privacy, cyber security and the role of the Reserve Bank Innovation Hub in fostering innovation while managing risks.
6. Foreign exchange management and currency stability. Explain how the RBI manages forex reserves and intervenes in the currency market to maintain stability; discuss the adequacy of reserves and their implications for external vulnerability.

Quick facts

• Establishment – 1 April 1935; nationalised 1 Jan 1949.
• Headquarters – Mumbai, Maharashtra.
• Governor (Oct 2025) – Shaktikanta Das (25th Governor). Four deputy governors assist him.
• Policy rates (Oct 2025) – Repo 5.50 %, SDF 5.25 %, MSF/Bank rate 5.75 %, CRR 4.5 %, SLR 18 %.
• Inflation target – 4 % with ±2 % band; reviewed every 5 years.
• Foreign exchange reserves – US $702.966 billion (as of 12 September 2025).
• Financial Inclusion Index – 67.0 (March 2025).
• Deposit insurance cover – ₹5 lakh per depositor.
• Composition of MPC – 6 members: 3 RBI officials (Governor, Deputy Governor and board member) + 3 external members.
• PSL sub‑target for MSMEs – 7.5 % of adjusted net bank credit to micro and small enterprises.
• Digital payment systems – NEFT & RTGS are available 24×7; UPI volumes exceed 12 billion transactions per month; digital rupee pilot launched 2022.

Previous year questions (indicative)

1. UPSC Prelims 2018 – In India, which institution is responsible for maintaining price stability while keeping in mind the objective of growth?
   Answer: Reserve Bank of India.

2. UPSC Prelims 2020 – Consider the following statements about the Monetary Policy Committee (MPC): (1) It decides the RBI’s benchmark interest rate, (2) It is a seven‑member committee including the Finance Secretary and three government nominees. Which statement(s) is/are correct?
   Answer: Only statement 1 is correct. The MPC has six members, not seven; it includes three government‑appointed external experts, not the Finance Secretary.

3. UPSC Prelims 2021 – With reference to the inflation‑targeting regime in India, consider the following statements: (1) The target is set by the RBI alone. (2) If inflation remains outside the prescribed band for three consecutive quarters, the RBI must explain the reasons. Which of the above is/are correct?
   Answer: Only statement 2 is correct. The inflation target is set by the Government in consultation with the RBI.

These examples illustrate the kind of factual knowledge the UPSC expects candidates to recall about the RBI’s functions and institutions.

Practice MCQs

1. Which of the following is/are core functions of the Reserve Bank of India?
   1. Formulation of monetary policy
      
   2. Regulation of stock exchanges
      
   3. Management of foreign exchange
      
   4. Supervision of payment systems
      Select the correct answer using the code below:
      
   1. 1, 3 and 4 only   (b) 1 and 2 only   (c) 2 and 3 only   (d) 1, 2, 3 and 4
      Answer: (a). The RBI formulates monetary policy, manages foreign exchange and regulates payment systems. Regulation of stock exchanges is the function of SEBI, not the RBI.
2. Which statement about the Monetary Policy Committee (MPC) is correct?
   1. It is a seven‑member committee headed by the Finance Minister.
      
   2. It meets quarterly and decisions are taken unanimously.
      
   3. It consists of six members, and the RBI Governor has a casting vote in case of a tie.
      
   4. Its decisions are advisory and not binding on the RBI.
      Answer: (c). The MPC has six members; the RBI Governor chairs it and has a casting vote.
3. Which of the following statements is/are true about the Liquidity Adjustment Facility (LAF)?
   1. It allows banks to borrow money overnight against government securities.
      
   2. The Standing Deposit Facility (SDF) is part of the LAF corridor.
      
   3. Open Market Operations are the principal instrument of the LAF.
      Select the correct answer using the code below:
      
   1. 1 and 2 only   (b) 2 and 3 only   (c) 1 and 3 only   (d) 1, 2 and 3
      Answer: (a). The LAF comprises overnight repo (borrowing) and SDF (deposit) operations; open market operations are a separate tool used alongside the LAF, not a component of it.
4. Which of the following are considered priority sectors under RBI’s Priority Sector Lending Directions, 2025?
   1. Agriculture and allied activities
      
   2. Renewable energy projects
      
   3. Micro, small and medium enterprises (MSMEs)
      
   4. Tourism and hospitality
      Select the correct answer using the code below:
      
   1. 1 and 3 only   (b) 1, 2 and 3 only   (c) 2, 3 and 4 only   (d) 1, 2, 3 and 4
      Answer: (b). The priority sectors include agriculture, MSMEs and renewable energy among others; tourism and hospitality are not explicitly listed.

Frequently Asked Questions (FAQs)

Why is the Reserve Bank of India considered the banker to the government?

The RBI acts as the banker, agent and debt manager to the central and state governments. It maintains their accounts, facilitates the receipt and payment of money, manages government debt issuances and advises on fiscal matters. It also manages ways‑and‑means advances to bridge temporary mismatches in government cash flows. This arrangement ensures efficient management of public funds and a unified debt market.

How does the RBI’s Monetary Policy Committee differ from the Federal Reserve’s Federal Open Market Committee (FOMC)?

While both bodies set monetary policy, the MPC comprises six members with three external experts appointed by the government; decisions are by majority with minutes published. The FOMC consists of twelve voting members (seven Board governors and five regional Reserve Bank presidents) and meets eight times a year. Unlike the FOMC, India’s inflation target is set jointly by the government and the RBI and is legally binding.

What is the Standing Deposit Facility (SDF) and why was it introduced?

The SDF, introduced in April 2022, allows banks to park excess liquidity with the RBI without providing collateral. It replaced the reverse repo rate as the floor of the Liquidity Adjustment Facility (LAF) corridor. The facility enables the RBI to absorb surplus liquidity more flexibly and at a rate lower than the repo rate, thereby strengthening the monetary transmission mechanism.

How does the Udyam Assist Platform help informal enterprises?

Many informal micro enterprises lack PAN or GSTIN numbers and cannot register on the Udyam portal. The Udyam Assist Platform (UAP), managed by SIDBI, allows such enterprises to obtain an Udyam Assist Certificate with the help of RBI‑regulated entities. The certificate classifies them as micro enterprises for the purpose of priority sector lending. This mechanism broadens the formal credit base and supports financial inclusion.

What is the significance of the Financial Inclusion Index (FI‑Index)?

The FI‑Index measures the extent of financial inclusion by tracking access, usage and quality of financial services across the country. An FI‑Index of 67.0 in March 2025 indicates sustained progress in financial inclusion initiatives. The index helps policymakers identify gaps and monitor the impact of schemes like Jan Dhan, digital payments, micro‑finance and financial literacy programmes.