BANKING SYTEM IN INDIA
All the modern economies are money economies .The process of growth and
expansion of banking sector has been evolutionaryin nature.There is no solitary
answer to the query of what banking is? This is because a bank performs a
multitude of functions and services,which cannot be comprehended into a single
definition. For a common man, a bank means a storehouse or lumber room of
money ; for a businessman it is an institution of finance and for a worker it may be
a depositary for his savings.
Etymologically, the word „bank‟ is derived from the Greek word „banque‟ or the
Italian word „banco‟ both meaning – a bench at which money-lenders and moneychangers used to display their coins and transact business in the market place. The
origin of modern banking in India can be traced back to the English Agency
Houses in Kolkata and Mumbai which used to serve as bankers to the East India
Company . The Hindustan Bank established in 1779 was the first banking
institutions of its kind in India.
Definition of Bank:
“A bank is defined as one which transacts the business of banking which means
accepting, for the purpose of lending or investment, of deposits of money from the
public, repayable on demand or otherwise and withdrawals by cheque ,draft,
order, or otherwise.”- The Banking Companies Act,1949
Need of the Banks:
Before the establishment of banks, the financial activities were handled by money
lendersand individuals. At that time the interest rates were very high. Again there
were nosecurity of public savings and no uniformity regarding loans. So as to
overcome suchproblems the organized banking sector was established, which was
fully regulated by thegovernment. The organized banking sector works within the
financial system to provideloans, accept deposits and provide other services to
their customers. The followingfunctions of the bank explain the need of the bank
and its importance:
• To provide the security to the savings of customers.
• To control the supply of money and credit
• To encourage public confidence in the working of the financial system, increase
savings speedily and efficiently.
• To avoid focus of financial powers in the hands of a few individuals and
• To set equal norms and conditions (i.e. rate of interest, period of lending etc) to
types of customers
Establishment of Reserve Bank of India (1935)
The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of the Reserve Bank of India Act, 1934. The establishment of this central
bank of the countryended the quasi-central banking role of the Imperial Bank. The
latter ceased to be bankers to the Government of India and instead became agent
of the Reserve Bank for the transaction of government business at centre at which
the central bank was not established. Even after the formation as well as
nationalization of RBI the growth of economy & banks was very slow and banks
still experienced periodic failure. Therefore in order to streamline the functioning
and activities of the 1100 commercial banks present then, the Government of India
came up with in March 1949, aspecial legislation, called the Banking Companies
The Banking Regulation Act
The Banking Act 1949 was a special legislation,applicable exclusively to the
banking companies. ThisAct was later renamed as the Banking Regulation Act
from March 1966. The Act vested in the Reserve Bankof India the responsibility
relating to licensing of banks,branch expansion, and liquidity of their
assets,management and methods of working, amalgamation,reconstruction and
liquidation. Thus giving RBI authorityalong with responsibility & igniting the first
part ofbanking transformation in India.The second path braking &transformation
effort tookplace in 1955 with the establishment of the IndianBanking Sector' State
Bank of India.
The need for nationalization was felt because government believed that private
commercial banks were lacking in fulfilling the social & developmental goals of
banking. This was evident from the fact that the industries' share in loans almost
doubled between1951 and 1968, from 34% to 68%. On the other hand, agriculture
which was a major occupation (and still is) received less than 2% of total credit
Thus with a view to serve the mass Government of India Nationalized14 banks
(refer table 1) in 1969 bringing the total number of branches under government
control to 84.Once again in April of 1980, the Government of India undertook a
second round of nationalization, placing under government control the six private
banks whose nationwide deposits were above R s. 2 billion, leaving approximately
10 percent of bank branches in private hands.
1. Allahabad Bank
1. Andhra Bank
2. Bank of Baroda
2. Corporation Bank New Bank
3. Bank of India
3. Punjab & Sind Bank
4. Bank of Maharashtra
5. Oriental Bank of Commerce
6. Central Bank of India
6. UTI Bank
7. Syndicate Bank
8. UCO Bank
9. United Bank of India
10. Union Bank
11. Punjab National Bank
12. Indian Overseas Bank
13. Indian Bank
14. Dena Bank
Major recommendations by the Narasimham
The Committee was set up under the chairmanship ofM. Narasimham. They
submitted their recommendations in the 1990s in reports widely known as the
Narasimham Committee-I (1991) report and the Narasimham Committee-II (1998)
Report. It was the recommendations of the two Narasimham Committees that
actually turned around the destiny of Indian Banking.
The year 1991 which is also called as the year of
'Banking Sector Reforms' opened the gates to the private sector & to foreign banks
which in turn significantly increased the level of competition . Seven new private
banks entered the market between 1994 and 2000. In addition, over 20 foreign
banks started operations in India since 1994. By March 2004, the new private
sector banks and the foreign banks had a combined share of almost 20% of total
In addition to above recommendation the other major contributors to the
revamping of the banking sector was the progressive lowering of SLR & CRR,
introduction of Basel Norms, , deregulation of interest rate, redefining of priority
sectors, Golden Handshake Scheme & merger of the week banks with the stronger
Functions of RBI
Bank of Issue
Regulator-Supervisor of the financial system
Manager of exchange control
Issuer of currency
Controller of Credit
Functions of Banks
Classification of Banking Industry in India
Indian banking industry has been divided into two parts, organized and
unorganizedsectors. The organized sector consists of Reserve Bank of
India, Commercial Banks and Co-operative Banks, and Specialized
Financial Institutions (IDBI, ICICI, IFC etc). The 28 unorganized sector,
which is not homogeneous, is largely made up of money lenders and
An outline of the Indian Banking structure may be presented as follows:1. Reserve banks of India.
2. Indian Scheduled Commercial Banks.
a) State Bank of India and its associate banks.
b) Twenty nationalized banks.
c) Regional rural banks.
d) Other scheduled commercial banks.
3. Foreign Banks
4. Non-scheduled banks.
5. Co-operative banks.
Banking Structure in India
Profile of Scheduled Commercial Banks in India
Source- Profile of Banks 2010-2011, RBI
Private Sector Banks:
In this type of banks, the majority of share capitalis held by private individuals and
corporate. Not all private sector banks were nationalized in 1969, and 1980. The
private banks which were not nationalized are collectively known as the old
private sector banks and include banks such as The Jammu and Kashmir Bank
Ltd., Lord Krishna Bank Ltd etc. Entry of private sector banks was however
prohibited during the post-nationalization period. In July 1993, as part of the
banking reform process and as a measure to induce competition in the banking
sector, RBI permitted the private sector to enter into the banking system. This
resulted in the creation of a new set of private sector banks, which are collectively
known as the new private sector banks.
Foreign Banks have their registered and head offices in a foreign country but
operate through their branches in India. The RBI permits these banks to operate
either through branches; or throughwholly-owned subsidiaries. Foreign banks in
India are required to adhere to all banking regulations, including priority-sector
lending norms as applicable to domestic banks. In addition to the entry of the
new private banks in the mid-90s, the increased presence of foreign banks in India
has also contributed to boosting competition. There are a total 33 foreign banks
with 316 offices acrossIndia.. (Profile of Indian Banks, RBI 2011). Citibankis the
largest Foreign Bank in India followed byStandard Chartered
India‟s Ten largest Banks are STATE BANK OF INDIA, PUNJAB NATIONAL
BANK, BANK OF BARODA, ICICI, BANK OF INDIA, CANARA BANK, HDFC,
IDBI, AXIS BANK, CENTRAL BANK OF INDIA
The Credit Composition of Financial Sector
Perspectives on Banking in India
India is a bank dominated financial sector: commercial banks account for over 60
per cent of the total assets of the financial system comprising banks, insurance
companies, non-banking financial companies, cooperatives, mutual funds and
other smaller financial entities.4 Banking expansion as reflected in the growth of
total assets of banks was rapid till the intensification of the global financial crisis
which affected the Indian economy through trade, finance and confidence
channels. Bank assets as a percentage of gross domestic product (GDP) rose from
60 per cent in 2000-01 to 93 per cent by 2008-09, but there after it has plateaued.
Bank credit to GDP ratio more than doubled from 24 per cent to 53 per cent
during this period but has remained around that level in the following years
The growth of the banking sector was influenced by the performance of the
economy, reflected in a co-movement between the growth in banking business
and real GDP growth (Chart 2). It is noteworthy that the period up to 2007-08 was
also a period of fiscal consolidation, with combined fiscal deficit of the centre and
the states falling from over 9 per cent of GDP in early 2000s to 4 per cent by 200708 (Chart 3). The consequent reduction in government borrowing requirement
opened up the space for expansion of credit to the commercial sector in a noninflationary manner.
While the financial expansion has slowed down in the post-crisis period, the Indian
banking sector has shown remarkable resilience and stability. During the global
financial crisis, the timely recourse to counter-cyclical prudential and monetary policy
measures helped the banking sector in transiting through this challenging period largely
unscathed. Most of the indicators of soundness bear out the stability of the Indian
banking sector. The capital to risk-weighted assets ratio (CRAR) at the aggregate and
bank group-levels have remained above the statutory minimum requirement of 9 per cent
and international norm of minimum 8 per cent since 2001 (Chart 4).
There was a steady improvement in the asset quality through the 2000s. For
instance the gross non-performing assets (NPAs) as per cent of gross advances
had declined from 12.0 per cent in 2000-01 to 2.4 per cent in 2007-08. Thereafter
it has increased to 3.7 per cent by December 2012, first with higher NPAs in
foreign and private sector banks and more recently in public sector banks (Chart
It has been a key objective of financial sector reforms to improve the
efficiency and profitability of the banking sector. In this regard, the interest rate
structure has been fully deregulated. The statutory pre-emptions of bank resources
through statutory liquidity ratio (SLR) and cash reserve ratio (CRR) have been
substantially reduced. Banks‟ access to central bank liquidity through export credit
refinance, marginal standing facility (MSF) and liquidity adjustment facility (LAF)
has been enhanced. Furthermore, branch licensing norms have been relaxed and
prudential norms have been strengthened. In addition, banks have increasingly
adopted technology and accorded greater focus to human resource management.
These changes have helped improve efficiency as borne out by various indicators.
The profitability of the Indian banking sector has been maintained at about 1.0 per
cent in terms of Return on Assets (RoA), even in the post-crisis period. The banks
have also shown significant improvement in other efficiency indicators such as cost
to income ratio, business per employee and business per branch. However, net
interest margin (NIM) has gone up indicating deterioration in allocative efficiency.
In order to sustain a higher economic growth, it is important to bring the
excluded segment of the society into the fold of the formal financial sector. In
recognition of this, the Reserve Bank has taken a number of steps to take formal
banking to door steps of habitations with population over 2000 through the
business correspondent (BC) model where the BCs provide basic banking
functions acting as agents of banks. Simultaneously, a number of initiatives such as
incentivisation of branch authorization scheme for banks to open branches in
unbanked centres, simplification of Know Your Customer (KYC) norms,
technological interventions and financial literacy-oriented programmes to increase
awareness have been taken. While the initial impact of these initiatives has been
positive, it has created a huge potential for expansion in banking business once the
level of activity is scaled up and government social benefit transfers increasingly
take place through the banking sector.
While we have our own data source to gauge financial inclusion, the Census of
India provides useful information on access to banking. It shows that about 59 per
cent of households had access to banking services in 2011 as compared with only
35 per cent in 2001. Increase in access for the eastern-region has also gone up
significantly from about 29 per cent in 2001 to 47 per cent in 2011, though the
region still lags behind the all-India average.
The Indian Banks have managed to grow with resilience during the post reform
era. However the Indian banking sector still has a large market unexplored. With
the Indian households being one of the highest savers in the world accounting for
69% of India gross national saving of which only 47% is accessed by the banks
more than half of the Indian population still unbanked with only 55 per cent of the
population have a deposit account and 9 per cent have credit accounts with banks.
India has the highest number of households (145 million) excluded from Banking
&has only one bank branch per 14,000 people.
On the other hand, Indian banking industry has to face challanges like financial
inclusion, deregulation of interest rates on saving deposits, slow industrial growth,
management of asset quality, increased stress on some sectors, transition to the
International Financial Reporting System, implementation of Basel II & so on.
Nevertheless seeing the credentials of the Indian Banks one can safely conclude
that the industry might have many stumbling blocks in the 'Road Ahead' but when
ever encountered with such blocks in the past it hasused them as a stepping stone
& has always'Transformed' itself ( for the better) and 'Evolved' as a winner.