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Banking in India : development and structure. 1963

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BANKING IN INDIA - DEVELOPMENT AND STRUCTURE by Swam Singh Upal B.A., University of British Columbia. A thesis submitted i n partial fulfilment of the requirements for the degree of MASTER OF ARTS in the Department of Economics and Political, Science We accept this thesis as conforming to the standard required from candidates for the degree of MASTER OF ARTS Members of the Department of Economics and P o l i t i c a l Science The University of. B r i t i s h Columbia October, 1963. In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of . Bri t i sh Columbia, I agree that the Library shal l make i t freely available for reference and study. I further agree that per- mission for extensive copying of this thesis for.scholarly purposes may be granted by the Head of my Department or by his representatives., It is understood that copying, or publi- cation of this thesis for financial gain shall not be allowed without my written permission. Department of / ^ ^ ^ f f Y T U ^ The University of Bri t i sh Columbia,. Vancouver 8, Canada. ^ t e &CU$M V , ff{3 BANKING IN INDIA - DEVELOPMENT AND STRUCTURE By SWARN SINGH UPAL (ABSTRACT) I n s p i t e of the f a c t t h a t I n d i a n c i v i l i z a t i o n was at the h e i g h t of i t s g l o r y when Western c i v i l i z a t i o n had not y e t seen t he l i g h t o f day, and I n d i a was once f a r more advanced i n d u s t r i a l l y than any; oneoo'f the p r e s e n t i n d u s t r i a l i z e d n a t i o n s , the Country u n t i l v e r y r e c e n t l y had l o n g been the f o r g o t t e n N a t i o n o f the E a s t bec'ause her a f f a i r s were c o n t r o l l e d f o r some two hundred y e a r s by a f o r e i g n c o l o n i a l power. I t ' was o n l y as r e c e n t l y as 19^7 t h a t I n d i a f i n a l l y got her independence and the n a t i o n a l Government was a b l e t o take s t e p s to improve the economic c o n d i t i o n o f i t s p e o p l e . T h i s was t o be a c c o m p l i s h e d through a broad developmental program, c o n s i s t i n g of a s u c c e s s i o n o f F i v e Year p l a n s . I n t h i s h e r c u l e a n u n d e r t a k i n g the Country ' s b a n k i n g system has. p l a y e d and c o n t i n u e s t o p l a y a l e a d i n g r o l e . I t p r o v i d e s the Co u n t r y ' s c u r r e n c y , f i n a n c e s i t s c u r r e n t output and m o b i l i z e s i n one form o r ano t h e r the s a v i n g s so d e s p e r a t e l y needed f o r the i n d u s t r i a l e x p a n s i o n program now underway i n I n d i a . In view o f i t s i m p o r t a n c e i n the expanding I n d i a n economy the a u t h o r undertook, as a t h e s i s , the t a s k o f s e t t i n g f o r t h b o t h h i s t o r i c a l l y and a n a l y t i c a l l y the s t r u c t u r e and development of the I n d i a n b a n k i n g system. The System i t s e l f c o n s i s t s o f two l a r g e non-competing, though not completely dis-associated, parts usually referred to as the "organized" and "unorganized" sectors of the Indian money market. The l ink between the two sectors i s so weak and tenuous that changes in one are seldom reflected in the other. The unorganized sector consists of a large number of Indigenous bankers and money lenders who, since time immemorial, have catered to the banking and credit needs of the Indian economy. With the institution of the European banks in India the act ivi t ies of these bankers were mainly restricted to financing the internal trade of the Country and to providing for the credit needs of agriculturists , artisans, small tradesmen,etc., and save for local trade associations, national trade organizations and such correspondents as outside collections and remittances make necessary, these bankers operate independently.without any direction or control by the Reserve'Bank. So far a l l attempts of the Reserve Bank to bring them within i t s province and thus regulate their banking business have borne no f ru i t . It has long been held, with some element of truth, that the members of the unorganized sector of Indian money market tend to charge exhorbitant rates of interest on their loans, and have long stood in the way of the economic progress of the Country. Moreover i t i s contended that they have further complicated and compounded the problems of their usually impoverished borrowers. However, this extremely one- sided view seems to overlook their real contribution to Indian banking needs and the important role they play in financing the internal trade of the Country. They provide credit fac i l i t i e s to those who can provide no tangible security and thus finance many undertakings which could not otherwise be carried out. 3 The so called organized sector of the Indian money market consists of: i ) a substantial number of privately owned Joint Stock banks incorporated under Indian laws and manned primarily by Indian nationals; i i ) a number of branches of foreign banks popularly known as Exchange Banks which are managed almost entirely by foreigners; i i i ) a State sponsored System of Cooperative and Land Mortgage banks designed ultimately to support the Indigenous bankers and money lenders; iv) a rather unique postal savings system which provides savings fac i l i t i e s to the lower income group of the Indian population and channel these savings into productive enterprises through the purchase of Government securities; v) the now publicly owned State Bank of India which even as a foreign owned and operated inst i tut ion, serving an immense private banking clientele, functioned for many years as a semi-central bank of India, and s t i l l .'retains many of i t s central banking functions; and f ina l ly , vi) the recently established and now nationalized Reserve Bank of India around which have been arranged a number of public and semi-public financial institutions which in one way or another are designed to help f u l f i l the twin groals of the National Government - i . e . , a modern self-sustaining industrial economy based on a social i s t ic pattern. In addition to the Reserve Bank i t s e l f the latter group includes among others the aforementioned State Bank of India, the Industrial Finance Corporation, the National Industrial Development Corporation and the Life Insurance Corporation of India. The latter has been given a monopoly of a l l l i f e insurance business within India and thus collects and makes available to the Government a large part of the 4 v o l u n t a r y s a v i n g s of the I n d i a n p e o p l e . The a u t h o r ' s t a s k i n t h i s t h e s i s i s a l a r g e y e t u n p r e t e n t i o u s one. By t r a c i n g the growth and development of each of the above c l a s s e s o f i n s t i t u t i o n s he has sought to b r i n g b e f o r e a Western a u d i e n c e not o n l y the n a t u r e of t h e b a n k i n g s t r u c t u r e and b a n k i n g p r a c t i c e s i n I n d i a but the r e l a t e d problems s t i l l t o be s o l v e d i f the C o u n t r y i s t o a c h i e v e the u l t i m a t e g o a l of a h i g h e r s t a n d a r d of l i v i n g i n a s e l f s u s t a i n i n g and dynamic economy. Each of the s e v e r a l c l a s s e s of banks has been a n a l y s e d w i t h a view to e s t a b l i s h i t s p a s t c o n t r i b u t i o n t o the development o f I n d i a and the r o l e i t i s d e s i g n e d t o p l a y f o r the f u t u r e growth of I n d i a n economy. Most of the C o u n t r y ' s f i n a n c i a l p l a n n i n g and p l a n n i n g i n s t r u m e n t - a l i t i e s o r i g i n a t e i n the j o i n t a c t i o n of the Government and the Reserve Bank w i t h the l a t t e r i n the r o l e of a c o n s u l t a n t a d v i s o r and f i n a l l y t h a t of a s e r v a n t t o c a r r y out the planned programme. I n an o v e r a l l sense the expanding r o l e of the Reserve Bank p r o v i d e s the most r e v e a l i n g p a r t of t h i s t h e s i s . T h i s i n s t i t u t i o n has developed i n t o a s t r o n g , a l l embracing c e n t r a l bank employing the most modern c r e d i t c o n t r o l and d i r e c t i o n measures. The bank has used these measures not o n l y t o check any undue i n c r e a s e i n bank c r e d i t but t o c h a n n e l i t i n t o v a r i o u s p l a n n e d p r o d u c t i v e e n t e r p r i s e s . Moreover i t f u n c t i o n s as a r e g u l a t o r y a u t h o r i t y over a l l p u b l i c and p r i v a t e , s c h e d u l e d and non-scheduled b a n k i n g i n s t i t u t i o n s . I n t h i s c a p a c i t y the Bank has s t r e n g t h e n e d the I n d i a n b a n k i n g ' s t r u c t u r e by e n c o u r a g i n g and i n s i s t i n g on the c o n s o l i d a t i o n of s m a l l banks and has improved t h e i r o p e r a t i o n s by a system o f r e g u l a r i n s p e c t i o n s . I t s achievements s i n c e i t s n a t i o n a l i z a t i o n b o t h i n the 5 f i e ld of monetary management and.the development of a sound and efficient banking system provide a new chapter in the history of Central banks. - -vi •" TABLE OF CONTENTS Chap t e r Page P r e f a c e . , i Ta b l e o f Con t e n t s v i L i s t o f T a b l e s x i i I ORIGINS AND ANTECEDENTS OF EXISTING BANKING INSTITUTIONS 1 P a r t 1. Indigenous Bankers and Money Lenders 1 2. I n d i a n J o i n t S t o c k Banks 10 Development t o i860 10 E a r l y Growth 11 Development Between 1860-1935 13 I n d i a n Banks and the Upsurge o f N a t i o n a l i s m 15 3« The P r e s i d e n c y Banks 20 C a p i t a l i z a t i o n 20 F u n c t i o n s 21 P r o g r e s s t o 1935 23 k/ Exchange Banks 26 F u n c t i o n s 27 5. C o o p e r a t i v e Banks 30 E s t a b l i s h m e n t 31 The C o o p e r a t i v e S o c i e t i e s A c t 31 P r o g r e s s to 1935 3^ 6. P o s t a l S a v i n g s Banks 38 I I . THE RESERVE BANK OF INDIA ^0 P a r t 1. A n t e c e d e n t s , P r o p o s a l s and I n s t i t u t i o n s ^1 I m p e r i a l Bank Experiment ^2 F i n d i n g s o f the H i l t o n - Y o u n g Commission kj> - v i i Page The Round T a b l e Conference and the Emergence of the Reserve Bank o f I n d i a 46 P a r t 2. P r o v i s i o n o f the E n a b l i n g A c t 47 C a p i t a l i z a t i o n and Ownership 48 A d m i n i s t r a t i o n and C o n t r o l 49 P r e r o g a t i v e s and F u n c t i o n s 51 Note I s s u e 51 Exchange C o n t r o l 53 F i s c a l Agent f o r Government 54 Reserve Bank as a Banker's Bank 55 Membership Q u a l i f i c a t i o n s 55 C l e a r i n g and C o l l e c t i n g F a c i l i t i e s 56 L e g a l Reserve D e p o s i t o r y 57 Lender o f L a s t R e s o r t 58 3. The R o l e of the Reserve Bank, 1935-49 59 As a Monetary A u t h o r i t y • 6 l As a Banker's Bank 64 As a Banker by Government 65 Reserve Bank C r e d i t and P r i c e s 69 I I I . DEVELOPMENT IN THE PRIVATE BANKING SECTOR, 1935-49 74 P a r t 1. _Indigenous Bankers and Money Lenders 75 Proposed I n c l u s i o n i n Reserve System 75 Money Lenders and Rates o f I n t e r e s t 78 C h a r a c t e r Loans - P r o f e s s i o n a l Money L e n d e r s 79 C h a r a c t e r of Loans - N o n - P r o f e s s i o n a l Money Lend e r s 79 Rates o f I n t e r e s t 80 Government R e g u l a t i o n s 81 2. I n d i a n J o i n t S t o c k Banks 82 Amendments to 1913 Companies A c t 84 Other L e g i s l a t i o n P r i o r t o 1949 87 Growth and O p e r a t i o n s . 1935-49 88 Comparative Importance - Scheduled and ' Non-Scheduled Banks 90 - v i i i - mm P a r t 3' I m p e r i a l Bank of I n d i a 96 R e l a t i o n s w i t h Government and Reserve Bank of I n d i a 96 Nature and S i z e o f O p e r a t i o n s 1935-49 100 4. The Exchange Banks 102 Nature of C r i t i c i s m 102 Growth 1935-49 104 5. The C o o p e r a t i v e Banks 106 R e s t r i c t i o n s and R e g u l a t i o n s 106 The Land Mortgage Banks 108 Membership and O p e r a t i o n s C o o p e r a t i v e C r e d i t S o c i e t i e s C o o p e r a t i v e C r e d i t S o c i e t i e s 110 The C e n t r a l C o o p e r a t i v e Banks 111 The S t a t e C o o p e r a t i v e Banks 115 Number and O p e r a t i o n of Land Mortgage Banks ' 117 Combined O p e r a t i o n s , P r i m a r y and C e n t r a l Banks 117 R e l a t i v e Importance of P r i m a r y and C e n t r a l Land Mortgage Banks 119 6 . The P o s t a l S a v i n g System 121 IV. NATIONALIZATION AND EXTENSION OF CENTRAL AUTHORITY 124 P a r t 1. N a t i o n a l i z a t i o n o f the Reserve Bank 126 Changes i n A d m i n i s t r a t i v e S t r u c t u r e 131 J u r i s d i c t i o n a l Changes 132 E x t e n s i o n o f R e g u l a t o r y A u t h o r i t y 133 The L i c e n s i n g o f Banks 134 D i r e c t i v e s t o Loans and I n t e r e s t Rates 135 Merger and Amalgamation 135 Appointment of O f f i c i a l s 13,6 I n s p e c t i o n , S u p e r v i s i o n and Su s p e n s i o n 137 - i x - A d d i t i o n s to I n s t r u m e n t s of Monetary P o l i c y 138 S e l e c t i v e C r e d i t C o n t r o l and C r e d i t R a t i o n i n g 138 I n t e r e s t R a t e s on D e p o s i t s 139 Reserve R a t i o M a n i p u l a t i o n 1 4 0 M o r a l S u a s i o n l 4 l 2. N a t i o n a l i z a t i o n of the I m p e r i a l Bank l 4 l Ownership o f the S t a t e Bank o f I n d i a 1 4 4 A d m i n i s t r a t i o n and Management 1 4 5 3. I n d u s t r i a l Banks and the L i f e I n s u r a n c e C o r p o r a t i o n of I n d i a 1 4 5 The I n d u s t r i a l F i n a n c e C o r p o r a t i o n 1 4 6 C a p i t a l i z a t i o n and Ownership 146 A d m i n i s t r a t i o n and C o n t r o l 1 4 8 Source of Working C a p i t a l 148 The S t a t e F i n a n c i a l C o r p o r a t i o n s 149 C a p i t a l i z a t i o n and Ownership 150 A d m i n i s t r a t i o n and C o n t r o l 151 Source of Working C a p i t a l 152 The N a t i o n a l I n d u s t r i a l Development C o r p o r a t i o n 152 C a p i t a l i z a t i o n and ownership 153 A d m i n i s t r a t i o n and C o n t r o l 153 The I n d u s t r i a l C r e d i t and.Investment C o r p o r a t i o n 154 C a p i t a l i z a t i o n and Ownership 155 A d m i n i s t r a t i o n and C o n t r o l 156 The R e f i n a n c e C o r p o r a t i o n . 157 C a p i t a l i z a t i o n and Ownership 157 A d m i n i s t r a t i o n and C o n t r o l 158 The N a t i o n a l S m a l l I n d u s t r i e s C o r p o r a t i o n 159 C a p i t a l i z a t i o n and Ownership l6o A d m i n i s t r a t i o n and C o n t r o l l 6 l The L i f e I n s u r a n c e C o r p o r a t i o n o f I n d i a l 6 l C a p i t a l i s a t i o n and Ownership 162 - X - Page CHAPTER V. OPERATIONS OF THE RESERVE BANES, THE STATE BANK AND OTHER FINANCIAL INSTITUTIONS 1949 ONWARD 164 P a r t 1. O p e r a t i o n s o f the Reserve Bank, 1949 onward 165 The E x e r c i s e o f Monetary A u t h o r i t y 165 Counter Measures f o r the Korean War I n f l a t i o n l66 Bank Rate 167 The B i l l Market Scheme 169 E x t e n s i o n o f B i l l Market Scheme 170 The Containment o f Budgetary I n f l a t i o n 172 Bank Rate and Open Market O p e r a t i o n s 173 S e l e c t i v e C r e d i t C o n t r o l i n A g r i c u l t u r a l P r o d u c t s 174 On Paddy and R i c e 174 Ground Nuts ' 178 Raw J u t e and J u t e goods 179 S e l e c t i v e C o n t r o l on S t o c k s and Shares l80 C r e d i t R a t i o n i n g l82 Reserve R a t i o V a r i a t i o n 184 M o r a l S u a s i o n 187 Accomplishments o f the Monetary C o n t r o l l88 Reserve Bank O p e r a t i o n s 191 P a r t 2/ The S t a t e Bank of I n d i a - O p e r a t i o n s and Growth 195 E x t e n s i o n of D u t i e s and F a c i l i t i e s 196 The S t a t e Bank and F i n a n c i n g o f S m a l l I n d u s t r i e s 197 The S t a t e Bank and A g r i c u l t u r a l F i n a n c e 199 Magnitude of O p e r a t i o n s 1949-61 200 P a r t 3. O p e r a t i o n s o f I n d u s t r i a l Banks and L i f e I n s u r a n c e 203 C o r p o r a t i o n o f I n d i a . The I n d u s t r i a l F i n a n c e C o r p o r a t i o n s 203 The S t a t e F i n a n c i a l C o r p o r a t i o n s 208 The I n d u s t r i a l C r e d i t and Investment C o r p o r a t i o n 211 The N a t i o n a l I n d u s t r i a l Development C o r p o r a t i o n 2l4 The R e f i n a n c e C o r p o r a t i o n 217 The N a t i o n a l S m a l l I n d u s t r i e s C o r p o r a t i o n 219 The L i f e I n s u r a n c e C o r p o r a t i o n - O p e r a t i o n s 222 - x i - joage CHAPTER VI• PROGRESS IN PRIVATE SECTOR 1949 ONWARD 227 P a r t 1. The Indigenous Bankers 228 Indigenous Bankers and the Reserve System 229 Formulae f o r C o n s i d e r a t i o n 230 P a r t 2. J o i n t S t o c k Banks 233 P r o v i s i o n s o f the Banking Companies A c t , 1949 233 Impact o f the Banking Companies A c t on I n d i a n J o i n t S t o c k Banks 237 On the Conduct of t h e s e Banks 237 On J o i n t S t o c k Bank's O p e r a t i o n s 1949 Onward 241 Scheduled and Non-Scheduled Banks 244 C o n c e n t r a t i o n of Bankin g B u s i n e s s 246 P a r t 3. The Exchange Banks 251 E f f e c t s of the 1949 Banking Companies A c t 251 Trend i n O p e r a t i o n s 253 Comparative Growth 255 P a r t 4. The C o o p e r a t i v e Banks 257 Measures R e l a t i n g t o C o o p e r a t i v e Banks 258 I n s p e c t i o n and T r a i n i n g o f P e r s o n n e l 26l O p e r a t i o n s o f C o o p e r a t i v e Banks 262 P r i m a r y C r e d i t S o c i e t i e s 262 The C e n t r a l C o o p e r a t i v e Banks 1 263 The S t a t e C o o p e r a t i v e Banks 266 O p e r a t i o n s o f the Land Mortgage Banks 268 P r i m a r y Land Mortgage Banks 269 C e n t r a l Land Mortgage Banks 269 Measures R e l a t i n g t o Land Mortgage Banks 272 P a r t 5- P o s t a l S a v i n g s Banks 273 CHAPTER V I I . SUMMARY AND CONCLUDING OBSERVATIONS 276 1 - xii<- ^ . List of Tables Page Number, Principal Assets and Liabilities of Indian Joint Stock Bank- ing Enterprises Between 1870 and 1935 18 Principal Assets and Liabilities of the Presidency Banks - 1870-20, and the Imperial Bank, 1920-35 Inc. 25 Number, Deposits, Cash in Hand and Earning Assets of Exchange Banks, 1870-1935 29 Number, Membership and Working Capital of Cooperative Credit Institutions in India, 1907-1935 37 Number, Deposits and Balances Outstanding of Postal Saving System Between 1885-1935 40 Short-term Operations of the Reserve Bank 1936-1949 Inc. 63 Operations of the Issue Department of the Reserve B ank, 1935-194-9 Inc. 67 Operations of the Banking Dep artment of the Reserve Bank 1935-4-9 Inc. 68 Combined Operation of the Reserve Bank of India 1936-49 Inc. 70 Government Debt, Reserve Banks' Credit and Purchasing Power of the Rupee 1936-1949 Inc. 72 Number, Principal Assets and Liabilities of Indian Joint Stock Banks (Excluding Imperial Bank) 1935-1949 Inc. 91 Number, Principal Assets and Liabilities of Non-scheduled Ba ks 1935-49 Inc. 92 Number, Principal Assets and Liabilities of Scheduled Banks (excluding Imperial Bank) 1935-49 Inc. 93 Comparative Number, Deposits and Earning Assets of Indian Scheduled and Non-scheduled Banks 1936, 1940, 1945 and 1949 95 Branches, Principal Sssets and Liabilities, Imperials Bank of India, 1935-49 Inc. . 105 Number, Deposits and Earning Assets of Exchange Banks in India, 1935-49 Inc. 105 Number and Business of Primary Cooperative Credit Societies, 1935- 1949 Inc. 112 Number and Business of Central Cooperative Banks, 1935*49 Inc. 134 - X1X1- Page Number and Business of State Cooperative Banks, 1935-49 Inc. 116 Number and Business of Central and Primary Land-Mortgage.Banks (Separately), 1945-1949 Inc. 118 Number, Deposits and Balances Outstanding Postal Savings System 122 Comparative Percentage Increase in Employment by Industries, Periods 1934-1939 and 1939-1945 126 Regional Distribution of Ownership of Reserve Bank Shares, 1935-1948 Inc. 128 Regional Distribution of Share-Holders, 1935-1948 Inc. 128 Comparable Rates of Growth of Public Debt, Reserve Banks Credit and National Income, 1949-1961 Inc. 190 Principal Assets and Liabilities of the Reserve Bank (Issue and Banking Departments) of India, 1949-1961 Inc. 192 Principal Assets and Liabilities, Reserve Bank (Issue Department) of India, 1949-1961 Inc. 193 Principal Assets and Liabilities, Reserve Bank (Banking Department) of India, 1949-61 Inc. 194 Branches, Principal Assets and Liabilities, State Bank of India 1949-61 Inc. 202 Operations of the Industrial Finance Corporations 1950-61 205 Business of State Financial Corporations, 1955-61 Inc. 2l0 Loans, Guarantees and Underwriting Operations of Industrial Credit and Investment Corporation, 1956-61 212 New Business of the Life Insurance Corporation and its Predecessor Insurance Companies 1954-61 223 Distribution of Investment Portfolio of the Life Insurance Corporation 1957-60 226 Number, Capital and Deposits of Banks, Liquidated or Otherwise Closed, 1953-61 239 Number, Principal Assets and Liabilities of Private Indian Joint Stock Banks 243 Comparative Number, Deposits and Earning Assets of Indian Scheduled and Non-scheduled Banks, 1950-1955 and I960 245 - x lv ' - — Number, Principal Assets and Liabilities of Non-scheduled banks 1949-61 247 Number, Principal assets and Liabilities of Privately owned Indian Scheduled Banks 1949-61 248 Relative Importance of Ten largest Indian Banks at the end of 1961 250 Number, Principal Assets and Liabilities of Exchange Banks, 1949-61 254 Relative Importance of Exchange Banks and other Primary lenders in Indian Banking Structure, 1950-1599 and i960 256 Number, l@ans and Working Capital of Primary Credit to Societies 1949-1960 264 Number and Business of Central Cooperative Banks 1949-61 267 Number and Business of State Cooperative Banks 1949-61 267 Number, Loans and Working Capital of Primary Land-Mortgage Banks 270 Number, Loans and Working Capital of Central Land-Mortgage Banks 271 Number and Deposits of Postal Savings offices 1949-61 274 PREFACE India, l ike many other developing countries, is in the process of attempting to accomplish through a succession of five year plans the enormously complicated task of modernizing her economy through the establishment of new industrial enterprises and the improvement of the Country's agricultural operations with a view to rais ing in so far as possible the l i v ing standard of the people which i s one of the lowest in the world today. In this mountainous task great reliance has been placed on f inancial institutions, some of the more important of which have emerged as a part of the planned development i t s e l f . Others are not of such recent origin yet s t i l l make very important contributions to the Indian banking structure and to the Indian economy in general. The author of this thesis has undertaken as his taskt'b present to a Western audience the origins and development of the several main categories of banking institutions in India, and in the process of doing so to analyse the problems that banks have encountered both in the past and more recently in connection with the projection of the Country's modernization program.... For purposes of exposition the development of Indian banking system is divided into three main periods: 1) developments from the earliest times down to 1935 when Reserve Bank of India was established as a private inst itution; 2) developments between 1935 and 19^9 when the Reserve Bank was nationalized - a period which includes not only the problems incidentto India's participation in World War II , but those as well that arose in connection with the partit ion of India and the Country's ultimate assumption of Sovereign authority over i t s own destiny; 3) developments after 19^9 the more important of which took place under the vigilance of the nationalized Reserve Bank now working hand in hand with the Government to expedite the planned economic development of the Country on a social i s t ic pattern. India how has five principal categories of banking institutions namely: Indigenous banks and money lenders; Indian Joint Stock banks organized and operated under. Indian banking laws and regulations; forei owned and operated Exchange banks; Cooperative banking institutions sponsored by the respective States; a postal savings system, and f ina l ly a group of public and quasi-public banks arranged around the nexus provided by the Reserve Bank of India. In addition to the Reserve Bank i t s e l f .• considerable importance is attached to the State Bank of India which as the Imperial Bank of India has s;erved to a l l intents and purposes as the Country's semi-central bank unt i l 1935; and.continues•to serve in that capacity at places where the Reserve Bank has.no competing branches. The State Bank and i t s subsidiaries play an important role in spreading banking f a c i l i t i e s to the remote corners of the Country and in providing short and medium term loans to agriculturists and to small industrial enterprises. Significant roles are also played by the Industrial Finance Corporation, the State Financial Corporations, the National Industrial Development Corporation, etc. , which are designed to handle the financial needs of industrial enterprises; and by the Life Insurance Corporation which has a monopoly of a l l the l i f e insurance business of the Country and thus can make available to the Government,for investment,most of the voluntary savings of the Indian people. - i i i - The material on each class of these banking institutions is so arranged that the reader may trace i t s development through each of the periods adopted for the overall plan of the thesis. Yet one may also concentrate on the comparative developments affecting each class in any one period. Thus i t follows that the origin of a l l constituents of Indian banking system save the recently established public and quasi-public banking institutions w i l l be found in Chapter One which brings their development down to 1935- Chapter Tivo i s devoted to the establishment and performance of the Reserve Bank of India between 1935 and 19^9. Chapter Three i s given over to the changes in laws affecting the private banks including the then Imperial Bank of India and to the performance of the various categories of banks between 1935 and 19^9. Chapter Four is given over to the nationalization of the Reserve Bank of India;,, the Imperial bank, the l i f e insurance business in India and to the establishment of several public, semi-public and private f inancial institutions designed to expedite the financing incident to the carrying out of the successive five year plans. Chapter Five traces the performance of each of these categories of financial institutions between 19^9 and 1961. In Chapter Six we have presented the important legislative measures affecting the operation of banking institutions s t i l l in the private sector. Here the growth and expansion of these banks and their relative importance in the Indian banking system Have been emphasized. In Chapter Seven the author has attempted to bring together such pertinent conclusions and observations as may properly be made from the analyses which have already been made in connection with the - iv - progress of each categories of banks particularly in respect of the Reserve Bank i t ee l f to which, save for the Indigenous bankers and money lenders, a l l other banking enterprises have been made more or less subordinate.. The study of the Indian banking system is fraught with more than the usual d i f f icul t ies encountered in undertaking a work of this character. There i s a considerable scarcity of original source material. The author had to .depend on inter- l ibrary loans which in i t s e l f was an arduous task and involved considerable delay.More often than not i t provided him with material that did not prove to pertain to the subject. The documentation of the l i t t l e material that is available in the Asian Studies Library has not yet been completed?. Final ly such information as is available is extremely fragmentary and often di f f icul t to translate into Western usage. The s ta t i s t i ca l data usually need more explanation before one can compieh'eaad, compare and interpret them inte l l igent ly . The data are sometimes changed from year to year without sufficient explanation. Moreover data even from the same source are sometimes conflicting. This study was undertaken at the suggestion of Professor Joseph A. Crumb and has been carried through under his constant guidance and often unrelenting crit ic ism. While I am wholly responsible for the demerits of the work, these would have been far greater but for his vigilance. In fact this work would have been impossible without his generous help. I am deeply indebted to other persons who have helped me in many ways to complete this work. I would l ike to thank the staff of the Social Sciences Division and the Humanities Division of the University l ibrary who kindly arranged a large number of books on inter- l ibrary loans for me and ful ly cooperated in obtaining other needed material. I would also l ike to thank Professor William L . Holland, Head of the Asian Studies Department, who so kindly arrang to lend me many useful books from his personal l ibrary and also made the Asian Studies l ibrary available to me. The Bank of Canada proved most cooperative in providing a copy of the Reserve Bank of India Act, 1934, and the Reserve Bank of India's Reportes on Currency and Finance without which a part of the information included in the thesis would • have been far less complete. CHAPTER I ORIGINS AND ANTECEDENTS OF EXISTING'BANKING INSTITUTIONS Though a t r a n s f o r m a t i o n o f c o n s i d e r a b l e consequence has r e c e n t l y - been made i n the s t r u c t u r e , ownership and c o n t r o l of b a n k i n g i n I n d i a , the u n d e r l y i n g p a t t e r n o f t h e s e i n s t i t u t i o n s and t h e i r p r a c t i c e s , many o f w h ich a r e of v e r y e a r l y o r i g i n , remains b a s i c a l l y unchanged. I t c o n s i s t s of n a t i v e or i n d i g e n o u s bankers and money l e n d e r s ; branches o f f o r e i g n banks known as exchange banks, l o c a l b a n k i n g i n s t i t u t i o n s o r i g i n a l l y sponsored by f o r e i g n i n t e r e s t s and r e s i d e n t a l i e n s ; now c l a s s i f i e d as I n d i a n j o i n t s t o c k banks; the p r e s i d e n c y banks; the c o o p e r a t i v e banks and the p o s t a l s a v i n g s system. P a r t 1 I n d i g e n o u s Bankers and Money Lenders The i n d i g e n o u s bankers and money l e n d e r s , who have t r a d i t i o n a l l y c a t e r e d t o the needs of p e a s a n t s , a r t i s a n s and s m a l l t r a d i n g and m a n u f a c t u r i n g e n t e r p r i s e s i n I n d i a , make up the o l d e s t i f not the most s i g n i f i c a n t p a r t of the c o u n t r y ' s b a n k i n g s t r u c t u r e . A l t h o u g h t h e r e i s no c l e a r d e m a r c a t i o n between i n d i g e n o u s bankers and money l e n d e r s , the f o r m e r , as a r u l e combine t h e i r b a n k i n g b u s i n e s s w i t h m e r c a n t i l e and t r a d i n g e n t e r p r i s e s , and do not n e c e s s a r i l y d i s t i n g u i s h the one t y p e o f u n d e r t a k i n g from the o t h e r . They acc e p t time d e p o s i t s w i t h d r a w a b l e by p e r s o n and c h a r a c t e r i s t i c a l l y f i n a n c e t r a d e and s m a l l i n d u s t r i e s . As they o f t e n advance s e c u r e d l o a n s and t h e i r c l i e n t s a r e p u n c t u a l i n r e p a y i n g t h e i r l o a n s the i n d i g e n o u s bankers g e n e r a l l y charge a lower r a t e o f i n t e r e s t t h a n the money l e n d e r s . The l a t t e r do not a c c e p t d e p o s i t s and m o s t l y f i n a n c e consumption and i n d e b t e d n e s s . The p r o f e s s - i o n a l money l e n d e r s known as Mahajans, Sahukars and i t i n e r a n t money l e n d e r s such as PATHANS, NAGAS, GOSSAINS, QUISTWALAS, e t c . , a r e g e n e r a l l y known t o be a v a i l a b l e t o anyone who d e s i r e s t o n e g o t i a t e a l o a n . The n o n - p r o f e s s i o n a l money l e n d e r s , who a r e m o s t l y w e l l - t o - d o a g r i c u l t u r i s t s , p e n s i o n e r s , widows, p r i e s t s , shopkeepers, l a b o u r foremen a r e not g e n e r a l l y known t o be money l e n d e r s , but l e n d as a r u l e t o t h e i r f r i e n d s and a c q u a i n t a n c e s . The n o n - p r o f e s s i o n a l and i t i n e r a n t money l e n d e r s a r e o f t e n more greedy and charge h i g h e r r a t e o f i n t e r e s t t h a n the p r o f e s s i o n a l money l e n d e r s . They g e n e r a l l y make un s e c u r e d l o a n s t o i m p r o v i d e n t and impov- e r i s h e d b o r r o w e r s . I f we were t o l o o k i n t o a n c i e n t I n d i a n h i s t o r y , we would f i n d t h a t the b u s i n e s s o f f i n a n c i n g and money l e n d i n g were f o l l o w e d o r i g i n a l l y by V a i s y a s and l a t e r on by B a n i y a n s , S h r o f f s , M u l t a n i s , C h e t t i a r s , e t c . , c a s t e s u s u a l l y i d e n t i f i e d w i t h commerce and t r a d e . Even d u r i n g the V e d i c Age, which a p p r o x i m a t e l y c o v e r s the p e r i o d from 2000 B.C. t o ikOO B.C. the g r a n t i n g o f l o a n s and c r e d i t s i n one form o r a n o t h e r was c a r r i e d on by I n d i a n merchants, t r a d e r s and money l e n d e r s Debt (Rna) i s r e p e a t e d l y mentioned i n the R i g Veda - the s a c r e d book o f the Hinduism - a p p a r e n t l y h a v i n g been a normal c o n d i t i o n among the V e d i c I n d i a n s . ^ However, l i t t l e i s known about e i t h e r t h e method o f r e c o r d i n g t h e l o a n s , t h e p e r i o d o f payment o r the r a t e of i n t e r e s t . L.C. J a i n , I n d igenous Banking i n I n d i a , M a c m i l l a n & C o . L t d . , London, 1929, p.3 . - 3 - After the sixth century B.C. Budhist writings reveal to some extent the nature of the prevailing lending practices and the heavy burden of interest borne by the debtor. According to Professor Jain, who obtained his information from the Budhist l i f e stories (Jatkas), the legal rate of interest was usually set at 2 15 per cent per annum, but this does not appear to have been an upper l imi t . In Kautalyas Arthashastra, an important compilation of rules governing among other things the liending of money, fixing of rent, rate of interest, etc. , which were current from about 400 to 200 B . C . , i t was held "that 15 per cent should be the maximum legal rate of interest on secured loans. On unsecured loans the nominal maximum was 60 per cent, but the actual rate could go as high as 240 per cent i f the r isk element was also very high".^ Between 200 B.C. to 200 A.D. trade and industry flourished in India and Indian merchant bankers, in addition to accepting deposits and making loans, engaged i n financing internal trade. According to Professor M. Taylor both the art and science of banking was compar- atively well developed at this time. He reaches this conclusion after familiarising himself with the writings of Manu - an leainent contemporary law-giver and advisor to the crown. The laws of Manu, 2. 3LVC-. ; Jain'? .op. c i t . , p. 5 3. ' S. G. Panandikar, Banking in India, Orient Longmans L t d . , Calcutta, 1948, p . l . 4. M. Taylor, Student's Manual of the History of India, as cited by G.B. Jather and S. G. Beri , Indian Economics, Vol . II . Humphrey Milford, Oxford University Press, Madras, 1937, p. 440. - 4 - he s t a t e s , " d i s c l o s e how t h o r o u g h l y the a r t o f b a n k i n g was known 2000 y e a r s ago. Then bankers u n d e r s t o o d and f o l l o w e d the f l u c t u a t i o n of money v a l u e . They k e p t account books and l e d g e r s by s i m p l e and double e n t r y . They charged i n t e r e s t and compound .... they g r a n t e d b i l l s o f exchange and, i n s h o r t , t h e y f o l l o w e d the p r a c t i c e s o f modern t i m e s which a r e l i t t l e changed from a n c i e n t r u l e s " . The M u slim i n v a s i o n s of I n d i a d u r i n g the 10th c e n t u r y A.D. brought a p e r i o d o f u n c e r t a i n t y and i n s e c u r i t y . As the i n v a d e r s were m a i n l y i n t e r e s t e d i n I n d i a n r i c h e s , they l o o t e d and p l u n d e r e d everywhere t h e y went. B a n i y a n s , S h r o f f s , M u l t a n i s and o t h e r b a n k i n g communities were h a r d e s t h i t . I n a d d i t i o n to p e r s o n a l losses, i.the i n v a s i o n s v i r t u a l l y brought t o an end t h e i r d e p o s i t o r s a f e k e e p i n g b u s i n e s s because t he pe o p l e no l o n g e r t r u s t e d the bankers w i t h t h e i r s a v i n g s . The g e n e r a l p u b l i c began t o hoard i t s money s a v i n g s by b u r y i n g p r e c i o u s m e t a l and c o i n , e i t h e r i n the ground, or i n the w a l l o r i n some o t h e r i n c o n s p i c u o u s p l a c e i n t h e i r homes - h a b i t s which have p e r s i s t e d t o some e x t e n t among I n d i a n s down t o the p r e s e n t t i m e . Even though t h a t o f a conqueror M uslim r u l e e s t a b l i s h e d l a w and o r d e r throughout the c o u n t r y and thus gave an impetus t o t r a d e and commerce. E v e n t u a l l y the c o u n t r y a g a i n p r o s p e r e d . L o c a l bankers took advantage o f the o p p o r t u n i t y and a g a i n added the f i n a n c i n g o f t r a d e t o t h e i r b u s i n e s s a c t i v i t i e s . The money l e n d e r s presumably c o n t i n u e d w i t h l i t t l e i n t e r r u p t i o n t h e i r a g e - o l d u s u r i o u s p r a c t i c e s . 5. • (3V-'Bs.,Ja>her-Va»d S.G. B e r i , pjo^ c i t . , p. 440 - 5 - 6 I t was d u r i n g t h i s p e r i o d t h a t t h e b i l l o f exchange ( H u n d i ) f as we know i t t o d a y , came i n t o common use. R e f e r r i n g t o the d i s c o u n t r a t e s charged on b i l l s o f exchange J.B. T a t e r n i e r , a Fre n c h t r a v e l l e r , r e p o r t e d t h a t " a t Lahore on S u r a t t h e exchange goes up t o 6.1/4 per c e n t ; a t A g r a from 4.1/4 t o 5 p e r c e n t ; a t Ahmadabad, from 1 t o 1.1/2 per c e n t ; a t S i r o n j , to 3 p e r c e n t ; a t Burhan P u r , from 2.1/2 t o 3 per c e n t ; a t Dacca, t o 10 per c e n t ; a t P a t n a , from 7 t o 8 per cent and a t 7 Benaras up t o 6 p e r c e n t " . A p p a r e n t l y these r a t e s v a r i e d a c c o r d i n g t o t h e e x t e n t o f c o m p e t i t i o n i n t h e r e s p e c t i v e exchange market; a l s o a c c o r d i n g t o the degree r i s k i n v o l v e d i n the movement o f b o t h . C o i n s and goods between d i f f e r e n t t r a d i n g c e n t r e s . T r a d i n g and f i n a n c i n g o f t r a d e has s i n c e become an i m p o r t a n t s o u r c e o f income to the I n d i g e n o u s ba n k e r s . 6. A Hundi may be d e f i n e d as a w r i t t e n o r d e r ( u s u a l l y uncon- d i t i o n a l ) made by one p e r s o n o r a n o t h e r f o r t h e payment, on demand o r a f t e r a c e r t a i n s p e c i f i e d time (mentioned i n the Hundi) o f a c e r t a i n sum of money t o a p e r s o n mentioned i n t h a t o r d e r . I n the former case i t i s c a l l e d a D a r s h a n i Hundi (demand b i l l o f exchange) and i n the l a t t e r c a s e , Muddati Hundi (usance o r time b i l l o f exchange). These h u n d i s can f u r t h e r be s u b - d i v i d e d i n t o the f o l l o w i n g c a t e g o r i e s : i . D h a n i j o g Hundi - p a y a b l e t o a Dhani o r a person.(commonly used) i i . Shahjog Hundi - payable, t o a Shah o r a r e s p e c t a b l e p e r s o n , i i i . F i r m a n j o g Hundi - pa y a b l e t o o r d e r , i v . Dekhanhai Hundi - p a y a b l e t o the p r e s e n t e r o r b e a r e r , v. Jokhami Hundi - t h i s h u n d i i s drawn a g a i n s t the goods d i s p a t c h e d and c o n t a i n s c e r t a i n c o n d i t i o n s a c c o r d i n g t o which i f the goods a r e l o s t o r d e s t r o y e d i n t r a n s i t , t h e drawer o r h o l d e r o f t h e h u n d i has t o s u f f e r the l o s s . I t i s i n t h e n a t u r e of a p o l i c y i n s u r a n c e . 7. . T r a v e l s i n I n d i a as quoted by L.C. J a i n . o p . c i t . p. 14. - 6 - Money changing was also an important source of income for the indigenous bankers during the period of Muslim rule. The Muslim rulers set up numerous mints in India and each succeeding ruler issued his own coins. Later issues were generally of different weight and design than were those minted earl ier . At that time only bankers were qualified to handle the exchange and assaying business and reconstitution of the coinage provided them with an added source of income. Moreover many bankers were appointed as the officers of the mint by the state. In this capacity they bought the metal, minted coins and shared the profits with the Muslim rulers. During the reign of the Mughal Emporer, Akbar the Great, there were four gold mints and the number of s i lver and copper coin mints were 8 estimated at fourteen. The market price of a coin, at that time, was determined not only by i t s face value but by the year and the reign during which i t was coined, also the wear and tear suffered during i t s use. Discontinued coins were frequently valued at considerably less than,their bullion value. The money changers melted down these' coins and got them recoined at a prof i t . Referring to the chicanery of these money changers, J . B . Tavernier stated, " A l l the Jews who occupy themselves with money and exchange in the Empire of the Grand Seigneur pass for being very sharp; but in India they would scarecely be apprentices to these Indian Money " 9 changers . However, the money changing business came to an end in 1835 when the currency of Bri t i sh India was unified by the East India Company. ^* N.K. Sinha, The Economic History of Bengal, v o l . 1 . Sri Lalchandroy Gossain and Co. Calcutta, 1 9 5 6 . p . l l 8 . 9- Travels in India as quoted by L . C. Jain, op.c i t . p. 1 1 . - 7 - I n a d d i t i o n t o t h e i r l e n d i n g and money ch a n g i n g a c t i v i t i e s , n a t i v e I n d i a n bankers r e n d e r e d i m p o r t a n t s e r v i c e s t o the s t a t e , such as l e n d i n g money t o the s t a t e , c o l l e c t i n g revenue, e t c . Some of t h e s e bankers h e l d p r i m i n e n t p o s i t i o n s i n the R o y a l C o u r t s . I n f a c t t h e r e was no Court w i t h o u t a s t a t e banker - a p o s i t i o n g e n e r a l l y h e l d by a w e l l - e s t a b l i s h e d and w e l l known merchant banker. T h i s gave the l o c a l bankers a p r i v i l i g e d p o s i t i o n . They performed most of the f u n c t i o n s o f a modern s t a t e bank. Of a l l the n a t i v e bankers i n I n d i a , the House of J a g a t S e t h was the most prominent. One may compare the p o s i t i o n o f t h i s b a n k i n g house w i t h t h a t of the Bank o f England i n i t s e a r l i e r s t a g e s of development. I t r e a c h e d the h e i g h t o f i t s g l o r y under F a t e h Chand, a merchant banker o f B e n g a l , who a p p a r e n t l y managed a l l the s t a t e l o a n s as w e l l as h i s own s u n s t a n t i a l b u s i n e s s . When r e f e r r i n g t o t h i s b a n k i n g house, P r o f e s s o r Muranja t e l l s us t h a t i n 1722 the Emperor Mohamad Shah c o n f e r r e d on F a t e h Chand the t i t l e o f J a g a t S e t h or w o r l d banker as a h e r i d i t a r y d i s t i n c t i o n ; a l s o , t he K h i l l a t ( i n s i g n i a o f the m a g n i f i c e n t robes o f h o n o u r ) , an e l e p h a n t and a p e a r l ear-ring."*"^ T h e r e a f t e r no Emperor o f D e l h i ever s e n t the K h i l l a t t o the Nizam, of B e n g a l w i t h o u t a l s o s e n d i n g one t o the J a g a t S e t h . When t h e European t r a d e r s came to I n d i a d u r i n g the f i r s t h a l f o f t h e 17th Century they found i n d i g e n o u s bankers t o be w e l l equipped t o h a n d l e domestic b a n k i n g needs but i n c a p a b l e o f h a n d l i n g the c r e d i t r e q u i r e d t o f i n a n c e e i t h e r t he newly i m p o r t e d p r o d u c t s o r t h e e x p o r t s 10. S.K. Muranjan, Modern B a n k i n g I n I n d i a , Kamla P u b l i s h i n g House, Bombay, 1952. p. 9. 1 - 8 - n e c e s s a r y t o pay f o r them. There were no m e r c a n t i l e e s t a b l i s h m e n t s t h r o u g h w h ich e x t e r n a l t r a d e c o u l d be channeled because I n d i a n b a n k e r s and merchants had l i t t l e knowledge o f e x t e r n a l t r a d e p r a c t i c e s . Moreover t h e r e was a language b a r r i e r and p r o b a b l y some h o s t i l i t y towards f o r e i g n p r o f i t s e e k e r s . I n o r d e r to overcome the s e d i f f i c u l t i e s the European t r a d e r s e m p l o y e d , f i r s t , I n d i a n bankers i n t h e i r s e r v i c e s but u l t i m a t e l y s e t up t h e i r own merchant houses. The E a s t I n d i a Company employed I n d i a n bankers a t i t s t r a d i n g c e n t e r s i n S u r a t , A g r a and C a l c u t t a . An i n d i g e n o u s banker by the name o f Burgee Pa r a c k was the banker arid f i n a n c i e r o f the company a t S u r a t . I n 1685 he was v o t e d the t r e a s u r e r and i n t e r p r e t e r ( B a n i y a ) a t S u r a t , a g o l d medal and a c h a i n o f the B e n g a l i b a n i y a was i n t e r p r e t e r , head book-keeper, head s e c r e t a r y , 12 head b r o k e r , the s u p p l i e r o f e a e h and cash k eeper . About a c e n t u r y l a t e r when the revenue c o l l e c t i o n o f Be n g a l was handed over t o the Eas t I n d i a Company, I n d i a n bankers s e r v e d as c o l l e c t o r s f o r t h e Company. By the end of the l 8 t h c e n t u r y t h e Muslim r u l e a t D e l h i had become weak, c o r r u p t and i n e f f e c t i v e and the B r i t i s h i n f l u e n c e i n Beng a l was b e i n g e s t a b l i s h e d . There were c o n t i n u o u s wars between the d i f f e r e n t s t a t e s o f I n d i a and between the I n d i a n S t a t e s and the East I n d i a Company. Under t h e s e u n s e t t l e d c o n d i t i o n s t r a d e p r a c t i c a l l y d i s a p p e a r e d and a l o n g w i t h i t the b u s i n e s s of n a t i v e I n d i a n b a n k e r s . P r o f e s s o r S i n a s t a t e s t h a t " the l 8 t h C e n t u r y 11. S.K. M u r a n j a i i , op_. c i t . , p. 9 . 12. N.K. S i n h a , o£. c i t V o l . 1 , p.118. Many o f them l o s t t h e i r p e r s o n a l f o r t u n e s because even t he owners o f p r i n c e l y s t a t e s c o u l d not repay t h e i r l o a n s . Many o t h e r b o r r o w e r s f a i l e d t o honour t h e i r o b l i g a t i o n s . The ra n k s o f the I n d i a n bankers were f u r t h e r t h i n n e d by the emerging c o m p e t i t i o n o f the former employees o f the Company who meantime e n t e r e d the b a n k i n g and t r a d i n g b u s i n e s s i n the more'important commercial c e n t e r s . These company s e r v a n t s were g i v e n s p e c i a l p r i v i l i g e s such as exemption from e x c i s e t a x e s ; they a l s o enjoyed c o r d i a l r e l a t i o n s w i t h Company o f f i c e r s . Sometimes they even double d as Company o f f i c i a l s t o get b e t t e r p r i c e s from I n d i a n d e a l e r s . Through the s e d e v i c e s and o t h e r s t h e y were a b l e i n many i n s t a n c e s t o t a k e over the b u s i n e s s o f I n d i a n merchants. The l o s s o f b u s i n e s s and p e r s o n a l f o r t u n e s b u i l t up e a r l i e r under t he Company's patronage by t h e Indigenous bankers was never f u l l y r e c o v e r e d . With t h e e s t a b l i s h m e n t of Company's r u l e i n B e n g a l , and t h e consequent i n c r e a s e i n i t s t r a d e , i t became e x p e d i e n t to r e p l a c e t h e n a t i v e bankers e i t h e r w i t h Agency Houses or Company e n t e r p r i s e s under i t s s p o n s e r s h i p . Company t r e a s u r y o f f i c e r s were s e t up at C a l c u t t a , Bombay and Madras. European t r a d i n g f i r m s were a l l o w e d t o e s t a b l i s h Agency houses i n Bombay, C a l c u t t a and p r o b a b l y 13 i n Madras. T h e r e a f t e r i n d i g e n u o u s bankers tended t o r e v e r t t o t h e i r s t a t u s as merchant bankers i n the i n t e r i o r p a r t s o f I n d i a - a r o l e t h e y have c o n t i n u e d t o p l a y down t o the p r e s e n t t i m e . No d a t a a r e a v a i l a b l e on the s i z e and e x t e n t o f t h e i r o p e r a t i o n s but th e y , n e v e r t h e l e s s , c o n s t i t u t e a s i g n i f i c a n t p a r t o f I n d i a n b a n k i n g e n t e r p r i s e s . The A l l I n d i a S u r a l C r e d i t Survey Report o f a l a t e r 13. M.V. Subba Rao. An O u t l i n e o f Banking System i n I n d i a . V o r a & Co. P u b l i s h e r s L t d , Bombay, 19^8, p. 18. - 1 0 - date (195^) e s t i m a t e s t h a t the Ind i g e n o u s bankers and the money- l e n d e r s p r o v i d e as much as 76 p e r ce n t o f a l l r u r a l c r e d i t s g r a n t e d . 14 i n I n d i a . They a r e a l s o v e r y i m p o r t a n t i n the s m a l l urban c i t i e P a r t 2. I n d i a n J o i n t S t o c k Banks C o r p o r a t e Banking v e n t u r e s i n I n d i a grew out of the t r a d i n g a c t i v i t i e s o f bot h European and n a t i v e I n d i a n s . As i n d i c a t e d above the E a s t I n d i a Company a l l o w e d European t r a d i n g f i r m s ±0 e s t a b l i s h Agency Houses i n the Country ' s i m p o r t a n t t r a d i n g c e n t r e s - Bombay and C a l c u t t a - and t o combine b a n k i n g f a c i l i t i e s w i t h t h e i r t r a d i n g a c t i v i t i e s . These Agency Houses were manned f o r the most p a r t by former Company s e r v a n t s who were o f t e n a b l e t o g a i n s p e c i a l c o n c e s s i o n s from the Company and o c c a s i o n a l l y doubled as Company a g e n t s , i . e . , Government Agents. Because of t h e i r knowledge of l o c a l customs, i n d i g e n u o u s bankers and money l e n d e r s were employed by t h e Agency Houses and not i n f r e q u e n t l y became p r i n c i p a l s i n th e s e b a n k i n g and t r a d i n g v e n t u r e s . Development t o i860 The f i r s t o f these B a n k i n g - t r a d i n g e n t e r p r i s e s , k n o w n as the Bank o f H i n d o s t a n , was e s t a b l i s h e d by Messrs.' A l e x a n d e r and Company i n 1770 a t C a l c u t t a . By the end o f l 8 0 3 i twenty n i n e such b a n k i n g - t r a d i n g v e n t u r e s were i n o p e r a t i o n i n I n d i a . 14. Reserve Bank o f I n d i a , A l l - I n d i a R u r a l C r e d i t Survey, p. .: . Repor t o f the Committee p f d i r e c t i o n . V o l . I I . Bombay, 1954. p. 15. N.K. S i n h a , Economic H i s t o r y o f B e n g a l , V o l . 1 . S r i L a i Chand Roy G o s s a i n and Co., C a l c u t t a , 1956, p. 90. - 11 - E a r l y Growth Some of the ba n k i n g e n t e r p r i s e s , which grew out o f the Agency Houses, i s s u e d t h e i r own c u r r e n c y n o t e s . Those o f t h e H i n d o s t a n Bank, though n o t a c c e p t e d by the Company Government, had a l o c a l c i r c u l a t i o n which o c c a s i o n a l l y r o s e t o as much as Rs 5»000,000."^ The e x t e n t t o w h i c h the notes a c q u i r e d c i r c u l a t i o n depended on t h e i r a c c e p t a b i l i t y a t the Governments' l o c a l t r e a s u r i e s and by the l o c a l m e r c a n t i l e and t r a d i n g e s t a b l i s h m e n t s i n the urban c e n t e r s . However, r e g a r d l e s s o f t h e e x t e n t o f t h e i r a c c e p t a b i l i t y , t h e s e n o t e s had l i t t l e o r no c i r c u l a t i o n i n the c o u n t r y s i d e where p e o p l e c u s t o m a r i l y used m e t a l l i c money. There was keen c o m p e t i t i o n among these b a n k i n g - t r a d i n g houses to s e c u r e the s t a t u s and p r i v i l i g e s o f Government b a n k e r s . Each b a n k i n g e n t e r p r i s e t r i e d t o make i t s n o t e s l e g a l t e n d e r a t Government t r e a s u r i e s because w i t h t h i s p r e r o g a t i v e i t c o u l d l e n d more t h a n i t s p r o p r i e t o r y a s s e t s and thus expand i t s o p e r a t i o n s . The E a s t I n d i a Company r e c o g n i z e d the advantages o f the banknotes i n the i n t e r n a l payment mechanism and e v e n t u a l l y a c c e p t e d those o f the G e n e r a l Bank of I n d i a . But t h i s Bank went i n t o l i q u i d a t i o n d u r i n g the l a t e 17 1780's and t h e Government then t u r n e d to the Bank o f C a l c u t t a w i t h w h i c h , presumably, i t c o n t i n u e d t o d e a l u n t i l 1806 when s t e p s were tak e n t o e s t a b l i s h a sfeate p a r t n e r e d bank c o m p l e t e l y d i v o r c e d from t r a d i n g a c t i v i t i e s . 16. N.K. Roy, I n d i a n Banking and Money Market, M.C. S a r k a r and Sons L t d , C a l c u t t a , 1952, p. 8. 17. L.C. J a i n , Indigenous B a n k i n g I n I n d i a , M a c m i l l a n and Company, L t d . London, 1929, p. l 4 l . S i n c e t h e s e b a n k i n g e n t e r p r i s e s were c a r r y i n g t r a d i n g a c t i v i t i e s a l o n g w i t h b a n k i n g , and t h e i r main motive was t r a d e p r o m o t i o n , r a t h e r than t he s t a b i l i t y o f t h e i r b a n k i n g e n t e r p r i s e s , a number o f t h e s e so c a l l e d banks over-extended t h e m s e l v e s and f a i l e d d u r i n g what has s i n c e been c a l l e d t h e 1829-32 b a n k i n g c r i s i s . I n a c r i t i c i s m o f the b a n k i n g p r a c t i c e s o f t h i s p e r i o d P r o f e s s o r J a i n s a i d , " t h a nks t o the c o m b i n a t i o n o f b a n k i n g w i t h s p e c u l a t i v e t r a d i n g v e n t u r e s , and a p o l i c y o f p l a c i n g p r o f i t s b e f o r e s a f e t y , t h e i n e v i t a b l e happened d u r i n g the 1829-331 when commercial d i s a s t e r o v e r t o o k the t r a d i n g f i r m s and brought s e v e r a l o f them a l o n g w i t h t h e i r b a n k i n g u n d e r t a k i n g s t o r u i n " . A l t h o u g h the Company gave some a s s i s t a n c e to t h e s e banks, i t was not s u f f i c i e n t to save them from b a n k r u p t c y . The commercial d i s a s t e r o f the p e r i o d 1829-33 appears t o show t h a t , i f bank f a i l u r e s a r e t o be a v e r t e d , b a n k i n g b u s i n e s s s h o u l d not be mixed w i t h c o m m e r c i a l under- t a k i n g s . D u r i n g t he p e r i o d from 1833 t o i860 t h e r e were few a d d i t i o n s and l i t t l e e x p a n s i o n of j o i n t s t o c k b a n k i n g and t r a d i n g v e n t u r e s . L a r g e s c a l e f a i l u r e d u r i n g t he 1829-32 c r i s i s had shaken the p u b l i c con- f i d e n c e i n the agency house b a n k i n g i n s t i t u t i o n s and the E a s t I n d i a Company s u b s e q u e n t l y took s t e p s to e s t a b l i s h and s u p p o r t b a n k i n g i n s t i t u t i o n s - the P r e s i d e n c y Banks - which devoted themselves e x c l u s i v e l y t o the b a n k i n g b u s i n e s s ."^ D u r i n g t he l840's and e a r l y l850's s e v e r a l j o i n t s t o c k t r a d i n g banks were e s t a b l i s h e d but most o f them e i t h e r f a i l e d o r were s u b s e q u e n t l y amalgamated w i t h o t h e r i n s t i t u t i o n s . 18. L.C. J a i n , op_. c i t ( ,p. ikl. 19- See p a r t 3 page 18. i n f r a . - 13 - The slow p r o g r e s s o f the I n d i a n b a n k i n g d u r i n g t h i s p e r i o d may a l s o be a t t r i b u t e d t o a t t e n d a n t economic and p o l i t i c a l c o n d i t i o n s . The Afghan War o f the l a t e t h i r t i e s ^ the S i k h Wars d u r i n g the f o u r t i e s , the. e v e r p r e s e n t a n t i - B r i t i s h f e e l i n g , and, f i n a l l y , the I n d i a n R e v o l u t i o n of 1857 k e p t the c o u n t r y i n a c o n t i n u o u s p o l i t i c a l t u r m o i l and i t s economy, u n s e t t l e d and d i s o r g a n i z e d . I t was o n l y a f t e r 1858, when the government o f I n d i a was t r a n s f e r r e d t o the B r i t i s h P a r l i a m e n t and o r d e r was r e s t o r e d , t h a t new a t t e m p t s were made t o e s t a b l i s h b a n k i n g and t r a d i n g e n t e r p r i s e s . Developments between i860 - 1935 The year i860 i s an i m p o r t a n t one i n the h i s t o r y o f I n d i a n b a n k i n g e n t e r p r i s e s . I n t h a t y e a r , under the A c t V I I , i860, the p r i v i l e g e o f l i m i t e d l i a b i l i t y was i n t r o d u c e d i n I n d i a and extended t o t h e j o i n t s t o c k t r a d i n g b a n k s . ^ Because o f t h i s p r i v i l i g e many i n s t i t u t i o n s were e s t a b l i s h e d i n the y e a r s i m m e d i a t e l y f o l l o w i n g but the n a t u r e o f t h e i r u n d e r t a k i n g s were such t h a t o n l y a few s u r v i v e d . I n most cases f a i l u r e t o s u r v i v e was due t o i n v e s t m e n t i n the I n d i a n c o t t o n boom which r e s u l t e d from the American C i v i l War. The o u t b r e a k o f t h i s war had c u t o f f the main s o u r c e o f the s u p p l y o f c o t t o n f o r England's L a n c a s h i r e m i l l s and t h e B r i t i s h c o t t o n goods i n d u s t r y had t u r n e d t o I n d i a , h i t h e r t o o n l y a s u p p l e m e n t a l s o u r c e o f ee&ton. f i b r e . As an immediate consequence 21 c o t t o n p r i c e s i n I n d i a r o s e t o about 10 times t h e i r normal l e v e l . 20. S.G. P a n a n d i k a r , Banking I n I n d i a , O r i e n t Longmans, Bombay, 19̂ 8. p. 11. 21. A F i n a n c i a l Chapter i n H i s t o r y of Bombay, C i t e d by L.C. J a i n , op. c i t . , pp. lk'j>-kk. - Ik - T h i s sudden and unexpected r i s e l e d to an e x t e n s i v e i n c r e a s e i n the p r o d u c t i o n o f c o t t o n i n I n d i a . The i n c r e a s e was m o s t l y f i n a n c e d by the newly e s t a b l i s h e d j o i n t s t o c k b a n k i n g - t r a d i n g v e n t u r e s . The u s u a l p r o c e d u r e , a c c o r d i n g t o P r o f e s s o r J a i n , was 22 as f o l l o w s . A l a n d r e c l a m a t i o n company would be formed and the c a p i t a l r e q u i r e d f o r p r e p a r i n g the l a n d f o r c u l t i v a t i o n would be s u p p l i e d by a f i n a n c i a l c o n s o r t i u m made up o f a group of owners of newly e s t a n l i s h e d t r a d i n g banks. Many of these r e c l a m a t i o n p r o j e c t s were not w e l l c o n c e i v e d , o t h e r s were mismanaged and p r o b a b l y burdened w i t h h e a v i e r f i n a n c i a l c h a r g e s than t h e y c o u l d c a r r y . Moreover, the end of C i v i l War i n the U n i t e d S t a t e s of A m e r i c a brought even the s u c c e s s f u l v e n t u r e s i n t o c o m p e t i t i o n w i t h o r i g i n a l s u p p l i e r s i n the U n i t e d S t a t e s . T h i s r e s u l t e d i n the l a r g e s c a l e f a i l u r e d u r i n g the y e a r s 19̂ 5 and 1966, i n v o l v i n g the t r a d i n g banks as w e l l as the c o t t o n e n t e r p r i s e s t h e m s e l v e s . D u r i n g the y e a r s which f o l l o w e d the c o t t o n boom the p r o g r e s s of I n d i a n banking e n t e r p r i s e s was u n d o u b t e d l y r e t a r d e d by the c u r r e n c y c o n f u s i o n t h a t e x i s t e d i n I n d i a between 1870 and l893> By 187O most of t h e w o r l d ' s l e a d i n g c o u n t r i e s had abandoned b i m e t a l i c s t a n d a r d s i n f a v o u r of g o l d . U n f o r t u n a t e l y f o r s i l v e r s t a n d a r d c o u n t r i e s l i k e I n d i a , almost i m m e d i a t e l y t h e r e a f t e r huge d e p o s i t s of s i l v e r were d i s c o v e r e d i n the A m e r i c a ' s , s u b s t a n t i a l l y i n c r e a s i n g the f l o w o f s i l v e r to the World markets and d e p r e s s i n g i t s p r i c e c o n s i d e r a b l y below i t s mint p a r i t y w i t h g o l d . T h i s had the e f f e c t of s e r i o u s l y d e p r e s s i n g the s t e r l i n g e q u i v a l e n t o f I n d i a n rupees and t h u s r a i s i n g c o n s i d e r a b l y i m p o r t p r i c e s i n I n d i a . For the time b e i n g at l e a s t , 22. L';Q.. . J a i n , .bp. c i t . , p. IV? - 15 - i t a l s o l o wered the s t e r l i n g r e c o v e r i e s o f I n d i a n - e x p o r t e r s c o m i t t e d to Rupee c o n t r a c t s . Underthe Coinage A c t of 1893, the f r e e c o i n a g e o f s i l v e r and of g o l d was abandoned and the r a t e on 23 s t e r l i n g was f i x e d a t 1 = Rs . 1 5 - Had i t not been f o r the exchange i n s t a b i l i t y and the a b o r t i v e c o t t o n boom which preceeded i t , i t seems r e a s o n a b l e to assume t h a t the growth of j o i n t s t o c k b a n k i n g and t r a d i n g e n t e r p r i s e s would have been s u b s t a n t i a l d u r i n g the 24 l a t t e r p a r t of the 1 9 t h c e n t u r y . As a r e s u l t of t h e s e u n h e a l t h y developments t h e r e were o n l y n i n e such t r a d i n g banks w i t h a c a p i t a l and r e s e r v e s o f Rs. 5 0 0 , 0 0 0 o r o v e r at the end o f the 1 9 t h c e n t u r y . I n d i a n Banks and the upsurge o f N a t i o n a l i s m D u r i n g the f i r s t decade o f the 2 0 t h c e n t u r y the N a t i o n a l i s t (Swadeshi) Movement i n I n d i a made c o n s i d e r a b l e p r o g r e s s . Among o t h e r accomplishments t h i s movement gave a s t i m u l u s t o the growth of j o i n t s t o c k bank and t r a d i n g companies which a t t h i s time had become almo s t c o m p l e t e l y i d e n t i f i e d w i t h n a t i v e I n d i a n v e n t u r e s . Between 1906 and 1913 the number of banks w i t h c a p i t a l and Reserves o f R s . 5 0 0 , 0 0 0 o r o v e r i n c r e a s e d from 9 t o 1 8 . On the l a t t e r d a t e t h e i r t o t a l p aid-up c a p i t a l and r e s e r v e s were Rs .40 m i l l i o n s , and t h e i r 25 t o t a l d e p o s i t s amounted t o Rs . 2 2 0 m i l l i o n s . Such i m p o r t a n t i n s t i t u t i o n s as the Bank o f I n d i a , t h e C e n t r a l Bank of I n d i a , the Bank of Baroda, the I n d i a n Bank of Madras and the Bank of Mysore were e s t a b l i s h e d d u r i n g t h i s p e r i o d . The number of s m a l l e r banks t h a t were e s t a b l i s h e d was much g r e a t e r . 23- B.E. D a d a c h a n j i , Monetary System o f I n d i a . , D.B. T a r a p o r e w a l a Sons & Co. L t d . Bombay, 1 9 4 8 , p. 2 2 3 . 24. fl.B. J a t h e r and S.J. B e r i . I n d i a n Economics. V o l . I I , O x f o r d U n i v e r s i t y P r e s s , Madras, 1937t P« 4 5 0 . 2 5 . S.G. P a n a n d i k e r , op_. c i t . ,pp. 1 1 -12 . - 16 - These banks were the i n s t r u m e n t s by which I n d i a n n a t i o n a l i s t s hoped e v e n t u a l l y t o compete on even terms w i t h the f o r e i g n i n s t i t u t i o n s . However, the owner-managers o f the newly e s t a b l i s h e d b a n k i n g e n t e r p r i s e s o f t e n l a c k e d t h e e x p e r i e n c e and f o r e s i g h t which would have saved them from a good many subsequent d i s a s t e r s . They i n v e s t e d t h e i r funds i n h i g h y i e l d i n g , n o n - l i q u i d s e c u r i t i e s and o f t e n kept low cash r e s e r v e s and p a i d h i g h i n t e r e s t r a t e s to, a t t r a c t d e p o s i t s b e f o r e and d u r i n g World War I . Many of the banks l e n t money on what e v e n t u a l l y proved t o be unsound b u s i n e s s u n d e r t a k i n g s . They a l s o f i n a n c e d t h e i r own o f t e n s p e c u l a t i v e t r a d i n g and m e r c a n t i l e e n t e r p r i s e s w i t h the r e s u l t t h a t most o f the s m a l l banks and a few l a r g e ones f a i l e d t o s u r v i v e the war p e r i o d . P r o f e s s o r J a i n p l a c e s the number o f f a i l u r e s which o c c u r r e d between 1913 and 1918 at 87 w i t h a combined paid-up c a p i t a l o f Rs. 1 7 , 5 0 0 , 0 0 0 . T h i s l a t t e r sum r e p r e s e n t e d more t h a n h a l f o f the t o t a l p a i d - u p c a p i t a l o f a l l j o i n t s t o c k banks t h a t were o p e r a t i n g a t the b e g i n n i n g 26 of t h i s p e r i o d . The p o s t World War I r e c o v e r y and the e s t a b l i s h m e n t o f the I m p e r i a l Bank of I n d i a i n 1 9 2 1 i n i t i a t e d a n o t h e r p e r i o d o f e x p a n s i o n of I n d i a n j o i n t b a n k i n g i n s t i t u t i o n s . Many new b a n k i n g t r a d i n g v e n t u r e s sprang up i n U t t a r P a r d e s h , Punjab and Western I n d i a , d u r i n g the f o l l o w i n g t e n y e a r s ; b u t , l i k e some of t h e i r p r e d e c e s s o r s , were e i t h e r p o o r l y c o n c e i v e d o r mismanaged. Co n s e q u e n t l y many of them f a i l e d d u r i n g the Great D e p r e s s i o n . A c c o r d i n g t o P r o f e s s o r s J a t h e r and B e r i the f a i l u r e s had many d i f f e r e n t c a u s e s . They l i s t 26. J.P. J a i n ^ I n d i a n B a n k i n g A n a l y s e d , Rajhan P u b l i c a t i o n s , D e l h i , 1 9 4 9 , pp- 1 9 - 2 0 . i ) the absence of a strong central bank; i i ) inadequate banking • legis lat ion; i i i ) lack of experience among the Indian bankers; iv) high rates of interest to attract deposits; v) indulgence in speculative act iv i t ies; (vi) dishonesty, fraud and mismanagement v i i ) cyc l ica l fluctuations in Indian agriculture and business act iv i ty; and f inal ly v i i i ) the negligence of the Indian Government i t s e l f . In spite of failures and other shortcomings' there was a substantial increase in the number and deposits of the Joint Stock banking enterprises between 1920 and ±935> The number of reporting Indian Joint Stock Banks increased from 2 to 38 and their deposits from Rs. 1,400,000 to Rs. 844 ,500,000. A summary of their development i s presented in table 1 on page 18. 18 Table 1 Number, Principal Assets and Liabilities of Indian Joint Stock Banking enterprises Between 1870-1935 No. of Cash in Loans Reporting Capital hand and and Year Banksl Funds Deposits at Banks^ Investments 1870 2 1.2 1.4 0.5 0.9 1875 3 1.7. 2.8 0.7 2.1 1880 3 2.1 6.3 1.7 4.6 1885 4 2.4 9.4 2.1 7.3 1890 5 5.1 27.1 5.6 21.5 1895 8 9.4 56.5 9.7 46.8 1900 9 12.8 80.8 11.9 69.9 190C5 9 16.2 119.9 17.4 102.5 1910 16 37.6 256.6 28.0 228.6 1912 18 42.6 272.6 40.0 232.6 1914 17 39.3 171.1 35.3 135.8 1915 20 43.8 178.7 39.9 138.8 1916 28 46.1 247.1 60.3 186.8 1918 19 60.2 405.9 84.9 311.0 1920 25 109.2 711.5 163.1 548.4 1925 28 106.0 544.9 101.0 443.9 1930 31 119.0 632.6 76.8 555.8 1935 38 132.0 844.5 191.2 653.3 Source: Adapted from Reserve Bank of India, Monetary and Banking Statistics of India, Bombay, 1954, p. 14. 1 Banks with Capital funds of Rs 500,000 or over. 2 Including gold bullion. Note: Loans and Investment column is derived by subtracting cash, etc. from total deposits. - 19 - The d a t a i n t h i s t a b l e r e v e a l t h a t u n t i l 1900 the p r o g r e s s o f these b a n k i n g e n t e r p r i s e s was r e l a t i v e l y slow. By the end of the 19th c e n t u r y t h e r e were o n l y 9 r e p o r t i n g banks w i t h d e p o s i t s o f Rs. 80,800,000 and e a r n i n g a s s e t s amounting t o Rs. 69,900,000. However, a f t e r 1905, when the N a t i o n a l i s t s movement s t a r t e d , t h e s e banks made c o n s i d e r a b l e headway. Between 1905 and 1912 t h e i r number i n c r e a s e d from 9 t o 18 and t h e i r d e p o s i t s , from Rs. 119,900,000 to Rs. 272,600,000 - about 100 and 240 per cent, r e s p e c t i v e l y . D u r i n g the same p e r i o d t h e i r e a r n i n g a s s e t s i n c r e a s e d from Rs. 102,500,000 to Rs. 232,600,000. Between 1912 and 19l8 the number o f t h e s e banks remained r e l a t i v e l y unchanged; i . e . , new banks d i d not exceed the number o f bank f a i l u r e s . However, t h e r e was a sha r p d e c l i n e i n t h e i r d e p o s i t s from Rs. 273,000,000 t o Rs. 171,000,000 between 1912 and 1914. A f t e r t h e l a t t e r y e a r t h e i r d e p o s i t s s u b s t a n t i a l l y i n c r e a s e d and r e a c h e d Rs. 406,000,000 by the end of 1918. D u r i n g the same time t h e i r e a r n i n g a s s e t s i n c r e a s e d by about 240 per c e n t . T h i s i n c r e a s e i n t h e i r d e p o s i t s and e a r n i n g a s s e t s , w i t h o u t an i n c r e a s e i n t h e i r number, may be a t t r i b u t e d t o the expa n s i o n o f I n d i a n t r a d e and i n d u s t r y d u r i n g World War I . Between 1918 and 1920 t h e r e was a sharp i n c r e a s e i n t h e i r number, d e p o s i s t s , c a p i t a l funds and e a r n i n g a s s e t s - about 33%, 80%, 90%, and 77%, r e s p e c t i v e l y . A f t e r the year 1920 t h e i r number c o n t i n u e d t o r i s e and reac h e d 38 by the end of 1935. However t h e i r d e p o s i t s d e c r e a s e d between 1920 and 1925 from Rs. 712,000,000 t o Rs. 544,000,000 but r o s e t o Rs. 844,500,000 by the end of 1935- Between 1920 and 1925 t h e i r e a r n i n g a s s e t s dipped from Rs. 548,400,000 t o Rs. 444,000,000, and the n i n c r e a s e d t o Rs. 653,300,000 by the end o f 1935- - 20 - P a r t 3. The P r e s i d e n c y Banks U n t i l the end o f the l 8 t h c e n t u r y the ba n k i n g b u s i n e s s o f the Ea s t I n d i a Company was handled by agency-house banks and Ind i g e n u o u s b a n k e r s . The Company i t s e l f appears t o have been r e l u c t a n t t o engage i n b a n k i n g e n t e r p r i s e s . However, the s e r v i c e s o f the I n d i a n b a n k e r s and the agency-house banks were o f t e n i n a d e q u a t e and, a t t i m e s , u n r e l i a b l e . Moreover the f a i l u r e o f the B e n g a l Bank and the G e n e r a l Bank o f , I n d i a - i n s t i t u t i o n s t h a t had handled the Company's b a n k i n g b u s i n e s s v i n the e a r l y 1790's-and the u n c e r t a i n f u t u r e o f more r e c e n t l y e s t a b l i s h e d banks l e d the Company t o sponsor and t o i n v e s t i n b a n k i n g i n s t i t u t i o n s d e s i g n e d t o handle i t s b a n k i n g b u s i n e s s and, a t the same t i m e , t o s u p p o r t the agency-house banks s t i l l i n e x i s t e n c e . The f i r s t o f these v e n t u r e s was e s t a b l i s h e d i n I 8 0 6 . L a t e r on i n J a n u a r y 1809, i t was i n c o r p o r a t e d by the Company as the P r e s i d e n c y Bank o f B e n g a l . (The word P r e s i d e n c y i s the I n d i a n e q u i v a l e n t o f a p r o v i n c e o r s t a t e ) . Two o t h e r p r o v i n c i a l b a n k i n g i n s t i t u t i o n s , t h e P r e s i d e n c y Bank of Bombay and the P r e s i d e n c y Bank o f Madras were e s t a b l i s h e d i n 1840 and 18V5, r e s p e c t i v e l y . C a p i t a l i s a t i o n The P r e s i d e n c y Bank of Ben g a l s t a r t e d i t s o p e r a t i o n s w i t h a f u l l y p a i d - u p c a p i t a l of Rs. 5,000,000 e q u a l l y d i v i d e d i n t o 500 s h a r e s . Of t h i s c a p i t a l Rs. : 1,000,000 was s u p p l i e d by the Company and t h e b a l a n c e , m o s t l y by Europeans. The share c a p i t a l o f the - 21 - P r e s i d e n c y Bank o f Bombay was Rs. 5!~ 000,000; t h a t o f the P r e s i d e n c y Bank o f Madras was Rs. 3,000,000* As i n the P r e s i d e n c y Bank o f B e n g a l , t h e Company h e l d s u b s t a n t i a l i n v e s t m e n t s i n b o t h o f the l a t t e r i n s t i t u t i o n s . The Company had the r i g h t t o a p p o i n t t h r e e of t h e d i r e c t o r s of each o f thes e banks. I n o r d e r t o ensure t r a i n e d p e r s o n n e l t h e i r s e c r e t a r i e s and t r e a s u r e r s were drawn from 27 the I n d i a n C i v i l S e r v i c e . F u n c t i o n s The P r e s i d e n c y Banks a c c e p t e d d e p o s i t s and made l o a n s and advances t o merchants and t r a d e r s . They a l s o n e g o t i a t e d domestic b i l l s o f exchange and i n v e s t e d i n s e c u r i t i e s of the Company and o t h e r government b o d i e s . They were a l l o w e d t o buy and s e l l g o l d and s i l v e r , and were a u t h o r i s e d t o a c t as the Company's f i s c a l agent i n the P r e s i d e n c y c a p i t a l s . They were a l s o a l l o w e d t o manage the f i s c a l a f f a i r s o f some of the m u n i c i p a l i t i e s . These banks d i d not compete w i t h o t h e r b a n k i n g e n t e r p r i s e s i n the f i e l d o f i n t e r n a t i o n a l f i n a n c e . They were f o r b i d d e n t o t r a d e i n c o i n s o r p r e c i o u s m e t a l o r t o un d e r t a k e the f i n a n c i n g o f e x t e r n a l t r a d e . They were not a l l o w e d t o r a i s e money o u t s i d e o f I n d i a o r to open branches i n any o t h e r c o u n t r y . I n a d d i t i o n t o t h e i r f i s c a l o p e r a t i o n s , t h e P r e s i d e n c y Banks unde r t o o k o t h e r d u t i e s u s u a l l y a s s o c i a t e d w i t h a c e n t r a l bank. As i m p l i e d above, they a c t e d as f i s c a l a g ents f o r the government o f I n d i a - the East I n d i a Company. They a l s o h e l d government b a l a n c e s i n t h e P r e s i d e n c y towns. As a banker's banks, they f r e q u e n t l y h e l d 27- S.G. P a n a n d i k a r , op. c i t . p. 5. - 22 - t h e c a s h b a l a n c e s of o t h e r b a n k i n g i n s t i t u t i o n s and a s s i s t e d them i n t i m e s o f s t r e s s . D u r i n g the 1829-33 commercial d i s a s t e r , when many b a n k i n g e n t e r p r i s e s f a i l e d , t h e p r e s i d e n c y Bank of B e n g a l 28 advanced Rs. 300,000 t o the H i n d o s t a n Bank. Under i t s c h a r t e r the P r e s i d e n c y Bank of Bengal was empowered to i s s u e c u r r e n c y notes p r o v i d e d t h a t i t s t o t a l nore l i a b i l i t y d i d not exceed i t s c a p i t a l o f Rs. 500 , 0 0 0 ; p r o v i d e d a l s o , t h a t i t s c a s h 29 on hand d i d not f a l l s h o r t of o n e - t h i r d of i t s demand l i a b i l i t i e s . As the Bank g a i n e d e x p e r i e n c e and demonstrated i t s s t a b i l i t y , t h e s e l a t t e r r e s t r i c t i o n s were g r a d u a l l y r e l a x e d . The P r e s i d e n c y Banks of Bombay and Madras, which were e s t a b l i s h e d somewhat l a t e r , were a l s o g r a n t e d p r i v i l i g e s s i m i l a r t o those of the P r e s i d e n c y Bank o f B e n g a l . On March 1, 1862, when the management of a l l paper c u r r e n c y was t a k e n o v e r by the I m p e r i a l Government of I n d i a , the note i s s u i n g p r i v i l i g e s o f the P r e s i d e n c y Banks were withdrawn. T h e r e a f t e r , the l e n d i n g a c t i v i t i e s of these banks were governed by the e x t e n t o f t h e i r c a p i t a l funds and the d e p o s i t s o f t h e i r customeers. As a p a r t i a l compensation f o r the r e s t r i c t i o n on t h e i r f i s c a l a c t i v i t i e s , the i n t e r e s t payment r e q u i r e d on government b a l a n c e s was s e t a s i d e . I n I876 the government o f I n d i a s o l d i t s i n t e r e s t i n t h e s e banks and w i t h d r e w from t h e i r management. However t o ensure t h a t t h e s e banks would not compete w i t h the exchange banks, which meantime had 28. V e r a A n t s e y , The Economic Development o f I n d i a , Longmans, Green and Company, London, 193&, p. 405. 2 9 * Reserve Bank of I n d i a , B a n k i n g and Monetary S t a t i s t i c s o f I n d i a . , Bombay, 1954, p. 3« ) - 23 - e s t a b l i s h e d themselves i n I n d i a , a n d i n d u l g e i n s p e c u l a t i v e a c t i v i t i e s the government o f I n d i a passed the P r e s i d e n c y Bank A c t o f 1876. Under t h i s measure i t was s t i p u l a t e d t h a t t h e s e b a n k s ^ 1 1. c o u l d not.draw, d i s c o u n t , buy o r s e l l b i l l s o f exchange u n l e s s t h e y were payable i n I n d i a or C e y l o n ; 2. t h a t t h e y c o u l d not borrow money o r r e c e i v e d e p o s i t s p a y a b l e o u t s i d e I n d i a or m a i n t a i n a f o r e i g n b a l a n c e o r agency f o r t h i s and s i m i l a r p urposes. I n o r d e r t o a s s u r e the s a f e t y of t h e s e banks' d e p o s i t s , t h i s A c t a l s o p r o v i d e d t h a t the P r e s i d e n c y Banks 3- c o u l d not l e n d f o r a p e r i o d l o n g e r than 6 months, and c o u l d not advance f u n d s , on the s e c u r i t y of immoveable p r o p e r t y , o r p r o m i s o r y n o t e s b e a r i n g l e s s t han two names; o r on p e r s o n a l s e c u r i t y . W ith t h e s e s t a t u t o r y s a f e g u a r d s i n f o r c e , the government o f I n d i a e n t r u s t e d some of i t s b a n k i n g b u s i n e s s to these banks. T h i s government patronage enhanced t h e i r p o s i t i o n i n t h e i r r e s p e c t i v e communities and h e l p e d t o a t t r a c t t o them a l a r g e amount o f b u s i n e s s from p u r e l y p r i v a t e e n t e r p r i s e s . P r o g r e s s t o 1935 I n s p i t e of t h e s e v e r a l r e s t r i c t i o n s imposed upon them, the P r e s i d e n c y Banks enjoyed no i n c o n s i d e r a b l e growth and p r o s p e r i t y . The i n c r e a s e ' i n t h e i r b a n k i n g o p e r a t i o n s was e q u a l l y as g r e a t as t h a t o f the I n d i a n j o i n t s t o c k b a n k i n g e n t e r p r i s e s as w e l l as t h a t o f the 32 Exchange Banks* N e i t h e r the j o i n t s t o c k banks nor the Exchange 30. i n f r a . , see p a r t k. p.g6 31. J.M. Keynes, I n d i a n C u r r e n c y and F i n a n c e N M a c m i l l a n and Company L t d , London, 1913. pp. 201-02. 32. See P a r t 4, p. 26 - 2k - banks were restricted in their operations. In fact the limitations imposed on the Presidency banks proved to be a blessing in disguise. They were shielded from the speculative act ivit ies which sounded the death-knell of many less restricted banking institutions. As Professor Keynes rightly pointed out "the restrictions under which they work have in the past contributed beyond doubt, to their s tabi l i ty". In 1920 these banks were amalgamated under the name of the Imperial Bank of India. Inaridition to ordinary banking act iv i t ies the latter inst itution served as the country's only central bank unt i l the establishment of the Reserve Bank of India in 1935« The progress made by the Presidency Banks before their amalgamation in 1920, and by their successor the Imperial Bank, between 1922 and 193^ i s shown in table 2 on page 25. The data in this table disclose that, while Government deposits of the Presidency Banks increased by about 60 per cent between 1870 and 1920, their private deposits increased by almost 1200 per cent during the same period. Even the banking di f f icul t ies of World War I, during which almost one-half of the Indian Joint Stock Banks fa i led, had l i t t l e i l l - e f f ec t on the operation of the Presidency Banks. In fact their private deposits almost doubled, increasing from Rs. 358,000,000 millions in 1912 to Rs. 509,000,000 in 1918. This shows that the Presidency Banks continued to hold the confidence of their customers and thus came through the 1913^18 banking cr i s i s unscathed. This table also reveals a decline in the Presidency Banks' Cash/deposit rat io , indicating the extent to which these Banks were 33- J.M. Keynes, op. c i t . , p. 203- 25 Table 2 P r i n c i p a l A s s e t s and L i a b i l i t i e s o f t h e P r e s i d e n c y Bank s — 1870-1920, and t h e I m p e r i a l B a n k , 1920-1935 (Rs.000,000) j Ca sh and G o v ' t . P r i v a t e Due f r o m Y e a r C a p i t a l R e s e r v e s D e p o s i t s D e p o s i t s Bank s I n v e s t m e n t Loan s 1870 33.6 2.6 54.3 64.0 99.7 13.0 5.6 1875 37.6 4 .2 49.8 50.7 69.5 24.9 6 .1 1880 35.0 '< 5.5 29.1 84.9 74.1 25.5 14.4 1885 35.0 7.7 23.1 76.9 59.7 18.2 22.1 1890 35.0 9 .8 35.9 147.6 129.7 33.4 20.4 1895 35.0 14.0 33.3 131.2 77.0 27.8 59.7 1900 36.0 20.0 28.1 128.8 50.4 30.3 76.2 1905 36.0 , 26.3 31.2 222.6 82.3 41.0 130.5 1910 36.0 r 33.1 42.4 323.0 113.5 61.0 190.9 1912 37.5 36.4 42.7 358.0 117.8 64.3 21816 19U 37.5 38.9 56.2 400.4 208.4 96.2 152.0 1915 1916 1918 37.5 37.5 37.5 37.3 36.1 34.5 48.9 52.1 86.4 386.1 447.1 509.8 146.5 172.5 170.8 125.8 124.5 127.4 162.7 202.0 298.0 1920 37.5 37.8 90.3 772.6 260.3 142.4 460.2 1922 56.2 40.6 156.3 617.8 259.4 109.4 490.6 1924 56.3 45 .1 184.3 738.6 200.2 138.4 697.5 1925 56.3 47.2 168.4 727.1 255.2 155.5 591.5 1926 56.3 48.8 169.6 748.7 541.8 185.4 471.6 1928 56.3 1 51.5 66.5 713.1 146.4 225.2 530.1 1930 56.3 53.5 144.9 717.7 185.4 292.9 478.5 1932 56.3 50.9 96.7 633.1 178.6 266.4 381.1 1934 56.3 52.5 72.2 7481 199.4 460.2 250.8 1935 56.3 53.9 — 749.9 177.6 421.3 258.8 S o u r c e : R e s e r v e Bank o f i n d i a , B a n k i n g and M o n e t a r y S t a t i s t i c s o f I n d i a . Bombay, 1954, p p . 10-11, and 30-31. N o t e : The Loan s and Advance s c o l umn i s d e r i v e d b y s u b t r a c t i n g t o t a l i n v e s t m e n t p l u s Ca sh b a l a n c e s f r o m t h e t o t a l d e p o s i t s . - 26 - a b l e t o put the Country's l i q u i d a s s e t s t o good use. Whereas t h i s r a t i o was as h i g h as 80% d u r i n g the l870's, i t had dropped to as low as 30% by 1920. The b a l a n c e had gone i n t o i n v e s t m e n t p o r t f o l i o , and i n t o l o a n s and advances. The former i n c r e a s e d from Rs. 13,000,000 i n 1870 to Rs. 41,000,000 i n 1910 and had rea c h e d Rs. 142,000,000 m i l l i o n s by 1920. The l a t t e r i n c r e a s e d from Rs. 5,600,000 i n I870 t o Rs. 76,000,000 i n 1900 and had r i s e n t o Rs. 460,000,000 by 1920 - a s u b s t a n t i a l sum i n d e e d . The p r o g r e s s made by the s u c c e s s o r ^ ..Imperial Bank though s u b s t a n t i a l was not so s p e c t a c u l a r . I n s p i t e o f i t s r o l e as a s e m i - c e n t r a l bank, i t s government d e p o s i t s a c t u a l l y d e c r e ased and t h e g a i n s made i n p r i v a t e d e p o s i t s - from Rs.617,000,000 i n 1922 t o Rs. 717,000,000 i n 1930 - was not phenomenal. D u r i n g the Great D e p r e s s i o n of the 1930's b o t h p u b l i c and p r i v a t e d e p o s i t s d e c l i n e d s u b s t a n t i a l l y . I n 1935 p r i v a t e d e p o s i t s were s t i l l below the peak r e c o r d e d i n 1926. P a r t 4 . ' The Exchange Banks A l t h o u g h ' a s t u d e n t o f b a n k i n g would g e n e r a l l y d e f i n e an exchange bank as a b a n k i n g i n s t i t u t i o n t h a t s p e c i a l i z e s i n f i n a n c i n g f o r e i g n t r a d e o r d e a l s i n f o r e i g n exchange, t h i s i s not so i n I n d i a . To the n a t i v e I n d i a n an exchange bank s i g n i f i e s a bank t h a t has i t s head o f f i c e o u t s i d e I n d i a and i s owned and o p e r a t e d by f o r e i g n e r s . The e x a c t date of t h e e s t a b l i s h e m n t o f the f i r s t o f t h e s e banks i s not known. However, i t i s g e n e r a l l y agreed t h a t they s t a r t e d o p e r a t i o n s d u r i n g the e a r l y 1850's s h o r t l y b e f o r e the Government o f I n d i a was t r a n s f e r r e d t o the - 27 - 34 B r i t i s h P a r l i a m e n t . S i n c e the P r e s i d e n c y Banks were not a l l o w e d to d e a l i n f o r e i g n exchange or t o f i n a n c e e x t e r n a l t r a d e , and the n a t i v e bankers had l i t t l e e x p e r i e n c e i n t h i s f i e l d , the p r o s p e c t s f o r t h e s u c c e s s o f f o r e i g n banks were undoubtedly b r i g h t . Branches of l e a d i n g B r i t i s h banks came f i r s t , soon t o be f o l l o w e d by branches of t h e i m p o r t a n t banks of o t h e r European c o u n t r i e s . By 1917 t h e r e were 10 exchange banks o p e r a t i n g branches i n most of the i m p o r t a n t 35 t r a d i n g c e n t r e s . The Exchange Banks may be d i v i d e d i n t o two c a t e g o r i e s - t h o s e which d i d a l a r g e p o r t i o n of t h e i r b u s i n e s s i n I n d i a , and t h o s e which had s m a l l b u s i n e s s t r a n s a c t i o n s i n I n d i a . The C h a r t e r e d Bank o f I n d i a , A u s t r a l i a and C h i n a ; the N a t i o n a l Bank of I n d i a ; the M e r c a n t i l e Bank of I n d i a ; the E a s t e r n Bank, and M e s s r s Cox and Company d i d most o f t h e i r f o r e i g n b u s i n e s s i n I n d i a i t s e l f . The Hong Kong and Shangai B a n k i n g C o r p o r a t i o n , t h e I n t e r n a t i o n a l B a n k i n g C o r p o r a t i o n , the Yokohama Bank, the C o m p t o i r N a t i o n a l d'Escompte de P a r i s and the R u s s o - A s i a t i c Bank had branches a l l o v e r A s i a and i n the Western 36 hemisphere as w e l l . F u n c t i o n s ; I n s p i t e o f t h e i r f o r e i g n o r i g i n , exchange banks p l a y e d a v i t a l r o l e i n the development of I n d i a n t r a d e and commerce and o c c u p i e d an i m p o r t a n t p l a c e i n the I n d i a n b a n k i n g s t r u c t u r e . They soon extended t h e i r o p e r a t i o n s t o i n c l u d e every i m p o r t a n t type o f b a n k i n g b u s i n e s s a v a i l a b l e t o Commercial banks i n I n d i a . By 1935 when the Reserve Bank 34. G.F. S h i r r a s , , The I n d i a n B a n k i n g and F i n a n c e t M a c m i l l a n & Co, L t d . , London, 1920, p. 344. 35. V e r a A u t s e y , The Economic Development o f I n d i a , Longmans, Green and Company, London, 1936. p. 4o8. 36. G.F. S h i r r a s . , op_. c i t . ' p. 384. - 28 - was formed they had not only acquired a monopoly of the Country's foreign exchange and external traded financing business; they were also important competitors of the Presidency and the Joint stock banks in the purely domestic banking sphere. They financed much of the inland movement and distribution of important merchandise. They also financed much of the outward movement of Indian export products. For this purpose they either maintained sub branches in most of the important' trading and commercial centres or obtained controlling interests in existing joint stock banks through the purchase of share capital . In 1 9 1 7 , the Exchange Banks had 4 6 branch offices in India. The Presidency banks had 69 and the joint stock banks had 199« The deposits of the Exchange banks amounted to Rs. 3^,000,000 as against the Rs. 50,000,000 of the 37 Presidency Banks and Rs. 21,000,000 of the I n d i a n Joint Stock Banks. Their progress is presented in table 3 on page 29. Progress 1870-1935 The,data i n table 3 reveal a gradual increase in the number, deposits and earning assets of (foreign) Exchange Banks from 187O to 1915. During this 45 years interval , their number increased from only 3 to 11 but their deposits, from Rs. 5,200,000 to Rs. 335,500,000 and their estimated earning assets, from Rs. 5,000,000 to Rs. 260,000,000. Durkng the next five years there was relatively rapid increase from 11 to 15 in their number, a doubling of their deposits and earning assets. Between 1920 and 1930, while the number in operation increased from 15 to 18, their deposits had declined from Rs. 748,000,000 to Rs. 681,100,000. During this, time their earning assets had increased 3 7 . G.F. Shirras, op. c i t . , p. 384. 29 Table 3 Number, Deposits, Cash on Hand and Earning Assets of Exchange Banks in India, 1870 to 1935 (Rs.000,000) Cash in Hand . No. of & at banks Estimated foreign Banks (including) Earning Year Represented Deposits ( bullion ) Assets 1870 3 5.2 6.1 — 1875 3 10.7 5.7 5.0 1880 4 34.0 18.0 16.0 1885 4 47.6 13.1 34.5 1890 5 75.4 35.0 40.4 1895 7 103.1 27.6 75.5 1900 8 105.0 24.0 81.0 1905 10 170.4 37.8 132.6 1910 11 247.9 43.9 204.0 1915 11 335.5 76.0 259.5 1920 15 748.1 251.8 496.3 1925 18 705.5 94.2 611.3 1930 18 681.1 77.1 604.0 1935 17 761.8 125.5 636.3 Source: Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, p. 14. Note: Earning Assets are estimated as the difference between deposits and Cash balances. - 30 - from Rs. 4 9 6 , 3 0 0 , 0 0 0 t o Rs. 6 0 4 , 0 0 0 , 0 0 0 . By 1 9 3 5 , t h e i r number< had d e c l i n e d t o 17 but t h e i r d e p o s i t s had r i s e n t o Rs. 7 6 1 , 8 0 0 , 0 0 0 , - somewhat i n excess o f the p r e v i o u s 1920 peak, and e a r n i n g a s s e t s , t o Rs. 6 3 6 , 0 0 0 , 0 0 0 . t h a t of the . L i k e / t h e P r e s i d e n c y Banks, the c a s h - d e p o s i t r a t i o o f th e s e banks d e c r e a s e d s u b s t a n t i a l l y d u r i n g t he p e r i o d under r e v i e w , i n d i c a t i n g , a more e f f e c t i v e use of t h e i r l o a n a b l e f u n d s . I n 1900 t h i s r a t i o was 1 t o 4 . By 1935 i t had d e c l i n e d t o about 1 t o 6 . Meanwhile t h e i r e a r n i n g a s s e t s had grown from an e s t i m a t e d amount o f Rs. 8 1 , 0 0 0 , 0 0 0 t o Rs. 6 3 6 , 3 0 0 , 0 0 0 . The N a t i o n a l P l a n n i n g Committee o f I n d i a a t t r i b u t e d t h e v e r y c o n s i d e r a b l e s u c c e s s o f f o r e i g n owned and o p e r a t e d exchange banks t o t h e competence and e x p e r i e n c e o f t h e i r management, a l s o t o t h e f a c t t h a t down t o 1935 t h e y e n c o u n t e r e d l i t t l e domestic c o m p e t i t i o n . The P r e s i d e n c y Banks were not a l l o w e d t o engage i n the f i n a n c i n g o f e x t e r n a l t r a d e and the J o i n t S t o ck Banks, c o u l d not match the Exchange Banks i n e i t h e r r e s o u r c e s o r e x p e r i e n c e . P a r t 5 . C o o p e r a t i v e Banks I n an attempt t o s o l v e the problems o f r u r a l i n d e b t e d n e s s and u s u r i o u s e x a c t i o n s by the money l e n d e r s , the I m p e r i a l Government o f I n d i a enacted from time t o time l e g i s l a t i o n d e s i g n e d t o a s s i s t t h e a g r i c u l t u r a l communities. The f i r s t o f suc h measures, the Land Improvement Loans A c t , I883 and the A g r i c u l t u r i s t s Loans A c t , 1 8 8 4 , 3 8 . ;K?..T> Shaw, j . Cur r e n c j c -and,; Banking;, r- {Nat ional- PI a nn ing. Committee „ Series) Vora and Co. , Bombay,' 1 9 4 8 . p. 115- - 31 - gave the fa r m e r ' s the r i g h t t o n e g o t i a t e s e c u r e d l o a n s a t the Governments Land Revenue O f f i c e s a t r e a s o n a b l y low r a t e s o f i n t e r e s t . U n f o r t u n a t e l y t h e s e measures d i d not bear much f r u i t . Most o f the people f o r whom these p r i v i l i g e s were i n t e n d e d s t i l l c o u l d n o t o b t a i n c r e d i t because the y had l i t t l e o r no s e c u r i t y t o o f f e r . E s t a b l i s h m e n t Towards the end of N i n e t e e n t h C e n t u r y S i r F. N i c h o l s o n conducted . an e x t e n s i v e e n q u i r y i n t o the problem o f r u r a l i n d e b t e d n e s s i n the s t a t e o f Madras. As a r e s u l t o f t h e e n q u i r y he recommended the i n s t i t u t i o n o f C o o p e r a t i v e C r e d i t S o c i e t i e s , b e l i e v i n g t h a t t h e y would meet the c r e d i t needs o f the r u r a l p e o p l e as w e l l as i n c u l c a t e h a b i t s of t h r i f t and s e l f h e l p among them. "The best way t o do t h i s " he 39 s a i d , "was t o f i n d R a i f f e i s e n " meaning t o e s t a b l i s h c o o p e r a t i v e banks p a t t e r n e d a f t e r the R a i f f e i s e n banks then o p e r a t i n g i n Germany. T h i s s o l u t i o n was a l s o advocated by P r o f e s s o r Dupernex, a t e a c h e r i n one hi of t h e A n g l o - I n d i a n c o l l e g e s , i n h i s P e o p l e ' s Bank i n N o r t h e r n I n d i a . The C o o p e r a t i v e S o c i e t i e s A c t I n k e e p i n g w i t h the N i c h o l s o n and Dupernex recommendations and r e a l i s i n g t h e need f o r such banks i n I n d i a , the I m p e r i a l Government passed the C o o p e r a t i v e S o c i e t i e s A c t i n 190k. The o b j e c t o f t h i s A c t was " t o encourage s e l f h e l p and c o o p e r a t i o n among a g r i c u l t u r i s t s , kl a r t i s a n s and pers o n s o f l i m i t e d means". 39. V e r a A n s t e y , The Economic Development of I n d i a , Longmans, Green and Company, London, 1936. p. 190. ko. i b i d . p. 192. kl. P.A. Wadia and K.T. Merchant. Our Economic Problems, V o r a and Company P u b l i s h e r s (PVT) L t d . , Bombay, 1957-p. 295. - 32 - I t p r o v i d e d f o r t h e e s t a b l i s h m e n t o f a C o o p e r a t i v e Department i n each p r o v i n c e under which C o o p e r a t i v e C r e d i t S o c i e t i e s would be a u t h o r i s e d and r e g i s t e r e d . I t s e t f o r t h the arrangements under which the S o c i e t i e s were t o be formed and the b u s i n e s s p r o c e d u r e s t o be f o l l o w e d . Each s o c i e t y was to c o n s i s t o f persons l i v i n g i n t h e same v i l l a g e o r l o c a l i t y so t h a t the members s h o u l d know each o t h e r s ' p o s i t i o n s and c h a r a c t e r . The w o r k i n g c a p i t a l o f these S o c i e t i e s was t o be o b t a i n e d from membership s u b s c r i p t i o n s , from i n t e r e s t b e a r i n g time d e p o s i t s and from government g r a n t s . Loans c o u l d be made o n l y t o members and were to be g i v e n f o r p r o d u c t i v e purposes o n l y . They were t o be s e c u r e d by e i t h e r r e a l o r p e r s o n a l p r o p e r t y . The C o o p e r a t i v e C r e d i t S o c i e t i e s were c l a s s i f i e d as " r u r a l " o r "urban" a c c o r d i n g t o t h e i r l o c a t i o n and the n a t u r e o f the l i a b i l i t y of t h e i r members. The r u r a l s o c i e t i e s conformed t o the U t o p i a n i d e a l s o f the R a i f f e i s e n S o c i e t i e s and t h e i r members had u n l i m i t e d l i a b i l i t y . The urban s o c i e t i e s f o l l o w e d S c h u l z e - D e l i t z s c h model and g e n e r a l l y had l i m i t e d l i a b i l i t y . Because o f the p o v e r t y o f t h e i r members and a r e s u l t a n t s h o r t a g e o f w o r k i n g c a p i t a l , e a r l y c o o p e r a t i v e c r e d i t s o c i e t i e s d i d not make much headway. In o r d e r t o e n l a r g e the scope o f t h e i r u s e f u l n e s s the Government o f I n d i a passed the C o o p e r a t i v e S o c i e t i e s A c t of 1912 which, amejif o t h e r t h i n g s , p r o v i d e d f o r t h e e s t a b l i s h m e n t of C e n t r a l o r l o c a l d i s t r i c t c o o p e r a t i v e banks; a l s o f o r the e s t a b l i s h m e n t of State c o o p e r a t i v e banks. The C e n t r a l c o o p e r a t i v e banks were d e s i g n e d t o c o o r d i n a t e the a c t i v i t i e s of the p r i m a r y s o c i e t i e s , and S t a t e coop- e r a t i v e bankswere de s i g n e d t o s u p e r v i s e and to promote t he e x p a n s i o n o f - 33 - the whole system; also to provide a channel for State grants to Control and Primary banks. The Primary credit societies characteristically became members of the Central Cooperative banks and the latter in turn became members of the State Cooperative banks. Both the State and Central cooperative banks also had some individual members. The working capital of the Central cooperative banks is built up from deposits of Primary credit § o c i e t i e s ; also from individuals both members and non-members, membership fees and from advances from the State cooperative banks. The working capital of State cooperative banks is built up from deposits of Sentral cooperative banks and individuals - both members or non members; from membership fees and advances from State Governments. On occasion commercial banks find i t convenient to maintain deposit accounts in the State cooperative banks. The management of the-.Cooperative banks is quite simple and direct. The operations of the Primary credit societies are in the hands of the members themselves and are generally recorded by a paid secretary who may or may not be a member of the society. The operations of the Central and the State cooperative banks are delegated to a paid secretary - manager designated by the Registrar of the Cooperative Departments of the respective States. Unti l 1917 the Cooperative banks were under the supervision of the Central Government of India. During that year their supervision was transferred to their respective State Governments with the result that there has since been no particular uniformity in their conduc t. - 34 - I n t e r e s t r a t e s charged by each t i e r i n the s t r u c t u r e v a r y f r o m s t a t e t o s t a t e as does t he c h a r a c t e r o f the l o a n s g r a n t e d . Even s o , i n t e r e s t r a t e s g e n e r a l l y a r e much l o w e r than those charged by competing money l e n d e r s and i n d i g e n o u s b a n k e r s . C o o p e r a t i v e C r e d i t S o c i e t i e s have charged as a r u l e between 6% and 25% f o r t h e i r l o a n s i n c o n t r a s t t o t h e 15% t o as much as 240% charged by the money l e n d e r s . One o f the more b e n e f i c i a l r e s u l t s o f the e s t a b l i s h m e n t o f the C o o p e r a t i v e banks was the subsequent r e d u c t i o n i n the r a t e s charged by t h e l o c a l 42 money l e n d e r s . P r o g r e s s t o 1935 A l t h o u g h by 1935 Cooperative C r e d i t S o c i e t i e s and C o o p e r a t i v e banks had T !.;:•..,/ been e s t a b l i s h e d o n l y i n the s t a t e s of Madras, Bombay, and U t t a r P a r d e s h , t h e i r o p e r a t i o n s had become, n e v e r - t h e - l e s s , q u i t e s i g n i f i c a n t f o r t h e ds>untry as a whole. S t u d i e s made by the s t a f f o f the Reserve Bank o f I n d i a i n d i c a t e t h a t about 800 P r i m a r y C r e d i t S o c i e t i e s w i t h a membership o f about 90,800 were i n o p e r a t i o n i n 1907» T h e i r c a p i t a l and r e s e r v e s amounted t o Rs. 600,000 and t h e i r borrowed funds and d e p o s i t s t o Rs. 1,800,000. By 1935, the time o f the e s t a b - l i s h m e n t o f t h e Reserve Bank o f I n d i a , the number o f P r i m a r y C r e d i t S o c i e t i e s had grown t o 104,974 and t h e i r membership t o 4,592,448. On t h i s l a t t e r date t h e i r c a p i t a l and r e s e r v e amounted t o Rs. 292,000,000; t h e i r borrowed funds and d e p o s i t s , t o Rs. 676,800,000. .. ., ?•'<: Dafai, showing t h e i r p r o g r e s s between 1907 and 1935 a r e g i v e n i n s e c t i o n A of t a b l e 4./on page 37. 42. V e r a . A n s t e y , op_. c i t . , pp. 195-96. - 35 - Data f o r the C e n t r a l C o o p e r a t i v e banks a r e a v a i l a b l e f rom 1916 onward and r e v e a l t h a t t h e number o f these i n s t i t u t i o n s c o n t i n u o u s l y i n c r e a s e d from 239 on t h a t date t o 615 i n 1935. However, a p a r a l l e l c o n t i n u o u s growth was not r e c o r d e d i n t h e number of t h e i r i n d i v i d u a l members, and P r i m a r y C r e d i t S o c i e t i e s . The number of i n d i v i d u a l members r o s e from 33,000 i n 19l6 to a peak o f 112,000 i n 1925, and s u b s e q u e n t l y d e c l i n e d t o 85,000 i n 1935. The number o f member s o c i e t i e s i n c r e a s e d from 11,800 i n 19l6 t o 101,500 i n 1930, t h e n d e c l i n e d t o 89,100 i n 1935• I n s p i t e o f the d e c l i n e i n t h e i r membership, the w o r k i n g c a p i t a l o f the C e n t r a l C o o p e r a t i v e banks c o n t i n u e d t o i n c r e a s e and reac h e d Rs. 61,000,000 i n 1935. No doubt, because o f the i n c r e a s e d a v a i l a b i l i t y o f membership funds the amount o f borrowed funds and d e p o s i t s decreased meanwhile from a peak o f Rs. 261,900,000 i n 1930 t o Rs. 233,000,000 i n 1935. The average w o r k i n g c a p i t a l p e r C e n t r a l C o o p e r a t i v e bank,made up o f memberships, d e p o s i t s and borrowed f u n d s , i n c r e a s e d from a p p r o x i m a t e l y Rs. 136,000 to Rs. 478,000 d u r i n g the same t i m e . / .' .'.ve y- - r " " Data showing t h e i r growth between 19l6 and 1935 a r e g i v e n i n S e c t i o n B of Table 4.on page 37. Between 1916 and 1935 the number o f S t a t e C o o p e r a t i v e banks i n c r e a s e d from f i v e t o e l e v e n ; t h e number of t h e i r i n d i v i d u a l members from 2,000 t o 3,000; and the number o f P r i m a r y C r e d i t S o c i e t i e s and C e n t r a l banks, from l600 t o 19,400. T h e i r w o r k i n g c a p i t a l r o s e from Rs. 7,700,000 i n 1916 to Rs. 116,400,000 i n 1935, r e v e a l i n g an average per s t a t e c o o p e r a t i v e bank o f Rs. 1,540,000 i n 19l6 and Rs. 10,580,000 i n 1935. I n 1916, t h e i r borrowed funds and d e p o s i t s h e l d amounted t o Rs. 6,400,000. By 19351 the amount had r i s e n t o - 36 - Rs. 100,900,000. • -jV. ij-j Data, showing t h e i r p r o g r e s s between 1916 and 1935 are g i v e n i n S e c t i o n C of T a b l e '4,on page 37. In-as-much as the d a t a a v a i l a b l e u n t i l 1935 do not r e v e a l the t o t a l amount of l o a n s o u t s t a n d i n g t o members as o f any p a r t i c u l a r date., t h i s i n f o r m a t i o n c o u l d not be i n c l u d e d i n the t a b l e . One c o u l d assume, however, t h a t about 90 p e r c e n t o f the w o r k i n g c a p i t a l o f t h e s e banks '.was. a t a l l t i m e s employed. These i n s t i t u t i o n s always appear t o have had a g r e a t e r demand f o r l o a n s from members t h a n t h e i r a v a i l a b l e w o r k i n g c a p i t a l would p r o v i d e . I t s h o u l d perhaps be noted t h a t one of the c o n t i n u i n g problems of t h e C o o p e r a t i v e banks was a s h o r t a g e o f funds which c o u l d s a f e l y be l e n t on a g r i c u l t u r a l l a n d improvements. A l l I n d i a n s t a t e s had made some p r o v i s i o n f o r l o a n s f o r such purposes underthe A g r i c u l t u r i s t s Loans A c t , l884,and the Land Improvements Loan A c t , 1883. A l t h o u g h e a r l y d a t a on the e x t e n t o f such l o a n s a r e not a v a i l a b l e , t h e i r volume i n 1954 was a p p r o x i m a t e l y the same as t h a t r e p o r t e d by the C o o p e r a t i v e 44 banks. . I n 1929 the S t a t e s o f Madras and Bombay undertook t o encourage such l o a n s by the e s t a b l i s h m e n t o f Land Mortgage Banks under the s u p e r v i s i o n o f t h e i r r e s p e c t i v e C o o p e r a t i v e Departments. However d a t a on t h e o p e r a t i o n s of t h e s e i n s t i t u t i o n s a r e not a v a i l a b l e u n t i l 1938, which t a k e s us beyond t he b o u n d a r i e s o f t h i s c h a p t e r . 43. S.G. P a n a n d i k a r , op. c i t . ,p. 139. 44. Reserve Bank o f I n d i a , A l l I n d i a R u r a l Credit.Survey« V o l . I I . G e n e r a l R e p o r t , Bombay.,,,1954, p. 169. Table 4 Number, Membership and Working Capital of Cooperative Credit Institutions in India, 1907-1935. Primary Credit Societies No. Membs. Working Cap.(b) Year Mem- Captl. Depsts. Ending No. bers and & bor. No. of Indiv. Soc. Central Coop. Banks (a) Members ~ Working Cap, (b) Captl. and Depsts. & hoTi State Coop. Banks (a) Members Working Cap.(b) Captl. Depsts. Indiv. Soc. and & bor. in June 000 000 Reserve money Banks 000 000 Resrvs. money 000 000 Resrvs. money 1907 0.8N90.8 0.6 1.8 1910 3.5 230.7 2.6 9.8 1915 17.1 831.7 20.1 68.7 239 33 11.8 5.7 26.6 5 2 1.6 1.3 6.4 1920 39.4 1641.9 52.0 162.1 393 93 29.1 12.2 52.1 7 2 2.8 3.0 21.2 ^ 1925 69.9 2814.2 110.8 371.1 546 112 65.4 26.9 135.1 9 2 10.8 6.0 44.4 1930 102.6 4388.1 212.3 682.9 588 90 101.5 47.1 261.9 10 2 18.6 10.1 76.1 1935 105.0 4592.4 292.0 676.8 615 85 89.1 61.0 233.0 11 3 19.4 15.5 100.9 Source: Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954. Pp. 410, 422, and 384. (a) Figures for Central Coop Banks and State Coop Banks start from the year 1916. (b) Working capital of these banks consists of capital and Reserve funds and deposits and money borrowed from other banks. - 38 - Part 6 Postal Savings Banks A discussion of the ramifications of Indian banking enterprises would not be complete without taking into account the development of the Country's postal saving system, which was instituted to encourage saving habits among the lower income group of Indian population. Some time after the establishment of Imperial rule in India, the Indian Government instituted small d i s tr ic t savings banks in various admin- istrat ive distr icts of Brit ish India. The Presidency Banks had also established savings offices in their respective Presidency towns. No authentic information is available on either the size of these i n s t i - tutions or their number. It is known that these earlier savings offices were eventually absorbed into the Country's postal•savings system which was established in 1882.^ T h e jgtter differs in some respects from the typical postal system of the Western World in that funds may be accumulated either by direct deposits at the post office or by the purchase of' savings certificates from rural mail couriers. In the early years of i ts operation the minimum deposit was 4 annas (a Anna = l / l 6 of a Rupee) or approximately 5 cents. This has since been raised to one Rupee or approximately 21 cents. The original legislation governing the operation of these postal banks limited the amount that any individual may deposit in a single year to Rs. 750; the total of the accumulated deposits to Rs. 5000 for an adult and to Rs. 1000 for a c h i l d . ^ 45 Reserve Bank of India, Banking and Monetary Statist ics of India, Bombay, 1954, p. 366. ^ * S.G. Panandiker, Banking in India, 6th ed.- Orient Longmans L t d . , Calcutta, 1934, p. 148. - 39 - T h i s l i m i t has been r a i s e d from time to t i m e . The most r e c e n t i n c r e a s e was i n 1956 when the N a t i o n a l Government o f I n d i a , i n o r d e r t o m o b i l i s e the s a v i n g s o f lo w e r and m i d d l e c l a s s p e o ple f o r the Second F i v e Year P l a n , r a i s e d t h e maximum to 15,000 f o r an i n d i v i d u a l ; and, t o Rs. 30,000 f o r a j o i n t a c c o u n t . I n t e r e s t at the r a t e o f ZWo was a l l o w e d on d e p o s i t s up to Rs. 10,000 and above t h a t , 2%. Except f o r temporary s e t b a c k s , the P o s t O f f i c e S a v i n g s System has expanded i t s b u s i n e s s c o n t i n u o u s l y . The v e r y c o n s i d e r a b l e amount t h a t thought has been accumulated by p e o p l e , g e n e r a l l y / t o be too i m p o v e r s i h e d t o be c a p a b l e of any t h r i f t whatever, i s t r u e l y r e m a r k a b l e . Between 1885 and 1900 b a l a n c e s i n P o s t a l s a v i n g s banks grew from Rs. 13,^00,000tto Rs. 96,500,000 - an i n c r e a s e of about 700%. By March, 1935 b a l a n c e s had grown t o Rs. 583,000,000 and l a t e r i n f o r m a t i o n r e v e a l s t h a t d u r i n g i960 t h e f i g u r e was i n excess o f Rs. 2,600,000,000. The f i v e y e a r l y d a t a showing the development o f P o s t a l S a v i n g s banks i s shown,in t a b l e 5. on page ho. hi. K.K. Dewett, J.C. S i n g h , I n d i a n Economics, P r e m i e r P u b l i s h i n g Co., D e l h i , 1959, p. 522. \ AO Table 5 Number, Deposits and Balances Outstanding of Postal Saving System Between 1885-1935 (Rs.000,000) Year Number Ended of Balances March Banks Deposits Int. Outstanding 1885 5A99 16.6 O.A 13. A 1890 6350 32.8 2.1 58.7 1900 6A79 A7.0 2.8 96.5 1905 7855 66.7 3.8 134.1 1910 8767 73.7 A.5 158.7 1915 10,161 116.1 5.A 1A8.9 1920 10,670 203.8 5.6 213.5 1925 10,727 205.5 7.1 256.A 1930 12,768 295.9 10.3 371.3 1935 12,679 430.6 13.5 583.0 Sources Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 195A. p. 369. Note: Deposits include Transfer transactions from one Post Office to another from 1900 onward. - ko - CHAPTER I I THE RESERVE BANK OF INDIA The f a i r l y l a t e e s t a b l i s h m e n t o f the Reserve Bank of I n d i a was n o t due t o a r e l a t i v e l y l a t e awakening o f t h e Country t o the advantages of a c e n t r a l b a n k i n g i n s t i t u t i o n . The need f o r a c e n t r a l f i s c a l agency was f e l t as e a r l y as the b e g i n n i n g of the 19th c e n t u r y when the r u l e o f the East I n d i a Company s p r e a d over the v a s t and d i v e r g e n t a r e a s of the Co u n t r y . I n 1809 i t was suggested t h a t the P r e s i d e n c y Bank of Bengal s h o u l d t a k e on thes e f u n c t i o n s . But f o r v a r i o u s r e a s o n s , economic as w e l l as p o l i t i c a l , the s u g g e s t i o n was n o t a c t e d upon. L a t e r , i n 1836 the i d e a o f e s t a b l i s h i n g a c e n t r a l bank p r i m a r i l y f o r f i s c a l o p e r a t i o n s was a g a i n b r o ught up among Company o f f i c i a l s . A c c o r d i n g t o P r o f e s s o r S h i r r a s , a p r o p o s a l was put f o r w a r d d u r i n g t h a t y e a r f o r a " g r e a t banking e s t a b l i s h m e n t f o r B r i t i s h I n d i a " t o f a c i l i t a t e the r e c e i p t o f revenue and i t s subsequent d i f f u s i o n t h r o u g h t h e v a r i o u s c h a n n e l s o f p u b l i c e x p e n d i t u r e , t o f u r n i s h the r e m i t t a n c e t o Great B r i t a i n o f the sums r e q u i r e d t h e r e f o r the Home Charges,"*" and t o enable t h e East I n d i a Company t o a c t up t o the i n t e n t i o n s o f the B r i t i s h P a r l i a m e n t by k e e p i n g t h e government o f I n d i a e n t i r e l y a l o o f from t h a t i n t e r f e r e n c e w i t h the Commerce of I n d i a w h ich the p r e s e n t system o f r e m i t t a n c e i n v o l v e s . But t h e Afghan War of t h e l a t e l830's and the S i k h Wars d u r i n g the l 8 4 0 ' s d i v e r t e d t h e Company's a t t e n t i o n from p r o p o s a l s f o r b a n k i n g r e f o r m t o the e s t a b l i s h m e n t o f i t s p o l i t i c a l a u t h o r i t y o v e r the Country. 1 ' Home charges were t he .payments t h a t I n d i a made to the U n i t e d Kingdom f o r maintence of l a w and o r d e r , P e n s i o n s to B r i t i s h o f f i c e r s and the e x p a t r i a t i o n o f B r i t i s h c a p i t a l i n v e s t m e n t i n I n d i a . p * G.F. S h i r r a s , I n d i a n B a n k i n g and F i n a n c e , M a c m i l l a n , London, 1920, pp. 350-51. - 41 - A f t e r the t r a n s f e r o f Government i h I n d i a from the E a s t I n d i a Company t o the B r i t i s h P a r l i a m e n t i n 1858, a s u c c e s s i o n of n o t e w o r t h y p r o p o s a l s f o r the e s t a b l i s h m e n t o f a c e n t r a l bank i n I n d i a were made. In t h e s e p r o p o s a l s the s t r u c t u r a l needs o f a banking system, as w e l l as t h o s e o f government t r e a s u r i e s were emphasized. There were a l s o some developments i n t h e c e n t r a l b a n k i n g f a c i l i t i e s p r o v i d e d by p r i v a t e banks b e f o r e a f u l l f l e d g e d c e n t r a l bank was a u t h o r i s e d and e s t a b l i s h e d . P a r t 1 Antecedent P r o p o s a l s and I n s t i t u t i o n s James W i l s o n , the fo u n d e r of the "Economist", and the f i r s t f i n a n c e member o f the I m p e r i a l government o f I n d i a , was a l s o the f i r s t a d vocate o f the e s t a b l i s h m e n t o f a f u l l f l e d g e d c e n t r a l bank i n I n d i a . I n 1858, he proposed the i n s t i t u t i o n o f a n a t i o n a l bank c a p a b l e of g r a d u a l l y embracing a l l b a n k i n g o p e r a t i o n s i n I n d i a , and o f e x t e n d i n g i t s b r anches t o the i n t e r i o r t r a d i n g c i t i e s as o p p o r t u n i t y might o f f e r . ^ A s i m i l a r p r o p o s a l , i n c l u d i n g the c o n s t i t u t i o n of the proposed c e n t r a l bank a l o n g l i n e s s i m i l a r t o those o f the Bank of F r a n c e , was put f o r w a r d i n 1870 but n e i t h e r p r o p o s a l bore f r u i t . Between 1870 and 1899 the u n c e r t a i n t y over s i l v e r p r i c e s and consequent changes i n the exchange v a l u e o f the Rupee was a more p r e s s i n g q u e s t i o n t h a n t h a t of a c e n t r a l bank, and no attempt was made t o e s t a b l i s h such an i n s t i t u t i o n d u r i n g t h i s p e r i o d . The q u e s t i o n of a c e n t r a l bank came up b e f o r e the F o w l e r Committee which was s e t up i n 1899 t o e n q u i r e i n t o the f e a s i b i l i t y o f i n t r o d u c i n g G.F. S h i r r a s , "A C e n t r a l Bank f o r I n d i a " , Economic J o u r n a l , V o l . 3 8 , 1928, p. 573. - k2 - a gold standard in India. S ir Everard Hambro of that Committee emphasized, as indeed did the witness Mr. Alfred de Rothschild, the advantages of having a strong central bank to assist in the exercise of current policy and in the development of banking institutions in India. Professor Panandikar claims that a witness before the Fowler Committee,presumably Alfred de Rothschild,advocated the establishment of a central bank but the Government of India, under Lord Curzon, did not favour the proposal.^ In 1913, when the Royal Commission on Indian Finance and Currency, usually known as Chamberlain Commission, was appointed, the proposal for inst i tut ing a central bank in India again came under discussion; this time with greater vigour. The Report of the Commission contained a submission by J .M. Keynes in which a comprehensive plan for a central bank was set out. His proposed inst i tut ion resembled the Bank of France in that i t combined central and commercial banking functions in the same inst i tut ion. Owing no doubt to the outbreak of World War I, this plan as well as other recommendations of the Commission were put aside i n - definitely, contributing l i t t l e i f anything to the central banking inst i tut ion which ultimately emerged. The Imperial Bank Jbciperiment . The large scale bank failures during the World War I and the uncertain exchange value of Indian Rupee thereafter clearly showed the defects and dangers of India's individual ist ic banking structure where G.F.-; Shirras, op. c i t . , p. 5 7 4 5. S.G. Panandikar, Banking in India, Bombay, 1959, Orient Longmans, p. 7. - 43 - each bank conducted i t s b u s i n e s s i n i t s own way w i t h o u t the h e l p o f a c e n t r a l i n s t i t u t i o n . Moreover t h e c l e a r i n g and c o l l e c t i n g a c t i v i t i e s c a r r i e d on by the P r e s i d e n c y Banks d u r i n g the World War I and t h e i r s u p p o r t o f o t h e r b a n k i n g i n s t i t u t i o n s brought t o l i g h t some o f the v e r y r e a l advantages of a f u l l y empowered c e n t r a l i n s t i t u t i o n . T h i s u ndoubtedly l e d t o the f o r m a t i o n o f the I m p e r i a l Bank of I n d i a which i n e f f e c t brought the t h r e e P r e s i d e n c y Banks under one c o n t r o l , and t h u s e n l a r g e d the scope of t h e i r c e n t r a l b a n k i n g a c t i v i t i e s . The I m p e r i a l Bank, however, d i d not c o n s t i t u t e a c e n t r a l bank i n the modern sense. The c o u n t r y ' s c o i n a g e and c u r r e n c y was s t i l l i s s u e d by the C o n t r o l l e r of C u r r e n c y Department, and n e i t h e r t h a t department nor t h e I m p e r i a l Bank e x e r c i s e d any c o n s c i o u s c o n t r o l over the c o u n t r y ' s monetary and b a n k i n g s t r u c t u r e . There was no d e v e l o p e d d i s c o u n t market th r o u g h which I n d i a n banks c o u l d o b t a i n s h o r t term c r e d i t and no o f f i c i a l l e n d e r o f l a s t r e s o r t 1 i n times of emergency. The absence o f adequate r e d i s c o u n t f a c i l i t i e s u n n e c e s s a r i l y t i e d up the l i q u i d funds o f I n d i a n banks refunds which t h e y had t o m a i n t a i n i n o r d e r t o meet u n c e r t a i n cash demands o f t h e i r d e p o s i t o r s . There was no machinery e i t h e r f o r r e g u l a t i n g the i n t e r e s t r a t e s o r - f o r p r o v i d i n g a measure o f u n i f o r m i t y i n them. There was no c e n t r a l a u t h o r i t y t o c o l l e c t d a t a on b a n k i n g o p e r a t i o n s o r t o p u b l i s h i n f o r m a t i o n on the c o n d i t i o n s i n t h e I n d i a n money market. F i n d i n g s of the H i l t o n - Y o u n g Commission I n October 1 9 2 0 , not l o n g a f t e r f o r m a t i o n of the I m p e r i a l Bank o f I n d i a as a s e m i - c e n t r a l bank, the I n t e r n a t i o n a l F i n a n c i a l Conference^, was h e l d a t B r u s s e l s t o s t u d y f i n a n c i a l c r i s e s and the means o f - hh - m i t i g a t i n g t h e i r consequences. Among i t s o t h e r f i n d i n g s was the need f o r the i n s t i t u t i o n of a c e n t r a l bank i n c o u n t r i e s where no such bank e x i s t e d . ^ T h i s i m p l i e d advocacy of a c e n t r a l bank f o r I n d i a was t a k e n up by I n d i a n n a t i o n a l i s t s i n c l u d i n g many I n d i a n b a n k e r s . As a c o n s e q u e n c e , i n 1926 the Government of I n d i a a p p o i n t e d the H i l t o n - Y o u n g Commission t o i n v e s t i g a t e and r e p o r t on the w o r k i n g of the I n d i a n exchange and c u r r e n c y system and t o recommend any changes o r m o d i f i c a t i o n s i n the i n t e r e s t o f the I n d i a n p e o p l e . T h i s Commission l a i d down a b l u e p r i n t f o r a c e n t r a l bank i n I n d i a , a bank which i n o r g a n i z a t i o n and s t r u c t u r e would not be u n l i k e the Bank of E n g l a n d as i t was t h e n c o n s t i t u t e d ; i . e , p r i v a t e ownership and s e p a r a t i o n o f i s s u e and b a n k i n g departments. But the l i n k i n g o f t h i s p r o p o s a l A i t h a h i g h e r exchange r a t e on s t e r l i n g aroused s u s p i c i o n among I n d i a n n a t i o n a l s who not o n l y r e a l i s e d the i n c r e a s e d burden o f t h e new r a t e on I n d i a ' s s t e r l i n g d e b i t but f e a r e d t h a t the c e n t r a l bank might a l s o be used as an i n s t r u m e n t t o e n f o r c e i t . Moreover the Commission had .recommended t h a t the Reserve Bank be a p r i v a t e l y owned i n s t i t u t i o n . T h i s r a n c o u n t e r t o the d e s i r e s o f I n d i a n n a t i o n a l i s t s who f a v o u r e d a p u b l i c owned i n s t i t u t i o n and i n s i s t e d t h a t the c e n t r a l bank s h o u l d be s u b j e c t onljr t o t h e c o n t r o l o f fehe r e p r e s e n t a t i v e p o l i t i c a l assembly r a t h e r t h an t o a body o f p r i v a t e s h a r e h o l d e r s . The l a t t e r t h e y h e l d was l i k e l y t o be c a p t u r e d by v e s t e d i n t e r e s t s w i t h i n and w i t h o u t the C o u n t r y and not o p e r a t e d i n the p u b l i c 7 i n t e r e s t . 6. League of N a t i o n s , The Monetary and Economic C o n f e r e n c e , I n f o r m a t i o n S e c t i o n S e c r e t a r i a t e o f League o f N a t i o n s , Geneva, 1933- P« 36. 7. K.N. R a j , The Monetary P o l i c y and Reserve Bank of I n d i a , N a t i o n a l , I n f o r m a t i o n and P u b l i s h i n g Co.,Bombay, 19^8, p. 6h. - ^5 - I n s p i t e o f the o p p o s i t i o n o f the I n d i a n n a t i o n a l i s t s , t h e I m p e r i a l Government of I n d i a a c c e p t e d the recommendations o f the HJiit on-Young Commission. A c c o r d i n g l y , i n J a n u a r y 1927 i t i n t r o d u c e d the G o l d S t a n d a r d and Reserve Bank o f I n d i a B i l l i n the I n d i a n l e g - i s l a t i v e Assembly. The t h e n f i n a n c e member of the Government of I n d i a commended t h i s B i l l as the g r e a t e s t measure of f i n a n c i a l l i b e r a l i s m 8 ever o f f e r e d t o t h e I n d i a n p e o p l e . The Government o f I n d i a l e f t no s t o n e u n t u r n e d t o p o i n t out the advantages of the B i l l and t o i n f l u e n c e I n d i a n o p i n i o n i n i t s f a v o u r , y e t when the B i l l was r e f e r r e d t o the S e l e c t Committ o f the Assembly, the l a t t e r recommended the f o l l o w i n g f a r r e a c h i n g changes which would have had the e f f e c t o f c r e a t i n g a t r u l y 9 n a t i o n a l i n s t i t u t i o n . 1. E i t h e r the Governor o r Deputy Governor s h o u l d be an I n d i a n n a t i o n a l . 2. The m a j o r i t y o f the members on t h e Board of D i r e c t o r s s h o u l d be of I n d i a n n a t i o n a l i t y . 3. The C a p i t a l of t h e bank s h o u l d be owned and s u b s c r i b e d by the s t a t e . 4. Members o f s t a t e or f e d e r a l l e g i s l a t u r e s s h o u l d not be b a r r e d from membership on the Board of D i r e c t o r s . These recommendations were q u i t e c o n t r a r y t o b o t h Government and • commission p o l i c y as e x p r e s s e d i n t h e B i l l - a p o l i c y which f a v o u r e d p r i v a t e s h a r e h o l d e r s , presumably o p e r a t i n g the bank f o r p r i v a t e g a i n - the arrangements then p r e v a i l i n g i n the U n i t e d Kingdom. The Commission, i t s e l f o v e r w h e l m i n g l y B r i t i s h , was not p r e p a r e d t o assume t h a t a t r u l y n a t i o n a l bank would p l a c e the i n t e g r i t y of money above the f i s c a l needs 8. K-.N. Rati,-op. c i t . , p. 64 9- S.K. Muranjan, Modern Banking i n I n d i a , Kamala P u b l i s h i n g House, Bombay, 1952, p. 246. - 46 - o f government. The economic i n t e r e s t o f t h e members of the Commission d i c t a t e d at l e a s t monetary n e u t r a l i t y ; f o r , r e p r e s e n t i n g a c r e d i t o r c o u n t r y , t h e y were concerned w i t h t h e f i n a n c i a l p o l i c i e s o f I n d i a , t h en g r e a t l y i n debt t o B r i t a i n . I f t h e Reserve Bank were f r e e from p o l i t i c a l p r e s s u r e , i t would f o l l o w the t r a d i t i o n a l B r i t i s h f i n a n c i a l p o l i c y and would h e s i t a t e t o e xperiment w i t h the new i d e a s on monetary r e f o r m then b e i n g d i s c u s s e d i n academic c i r c l e s . As a r e s u l t of t h i s c o n f l i c t o f i d e a s and i n t e r e s t s the Government o f I n d i a w ithdrew the B i l l i n F e b r u a r y 1928 and thus s h e l v e d the i d e a of a c e n t r a l bank f o r I n d i a f o r a few more y e a r s . The Round Table Conference and Emergence of the Reserve Bank o f I n d i a I n 1931i when the Round Table C o n f e r e n c e s between the r e p r e s e n t a t i v e s of t h e I n d i a n p e o p l e and the B r i t i s h government were h e l d to d e c i d e the f u t u r e p o l i t i c a l s t a t u s o f I n d i a , the q u e s t i o n of e s t a b l i s h i n g a c e n t r a l bank was r a i s e d once more; t h i s t i m e w i t h good p r o s p e c t s f o r f a v o u r a b l e a c t i o n . To b e g i n w i t h , I n d i a c o u l d l o o k f o r w a r d w i t h a s s u r a n c e t o l e s s B r i t i s h i n t e r f e r e n c e i n h e r p u r e l y domestic a f f a i r s , i n c l u d i n g the e s t a b l i s h m e n t o f a c e n t r a l bank.,, as l o n g as the l a t t e r appeared t o f a l l w i t h i n the p a t t e r n o f s i m i l a r i n s t i t u t i o n s t h a t were b e i n g e s t a b l i s h e d i n o t h e r commonwealth c o u n t r i e s . Moreover t h e r e appears t o have been a d e s i r e t o g i v e the p e o ple o f I n d i a a g r e a t e r measure of r e s p o n s i b i l i t y i n the management of t h e i r p u b l i c d e b t ; y e t , as shown l a t e r on, the d e s i r e o f I n d i a n n a t i o n a l i s t s f o r a state-owned and o p e r a t e d c e n t r a l bank s t i l l went unheeded. - k? - At the time the Round Table Conference was called, the world appeared to be rapidly sinking into the great Depression of the 1930 ' s . Britain had just gone off the gold standard and the United States appeared to be contemplating a similar action. Then too there was uncertainty over the future of some of the established central banks and misgivings on the prudence of establishment of a new inst i tut ion when the outlook was s t i l l so uncertain. Even so, the complementary nature of the economies.: of the Bri t i sh Empire countries, and a need for Imperial cooperation appeared to ca l l for the early establishment of central banks in a l l Commonwealth countries. It was f ina l ly decided that while the new institution should be established i t s actual opening should be postponed unt i l after the depression had at least indicated i t s course and the country had achieved a favourable balance of trade and a balanced budget. These conditions were realized in 1933• In the Autumn of that year the Government of India introduced the Reserve Bank of India B i l l in the Central Legislative Assembly and piloted i t successfully through both Houses. The B i l l received the assent of the Governor General in March 193^ and became the Reserve Bank of India Act of that date. The Reserve Bank, emerging from this Act, started i t s operations on A p r i l 1 s t , 1935. Subsequent amendments to the Reserve Bank Act have not s ignif icantly altered the basic structure and administration of theReserve Bank i t s e l f . Part 2 Provisions of the Enabling Act The Reseeve Bank of India has i t s head office in Bombay and i t s main branches in Calcutta, Delhi, Madras, Karachi, Lahore, unt i l 19^8 - 48 - in Rangoon, and a branch, in London."^" It i s authorised, subject to government approval, to establish branches or agencies in any other place in India. After 1942, the Reserve Bank ceased to be the central bank of Burma. Like the original Bank of England, the Reserve Bank's Issue and Banking Departments are operated as separate entit ies . Although the Bank is authorised to deal with the public in emergency cases, the Act generally restricts the Banks'operations to banking institutions only. Cap i t a l jjzat ion 'an"d 0 wfle r s hi p'- . -''... Under the enabling Act, the Bank began i t s operations as a private shareholders' inst itution with a paid-up capital of Rs. 50 ,000*000. This capital was divided into 500,000 shares of Rs. 100 each. However, in excess of 900,000 shares were subscribed. In order to ensure a wide and 12 representative distribution of these shares throughout Brit i sh Indxa, the government divided the country into five regional allotment centers; Bombay, Delhi, Calcutta, Madras and Rangoon. The number of shares allotted to these centers were 140,000; 115,000; 145,000; 70,000 and 30,000 respectively. The Government i t s e l f purchases 2200 shares to be held for such directors as might be short of the minimum qualifications of 50 shares. 1^ The share capital of the Reserve Bank could not be increased without the prior approval of the Governor-General in Council and the Central Legislature of India. The extent and manner of such an increase was to be decided by the Bank's shareholders ina general meeting. 11. Government of India. Reserve Bank of India Act, 1934 (as modified up to November 1, 1956.) Section 6, New Delhi, 1957. P-3. 12. At the time of the inception of the Reserve Bank, Burma was also a part of India. 13. In addition to this purchase of share capital , the Government of India transferred to the Bank Rs. 50 ,000,000 worth of govefnment securities which were to serve as additional backing for the treasury note currency taken over by the Bank. - 49 - To keep the Bank i n I n d i a n hands, the A c t s t i p u l a t e d t h a t a s h a r e - h o l d e r of the Bank must be e i t h e r an I n d i a n o r a p e r s o n d o m i c i l e d i n I n d i a . A c o n c e s s i o n was made t o a B r i t i s h s u b j e c t o r d i n a r i l y r e s i d e n t i n I n d i a , but t e m p o r a r i l y d o m i c i l e d i n any p a r t o f the B r i t i s h Empire, p r o v i d e d t h e r e was no l o c a l government d i s c r i m i n a t i o n a g a i n s t I n d i a n s or a g a i n s t I n d i a n companies e i t h e r r e g i s t e r e d under the I n d i a n Companies 14 A c t o r i n c o r p o r a t e d under the law o f any p a r t o f the B r i t i s h Empire. I n o r d e r t o f o r e s t a l l the c o n c e n t r a t i o n of Bank s h a r e s i n a few hands, the A c t put the maximum i n d i v i d u a l h o l d i n g s o r i g i n a l l y a t f i f t y s h a r e s . Somewhat l a t e r t h i s maximum was r a i s e d t o 200 s h a r e s . W h i l e the owner- s h i p o f f i v e s h a r e s e n t i t l e d the h o l d e r t o v o t e , no s h a r e - h o l d e r c o u l d c a s t more than t e n v o t e s i r r e s p e c t i v e o f the number o f s h a r e s h e l d . These p r o v i s i o n s remained s u b s t a n t i a l l y unchanged u n t i l the R e s erve Bank was n a t i o n a l i z e d i n 1948. A d m i n i s t r a t i o n and C o n t r o l The a d m i n i s t r a t i o n of the Reserve Bank, s u b j e c t t o any d i r e c t i o n s from the G o v e r n o r - G e n e r a l - i n - C o u n c i l , w&.s e n t r u s t e d t o a main body made up of a C e n t r a l Board of D i r e c t o r s and f i v e s u b o r d i n a t e L o c a l R e g i o n a l B oards. The f o r m e r c o n s i s t s d o f s i x t e e n members i n c l u d i n g the Governor and two deputy g o v e r n o r s . I n o r d e r t o keep a c l o s e watch o v e r the o p e r a t i o n s of the Bank, the G o v e r n o r - G e n e r a l - i n - C o u n c i l was empowered to nominate the Governor of the Bank and h i s two d e p u t i e s , a f t e r c o n s i d e r i n g the recommendation of the C e n t r a l Board. The Governor G e n e r a l was a l s o a u t h o r i z e d t o nominate f i v e o f the t h i r t e e n o t h e r d i r e c t o r s , f o u r of whom r e p r e s e n t i m p o r t a n t elements o f I n d i a n economy, i . e , 14. S.G. P a n a n d i k a r , Banking i n I n d i a , 6 Ed. O r i e n t Longmans, Bombay, 1948, p. 341. - 50 - agriculturists , industr ia l is ts , etc . , and.the Government representative on. the Board. .The remaining eight directors were elected by the share holders; two each from the regions of Bombay, Calcutta and Delhi, and one each from the regions of Madras and Rangoon. The balance of power s t i l l rested with the elected members of the Central Board because the Deputy Governors and the Governments representative on the Board are not authorized to vote. However the Governor-General-in-Council had the privilege of disapproving any action of the Central Board deemed not to be in the public interest. The Central Board of Directors was associated by Local Regional Boards representing each of the five regions. The Local Boards consist of eight directors five of whom were elected by the share-holders of the region. The remaining - three were nominated by the Central Board and represented the t e r r i t o r i a l and economic interest of their respective areas. The Governor and the two Deputy Governors held office for five years and were el igible for re-appointment. The elected members of the Central Board as well as those of the Local Boards held office for five years and were el igible for re-election. However, the term of office of the appointed directors, both on the Central Board and the. Local Boards, depended on the pleasure of the nominating authority. Ro change was made in this set up unti l the Bank was- nationalized in 19^8. - 51 - P r e r o g a t i v e s and F u n c t i o n s L i k e c e n t r a l banks i n o t h e r c o u n t r i e s , the Reserve Bank of I n d i a was e s t a b l i s h e d to s t a b i l i z e the v a l u e of money and t o c o o r d i n a t e the o p e r a t i o n s o f the Country's u n d e r l y i n g b a n k i n g s t r u c t u r e . I n terms of the preamble t o the e n a b l i n g A c t , i t s main o b j e c t i v e s were " t o r e g u l a t e the i s s u e of bank n o t e s and the k e e p i n g of r e s e r v e s w i t h a v i e w t o s e c u r i n g monetary s t a b i l i t y i n B r i t i s h I n d i a and g e n e r a l l y t o o p e r a t e the c u r r e n c y and c r e d i t system of the Country t o i t s 15 advantage". I n o r d e r to a c h i e v e t h e s e ends the Bank was g i v e n r e s p o n s i b i l i t y f o r the i s s u e and r e g u l a t i o n of the C o u n t r y ' s paper c u r r e n c y and the maintenance of i t s e x t e r n a l v a l u e . I t was a l s o d e s i g n a t e d as the Governments' banker and f i s c a l agent, and equipped t o f u n c t i o n as a banker's bank. I n the e x e r c i s e o f t h e s e f u n c t i o n s and p r e r o g a t i v e s the Reserve Bank became the Country's o f f i c i a l monetary a u t h o r i t y . I n some r e s p e c t s i t became a r e g u l a t o r y a u t h o r i t y as w e l l . Note I s s u e The f i r s t o f f i c i a l o p e r a t i o n of the Reserve Bank was the t a k e - over o f the r e s p o n s i b i l i t y f o r note i s s u e from the C o n t r o l l e r of C u r r e n c y Department. I n c i d e n t a l l y , the amount of n o t e - i s s u e t hen o u t s t a n d i n g was Rs. 1,861,000,000^ Under the e n a b l i n g A c t the s o l e 15- Government o f I n d i a , Reserve Bank of I n d i a A c t , 1934, (as m o d i f i e d up t o November 1, 1956). Preamble, New D e l h i , 1957. Reserve Bank of I n d i a , B a n k i n g and Monetary S t a t i s t i c s of I n d i a , Bombay, 1954, p. 648. - 52 - r i g h t o f c u r r e n c y note i s s u e was c o n f e r r e d on the Reserve Bank but t h e T r e a s u r y Department c o n t i n u e d t o i s s u e one rupee n o t e s , s e c u r e d by d e p o s i t s o f c o i n s , f o r the convenience o f p u b l i c . O r i g i n a l l y the Bank i s s u e d n o t e s i n the denomin a t i o n o f Rs. 2, 5, 10, 100, 1000 and 10,000. The l a t t e r two de n o m i n a t i o n were withdrawn i n 1946. The n o t e s o f the Reserve Bank a r e l e g a l t e n d e r throughout B r i t i s h I n d i a . A t the time o f the Reserve Bank's 17 n a t i o n a l x z a t i o n the o u t s t a n d i n g note i s s u e was Rs. 11,250,000,000. Under S e c t i o n 33(1) o f the o r i g i n a l A c t , i t was l a i d down t h a t the a s s e t s o f the Is s u e Department s h a l l c o n s i s t o f g o l d c o i n , g o l d b u l l i o n , s t e r l i n g s e c u r i t i e s , rupee c o i n , rupee s e c u r i t i e s , and such b i l l s o f exchange and p r o m i s o r y n o t e s p a y a b l e i n I n d i a as a r e e l i g i b l e l 8 f o r p u rchase by the Bank. Of the t o t a l a s s e t s 40 p e r cent to a minimum of Rs. 400,000 w i t h o u t s p e c i a l p e r m i s s i o n must c o n s i s t o f g o l d , g o l d c o i n , and s t e r l i n g s e c u r i t i e s . ( G o l d was v a l u e d a t the r a t e o f 8.47512 g r a i n s o f pure g o l d p e r r u p e e ) . I t was f u r t h e r p r o v i d e d t h a t the v a l u e o f Government s e c u r i t i e s s h o u l d not be more than 25,per c e n t o f the t o t a l a s s e t s o f Rs. 500,000,000 which ever was 19 g r e a t e r . I n ti m e s o f emergency and s h o r t a g e o f money i n c i r c u l a t i o n , government s e c u r i t y h o l d i n g s c o u l d w i t h the consent of the government go up t o Rs. 600,000,000 and s t e r l i n g s e c u r i t i e s c o u l d f a l l below 40 per c e n t of the t o t a l a s s e t s . I n the l a t t e r e v e n t t h e Bank was 17. Reserve Bank o f I n d i a , op_. c i t . , p. 648. 18. • , Government,of.-.India, ..op. citl.i,v S e c t i o n 33.-':. 19. P.O. J a i n , C u r r e n c y B a n k i n g and F i n a n c e i n I n d i a , C h a i t a n y a P u b l i s h i n g House, A l l a h a b a d , i960, p. 193. - 53 - r e q u i r e d t o pay a p e n a l t y on the amount o f the d e f i c i e n c y , s t a r t i n g a t one per c e n t above the Bank's l e n d i n g f a t e and r i s i n g by one p e r cent w i t h each 2.1/2 per cent i n c r e a s e i n the d e f i c i e n c y . I n c o n t r a s t t o the r i g i d f i d u c i a r y r e s e r v e system under which the Bank o f England o p e r a t e d d u r i n g most of i t s h i s t o r y , the a b i l i t y o f the Reserve Bank t o t a k e advantage o f i n c r e a s e s i n g o l d and s t e r l i n g s e c u r i t i e s t o i n c r e a s e i t s note i s s u e adds c o n s i d e r a b l e f l e x i b i l i t y t o i t s c u r r e n c y o p e r a t i o n s and, i n d i r e c t l y , t o the o p e r a t i o n s of p r i m a r y l e n d e r s i n the Country's money market. A g i v e n i n c r e a s e i n the I s s u e Departments g o l d and s t e r l i n g s e c u r i t y h o l d i n g s c o u l d r e s u l t i n 2.1/2 t i m e s t h a t much c u r r e n c y b e i n g added t o the c o u n t r y ' s money s u p p l y . As the Reserve Bank c o u l d a l s o i s s u e bank n o t e s a g a i n s t the s e c u r i t y o f ' e l i g i b l e ' b i l l s of exchange, any i n c r e a s e i n t h e volume of the l a t t e r c o u l d be used t o s u p p o r t an i n c r e a s e d demand f o r bank c r e d i t on the p a r t of p r i m a r y l e n d i n g banks as l o n g as 60 per c e n t of the t o t a l a s s e t s o f the I s s u e Department were not exceeded. Exchange C o n t r o l Under the p r o v i s i o n s of the R e s e r v e Bank A c t , 1934, the Bank was charged w i t h the r e s p o n s i b i l i t y o f m a i n t a i n i n g the e x t e r n a l v a l u e of the Rupee a t l 8 d . w i t h upper and l o w e r l i m i t s o f 183 d-and 1 7 ^ d • iZ 6k r e s p e c t i v e l y . I n o r d e r t o m i n i m i s e the s p e c u l a t i v e h o l d i n g o f f o r e i g n . funds on the p a r t of w e l l - t o - d o I n d i a n r e s i d e n t s , the Reserve Bank was empowered t o l i m i t the purchase and s a l e of s t e r l i n g funds t o a u t h o r i z e d banks w h i c h i n c l u d e d a l l Exchange Banks and a few l a r g e I n d i a n J o i n t S t o c k Banks. These Banks were e n t i t l e d t o buy and s e l l f o r e i g n exchange a t the Reserve Bank i n amounts not l e s s than Rs. 200,000,the e q u i v a l e n t - 5 4 - of<5^13>333«2° T h i s c o n t r o l was extended d u r i n g World War I I , and a l l f o r e i g n exchange t r a n s a c t i o n s were handled through the Exchange C o n t r o l Department o f the Bank t h a t was s e t up under the Defence o f I n d i a R e g u l a t i o n s . S i n c e the exchange c o n t r o l was m a i n t a i n e d a f t e r the War i n o r d e r t o cons e r v e f o r e i g n exchange f u n d s , p r e v e n t f l i g h t o f c a p i t a l and t o check s p e c u l a t i v e d e a l i n g s i n f o r e i g n f u n d s , t h i s Department c o n t i n u e s to o p e r a t e even today. The exchange r e g u l a t i o n s i n t r o d u c e d d u r i n g the War were c o n t i n u e d u n t i l 1948. When I n d i a became a member o f the I n t e r n a t i o n a l Monetary Fund i n 1 9 4 5 , the Reserve Bank was a u t h o r i s e d t o d e a l i n c u r r e n c i e s o f a l l member c o u n t r i e s of the Fund. However the Reserve Bank's exchange t r a n s a c t i o n s were m o s t l y c o n f i n e d t o s t e r l i n g as I n d i a n t r a d e was c a r r i e d on p r i m a r i l y w i t h c o u n t r i e s i n the s t e r l i n g a r e a . Even the r e s t o f the t r a d e was f i n a n c e d t h r o u g h the London Money M a r k e t . F i s c a l Agent f o r Governments As the c e n t r a l Bank of I n d i a , the Reserve Bank took over the c e n t r a l Government's b a n k i n g b u s i n e s s from the I m p e r i a l Bank and was d e s i g n a t e d l a t e r on, as banker f o r S t a t e governments. U n l i k e the I m p e r i a l Bank, the Reserve Bank r e c e i v e s some s p e c i a l b e n e f i t s from h a n d l i n g the governments b a n k i n g b u s i n e s s . I t does not have t o pay i n t e r e s t on government b a l a n c e s and r e c e i v e s some compensation f o r f l o a t i n g i t s s e c u r i t i e s . A l t h o u g h t h e r e i s no l o w e r l i m i t t o the d e p o s i t s which the C e n t r a l government may keep w i t h the Bank, the P r o v i n c i a l o r S t a t e governments have t o m a i n t a i n such minimum b a l a n c e s 2 0 . Government o f I n d i a , op_. c i t . , Sec. 4 0 . - 5 5 - as are agreed upon between them and the Bank. If the amount of a Provincial Government's balance fa l l s below this minimum, the deficiency must be made good either by sel l ing treasury b i l l s to the Bank or by negotiating a loan at rates which do. not exceed the 2 1 Bank rate. The Reserve Bank was also given responsibility for managing the public debt of the Central and Provincial governments. For this purpose the Bank set up a Public Debt Office through which the floatations of government bonds, interest payments, conversions, consolidations, renewals, and redemptions may be handled. For these services the Bank is entitled to receive a commission of 0 . 0 2 per cent of the amount of loans involved. Reserve' Bank as 'a Banker-'-s- Bank .... ': In order to ensure that the Reserve Bank would be a banker's bank as well as a monetary authority - and thus systematize the country's banking structure - the Reserve Bank Act, i t s e l f , designated in i t s second schedule or appendix the private banks which were to become . participating member inst i tut ion. Membership Qualifications The scheduled banks, as members of the Reserve System are known in India, had., to be primarily engaged in the banking business and to maintain capital and reserves of not less than Rs. 5 0 0 , 0 0 0 - then equivalent to about $ 1 5 0 , 0 0 0 . These requirements eliminated from membership a l l relat ively small joint stock banking ventures, 2 1 . S.G. Panandikar, op_. c i t . , 9 ed., p. 389- - 56 - and, of course, alllindigenous bankers and money lenders. The schedule, as originally drawn, l i s ted the Imperial Bank, twenty-nine joint stock banks and twenty exchange banks - a total of f i f ty , with aggregate capital and reserves estimated at Rs. 230,000,000 and aggregate deposits of s l ight ly less than Rs. 2,500,000,000. The: f i f ty banks included in the schedule constituted about 38 per cent of the 132 corporate banking institutions then reporting in India. They held an estimated 87 per cent of the capital and reserves of 22 reporting banks and 95 per cent of their deposits. By the end of 19^8, when the Reserve Bank was nationalised, the number of scheduled banks had increased to 94. At this latter date the scheduled banks constituted only 15 per cent of a l l reporting corporate banking institutions but these banks held 92 per cent of the total deposits of a l l reporting commercial banks. Of the total deposits of Rs. 11,182,200,000, the share of scheduled banks was about Rs. 10,354,000,000. Clearing and Collection F a c i l i t i e s The Reserve Bank and its branches were made reserve depositories and clearing agents for Indian banks, and. were equipped to transfer money (cash currency) from one part of the Country to another. In the exercise of i t s clearing functions, the Bank was empowered to take over the clearing houses which ear l ier had been established by the Government of India. The Imperial Bank of India was designated the Reserve Banks agent at places where the latter had no branches. 22. Reserve Bank of India, Banking and Monetary Stat ist ics of India, Bombay, 1954, pp. 8 - 9; 14 - l £ . - 57 - The branches of the Reserve Bank not o n l y p r o v i d e r e s e r v e d e p o s i t o r i e s and c l e a r i n g f a c i l i t i e s f o r l o c a l banks under t h e Reserve Banks j u r i s d i c t i o n , but r e m i t t a n c e f a c i l i t i e s as w e l l . A l o c a l b r a n c h can t r a n s f e r , w i t h o u t c o s t , Rs. 10,000 or any m u l t i p l e t h e r e o f between any of the branch o f f i c e s o f the Reserve Bank and the main o f f i c e a t Bombay. A l o c a l bank can make weekly r e m i t t a n c e s o f Rs. 5,000, or any m u l t i p l e t h e r e o f , w i t h o u t c o s t t o i t s p r i n c i p a l account w i t h the Reserve Bank p r o v i d i n g the l a t t e r has a l o c a l o f f i c e o r agency. F o r n o n - m u l t i p l e r e m i t t a n c e s i n ex c e s s o f Rs. 10,000 the Reserve Bank r e c e i v e s a commission o f l/ g i ^ . o f one per c e n t . F o r weekly r e m i t t a n c e s below Rs. 5,000 the commission i s I/32 °^ o n e p e r c e n t . L e g a l Reserve D e p o s i t o r y I n common w i t h o t h e r more r e c e n t l y e s t a b l i s h e d c e n t r a l i n s t i t u t i o n s , the R e s e r v e Bank was made the s o l e d e p o s i t o r y o f the l e g a l r e s e r v e s o f the s c h e d u l e d banks. Under S e c t i o n kZ of the 193^ A c t a l l s c h e d u l e d banks a r e r e q u i r e d t o m a i n t a i n o r d e p o s i t a t t h e Reserve Bank a t l e a s t 5 p e r ce n t o f t h e i r demand d e p o s i t s and 2 per cent o f t h e i r t i m e d e p o s i t s . I f a bank f a i l e d t o m a i n t a i n the r e q u i r e d l e g a l r e s e r v e s , i t i s p r o - h i b i t e d from a c c e p t i n g a d d i t i o n a l d e p o s i t s and i s s u b j e c t e d to a p e n a l t y c h a r g e . The l a t t e r i s computed a t 3 per cent above the Bank r a t e on the d e f i c i e n t amount f o r p e r i o d s up t o one week, and at 5 per cent above 25 the Bank r a t e f o r p e r i o d s i n excess o f one week. The Reserve Bank 23. S.G. P a n a n d i k a r , op. c i t p. 353- 2k. Government of I n d i a , op. c i t S e c t i o n k2. 25. Government o f I n d i a , op_. c i t Sec. k2 ( 3 ) . - 58 - determines whether or not the reserve requirements have been main- tained by the scheduled banks from the weekly statements which the latter are required to submit. Under section 42 (2) of the Reserve Act, fai lure to submit a weekly statement i s subject to a penalty of Rs. 100 per day of default. ' In addition to information on reserves these weekly statements provide the Reserve Bank with the basic data published in i t s weekly, monthly and annual reports. Lender of Last Resort In i t s role as a 'lender of last resort* the Reserve Bank under Section 1 7 ( 2 ) of the enabling Act, i s empowered to purchase, s e l l or discount b i l l s of exchange and promisory-notes, which arise out of bona fide trade transactions and are drawn on and payable in India. These credit instruments must bear two or more good signatures, one of which shal l be that of a scheduled bank, and mature within 90 days. On b i l l s covering the marketing of agricultural products the time l imit may be extended to nine months (later on increased to 15 months) and 26 the bank signature may be that of a cooperative bank. Although the scheduled banks seldom took advantage of these rediscounting f a c i l i t i e s before the nationalization of the Reserve Bank, such f a c i l i t i e s are, nevertheless, an essential part of a properly conceived central banking mechanism. In addition to rediscounting the schedule banks may, under Section 17 (4) of the Reserve Act, borrow directly from the Bank on the security of gold, s i lver , and other marketable securities for 27 periods not exceeding 90 days. 2 6 . Bbvernment, of/Jndia, op. c i t . , Sec. 17(2) 7 . Ibid. Sec. 17(4) - 59 - P a r t J The R o l e o f the Reserve Bank, 1935 - 1948 In-as-much as the c e n t r a l b a n k i n g o p e r a t i o n s of the I m p e r i a l Bank o f I n d i a had not been e n t i r e l y r e s t r i c t e d i n t h e o r i g i n a l Reserve Bank A c t , and the p a r t i c i p a t i o n i n the Reserve System had been r e s t r i c t e d to l a r g e and t h e r e f o r e u s u a l l y s e l f r e l i a n t s c h e d u l e d banks, the r o l e o f the Reserve Bank d u r i n g t h e f i r s t t h i r t e e n y e a r s o f i t s e x i s t e n c e , was not p r e d e s t i n e d to be a p a r t i c u l a r l y i m p r e s s i v e one. The Bank exe c u t e d the more o r l e s s r o u t i n e t a s k s i n v o l v e d i n the management o f the C o u n t r y ' s money s u p p l y and i n the h a n d l i n g of such c l e a r i n g and cash t r a n s f e r s as the l o c a t i o n o f i t s p r i n c i p a l o f f i c e s and branches made p o s s i b l e . While i t h e l d c o n s i d e r a b l y more o f the d e p o s i t s o f the s c h e d u l e d bank than p r e s c r i b e d under the Reserve Bank A c t , t h e l a t t e r i n s t i t u t i o n s made o n l y o c c a s i o n a l use of the Reserve Banks' r e d i s - c o u n t i n g and l e n d i n g f a c i l i t i e s . Between 1936 and 1948 the Bank purchased o r r e d i s c o u n t e d b i l l s o f exchange amounting o n l y t o 28 Rs. 200,000. Even i t s o t h e r l o a n s and advances never exceeded Rs. 1,500,000 between 1936 and 1946. I t was o n l y i n 1947 and 1948 t h a t t h e amounts had i n c r e a s e d to Rs. 8,200,000 and Rs. 12,100,000, 29 r e s p e c t i v e l y . The sc h e d u l e d banks had a l r e a d y e s t a b l i s h e d m u t u a l l y advantageous' c o r r e s p o n d e n t r e l a t i o n s h i p s w i t h t h e w e l l e s t a b l i s h e d I m p e r i ^ i Bank. These banks c o u l d not have been e x p e c t e d t o t r a n s f e r t h e i r b u s i n e s s t o the new and i n e x p e r i e n c e d Reserve Bank and go thro u g h 28. Reserve Bank of I n d i a . B a n k i n g and Monetary S t a t i s t i c s o f I n d i a , Bombay, 1954, p. 561. 29. . I n f r a . T a b l e No. 6, p. 63. - 60 - a l l the formalities that were involved in securing a loan from the Bank. Meanwhile no extraordinary conditions had arisen that would make an exercise of the Reserve Bank's emergency powers and duties necessary. As a consequence the policy makers of the Bank concerned themselves for the most part with measures designed to unify and regulate the operations of the indigenous bankers and thus to expand the scope of the Reserve Banks' jurisdict ion to both the organized 30 and unorganized sectors of the banking system of India. With the outbreak of World War II , and India's very considerable direct as well as indirect participation on behalf of the United Kingdom, the role of the Reserve Bank became singularly important. The Indian Government had undertaken to train and equip a native army not only to free the Brit i sh garrisons for duty elsewhere but to take active part in defence of the freedom and the l iberation of other countries - act iv i t ies which incidentally India herself had been denied. This involved considerable expense to the Indian Treasury. As the areas of conflict expanded India undertook to provide troops, equipment, and other supplies for the Asian and African theatre. Although most of these latter undertakings were underwritten by the United Kingdom Government, they s t i l l had to be financed in India. The total cost of supplying these war requirements amounted to a staggering sum of n 31 Rs. 17,000,000 f000. Much of this was represented on the one hand by an increase in Indian public debt and in notes outstanding at the Reserve Bank of India; on the other by the increased holdings of blocked See: Reserve Banks' proposals regarding extension of membership to Indigenous bankers i n Chapter 5> P. • • 31. Reserve Bank of India. Report on Currency and Finance, 1944-M-5< Bombay 19^5, pp. 38-39. - 61 - s t e r l i n g a s s e t s . As a Monetary A u t h o r i t y The o p e r a t i o n s of t h e Reserve Bank as a monetary a u t h o r i t y were more o r l e s s c o n f i n e d t o i ) f i x i n g and m a i n t a i n i n g a Bank Rate a t which i t was p r e p a r e d t o make l o a n s o r t o p r o v i d e d i s c o u n t f a c i l i t i e s t o i t s member banks, i i ) i n c i d e n t a l a t t e m p t s t o u n i f y s h o r t term r a t e s and l e n d i n g p r a c t i c e s i n the c o u n t r y ' s s h o r t term money mar k e t s , and i i i ) s u p p l y i n g a t r e a s o n a b l e r a t e s the massive amounts o f c r e d i t t h r o u g h w h i c h , i n the main, the Government's war c o n t r i b u t i o n s were f i n a n c e d . The Bank Rate vwas f i r s t s e t a t 3.1/2 per c e n t . T h i s was the l e v e l at which the Bank was p r e p a r e d t o s u p p l y day t o day l o a n s a g a i n s t Government s e c u r i t i e s and oh.--J e l i g i b l e commercial paper. However the 3 v l / 2 per cent r a t e o o f f e r e d no margin to p o t e n t i a l d e a l e r s i n the s h o r t t e r m money markets and was soon reduced t o 3 per c e n t . B e f o r e the War some advances' were made t o the s c h e d u l e d banks but the t o t a l s were n e g l i g i b l e - not e x c e e d i n g Rs. 200,000 i n any one y e a r . Even d u r i n g the War the amount of R e s e r v e Bank l o a n s and advances t o s c h e d u l e d banks remained r e l a t i v e l y i n s i g n i f i c a n t . However, a f t e r a the war t h e r e w a s / s u b s t a n t i a l i n c r e a s e i n such advances; t h e amount ro s e t o Rs. 12,100,000 i n 1948. P u r c h a s e s of commercial p a p e r , i f made a t a l l , were at no time s i g n i f i c a n t . Meanwhile the Reserve Bank engaged i n open market o p e r a t i o n s t o s u p p o r t the p r i c e of s h o r t term government s e c u r i t i e s a t something a p p r o a c h i n g the 3 per cent r a t e . I t s d i r e c t advances t o the T r e a s u r y had t a k e n on s i g n i f i c a n t p r o p o r t i o n s even b e f o r e World War I I and r o s e . - 62 - to as much as Rs. 26,200,000 during 1948. Roughly equivalent amounts of Treasury B i l l s were acquired in open market operations in order to maintain a 3 per cent market for the latter type of issue. Some idea of the size of the Reserve Banks purchases of short term Government securities as well as i t s short term loans and advances during the period under review is given in Table"oHo.»w6.r,ontpage «63. .-\;s Some of the advances made to the scheduled banks and a part of the Bank's commitments in Treasury B i l l s arose out of a successful attempt to minimise the spread in short term money rates between the Bombay and Calcutta money markets. Before the intercession of the Reserve Bank the spread on secured loans and c a l l money to support trading on the stock markets,on the average,had been about 1/2 of 1 per cent,with banks in Bombay money market charging the higher rate. When the Reserve Bank entered these markets as a buyer of Treasury B i l l s ; also, of other g i l t edged securities; short term money became more p lent i fu l . Interest rates were driven down and also equalized in the two money markets. The results of these operations are re- flected in the following summary of interest rate levels recorded in the two markets. YEAR 1935 1938 1941 1944 1947 1948 Average Rate: Bombay Money Market m 1 / 2 1/4 1/4 1/2 1/2 Calcutta t t 11 7/8 5/8 1/2 1/2 1/2 1/2 Table 6 Short Term Operations of The Reserve Bank, 1936-1949 Inc. (Rs.000,000) Year ending i n March Advances to Gov't. Holding of Treasury B i l l s Investment i n Rupee Se c u r i t i e s ^ Advances i . to Banks • Internal B i l l s Purchased and Rediscounted^ 1936 8.7 — 54.8 0.1 — 1937 15.4 60.5 0.1 0.1 1938 7.9 0.5 71.2 0.2 0.1 1939. 17.2 15.3 63.6 0.2 — 1940 10.5 28.7 72.5 1.0 — 1 9 a 20.1 9.7 77.8 0.7 — 1942 40.9 2.7 89.6 0.4 — 1943 14.9 6.8 71.2 0.4 — 1944 4.9 9.1 76.1 1.5 1945 4.3 14.6 131.3 1.1 mn mm 1946 2.2 33.5 246.5 1.2f; — 1947 0.5 23.3 317.0 8.2 — 1948 15.7 26.2 815.3 12.1 — 1949 17.1 39.3 756.3 33.4 2.9 Source: Reserve Bank of India. Banking and Monetary S t a t i s t i c s of India. Bombay. 1954, p. 561. 1 The Reserve Bank of India ceased to be the banker to the Governments' of Burma and Pakistan on A p r i l 1, 1947 and July 1, 1948 respectively. 2 No external b i l l s were discounted during t h i s period. 3 Investment of the Banking Department consists mainly of Rupee se c u r i t i e s of the Government of India and of the State Governments. - 64 - As a B a n k e r ' s Bank As a banker's bank the Reserve Bank was put to a severe test when i t was s t i l l at an early stage of development. In order to weed out inefficient and weak banking institutions and thus to sponsor the development of a sound banking system i t had encouraged the amalgamation of banks. In 1937, i t had advanced substantial sums (amount not disclosed) to the TravaaCop©; National Bank and the Quilan Bank to make their amalgamation scheme possible. However, a banking scare in South India during 1938 caused large withdrawals of deposits which the newly amalgamated bank could not meet. For undisclosed reasons the amalgamated banks could- not support additional advances at the Reserve Bank and was forced to close i t s doors in June 1938. As i t did not allow the Reserve Bank to inspect i t s accounts and determine the value of i t s assets, the latter did not 32 feel obliged to come to i t s rescue. The Reserve Bank was able to give substantial help to other banks which were adversely affected by the Travancore - Quilan fa i lure . Professor Sayers stated that "as soon as the news of the cr i s i s was received, credit l imits were granted to many banks in South India and these l imits were later doubled".^ During this cr i s i s the inspection of the accounts of many banks by the Reserve Bank revealed that their el igible l iquid assets were quite limited and thus insufficient to support substantial withdrawals during a banking scare. These banks needed considerable advances to meet a "run". This was revealed in a circular which was intended to 32. R.'S. Sayers, Banking in Br i t i sh Commonwealth, Oxford University Press, London, 1952, p. 233. 33. Loc. C i t . - 65 - be instructive but, unfortunately, the bankers interpreted i t as a refusal of the Reserve Bank to grant emergency assistance in the future. This considerably undermined confidence in the Reserve Bank - a confidence which was badly needed by the young and s t i l l not ful ly accepted inst i tut ion. As a Banker. to.-.Government,, .....•- In theory i t is possible to distinguish between the f i sca l and the banking operations of a central bank but in practice the former has usually dictated the latter and monetary policy has become the hand maiden of f i scal necessity. The operations of the Reserve Bank during both World War II and the Communal riots of 1947 were no ex- ception to this general observation. The Government's revenues from ordinary sources and from voluntary savings spent on Government bonds f e l l far short of requirements during both emergencies and the balance had to be made up from forced savings provided, as in other countries, through the credit granting fac i l t i e s of the Central Bank. At the beginning of World War II , the central Government's funded and unfunded rupee debt stood at a l i t t l e over Rs. 7 b i l l ions , i t s sterl ing debt at about Rs. 4.7 b i l l i ons . The combined total was thus about Rs. 11.7 34 b i l l i ons . Even though the ster l ing debt had been reduced to about Rs. 0 .64 bi l l ions during the war, the Rupee debt of the Government of India had increased to Rs. 19.1 b i l l i ons . In the meantime the Reserve Bank of India had granted Government credits on blocked sterl ing assets 35 equivalenttcthe-staggering sum of Rs. 15.5 b i l l x o n s . i n a l l , funded ^ * Reserve Bank of India, op_. c i t . , p. 560. 35. Ibid. , p. 88l. so .. .. , e x p e n d i t u r e s and c u r r e n t advances had i n c r e a s e d from Rs. 11.7 h i l l i o n s at t h e b e g i n n i n g o f World War I I t o Rs. 35.2 b i l l i o n s at t h e end of the War or by Rs. 23.5 b i l l i o n s . Of t h i s l a t t e r sum a p p r o x i m a t e l y Rs. 9.7 b i l l i o n s - almost a l l i n f o r e i g n c u r r e n c y a s s e t s - was funded by an i n c r e a s e i n the note i s s u e o f the Reserve Bank. The l a t t e r r o s e from Rs. 2.1 b i l l i o n s i n 1939 t o Rs. 11.8 b i l l i o n s i n 1946. By t h e end of 1948, the l a s t y e a r of the p e r i o d under r e v i e w , the Reserve Bank's note i s s u e had i n c r e a s e d t o Rs. 12.75 b i l l i o n s . The e x t e n t t o which d i r e c t and i n d i r e c t Government advances c o n t r i b u t e d t o the o u t s t a n d i n g note i s s u e o f the Reserve Bank d u r i n g i t s f i r s t t h i r t e e n y e a r s o f o p e r a t i o n s i s d e t a i l e d i n Table 7 , P a g e 67. I t w i l l be noted from t a b l e 7 t h a t w h i l e the I s s u e Departments' h o l d i n g s o f g o l d - c o i n s and b u l l i o n remained f a i r l y c o n s t a n t , the note c i r c u l a t i o n i n c r e a s e d from about Rs. 3 ,106,000,000 i n 1939 t o Rs. 9,796,000,Ooo i n 1945 and f u r t h e r i n c r e a s e d t o . R s . 12,7^9,000,000 by the end of March, 1948. T h i s s u b s t a n t i a l i n c r e a s e i n note i s s u e reduced the banks m e t a l c o v e r from about 53 per cent i n 1938 to 6 per ce n t i n 1948. Meanwhile the f o r e i g n c u r r e n c y c o v e r i n c r e a s e d from Rs. 621,000,000 i n 1936 t o Rs. 8 ,637,000,000 in, 1 9 4 5 . I t had reached Rs. 11 ,353,000,000 by the end of March 1948. Not a l l the evidence o f the Reserve Banks f i s c a l o p e r a t i o n s i s c o n t a i n e d i n the statement of the I s s u e Department. As n o t e d e a r l i e r the Reserve Bank made s u b s t a n t i a l s h o r t term advances to the Government and a l s o a c q u i r e d s u b s t a n t i a l h o l d i n g s o f T r e a s u r y b i l l s . These o p e r a t i o n s a l o n g w i t h t h o s e undertaken i n the o r d i n a r y course o f i t s d e a l i n g s ' ~ w i t h the sc h e d u l e d banks are r e v e a l e d i n the a n n u a l s t a t e m t n t s o f the page 68. B a n k i n g Department which are summarized i n Ta b l e 8/, The summary of the Table 7 Operations of The Issue Department of The Reserve Bank, 1935-1949, Inc. (Rs.000,000) Note Liabilities NiTote Cover Year Ending in March in general Circln. Held in Banking Dept. Total Uold coins and n bullion 1 Rupee Coins2 Foreign Currency Assets-? Gov't of India Rupee Securities Bullion Coin as of note 1936 1640.6 275.8 1916.4 442.2 555.1 620.9 296.2 52.2 1937 1758.1 258.1 2016.2 442.2 640.1 695.7 236.2 53.7 1938 1861.5 256.1 2117.6 444.2 662.4 799.2 271.9 49.9 1939 1823.6 282.8 2106.4 444.2 671.1 669.5 321.6 52.9 1940 2092.2 187.9 2280.1 444.1 675.2 786.4 374.4 49.9 1941 • 24U. 1 172.7 2586.7 444.1 358.7 1299.2 484.7 31.1 1942 3076.8 122.2 3199.0 444.1 352.8 1650.0 752.0 24.9 1943 5134Q4 n$m .52.52H 444.1 223131 3191.1 1393.9 12.7 1944 7771.7 105.0 7876.7 444.1 142.8 6435.2 854.5 7.4 1945 9686.9 109.3 9796.1 444.1 135.1 8637.4 579.5 5.9 1946 11,626.4 164.1 11,790.5 444.1 155.2 10612.7 578.4 5.1 1947 12,229.6 326.1 12,555.7 444.1 194.3 11338.9 578.4 5.1 1948 12,278.2 471.2 12,749-5 444.1 323.6 11353.3 628.4 6.0 1949 12,374.2 220.2 12,594.4 424.9 438.6 9074.7 2656.2 6.9 Source: Reserve Bank of India. Banking and Monetary Statistics of India, Bombay, 1954* P. 560. 1 Gold valued at 8.47512 grams per rupee. 2 Including government of India Rupee notes issued from July 24, 1940. 3 Only sterling securities up to December 31, 1948. Table 8 Operations of The Banking Department of the Reserve Bank, 1936-1949 Inc. (Rs.000,000) Liabilities Assets Tear Bills Other Cash Balance Loan & Other Trea-- Gov't ending Deposits Pay- Lia- Rupee and held advncs. , Loans & sury Rupee Other in March Gov't. Banks Others able bilities Total 1 Notes other co iins abroad^ to gov' t Advances3 Bills Secur.Asset 1936 112.6 272.6 0.9 0.7 8.4 495.2 275.8 1.3 149.9 8.7 0.1 — 54.8 5.1 1937 98.3 265.6 4.0 0.8 10.6 479.3 258.1 1.0 136.2 15.4 0.2 60.5 8.1 1938 113.7 249.6 7.0 0.9 7.7 478.9 256.1 0.8 134.8 7.9 0.2 0.5 71.2 7.2 1939 132.1 161.9 7.5 1.0 11.8 431.2 282.8 1.0 42.1 17.2 0.2 15.3 63.6 9.0 1940 115.0 178.0 10.4 1.0 14.5 442.5 187.9 0.9 123.4 10.5 1.0 28.7 72.5 17.5 1941 152.9 368.4 19.2 3.2 22.4 687.1 172.7 1.2 393.2 20.1 0.7 9.7 77.8 11.7 1942 151.8 377.3 38.9 7.8 35.5 735.5 122.2 1.3 460.8 40.1 0.4 2.7 89.6 17.6 « 1943 203.9 573.6 32.9 28.0 51.1 996.6 118.0 1'3 751.1 14.9 0.4 6.8 71.2 33.0 1944 418.5 646.9 66.5 25.4 82.8 1346.3 105.0 2.7 1117.2 4.9 1.5 9.1 76.1 30.8 1945 1786.9 905.7 132.5 34.8 105.8 3Q73.8 109.3 2.6 2772.8 4.3 1.1 14.6 131.3 37.8 1946 4063.8 902.2 165.6 32.6 130.6 5407.1 164.1 3.1 4882.3 2.2 1.2 33.5 246.5 74.2 1947 4907.7 850.4 142.4 42.3 130.9 6187.6 326.1 2.4 5288.3 0.5 8.2 23.3 317.0 221.8 1948 3691.7 1024.7 3421.1 29.2 116.4 5449.6 471.2 122 4069.5 15.7 12.1 26.2 815.3 485.5 1949 2387.9 805.3 565.2 39.5 112.8 4190.5 220.2 1.1 3077.8 17.1 36.3 39.9 756.5 41.4 Source: Reserve Bank of India, Banking and Monetary Statistics of India , Bombay, 1954. p. 561. 1 Includes Rs. 100,000̂ 000 of paid up capital and reserves 2 Includes Cash and short term securities. 3 There are no external b i l l s purchased or discounted during this time. - 69 - Reserve Bank's operations presented in the previous Table reveals that i t s holdings of Government Rupee securities continuously increased during the period under review. Between March 1936 and March 1949 the amount of such holdings rose from about Rs. 55,000,000 to the substantial sum of Rs. 756,500,000. Its investment in treasury b i l l s increased from a nominal sum of Rs. 500,000 in 1938 to about Rs.40,000,000 at the end of March 1949. It also reveals the substantial growth in the Bank's holdings of foreign assets (sterling securities) which reached a peak of Rs. 5.3 b i l l ions at the end of March 1947 and then decreased to about Rs. 3.1 b i l l ions at the end of March 1949. The Issue Department as shown earlier held foreign securities; on the latter date, amounting to approximately Rs. 9«1 b i l l ions ,thus making a combined total of about Rs. 12.2 b i l l ions of these securities. Meanwhile the deposits of scheduled banks with the Reserve Bank increased from Rs. 272,600,000 in 1936 to a peak of Rs. 1,024,700,000 in March 1948 then decreased to Rs. 805,0.00j000• • in the following year. Government deposits increased from Rs. 112,600,000 in 1936 to approximately Rs. 2^83,000,000 in 1949- The combined summary of the Bank's operation for the period under review is presented in Table No.9, on page 70. Reserve Bank Credit and Prices It goes without saying that no central bank could have financed such a major portion of a country's credit needs as that revealed in the foregoing tables without generating a rapid rise in prices which i t was powerless to control. And in this case the magnitude of the Reserve Table 9 Combined Operations of the Reserve Bank of India, 1936-1949 Inc. (Rs.000,000) Liabilities Assets Year ending in March Notes in Circu- lation Deposits Other Lia- bilities Total 1 Gold Coin and 0 Bullion^ Foreign Currency Assets Rupee and Subsidiary Coins Gov't Securities Advncs• and Re- discnts. Other Assets 1936 1640.6 3861 9.1 2135.8 444.2 770.8 55611 350.9 8.7 5.1 1937 1758.1 367.9 11.4 2237.4 444.2 831.8 641.1 296.7 15.5 8.1 1938 1861.5 370.2 8.7 2340.4 444.2 934.0 603.2 343.1 8.7 7.2 1939 1823.6 318$ 5 12.8 2254.8 444.2 711.6 672.1 385.2 32.7 9.0 1940 2029.2 . 327.1 15.4 2534.7 444.1 909.8 676.1 447.0 40.2 17.5 1941 2414.1 561.5 25.5 3101.2 444.1 1692.3 360.0 562.4 30.5 11.7 1942 3076.8 592.2 43.3 3812.3 444.1 2110.8 354.1 841.6 44.0 17.6 19433 5134.4 817.5 79.1 6131.0 444.1 . 3942.2 224.5 1465.1 22.1 33.0 1944 7771.7 1138.1 108.2 9118.0 444.1 7552.5 144.5 930.6 15.4 30.8 1945 9686.9 2833.2 140.6 12,760.6 444.1 11,410.2 137.7 710.8 20.0 37.8 1946 11,626.4 5143.8 163.2 17,0334.4 444.1 15,495*0 158.3 824.9 36.8 74.2 1947 12,229.6 5904.4 183.2 18,417.1 444.1 16,627.2 196.6 895.4 31.9 221.8 1948 12,278.2 5204.0 145.5 17,727.8 444.1 15,422.8 324.8 1443.7 44.0 48.5 Sources Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954. p. 560. 1 Includes Rs 100 millions of paid up Capital and Reserves. 2 Valued at an rate of 8.47512 grains of fine gold per rupee. 3 Reserve Bank ceased to be the Currency authority and the bankers for the Government of Burma with effect from June 6, 1942 and April 1, 1947 respectively. - 71 - Bank's undertakings on behalf of the Government i s not revealed in i t s entirety by purchases of Indian Government securities. To the latter must be added the Reserve Banks' holdings of foreign currency assets which secure Reserve Banks advances oh foreign indebtedness to the page 72 Indian Government. In Table No. 10,/bhe total of these investments and advances is compared to the 'Gauntry's total funded debt and contingent l i a b i l i t i e s in foreign currency assets. Price and purchasing power index are presented, also. The extent to which this massive support of the Government's credit needs contributed to the rise in the Bank's outstanding note issue and decline in the in turn to the/purchasing power of the Rupee needs l i t t l e additional comment. There was anotre: .thans;;. a three-fold increase in prices and a related decline in the value of the Rupee. By no stretch of the imagination could the increase in the Bank's note issue have been absorbed in the cash needs of the Indian economy without inf lat ion and i t s forced savings counterpart. One may not seriously contend that the implied forced savings could have been avoided by higher taxes and attractive interest rates on Government securities without seriously •restricting the War efforts themselves. The patriotic fervour of a nation seldom reaches such a height that people w i l l surrender a l l of their War gains voluntarily. During the f i r s t two years of World War I the price rise was not considered significant. In his budget speech of March 1943? the then Finance Minister held that " . . . there i s not the remotest r isk of inf lat ion of the nature and on the scale which occured in some of the countries 36 which suffered utter defeat in the last War". But Indian economists 36. Budget Speech, 19k3-kk, Paras. 50-55. As quoted in G.P. Gupta, op. c i t . , p. 288. Table 10 Government Debt, Reserve Banks Credit and Purchasing Power of the Rupee, 1936-1949 Inc. (Rs.000,000) Public Debt i n India Reserve Bank Credit Indexes Year Ending i n March Debt of Indian Gov't. Indian Debts of For. Gov'ts. Total Debt to Indian People Holding of Indian and For. Debts % of To t a l Debt Outstand- ing Note Issue General Price Index Index of Value of Rupee 1936 11,910 771 12,681 1916 15.1 1130.0 1939-100 N.A. N. A. 1937 ll|794 832 13,626 2016 14.9 1144 N. A. N. A. 1938 11,747 934 12,681 2118 16.8 1286 N. A. N. A. 1939 11,791 712 12,502 2106 16.8 1129 100.0 100.0 1940 11710 910 12,619 2280 18.1 1696 125.6 79.8 1941 12,061 1692 13,753 2587 18.8 2285 114.8 87.5 1942 11,517 2111 13,628 3199 23.4 2996 137.0 73.0 1943 12,978 3942 16,920 5252 31.0 5429 171.0 58.5 1944 14,146 7553 21,699 7877 36.3 8497 236.5 42.3 1945 16,390 11,410 27,800 9796 35.2 12,140 244.2 40.9 1946 19785 15,495 35,280 11,790 33.4 16,356 244.9 40.8 1947 21,852 16,627 38,479 12,556 32.6 17,556 275.4 36.3 1948 21,456 15,423 36,879 12,749 34.5 16,898 308.2 32.5 1949 23>853 12>153 36,005 12,594 34.9 15,632 376.2 26.5 Source * 1 Adapted from Reserve Bank of India, Report on Currency and Finance. 1951-52. Bombay 1952. p. Ii 2 Adapted from Reserve Bank of India, Banking and Monetary S t a t i s t i c s of India. Bombay, 1954, pp. 560, 561, and 881. - 73 - i n a m a n i f e s t o i s s u e d on A p r i l 12, 1943 p o i n t e d out the dangers of c r e e p i n g i n f l a t i o n generated by the p e c u l i a r system of War f i n a n c e adopted by the C e n t r a l Government. They were p a r t i c u l a r l y concerned w i t h t h e i m p l i c a t i o n of the p r o c e s s by which the U n i t e d Kingdom Government and o t h e r A l l i e d Governments purchased m a t e r i a l from I n d i a and p a i d f o r t h e i r p u r chases i n i n c o n v e r t i b l e s t e r l i n g s e c u r i t i e s and b l o c k e d s t e r l i n g b a l a n c e s . As n o t e d , the Reserve Bank i s s u e d c u r r e n c y and c r e d i t a g a i n s t t h e s e s e c u r i t i e s and i t was not a b l e t o l i q u i d a t e them from the proceeds o f c u r r e n t i m p o r t s . I n o r d e r t o check f u r t h e r i n f l a t i o n the economists suggested p r i c e c o n t r o l s and r a t i o n i n g ; a l s o i n c r e a s e d dependence on l o n g - t e r m b o r r o w i n g and' i n c r e a s e d t a x a t i o n . A l l o f thes e d e v i c e s were put i n t o e f f e c t and, no doubt, d i d a r r e s t t he pace of the i n f l a t i o n between 1944 and 1946. D u r i n g t h i s p e r i o d t h e g e n e r a l p r i c e i n d e x i n c r e a s e d from 237 to 245. But, as shown,continued a c q u i s i t i o n o f l o n g - t e r m s e c u r i t i e s by the Bank to support t h e i r p r i c e s and the c o n t i n u e d acceptance o f f o r e i g n c u r r e n c y a s s e t s brought p a r a l l e l i n c r e a s e i n t h e money s u p p l y . Hence, i n s p i t e of p r i c e c o n t r o l s , p r i c e s c o n t i n u e d t o r i s e . I n a d d i t i o n t o the c o n t r o l s the Government attempted to s i p h o n o f f some of the excess s u p p l y of money by s e l l i n g 37 a p p r o x i m a t e l y Rs. 800,000,000 w o r t h o f g o l d . I t appears t h a t t h e s a l e o f g o l d s o u p l e d w i t h o t h e r d e f l a t i o n a r y measures d i d a r r e s t the p r i c e r i s e between 1944 and 1946 but o n l y t e m p o r a r i l y . I n 194? when the c o n t r o l s were r e l a x e d the g e n e r a l p r i c e i n d e x moved r a p i d l y from 275 t o 376, the f i g u r e r e c o r d e d f o r March 1949. On the l a t t e r date the Rupee was worth i n r e a l goods about o n e - f o u r t h of i t s p r e - W o r l d I I v a l u e . 37. G.P. Gupta, op. c i t . , pp. 191-192. - 74 - CHAPTER III DEVELOPMENTS IN THE PRIVATE BANKING SECTOR, 1935-1949 INC. The establishment of the Reserve Bank of India and i t s banking operations before 1949 appear, on the surface at least, to have had l i t t l e i f any impact on the day-to-day operations of the several classes of primary banking enterprises which function in the Indian economy. The Indigenous bankers and money lenders continued to provide the bulk of the credit required by the agriculturists , small tradesmen, and other artisans, with l i t t l e effective competition from the cooperative banks which were particularly designed to meet the credit needs of such people. The Imperial Bank improved' upon i t s already significant role as a primary lender and a quasi-central bank; the Joint Stock Banks continued to finance domestic commerce and trade. Meanwhile the Exchange banks as before, financed most of the country's external trade. These banks also competed with the Indigenous bankers and the Indian Joint Stock banks in financing the internal trade of the country. Yet . / i t would be quite misleading to leave the impression that these several classes of primary lenders were neither affected by the existence of the Reserve Bank nor by what, for lack of more accurate term, we may c a l l the Reserve Bank's non-banking undertakings. The latter took on the form of attempts to increase the scope of i t s jurisdict ion to Indigenous bankers and non-scheduled Joint Stock banks, participation in attempts to eliminate the usurious rates charged by money lenders, and prime mover in strengthening the laws under which the ordinary banks operated. In fact during this period the foundations were l a i d for ••.•r the future extension and expansion of the Reserve Bank's regulatory- authority over a l l incorporated banking institutions. The nature and implications of these non-banking undertakings on the operation and accomplishments of each class of banking enterprises are now our immediate concern; Part I Indigenous Bankers and Money Lenders Two significant undertakings mark the progress of indigenous bankers and money lenders between 1935 and 19^9. However neither undertaking was promoted by these self rel iant , tradition-bound native bankers who provide such a significant part of India's banking needs and make up the so-called "unorganized" sector of the Indian money market. One was an attempt of the Reserve Bank to extend i t s jurisdict ion to include such indigenous banking enterprises as could meet the conditions la id down by the Bank and thus qualify for membership in the Country's Reserve Bank system. The other was a more or less concerted move on the part of governmental agencies to control the interest rates charged on loans to the usually hard pressed agriculturists and small tradesmen to whose financial needs the money lenders catered. Proposed Inclusion in Reserve System Probably because the Indigenous bankers and money lenders do not operate under formal banking legis lat ion and are not subject to public supervision or control, i t has become customary to designate them as - 76 - the 'unorganized' sector of the Indian money market. But, to a Westerner at least, such a designation could be quite misleading. In fact i t would be nearer the truth to designate them as the "native banking system" and thus eliminate the erroneous suggestion that they are either disorganized or are lacking in unifying relationships. The indigenous bankers serve each other as correspondents in the handling of internal b i l l s of exchange (Hundis). They help each other finan- c ia l l y o •: . ' . . ,ar !c i? . l ly or otherwise in times of emergency to keep up the 'name' of their ancestral profession. They also act as banker's banks for the professional money lenders who generally cater to the credit needs of peasants and other rural dwellers. As noted earlier these patriarchal lending institutions have, on occasion, served as state bankers and exercised the important note-issue privilege."'" Because of their number and basic importance in the Indian economy (exact data are unavailable) the Central Banking Enquiry Committee recommended that, on the establishment of the Reserve Bank, such indigenous bankers as were engaged exclusively in the banking business, or would divest themselves of a l l non-banking business, be brought into direct association with the Reserve Bank in the same manner as the Joint Stock banks. This presumably implied the maintenance of reserve accounts at the central bank, use of the lat ter 's clearing and cash transfer f a c i l i t i e s and the important privilege of rediscounting el igible commercial paper. It probably also implied the l i s t i n g of qualified indigenous bankers, many of whom are r ich and inf luent ia l , as "scheduled' banks. 1. Government of India, Report of the Central Banking Enquiry Committee, Bombay, 1 9 3 1 , P« 1 0 7 . - 77 - In spite of these attractions, however, none of the indigenous bankers sought association with the Reserve Bank and the Reserve Bank i t s e l f took steps to remedy the situation early in 1937. It issued a c ircular to a l l scheduled banks and Indigenous bankers seeking a concensus on the question of l inking the Indigenous bankers directly to the Reserve System and the extent of the changes which the Indigenous bankers should be required to make to secure this linkage. On the basis of replies, i t would appear of the scheduled banks only, the Reserve Bank drew up a plan under which the indigenous bankers would be granted the same f a c i l i t i e s and privileges as the scheduled banks 2 providing the Indigenous bankers undertook to: i . segregate their banking business from their trading and non-banking business; i i . maintain proper records and make them available for inspection by the Reserve Bank; i i i . submit regular statements of their banking business to the Reserve Bank; and to i v . have a minimum working capital of Rs. 200,000 which would be increased to Rs. 500,000 within a reasonable period of time. As might have been expected none of the Indigenous bankers was wil l ing to comply with these conditions. In many cases their banking business was not as important as their mercantile bsuiness. Sometimes their loans were made in kind and thus posed the di f f icul ty of recording them in monetary units. There was also considerable reluctance on the part of indigenous bankers to disclose the nature of their business to the Reserve Bank authorities. Yet one may infer that a significant thought not explicit reason was the fact that the Reserve Bank could 2. S.R.K. Rao, The Indian Money Market, Allahabad, Chaitanya Publishing House, 1959, PP« 87-88. - 78- provide no f a c i l i t y or privilege which was not already available within the Indigenous system Itself or through correspondents relationships with the Imperial Bank and other larger joint stock inst i tut ions. The question of a f f i l i a t ion with the Reserve Bank was brought up again in 19^1, interestingly enough, by the Bombay Shroffs who desired to make their internal b i l l s available for rediscount and were impressed by the possibi l i ty of developing a deposit business to supplement their working capital . This group was wil l ing to meet the original conditions set out by the Reserve Bank save the giving up of a l l their ancestral non-banking undertakings and the disclosure of the extent of their business. The Reserve Bank was prepared to allow the Shroffs a number of years in which to make other provisions for non-banking undertakings but not to concede the ruling principle that a participating or member bank should be engaged exclusively in the banking business. Hence nothing came of this second attempt to incorporate the Indigenous bankers in the country's Reserve Bank system. Even so, the move does reveal the realization on the part of the Shroffs that some advantages could be gained by a f f i l i - ating with the Reserve Bank. As indicated in Chapter V, another un- successful attempt was made in 1951. Money Lenders and the Rate of Interest The practices of money lenders, as would be expected in any unorganized profession, are not uniform throughout the Country but vary from State to State, and even from one place to another in the same State. They vary according to local customs and traditions, to the needs and circumstances of the borrowers and to the nature of security, i f any, offered. - 79 - Character of Loans - Professional Money Lenders The professional money lenders make many small loans to borrowers whom they can trust without even the formality of a promisory note. But when the loans involve a substantial amounts of money and renewals, or are made to strangers,promisory notes with witnessed signatures are taken from the borrowers. When security i s required i t may consist of conditional b i l l s of sale on ornaments, land, houses, and other valuable property. Cases are not uncommon where the loan i s secured by cattle , crops or other movable property. Loans are made to farmers on the security of crops with the understanding, expressed or implied, that the borrower wi l l s e l l the crop through the money lender or his agent - in some cases, no doubt, the Indigenous banker or agent from whom the money lender obtains his funds. Loans are generally for short periods but, since their proceeds are used primarily for personal needs or to meet consumer obligations rather than for productive purposes, •t.heycarry usurious interest rates. The debtor may become more or less permanently enslaved to the money lender. The act iv i t ies of the money lender, who may also be a borrower, may also be restricted. Character of Loans - Non-Professional Money Lenders The non-professional money lenders, as described in Chapter One, generally lend in kind; i . e . , seeds, consumer goods, etc. , usually on the security of land and chatties. In many cases no security whatever may be required and the loan may be made on mutual trust. No formal records are kept of the transactions and sometimes the i l l i t e r a t e and ignorant borrowers are cheated to their last penny by greedy non- professional money lenders. Since the loans made by the non-professionals - 80 - are usually to a more impoverished group of borrowers than those made by the professionals,interest rates are often higher. Yet the non-professional lenders are able to secure the payment of a larger proportion of their loans than are the professional money lenders at,; the former generally lend to their friends and usually hold a strategic economic and social position in the community. Rates - of Interest As would be expected there was and continues to be a great diversity in rates of interest charged by money lenders. Individual rates vary from one State to another,from one money lender to another, . and according to the degree of risk involved. According to the Provincial Banking Enquiry Committee set up in most of the provinces ' of India during the early 1930's, interest rates charged by money lenders ranged anywhere from 12 per cent to 373& per cent depending on the security offered, the amount of loans and on the. amount of credit available to the borrower from other sources.^ On unsecured loans made by the money lenders interest rates were much higher. Those charged by itinerant money lenders are the highest and range from 75 per cent to 360 per cent. Professor Jain, referring no doubt to the local money lenders, states in effect that interest charges may vary from % Anna to two Annas per Rupee per month or from ~5TU per cent to 150 per cent per annum.^ He further states that the rate of interest classes of charged by the Pathans (one of the..several/itinerant money lenders) 6 comes to over 300 per cent per annum. 3. S.G. Panandikar, Banking in India, Bombay, Orient Longmans, 1959, P.50 4. JLTacv-'cU&vy £.._;. \ ~,-„\ '. • - 5. I.Anna = l / l 6 of a Rupee 6. J . C . Jain, Indigenous Banking in India, Macmillan, London, 1928, The personal experience of the writer confirms the observations of Professor Jain. - 81 - Government R e g u l a t i o n M o d e r a t e l y h i g h i n t e r e s t r a t e s can be accounted f o r and j u s t i f i e d by the element o f r i s k i n v o l v e d i n the l o a n s made by the money l e n d e r s , but r a t e s i n e x cess of say 3 per c e n t per month c o u l d a r i s e o n l y from the i l l i t e r a c y and i g n o r a n c e of the borrowers p l u s the i n d i f f e r e n c e of the Government. In o r d e r to p r o t e c t the s i m p l e c o u n t r y f o l k ? from the m a l p r a c t i c e s o f t h e money l e n d e r s , the Government of I n d i a passed a U s u r i o u s Loans A c t as e a r l y as 1918. T h i s measure empowered the c o u r t s t o examine a l l l o a n t r a n s a c t i o n s i n c ases where the c o u r t was c o n v i n c e d t h a t the r a t e was e x c e s s i v e and e x c e p t i o n a l l y h i g h . How- ever l i k e many o t h e r p i o u s u n d e r t a k i n g s , no agency was s e t up to weed out the m a l p r a c t i c e s , and the onus of p r o v i n g g u i l t . ; i - r v ; . appears t o have been l e f t t o a p l a i n t i f f , o f t e n too i g n o r a n t t o know h i s r i g h t s and always too i m p o v e r i s h e d t o p l e a d them. At a somewhat l a t e r d a t e v a r i o u s S t a t e s took s t e p s t o e l i m i n a t e the u s u r i o u s p r a c t i c e s of money l e n d e r s . I n 1930,-. the Punjab Government passed a r e g u l a t i o n of a c c o u n t s A c t r e q u i r i n g a l l l i c e n s e d money l e n d e r s t o keep i n a p r e s c r i b e d form a s e p a r a t e account f o r each d e b t o r . The form r e v e a l e d t h e date and the p r i n c i p a l o f the l o a n , the r a t e of i n t e r e s t , the amount and the date of repayment, and the amount r e p a i d . The money l e n d e r s were a l s o r e q u i r e d t o p r o v i d e t h e i r b o r r o w e r s w i t h semi-annual s t a t e m e n t s i n which p r i n c i p a l and i n t e r e s t were shown s e p a r a t e l y . I f the money l e n d e r f a i l e d t o comply w i t h the law, t h e C o u r t s were empowered t o d i s - a l l o w e i t h e r p a r t o f a l l of the a c c r u e d i n t e r e s t . I n 193^, the same S t a t e passed a r e l i e f o f 7- P a n a d i k a r , op. c i t . , op>. 52 - 82 - indebtedness Act fixing the maximum allowed rates of interest at Th per cent on secured loans and at 12)6 per cent on unsecured loans. The extent to which measures of this character were enacted either before or during the period under review and the l imits placed on interest rates i s summarised on the following page. Although these Acts probably have unified the practices of professional money lenders and to some extent checked the abuses practiced on impoverished borrowers, they did not result in the complete elimination of these practices. Some unscrupulous non-professional lenders continue to exploit their needy and captive borrowers, i f not by one device then another. Moreover, while the professional money lenders did keep within the laws, they did so by restr ict ing or even denying loans to these more impoverished and hence unreliable borrowers. Many of them discontinued their lending operations and devoted their talents to:other a l l ied occupations. Since most of the customers of money lenders are agriculturists , the problem of credit ava i labi l i ty has since taken the place of extortionate rates of interest. Part 2 Indian Joint Stock Banks The 1935-48 period was one of singular importance for the banking enterprises incorporated in India. The conduct and operations of both the scheduled and non-scheduled banks were affected by a tight- ening of the Companies Act of 1913 under which they were incorporated and by the extension of the authority of the Reserve Bank, In spite - 83 - MEASURES TO REGULATE MONEY LENDING IN INDIA Maximum interest rate allowed; On On unsecured State T i t l e of Act secured loans loans % % Assam The Assam Money Lenders Act, 1934 9 3/8 12 1/2 Bihar The Bihar Money Lenders (Regulation of transactions) 9 12 Act, 1939 Bombay The Bombay Money Lenders Act, 1946. 9 12 Madbya Pardesh The Usurious Loans Act.of 1918 as Amended in 1934. 12 18 Madras The Madras Pawnbrokers Act, 1943. 6)4 - 9 3/8 The Madras Debtors Protection Act, 1934. 9 15 Orissa The Orissa Money Lenders Act, 1934. 9 12 Punjab The Usurious Loans Act, 1918 (as amended by the Punjab Relief of Indebtedness Act, 1934) also Regulations of Accounts Act, 1930. 2% above bank rate 12% Uttar Pardesh The Usurious Loans Act, 1918, as amended in 1934. 12 24 West Bengal The Bengal Money Lenders Act, 1940. 8 10 Hydrabad The Hydrabad Money Lenders Act, 6 9 Mysore The Mysore Money Lenders Act, 1939. 9 12 Coorg. The Coorg Money Lenders Act, 1939. Th 12 8. S.R.K. Rao, The Indian Money Market, Chaitanya Publishing House, Allahabad, 1959, pp. 94-96. - Sh - of this attempt to circumscribe their operations, especially those of the non-scheduled banks to banking business only - or perhaps because of this - a substantial growth in both their number and volume of business was•recorded. Like the Reserve Bank, i t s e l f , these predominantly Indian banking enterprises participated heavily in the financing of act ivi t ies growing out of World War I I . Through them l iquid funds,•originally provided for the war effort were mobilized, then channeled into peace-time pursuits. Amendments to the 1913 Companies Act It w i l l be recalled that Indian Joint Stock banks; i . e . , banking institutions incorporated under the Indian Companies Act of 1913? began as a rule as banking-trading ventures. In this latter respect they were not unlike the enterprises of the competing indigenous bankers. It w i l l also be recalled that the growth of these banks down to 1935, while substantial, was nevertheless marked by numerous failures and intermittant public cri t ic ism of both their management and the lack of a proper banking law, prescribing the boundaries of their operations. In 1931 the Indian Central Banking Enquiry Committee, which was set iip'to investigate and report on the operations of Indian banking enterprises, and to make suggestions for their future development, recommended that a special bank act be passed, defining the business of banking and laying down the restraints and conventions under which this business was to be conducted. Such statutory definition of banking in India, as against l i t t l e or no banking legislation in England, was considered necessary because of conditions peculiar to India. It i s true of course that sound banking practices depend on good bankers rather - 85 - than pn banking laws, but not a l l bankers are good bankers. A majority of the unscrupulous bankers would be influenced in the right direction and might be kept on a sound banking track by means of judicious banking legis lat ion. Foreign experts, whose opinion was sought by the Government, advised that the same end could be achieved with less complication by amendments to the Companies Act of 1913• some presumably Their advise was eventually followed. In 1936/far-reaching additions were made to the 1913 measure. The more important ones may be grouped 9 as follows: 1. No banking company can be registered under the Companies Act, 1937 i unless i t l imits i t s e l f to the business of banking. The latter is specif ical ly defined as: a. the accepting of deposits withdrawable by cheque, draft or order; b. the granting of loans; c. dealing in b i l l s of exchange, promisory notes, Government and stock exchange securities etc.; d. the handling of collections, remittances, trust funds, etc. 2. A bank may not be managed by an agent other than another bank unless given special permission by the Government. It may not hold shares in non-banking enterprises. 3. No bank may be chartered after 1937, a. with less than Rs.50,000 in paid up capital and no such bank may b. make charges against i ts unpaid capital , c. A l l non-scheduled banks shal l apply at least 20 per cent of their profit to reserves unt i l the latter are equal to paid-up capital . 4. A l l non-scheduled banks are required a. to maintain cash reserves of at least 5 per cent of their demand deposits and Yjk per cent of their time deposits; 6. to f i l e monthly statements of their l i a b i l i t i e s and cash reserve position (as declared each Friday) with the Registrar of Companies. 5. Both scheduled and non-scheduled banks were required to display in their offices an audited statement of their condition certif ied by independent auditors not indebted to the bank. 9. S.G. Panandikar, op. c i t . , 9th ed. pp. 431-33- - 8 6 - These amendments suggest that many of the banks were in fact primarily under-capitalized trading companies; that some were operated by people without banking experience $ that in many cases their depositors could obtain no rel iable information on their solvency. In one way or another however the bankers managed to circumvent most of these new restrictions and the legis lat ion appears to have accomplished l i t t l e more than to reveal the ingenuity of the bankers and the courts in working towards this end. The courts generally upheld the contention that conformity to the new definition of a banking enterprise was not mandatory on existing banks. Most of the other restrictions were held not to apply on the technicality that a mixed banking trading venture did not conform to the new definition of a bank. It would appear, as i f by design of the law makers themselves, that no provision was made for an enforcement agency; and this more than anything else lef t the provisions of the 1936 amendment Act without sanctions. Afterthe failure of Travancore National and Quilan Bank in 1 9 3 8 , the Reserve Bank took cognizance of the extent of questionable banking practices. It appealed to the Government for s tr ic ter legis lat ion to be enforced, presumably., by i t se l f , and submitted a draft banking b i l l to the Government in November 1 9 3 9 . 1 0 But the lat ter 's preoccupation with the emergent problems introduced by World War II limited i ts immediate reaction to measures designed to enforce compliance with the more important provisions of the 1 9 3 6 amendments. A 1 9 4 2 amendment to the 1 0 . A.B.' Dass and M.N. Chatterj i , Indian Economy; i t s Growth and Problems, Calcutta, Bookland, 1 9 5 3 > p. 424. - 87 - . . Indian Companies Act provided in effect that any enterprise which after November 1943 continued to use the term 'bank' or 'banking' in i t s t i t l e would be deemed to be a bank and would be subject to the provisions of the 1936 amendment of the Indian Companies Act regardless of the extent of i t s non-banking act iv i t ies . Another amendment in 1944 provided that, after July, 1946, the banks were prohibited from paying their managers in whole or in part on a commission basis. Banks incorporated after Jan. 15, 1937 were required to pay up at least one-half of their sub- scribed capital and voting rights were limited to paid-up shares. This lat ter restrict ion grew out of the practice of issuing non-voting preference shares and deferred payment voting shares in addition to ordinary shares; i . e , , divorcing management from responsible ownership. Other Legislation prior to 1949 Of considerable significance to the conduct of banking enterprises in India was an interim measure entitled the Banking Companies (Inspection)) Ordinance Act, brought down by the Government on January 1, 1946 at the insistence of the Reserve Bank. 1 1 This Act gave the Reserve Bank with the permission of theGovernment authority to inspect the books and accounts of any banking company with a view to determine whether or not i t should continue in the banking business. The granting of such an authority would in i t s e l f have a salutory effect on any questionable banking under- taking. It not only marks the beginning of the exercise of regulatory authority in India but for the f i r s t time on record makes the exercise of that authority the responsibil ity of a central bank. In the same year the Government enacted a law under which new branches of a bank 11. Reserve Bank of India, Report on Currency and Finance, 1946-47, Bombayil947, p. 112 - 88 - could be established only on procurement of a licence from the Reserve 1 2 . Bank. * Under the Banking Companies Control (Ordinance) B i l l of September 1 8 , 1 9 4 8 , the Reserve Bank was given sweeping authority to determine the lending policy of a bank, the purposes for which loans could be made, the margins to be maintained, and even the rate of interest 13 to be charged. A year later a comprehensive banking measure incorp- orating a l l these earlier amendments or ordinances was enacted. This lat ter measure known as the Banking Companies Act of 1949 went into effect in 1 9 3 0 and belongs, chronologically at least, to the material covered in Chapter V. Growth and Operations, 1935-1949 Inc. In spite of a significant fai lure rate and alienations resulting' from the separation of Burma (in 1 9 3 7 ) and of Pakistan (in 1 9 4 6 ) ; Indian Joint Stock banks achieved a phenomenal growth during this short but eventful period under review. The number of reporting grew from 100 in 1935 to a peak of 678 in 1 9 3 9 . Thereafter many small trading enter- prises appear either to have stopped reporting or to have complied with the amendment to the Indian Companies Act by eliminating their banking operations; for, by 1 9 4 l , the number of reporting banks had decreased to 4 5 5 . During World War II, many new banking enterprises were incorp- orated, raising the number -reporting in 1945 to a new peak of 7 2 1 . However* the measures enacted during the war to force compliance with the 1936 amendment of the Indian Companies Act and the eventual alienation of banks now in Pakistan reduced the number to 598 by 1949. 1 2 . Reserve;-Bank.:e£.;3ndia, Report 1 9 4 6 - 4 7 , op. c i t . , pp. 1 1 2 - 1 1 3 . 1 3 . Because of some technical d i f f icul t ies the B i l l did not become an.Act in that year. Its provisions were incorporated in the Banking Companies Act of 1 9 4 9 . - 89 - While admittedly significant in other ways, the progress in numbers i s a misleading indicator of the volume of banking business - the l i a b i l i t i e s and easrning assets - of the reporting banks. Except for the decrease in their capital funds from Rs. 153,600,000 in 1936 to Rs. 146,700,000 in 1938, there was a continuous increase in their aggregate capital and reserve funds. The,, earlier decrease may be attributed to the failure of the Quilan Bank and the alienation of many hanks with the separation of Burma from India. The capital funds of the Banks increased from Rs. 146,700,000 in 1938 to Rs. 171,400,000 in 1939. In spite of the decrease in the number of reporting banks from 678 in 1939 to 475 in 1942,capital funds increased from Rs. 171,400,000 to Rs. 229,200,000 during the same period. Between 1942 and 1945 reported capital funds increased by almost 100 per cent, reaching Rs. 509,000,000 on the latter date. This substantial increase in such a short period may be attributed to excessive earnings arising from an increase in trade and industrial act ivity. After 1945 the rate of increase in capital funds was considerably decreased but, even so ,the amount reached Rs. 645,000,000 at the end of 1949. There was also a phenomenal growth in their deposit l i a b i l i t i e s and earning assets of the Joint Stock banks during the period under review. Total deposits increased from Rs. 897,300,000 in 1935 to a peak of Rs. 7,222,400,000 in 1946, then decreased to Rs. 5,808,100,000 in 1949. Meanwhile loans and discounts grew from Rs. 565,200,000 in 1936 to a peak of Rs. 3,647,600,000 in 1946 then declined to Rs. 3,038,600,000 in 1949. Because of active participation in the - 90 - Country's war effort, the Banks holdings'of Government bonds and other securities increased from Rs. 383,000,000 in 1936 to a peak of Rs. 3»110,100,000 in 1945. These holdings remained relatively unchanged during 1946 and 1947, despite the uncertainties prevailing during that period but declined to Rs. 2 ,639,600,000 in 1949. The annual data revealing the progress of Indian Joint Stock banks is presented in .tables 11, 12 and 13 on pages 91, 92 and 93 respectively. 'Comparative Importance Scheduled and Non-Scheduled Banks Attention has already been directed to the fact that only the very large banking enterprises which carry on no non-banking act iv i t ies were placed on the schedule of banks associated with the Reserve Bank of India. A breakdown of the data relating to scheduled and non-scheduled banks given in tables 12 and 13 reveals the progness made by each sub-division. As is shown in table 12 there was a substantial increase both in the number and operations of the non-scheduled banks between 1936 and 1945. But this growth may hot be attributed to new banking institutions alone, because a considerable number of small banks began to report their business only after 1938 when the provisions of the 1937 Indian Companies (Amendment) Act went into effect, Even after taking this factor into consideration, however, the data reveal that between 194l and 1945 the number of reporting non-scheduled banks increased from 413 to 646 and their deposits from Rs. 246,900,000 to Rs. 1 ,107,500,000 - an. indeed remarkable increase. Meanwhile earning assets grew from Rs. 249,400,000 to Rs. 893,100,000. After 1945 there was a substantial decrease both in Table 11 Number, Principal Assets and Liabilities of Indian Joint Stock Banks (Excluding Imperial Bank), 1935-1949 Inc. (Rs.000,000) Year Number Reporting Capital and Reserves Total Deposits Cash oh hand & at banks-' Loans and Discounts Gov't Bonds Total Earning Assets 1935 100 146.7 897.3 199.4 N.A. N.A. N.A. 1936 112 153.6 1028.4 162.5 565.2 383.0 948.2 19371 148 J50.2 1086.6 181.2 626.5 396.4 1022.9 1938 161 140.7 1066.2 152.6 598.5 436.5 1035.0 1939 678 171.4 1154.4 189.2 719.8 416.8 1136.6 1940 630 182.6 1304.8 294.8 672.5 479.0 1151.5 1941 455 196.2 1536.8 293.8 810.3 649.6 1459.9 1942 475 229.2 2140.6 535.8 823.3 1109.5 1932.8 1943 546 309.7 3726.0 897.1 1367.1 1782.5 3149.6 1944 558 414.5 5126.7 1166.8 1976.4 2501.6 4478.0 1945 721 508.8 6535.5 1404.5 2788.7 3110.1 5808.8 19462 619 551.9 7222.4 1438.8 3647.6 2943.6 6591.3 1947 624 586.6 • 7031.9 1387.5 3437.9 3111.5 6549.4 1948 618 635.4 6705.6 1286.0 3301.0 3037.2 6338.2 1949 598 645.0 5808.1 1033.5 3038.6 2639.6 5678.2 Source: Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, pp. 14-16. 1 Excluding Burma banks from 1937 onward. 2 Data relates to banks in Indian Union from 1946 onward. 3 Including gold bullion up to 1938. Table 12 'Number, Principal Assets and Liabilities of Non-scheduled Banks, 1935-1949 Inc. (Rs.000,000) Year Number Report- ing Capital Reserves Total Deposits Cash on hand at banks3 Loans and Discounts Gov't Bonds Total Earning Assets 1936 82 40.2 126.3 18.0 105.5 20.0 125.5 19371 117 33.1 144.8 22.0 115.8 . 29.6 145.4 1938 129 37.4 148.4 18.1 121.6 34.1 155.7 1939 641 54.6 217.4 28.2 195.7 52.2 247.9 1940 591 58.4 243.7 44.8 184.8 55.1 239.9 1941 413 62.8 246.9 52.0 184.4 65.0 249.4 1942 431 66.7 247.2 98.1 216.5 91.8 308.3 1943 489 72.5 481.0 154.6 277.8 112.3 390.1 1944 499 93.9 756.0 262.8 347.6 180.8 578.4 19452 646 121.1 1107.5 342.2 573.2 319.9 893.1 1946 542 118.2 1110.3 274.4 587.1 241.8 828.9 1947 544 120.9 833.2 172.7 553.8 263.1 816.9 1948 540 127.6 756.5 132.7 526.0 240.8 766.8 1949 521 133.9 715.5 118.4 528.0 221.0 749.0 Source: Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, pp. 14-17. 1 Excluding Burma banks from 1937. 2 Data relates to banks in Indian Union from 1946 onwards. 3 Including gold bullion up to 1938. Table 13 Number, Principal Assets and Liabilities of Indian Scheduled Banks (Excluding Imperial Bank). 1935-1949 Inc. ' (Rs.000,000) Year Number Report- ing Capital and Reserves Total Deposits Cash on hand and at banks^ Discounts Gov't Bonds Total Earning Assets 1936 30 113.4 902.1 144.5 459.7 363.0 822.7 19371 31 117.1 941.8 159.2 510.7 356.8 867.5 1938 32 109.3 917.8 134.5 476.9 402.4 879.3 1939 37 116.8 937.0 161.0 524.1 364.6 888.7 1940 39 124.2 1060.5 250.0 487.7 423.9 911.6 1941 42 133.4 1289.9 241.8 625.9 584.6 1210.5 1942 44 162.5 1893.4 437.7 606.8 1017.7 1624.5 1943 57 237.2 3245.0 742.5 1089.3 1670.2 2579.5 1944 59 320.6 4365.7 904.0 1578.8 2320.8 3899.6 1945 75 387.7 5428.0 1062.3 2215.5 2790.2 5005.7 19462 77 433.7 6112.1 1164.4 3060.7 2701.9 5762.6 1947 80 465.7 6198.7 1214.8 2884.1 2848.4 5732.5 1948 78 507.8 5949.1 1153.3 2775.0 2796.4 5571.4 1949 77 511.1 5092.6 925.1 2510.6 2418.6 4929.2 Source t Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, p. 15. 1 Excluding Burma banks from 1937 onward. 2 Data relates to banks in Indian Union from 1946 onward. 3 Including gold Bullion up to 1938. - 9h - the number of banks reporting and their deposits. This may be attributed both to the partit ion of India and to the restrict ive authority conferred on the Reserve Bank. By 1949, the number reporting had decreased to 521; their deposits, to Rs. 715,500,000. On this latter date earning assets amounted to Rs. 749,000,000. The progress made by the scheduled banks, though not as phenomenal as that of the non-scheduled banks i s , nevertheless, s ignif icant. During the period under review the number reporting increased from 30 to 77; their deposits from Rs. 902,100,000 to Rs. 5,092,600,000. Meanwhile their earning assets increased from Rs. 822,700,000 to Rs. 4,929,200,000. After 1947 a slight decrease i s recorded in their deposits and earning assets. This may be attributed to the dislocation of Indian trade and commerce during, and subsequent to, parti t ion. The tabular analysis on page 95 gives perhaps a better answer to the significant question of the relative importance of the mixed banking- trading ventures represented by the non-scheduled banks and the more orthodox banking enterprises represented by the scheduled banks. The Table displays a marked contrast in the number and the size of operations of the scheduled banks, on the one hand, and the non- scheduled banking-trading ventures, on the other. Although the number of scheduled banks is substantially less than that of the non-scheduled banks, the former hold between 80 per cent and 90 per cent of the. total banking business of the Indian Joint Stock banks. By the end of the period under review the scheduled banks constituted only about 13% of the total number in operation, but they held 88% of the deposits, 83% of the total of loans and b i l l s discounted, and 92% of the total investment 95 Table U Comparative Number, Deposits, and Earning Avssets of Indian Scheduled and Non-scheduled Banks, Years 193&-*1940, 1945 and 1949. (Rs.000,000) 1936 1940 1945 1949 1. Number of Indian Joint Stock Banks: 112 630 721 598 Scheduled Banks: 30 39 75 77 Non^scheduled banks: 82 591 646 521 Percent Scheduled 27% 6% 10% 13% 2. Total deposits: 1028.4 1304.2 6535.5 5808.1 Scheduled banks: 902.1 1060.5 5428.0 5092.6 Non-scheduled banks: 126.3 243.7 1107.5 715.5 Share of scheduled banks: 88$ si% 83% 88% 3. Total loans and Discounts: 565.2 672.5 2788.7 3038.6 Scheduled banks: 459.7 487.7 2215.5 ' 2510.6 Non-scheduled bands: 105.5 184.8 573.2 528.0 Share. of. scheduled: banks: 81% 72% 79% 83% 4. Total Investments: 383.0 479.0 3110.0 2639.6 Scheduled Banks: 363.0 423.9 2790.2 2418.6 Non-scheduled banks: 20.0 55.1 319.9 221.0 Share of scheduled banks: 94% 88% 89% 92% 5. Comparative Size in Deposits: Average a l l banks: 1028.4 1304.2 6535.5 5808.1 Average Scheduled Banks: 30.1 27.2 72.4 66.1 Average NNon-scheduled Banks: 1.5 0.4 1.7 1.3 - 9 6 - p o r t f o l i o . As can be seen from t h e Table, i n s p i t e o f the c o n s i d e r a b l e i n c r e a s e i n the number of non-scheduled banks, the s c h e d u l e d banks c o n t i n u e d to c o n t r o l the b u l k o f the b u s i n e s s c a r r i e d on by the I n d i a n J o i n t S t o c k banks. P a r t 3 I m p e r i a l Bank of I n d i a As not e d i n Chapter One, the I m p e r i a l Bank, r e p r e s e n t i n g a merger of t he P r e s i d e n c y Banks i n 1 9 2 1 , had become an i m p o r t a n t semi- c e n t r a l b a n k i n g i n s t i t u t i o n decades b e f o r e the e s t a b l i s h m e n t o f t h e Reserve Bank of I n d i a . L i k e the Bank o f F r a n c e , The Commonwealth Bank o f A u s t r a l i a and t h e Ottoman Bank o f Turkey, i t c a r r i e d on i t s C e n t r a l b a n k i n g f u n c t i o n s a l o n g w i t h i t s o r d i n a r y commercial b a n k i n g u n d e r t a k i n g s . B e f o r e the e s t a b l i s h m e n t o f the Reserve Bank I n d i a n n a t i o n a l s f a v o u r e d the c o n v e r s i o n o f the I m p e r i a l Bank i n t o a c e n t r a l Bank o f I n d i a . But the I m p e r i a l Government opposed the move on the grounds t h a t the C§untry s h o u l d not be d e p r i v e d o f the p r i m a r y b a n k i n g s e r v i c e s o f such a v a s t c ommercial b a n k i n g i n s t i t u t i o n . I n 1 9 3 5 , when the Reserve Bank s t a r t e d i t s o p e r a t i o n , the I m p e r i a l Bank had a wide net of branches s p r e a d t h r o u g h o u t I n d i a and h e l d almost 25 per cent o f the d e p o s i t s o f a l l r e p o r t i n g commercial banks. R e l a t i o n s w i t h Government and R e s e r v e Bank of I n d i a With the e s t a b l i s h m e n t o f the Reserve Bank of I n d i a i n 1 9 3 5 , the I m p e r i a l Bank e x p e r i e n c e d some changes i n the c h a r a c t e r of i t s o p e r a t i o n s , but l i t t l e o r no r e d u c t i o n i n t h e i r volume. I t r e l i n q u i s h e d i t s r o l e as a banker and f i s c a l agent f o r the Government t o the Reserve Bank but - 97 - by way of compensation the Government removed most of the restrictions on i t s primary banking operations.. It was granted the right to lend money on the security of real property and to make advances for more than six months. Though a. \-'questionable practice, i t could, in common with the Indian banks, lend on the security of i ts own shares. The Imperial Bank was f inal ly allowed to deal in foreign exchange; - a significant concession indeed. But most important of a l l , no restrict ions were placed on i t s role as a central correspondent to other banking institutions. Indeed, one may assume that the Government and the Reserve Bank were disposed, on economic grounds at least, to take f u l l advantage of the experience and structural f a c i l i t i e s already available at this pioneer foreign inst i tut ion. Because of i t s past experience, country-wide branches and ample resources the Reserve Bank Act i t s e l f provided that the Imperial Bank could be appointed as an agent of the Reserve Bank at places where the latter had no office Ik or branch but the former had one. In these places the Imperial Bank continued to manage currency chests and to handle Government receipts and payments. For such services the Bank was to receive during the f i r s t ten years a Commission fixed by the Government at the rate of l / l 6 of one per cent for the f i r s t Rs. 2,5Q0\QQ0r and 1/32 of one per cent for the remainder. 1^ After ten years these rates were to be revised s,.; :cr every five years. In addition to the Commission the Reserve Bank undertook to pay Rs. 1 , 9 0 0 , 0 0 0 to the Imperial Bank during the ensuing fifteen years for the retention of the la t ter 1 s existing branches many of which, i t would seem, might Ik. Section V? ( 1 ) , Reserve Bank of India Act, 19J>k 1 5 . S.G. Panandikar, op. c i t . , p. 4l8 - 98 - 16 have been closed down because of un-economic operations The Imperial Bank could not open a new branch in substitution of an existing one without prior approval of the Reserve Bank. Although the Imperial Bank lost i t s privi l iged position as a Government banker,its nomination as an agent of the Reserve Bank and the consequent handling of Government transactions at' many of i t s branches considerably enhanced i t s prestige in the financial c irc le .o f the Indian economy. It continued to function, though unoff ic ia l ly , as a banker's bank after the establishment of the Reserve Bank. As the Bank Rate, and the Hundi Rate were both equal to three per cent during the period under review, Indian banks who were accustomed to borrow.from the Imperial Bank, continued their practice and turned to this Bank when they were short of funds. This is clearly revealed in Table 14 which shows that the amount of b i l l s purchased and discounted by the Imperial Bank reached the s igni- fiacant total of Rs. 99,300,000 in 19^6. The corresponding total for the Reserve Bank was relat ively insignif icant. While in 1935 the Imperial Bank held about 33 per cent of the deposits of a l l scheduled banks compared to about 26 per cent in 19^6, i t s vast network of branches (the number increased from 228 to 358) and association with the Reserve Bank, assured i t s continuance as the most important Bank in the Indian banking structure. The predominant position of the Imperial Bank as a functioning central banking inst i tution and the consequent restrict ion of the act iv i t ies of the Reserve Bank appears not to have been seriously quest- ioned before 19^7, at least by the Government and the Reserve Bank. 16. K.T. Shahi?. Currency and Banking (National Planning Committee Series), Vora and Co. , Bombay, 19^8, p. k$ - 99 - But some Indian bankers objected to the appointment of the Imperial Bank as an agent of the Reserve Bank on the ground that i t was not in the interest of other Indian Joint Stock banks to have a l l this business and prestige in the hands of one bank - and a foreign one at that. It was pointed out that, i f the Imperial Bank was put on the same basis as other Indian banks, i t would be able to realize the d i f f i cu l t ies against which other banks were operating. It would then use i t s weight to remove the di f f icul t ies and, in seeking to promote i t s own interest, would also promote those of other Indian banks. They further suggested that the Reserve Bank be free to appoint any Joint Stock bank as i t s agent and thus distribute the 17 privileges that go with such appointments. However l i t t l e attention was paid to this suggestion. i s t As the National/Movement grew stronger during the early 1940's, public resentment of the Imperial Bank's foreign origin and foreign personnel became widespread. Its natural opposition to Indian nation- alism and to Government ownership combined to raise many voices against the privileged position i t occupied in the Indian economy. The Eastern Economist .after noting the r i s ing public opinion against the Bank and accusing i t of an anti-national tradition, goes on to ask "is there no way of bringing this public inst i tution to a due sense of "18 i t s responsibilit ies? As a result of these criticisms and in keeping with i t s professed co l lect iv i s t philosophy, the National Government of India,on assuming Central Committee, Minority Report, pp. 279, 283-85, as quoted in S.G. Panandikar, Banking in India, 9ed. p. 297 18. The Eastern Economist, February 28, 1947. New Delhi, p. 397 - 100 - office in August 1947, announced i t s intention to nationalize the Imperial Bank along with the Reserve Bank of India. But for reasons that w i l l be dealt with in Chapter V the Government withheld action on the Imperial Bank unt i l 1956. The only immediate consequence was the appointment of a Government representative who was to participate in a l l meetings of the Bank's Central Board of Directors, and to observe the Bank's operations. Nature and Size of Operations, 1935-1949 Though impressive, the growth experienced by the Imperial Bank from 1935 to 19^9 was not as phenomenal as that of the Indian Joint Stock banks of which in some respects i t was a competitor. If deposits are taken as an indicator of growth of these banks, the deposits of Indian Joint Stock banks increased by about 700 per cent during this period and those of the Imperial Bank, by about 352 per cent. Branch offices of. the Imperial Bank grew from 228 in 1935 to a peak of 426 in 1946; then, after a sudden drop to 35& in 1947, increased to 377 in 1949. This substantial earl ier decrease was no doubt due to part i t ion. The Capital funds of the Bank increased from Rs. 110,200,000 in 1935 to Rs. 119,200,000 in 1949; deposits, from Rs. 768,600,000 to Rs. 2,639,700,000 during the same period. Meanwhile total earning assets increased from. Rs. 680,100,000 to Rs. 2,234,300,000 indicating an ever three-fold increase. The annual data showing the progress of the Imperial Bank during this period under review are given i n Tafele 7'4'lbn. page i; 101«. Among other things this Table reveals the very extensive operations of the Imperial Bank on behalf of the Indian Government during and Branches, Principal Assets and Liabilities, Imperial Bank of India, 1935-1949, Inc. (Rs.000,000) Year No. of Branches Capital and Reserves Total Deposits Cash on hand and at banks Loans and Advances Bil l s prchd. and Discounted Gov't securi- ties Other Invest- ment Total Earning Assets 1935 228 110.2 768.6 177.7 233.7 25.1 418.7 2.6 680.1 1936 269 111.1 787.2 207.9 200.7 29.0 436.4 1.5 667.6 1937 319 111.3 818.4 176.3 239.4 37.3 443.1 12.9 732.7 1938 358 111.4 812.2 H9.3 278.7 37.6 428.0 11.4 755.7 1939 381 111.9 844.7 138.6 319.5 40.2 431.9 917 801.3 1940 390 112.4 911.4 174.4 380.7 44.5 397.5 9.7 832.4 1941 401 112.6 1018.2 191.9 303.0 44.6 562.9 11.5 922.0 1942 398 112.9 1340.2 293.9 276.3 40.3 813.3 12.4 1142.3 1943 404 113.8 1877.8 338.6 320.5 34.9 1263.6 20.2 1639.2 1944 419 115.1 2242.8 402.5 528.5 50.3 1339.2 32.3 1950.3 1945 426 116.5 2393.1 403.1 613.2 44.7 1413.4 45.2 2090.5 1946 358 117.3 2636.5 4U.2 633.4 99.3 1525.3 66.5 2324.5 1947 362 118.3 . 2733.5 509.2 735.6 58.6 1459.5 64.9 2318.6 1948 307 118.8 2830.3 496.6 825.0 50.5 1*79.4 83.9 2438.8 1949 377 119.2 2639.7 513.7 998.0 63.1 1070.8 102.4 2234.3 Source: ^ • * Reserve Bank of India, Banking and Monetary Statistics of India. Bombay. 1954, pp. 30-31. 1 As given by S. G. Panandikar, Banking in India. 9 ed. p. 9. - 102 - following World War II. During the War, when the Government was a heavy borrower in the market, the Bank's investment in Government Securities increased from Rs. 397,500,000 in 1940 to Rs. 1 ,525,300,000 in 19^6, thus showing about four-fold increase during the War. The Imperial bank placed, as a rule, more than half of i t s customers funds at the Government's disposal. Meanwhile the Imperial Bank continued to serve i t s correspondent banks through the purchase and discount of b i l l s of exchange. The amount of ...such b i l l s increased from Rs. 25,100,000 in 1935 to a peak of Rs. 99,300,000 in 1946. As a result of Partit ion, the amount was substantially reduced in 1947 but had reached Rs. 63,100,000 by 1949. Part 4 The Exchange Banks Although the Indian branches of the several foreign owned and operated Exchange Banks must always have been a target for the resent- ment generally directed against foreign agencies, fhis resentment became increasingly vocal during the period under review. In spite of the public crit ic ism these banks continued to make substantial material progress. Nature of Criticisms The Exchange Banks and their operations were cr i t i c i zed on many grounds. Native Indian bankers were of the opinion that Exchange Banks presented an effective barrier against the development of foreign exchange business by the less well equipped Indian Joint Stock banks. Moreover they complained against fa i lure , or perhaps more appropriately - 103 - the unwillingness, of the Exchange Bank to appoint native Indian's to their o f f i c ia l personnel. The banks were also accused of investing Indian earnings abroad and thus hindering the development of the Country. Lack of interest or enthusiasm in the development of a domestic exchange market - a project hardly less appealing to Indian nationalists than the Reserve Bank project itselfr-was probably the most significant of a l l the criticisms levelled at the Exchange Banks. At one time i t was formally proposed that a l l India Exchange and, Bank be nationalized/, in order to ensure the success of this project, considerable restrict ion be placed on the Exchange Banks operations. The only tangible immediate result , however, was the setting aside of the restrictions imposed on the exchange operations of the Imperial Bank,itself a foreign inst i tut ion. This did make possible, though, the eventual breach of the Exchange Banks monopoly of the financing of India's external trade. The 1936 and the subsequent amendments to the Companies Act, 1913, did not in the main apply to the scheduled banks - which incidentally included a l l Exchange Banks. The only significant legal enactment that may have restricted their operations between 1935 and 19^8 was the Branches Restriction Act of 1946. The lat ter , as noted under the discussion of the Indian Joint Stock Banks, gace the Reserve Bank the authority to restrict the establishment of new branches; also to pass on changes in existing locations. - i o 4 - Growth 1935 - 1949 Inc. It i s significant to note that the number of Exchange Banks was smaller at the end of this period than at i t s beginning. Yet this comparison may be misleading because of insufficient data on branches and changes of identity within the group. The number of branches in operation at the beginning of 1946 was 84 and i t may well be that this figure represents a substantial increase over the number in operation The in 1935, Moreover, the withdrawal of/Yokohama Specie Bank, the Mitsui Bank and the Bank of Taiwan on the outbreak of World War II,and a number of consolidations during this conflict,suggests that there s t i l l may have been several new recruits among the banks reporting in 1949. End of the year data on the number of Exchange Banks, their deposits, cash reserves, loans and b i l l s discounted are presented in Table 15.on page 105• These data reveal a considerable increase in demand deposits and in b i l l s discounted,,: although the latter were at a l l times considerably less than the former. Demand deposits increased from Rs. 395,000,000 in 1935 to a peak of Rs.. 5l6,000,000 in 1946. Thereafter a rather significant decline set in, reducing the amount recorded in 1949 to Rs. 1227,100,000. Meanwhile loans and advances pursued an even more erratic course. From a previous a l l time high of Rs. 424,300,000 in 1939, the.total decreased to Rs. 177,800,000 in 1942, then rose very signif icantly to a new a l l time high of Rs. 1,076,100,000 i n 1948. In the following year the total was Rs. 1, 048,400,000,Whereas loans and discounts constituted about 50 per cent of total deposits in 1935, these earning assets constituted about 66 per cent in 1935* Although data on investment were not available for the period under review, i t may be properly assumed the remainder of the deposited funds were re- invested in Government of India bonds and other securities. Table 16 Number Deposits and Earning Assets of Exchange Banks in India, 1935-1949 Inc. (Rs.000,000) End of No. of Captl, Year Banks Funds 1935 20 1936 20 8- 19371 18 t— 1 o 1938 18 S- p i 1939 17 ^ 1940 17 8 1941 15 H 1942 16 1943 16 1944 15 Deposits Cash on Hand and Loans and Bil l s Demand Time Total at Banks Discounted 395.0 298.0 639.9 27.1 316.4 413.7 284.7 698.4 23.0 345.5 387.3 281.8 669.1 43.8 312.6 375.6 263.7 639.3 24.6 312.6 432.2 238.7 670.9 37.6 424.2 557.5 217.7 775.2 132.6 255.7 722.7 228.8 951.5 83.9 295.1 977.9 190.6 1168.5 67.4 177.8 1181.1 220.8 1401.9 109.0 301.3 1403.2 250.5 1653.7 115.9 352.9 1515.0 275.0 1790.0 102.0 458.2 1516.0 272.3 1788.3 88.6 699.6 1359.8 298.6 1658.4 177.7 791.7 1184.7 352.5 1547.4 63.8 1076.4 1184.7 .145.-5 1581.6 79.0 1048.4 o 1945 15 19462 15 1947 15 1948 15 1949 15 Source: Adapted from Reserve Bank of India, Banking and Monetary Statistics of India, Bombay, 1954, pp. 192-227. 1 Excluding Burma banks from 1937 onwards. 2 Data after 1946 relates to Indian Union. - 106 - Part 5 The Cooperative Banks Though significant, the progress made by the Cooperative banks from 1935 to 19^9 was not impressive. Many of the primary credit societies did not survive the great depression. Among those which did were many with uncollectible loans and exhausted cash reserves. The period could best be characterized as one of retrenchment and a growing concern for the future of the cooperative movement by both State and Federal Governments and by the Reserve Bank. On the one hand this took the form of restrictions on questionable loans and the inst i tution of a system of regulations; on the other, increased access to loanable funds and r e l i e f from the pressure of non-liquid farm improvement loans. The latter was accomplished through the inst i tut ion and development of Land Mortgage Banks under the j u r i s - diction of Cooperative Departments of the several States. Restrictions and Regulations In the wake of failure of the cooperative credit societies - a l l too casually attributed to the great depression - were many examples of bad lending practices and too great a dependence on the basic integrity of the borrower. Many who could have paid their loans took advantage of legislation providing for the scaling down of debts. Cases were not uncommon where the borrowers refused to repay simply on the ground of an inabi l i ty which could have been known at the time the loan was originally granted. Collateral security, though often required, was seldom properly assessed and executed, and the v i t a l question of - 107 - the ab i l i ty of the loan to provide for i t s own repayment appears not to have been the governing consideration in granting i t . In fact the se l f - rea l i zab i l i ty test could seldom, i f ever, have been used.. In response no doubt to the recommendations made by the Agricultural Commissions and Provincial Banking Enquiry Committeesset by 16 States during the depression several State Governments through their supervisory Cooperative Departments brought down regulations governing the type of loans to be granted and the nature of security to be provided. These supervisory.departments also in i t iated the requirement that a l l Primary Credit Societies arrange for individual audits. The latter were to include not only an investigation of the adequacy of records and the ji.bo'.b'k.- values of their assets and l i a b i l i t i e s ; but also called for an assessment of the rea l i zabi l i ty of their outstanding loans; hence an 19 estimate of the extent of their solvency or insolvency. The Registrars of the respective States were empowered to liquidate the affairs of societies classed as hopeless and to assist, through consoli- dation and advances,in the reconstruction and rehabil itation of others with some chanee of recovery. In a study made in 1939, i t was estimated that nine per cent of the. Primary Credit Societies were in liquidation and that anywhere from 25 per cent to kO per cent, depending on the 20 State, were in the hopeless class. Meanwhile in 19̂ 2, the Reserve Bank i t se l f undertook to make advances on properly negotiated crop loans and to rediscount domestic 19- 20. Panandikar, Banking in India ,9th ed. Bombay 1959, P« 33̂ Ibid . , p. 95 - 108 - time b i l l s of exchange to fac i l i ta te crop movement and marketing. The Bank supplied much needed information on the form and requirements of the loans and inland b i l l s which the Reserve Bank was authorised to purchase OJE rediscount. The Land Mortgage Banks Definite steps were taken to relieve the Cooperative banks of the constant pressure to negotiate five or more years loans on the security of real property and improvements. This was a type of loan that they were not real ly equipped and qualified to make because of the necessity of maintaining considerable l iqu id i ty in their funds and the existing loans excessive demand for current outpui/. The re l ie f came in the form of additional support through the inst i tut ion of Land Mortgage Banks. Although the f i rs t Land Mortgage Bank was established during 1920 at Jhang in Punjab, a real beginning in this f i e ld was not made unt i l 1929 21 when a Central Land Mortgage Bank was established in Madras. During the latter year a few primary Land Mortgage Banks were also established in Bombay and Madras, and a few more States had established Central Land Mortgage Banks by 19^9. Like the Cooperative banking system there are Primary Land Mortgage Banks and Central Land Mortgage Banks but not a separate structure of State Land Mortgage Banks. The Central Banks coordinate the lending policies and operation of primary institutions} and,with the cooperation i of State Cooperative Departments and the Reserve Bank, cf loaf.debentures to secure loanable" funds. The management of the Land Mortgage Banks i s 2 1 . . P.C. Jain, Currency, Banking and Finance in India, Allahabad, Chaitanya Publishing House, i 9 6 0 , p. 2^4 - 109 - entrusted t,o the elected representatives of their members. Their operations are supervised and audited by the Registrars of the Cooperative Departments of their respective States. Day to day operations are carried on by paid managers. The working capital of Land Mortgage Banks consists of membership fees, loans and deposits from State Governments and State Cooperative Banks and, most important of a l l , the proceeds of the sale pf debentures. These banks are also authorised to accept time loans from members and non-members but such deposits must be committed for a period of five years or over. As a result of this long withdrawal restrictions the deposit of these banks form an insignificant part of their working capital . Yet i t should be realized that commitments for a period shorter than five years could hardly be accepted i f long term loans were to be negotiated. In order to ensure a market for the debentures which provide most of their loanable funds, State Governments guarantee both their principal and interest. Unt i l 1951 when the Reserve A'c.tk was l iberal ized, the Reserve Bank was authorized to take up any short f a l l in popular 22 subscriptions to the extent of 10% of the total offered for sale. As the name suggests the loans of Land Mortgage Banks are to be made to members against the mortgaged security of their land and improvements. These loans as a rule may hot exceed one halef of the value of the security so mortgaged. In some States the loan ratio is fixed at one-third the value of land, but most States provide upper l imits on 23 the amount of the loans ,ranging from Rs. 5,000 to R. 10,000. 2 2 * See Chap. VI, part k 23 J * Panandikar, op. c i t . , p, 120 - 110 - Loans are granted for periods ranging from sixteen to twenty years, depending on the State, and are repayable in equal annual instalments so arranged that they f a l l due at the end of the harvest season. Loans are made principal ly on the demonstrable need of the borrower and his capacity to meet the instalments and they carry interest rates varying from six to nine per cent. 2 ^ As the Land Mortgaged Banks are of fa ir ly recent origin and few in number, no data are available showing the amounts outstanding unt i l 1938. Between 1929 and 1938 only a few States with well-developed cooperative systems had made much progress in this f i e l d . In other States Land Mortgage Banks were either non-existent or s t i l l in an infant stage of development. Such data as are available are presented •SiSlTftble ̂ 20'i:?pfgefU8^ c ; >...„•>.•.:.• . 3 . Membership and Operations Cooperative Credit- Societies, 1935-1949 Inc. The Primary Societies In spite of many failures, and some consolidations, the number of Primary Credit Societies grew from approximately 931000 with a membership of a l i t t l e over 3,000,000 in 1935 to a peak of about 147,000 with ovef 5,500,000 members in 1946. As a result of the Partit ion of the Indian sub-continent into Indian Union and Pakistan, the number dropped to about 117,000 in 1947, but there was no. absolute decline in their memberships i t remained at approximately the 1946 level . By the end of June 1949, their number had moved up to 1351000 and membership had gone to almost 7,000,000. The membership per society increased from an 24. Panandikar, op. c i t . , p. 120 - I l l - average of about 34 before the War to about 51 in 1949.. Although there was a considerable reduction in the number of Cooperative Credit Societies after the Partition of India, substantial gains in capital and reserve were, nevertheless, made by the societies s t i l l reporting in 1949. Moreover the war prosperity and better credit standards appear to have reduced the amount of overdue loans without discouraging new advances. The annual growth of Primary Credit Societies between 1935 and 1949 in shown in Table l6 , o n page 112. The data reveal that,despite jurisdict ional losses during the period under consideration, the capital and reserves of these societies increased from Rs. 134,800,000 in 1935 to Rs. 193,700,000 in 1949; deposits, from Rs. 31,600,000 in 1935 to Rs. 57,300,000 in 1949; and total working capital , from Rs. 342,000,000. to Rs. 454,100,000 during the same period. As a result of significant increases made during and after the War, total loans outstanding (made up of loans due and new loans made) increased from Rs. 333,800,000 to Rs. 509,700,000. In the absence of information to the contrary i t may be assumed that an excess of loans over working capital was made possible by rediscounting at the Reserve Bank and other banking inst i tut ions. The Central Cooperative Banks ;.:::c. . . ct The separation of Burma from India in 1937 and the and •• . ' creation of Pakistan in 1947/the consequent reduction in the number of Central Cooperative Banks did not have an appreciable effect on the membership of these banks. In spite of the expected reduction in their capital and reserves, substantial gains were recorded in their average Table 17 Number and Business of Primary Cooperative Credit Societies, 1935-1949 Inc. (Rs.000,000) Working Capital Loans to Members Number in 000 Deposits and borrowed money from; Tear ending June Soci- eties Mem- bers Capital and Reserves Members and Non- members Other Co- operative Gov't. Total Current Loans Due and Unpaid Total 1935 93 3008 134.8 31.6 173.9 1.8 342.1 • 59.5 274.2 333.7 1936 94 3047 139.6 29.1 175.4 1.6 345.7 60.50 272.0 332.5 19371 96 3152 141.9 28.1 174.7 1.1- 345.8 65.1 269.6 334.7 1938 96 3163 135.0 26.3 157.3 0.9 319.5 62.8 244.7 307.5 1939 105 3560 127.8 26.6 160.9 0.8 316.1 73.9 248.0 321.9 1940 119 4098 123.5 24.3 156.5 0.9 305.2 81.8 239.5 321.3 1941 124 4341 126.6 23.8 154.1 0.8 305.3 • 82:41 233.1 315.5 1942 126 4573 129.8 24.1 147.4 0.7 302.0 91.1 226.3 317.4 1943 126 4493 132.8 28.5 128.7 1.0 291.0 130.4' 215.8 346.2 1944 135 4815 143.6 38.3 115.2 1.3 298.4 146.4 195.4 341.8 1945 136 5013 152.9 42.2 108.7 1.6 305.4 147.3 209.1 356.4 1946 147 5501 164.6 51.9 111.0 2.4 329.9 182.1 223.2 405.3 19472 117 5539 141.1 45.7 114.8 4.0 305.6 196.0 204.4 400.4 1948 126 6216 168.2 43.9 131.1 3.8 347.0 214.3 231.7 446.0 1949 135 6963 193.7 57.3 167.1 36.0 454.1 262.6 247.1 509.7 Source: Reserve Bank of India. Banking and Monetary Statistics of India. Bombay. 1954. pp. 448-49. 1 Excluding Burma and excluding Land Mortgage Banks from 1938 onward. 2 Relating to Indian Union after 1947. - 113 - working capital - increasing from about Rs. 480,000 in 1935 to about Rs. 990,000 in 1949. Similar growth is indicated in the loans they, made to members. The extent of their operations between 1935 and 1949 i s given in Table 17-on page 114. The data disclose that before Partit ion the number of Central Cooperative Banks remained at about 600 and that immediately thereafter dropped to less than 500; that the number of member societies, however, rose from 89,000 in 1935 to a peak of 121,000 in 1941. After a sharp decline in 1942 the number gradually increased to 118,000 in 1946. By 1949 the number was 93,800. The number of individual members on this lat ter date was 89,000 - approximately the same as in 1935* The average membership of Primary Credit Societies in ihe Central Cooperative Banks had thus increased from about 145 in 1935 to about 194 in 1949; and those of the individual members, from 139 to .184 during the same period. Meanwhile loanable funds made up of borrowed money and capital sub- scriptions rose from Rs. 294,000,000 in 1935 to a peak of about Rs. 451,000,000 in 1946; then dropped back to Rs. 402,000,000 in 1947 as a result of part i t ion. By 1949 the amount had reached a new peak of Rs. 481,000,000. During the period under consideration, the average working capital of the Central societies rose from about Rs.479,000 to a l i t t l e less than Rs. 994,000. Unti l 1942 there was l i t t l e increase in the loans made by these banks. After that year we notice a consid- erable increase in their landing operations. Their current loans increased from Rs. 130,000,000 in 1942 to Rs. 927,000,000 in 1949- In spite of this considerable increase in current loans after Part i t ion, the ratio of loans due and unpaid to current loans decreased from 48 Table 18 Number and Business of Central Cooperative Banks, 1935-1949 Inc. (Rs.000,000) Membership (000) Working Capital Loans to Members Year ending in June No. of Banks Individ- uals Primary- Soci- eties Capital and Reserves Deposits and bor. money Total Due and Unpaid Current Loans Total 1935 615 85 89.1 61.0 233.0 294.0 204.1 100.0 304.1 1936 615 84 89.7 62.9 231.4 294.3 202.3 98.7 301.0 1937 611 85 91.3 65.1 229.9 295.0 196.9 91.4 288.3 19381 599 82 91.8 65.2 225.7 290.9 195.9 109.5 305.4 1939 594 81 96.1 66.5 227.7 294.2 199.2 105.1 304.3 1940 600 80 104.1 68.5 223.7 292.2 197.5 108.7 306.2 1941 601 80 121.3 70.5 222.8 293.3 189.8 110.5 200.3 1942 595 80 110.6 73.0 225.4 298.4 187.8 130.1 317.9 1943 589 79 111.5 73.7 254.7 328.4 189.2 210.7 399.9 1944 601 84 115.5 77.2 288.7 365.9 185.6 280.1 465.7 1945 602 84 116.4 80.6 317.6 398.2 190.9 392.2 483.1 1946 601 80 118.1 84.5 366.2 450.7 203.6 430.7 634.3 19472 469 74 86.0 63.7 338.2 401.9 211.3 612.7 824.0 1948 469 79 88.3 67.0 352.0 419.0 217.8 629.1 846.9 1949 484 89 93.8 72.7 408.5 481.5 290.2 926.8 1217.0 Source: Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, pp. 422-23. Note: 1 2 Excluding Burma from 1938 onwards. Relating to Indian Union from 1947 onwards. - 115 - per cent in 1946 to 31 per cent in 1949. The State Cooperative Banks, Operations 1935-1949, Inc. The number of State Cooperative Banks or top t ier ©©operat ives , remained more or less unchanged during the period under review. The more significant changes in number were brought about by the.alien- ation of Burma and Pakistan from the Indian sub-continent. The number of individual members gradually increased from about 3000 in 1935 to about 7000 in 1949- However the number of member societies which remained about 19,000 unt i l 1946 sharply decreased to about 8000 in 1947, then moved up to 89OO in 1949- Yearly data showing their progress are given in Table l8 . on page 116. This summary reveals that the capital and reserves of the State Cooperatives continued on the whole to increase, though erract ical ly . The total rose from Rs. 15,5000,000 in 1935 to Rs. 30,300,000 in 1946, and after a decline ±0 Rs. 25,400,000 in 1947 again increased to Rs. 29,200,000 in 1949. Average working capital rose from Rs. 10,600,000 in 1935 to Rs. 16,800,000 in 1946 and the amount further increased to Rs. 23,400,000 in 1949* The increase in the amount of loans due and unpaid was arrested in 1940 because the war prosperity enabled many defaulting members to pay their obligations to these banks. But after the war, the amount again increased and reached Rs. 167,600,000 in 1949- However there was a substantial increase in their total loans after the war and the proportion in default was no higher than during the war period i t s e l f . Current loans grew from Rs. l68,800,000 in 1946 to Rs. 4o8,6oO,000 in 1949. The very considerable increase in loans made Table 19 Number and Business of State Cooperative Banks, 1935-1949 Inc. (Rs.000,000) Membership .000 Working Capital Loans to Members Year Ending In .iune Number of Banks Individ- uals Primary & Central Societies Capital and Reserves Deposits & Borrowed Money Total Due and Unpaid Current Loans Total 1935 11 3 19.4 15.5 100.8 116.3 49.8 69.2 119.0 1936 11 4 19.3 18.1 108.2 126.3 54.5 66.6 121.1 1937 11 4t 19.2 18.3 107.5 125.8 57.3 80.5 137.8 19381 10 4 19.2 18.9 104.3 123.2 62.4 70.2 132.6 1939 10 4 19.1 20.6 108.7 129.3 66.4 73.3 139.7 1940 10 . 4 19.0 22.5 111.7 134.2 70.1 70.6 140.7 1941 10 5 18.8 23.8 115.2 139.0 70.0 69.3 139.3 1942 10 5 18.8 22.6 122.7 145.3 65.8 79.8 145.6 1943 10 5 18.7 23.4 151; 5 174.9 56.4 99.6 156.0 1944 10 6 19.2 24.6 162.8 187.4 61.6 179.0 240.6 1945 11 6 19.5 27.1 178.7 205.8 63.7 163.5 227.2 1946 13 8 20.1 30.3 218.7 249.0 65.4 168.8 234.2 19472 11 6 8.1 25.4 194.4 219.8 90.6 246.9 337.5 1948 11 7 8.5 26.0 214.5 240.5 89.6 217.8 307.4 1949 12 7 8.9 29.2 218?9 311.1 167161 ljl©g£6 §76*2 Sources Reserve Bank of India . Banking and Monetary S t a t i s t i c s of India. Bombayf 1954. pp. 410-11. 1 Excluding Burma from 1938 onward. 2 Relating to Indian Union from 1947 onward. . - 117 - during the late 1940's was made possible presumably by taking advantage of the rediscounting f a c i l i t i e s available at other banking inst i tut ions. Number and Operations of Land Mortgage Banks As the Land Mortgage Banks are of very recent origin in India the data with respect to the number and the size of their operations not are not available before 1938, and then/in particularly revealing form. Annual data compiled by the Reserve Bank from 1938 J.'-;'.. " to 1951 combine the operations of both the Primary Land Mortgage banks and the Central Land Mortgage banks and thus give an exaggerated picture of the amount of business originated by the system as a whole. A break- down of the data is available only after 1945. However the combined totals may be used to indicate the direction of the growth and the importance of these banks in the Country's f a c i l i t i e s for agricultural finance, and some estimate of the amount of duplication may be had from a scrutiny of the breakdown of the data after 1945. Combined Operations - Primary and Central Banks The combined data for Primary and Central Land Mortgage banks presented in Table 19 on page 118 display a fa i r ly constant expansion and growth in membership i f not in number. The membership grew from 63,000 in 1938 to 139,000 in 1945 and reached 180,000 in 1949 - an almost three-fold increase. Such a remarkable growth is not feowever revealed in the number of banks which increased from 202 in 1938 to only 268 in 1949. Yet, in spite of this small increase, working capital , made up of membership fees, deposits, borrowed money, and the proceeds of debentures, scored an impressive gain, moving from Rs. 41,200,000 in 1938 to Rs. 164,700,000 in 1949. Table 20 , KG/":oysbipNjnibe5^ Cenferaltand c f Centr-;;. Primary Land Mortgage Banks, 1938-1949 Inc. (Rs. 000,000) Number of: Working Capital Loans Year ending in June. Banks and So- pieties Indiv. members (000} Capital and Reserves Depsts. and bor- owed money Deben- tures Total Current Uik>ans Due and Unpaid Total 1938 202 63 3.7 20.8 16.7 41.2 10.6 36.9 47.5 1939 226 80 4.4 28.6 20.4 53.4 15.6 49.4 55.0 1940 243 92 5*1 32.5 25.1 62.7 11.6 57.0 68.6 1941 252 105 5.8 33.8 30.9 70.5 11.4 63.5 74.9 1942 269 116 6.4 35.4 34.4 76.2 11.2 68.2 79.4 1943 271 120 7.2 33.5 37.1 77.8 7.5 65.3 72.8 1944 285 126 7.3 31.7 36.3 75.3 5.8 60.8 66.6 1945 289 139 8.0 69.9 38.0 115.9 7.8 60.8 68.6 1946 289 142 8.7 74.9 40.5 124.1 12.1 65.0 72.1 1947 273 145 9.1 62.5 43.5 135.1 13.7 70.2 84.0 1948 277 158 9.7 86.6 43.5 139.7 16.8 79.1 95.9 1949 268 180 10.5 100.7 53.6 164.7 21.7 92.5 115.2 Source: Adapted from Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, p. 504. - 119 - Loans and advances made by these banks,both current and unpaid, amounted to Rs. 4y,500,000 in 1938. By 1949 the comparable total had grown to Rs. 124,800,000. Unfortunately, however, the breakdown of loans reveals that those due and unpaid had increased by considerably more than had new commitments. This may be attributed in part to the long-term nature of loans made by these inst itutions. The fact that before 19^2 the total loans outstanding are in excess of the working capital suggests that the column on loans due and unpaid contain a carry over of loans outstanding from preceeding years. Definite information is not available. Relative Importance of Primary and Central Land Mortgage Banks The combined statements of the Central Land Mortgage banks and the Primary Land Mortgage banks presented in the table does not reveal the relative importance of the two categories of Land Mortgage banks. Since separate data are available on their respective operations after 1945, some estimate of their relative importance may now be made. Separate summaries are presented in Table 20. There ,as would be expected is shown that the number of Central Land Mortgage banks i s considerably smaller than that of the Primary Land Mortgage banks. While the number of the former remained at five during this period, the number of the latter decreased from 284 in 1945 to 263 in 1949- In spite of this decrease in number their operations, on the surface at least,appear to have been l i t t l e affected. The working capital and the outstanding loans of the Central Land Mortgage banks increased from Rs. 43,100,000 and Rs. 32,900,000, respectively in 1945; to Rs. 59,800,000 and u Table 21 N u i ^ r 1 zaiieNumbgr aMiBusineassof ECentralaaMiEP.amaoJ^rriiriarv Land Mortgage Banks, 1945-1949 Inc. (Rs.000,000) Number of Year ending in June Banks and Indiv. Soci- Membs. eties Working Capital Capital Depsts. Total and and Bor- Deben- working Reserves rowed money tures capital Central Land Mortgage Banks Loans to Members Due and Current Unpaid Loans Total 1945 5 6 3 . 8 2 .0 37.3 4 3 . 1 2 9 . 4 3 . 5 32.9 1946 5 6 4 .2 2 .5 39 .7 4 6 . 4 31 .3 5 . 4 36 .7 1947 5 6 4 . 5 4 . 3 42 .9 51 .7 34 .3 6 . 3 4 0 . 6 1948 5 7 4 . 8 4 . 7 42 .8 5 2 . 1 38.5 7 . 8 4 6 . 3 1949 5 8 5 . 1 2 .0 52.7 59 .8 4 4 . 9 1 0 . 3 55.2 Primary Land Mortgage Banks 1945 284 133 4 . 3 30 .8 0 . 8 3 5 . 1 31 .5 4 .4 3 5 . 9 1946 284 136 4 . 6 32.0 0 . 8 3 7 . 4 3 3 . 8 6.5 4 0 . 3 1947 268 139 4 . 6 34.8 0 .6 40.0 36 .0 7 . 4 4 3 . 4 1948 272 151 4 . 9 38.5 0 .6 4 4 . 0 40.7 9 . 1 4 9 . 8 1949 263 172 5 .4 4 5 . 1 0 . 9 5 1 . 4 4 7 . 7 11.5 59.2 l—1 to o Source: Reserve Bank of India, Banking and Monetary Statistics of India. Bombay, 1954, p. 504. - 121 - Rs. 55,200,000,respectively in 1949. The corresponding figures for Primary Land Mortgage banks were Rs. 35,100,000 and Rs. 35,900,000 respectively in 19^5; Rs. 51,.700,000 and Rs. 59,200,000,respectively in 194-9. This table further discloses that, while there were only five Central Land Mortgage banks during this period, they supplied the bulk of the working capital used by themselves and the Primary Land Mortgage banks through the sale of debentures. The data on the Central Banks reveal that the proceeds of debentures accounted for 86 per cent of their working capital in 1945 and 88' per cent in 1949« In the case of these primary institutions, money borrowed presumably from the Central Land Mortgage Bank provides the major portion of the working capital . Under these conditions i t would appear f a i r l y safe to conclude that the net total of primary advances by the system as a whole did not exceed the proceeds of the debentures plus capital and reserves of both classes of banks. Table No. 19 disclosed that in 1938 this sum would have been approximately Rs. 20,000,000. In 1949 the corresponding figure would have been approximately Rs. 64,000,000. The 'window dressed' combination of both the primary and secondary advances would encourage one to believe that the total amounted to Rs. 114,400,000. Part 6 The Postal Savings System There i s l i t t l e to add to the material already given on India's unique Postal Savings System, save the substantial progress recorded by i t during the 1935-1949 period. This is accomplished through - 122 - Table No. 21 which, in keeping with the summary of Chapter I , sets forth the annual data on the number of savings offices, their receipts during the year and the total of individual balances outstanding. TABLE 21 Number, Deposits and Balances outstanding Postal Savings System 1935-1949 Inc. (Rs. 000,000) Year ending in March No. of Savings Offices Deposits During Year Balanci Out stai 1935 12,679 430.6 583.0 1936 12,926 510.9 672.5 1937 12,903 493.6 746.8 1938 1 12,631 488.9 744.9 1939 12,109 504.3 818.6 19^0 11,870 462.5- 783.2 1941 11,883 305.9 595.1 1942 11,667 263.9 520.7 1943 11,324 262.5 522.2 1944 • 11,296 388.6 641.8 1945 ' 11,227 479.1 1150.5 1946 11,202 809.4 1423-5 1947 2 11,189 1021.0 1372.5 1948 9,939 436.1 1281.1 1949 9,090 529.2 1484.9 Source: Reserve Bank of India, Banking and Monetary Stat ist ics of India, Bombay, 1954. p. 369 1. Excludes Burma from 1938 onwards 2. Excludes Pakistan - 1 2 3 - Here i t can be seen that the jurisdict ional alienations ,caused by the partit ion of India in 19^7 and the separation of Burma in 1937, reduced the number of offices from a peak of 12,679 in 1935 to 9,090 in 194-9« In spite of this considerable decrease in the number of savings offices annual accumulation brought deposit balances on this latter date to approximately 2k0 per cent of what they had been at the beginning of this period. By 19^9 the accumulated savings amounted to almost Rs. 1,500,000,000 which i s not an insignificant sum considering the economic condition of India and especially that of the customers of these banks. - 124 - CHAPTER IV NATIONALIZATION AND EXTENSION OF CENTRAL AUTHORITY World War II brought significant changes in the Indian economy both p o l i t i c a l l y and economically. In the p o l i t i c a l sphere, India was midway between national and colonial status. The Brit i sh Government's promise of a f u l l independence after the war provided the Indian nationals an opportunity to f u l f i l l their long cherished desire of moulding their own destiny and of planning their future themselves. In the economic sphere India has made great strides during World War II. Her balance of trade had increased from Rs. 82.7 mill ion in 1938 to a peak of Rs. 379-4 mil l ion in 1944 . Indian industry, in order to meet the war needs of the Bri t i sh Government and her a l l i e s , had been considerably diversif ied. Meanwhile many Brit ish establishments had 2 been purchased by the Indian business interests , and this brought a significant increase in the percentage of Indian owned industrial enterprises. Though national income and product data are not available for the war period, the rapid pace of.the industrial expansion which took place may be demonstrated byr. a comparison of rates of increases in employment in various industries between 1934 and 1939 on the one hand, and between 1939 and 1945"'' on the other. 3 1 * Reserve Bank of India, Report on Currency and finance, 1946-47, Bombay p. 47 2 * ' For further details see H. Venkatasubiah, Indian Economy Since Independence, Asia Publishing House, New York, 196l, p. 80 3. Ibid, p. 8 l - 125 - Comparative Percentage increase in Employment by Industries, Period 1934-1939 and 1939-1945. Industries Percent Between Increase 1934-39 Percent Increase Between 1939-45 Ordinance factories % 67 % 505 Clothing 62 958 Railway workshop 7 109 Textile 24 24 Food, drink & tobacco 31 25 Paper and printing 33 27 Hides and skin 87 181 Wood stone and glass 82 • 101 Engineering 25 97 Minerals and metals 39 128 Chemicals and dyes 24 75 Miscellaneous 4 l 194 This comparison reveals a phenomenal expansion in industries that were closely related to the prosecution of War; i . e . , arms and ammunition, clothing for the forces, the repair and construction of railway ro l l ing stock, and the production of minerals and metals. The other industries experienced on the whole a substantial growth but, for obvious reasons, the rates were not so phenomenal. Once assured of Independence by the Labour Government of Bri ta in , Indian nationalists faced the choice of following either a free enterprise capital ist system or a planned co l lect iv i s t pattern of economic development. - 126 - They had already expressed their choice in their original proposal to establish the Reserve Bank of India as a national inst i tut ion. Since, after 19^7, they were free to choose what they believed would be best suited to Indian conditions, they elected not only to nationalize the Reserve Bank; they also took steps to nationalize i t s competitor, the Imperial Bank, and to establish a number of governmentally sponsored quasi-public financial institutions to expedite.their ambitious plans for the Country's industrial izat ion. Part 1 Nationalization of the Reserve Bank • The most impressive argument made for the nationalization of the Reserve Bank was the growing concentration of the ownership and control of the Bank's shares in the hands of the vested financial interests. At the time of the establishment; of the Bank, the Imperial Government of India had attempted to make i t a truly representative share-holders bank by dividing the Country, as mentioned! earl ier , into five regions and by allocating a fixed number of shares to each. It had also placed a l imit on the number of shares that an individual could hold. In spite of these measures, the distribution of the ownership of the shares changed considerably in the years immediately following. This i s k revealed in some detail in the following table. 4. J .P . Jain, Indian Banking Analysed, Rajhan Publications, Delhi 1949, p. 157 also S.K. Basu, A Survey of Contemporary Banking Trends, Book Exchange, Calcutta, 1957,. p. 51 - 127 - Regional Distribution of Ownership of Reserve Bank Shares, 1935 © 1948 Inc. (In,000) Regions A p r i l Dec. Dec. June June June June June June 1935 1936 1938 1940 1942 1944 1946 1947 1948 Bombay i4o 190 206 211 219 231 236 237 239 Calcutta 145 131 123 120 120 119 124 126 128 Delhi 115 97 93 93 86 85 79 79 79 Madras 70 61 60 59 59 55 51 50 49 Rangoon 30 20 18 17 17 10 8 8 5 This summary reveals an eventual concentration of shares in the Bombay region at" the cost of the other regions. Whereas the number of shares in the Bombay region increased from 140,000 in 1935 to about 239»000 in 1948, the number in the Calcutta region declined from 145,000 to 128,000. In the Delhi region the decline was from 115,000 to 79^000; in the Madras region, from 70,000 to 49,000; and in the Rangoon region, from 30,000 to 5,000. The regions of Delhi and Rangoon were the heaviest losers. The data below reveal the reduction that meanwhile had taken place in the number of Individual Shareholders. Regional Distribution of Share-Holders, 1935-1948, Inc. (00 omitted) Region Bombay Apr i l 1935 28 0 Dec. 1936 22 3 Dec . 1938 20 8 June 1940 19 8 June 1942 18 0 June 1944 18 0 June 1946 17 4 June 1947 17 4 June 1948 17 2 Calcutta 23 9 15 6 13 8 12 8 11 6 11 0 10 6 10 5 10 4 Delhi 23 0 16 7 14 9 13 7 12 2 11 5 10 6 10 3 10 1 Madras 14 0 9 7 8 7 8 2 7 7 7 1 6 6 6 4 6 2 Rangoon 3 1 1 9 l 6 1 4 1 2 0 6 0 6 0 5 0 4 TOTAL . . . 92 0 66^2 59 8 55 9 51 1 48 2 45 7 45 0 44 4 Av. NO. O f ' c ;, shares per 7.5 8.4 8.9 9.8 10.4 10.9 11.1 11.3 share-holder - 128 - It i s significant to note that the total number of share-holders of the Bank decreased from 92,000 in 1935 to 44,400 in 1948; that meanwhile the average number of shares held by a share-holder increased from 5.4 to 11.3. The data further reveal that the number of share- holders in a l l regions except Bombay decreased by considerably more than 50 per cent. Taken together, these tables reveal that the Bombay region had acquired almost half of the Bank's outstanding shares and about 40 per cent of the share-holders. Thus the Reserve Bank was rapidly losing i t s status as a representative public inst itution and the original attempt of the Imperial Government to keep the Bank's electorate as wide as possible was being defeated. The Bank was coming increasingly under the domination of vested interests in the Bombay region. Nationalization appeared to be the most decisive way of permanently restoring the Bank to the status of a representative public inst i tut ion. The proponents of state-ownership of the Bank also held the view that to entrust the control of the Bank - the proposed hub of the Indian Banking System - to private share-holders; and i t s management to directors belonging largely to the capital ist class; was not in the best interest of the whole country. Such a public inst i tut ion should, they believed, represent a l l interested groups in the Country. It was feared moreover that, since much of the financial structure of India was already in European hands, the policy of the Bank might not coincide with the national interest. - 1 2 9 - Confidence in the success of the nationalization measures on economic grounds was enhanced by the fact that the earlier take-over and management of the Indian Railways by the Government had proved to be very successful. The profits earned by the nationalized railways had been used both to improve the service and to expand the system. The proponents of nationalization felt that profits earned by the Bank from the free use of public funds and from the issue of the Nation's currency should be used for the benefit of the Country as a whole rather than be left to the disposition of a relat ively small group of share-holders. Unlike the people of the United States of America, the Indian people do not suffer from an innate skepticism of the extension of government authority in the f i e ld of business enterprise. The people of India sincerely believed that a publicly owned central bank would win the confidence and cooperation of a great number of private banking institutions which, hitherto, had not seen f i t to associate themselves with the privately owned Bank. In spite of the popular appeal of public ownership of the Reserve Bank, the move was not unchallenged. The Central Board of Directors of the Bank was highly c r i t i c a l , contending that the move was premature and hazardous in the existing state of Indian economic a f fa irs . They feared that i t might reduce the flow of incoming foreign capital by creating the impression that this was but the f i r s t step towards nationalization of other industries and financial inst i tutions. They also contended that the Bank would become even more the hand maiden of - 130 - the Government and so abuse the privilege of note issue as to destroy confidence in the Indian currency. To a l l intents and purposes the arguments in favour and against the take-over of the Reserve Bank were concluded by the Minister of Finance, Mr. Liakat A l i Khan, who, in February 1947 made the following announcement;^ "I have since given further thought to the matter and am convinced that the advantages of nationalization outweigh any possible disadvantages. I have, therefore, come to the conclusion that the Reserve Bank of India should be nationalized . . . " In order to implement this conclusion, the Government of India passed the Reserve Bank (Transfer to Public-ownership) Act on September 3» 1948. This Act, among several other significant provisions, empowered the Government to purchase a l l outstanding privately owned shares of the Bank. The effective date of the transfer of ownership was January 1, 19^9. The purchase price of the shares was based on the average market price during the preceding 12 months. The latter turned out to be Rs. II85/8 per share. The par subscription price had been Rs. 100. The share-holders were paid partly in cash and partly in 20 to 25 year 3% Government promisory notes. Unlike the take-over of the Bank of Canada or that of the Bank of England, the nationalization of the Reserve Bank of India was not merely a p o l i t i c a l gesture to the pro-col lect ivist group among the Indian nationalists. It was part of a comprehensive plan to place a l l banking Reserve Bank of India, Report on Currency and Finance, 1947-48, Bombay, 1948. p. 113 - 1 3 1 - institutions under Government regulation and control with the Reserve Bank as the principal instrument for accomplishment. One of the more significant parts of the Transfer Act i s Section 7 which provides that, "The Central Government may from time to time give such directions to the Bank as i t may, after consultation with the Governor of the Bank, consider necessary in the public interest". Other sections of this Act in combination with the provisions of the Banking Companies Act of 1 9 ^ 9 provide for an extension of the authority of the Bank to pract ical ly a l l formalized banking institutions in India. Changes in Administrative Structure As before, the administration of the Bank was entrusted to a Central Board of'Directors. But under the Nationalization Act, their number was reduced from sixteen to fourteen. Whereas before national- ization the private share-holders of the Bank controlled the majority of the voting members on the Central Board, the Government take-over made a l l of them in effect appointees of the Government. Now the directors of the Bank are presumably more concerned with promoting the general interest of the economy than with the profit making potential of the Bank. The Central Board of Directors now consists of a Governor, two deputy governors ,a Government representative and ten other directors. Of these latter ten, four represent the Regional Boards provided in the original Act.^ The remaining six directors are representatives of agriculture, Industry, Jfcrade and commerce, cooperative banks, etc. 6 The original Act provided for five Regional Boards: Bombay, Delhi, Calcutta, Madras and Rangoon. The latter region was eliminated by virtue of the separation of Burma. - 132 - Under the Transfer Act, the Governor and the Deputy Governors held office for such terms as may be determined by the Government at the time of their appointment. However i t was la id down in the Act that their terms may not exceed five consecutive years. The Government o f f i c i a l on the Board holds office during the pleasure of the appointing authority. The Government's representatives on the Board hold office for five years; the representatives of the Regional Boards, for four years; and the representatives of agriculture, industry etc., for three years. The Regional Boards now consist of five members instead of eight as previously. The directors of these Boards are appointed by the Government to represent local economic interests. They hold office for four years. A l l the members of the Central Board of Directors, except the Government o f f i c i a l and the directors of Regional Boards, are el igible for re-appointment. Jurisdict ional Changes Originally membership in the Indian Reserve Bank system was limited to banks with Rs. 500,000 or more paid-up capital . Only these normally designated scheduled banks were required to deposit their statutory reserves with the Reserve Bank, and to submit weekly reports of their principal assets and l i a b i l i t i e s . A l l non-scheduled banks and indigenous bankers were thus outside the Reserve Bank's province. Presumably to protect the correspondent business of the larger scheduled Banks, discount and remittance f a c i l i t i e s were restricted to member banks only. During World War II these f a c i l i t i e s were extended to The State Cooperative Banks but not to the other non-scheduled institutions. - 133 - However, in the Banking Companies Act of 19^9, a l l non-scheduled banks were,in effect, brought within the scope of the Reserve Bank's authority by the provision that "every banking company not being a scheduled bank shal l maintain by way of cash reserves in cash with i t s e l f , or in account opened with the Reserve Bank . . . a sum equivalent to at least two per cent of i t s time l i a b i l i t i e s and five per cent of i t s demand l i a b i l i t i e s and shal l f i l e with the Reserve Bank before the 15th day of every month three copies of a statement of the amount so held on Friday of each week of the preceding month with particulars of i ts time and demand l i a b i l i t i e s 7 on each Friday". Subsequent to this Act the discount and remittance f a c i l i t i e s of the Reserve Bank were extended to a l l banking companies that may see f i t to employ them. Extension of Regulatory Authority Although the Transfer Act of 19^8 i t s e l f did not s ignif icantly alter the functions of the Reserve Bank with respect to the exercise of i t s monetary policy, other banking measures enacted by the Government greatly increased i t s power and extended i t s authority to include regulatory authority over a l l banking institutions. Early in 19^9, The Government of India f inal ly passed the revised and comprehensive Banking Companies Act which had been in process of development from 19^4 onward. This new l ig i s la t ion included the earlier ad hoc measures such as inspection, and branch limitation along with several others which quite definitely placed a l l private banks under the supervision of the Reserve Bank. These included the licensing of banks, dictation of their lending pol ic ies , responsibility for their inspection and the authority to suspend their operations. 7. Government of India, Banking Companies Act, 19^9, Sec. l 8 , Government °? India Press, Delhi, 19^9. - 134 - The L i c e n s i n g of Banks At the time o f the i n s t i t u t i o n o f the Reserve Bank of I n d i a , and f o r some y e a r s f o l l o w i n g , no r e s t r i c t i o n s were p l a c e d on the e s t a b l i s h m e n t of p r i v a t e b a n k i n g i n s t i t u t i o n s . T h i s s i t u a t i o n , combined w i t h the b u s i n e s s e x p a n s i o n t h a t o c c u r r e d d u r i n g World War I I , prompted the o r g a n i z a t i o n o f many p r e d o m i n a n t l y s m a l l e n t e r p r i s e s which c a l l e d them- s e l v e s banks. B e f o r e 194-9, the o n l y r e s t r a i n t upon t h i s mushroom growth was the requ i r e m e n t t h a t the bank be r e g i s t e r e d w i t h the R e g i s t r a r of Companies. The o n l y r e s t r i c t i o n on e s t a b l i s h e d banks was the 1946 o r d i n a n c e p r o v i d i n g f o r the l i c e n s i n g o f branches. I n o r d e r t o check t h i s w i l d and u n h e a l t h y growth and t o encourage the development o f sound b a n k i n g i n s t i t u t i o n s , the 1949 A c t r e q u i r e d a l l e x i s t i n g b a n k i n g companies to se c u r e a l i c e n c e from the Reserve Bank of I n d i a i f t h e y were to c o n t i n u e i n b u s i n e s s . A l l new banking companies were r e q u i r e d 8 t o g e t a l i c e n c e from t h e Bank b e f o r e they c o u l d be e s t a b l i s h e d . When g r a n t i n g l i c e n c e s to e x i s t i n g banks the Reserve Bank was t o be s a t i s f i e d , by i n s p e c t i o n o r o t h e r w i s e , t h a t the a p p l i c a n t bank was i n a p o s i t i o n to meet i t s o b l i g a t i o n s and conduct i t s b u s i n e s s on sound b a n k i n g p r i n c i p l e s . W i t h r e s p e c t t o the new banks and branches the Reserve Bank was t o be s a t i s f i e d t h a t t h e r e was a need f o r a bank i n the a r e a where the bank proposed t o o p e r a t e . I f a b a n k i n g company s h o u l d not f o l l o w a p o l i c y c o n s i s t e n t w i t h • the n a t i o n a l i n t e r e s t and i n the i n t e r e s t of i t s d e p o s i t o r s , the Reserve Bank w i t h the consent o f the Government i s a u t h o r i s e d t o c a n c e l i t s l i c e n c e . The a g r i e v e d b a n k i n g company may a p p e a l t o the C e n t r a l 9 Government but a f t e r the s u s p e n s i o n not b e f o r e . 8 Government of I n d i a , op. c i t . , S e c t i o n 22(1) 9 * I b i d . , 22(4) - 135 - D i r e c t i v e s on Loans and I n t e r e s t Rates The Banking Companies A c t of 19^9 c o n t a i n e d s e v e r a l o t h e r measures which c o n s i d e r a b l y i n c r e a s e d the scope of the r e g u l a t o r y powers of the Reserve Bank as w e l l as i t s i n s t r u m e n t s of monetary c o n t r o l . S e c t i o n 21 ( l ) p r o v i d e s t h a t the Reserve Bank may g i v e d i r e c t i o n s to b a n k i n g companies, e i t h e r g e n e r a l l y or to any b a n k i n g company o r a group o f b a n k i n g companies i n p a r t i c u l a r , as to the purpose f o r w h i c h advances may or may not be made, the margins t o be m a i n t a i n e d i n r e s p e c t of s e c u r e d advances and the r a t e of i n t e r e s t to be charged, and each b a n k i n g company s h a l l be bound t o comply w i t h any d i r e c t i o n s so g i v e n . Under S e c t i o n 36 (1) of the 19^9 Companies A c t , the R e s erve Bank i s empowered to c a u t i o n and to p r o h i b i t banks g e n e r a l l y , o r anybbanking company i n p a r t i c u l a r , a g a i n s t e n t e r i n g i n t o any p a r t i c u l a r t r a n s a c t i o n s or c l a s s o f t r a n s a c t i o n s not i n the p u b l i c i n t e r e s t . 1 1 W i t h the p o s s i b l e e x c e p t i o n of the Commonwealth Bank o f A u s t r a l i a , no s i m i l a r d i r e c t r e g u l a t o r y a u t h o r i t y has been g r a n t e d t o any p r e s e n t day c e n t r a l bank. Merger and Amalgamation Under the p r o v i s i o n s o f the Banking Companies A c t , 19^9 banks had t o seek the p e r m i s s i o n of t h e Reserve Bank f o r t h e i r amalgamation, merger But and d i s c o n t i n u a n c e of t h e i r b a n k i n g b u s i n e s s . /The Reserve Bank was not a u t h o r i s e d t o impose compulsory merger o r amalgamation on b a n k i n g companies which i t c o n s i d e r e d weak or not p r o p e r l y managed. I t c o u l d , and d i d b r i n g p r e s s u r e on them to undertake such moves cwh'en c o n d i t i o n s p e r m i t t e d them t o do s o . A f t e r the r a t h e r d i s a s t r o u s f a i l u r e o f the P a l a i C e n t r a l Bank 1 and the Loxmi bank i n e a r l y i960,to w h i c h - a d d i t i o n a l 9̂/ Government-.of-India, B a n k i n g Companies A c t , 19^9, S e c t i o n 21, D e l h i , 1949. 1 1 * I b i d . , S e c t i o n 36 (1), 12. I b i d . , S e d t i o n s kk and 45- - 136 - r e f e r e n c e i s made i n Chapter V I , the Banking Companies A c t was amended. Under the p r o v i s i o n s o f Bank i n g Companies (Second Amendment) A c t , i 9 6 0 the Reserve Bank was a u t h o r i s e d , w i t h the p r i o r p e r m i s s i o n of such the Government, t o i n i t i a t e / m e r g e r s and amalgamations as appeared t o be i n the p u b l i c i n t e r e s t and t h a t of the banks t h e m s e l v e s . " ^ T h i s same amendment p r o v i d e d t h a t i n case o f a bank f a i l u r e d e p o s i t o r s were t o be 14 g i v e n p r i o r i t y over a l l o t h e r c r e d i t o r i s , s e c u r e d or o t h e r w i s e . Sub- s e q u e n t l y i n I96I, i n o r d e r t o speed up the p r o c e s s o f amalgamation o r the merger,/Banking, Companies A c t was f u r t h e r amended. Under the p r o v i s i o n s o f B a n k i n g Companies (Amendment) A c t , 196l the Reserve Bank was a u t h o r i z e d t o pr e p a r e p l a n s under which weak and mis-managed banks c o u l d be absorbed by the S t a t e Bank of I n d i a o r some o t h e r w e l l e s t a b l i s h e d bank."^ Such amalgamation p l a n s a r e binding-• not o n l y on banks concerned, t h e i r d e p o s i t o r s and c r e d i t o r s , but on t h e i r employees as w e l l . Appointment of O f f i c i a l s I n a d d i t i o n t o the power t o d i r e c t the l e n d i n g a c t i v i t i e s of the p r i v a t e banks, the 1949 A c t gave the Reserve Bank the a u t h o r i t y to approve the appointment o f managers and c h i e f e x e c u t i v e o f f i c e r s o f p r i v a t e b a n k i n g i n s t i t u t i o n s . I t a l s o gave the Bank the power to p r o h i b i t i n t e r - l o c k i n g d i r e c t i o n s , the employment o f managing a g e n t s , and the g r a n t i n g of unsecured l o a n s e i t h e r t o d i r e c t o r s or t o f i r m s i n which d i r e c t o r s had i n t e r e s t s . Government of I n d i a , Banking Companies (Second Amendment) A c t , i 9 6 0 , S e c t i o n 43 A. I b i d . , S e c t i o n 44 B Government of I n d i a , Banking Companies (Amendment) A c t , 1 9 6 l , S e c t i o n 45 l 6 Government of I n d i a , B a n k i n g Companies A c t , 1949, S e c t i o n 10. - 137 - These powers of appointment, etc.were considerably enlarged by a 1959 amendment to the Banking Companies Act which gave the Reserve Bank the right to "remove from office the chairman, any director, manager or chief executive officer of a banking company found guilty 17 of contravening any law relating to the operation of the bank". Furthermore, banking institutions were required to seek the approval of the Reserve Bank on such matters as the appointment, reappointment any or remuneration of/; director, manager, secretary or treasurer who may be employed by them. Banks have also to seek permission from the 18. Reserve Bank for a grant of retirement benefits to any of these persons. Inspection, Supervision and Suspension Before i t s nationalization, the Reserve Bank was not authorized to inspect the working and accounts of banking inst i tut ions. A scheduled bank had to submit i t s accounts to the Reserve Bank for review but i t did not have to submit to audit and inspection by Reserve Bank o f f i c ia l s . The Banking Companies Act of 19^9, specifies that "the Reserve Bank at any time may, and on being directed so to do by the Central Government shal l , cause an inspection to be made by one or more of i t s officers of any banking company and i t s books and accounts, and the Reserve Bank shal l supply to the Banking Company a copy of i t s report on such inspection". * If after due inspection, i t is disclosed that the bank had not been operated in a proper manner, the Reserve Bank was authorized to prohibit the bank from accepting new deposits and to apply to the proper court for an order to wind up the bank's af fa irs . However, i f the Reserve Bank considered that a banking •I n G6've:rnmeftt of India, Banking Companies Act, 19^9, Section 6 op_. c i t . , | 8 , Reserve Bank of India, Trend and Progress of Banking in India during 1959, Bombay, i960, p. 16 Section 35 (l) Banking Companies Act, 19^9, Government of India, 1949 - 138 - company could be salvaged, application could be made to the Central Government for an order of moratorium. During this moratorium the Reserve Bank could prepare a plan either for the bank's reconstruction or foi? i t s amalgamation with another banking company and submit i t for approval to the Central Government. Additions to Instruments of Monetary Policy Under the original Reserve Bank Act the instruments by which the Bank could attempt to exercise a measure of control over the money supply, credit and prices were quite limited. They consisted of: i . the authority to engage in open market operations; To i i . /make or to deny advances to the scheduled banks or to rediscount their e l igible paper; and i i i . the right to fix the interest or 'bank rate' at which such transactions would be made. The Bank neither had the authority to manipulate the reserve ratio nor to ration credit. It did not have sufficient stature in the banking community to exercise moral suasion. Most of these short- comings were met by provisions of the Banking Companies Act of 19^9 and subsequent amendment of this Act and to the Reserve Bank i t s e l f . Selective Credit Control and Credit Rationing As noted in connection with the Reserve Bank's newly acquired regulatory authority the new Bank Act gave the Reserve Bank the authority to dictate the purpose for which advances by primary lenders may or may not be made as well as the rate of interest to be charged. The monetary - 139 - 16. policy implications of this authority are spelled out as follows: Where the Reserve Bank i s satisfied that i t i s necessary or expedient in the public interest so to do, i t may determine the policy in relation to advances to be followed by banking companies generally or by any banking company in particular, and when the policy has been so determined, a l l banking companies or the banking companies concerned as the case may be, shal l be bound to follow the policy as so determined. Later on credit rationing was imposed under this authority in an attempt to arrest the inflationary effects of the Government's "on vast deficit financing during the Second Five Year Plan. The Reserve Bank has also used this authority to channel credit away from the speculative stock and produce markets, and into the basically productive sectors of the economy. Interest Rates on Deposits In addition to i t s authority to impose selective credit measures, the Banking Companies Act of 1949 confers upon the Reserve Bank the authority to l imit the rates of interest paid on short term deposits by the private banks. This is a subtle way of closing an important avenue of re l i e f of cash shortages resulting from the operation of a restr ict ive bank rate and considerably enhances the power of the central bank. The 1949 measure provided in effect that the Reserve Bank could force the private inst itution to keep the interest rate paid on customers' deposits at two percentage points below the Reserve Bank's discount rate. Section 21 (1) Banking Companies Act, 1949, Government of India, 1949- See Chapter V, page l64. 20. 2J. - 140 - Reserve R a t i o M a n i p u l a t i o n I n an attempt to m i t i g a t e the i n f l a t i o n a r y e f f e c t s of e x t e n s i v e r e l i a n c e on c e n t r a l bank c r e d i t i n the f i n a n c i n g o f the C o u n t r y ' s r e c o n s t r u c t i o n program, Reserve Bank o f f i c i a l s i n 195& sought out and were g r a n t e d the a u t h o r i t y to m a n i p u l a t e the r a t i o s g o v e r n i n g 22 the r e s e r v e s of member b a n k i n g i n s t i t u t i o n s . T h i s was a c c o m p l i s h e d by an amendment t o the Reserve Bank A c t i t s e l f which empowered the Bank to s e t the p r e v a i l i n g r a t i o on t i m e d e p o s i t s anywhere between 2 per cent and 8 per c e n t ; the r a t e on the demand d e p o s i t s anywhere from 5 p e r cent to 20 per c e n t . Of c o n s i d e r a b l y more s i g n i f i c a n c e was the a d d i t i o n a l p r o v i s i o n t h a t under emergency c o n d i t i o n s t he s t a t u t o r y p r o v i s i o n may be exceeded by as much as f i f t y per cent on a d d i t i o n a l d e p o s i t s . That i s t o say, a f t e r t h e e s t a b l i s h m e n t of a g i v e n r ^ r a t i o between the a u t h o r i z e d l i m i t s an a d d i t i o n a l r e s e r v e r e q u i r m e n t may be imposed on new d e p o s i t s o f the.banks p r o v i d e d the average o f 20% and 8% a r e not exceeded. T h i s i s r e a l l y a d e c i s i v e power, f o r i t has the e f f e c t of b u r d e n i n g the banks w i t h o p p o r t u n i t y c o s t of h o l d i n g i n e x t r e m i t y as much as 100 per cent o f new d e p o s i t s |n i d l e r e s e r v e b a l a n c e s . I t a l s o reduces s u b s t a n t i a l l y the i n f l a t i o n a r y p o t e n t i a l o f the c e n t r a l bank c r e d i t made a v a i l a b l e to Government and o t h e r s p e n d i n g a g e n c i e s . Government of I n d i a , Reserve Bank (Amendment) A c t , 1956, S e c t i o n 42. - 141 - Moral Suasion Though tangible areas of application are not specified, Indian writers on.the role of the Reserve Bank hold the view that national- ization generally enhanced the persuasive power and prestige of the Reserve Bank. This i s undoubtedly true but one may s t i l l wonder i f this enhancement was not the result of a very considerably enlarged kit of (.control instruments and the fact that there was no longer any dist inction between Government policy and central bank policy. With the -possible exception of the Commonwealth Bank of Austral ia , no central bank in the admittedly more advanced Western Countries has been granted such a wide range of authority over both the public and 2-3 private interests of the subordinate banks. Thus, for example, an announcement of the poss ibi l i ty of a change in the reserve ratio or a reduction in the rate of interest in short term funds may be even more effective than the posting of the change i t s e l f . Part 2 Nationalization of the Imperial Bank As mentioned in Chapter III, the Government of India had decided to nationalize the Imperial Bank as early as 1947- Owing, as i t was said, to some technical d i f f i cu l t i e s presented by the Imperial Banks network of branches in Pakistan, Burma and Ceylon: but more probably to the financial consideration involved in the take-over of this largest of a l l private banking inst i tut ion at the i n i t i a l stage of the country's eoonomic development; the Government had to postpone the This conclusion was reached by Professor Crumb of the University of Bri t i sh Columbia after studying the powers and duties of many of the world's leading central banks. - 142 - a c t u a l t a k e - o v e r u n t i l 1955. By t h i s time the a c c o m p l i s h e d n a t i o n a l - i z a t i o n of the Reserve Bank and the announcement of the p e n d i n g n a t i o n a l i z a t i o n o f the i n s u r a n c e companies and o t h e r e n t e r p r i s e s no l o n g e r l e f t any v a l i d p o l i t i c a l excuse f o r m a i n t a i n i n g a p a s s i v e a t t i t u d e towards t h i s v i t a l " f o r e i g n " i n s t i t u t i o n . There was a l s o the hope t h a t i t s v a s t r e s o u r c e s , wide net-work o f bra n c h e s , and i t s s k i l l e d p e r s o n n e l c o u l d take on t h e v e r y r e a l t a s k of i m p r o v i n g f a c i l i t i e s f o r f i n a n c i n g I n d i a ' s g r e a t e s t i n d u s t r y - a g r i c u l t u r e . T h i s l a t t e r view had a l r e a d y been exp r e s s e d by the R u r a l B a n k i n g E n q u i r y Committee which the newly n a t i o n a l i z e d Reserve Bank had s e t up to s t u d y a g r i c u l t u r a l f i n a n c e and to make recommendations to speed up t h e sp r e a d o f a g r i c u l t u r a l b a n k i n g f a c i l i t i e s . Among i t s o t h e r recommendations was one t h a t the I m p e r i a l Bank s h o u l d work as an a u x i l i a r y to t h e Reserve Bank and t h a t i t s h o u l d e s t a b l i s h 270 branches i n unserved 24 and o u t l y i n g a r e a s w i t h i n the f o l l o w i n g f i v e y e a r s . . T h i s i t began t o do. As a p a r t i a l compensation f o r l o s s e s on the new branches the Reserve Bank i n c r e a s e d the commission p a i d to the I m p e r i a l Bank on c o l l e c t i o n s and 25 payments made f o r i t s a c c o u n t . L a t e r on the Reserve Bank a p p o i n t e d the A l l I n d i a R u r a l C r e d i t S u r v e y Committee to s t u d y the r u r a l c r e d i t problems and t o make recommendations t o f a c i l i t a t e the f r e e f l o w o f c r e d i t to a g r i c u l t u r e ?4 S.G. P a n a n d i k a r , B a n k i n g i n I n d i a , 9th ed, O r i e n t Longmans, Bombay, 1959, p. 514 The new r a t e s o f Commission were l / l 6 o f one per ce n t on the f i r s t Rs. 1 ,500,000,000; 1/32 of one per cent on the next Rs. 3 , 0 0 0 , 0 0 0 , 0 0 0 ; 1/64 of one per cent on b u s i n e s s o v e r Rs. 3 , 0 0 0 , 0 0 0 , 0 0 0 but not ex c e e d i n g Rs. 12 ,000,000,000 and 1/128 of one per cent on b u s i n e s s e x c e e d i n g Rs. 1 2 , 0 0 0 , 0 0 0 , 0 0 0 . - 143 - and a l l i ed industries in rural areas. This Committee was c r i t i c a l of the progress made by.the Imperial Bank between 1950 and 1954 in i t s branch expansion program. The slow progress, the Committee contended, was due to the primary profit motive of the Bank. It could not keep i t s owners content with the lower dividends that would result from a primary interest in the development of the Indian economy. In i t s integrated scheme to reorganize the rural credit and thus to provide adequate credit f a c i l i t i e s to the rural population, the Committee of Direction of the A l l India Rural Credit Survey recommended that the Imperial Bank,along with other State associated banks, be made a state inst i tut ion in language that appears to have presumed as much on the Imperial Bank's existing f a c i l i t i e s as on new ones to be added.. The Committee concluded in approved col lect iv is t style that the proposed State Bank be: "one strong, integrated, state-sponsored, state- partnered commercial banking inst i tution with an p, ! r , effective machinery of branches spread over the whole country, which, by further expansion can be put in a position to take over cash work from non-banking treasuries and sub-treasuries, provide vastly extended remittance f a c i l i t i e s for cooperative and other banks, thus stimulating the further establishment of such banks, and, generally, follow a policy of advances - including advances for agricultural purposes - which, while not deviating from the cannons of sound business, wi l l be in effective consonance with national policies as expressed through the central govefnemtn and the Reserve Bank".2© The Committee went on to state that the Government of India and the Reserve Bank together should hold 52 per cent of the share capital of the proposed State Bank; i t also made proposals t&r the management and operations of the nationalized inst i tut ion. Similar proposals were Reserve Bank of India, Report on Currency and Finance, 1954-55, Bombay, p. 91 - 144 - remade:; hy the Shroff Committee appointed by the Reserve Bank to enquire into problems of finance in the private 6gct;Oi!. ^(Jher. i h e Government f inal ly announced i t s decision to nationalize the Imperial Bank on December 20, 1954. In May of the following year the State Bank of India Act was passed by the Indian Parliament, and on July 1, 1955 the State Bank took over the operations of the former Imperial Bank. Ownership of the State Bank of India The conversion of the Imperial Bank into the State Bank was accomplished by the directed sale of the shares of the Imperial Bank to the state owned Reserve Bank at a price of Rs. 1,765 5/8 per share. 22 This was more than three times the original par value of Rs. 500. The payment i t s e l f was made partly in cash and partly in Government National Plan Bonds bearing interest at Jjk per cent. Under the provisions of the State Bank of India Act, the Reserve Bank was authorized to dispose of 45 per cent of the share capital of the State Bank to the general public with preference given to the former share holders of the Imperial Bank. The Central Board of the State Bank was authorised to increase the outstanding shares of the State Bank providing the holdings of the Reserve Bank did not f a l l below 55 per cent of the total . The State Bank of India Act of 1955 also contained provisions under which other banking companies may be and subsequently were amalgamated with the State Bank. Partly paid-up share of Rs. 100 were bought at Rs. 431 3/4. Their price was based on the average market price for the past twelve months. - 145 - Administration and Management The Administration of the State Bank was entrusted to a Central Board of Directors. This Board consists of twenty members. The chairman and vice-chairman are appointed by the Central Government in consultation with the Reserve Bank. Two managing directors are appointed by the Central Board with the approval of the Central Government. Six directors are elected by shareholders other than the Reserve Bank. Eight directors are nominated by the Government in consultation with the Reserve Bank and these directors represent various economic interests of the country, i . e . agriculture, industry, trade and commerce, and the cooperative banks. One is appointed by the Reserve Bank and one by the Central Government. The management of the State Bank continued in the hands of the former o f f i c i a l and personnel of the Imperial Bank. Part 3 Industrial Banks and the Insurance Corporation of India After August 15, 1947, when India became a sovereign state, the Indian Government was f inal ly free to chart the country's future development. This was done along lines dictated by the needs and aspirations of the Indian people. These needs and aspirations could be summed up in the expression, self generated industrial izat ion. The Indian people looked upon industrial ization not only as a means of improving per capita incomes, l i v ing standards and employment opport- unit ies , but as an eventual escape from dependence on foreign interests * Reserve Bank of India, op. c i t . , p. 42 - 146 - for the development of the Indian economy. The program of development which ultimately emerged in a series of five year plans, encompassed agricultural improvements, natural resources exploitation, and the development of iron and steel , ship building and aircraft industries - a l l to be financed as far as possible from domestic sources. Considering the relat ively impoverished state of the Indian economy this was, to say the least, a very ambitious undertaking. In a l l , the Government in cooperation with the Reserve Bank and various private financial inst i tutions, established six different f inancial corporations through which the credit needs of the program of industrial ization were to be channelled and in part provided. In approximate order of establishment they were: the Industrial Finance Corporation, the State Financial Coporations, the National Industrial Development Corporation, the Industrial Credit and Investment Corporation of India, the National Small Industries Corporation and the Refinance Corporation. It also nationalized the Country's insurance business through the establishment of the Life Insurance Corporation of India. The Industrial Finance Corporation The Industrial Finance Corporation was established on July 1, 1948. This agency was authorized to grant long term capital loans to public limited companies and to cooperative ventures engaged in manufacturing, mining, and the generation and distribution of power. Subsequently ship building was brought within the sphere of i t s lending operations. Capitalization and Ownership This agency has a paid up capital of Rs. 50,000,000 which was subscribed by the Government, the Reserve Bank, the Scheduled Banks, - 147 - the Insurance companies and the cooperative banks in the following proportions. Subscribers Amount subscribed Percent of (000,000) Total Insurance companies 13.0 26.0 Scheduled banks 12.0 24.0 Government of India 10.0 20.0 Reserve Bank of India 10.3 20.6 Cooperative banks 4.7 9.4 The Government of India in conjunction with the Reserve Bank of India contributed about 4l per cent of the share capital of the Corporation. With the nationalization of the Imperial Bank and the l i f e insurance companies of India in 1955 and 1956 respectively, the total share of Government and public institutions became something more than 70 per cent. In order to make the shares of the Corporation a reasonably attractive investment for the private banks and insurance companies, the Government undertook to guarantee i t s par value and a minimal dividend of 2% per cent. The maximum dividend allowed was 5 per cent. Any net profit above this maximum accrued to the Government. In 1952 the Enabling Act was amended to provide that dividends payable to the Government and, the Reserve Bank be placed in a special fund unt i l such payments amounted to Rs. 5,000,000. S.L.N. Simha, The Capital Market of India, Bombay, Vora & Co. , Bombay, i960, p. 144 3ft* Reserye Bank of India, Report on Currency and Finance, 1952-53- Bombay, 1953, p. 54 - 148 - Administration and Control The administration of the Industrial Finance Corporation is entrusted to a Board of Directors consisting of 13 members. The Government of India on behalf of i t s e l f and the Reserve Bank appoints seven members of this Board including the managing director and the chairman. The other directors are appointed by the scheduled banks, the insurance companies and the cooperative banks. In addition to i t s majority control, the Government has the right to discharge the entire Board i f the latter should f a i l to follow Government policy. Sources of Working Capital In order to augment i t s capital funds the Industrial Finance Corporation was original ly authorised to issue bonds and debentures up to five times i ts paid-up capital . By 1957 this authorization had been 31 raised to ten times the paid-up capital . Meanwhile bonds and debent- ures issued by the Corporation had risen from Es. 58 ,000,000 in 1951 to Rs. 222,000,000 by the end of i 9 6 0 . Under the original Act the Corporation was not authorised to borrow from the Reserve Bank. In order to increase i t s immediately available lending capacity and thus to enable the Corporation better to serve i t s customers, the Act was amended in 1952 to permit such borrowing'provided proper col lateral was presented. The latter included securities of the Corporation i t s e l f and other securities acceptable to the Reserve Bank. The total of such loans could not exceed Rs. 3 0 , 0 0 0 , 0 0 0 . 32 In 1957 the 31. Reserve Bank of India, Report 1952-53, op. c i t p. 44. 32. Reserve Bank of India, Report on Currency and Finance, .1957-58, Bombay, p. 54. - I n - corporation was authorised to borrow directly from the Government provided i t s total borrowings from the Government, the Reserve Bank and i t s own outstanding bonds and debentures did not exceed ten times i t s capital and reserves. In 1958 the authority to underwrite security issues for other Government corporations was added to this agency's growing powers and duties. In i960 the Original Act was amended to allow the Corporation to subscribe directly to the common stock of the various industrial enterprises which borrowed from i t and for whom i t had underwritten share capital . It was also authorised to convert loans already granted and debentures into the share capital 33 of the borrowing concern in question. Under the amended Act the Government was authorised to guarantee such foreign loans as the Corporation may seek from the International Bank for reconstruction and development or from other international f inancial institutions for making loans in foreign currency to i t s customers. Before i960 the Government was not authorised to guarantee such loans. As we shall see in Part 3 of Chapter V the Industrial Finance Corporation played an important role in the financing of the Government enterprises in India. Its successful beginning led to the- establishment of various other financial institutions to meet the growing needs of the Government's expansion program. The State Financial Corporations At the time of i t s organization the operations of the Industrial Finance Corporation were limited to large public and cooperative enterprises and other private industrial ventures within the jur i s - the diction of/States also needed financial assistance for their development Reserve Bank of India, Report 1957-58, op. c i t . , pp. 5^-55. - 150 - and expansion. In order to make this' possible the Government of India passed the State Financial Corporation Act on September 28, 1951. Under the provisions of this measure the State Governments were authorized to set up their own financial corporations. By 1961 there were fifteen such corporations - one in each State. Capitalization and Ownership The State Financial Corporation Act empowers each State Government to f ix the authorized capital of i t s corporation according to i ts own needs subject to minimum and maximum limits of Rs. 5,000,000 and Rs. 50,000,000, respectively. The authorized capital of the existing corporations ranges between Rs. 20,000,000 and Rs. 4-0,000,000. The paid- up capital of these Corporations i s Rs. 10,000,000 except for the States of Bombay, Madras, Andhra Pardesh and Orissa where Rs. 20,000,000, Rs.. 13,200,000, Rs. 15,000,000 and Rs. 5,000,000 respectively, have been paid i n . The par value of the share capital of each State Finance Corporation and a minimum dividend of three per cent is guaranteed by the respective state Governments. Minimum and maximum rates are fixed at 3 per cent and 5 per cent, respectively. Within these l imits , each State Corporation i s free to f ix i t s actual dividend rate to reflect the local pattern of interest rates. The guanranteed rate of dividend is Jfe per cent in a l l States except Punjab and Madras where i t i s 3 per cent. Like the l imitation imposed on the Industrial Finance Corporation, the rate of dividend of the state financial corporations cannot exceed the S.L.N. Simha, op. c i t . , p. 160 - 151 - guaranteed minimum unt i l reserve funds are equal to paid up capital , and the State Government has been repaid any debt resulting from obligations incurred on behalf of the corporation. Unlike the Industrial Finance Corporation whose entire stock i s either Governmentally or inst i tut ional ly held, the general public can subscribe to the share capital of State Financial Corporations up to a maximum limit of twenty-five per cent. The remainder is subscribed by the respective State Governments, the Reserve Bank and other financial institutions. As of March 1959? the subscription of State Governments averaged 47 per cent of the total paid up capital , that of the Reserve Bank was 15 per cent and other financial institutions had subscribed on the average about 35 per cent. The remaining 5 per cent was subscribed by the general public. Thus the State Governments along with the Reserve Bank controlled about 62 per cent of the total capital of these Corporations. Administration and Control The administrations of the State Financial Corporations are entrusted to boards of directors, consisting of ten members. The respective State Governments in consultation with the Reserve Bank appoint the managing directors and nominate three other directors including the board chairman. The Reserve Bank and the Industrial Finance Corporation nominate one director each. The scheduled banks, Cooperative banks, insurance companies arid other financial institutions elect three directors from among themselves. The rest of the share- holders elect one director. Thus the majority of the directors are •gs,^ S.L.'Simhav op. c i t . , p. loO. - 152 - a p p o i n t e d by the S t a t e Governments and p u b l i c i n s t i t u t i o n s . The e n a b l i n g A c t s t i p u l a t e s t h a t each board s h a l l f o l l o w the p o l i c i e s d i c t a t e d by i t s Government i n c o n s u l t a t i o n w i t h the Reserve Bank. Sources of Working C a p i t a l I n o r d e r t o supplement t h e i r c a p i t a l funds these c o r p o r a t i o n s are a u t h o r i z e d t o i s s u e bonds and debentures up t o a maximum l i m i t of f i v e t i m e s t h e i r p a i d up c a p i t a l . L i k e the share c a p i t a l o f the c o r p o r a t i o n s t h e i r bonds and debentures are guaranteed by the r e s p e c t i v e S t a t e Governments. Some i n d i c a t i o n o f the im p o r t a n c e of the S t a t e C o r p o r a t i o n s may be ga i n e d from the f a c t t h a t by March, 1961 these C o r p o r a t i o n s had approved l o a n s amounting t o Rs. 361,700,000. Of t h i s sum Rs. 221,600,000,or o r about 60 per cent,was a c t u a l l y d i s b u r s e d . A t t h i s l a t t e r date the 36 amount of l o a n s and advances o u t s t a n d i n g was Rs. l4l,900,000. The N a t i o n a l I n d u s t r i a l Development C o r p o r a t i o n W i t h the o p e r a t i o n s o f the I n d u s t r i a l F i n a n c e C o r p o r a t i o n l i m i t e d t o l a r g e p u b l i c and c o o p e r a t i v e e n t e r p r i s e s , and thos e o f the S t a t e F i n a n c i a l C o r p o r a t i o n s l i m i t e d t o s t a t e and s m a l l l o c a l p r i v a t e i n d u s t r i a l u n d e r t a k i n g s , t h e r e was s t i l l need f o r a f i n a n c i a l i n s t i t u t i o n t h a t c o u l d p r o v i d e l o n g term c a p i t a l to l a r g e p r i v a t e i n d u s t r i e s and a s s i s t i n the e s t a b l i s h m e n t o f new ones. The p r i v a t e s e c t o r , i t was r e a l i z e d , a l s o had to be encouraged i f the Country was to r e a l i z e i t s f u l l i n d u s t r i a l p o t e n t i a l . I n r e c o g n i t i o n o f the d i f f i c u l t i e s o f p r i v a t e f i r m s i n a c q u i r i n g e q u i t y c a p i t a l f o r r i s k y v e n t u r e s and to Reserve Bank of I n d i a , Report on Curr e n c y and F i n a n c e , I96O-61, Bombay, 196l, p. 64 - 153 - encourage balanced growth of the industrial sector, the Government established the National Industrial Development Corporation on October 20, 1954."^ This Corporation was intended primarily to promote new industrial enterprises for the planned development of the Country's industrial sector and to finance improvements and extensions in existing ones . Particular attention was to be given to the jute industry, to cotton textiles and to the manufacture of machine tools. Priori ty was to be given to such firms as could make use of equipment, experience and s k i l l available in India. Capitalization and Ownership The National Industrial Development Corporation had a paid-up capital of Rs. 1,000,000. Unlike the Industrial Finance Corporation and the State Financial Corporations, where participation in ownership was fa ir ly broad, the Government of India was the sole subscriber to and shareholder of this Corporation. The Government has increased the working capital of the Corporation through loans and grants. During 1956 these loans and grants amounted to Rs. 14,900,000. Administration and Control The administration of the National Development Corporation i s entrusted to a Board of fourteen Directors drawn from the private business sector and chaired by the Minister of Commerce and Industry. 37- • 38. 39- Reserve Bank of India, Report on Currency and Finance, 1954-55 Bombay, 1955, p. 50 Loc -. . c i t . ,'', -Its authorized capital was Rs. 10,000,000 - 1 5 4 - The representatives of private business are nominated by the Government in consultation with the Industrial Finance Corporation and the Reserve Bank. Such prominent industrial ists as Tate, B i r l a , and Medi are represented on the Board. This was done to ensure sound advice and guidance to the Corporation in undertaking and developing new projects. The summary of the.operations of the various quasi-public financial corporations given in Part 3 of Chapter V reveals that this Corporation (N.I.D.C) has already made a very substantial contribution to the country's jute and cotton textile industries. Industrial Credit and Investment Corporation Although considerable progress towards industrial development was made during the First Five Year Plan the pace of this development was undoubtedly retarded by the fact that l i t t l e or no inducement had been given to local private enterprises or to foreign investors. No particular attempt had been made to provide instrumentality through which private equity capital could be channelled into industrial undertakings, and no special attempt had been made to tap either the vast capital resources or the technical proficiencies of the Western World. An institution that could bridge this gap was urgently needed. In 1954, when the Indian Planning Commission was working on the Second Five Year Plan, discussions were held with the representatives of the World Bank, the Foreign Operation Administration of the United States Government and the Commonwealth Development Finance Company on the feas ib i l i ty of establishing a nominally private investment corporation, to assist in promoting private enterprise. These discussions bore frui t in the form of a recommendation that an industrial - 155 - credit and investment corporation be set up in India under which a Indian and foreign investors would join hands to provide equity- capital and other benefits to private industrial enterprises. As a result, an institution bearing that name was established on January 5, 1955. Duties of this Corporation consisted in the main of f inancial and technical assistance to private industries.a One of i t s principal of tasks was to help in the provision loans in foreign currencies for importing urgently needed machines and equipment. The Reserve Bank of India gave a BiffiEt detailed summary i t s main objectives as follows: a. To assist in the creation, expansion and modernization of private industries b. To encourage and promote the participation of private capital , domestic and foreign, in the ownership of industrial investment and thus expand the investment market by: i . providing long and medium term loans and equity capital i i . underwriting new issue of stocks and bonds of private industries, or by guaranteeing loans from private institutions to such industries i i i . furnishing managerial, technical and administrative services to industries3® Capitalization and Ownership The Industrial Credit and Investment Corporation had an authorized capital of Rs. 250,000,000 of which Rs. 50,000,000 was paid up. Of the latter sum Rs. 35,000,000 was subscribed by Indian nationalists and other financial institutions; Rs. 10,000,000 were contributed by Brit ish Eastern Exchange banks, Bri t i sh insurance companies and the Reserve Bank of India, Report on Currency and Finance, 1954-55> Bombay, 1955* P- 50 - 156 - Commonwealth Development Finance Company. The rest of the Es. 5,000,000 were subscribed by public corporations in the United States and by individuals. In addition to i t s share capital the Corporation received an interest free loan of Rs. 75,000,000 from the Government of India repayable after 15 years in 15 annual instalments. It was also granted a 4.5% loan of $10,000,000 for 15 years from the World Bank. The latter sum was to be used to advance loans in foreign currencies to private firms to enable them to purchase from abroad machinery,equipment, material and services not available in India. Because of the considerable increase in demand for loans from the Corporation, both in domestic and foreign currencies, i t s capital funds were further increased in 1959. By an agreement between the Government of India and the United States Technical Corporation Mission on May 21, of that year, the Corporation was provided a loan of 4 2 Rs. 100,000,000 out of Public Law 480 funds. During this year the International Bank for Reconstruction and Development granted the 43 corporation an additional loan of $10,000,000. Administration and Control The Industrial Credit and Investment Corporation is administered by a Board of Directors consisting of fifteen members, who are elected 4 l Reserve Bank of India, op. c i t . , p. 51 i f 2 * The legislation under which the United States Government makes grants in aid to foreign countries. Reserve Bank of India, Report on Currency and Finance, 1958-59, Bombay, 1959, p. 47, - 157 - by the shareholders. It is stipulated that the chairman of the Corporation must be an Indian national. The Government of India has the right to appoint one director unt i l the Government loan i s fu l ly repaid. The day to day business of the Corporation i s carried on by the salaried general manager who is also to be an Indian national. The World Bank acts as the Corporation's adviser. ghe Refinance Corporation Under an agreement between the United States Government and the Government of India, i t was stipulated that Rs. 260,000,000, the equivalent of 355,000,000 aris ing out of the sale of imported food grains from the United States, be reserved for relending to private enterprise through established banking institutions. In order to take advantage of this arrangement, the Indian Government in June 1958 set up the Refinance Corporation - an institution empowered to make advances to member scheduled banks against loans granted to medium sized industrial kk undertakings. Advances not exceeding Rs. 5,000,000 to a single concern, were to be made for periods running from three to five years. Preference was to be given to industries included in the Second Five Year Plan and the succeeding plans. Capitalisation and Ownership The Refinance Corporation had a paid-up capital of Rs. 25,000,000 k3 which was subscribed by various financial institutions as follows: A medium sized industry is defined as a concern whose paid-up capital and reserves are not less than Rs. 500,000 and not more than Rs. 25,000,000. Reserve Bank of India, Report 1958-59, op. c i t . , p. k7 158 - Subscriber Amount of Subscription Per Cent of Total Reserve Bank of India 10,000,000 ko Life Insurance Corporation 5,000,000 20 State Bank of India 4,500,000 18 Fourteen scheduled banks 5,500,000 22 In addition to i t s share capital , counterpart funds arising from the wheat sale were made available to the Corporation in the form of an interest bearing loan of Rs. 260,000,000. Administration and Control The management of the Refinance Corporation i s entrusted to a Board of Directors consisting of seven members. The Governor of the Reserve Bank is i t s chairman. The other directors include the Dep&ty Governor of the Reserve Bank, the Chairman of the State Bank of India and the Chairman of the Life Insurance Corporation of India. The remaining three directors represent the participating scheduled banks. The day-to-day operations of the Corporation are carried on by a salaried general manager. In the beginning loans to banks were restricted to the fourteen scheduled institutions which subscribed to the corporation's capital . These loans carried an interest rate of 5 per cent, and the borrowing banks were not to charge more than V/z per cent above this ratet.ton xhe borrowing customer.. Obviously this maximum did not provide enough profit margin for the member banks and hence no particular inducement to u t i l i ze the corporation's f a c i l i t i e s . In view of these d i f f icu l t ies - 159 - the 6% per cent primary rate l imit was relaxed providing the latter did not exceed rates on other types of loans in the same loca l i ty . After these concessions the Corporations's lending fac i l i t i e s were extended to fourty three scheduled banks, to a l l State Financial 46 Corporations and to three Cooperative banks. National Small Industries Corporation Although the development of small industries fa l l s within the purview of the State Governments, the Central Government has also stepped in to hasten the process. In order to assist in providing the financial as well as technical needs of such industries the Government of India established the National Smaill Industries Corporation in February 1955 with a main office in Bombay. In order to supplement the operations of this Corporation subsidiary corporations were established in Calcutta, Delhi, Madras: also in Bombay in 1957- In addition to financial assistance in acquiring machinery under a hire-purchase arrangement, the National Small Industries Cooperation attempts to secure a reasonable share of Government orders for small industries and to provide such technical assistance as may be necessary to f u l f i l l these orders. It also endeavours to secure coordination between large and small scale undertakings to enable the latter to 47 supply ancil iaries and components required by the large ones. Originally the hire-purchase scheme was limited to Indian-made machinery. It was eventually extended to imported machinery as well. ^ * Reserve Bank of India, Report I96O-61, pp. c i t . , p. 65. Reserve Bank of India, Report 1954-55, op. c i t . , p. 51 - 160 - Under the original scheme loan applicants were required to make a down payment of 20 per cent of the value of a general purpose machine and ^yM per cent of that of a special purpose machine. The balance of the cost was repayable in half yearly instalments spread over a period not exceeding eight years. The f i r s t instalments of such loans were repayable after six months. In 1959 this scheme was l iberal ised by reducing the down payments on a special purpose machine to the same level as that of the general purpose machine. The down payment of machines valued at less than Rs. 200 was reduced to 10 per cent as against 20 per cent previously; and the f i r s t instalment on a l l loans under the hire-purchase scheme was made payable after one year. In 19s>0 the down payment on such machines was further reduced to 5 per cent, ^9 providing the remaining 15 per cent was guaranteed by the Government. Capitalization and Ownership When originally established this Corporation had a paid-up capital of Rs. 1,000,000 - alllsubscribed by the Government of India. Because of the great demand for i t s loans and other assistance, i t s capital was •5© increased to Rs. 4,000,000 in 1959. Each of the four subsidiary Corporations had a paid-up capital of Rs. 250,000. In i960 the Corporation obtained a long term loan of $10,000,000 from the United States Development Loan Fund. This loan was to be used for procuring machinery from non-Communist countries. Machines valued at more than $50,000 were to be obtained in the United States only. ^ * Reserve Bank of India, Report on Currency and Finance, 1959-60, Bombay, i960, p. 54 Reserve-Bank;.of-Indda, Report 1960-61, op. cit • , p. 68 Originally i t s authorised capital was equal to Rs. 1,000,000. In '1959 i t was increased to Rs. 20,000,000 - 161 - I n a d d i t i o n to i t s c a p i t a l funds the Government supplements the C o r p o r a t i o n ' s w o r k i n g c a p i t a l w i t h l o a n s and g r a n t s . A d m i n i s t r a t i o n and C o n t r o l The N a t i o n a l S m a l l I n d u s t r i e s C o r p o r a t i o n i s a d m i n i s t e r e d by a Board o f D i r e c t o r s a p p o i n t e d by the Government o f I n d i a i n c o n s u l t a t i o n w i t h the Reserve Bank and the I n d u s t r i a l F i n a n c e C o r p o r a t i o n . Each o f i t s s u b s i d i a r i e s i s a d m i n i s t e r e d by a board of d i r e c t o r s made up of the r e g i o n a l heads o f the J o i n t Development Commission, the S m a l l I n d u s t r i e s S e r v i c e I n s t i t u t e , a r e p r e s e n t a t i v e o f s m a l l i n d u s t r i e s and $ 1 the managing d i r e c t o r o f the C o r p o r a t i o n . ' The n a t u r e and e x t e n t o f t h i s C o r p o r a t i o n ' s a c t i v i t i e s w i l l be found i n P a r t 3 of Chapter V. The L i f e I n s u r a n c e C o r p o r a t i o n of I n d i a I n l i n e w i t h i t s p o l i c y o f development o f the I n d i a n economy on a s o c i a l i s t i c p a t t e r n , the Government o f I n d i a announced i t s d e c i s i o n t o n a t i o n a l i z e the l i f e i n s u r a n c e b u s i n e s s i n I n d i a i n 1955« I n e a r l y 1956 the L i f e I nsurance C o r p o r a t i o n B i l l was i n t r o d u c e d and s u c c e s s f u l l y p i l o t e d through b o t h Houses o f the I n d i a n P a r l i a m e n t , i t was approved on J u l y 1, 1956. Under the p r o v i s i o n s o f t h i s measure the L i f e I n s u r a n c e C o r p o r a t i o n o f I n d i a was s e t up on September 1, 1956, and a l l the l i f e i n s u r a n c e b u s i n e s s o f e x i s t i n g companies i n and o u t s i d e of I n d i a was t r a n s f e r r e d t o i t . The C o r p o r a t i o n was g i v e n an e x c l u s i v e r i g h t t o c a r r y on l i f e i n s u r a n c e b u s i n e s s i n I n d i a and t o c o n t i n u e the f o r e i g n a c t i v i t i e s o f the former p r i v a t e eompaniesi; - However i t i s Reserve Bank o f I n d i a , Report on C u r r e n c y and F i n a n c e , 1957-58 Bombay, 1958, p. 48 - 162 - authorized to transfer i ts foreign business to such insurance companies as i t may deem f i t . At the time of i t s establishment the Corporation took over the l i f e insurance business of 245 insurance companies that were engaged in business in India. The total assets of these latter institutions on August 31, 1956 amounted to about Rs. 4,110,000,000; the total number of policies in force were a l i t t l e over 5,000,000 with an 52 assured value of approximately Rs. 12,500,000,000. This was indeed a major conquest for the Indian Government, bringing within i t s reach a considerable sum of voluntary savings. Ownership and Control The Life Insurance Corporation has a paid-up capital of Rs. 50,000,000 a l l provided by the Central Government. It is managed by a.Board of Directors consisting of not more than fifteen members including the chairman. The Board is charged with the responsibility of managing the affairs of the Corporation along proper actuarial lines subject only to such directives on policy matters as may be given by the Government. The Corporation has an Executive Committee, and an Investment Committee. The former, consisting of five members, appointed by the Board, is entrusted with the day to day operations of the Corporation; the latter is responsible for the investment policy. The nationalization of the l i f e insurance business was strategic as well as a po l i t i ca l move which brought into the Government's orbit the only really significant savings instrumentality in the Indian economy. Through this newly acquired agency the Government was able to 52- India, Ministry of Information and Broadcasting, India, 195°, Delhi, p. 251. - 163 - channel much of the real savings of the Indian people into Government enterprises. The operations of the Life Insurance Corporation along with the other public and semi-public financial institutions are reviewed in Part 3 of Chapter V. - 164 - CHAPTER V OPERATIONS OF THE RESERVE BANK, THE STATE BANK AND OTHER PUBLIC FINANCIAL INSTITUTIONS 1949 ONWARD The banking legislation enacted by the Indian national Government f inal ly provided the framework for a complete re-orientation of the direction and outlook of the Indian banking system. What formerly had been a privately controlled and directed system without a strong centralized authority, to help and guide i t had been subordinated to a central bank redesigned to execute Government policy as well as to meet the day-to-day credit and clearing needs of i t s bank and Government customers. The Reserve Bank of India had been nationalized. Its instruments of monetary control had been considerably enlarged. Moreover i ts authority was extended to include, where necessary, regulation and direction of the operations of a l l the private banking enterprises, large or small, sheduled or non-scheduled. Steps had been taken to convert the Imperial Bank to the State Bank of India, to extend i t s agricultural finance business independently as well as through Cooperative banks, and to expand even further i t s already wide-spread physical f a c i l i t i e s . Among others, the inst i tution of the Industrial Finance Corporation, the State Financial Corporations,the Industrial Credit and Investment Corporation, etc. , had provided agencies for making investment funds available for an ambitious program of industrialization - a program which, i t was hoped, would provide the .Country with a higher standard of l i v i n g , and at the same time, a measure of economic independence and self reliance. - 165 - The operations of what we may now ca l l the governmentally controlled banks and their contribution to monetary policy, and to onward, the Government's program of development from 19^9/may now be reviewed. They shed some light on the extent to which an orthodox conception of the business of both public and private banks must,perforce,be dis- regarded i f a planned economic expansion is to go forward under forced draft. Part I . Operations of the Reserve Bank After 19^9. The operations of the Reserve Bank from 19^9 to date display the often conflicting roles of a Government banker, a banker's banker, and a guardian of the integrity of a country's money. Most of these conflicts are revealed by the Reserve Bank's continuous attempts to restr ict price rises in face of a constantly increasing Government reliance on Reserve Bank credit in projecting i ts program of industrial development. The exercise of Monetary Authority At the beginning of 19^9* Reserve Bank credit as measured by the Reserve Bank's notes outstanding stood at Rs. 11,635>200,000 and the general price level on a 1939 base at 385.4. Unti l this time the monetary policy of the Reserve Bank, i f one could c a l l i t such, was designed to maintain the market for Government securities and thus help to minimise the cost of the rapidly r i s ing Government War debts. During the late 1940's the Bank's open market policy, i f used at a l l , consisted of encouragements in the form of small percentage discounts to the - 166 - inst i tut ional investors to take off the Bank's hands particular types of securities which at once suited their investment needs and relieved the Bank of the burden of carrying them."*" Counter Measures for the Korean Inflation Before and during the Korean conflict many foreign countries, particularly the United States of America and the United Kingdom, were stockpiling industrial raw materials in anticipation of a f u l l scale war. This had led to a considerable increase in Indian exports, a rise in prices and a general spurt in Indian trade and industrial act iv i ty . ? There was a concomitant increase in demand for bank credit and the scheduled banks eventually began to liquidate Government securities in order to meet i t . This, in the absence of support by the Reserve Bank, led to a f a l l in prices of these securities and the corresponding increase iii interest rates. To prevent any further decrease in the prices of these securities •• the Reserve Bank entered the Securities market as a buyer on an unprecedented scale. The Bank's net purchases of Government 2 securities during 1950 amounted to Rs. 562,700,000 . This action, coupled with a trade surplus of Rs. 700,000,000 between July 1950 and March 1951, contributed to a sharp increase in the country's money supply and in the general level of prices. Between March 1950 and March 1951 the Reserve Bank's note circulation rose from Rs. 11,635,200,000 to Rs. 12,474,100,000 or by about Rs. 849,000,000. 1 * J . S . G . Wilson, "The Rise of Central Banking in India", as quoted in R.S. Sayers, Banking in the Brit ish Commonwealth, Oxford University Press, London, 1952, p. 240. 2. For further details of the Reserve Bank's dealings in Government securities, see Appendix I at the end of Chapter VII. - 167 - This, as is shown in the table .on. the combined operations of the Reserve Bank, was largely a result of Government bond purchases. This expansionist monetary policy, coupled with a continuous increase in both domestic and foreign demand for Indian goods, created boom conditions in India. Prices of industrial raw materials, finished and semi-finished goods were on an uptrend. The General Price Index (1939-100) increased from 410 in 1950 to 435 in 1951. A speculative act ivi ty had developed in the goods market. In order to curb this, the Reserve Bank exercised i t s newly acquired selective credit control authority to direct a l l banking institutions to restrict their advances against raw jute and jute goods. Scheduled banks in Calcutta and surrounding areas particularly were asked to recal l their advances against jute stock, to parties other than jute mills and jute exporters, within a specified period of time. Bank Rate In order to counteract the general rise in prices the Bank increased i ts discount rate (Bank Rate) from 3 per cent to yh per cent, on November 15, 1951, and simultaneously announced that i t would not, except in emergency cases, continue to buy Government securities from the scheduled banks at the existing price of Rs. 92.7 per Rs.100. In fact, during the following two years the Bank disposed of almost Rs. 1,300,000,000 worth of Government bonds and thereby reduced the outstanding notes in circulation by approximately the same amount. The Imperial Bank followed the Reserve Bank's lead by raising the rate (Advance Rate) at which i t was prepared to make short term loans. from 2& per cent to %• per cent and i t s Hundi Rate from 3# per cent to - 168 - 4)4 per cent. The Exchange Banks increased their lending rates on acceptances from 1 per cent to Vk per cent. The Indian Joint Stock banks generally passed the increase in bank rates along to their customers in the form of higher interest rates. As an immediate consequence of these act ivi t ies the Government's 3 per cent I985 conversion bonds, which had been supported at Rs. 92.7, had declined to Rs. 80 by December 3, 1951 and the yield 4 had risen to approximately 4 per cent. Thereafter the price was held at about this level , though not without subsequently adding to the Bank's investment account and i t s outstanding circulation. The increase in the Bank Rate, coupled with the changes in open market policy, may have put a brake on credit expansion by the commercial banks. The amount outstanding at the scheduled banks decreased from Rs. 5,321,000,000 at the end of March 1951 to a total of Rs. 5,195,000,000 at the end of March 1952, and to Rs. 4,914,000,000 at the end of March 5 1953. Yet i t must be realized that the inventory stock-piling by foreign interests had been discontinued and thus one of the temporary but significant pressures on prices had been removed. This, coupled with increased agricultural production, had eased the pressure on the price level . The Consumer Price Index (1949-100) decreased fjr,om lOoVirf; 1953 to 99 in the following year, and declined further to 96 in 1955. 5* Reserve Bank of India, Report on Currency and Finance, 1957-1958, Bombay, 1958, Statements 30 and 31. L G.P. Gupta, The Reserve Bank of India and Monetary Management, New York, Asia Publishing House, 1962, p. l64. 5. Reserve Bank of India, Trend and Progress of Banking in India - I960, Bombay, 196l, p.6o. - 169 - The B i l l Market Scheme Although the Reserve Bank was authorized under the original enabling Act and i t s subsequent amendments to rediscount bona fide commercial b i l l s , l i t t l e use had been made of the Bank's fac i l t i es by the private banks unt i l 1951. This indifferehce may be attributed to the existence of other less expensive and more convenient methods of obtaining l iquid funds, such as disposing of investments and so l i c i t ing deposits, as well as by the traditional association of private banks with the Imperial Bank of India. It left the Reserve Bank without the means of making effective use of the discount rate in the exercise of a short term money policy. In order to correct the situation the Reserve Bank off ic ia ls in consultation with representatives of some of the large scheduled banks evolved what has since been called the B i l l Market Scheme, and introduced i t on an experimental basis on January 16, 6 1952. The important features of the Scheme were: i . An undertaking on the part of the Reserve Bank under Section 17 (4) (C) of the Reserve Bank Act, 1934, to make loans against bona fide commercial time b i l l s of exchange and promissory noted drawn on and payable in India, and counter- signed by a scheduled bank at % of 1 per cent below the posted discount rate. i i . An additional undertaking oh the part of the Bank to bear yk of 1 per cent stamp duty imposed on the conversion of demand b i l l s to time b i l l s by the central Government. Subsequently this duty was withdrawn. i i i . The Scheme was limited to large scheduled •hanksiwaitfiodeposits of Rs. 100,000,000 or over. iv . The minimum value of an individual b i l l "to be discounted under the Scheme was fixed at Rs. 100,000 and the minimum that a bank could rediscount was fixed at Rs. 250,000. Reserve Bank of India, Report on Currency and Finance, 1953-54, Bombay, 1954, p. 46. - 170 - With these enticements the reluctance of the private banks to patronize the Reserve Bank were quickly overcome, and the Scheme proved to be successful. F inal ly , effective from July 14, 195k, i t was extended to a l l scheduled banks irrespective of their size. The minimum limit on advances to a single bank was reduced to Rs.1,000,000 7 and that on individual b i l l s was reduced to Rs. 50,000. The Government added to the attractiveness of the Scheme by temporily removing the stamp duty altogether. Although, as disclosed above, the Reserve Bank raised i t s discount rate on advance secured against Government bonds during the latter part of the Korean confl ict , i t did not change the rate on discounted b i l l s . This presumably further explains the immediate success of the Scheme and the phenomenal increase in the advances made under i t even while the Bank was pursuing, on the surface at least, a restrict ive monetary policy. By 1952 advances under the Scheme had risen to Rs. 8l4,500,000 and by 1957 had reached the impressive figure of Rs. 4,148,100,000. Extension of the B i l l Market Scheme The success of the B i l l Market Scheme with respect to the internal b i l l s of exchange led • the Bank to extend this scheme for one year to export b i l l s on October 1, 1958. In this f ie ld this Scheme was introduced (and s t i l l operates) on an experimental basis at Bombay and Calcutta. Under this scheme the banks that were el igible to borrow against the time b i l l s under the original B i l l Market Scheme Reserve Bank of India, Trend and Progress of Banking in India during 1954, Bombay, 1955, P-8. - 171- and those which were authorised dealers in foreign exchange, could also borrow under the extended Scheme against their export b i l l s . In order to make advances available to small exporters under this scheme the minimum amount to be advanced to a bank and the minimum amount of an individual time b i l l of exchange to be accepted as security were fixed at Rs. 200,000 and Rs. 20,000 Respectively as respectively against Rs. 500,000 and Rs. 50,000,,in the case of other advances g under the scheme. Although the interest rate charged on these loans was the same as on other loans against internal time b i l l s , i . e , four per cent, the Reserve Bank was to bear half the stamp duty cost required for the conversion of demand b i l l s into time b i l l s . This scheme was further l iberal ised and extended unt i l September and 30, 196l, / i n order to increase exports by assisting Indian exporters, The Bank undertook to pay a l l the cost of the Stamp Duty. Since the original limits were high for a number of Indian exporters, they were further slashed to bring them within the reach of the average Indian exporters. Thus the minimum amount of borrowing by an el igible bank at any one time, and the amount of an individual time promisory note, were reduced to Rs. 100,000 and Rs. 10,000 respectively. Since January 9 12, 1961, the latter limit has further been reduced to Rs. 5,000. In addition to the reduction of these l imits , the f a c i l i t i e s provided under this Scheme,which were original ly limited to Bombay and Calcutta, branches of were extended to a l l places where/the Banking ©epartment of the Reserve o Reserve Bank of India, Trend and Progress of Banking in India during 1958,Bombay, 1959, PP> IO6-7. 9- c c Reserve Bank of India, Report on Currency and Finance, 1960-61, Bombay, 1961, p. ̂ 7. • ' - 172 - Bank was located. These places include, Madras, Bangalore, Kaupur, Nagpur, and New Delhi. Moreover, the stipulation that the parties concerned should either cover the exchange r i sk , or maintain the specific margin of relative loans accounts, has been withdrawn and left ot the discretion of the banks concered.'1'0 Since the B i l l Market Scheme in this f i e ld is quite new, the data required for a proper study of i t s operations arenot yet available in sufficient detai l . The Containment of Budgetary Inflation The trend of both wholesale and re ta i l prices turned downward to well below the 1949 level after the collapse of the economic boom caused by the Korean War. A new and sustained upward trend began late in 1955. This was no doubt due to the effect of the mounting budgetary deficits by means of which the Indian Government was able to accelerate i t s plans for industrial growth and development from that time onward. By 1955, the last year of the F ir s t Five Year Plan, annual deficits had reached Rs. 1,500,000,000 and were s t i l l growing. By the end of March 1956, these deficits had raised the note circulation of the Reserve Bank to about Rs. 14,700,000,000, an increase of almost Rs. 2,000,000,000 over 1954 and approximately Rs. 3,300,000,000 over ted 1951. Before this large and not immediately substantia/ increase could be ansorbed in transaction and reserve cash needs, the general level of wholesale prices had been pushed up ŝome fifteen points, from 91.4 in 1955 to 107.1 in 1957. The comparable change in the Consumer Price Index was from 96 to 112. 10. •seser.ve .Bank of India, Report I96O-6I, op. c i t . , p. 47 - 173 - Bank Rate Adjustments and Open Market Operations Although the Reserve Bank could not have hoped to arrest an.i inf lat ion for which i t s own Issue Department was supplying the necessary i n i t i a l fuel, i t could, nevertheless, attempt to constrain i t . The f i r s t control measure which i t employed, not too logical ly , came in the form of an increase^ in the Bank's rate on advances against inland b i l l s . This special rate under the B i l l Market Scheme was f i r s t raised from i t s original base of 3 per cent to 3% per cent in March of 1956. In the following November i t was further raised to 3% per cent where, for the moment i t was even with the Bank's rate on advances secured by Government bonds. In February 1957, however, the Government reimposed the stamp duty at a rate of ^ of 1 per cent. Unti l the following May, when the Reserve Bank raised i t s rate on Government securities from 3)& per cent to 4 per cent, and the Government reduced the stamp duty to 1/5 of 1 per cent, the effective inland b i l l rate exceeded the Government security rate by % of 1 per cent. Thereafter the B i l l rate exceeded the Security rate by 1/5 of 1 per cent, the latter being effective at k per cent. Meanwhile the state Bank of India had increased i t s Hundi Rate from 5 per cent to 51/£ per cent; i t s rate on short term advances, from k per cent to h-Vz per cent; and i t s Cal l Loan Rate (on loans of Rs. 500,000 or over) from 31/2 per cent to k per c e n t . 1 1 Similar actions were taken by the Exchange Banks and the Indian Joint Stock banks,but the extent of the change in their rates varied. A l l banking institutions, 11. Reserve Bank of India, Trend and Progress of Banking in India, during 1958, Bombay, 1959, PP- kk-k^. _ 174 - large or small, followed the lead provided by the Reserve Bank and passed the. related rate increases along to their borrowers. No subsequent increase was posted in the Bank rate on advances against Government securities because of the related increase in the carrying cost of the Government's mounting debt and i t s effect on the prices of securities already outstanding. Because of possible dis- couragement of new enterprises and real expansion in the private sector of the economy, ho subsequent increase was posted in the rate on advances against inland b i l l s and other commercial paper'.. .There- after the Bank had to rely on i t s other credit control measures. In fact, ripen market acquisitions of long term Government bonds had to be continued from that time on to sustain a market price of.Rs. 80 and a not too attractive yield of 4 per cent. Selective Credit Controls in Agricultural Products During the late 1950 ' s the Reserve Bank turned to the use of selective Credit control measures, boih in the form of rais ing margin requirements and of f ixing a maximum ceil ing on bank loans, which i t had f i rs t employed to restr ict bank advances to speculators in raw jute. The Bank resorted to this measure to curb the abuse of bank credit and, at the same time ,to supress i t s inflationary potential. It could not the of course hope to hold back the tide of/creeping inflat ion by such short term measures, but i t could contain some of the secondary aggravations most of which had appeared in the agricultural sector. On Paddy Rice and Food Grains A substantial increase in developmental expenditure involving large deficit financing during 1955 and 1956 appears to have contributed - 175 - to an inflationary psychology. This led to hoarding of agricultural commodities, particularly those in short supply, in an anticipation of future price increases. From the reports submitted by banks during 1956 the Reserve Bank authorities noticed a significant increase in bank loans against paddy and r ice , beyond a level that could be just i f ied by the increase in their production. Whereas the total bank advances against paddy and rice amounted to Rs. 116,000,000 during the 1955 crop season, these had increased to Rs. 246,000,000, with l i t t l e o r e v e n no i n c r e a s e s i n t o t a l r i c e l p r o d u c t i o n , d u r i n g t h e 1956 c r o p 12 season. To arrest the price increases of paddy and r i ce , the Reserve Bank directed a l l banks on May 17, 1956 not to grant ..new advances in excess of Rs. 50,000 to individual parties against rice and paddy, and to raise the existing margin requirement on such loans by 10 per cent. The banks were further instructed to bring down their advances against these commodities to a level of 125 per cent of the level of such loans in the corresponding period of the preceding year.*^ Through another directive on July 12, 1957, bank credit against paddy and r ice was further restricted to 66.2/3 oer cent of the level prevailing in the 14 corresponding week in 1956. These restrict ive measures resulted in a phenomenal cut back in bank loans against paddy and r i ce , and in the respective prices of these commodities. The Bank in 1957 made a frontal attack to arrest the price increases in other food grains which were in short supply. Unfavourable G.P. Gupta, op. c i t . , pp. 206-207- Reserve Bank of India, Report on Currency and Finance, 1955-56, Bombay, '1956, p. 32. Ibid, 1956-57, p. 33. 12. 13. 14. - 176 - weather conditions had resulted in a considerable reduction in the 1956 harvest of food grains. Their production that year was ten per eent lower than in 1955. Yet, despite the decrease in harvest and the Bank's earlier general directive, the amount of bank credit extended against these crops had continued to increase. This had made possible the speculative hoarding of these commodities and a rise in their price. In June of 1956 the Reserve Bank directed a l l commercial banks to increase their margin requirements for advances on food grains to kO per cent, and to limit i n d i v i d u a l l o a n s a g a i n s t food g r a i n s to Rs. 50,000. The banks were directed to restr ict the aggregate of such advances made in succeeding years to 80 per cent of the amount outstanding on the following July 12, 1957. These selective controls appear for the time being to have accomplished their respective tasks. Restrictions on paddy and rice therefore were relaxed in 1958 to 75 per c ent of the average amount of such loans outstanding in the corresponding months of 1955» 1956-and 1957. This somewhat more flexible base was applied to advances on other food grains, but the 80 per cent restrict ion remained as unchanged. The production of other food grains was disappointing in the following year and i t was feared that their price level would increase substantially. Some State Governments introduced a program for procurement of food grains to counteract the expected price increases. To help them in this program the Bank modified i t s existing selective credit control measures against food grains. On July 10, 1959, the Bank enjoined a l l scheduled banks to continue to maintain the existing margin 'requirements of 40 per cent of the value of stock in respect of - 177 - their advances against food grains, but revised these limits down to 25 per cent in respect of their advances against paddy and rice to purchasing agents of the Government of Orissa, and against wheat to storage delivery contractors operating on behalf of the Punjab Government. The production of food grains during i960 increased by about 6 per cent over the preceding year, while supplies were further augmented by imports under the Public Law 480 from the United States. Credit controls against food grains were relaxed accordingly, and their at Ions oper/was made more flexible by relating i t to the amounts of such credits granted during the corresponding months of 1958 or 1959, which- ever was higher. The prospect of a good crop in 196l had a dampening effect on food g*ain prices. In February of tha|- year, the Bank accordingly reduced the margin requirements on advances against food grain from 40 per cent to 35 per cent. With respect to their advances against paddy and r ice beginning with March, A p r i l of 1961 , the banks were required to maintain a level of 110 per cent of the average level of the advances prevailing in the corresponding period of 19°0. Fortunately for a l l concerned, continuing good crops and a f a i r l y stable price had made possible the elimination of a l l controls on wheat as of May 15, 19&1. However in the absence of similar production increase, the controls on bank credit against paddy and r ice were continued. 15. 16. Reserve Bank of India, Report, 1959-60, op. c i t . , p. 34. Reserve Bank of India, Report 1960-61, op. c i t . , p. 44 - 178 - Ground nuts During the f i rs t two months of 1959 the spot and forward prices of ground nuts had shown sharp increases, Though a part of these increases could be attributed to a significant decrease in the 1958 crop, which f e l l by about 8 per cent over the level of production in the previous year, a large part .appeared to be due to excessive 17 hoarding supported by bank credit . The amount outstanding of such credit had increased from Es. 15,800,000 in October 1958 to Rs.129,500,000 by the end of Apri l 1959• In order to check the speculative hoarding of ground nuts without at the same time affecting the operations of legitimate producers and dealers, the Reserve Bank on February 8, 1958 directed a l l scheduled banks to increase existing margin requirements for advances against the security of ground nuts granted before February 9, 1959 to not less than 45 per cent.of the value of stock and to maintain this ratio for a l l such future advances. For each month hereafter the scheduled banks were enjoined to restrict their total current advances against ground nuts to the level maintained in the corresponding months of 1957 and 1958, whichever was the higher. These provisions did not apply to persons holding valid export licenses for l 8 ground nuts and to manufacturers of ground nut o i l . Though at f i r s t d i f f icu l t to apply, these restrict ive measures appear to have been instrumental in reducing the bank credit against 19 the security of ground nuts- But, despite this fact, the prices of Reserve Bank of India, Bul let in, November i960, pp. 1692-93. Reserve Bank of India, Trend and Progress of Banking in India during 1959, Bombay, i960, p. 126 Ibid, p. 144 17. 18. 19. - 179 - ground nuts and other o i l seeds continued to r i se . The Bank noticed that speculative hoarding of 'oilseeds' had developed, as bank credit against o i l seeds was considerably higher in 1959 that in 1958 . i t was beyond a level justif ied by any increase in production. In order to discourage this unhealthy development the Reserve Bank directed a l l scheduled banks on December 11, 1959 to maintain kO per cent margins against advances on o i l seeds. But, as in the case of ground nuts, these restrictions did not apply to genuine exporters of o i l seeds or to manufacturers of vegetable o i l . 2 ^ It appears that these restrict ive measures helped to reduce the demand for o i l seeds and the pressure on their prices. Raw Jute and Jute goods After a peak crop of jute in 1958 the output of that product was relatively small in the following two years. Prices of raw jute and jute goods reached new heights and- because?;ofsthis supplies were hoarded in anticipation of even higher prices in the future. The price of raw jute rose- .-."by 72 per cent, and that of jute goods by 5k per cent between November 1959 and November, i960. From the weekly and monthly statements submitted by the scheduled banks, the Reserve Bank off ic ials concluded that a substantial part of the price increase was supported by an unwarranted increase in bank credit against jute and jute products. Between October 28, and November 11, i960 the bank credit against jute had increased by Rs.20,000,000 21 and a similar increase was noticed against jute goods. In order to discourage the speculative hoarding and to check any further increase 20. 21. Reserve• Ba-rik • o f India, Trend and Progress of Banking in India during 1959, Bombay, i960, p. ikk. Reserve Bank of India, Report I960-61, OJK c i t . , p. kk - 180 - in jute prices the Bank issued a directive, in December i960, to a l l scheduled banks to maintain a minimum margin of kO per cent of the value of stock against advances, both old and new, on stocks of jute and jute goods and restricted the totals of such advances,every two months, starting from January 196l, to 130 per cent of the average amount recorded for the corresponding period of i960. In order to avoid any adverse effects on the production and export of jute goods, the maximum margin requirements for advances on raw jute to jute mi l l operators and exporters of jute goods was fixed at 25 per cent. The selective credit control measures against jute and jute goods were successful in restraining bank credit against these products, as the Reserve Bank later reported. The ko per cent margin requirements 22 against jute and jute goods were therefore withdrawn in June 1961. However, in evaluating the success of the credit control measure one should not lose sight of the fact that the supply of jute had consider- ably improved during 1961. In fact, as a result of a bumper crop of jute that year, a l l restrictive measures against this product were withdrawn on August 29, 196l. Selective Controls on Stock Trading Although the A l l India Index of Industrial securities prices increased only by Ik per centage points between March 1959 and March i960, the more sensitive index of the Bombay Schoffeincreased by as much as 27 per cent over the same period. In the opinion of the Bank this was partly due to narrow margin requirements on ca l l loans, and partly due to an absence of restrictions on the amount of credit Reserve Bank of India, Report, 1960-61, op. c i t . , p. kk - 181 - available to professional speculators. But i t may have been the result of a growing number of prudent investors who were hedging against the continued decline in the purchasing power of the Kupee. The former view seems to be nearer to the truth, because between February 1959 and February i960 bank loans on stocks had increased from 8.6 per cent to 15 per cent of total bank advances, thus restr ict ing the amount of credit available for more social ly productive 25 undertakings. To check any further increase in prices in the share market, and to eliminate i l l effects that might follow such an unhealthy situation, the Bank on March 11, i960 raised the margin jrequirements on loans against stocks to 50 per cent of the value of the Shares traded. But most of the potential restrict ive effect of this measure was dissipated by the Bank's attempt to restrict i t s application to large speculative dealers, and by exempting a l l purchases of shares amounting to Rs. 5,000 or less. The Reserve Bank, in order to prevent any circumvention of this directive, prescribed that, in the absence of i t s special consent, the average ratio of clean advances to toal advances in any month starting from Apr i l i960 was not to exceed the average ratio in the corresponding month of 1959. In view of these maximum limits on clean advances, their ratio to toal bank advances was reduced from 17.3 per cent in September i 9 6 0 to 13.3 per cent in September 1961. When the stockmarket resumed i t s normal course, these restrictions were set aside, effective from October 23, 19&1. Reserve Bank of India, Trend and Progress of Banking in India during i 9 6 0 , Bombay, 1 9 6 l , p. 133 Ibid . , p. 12 - 182 - The Reserve Bank concluded in a 1961 review of the efficacy of selective credit controls as an instrument of monetary policy, that by and large i t s operations during i960 and 1961 had been effective. The banking institutions were wor2<ing within the framework of the Reserve Bank's control measures. Throughout the years advances against paddy and rice remained well below the 35 per cent l imit allowed under the directive. Bank advances against food grains and ground nuts were, respectively 26 per cent and 23 per cent below the permitted levels of 35 per cent. Although in A p r i l 1961 advances against stocks and shares reached the maximum level permitted, after that date the amount remained well within the l imits prescribed by the Bank. Credit Rationing As the selective credit controls on agricultural advances and stock trading did not stop the tide of inf lat ion arising from the use of Reserve Bank credit by i t s member banks, the Reserve Bank turned to other as yet untried expedients. Among these was the rationing of Reserve Bank credit to the commercial banks, and the manipulation of the statutory reserve ratios of banking enterprises. As noted earl ier , a considerable increase in prices during i960 was supported by an extension of bank credit . During the same year the borrowings of the scheduled banks from the Reserve Bank had increased to Rs. 384,000,000 from a considerably less amount of Rs. 185,000,000 in 1959. In order to curb this source of inflation the Reserve Bank issued a circular on September 21, i960 according to which the Bank rate - 183 - was suspended beyond the quota fixed for each scheduled bank. In the circular eaah scheduled bank was assigned a borrowing quota equal to 50 per cent of i t s average of statutory reserve requirements during the preceding quarter. Any bank that borrowed above this l imit was charged a penalty rate. According to the directive "any borrowing over this l imit up to 200 per cent of the quota would bear a penal rate of 1 per cent over the Bank Rate; i . e . , 5 per cent, and borrowing above 200 per cent of the quota, a penal rate of 2 per cent above the Bank "25 Rate. J Generally an increase in the borrowing rate of the scheduled banks should lead to an increase in their lending rate to primary borrowers. Biit i t need not be true for banks that have excess reserves and that do not need to borrow from the Reserve Bank. Moreover, as the Bank Rate was not increased, such scheduled banks would have found i t expedient not to increase their lending rates. Borrowing banks that may be financing the productive credit needs of their borrowers would have been the victims of this restrictive measure. To avoid this the Reserve Bank issued another directive on October 1, I 9 6 0 , requiring a l l scheduled banks to charge a minimum lending rate of one per cent above the Bank Rate on a l l advances except the inter-bank loans and the loans to their employees. The banking institutions were further directed, under Section 21 of the Banking Companies Act of 19^9, -to iraise their average lending rate at least by # of one per cent (the base being June 30, i960) and not to pay interest rates higher than 2 per cent on deposits repayable 26 within 21 days. 2 5 * Reserve Bank of India, Report, 1960-61, op_. c i t . , p. k2 26. Loc. c i t . . - 184 - The Reserve Bank modified this three t ier rate formula, where necessary to meet the genuine credit needs of expanding industry and trade in order to provide adequate bank credit to jute and sugar mi l l s . It sanctioned large l imits on the b i l l s discounted by these mi l l s . The Bank also used this measure to encourage commercial bank loans to small and cooperative industries. To this end i t sanctioned additional quotas equivalent to the increase in their loans to such enterprises in the f irst half of 1961 over the corresponding period of I960. 2 7 It appears that the increased lending rate of the Reserve Bank above a certain l imit restrained the scheduled Banks,borrowing from the Bank. The total amount of their borrowing decreased from Rs. 384,000,000 in i960 to Rs. 282,000,000 in 1961. The'.precise- effect cannot be observed, however, as other restraining forces were also at work. Reserve Ratio Variation The Reserve Bank also took action to restrict further, and more decisively, the ab i l i ty of commercial banks to expand credit and increase the money supply more rapidly than the output of goods. It exercised i t s newly acquired authority to raise the statutory reserve ratio of the scheduled banks .requiring them to maintain with i t an additional average daily balance equivalent to 25 per cent of the increase in their 28 time and demand deposits accruing after this date. These reserve requirements were in addition to the existing statutory reserves of 27. Reserve Bank of India, Trend and Progress of Banking m India during 196l, Bombay, 1962, p. 11 28. Ibid . , Trend and Progress - i960, pp. 120-25 - 185 - 5 per cent of their demand deposits and 2 per cent of their time deposits. By way of part ia l compensation for this s ter i l i zat ion of deposits, the Reserve Bank undertook to pay interest on reserve deposits at a rate determined by the average rate paid by the depository banks provided the rate did not exceed the Bank R a t e . 2 9 As might have been expected this increase in the reserve ratio had l i t t l e i f any effect, probably because Indian banks had long been in the habit of actually maintaining considerably more reserves than the addition made necessary. Consequently on May 5, 19^0 the Reserve Bank increased the scheduled banks reserve requirements rather drastical ly. Under the new directive, the scheduled banks were required to maintainj i ) 25 per cent of the amount by which their total deposits on May 6, i960 exceeded the comparable total on March 11, i960; i i ) 50 per cent of the amount by which their total deposits exceeded the corresponding total on May 6, I 9 6 0 . 5 0 These measures did of course reduce the credit expansion ab i l i ty of the scheduled banks, and in the f inal analysis checked the pace of inflationary forces by making i t necessary for primary borrowers to finance a r is ing real output with the same or even a declining amount of credit . This considerably reduced the credit expansion capacity of the scheduled banks, and placed excessive burdens on them in the form of large reserves. To compensate for losses in their earning capacity the Reserve Bank undertook to pay interest on the Reserve Bank of India, Trend and Progress - I960, op. c i t . , p. 124 * Ibid, p. 126 - 186 - additional reserves, this time at # of 1 per cent above their average 31 rate of interest subject to a maximum of tyz per cent. In spite of this decrease in the l iquid reserves of the scheduled banks, resulting from the increase in their reserve requirements, bank credit continued to expand. This was made possible by the banks increased borrowing and from the sale of Government securities at the Reserve Bank. In this latter expedient, the open market operation was in i t iated by the member banks and, as long as the Reserve Bank persisted in maintaining the price of Government bonds and a cei l ing on interest,: rates, nothing could be done about i t except to resort to measures which limited the Reserve Bank credit to member banks. This latter took the form of the already discussed credit rationing. As would be expected under the prevalent conditions in the Indian money market, the substantial increase in reserve ratios do not seem to have achieved the desired objectives. They merely burdened the Reserve Bank with calculating and doling out the interest rates on additional reserves, and discouraged deposit mobilization by .scheduled banks. In view of the considerable increase in demand for bank credit during i960 and 196l, and the unnecessary constraint placed on real growth in the economy, the Reserve Bank removed additional reserve requirements on a l l deposits subsequent to November 11, i960. The 50 per cent reserve requirements on additional deposits was reduced to 25 per cent in the following month. F inal ly , in January 196l, the rest of the reserve restrictions were set aside as the money market showed signs of re l i e f and prices were relat ively stable. 31. Reserve Bank of India, Trend and Progress - i960, op. c i t . , p. 126 - 18? - Moral Suasion To Westerners, moral suasion as an instrument of credit control refers to requests for the exercise of restraint that are not covered by the instruments of monetary policy which the central bank has already been authorised to use. This method of friendly persuasion and advice to influence the lending policy of commercial banks has long been used both by the old and newly established central banks. But i ts effects have been more pronounced in the former case rather than in the lat ter . Although the Governor of the Reserve Bank had requested the cooperation of commercial banks on a number of occasions before 19^9, i t had rarely been complied with. After that year, however, when the Reserve Bank was equipped with sweeping regulatory powers over a l l banking institutions, the Governor's requests carried more weight and were usually acted upon. During 1957, when prices of agricultural commodities were increasing continuously, the Bank authorities used moral suasion in addition to selective credit control in order to l imit the examinsion in Bank credit . During a conference with the represent- atives of banks in August 1957, the Governor of the Bank advised them to bring down their advances to a level of Rs. 8,000,000,000 by the middle of October 1957 and thus help to contain the inflationary forces at work. As the Bank later reported, the Commercial banks fu l ly cooperated and the total bank credit decreased from Rs. 9,380,000,000 32 in July 1957 to Rs. 8,470,000,000 in September 1957. Reserve Bank of India, Report 1957-58, op. c i t . , p. 31 — 188 - The latest use of this measure was in May i960. During that- year, the general price level was considerably higher than in the corresponding period of 1959 although the production of both agricultural and industrial goods was higher. From the weekly state- ments submitted by commercial banks, the Bank authorities noticed that the a considerable increase in prices was supported by/expansion of bank credit. In order to remove this source of inf lat ion, the Governor of the Bank enjoined a l l commercial banks to.reduce their total advances by about Rs. 11,000,000,000, or about 10 per cent, during the slack season (May to November). There seems to have been l i t t l e response from the banks, as bank credit decreased by only Rs. 203,000,000 during 33 that time. On the whole the Bank authorities have been able to influence the lending policy of commercial banks through this method of credit control. This may partly be attributed to the substantial powers vested in the Reserve Bank. Banking institutions are well aware of the fact that i f the friendly nod f a i l s , the regulatory rod is bound to follow. The Accomplishments of Monetary Control The Reserve Bank in general has employed in one form or another the entire arsenal of i ts credit control instruments. Although each appeared to be justif ied in the particular circumstances prevailing at the time, none of them constituted a frontal attack on the basic prompting force in the country's creeping inf lat ion, i . e . , continued 33. Reserve Bank of India, Trend and Progress of Banking in India during i960, Bombay, 1961, pp. 137-38. - 189 - budgetary imbalances and heavy reliance on Reserve Bank credit in financing the country's planned program of industrialization and economic development. But to have attempted such a frontal attack in the special case of India, particularly during the prosecution of the Second Five Year Plan, would have been tantamount to defeating the program i t se l f . Voluntary savings and foreign assistance were not sufficient, and forced savings with i ts price increase counterpart real was th© only answer i f a perceptable rate of/growth was to be maintained. Some of the more important indicators of the nature and extent of the price control problem are brought together in Table.jNo. 26 on'page 190.-. This somewhat random display reveals, f i r s t , the very rapid increase in India's outstanding funded debt after 1954, and the extent to which the Reserve Bank was called upon to support i t at a 4 per cent rate by taking excess offerings off the market. After 1954 this one-sided open market operation eventually brought an almost four-fold increase in the Reserve Bank's holdings of Government bonds. In less compelling c i r - cumstances the increase in the Bank's share of the total outstanding debt would undoubtedly have been considered alarming. The Reserve Bank's holding of Government debt amounted to Rs. 5,159,000,000 in 1949, which constituted a l i t t l e over 21 per cent of the total outstanding debt. By 196l i t s holdings of Rs. 19,106,000,000 constituted a l i t t l e over 35 per cent of the total outstanding debt. Meanwhile the increase in the Reserve Bank's credit was put to good use even i f i t was i n - flationary. The national income at current prices increased from approximately Rs. 90,000,000,000 in 1949 to an estimated sum of Rs. 142,000,000,000 in i960 roughly a 57 per cent gain during this period. 190a Table 26 '", Comparable Rates of Growth of Public Debt, Reserve Bank Credit and National Income, 1949-1961, Inc. (Rs. 000,000) Reserve Bank Credit National Income Year Total Public Debt Holders of Gov't. Securities Notes Out- standing Current Prices 1949 Prices Public debt Index 1949 23,781 5,159 11,529 90,100 90,100 100 1950 24,627 5,858 11,804 95,300 94,400 103.7 1951 24,722 5,667 12,176 99,700 95,900 104:i 1952 24,598 4,560 11,427 98,200 94,400 103.6 1953 24,935 4,875 11,570 104,800 98,900 105.0 1954 25,052 5,533 12,192 96,100 97,100 105.5 1955 28,439 7,260 13,565 99,800 104,000 119.7 1956 30,672 10,062 14,945 113,100 105,700 129.1 1957 30,078 14,095 15,525 113,900 101,700 147.7 1958 41,179 15,429 16,132 126,000 106,800 173.4 1959' 46,235 16,945 17,508 129,400 105,200 194.7 I960 51,291 18,821 18,821 142,100a 114,600 215.9 1961 54,628 19,106 19,770 N. A. N. A. 230.0 Source: 1 Government of India, India. 1958, 1961 and 1962. 2 Reserve Bank of India, i) Report on Currency and Finance. 1952-53, 1957-58 and 1960-61. Statements 54, 65 and 66 respectively, ii) Report on Currency and Finance. 1956-57 and 1961-62. Statements 19, 20 and 17, 19 respectively. a Figures are provisional. 190b Comparable Rates of Growth, 1949=100 ~% at Res.- Bank % inc. in R. B. Notes National Income Current Price '49 Price Consumer Price Index 21.2 100 100 100 100 23.8 102.6 105.2 104.7 101 22.9 106.1 115.6 106.5 104 18.9 99.1 109.0 104.9 104 19.6 100.8 116.4 109.9 106 22.1 106.1 106.4 107.9 99 25.6 118.2 110.9 115.5 96 32.2 129.6 125.5 117.4 107 40.2 134.8 126.6 113.0 112 37.5 140.0 141.7 118.0 118 36.7 152.2 143.6 116.9 123 35.3 163.5 157.8 127.2 125 34.9 172.2 N. A. N. A. 127 - 191 - After allowing for the price increase in terms of the relatively- conservative Consumers Price Index, the real growth as measured in 1949 rupees was from Rs. 90,100,000,000 to Rs. 114,600,000,000 or about 27 per cent for the period. Most of this increase is been revealed to have/realized after 1955 when prices began to register the effects of the plan period expansion program. If one may use the real national income estimate as a guide, i t would appear that something in the neighbourhood of Rs. 15,000,000,000 in Reserve Bank notes would have been sufficient to meet the uninflated cash needs of the Indian economy in i960. But the amount made available.by the rather one- sided open market operations of the Reserve Bank was close to Rs.19 b i l l i o n . The difference of some Rs. 4000,000,000 may, in the absence of a more refined estimate, be said to indicate the magnitude of the forced savings effected by the Government through the Reserve Bank. Reserve Bank Operations The annual operations of the Reserve Bank portrayed in Tables t.2'7, 28,-andi29 .;••„-_ on pages 192, 193 and 1Q4. They do not appear to have been greatly affected by the Government take-over, or by the progress of the F irs t Five Year Plan. It is noteworthy, however, that - this period was marked by a rapid depletion of the Bank's foreign currency assets. In the absence of this backlog of savings there would undoubtedly have been a reverse trend in the Bank's holdings of Government securities and in outstanding note issue, with a l l i t s i n - flationary implications. The point is that the use of foreign currency assets provided the Government with revenue that did not have to be created either through the budget or through increasing i t s borrowings 192a Table 27 Principal Liabilities and Assets of the Reserve Bank (Issue and Banking Departments) of India 1949-1961, Inc. (Rs.000,000) Last F r i . in March 1949- 50 1950- 51 1951- 52 1952- 53 1953- 54 1954- 55 1955- 56 1956- 57 1957- 58 1958- 59 1959- 60 1960- 61 1961- 62 Capital and Reserves 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 800.0 800.0 800.0 800.0 800.0 800.0 Notes Out- standing 11635.2 12474.1 11411.1 11331.2 11859.2 12770.9 14666.9 15260.9 15791.3 17015.3 18449.0 19847.4 20703.0 Liabilities Deposits Gov't" Banks 1749.1 529.2 1884.4 592.8 2052.2 469.9 1556.3 465.2 1283.6 424.1 1197.2 477.2 1293.7 532.4 965.2 577.7 1031.8 678.3 805.5 675.7 1061.2 929.0 1054-5 708.5 871.9 727.3 Other . Others Liabs.! 636.1 723.1 659.0 628.1 437.6 215.3 166.8 742.8 1175.2 1190.7 1001.0 879.6 1523.6 198.1 231.0 259.0 307.0 250.8 298.6 494.6 1610.3 910.3 974.6 1106.7 1363.4 1413.9 1518.4 Total Liabs. and '•"Assets 14847.7 16005.4 14951.1 14387.8 14355.2 15059-2 17254-1 19256.8 20451.2 21593.8 23603.4 24703.9 26144.2 Gold Coin and Bullion2 400.2 400.2 400.2 400.2 400.2 400.2 400.2 400.2 1176.6 1176.6 1176.6 1176.6 1176.6 1176.6 Source: Adapted from Reserve Bank of India, Reports on Currency and Finance, 1952, 1953, 1955-67, and 1961-62. Statements, 21, 37, and 36 respectively. 1. Includes: i National Agricultural Credit (Long-term operations) fund. Details i i National Agricultural Credit (Stabilization) fund. Opposite 2. Gold valued at 8.47512 grains per rupee up to October 5, 1956 and at 2.88 grains per rupee thereafter. 3. Including one rupee notes. 192 b Assets Rupee„ coins--5 For. cmcy. Inv. in Gov't. Securities - Loans to Gov't. Other Loans Bi l l s Disc'd Other Assets 512.3 8587.8 5159.4 2.4 112.1 19.7 53.8 545.1 8841.8 5858.3 15.6 167.5 82.1 92.0 692.9 7230.7 5667.3 9.4 613.7 37.2 299.9 823.2 7236.8 4559.8 33.0 269.5 88.0 77.2 939.7 7529.7 4875.0 5.1 411.0 107.4 87.2 1025.0 7300.0 5533.2 4.5 478.7 103.7 213.9 1033.1 7461.3 7260.1 0.0 799.4 122.3 177.7 1227.9 5268.3 10062.0 76.5 1278.7 28.9 136.1 12942.2 2670.0 14095.5 212.3 784.0 76.8 140.8 1301.6 2130.6 15429.6 247.7 1134.4 51.8 120.5 1242.3 1971.2 16945.1 223-4 1565.4 336.0 142.6 1197.1 1362.5 18131.5 390.2 1855.0 391.7 198.2 1169.7 1297.0 19105.7 808.9 1776.9 466.0 342.4 i) Rs.100,000,000 from Feb. 3, 1956 150,000,000 from Jul. 6, 1956 200,000,000 from Jul. 5, 1957 250,000,000 from July 4, 1958 300,000,000 from July 3, 1959 400,000,000 from July 1, i960 500,000,000 from July 30, 1961 ii ) Rs. 10,000,000 from July 6-, 1956 20,000,000 from July 5, 1957 30,000,000 from July 4, 1958 40,000,000 from July 3, 1959 50,000,000 from July 1, i960 60,000,000 from June 30, 1961 Table 28 ' , Principal Assets and Liabilities, Reserve Bank (Issue Department) of India, 1949-61, Inc. (Rs.000,000) Ave. of " Friday- figures. LIABILITIES Note In banking Circltn. dept. Total Gold coin & bullion Rupee coins 2 Foreing secrts. Gov't of India rupee secrts. 1949-50 11,289.4 240.0 11,529.4 400.2 505.3 6470.4 4153.6 1950-51 11,632.1 171.9 11,804.0 . 400.2 572.1 6247.0 4584.7 1951-52 11,898.4 277.8 12,176.2 400.2 639.8 6252.7 4883.3 1952-53 11,148.4 278.7 11,427.2 400.2 802.2 5644.0 4580.8 1953-54 11,339.5 230.3 11,569.7 400.2 928.3 •5940.2 4301.1 1954-55 11,961.9 229.8 12,191.8 400.2 1022.6 6488.1 4280.9 1955-56 13,393.9 170.8 13,564.7 400.2 1068.7 6565.2 5530.6 1956-57 14,757.7 187.5 14,945.2 400.2 1159.3 5459.8 7552.2 1177.6 1957-58 15,293.6 231.8 15,525.3 1177.6 1300.6 3296.5 9750.6 1958-59 15,938.8 193.0 16,132.1 1177.6 1339.9 1820.4 11,794.2 1959-60 17,309.0 198.6 17,507.7 1177.6 1315.0 1676.2 13,338.8 1960-61 18,631.3 189.4 18,820.7 1177.6 1268.4 1349.9 15,024.8 1961-62 19,574.2 195.8 19,770.0 1177.6 1216.5 1159.3 16,216.7 Source: Adapted from Reserve Bank 1 of India. Report on Currency and Finance >, 1952-53, 1954-55 and 1961-62. Statements no. 29, 35 and 37 respectively. 1 Gold valued at Rs 21.24 per tola or 8.47512 grains per rupee up to October 5, 1956 and at Rs. 62.5 per tola or 2.88 grains per rupee there after. 2 Including one rupee notes. ' Table 29 Principal Liabilities and Assets of the Reserve Bank (Banking Department) of India, 1949-1961, Inc. (Rs.000,000) Liabilities Ave. of Friday Figures Capital and Deposits Other Reserves Gov't. Banks Others Liabs. 1 Total 1949-50 100.0 1643.1 670.0 643.9 157.6 3214.5 1950-51 100.0 1663.1 622.2 622.9 181.4 3189.7 1951-52 100.0 1972.5 586.8 692.2 186.2 3537.7 1952-53 100.0 1441.9 528.9 619.3 236.9 2927.1 1953-54 100.0 1288.4 465.2 574.5 239.1 2667.2 1954-55 100.0 1097.9 552.0 362.9 236.2 2349.0 1955-56 100.0 799.6 537.7 183.1 355.1 197694 1956-57 100.0 716.2 524.6 197.3 912.1 2450.2 1957-58 800.0 658.9 810.0 1113.8 639.6 4076.3 1958-59 800.0 784.2 875.3 1187.3 767.7 4414.4 1959-60 800.0 787.4 796.1 1234.8 881.8 4500.1 1960-61 800.0 830.0 973.0 987.6 1053.3 4643.9 1961-62 800.0 772.6 819.5 1407.3 1241.3 5040.8 Source: Adapted from Reserve Bank of India, Report on Currency and Finance. 1952-53, 1954-55, and 1961-62. Statements 28, 36 and 38 respectively. 1. Includes i) National Agricultural Credit (Long-term operation) Fund. Details i i ) National Agricultural Credit (Stabilization) Fund. Opposite 2 Incites one rupee notes. 194 b Assets Notes & Coins For'gn. Balance Gov't. Loans Other Loans Bi l l s Disc'd. Invest- ments Other Assets 241.2 1809.1 33.5 83.9 43.0 960.4 43.4 173.1 2077.9 23.7 67.7 30.5 767.2 50.6 279.2 1871.4 59.0 194.2 63.1 951.9 119.2 280.3 1335.6 28.5 190.3 66.4 897.7 128.3 232.2 1233.1 17.8 198.4 94.6 815.8 75.1 232.4 875.3 11.4 265.5 61.0 805.2 98.2 172.1 669.6 17.3 369.9 97.8 493.6 156.1 189.1 647.7 48.9 853.4 56.9 518.2 136.0 233.0 404.7 329.0 779.1 48.1 2139.2 143.2 194.1 255.7 282.3 658.3 61.8 2844.9 117.3 199.4 289.7 255.3 889.2 155.4 2589.0 122.2 190.2 207.4 381.9 1327.8 287.1 2095.6 153.8 196.4 181.1 638.7 1376.9 341.0 2077.4 229.3 i) Rs. 100,000,000 from Feb. 3, 1956 150,000,000 from July 6, 1956 200,000,000 from July 5, 1957 250,000,000 from July 4, 1958 300,000,000 from July 3, 1959 400,000,000 from July 1, i960 500,000,000 from June 30, 1961 ii) Rs. 10,0009000 from July 6, 1956 20,000,000 from July 5,' 1957 30,000,000 from July 4, 1958 40,000,000 from July 3, 1959 50,000,000 from July 1, i960 60,000,000 from June 30, 1961 - 195 - at the Reserve Bank. This, in the main, is why there was l i t t l e i f any decline in the purchasing power of the rupee during the First Five Year Plan period. Beginning with 1955, however i t became strikingly apparent that the demands of the Second Five Year Plan were leading to an over burdened budget. Government bond holdings and their circulation counterpart increased very rapidly. Towards the end of the period, moreover, there was a sharp increase in direct loans to Government and Governmentally sponsored lending agencies. Reserve Bank <credit as measured by investment in Government securities, loans to Government, and "other loans" (presumably to governmentally sponsored industrial lending agencies), rose from approximately Rs. 6,000,000,000 at the beginning of 1955 to nearly Rs. 22,000,000,000 by 1962. It i s noteworthy that during the whole period there was no really' significant increase in the magnitude of advances made to the commercial banks. While the increase in the amount outstanding was remarkable, i t was s t i l l under Rs. 500,000,000 at the beginning of 1962. Part 2 The State Bank of India: Operations and Growth The nationalization of the Imperial Bank and the changing of i t s name to the State Bank of India did not bring, any immediate change in the nature of i t s operations. It continued to function as a primary lender and asteheReserve Bank's agent at places where the latter had no branch or office. But subsequent extension in both i t s branches and operational fac i l i t i e s added considerably to i t s duties and further - 196 - enhanced the pre-eminent position the Bank held, and continues to hold, in the Indian banking system. Extension of Duties and Fac i l i t i e s In keeping with the recommendations of the A l l India Rural Credit Survey Committee and the Committee on Finance for the Private Sector, better known as the Shroff Committee, the duties and f a c i l i t i e s of the State Bank were considerably expanded. In addition to i t s ordinary commercial banking business the main functions of the State Bank were to spread banking f a c i l i t i e s in rural India and to provide short-term credit f ac i l i t i e s to agriculture, small industries and handicrafts. Through the expansion of i ts branches, especially in areas where no banking institutions exist, the State Bank would help to mobilize the savings of the rura l population and channel these to meet productive credit needs. Under the State Bank of India Act of 1955> the Bank undertook to open kOO new branches within five years of i t s operation as a national inst i tut ion. By the end of i960 i t had opened k±6 new branches. The importance of these l ies in the fact that about 75 per cent of them are established in rural and semi-urban areas, 3k i . e . , towns with population of 30,000 or less. In order to meet losses on the newly established branches, the State Bank maintains an 'Integration and Development Fund', in which a l l the dividends payable to the Reserve Bank a n d a l l contributions which the Reserve Bank and the Government of India may make to the State Bank, are to be kept. The proceeds of this fund are to be used exclusively for meeting losses on i t s branches, a n d for defraying other expenditures approved by the Central Government. 3k. Reserve Bank of India, Trend and Progress of Banking in India during i960, Bombay, i960, p. 31 - 197 - AIL A l l S t a t e a s s o c i a t e d banks were made s u b s i d i a r i e s o f the S t a t e Bank, under the p r o v i s i o n s o f the S t a t e Bank o f I n d i a ( S u b s i d i a r y - Banks) A c t of 1959, i n o r d e r t o widen the scope o f o p e r a t i o n s o f the 35 S t a t e Bank and thu s p r o v i d e b e t t e r and e x t e n s i v e b a n k i n g f a c i l i t i e s . The s u b s i d i a r y banks and t h e i r branches conduct Government b u s i n e s s at t r e a s u r y and s u b - t r e a s u r y o f f i c e s i n t h e i r r e s p e c t i v e a r e a s , and t h u s p r o v i d e b e t t e r r e m i t t a n c e f a c i l i t i e s to o t h e r banks and t o the p u b l i c on b e h a l f o f the Reserve Bank and the S t a t e Bank o f I n d i a . These, o f c o u r s e , have f u r t h e r extended the o p e r a t i o n s o f t h i s s i n g u l a r l y i m p o r t a n t Bank. By t h e end of December i960 the number of branches o f the S t a t e Bank, a l o n g w i t h s u b s i d i a r i e s , t o t a l l e d 1 2 8 l , w h i c h accounted f o r about 31 per cent o f the 4150 branches o f a l l the s c h e d u l e d banks. T h e i r d e p o s i t s ,amounting to Rs. 3 , 9 4 0 , 0 0 0 , 0 0 0 , c o n s t i t u t e d about 25 36 per c e n t o f the t o t a l d e p o s i t s o f a l l s c h e d u l e d banks. The S t a t e Bank and F i n a n c i n g o f S m a l l I n d u s t r i e s As the branches o f the newly e s t a b l i s h e d N a t i o n a l S m a l l I n d u s t r i e s C o r p o r a t i o n were l o c a t e d i n a few i m p o r t a n t t r a d i n g c e n t e r s and l a c k e d a wide network o f branches i n t h e u p - c o u n t r y , t h e i r c r e d i t f a c i l i t i e s were not e a s i l y a c c e s s i b l e t o s m a l l i n d u s t r i a l u n i t s l o c a t e d i n s m a l l towns i n t h e i n t e r i o r o f the Co u n t r y . The f l o w of c r e d i t t o such f i r m s was impeded and a c o n s i d e r a b l e waste o f time and money was i n v o l v e d i n the p r o c e s s of g r a n t i n g and c o l l e c t i n g l o a n s , because t h e r e was l a c k of d i r e c t and p e r s o n a l c o n t a c t between the o r g a n i z e d l e n d i n g a g e n c i e s 35. The f o l l o w i n g S t a t e a s s o c i a t e d banks were made s u b s i d i a r i e s o f the S t a t e Bank: The S t a t e Bank o f Hydrabad, Oct, 1959; the S t a t e Bank of B i k a n e r , the S t a t e Bank o f Indore and the S t a t e Bank o f J a i P u r , on January 1, i 9 6 0 ; the S t a t e Bank of Mysore, the S t a t e Bank o f P a t i a l a , the S t a t e Bank of S u r a s h t r a , on March 1, A p r i l 1, and May 1, i960 r e s p e c t i v e l y . 36. Reserve Bank o f I n d i a , Trend and P r o g r e s s - I 9 6 0 , op. c i t . , p. 32 - 198 - and small industrial enterprises. The local credit granting agencies, which the State Bank was spreading up-country, could meet the credit needs of small industries more readily ,a-nd eff ic iently, and could exercise better supervision over the use of the credi/tamade^ available, than could an agency away from the scene. To f u l f i l this objective the State Bank introduced the 'Pi lot Scheme' on an experimental basis in 1956 at nine centers where the Bank had i t s branches. Under the provisions of this scheme the State Bank granted short-term loans to small industries against the security of their readily marketable raw materials and finished products. The successful operation of the 'Pilot Scheme' encouraged the Bank to extend i t to 36 centers in 1957, 37 and f inal ly , on January 1, 19.59, to a l l of i t s branches. The rate of interest charged under the 'Pilot Scheme' was 4}& per cent original ly , but the borrowers had to pay a Godown Keepers' fee and an Inspection fee, which came to about 2 per cent per annum. Thus the effective rate of interest under the Scheme was 6)£ per cent. The rate of interest was fixed at 6 per cent on an a l l inclusive basis during 1959, when the Scheme was extended to a l l branches of the State Bank. The State Bank had committed Rs. 46,000,000 to 1496 small industrial units under the 'Pilot Scheme' by the end of December 1959. The l iberal izat ion of the Scheme, and i t s extension to a l l branches of the State Bank, considerably increased the demand for i t s loans. The amount of loans committed had increased from Rs. 78,000,000 in December i960 to Rs. 101,300,000 to 2811 small firms by the end of December 19bl.. 37. Reserve-Bank of India,sTrend,and Progress - 1958, op. c i t . , p. 13 - 199 - On this latter date, the outstanding loans amounted to Es. 51,000,000.^ Although the State Bank was authorized in 1958 to make medium term loans to small industries, no such loans were made unt i l the end of 196l. The State Bank of India has also entered into an agency arrangement with the State Financial Corporations and- the National Small Industries Corporation. It makes loans and collects such loans as f a l l due on behalf of these Corporations at places where i t has i t s branches. It gathers such information from the borrowers as i s necessary to make them loans. Thus i t avoids duplication of such act ivi t ies and considerably reduces the cost both to the borrower and to the lender. The State Bank and Agricultural Finance The State Bank since i t s inception has been playing an increasingly active role in providing short-term, and to some extent medium-term, agricultural credit, directly as well as through cooperative banks. It provides short term loans to cooperative banks against the security of debentures of Land Mortgage Banks, Government Securities and guarantees, and warehouse receipts. The cooperative banks in turn •t provide credit f ac i l i t i e s to agriculturists and other artisans. Up to the end of September i960, the credit l imits committed by the State Bank against the above mentioned securities, except the warehouse receipts, amounted to Es. 151,800,000; the amount of such outstanding loans was Rs. 53,500,000. On this latter date the amount committed against warehouse receipts was Rs. 21,600,000, of which about Rs.4,000,000 were outstanding. 38. Reserve Bank of India, Trend and Progress of Banking in India during 1961, Bombay, 196l, pp. 26-2? - 200 - Cooperative marketing and processing societies have been established in India recently in order to eliminate a chain of intermediaries between agricultural producers and consumers and thus to assure a fa ir return to agriculturists . These societies have limited funds because of the poverty of. their membership, and are unable to meet the increasing demand (during the busy season) for loans from their members. The State Bank is now authorized to provide additional funds against i a. Government guarantee or the stock of these cooperative societies. The Bank had committed a total of approximately Rs. 20,000,000 to 107 such undertakings by October 1959• By October i960 the number of borrowing societies had increased to l 6 6 , while the total committed 39 had increased to about Rs. 41 ,000,000. In addition to these particular act ivit ies the State Bank provides free remittance fac i l i t i e s to cooperative banks. The latter can transfer funds twice a week from their head offices to their up-country branches, and three times a week for transfers in the reverse direction. These transfer provisions enable the cooperative banks to meet the seasonal demand for their loans at a relatively constant lending rate. Magnitude of Operations 1949-1961 The number of branches and pay offices in India operated by the State Bank increased continuously from 377 in 1949 to'946 in l 9 6 l . There was, however, a considerable reduction in i t s foreign branches, which decreased from 36 in 1949 to 8 in 1956. The operations of the Imperial Bank, predecessor of the State Bank, had showa a downward 39. Reserve Bank of India, Trend and Progress of Banking in India during i960, Bombay, 1961, pT 32 - 201 - trend. Its deposits decreased from Rs. 2,505,000,000 in 1949 to Rs. 2,198,000,000 in 1955. Its investment portfolio decreased from Rs. 1069,000,000 in 19^9 to a low level of Rs. 852,000,000 in 1951, and then increased to Rs. 1170,000,000 in 1955. But the amount of i t s loans and b i l l s discounted increased from Rs. 918,000,000 in 1949 to a peak of Rs. 1,428,000,000 in 1951 and then declined to Rs. 1,058,000,000 in 1955- This variation in investments and in loans and advances was due mainly to the Korean War boom. A significant increase was recorded in the operations of the State Bank after i t s conversion in 1955. Its capital funds increased from Rs. 120,000,000 to Rs. 128,000,000, and i t s deposits from approximately Rs. 2355,000,000 to a peak of Rs. 5821,000,000 between 1956 and 1959. Its investment portfolio increased from Rs. 10b9,000,000 to Rs. 3780,000,000 during the same period, but the amount of i t s loans and b i l l s discounted increased only s l ight ly , from Rs. 1,402,000,000 to Rs. 1,669,000,000, The considerable increase in i t s deposits and investment portfolio was due partly to the P. L . 480 funds which were kept with this Bank. Subsequently from 1959 onward these funds were gradually transferred to the Reserve Bank, leading to a decrease in both portfolios. 'After 1959, whereas i ts capital funds increased from Rs. 128,000,000 to Rs. 138,000,000, i t s deposits decreased considerably from Rs. 5,821,000,000 to Rs. 5,325,000,000 by the end of I961. As would be expected, i t s investment portfolio also decreased from Rs. 3,779,000,000 to Rs. 2,367,000,000 during the same period. However the amount of i t s loans and b i l l s discounted increased from Rs. 1,668,000,000 in 1959 to Rs. 2,553,000,000 by the end of 1961. Table 30, showing the annual progress of the State Bank follows: Table 30 Branches, Principal Assets and Liabilities, State Bank of India, 1949-1961, Inc. (Rs.000,000) Year No. of branches in India Capital and Reserves Total Deposits Cash in hand and at banks Loans and Bi l l s Discounted Invest- ments Total earning Assets 1949 377 119.3 2504.6 658.9 918.1 1068.5 1968.6 1950 382 119.6 2313.7 281.8 1019.5 1215.5 2235.0 1951 393 119.8 2309.1 295.7 1427.7 851.6 2279.3 1952 410 119.8 2058.5 254.5 1131.7 971.5 2103.2 1953 424 119.8 2069.7 196.4 1063.1 941.4 2004.5 1954 455 119.8 2311.3 363.7 1023.2 1087.2 2110.2 1955 484 119.8 2198.0 293.8 1058.1 1169.8 2227.9 1956 538 120.1 2354.7 277.8 1401.6 1068.7 2470.3 1957 622 122.6 3666.8 395.2 1734.8 1834.3 3569.1 1958 712 126.3 4786.8 554.7 1720.6 2845.7 4566.2 1959 823 128.3 5821.1 648.3 1668.8 3779.3 5448.1 I960 901 130.8 5773.5 679.5 2322.4 3067.6 5390.0 1961 946 138.3 5324.6 675.4 2553.3 2367.3 4920.4 Source: From the Reserve Bank of India, Statistical Tables Relating to the Bank in India. 1952-1961, pp. 3-7. 1 The deposit figures from 1949 to 1955 are not strictly comparable with those for 1955 onward. After the latter year Provident funds, staff security deposits, etc. are excluded. Similarly after 1955, money at call and at short notice are excluded from loans and discounts. 2 Figures for 1949 in this table do not tally with those given in Table no. 14. Probably their later figures are more reliable. - 2 0 3 - P a r t 3 O p e r a t i o n s o f the I n d u s t r i a l Banks and the L i f e I n s u r a n c e C o r p o r a t i o n of I n d i a . I n terms o f magnitude o f o p e r a t i o n s , the I n d u s t r i a l F i n a n c e C o r p o r a t i o n was by f a r the most i m p o r t a n t of the p u b l i c and q u a s i - p u b l i c i n d u s t r i a l banks e s t a b l i s h e d by the Government, w i t h the c o o p e r a t i o n o f the Reserve Bank. The former, i t w i l l be r e c a l l e d , was charged w i t h the r e s p o n s i b i l i t y of f i n a n c i n g p u b l i c and c o o p e r a t i v e i n d u s t r i a l u n d e r t a k i n g s . Only r e c e n t l y i t s o p e r a t i o n s were extended to f i n a n c e the i m p o r t s o f machinery by p r i v a t e i n d u s t r i e s . The S t a t e F i n a n c i a l C o r p o r a t i o n s , through w h i c h medium s i z e d i n d u s t r i a l under- t a k i n g s , both p u b l i c and p r i v a t e , were t o be f i n a n c e d w i t h i n t h e i r r e s p e c t i v e S t a t e s , made a s i g n i f i c a n t showing i n the aggr e g a t e as d i d the I n d u s t r i a l C r e d i t and Investment C o r p o r a t i o n o f I n d i a . The N a t i o n a l I n d u s t r i a l Development C o r p o r a t i o n , t h e R e f i n a n c e C o r p o r a t i o n and the N a t i o n a l S m a l l I n d u s t r i e s C o r p o r a t i o n made s i g n i f i c a n t , though perhaps l e s s i m p r e s s i v e , advancements. The e s t a b l i s h m e n t o f the s t a t e owned L i f e I n s u r a n c e C o r p o r a t i o n of I n d i a appears not to have a f f e c t e d , one way o r a n o t h e r , the a c c u m u l a t i o n o f p o l i c y r e s e r v e s and . i n s u r a n c e , ..hut:, the o p e r a t i o n o f t h i s C o r p o r a t i o n were c o n s i d e r a b l y extended. Such i n f o r m a t i o n as was a v a i l a b l e u n t i l 196l s u p p o r t s these g e n e r a l o b s e r v - a t i o n s . The I n d u s t r i a l F i n a n c e C o r p o r a t i o n A l t h o u g h the o p e r a t i o n s of the I n d u s t r i a l F i n a n c e C o r p o r a t i o n Were r e s t r i c t e d t o p u b l i c and c o o p e r a t i v e l a r g e f i r m s engaged i n m i n i n g , - 204 - manufacturing, generation and distribution of power,.and shipbuilding, i t opened a new era of •, industrial finance in India. In the wake of successful operations of this Corporation, which is noticeable after 1954, several other industrial banks were established to meet the credit needs of other industries, both in the public and private sectors. The operations of the Corporation are revealed in Table No.31 on page 205. As would be expected, in the absence of many new industries in the public sector between 1949 and 1954, there was not sufficient demand for loans from the Corporation even to absorb i t s capital funds. Consequently the Corporation invested i t s surplus funds in Government securities, and continued this practice unt i l 1954 when sufficient demand was generated to absorb i t s available funds. By the end of March 1955 the amount of .' .. loans disbursed was Rs. 1.41,000,000 and the amount outstanding was Rs. 128,000,000. The demand for financial assistance from the Corporation increased at an unprecedented scale with the inauguration of the Second Five Year Plan, in which considerable industrial expansion both, in the public and private sector was envisaged. Whereas between June 1949 and March 1956 the amount of loans committed and disbursed had increased only to Rs. 386,000,000 and Rs. l62,400,000 respectively, they had reached respectively, ^ 0 Rs. 484,000,000 and Rs. 24l,000,000/by the end of March 1957- Outstanding loans by then amounted to Rs. 207,000,000. This absolute 40. Reserve Bank of India, Report 1956-57, op. c i t . , p. 45 Table 31 Operations of the Industrial Finance Corporation, 1950-61 Inc. (Rs,000,000) LIABILITIES _ ASSETS Year ending March WORKING Capital CAPITAL - - - Reserves Deben- tures Re§ an3 Bank loans Gov't loans Other Liabi- lit i e s Total Cash on Inv. in hand and gov't at banks securities Loans Out- standing: Other 1.Assets 1950-51 50.0 — 53.0 — 3.7 106.8 4.7 45.8 52.1 4.1 1951-52 50.0 0.2 58.0 — — 4.1 112.3 5.5 35.8 65.6 5.4 1952-53 50.0 0.3 58.0 — 6.1 114.4 2.6 20.1 86.2 5.6 1953-54 50.0 2.8 78.1 2.9 — 4.6 138.4 5.5 20.1 112.0 5.9 1954-55 50.0 3.1 78.1 — — 5.2 136.2 2.4 127.8 6.0 1955-56 50.0 5.0 78.1 6.1 — 8.0 147.0 0.2 140.1 6.7 1956-57 50.0 8.7 78.1 10.7 60.0 10.2 217.5 0.9 207.0 9.6 1957-58 50.0 6.1 123.7 — 150.0 10.2 339.9 59.9 262.0 18.0 1958-59 50.0 8.4 167.5 9.4 100.0 15.1 350.4 7.2 321.0 22.31 1959-60 50.0 11.7 222*4 8.8 82.5 35.32 410.7 0.4 367.3 43.02 1960-61 50.0 17.1 222.4 5.1 152.5 63.72 510.9 30.0 407.4 73.42 1961-62 68.4 24.8 222.4 — 177.5 120.32 613.4 29.1 454.8 129.52 Source: Reserve Bank of India , Reports on Currency and Finance, 1955-56 and 1961-62. Statements 48 and 42 respectively. 1 Includes Rs 6,600,000 in respect of debentures. 2 Includes Rs. 19.9 million as of March 25, I960 and Rs 47.7 million as of March 31, 1961, and Rs. 104.0 million as of March 30, 1962 in respect of guarantees and underwriting agreements per contra. - 206 - rate of increase in loans was maintained fa ir ly steadily thereafter. However, during 1961 and 1962 there was a sharp increase in the volume of loans committed. They rose from Rs. 722 ,000,000 in March I 9 6 0 to Rs. 1,257,000,000 by March 1962. This sudden increase may be attributed to industrial expansion during the Second Five Year Plan, to and/the continuous emphasis on industrial development in the Third Five Year Plan. Since i t s inception in 1948 up to the end of March 1962, the Corporation had disbursed loans amounting to Rs. 630,200,000, and of , , o 4i this sum Rs. 454,500,000 were outstanding.on•that date. As was originally envisaged, a major part of the f inancial assistance provided by the Corporation had been granted to new industrial enterprises - the ventures that were set up after 194?. Of the total amount of loans sanctioned up to the end of March 1959 (Rs. 643,400 , 0 0 0 ) about 66 per cent were given to new industries, and the remaining 34 4 2 per cent to existing ventures for expansion and modernization. The majority of loans granted after 1959 were for new industries. The Corporation did not engage in underwriting operations unt i l 1958, as i t was not authorised under the original Act to hold shares of industrial concerns for more than seven years. The Act was amended in 1957 to enable the Corporation to provide equity capital to industrial concerns. During 1958 for the f i r s t time, i t underwrote, in conjunction with two other financial inst i tut ions, two issues of 61/£ per cent re- deemable and convertible debentures for Rs. 16,000,000. Of this amount 43 the Corporation had to take up only Rs. 2,085,000. By the end of 4 1 . Reserve Bank of India, Report, 196I-62, op. c i t . , p. 69 4 2 . S .L.N. Simha, The Capital Market of India, Bombay, Vora, i960, p. 151 4 3 . Reserve Bank of India, Report, 1958-59, op. c i t . , pp.44-45 - 207 - March 1962 the Corporation had underwritten sixteen issues of redeemable, in a l l convertible debentures and preferred and common shares amounting/to Rs. 46,000,000. These issues carried interest rates varying between underwritten . 6]£ per cent and 7% per cent. Of the;, amount/the Corporation had to take up-about Rs. 20,000,000 or about 44 per cent, indicating that the economy's capacity for voluntary investment, evenaat 6}£ per cent, was considerably less than anticipated. This may. further reinforce an earlier conclusion that, without the cooperation of the Reserve Bank, the Government could not have made much progress with i t s program of planned development. In addition to i t s underwriting operation, the Corporation undertook to provide financial assistance to various industrial ventures for importing machinery, by guaranteeing their deferred payments. It approved deferred payments to the extent of Rs. 36,800,000 during 1958. The amount increased by Rs. 131,300,000 by i960, then decreased to Rs. 6,500,000 during 1961. In the latter year i t s assistance in the form of letter of 44 guarantees amounted to Rs. 55,800Q000 as against Rs. 29,500,000 in i960. In view of this considerable expansion in i t s lending operations, the Corporation strengthened i t s capital funds by issuing additional share capital of Rs. 18,400,000, and increased i ts Government borrowings to Rs. 177,000,000 during 1961. It also secured foreign loans to finance the imports o f machinery by various industrial enterprises. It arranged a loan of $20,000,000 with the Agency for International Development of the United States (formerly known as Development Loan Fund) and a loan of Reserve Bank of India, Report, 1961-62, op. c i t . , p. 69 - 208 - D.M. 15 ,000,000 from the Reconstruction Loan Corporation of West " 44. Germany. Thus the Corporation has strengthened i ts capital funds to meet the increased demand for assistance during the Third Five Year Plan. The State Financial Corporations The State Financial Corporations, as described earl ier , were set up to provide long term credit both to public and private medium-sized industries that were left outside the province of the Industrial Finance Corporation. However the operations of these Corporations were limited to their respective states. Although the State Governments were authorized to establish these State Financial Corporations in 1952, not a l l of them immediately exercised the privi lege. By 1953 two State Governments had established such Corporations. The number increased to eight in the following year, to twelve by the end of 1955, and fifteen by the end of i 9 6 0 , or one in each State. The loans of the State Financial Corporation are generally made to provide equity.capital, and run from ten to twelve years. They provide working capital to firms which have not been able to raise i t from a 45 bank. In such cases their loans are not to exceed five years. The loans are granted on the merit of individual undertakings, after a technical examination of the firms' developmental programs. Their rate of interest varies from State to State, but i s generally in the neigh- bourhood of 6}& per cent. . ->':'.< '..c; . Z f i + ' Reserve Bank of India, Report, 196I-62, op. c i t . , p. 69 45. ' S.L.N. Simha, op_. c i t . , p. 167 " - 209 - It is not possible to compare the progress made by these financial Corporations individually as the requisite data are not available but the annual progress made by these banks as a group after 1956, when the industrial development envisaged in the Second Five Year Plan was in i t ia ted , is indicated in the data in Table No. 32 on page 210. The amount of loans committed by the eleven Corporations established by that time stood at Rs. 69,000,000, and loans disbursed at Rs. 33,000,000. The amount of loans committed and disbursed increased to about Rs. 2?l,000m000 and Rs. 172,000,000, respectively, by the end of March i960 and reached peaks of Rs. 491,000,000 and Rs. 300,000,000, respectively, by March 1962. Meanwhile their outstanding loans had increased from Rs. 27,000,000 in 1956 to Rs. 233,000,000 by the end of March 1962. As w i l l be noticed from the Table there is a considerable increase in the lending act ivi t ies of these Corporations during 1961. The volume of loans committed and disbursed during that year increased by approximately 36 per cent, indicating a considerable increase in demand for loanable funds. The borrowing limit for these Corporations was relaxed from five times their paid-up capital to ten times that amount, to handle this increase in demand. In addition, these Corporations were allowed to -borrow from the Reserve Bank for eighteen months, as against only three months as originally provided. It would seem from the Table that the State Financial Corporations have had considerable excess funds as their lending operations did not Table 32 Business of State Financial Corporations, 1955-61, Inc 8 Rs,000,000 Total Year Capital Proceeds of Liabs. Cash in Inv. in Total Loans Ended and Boards & and hand and gov't Out- Other March Reserves Debentures Assets at banks securities Committed Disbursed standing Assets 1955-56 102.9 N.A. 107.0 36.0 39.4 69.0 33.3 27.2 4.4 1956-57 123.6 3.6 147.5 35.9 40.1 113.9 62.0 65.0 6.5 1957-58 132.1 26.0 180.4 46.0 30.6 161.7 98.9 93.5 10.3 1958-59 134.6 61.2 232.2 79.2 28.0 211.6 132.2 113.4 12.6 1959-60 144.8 71.7 263.8 72.1 32.2 270.7 172.1 139.2 20.5 1960-61 154.3 71.7 298.0 45.6 46.0 362.3 219.6 171.2 35.2 1961-62 160.8 135.4 402.0 74.3 45.5 491.4 300.3 232.8 50.8 Source: 1. Reserve Bank of India, Report on Currency and Finance. 1955-1962. Statements 35-42 2. Reserve Bank of India, Bulletin. April, 1962, p. 600. 1 Including debentures amounting to Rs 1,400,000 "*'..*.'. ••••• •/ -.. • 1, - 211 - the fu l ly u t i l i ze their capital funds and proceeds from/sale of debentures. It should be borne in mind that the Corporations in industrial ly advanced States such as West Bengal, Gujrat, and Maharashtra had not only ut i l ized their funds, but resorted to borrowing from the Reserve Bank. Corporations in less industrialized States, however, had excess funds, as reflected in the combined operations of a l l State Financial Corporations. It was to meet the growing needs of the former that their borrowing l imits had been relaxed. The cash balances and investment in Government securities of these Corporations was about 50 per cent of their loans outstanding during the last year under review. This indicates that a large proportion of their funds were committed for loans but not disbursed. The Industrial Credit and Investment Corporation of India Unlike the other newly established financial corporations, the Industrial Credit and Investment Corporation was.broadly based from the very beginning. Among i t s sponsors were the World Bank, the United States Government and the United Kingdom Government as well as the Government of India. Its operations included not only the provision of both foreign and domestic loans to private industries, but equity capital and technical assistance as well. The financial assistance came: for the most part in the form of underwriting stocks and debentures of industrial enterprises as well as by direct subscription to the securities themselves. Technical assistance took on the form of managerial, technical and administrative advice and help in obtaining ski l led personnel. - 212 - The financial assistance provided to private enterprises by this corporation included undertakings in the following industries; pulp and paper, chemicals, pharmaceuticals, fuel injection devises, e lectr ica l equipment, texti les , sugar, metal ores, lime, cement and glass. The magnitude of tangible assistance from the year of i t s establishment down to i960 i s displayed in the following summary. There i s no information available as to the extent of i t s technical assistance program. TABLE NO. 33 Loans and Guarantees, Underwriting and Subscription Operations of Industrial Credit and Investment Corporation, 1956-1961, Inc. (Rs. 000,000.) Loans 8c Guarantees Underwritings & Subscript ions Year Foreign Currehc; Rupee loans y & guarantees Total Shares Und.wrtn.' Purch. Total GRAND' TOTAL 1956 - 29.5 29.5 23.8 6.8 30.6 60.1 1957 22.1 32.3 54.4 53-5 8.6 62.1 116.5 1958 31.6 34.8 66.4 55.0 12.3 67.3 133.7 1959 67.4 35.0 102.4 83.O? 18.6 .. 101.6 204.0 I 9 6 0 126.3 65.5 191.8 96.7 25.6 122.3 314.1 1961 194.2 102.1 296.3 102.2 28.6 130.8 427.1 Source: Reserve Bank of India, Report on Currency and . Finance, 195& to 1961, Bombay, 1957-1962., Section: Capital Market. - 213 - These data reveal among other things, the increasing contributions made by foreign capital through this Corporation to the economic development of India. Except for the f i rs t two f u l l years of i t s operation, foreign loans granted by the Corporation constituted about two-thirds of i ts total loans and guarantees. Whereas i t s Rupee loans increased from Rs. 32,300,000 in March 1957 to Rs. 102,000,000 in March 1962, the corresponding foreign loans increased from Rs. 22,100,000 to Rs. 19^,200,000 during the same period. This considerable increase in foreign loans was made possible by the foreign connections of the Corporation that enabled i t to raise money outside India more easily than could other financial inst i tut ions. The rate of interest charged on i t s foreign loans i s s l ight ly higher than on domestic loans; namely, 7 3/4 per cent as compared to 6 1/2 per cent. In addition, borrowers have to pay a % of 1 per cent commission 46 on the former. The Table further reveals the considerable increase in total f inancial assistance approved by the Corporation which, starting from a modest amount of Rs. 60,000,000 in March 1956,increased to Rs. 204,000,000 to in March 1959 and/Rs. 427,000,000 in March 1962. Of the latter amount, however, only Rs. 184,000,000 or about 43 per cent was., disbursed by the 47 end of March 1962. Direct subscriptions to the equity capital of various industrial enterprises shows a considerable growth between 1957 and i960, but the.' y ' S .L.M. Simha, The Capital Market of India, Bombay, Vora, i960, p. 183 Reserve Bank of India, Report 1961-62, op. c i t . , pp. 71-72 - 214 - growth slackened thereafter. Whereas between 1957 and i 9 6 0 the amount of shares purchased had increased from Rs. 8 , 6 0 0 , 0 0 0 to Rs. 2 5 , 6 0 0 , 0 0 0 , this had increased to only Rs. 2 8 , 6 0 0 , 0 0 0 by the end of March 1 9 6 2 . The underwritings of the Corporation were on a modest scale, and in the beginning were not too successful. Of the Rs. 9 , 3 0 0 , 0 0 0 shares floated during 1957 the Corporation i t s e l f had to take up about Rs. 5 , 8 0 0 , 0 0 0 or 63 per cent. In the following year, however, of under- writing operations amounting to Rs. 2 1 , 8 0 0 , 0 0 0 i t had to take up only Rs. 4 , 5 0 0 , 0 0 0 or about 21 per cent. During 1959 the Corporation was s t i l l more successful. Of underwritings amounting to Rs. 1 9 , 3 0 0 , 0 0 0 , i t had to take up only Rs. 2 , 8 0 0 , 0 0 0 , which was about 15 per cent of the to ta l . By i 9 6 0 however, the Indian money market had become so exhausted that the Corporation had to take up as much as. Rs. 1 2 , 3 0 0 , 0 0 0 or about 48 67 per cent of the Rs. 1 7 , 2 0 0 , 0 0 0 underwritten. This may be attributed to the fact that other similar f iancia l institutions had entered the underwriting business. Moreover, i t should be realized that this was one of the principle reasons for establishing this Corporation in the f irst place, i . e . , to help finance unproven private ventures entering new fields of enterprise. The National Industrial Development Corporation The National Industrial Development Corporation was established principal ly to help in setting up new industries and in the rehabilitation of old ones in the private sector, where the amount of capital required ed and the degree of r isk involved tend/to rd.bter private investment. It was 48 Adapted from, Reserve Bank of India, Report on Currency and Finance, 1957 to 1961.Ch.Capital Market. - 215 - d e s i g n e d m a i n l y to e s t a b l i s h t h o s e i n d u s t r i e s t h a t were deemed n e c e s s a r y to f i l l the gap i n t h e planned i n d u s t r i a l s e c t o r , and e s p e c i a l l y t h o s e i n d u s t r i a l u n d e r t a k i n g s which promis e d t o remove the c o u n t r y ' s dependence upon i m p o r t s o f heavy i n d u s t r i a l machinery, raw f i l m , a l u m i n i u m , s y n t h e t i c i+q r u b b e r and the p r i m a r y i n g r e d i e n t s f o r drugs, d y e s t u f f s , and p l a s t i c s . T h i s C o r p o r a t i o n s u p p l i e d t h e o n l y c h a n n e l l t h r o u g h which s p e c i a l l o w - c o s t government l o a n s would be made a v a i l a b l e f o r the m o d e r n i z a t i o n of t h e j u t e and c o t t o n t e x t i l e i n d u s t r i e s . L a t e r on, d u r i n g 1958, the C o r p o r a t i o n adopted a h i r e - p u r c h a s e scheme under which i n s t a l m e n t l o a n s were made t o f a c i l i t a t e the purchase o f new machinery, p r o v i d i n g t h a t i t was produced i n I n d i a . Under t h i s p l a n the b o r r o w i n g f i r m s d e p o s i t 25 per cent o f the c o s t o f machines and pay the ba l a n c e i n f i v e e q u a l annual i n s t a l m e n t s a t a 6 per ce n t r a t e of i n t e r e s t . S u b s e q u e n t l y t h i s h i r e - p u r chase scheme was extended t o the machine t o o l i n d u s t r y i t s e l f . The need was so gre a t and immediate f o r i m p o r t s o f machinery, however, t h a t the C o r p o r a t i o n i n i960 extended i t s l e n d i n g a c t i v i t i e s t o the f i n a n c i n g of machinery made abroad, a g a i n s t guarantees and c o l l a t e r a l s e c u r i t i e s . A l t h o u g h b a l a n c e sheet summaries o f the o p e r a t i o n s o f the N a t i o n a l I n d u s t r i a l Development C o r p o r a t i o n a r e not a v a i l a b l e one may conclude t h a t t h e y were most s i g n i f i c a n t i n h e l p i n g t o r e a l i z e the o b j e c t i v e s o f the Second F i v e Year P l a n . Up t o the end of March 1959 the C o r p o r a t i o n had committed l o a n s under the h i r e - p u r c h a s e scheme amounting to Rs. 2,100,000 t o the j u t e and c o t t o n t e x t i l e i n d u s t r y . By the end of March 1961 the amount o f such l o a n s had i n c r e a s e d t o Rs. 3,000,000 - an i n c r e a s e o f about 4 8 per ce n t o v e r a two-year p e r i o d . By t h i s l a t e r * Reserve Bank of I n d i a , R e p o r t 1956-57, op. c i t . , p. 47 Reserve Bank of I n d i a , R e p o r t 1958-59, op. c i t . , p. 49 - 216 - date the Corporation had also sanctioned, under the hire-purchase scheme, 51 loans amounting to Rs. 3)500,00 to the machine tool industry. The loans under the hire-purchase scheme originally carried a 4>& per cent rate of interest, but i t was raised to Tk- per cent in 1958. These loans are repayable in fifteen equal annual instalments. In addition to the hire-purchase scheme the National Industrial Development Corporation since i t s inception had committed loans amounting to Rs. 144,100,000 up to the end of March i 9 6 0 for the rehabilitation and modernization of the jute and cotton textile industries. By the end of March I96I the amount had increased to Rs. 196,000,000. But the amount of loans disbursed increased only from Rs. 50,100,000 to Rs. 65 ,800,000 during the same period. Whereas the loans committed increased by about 36 per cent, the loans disbursed increased by about 30 per cent. ' With respect to the establishment of new industrial enterprises, the progress of the Corporation is hampered by the shortage of exchange reserves of the Government of India. Nevertheless,with the collaboration of the Czechoslovakian Government the Corporation has been instrumental in establishing a heavy foundry forge. With the help of the Russian Government, i t has established a heavy machine building plant, a mining 52 machinery plant and an optical glass plant. With the cooperation of Russian technicians, i t has prepared plans for the establishment of drugs and pharmaceutical industries, but these have been delayed by a shortage of foreign funds. The Corporation in 1959 promoted the estab- lishment of a Chemical Development Company to engage in the production of Reserve Bank of India, Report on Currency and Finance, I96O - 6 1 . , Bombay, 1 9 6 l , p. 66 S.L.N. Simha, The Capital Market of India, Bombay, Vora, i 9 6 0 , p. I76 - 2 1 7 - s u l p h u r from P y r i t e s . I t has a l s o drawn up p l a n s f o r the e s t a b l i s h m e n t of a l u m i nium and s y n t h e t i c r u b b e r p l a n t s , but the p r o j e c t s themselves the have been d e l a y e d by a c o n s t a n t s h o r t a g e o f / f o r e i g n exchange r e q u i r e d to i m p o r t the s p e c i a l i z e d machinery r e q u i r e d f o r such p r o j e c t s . The R e f i n a n c e C o r p o r a t i o n The R e f i n a n c e C o r p o r a t i o n , as noted i n Chapter IV, was e s t a b l i s h e d t o encourage the p a r t i c i p a t i o n o f I n d i a n banks i n f i n a n c i n g the development of medium s i z e d p r i v a t e e n t e r p r i s e s i n the I n d i a n economy. Th i s and o t h e r s i g n i f i c a n t d e v i a t i o n s from the s o c i a l i s t i c i d e a l s o f the r u l i n g Congress p a r t y was no doubt a c o n c e s s i o n t o the U n i t e d S t a t e s , whose Government p e r m i t t e d the Government of I n d i a t o use the proceeds of the s a l e of a g r a i n l o a n , amounting to Rs. 2 6 0 , 0 0 0 , 0 0 0 , to make advances t o p r i v a t e i n d u s t r i e s through the e x i s t i n g b a n k i n g i n s t i t u t i o n s . Such advances were to be made to new e n t e r p r i s e s i n c l u d e d i n the Second and s u c c e e d i n g F i v e Year P l a n s . I n a d d i t i o n t o t h i s f u n d , a share c a p i t a l o f Rs. 2 5 0 , 0 0 0 , 0 0 0 was s u b s c r i b e d by the Reserve Bank, the L i f e I n s u r a n c e C o r p o r a t i o n , the S t a t e Bank, and f o u r t e e n s c h e d u l e d banks. I n as much as the l o a n s made p o s s i b l e by t h i s C o r p o r a t i o n were a v a i l a b l e t o the borrower a t 6% per c e n t (the b o r r o w i n g banks were not a l l o w e d t o charge more than Vfe p e r cent above the 5 per c e n t l e n d i n g r a t e of the C o r p o r a t i o n ) one would have expected t h a t c o n s i d e r a b l e advantage would have been ta k e n by the more e n t e r p r i s i n g I n d i a n s . Yet d u r i n g i t s f i r s t y ear of o p e r a t i o n i n 1 9 5 8 , o n l y Rs. 2 4 , 3 0 0 , 0 0 0 had been committed, o f which o n l y about Rs. 2 , 0 0 0 , 0 0 0 was d i s b u r s e d . D u r i n g the f o l l o w i n g y e a r , though the amount o f l o a n s committed decreased t o Rs. 1 7 , 3 0 0 , 0 0 0 , the amount d i s b u r s e d i n c r e a s e d t o Rs. 1 1 , 6 0 0 , 0 0 0 . By the end of March - 218 - 196l the total amount of loans committed amounted to Rs. 76,900,000; the total amount disbursed, to Rs. 32,200,000 At this later date i ts outstanding loans amounted to Rs. 30,900,000 or about 96 per cent 53 of the loans disbursed. This high proportion was due to the medium- term nature of the loans advanced by the Corporation. The relatively slow response to the advantages of the medium term 6)4 per cent loans made possible by the Corporation to private industries was no doubt due to the fact that the Corporation i t s e l f charged the lending banks 5 per cent for i t s loans, thus leaving an operation margin of 1)4 per cent for the primary lenders. No private bank can lend at such a low rate and come even close to meeting i ts operating expenses. As a result the member banks had l i t t l e incentive to use the lending f a c i l i t i e s of this Corporation. In order to expand i t s operations and thus ut i l i ze i t s substantial capital funds, i t s f a c i l i t i e s were extended in i960 to twenty-eight non- member scheduled banks, a l l State Financial Corporations and three State Cooperative banks. In addition, the