The sixth annual conference of state financial corporations at the RBI in Bombay, December 1959. (Photograph: RBI History Volume-II)

When RBI Played Angel Investor To India’s Early Financial Institutions

BloombergQuintOpinion

The Reserve Bank of India recently announced that it has divested its entire share in National Bank for Agriculture and Rural Development and National Housing Bank to the Government of India. This news might have gone unnoticed by most people, but it is deeply linked to the history of India’s central bank and its financial institutions.

YV Reddy, the former Governor, has often termed RBI as a full-service central bank “encompassing regulatory and developmental roles in the financial system”. That comment stems from the many roles that the RBI has played since independence.

Post-independence, India adopted centralised planning to develop the Indian economy, which required financial resources. India’s financial system was too underdeveloped to mobilise and channelise these resources. Both credit and capital markets were inadequate.

This led the RBI to take a central role in the development of India’s financial system. One of the developmental roles has been sponsoring and developing several financial institutions that have served different purposes in India’s financial sector.

RBI was like a venture capitalist to these institutions. It provided not just initial capital but also guided their growth.

RBI also provided liquidity support and channelised part of its balance sheet resources towards the functioning of these lending institutions. In this aspect, RBI is perhaps one of the few central banks (if not the only) to have played this role.

Promoting Banks or Lending Institutions

RBI’s role can be divided across four different types of financial institutions. The first among them is the role played by the central bank in promoting banks and lending institutions.

This was the first need post-independence as we lacked formal lending institutions across all kinds of activity: commercial banking, industrial finance, agriculture and rural credit, housing and infrastructure. Name it and we lacked it.

In 1955, Imperial Bank of India was nationalised and renamed as State Bank of India. The government left the ownership details to the RBI with the condition that the sovereign should own 55 percent of the bank at all times. RBI ended up owning 92 percent of SBI.

Despite being owners, RBI gave functional autonomy to SBI, so much so that the two did not agree on many crucial policies. Some things never change! It was only in 2007 that the RBI transferred its stake in SBI to the government.
Stamp of Imperial Bank of India. (Photograph: SBI website)
Stamp of Imperial Bank of India. (Photograph: SBI website)

The next on the list was industrial finance. Though, there were two existing institutions in this space—IFCI and ICICI—a need was felt to have a third institution sponsored by the RBI. This led to formation of Industrial Development Bank of India in 1964*. Despite a stellar start, the government soon became uncomfortable with RBI’s ownership of IDBI, and it was transferred to the government in 1976.

Over time, Indian polity had experimented quite a bit in agricultural and rural credit space. By 1980s, the policy thinking was that there was a need to coordinate all these activities under one RBI-led umbrella organisation. This led to formation of NABARD in 1982, as an apex bank for agricultural and rural development. This was based on the IDBI-model with a deputy governor of the RBI acting as the chair of NABARD board and three members of RBI’s central board serving as NABARD’s directors. The government and RBI held equal share in this apex rural organisation.

Finance Minister Arun Jaitley chairing the NABARD board meeting in New Delhi, on Feb. 26, 2018. (Photograph: Arun Jaitley/Twitter)
Finance Minister Arun Jaitley chairing the NABARD board meeting in New Delhi, on Feb. 26, 2018. (Photograph: Arun Jaitley/Twitter)

In the same year, IDBI’s role of financing international trade was transferred to a new organisation named Exim Bank.

In 1988, the government advocated in its National Housing Policy that shortage of houses should be eradicated by the end of the century. The policy also suggested that there should be a formal framework to mobilise savings for housing. This led to the formation of National Housing Bank, which was again fully sponsored by RBI.

The last of these lending institutions was IDFC which was established in 1997 for financing the country’s infrastructure needs.

Capital Market Institutions

Apart from banking, there was also a need to develop the capital markets.

The role of investment trusts had helped some countries mobilise savings and channelise those to the capital markets. The discussions to put in place a similar trust started in India. Again, RBI took the lead by forming Unit Trust of India in 1964, same year as IDBI. However, once again RBI’s relationship with the new entity was short-lived, like it was with IDBI. Under the Public Financial Institutions Laws (Amendment) Act of 1975, UTI was placed under IDBI in July 1976. As IDBI ownership was transferred to Government in February 1976, UTI also came under government ownership, albeit indirectly.

A cartoon on the Unit Trust of India, from RBI’s official history. (Photograph: RBI History, Volume-II)
A cartoon on the Unit Trust of India, from RBI’s official history. (Photograph: RBI History, Volume-II)

The third volume of RBI’s History (1967-81) narrates a fascinating tale of how RBI bailed out UTI from a financial crunch in 1974-75. The government had restricted the rate of corporate dividends to four percent to curb inflation. This led to a decline in the stock market. As a result, people withdrew investments from UTI, creating financial stress. The RBI didn’t just provide the initial paid-up capital but also emergency funds.

Debt And Money Market Institutions

Once the lending market was better organised, it was time to apply the same towards money and debt markets.

In 1988, RBI established Discount and Finance House of India Ltd to operate along with public sector banks and other financial institutions. The role of DFHI was to promote liquidity in money markets and it participated in the market as both a lender and a borrower.

After the 1991 reforms, the government announced that it would do away with automatic financing of its deficit from RBI. The government would be required to manage its fiscal deficit by borrowing from the debt markets. This required the development of primary and secondary markets for government securities.

RBI first established a primary dealership system to develop the government securities markets and then also formed Securities Trading Corporation of India Ltd. in 1994*, as the first primary dealer.

Supporting Institutions

It is not just enough to establish financing institutions alone. One also needs supporting institutions to help in functioning of these very institutions.

Here, RBI established Deposit Insurance Corporation in 1961 following the failure of Palai Central Bank in 1960. It also established Credit Guarantee Corporation in 1971 to encourage the commercial banks to meet the credit needs of the neglected sectors. These two were merged to form Deposit Insurance and Credit Guarantee Corporation of India in 1978.

A cartoon on the collapse of Palai Central Bank in 1960, from RBI’s official history. (Photograph: RBI History, Volume-II)
A cartoon on the collapse of Palai Central Bank in 1960, from RBI’s official history. (Photograph: RBI History, Volume-II)

RBI was also instrumental in starting Stock Holding Corporation of India Ltd. along with seven financial institutions. This helped in accounting for the transfer of shares from one person to another via a book-keeping system.

The Exit Process

In 1999-2000, when RBI first made its annual report available on its website, the central bank had sponsored eight financial institutions.

In 1998, Narasimham Committee-II on financial sector reforms had suggested that the RBI divest stake in the financial institutions it had sponsored. The premise was that the central bank should not own the institutions it regulates. This led to divestment of ownership in six entities.

The most notable divestment was that of SBI where RBI transferred its entire 59 percent stake to the government. This resulted in a profit of Rs. 34,308.6 crore which was also transferred to the government.

Overtime, RBI has divested out of most of these institutions for varied reasons at varied times. The latest being the exits from NABARD and NHB.

When RBI Played Angel Investor To India’s Early Financial Institutions

What Remains

The two investments that remain are in Bharatiya Reserve Bank Note Mudran Pvt. Ltd. and DICGC. BRBNML was established in 1956 for the central bank’s currency management tasks.

In 2016-17, the RBI added Reserve Bank Information Technology Pvt. Ltd in its list of sponsored institutions. RBI’s annual report for 2016-17 mentions “ReBIT was set up to take care of the Information Technology (IT) requirements including cyber security needs of the Bank as also the other entities regulated by it.”

RBI will likely divest its ownership in ReBIT once the organisation matures.

However, it may maintain ownership over DICGC and BRBNML as both currency management and deposit insurance are highly sensitive matters.

* Disclaimer: The author has worked for both IDBI and STCI.

Amol Agrawal is a faculty member at Ahmedabad University. He has a PhD in Indian Banking History and writes the Mostly Economics blog.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.