Subjects /Indian Economy / Banking System in India

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Introduction
27 Mar 2021

Banking system laid the foundation of economic development in India. The process of banking in India started in colonial era, when in 1970 Bank of Hindustan was established and the process of development of banking system is still going incorporating technological development. In this article we will cover in detail:

  • The evolution of the banking system
  • Types of system in India
  • Advantages of banking system in India
  • Nationalisation of Banks
  • Indian Banks Association

History of Banking in India

Bank of Hindustan was the first bank to be established, based on the European Banking system in 1770, by Alexander and Co.

List of banks after the first bank is:

  • In 1773, The General Bank of Bengal and Bihar on the proposal by Governor Warren Hastings.
  • In 1806, Bank of Bengal was established. It was the first Presidency bank with the capital of Rs. 50 lakh.
  • In 1840, Bank of Bombay was established.
  • In 1843, Bank of Madras was established.
  • In 1921, all these 3 banks were merged and renamed as Imperial Bank of India. This bank worked as a central bank and performed the functions of commercial banking, central banking and the banker to the government.
  • In 1955, Imperial bank was Nationalised and renamed as State Bank of India, at present it is the largest Commercial Bank of India.
  • In 1881, Oudh Commercial Bank was established. It was the first bank by Indians. But it also contained Foreign Capital.
  • The First fully Indian Bank was Punjab National Bank, established in 1894.
  • In 1969, 14 Banks were Nationalised and in 1980, 6 other banks were nationalised.
  • Later on, New Bank of India was merged in Punjab National Bank.

At present there are 12 National Banks in India.

Nationalisation of Banks

Nationalisation of banks brought major banks under the control of government.

  • The first bank to be nationalised was Reserve Bank of India. It was nationalised after the passage of Reserve Bank (Transfer of Public Ownership) Act 1948.
  • The first commercial bank to be nationalised was State Bank of India on 1st July 1955. After this, 7 State associated banks were nationalised as subsidiaries of the State Bank of India.
  • Major nationalisation of bank took place in 1969 when, 14 major commercial banks with deposits exceeding Rs. 50 crores were nationalised.
  • In 1980, 6 more commercial banks that had deposits above Rs. 200 crores were nationalised.
  • On 1st April 2017, 5 associates and Bhartiya Mahila Bank were merged with SBI.

Reasons for Nationalisation of Banks

The main objective of nationalisation was “to serve better the needs of development of the economy in conformity with national policy and objectives and for matters connected with it”. Other objectives include:

  • To ensure the operations of banking system for a larger social purpose and to subject them to close public regulation.
  • To meet the legitimate credit needs of private sector industry and trade big or small.
  • To actively foster the growth of the new and progressive entrepreneurs and credit fresh opportunities for neglected and backward areas in different parts of the country.
  • To curb the use of bank credit for speculative and other unproductive purposes
  • To reduce regional and sectoral imbalance in banking and through that in economic development.

Types of Banks in India

Banks are classified as Scheduled and Non-scheduled Banks according to the RBI Act 1939.

  • The banks which are included in the Second Schedule of RBI Act, 1939 are called the scheduled banks.
  • All Commercial Banks, Regional Rural Banks and State Cooperative Banks fall under the category of scheduled banks.
  • All banks that are not included in the second schedule of RBI Act, 1934 are called Non-schedule banks. The RBI has no control over such banks.

Types of Banks

Central Bank

Commercial Banks

Development Bank

Co-operative Banks

Specialised Banks

  • National Housing Bank
  • Public Sector Banks
  • Private Sector Banks
  • Foreign Sector Banks
  • Development Financial Institutions (DFI)
  • Primary Credit Societies.
  • Central Co-operative Banks.
  • State Co-operative Banks
  • EXIM
  • SIDBI
  • NABARD

 

 

Commercial Banks

The banks that do the banking business i.e. deals with general public, accept deposits, give loans to large number of enterprises and personal loans.

Example: PNB, ICICI, HDFC

Types of Commercial Banks

  • Public Sector Banks: When majority stake in bank is held with the government of India, then it is called public sector bank.
  • Private Sector Bank: When majority of shares of bank is held by private individuals and these are registered as companies with limited liability, then these banks are called private sector banks.
  • Foreign Banks: The banks that are registered and has their headquarters in a foreign country and operate through their branches in India, then these banks are called foreign banks. For example: HSBC, Citibank.


Development Banks

These are financial institutions which are formed to promote the economic development of the country.

These banks provide medium term and long-term loans to the entrepreneurs at relatively low rates of interest.

Example: DFI – Development Financial Institutions


Co-operative Banks

Originally, co-operative banks were set up in India to provide credit to farmers at cheaper rates. However, now they function in urban sectors as well.

They primarily finance and provide wide range of banking and financial services to for the agricultural activities, small-scale industries and self-employed workers.

Anyonya Co-operative Bank Limited is the first co-operative bank in India. It is located in Gujarat.

Types of Co-operative Banks

Cooperative Banks

State Co-operative Banks

State Land Development Banks

Urban Co-operative Bank

District Co-operative Bank

District land development Bank

 

Primary Credit Society

Primary Land Development Bank

 

                        

Regional Rural Bank ­

In 1975, in all states except Sikkim and Goa and their capital is divided into 3 parts. 50% Central Govt, 15% State Govt, 35% sponsored.

 

Other Public Sector Bank - IDBI

  • Mahila Bank - Announced by P. Chidambaram
  • UTI bank got the first licence of Private banking later on it was renamed as Axis bank.
  • In 2013, RBI approved two new licence to banking namely IDFC and Bandhan Bank.
  • ICBC – Industrial and Commercial Bank of China. It is world’s largest bank in Capital.

 

NBFC – Non-Banking Financing Companies.

NBFCs were established under Company Act, but regulated by RBI.

  • It can now open Saving Accounts, Current Accounts.
  • It cannot issue Cheques and Drafts
  • It can accept deposits under any scheme.
  • They can participate in sale and purchase of Government Securities like other bank.

Example:

Sahara Bank, Muthoot Finance.

 

Specialised Banks

NABARD – National Bank for Agriculture and Rural Development

  • It was established in 1982, on the recommendation of Shiv Raman Committee.
  • It is the apex institution for the rural and agricultural development.

 

Indian Banks Association

Indian Bank's Association (IBA) was formed on 26th September 1946 with 22 members. Currently, there are 247 members.

The list of members is:

  • Public Sector Banks
  • Private Sector Banks
  • Foreign Banks with offices in India
  • Co-operative Banks
  • Regional Rural Banks
  • All India Financial Institution

Current Chief Executive: Sh. Sunil Mehta (Year 2021)

Current Deputy Chief Executive: Mr. Gopal Murli Bhagat (Year 2021)

Current Chairman of IBA: Sh. Rajkiran Rai (Year 2021)


Objectives of IBA

  • To promote and develop in India sound and progressive banking principles, practices ad conventions and to contribute to the developments of creative banking.
  • To render assistance and to provide various common services to members and to the banking industry.
  • To develop and implement new ideas and innovations in banking services, operations and procedures.
  • To collect, classify and circulate statistical and other information on the structure and working of the banking system
  • To organize exchange of credit information and opinions, export information or information and views on any other aspects of interest to banks or the banking industry.
  • To project a good public image of banking as a service industry and develop good public relations.


Financial Inclusion

Financial Inclusion refers to all the activities and steps taken by RBI and Government of India to improve the accessibility of Banking and Financial System to deprived sections of society as well as to the remote area of country.

Financial Inclusion involves activities like

  • Nationalisation of Banks
  • Establishment of RRBs
  • Adoption of Villages by Banks
  • Promotion of Self-Help Groups
  • Establishment of White Level ATMs
  • Improving Mobile Banking
  • Opening Zero Balance account or No Frill Accounts
  • Adopting Universal Banking
  • Micro Credit and Micro Finance

Note:

Adopting Universal Banking was recommended by Nachiket Mor Committee.

Micro Credit and Micro Finance were recommended by Malegam Committee.

Universal Banking

When a bank involves in extra-activities apart from its traditional functioning like insurance, share market, etc, is considered as Universal Banking.

ICICI is the first bank in India falling under this category.

Note:

LIBOR -London Inter Bank Offer Rate

MIBOR – Mumbai Inter Bank Offer Rate

These are rate of interests for bank-to-bank transaction in London and Mumbai as well as also used as reference rate of Interest.

Other important terms

Non-Performing Assets (NPA)

When loan of a bank is not paid up to 90 days. In other words when Principal and Interest of a loan is unpaid for 90 days. It is considered as NPA by the bank.

It is one of the important challenges before Public Sector Bank.


CAR/CRAR

Capital Adequacy Ratio which is better expressed as Capital to Risk Weighted Asset Ratio.

Under this every bank has to maintain a certain part of its own capital against every loan extended by it.

At present it is 9% in India.

It is one of the measures to avoid any financial crisis in future.


Base Rate

It is that rate of interest below which a bank cannot extend a loan to anyone.

  • It was adopted in 2010, in order to maintain transparency in the system.
  • It is decided by the bank themselves, according to their costs and profits.


Banking Ombudsman

  • It is a semi-judicial office appointed by RBI to resolve the disputes between bank and customers.
  • No fee is given for the service but appeal could be made against his verdict to the deputy Governor of the RBI, which means his decision is not final.
  • At present 15 such men are functioning in the country.


PLR – Prime Lending Rate

PLR of a bank is that rate of interest at which bank is ready to extend loan to its most reliable customer, about which the risk is relatively low.

RBI has removed this facility and introduced Base rate.