CHAPTER -1 HISTORICAL DEVELOPMENT OF CENTRAL BANKING SYSTEM IN THE WORLD 1.1 - EVOLUTION OF CENTRAL BANKING Before the 20 Century the concept of Central Banking was not clearly defined. The Central Banking system developed in various countries over a long period of time. In fact Central Banking system developed recently even though some Central Banks were established more than two centuries ago. The Risk Bank in Sweden was established in the year 1668 followed by in 1694, which was the first Bank to assume the position of a , hence it is known as the 'Mother of Central Banks'. The System in America was established in 1913 while the was established in 1934. By and large, the establishment of a Central Bank was encouraged in the countries all over the world. In 1920, a financial conference was held at Brussels. A resolution was passed in the conference that, "all those countries which had not yet established a Central Bank should proceed to do so as soon as possible, not only with a view to facilitating the restoration and maintenance of stability in their monetary and Banking systems but also in the of the world cooperation."^ Commencing with the South Africa Reserve Bank in 1921, Central Banks have been established not only in the existing independent or self governing Countries which had not yet have a Central Bank, but also in many new independent states during the past fifty years as shown in the following chart. A Chart showing establishment of some important Central Banks in the World.

Year of Name of the Central Bank Establishment 1921 South African Reserve Bank 1922 Reserve Bank of Peru (Reconstituted as Central Reserve Bank of Peru in 1931) 1923 Bank of the Repubhc of Colombia 1924 of Hungary Bank of Poland Common wealth Bank of Australia and Bank of the Republic of Uruguay converted into Central Banks. 1925 National 1926 National Bank of Czechoslovakia Central (reconstituted as Bank of Gautemala in 1946) 1927 converted into a Central Bank. 1928 Central Bank of National Bank of Central Bank of Bohvia (in place of National Bank of Greece) National Bank of Iceland Converted into a Central Bank. 1929 National Bank of Yugoslavia (in place of former ) 1931 Central Bank of the Republic of Turkey 1932 converted into a Central Bank. 1934 Reserve Bank of New Zealand Central Reserve Bank of El Salvador 1935 Bank of Canada Reserve Bank of Central Bank of the Argentine Republic 1936 Bank of the Republic of Paraguay (reconstituted as Bank of Paraguay in 1944). 1937 National Bank of Costa Rica 1939 Bank of Afghanistan 1940 Central Bank of 1941 National Bank of Nicaragua converted into a Central Bank. 1942 State Bank of Ethiopia 1945 (in place of Bank of Poland) 1947 Central Bank of the Dominican Republic 1948 . Bank of the German States - Bank Deutscher Lander (in place of ReichsBank in West Germany). Central Bank of the Philippines. 1949 National Bank of Iraq 1950 Central Bank of Ceylon National Bank of Cuba Central Bank of Costa Rica (in place of National Bank of Costa) German Bank of Issue - Deutsche Noten Bank (in place of ReichsBank in East Germany) 1952 Central Bank of Belgian Congo (replaced by Monetary Council in 1960 and by National Bank of Congo in 1964) Union Bank of Burma converted into Central Bank. Central Bank of Paraguay (in place of Bank of Paraguay) Bank of Issue of Associated States of Indo-China (split into the National Banks of Cambodia, Laos and Vietnam in 1955) 1953 Bank of Indonesia (in place of Bank of Java) 1954 1955 National Bank of Libya (renamed Bank of Libya in 1963) 1956 (in place of National Bank of Iraq) Bank of Rhodesia and Nyasaland (split into Reserve Bank of Rhodesia, and in 1964) Central Bank of Nepal 1957 German Federal Bank - Deutche BundesBank (in place of Bank Deutscher Lander) Central Bank of Surinam 1958 Central Bank of Malaya (renamed Central Bank of in 1963) 1959 Bank of Morocco Reserve Bank of Australia (Commonwealth Bank split into Reserve Bank and Commonwealth Banking Corporation) Central Bank of West African States Central Bank of Equatorial Africa and Cameroon. 1960 Bank of Republic of Guinea Bank of Sudan National Bank of Somalia converted into a Central Bank. 1961 (in place of National Bank of Egypt) Central Bank of Nicaragua (in place of National Bank of Nicaragua) (in place of National Bank of Iran) (in place of National Bank of Iceland) 1962 Central (in place of Bank of Algeria) Bank of Republic of Mali Bank of the Netherlands Antilles 1963 . National Bank of Ethiopia (in place of State Bank of Ethiopia) 1964 Bank of Lebanon Central Bank of Trinidad and Tobago Bank of Burundi 1965 Bank of Guyana 1966 1967 (in place of Bank of Republic of Uruguay) 1968 Central Bank of Mali (in place of Bank of Republic of Mali) 1969 Central Bank of Republic of Equatorial Guinea. 1971 Central Bank of The Gambia. Source : M.H.De Koek, Central Banking, Fourth Edition, Universal Book Stall, New Delhi, 1997, P.10,11,12. A clearly defined concept which has been evolved about Central Bank is that it is generally recognized as the Bank which constitutes the apex of the monetary and Banking structure of its country and which performs, as best it can, in the national economic interest. Historically, all the Central Banks were originally started as privately managed joint stock Banks. But gradually they have become the government organizations and their main objective is to support the economic policy of the government. In several countries, one Bank gradually came to assume more and more the position of a Central Bank, mainly due to its enjoying the sole or the principal right of note issue and acting as the Government Banker and agent. They were not originally known as Banks of issue or as national Banks. The regulation of the note issue was subject to safeguards imposed by the state, and the maintenance of the convertibility of their notes into or silver or both were such as in force, were the principal fiinctions of these Banks. In due course, such Banks of issue acquired other functions, duties and powers until the term 'Central Bank' came to be generally used to have a more or less standardized meaning. In various countries, during the course of the 19* century the state endowed an existing Bank with the sale or principal right of note issue, or caused a new Bank of issue to be established with special powers and privileges, accompanied by varying degrees of state control and supervision. In the countries such a Portugal, Romania Bulgaria, Serbia, Turkey, Java, Egypt and Algeria, Banks with a monopoly of note issue were also brought into being during the nineteenth century. Thus, by the end of the nineteenth century almost every country in the world had established a Bank of issue with special rights and powers. All these Banks became the Bankers and financial agents of the governments of their countries, and in different ways or in varying degrees they also assumed the other functions developed by the Bank of England and which have come to be regarded as essential functions of 'Central Banks'.

1.2 - CENTRAL BANKING SYSTEM IN THE WORLD L2.1 Banking System In America (U.S.A.) L2.L1 - Structure of the Federal Reserve System In Most of the countries of the world there is one Central Bank, in an economy usually owned and operated by the government. American's Central Banking system is unique in a number of respects, with too much centralization. The Congress established a Central Banking system with a Board of Governors and 12 district Federal Reserve Banks in various parts of the country. The capital stock of each Federal Reserve Bank is owned by the "member" Banks in its district. Dividends on the stock are limited to a maximum of 6 per cent. The Federal Reserve Banks operate generally under the guidance of the Board of Governors of the Federal Reserve System in Washington. The Board appoints three of the nine directors of each Federal Reserve Bank; the other directors are elected by member Banks in the district. The Federal Reserve Banks are operated in the public interest, rather than to make profits. Since 1947 more than 90 per cent of their earnings, after expenses and dividends, have been turned over to the United States Treasury. Members of the Board of Governors are appointed by the President of the United States, subject to confirmation by the Senate. The members are appointed for 14 year, non-renewable terms, and so arranged that the term of one member expires every 2 years. Once appointed, members of the board cannot be removed by the President as like the members of the cabinet. Thus, the board enjoys a degree of independence within the U.S. government. The Federal Reserve System represents an ingenious compromise designed to avoid domination of the monetary system by either political authorities or private financial and to work within the dual Banking system. The Congress could have required all Banks to become members of the system. Membership is compulsory for national Banks; for state chartered Banks, however, membership is optional.

1.2.1.2 - Central Banking Functions of the Federal Reserve of USA The Federal Reserve Banks and the Board of Governors perform various central-Banking functions, viz. : (1) They supervise Banks. Supervisory functions include the issue and enforcement of regulations, disciplinary action to remove Bank officers and Directors for unsafe or unsound Banking practices, and approval to Bank holding companies to engage in new business ventures. Examinations of state member Banks are conducted by the Federal Reserve; examinations of national Banks are conducted by the Comptroller of the . (2) The Federal Reserve Banks clear and collect and provide other payment services to depositories, such as the electronic transfer of funds and securities. Cheques- and collection are now much more efficient than before 1913, and today funds can be transferred from one part of the country to another electronically with great speed. (3) The Federal Reserve Banks act as fiscal agents for the government, holding its deposits and performing other functions. (4) The Federal Reserve Banks are also responsible for issuing the nation's paper currency. Since 1913 Federal Reserve Banks have issued notes called Federal Reserve notes. These notes, together with coins issued by the treasury, make up the nation's circulating currency. Federal Reserve notes are direct obligations of the U.S. government. (5) The Federal Reserve Banks hold the reserve deposits of the nation's other Banks and thrift institutions. All depository institutions—about 40,000 in the mid-1980s—are required by law to maintain specified per centages of reserves assets (cash or deposits at the district reserve Bank) against their demand and other checkable deposits and time deposits held for business. These reserves must be kept on deposit with the district Federal Reserve Bank, excluding any amount the depository keeps in currency in its vaults. (6) The Federal Reserve. Banks can advance loans (called "advances") to depositories when they need additional cash reserves. Thus, if a Bank is faced with unexpected deposit withdrawals or unusually heavy loan demands, it can turn to the District Reserve Bank for help. One of the weaknesses of the Banking system before 1913 was the absence of any Central Reservoir of Funds which Banks could tap in emergencies. 1.2.1.3 - Banking Structure The 1950s USA saw the beginnings of yet another development in Banking, i.e. mergers. In 1920 there were 28,700 commercial Banks; in the USA. The number decreased to 14300 in 1940. The number of Banks moreover stabilized in the 1940s and stood at 14,000 in 1950. However, in the 1950s the number of Banks declined again, dropping to 13,500 by 1960. The chief factor accounting for the decline in the 1920s and 1930s was large-scale Bank failures. The reduction in the number of Banks in the 1950s, however, was mainly due to Bank mergers.^ Bank mergers were stimulated by a number of factors. Banks merged with other Banks to acquire branches in areas where they wanted to expand their business. Automation created pressure for merger because it involved installation of costly new equipment, which require a large volume of work for efficient operation. Another factor was the increasing size of farm and business loans, which were difficult for some smaller institutions to accommodate. Developing competent management succession was another problem in many small Banks and made merger attractive. The transition in U.S. agriculture sector also had a tremendous impact on Banking system. As farm population declined, many small towns ceased functioning as retail trading centers. This made it difficult for small Banks to survive, and they were forced to either go out of business or sell out to larger Banks. The wave of Bank mergers that engulfed Banking in the 1960s, prompted the Congress, in 1960, to enact the Bank Merger Act. The Act subjected Bank mergers to federal antitrust laws and, in essence, prohibited Banks that were significant competitors in the same market from merging. In 1966 Congress passed another Bank Merger Act, which required that Bank mergers had to be beneficial for the public in order to be approved. These two Acts stopped the wave of Bank mergers and shifted attention to the formation of Bank holding companies— corporations that own or control one or more Banks—as a structural means of becoming bigger, expanding business, and coping with the changing Banking environment. The Bank holding company movement continued through the 1970s and into the 1980s.

1.2.2 - Banking System in United Kingdom (UK) 1.2.2.1 - Bank of England The Bank of England is the Central Bank of the UK. Established in 1694 it was nationalized in 1946. It discharges the usual functions of a Central Bank: acting as Banker to the government and private Banks, regulating the Banking system and acting as the government's agent in carrying out . In England and Wales, but not elsewhere in the UK, it has a monopoly of the issue of and is responsible for the printing, circulation and withdrawal of notes. The Bank has developed money and capital markets of London which is one of the important money and capital market of the world.'' 1.2.3 - Banking System in Japan 1.2.3.1 - Introduction The financial system of Japan has undergone significant changes since the Second World War, and can now be broadly divided into three sectors like ; • The Central Bank, Japan; • the private financialinstitutions : These may be classified as - Ordinary Banks, which have been working as commercial Banks.

10 - the specialized foreign exchange Banks, estabhshed under the Foreign - Exchange Bank Law of 1954, have advantage for foreign trade. - The Long-term Banks & trust Banks, - Institutions specialized in small business financing; - Institutions specialized in financing agriculture, forestry and fishery;

5 • Government financial institutions, etc.

1.2.3.2 - Regulatory Framework A new Banking Law was enacted in 1981. The Banking Law of 1981 contains detailed provisions for the establishment and organization of Banks. It provides that Banking business be undertaken under license from the Ministry of Finance. The approval of the Ministry of Finance is required for changes in the amount of capital; the establishment of an office; amalgamation, dissolution, or liquidation; and the holding of concurrent posts by a Bank officer. Any Bank which intends to do foreign exchange business or to gain the status of an authorized foreign exchange Bank is required to obtain authorization from the ministry of finance under the Foreign Exchange and Foreign Trade Control Law of 1949. To establish a branch office in Japan, a foreign Bank is required to obtain a license from the minister of finance. A licensed office is qualified to operate under the regulations of the Banking Law.

1.2.4 - Banking System in France 1.2.4.1 - The Regulation and Supervision of Banking and Finance Over the last 10 years Banking and finance in France have undergone a thorough overhaul. This development has been marked, from a legal standpoint, by the introduction of a new Banking law in

11 1984 and in 1988 of a new stock exchange law, and, in Banking practice, by the disappearance of most of a range of long-standing specific constraints. Credit restrictions and exchange controls were abolished respectively in 1987 and 1989. Over the next few years French legislation governing such activity is destined to evolve further as the European single market gradually becomes a reality in the Banking, financial and monetary fields. Specifically, new legislation will need to be enacted to permit the free establishment of financial institutions with head offices in other member states and the free movement of services, As far as Banking practice in the broader sense is concerned, the Banking law of 24 January 1984 lays down the ground rules and confers a central role on the . With finance activities the same law delegates the essential regulatory and supervisory functions to autonomous bodies — the Commission des Operations de Bourse (COB — Stock Exchange Transactions Commission), the Conseil des Bourses de Valeurs (Stock Exchanges Council) and the Conseil des Marches a Terme (Futures Markets Council). It should also be remembered that, pursuant to an agreement of 14 April 1945, credit institutions established in the Principality of Monaco are fully subject to French Banking law, currently, that is, to the law of 24 January 1984 and its implementing provisions.^

1.2.4.2 - The Bank of France Established in 1800, the Bank of France is the country's Central Bank. Its purpose and structure are currently defined by the law of

12 3 January 1973. The Bank is managed by a governor who is assisted by two deputy-governors. The Bank's responsibilities cover six areas: • like other Central Banks, it alone is entitled to issue legal tender; • it prepares and implements monetary policy; • it regulates the relationships between the franc and foreign and administers the national exchange reserves; • it is responsible for ensuring the proper functioning of the Banking system; • it keeps the treasury accounts and manages treasury bills and the obligations assimilables du tresor (OATs — treasury-bond equivalent instruments); • it also monitors the state of the economy and the health of business enterprises, assists in the compilation of financial statistics ( and the financial section of national accounts), and provides services of general interest to business(central balance-sheet office) and to the Banking system (clearing of cheques and keeping of records on risks, payment difficulties and dishonored cheques, etc.). The Bank of France performs these tasks through its central services — which are organized into nine directorates general — and its territory- wide network of 210 branches.

1.2.5 - Central Bank of every country acts as a Banker to the government, it has monopoly of note-issue and controls its entire Banking system. Such a Bank is known as "Central Bank" of the

13 country. The Central Bank in India is Reserve Bank of India. It is also called the Monetary Authority of the country.^ The Reserve Bank of India was originally a shareholders' Bank and established by an Act of Parliament (viz., the Reserve Bank of India Act, 1934) with a share capital of Rs.5 crore divided into 5 lakh fully- paid shares of Rs.lOO each. It commenced operations from 1st April, 1935. However, in order to have a close integration between the monetary and credit policies of the Bank and the of the Government, the Reserve Bank was nationalised under the Reserve Bank (Transfer to Public Ownership) Act, 1948 and its entire share capital was acquired by the Central Government. From 1st January, 1949 the Reserve Bank of India started functioning as a State-owned and State-controlled Central Bank of the country. Its affairs are regulated by a Central Board of Directors consisting of twenty members viz., a Governor, not more than four Deputy Governors, fourteen directors and a government / official. It is necessary for the Central Board to have at least six meetings in a year and not less than one in a quarter. For each one of the four regional areas of the country (viz., western area, eastern area, northern area and southern area) there is a local hoard having headquarters at Mumbai, Calcutta, Delhi and Chennai respectively. A Local Board consists of five members appointed by the Central Government. The functions of the local boards are to advise the Central Board on such matters as may generally or specifically be referred to them and to perform such duties as the Central Board may, by regulations, delegate to them. The Central Office of the Bank is located in Mumbai.

14 1.2.6 - Banking System in China 1.2.6.1 - Introduction Since 1949 China has been ruled by its Communist Party as a People's Republic. Although economic policy has fluctuated considerably during the last four decades, the Banking system remained until very recently somewhat static, monolithic and bureaucratic, rather resistant to the multifarious demands of commerce. Since the economic reforms starting in 1978, however, there has been great change in the Banking system, culminating in interim regulations or Bank management promulgated by the State Council on 7 January 1986. In Chapter 2 of these regulations, headed The Central Bank, the People's Bank of China, which is the final authority in Banking activities, is described as a state organ under the leadership of the State Council, which manages the financial affairs throughout the country'. A number of specialized Banks operate under the People's Bank of China, and another feature of recent years has been some increase in the representation and business participation by foreign Banks, notably from Japan, Europe and the US. One can therefore say that in the past decade China's Banking system has become not only more sophisticated, but also more internationalized. Another interesting feature of Chinese Banking is that a very small residual element of private ownership has been retained in some of the Banks throughout Communist rule, and a share of profits has been paid to these few private shareholders for most of that time. This suggests the possibility that such old private entrepreneurs and their heirs may play a bigger role in the mixed economy, which is now the goal of the Chinese authorities. While it is best to work on the

15 assumption that the Banks are, for all practical purposes, state organizations, there may remain in the future some opportunities for the private sector to re-emerge.^

1.2.6.2 - Banking Policy, Control And Supervision When China's economy was state-run on Soviet lines during the period 1949-1978, Banking appeared to operate with little regulation. Only when Deng Xiaoping consolidated his authority in 1978 and introduced an opening-up in trade and technology to the West, did the Chinese authorities begin to produce suitable legislation affecting such matters as patents, copyright, foreign exchange, arbitration and taxation affecting foreign enterprises in China. The People's Bank of China is both an economic department of government and a state organ in its own right. It exercises responsibility over the working of the specialized Banks, namely the Bank of China (dealing with foreign exchange), the Agricultural Bank of China, the Industrial and Commercial Bank of China, the People's Construction Bank of China and the (each of which deals with significant specialized sectors of domestic credit). It also supervises the new provincial Banks, which are beginning to form, including two in Guangdong and Fujian provinces, and other newly formed joint-venture Banks. The People's Bank comes directly under the State Council, which runs the government of China almost as a cabinet, organized in various ministries including the ministry of finance. The People's Bank and the finance ministry appear to be of equal standing, sharing with apparent equity two halves of the same building in Beijing. In 1989 Mr. Li Quixian was President of the People's Bank.

16 The People's Bank prints the country's Banknote, mints its coins, and issues them in general currency. It formulates credit planning, and until 1984 ran urban commercial Banking functions which are now the responsibility of the industrial and Commercial Bank of China. The People's Bank of China controls monetary policy through quantitative restrictions on the credit activity of the specialized Banks, setting re-deposit requirements for them, varying the volume and terms of its lending to them, and controlling the structure.

1.3 - HISTORICAL DEVELOPMENT OF BANKING SYSTEM IN IRAN 1.3,1- Banking Development in Iran Before Establishment of Central Bank of Iran.

1.3.1.1 - New Oriental Bank. The first Bank, which initiated its work in Iran, was called New Oriental Bank. The head office or center of this Bank was in London without obtaining any concessions and advantages from Iran government and it was established and endeavored Banking activities in the year 1888. This Bank set up many branches in Tabriz, Mashhad, , Shiraz, Rasht and Booshehr. New Oriental Bank paid interest on different kinds of deposits in order to absorb people's funds and paid 2.5 per cent interest and profit to sight deposits and 4.5 per cent interest to six- months deposits and 6.per cent to yearly deposits. The Bank didn't publish Bank bill but it gave and circulated Five-rial drafts or bills. New Oriental Bank had Banking endeavor in Iran for two years. This Bank reached an agreement with on 31 March 1890. According to this

17 agreement, New Oriental Bank gave all its installations and services to Imperial Bank of Persia for the sum of (20,000) .^

1.3.1.2 - Imperial Bank of Persia. According to an agreement which was held between "Nasereddin Shah" and Baron Jolius Roller, the king of Iran had granted numerous concessions and preferences to the English. One of these concessions was the right of Bank establishment, but this agreement or contract wasn't executed and also the Bank wasn't set up and again according to an agreement on 30 January in the year 1889 Roeeter and his son succeeded to obtain the concession of Bank establishment and exploitation of mines as a kind of Compensation and indemnity. Roeeter only established the Bank and he didn't take any action in the field of exploitation of mines. The duration of this concession was sixty years and Bank had the publication right of Bank-bill amounted to 80,000 pound sterling and Bank was charged to have Banking equal to lOOper cent of published Bank-bill, precious metals and foreign exchange as Banking. Bank bill was interchangeable to its backing. First, they agreed that the capital and invest of Bank be 4,000,000 pound sterling. But according to the amendatory law in Sept. in the year 1889, Bank's capital was reduced to 1,000,000 pound sterling and Bank central office was also transferred from to London. Imperial Bank of Persia started its functions and endeavors in Iran, Tehran at the end of Sep.1889.As we have seen, according to mutual agreement this Bank bought all installations of New Oriental Bank for 20,000 pound sterling. This Bank paid 8per cent profit and interest to shareholders at the end of first year of his endeavor. In

18 consequence with the law of Imperial Bank of Persia, government Bankers were Bank-bill publication Bank and a commercial Bank. At the time of Bank establishment, currency money in Iran was silver Rial. Iran like India had basic monetary system of silver metal. But the silver price decline in world-wide market in the second half of the nineteenth century had caused many difficulties for traders, according to the agreement with Imperial Bank of Persia requested Bank to help Iran government in the field of changing the monetary basis from silver to gold but the Bank didn't take any action. Anyhow the trade of silver bar was profitable for Imperial Bank of Persia. The Bank bought the bars from London market and paid pound sterling to sellers. These silver bars were transported to Tehran. Imperial Bank of Persia that exclusively had copyright and Bank bill publication right published Bank bills such as 1- 2-3-5-10-20-50-1 GO-500 and 1000 Rials. On the Bank bills a sentence was printed i.e. "only in ... will become". Bank-bill owners could ask silver by presenting it to the Bank and the aim of this phrase was that these Bank-bills could be used in regional transactions. Consequently Banking or silver Rial was used to transfer fund from one region to another because their transportadon had many difficulties. Imperial Bank of Persia also was active in the field of international Banking. Foreign exchange price and rate was determined according to silver price in Europe market daily. Imperial Bank of Persia was issuing Bank bill for his British shareholders in order to make maximum profit. As we will see. Bank donated Bank-bill publication concession to Iran government in the year 1930, in return the Bank received some advantages and concessions such as taking 200,000 pound sterling. The

19 Bank continued the aforesaid operations till the end of sixty-year-olds concession period.

1.3.1.3 - The loan Bank of Russia In the year 1890, "Nasereddin Shah" gave the concession of loan and mortgage institution establishment to "Poliakof for a period of 75 years. In the year 1891, the aforesaid institution was known as mortgage Bank, at the time of opening in Tehran. The investment of Bank was 30 million Russian rouble. In the year 1899, the shares and stocks of this Bank reposed in taking possession of Russian Tezar government and attached to Peterz boorg governmental Bank. From this time. Bank becomes a factor which executed political goals of Tezari Russian government in Iran.'° In the year 1902, Loan Bank was named Iran Mortgage Bank. According to the treaty in the year 1921 among Iran and soviet unions, this Bank was donated to Iran government in the year 1922 that endeavored under the title of Iran Bank until the year 1933 and this Bank was disbanded in that year. Iran Loan Bank from the beginning of his activity gave enormous amounts of loans to Iran government many times and the annual interest were 5 per cent to 12 per cent. Iran Loan Bank vigorously intervened in international trade affairs. In this case, the major goal of this Bank was to set Iran market under the control of Russian products and goods. Also the Bank succeeded in this case because the Bank opened unlimited credit for Iranian traders who ordered Russian products. One of the other important activities of Iran Loan Bank was mortgage and credit operations, in the manner that Bank gave a loan in

20 lieu of obtaining immovable properties as mortgage and because of most debtors couldn't pay their debts, this Bank took an action about obliged occupation. Finally, the Bank took an action to provide / secure financial aid for some projects. So, Iran Loan Bank undertook a concession to construct some highways and roads.

1.3.1.4 - Turkey Bank Basically, Turkey Bank was an English Bank that was established by joint capital of England and France in the nineteenth century in a country that nowadays is called Turkey and its branches were gradually spread over in neighboring countries. In the beginning of Bank establishment, i.e. in the year 1856, the initial Bank capital was 500 pound sterling that was paid by English investors but in the year 1863 this amount increased to 4100 pound sterling with contribution and assistance of French capitals and this Bank firstly obtained exclusive publication of Bank-bill and they gradually gained other concessions such as government treasury in ottoman or Turkey Empire. Turkey or Ottoman Bank established many branches in Iran in the year 1922.

1.3.1.5 - Russia and Iran Bank In the year 1926, Russia and Iran Bank was established in Iran on behalf of Soviet government in order to facilitate trade exchanges between two countries. Head and central office of this Bank was in Tehran and it set up many branches in northern townships in the country. From the beginning, the endeavors of Iran and Russia Bank were limited / confined to execute financial affairs of trade institutions related to Soviet Union Government in Iran and trade exchanges

21 between two countries. Before Islamic revolution victory, Russia and Iran Bank was the only foreigner Bank in Iran.

1.3.1.6 - Private Bank establishment after second world war. Generally, delay and lateness in establishing modem internal - Banks can be found in the point that the capability of personal and private Banks was taken into consideration and according to this case, no person could signalize and resist against them. Besides, unfavorable experiences about institutions' defeat was a preventive factor in taking an action to establish the Bank. So, in the month tir of the year 1946 some regulations and provisions were enacted about supervising on Banking activities and at first many reforms were accomplished concerning legal treasure rate in it, and in the year 1948, legal restrictions and limitations were enacted for foreign Banks because of public opinion at the war time and Iran occupancy and also because of expansion first program.''

1.3.2 - The establishment of The Central Bank of Iran The Central Bank of Iran was established in 1961 with the approval of Monetary and Banking legislation. According to this law the initial capital of Central Bank was Rials 3.6 billion. It rose to Rials 125 billion in 1984. Central Bank of Iran acts as Banker to the government and all Banks, regulates the Banking System and acts as the government's agent in carrying out monetary policy, and supervises and controls the Banking system of the country. Also with the approval the law for

22 -free Banking in 1983, (after the Iranian Islamic Revolution), new responsibilities were entrusted to this Bank. At present the Central Bank's fundamentals are as follows : - General Assembly. - Executive Board. - Money and Credit Council. - Note - Reserve Control Board. - Supervisory Board.

1.3.3 - Banking development in Iran Since 1979 and thereafter (After Iran's Revolution)

1.3.3.1 - Nationalization of Banks in Iran After Islamic revolution victory in 1979, the necessity of fundamental revision in the country Banking system was felt / perceived to be more necessary than the other time. Unlimited and excessive spreading of banking network, that had been established according to profit - making goals of internal and external capitalists, could not be coordinated with revolution's aims and new economic condition in the country. In this condition, revolution assembly that was a legislator institution in the country, took a revolutionary action and ratified a bill in June in the year 1979 and notified that Banking system in the country was nationalized.^^

According to this bill, twenty-eight Banks, sixteen savings and house loan companies and two investment companies were manifested to be nationalized and their possession was deprived of private sector

23 and was given to government. The reasons of Banks' nationalization, as existed in legal bill context were as follows: 1. The manner to earn Banks' incomes and illegal transfer of investments abroad. 2. Fundamental role of Banks in the economy and natural relationship of economy with Banking institutions. 3. Banks were indebted to government and they required government supervision. 4. The necessity for coordinating Banks' actions to other organizations in the country. 5. The Necessity for leading Banks activities in the direction of Islamic administrative and profit - making pattern.

1.3.3.2 - Fundamentals of Banking System After "Banks were nationalized and all authorities were negated from their previous owners and managers, the necessity of revising or reconsidering the elements / Fundamentals of Banking system was severely perceived. So lawflil bill for administration of Bank operations were approved by revolutionary council in the year 1979 according to which, "Bank's fundamentals are as follows : - General Assembly of Bank. - High Council of Banks. - Board of Directors of each Bank. - Managing Director of each Bank. - Legal Inspectors of each Bank.

24 1.3.3.3 - Combination of Banks Article 17 of lawful bill for administration of Bank operations had anticipated that general assembly of Banks can take action to classify and combine the Banks if necessary. Before Islamic revolution, country Banking system had widely developed their operations and network along with economic unreal prosperity. In any case, this development wasn't proportionate to actual economic needs and wasn't efficient for development and growth of the country. The assignment of personal and private Banks ownership to government, that was accomplished according to Banks' nationalization law, alone was insufficient to mobilize Banking system and to coordinate with national economic goals and so the combination of Banks appeared a necessary case. We can summarize the reasons of Bank combination as follows : 1. Increasing personnel and official expenses. 2. Waste of financial and human resources. 3. Irrational and unreasonable increase of profit - making and advantageous rate for many Banks. 4. The shortage of financial sources for a number of Banks forcing them to take foreign loans with too much expense. 5. The appearance of difficulties on the field of enforcing monetary and credit policies improperly because of improper co-ordination between different units. With regard to aforesaid reasons and according to the decision which was made at IW the tenth month of Iranian Calendar in the year 1979, General assembly of Banks reorganized the Banking network of the

25 country that consisted of 36 Banks. Some of them are as follows :

A. Commercial Banks : 1. National Bank of Iran 2. Army Bank 3. Labors Welfare Bank. 4. Export Bank of Iran. 5. Commerce Bank 6. Nation Bank B. Specialized Banks : 1. Mine and Industry Bank. 2. Agricultural Bank. 3. Home Bank.

1.3.3.4 - Usury-Free Banking Operations in the Islamic Banking of Iran 1.3.3.4.1 - Basic Approvals to Islamic Banking of Iran. The Iranian Islamic Banking System has a very important role to play in the economic life of Muslims. So, a distinction should be made between a Bank's function of gathering capital, as in case of capitalist Banking, and its commercial Banking services. In this context, a Bank's services can be made to conform to Islamic Laws or the principles mentioned below : 1. Banks should provide more than commercial Banking services, receiving charges at rates oriented to cost of services. In the name of charging commission, a Banking service should not become a cover for any capitalistic exploitation.

26 2. The services of Banks, for which they are paid, should not cause any damage to the society, whose overall interest they are expected to serve.

3. The Banking methodology should not in any way contradict the Islamic ideology. On the contrary it should conform precisely to Islamic Laws. For overcoming the shortcoming of capitalism, re-defmition of "capital" and the relevant economic school of thought is necessary. Islamic Banks should be able to eliminate scope for exploitation of man by man, in terms of the profit motive, as in capitalist economic theory. They should not draw inspiration from any capitalist practice, for capitalist methods are rooted deeply in individualistic self-centeredness. Instead of resorting to capitalist methods of increasing capital with interest, Islamic Banks should have a moral orientation based on Islamic principles and standards. Subject to the Islamic criteria. Islamic Banks should evolve ways and means of achieving economic growth without the capitalist Banking system. Activities of Islamic Banks, when based on Islamic principles, will bring about the changes summarized below :

4. Deposits in the Iranian Islamic Banking System will be under written by an Islamic Government's Central Bank, and no person or group will be discriminated against or exploited. These safeguards allow separation of any capitalistic accumulation or use of capital in the process of ensuring socio-economic growth. The task of capital formation is best undertaken by the society as

27 a whole, and an Islamic Government should involve itself in it on behalf of the depositors. Now wealth and power resulting from this activity would not belong to any person or group. Thus, any situation where some people grab the Banks' resources and power, so as to hold the financial and economic life of the people at large in their hands, is prevented.

The Islamic Government of Iran is always expected to be following the Law, including the socio-economic principles, criteria and standards evolved on the basis of the legal and moral requirements of . So, in promoting an Islamic Economy, implementation of the relevant Sharia laws is crucial.

5. No interest, such as prohibited in Islam, should be charged by Islamic Banks. After all, interest on loans or deposits, is really an unearned wage given to users for the "trouble" of lending money. Capitalist economic theory recognizes this "wage" (or profit). However, in Islam, wages are lawful only when they represent payment for services involving performance of work for the benefit of others, as specifiable on a contract basis. Moreover, capital does not necessarily imply accumulated savings obtained from measurable work. Also, repaid loans do not mean any net addition to capital or to a society's resources. These and similar other reasons are attributable to the prohibition of usury in Islam.'^

28 1.3.3.4.2 - Modality of Usury-free Banking in the Islamic Banking System of Iran

The Iranian Islamic Banking System has been started in 1984, with approval of the law for usury-free Banking in 1983. To start with, an Islamic Bank of Iran announces its readiness to accept any amount of money or valuables. The basis of acceptance could be safe deposit only. Alternatively, the deposits could be treated as loans to the Islamic Bank. In either case, no payment of interest is involved. In both cases, the deposits are returnable on demand. To offset any reduction in purchasing power of money due to or rise in cost of living, the value of deposits can be adjusted on basis of gold. Accordingly, Islamic Banks not only undertake safe deposits, but underwrite real value of the same. Any upward adjustment of the value at the time of returning a deposit will not mean interest of usury. On the other hand, a depositor can request the Bank to use the money in an economic plan with social benefit. Any resultant gain will be shared between the depositor and the Bank on a mutually agreed basis. This bilateral arrangement is called Waaguzari. If, however, the Bank assigns the planned utilisation to another of its customers, the trilaterial arrangement is called Mozarebeh. In the latter case, any profit is shared by the three parties on a mutually agreed basis. Also the Bank can ask for "wages" for its efforts in arranging the deal. The amount of wages should be commensurate with the work carried out. In the case of Mozarbeh, there will be no guarantee for the depositor's money, and he will have to bear any unintentional loss. This is because of his role as an investor only, who is not supposed to perform any work.

29 The deposits with the Islamic Banking of Iran, which are invested in bilateral or trilateral socioeconomic plans, are exempt from wealth tax. What is more, any charitable use of one's deposit would mean spiritual reward on the Day of Judgment. This does not, however, entail any payment of "wages" by a Bank to depositors for the latter's charitable acts, for both the Bank and the depositors act in good faith and with mutual goodwill and understanding reflected in their well- intended services. The Iranian Islamic Banking provides physical and economic security for deposits entrusted to it for safe-keeping. Their economic security is ensured by provision of effective safeguards against inflation, based on gold. This is necessary to ensure real value of assets at the time of their return. After collecting deposits on the basis of the provisions mentioned above, an Islamic Bank will be responsible for making appropriate use of the same, in order to keep the money or wealth in circulation. Also the Islamic Banks of Iran can make appropriate use of the deposits, while remaining liable to return any deposit in part or in toto, on demand. Based on the deposits, an Islamic Bank can extend the loans to deserving people, including for private use, after obtaining guarantee of refund. It can extend the loans to finance productive enterprises conducive to legitimate earnings, also with a view to sharing the net profits. The financing plan can also help establish honest, capable and reliable persons in capital-intensive business activities. Where depositors authorize investment by the Islamic Banks of Iran the latter's role can be either that of an agent or an active participant. As an agent, it can bring about partnership between a third

30 party and the depositor(s) in a business venture, so that any profit from the same will not be shared with the Bank, which can claim only "wages" for its services as intermediary. If the Bank itself uses the money in a productive and profitable way, then the resultant profits can be shared between it and the owner of capital. If Islamic Banks carry out their functions correctly and competently, capital formation and circulation are both taken care of As a result, socio-economically productive and beneficial activities will flourish. Accordingly, the Banks should not be motivated by their own (profit making) interest when inviting suitable and competent organization to participate in joint ventures aimed at fulfilling genuine socio-economic needs. This is necessary to avoid any undue stagnation or concentration of wealth. No doubt, Islamic Banks have a crucial role to play in terms of leading, guiding and monitoring socioeconomic activities.

31 References :

1. M.H. D. Kock, Central Bank, Fourth Edition, Universal Book Stall, New Delhi, 1997, p.3 2. Dr. P.A. Kumugam, Banking systems of the world. Skylark Publications, New Delhi, 1999, p.6. 3. Ibid, p.8 4. Anne Hendrie, Banking in the EC, structures and source of finance", Financial Times Business Information, London, SWIHODB, 1991, p.334. 5. Anne Hendrie, Banking in the Far East, structures and source of Finance, Financial Times Business information, London, SWIHODB, 1990, p. 105. 6. Anne Hendrie, Banking in the EC", Opcit, p.58 7. Manubhai Shah 77?^ new role of Reserve Bank in India's Economic Development, Vora & Co. Publisher Pvt. Ltd., Bombay, First Edition 1970, p.86. 8. Anne Hendrie, Banking in the Far East, Opcit, p.33. 9. Ali Majedi, Hasan Golriz, Money and Banking, Monetary and Banking Research Academy (M.B.R.A.), Iran, 1990 p.60. 10. Ibid p.65. 11. Ibid p.70. 12. Ibidp.85. 13. P. A. Kumugam, Banking Systems of the World, Opcit, p. 92.

32