RBI, The history of Reserve Bank of India. A brief analysis of its history from nothing to everything.

Reserve Bank of India- The Birth Of Paper Currency

 The Reserve Bank of India was established under Act 2 of 1934 for the purpose of 

  (i) regulating the issue of bank notes,

 (ii) keeping of reserves with a view to securing monetary stability in the country and

 (iii) operating the currency and credit system of the country to its advantage. 

The role of a central bank such as the Reserve Bank in an economy is to manage 

(i) the currency 

(ii) the money supply and 

(iii) interest rates. 

The unique feature of a central bank is the monopoly that it has on increasing the monetary base in the state and the control it has in the printing of the national currency. The central bank virtually functions as “a lender of last resort” to banks suffering a liquidity crisis.

Historians trace the rise of modern central banks to the establishment of the Bank of England under a Royal Charter granted on 27-07-1694 through the Tunnage Act, 1694. The establishment of this bank in 1694 was not actually for stimulating the economy but for financing the war that England had with France. The currency crisis of 1797 and the creation of a ratio between the gold reserves held by the Bank of England and the notes that the bank could issue, under the Bank Charter Act, 1844 brought huge changes in the way the central bank was supposed to function.

In so far as India is concerned, the functions of a central bank were originally conferred upon the Imperial Bank of India, established in the year 1921, under the Imperial Bank of India Act, 1920. The reason why and the manner in which the Imperial Bank was established, is quite interesting to see. At the time when the British Crown took over the control of the territories in India, after the Sepoy Mutiny of 1857, there were three Presidency Banks, one in Calcutta, another in Bombay and the third in Madras. All these three banks established respectively in 1809, 1840 and 1843, were authorized to issue notes up to certain specified limits. But this privilege was withdrawn in 1862 under the Paper Currency Act, which vested the sole right to issue notes with the Government of India.

The question of absorption of the three Presidency Banks into a central bank came up for consideration on and off. Though the Chamberlain Commission, known as the Royal Commission on Indian Finance and Currency, appointed in 1913, felt the need for setting up a central bank, the proposal did not materialize. But after the First World War, the Presidency Banks themselves favored an amalgamation. Therefore, the Imperial Bank of India Bill providing for the amalgamation of all the three Presidency Banks was passed in September 1920 and came into effect in January 1921. The trend of setting up central banks gained momentum internationally, after the International Financial Conferences held at Brussels in 1920 and at Genoa in 1922.

But the maintenance of an overvalued exchange rate to help British exporters, gave rise to a clash between the colonial administration and Indian business interests. The Congress sought devaluation and hence a Royal Commission was set up in 1925 to examine the matter. This Royal Commission on Indian Currency and Finance, also known as Hilton Young Commission (to which Dr. B. R. Ambedkar also contributed a statement), recommended the creation of a strong Central Bank for India in 1926. Though a bill known as the Gold Standard and Reserve Bank of India Bill, 1927 to give effect to the recommendations was introduced in the Legislative Assembly, it was withdrawn on 10-02-1928. From 1930 onwards, the question of establishing a Reserve Bank received fresh impetus, when Constitutional reforms for the country were undertaken. 

The White Paper on Indian Constitutional Reforms, presented in March 1933, assumed that a Reserve Bank, free from political influence, would have to be set up and should already be successfully operating before the first Federal Ministry was installed.

Subsequently, a Departmental Committee was appointed in London by the India Office, which submitted a report dated 14-03-1933. This report was followed up by the appointment of the “London Committee”, which endorsed the India Office Committee’s view that the Reserve Bank should be free from any political influence.

It may be observed from the newly substituted paragraphs that

RBI is now vested with the obligation to operate the monetary policy framework in India.

 An indication of the primary objective of the monetary policy is provided in paragraph 3 which says that the maintenance of price stability is the prime objective even while the objective of growth is to be kept in mind. Paragraph 2 recognizes the necessity to have a modern monetary policy framework to meet the challenge of an increasingly complex economy.

Therefore, it is clear that after the amendment under Act 28 of 2016, the very task of operating the monetary policy framework has been conferred exclusively upon RBI.

Therefore, a Bill drafted on the basis of the recommendations of the London Committee was introduced in September 1933. In 1934, the Bill was passed. The Reserve Bank of India commenced operations as the country’s central bank on 01-04-1935. Under the Reserve Bank (Transfer of Public Ownership) Act, 1948, the bank was nationalized.

Once the historical background of the creation of RBI is understood, it will be easy to appreciate its role in the economy of the country and the functions and powers exercised by it statutorily.

As the Preamble of the RBI Act suggests, the object of constitution of RBI was threefold namely 

(i) regulating the issue of bank notes 

(ii) keeping of reserves with a view to securing monetary stability in the country and 

(iii) operating the currency and credit system of the country to its advantage.

In fact, the original Preamble of the Act contained only three paragraphs. But paragraphs 2 and 3 of the Preamble were substituted with 3 new paragraphs by Act 28 of 2016. Paragraphs 2 and 3 of the original Preamble and paragraphs 2 to 4 substituted in 2016

It may be observed from the newly substituted paragraphs that RBI is now vested with the obligation to operate the monetary policy framework in India. An indication of the primary objective of the monetary policy is provided in paragraph 3 which says that the maintenance of price stability is the prime objective even while the objective of growth is to be kept in mind. Paragraph 2 recognizes the necessity to have a modern monetary policy framework to meet the challenge of an increasingly complex economy.

 Therefore, it is clear that after the amendment under Act 28 of 2016, the very task of operating the monetary policy framework has been conferred exclusively upon RBI.

Bishwa Kumar Jain #B com (h). L.L.B. DIP Cyber Law. Member International Arbitration U.K. Practice Advocate Supreme Court and High Court of Delhi.

                                                                       

 Adv Bishwa Kumar Jain