New RBI Governor Appointed; What Role Does the Central Bank Play in Our Lives?

December 10, 2024

The outgoing Union Revenue Secretary, Sanjay Malhotra, has been appointed as the next Governor of the Reserve Bank of India (RBI), set to take office on Dec. 11 for a three-year term. To explain the importance and relevance of the country’s central bank, the following describes its role in our lives.

First, here’s a brief on Mr. Malhotra: He holds a degree in Computer Science from the Indian Institute of Technology (IIT) Kanpur and a Master’s in Public Policy from Princeton University in the U.S. More importantly, we must understand the RBI and its functions to be able to evaluate any RBI governor’s tenure effectively.

The RBI is like the country’s financial manager, responsible for keeping the economy stable and ensuring that the Indian currency remains trustworthy. It regulates how banks operate to protect depositors, controls the amount of money flowing in the economy to manage prices and inflation, and oversees the exchange of the rupee with other currencies to facilitate international trade and maintain its value.

The RBI governor is appointed by the Government of India, specifically through the Prime Minister’s Office, on the recommendation of the Finance Ministry. However, the governor does not directly report to the Finance Ministry. Instead, the RBI operates with a degree of autonomy to ensure that its monetary policy decisions are made based on economic indicators and analysis rather than political pressures.

The RBI is mandated to operate independently within the framework set by the RBI Act of 1934, which insulates the central bank from immediate political pressures and thereby enable it to make decisions that are in the best long-term interests of the economy.

The RBI also has a Board, its highest governing body overseeing its operations and policy framework. Composed of the RBI governor, four deputy governors, government officials from the Ministry of Finance, 10 nominated directors from various fields, and one member from each of the local boards in Mumbai, Kolkata, Chennai and New Delhi, the Board ensures the RBI adheres to its regulatory responsibilities, approves its budget, and formulates policy guidelines for the financial system.

However, Section 7 of the RBI Act allows the central government to give directions to the RBI in the public interest, after consultation with the RBI governor. This section serves as a mechanism for the government to exert authority over the RBI if deemed necessary under extraordinary circumstances. This provision has been considered a tool of last resort and is meant to be used when there is a significant disagreement between the RBI and the government on policy matters that could not be resolved through regular consultations.

While the RBI’s responsibilities are macroeconomic in nature, they have direct and indirect impacts on our daily lives.

Do you remember the 2016 demonetisation of 500 and 1,000 rupee banknotes? An investigative report by The Indian Express, citing minutes from an urgent RBI board meeting held on Nov. 8, 2016, revealed that the board warned of short-term adverse effects of demonetisation and disagreed with the government’s rationale that it would eliminate black money and counterfeit notes—the reasons the government claimed were its primary objectives.

Beyond such drastic decisions, the RBI’s core responsibilities also influence our everyday lives.

For instance, when the RBI decides to lower interest rates, it means lower monthly payments on new loans for homes, cars, or lower costs for businesses wanting to expand. On the flip side, when the bank raises rates, while loans might get pricier, savings rates might improve, meaning people earn more on their deposits.

The RBI also ensures that there are enough bank notes in circulation for everyday transactions. This management helps prevent the chaos of cash shortages and fights against fake currency notes, which can disrupt the economy.

The regulation of banks is perhaps one of the RBI’s most direct connections to the average citizen. The RBI sets rules that banks need to follow, which ensures that these institutions are stable and that people’s money is safe. This oversight helps prevent situations where banks might otherwise take on too much risk and potentially fail, risking the deposits of millions of people.

Another significant area is the management of India’s foreign exchange. The RBI’s policies help stabilise the value of the Indian rupee against other currencies. This stability is crucial for anyone buying goods from abroad or traveling overseas, as it affects how much they pay for foreign products and services. For instance, a stable rupee makes it more affordable for families to plan vacations abroad or for students studying overseas.

The RBI also plays a role in making sure that even people in the most remote areas have access to banking services, thereby helping to improve economic stability and increase access to opportunities in those areas.