OVERVIEW, EVOLUTION AND

REFORMS IN INDIAN BANKING

SECTOR
 History
• An indigenous Banking system was carried out by businessmen called
Sharoffs, Sahukars, Mahajans, Chettis, etc since ancient time.
• Modern Banking originated in the last decades of 18th Century. The
first banks were The Bank of Hindusthan which started in 1770, and
later The General Bank of India in 1786.
• The three Presidency banks namely Bank of Bengal (started as Bank
of Calcutta in 1806) in 1809, the Bank of Bombay in 1840 and Bank of
Madras in 1843 was set up.
• The three banks merged in 1925 to form the Imperial Bank of India. It
later became State Bank of India on 1st July, 1955.
• Allahabad Bank established in 1865 is the oldest joint stock bank in
India.
• Punjab National Bank established in Lahore in 1895 was the first bank
to be started purely by Indian nationals (as a result of Swadeshi
movement).
 Central Bank – Reserve Bank of India
• Reserve Bank of India started functioning in 1935 as the
central bank of the country (as a private shareholder’s bank).
• RBI replaced Imperial Bank of India and started issuing
currency notes and acting as banker to the government.
• From 1st July, 1949, RBI started functioning as a state-
owned and state controlled central bank (nationalization of
RBI).
• GOI enacted the Banking Companies Act, 1949 which was
later changed to Banking Regulation Act, 1949 to streamline
the functioning of commercial banks.
• RBI act as regulator, banker’s bank and banker to the
government.
 State Bank of India and its Associates
• SBI was created on 1st July, 1955 by an act passed by
Parliament.
• SBI (Subsidiary Banks) Act was passed in 1959 which enabled
it to take over seven former state associate banks i.e., State
Bank of Hyderabad, State Bank of Mysore, State Bank of
Bikaner and Jaipur, State Bank of Travancore, State Bank of
Patiala, State Bank of Indore (merged earlier) and State Bank
of Saurashtra (merged earlier).
• All the remaining five associate (subsidiary) banks have been
merged with SBI from 1st April, 2017.
• Bharatiya Mahila Bank is also merged with SBI.
 Nationalization of Banks
• Indian Banking System witnessed a major revolution on 19th July,1969
when 14 major commercial banks were nationalized having deposits of
more than Rs.50 crores i.e., Allahabad Bank, Bank of Baroda, Bank of
India, Bank of Maharashtra, Canara Bank, Central Bank of India, Indian
Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank,
Union Bank of India, United Bank of India and United Commercial Bank
(UCO Bank).
• The purpose of nationalization was to increase the presence of banks
across the nation, to provide banking services to different segments of
the society, change the concept of class banking into mass banking and
support priority sector lending and growth.
• In 1980, another six commercial banks were nationalized with deposits of
above Rs.200 crores i.e., Andhra Bank, Corporation Bank, New Bank of
India, Punjab and Sind Bank, Oriental Bank of Commerce and Vijaya
Bank.
 Structure of Banking Sector in India
• RBI – Central Bank of the country.

• Commercial Banks – Scheduled banks (listed in second schedule of RBI

Act, 1934) which enjoy facilities such as refinance facilities of RBI,
currency chest facilities, can become members of the clearing house) and
non-scheduled banks (which are not listed in second schedule) and are
not capable of serving and protecting the interest of depositors as per RBI
act (46 foreign banks having representative offices, non-scheduled co-
operative banks).

• Scheduled Banks: 12 PSU banks including SBI,13 old private sector

banks (ING Vysya, Federal Bank, J&K Bank, etc.) and 09 new private
sector banks – incorporated as per revised guidelines of RBI in 1993
(Axis Bank, HDFC Bank, ICICI Bank, Yes Bank, etc.) - 22 private banks at
present, 11 small finance banks (Ujjivan small finance banks, Jana small
bank, etc.), 06 payment banks (Paytm, Indian Post, etc.) 44 foreign banks
operating as branches in India and 46 foreign banks with representative
offices, 43 Regional Rural Banks (RRBs) and 03 Local Area Banks
(LABs).
Structure of Banking Sector in India (Contd..)
• Regional Rural Banks were started in 1970 for rural sector
with shareholding pattern (i.e., Central Government –
50%, Sponsor Bank- 35% and State Government – 15%).
• Co-operative Banks are established as short-term and
long-term credit institutions at the village level with the
passing of the Act in 1904. There are 31 state co-operative
banks.
• A co-operative bank is a co-operative society registered
under any Central or state act. The urban co-operative
banks refers to primary cooperative banks located in
urban and semi-urban areas.
• Developmental Banks started with establishment of
Industrial Finance Corporation of India in 1948 (Financial
Institutions) like NABARD, Exim Bank, NHB, SIDBI,
Industrial Investment Bank of India for refinance facilities
for different sectors of the economy.
 Structure of Banking Sector in India
(Contd..)
• The Local Area Bank Scheme was introduced in August 1996 pursuant to
the announcement of the then Finance Minister. In his budget speech, the
Finance Minister referred to the setting up of new private local banks with
jurisdiction over two or three contiguous districts.
• This would enable the mobilization of rural savings by local institutions and
make them available for investments in the local areas. The Local Area
Banks (LABs) were expected to bridge the gaps in credit availability and
strengthen the institutional credit framework in the rural and semi-urban
areas.
• Small Finance Banks were set up to further financial inclusion by (a)
provision of savings vehicles, and (ii) supply of credit to small business
units; small and marginal farmers; micro and small industries; and other
unorganised sector entities, through high technology-low cost operations.
• Payment Banks were established to further financial inclusion by providing
(i) small savings accounts and (ii) payments/remittance services to migrant
labour workforce, low income households, small businesses, other
unorganised sector entities and other users.
 Recent mergers in PSU Banks
• Oriental Bank of Commerce and United
Bank of India merged into Punjab National
Bank.
• Syndicate Bank merged into Canara Bank.
• Indian Bank merged with Allahabad Bank.
• Andhra Bank and Corporation Bank
merged with Union Bank of India.
• Vijaya Bank and Dena Bank merged with
Bank of Baroda.
 Functions of Commercial Banks
• Major Functions: Accepting deposits and granting advances.
• Other functions: Collection of bills and cheques, Discounting
of bills and cheques, Remittances, Safe custody of articles,
safe deposit lockers, issue of bank guarantees and letter of
credit.
• Associate functions: Investment counselling, Investment
Banking, Mutual Fund, Project Appraisal, Merchant Banking,
Taxation Advisory services, Credit card, Forex consultancy,
Securities trading, Venture Capital, Bancassurance,
Factoring, Gold/silver/platinum trading.
 Functions of RBI
 Notes/currency issuance
 Government’s banker
 Banker’s Bank
 Bank’s supervision
 Development of the financial system through agricultural credit (NABARD in 1961),
industrial finance (IDBI in 1964 and SIDBI in 1989), Export import finance (Exim Bank
in 1981) and Deposit Insurance and Credit Guarantee Corporation (DICGC) in 1961.
 Exchange control
 Monetary control i.e., CRR (4%), SLR (19.5%), Bank rate (6.75%), Repo (6.50%) and
Reverse Repo rate (6.25%), and Open market operations.
 Consumer education and protection
 Financial Inclusion and development
 Payment and settlement system (There is a board for payment and settlement
system)
 Tools of Monetary Control
 Cash Reserve Ratio (CRR - 4%) – It refers to the cash that all banks are required to
maintain with RBI as a certain percentage of demand and time liabilities (DTL) i.e.,
current and savings deposits, time deposits.
 Statutory Liquidity Ratio (SLR- 18%) – It refers to supplementary liquid reserve
requirements in banks, in addition to CRR. SLR is maintained by all banks in form of
cash in hand (exclusive of minimum CRR), current account balances with SBI and other
public sector commercial banks, unencumbered approved securities and gold.
 Repo rate (4.00%) is the rate at which RBI lends money to commercial banks in case of
shortfall of funds. Reverse repo (3.35%) is the rate at which RBI borrows from
commercial banks (i.e. banks purchase government securities from RBI).
 Bank rate (4.25%) is the standard rate at which RBI is prepared to buy or rediscount bills
of exchange or other eligible commercial papers from banks. It is the cost of
rediscounting and refinance facilities from RBI.
 Open Market Operations refers to the sale or purchase of government securities by RBI
in open market to increase or decrease liquidity in the banking system and effect the
loanable funds with banks.
 Lending/Deposit Rates
• Base Rate (7.40-8.80%) is the minimum rate set by RBI
below which banks are not allowed to lend to its customers.
• Loan pricing will be done by adding base rate and a suitable
spread depending on the credit risk premium.
• MCLR (6.55-7.00%) is the Marginal cost of funds based
lending rate introduced by RBI that sets the lending rates by
commercial banks.
• Depending on MCLR, the standard interest rates for various
customers should be fixed based on riskiness.
• The base rate is fixed based on MCLR.
• LIBOR (London Inter Bank Offer Rate) is a benchmark rate
that some of the world’s leading banks charge each other for
short-term loans.
 Organizational Structure of RBI
• RBI is governed by central board of directors, appointed by Central
Government as per RBI Act.
• They are appointed/nominated for a period of four years.
• There is one Governor and not more than four deputy governors.
• Non official directors are ten nominated from various fields and two
government officials. Also, four directors, one from each local board.
• In RBI, there is a board for financial supervision (BFS) chaired by
governor, and four deputy governors along with four directors co-opted
from Central Board for a period of two years.
• BFS considers inspection reports and other supervisory issues placed
before it by the supervisory departments.
• BFS through the Audit Sub-Committee also aims at upgrading the quality
of the statutory audit and internal audit functions in banks and financial
institutions.
• The BFS oversees the functioning of Department of Banking Supervision
(DBS), Department of Non-Banking Supervision (DNBS) and Financial
Institutions Division (FID) and gives directions on the regulatory and
supervisory issues.
 Characteristic features of Commercial Bank
• Banks can only issue cheques drawn on themselves as
they are part of payment and settlement system.
• Banks can accept current and saving deposits and also
fixed deposits (demand and time deposits). No other
financial institution other than bank can accept demand
deposit.
• Banks will be adhering to reserve ratio requirements (CRR
and SLR) and follow the policy rates (repo, reverse repo,
bank rate) of RBI.
• All deposits of banks upto Rs. 1 lakhs for both principal and
interest amount are protected by DICGC.
• Banks will have to lend a certain percentage of net credit
towards priority sectors.
 Regulations in Banking Sector
• Reserve Bank of India Act, 1934
• Banking Regulation Act, 1949
• Government Securities Regulations, 2007
• Foreign Exchange Management Act, 1999
• Payment and Settlement Systems Act, 2007
• Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002
• State Bank of India Act, 1955
• Deposit Insurance and Credit Guarantee Corporation Act, 1961
• Securities Contract (Regulation) Act, 1956
• Companies Act, 1956/ Companies Act, 2013
• Regional Rural Banks Act, 1976
• Banking Companies (Acquisition and Transfer of Undertakings) Act,
1970/1980
• Insolvency and Bankruptcy Code, 2016
 Reforms in Indian banking sector
• Narasimhan Committee Report (1991): It suggested
measures such as reduction of CRR and SLR, phasing out
directed credit programme, interest rate determination by
market forces of demand and supply, structural
reorganizations of the banking sector, establishment of
ARF (asset reconstruction fund) for NPA, removal of dual
control and banking autonomy.

• Narasimhan Committee Report (1998): It recommended

measures such as strengthening of banks, narrow
banking, capital adequacy ratio, bank ownership, review of
banking laws, computerization and technology
upgradation, professionalism in banking.
 New rules for banking license issued
by RBI
• Resident individuals and banking professionals with 10 years of
experience in finance and banking and with minimum capital of Rs. 500
crores can apply for granting on-tap license to new universal banks
which will function as street lenders offering loans, accepting deposits,
and carrying out fee based services.
• Companies and Conglomerates with total assets of Rs. 5,000 crores
and having 60% of their businesses in financial services can also
apply.
• Corporates will not be allowed to hold more than 10% in banks.
• Kotak Mahindra Bank is the first NBFC (Kotak Mahindra Finance) to be
converted into full fledged commercial bank in 2000.
 NPA (Non Performing Asset)
According to RBI, 25% of total NPA in all banks are contributed by 12
companies:
 Bhushan Steel- Rs.44,478 crores
 Lanco Infratech – Rs. 44,364 crores
 Essar Steel Ltd – Rs.37,284 crores
 Bhushan Power & Steel Ltd- Rs. 37, 248 crores
 Alok Industries – Rs.22,075 crores
 Amtek Auto Ltd – Rs. 14,074 crores
 Monnet Ispat & Energy Ltd – Rs.12,115 crores
 Electrosteel Steels Ltd – Rs.10, 273 crores
 Era Infra Engineering Ltd – Rs.10,065 crores
 Jaypee Infratech Ltd – Rs.9,635 crores
 ABG Shipyard Ltd – Rs.6,953 crores
 Jyoti Structures Ltd –Rs.5,165 crores
(Source: Financial Express, October, 2017)