A STUDY ON THE EVOLUTION OF

CENTRAL BANKS: A CASE STUDY 0F INDIA

ABSTRACT:

The past two decades we have seen various changes in central banks
And the way they function. Central banks are something which have
Evolved so much during the start till now that there has been end
Number of policy changes and laws in the central banks of most of
The countries. These changes are not just seen in any one countryBut
in most of the countries all over the globe. I personally believe that
this evolution in the central bank although it faced many many ups
and downs financially and politically but this was all for good in each
of the country, as its said that modern problems are required to be
solved with new methods and they cannot be solved with old policies.
If we talk about the evolution of the central banks on a global basis
then there are some countries that have restructured their older
institutions as central banks. Where as there are some countries like
the countries of soviet union, they have established entirely new
central banks.so, in this research report we will study about the
progress and downfall of central banks as well as the independence
and transparency of the central banks of various nations during the
past 10 to 15 years. Although we will be discussing the global
perspective of the central banks and comparing it with the central
bank of India and analyse where does India stand globally, but this
study will mainly be a case study of India wherein we will be using
the data of other countries for the comparison so that we get a detailed
data analysis for our research.
INTRODUCTION:

1 overview:
The central bank in India is known the central bank of India or RBI,
the central bank of India, was established in the year 1934 under the
Reserve Bank of India Act 1934 (II of 1934). Although the bank was
established in the year 1934 that is even before the time India got it’s
Independence, but the bank commenced it’s operations on 1st of April
in the year 1935. Initially when the Reserve Bank of India started
operating in India as the central bank of the country it had very
limited functions as compared to the current scenario. These functions
were to ensure the regulation of the issue of the bank notes, in order to
maintain monetary stability it was the job of the central bank to
maintain reserves and operate the credit and currency system of India
in such a way that it is advantageous to the country’s economy.

Background:

Now, coming to history of the central bank of India i.e RBI . During
my research I found out that the establishment of the Reserve Bank of
India was a long process along with the process of legislation which
began in January 1927 that is 7 years before the central bank was
actually established as the presentation took place in March in the
year 1934. The idea of central bank in India actually evolved from a
process that can be traced through the efforts which were made to set
up a banking institution in the year 1773 when the governor of Bengal
who later became the governor general, proposed his plan for a
General Bank in Bengal and in Bihar, the governor was known as
Warren Hastings. This general bank was set up in April in the year
1773 itself. This bank which was the general bank had some
characteristics of a central bank because it could act as a asset for the
revenue collections in some districts. Not just this but other than
facilitating government revenue collections the general banks could
also take payments on behalf of the merchants, who could also be
saved the risk and the expenses involved in making remittances to the
depots for manufactured goods. This project was very short lived as
the bank got closed in the year 1975. The closing of the bank did not
mean that the objectives of the bank were not met, actually it had also
made considerable profits.
Now, at the beginning of the year 1806, with the bank of Bengal, the
government of India established three main functional banks and
these banks were granted the permission to issue notes but up to a
certain limit, this went on till the year 1862, till the time government
was given the right to issue notes under the paper currency Act. These
banks were basically three operational central banks of India, as these
banks were trusted with public debt management ad also were liable
to manage the cash balances of the government of India. Soon after
the government realised that as the economy is growing and as we
enter the modern era there felt a need to centralize these government
balances which were currently being controlled by three banks. The
government started realising that this way economy cannot function
systematically so a single bank could increase the banking presence
across India. However, as it is not easy to combine the work of three
banks into one and function as one single central bank for the whole
country, so on this opinion there were a lot of debates which could not
reach to the conclusions or consensus. On the proposals of the
merging of these three banks and establish a separate central bank.
Later, after many debates the government could reach a conclusion
and these three presidency banks were merged in the year 1921,
which led to the formation of the Imperial bank of India, which was a
commercial bank. The Imperial bank of India performed some central
banking functions like it was the banker of the government of a
country and it was a banker’s bank, alongside the core duty of a bank
which was issuance of the currency notes and management of foreign
exchange still continued to be the responsibilies of the central
government of a country. The running of three presidency banks did
give some experience to the government of that time. Experiences
such as the managerial and regulatory aspects leading to financial
difficulties in the Bombay Presidency bank, which made it difficult
for the government to withdraw it’s own cash balances. This was the
time when government also realised that keeping large balances with
presidency banks was not giving any advantages in terms of trade and
market. The government could not even instantly withdraw all of its
large cash balances as that could lead to crisis. After this experience
the government of India was suggested that they should keep it’s
reserves in it’s own custody. After this incidence the establishment of
the government treasuries took place. However, later after the
establishment of Imperial bank these treasuries were abolished and all
asset balances were kept with the Bank as they were also made the
only banker to the Government.

RESEARCH METHODOLOGY:

To conduct this research report, I devised a methodology that

allowed me to understand the evolution of central banks and how it
functions, and it’s impact on the economy. I tracked down the
information through the newspapers, various websites and research
papers given in the bibliography after the concluding part of the
report.
I followed the following methods to complete my report:

1. With the help of newspapers, articles and websites I studied about

the basic information on the central banks.

2. This also helped me understand about what role does a central bank
plays in the economy.

3. I tracked down the data of various months and previous years to

understand the difference between various changes in policies in the
various years.
4. I collected the data on the downfall and rise of the central banks, in
which I studied about how the central bank of India went through
various ups and downs.

5. After studying the data I have also worked upon the reasons for
such changes.

6. The research report also talks about the central banks of various
countries

7. While I studied the data daily but covering each and every data was
not possible so I took help of some of the research papers by some
renowned researchers and economists.

8. On the basis of this research analysis I drew the conclusion of my

research.

9. In the abstract I have summarized the main purpose of the study for
those who may not have the time to go through the whole report.
10. All the reference sites are attached in the bibliography provided in
the end.

Theoretical framework:

3.1. ESTABLISHMENT OF THE RESERVE BANK OF INDIA:

The legal process of establishing the Reserve Bank of India began in
the year 1927 with the introduction of Gold Standard and Reserve
Bank of India Bill in the Legislative Assembly. This bill was passed
with provisions for the reserve Bank to take over the management of
the currency notes from the Governor-General in the Council. The
introduction of this Bill in the year 1927 gave rise to a lot of debates
and discussions, after these debates and discussions, this Bill was re-
introduced in the year 1933 as “The Reserve Bank of India Bill”
which was passed by Assembly in the same year and by Council of
States in 1934. In the year 1935, the Reserve Bank of India was
established as a shareholder’s institute in the month of April. This
1934 act of reserve bank of India states the objectives of RBI which
are - to “regulate the issue of bank notes and the keeping of the
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”. There were three main functions of the Reserve Bank
of India during the time it was established, these functions were- (1)-
issue of currency (rupees), (2)- banker to the Government; and, (3)-
banker to other banks.
In the year 1947, after the partition of India, the Reserve Bank served
as the Central Bank of Pakistan up till June till the year 1948 when
the Bank of Pakistan commenced operations. The Reserve Bank was
nationalized in the year 1949. However, in terms of various economic
and the financial developments the focus and priorities related to the
functions by the reserve bank of India have been changed. As in India
like many other countries the focus of the central bank was not just on
the subject of banking but they also started prioritizing matters
relating to currency and exchange like the question of the monetary
standard and the foreign exchange rate became a function of the
central bank of India. The reserve Bank began its operations by taking
over from the Government, the functions that were thus far,
performed by the Controller of Currency and from the Imperial Bank
of India, also the management of Government accounts and public
debt. Soon after independence of the country in the year 1947, India
began pursuing its development aspirations and the reserve Bank was
seen playing a crucial in the process, particularly for the agriculture
sector. The role of central ban became even for prominent and
important during the 1960s as tis was the time when finance was
starting to be considered as a major catalyst for the development
process of the country. The reserve bank of India was not just doing a
good job in framing policies for the country but they were also putting
in place a policy framework for sectoral lending such as priority
sector lending norms. The Bank also played a crucial role in
establishment of development institutions in the country which
specialized in sector-specific finance needs as well as finance
infrastructure in the country. During the years 1970s and 1980s,
exchange rate related issues and price stability began receiving even
more attention.

Beginning the 1980s, managing the inflation in the economy became

a focus area and the monetary framework put in place was an
outcome of global thinking in favor of the Monetary approach. This
period saw a significant expansion of the domestic monetary base due
to a large budgetary deficit of the Government and the Reserve
Bank’s financing of these deficits. The Committee to Review the
Working of the Monetary System suggested that monetary targeting
should be made in a formal and secure manner whereby the monetary
targets are decided on the basis of desired growth in output and the
tolerable level of inflation. Beginning the 1990s the policy framework
in the Indian economy saw a major shift with a move towards
liberalization and globalization with appropriate implications for the
role of the Reserve Bank in the Indian economy, which warranted a
change in its focused areas as well as operational framework.
Beginning of the 2000s the liquidity framework went through a major
shift with the implementation of full-fledged Liquidity Adjustment
Facility (LAF) in June in the year 2000 with the policy rate
representing the interest rate corridor for monetary policy
transmission. During this decade, the Reserve Bank discontinued
buying government securities in the primary market under the Fiscal
Responsibility and Budget Management (FRBM) Act 2003, imparting
autonomy and effectiveness to its monetary and liquidity management
operations. Beginning 2005, the Reserve Bank placed a major focus
on financial inclusion with several initiatives taken to bring the
hitherto excluded population in the ambit of the formal banking and
financial sector. Financial inclusion efforts during the 2000s differed
from earlier efforts as the focus this time was on individuals, rather
than an aggregative approach aimed at sectoral and regional levels.
Efforts were also made for the promotion of financial literacy to
enable the public to avail banking services on the one hand, and to
create awareness about the increasing number of fraudulent activities
on the other. Inflation management saw a paradigm shift beginning
2014, with a change in the anchor from WPI-based inflation to CPI-
based inflation and the adoption of a disinflation glide path to reduce
the inflation rate to below 6% January 2016. The inflation targeting
framework was formalized with the signing of an agreement between
the Government and the Reserve Bank in February 2015, to reduce
the inflation rate to 4+/-2% by 2017-18 and maintain it at that level
thereafter. To incorporate the evolution of monetary and financial
developments in the country, the Reserve Bank felt the need to
rearticulate, in contemporary terms, its core purpose as given in the
preamble to the RBI Act 1934. The purpose was to delineate the
Reserve Bank’s strategic objectives and provide a framework and
backdrop for the formulation of Reserve Bank policies and the
charting of its direction. Accordingly, the Reserve Bank issued its
‘Core Purpose, Values and Vision’ Statement in April 2015. The Core
Purpose is defined as fostering monetary and financial stability
conducive to sustainable economic growth and ensuring the
development of an efficient and inclusive financial system. The
Statement also delineated the shared values that guide organizational
decisions and employee actions in pursuit of the Reserve Bank’s Core
Purpose. Setting a vision for itself, the Bank is committed to pursue
public interest and common good as a leading central bank that is
recognized for its credible, transparent and proactive policies.

Analysis:

4.1 Independence and transparency of central banks: case of India-A

number of economists and researchers have investigated/researched
and constructed an index of independence of central banks, the have
basically constructed a framework within which central bank of some
nations operate and constructed index to which the central banks
of their countries are independent. These indexes are based on some
traits like length of bankers’ terms, or the role government officials on
the bank board and even on the contract among the government and
the central bank.

Some of the major findings of these researchers or economists are that

countries with a more independent central bank have less
comparatively lower inflation and these countries did not have higher
unemployment, they also had lower real GDP growth or
comparatively larger business cycles.

In India, the RBI is the central bank of India, it is a government

organisation like other public sector unit. At present the reserve bank
of India (RBI) is not as independent as other nations, thus it does not
enjoy the power to conduct an independent monetary policy.

Although the issuing of ad hoc T- bills has been abolished from India
recently but the central government of India has to borrow from the
reserved bank of India the reason behind this need is when the fiscal
deficit cannot be covered by additional taxes or borrowing from
markets then the government of India has to borrow. Undoubtedly,
the RBI has been putting strict controls on the member bank of RBI
so that they cannot lend to anyone beyond a limit, but still it has to
lend to the central government whenever there is need for
monetisation of fiscal deficit. As things stand today, the achievement
of India's financial arrangement relies upon the accomplishment of
financial approach because of the present money related monetary
connection. Furthermore, this empowers the government of India to
enjoy inflationary financing of its fiscal deficit. So, the only way to
control inflation in India at the current period is the link between
various monetary and fiscal policies. This can only become true if and
when the reserve bank of India becomes an independent unit, that is
free from all government control.

Economists have proved that the countries which have an independent

central bank for example Germany, Switzerland, and the USA, they
have always tended to have a comparatively lower inflation rate as
compared to the countries with a dependent central bank like India,
Spain, etc. Although an independent or dependent central bank does
affect the inflation rate of a country but still is not directly correlated
with the level of employment or the real GDP growth rate, nor does it
involve any trade-off intead it has a benefit of lower inflation without
any visible cost.

CONCLUSION:

To conclude these above research papers and the government issues

and poloicices we can understand that there were two main aped
narratives about the increased transfer of the Reserve Bank Of India
surplus; which were The first one is: the government, facing a
resource crisis, has arm-twisted the “Reserve Bank of India to transfer
some of its reserves, which is almost in the nature of family silver.
This is not good for the country. As when and if the country faces a
crisis, the Resreve Bnak of India may not have the desired amount of
money to protect it. Also it denotes an erosion of the RBI’s
independence.”
“The second, on the contrary, is: the central bank is a unique
institution; it is backed by the faith reposed on it by the central
government, and therefore, a huge amount of reserves with the central
bank is in the nature.
of idle cash which could have been utilized more productively in the
economy. This year, the central government has done precisely this."
Economists have proved that the countries which have an independent
central bank for example Germany, Switzerland, and the USA, they
have always tended to have a comparatively lower inflation rate as
compared to the countries with a dependent central bank like India,
Spain, etc. Although an independent or dependent central bank does
affect the inflation rate of a country but still is not directly correlated
with the level of employment or the real GDP growth rate, nor does it
involve any trade-off instead it has a benefit of lower inflation without
any visible cost.