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Role of Commercial Banks in the Economic Development of a Country:- An

Indian Perspective

Preprint  in  SSRN Electronic Journal · May 2021

DOI: 10.2139/ssrn.3884302

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 ROLE OF COMMERCIAL BANKS IN THE ECONOMIC
DEVELOPMENT OF A COUNTRY:- AN INDIAN
PERSPECTIVE
SHEIKH AAMIN HUSSAIN (1)
(1)
Undergraduate Student at Government Degree College, Anantnag, Jammu and Kashmir, INDIA
aaminhussainsheikh@gmail.com
AATIF JAVAID (2)
(2)
Undergraduate Student at Govt. Degree College, Bijbehara, Jammu & Kashmir, INDIA
aatifjavaid681@gmail.com

Abstract

India is not only the world’s largest independent democracy, but also an emerging economic giant.
Without a sound and effective banking system, no country can have a healthy economy. Banks play a
vital role in the economic development of a country. The Banking sector acts as a backbone of modern
business. A well organized banking system is necessity for the economic development of a country.
Banks being fundamental components of financial system are the most effective way to generate the
credit flow of money in markets. The banking is one of the most essential and important parts of the
human life. In current faster lifestyle peoples may not do proper transitions without developing the
proper bank network. The banking System in India is dominated by nationalized banks. The
performance of the banking sector is more closely linked to the economy than perhaps that of any
other sector. At the same time banking industry like many other financial services face a rapidly
changing market, new technologies, economic fears, nasty competition and especially more
customers demands. The central objective of the study is to empirically investigate a role of Indian
banks in capital formation and economic growth. Research is based upon the secondary data which
provide the findings on commercial banks and how it is helpful in economic development.

Keywords: Banking, Credit Facility, Economic Growth, Indian Economy.

JEL Classification: G20, O1.

INTRODUCTION:
Bank is a financial institution that performs several functions like accepting deposits, lending loans,
agriculture and rural development etc. Bank plays an important role in the economic development of
the country. It is necessary to encourage people to deposit their surplus funds with the banks. These
funds are used -for providing loans to the industries thereby making productive investments. A bank
is a financial intermediary that accepts deposits and channels those deposits into lending activities.
They are the active players in financial market. The essential role of a bank is to connect those who
have capital with those who seek capital. After the post economic liberalization and globalization,
there has been a significant impact on the banking industry. Banking in India originated in the 18th
century. The oldest bank in existence in India is the State Bank of India, a government-owned bank
in 1806. SBI is the largest commercial bank in the country. Due to liberalization, privatization and
globalization the role of banking sector changed dramatically. The credit is one of the critical inputs
for agricultural development. Around the turn of the 20th Century, the Indian economy was passing
through a relative period of stability. Indians had established small banks, most of which served
particular ethnic and religious communities. The presidency banks dominated banking in India. There
were also some exchange banks and a number of Indian joint stock banks. All these banks operated
in different segments of the economy. The exchange banks, mostly owned by Europeans,
concentrated on financing foreign trade. Indian joint stock banks were generally undercapitalized and
lacked the experience and maturity to compete with the presidency and exchange banks. This
segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times.
We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and
cumbersome compartments." A number of banks established then have survived to the present such
as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank
of India. The Government of India initiated that banks play an vital role in the economic roadmap of
the nation, the Indian government was adopted the mixed economy in 1948. Indian Government took
big decision concerning the Indian Banking Sector Reform after independence. Firstly, Indian
government transformed Imperial Bank of India converted into a nationalized bank and it became the
State Bank of India{SBI} with extensive banking facilities on a large scale especially in rural and
semi-urban areas. Government of India took many banking initiatives. These were aimed to provide
banking coverage to all section of the society and every sector of the economy. In the First phase of
nationalisation process, Fourteen banks were nationalized in 1969. Before 1969, State Bank of India
(SBI) was only the public sector bank in India. And second phase of Indian banks nationalization
process was in 1980. Seven more banks were nationalized with deposits over 200 crores.

Figure 1: Indian Banking System {Source:- https://m.rbi.org.in }

Reserve Bank of India Central

Bank & Monetary Authority

Commercial Regional Rural Co - operative Banks

Banks Banks

Public Sector Private Banks State Co - operative

Banks Banks

Central Co - operative
Indian Banks Foreign Banks
Banks

OBJECTIVE OF THE STUDY:

 ➢ To study the Indian banking sector and performance of Indian banks.
➢ To study how the Indian Banking Sector helps in the development of Economy of India.
Table 1: Indian Banking Sector performance report 2019-20 {Source:- https://dbie.rbi.org.in
Sr. Items Amount Outstanding (As Percentage Variation
No at end-March)
2019 2020 (P) 2018-19 2019-20
1 2 3 4 5 6
1 Balance Sheet Operations 1.1
Total Liabilities/assets
1,66,01,045 1,80,14,875 8.8 8.5
1.2 Deposits 1,28,86,643 1,39,75,095 9.3 8.4

1.3 Borrowings 17,09,670 16,96,046 1.6 -0.8

1.4 Loans and advances 96,76,183 1,03,01,914 10.6 6.5

1.5 Investments 43,22,464 46,89,842 4.8 8.5

1.6 Off-balance sheet exposure

(as percentage of on-balance sheet liabilities) 122.8 125.3 - -
1.7 Total consolidated international claims 6,29,621 5,78,412 -1.3 -8.1

2 Profitability 2.1
Net profit
-23,397 10,911 - -
2.2 Return on Asset (RoA) (Per cent) -0.09 0.15 - -
2.3 Return on Equity (RoE) (Per cent) -1.9 0.8 - -

2.4 Net Interest Margin (NIM) (Per cent) 2.7 2.8 - -

3 Capital Adequacy
3.1 Capital to risk weighted assets ratio (CRAR) @ 14.3 14.7 - -
3.2 Tier I capital (as percentage of total capital) @ 85.5 85.5 - -

3.3 CRAR (tier I) (Per cent) @ 12.2 12.6 - -

4 Asset Quality 4.1

Gross NPAs
9,36,474 8,99,803 -9.9 -3.9
4.2 Net NPAs 3,55,068 2,89,531 -31.8 -18.5

4.3 Gross NPA ratio (Gross NPAs as percentage of gross advances) 9.1 8.2 - -

4.4 Net NPA ratio (Net NPAs as percentage of net advances) 3.7 2.8 - -

4.5 Provision Coverage Ratio (not write-off adjusted) (Per cent)** 60.5 66.2 - -

4.6 Slippage ratio (Per cent) 4.0 3.8 - -

5 Sectoral Deployment of Bank Credit

5.1 Gross bank credit 95,26,932 1,00,98,420 13.4 6.0
5.2 Agriculture 12,17,594 12,39,575 10.0 1.8

5.3 Industry 32,93,638 32,52,801 5.2 -1.2

5.4 Services 26,02,287 27,54,824 25.1 5.9
5.5 Retail loans 23,04,313 26,59,250 18.6 15.4

6 Technological Development
6.1 Total number of credit cards (in lakhs) 471 577 25.6 22.5
6.2 Total number of debit cards (in lakhs) 9,058 8,286 5.2 -8.5

6.3 Number of ATMs 2,02,196 2,10,760 -2.3 4.2

7 Customer Services
7.1 Total number of complaints received during the year 1,84,730 3,06,702 22.7 66.0
7.2 Total number of complaints addressed 1,82,602 3,05,592 23.3 67.4
7.3 Percentage of complaints addressed 89.1 92.9 - -

8 Financial Inclusion
8.1 Credit-deposit ratio (Per cent) 75.1 73.7 - -
8.2 Number of new bank branches opened 4,516 4,116 14.6 -8.9

8.3 Number of banking outlets in villages (Total) 5,97,155 5,99,217 4.8 0.3
Notes: 1. P: Provisional.
2. **: Based on off-site returns.
3. @Figures are as per the Basel III framework. Percentage variation could be slightly different as figures have been rounded off to lakh/crore.

ROLE OF BANKS IN THE DEVELOPMENT OF THE ECONOMY:

1) Mobilizing Saving for Capital Formation:-

The commercial banks help in mobilizing savings through network of branch banking. People in
developing countries have low incomes but the banks encourage them to save by introducing variety
of deposit schemes to suit the needs of individual depositors. They also mobilize idle savings of the
few rich. By mobilizing savings, the banks channelize them into productive investments. Thus they
help in the capital formation of a developing country.

2) Financing Industry:-

The commercial banks finance the industrial sector in a number of ways. In generally they provide
short-term, medium-term and long-term loans to industry. In India they provide mainly short-term
loans as well medium-term loans for one to three years. But in Korea, the commercial banks also
advance long-term loans to industry.

3) Generate Employment Opportunities:-

Since a bank promote industry and investment, there automatically generate employment
opportunity. So, a bank enables an economy to generate employment opportunity.

4) Smoothing of trade and commerce functions:-

In this modern era trade and commerce plays vital role between any countries. So, the money
transaction should be user friendly. A modern bank helps its customers to sent funds to anywhere
and receive funds from anywhere of the world. A well developed banking system provides various
attractive services like mobile banking, internet banking, debit cards, credit cards etc. these kinds of
services fast and smooth the transactions. So, bank helps to develop trade and commerce.

5) Financing Agriculture:-

The commercial banks help the large agricultural sector in developing countries in a number of ways.
They provide loans to traders in agricultural commodities. They provide finance directly to farmers
for the marketing of their produce, for the modernization and mechanization of their farms, for
providing irrigation facilities, for developing land, etc. They also provide financial assistance for
animal husbandry, dairy farming, sheep breeding, poultry farming, and horticulture.

6) Application of Monetary Policy:-

Monetary policy is a important policy of any government. The major aim of monitory policy is to
stabilize financial system of the country from the dangerous of inflation, deflation, crisis etc.

7) Financing Small Businesses:-

Commercial banks also finance business lending in a variety of ways. A business owner may solicit
a loan to finance the start-up costs of a small business. Once funded, the small business may begin
operations and embark on a growth plan. The aggregate effect of small business activity generates a
significant portion of employment around the country. According to the U.S. Census Bureau,
businesses employing between one and 19 people accounted for 4.4 million jobs in 2004. In contrast,
businesses with more than 20 employees only accounted for 1.2 million in the same year.

8) Promotion of Saving habits:-

Bank attracts depositors by introducing attractive deposit schemes and providing rewards or return
in the form of interest. Banks providing different kinds of deposit schemes to its customers. It enables
to create banking habits or saving habits among people.

9) Support the Government Spending:-

Commercial banks also support the role of the federal government as an agent of economic
development. Generally, commercial banks help fund government spending by purchasing bonds
issued by the Department of the Treasury. Both long and short term Treasury bonds help finance
government operations, programs and support deficit spending.

10) Arbiters of Risk:-

One of the most significant roles of commercial banks in economic development is as arbiters of
risk. This occurs primarily when banks make loans to businesses or individuals. For instance, when
individuals apply to borrow money from a bank, the bank examines the borrower's finances,
including income, credit score and debt level, among other factors. The outcome of this analysis
helps the bank gauge the likelihood of borrower default. By weeding out risky borrowers,
commercial banks lessen the risk of financial losses. As a result, loans that mature without any
problems generate a larger pool of funds for the bank to lend, further supporting economic
development.

Modern banks are spreading its operations throughout the world. We can see number
of big banks like HDFC bank, Baroda bank, ICICI Bank etc. It helps a country to spread banking
activities in rural and semi urban areas. With the spreading of banking operations around the country,
helps to attain balanced development by promoting rural areas. Modern bank plays vital role in the
socio- economic development of the country. A developed banking system enables the country to
attain balanced development without any special consideration of rich and poor, cities and rural areas
etc.

Statistics and Facts

Table 2: Industry-Wise Deployment of Bank Credit

❖ Note:- Data are provisional and related to select 47 banks, which account for 95% of total
non-food credit extended by all schedule commercial banks. {Source:-
https://dbie.rbi.org.in}
 Results
Figure 2: Bank Credit Fluctuation {Source:- https://dbie.rbi.org.in}
40
G
r 35
o
w 30
i
n 25 Textiles
g
20 Chemicals &
Chemical Products
r
a 15 Basic Metal &
t Metal Product
e 10 Infrastructure

5
%
0
2008 2009 2010 2011 2012 2013 2014 2015 2016
Years

{Figure 2} shows some of the major sectors that could avail maximum loan from the banks
includes that include: Textiles, Chemical and chemical products, basic metal & metal
products and infrastructure. But infrastructure and basic metal & metal products sector are
increasing in every year. And chemical & chemical products and textiles sector are
decreasing in every year. Analysis of the loans provided to different sectors by the 47
commercial banks during the period 2008-2016 revealed spontaneous increased in most
sectors.

CONCLUSION:

Over the last ten years Banking system in India has undergone significant changes. The commercial
banks play a vital role in its economic development. The Statistics helps us to understand the
commercial bank sector in India. Banks in India has a got a great response in terms of service and
quality banking. Over a significantly long period of time, countries embarking on a process of
development within the framework of mixed, capitalist economies have sought to use the developing
banking function, embedded in available or specially created institutions, to further their
development goals. The role of these institutions in the development trajectories of late
industrializing, developing countries cannot be overemphasized. Banking sector reform has been
unique in the world in that it combines a comprehensive reorientation of competition, regulation and
ownership in a non-disruptive and cost-effective manner. Globalization has encouraged
multinationals and foreign banks to set up their business unit in a developing country like India.
Growth of this sector is directly related to the economic development of the country.
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(Narasimham Committee-II), April
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➢ Saini Priyanka, Sindhu Jyoti,( 2014) “Role of Commercial Bank in the Economic
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