RNase H2 of Saccharomyces cerevisiae consists of three essential subunits (Rnh201, Rnh202 and Rnh203) and plays a critical role in the removal of RNA incorporated in duplex DNA. In the present study, we purified individual subunits and heterodimeric subcomplexes to examine the assembly and biochemical function of subunits of RNase H2 in vitro. Reconstitution experiments revealed that Rnh202 and Rnh203 first form a subcomplex, followed by the recruitment of Rnh201 to complete complex formation. Rnh201 alone or in combination with Rnh203 showed neither substrate–binding, nor catalytic activity, indicating that both activities of Rnh201 are latent until it becomes an integral part of the complex. However, Rnh202 by itself showed substrate–binding activity. RNase H2 containing mutant Rnh202 defective in substrate binding had decreased substrate–binding activity, indicating that Rnh202 contributes directly to substrate binding. Reconstitution of RNase H2 complexes with various mutant subunits allowed us to assess the influence of conserved amino acid residues in either Rnh201 or Rnh202 on substrate–binding and catalytic activities. We found that the substrate–binding activities of both Rnh201 and Rnh202 were critical for cleavage of the phosphodiester bond present between DNA and RNA in RNase H2 substrates.