Not many people know that the Reserve Bank of India was established by the British in 1935 as a financial enterprise and a watchdog with majority private investors and the then government of India holding minority shares in the bank!! 

The Bank began in 1935 by taking over responsibilities from and of the Controller of Currency, Imperial Bank of India, Government accounts and Management of public debt. The then currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Kanpur became branches of the Issue Department and Offices of the Banking Department were established at Calcutta, Bombay, Madras, Delhi and Rangoon. Burma had seceded from India in 1937 but the Reserve Bank continued to act as the Central Bank for Burma till the Japanese Occupation of Burma and later upto April 1947. After the partition of India, the Reserve Bank of India served as the central bank of Pakistan up until June 1948 when the State Bank of Pakistan commenced its operations.

RBI 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, it was seen playing a special role in the context of development, especially Agriculture. When India commenced its planning commission, the development role of the Bank came into focus, especially in the 1960’s when the Reserve Bank pioneered the concept and practice of using finance to catalyze development. The Bank was also instrumental in institutional development and helped set up the Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India (UTI), the Industrial Development Bank of India (IDBI), the National Bank of Agriculture and Rural Development (NABARD), the Discount and Finance House of India to build and lay the foundation for the financial infrastructure of India. 

In the tumultuous 70’s and 80’s, the Reserve Bank of India was hapless witness to a stunted rate of national growth (wrongly called the “Hindu rate of growth”) partially due to India’s compulsions at the International level and also due to the socialist domestic policies of Smt. Indira Gandhi.

As of April 1969, as many as 617 towns out of 2,700 in the country had not been covered by commercial banks. Of these, 444 did not have cooperative banking facilities and out of 6,00,000 villages, hardly 5,000 had banks.

While the credit–deposit ratio was as high as 89 per cent in centers with a population above 10 Lakhs or 1 Million, the declining trend in lower population centers was equally glaring. Centers with population groups with less than 10,000 averaged a credit–deposit ratio of 41 per cent. It was an inevitable step to designate a lead bank for each district to carry out the task of expanding credit to hitherto unserved customers. The efforts in this direction were truly monumental. With the benefit of hindsight, it can now be argued that this was an incorrect move. But the fact is that the 1970s saw credit going to the poor and the issue ceased to be a political stick to beat the Indira government with. The failures would come later, but for that moment it was a sea change that had been achieved in the economic sociology of the country.

The problem was not restricted to the uneven spread of banking. There was not enough credit to go round either. Even if bank branches expanded, they did not have enough to lend. This led, inevitably, to the only solution that was possible in a “democracy”, even though it was a political solution: the rationing of credit while deposits were being ‘mobilized’. Once this had become the cornerstone of political policy, the next step was to determine who would get how much, for what purpose and, most importantly, at what price, that is, the rate of interest to be charged. But who was to decide all this? Central to this worthy endeavor was the concept of the priority sector.

The problem was that no one ever dared asked, whose priority and for what purpose? But the answer became clear when the Differential Interest Scheme was introduced. The scheme was based on the budget speech for 1970–71 by Smt.Indira Gandhi, who had kept the Finance portfolio with herself after the split in the Congress party in July the previous year. She had said, ‘The weaker sections of the society are the greatest source of the potential strength and with our limited resources, a balance has to be struck between outlays which may be immediately productive and those which are essential to create and sustain a social and political framework which is conducive to growth in the long run.'

The scheme was the brainchild of Ashok Mitra, Chief Economic Adviser at the Finance Ministry. In 1977, he became the Finance Minister of West Bengal under the first communist government of the state. The logic of the situation also led to the Finance Ministry and the Reserve Bank becoming the arbiters of India’s financial destiny in ways that had never been envisaged, at least in the manner that took shape over the 1970s.With this role came power, to be used or misused. In the event, during the period under consideration, barring a few isolated cases involving some well-connected political figures, there was no general misuse. That was to come later. But there was plenty of what the British so charmingly call muddling along.One question that can be reasonably asked is, did the RBI become overly accommodative of the government in those years? After examining the political decisions of those years and the lending policies at that time, it appears difficult to conclude otherwise.

With liberalization in the early 90’s, the Bank's focus shifted back to core central banking functions such as Monetary Policy, Bank Supervision and Regulation, Overseeing the Payments System and onto developing financial markets. Shri PV Narasimha Rao and Shri Atal Bihari Vajpayee gave RBI its truly deserved autonomy to independently steer monetary policy.

part 2: https://www.myind.net/reserve-bank-india-rbi-and-its-historic-role-part2