Evolution and History of Banking in Perspective of India and its

Modern Framework Challenges

MID-SEMESTER TERM PAPER

EP521 BANKING MONETARY SYSTEMS

SUBMITTED TO:
PROF. SHAKTI KUMAR
&
PROF. ASHOK

SUBMITTED BY: GROUP 1

BHAVISHYA RAJ(18/11/EC/011)
AAYUSH NEELKANTH(18/11/EC/048)
POTHKANURI MANASA(18/11/EE/034)
BADAL RAJ BIJAWAT (18/11/EE/040)
ISHAN DHAWAN (18/11/EE/050)
HARSHVARDHAN SINGH(19/11/EE/015)
MOHIT KHUSHLANI(19/11/EE/026)
SUHAAS NEEL (19/11/EE/042)
ARPIT YADAV(19/11/EE/054)
ANANDA MONDAL(21/42/HE/003)
 CONTENTS

Abstract

1. Introduction
- Definition of banking
- Overview of the Indian banking system
- Why do we need Banks?
2. Early Banking in India
- Ancient banking practices in India
- Emergence of indigenous banking systems like chit funds and hundis
- Role of early European traders and settlers in introducing modern banking
practices
3. Establishment of the First Banks
- Foundation of the Bank of Hindustan and General Bank of India
- The impact of the establishment of these banks on Indian trade and economy
- Challenges faced by early banks and their impact on banking practices
4. British Era and Banking Regulation
- The influence of British colonial rule on Indian banking
- Charter Act 1833
- RBI ACT 1935
5. Nationalisation of Banks
- Reasons behind the nationalisation of banks in 1969 and 1980
- Objectives and outcomes of bank nationalisation
6. Liberalisation and Modernization
- The introduction of economic reforms in the early 1990s
- Role of the Narasimham Committee in banking sector reforms
7. Technology and Digital Banking
- Adoption of technology in Indian banking
- Introduction of core banking solutions, ATMs, and online banking
8. Non-Performing Assets (NPA) and Bad Loans
- Rise of NPAs and its impact on the banking sector
- Measures taken to address the NPA crisis
- Challenges in managing and resolving NPAs effectively
9. Conclusion: Future Challenges and Way Forward
- Strategies to overcome challenges and ensure a robust and inclusive banking
system in India.
10. Bibliography
 ABSTRACT
This term paper explores the evolution and history of banking in India, highlighting the
significant milestones and transformations in the banking sector. It also discusses the
modern framework challenges faced by the Indian banking system. The paper aims to
provide a comprehensive overview of the development of banking in India and the
current challenges that need to be addressed. It explores the advent of the new age fintech
to that of how monetary policies and banking systems evolved over the years
 1. INTRODUCTION

In the Indian context, Banking is defined as the accepting of deposits of money from the
public repayable on demand or otherwise, for lending or investment. The Reserve Bank of
India (RBI) serves as the regulatory body in the banking system in India through the
provisions of the Banking Regulation Act, of 1949. Modern banking in India originated in the
mid-18th century with the establishment of banks such as the Bank of Hindustan and the
General Bank of India. The Indian banking industry became an important tool to facilitate the
development of the Indian economy by the 1960s.

Overview of the Indian Banking System

The Indian banking system is one of the largest and most complex in the world, with more
than 100 scheduled commercial banks and over 96,000 branches. It plays a crucial role in the
economy by mobilising savings, creating credit, channelizing funds to productive investment,
promoting financial inclusion, influencing economic activity, providing employment
opportunities, and safeguarding depositors' assets. underwent significant evolution since the
country's independence in 1947. It underwent multiple challenges after post-war and multiple
structural shifts in the banking sector and in the economy.

With the IT revolution, The Indian banking system is undergoing a digital transformation to
keep up with technological advancements. Several banks have embraced technology to offer
digital services such as mobile banking, internet banking, and digital wallets.

Why do we need Banks?

In many ways, Banking financial institutions significantly contribute to people's

socio-economic growth. These are essential because they mobilise people's meagre resources
and direct them towards profitable investments. The population and businesses are served by
the banking sector, which is part of the tertiary sector. The banking industry's financial
activities are important catalysts for accelerating socio-economic growth. Economic
development consequently grows when a country's banking industry becomes more effective.
Banks also safeguard depositors' assets and make loans to individuals and businesses, which
are regulated by the federal government to keep them from taking on too much risk and
imperilling the economy.
Banks are important in capital formation, which is essential for the economic development of
a country. They mobilise the small savings of the people scattered over a wide area through
their branches throughout the country and make it available for productive purposes. Banks
also create credit to provide more funds for development projects.

Banks promote financial inclusion, which is a key enabler to reduce extreme poverty and
boost shared prosperity. The World Bank Group considers financial inclusion as a critical
element of social inclusion, particularly useful in combating poverty and income inequality
by opening blocked opportunities. They influence the economic activity of the country
through their influence on the availability of credit and the rate of interest. If the commercial
banks can provide credit at a lower rate of interest, it will encourage investment and
production in the economy. Banks also create employment opportunities for people in various
fields such as accounting, finance, marketing, and management safeguarding depositors'
assets and making loans to individuals and businesses.

2. EARLY BANKING IN INDIA

The traditional banking procedures in India included currency and monetary system
development. One of India's earliest banking practices dates back to the Vedic era, which
began approximately 2000 BCE. During this period, farming communities stored their excess
grain in enormous structures known as "goshthas," which were overseen by the local
authorities. These “goshthas” served as the forerunners of modern banks, where customers
could make deposits, apply for loans, and pay interest. The current idea of savings and loan
associations can be considered as having its roots in this practice.

Banking techniques made great breakthroughs during the Maurya Empire (322–185 BCE).
An effective banking and financial system called "Shreni" was founded by Emperor
Chandragupta Maurya. In the Shreni system, moneylenders and bankers were performed by
guilds of merchants and artisans. These guilds supported trade by facilitating the exchange of
products and services and by lending money to merchants and artisans. Checks and
promissory notes were also established by the Shreni system, enabling safe and practical
transactions. Emperor Ashoka established a standardised monetary system known as
"punch-marked coins" during the Maurya Empire. These copper or silver coins had a variety
of punch marks and symbols that indicated their value. This uniform system of money
enabled trade and encouraged the expansion of the economy across the empire. In addition,
there was a well-established system of money lending in ancient India known as "usury" or
"Kusidin." "Sahukars," or moneylenders, gave loans to people, companies, and even
governments.
Ancient India also practised the "Hundi" idea in addition to usury. Similar to a promissory
note or a bill of exchange, the hundi was a negotiable document. It made it possible for
traders and businesspeople to send money securely over great distances. Hundi transactions
were made possible by knowledgeable middlemen known as "Shahs" or "Hundiwallas" who
made sure that money was transferred securely and effectively.

The native financial community known as the "Shroffs" or "Shrotriya," which is also known
as the old band provided loans..king in India, made another vital contribution. The Shroff
family first appeared during the Middle Ages and was extremely important in enabling trade
and finance. They served as middlemen in global trade and took deposits, and European
nations like the Dutch, English, and Portuguese were instrumental in developing international
trade networks.In addition to their trading activities, they also created innovative banking
practices that were more advanced and effective than the current methods. The idea of joint
stock firms was also introduced by European traders, allowing several investors to combine
their financial resources for business endeavours. Modern enterprises and the stock market
emerged, thanks to the creation of joint-stock companies.
In conclusion, the early European traders and settlers played a pivotal role in introducing
modern banking practices to various parts of the world. Their establishment of banks, the
introduction of bills of exchange, the implementation of joint-stock companies, and
advancements in accounting methods transformed local financial systems and laid the
foundation for the development of modern banking practices that we see today.

3. THE ESTABLISHMENT OF THE FIRST BANKS

The establishment of the first banks in India can be traced back to the colonial era during
British rule. Bank of Hindustan (1770), General Bank of India (1786), Bank of Bengal
(1806), Bank of Bombay (1840), Bank of Madras (1843) are some of the earliest banks
established in India:

Foundation of the Bank of Hindustan and General Bank of India:

Bank of Hindustan(1770): The Bank of Hindustan was established in 1770, making it one of
the oldest banks in India. It was founded by European traders, most notably English and
Scottish traders, to meet the financial requirements of the growing trade and commerce in
India.

General Bank of India(1786):

The bank was founded by the British Government to facilitate commercial activities in the
region. The General Bank of India primarily catered to the banking needs of British
merchants and traders in Calcutta (now Kolkata).

The impact of the establishment of these banks on Indian trade and economy

The establishment of the Bank of Hindustan and the General Bank of India had a significant
impact on Indian trade and economy during the colonial period:

1) Facilitating Trade: They provided financial services such as credit facilities,

remittances, and the safekeeping of wealth, which were essential for conducting trade
transactions.

2) Mobilising Capital: They helped gather savings from individuals and businesses,
which could then be channelled towards productive investments.

3) Encouraging Entrepreneurship: Banks offered loans, credit facilities, and other

financial products that encouraged entrepreneurial activities.

Challenges faced by early banks and their impact on banking practices:

The early banks of India faced several challenges during their establishment and operations,
which had a significant impact on the development of banking practices in the country.

1) Lack of Regulatory Framework: This absence of clear regulations led to a lack of

oversight and control over the banking sector.
Impact: The challenges faced by early banks highlighted the need for a robust
regulatory framework to ensure the sound functioning of banks.

2) Limited Capital Base: Insufficient capital made it difficult for banks to provide
adequate credit and financing facilities to support economic activities.
Impact: They began issuing shares and seeking investments from individuals and
businesses. This laid the foundation for modern banking practices of raising funds
through equity and debt instruments.

3) Lack of Public Trust: This lack of confidence in the banking system hindered the
acceptance of banking services among the general population.

4) Limited Reach and Connectivity: Limited reach made it difficult for banks to provide
financial services to individuals and businesses in rural and remote areas.
 5) Currency and Coinage Issues: Banks had to contend with the circulation of multiple
currencies, including various regional and foreign currencies, which complicated
banking operations.

4. BRITISH ERA AND BANKING REGULATIONS IN INDIA

The Influence of British colonial rule on Indian Banking

The inception of modern banking in India can be traced back to the establishment of the Bank
of Hindustan in 1770, followed by the Bank of Bengal, Bank of Bombay, and Bank of
Madras in 1806. These banks paved the way for the formalisation of banking practices and
the subsequent need for regulations. The British colonial rulers aimed to safeguard their
economic interests, maintain control over the financial system, and promote trade and
investment, driving the establishment of banking regulations.

The Charter ACT 1833:

The Charter Act of 1833 marked a significant turning point as it established the Presidency
Banks Additionally, it established the groundwork for an extensive regulatory framework and
introduced provisions for limited liability banks. The three Presidency Banks played a vital
role in the evolution of banking regulations; they facilitated trade, issued currency, and
operated as repositories of public funds.

RBI ACT 1935:

The Reserve Bank of India (RBI) was established in 1935 as the central bank of British India.
The RBI played a pivotal role in regulating and supervising the banking sector. It formulated
policies and guidelines, set interest rates, and ensured stability and growth in the banking
industry. During the British era in India, a variety of factors contributed to the establishment
of banking regulations. Regulations were also developed to address problems with
mismanagement in the banking industry, fraud, and counterfeit money.

5. NATIONALISATION OF BANKS

In post-independent India, the first major banking reform or change occurred when the
government of India at that time decided to nationalise banks.The nationalisation of banks in
India in 1969 and 1980 represented a significant step in the country's banking sector reforms.
The key reasons behind the nationalisation included addressing economic power
concentration, promoting financial inclusion, and reducing the influence of private
ownership. The objectives of bank nationalisation encompassed democratising credit,
expanding the branch network, encouraging priority sector lending, and reducing regional
disparities.
This significant event in Indian economic history took place in two phases: first in 1969 and
then in 1980.
1. 1969 Nationalisation: On July 19, 1969, the Indian government, led by Prime
Minister Indira Gandhi, announced the nationalisation of 14 major commercial banks.
This move was primarily aimed at addressing the issue of concentrated economic
power in the hands of a few industrial houses and promoting social welfare by
directing bank credit to priority sectors like agriculture and small-scale industries.

2. 1980 Nationalisation: On April 15, 1980, the government carried out the second
wave of nationalisation, bringing six more banks under state control. This decision
was made to further strengthen the banking sector and expand the reach of banking
services to rural and semi-urban areas. The banks that were nationalised in 1980
include Andhra Bank, Corporation Bank, Indian Bank, Oriental Bank of Commerce,
Syndicate Bank, and Union Bank of India.

Objectives and Outcomes

● To avoid private banks having a monopoly over the market while making banking
services accessible to the masses, in 1969, the nationalisation of major Indian banks
took place.With nationalisation of banks coming in right after the wars in 1962 and
1965, India being under huge economic pressure, needed the banking sector to move
to the more rural areas.
● The overall outcomes of bank nationalisation were generally positive, with increased
banking penetration, improved credit flow to priority sectors, strengthened capital
bases, and expanded rural branch networks.

6. LIBERALISATION AND MODERNISATION

“Nothing is More Powerful than an Idea Whose Time has Come"

This quote of victor hugo was used by the finance minister of India Dr Manmohan Singh
while implementing LPG reforms to address the BOP crisis of 1990s.

The introduction of economic reforms in the early 1990s

India underwent significant economic reforms in the early 1990s to liberalise and modernise
its economy. The reforms aimed to address a balance of payment crisis and the recognition
that the previous system of closed markets and extensive government control hindered
economic growth. The reforms covered various sectors, such as industry, trade, and finance,
to promote market-oriented policies, attract foreign investment, and enhance competitiveness.
A critical focus of these reforms was the restructuring and revitalization of the banking
sector. The existing banking system faced challenges and limitations that impeded economic
growth and efficiency. Some of these issues included:

1. Outdated Regulatory Framework: The regulatory framework governing the banking

sector was outdated and restrictive.
2. Inefficient Public Sector Banks: The dominance of public sector banks (PSBs) led to
inefficiencies.
3. Weak Risk Management and Corporate Governance: The banking sector lacked
robust risk management systems and proper corporate governance practices.
4. Inadequate Capital Markets: Underdeveloped capital markets limited banks' ability to
raise funds and effectively manage their capital requirements. This restricted the
availability of long-term financing options and hindered efficient capital allocation
across various sectors of the economy.

To address these challenges, banking sector reforms were introduced as part of the broader
economic reforms. The reforms aimed to improve the governance and autonomy of banks,
enhance transparency and accountability, foster competition, strengthen risk management
frameworks, and promote financial inclusion.

Role of the Narasimham Committee in banking sector reforms

The Narasimham Committee, led by M. Narasimham, played a crucial role in proposing

important reforms for India's banking sector. Established in 1991, the committee submitted
two reports: one in 1991 (Narasimham Committee I) and another in 1998 (Narasimham
Committee II). These reports laid the groundwork for significant transformations in the
Indian banking system, addressing various issues and introducing key reforms.

1. Capital Adequacy Norms: The committee recommended adopting international

standards for capital adequacy, as defined by the Basel Committee on Banking
Supervision..
2. Strengthening Bank Supervision: The committee emphasised the need for an
independent and effective supervisory mechanism to ensure the soundness and
stability of banks..
3. Establishment of Asset Reconstruction Companies (ARCs): To address the problem of
non-performing assets (NPAs) and improve banks' asset quality, the committee
proposed establishing specialised asset reconstruction companies.
4. Liberalisation of Interest Rates: The committee recommended gradually deregulating
interest rates to introduce market-based pricing mechanisms..
5. Entry of New Banks and Foreign Banks: The committee suggested allowing the entry
of new private sector banks to encourage competition and bring in fresh capital and
technology.
 7. EVOLUTION OF TECHNOLOGY AND DIGITAL BANKING IN
INDIA

The adoption of technology in the Indian banking sector has unfolded as a significant
milestone in its historical trajectory. Over the years, the Indian banking industry has
witnessed a transformative journey driven by technological advancements, bringing about
progressive changes in the way banking services are delivered and accessed.

Introduction Of CBS, ATM and Online Banking:

In the later years of the 20th century, the Indian banking landscape experienced a paradigm
shift with the introduction of core banking solutions (CBS). This marked a departure from the
traditional decentralised approach to a centralised system, where banks embraced
computerised software applications to streamline their operations. CBS enabled banks to
manage customer accounts, deposits, loans, and transactions in a real-time and integrated
manner. This shift toward centralized operations enhanced efficiency, reduced redundancy,
and made the process seamless across multiple branches.

Another central development in the digitalisation of Indian banking was the introduction of
Automated Teller Machines (ATMs). In the early 1990s, ATMs made their appearance,
revolutionising the way customers accessed their money and basic banking services. These
self-service machines enabled individuals to withdraw cash, check their account balances,
transfer funds, and perform other routine banking tasks independently and conveniently. The
increasing significance of ATMs across the nation brought banking services closer to the
people, transforming the common person’s banking experience.

The 21st century saw a surge in Internet connectivity Banks seized this opportunity and
introduced online banking services, also known as Internet banking. It empowered customers
to access their bank accounts and conduct various transactions through secure websites or
mobile applications. Online banking has become increasingly popular due to its convenience,
accessibility, time, and other benefits.

A Central Bank Digital Currency (CBDC) pilot project was started by the RBI in November
2022. Overall, the Indian banking system has undergone significant evolution over the years
and today plays a vital role in the economic development of India.
 8. NON-PERFORMING ASSETS (NPAS) AND BAD LOANS

The rise of NPAs and bad loans in India

Non-performing assets (NPAs) are loans that have not been repaid by borrowers for a while.
Bad loans are a subset of NPAs that are considered to be unlikely to be repaid. NPAs and bad
loans have been a significant concern in the Indian banking sector over the years. The
introduction of economic reforms and the opening up of markets led to a surge in credit
availability, which subsequently resulted in increased lending by banks. However, this rapid
credit expansion also brought about challenges in terms of loan quality and repayment.

The Non-Performing Assets (NPA) crisis in India has emerged as a significant challenge in
the banking sector, posing threats to financial stability and economic growth.
The development of NPAs has been significantly influenced by weak risk management
systems, loose lending standards, and insufficient credit appraisal mechanisms. Furthermore,
the issue has been made worse by outside factors like sector-specific problems, policy
uncertainties, and economic downturns. The NPA crisis has also been exacerbated by
high-profile willful defaults and corporate governance failures.

The NPA crisis has severe implications for India's banking sector, economy, and society as a
whole. Financial institutions face increased credit risk, reduced profitability, and weakened
balance sheets. This, in turn, constrains banks' ability to lend, impacting economic growth
and investment. Additionally, the NPA crisis has implications for financial stability, as it can
erode public confidence in the banking system.
Addressal of NPA issue

The NPA crisis has been addressed by regulatory reforms, such as the 2016 introduction of
the Insolvency and Bankruptcy Code (IBC). The IBC offers a structured framework with
deadlines for the resolution of stressed assets, enhancing transparency and creditor rights.
Asset Reconstruction Companies (ARCs), which buy bank-owned distressed assets to restore
and revitalise them, have also grown in popularity. Additionally, the creation of a "bad bank"
or National Asset Reconstruction Company (NARC) is being considered. By centralising
NPAs, banks will be able to offload them and concentrate on their core business of banking.
The banking industry and the country's economy are both greatly hampered by the NPA
crisis. Recent events, such as regulatory changes, the function of ARCs, and the proposed bad
bank idea, show that the crisis is being addressed.

9. CONCLUSION: FUTURE CHALLENGES AND THE WAY

FORWARD

With the constant Evolution of the monetary banking system and banking as we have
explored throughout this paper, in today’s technological close-knit global world there is
no such thing as independent monetary policy, the new decentralised system like Bitcoin
has presented new challenges and the development of the fintech world has questioned

the financial prudence and penetration of country like India. The above-mentioned
challenges were explored and at last, we put these tentative strategies.

The Way Forward: Strategies to Overcome Challenges and Ensure a Robust and
Inclusive Banking System in India
To overcome the challenges faced by the Indian banking system and ensure its resilience and
inclusivity, several strategies can be adopted. These include:

1. Strengthening Risk Management: Banks should enhance their risk management

frameworks, including credit risk assessment, liquidity management, and stress
testing, to mitigate potential risks effectively.
2. Embracing Technology: Continued investment in technology infrastructure, digital
banking solutions, and automation can improve operational efficiency, enhance
customer experience, and enable robust cybersecurity measures.
3. Collaboration and Partnerships: Collaborations between banks, fintech companies,
and other stakeholders can drive innovation, develop new products, and expand
access to financial services, particularly in underserved areas.
4. Promoting Financial Literacy: Educating customers about banking services, digital
literacy, and responsible financial practices can enhance financial inclusion and
empower individuals to make informed financial decisions.
5. Strengthening Regulatory Framework: Regular evaluation and updating of
regulatory frameworks to address emerging risks, promote consumer protection, and
ensure compliance can contribute to a robust and well-regulated banking system.
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