1

CHAPTER : 1
HISTORY OF INDIAN BANKING SYSTEM

The Beginning

The English traders that came to India in the 17th century could not make much use of the indigenous
bankers, owing to their ignorance of the language as well the inexperience indigenous people of the
European trade.

Therefore, the English Agency
1
Houses in Calcutta a Bombay began to conduct banking
business, besides their commercial business, based on unlimited liability. The Europeans with aptitude
of commercial pursuit, who resigned from civil and military, organized these agency houses. A
type of business organisation
recognizable as managing agency took form in a period from 1834 to 1847.






The primary concern of these agency houses was trade, but they branched out into banking as a
sideline to facilitate the operations of their main business. The English agency houses, that began to
serve as bankers to the East India Company had no capital of their own, and depended on deposits for
2

their funds. They financed movements of crops, issued paper money and established joint stock banks.
Earliest of these was Hindusthan Bank, established by one of the agency houses in Calcutta in 1770.

Banking in India originated in the last decades of the 18th century. The first bank in India, though
conservative, was established in 1786 in Calcutta by the name of bank of Bengal. Indian banking
system, over the years has gone through various phases. For ease of study and understanding it can be
broken into four phases



These phases are based upon personal study and understanding and many experts may ir may not
agree this chronological segmentation.

Prof K.V. Bhanu Murthy

has also segregates the Indian banking periods into four eras. These are

1. Early historical and formative era: 1770-1905

2. Pre-independence era: 1906-1946

3. Post independence regulated era: 1947-1993

4. Post independence deregulated era from 1993 onwards

3

1.1
EARLY PHASE (1786 TO 1935)

Banking in India originated in the last decades of the 18th century. The first banks were The
General Bank of India, which started in 1786, and the Bank of Hindustan, both of which are now
defunct.





The oldest bank in existence in India is the State Bank of India, which originated in the Bank of
Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the
three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three
of which were established under charters from the British East India Company.

For many years the Presidency banks acted as quasi-central banks, as did their successors. The East
India Company established Bank of Bengal, Bank of Bombay and Bank of Madras as independent
units and called it Presidency Banks. The three banks merged in 1925 to form the Imperial Bank of
India, which, upon India's independence, became the State Bank of India.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire dEscompte
de Paris opened a branch in Calcutta in 1860 and another in Bombay in 1862; branches in Madras and
Pondichery, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was
the most active trading port in India, mainly due to the trade of the British Empire, and so became a
banking center.

4

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in
1848 because of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still
functioning today, is the oldest Joint Stock bankin India.

JointStock Banks
American Civil War played a major role in the development of banking in India. The next big thing
unfolded in the early phase of banking was formation of joint stock companies, with limited liability.
The American Civil War cut off the supply of American cotton to England caused an unprecedented
boom in Indias cotton trade with England.

The first joint stock bank was Bank of Upper India, which was established in 1863, and which
survived until 1913, when it failed, with some of its assets and liabilities being transferred to the
Alliance Bank of Shimla.

The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in
Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895,
which has survived to the present and is now one of the largest banks in India

Stability & Growth
Around the turn of the 20th Century, the Indian economy was passing through a relative period of
stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other
infrastructure had improved. Indians had established small banks, most of which served particular
ethnic and religious communities.
5

The presidency banks dominated banking in India but 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 under capitalized and lacked the experience and maturity to
compete with the presidency and exchange banks.

"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."

SWADESHI MOVEMENT

The Swadeshi movement inspired local businessmen and political figures to found banks of and for
the Indian community. 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.

Ammembal Subba Rao Pai founded Canara Bank Hindu Permanent Fund in
1906. Central Bank of India was established in 1911 by Sir Sorabji Pochkhanawala and was the first
commercial Indian bank completely owned and managed by Indians. In 1923, it acquired the Tata
Industrial Bank.

The fervor of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada
and Udupi district which were unified earlier and known by the name South Canara (South Kanara )
district.

6

Four nationalized banks started in this district and also a leading private sector bank. Hence,
undivided Dakshina
Kannada district is
known as "Cradle of
I ndian Banking".


Banks with Year of Start
Bank of Bengal 1809
Bank of Bombay 1840
Bank of Madras 1843
Allahabad Bank 1865
Punjab National Bank Ltd. 1894
Canara Bank 1906
Indian Bank 1907
Bank of Baroda 1908
Central Bank of India 1911
Bank of Mysore 1913
Union Bank if India 1922
7

FAILURE IN THE EARLY PHASE

During the first phase, the growth was very slow and banks experienced periodic failures during the
Early Phase between. There were approximately 1100 banks, mostly small which failed within
the early phase

The first major bank failure took place in 1791, when General Bank of India was voluntarily
liquidated, due to inability to earn profits following the currency difficulties in 1787. Bengal
Bank failed around 1791, due to a run on it caused by emergence of difficulties of a related firm.

A large number 14 of banks failed within a short time, and public confidence in banks was
destroyed. The currency confusion during 1873-1893 caused trade uncertainties and also played its
role in creating an atmosphere unfavorable to establishment of new banks.

Due to war and uncertainty in Europe let to speculative activity, which eventually caused bank
failures. The depositors lost money and lost interest in keeping deposits with banks. Subsequently,
banking in India remained the exclusive domain of Europeans for next several decades until the
beginning of the
20th century.

Development of banking, during this period, was mostly because very deregulated (laissez
faire policy). This also played a major role in failures. The deficiency of capital made newly
established banks almost wholly dependent on deposits. Keen rivalry among them to attract deposits
led to luring of depositors, with rates of interest much higher than they could really afford.

8

During 1913, Indian Companies Act
3
was passed. It contained a few sections related to joint
sector banks. While this act is significant, being the first legislation related to banks, it was not
adequate for regulation of banking activity. Many banks were left altogether free from regulation.
9

1.2 PRE NATIONALIZATION PHASE (1935 TO 1969)

Organized banking in India is more than two centuries old. Until 1935 all, the banks were in private
sector and were set up by individuals and/or industrial houses, which collected deposits from
individuals and used them for their own purposes.

In the absence of any regulatory framework, these private owners of banks were at liberty to use the
funds in any manner, they deemed appropriate and resultantly, the bank failures were frequent.

For many years the Presidency banks acted as quasi- central banks, as did their successors. Bank
of Bengal, Bank of Bombay and Bank of Madras merged in 1925 to form the I mperial Bank of
India, which, upon India's independence, became the State Bank of I ndia.

Even though consolidation in banking was building trust among the investors but a central
regulatory, authority was much needed. British Government in India passed many trade and
commerce laws but acted little on regulating the banking industry.

Reserve bank of india

Another breakthrough happened in this phase, which was Reserve Bank of I ndia.
The Reserve Bank of India was set up on the recommendations Royal Commission
on Indian Currency and Finance
4
also known as the Hilton-Young
Commission. The commission submitted its report in the year 1926, though the bank
was not set up for nine years.

10

Reserve Bank of India (RBI) was created with the central task of maintaining monetary stability in
India. The Government on December 20, 1934 issued a notification and on January 14, 1935, the
RBI came into existence, though it was formally inaugurated only on April 1, 1935.

Main functions of RBI were
1. Regulate the issue of banknotes

2. Maintain reserves with a view to securing monetary stability and

3. To operate the credit and currency system of the country to its advantage

The Bank began its operations by taking over from the Government the functions so far being
performed by the Controller of Currency and from the Imperial Bank of India. Offices of the
Banking Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon.
Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank continued to act as
the Central Bank for Burma until Japanese Occupation of Burma and later unto April 1947.

After the partition of India, the Reserve Bank served as the central bank of Pakistan up to June 1948
when the State Bank of Pakistan commenced operations.
11

India Wins Freedom

I think the second milestone in history of Indian banking was India becoming a sovereign republic.
The Government of India initiated measures to play an active role in the economic life of the nation,
and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed
economy

. This resulted into greater involvement of the state in different segments of the economy
including banking and finance.

The banking sector also witnessed the benefits; Government took major steps in this Indian
Banking
Sector Reform after independence.

First major step in this direction was nationalized of Reserve Bank in 1949.
Enactment of Banking Regulation Act in 1949
Reserve Bank of India Scheduled Banks' Regulations, 1951.
Nationalization of Imperial Bank of India in 1955, with extensive banking facilities on a
large scale especially in rural and semi-urban areas.
Nationalization of SBI subsidiaries in 1959


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. -

1955 The I ndustrial Credit and I nvestment Corporation of I ndia Limited (I CI CI ) was
incorporated at the initiative of World Bank, the Government of India and representatives of
Indian industry, with the objective of creating a development financial institution for
12

providing medium-term and long-term project financing to Indian businesses.

I ndustrial Development Bank of I ndia Limited (I DBI ) was established in 1964 by an Act of
Parliament to provide credit and other facilities for the development of the fledgling Indian
industry. Some of the institutions built by IDBI are The National Stock Exchange of India
(NSE), The National Securities Depository Services Ltd. (NSDL) and the Stock Holding
Corporation of India (SHCIL) IDBI BANK, as a private bank after government policy for
new generation private banks.

This phase of Indian banking was eventful and was a phase of restructuring, regulation.
However, despite these provisions, control and regulations, banks in India except the State Bank of
India, continued to be owned and operated by private persons.














13

1.3 POST NATIONALIZATION PHASE (1969 TO 1990)

I think nationalization
7
of banks in India was an important phenomenon. On J uly 19, 1969 - the
erstwhile government of India nationalized 14 major private banks. Nationalization of bank in
India was not new or happening first time. From 1955 to 1960, State Bank of India and other seven
subsidiaries were nationalized under the SBI Act of 1955.


List of Nationalized Banks in 1969

1 Central Bank of India 8 Indian Overseas Bank
2 Bank of Maharashtra 9 Bank of Baroda
3 Dena Bank 10 Union Bank
4 Punjab National Bank 11 Allahabad Bank
5 Syndicate Bank 12 United Bank of India
6 Canara Bank 13 UCO Bank
7 Indian Bank 14 Bank of India

It was not a step taken at random or because of the whims of the leadership of the time, but
reflected a process of struggle and political change which had made this an important demand of the
people.

Nationalisation took place in two phases, with a first round in 1969 covering 14 banks followed
by another in 1980 covering seven banks. Currently there are 27 nationalized commercial banks.

The following are the steps taken by the Government of India to Regulate Banking Institutions in the
Country:
14

1949 : Enactment of Banking Regulation Act.
1955 : Nationalisation of State Bank of India.
1959 : Nationalisation of SBI subsidiaries.
1961 : Insurance cover extended to deposits.
1969 : Nationalisation of 14 major banks.
1971 : Creation of credit guarantee corporation.
1975 : Creation of regional rural banks.
1980 : Nationalisation of seven banks with deposits over 200 crore.
After the nationalisation of banks, the branches of the public sector bank India rose to approximately
800% in deposits and advances took a huge jump by 11,000%.

Reasons for Nationalization

1. The need for the nationalization was felt mainly because private commercial banks were
not fulfilling the social and developmental goals of banking, which are so essential for any
industrializing country. Despite the enactment of the Banking Regulation Act in 1949 and
the nationalization of the largest bank, the State Bank of India, in 1955, the expansion of
commercial banking had largely excluded rural areas and small-scale borrowers.

2. The developmental goals of financial intermediation were not being achieved other than for
some favored large industries and established business houses. Whereas industrys share
in credit disbursed by commercial banks almost doubled between 1951 and 1968, from 34
per cent to 68 per cent, agriculture received less than 2 per cent of total credit.

15

3. The stated purpose of bank nationalization was to ensure that credit allocation occur in
accordance with plan priorities.

4. Reduce the hold of moneylenders and make more funds available for agricultural
development.
Nationalization of bank was to actively involve in poverty alleviation and
employment generation programs.

Advantages of Nationalization

1. Nationalized banks had to provide 18 per cent of their net credit to the agricultural
sectors.
This was targeted to reduce the hold of moneylenders and make more funds available
for agricultural development. This has substantially helped farmers.

2. The reach of banking widened; the entry barriers that existed for customers to bank,
social economic and political were lowered. This resulted in a massive quantitative
expansion of the bank customer base as well as in the nature of services provided. Absence
of concern for profitability and targeting made banks to expand rapidly in un-banked
areas thereby the entire country was linked to banking activity.

3. Enhanced bank credit to the farm sector became instrumental for the success of
green revolution and the increase of aggregate food grain production in north and northwest
India in the 1970s and in the eastern region in the 1980s.

16

4. Increase in exports by small-scale manufacturers over the 1980s and 1990s, such that
they accounted for around two-third of the total value of all exports, was strongly related to
access to bank credit provided by priority sector norms.

5. Collection of saving: Private banks were not that good in attracting more saving.
However, with nationalization banks were now backed by Government of India, which
tremendously improved their credibility. This helped in more deposits, more savings hence
more supply of money.



National Bank for Agricultural and Rural Development (NABARD) was set up in 1982, as an
apex institution for agricultural and rural credit, though primarily, a refinance extension institution.

Board for Industrial & Financial Reconstruction (BI FR) came into existence under Sick
Companies (Special Provisions) Act 1985 and started its operations wef May 15, 1987. It is meant
to deal with sick companies or potential sick companies as defined under the Act. BIFR, based
on a reference by the concerned sick company, takes a decision whether the company should be
rehabilitated or wound up.







17

1.4 MODERN PHASE FROM 1991 TILL DATE

This is the phase of New Generation tech-savvy banks. This phase can be called as The
Reforms Phase. Starting of the modern and current phase of Indian Banking is marked by two
important events.

Narasimhan Committee
The Committee on Banking Sector Reforms Committee
8
headed by Mr. M. Narasimhan, it is also
known as Narasimhan Committee. The Committee, headed by former Reserve Bank of India
governor M Narasimhan, was appointed by the United Front government to review the progress in
banking sector reforms. The committee submitted its recommendations to union Finance Minister
Yashwant Sinha in November of 1991.

The Committee was required to review the progress in the reforms in the banking sector over the
past six years with and to chart a programme on Financial Sector Reforms necessary to
strengthen the India's financial system and make it internationally competitive taking into account
the vast changes in the international and financial markets, technogical advances. Some of the
recommendations offered by the committee are:
1. A reduction, phased over five years in the Statutory Liquidity Ratio (SLR) to 25
percent, synchronized with the planned contraction in Fiscal Deficit.
2. A progressive reduction in the Cash Reserve Ratio (CRR).
3. Gradual deregulation of interest rates.
4. All banks to attain Capita Adequacy 8% in a phased manner.
5. Banks to make substantial provisions for bad and doubtful debts.
6. Profitable and reputed banks be permitted to raise capital from the public.
18

7. Instituting an Assets Reconstruction Fund to which the bad and doubtful debts of banks
andFinancial Institutions could be transferred at a discount.
8. Facilitating the establishment of new private banks, subject to RBI norms.
9. Banks and financial institutions to classify their assets into four broad groups, viz,
Standard, Sub-standard, Doubtful and Loss.
10. RBI to be primarily responsible for the regulation of the banking system.
11. Larger role for Securities Exchange Board of India (SEBI), particularly as a market
regulator rather than as a controlling authority.


Economic Liberalization in India

The second major turning point in this phase was Economic Liberalization in I ndia. After
Independence in 1947, India adhered to socialist policies. The extensive regulation was
sarcastically dubbed as the "License Raj".

The Government of India headed by Narasimha Rao decided to usher in several reforms that
are collectively termed as liberalization in the Indian media with Manmohan Singh whom he
appointed Finance Minister.

Dr. Manmohan Singh, an acclaimed economist, played a central role in implementing these
reforms. New research suggests that the scope and pattern of these reforms in India's foreign
investment and external trade sectors followed the Chinese experience with external economic
reforms.

Reasons for the Reforms
19

A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF
bailout, gold was transferred to London as collateral, the Rupee devalued and economic reforms
were forced upon India.

That low point was the catalyst required to transform the economy through badly needed reforms to
unshackle the economy. Controls started to be dismantled, tariffs, duties and taxes progressively
lowered, state monopolies broken, the economy was opened to trade and investment, private sector
enterprise and competition were encouraged and globalisation was slowly embraced.

Impact of Economic Liberalization on Finance & Banking
Post nationalization now Indian banking sector was unshackled, and along with the
government banks a thick layer of private and foreign banks was taking shape. The first of such new
generation banks to be set up was Global Trust Bank, which later amalgamated with Oriental Bank
of Commerce, ICICI Bank, HDFC Bank and Axis Bank.
This move, along with the rapid growth in the economy of India, revitalized the banking sector in
india.
The next stage for the Indian banking has been setup with the proposed relaxation in the norms for
Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights, which
could exceed the present cap of 10%, at present it has gone up to 49% with some restrictions.
The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks.
All this led to the retail boom in India. People not just demanded more from their banks but also
received more.



Banking Sector Reforms since 1992
20

The first type of reforms mainly based on Narasimhan Committee recommendations and the
principals of new liberalized Indian economy.
Out of the 27 public sector banks (PSBs), 26 PSBs achieved the minimum capital to risk
assets ratio (CRAR) of 9 per cent by March 2000. To enable the PSBs to operate in
a more competitive manner, the Government adopted a policy of providing autonomous
status to these banks, subject to certain benchmarks.
The Reserve Bank advised banks in February 1999 to put in place an ALM system,
effectiveApril 1, 1999 and set up internal asset liability management committees (ALCOs)
at the top management level to oversee its implementation. Banks were expected to cover at
least 60 percent of their liabilities and assets in the interim and 100 per cent of their business
by April 1,2000.
Interest rate deregulation has been an important component of the reform process. The
interest rates in the banking system have been largely deregulated except for certain specific
classes; these are savings deposit accounts, non-resident Indian (NRI) deposits, small loans up
to Rs.2 lakh and export credit.
In 1994, a Board for Financial Supervision (BFS) was constituted comprising select
members of the RBI Board with a variety of professional expertise to exercise 'undivided
attention to supervision'. The BFS, which generally meets once a month, provides
direction on a continuing basis on regulatory policies including governance issues and
supervisory practices. It also provides direction on supervisory actions in specific cases.
The share of the public sector banks in the aggregate assets of the banking sector has come
down from 90 per cent in 1991 to around 75 per cent in 2004. The share of wholly
Government-owned public sector banks has declined from about 90 per cent to 10 per cent of
aggregate assets of all scheduled commercial banks during the same period. Diversification
of ownership has led to greater market accountability and improved efficiency. Current
market value of the share capital of the Government in public sector banks has increased
21

manifold and as such, what was perceived to be a bailout of public sector banks by
Government seems to be turning out to be a profitable investment for the Government.
A Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) has
also been recently constituted to prescribe policies relating to the regulation and supervision
of all types of payment and settlement systems, set standards for existing and future systems,
authorize the payment and settlement systems and determine criteria for membership to these
systems. Both the Houses of the Parliament have passed the Credit Information Companies
(Regulation) Bill, 2004.
Consolidation in the banking sector has been another feature of the reform process. This also
encompassed the Development Financial Institutions (DFIs), which have been providers of
long-term finance.

Since 1993, twelve new private sector banks have been set up. As already mentioned, an element of
private shareholding in public sector banks has been injected by enabling a reduction in the
Government shareholding in public sector banks to 51 per cent. As a major step towards enhancing
competition in the banking sector, foreign direct investment in the private sector banks is now
allowed up to 74 per cent, subject to conformity with the guidelines issued from time to time.
Currently, banking in India is generally fairly mature in terms of supply, product range and reach-
even though reach in rural India still remains a challenge for the private sector and foreign banks. In
terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and
transparent balance sheets relative to other banks in comparable economies in its region.
Reserve Bank of India in March 2006 allowed Warburg Pincus to increase its stake in
Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been
allowed to hold more than 5% in a private sector bank.
22

CHAPTER : 2
ORGANISATIONAL STRUCTURE
The entire organised banking system comprises of scheduled and non-scheduled banks. Largely, this
segment comprises of the scheduled banks, with the unscheduled ones forming a very small
component. Banking needs of the financially excluded population is catered to by other unorganised
entities distinct from banks, such as, moneylenders, pawnbrokers and indigenous bankers.
Scheduled Banks A scheduled bank is a bank that is listed under the second schedule of the RBI Act,
1934. In order to be included under this schedule of the RBI Act, banks have to fulfill certain
conditions such as having a paid up capital and reserves of at least 0.5 million and satisfying the
Reserve Bank that its affairs are not being conducted in a manner prejudicial to the interests of its
depositors. Scheduled banks are further classified into commercial and cooperative banks. The basic
difference between scheduled commercial banks and scheduled cooperative banks is in their holding
pattern. Scheduled cooperative banks are cooperative credit institutions that are registered under the
Cooperative Societies Act. These banks work according to the cooperative principles of mutual
assistance.
Scheduled Commercial Banks (SCBs): Scheduled commercial banks (SCBs) account for a major
proportion of the business of the scheduled banks. As at end-March, 2009, 80 SCBs were operational
in India. SCBs in India are categorized into the five groups based on their ownership and/or their
nature of operations. State Bank of India and its six associates (excluding State Bank of Saurashtra,
which has been merged with the SBI with effect from August 13, 2008) are recognised as a separate
category of SCBs, because of the distinct statutes (SBI Act, 1955 and SBI Subsidiary Banks Act,
1959) that govern them. Nationalised banks (10) and SBI and associates (7), together form the public
sector banks group and control around 70% of the total credit and deposits businesses in India. IDBI
23

ltd. has been included in the nationalised banks group since December 2004. Private sector banks
include the old private sector banks and the new generation private sector banks- which were
incorporated according to the revised guidelines issued by the RBI regarding the entry of private
sector banks in 1993. As at end-March 2009, there were 15 old and 7 new generation private sector
banks operating in India.
Foreign banks Foreign banks are present in the country either through complete branch/subsidiary
route presence or through their representative offices. At end-June 2009, 32 foreign banks were
operating in India with 293 branches. Besides, 43 foreign banks were also operating in India through
representative offices.

Regional Rural Banks Regional Rural Banks (RRBs) were set up in September 1975 in order to
develop the rural economy by providing banking services in such areas by combining the cooperative
specialty of local orientation and the sound resource base which is the characteristic of commercial
banks. RRBs have a unique structure, in the sense that their equity holding is jointly held by the
central government, the concerned state government and the sponsor bank (in the ratio 50:15:35),
which is responsible for assisting the RRB by providing financial, managerial and training aid and
also subscribing to its share capital.
Between 1975 and 1987, 196 RRBs were established. RRBs have grown in geographical coverage,
reaching out to increasing number of rural clientele. At the end of June 2008, they covered 585 out of
the 622 districts of the country. Despite growing in geographical coverage, the number of RRBs
operational in the country has been declining over the past five years due to rapid consolidation
among them. As a result of state wise amalgamation of RRBs sponsored by the same sponsor bank,
the number of RRBs fell to 86 by end March 2009.
24

Scheduled Cooperative Banks: Scheduled cooperative banks in India can be broadly classified into
urban credit cooperative institutions and rural cooperative credit institutions. Rural cooperative banks
undertake long term as well as short term lending. Credit cooperatives in most states have a three tier
structure (primary, district and state level).
Non-Scheduled Banks: Non-scheduled banks also function in the Indian banking space, in the form
of Local Area Banks (LAB). As at end-March 2009 there were only 4 LABs operating in India. Local
area banks are banks that are set up under the scheme announced by the government of India in 1996,
for the establishment of new private banks of a local nature; with jurisdiction over a maximum of
three contiguous districts. LABs aid in the mobilisation of funds of rural and semi urban districts. Six
LABs were originally licensed, but the license of one of them was cancelled due to irregularities in
operations, and the other was a malgamated with Bank of Baroda in 2004 due to its weak financial
position.
25

CHAPTER : 3
RECENT BANKING DEVELOPMENTS IN INDIA

The Indian banking sector has witnessed wide ranging changes under the influence of the financial
sector reforms initiated during the early 1990s. The approach to such reforms in India has been one of
gradual and non-disruptive progress through a consultative process. The emphasis has been on
deregulation and opening up the banking sector to market forces. The Reserve Bank has been
consistently working towards the establishment of an enabling regulatory framework with prompt
and effective supervision as well as the development of technological and institutional infrastructure.
Persistent efforts have been made towards adoption of international benchmarks as appropriate to
Indian conditions. While certain changes in the legal infrastructure are yet to be effected, the
developments so far have brought the Indian financial system closer to global standards.

Statutory Pre-emptions
In the pre-reforms phase, the Indian banking system operated with a high level of statutory
preemptions, in the form of both the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio
(SLR), reflecting the high level of the countrys fiscal deficit and its high degree of monetisation.
Efforts in the recent period have been focused on lowering both the CRR and SLR. The statutory
minimum of 25 per cent for the SLR was reached as early as 1997, and while the Reserve Bank
continues to pursue its medium-term objective of reducing the CRR to the statutory minimum level
of 3.0 per cent, the CRR of the Scheduled Commercial Banks (SCBs) is currently placed at 5.0 per
cent of NDTL (net demand and time liabilities). The legislative changes proposed by the Government
in the Union Budget, 2005-06 to remove the limits on the SLR and CRR are expected to provide
freedom to the Reserve Bank in the conduct of monetary policy and also lend further flexibility to the
banking system in the deployment of resources.

26



Interest Rate Structure
Deregulation of interest rates has been one of the key features of financial sector reforms. In recent
years, it has improved the competitiveness of the financial environment and strengthened the
transmission mechanism of monetary policy. Sequencing of interest rate deregulation has also
enabled better price discovery and imparted greater efficiency to the resource allocation process. The
process has been gradual and predicated upon the institution of prudential regulation of the banking
system, market behaviour, financial opening and, above all, the underlying macroeconomic
conditions.
Interest rates have now been largely deregulated except in the case of: (i) savings deposit accounts;
(ii) non-resident Indian (NRI) deposits; (iii) small loans up to Rs.2 lakh; and (iv) export credit.
After the interest rate deregulation, banks became free to determine their own lending interest rates.
As advised by the Indian Banks Association (a self-regulatory organisation for banks), commercial
banks determine their respective BPLRs (benchmark prime lending rates) taking into consideration:
(i) actual cost of funds; (ii) operating expenses; and (iii) a minimum margin to cover regulatory
requirements of provisioning and capital charge and profit margin. These factors differ from bank to
bank and feed into the determination of BPLR and spreads of banks. The BPLRs of public sector
banks declined to 10.25-11.25 per cent in March 2005 from 10.25-11.50 per cent in March 2004.
With a view to granting operational autonomy to public sector banks, public ownership in these
banks was reduced by allowing them to raise capital from the equity market of up to 49 per cent of
paid-up capital. Competition is being fostered by permitting new private sector banks, and more
liberal entry of branches of foreign banks, joint-venture banks and insurance companies. Recently, a
roadmap for the presence of foreign banks in India was released which sets out the process of the
gradual opening-up of the banking sector in a transparent manner. Foreign investments in the
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financial sector in the form 238 BIS Papers No 28 of Foreign Direct Investment (FDI) as well as
portfolio investment have been permitted. Furthermore,
banks have been allowed to diversify product portfolio and business activities. The share of public
sector banks in the banking business is going down, particularly in metropolitan areas. Some
diversification of ownership in select public sector banks has helped further the move towards
autonomy and thus provided some response to competitive pressures. Transparency and disclosure
standards have been enhanced to meet international standards in an ongoing manner.

Prudential Regulation
Prudential norms related to risk-weighted capital adequacy requirements, accounting, income
recognition, provisioning and exposure were introduced in 1992 and gradually these norms have been
brought up to international standards. Other initiatives in the area of strengthening prudential norms
include measures to strengthen risk management through recognition of different components of risk,
assignment of risk-weights to various asset classes, norms on connected lending and risk
concentration, application of the mark-to-market principle for investment portfolios and limits on
deployment of funds in sensitive activities.
Keeping in view the Reserve Banks goal to achieve consistency and harmony with international
standards and our approach to adopt these standards at a pace appropriate to our context, it has been
decided to migrate to Basel II. Banks are required to maintain a minimum CRAR (capital to risk
weighted assets ratio) of 9 per cent on an ongoing basis. The capital requirements are uniformly
applied to all banks, including foreign banks operating in India, by way of prudential guidelines on
capital adequacy. Commercial banks in India will start implementing Basel II with effect from March
31, 2007. They will initially adopt the Standardised Approach for credit risk and the Basic Indicator
Approach for operational risk. After adequate skills have been developed, at both bank and
supervisory level, some banks may be allowed to migrate to the Internal Ratings-Based (IRB)
Approach. Banks have also been advised to formulate and operationalise the Capital Adequacy
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Assessment Process (CAAP) as required under Pillar II of the New Framework.
Some of the other regulatory initiatives relevant to Basel II that have been implemented by the
Reserve Bank are:
management framework oriented towards their
requirements and dictated by the size and complexity of their business, risk philosophy,
market perceptions and expected level of capital.
-Based Supervision (RBS) in select banks on a pilot basis.

performance budgeting system. This, together with the adoption of RBS, should aid in
fulfilling the Pillar II requirements under Basel II.
closures (Pillar III) so as to achieve greater transparency regarding
the financial position and risk profile of banks.

adopt IRB/Advanced Measurement approaches.
With a view to ensuring migration to Basel II in a non-disruptive manner, a consultative and
participative approach has been adopted for both designing and implementing the New Framework.
Steering Committee comprising senior officials from 14 banks (public, private and foreign) with
representation from the Indian Banks Association and the Reserve Bank has been constituted. On the
basis of recommendations of the Steering Committee, draft guidelines on implementation of the New
Capital Adequacy Framework have been issued to banks.
In order to assess the impact of Basel II adoption in various jurisdictions and re-calibrate the
proposals, the BCBS is currently undertaking the Fifth Quantitative Impact Study (QIS 5). India will
beparticipating in the study, and has selected 11 banks which form a representative sample for this
purpose. These banks account for 51.20 per cent of market share in terms of assets. They have been
advised to familiarise themselves with the QIS 5 requirements to enable them to participate in the
29

exercise effectively. The Reserve Bank is currently focusing on the issue of recognition of the
external rating agencies for use in the Standardised Approach for credit risk.
As a well-established risk management system is a pre-requisite for implementation of advanced
approaches under the New Capital Adequacy Framework, banks were required to examine the
various options available under the Framework and draw up a roadmap for migration to Basel II. The
feedback received from banks suggests that a few may be keen on implementing the advanced
approaches. However, not all are fully equipped to do so straightaway and are, therefore, looking to
migrate to the advanced approaches at a later date. Basel II provides that banks should be allowed to
adopt/migrate to advanced approaches only with the specific approval of the supervisor, after
ensuring that they satisfy the minimum requirements specified in the Framework, not only at the time
of adoption/migration, but on a continuing basis. Hence, banks desirous of adopting the advanced
approaches must perform a stringent assessment of their compliance with the minimum requirements
before they shift gears to migrate to these approaches. In this context, current non-availability of
acceptable and qualitative historical data relevant to internal credit risk ratings and operational risk
losses, along with the related costs involved in building up and maintaining the requisite database, is
expected to influence the pace of migration to the advanced approaches available under Basel II.

Exposure Norms
The Reserve Bank has prescribed regulatory limits on banks exposure to individual and group
borrowers to avoid concentration of credit, and has advised banks to fix limits on their exposure to
specific industries or sectors (real estate) to ensure better risk management. In addition, banks are
also required to observe certain statutory and regulatory limits in respect of their exposures to capital
markets.

Asset-Liability Management
In view of the growing need for banks to be able to identify, measure, monitor and control risks,
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appropriate risk management guidelines have been issued from time to time by the Reserve Bank,
including guidelines on Asset-Liability Management (ALM). These guidelines are intended to serve
as a benchmark for banks to establish an integrated risk management system. However, banks can
also develop their own systems compatible with type and size of operations as well as risk perception
and put in place a proper system for covering the existing deficiencies and the requisite upgrading.
Detailed guidelines on the management of credit risk, market risk, operational risk, etc. have also
been issued to banks by the Reserve Bank.
The progress made by the banks is monitored on a quarterly basis. With regard to risk management
techniques, banks are at different stages of drawing up a comprehensive credit rating system,
undertaking a credit risk assessment on a half yearly basis, pricing loans on the basis of risk rating,
adopting the Risk-Adjusted Return on Capital (RAROC) framework of pricing, etc. Some banks
stipulate a quantitative ceiling on aggregate exposures in specified risk categories, analyse rating-
wise distribution of borrowers in various industries, etc.
In respect of market risk, almost all banks have an Asset-Liability Management Committee. They
have articulated market risk management policies and procedures, and have undertaken studies of
behavioural maturity patterns of various components of on-/off-balance sheet items.

NPL Management
Banks have been provided with a menu of options for disposal/recovery of NPLs (non-performing
loans). Banks resolve/recover their NPLs through compromise/one time settlement, filing of suits,
Debt
Recovery Tribunals, the Lok Adalat (peoples court) forum, Corporate Debt Restructuring (CDR),
sale
to securitisation/reconstruction companies and other banks or to non-banking finance companies
(NBFCs). The promulgation of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest (SARFAESI) Act, 2002 and its subsequent amendment have
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strengthened the position of creditors. Another significant measure has been the setting-up of the
240 BIS Papers No 28 Credit Information Bureau for information sharing on defaulters and other
borrowers. The role of Credit Information Bureau of India Ltd. (CIBIL) in improving the quality of
credit analysis by financial institutions and banks need hardly be overemphasised. With the
enactment of the Credit Information Companies (Regulation) Act, 2005, the legal framework has
been put in place to facilitate the fullfledged operationalisation of CIBIL and the introduction of other
credit bureaus.

Board for Financial Supervision (BFS)
An independent Board for Financial Supervision (BFS) under the aegis of the Reserve Bank has been
established as the apex supervisory authority for commercial banks, financial institutions, urban
banks
and NBFCs. Consistent with international practice, the Boards focus is on offsite and on-site
inspections and on banks internal control systems. Offsite surveillance has been strengthened
through control returns. The role of statutory auditors has been emphasised with increased internal
control through strengthening of the internal audit function. Significant progress has been made in
implementation of the Core Principles for Effective Banking Supervision. The supervisory rating
system under CAMELS has been established, coupled with a move towards risk-based supervision.
Consolidated supervision of financial conglomerates has since been introduced with bi-annual
discussions with the financial conglomerates. There have also been initiatives aimed at strengthening
corporate governance through enhanced due diligence on important shareholders, and fit and proper
tests for directors.
A scheme of Prompt Corrective Action (PCA) is in place for attending to banks showing steady
deterioration in financial health. Three financial indicators, viz. capital to risk-weighted assets ratio
(CRAR), net non-performing assets (net NPA) and Return on Assets (RoA) have been identified with
32

specific threshold limits. When the indicators fall below the threshold level (CRAR, RoA) or go
above it (net NPAs), the PCA scheme envisages certain structured/discretionary actions to be taken
by the regulator.
The structured actions in the case of CRAR falling below the trigger point may include, among other
things, submission and implementation of a capital restoration plan, restriction on expansion of risk
weighted assets, restriction on entering into new lines of business, reducing/skipping dividend
payments, and requirement for recapitalisation.
The structured actions in the case of RoA falling below the trigger level may include, among other
things, restriction on accessing/renewing costly deposits and CDs, a requirement to take steps to
increase fee-based income and to contain administrative expenses, not to enter new lines of business,
imposition of restrictions on borrowings from the inter bank market, etc.
In the case of increasing net NPAs, structured actions will include, among other things, undertaking a
special drive to reduce the stock of NPAs and containing the generation of fresh NPAs, reviewing the
loan policy of the bank, taking steps to upgrade credit appraisal skills and systems and to strengthen
follow-up of advances, including a loan review mechanism for large loans, following up suitfiled/
decreed debts effectively, putting in place proper credit risk management
policies/processes/procedures/prudential limits, reducing loan concentration, etc.
Discretionary action may include restrictions on capital expenditure, expansion in staff, and increase
of stake in subsidiaries. The Reserve Bank/Government may take steps to change promoters/
ownership and may even take steps to merge/amalgamate/liquidate the bank or impose a moratorium
on it if its position does not improve within an agreed period.

Technological Infrastructure
In recent years, the Reserve Bank has endeavoured to improve the efficiency of the financial system
by ensuring the presence of a safe, secure and effective payment and settlement system. In the
process, apart from performing regulatory and oversight functions the Reserve Bank has also played
33

an important role in promoting the systems functionality and modernisation on an ongoing basis.
The consolidation of the existing payment systems revolves around strengthening computerised
cheque clearing, and expanding the reach of Electronic Clearing Services (ECS) and Electronic
Funds BIS Papers No 28 241
Transfer (EFT). The critical elements of the developmental strategy are the opening of new clearing
houses, interconnection of clearing houses through the Indian Financial Network (INFINET) and the
development of a Real-Time Gross Settlement (RTGS) System, a Centralised Funds Management
System (CFMS), a Negotiated Dealing System (NDS) and the Structured Financial Messaging
System
(SFMS). Similarly, integration of the various payment products with the systems of individual banks
has been another thrust area.

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CONCLUSION

T he India n Ba nks have ma na ged t o gr ow wit h resilience during the post reform era. However
the India n b anking sect or st ill has a la rge ma r ket unexplored. With the Indian households
being one of the highest savers in the world accounting for 69% of India gross national saving of
which only 47% is accessed by the banks more than half of the Indian population still unbanked
with only 55 per cent of the population have a deposit account and 9 per cent have credit accounts
with banks. India has the highest number of households (145 million) excluded from Banking & has
only one bank branch per 14,000 people.
On the other hand, Indian banking industry has to face challanges like financial inclusion,
deregulation of interest rates on saving deposits, slow industrial growth, management of asset quality,
increased stress on some sectors, transition to the International Financial Reporting System,
implementation of Basel II & so on.
Nevertheless seeing the credentials of the Indian Banks one can safely conclude that the industry might
have many stumbling blocks in the 'Road Ahead' but when ever encountered with such blocks in the
past it has u s ed t hem a s a s tep p ing s tone & has a lwa ys'Transformed' itself ( for the better)
and 'Evolved' as a winner.













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BIBLIOGRAPHY

ARTICLES


RECENT HISTORY OF INDIAN BANKING at
http://www.bankingindiaupdate.com/general.html


RBI Publications at http://www.rbi.org.in/scripts/publications.aspx


The Economic Journal, Vol. 37, No. 146. Published by: Blackwell Publishing for the Royal
o Economic Society.

NEWSPAPERS / MAGAZINES
The Economic Times
The Insurance Times
Insurance Post
WEBSITES
w.w.w.google.com
www.indiainfoline.com
www.scribd.com
www.google.com
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