You are on page 1of 17

HISTORY OF

RESERVE BANK OF
INDIA
1935-1951

BY

SWATHY V KUMAR (HS09H037)


VIGNESHKUMAR S (HS09H038)
VIKASH GUNASEKAR (HS09H039)

Department of Humanities and Social Sciences


Indian Institute of Technology Madras, Chennai.
November,2009
Table of Contents
Introduction...............................................................................................................................4
Preamble....................................................................................................................................4
THE PREPARATORY YEARS....................................................................................................4
Plan of Warren Hastings........................................................................................................4
Robert Rickards’s Scheme......................................................................................................4
Hilton Young Commission Report.........................................................................................5
1927 Reserve Bank Bill...........................................................................................................5
1928 Reserve Bank Bill...........................................................................................................5
Reserve Bank Bill, 1933..........................................................................................................5
The Reserve Bank of India Act...............................................................................................6
Ownership of the Bank...........................................................................................................6
Dispersal of Ownership..........................................................................................................6
Government’s Powers.............................................................................................................6
Election of Directors through Local Boards...........................................................................6
The First Central and Local Boards........................................................................................6
Banker to Government...........................................................................................................7
Sole Right of Note Issue.........................................................................................................7
Bankers’ Bank.........................................................................................................................7
Instruments of Credit Control................................................................................................7
THE FORMATIVE YEARS: 1935-39..........................................................................................7
The Beginnings.......................................................................................................................7
Governor and Deputy Governors...........................................................................................8
Central Board of Directors.....................................................................................................8
Monetary Management -General Aspects..............................................................................8
Bank Rate Procedures and Policy...........................................................................................9
Exchange Management and Policy........................................................................................9
Emerging Role as a Bankers’ Bank.........................................................................................9
Reserve Bank and Non-Scheduled Banks............................................................................10
Growth of Joint-Stock Banking: 1935-38.............................................................................10
South Indian Banking Crisis.................................................................................................10
Banking Development in the Post-Crisis Period..................................................................10
Governors, Government, Board and Shareholders...............................................................11
Change of Deputy Governor..................................................................................................11
Annual Meetings of Shareholders.........................................................................................11
THE WAR YEARS: 1939-45.....................................................................................................12
Exchange Control Department.............................................................................................12
Expansion of the Banking Department................................................................................12
Bank's Functioning in Burma...............................................................................................12
The Pattern and Consequences of War Financing................................................................12
Budgetary Position of Government: General View...............................................................13
War-Time Central Banking Operations................................................................................13
Bank’s Monetary Policy Defined...........................................................................................13
Bank’s Open Market Operations...........................................................................................13
Treasury Bill Operations and Policies..................................................................................14
Participation in Post-War Currency Plans...........................................................................14
Bretton Woods Conference...................................................................................................14
THE POST-WAR YEARS: 1945-51...........................................................................................14
Department of Banking Development..................................................................................15
Nationalisation Of The Bank................................................................................................15
The Bank and The Partition..................................................................................................15
Termination Of Bank’s Role in Pakistan...............................................................................15
Termination Of Monetary Arrangements with Burma.........................................................15
Membership Of The I.M.F. And The I.B.R.D........................................................................15
Signing Of The Bretton Woods Agreements.........................................................................15
Epilogue................................................................................................................................16
Epilogue
RESERVE BANK OF INDIA: 1935 to 1951

Introduction

The 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 was constituted to

• Regulate the issue of banknotes


• Maintain reserves with a view to securing monetary stability and
• To operate the credit and currency system of the country to its advantage.

Preamble
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as:
"...to regulate the issue of Bank Notes and 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."
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.

THE PREPARATORY YEARS

Plan of Warren Hastings

The earliest reference that has been traced regarding an attempt to set up in India a bank which had
some characteristics of a central banking institution of today dates as far back as January 1773, when
Warren Hastings, Governor (later Governor-General) of Bengal, placed before the Board of Revenue
his ‘Plan’ for a ‘General Bank in Bengal and Bihar’; Bengal and Bihar, it may be mentioned, comprised,
at that time, the main British territory in India. The plan for the proposed bank was approved by the
Board, with some changes, and the bank was set up in April 1773, but it proved to be only a short-lived
experiment.

Robert Rickards’s Scheme

The next attempt in the direction of a central bank was made in 1807-08, when Mr. Robert Rickards, a
Member of the Bombay Government, submitted a scheme for a ‘General Bank’. The bank was
proposed more as a means to pay off, through it, the then large public debt, than with the object of
deriving from it the usual benefits likely to be realised from the establishment of a central bank. Mr.
Robert Rickards submitted the scheme for consideration to the Governor-General in Council of
Bengal, but the scheme was rejected by the Directors of the East India Company.

Hilton Young Commission Report

The Hilton Young Commission was appointed in August 1925 ‘ to examine and report on the Indian
exchange and currency system and practice ; to consider whether any modifications are desirable in
the interests of India ; and to make recommendations ‘. The question of the need for a central or State
bank was thus not referred to it. The Commission, however, examined this matter and in its Report,
submitted in July 1926, strongly recommended the establishment of a central bank. The bank was to
be called the ‘Reserve Bank of India’, and all central banking functions were to be entrusted to it. The
Hilton Young Commission too recommended the setting up of a new institution to perform solely
central banking functions. In the Commission’s view, the benefit of the elaborate and widespread
organization which the Imperial Bank had already built up should not be lost to India and the bank
should be left free to attend to its essential task of giving India a network of banking facilities; in the
Commission’s view India needed not only a central bank, but a central bank and a great commercial
bank.

1927 Reserve Bank Bill

The Gold Standard and Reserve Bank of India Bill, to implement the recommendations of the Hilton
Young Commission, was introduced in the Legislative Assembly on January 25, 1927. The Bank was to
take over the management of the currency from the Governor-General in Council and was to carry on
the business of banking in accordance with the provisions of the Act. The Bill was referred to a Joint
Committee of 28 members, in March 1927. The Bill did not have a smooth sailing and was withdrawn
from support.

1928 Reserve Bank Bill

In January 1928, the Government of India published a new Gold Standard and Reserve Bank Bill. The
Bill broadly followed the 1927 Bill, as amended by the Joint Committee, important exceptions being
the provisions relating to the ownership of the Bank and the constitution and composition of the
Board. As regards the ownership of the Bank, the new Bill, like the original 1927 Bill, provided for a
shareholders’ bank. On February 10, 1928, the Finance Member announced Government’s decision
not to proceed further with the Bill. The further consideration of the Bill was thus postponed sine die.

Reserve Bank Bill, 1933


The Reserve Bank of India Bill, 1933, drafted on the basis of the recommendations of the London
Committee, was introduced in the Legislative Assembly by the Finance Member, Sir George Schuster,
on September 8, 1933.The Bill was referred to a Joint Select Committee on September 13, 1933, and as
amended by the Committee was introduced in the Legislative Assembly on November 27, 1933, at a
special session. This session was not attended by the Congress party, which had vigorously and
successfully championed the principle of State ownership of the proposed Reserve Bank. The Bill was
passed by the Assembly on December 22, 1933, and by the Council of State on February 16, 1934. The
Bill received the assent of the Governor-General on March 6, 1934.The Act was more or less in the
form in which Government wanted it.

The Reserve Bank of India Act

Applicability

The Act extended to ‘the whole of British India, including British Baluchistan and the Sonthal
Parganas ‘, i.e., it extended to all territories governed by His Majesty through the Governor General of
India or through any Governor or officer subordinate to him. With regard to Burma, to which the Act
applied as Burma was then part of British India, the London Committee hoped that if separated from
India, it would continue to utilize the Indian currency system so that few changes in the Act would be
necessary.

Ownership of the Bank

The question whether the Reserve Bank of India should be a Government-owned bank or a bank
owned by private shareholders was, as in 1927, one of the most extensively discussed issues during the
passage of the 1933 Bill. It was, quite clear that no central bank could in practice be either the one or
the other in its purest form. With the unfortunate experience of countries with State-controlled banks
during and after the First World War behind them, the trend in many countries which had set up new
central banks or reconstituted existing ones was to provide the bank with private capital.

Dispersal of Ownership

A very wide distribution of the ownership of the Bank’s share capital was envisaged through the
demarcation of the country into five geographical areas as defined in the First Schedule to the Act and
by assigning a specified portion of the capital to each of these areas. In order to bring the shares
within the reach of the common man, the value of each share was fixed at Rs.100. The role of the
shareholders was limited to serving as electoral colleges; they could not directly exercise a controlling
influence on the management of the affairs of the Bank. At the annual general meeting, besides the
election of the auditors, the shareholders had the limited function of discussing the Bank’s annual
accounts and the annual report.

Government’s Powers

Provision was made for close co-operation between the Bank and the Government in vital policy
making spheres and for the exercise of a measure of Government influence in the composition of the
Directorate of the Bank, including its chief executives, namely, the Governor and the Deputy
Governors. The Governor and the Deputy Governors were to be appointed by the Governor General in
Council on the recommendations of the Central Board of Directors. Besides Government’s
representation (through one of their officials) on the Bank’s Central Board, four Directors were to be
nominated by the Governor General in Council.

Election of Directors through Local Boards


The Act stipulated the establishment of a Local Board for each of the five geographical divisions, for
the primary purpose of electing Directors of the Central Board. The shareholders on each register were
required to elect from amongst themselves five members for that particular Local Board. These
members would then elect one or two, as the case might be, of themselves as Directors to represent
that area.

The First Central and Local Boards

The first Governor and Deputy Governors were to be appointed by the Governor General in Council on
his own initiative. The first Central Board was to be constituted by nomination by the Governor
General in Council of not only the four Directors to be nominated by him in the usual course but also
the eight Directors to represent the shareholders on the various registers, to be replaced by elected
Directors in stages.

Banker to Government

The Bank was obliged to accept monies for account of Government, viz., monies not only of the
Government at the Centre but also of such Local (that is to say, ‘Provincial’)Governments as had
independent budgets and managed their own finances, and to make payments up to the amounts
standing to the credit of their respective accounts. The Bank was also required carrying out their
exchange, remittance and other banking operations, managing their public debt and arranging for
issue of their new loans.

Sole Right of Note Issue

The Reserve Bank was entrusted with the sole right .to issue bank notes in British India. The
expression in the 1928 Bill was ‘paper money’. The Act prescribed the denominations in which the
notes were to be issued, viz., 5, 10,50,100,500,1000 and 10,000 rupees.

Bankers’ Bank

An important function of a central bank is to regulate the banking system of the country, holding
custody of the cash reserves of banks, granting them accommodation in a discretionary way and
regulating their operations in accordance with the needs of the economy, through instruments of
credit control. In accordance with general central banking practice, the relations of the Reserve Bank
with the money market were to be largely conducted through the medium of member banks, namely,
the ‘scheduled’ banks and the provincial co-operative banks.

Instruments of Credit Control

The instruments of credit control available to the Reserve Bank under the Act were primarily the Bank
rate and open market operations. The provision for the former was made in Section 49 which read as
follows : ‘ The Bank shall make public from time to time the standard rate at which it is prepared to
buy or rediscount bills of exchange or other commercial paper eligible for purchase under this Act
‘.The other instrument of credit control available to the Bank was open market operations, that is to
say, the buying or selling of securities or bills of exchange in the open market with a view to putting
additional funds into the market or withdrawing funds there from and thus expanding or contracting
credit. Although there were certain limitations concerning the quantum and maturity of the
Government securities the Bank could hold in its portfolio (vide S.17 and 33), the scope for the Bank
to engage in open market operations was wide.
THE FORMATIVE YEARS: 1935-39
The Beginnings

The Reserve Bank of India Act was placed on the Statute-book on March 6, 1934. It was, however, not
before another year had passed that the Bank was inaugurated. The Government of India was keen on
starting the Bank as early as possible, especially in view of the fact that the Reserve Bank Bill had been
rushed through the Legislature in a special session. The Bank began operations by taking over from
the Government the functions hitherto performed by the Controller of the Currency and from the
Imperial Bank of India the management of Government accounts and public debt. The then existing
Currency Offices in Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Cawnpore became the
branches of the Issue Department of the Bank. The formal assumption of the functions of a bankers’
bank came a little later, on July 4, 1935, when the first official Bank rate was announced, followed by
the lodgment with it the next day of the statutory deposits of scheduled banks. However, some banks
had begun maintaining balances with the Reserve Bank even earlier, particularly the Imperial, which
did so from the beginning, that is, April 1.

Governor and Deputy Governors

Sir Osborne Smith was appointed as the Governor of the Reserve Bank. Sir Osborne’s reputation as a
banker was quite high; his successful stewardship of the Imperial Bank through the difficult years of
depression and the salutary reforms he carried out for remodeling its working had received wide
recognition. The first Deputy Governors of the Bank were Mr. (later Sir) James Braid Taylor and Sir
Sikander Hyat-Khan, appointed for terms of office not exceeding five years. Sir James belonged to the
Indian Civil Service.

Central Board of Directors

the Directors of the first Central Board, other than the Governor, the Deputy Governors and the
Government official (Mr. J. W. Kelly, Controller of the Currency), were:

Sir Homi Mehta, Kt., Bombay.


Mr. A. A. Bruce, Rangoon.
Lala Shri Ram, Delhi.
Khan Bahadur Adam Hajee Mohammad Sait, Madras.

(1) Bombay register


Sir Purshotamdas Thakurdas, Kt., C.I.E., M.B.E.
Mr. F. E. Dinshaw.

(2) Calcutta register


Sir Edward Benthall, Kt.
Rai Bahadur Sir Badridas Goenka, Kt., C.I.E.

(3) Delhi register


Khan Bahadur Nawab Sir Muzammilullah Khan, K.C.I.E.,
Aligarh.
Sir Sundar Singh Majithia, K.C.I.E., Amritsar.

(4) Madras register


Dewan Bahadur M. Ramachandra Rao, Kt.

(5) Rangoon register


U Bah Oh.
Early Central Banking Policies and Operations

The Reserve Bank of India came on the scene when the Indian economy, like that of the rest of the
world, was gradually recovering from the severe depression of the early ‘thirties, which hit in
particular agricultural countries.

Monetary Management -General Aspects

Monetary management in the early years of the Bank had both potentialities and limitations. Much of
the period was characterized by extremely easy money conditions but these reflected primarily the low
tempo of economic activity. Easy conditions were also largely confined to the organized sector of the
money market. There was the task of taking the benefit of cheap credit to the large unorganized sector,
but the Bank’s links with this sector were, if anything, remote. The freedom of movement of funds
across the country in the absence of exchange control, the need to find foreign exchange to meet
Home Charges and the obligations placed on the Bank to maintain fixed exchange parity, acted as
constraints on the Bank’s freedom and called for considerable skill and finesse on its part. The Bank
had also to keep a sensitive ear to monetary and exchange developments abroad, especially in the U.K.
While, on the whole, monetary management called for a great deal of vigilance, skill and adaptability,
the scope for active policies to influence the range or level of economic activity was not large. It must
also be recognized that the prevailing views on the subject in central banking circles generally were
not oriented to any positive action bearing on the course of the economy.

Bank Rate Procedures and Policy

The initial task of the Reserve Bank was to establish contact with the money market in its role as the
lender of last resort through the normal channels of discounts and advances. The Reserve Bank fixed
its first Bank rate at 3½ per cent; the decision was taken at a meeting of the Committee of the Central
Board held on July 3, 1935. The announcement of the Bank rate was timed just before the day (July 5,
1935) fixed for the scheduled banks to lodge their statutory deposits with the Reserve Bank, so that, in
the event of some banks requiring advances to meet their obligations, the Reserve Bank would be in a
position to make advances to them at the Bank rate.

Open Market Operations

As compared to discounts and advances, the Bank was somewhat active in the sphere of open market
operations. Open market operations constitute an important weapon of monetary regulation in the
armory of central banks. In a broad sense, open market operations may be said to cover purchases and
sales by the central bank of not only Government securities including Treasury bills, but a variety of
assets such as gold, foreign exchange, commercial bills and, in rare cases, even corporate securities. In
the conventional sense, however, the operations cover purchase and sale of Government securities.
Open market operations are conducted having regard not only to the state of the money market but
also the requirements of the Treasury; indeed, often, the latter objective is the predominant one. In
other words, open market operations are usually integrated with a central bank’s debt management
policies. This was very much so in India in the formative years. These operations have also to be
integrated with loans and discounts policies and operations ; that is to say, these operations are
intended to bring about desired changes not only in the flow of credit but also in the pattern of interest
rates.

Exchange Management and Policy

Another very important aspect of the Bank’s operations is concerning the management of foreign
exchange. The Bank was placed under the legal obligation to maintain the sterling rate through
purchases and sales of sterling at specified rates. It was also the Bank’s responsibility as banker to
Government to meet the exchange requirements of Government for remittances to London and
repayment of sterling obligations. An account of the Bank’s exchange management and policy during
this phase is full of interest in view of the revival of the exchange rate controversy occasioned by the
vicissitudes in the course of the foreign exchange market.

Emerging Role as a Bankers’ Bank

The basic purpose of the establishment of the Reserve Bank of India was the unification of the
authority for the regulation of currency and of credit. In regard to the banking system of the country,
the primary role of the Reserve Bank was conceived as that of the lender of last resort for the purpose
of ensuring the liquidity of the short-term assets of banks. Hence, the provision of credit facilities to
banks through discounts and advances was to constitute the centre of relationship between the central
banking authority and the scheduled banks. The custody of the cash reserves of banks vested in the
Bank was primarily meant to serve as a central pool to be available for use in times of emergency for
supporting scheduled banks, rather than constitute an instrument of credit control.

Reserve Bank and Non-Scheduled Banks

The amended Indian Companies Act, no doubt, placed some restrictions on the business of non-
scheduled banks, but they were still outside the purview of the central banking authority, which
practically had no information on their working. In view of the fact that over 200 out of 1,421 banking
and loan companies had paid-up capital and reserves of over Rs. 50,000 and several of them could be
regarded as potential scheduled banks, the Bank considered that it should establish closer contacts
with them. Accordingly, at the instance of the Bank, the Central Government passed, in February
1938, an amendment to the Indian Companies -Act, under which non-scheduled banks were required
to submit an additional copy of their returns (such as cash reserve returns, balance sheets, etc.) to the
Registrars of Joint-Stock Companies for being transmitted to the Reserve Bank for information.

Growth of Joint-Stock Banking: 1935-38

A brief survey of the growth of joint-stock banking in the years immediately following the Bank’s
inception may be introduced at this stage so that subsequent banking developments may be viewed in
proper perspective. The first three years of the Bank’s functioning synchronized with a fairly steady
growth of commercial banking. The scheduled banks (inclusive of four banks incorporated in the
Burma region): 48 in number at the time of the establishment of the Bank rose to 57 by the end of
1938. Their demand and time liabilities increased from Rs. 208 crores in July 1935 to Rs. 239 crores
in December 1938.

South Indian Banking Crisis

Since the banking crisis of 1913-14 which brought disaster to many a joint-stock bank, bank failures in
the decades following constituted, by and large, individual failures resulting from endemic weakness
and deficiencies to which several banking companies were prone in the days of unregulated banking.
The failure of the Travancore National and Quilon Bank (TNQBank) in the middle of 1938 created a
public scare of which the Government and the Bank had to take notice. It drew attention to the urgent
need for comprehensive banking reform and legislation to avert the dangers of policies of unbridled
expansion of branches, frittering away of profits by distributing high dividends, speculation in
investments, granting of advances without security or on inadequate security, incompetence or
dishonesty of management and so on. The size and standing of the TNQ Bank were such that its
failure sparked off a banking crisis in Southern India in the form of heavy withdrawals of deposits.
Luckily, the crisis in a severe form lasted only for a short period; but an underlying feeling of
nervousness persisted in the region until the close of the year. The Reserve Bank, on receiving news of
the crisis, sanctioned increased borrowing limits to banks in that region up to their statutory deposits;
the limits were doubled subsequently. Additional assistance was extended by the Bank to some of the
banks which approached it for help during the closing months of the year. Yet, there was much
adverse criticism of the Reserve Bank’s policy in relation to the banking crisis in- general and the TNQ
Bank in particular.

Banking Development in the Post-Crisis Period

The banking crisis of 1938 was largely a localized affair confined to South India; it had no serious
repercussions on the banking system in the country as a whole. On the other hand, the number ‘of
scheduled banks increased from 57 in December 1938 to 61 in December 1939, despite the exclusion,
from the Second Schedule, of the TNQ Bank on account of its liquidation, and of two other banks
following a change in constitution and amalgamation with another bank, respectively. The increase
was partly explained by the entry into scheduled status of some non-scheduled banks to secure the
exemptions given to the scheduled banks from the operation of debt relief legislation and to acquire
the status and publicity that scheduled banks enjoyed in the public mind.

Governors, Government, Board and Shareholders

Quite early in its career the Bank witnessed important changes in its top management. The change of
Governor raised fundamental issues concerning relations between the central bank and the
Government. The elected members of the Central Board as a whole endeavored to play an active role
in the shaping of the Bank’s policies, in maintaining its independence and generally in safeguarding
the interests of the country. Some of the Local Boards were dissatisfied with the passive role assigned
to them and made unsuccessful efforts to be entrusted with important responsibilities. Yet another
aspect of some interest is the proceedings of the annual general meetings of the shareholders of the
Bank.

Sir Osborne Smith’s Resignation

Sir Osborne Smith, Governor, tendered his resignation towards the end of October 1936. The
resignation was accepted by the Governor General; though it became effective July 1, 1937, consequent
on Sir Osborne’s being sanctioned eight months’ leave from November 1, 1936. The duties of the
Governor were carried on by the ‘senior’ Deputy Governor, Sir James Taylor, who was appointed
Governor, with effect from July 1, 1937. A few days earlier to Sir Osborne’s resignation, that is to say,
with effect from October 20, 1936, Sir Sikander Hyat-Khan had also resigned from the Deputy
Governorship. Sir Sikander’s place was taken by Mr. Manila1 B. Nanavati, who assumed office on
December 21.Sir Osborne’s resignation aroused widespread interest in the press and in the
Legislature, although newspapers and journals do not give the full story, apart from the fact that in
such matters the complete story can seldom be known.

Change of Deputy Governor

Sir Sikander Hyat-Khan resigned his post as Deputy Governor, effective October 20, 1936, to return to
politics in the Punjab. His successor was appointed fairly expeditiously. Apparently, in those years the
Deputy Governorship of the Reserve Bank was regarded as a prize post. Apart from the salary (which
was Rs. 5,500 per month in the case of Taylor and Khan but reduced in respect of later appointments),
there was also a lot of prestige and halo attached to the top posts in the Bank. It would seem that
about twenty-five people were in the run for the post vacated by Sir Sikander. The person finally
recommended by the Central Board of the Bank and approved by the Governor General in Council was
Mr. Manilal B. Nanavati, a Naib Dewan of Baroda State.
Annual Meetings of Shareholders

Annual meetings of shareholders are, generally speaking, a tame affair all over the world. The
meetings of central bank shareholders are not very different. Under the Reserve Bank of India Act, the
main function of the shareholders was to elect members of the respective Local Boards. So far as
annual meetings were concerned, the two items of business were (i) consideration of the balance-
sheet, the profit and loss account and the auditors’ report and (ii) the selection of auditors and the
fixing of their remuneration. The first annual general meeting was held on February 3, 1936 in
Calcutta. 2,677 shareholders were present, 66 in person and the rest by proxy.

THE WAR YEARS: 1939-45

For the Reserve Bank of India, as for the Indian economy and indeed generally for central banks
everywhere, the years of World War II constituted a distinct and important phase of history. To an
extent the war interrupted the normal evolution of the new central bank. Yet the Bank had developed
sufficiently to be able to face with reasonable success the numerous and complex problems created by
the war. Not only did the war bring challenges but it also offered some opportunities. A landmark of
the war years was the appointment of the first Indian Governor, though the opportunity for this came
in a sad way, through the premature demise of the British Governor who, it must be added, had
consciously worked for Indianisation.

Exchange Control Department

The immediate organizational problem posed by the war was the establishment of an exchange
control wing in the Bank. Although the exercise of control over transactions in foreign exchange was a
function of the Central Government -they had assumed powers for such control under Part XIV of the
Defence of India Rules -it was decided for reasons of administrative convenience that control in India
and Burma should be exercised by the Reserve Bank, as their agent. Preliminary arrangements for the
introduction of exchange control had been made well before the outbreak of the war but were kept
secret. The necessary notices and circulars were prepared by the Secretary’s Department of the Bank
under the immediate supervision of the Governor. It was realised, however, that the work of control
over all the foreign exchange transactions would necessitate the creation of a special department and a
few days after the war started the Exchange Control Department was formally established.

Expansion of the Banking Department

With the institution of exchange control, it was considered desirable to make available fuller banking
facilities at Karachi and so a branch of the Banking Department was established there on February 1,
1940. For the same purpose, a branch of the Department was opened at Lahore later that year, with
effect from October 18. Besides organizing exchange control work with respect to the surrounding
districts, these branches maintained principal accounts of the scheduled banks and managed the
Clearing House.

Bank's Functioning in Burma

The Burma Monetary Arrangements Order, 1937, contemplated that at least for a period of three years
from the separation of Burma from India the currency and exchange of both countries should be
closely linked and managed by a common central bank. During the currency of the Order, the Reserve
Bank was also to act as banker to the Government of Burma. The Reserve Bank continued, however, to
be the currency authority for Burma until June 1942 when it was divested of the liability for the note
issue in that country.

The Pattern and Consequences of War Financing

Of the several functions of a central bank, perhaps the most significant one during a period of war is
that of banker to Government. Apart from handling the vastly expanded volume of Government
transactions, the central bank has a special role to play in assisting Government to raise resources in
the form of borrowings, to supplement those raised through taxation. The fundamental principle of
war financing is to divert such portion of the Gross National Product to Government as might be
necessary for the defence effort; the community has to make the requisite sacrifice.

Budgetary Position of Government: General View

It was the responsibility of the Government of India to find the resources not merely for the
Government of India’s own defence expenditure but also for the requirements of the Allied
Governments, in particular the U.K. It turned out that the requirements of the Allies were in the
aggregate almost as large as those of the Government of India. Of course, the Government of India
were entitled to recover from the U.K. (and other Allies) the expenditure incurred on behalf of the
latter. The basis of reimbursement of defence expenditure on behalf of the U.K. was set out in an
agreement, called the Financial Settlement, which was concluded in November 1939 between the
British Government and the Government of India and given retrospective effect from April 1, 1939.
According to the Agreement, the whole of the defence expenditure incurred by India was to be
apportioned between the two Governments on the following basis: India was to bear (1) a fixed annual
sum representing the normal net effective costs of the Army in India under peace conditions, (2) an
addition to allow for rises in prices, (3) the cost of such war measures as could be regarded as purely
Indian liabilities by reason of their having been undertaken by India in her own interests, and (4) a
lump sum payment of Rs. 1 crore towards the extra cost of maintaining India’s external defence troops
overseas. The total amount by which the net annual defence expenditure incurred in India during the
war years exceeded the aggregate of items (1) to (3) was to be recovered from the British Government.

Overall Inflationary Impact

Taking the period of six years 1940-46, approximately 55 per cent of the combined outlay of the order
of Rs. 4,000 crores, on account of the Government of India and the Allies, was financed in a non-
inflationary way, that is, through current revenues and borrowing from the public. Because of the high
proportion of deficit financing, there was substantial monetary expansion of the order of 400 per cent.
Data on India’s Gross National Product for the war years are not available.

War-Time Central Banking Operations

The nature of the inflationary process during the war was such that there was not much that monetary
policy could do to counter it. In fact, it has been the experience of the world in the post-war years too
that when there is a serious fiscal imbalance, the scope for and the efficacy of monetary policy is
comparatively limited. During the war years, nearly all over the world the monetary instruments
remained passive, this being especially true of the instrument of interest rate.
Bank’s Monetary Policy Defined

In the first public utterance after the outbreak of the war, namely, at the annual general meeting of the
Bank’s shareholders held in February 1940, the Governor, Sir James Taylor, set out in clear terms the
Bank’s views with regard to monetary control during the war. After warning against oversimplification
of problems, the Governor referred to the fact that the machinery of monetary control was more
highly organised than in the last war and he made a case for a policy of stable interest rates. That is to
say, he was for neither high rates nor artificial cheapening of money.

Bank’s Open Market Operations

The Bank’s open market operations were on a modest scale in the first three years or so after the
outbreak of the war, but from 1942-43 (July-June) onwards, they assumed substantial dimensions. In
1940-41, the purchases and sales amounted to Rs. 5.64 crores and Rs. 7.34 crores, respectively; in
1944-45, these went up to Rs. 66.08 crores and Rs. 61.06 crores, respectively. The Bank was on the
whole a net buyer to the extent of over Rs. 20 crores during the 5½ year period January 1940 to June
1945. It operated in all the maturities, while concentrating on issues that were either due to mature or
were close to the maturity of loans that were in the process of being issued. The Bank’s operations
were integrated with those of transactions in the Government’s Cash Balance Investment Account.
Including securities acquired otherwise than through the market, the Reserve Bank’s holdings of
Government securities increased by about Rs. 62 crores in the six-year period 1940-46; this should be
regarded as modest in relation to the net increase in the Central Government funded debt of about Rs.
1,050 crores.

Treasury bill Operations and Policies

Unlike in the pre-war days, the Treasury bill issues were not governed by any consideration of
inducing inflow of foreign funds. The offer of these bills was governed largely by the requirements of
the Government in earlier years and later by the need to provide the banking system with a short-term
liquid asset. Partly for the latter reason, the Bank did not favour any substantial issue of short-dated
Government bonds.

Participation in Post-War Currency Plans

A feature of World War II was that even as advance arrangements had been made for financial and
economic control on the outbreak of war, preparations were made during the war period itself for the
drawing up of comprehensive plans for international monetary co-operation in the post-war years.
These efforts resulted in the establishment of the International Monetary Fund and the International
Bank for Reconstruction and Development, of both of which India has been an important member
from the beginning.

Bretton Woods Conference

Towards the end of May 1944 President Roosevelt issued invitations to ‘United and Associated
Nations’ to send their delegates to a conference to be held at Bretton Woods, New Hampshire, U.S.A.,
for ‘formulating proposals of a definite character for an international monetary fund and possibly a
bank for reconstruction and development’. The invitations explicitly stated that the delegates were not
required to hold ‘plenipotentiary powers’; and that the proposals formulated at the conference would
be referred to the Governments of the participating countries for their acceptance or rejection. Forty-
four nations, including India, participated in the conference, which came to be known as the United
Nations Monetary and Financial Conference, lasting from July1 to July 22, 1944. The Governor of the
Bank, along with the other members of the Indian Delegation, played a leading role, in pressing
forward the case of the less developed countries generally and of India in particular. Incidentally, the
participation of the Governor in the Delegation, as he stated later, led to a greater understanding and
friendship between him and the Finance Member, Sir Jeremy Raisman, leader of the Delegation. The
size of the Indian Delegation(six in all) was small in comparison with those of countries like China, the
U.S.A., Russia and the U.K., but it was ‘ a hand-picked and a high-powered one ‘. The Governor felt
subsequently that there was a case for a larger delegation from India, considering its size and
importance, and particularly since as many as four committees often sat at the same time.

THE POST-WAR YEARS: 1945-51

Department of Banking Development

A new Department of Banking Development was set up in October 1950, mainly with the object of
making arrangements for the early implementation of those proposals of the Rural Banking Enquiry
Committee on which action on the Bank’s part was called for, and in particular, to give concentrated
attention to the extension of banking facilities to semi-urban areas and to the problems of rural
finance.

Nationalisation of the Bank

On January 1, 1949, that is to say, 13 years and 9 months after its establishment, the Bank was
transformed into a State-owned institution, in terms of the Reserve Bank (Transfer to Public
Ownership) Act, 1948 -a landmark in the Bank’s history. The nationalisation of the Bank was in line
with the general trend towards nationalisation of central banks abroad, which had set in three to four
years before the outbreak of the Second World War, and which gathered momentum after the war
ended. Sir Benegal Rama Rau took over as Governor from July 1, 1949.

The Bank and the Partition

The partition of India into the new Dominions of India and Pakistan, in 1947, posed several delicate
problems. The Bank ceased to function as the central bank for Pakistan from July 1, 1948. The biggest
hurdle was the division of the assets and liabilities of the Bank, and even to this day some differences
on this issue have remained unresolved.

Termination of Bank’s Role in Pakistan

The termination of the arrangements for the Bank’s role as Pakistan’s central bank may now be
mentioned briefly. Relations between the Pakistan authorities and the Bank were strained because of
the events mentioned earlier. In the circumstances, the Governor declined two invitations extended to
him by the Pakistan Finance Minister to visit Karachi, and offered to depute a Deputy Governor, Mr.
Trevor or Mr. Mehkri, instead.

Termination of Monetary Arrangements with Burma


Even before the partition of India, that is to say, with effect from April 1, 1947, the Reserve Bank of
India ceased to be Burma’s central bank; this did not, however, create any serious difficulties, unlike
in the case of the cessation of the central banking functions for Pakistan. The Government of Burma
gave notice, effective October 1, 1946, determining the operation of the provisions of Part II of the
India and Burma (Burma Monetary Arrangements) Order, 1937.

Membership of the I.M.F. And The I.B.R.D

Signing Of the Bretton Woods Agreements

The Articles of Agreement of the International Monetary Fund (IMF) and the International Bank for
Reconstruction and Development (IBRD) adopted at the Bretton Woods Conference, in July 1944,
were to become effective any time after May 1, 1945 when the Agreements were signed on behalf of
countries with at least 65 per cent of the total quotas in the Fund and the same percentage of total
subscriptions in the Bank. The Articles provided that the Bretton Woods participants, i.e., countries
which were represented at the Bretton Woods Conference and included in Schedule A of the Articles,
were to qualify as original members only if they signed the Agreements by December 31, 1945. With a
view to securing for India the advantages of original membership, the Government of India decided to
adhere to the Agreements before the close of 1945 and then place the matter before the Legislature for
its approval. The Agent-General for India in Washington was therefore authorised to sign the
Agreements on behalf of India on December 27, 1945.

Formative Years of the Fund and the World Bank

In the formative years of the International Monetary Fund and the World Bank, there was much work
for the Board of Executive Directors and the Governors. Since India was one of the big five, she had an
active share of responsibility in the formulation of policies and procedures for the grant of assistance
and in the interpretation of the flexible Statutes, especially in the case of the Fund. With Sir
Chintaman Deshmukh as the Governor for India on the Fund and the World Bank, the Reserve Bank
was in intimate touch with the working of these two institutions. The Executive Directors kept the
Governor informed of all the developments and took instructions from him regarding the stand they
should take on various matters coming up before the Fund and the Bank Boards. There was of course
very close consultation between the Reserve Bank and Government on all important issues.

Epilogue

The first sixteen years of the Reserve Bank’s functioning, constitute an eventful period. The major part
of the sixteen-year period comprised abnormal years -six war years followed by over three years of
political strife culminating in partition of the country and its aftermath. Normalcy could be said to
have returned only in 1949. Till about the 1950s, the Bank did not take an active interest in matters
like extension of banking facilities and promotion of the banking habit. The Bank’s philosophy
apparently was that its first responsibility was to help the establishment of a sound banking system.
Perhaps the most active part of the bank’s operation during this period is its responsibility as the
banker to the government. In the sphere of monetary policy there was not much experimentation in
the period. There were hardly any problems like restraining inflation or curbing investment,
management of the foreign exchange and especially the maintenance of the exchange rate. It was
perhaps the Bank’s role in the sphere of rural credit that formed the main target of criticism during
these years. The Government, at the time of the passing of the Reserve Bank Bill, did not envisage an
active role for the Bank in the supply of finance for agricultural purposes. From 1949 onwards, the
Government’s and the Bank’s interests in agricultural credit deepened considerably, leading to the
appointment first of the Rural Banking Enquiry Committee in 1949 and the All-India Rural Credit
Survey Committee in 1951. Again, in the establishment of the International Monetary Fund and the
International Bank for Reconstruction and Development, the Bank played an important role. The
Bank’s executives and the Central Board took considerable initiative in these matters from very early
stages. The Bank’s efforts facilitated India’s getting a better deal than looked likely in the early stages
of the formulation of the international currency plans. The Bank’s organisation was steadily geared to
meeting its increasing responsibilities. The Bank opened from time to time new offices and in
particular new departments.