Banking in India – Bank PO Study Material

Banking practice was prevalent in ancient India too, it was not as organised and consolidated as it is today. The practice of giving out loans was widely prevalent in the Vedic period. The concept of usury even finds mention in the Vedas, apart from the Sutras and the Jatakas. While some texts condemn usury, others like Manusmriti consider it an acceptable practice. Loan deeds find mention in the Jatakas, Dharmashastras as well as Kautilya’s Arthashastra.

It was common for people to deposit their money in temples, during ancient times in India. The temples acted as a safeguard of sorts, by protecting the wealth of the people from invaders, warriors etc.

Coinage was prevalent in ancient India. Coins were minted in either gold or silver or copper or bronze and often carried the stamp of the monarch or king. A money economy has existed in India since the time of Buddha.

The Mauryan period marked the existence of instrument named ‘adesha’ which is very similar in usage to a bill of exchange. The Buddhist period witnessed large-scale usage of adesha. Trade during this period was also flourishing, so it was common for merchants in large towns to give letters of credit to each other. Trade guilds also performed many banking functions enabling economic activities.

Banking in Colonial India

Formally, banking in India originated in last decades of the 18^th century. The first banks in existence in India are the General Bank of India, which started in 1786, and the Bank of Hindustan, which started in 1790. Both of these banks are defunct now. The oldest existing bank in India is the SBI (State Bank of India) which originated as the Bank of Calcutta in 1806, and then became the Bank of Bengal, and was then became one of all the Presidency Banks which were transformed into the Imperial Bank of India.

The Presidency Banks formed the bedrock of the banking system in the earlier colonial times, and acted like quasi-central banks. There were three Presidency banks, namely, the Bank of Bombay, the Bank of Madras, and the Bank of Bengal. All the three Presidency banks were established under Charters of the British East India Company. These three Presidency banks were merged to form the Imperial Bank of India in 1921.

Foreign banks such as the Comptoire d’Escompte de Paris and HSBC were also active in colonial India from the 1860s.

The earliest mention in the colonial era of Indians forming a bank was the Union Bank in Calcutta, which was formed by Indian merchants in 1839. The Allahabad Bank, which is still active today, was established in 1865 and is the oldest Joint Stock bank in India.

The Swadeshi movement propelled many Indians to found banks. Some of the banks established during this time are the Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. Many banks were found in South Karnataka, especially in the Udipi district. This area, known as South Canara or Dakshina Kannada was home to four nationalised banks and a private sector bank, and is thus, known as the cradle of Indian Banking.

The First and the Second World War saw the banks fall upon hard times. The world wars affected economic activities, which in turn, adversely affected banking activities, with at least 94 banks failing between the years of 1913 and 1918 in India.

Banking in India during the post-independence era (1950s)

The achievement of independence changed the face of banking in India and affected it in multiple ways. The reasons for this change are as follows:-

• The government adopted a mixed economy, which involved the state playing a greater role in regulating and monitoring the activities of banks. Thus, there was no template on which the new Indian government could work on, and the government had to determine from scratch the role it wanted to play in the banking industry. It also had to determine what functions the banks in India would prioritise. Basically, the policy towards banks had to be etched out from the beginning and this meant drastic change.
• Banking activities came to a standstill, especially in Punjab and West Bengal, due to the carnage and riots caused by the partition
• Independence also marked the end of laissez-faire economics in the banking industry

A slew of legislations were enacted by the Indian government to govern the banking industry post-independence:-

• The Reserve Bank of India (Transfer to Public Ownership) Act, 1948 was passed to effect the nationalisation of the RBI which was initially established in 1935 under British rule
• The Banking Regulation Act of 1949 was enacted. It established RBI’s control over banks by requiring them to take RBI’s permission to open a new branch and a license from RBI if a new bank was going to be opened. The Act also gave RBI power to inspect banks, apart from exercising regulatory control over them

Banking in India during the 1960s

Nationalisation of Banks

In 1969, a watershed moment for the banking sector in India was marked by the nationalisation of 14 banks. Prime Minister Indira Gandhi first carried out the nationalisation through the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance of 1969. This Ordinance was made into law in two weeks when the Banking Companies (Acquisition and Transfer of Undertakings) Bill was passed in the Parliament, and it received presidential assent within a month of the Ordinance being passed. All commercial banks which had deposits of over Rs. 50 crores, which amounted to 14, were nationalised. This marked the first major nationalisation. Earlier, in 1955, only one bank, i.e. the Imperial Bank, was nationalised, and renamed the State Bank of India. However, the 1969 round of nationalisation wasn’t the only major nationalisation of banks. In 1980, six more commercial banks were nationalised by the bank.

In 1969, there was popular support among the people and the Congress Party for the nationalisation of banks. There was a belief that private banks weren’t working with efficiency and speed towards making credit easily available, especially in the rural areas. To make banking inclusive, it was considered necessary for the state to take over the businesses of these banks. Officially, the reasons given for nationalisation were to control the heights of the economy, promote the welfare of the people, and to meet and serve better the needs of the development of the economy.

Banking Laws (Amendment) Act, 1983

The Banking Laws (Amendment) Act of 1983 brought a change in the restrictive policy adopted towards banks till then, and was a precursor to the coming era of liberalisation. The legislation widened the list of approved activities that a bank could undertake. In the regulatory front, it strengthened the powers accorded to RBI and in an attempt to contain fraudulent activities, prohibited unincorporated bodies from accepting deposits from the public.

Pre-liberalisation Era

This roughly marks the years between the mid-1980s and 1991, when the government embraced the troika of LPG (Liberalisation-Privatization-Globalisation). This period was indicative of the time to come. In the mid 1980s, mandatory requirements attached to a bank’s deposits such as CRR, SLR etc stood at over 45%. This already high level of statutory pre-emption of banks’ resources rose to over 53% in 1989. This put the banks in an untenable position, and severely encumbered their growth and reach.

However, this period also marked some developments in the area of banking. Steps were taken to introduce new measures in banking such as:-

• Banking, Public Financial Institution and Negotiable Instruments Laws (Amendment) Act, 1988 was enacted to encourage the use of cheques in India
• Use of Magnetic Ink Character Recognition (MICR) technology as mandated by the Committee on Mechanisation in the Banking Industry in 1984 and other measures mechanising cheque clearing operations were introduced to bring ease to clearing of cheques
• Certificates of Deposit and Commercial Paper were introduced for the first time in India
• The government dismantled the maximum lending rate regulations it had imposed

Liberalisation Era

The 1990s heralded a period of great change in all economic arenas, including banking. The 1991 economic crisis forced India to accept an IMF bailout along with the accompanying conditions to liberalise the economy. Also, in 1991, the Narsimahmam Committee Report suggested multiple reforms to the Banking sector. The Asian Currency crisis also led the government to introduce certain reformative measures.

The newly adopted policy of liberalisation led the RBI to provide licenses to conduct banking operations to some private banks such as ICICI Bank, HDFC Bank etc. The growth of industries and expansion of economic operations also revitalised banking operations, which had to keep up with the demand for various banking operations by the flourishing and even nascent enterprises.

Bankers also responded to the renewed demand from the industrial sector and regular customers. New technology and customer-friendly measures were adopted by bankers to attract and retain customers. The Banking Ombudsman was established, so that consumers could have a forum to address their grievances against banks and the services they provided.

Another outcome of liberalisation was the dismantling of prohibitions against foreign direct investment. Some other outcomes of LPG that impacted the banking sector were:-

• Steps were taken to move to a market determined exchange rate system, and a unified exchange rate was achieved in the 1990s itself
• The government also released a slew of norms pertaining to asset classification, income recognitions, capital adequacy etc which the banks had to comply with
• Current account convertibility was allowed for the Rupee in accordance with IMF conditions
• Nationalised banks were allowed to raise funds from the capital markets to strengthen their capital base
• The lending rates for commercial banks was deregulated, thereby freeing them to lend more or as they saw fit
• Also, banks were allowed to fix their own interest rates on domestic term deposits that matures within two years
• Customers were encouraged to move away from physical cash, as RBI issued guidelines to the banks pertaining to the issuance of debit cards and smart cards
• The process of introducing computerisation in all branches of banks began in 1993 in line with the Committee on Computerisation in Banks’ recommendations, which had been submitted in 1989
• FII (Foreign Institutional Investors) were allowed to invest in dated Government Securities
• The Foreign Exchange Management Act (FEMA) was enacted in 1999 and effectively repudiated the Foreign Exchange Regulation Act (FERA) of 1973. FEMA enabled the development and maintenance of the Indian foreign exchange markets and facilitated external trade and payments
• The NSE (National Stock Exchange) began its operations in 1994
• RBI began the practise of auctioning Treasury Bills spanning 14 days and 28 days
• Capital index bonds were introduced in India for the first time

Post liberalisation

The early 2000s saw India continue on the path of LPG (Liberalization, Privatization and Globalization).

Establishment of new authorities/entities:-

• The Clearing Corporation of India was established in 2001, and became functions by early 2002. The purpose of the Clearing Corporation was to provide a forum for integrated clearing and settlement across different markets including foreign exchange.
• The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was enacted in 2002. It helped the cause of fast recovery of money by banks and other financial institutions.

Banks were given greater leeway in certain areas such as:-

• Certain exemptions from CRR were granted such as inter-bank term liabilities that matured after 15 days or more
• Banks were allowed to offer special Fixed Deposit Schemes (FD) for senior citizens with higher rates of interest
• Banks were allowed to open Offshore Banking Units in Special Economic Zones (SEZ). Offshore Banking units acted like foreign branches of Indian banks, but were in reality located on Indian soil

Other major steps taken include:-

• RBI issued guidelines for internet banking
• RBI adopted risk-based supervision of banks
• Inclusive banking received an impetus by the introduction of Kissan Credit cards
• Certain stock exchanges were allowed to undertake retail trading in Government securities

Post- 2008 recession

The sub-prime crisis in USA had a domino effect and affected economic activities worldwide. Though Asia managed to retain a degree of stability, Europe was hit the hardest after USA, with many countries on the brink of bankruptcy due to the recession that ensued. The Indian banks emerged relatively unscathed due to RBI’s regulatory oversight and its setting of already high mandatory pre-emption limits on a bank’s funds through CRR, SLR etc. While the early and mid-2000s saw RBI give greater freedom to banks, the post-2008 era saw central governors worldwide increase their regulatory oversight and strengthen norms such as capital adequacy ratios etc.

From the late 2000s and 2011 onwards, the Indian economy faced inflationary pressure. This led to the RBI intervening on multiple occasions with measures to reduce inflation. The resulting high lending rates resulted in negative effects on businesses which chose to put off expansion because of the high costs of borrowing. The RBI has become more proactive and strengthened net banking, usage of credit cards, and in general took efforts to steer the consumer towards paperless transactions.

Post-2011, the health of multiple banks, especially public banks, has suffered to a large extent. This has been due to their rising NPAs and erosion of their capital base. The government plans to reduce its stake in public sector banks to 52%, in an effort to help banks shore-up capital, amongst other reasons. Other than betterment of the health of ailing public sector banks, the focus of the government has been to further financial inclusion through schemes such as Pradhan Mantri Jan Dhan Yojana etc.

The post-2000 era has seen the flourishing of microfinance institutions (MFIs), Non-Banking Financial Companies (NBFCs) etc; and the authorities have struggled to find ways to regulate the activities of such organisations.

In 2013, in a major development, RBI issued guidelines in accordance with which it could provide banking licenses to some private players. India Post and multiple corporate houses applied for banking licenses. As of now, RBI has granted licenses to IDFC Ltd. and the MFI, Bandhan Financial Services Pvt. Ltd.

Structure of Banking in India

The Indian Banking sector can largely be divided into scheduled banks and unscheduled or non-scheduled banks. The scheduled banks are those that find mention in the Second Schedule of the Reserve Bank of India Act, 1934, while the rest fall into the non-scheduled category. To be included under the second schedule, banks have to fulfil certain requirements such as have a paid-up capital, minimum reserves of 0.5 million and satisfying the RBI that its affairs are not being conducted in a manner prejudicial to the interests of its depositors. Non-scheduled banks exist in the form of Local Area Banks (LAB) in India. LABs are set up under a Central government scheme announced in 1996 that provides for the establishment of new private banks of a local nature. LABs have jurisdiction over a maximum of three contiguous districts, and their basic function is to mobilise funds in rural and semi-urban areas.

Scheduled banks are further divided into Commercial Banks and Cooperatives. The major difference between Commercial Banks and Cooperatives is their holding pattern, since cooperatives are registered under the Cooperative Societies Act as cooperative credit institutions.

• Cooperatives are further divided into Urban cooperatives and State/Rural cooperative banks. Cooperatives in most states function at the primary, district and state level.
• Scheduled Commercial banks (as well as non-scheduled commercial banks) are regulated under Banking Regulation Act, 1949. Scheduled Commercial banks are divided into Public sector banks, Foreign banks, Regional Rural Banks, and private sector banks.
• Public sector banks refer to the group of SBI (State Bank of India) and its associate banks, and other nationalised banks.
• Banks such as HDFC, ICICI, Axis Bank etc that are held by private parties fall into the category of private banks.
• A foreign bank refers to banks that are based abroad but conduct operations in India either through a branch or via a subsidiary or through representative offices.

Regional Rural Banks (RRBs) were set up in 1975 with the goal of providing banking services in rural areas by combining the suitable and appropriate positive characteristics of commercial banks and cooperatives. RRBs are jointly held by the central government, state government and a sponsor bank. The sponsor bank can be any bank which helps the RRB by providing financial, managerial and training assistance and also subscribed to the RRB’s share capital.