OVERVIEW OF BANKING & STRUCTURE OF BANKING IN INDIA INTRODUCTION We have all been availing banking services.

Students go to banks to get Demand Drafts to pay their University fees. Most working people have to open a bank account in which their monthly salary is credited. From this account, people make payments through cheques. We also approach banks for availing loans for buying a house, or a car or take education loans for studying in India or abroad. Banking, therefore, touches the lives of most of us. It is pertinent to understand the origin of banking and how it evolved and grew over the centuries gone by. In the Indian context, banking went through a difficult phase of evolution in the preindependence era and there were many bank failures. After independence, the Government passed the Banking Regulations Act, 1949 for regulating the business of banks to provide protection to depositors. The importance of the banking system as a vital tool for economic development and progress was recognized and numerous measures were initiated. During this period, the thrust was on institution building and getting the banks to contribute effectively to the national objectives of poverty-alleviation, achieving balanced regional growth and ensuring availability of bank finance to the needy. The nationalized banks came to dominate the banking scene and played a vital role in changing the business from class banking to mass banking. Branch expansion happened at a rapid pace and banking was extended to hitherto unbanked areas. The era of Liberalization which started in the early 90s marked a shift in approach and it was recognized that the banking system, characterized by inefficiency and poor service quality of nationalized banks, needed an overhaul. It was decided that private banks should be permitted to be set up to inject competition and improve the overall efficiency of the banking system. This period brought about a rapid change as regulation was eased and banks were allowed to enter into new areas. While this created new opportunities for banks, they were exposed to new and greater risks. Banks have responded by extensively using technology and bringing about improvements in their processes. Some banks, which were originally set up as specialized

institutions catering to the needs of specific target groups and sectors, have diversified their activities and now offer a wide variety of products and services to a broader group of clientele. HOW DID BANKING START? The word bank is derived from the Latin word banca meaning bench or counter. The business of banking is believed to have started even before 2000 BC in Babylonia when temples and palaces used to perform the function of safekeeping of valuables such as grains and precious metals. The temples and palaces would issue receipts which were then used to transfer the stored items to third parties. Gradually, this business was taken up by goldsmiths who started accepting valuables for safekeeping. People started depositing their surplus money with the goldsmiths, who, much like the present day bankers, had strong rooms and employed watchmen. The written note of the owners (depositors) to the goldsmith to deliver the valuables to third parties evolved into cheques. Over the years, the goldsmiths started enjoying the trust of people as custodians of their money and people would leave it with them for long periods. The goldsmiths saw an opportunity to earn interest by lending a part of the money profitably for a definite period of time. As their interest earning from such lending activity increased and on sensing a growing demand for loans arising out of expanding commerce and trade, the goldsmiths began offering interest on money deposited to attract more deposits. Thus, modern banking evolved and institutions in the form of banks emerged as custodians of peoples money and the trust gained by them encouraged them to lend a portion of such funds. Over the centuries, the scope of banking activity widened and today it covers a broad range of financial activities which we shall understand subsequently. BANKING IN INDIA Since ancient times, banking activities were conducted in India by pawn brokers, nidhis and chit funds. In most parts of the country, the needs of people were met by moneylenders, who lent out of their own resources and were therefore, not bankers. Banks were set up during the British era and were modelled along the lines of British banks. We shall now look at the evolution of banking during the following phases:

1. Pre-Independence Era 2. Post-Independence Era

1. Pre-Independence Era: Most of the early banks were promoted by Europeans. Bank of Hindustan was among the earliest such bank which could not last long and went into liquidation in 1832. In early 19th Century, the East India Company promoted three banks at port centres to finance trade. These banks were:

Bank of Bengal in 1809 - which was earlier set up as Bank of Calcutta in 1806 Bank of Bombay in 1840 and Bank of Madras in 1843

These banks together came to be known as Presidency Banks. Many other banks were floated in this period but they all collapsed and went into liquidation. The banks to survive those early and turbulent times are Allahabad Bank, which was set up in 1865 and Punjab National Bank which was established in 1895. Foreign banks also started setting up offices in this period. Hong Kong Shanghai Banking Corporation (HSBC) set up its office in 1869. Thanks to the Swadeshi movement, the first decade of the 20th Century saw the setting up of many banks by Indians. Bank of India, Central Bank of India and Indian Bank are some present day banks which were set up in that period. The Presidency Banks were merged in 1921 to form the Imperial Bank of India. The new bank performed the functions of a commercial bank and was also the banker to the government. Thereafter, the Reserve Bank of India (RBI) was established as the central bank of the country in 1935 and Imperial Bank ceased to be banker to the Government of India and instead became an agent of the Reserve Bank for the transaction of government business at centres at which the central bank was not established.

2. Post Independence Era: As we have seen earlier, the pre-independence era was marked by numerous bank failures. The Government initiated steps to streamline the functioning of banks and to safeguard the interests of the depositors and enacted Banking Regulations Act, 1949. Reserve Bank of India was granted powers of supervising the functioning of banks. RBI, which was originally a shareholders bank, was nationalized in 1948. After independence, a need was felt to develop a suitable banking structure for meeting the credit requirements of both agriculture and industry. Towards this end, the Reserve Bank concentrated on regulating and developing mechanisms for institution building. (A) Setting up of Term Lending Institutions The commercial banks in existence until then were unwilling to give large quantum of loans to industries and also stipulated short repayment periods, which did not meet the needs of industries. With a view to ensure rapid industrialization and to meet the specific credit needs of industries, RBI promoted term lending institutions or development financial institutions. 1. Industrial Finance Corporation of India (IFCI) was the first such institution promoted in 1948 with its headquarters at New Delhi. Its objective is to provide medium and long-term loans to industrial concerns. 2. Industrial Credit & Investment Corporation of India Limited (ICICI) the earlier avtaar of the present day ICICI bank was set up as a joint stock company and focused on granting long-term loans to industries, including loans in foreign currencies. The unique thing about it was that it was a privately owned term lending institution. 3. Industrial Development Bank of India IDBI was set up in 1964 as a wholly owned subsidiary of RBI. In 1976, the ownership of IDBI was transferred to the Government of India. It performed the role of a principal financial institution for coordinating the activities of institutions engaged in financing, promoting and developing industry in the country.

4. Industrial Investment Bank of India - The Industrial Reconstruction Corporation of India Ltd was set up in 1971 primarily for undertaking rehabilitation of sick industrial units. It was subsequently renamed as Industrial Reconstruction Bank of India (IRBI). In 1997, it was again renamed as Industrial Investment Bank of India (IIBI). Its role was enlarged and it became a full-fledged development financial institution. 5. Small Industries Development Bank of India (SIDBI) was set up in 1990 as the principal Development Financial Institution of other institutions engaged in similar activities. 6. National Bank for Agriculture & Rural Development (NABARD) which was set up in 1982 is an apex institution specializing in agriculture & rural credit. It is also the regulator of co-operative banks and Regional Rural Banks (RRBs). 7. Export & Import Bank (EXIM Bank) is wholly owned by Government of India and was set up in 1982 as the apex financial institution for financing foreign trade. It performs the roles of a financer, promoter, consultant and coordinator with regard to Indias foreign trade. The above referred institutions operated at the national level and a need was felt to promote institutions at the state level to ensure balanced regional growth and accelerated industrialization. Towards this end, State Finance Corporations (SFCs) and State Industrial Development Corporations (SIDCs) were set up by State Governments. To take the case of Maharashtra, Maharashtra Industrial Development Corporation (MIDC) and Maharashtra State Finance Corporation (MSFC) have been set up by the state government. (B) Credit Guarantee Institutions for promotion, financing and development of industries in the small scale sector and for coordinating the functions

1. Export Credit Guarantee Corporation ECGC, a Government of India undertaking, was set up in 1957 to provide export credit insurance support to Indian exporters. It provides guarantee cover to banks for the loans granted for foreign trade. It also insures exporters against various risks involved. 2. Deposit Insurance and Credit Guarantee Corporation of India DICGC, a wholly owned subsidiary of RBI, was set up in 1962 and its primary function is to provide insurance cover to depositors of banks and to provide guarantees to banks to cover loans granted to small borrowers. You may have heard people say that money deposited in banks is safe. This is certainly true about Public Sector Banks where Government has a majority stake. But it is also true for private sector banks and co-operative banks. Do you know why? It is because deposits with banks, including co-operative banks, are insured by DICGC without the depositor having to pay any premium-it is paid by banks. If a bank collapses, then DICGC repays an amount up to Rs. 1 lac per depositor for the deposit held in the failed bank. So, if you are not sure about the future of private banks but still find the interest rate or service attractive, then it would be a good idea to spread deposits among different banks and keep the aggregate amount within Rs. 1 lac and get the protection from DICGC. (C) Commercial Banks You may have heard the word scheduled banks. Schedule banks are those banks which are included in the Second Schedule to the Reserve Bank of India Act 1934. Before including a bank in the Second Schedule, RBI ensures that the following conditions are met: (a) The bank must have paid up capital and reserves of not less than Rs. 5 lacs. (b) It must also satisfy the RBI that its affairs are not conducted in a manner which is harmful to the interests of its depositors.

Schedule banks are required to maintain a certain amount of reserves with the RBI. In return, they enjoy certain financial facilities from RBI at concession. For the purpose of our discussion, we shall further refer to Scheduled Commercial banks as commercial banks. Commercial banks are banks engaged in accepting deposits and granting short to medium term loans (typically with tenures up to 10 years or so). Among the few banks which survived the pre-independence phase, Imperial bank of India (IBI) was the largest commercial bank. However, like all other banks of that era, it had a narrow sphere of operation and concentrated mostly on affluent customers in urban areas. In the First Five Year Plan launched in 1951, the thrust was on rural development. The All India Rural Credit Survey Committee recommended that a state-sponsored bank be set up to enhance formal credit in rural areas. In accordance with an enactment in Parliament, IBI was taken over and converted into State Bank of India in 1955 with the mandate of rapidly developing its branch network in rural areas. Later, the State Bank of India (Subsidiary Banks) Act was passed in 1959, enabling the State Bank of India to take over seven former State-associated banks as its subsidiaries (later named Associates).These banks together constitute the State Bank Group. SBI has done pioneering work in extension of rural credit and providing need-based finance to the hitherto neglected SSI sector through its Liberalised Scheme. As regards the other major scheduled banks, it was found that large business houses exercised control over a number of them and were cornering away a large chunk of loans thereby depriving other priority sectors such as agriculture, small scale industries and exports of their due share of bank finance. With a view to curbing such mismanagement of banks, the Government initially imposed controls and restrictions which were referred to as social control. Soon thereafter, the Government decided to nationalize 14 large banks on 19th July 1969 and it took over the ownership and control of these banks. It was felt that public ownership of the major banks would help to effectively mobilize and develop national resources for productive purposes in

accordance with the national objective of achieving socialistic pattern of society. Nationalization was viewed as a revolutionary step signifying not merely a change of ownership but a purposeful effort to use the banks as an instrument for achieving economic development and social justice. In April 1980, six more private banks were nationalized taking the tally of nationalized banks to twenty and further extending public control over the countrys banking system. Of these twenty banks, one bank, New Bank of India was merged with Punjab National Bank, bringing down the tally to nineteen. Why is it that SBI and its associates which were also taken over, are not referred to as nationalized banks? Actually, the SBI Group was on a slightly different footing as compared to nationalized banks. While the nationalized banks were wholly owned by the Government of India, the ownership of SBI was mainly with RBI. Together these 27 banks were referred to as Public Sector Banks. The Public Sector Banks dominated the banking scene during the postnationalization era. The benefits of nationalization were mainlyi) Extension of branches to hitherto unbanked areas ii) A quantum jump in the flow of credit to the priority sectors of the economy. The banks shifted focus from class banking to mass banking and from elite banking to social banking. RBI also set targets for lending by banks to Priority Sectors of the economy, mainly comprising agriculture, small scale sector and units engaged in exports. Many schemes have been prepared to ensure that bank finance is made available to the poor and the weaker sections of the society. With a view to promote balanced regional development, RBI also launched two important schemes: A. Lead Bank Scheme in 1969 B. Service Area Approach in 1989.

Under the Lead Bank Scheme, specific districts were allotted to each commercial bank and the bank was designated as the Lead Bank for the district. The Lead Bank has a major role in the development of the district. It has the responsibility of drawing up District Credit Plans for extending banking facilities to unbanked areas and ensuring availability of finance to hitherto neglected sections of the district in coordination with other banks operating in the district. For example, Pune district has been allotted to Bank of Maharashtra. Service Area Approach (SAA) was introduced by RBI in 1989 in order to bring about an orderly and planned development of rural and semi- urban areas of the country. Under the SAA, all rural and semi-urban branches of banks were allocated around 15-25 villages. These branches had to conduct a survey of the villages, draw up an Annual Credit Plan and ensure that the credit needs of people in the identified villages were met.

STRUCTURE OF BANKING INSTITUTIONS Let us now study the present structure of banking institutions in India. The apex banking institution is RBI, which as the central bank, exercises supervision and control over banks. The banking institutions comprise of the following:
a) Commercial banks b) Co-operative banks c) Regional Rural Banks

a) Commercial banks are further sub-divided into:

1. Public Sector Banks 2. Private Sector Banks 3. Foreign Banks

1. Public Sector Banks (PSBs) comprise the nationalized banks, SBI and its seven associates. Some nationalized banks are Punjab National Bank, Bank of India, Bank of Maharashtra, Bank of Baroda, Canara Bank etc. In addition, IDBI Bank is also a public sector bank. The seven associates of SBI are- State Bank of Saurashtra, Indore, Patiala, Travancore, Mysore, Bikaner & Jaipur and Hyderabad. Of these, State Bank of Saurashtra and State Bank of Indore have since been merged with SBI in 2008 and 2010 respectively. The ownership pattern of PSBs has also undergone a change in recent years. The Government, which was the sole owner of nationalized banks, has now retained majority shareholding. However, these banks have enlarged their capital base by offering shares to the public and the shares of nationalized banks are now listed and traded on stock exchanges. Further, RBI which had a majority stake in SBI has now transferred its shares to the Government of India in 2007. Today, there is very little distinction between SBI Group and the nationalized banks. 2. Private Sector banks are of two types:
Old Private Sector Banks New Generation Private Sector Banks

The old private sector banks have existed even prior to nationalization but were not nationalized because of their small size of operations. Some old private sector banks are Catholic Syrian Bank, Federal Bank, Dhanalaxmi Bank, Karnataka Bank etc. The year 1991 saw the dawn of the era of liberalization, globalization and privatization. The Industrial Policy, 1991 was a major step in dismantling government control over industries. In this environment, the performance of PSBs

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also came under scrutiny. It was found that PSBs were saddled with problems of inefficiency, overstaffing, low employee productivity, unsatisfactory customer service and poor decision making. Narasimham Committee on Financial Sector (1991) recommended that setting up of banks in the private sector be allowed to inject competition amongst the PSBs and to induce them to improve their operational efficiency. The recommendations were accepted and the RBI decided to allow financially strong entities to float banks. The new banks were required to leverage technology to improve efficiency and offer superior quality of service. Private sector banks are required to be registered under Companies Act, 1956. The initial paid up capital of Rs. 100 crores stipulated in 1993 were subsequently raised in 2002 to Rs. 200 crores. This is further required to be raised to Rs. 300 crores within three years. The early banks that were set up were mostly promoted by institutions-UTI Bank (which was later renamed as Axis Bank), HDFC Bank and ICICI Bank. These banks were lean outfits, with minimum staff compliment, and optimized the use of technology. They are known as New Generation Private Sector Banks. 3. Foreign Banks: Foreign banks are banks incorporated abroad and are required to obtain a license from RBI to operate in India. RBI gives 12 new branch licenses to foreign banks every year. Earlier, they were allowed to operate only through branches. Now, RBI has permitted foreign banks to set up subsidiaries also. The capital requirement for a foreign bank to open a branch in India is $25 million spread over three years. Foreign banks bring in new technology and facilitate in the introduction as well as assimilation of international products into the domestic markets. They also help provide Indian corporations access to foreign capital markets. As of March 2010, there are 31 foreign banks with 310 branches. Foreign Banks with a large presence in India include Standard Chartered Bank (95 branches), HSBC (50 branches) and Citi Bank with 43 branches. b) Co-operative banks

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Co-operative banks are organized on a co-operative basis and are governed by their members according to co-operative laws. The beginning of co-operative banking in India dates back to 1904, when efforts were made to create a new type of institution based on principles of co-operative organization and management, which were considered to be suitable for solving the problems peculiar to Indian conditions. The co-operative banking structure in India comprises:
1. Urban co-operative banks (UCBs) and 2. Rural co-operative credit institutions

1. Urban co-operative banks: UCBs form an important part of the Indian banking system. In the past, these banks had numerous financial problems and had suffered losses. In recent years, the performance of UCBs has shown improvement and there has been an increase in the number of financially stronger UCBs. Some UCBs have operations in many states and are governed by Multi-State Co-operative Societies Act, 2002. Saraswat Co-operative Bank and Cosmos Co-operative Bank are some co-operative banks having a presence in many states. 2. Rural Co-operative Credit Institutions: Rural co-operative credit institutions have a three-tier structure. This sector comprises primary agricultural credit societies (PACS), district central co-operative banks (DCCBs) and the state co-operative banks (StCBs). However, these institutions have many problems such as low resources, inadequate business diversification and recoveries, high levels of accumulated losses, weak management information systems (MIS) and poor internal controls. c) Regional Rural Banks (RRBs) In accordance with the recommendations of Narasimham Committee, RRBs were set up in 1975 under the Regional Rural Banks Act, 1976 and were permitted to establish branches within a notified area. The capital of RRBs is contributed by Central Government (50%),

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concerned State Government (15%) and the sponsoring commercial bank (35%).The need for setting up RRBs was felt because neither commercial banks nor co-operative banks could effectively meet the needs of rural people. The co-operative banks lacked a professional approach to appraisal, delivery and supervision of credit. The commercial banks, on the other hand, were urban-oriented and were unable to tune their operations to meet the specific needs of the rural masses. RRBs were conceived as banks with a local feel and familiarity with the rural economy and as a low cost alternative to commercial banks while doing away with the failings of cooperative banks. However, the RRBs have not functioned effectively. The limited area of operation in resource poor areas, poor management, low employee productivity and high staff costs resulted in mounting losses and most of the RRBs have become unviable. There has been a consolidation amongst RRBs and their number has declined from 197 to 86 at present. As per data released by RBI, as of March 2009, there are 27 public sector banks, 7 new private sector banks, 15 old private sector banks, 31 foreign banks and 86 regional rural banks in India. CHANGING ROLE OF DEVELOPMENT FINANCE INSTITUTIONS (DFIS) We have seen earlier that numerous term lending institutions were set up by RBI to achieve industrial progress and overall economic development. After the launch of financial reforms in 1991, the operating environment changed and the DFIs found themselves facing new challenges. Earlier, the RBI and Central Government used to provide long term funds to DFIs at concession. With the implementation of financial reforms, this facility was withdrawn. DFIs had to raise funds from the public at market related rates, which were obviously higher. This pushed up the cost of funds and their viability was threatened. DFIs broad-based their activities and started granting short-term loans in direct competition with commercial banks. The PSBs were also facing competition from the newly floated private sector banks which were aggressively seeking to grab some of PSBs market share. PSBs also responded by venturing into the business of

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granting long-term loans to corporate customers and started competing with DFIs. The distinction between DFIs and commercial banks disappeared gradually. In such a scenario, an institution like ICICI found it futile to operate as a DFI and have a separate existence from its own commercial banking arm, ICICI Bank. The two, therefore, merged in 2002 and ICICI Bank now operates as a commercial bank, conducting the complete range of banking activities. IDBI followed suit and merged with IDBI Bank in 2004. This has been referred to universal banking, under which banks offer a wide range of financial products and services under one roof.

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