Developmental Role of the RBI


As in many developing countries, the central bank is seen as a key institution in bringing about development and growth in the economy. In the initialyears of the RBI before independence, the banking network was thinly spread and segmented. Foreign banks served foreign firms, the British army and the civil service. Domestic/Indian banks were linked to domestic business groups  and managing agencies, and primarily did business with their own groups. The coverage of institutional lending in rural areas was poor despite the cooperative movement. Overall financial intermediation was weak. In an agrarian economy, where more than three-fourth of the population lived in the rural areas and contributed more than half of GDP, a constant and natural concern was agricultural credit. Therefore, almost every few years a committee was constituted to examine the rural credit mechanism. There has perhaps been one committee every two or three years for over a hundred years.

A clear objective of the development role of the RBI was to raise the savings ratio to enable the higher investment necessary for growth, in the absence of efficient financial intermediation and of a well developed capital market. The view was that the poor were not capable of saving and, given the small proportion of the population that was well off, the only way to kick start the savings and investment process in the country was for government to perform both functions. Thus the RBI was seen to have a legitimate role to assist the government in starting up several specialized financial institutions in the agricultural and industrial sectors, and to widen the facilities for term finance and for facilitating the institutionalisation of savings. A special need was felt for accelerating industrial investment, particularly with the launching of the Second Five Year Plan in 1956. Over time, various term lending industrial finance institutions were established with varying degrees of RBI involvement: the Industrial Finance Corporation of India (IFCI), State Financial Corporations (SFCs), Industrial Development Bank of India (IDBI) and the Industrial Credit and Investment Corporation of India (ICICI).
The traditional concern with agricultural credit continued and the Agriculture Finance Corporation was established in 1963, followed by its transformation into the National Bank for Agriculture and Rural Development in 1982 for extending refinance for short, medium and long term finance for agriculture. The Unit Trust of India was established in 1964 to mobilize resources from the wider public and to provide an opportunity for retail investors to invest in the capital market, thereby also aiding capital market development. The National Housing Bank was set up in the late 1980s to develop housing finance and the Infrastructure Development Finance Company (IDFC) in the late 1990s for infrastructure finance. The Reserve Bank also actively promoted financial institutions to help in developing the Government securities market.

The Discount and Finance House of India (DFHI) was set up in 1988; primary dealers were promoted in the late 1990s; and the Clearing Corporation of India was incorporated in 2001 to upgrade the financial infrastructure in respect of clearing and settlement of debt instruments and foreign exchange transactions. More recently, the Board for Regulation and Supervision of Payment and Settlement System has been constituted in 2005, and the Banking Codes and Standards Board of India in 2006 to develop a comprehensive code of conduct for fair treatment of bank customers. The RBI has been continuously involved in setting up or supporting these institutions with varying degrees of involvement, including equity contributions and extension of lines of credit.

Thus, the developmental role of the RBI has spanned all the decades since independence and is quite different from central banks in developed countries. Although the Reserve Bank was actively involved in setting up many of these institutions, the general practice has been to hive them off as they came of age, or if a perception arose of potential conflict of interest. There can be little doubt that the establishment of these institutions has helped financial development in the country greatly, even though some of them have been less than successful in their functioning. It can be argued, of course, that similar institutional development could have taken place through private sector efforts or by the Government. The availability of financial sector expertise in the Reserve Bank, however, was instrumental in these tasks being performed over time by the Reserve Bank. 

Monday, 08th Feb 2016, 11:27:29 AM

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