How the seminal contribution of one of India's greatest thinkers led to the RBI being formed!
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Establishment of the RBI - Ambedkar's contribution
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- British Raj feels the need: After amalgamating the three Presidency Banks (Bombay, Bengal and Madras), a larger bank 'The Imperial Bank of India' was constituted, but it was functioning like a quasi-central bank. The prevailing economic conditions particularly regulating issue of notes, money supply, money maintenance, economic policy, monetary and payments system and regulating and controlling the banking system in India needed a centralized institution which could function as a central bank of India.
- Nascent efforts: Due to economic crises during 1913-17 and later in 1922 a number of banks had failed because of their unregulated activities. These circumstances created a need to seriously consider establishment of Central Bank for India. The efforts of creating a banking institution with central banking character had been considered from time to time. In late 18th century in 1773 a bank with character of a central bank was established in Bengal on the recommendations of Governor of Bengal but it could not sustain. Another effort for establishment of a Central Bank was made by a member of Bombay Government. He had in 1807-08 prepared a scheme for a General Bank. The Governor General in Council of Bengal, to whom the scheme was submitted for consideration expressed – “The idea of Mr. Richard appeared to us to resolve themselves into mere speculation, without embracing objects capable of being realized while the machinery proposed by the gentleman for the performance of a very simple operation, was extremely cumbersome and complicated.” The scheme was rejected by the East India Company.
- Hilton Commission: In 1926 the Royal Commission of Currency & Finance (Hilton Young Commission), after carrying out a widespread survey on currency, economy and banking conditions, recommended a Central Bank to take over the entire control of banks to end the dichotomy of functions and divisions of responsibilities for control of currency and credit. Its recommendations envisaged that the central bank should have its separate existence for augmenting banking functions throughout the country.
- Sir Hilton Young had vast experience on financial matters and had been working as financial journalist writing for the ECONOMIST. He was the London correspondent of the Financial Supplement of the New York Times. Later in 1915 he was elected to the House of Commons. Before recommending the central bank for India he had in 1925 prepared a scheme for the Government of Iraq for enabling them to issue their own currency through a Board located in London.
- Before having their currency the Indian Rupee was introduced in Iraq by the British expeditionary forces. Firstly Iraq did not accept the proposal but later in 1930 Iraq agreed to the proposal as London based currency board model was already in use by Britain in numbers of its colonies. Mr. Hilton Young also played a vital role in establishing the framework in which the Iraq Currency Board was to operate.
- Hilton Young had also headed a mission to Poland from 1923-25 to help establish a stable economy which introduced the Zloty. In 1925-26 he was Chairman of a Royal Commission on Indian finance, which inter-alia drew up the constitution of the Reserve Bank of India) He also served as a Director of British Bank of Middle East.
- Recommendations: Hilton Young Commissions recommendations for creating a Central Bank for India was backed by Mr. Hilton’s rich experience in financial, economic and banking matters. But it was not so easy that the recommendations were accepted solo motto. The bill to establish a central bank for India was first introduced in January 1927 in the Legislative Assembly. A long drawn discussion among members took place with large number of differences in views regarding ownership, constitution and composition of its Board of Directors that made the whole atmosphere so clouded that the proposal was dropped.
- What should be the Name of Central Bank - First of all what is a Central Bank and on what principles it should be based. If the purpose is to centralizes the control of all banks it should be known as central bank and not the Reserve Bank. As regards the meaning of a Central Bank, it can be and has been defined in many ways. But in simple words a Central Bank may be described as “The people’s agency to govern their supply of currency and credit, free from any undue influence of political or profits.” The purpose of Hilton Young Commission 1926 in suggesting the name as Reserve Bank was to avoid ambiguity. In India a number of banks existed having concept or nomenclature suggesting the name of Central Bank! The Central Bank of Africa was also founded in 1920 with the similar name i.e., Reserve Bank of South Africa. In view of this consideration the name of the Reserve Bank seemed quite suitable and people had also become familiar with it since it had been used not only in the report of the Hilton Young Commission, but also in number of reports of the provincial and Indian Banking Enquiry Committees (1929-31).
- What should be the functions and mechanisms - According to the Indian Central Banking Enquiry Committee (1929-31), the two principal tasks of the Reserve Bank will be to maintain the international value of the rupee and to control the credit situation in India, which would include the rate of interest at which credit would be available to trade and industry’. It should have the sole right of note issue; it should be the channel, and the sole channel, for the output and intake of legal tender currency. It should be the holder of all the Government balances; the holder of all the reserves of the other banks and branches of banks in the country. It should be the agent, so to speak, through which the financial operations at home and abroad of the Government would be performed. It would further be the duty of a central bank to effect, so far as it could, suitable contraction and suitable expansion, in addition to aiming generally at stability, and to maintain that stability within as well as without. When necessary it would be the ultimate source from which emergency credit might be obtained in the form of rediscounting of approved bills, or advances on approved short securities, or Government paper.
- Summary: The conclusion was that a central Bank must have four functions or rights - 1) The right of note issue, 2) The right to hold the reserves of the commercial banks, 3) The right to buy and sell securities, and 4) The right to discount. The above four were strongly recommended by the Committee on Finance and Industry in its report of 1931. The committee was of the view that the main objective of a central Bank is to maintain stability in the value of money or, which is the same thing, steady prices.
- Mechanism: It should be obvious that the twin rights of note issue and holding the reserves of the commercial banks place the Central Bank in the best position to control the existing supply of currency and credit. As the only bank of issue it has the power, broadly speaking, to expand and contract currency, as it may deem fit; while in its capacity as the custodian of the reserves of commercial banks, it occupies the position of a sovereign bank, bankers’ bank or a Central Bank a bank which is the central supervisory body to co-ordinate the activities of all banks in the country.
- Safeguards and Restrictions: A Central Bank has very wide powers in the realm of finance for it is charged with the supreme duty of maintaining stability in the value of money or a steady price-level and, therefore, equipped with the sole right of note issue coupled with the custody of the nation’s ultimate cash reserves both governmental and banking. A Central Bank is thus both a Bankers’ Bank and a State Bank in the sense that it serves both the banks as well as the State. But it is more. It is the Nation’s Bank which exists for the larger service of the nation, sectional interests having no place in it. It must adequately also be safeguarded from all undue influence of politics or profits, from sectional influences whether of institutions or individuals, and particularly from all extraneous and foreign influences. The ultimate responsibility for the stability of national currency must, of course, rest with the national government. But in the interests of such stability itself, it is best that the regulation of currency and credit is in the hands of a bank free from governmental control.
- Position of Credit: India was not altogether lacking in the elements which go to make up a sound banking system. There did exist the indigenous bankers, co-operative societies, commercial banks, exchange banks, savings banks, investment securities, even some bills of exchange and stock exchanges, but they are all ill-developed and lack co-ordination. The banking reserves of the country were scattered among various agencies with no mechanism for their mobilisation, while credit, was also divorced from currency. This was perhaps the greatest weakness of the banking system in India, and was responsible for the evils of fluctuating and high rates of interest. An annual range of three per cent, in interest rates was unheard of in other countries, but was quite ordinary in India and exercises a detrimental influence on the economic life of the country. variation in the bank rate.’
- Role of Dr. Ambedkar: He was an economist, politician, and social reformer who was known for his campaigns against social discrimination against Dalits, women and labour. He was the first untouchable to pass matriculation and become first Indian to pursue an Economic doctorate degree abroad. The Reserve Bank of India was conceptualised in accordance with the guidelines presented by Dr Ambedkar to the Hilton Young Commission (also known as Royal Commission on Indian Currency and Finance) based on his book, 'The Problem of the Rupee – Its Origin and Its Solution'.
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