1. Banking I. Introduction
Indian banking industry, the backbone of the country’s economy, has always
Played a key role in prevention the economic catastrophe from reaching terrible
Volume in the country. It has achieved enormous appreciation for its strength,
Particularly in the wake of the worldwide economic disasters, which pressed its
Worldwide counterparts to the edge of fall down. If we compare the business of top
three banks in total assets and in terms of return on assets, the Indian banking
system is among the healthier performers in the world. This sector is
tremendously competitive and recorded as growing in the right trend (Ram
Mohan, 2008). Indian banking industry has increased its total assets more than
five times between March 2000 and March 2010, i.e., US$250 billion to more than
US$1.3 trillion. This industry recorded CAGR growth of 18 percent as compared to
country’s average GDP growth of 7.2 percent during the same period. The
commercial banking assets to GDP ratio has increased to nearly 100 percent
while the ratio of bank’s business to GDP has recorded nearly twofold, from 68
percent to 135 percent. The overall development has been lucrative with
enhancement in banking industry efficiency and productivity. It should be
underlined here is financial turmoil which hit the western economies in 2008 and
the distress effect widened to the majority of the other countries but Indian
banking system survived with the distress and showed the stable performance.
Indian banks have remained flexible even throughout the height of the sub-prime
catastrophe and the subsequent financial turmoil.
The Indian banking industry is measured as a flourishing and the secure in the
banking world. The country’s economy growth rate by over 9 percent since last
several years and that has made it regarded as the next economic power in the
world. Our banking industry is a mixture of public, private and foreign ownerships.
The major dominance of commercial banks can be easily found in Indian banking,
although the co-operative and regional rural banks have little business segment.
Banking in India broadly falls under two categories: (a) Commercial
banks and (b) Co-operative banks. Commercial banks are the major players as far as
industry and trade sectors are concerned whereas co-operative banks cater to the needs of
rural economy particularly agriculture sector. Commercial banks fall under two distinct
categories, namely, Scheduled commercial banks and non-scheduled Commercial banks.
Scheduled commercial banks means the banks which are listed in the Second Schedule
of RBI Act, 1934. Under section 42 (1) of the Act, scheduled commercial banks are
expected to maintain cash balance to a minimum of three per cent of their net demand
and time liabilities, The cash reserve ratio is subject to upward / downward revision by
RBI. The scheduled commercial banks enjoy certain special privileges like availing
financial assistance under section 17 of the RBI Act. Non-scheduled Commercial banks
are not listed and they do not have any large network. As of now only, one nonscheduled
bank is functioning in India as compared to 16 nos on the eve of bank nationalisation.
Banks in India
In India, banks are segregated in different groups. Each group has its own benefits and limitations in operations. Each has its own
dedicated target market. A few of them work in the rural sector only while others in both rural as well as urban. Many banks are
catering in cities only. Some banks are of Indian origin and some are foreign players.
Banks in India can be classified into:
• Public Sector Banks
• Private Sector Banks
• Cooperative Banks
• Regional Rural Banks
• Foreign Banks
One aspect to be noted is the increasing number of foreign banks in India. The RBI has shown certain interest to involve more foreign
banks. This step has paved the way for a few more foreign banks to start business in India.

2. Reserve Bank of India (RBI)
The central bank of the country is the Reserve Bank of India (RBI). It was established in April 1935 with a share capital of Rs 5 crore
on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into fully paid shares of Rs 100
each, which was entirely owned by private shareholders in the beginning. The government held shares of nominal value of Rs
220,000.
The RBI commenced operation on April 1, 1935, under the Reserve Bank of India Act, 1934. The Act (II of 1934) provides the
statutory basis of the functioning of the Bank. The Bank was constituted to meet the following requirements:
• Regulate the issue of currency notes
• Maintain reserves with a view to securing monetary stability
• Operate the credit and currency system of the country to its advantage
5.2 Progress of Banking in India
The progress of Commercial banking in India can be categorised under
the following four distinct phases: Phase I (1 860-1 946 ); Phase I1 (1 947-1968 ); Phase
111 (1969-1 990); Phase IV (1991- till date).
Banking Sector Reforms
As the real sector reforms began in 1992, the need was felt to restructure the Indian banking industry.
The reform measures necessitated the deregulation of the financial sector, particularly the banking sector.
The initiation of the financial sector reforms brought about a paradigm shift in the banking industry. In
1991, the RBI had proposed to form the committee chaired by M. Narasimham, former RBI Governor in
order to review the Financial System viz. aspects relating to the Structure, Organizations and Functioning
of the financial system. The Narasimham Committee report, submitted to the then finance minister,
Manmohan Singh, on the banking sector reforms highlighted the weaknesses in the Indian banking system
and suggested reform measures based on the Basle norms. The guidelines that were issued subsequently
laid the foundation for the reformation of Indian banking sector.
Economic Reforms of the Banking Sector in India Indian
banking sector has undergone major changes and reforms during economic reforms. Though it was a part
of overall economic reforms, it has changed the very functioning of Indian banks. This reform has not only
influenced the productivity and efficiency of many of the Indian Banks, but has left everlasting footprints
on the working of the banking sector in India. Let us get acquainted with some of the important reforms
in the banking sector in India below with a graph.
1. Reduced CRR and SLR: The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR) are gradually reduced during the economic reforms period in India. By Law in India the CRR
remains between 3-15% of the Net Demand and Time Liabilities. It is reduced from the earlier high level
of 15% plus incremental CRR of 10% to current 4% level. Similarly, the SLR Is also reduced from early
38.5% to current minimum of 25% level. This has left more loanable funds with commercial banks,
solving the liquidity problem.
2. Deregulation of Interest Rate: During the economics reforms period, interest
rates of commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and upper limit
of interest on deposits. Interest rate slabs are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs. Interest

3. rates on the bank loans above Rs.2 lakhs are full decontrolled. These measures have resulted in more
freedom to commercial banks in interest rate regime.
3. Fixing prudential Norms: In order to induce professionalism in its operations, the RBI
fixed prudential norms for commercial banks. It includes recognition of income sources. Classification of
assets, provisions for bad debts, maintaining international standards in accounting practices, etc. It helped
banks in reducing and restructuring Non-performing assets (NPAs).
4. Introduction of CRAR: Capital to Risk Weighted Asset Ratio (CRAR) was introduced in
1992. It resulted in an improvement in the capital position of commercial banks, all most all the banks in
India has reached the Capital Adequacy Ratio (CAR) above the statutory level of 9%.
5. Operational Autonomy: During the reforms period commercial banks enjoyed the
operational freedom. If a bank satisfies the CAR then it gets freedom in opening new branches, upgrading
the extension counters, closing down existing branches and they get liberal lending norms.
6. Banking Diversification: The Indian banking sector was well diversified, during the
economic reforms period. Many of the banks have stared new services and new products. Some of them
have established subsidiaries in merchant banking, mutual funds, insurance, venture capital, etc which
has led to diversified sources of income of them.
7. New Generation Banks: During the reforms period many new generation banks have
successfully emerged on the financial horizon. Banks such as ICICI Bank, HDFC Bank, UTI Bank have
given a big challenge to the public sector banks leading to a greater degree of competition.
8. Improved Profitability and Efficiency: During the reform period, the
productivity and efficiency of many commercial banks has improved. It has happened due to the reduced
Non-performing loans, increased use of technology, more computerization and some other relevant
measures adopted by the government.
Differential Rate Interest:
The differential Rate of Interest (DRI) is a leading programme launched by the Government in April 1972
which makes it obligatory upon all the Public Sector Banks in India to lend I percent total leading of the
preceding year to the “The poorest among the poor” at an interest rates of 4 percent paranom the total
leading in 2005 – 06 was Rs. 351 crores, period 1969-2000 gives the following: from 1969-1980, the ratio
of deposits in nationalized banks to deposits in private banks was approximately 5 to 1; from 1980 to
1993, the ratio was approximately 11-1; post liberalization, the ratio has been falling, and in 2000 stood
at about 7.5 to 1.47 Thus, under the accounting that is most favorable to public sector banks, they squeak
by as less costly to the government than private sector banks (the ratio of money spent bailing out public
vs. private banks would be 62 3 to 1, less than the deposits ratio). However, using the estimate of 540
billion rupees total cost gives a 12-1 ratio, which would imply that the public sector banks lost a greater
portion of their deposits to bad loans.
The Future of Banking Reform
Prior to the economic reforms, the financial sector of India was on the crossroads. To improve the
performance of the Indian commercial banks, first phase of banking sector reforms were introduced in
1991 and after its success; government gave much importance to the second phase of the reforms in
1998. Uppal (2011) analyzes the ongoing banking sector reforms and their efficacy with the help of some
ratios and concludes the efficacy of all the bank groups have increased but new private sector and foreign

4. banks have edge over our public sector bank. The efficient, dynamic and effective banking sector plays a
decisive role in accelerating the rate of economic growth in any economy. In the wake of contemporary
economic changes in the world economy and other domestic crises like adverse balance of payments
problem, increasing fiscal deficits etc., our country too embarked upon economic reforms. The govt. of
India introduced economic and financial sector reforms in 1991 and banking sector reforms were part and
parcel of financial sector reforms. These were initiated in 1991 to make Indian banking sector more
efficient, strong and dynamic.
Rationale of Banking Sector Reforms
To cope up with the changing economic environment, banking sector needs some dose to improve its
performance. Since 1991, the banking sector was faced with the problems such as tight control of RBI,
eroded productivity and efficiency of public sector banks, continuous losses by public sector banks year
after year, increasing NPAs, deteriorated portfolio quality, poor customer service, obsolete work
technology and unable to meet competitive environment. Therefore, Narasimham Committee was
appointed in 1991 and it submitted its report in November 1991, with detailed measures to improve the
adverse situation of the banking industry (Uppal; 2011. p. 69). The main motive of the reforms was to
improve the operational efficiency of the banks to further enhance their productivity and profitability.
First Phase of Banking Sector Reforms
The first phase of banking sector reforms essentially focused on the following:
1.) Reduction in SLR & CRR
2.) Deregulation of interest rates
3.) Transparent guidelines or norms for entry and exit of private sector banks
4.) Public sector banks allowed for direct access to capital markets
5.) Branch licensing policy has been liberalized
6.) Setting up of Debt Recovery Tribunals
7.) Asset classification and provisioning
8.) Income recognition
9.) Asset Reconstruction Fund (ARF)
Second Phase of Banking Sector Reforms
In spite of the optimistic views about the growth of banking industry in terms of branch expansion,
deposit mobilization etc, several distortions such as increasing NPAs and obsolete technology crept into
the system, mainly due to the global changes occurring in the world economy. In this context, the
government of India appointed second Narasimham Committee under the chairmanship of Mr. M.
Narasimham to review the first phase of banking reforms and chart a programme for further reforms
necessary to strengthen India’s financial system so as to make it internationally competitive. Uppal (2011.
p. 70) the committee reviewed the performance of the banks in light of first phase of banking sector
reforms and submitted its report with some more focus and new recommendations. There were no new
recommendations in the second Narasimham Committee except the followings:
- Merger of strong units of banks
- Adaptation of the ‘narrow banking’ concept to rehabilitate weak banks.
As the process of second banking sector reforms is going on since 1999, one may say that there
is an improvement in the performance of banks. However, there have been many changes and challenges
now due to the entry of our banks into the global market.

5. Third banking sector reforms and fresh outlook
Rethinking for financial sector reforms have to be accorded, restructuring of the public sector banks in
particular, to strengthen the Indian financial system and make it able to meet the challenges of
globalization. The on-going reform process and the agenda for third reforms will focus mainly to make the
banking sector reforms viable and efficient so that it could contribute to enhance the competitiveness of
the real economy and face the challenges of an increasingly integrated global financial architecture.
When we take this evidence together, where does it leave us? There are obvious problems with the
Indian banking sector, ranging from under-lending to unsecured lending, which we have discussed at
some length. There is now a greater awareness of these problems in the Indian government and a
willingness to do something about them. One policy option that is being discussed is privatization. The
evidence from Cole, discussed above, suggests that privatization would lead to an infusion of dynamism in
to the banking sector: private banks have been growing faster than comparable public banks in terms of
credit, deposits and number of branches, including rural branches, though it should be noted that in our
empirical analysis, the comparison group of private banks were the relatively small ”old” private banks.48
It is not clear that we can extrapolate from this to what we could expect when the State Bank of India,
which is more than an order of magnitude greater in size than the largest “old” private sector banks. The
“new” private banks are bigger and in some ways would have been a better group to compare with.
However while this group is also growing very fast, they have been favored by regulators in some specific
ways, which, combined with their relatively short track record, makes the comparison difficult.
Privatization will also free the loan officers from the fear of the CVC and make them somewhat more
willing to lend aggressively where the prospects are good, though, as will be discussed later, better
regulation of public banks may also achieve similar goals.
Historically, a crucial difference between public and private sector banks has been their
willingness to lend to the priority sector. The recent broadening of the definition of priority sector has
mechanically increased the share of credit from both public and private sector banks that qualify as
priority sector. The share of priority sector lending from public sector banks was 42.5 percent in 2003, up
from 36.6 percent in 1995. Private sector lending has shown a similar increase from its 1995 level of 30
percent. In 2003 it may have surpassed for the first time ever public sector banks, with a share of net
bank credit to the priority sector at 44.4 percent to the priority sector.
Still, there are substantial differences between the public and private sector banks. Most notable
is the consistent failure of private sector banks to meet the agricultural lending sub-target, though they
also lend substantially less in rural areas. Our evidence suggests that privatization will make it harder for
the government to get the private banks to comply with what it wants them to do. However it is not clear
that this reflects the greater sensitivity of the public banks to this particular social goal. It could also be
that credit to agriculture, being particularly politically salient, is the one place where the nationalized
banks are subject to political pressures to make imprudent loans.
Finally, one potential disadvantage of privatization comes from the risk of bank failure. In the
past there have been cases where the owner of the private bank stripped its assets, and declared that it
cannot honor its deposit liabilities. The government is, understandably, reluctant to let banks fail, since
one of the achievements of the last forty years has been to persuade people that their money is safe in
the banks. Therefore, it has tended to take over the failed bank, with the resultant pressure on the fiscal
deficit. Of course, this is in part a result of poor regulation–the regulator should be able to spot a private

6. bank that is stripping its assets. Better enforced prudential regulations would considerably strengthen the
case for privatization.
On the other hand, public banks have also been failing–the problem seems to be part corruption
and part inertia/laziness on the part of the lenders. As we saw above, the cost of bailing out the public
banks may well be larger (appropriately scaled) than the total losses incurred from every bank failure
since 1969. Once again the fact that the “new” private banks pose a problem: So far none of them have
defaulted, but they are also new, and as a result, have not yet had to deal with the slow decline of once
successful companies, which is one of the main sources of the accumulation of bad debt on the books of
the public banks. On balance, we feel the evidence argues, albeit quite tentatively, for privatizing the
nationalized banks, combined with tighter prudential regulations. On the other hand we see no obvious
case for abandoning the “social” aspect of banking. Indeed there is a natural complementarity between
reinforcing the priority sector regulations (for example, by insisting that private banks lend more to
agriculture) and privatization, since with a privatized banking sector it is less likely that the directed loans
will get redirected based on political expediency.
However there is no reason to expect miracles from the privatized banks. For a variety of reasons
including financial stability, the natural tendency of banks, public or private, the world over, is towards
consolidation and the formation of fewer, bigger banks. As banks become larger, they almost inevitably
become more bureaucratic, because most lending decisions in big banks, by the very fact of the bank
being big, must be taken by people who have no direct financial stake in the loan. Being bureaucratic
means limiting the amount of discretion the loan officers can exercise and using rules, rather human
judgment wherever possible, much as is currently done in Indian nationalized banks. Berger et al. have
argued in the context of the US that this leads bigger banks to shy away from lending to the smaller
firms.50 Our presumption is that this process of consolidation and an increased focus on lending to
corporate and other larger firms is what will happen in India, with or without privatization, though in the
short run, the entry of a number of newly privatized banks should increase competition for clients, which
ought to help the smaller firms.
In the end the key to banking reform may lie in the internal bureaucratic reform of banks, both
private and public. In part this is already happening as many of the newer private banks (like HDFC,
ICICI) try to reach beyond their traditional clients in the housing, consumer finance and blue-chip sectors.
This will require a set of smaller step reforms, designed to affect the incentives of bankers in private and
public banks. A first step would be to make lending rules more responsive to current profits and
projections of future profits. This may be a way to both target better and guard against potential NPAs,
largely because poor profitability seems to be a good predictor of future default. It is clear however that
choosing the right way to include profits in the lending decision will not be easy. On one side there is the
danger that unprofitable companies default. On the other side, there is the danger of pushing a company
into default by cutting its access to credit exactly when it needs it the most, i.e. right after a shock to
demand or costs has pushed it into the red. Perhaps one way to balance these objectives would be to
create three categories of firms:
(1) Profitable to highly profitable firms. Within this category lending should respond to
profitability, with more profitable firms getting a higher limit, even if they look similar on the other
measures.
(2) Marginally profitable to loss-making firms that used to be highly profitable in the recent past but have
been hit by a temporary shock (e.g. an increase in the price of cotton because of crop failures, etc.). For
these firms the existing rules for lending might work well. (3) Marginally profitable to loss-making firms
that have been that way for a long time or have just been hit by a permanent shock (e.g., the removal of
tariffs protecting firms producing in an industry in which the Chinese have a huge cost advantage). For

7. these firms, there should be an attempt to discontinue lending, based on some clearly worked out exit
strategy (it is important that the borrowers be offered enough of the pie that they feel that they will be
better off by exiting without defaulting on the loans). Of course it is not always going to be easy to
distinguish permanent shocks from the temporary. In particular, what should we make of the firm that
claims that it has put in place strategies that help it survive the shock of Chinese competition, but that
they will only work in a couple of years? The best rule may be to use the information in profits and costs
over several years, and the experience of the industry as a whole
CONCLUSION
Since the banking reforms of 1991, there have been significant favorable changes in India’s highly regulated banking sector. This
project has assessed the impact of the reforms by examining several hypotheses. It concludes that the banking reforms have had a
moderately positive impact on reducing the concentration of the banking sector (at the lower end) and improving performance.
Allowing banks to engage in non-traditional activities has contributed to improved profitability and cost and earnings efficiency of the
whole banking sector, including public-sector banks. By contrast, investment in government securities has lowered the profitability
and cost efficiency of the whole banking sector, including public-sector banks. Lending to priority sectors and the public-sector has
not had a negative effect on profitability and cost efficiency, contrary to our expectations. Further, foreign banks (and private domestic banks in
some cases)have generally performed better than other banks in terms of profitability and income efficiency. This suggests that
ownership matters and foreign entry has a positive impact on banking sector restructuring.
.