Origin and Establishment of RBI

Prior to the RBI, India’s banking and currency management lacked a dedicated central authority. The Imperial Bank of India (est. 1921) performed some quasi-central banking functions like managing government accounts and acting as banker to banks, but a separate central bank was deemed necessary for a growing economy. In the 1920s, instability in currency and credit (exacerbated by World War I and the Great Depression) stressed the need for central monetary authority. The government appointed the Royal Commission on Indian Currency and Finance (Hilton Young Commission) in 1926 to examine India’s financial system.

Recommendation of the Hilton Young Commission

The Hilton Young Commission (1926) recommended the creation of a central bank for India to independently oversee currency issuance and credit control. As a result, a bill proposing an independent Reserve Bank was introduced in 1927 in the Indian Legislative Assembly. Although that initial attempt faced disagreements and was withdrawn, the idea gained traction over the next few years.

Establishment under the RBI Act, 1934

The concept was revived by various committees and discussions (including an Indian Central Banking Enquiry Committee in 1931). Finally, the Reserve Bank of India Act, 1934 was passed by the Legislative Assembly.

Incorporation

The Reserve Bank of India was established as a shareholders’ bank under the RBI Act, 1934 and commenced operations on April 1, 1935. It began as a privately-owned institution with an initial paid-up capital of ₹5 crore, divided into shares of ₹100 each. The central government held only a small portion of these shares initially, with the majority owned by private shareholders (mostly banks and the public). Out of this Rs. 5 Crore, the amount of Rs. 4,97,8000 was subscribed by the private shareholders while Rs. 2,20,000 was subscribed by central government.

First Offices

The RBI’s original Central Office (headquarters) was in Calcutta (Kolkata). In 1937, the headquarters was permanently moved to Bombay (Mumbai), where it remains today. The Bank opened regional offices in major cities: Calcutta, Bombay, Madras (Chennai), Delhi, and Rangoon (Yangon), reflecting its remit across British India (including Burma then).

Early Governance and Leadership

The RBI was governed by a Central Board of Directors, appointed under the provisions of the RBI Act. The Board was chaired by the Governor. Sir Osborne Smith became the first Governor of the RBI in 1935.

The early leadership of RBI included both British and Indian officials. Sir James Taylor succeeded Osborne Smith in 1937, and later Sir C.D. Deshmukh (appointed 1943) became the first Indian Governor of the RBI. The Bank also had four Local Boards (for the Northern, Eastern, Southern, and Western areas of India) to advise on local matters, reflecting the federal nature of its operations across regions.

Initial Functions and Responsibilities

At its inception, the Reserve Bank’s primary purpose was to bring stability to India’s currency and credit systems. Key functions laid out in the Act included:

• Issuance of Currency: RBI obtained the sole right to issue banknotes in India (the one-rupee notes and coins remained issued by the Government). It took over currency issuance from the Government’s Controller of Currency.
• Banker to Government: The RBI assumed the role of banker, agent, and debt manager to the Government of India. It took over management of the government’s accounts and public debt from the Imperial Bank of India.
• Banker’s Bank: The RBI became the banker to other banks, holding their reserves and acting as lender of last resort. It was entrusted with maintaining reserve ratios and financial stability.
• Credit Control: Even in its early years, the RBI was tasked with regulating credit in the economy to ensure monetary stability. It could use tools like the bank rate (interest rate at which it would lend to commercial banks) and open market operations in government securities to influence liquidity.

These objectives were concisely stated in the Preamble of the RBI Act: to regulate the issue of banknotes, maintain reserves to secure monetary stability in India, and to operate the currency and credit system of the country to its advantage.

Early Challenges and Developments

• Currency and Exchange: Soon after establishment, RBI faced the challenge of managing India’s currency in a turbulent period. It issued the first RBI currency notes in January 1938 (Rs. 5 and Rs.10 notes initially, followed by higher denominations). The Bank introduced security features like the security thread in notes as early as 1944 to improve trust in paper currency.
• World War II Era: The outbreak of World War II and its economic impacts meant the RBI had to finance war expenditures and manage inflationary pressures. In 1939, the RBI implemented exchange control regulations for the first time (under the Defence of India Rules) to stabilize the external value of the rupee amid global uncertainty.
• Burma (Myanmar) Operations: Burma was separated from India politically in 1937, but the RBI continued to act as the central bank for Burma until 1947. This arrangement lasted until the Japanese occupation of Burma during the war and was formally ended when Burma established its own central bank.
• Role in Pakistan’s Creation: After the partition of India in 1947, the RBI served as the de facto central bank for the newly formed Pakistan until Pakistan could establish the State Bank of Pakistan. RBI performed this role for about one year after independence – Pakistan’s central bank started operations in July 1948, after which RBI ceased to function in Pakistan.

Important Facts

• First Reserve Bank note was issued in January 1938.
• From 11 March 1940, RBI’s accounting year was changed from January-December to July-June.
• In 1940, the silver rupee was replaced by the quaternary alloy rupee and in the same year, the one Rupee note was reintroduced. This note had the status of a rupee coin and represented the introduction of official fiat money in India.
• RBI had introduced exchange control in India for first time in 1939 under the Defence of India rules. These rules were also invoked in 1945 due to increase speculative activity in the financial and bullion markets.
• For the first time, security threads were introduced in 1944 on rupee notes as security feature.
• High Denomination Bank Notes of Rs 500, Rs 1000 and Rs 10,000 were demonetized on 12 January 1946 to curb unaccounted money.

Towards Nationalization

Throughout the 1935-1947 period, the RBI remained a private institution but worked closely with the government, sometimes facing differences (for example, on issues like interest rates and deficit financing). With India gaining independence in 1947, there was a broad consensus to bring the central bank under full state ownership for sovereign control over monetary policy.

The groundwork for nationalization was laid by late 1940s. The Reserve Bank (Transfer to Public Ownership) Act, 1948 was passed to acquire the privately held shares of the RBI. Thus, at the dawn of 1949, the stage was set for transforming the RBI into a fully government-owned institution.