Banking law avi

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[BANKING LAW] November 6, 2016

INDORE INSTITUTE OF LAW(Affiliated to D.A.V.V. & Bar Council of India)

B.A.LL.B. (HONS)Project on

(Subject)_______________________________

Topic: 01_______________________________

Submitted to:

Asst. Prof._____________________________

Submitted by: Name ____________________Signature______

Year _____ Semester ______

Date-:___/___/__

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DECLARATION

I , Avinash Rai student of B.A.LLB.(H) 7THsem studying at INDORE INSTITUTE OF LAW declare that the project work entitled “ was carried by me on my own research .”

This project was undertaken as a part of academic curriculum according to the university rules and regulations and it has no commercial interest and motive, it is my original work. It is not submitted to any other organization for any other purpose.

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CERTIFICATE

THIS IS TO CERTIFY THAT AVINASH RAI HAS SUCESSFULLY COMPLETED THE PROJECT WORK

TITLED “ACTIONABLE CLAIM”

IN PARTIAL FULFILLMENT OF REQUIREMENTS FOR THE KNOWLEDGE OF

______________________PRESCRIBED BY INDORE INSTITUTE OF LAW.

THIS PROJECT IS THE RECORD OF AUTHENTIC WORK CARRIED OUT DURING THE ACADEMIC

YEAR 2016-2017

Teacher's signature....................

DATE...................

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Table of content

1. Introduction 6

2. Origin of RBI. 7

3. Brief History of RBI. 8-10

4. Evolution of Reserve Bank of India 11

5. Function of RBI. 12-14

6. Structure of RBI. 15

7. Development of RBI. 17-19

8. Conclusion. 22

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Acknowledgement

A research work of such great scope and precision could never have been possible without great

co-operation from all sides. Contributions of various people have resulted in this effort. Firstly, I

would like to thank God for the knowledge he has bestowed upon us.

I would also like to take this opportunity to thank Asst. Prof. .............................. without whose

valuable support and guidance, this project would have been impossible. Also, I would like to

extend sincere gratitude to my parents, who guided me at every point during the research of this

project. I would also like to thank the library staff for having put up with my persistent queries

and having helped me out with the voluminous materials needed for this work. I would also like

to thank my seniors for having guided me and culminate this acknowledgement by thanking my

friends for having kept the flame of competition burning, which spurred me on through these

days.

And finally my parents, who have been a support to us throughout my life and have helped me, guided me to perform my best in all interests of our life, my grandparents who have always inculcated the best of their qualities in me.

Avinash Rai

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INTRODUCTION

The Reserve Bank of India is India's central banking institution, which controls the monetary policy of the Indian rupee. It commenced its operations on 1 April 1935 during the British Rule in accordance with the provisions of the Reserve Bank of India Act, 1934. The original share capital was divided into shares of 100 each fully paid, which were initially owned entirely by private shareholders. Following India's independence on 15 August 1947, the RBI was nationalized on 1 January 1949. The RBI plays an important part in the Development Strategy of the Government of India. It is a member bank of the Asian Clearing Union. The general superintendence and direction of the RBI is entrusted with the 21-member Central Board of Directors: the Governor, 4 Deputy Governors, 2 Finance Ministry representatives, 10 government-nominated directors to represent important elements from India's economy, and 4 directors to represent local boards headquartered at Mumbai, Kolkata, Chennai and New Delhi. Each of these local boards consists of 5 members who represent regional interests, and the interests of co-operative and indigenous banks.

1935 - 1950

The Reserve Bank of India was founded on 1 April 1935 to respond to economic troubles after the First World War. The Reserve Bank of India was conceptualized based on the guidelines presented by the Central Legislative Assembly passed these guidelines as the RBI Act 1934. RBI was conceptualized as per the guidelines, working style and outlook presented by Dr B R Ambedkar in his book. The bank was set up based on the recommendations of the 1926 Royal Commission on Indian Currency and Finance, also known as the Hilton–Young Commission. The original choice for the seal of RBI was The East India Company Double Mohur, with the sketch of the Lion and Palm Tree. However it was decided to replace the lion with the tiger, the national animal of India. The Preamble of the RBI describes its basic functions to regulate the issue of bank notes, keep reserves to secure monetary stability in India, and generally to operate the currency and credit system in the best interests of the country.

1950 - 1960

In the 1950s, the Indian government, under its first Prime Minister Jawaharlal Nehru, developed a centrally planned economic policy that focused on the agricultural sector. The administration nationalized commercial banks and established, based on the Banking Companies Act of 1949 (later called the Banking Regulation Act), a central bank regulation as part of the RBI. Furthermore, the central bank was ordered to support economic plan with loans.

1960 - 1969

As a result of bank crashes, the RBI was requested to establish and monitor a deposit insurance system. It should restore the trust in the national bank system and was initialized on 7 December 1961. The Indian government found funds to promote the economy and used the slogan "Developing Banking". The government of India restructured the national bank market and nationalized a lot of institutes. As a result, the RBI had to play the central part of control and support of this public banking sector.

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Origin of RBIThe genesis of Reserve Bank of India (RBI) started in 1926 when the Hilton-Young Commission or the Royal Commission on Indian Currency and Finance made recommendation to the British Government of India for creation of a central bank. The chief objective of such recommendation were two fold

1. To separate the control of currency and credit from the government.

2. To augment banking facilities throughout the country.

To give effect to above recommendations a bill was introduced in Legislative Assembly in 1927 but this bill was withdrawn because various sections of the people were not in agreement. The recommendation to create a reserve bank was made by White Paper on Indian Constitutional Reforms. Thus a fresh bill was introduced and was enacted in 1935. Thus, Reserve Bank of India was established the RBI Act of 1934 as the banker to the central government. RBI launched its operations from April 1, 1935. Its headquarters were in Kolkata in the beginning, but it was shifted to Shahid Bhagat Singh Marg, Mumbai in 1937. Prior to establishment of RBI, the functions of a central bank were virtually being done by the Imperial Bank of India, which was established in 1921 by merging three Presidency banks. It was mainly a commercial bank but also served as banker to the government to some extent. It’s worth note that RBI started as a privately owned bank. It started with a Share Capital of Rs. 5 Crore, divided into shares of Rs. 100 each fully paid up. In the beginning, this entire capital was owned by private shareholders. Out of this Rs. 5 Crore, the amount of Rs. 4,97,8000 was subscribed by the private shareholders while Rs. 2,20,000 was subscribed by central government. After independence, the government passed Reserve Bank (Transfer to Public Ownership) Act, 1948 and took over RBI from private shareholders after paying appropriate compensation. Thus, nationalisation of RBI took place in 1949 and from January 1, 1949, RBI started working as a government owned central bank of India.1

1 gktoday.in

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Brief HistoryThe Reserve Bank of India is the central bank of the country. Central banks are a relatively recent innovation and most central banks, as we know them today were established around the early twentieth century. The Reserve Bank of India was set up on the basis of the recommendations of the Hilton Young Commission. The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank which commenced operations on April 1, 1935. The Bank began its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India, the management of Government accounts and public debt. The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Cawnpore (Kanpur) became branches of the Issue Department. Offices of the Banking Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon.

Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank continued to act as the Central Bank for Burma till Japanese Occupation of Burma and later up to April, 1947. After the partition of India, the Reserve Bank served as the central bank of Pakistan up to June 1948 when the State Bank of Pakistan commenced operations. The Bank, which was originally set up as a shareholder's bank, was nationalized in 1949.

An interesting feature of the Reserve Bank of India was that at its very inception, the Bank was seen as playing a special role in the context of development, especially Agriculture. When India commenced its plan endeavors, the development role of the Bank came into focus, especially in the sixties when the Reserve Bank, in many ways, pioneered the concept and practice of using finance to catalyze development. The Bank was also instrumental in institutional development and helped set up institutions like the Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India, the Industrial Development Bank of India, the National Bank of Agriculture and Rural Development, the Discount and Finance House of India etc. to build the financial infrastructure of the country. With liberalization, the Bank's focus has shifted back to core central banking functions like Monetary Policy, Bank Supervision and Regulation, and Overseeing the Payments System and onto developing the financial markets.

In India, the efforts to establish a banking institution with central banking character dates back to the late 18th century. The Governor of Bengal in British India recommended the establishment of a General Bank in Bengal and Bihar. The Bank was set up in 1773 but it was short-lived. It was in the early 20th century that, consequent to the recommendations of the Chamberlain Commission (1914) proposing the amalgamation of the three Presidency Banks, the Imperial Bank of India was formed in 1921 to additionally carry out the functions of central banking along with commercial banking. In 1926, the Royal Commission on Indian Currency and Finance (Hilton Young Commission) recommended that the dichotomy of functions and divisions of responsibilities for control of currency and credit should be ended. The Commission suggested the establishment of a central bank to be called the Reserve Bank of India, whose separate existence was considered necessary for augmenting banking facilities throughout the country. The Bill to establish the RBI was introduced in January 1927 in the Legislative Assembly, but it was dropped due to differences in views regarding ownership, constitution and composition of its Board of Directors. Finally, a fresh Bill was introduced in 1933 and passed in

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1934. The RBI Act came into force on January 1, 1935. The RBI was inaugurated on April 1, 1935 as a shareholders’ institution and the Act provided for the appointment by the Central Government of the Governor and two Deputy Governors. The RBI was nationalized on January 1, 1949 in terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).

The main functions of the RBI, as laid down in the statutes are - a) issue of currency, b) banker to Government, including the function of debt management, and c) banker to other banks. The Preamble to the RBI Act laid out the objectives as “to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.” Unusually, and unlike most central banks the RBI was specifically entrusted with an important promotional role since its inception to finance agricultural operations and marketing of crops. In fact, the Agricultural Credit Department was created simultaneously with the establishment of the RBI in 1935.

The RBI, as a central bank, has always performed the function of maintaining the external value of the rupee. Historically, the rupee was linked with pound sterling, which continued even after the establishment of the RBI. It was only in late September 1975 that the rupee was delinked from pound sterling and the value was determined with reference to a basket of currencies until 1991. The exchange rate regime, soon thereafter, transited from a basketlinked managed float to a market-based system in March 1993, after a short experiment with a dual exchange rate regime between March 1992 and February 1993. Prior to the Second World War, India was a net debtor country and the British introduced exchange controls to conserve foreign exchange. Exchange Control was introduced in India on September 3, 1939 on the outbreak of the Second World War by virtue of the emergency powers derived under the financial provisions of the Defence of India Rules, mainly to conserve the nonsterling area currencies and utilize them for essential purposes. Even after the War, the controls continued mainly to ensure the most prudent use of the foreign exchange resources. However, the vast accumulation of sterling balances during the Second World War provided an opportunity for repatriation of the sterling debt, an initiative which came at the behest of the RBI.

The RBI’s responsibility as bankers’ bank was essentially two-fold. First, it acted as a source of reserves to the banking system and served as the lender of last resort in an emergency. The second, and more important responsibility, was to ensure that the banks were established and run on sound lines with the emphasis on protection of depositors’ interest. A banking crisis in 1913 revealed major weaknesses in the banking system, such as, maintenance of low reserves and large volumes of unsecured advances. Thus, regulation of the banking system was considered essential to maintain stability in the economy.2

2 rbi.org.in

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Some points related to the RBI In 1926, the Royal Commission on Indian Currency and Finance recommended creation

of a central bank for India.

In 1927, a bill to give effect to the above recommendation was introduced in the Legislative Assembly, but was later withdrawn due to lack of agreement among various sections of people.

In 1933, the White Paper on Indian Constitutional Reforms recommended the creation of a Reserve Bank. A fresh bill was introduced in the Legislative Assembly.

In 1934, the Bill was passed and received the Governor General’s assent

In 1935, Reserve Bank commenced operations as India’s central bank on April 1 as a private shareholders’ bank.

In 1942 Reserve Bank ceased to be the currency issuing authority of Burma (now Myanmar)

In 1947, Reserve Bank stopped acting as banker to the Government of Burma

In 1948, Reserve Bank stopped rendering central banking services to Pakistan.

In 1949, the Government of India nationalized the Reserve Bank under the Reserve Bank (Transfer of Public Ownership) Act, 1948.

In 1949, Banking Regulation Act was enacted.3

3 gktodya.in

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RESERVE BANK OF INDIA, EVOLUTION

RESERVE BANK OF INDIA, EVOLUTION OF The shape of the Reserve Bank of India (RBI) which was set up in 1935 during British rule, was influenced by two different attitudes, though with agreement that it should be independent of government. The British rulers were swayed by the prevailing monetary orthodoxy, of keeping the functions of raising and using money separate from that of creating money, while the nationalists wanted independence for the RBI in order to insulate it from the interference of the alien power. Despite this general agreement, the act establishing the RBI was so drafted that it left several gray areas for interpretation of the RBI-government relationship. As a result, the executive started, from the beginning, to encroach on the autonomy of the RBI, as evidenced by the finance member of the government of India selecting the composition of the RBI Board, and also by a virtual dismissal of its first governor, Sir Osborne Smith, on the ostensible grounds of disagreement on the issue of fixing the bank rate. During World War II, the authority of the RBI was further clipped in regard to its monetary policy, when it was forced to pursue a government-initiated low interest rate policy to keep the cost of financing the war low and to expand money supply through accumulation of sterling balances.4

RBI's monetary policy domain shriveled rapidly when planning dominated India's overall economic policy. Since 1951, the government aimed at a mixture of public and private sectors, but much greater weight was assigned to the former. This had serious consequences for the RBI's functioning, organization, and the use of its policy instruments. Its main policy instruments, such as open market operations, and cash reserve and statutory liquid assets ratios, took the character of fiscal instruments directed more toward raising resources for the government than facilitating the financing of private sector investment the main area for the exercise of monetary policy. Even more significantly, the RBI was obliged to extend credit to government, which fueled inflationary pressures in the economy. In the area of bank supervision and inspection, the RBI's record was marred by government decree. In the beginning, the RBI discharged its prudential control policies efficiently, but with the advent of Indian official intervention, this function was increasingly politicized. In the case of Palai Central Bank of Kerala State, where the government disregarded the RBI's advice, a serious banking crisis emerged a few years later. The RBI's prudential responsibilities were further downgraded in 1969 when banks were nationalized, the government of India assuming more direct and tighter control of banks.5

After a brief interlude of relative autonomy experienced after independence in 1947, the RBI's monetary policy domain shriveled rapidly when planning dominated India's overall economic policy. Since 1951, the government aimed at a mixture of public and private sectors, but much greater weight was assigned to the former. This had serious consequences for the RBI's functioning, organization, and the use of its policy instruments. Its main policy instruments, such as open market operations, and cash reserve and statutory liquid assets ratios, took the character of fiscal instruments directed more toward raising resources for the government than facilitating the financing of private sector investment the main area for the exercise of monetary policy. Even more significantly, the RBI was obliged to extend credit to government, which fueled inflationary pressures in the economy.

4 worldhistory.biz5 encyclopedia.com

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Major functions of the RBI are as follows

Issue of Bank Notes Banker to Government Custodian of Cash Reserves of Commercial Banks Custodian of Country's Foreign Currency Reserves Lender of Last Resort Central Clearance and Accounts Settlement Controller of Credit

Issue of Bank Notes: The Reserve Bank of India has the sole right to issue currency notes except one rupee notes which are issued by the Ministry of Finance. Currency notes issued by the Reserve Bank are declared unlimited legal tender throughout the country. This concentration of notes issue function with the Reserve Bank has a number of advantages: (i) it brings uniformity in notes issue (ii) it makes possible effective state supervision (iii) it is easier to control and regulate credit in accordance with the requirements in the economy (iv) it keeps faith of the public in the paper currency.

Banker to Government: As banker to the government the Reserve Bank manages the banking needs of the government. It has to-maintain and operate the government’s deposit accounts. It collects receipts of funds and makes payments on behalf of the government.

Custodian of Cash Reserves of Commercial Banks: The commercial banks hold deposits in the Reserve Bank and the latter has the custody of the cash reserves of the commercial banks.

Custodian of Country’s Foreign Currency Reserves: The Reserve Bank has the custody of the country’s reserves of international currency and this enables the Reserve Bank to deal with crisis connected with adverse balance of payments position.Lender of Last Resort: The commercial banks approach the Reserve Bank in times of emergency to tide over financial difficulties and the Reserve bank comes to their rescue though it might charge a higher rate of interest. Central Clearance and Accounts Settlement: Since commercial banks have their surplus cash reserves deposited in the Reserve Bank it is easier to deal with each other and settle

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the claim of each on the other through book keeping entries in the books of the Reserve Bank. The clearing of accounts has now become an essential function of the Reserve Bank.Controller of Credit: Since credit money forms the most important part of supply of money and since the supply of money has important implications for economic stability the importance of control of credit becomes obvious. Credit is controlled by the Reserve Bank in accordance with the economic priorities of the government.The Reserve Bank of India was established in the year 1935 in accordance with the Reserve Bank of India Act, 1934. The Reserve Bank of India is the central Bank of India entrusted with the multidimensional role. It performs important monetary functions from issue of currency note to maintenance of monetary stability in the country. Initially the Reserve Bank of India was a private share holder’s company which was nationalized in 1949. Its affairs are governed by the Central Board of Directors appointed by the Government of India. Since its inception the Reserve Bank of India had played an important role in the economic development and monetary stability in the country.

The Royal Commission on Indian Currency and Finance appointed on August 25, 1925 has suggested the establishment of the Central Bank in India, later the Indian Central Banking Enquiry Committee, 1931 stressed the establishment of the Central Bank in India. The Reserve of Bank was established on April 1, 1935 under the Reserve Bank of India Act, 1934. “to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency any credit system of the country to advantage.

The Reserve Bank of India was established as a private share holder’s bank. The Central office of Reserve Bank of India was initially located in Calcutta which was later shifted to Bombay. The Reserve Bank of India issued first of its currency notes in January 1938 in denomination of Rs.5 and Rs.10 and later in the same year denomination of Rs.100, Rs.1000 and Rs.10000 were issued

Post Independence

The Reserve Bank of India was nationalized in the year 1949 through the Reserve Bank (Transfer of Public Ownership) Act, i948 and all shares were transferred to Central Government. The Reserve bank of India is constituted for the management of currency and for carrying the business of banking in accordance with provisions of the Act. It is a body corporate having perpetual succession, common seal and can be sued or sue in its name. The general supervision and direction of the affairs of the Reserve Bank is entrusted with Central Board of Directors.

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Composition of Central Board

The Central Board consists of Governor, deputy Governor, Ten Director nominated by the Central Government and two Government official nominated by the Central Government. The deputy Governor and Director are eligible to attend meeting of the Central Board but are not entitled to vote. The Governor and deputy Governor hold office for term of five years and are entitled for a re-appointment. The Directors are appointed for a term of four and hold office during the pleasure of the president. The meeting of the Central Board is convened at least six times in a year.

Composition of Local Board

A local board is formed in each four zones consisting of five members which are appointed by the Central Government. There is Chairperson of the Board who is elected among the member. The members of the Board have a hold office for a term of four years and eligible for reappointment. The Local Board advice on matters referred to it by the Central Board and performs duties delegated to it by the Central Board.

Banker to Government

The Reserve Bank of India accepts and makes payment on behalf of Central Government. It carries out its exchange, remittance, management of public debt and other banking function of the Central Government. The Central Government entrusts its money, remittance, exchange and banking transactions in India with the Reserve Bank of India. It deals in repo or reverse repo.

Formulates Banking policy

The Reserve is empowered to formulate banking policy in the interest of the public or depositors banking policy in relation to advances and provide direction on the purpose of the advances margins to be maintained in a secured advances, the maximum amount of advance may be made the rate of interest, terms and conditions for advances or guarantees may be given.6

6 Finance and basics

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STRUCTURE OF RBI

1. Central board of director

One governor Four deputy governor Four non official director (which is nominated by central government ) Ten non official director (nominated by RBI) ONE representative of central government

2. Committee of central board

3. Board of financial supervision

4. Board of payment and settlement system

5. Subcommittees of central board

6. Local board

IMPORTANT POINTS

It was nationalized on 1 January 1949.

It is headquarter in Mumbai .

It is 19 regional office.

Its print currency in 15 language.

It is the member bank of asian clearing union (acu) and international monetary fund (imf).

The governor of RBI Raghuram Rajan and 4 deputy governor HR Khan, Dr Urjit Patel , R Gandhi, SS Mundra .

RBI does not pay interest on government deposits

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Back to the Basics of Central BankingThe economic context in which the RBI functioned was radically transformed in 1991, when economic rationality was given precedence over ideology and politics. The private sector was liberalized from the straight jacket of industrial licensing, trade barriers were lowered, the foreign exchange control regime was gradually transformed into a market-oriented foreign exchange management system and, most important, the financial sector was liberalized from the earlier restrictive regime, which had substantially erased the distinction between the monetary policy of the RBI and the fiscal policy of the government. Those economic and financial reforms gave primacy to markets, incentives, and prices, thereby creating ideal conditions so essential for the unhampered exercise of the RBI's monetary policy instruments. The RBI's freedom to exercise its policies was facilitated by two important developments. First, India liberalized its current balance of payment account, almost totally by 1995, and followed that up by selectively eliminating some restrictions on the capital balance of payments account. This led to a large movement of capital across India's borders, requiring the RBI to remain alert to both the exchange rate and interest rate movements, since both of these affected capital flows. The second development was the deregulation of domestic interest rates, thereby giving greater leverage to the RBI to influence them through its various policy instruments.

The RBI regulates the cost and availability of aggregate money by controlling the determinants of reserve money, that is, currency in circulation and banks' cash on hand and bank deposits held with the RBI. The determinants of reserve money are net bank credit to the government and to banks, and its holding of net foreign exchange assets. Prior to 1991, the RBI regulated reserve money by changing the quantity of its credit to government and banks, and varying its cash reserve requirements ratio, but currently, the RBI relies more on open market operations, that is,

the purchase and sale of government securities held by it, varying its lending rates on credit extended to banks as well as to the central and state governments. Since 1994 and 1995, a concordat was entered into between the RBI and the government of India under which automatic financing of government deficit by the RBI (called monetization) was capped. Only short-term credit to government was extended, which was required to be cleared at the end of the fiscal year. Any credit beyond the limit was treated as an overdraft, permissible for not more than ten consecutive days and on which interest rate was charged at bank rate plus two percentage points. This landmark decision has strengthened the RBI as a monetary authority. In regard to the net credit to banks, the RBI made its bank rate and other refinancing rates more effective. It instituted a Liquidity Adjustment Facility for banks for meeting temporary liquidity shortages, the rates on which were linked to the bank rate, thereby reviving the bank rate as a reference rate as in many central banks. The RBI's role in regulating net foreign exchange assets has become dominant. It now intervenes in the foreign exchange market by the purchase and sale of foreign exchange and offsets the impact of these transactions on money supply by countervailing sale and purchase of securities. During 1992 to 1993 and 1998 to 1999, when there was a large inflow of private capital in India, the RBI bought foreign exchange to maintain a stable exchange rate, but at the same time, it sold securities to absorb liquidity so as not to weaken its restrictive

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monetary policy. Though the RBI has moved in the right direction of greater independence and power in formulating its policies, it has considerable ground to cover.

DEVELOPMENT OF RBI

As in many developing countries, the central bank is seen as a key institution in bringing about development and growth in the economy. In the initial years of the RBI before independence, the banking network was thinly spread and segmented. Foreign banks served foreign firms, the British army and the civil service. Domestic/Indian banks were linked to domestic business groups and managing agencies, and primarily did business with their own groups. The coverage of institutional lending in rural areas was poor despite the cooperative movement. Overall financial intermediation was weak. In an agrarian economy, where more than three-fourth of the population lived in the rural areas and contributed more than half of GDP, a constant and natural concern was agricultural credit. Therefore, almost every few years a committee was constituted to examine the rural credit mechanism. There has perhaps been one committee every two or three years for over a hundred years.

A clear objective of the development role of the RBI was to raise the savings ratio to enable the higher investment necessary for growth, in the absence of efficient financial intermediation and of a well developed capital market. The view was that the poor were not capable of saving and, given the small proportion of the population that was well off, the only way to kick start the savings and investment process in the country was for government to perform both functions. Thus the RBI was seen to have a legitimate role to assist the government in starting up several specialized financial institutions in the agricultural and industrial sectors, and to widen the facilities for term finance and for facilitating the institutionalization of savings. A special need was felt for accelerating industrial investment, particularly with the launching of the Second Five Year Plan in 1956. Over time, various term lending industrial finance institutions were established with varying degrees of RBI involvement: the Industrial Finance Corporation of India (IFCI), State Financial Corporation's (SFCs), Industrial Development Bank of India (IDBI) and the Industrial Credit and Investment Corporation of India (ICICI).

The traditional concern with agricultural credit continued and the Agriculture Finance Corporation was established in 1963, followed by its transformation into the National Bank for Agriculture and Rural Development in

1982 for extending refinance for short, medium and long term finance for agriculture. The Unit Trust of India was established in 1964 to mobilize resources from the wider public and to provide an opportunity for retail investors to invest in the capital market, thereby also aiding capital market development. The National Housing Bank was set up in the late 1980s to develop housing finance and the Infrastructure Development Finance Company (IDFC) in the late 1990s for infrastructure finance. The Reserve Bank also actively promoted financial institutions to help in developing the Government securities market. The Discount and Finance House of India

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(DFHI) was set up in 1988; primary dealers were promoted in the late 1990s; and the Clearing Corporation of India was incorporated in 2001 to upgrade the financial infrastructure in respect of clearing and settlement of debt instruments and foreign exchange transactions. More recently, the Board for Regulation and Supervision of Payment and Settlement System has been constituted in 2005, and the Banking Codes and Standards Board of India in 2006 to develop a comprehensive code of conduct for fair treatment of bank customers. The RBI has been continuously involved in setting up or supporting these institutions with varying degrees of involvement, including equity contributions and extension of lines of credit.

Thus, the developmental role of the RBI has spanned all the decades since independence and is quite different from central banks in developed countries. Although the Reserve Bank was actively involved in setting up many of these institutions, the general practice has been to hive them off as they came of age, or if a perception arose of potential conflict of interest. There can be little doubt that the establishment of these institutions has helped financial development in the country greatly, even though some of them have been less than successful in their functioning. It can be argued, of course, that similar institutional development could have taken place through private sector efforts or by the Government. The availability of financial sector expertise in the Reserve Bank, however, was instrumental in these tasks being performed over time by the Reserve Bank.

Expansion of Banking In the initial years of the RBI, considerable progress was made in extending the banking system but there was continuing concern about the overall accessibility of banking to the needy. In terms of coverage, many rural and semi-urban areas were yet to be covered by banking services. The transformation of the Imperial Bank of India into the State Bank of India in July 1955 was mainly motivated by the desire to extend branches across the country to stimulate banking activity. It was in continuation of the same policy to serve the needs of the developing economy that 14 large banks were nationalized in 1969 followed by six more in 1980. The nationalization of banks, mainly attempted to align banking activities with national concerns and norms, as it was perceived that the private banks neither understood social responsibilities nor observed social obligations. The general inclination in the 1950s, 1960s and 1970s was essentially to get Government to become active in economic activities where it was felt that the private sector was not able or willing to perform actively. As a result of nationalization, the total number of branches rose from 8,262 in 1969 - to 60,220 in 1991 and those in rural areas from 1,833 to 35,206. The increased network of branches certainly led to a large expansion of rural credit. This dimension of nationalisation and expansion had its impact on the functioning and working of the RBI. Despite such vast expansion, it is interesting that we still have concern with financial inclusion today.

Development of the Payments System

The development of a payments system is one development role that is common to most central banks. It is well recognized that an efficient payment and settlement system is essential for a well

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functioning modern financial system. Therefore, in recent years, banks have been making efforts to upgrade payments and settlement systems utilizing the latest technology. One of the characteristic features of the Indian economy, historically, has been the widespread use of cash in the settlement of most financial transactions. While this has been the trend for several years, it is noteworthy that India had pioneered the use of non-cash based payment systems long ago, which had established themselves as strong instruments for the conduct of trade and business. The most important form of credit instrument that evolved in India was termed as ‘Hundis’ and their use was reportedly known since the twelfth century. Hundis were used as instruments of remittance, credit and trade transactions. In modern times, with the development of the banking system and higher turnover in the volume of cheques, the need for an organized cheque clearing system emerged. In India, clearing associations were formed in the Presidency towns in the nineteenth century and the final settlement between member banks was effected by means of cheques drawn on the Presidency Banks. With the setting up of the Imperial Bank in 1921, settlement was done through cheques drawn on that bank. After the establishment of the RBI in 1935, the Clearing Houses in the Presidency towns were taken over by the RBI, and continued for more than five decades. In recognition of the importance of payment and settlement systems, the RBI had taken upon itself the task of setting up a safe, efficient and robust payment and settlement system for the country for more than a decade now. In the recent past, the RBI has been placing emphasis on reforms in the area of payment and settlement system. It was with this objective that the Real Time Gross Settlement (RTGS) system was planned, which has been operationalised in March 2004. The system, once fully operational, in its present form, would take care of all inter-bank transactions and other features would be added soon.In view of the positive response to reforms in the financial sector and the banking segment also coming of age, the RBI has now taken the policy perspective of migrating away from the actual management of retail payment and settlement systems. Thus, for a few years now, the task of setting up new MICR based cheque processing centers has been delegated to the commercial banks. This approach has yielded good results and the RBI now envisions the normal processing functions to be managed and operated by professional organizations, which could be constituted through participation of commercial banks. This would be applicable to the clearing houses as well, which will perform the clearing activities, but the settlement function will continue to rest with the RBI. A beginning has been made in the form of the operations performed by the Clearing Corporation of India Ltd. for effecting the clearing processes related to money, government securities and foreign exchange markets. Under this arrangement, the RBI will continue to have regulatory oversight over such functions without actually acting as the service provider. The RTGS, which provide for funds transfers across participants in electronic mode with reduced risk, will continue to be operated by the RBI7.

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Relationship of the RBI with the Government

The RBI is a banker to the Central Government statutorily and to the State Governments by virtue of specific agreements with each of them. The loss of autonomy of the RBI that took place in early decades was not because of any conscious decision based on the currently prevalent thinking on the relationship between central banks and the Government, but rather as a consequence of overall economic policy then prevailing regarding the appropriate dominant role of the Government in the economy as a whole. Thus, it is useful to review the relationship of the Reserve Bank with the Government as it has evolved over time.

The Monetary Fiscal Interface

It is common for central banks in developing countries to act as debt managers of their respective governments. Central Banks have typically financed governments through monetisation as and when the need arose for expansionary fiscal policy which has been often in developing countries. War financing through monetization has also been the norm for developed countries. Such financing has normally had predictable inflationary consequences for the economy. The Indian experience has been no different and expansionary fiscal policy was indeed financed by resort to automatic monetization, accompanied by financial repression and effective loss of central bank autonomy with respect to monetary policy.

In 1951, with the onset of economic planning, the functions of the RBI became more diversified. As the central bank of a typical developing country emancipated from centuries old colonial rule, the RBI had to participate in the nation building process. Fiscal policy assumed the responsibility of triggering a process of economic growth through large public investment, facilitated by accommodative monetary and conducive debt management policies. The RBI played a crucial role in bridging the resource gap of the Government in plan financing by monetising government debt and maintaining interest rates at artificially low levels for government securities to reduce the cost of government borrowing.

The provisions of the Reserve Bank of India Act, 1934 authorizes the RBI to grant advances to the Government, repayable not later than three months from the date of advance. These advances, in principle, were to bridge the temporary mismatches in the Government’s receipt and expenditure and were mainly intended as tools for Government’s cash management. However, in practice, the tool of short-term financing became a permanent source of funds for the Government through automatic creation of ad hoc Treasury bills whenever Government’s balances with the RBI fell below the minimum stipulated balance. This automatic monetization led to the RBI’s loss of control over creation of reserve money. In addition, the RBI also created

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additional ad hoc Treasury bills whenever funds were required by the Government. As there was unbridled expansion of fiscal deficits and the Government was not in a position to redeem the ad hoc Treasury bills, the RBI was saddled with a large volume of these bills constituting a substantial component of monetized deficit. This process continued from the 1950s to the 1990s.

By the end of the 1980s a fiscal-monetary-inflation nexus was increasingly becoming evident whereby excessive monetary expansion on account of monetization of fiscal deficit fuelled inflation. The RBI endeavored to restrict the monetary impact of budgetary imbalances by raising the required reserve ratios to be maintained by banks. As the growth of pre-empted resources was inadequate to meet the Government’s requirement, it had to perforce borrow funds from outside the captive market through postal savings and provident funds, by offering substantial fiscal incentives and at administered low rates of interest. Thus, the economy was pushed into the throes of financial repression.

The logical question that follows is whether the experience of fiscal dominance over monetary policy would have been different if there had been separation of debt management from monetary management in India Or, were we served better with both the functions residing in the Reserve Bank. What has really happened is that there was a significant change in thinking regarding overall economic policy during the early 1990s, arguing for a reduced direct role of the Government in the economy. A conscious view emerged in favor of fiscal stabilization and reduction of fiscal deficits aimed at eliminating the dominance of fiscal policy over monetary policy through the prior practice of fiscal deficits being financed by automatic monetization. It is this overall economic policy transformation that has provided greater autonomy to monetary policy making in the 19908.

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CONCLUSON

The Reserve Bank of India was founded on 1 April 1935 to respond to economic troubles after the First World War. The Reserve Bank of India was conceptualized based on the guidelines presented by the Central Legislative Assembly passed these guidelines as the RBI Act 1934. RBI was conceptualized as per the guidelines, working style and outlook presented by Dr B R Ambedkar in his book. The bank was set up based on the recommendations of the 1926 Royal Commission on Indian Currency and Finance, also known as the Hilton–Young Commission. The original choice for the seal of RBI was The East India Company Double Mohur, with the sketch of the Lion and Palm Tree. However it was decided to replace the lion with the tiger, the national animal of India. The Preamble of the RBI describes its basic functions to regulate the issue of bank notes, keep reserves to secure monetary stability in India, and generally to operate the currency and credit system in the best interests of the country.

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BIBLIOGRAPHY AND WEBLIOGRAPHY

gktoday.in RBI.org.in worldhistory.biz encyclopedia.com yourarticlelibrary.com Finance and Basics

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Law

Banking law avi