Indian Currency and Finance

by John Maynard Keynes

3. How close a connexion exists between the two money markets—native and European—how nearly the rates ruling in one agree with those in the other, and how readily capital flows from one to the other, I am not clear. Some evidence bearing on these points was laid before the Fowler Committee of 1898, but such facts are now fifteen years old. In the pre–1899 period it was not uncommon in times of stringency for the bazaar rate to be appreciably lower than the Presidency Bank rate, and the connexion between the two money markets seems to have been very incomplete. The following quotation from a letter by Mr. J. H. Sleigh, Secretary and Treasurer of the Bank of Bombay, written in 1898 (reprinted in the Appendix to the Fowler Committee’s Report), is interesting:—

During the last export season, Shroffs’ 60 days’ sight bills were not obtainable over 8 per cent discount.... This was the rate then ruling in the native bazaar both in Bombay and Calcutta, and that, too, while the Exchange Banks were greedy to receive fixed deposits for short periods at 9, 10, and even 11 per cent per annum, and while the Presidency Banks were straining to meet the demands for loans at 12 and 13 per cent per annum. But there is no singularity in these facts. The same peculiarity has shown itself over and over again during periods of financial pressure; and even at the present moment (November 1898), while money is not by any means tight, there exists a difference of about 2 per cent between the bazaar and the Presidency Bank rates. I have ever found that when the official rate rose abnormally high, the rate in the native market did not respond to the full extent, but generally stopped at 7 or 8 per cent, though the Presidency Banks’ rate might rise to 10 or 12 per cent. The explanation is simple. The Shroffs, who finance nearly the whole of the internal trade of India, rarely, if ever, discount European Paper and never purchase foreign or sterling bills. Neither do they lend money on Government Paper or similar securities, but confine their advances to the discount of hoondees, to loans to cultivators, and against gold and silver bullion. The hoondees they purchase are for the most part those of traders, small and large, at rates of discount ranging from 9 to 25 per cent per annum, but the hoondees they buy and sell to each other, which are chiefly the traders’ hoondees bearing the Shroffs’ own endorsements, rule the rates in the native bazaar, and are generally negotiated, during the busy season, at from 5 to 8 per cent discount. They also discount their endorsements pretty largely with the Presidency Banks when rates are low, and discontinue doing so when they rise above 6 per cent. They also speculate largely at times in Government Paper, especially during the off season, but rarely or ever hold it or lend on it.

I have seen no evidence for supposing that the general conditions outlined in this quotation do not still hold; but in recent years the Presidency Bank rates have not risen above 9 per cent, and occasions for the operation of the tendencies described above have been rarer. The conditions prevailing in the Indian Money Market in the period immediately preceding 1898 were in many respects very abnormal. I suspect that the rates in the two markets may appear to be more different than they really are, and are explicable by the difference of the conditions and of security, subject to which business is transacted. It is, however, plain that the main movements of the interest rate up and down, which result from the central facts of the Indian seasons and harvests, must be the same in both markets, and that the Native Money Market must ultimately depend on the European for additional supplies of cash.

4. As I am chiefly interested in the Indian Banking System, so far as this book is concerned, from the point of view of its effect on the remittance of funds to and from India, I shall be concerned for the most part with what I have called the European Money Market—the Presidency and Exchange Banks. But an Indian writer, in a position to know the facts, could throw much useful light on a question where I must necessarily be content with somewhat doubtful conjecture.

5. The Presidency Bank of Bengal was opened in 1806 and received its charter of incorporation from the East India Company in 1809.[86] The first Bank of Bombay[87] was established under a similar charter in 1840, and the Bank of Madras in 1843. The establishment of these Banks in the other Presidencies put an end to the possibility that the Bank of Bengal might become a Bank for all India. The Presidency Banks had, at first, a semi–official character. At the foundation of the Bank of Bengal, the East India Company contributed one–fifth (the proportion became smaller subsequently) of the capital and appointed three of the directors. Up to the time of the Mutiny the office of Secretary and Treasurer was held by a Covenanted Civilian.

Up to 1862 the Banks had the right of note issue; but this right was so hedged about by a restriction of the total liabilities payable on demand to a certain multiple (at first three times, later four times) of the cash reserve, and of the total liabilities of all kinds to the amount of the Bank’s capital (up to 1839), or of the total note issue to a fixed amount (from 1839 to 1862), that the note issue of the Presidency Banks never became important. In 1862 the management of the note issue was taken over by the Government in the manner described in Chapter III. At the same time the right of note issue by private Banks was finally abolished.[88] In 1876 the Government relinquished their share of the capital of the Banks and their right of appointing directors.[89] Since then the Presidency Banks have lost their official character, but remain distinct from other Banks in that they are governed by a special Charter Act (the Presidency Banks Act of 1876).

6. The Presidency Banks have worked from the beginning under very rigorous restrictions as to the character of the business which they might undertake. These restrictions were originally due partly, perhaps, to a feeling of jealousy on the part of the Court of Directors of the East India Company lest the Banks should compete in business (such as foreign exchange) which the Company regarded as its own; but chiefly from a proper wish that semi–official institutions, in a country so dangerous for banking as India, should be conducted on the safest possible principles.[90] An exceedingly interesting history of the restrictions is to be found in Mr. Brunyate’s Account. In 1862 they were greatly relaxed, but the most important limitations were reimposed in 1876.[91] Since that time only minor charges have been effected.

7. The principal restrictions on the Presidency Banks are now the following:—

(i.) The Banks may not draw, discount, buy, or sell bills of exchange or other negotiable securities unless they are payable in India[92] or in Ceylon; this restriction has cut off the Presidency Banks completely from dealing in sterling drafts or any kind of foreign exchange; (ii.) they may not borrow, or receive deposits payable, outside India, or maintain a foreign branch or agency for this or similar purposes, and they are thus prevented from raising funds in London for use in India[93]; (iii.) they may not lend for a longer period than six months[94]; (iv.) or upon mortgage, or in any other manner upon the security of immovable property; (v.) or upon promissory notes bearing less than two independent names; (vi.) or upon personal security; (vii.) or upon goods, unless the goods, or the title to them, are deposited with the Bank as security.

The fifth of these provisions allows a loophole by means of which the rules can be made to work in practice less rigorously than appears on paper. Any two names will satisfy the letter of the Presidency Banks Act; but any two names are not necessarily very good security. After getting two names to satisfy the Act, the authorities of the Banks can then proceed to satisfy the dictates of cautious banking by taking, as well, some of the other kinds of security upon which, technically, they are forbidden to lend. It is an excellent instance of the consequences of an attempt to control banking by an elaborate Act forty years old. The last provision has led, I believe, to the Banks establishing a kind of bonded warehouse for the reception of merchandise. In other cases the borrower’s own mill or warehouse is made to serve the purpose by the expedient of the Bank’s paying the wages of his watchman. Where the personal security of the borrower is obviously good, there must be a temptation to allow him to value the goods generously, rather than to put the Bank to the inconvenience of housing or watching a greater bulk of merchandise.