EVOLUTION OF BANKING

Introduction
In the earlier societies functions of a bank were done by the corresponding
institutions dealing with loans and advances. Britishers brought into India the
modern concept of banking by the start of Bank of England in 1694. In 1708, the
bank of England was given the monopoly for the issue of currency notes by an Act.
In nineteenth century various banks started operations, which primarily were
receiving money on deposits, lending money, transferring money from one place to
another and bill discounting.
History of Banking in India:
Banking in India has a very old origin. It started in the Vedic period where
literature shows the giving of loans to others on interest. The interest rates ranged
from two to five percent per month. The payment of debt was made pious
obligation on the heir of the dead person.
Modern banking in India began with the rise of power of the British. To raise the
resources for the attaining the power the East India Company on 2nd June 1806
promoted the Bank of Calcutta. In the mean while two other banks Bank of
Bombay and Bank of Madras were started on 15 th April 1840 and 1st July, 1843
respectively. In 1862 the right to issue the notes was taken away from the
presidency banks. The government also withdrew the nominee directors from these
banks. The bank of Bombay collapsed in 1867 and was put under the voluntary
liquidation in 1868 and was finally wound up in 1872. The bank was however able
to meet the liability of public in full. A new bank called new Bank of Bombay was
started in 1867.
On 27th January 1921 all the three presidency banks were merged together to form
the Imperial Bank by passing the Imperial Bank of India Act, 1920. The bank did
not have the right to issue the notes but had the permission to manage the clearing
house and hold Government balances. In 1934, Reserve Bank of India came into
being which was made the Central Bank and had power to issue the notes and was
also the banker to the Government. The Imperial Bank was given right to act as the
agent of the Reserve Bank of India and represent the bank where it had no braches.

In 1955 by passing the State Bank of India act 1955, the Imperial Bank was taken
over and assets were vested in a new bank, the State Bank of India.
Bank Nationalization:
After the independence the major historical event in banking sector was the
nationalization of 14 major banks on 19th July 1969. The nationalization was
deemed as a major step in achieving the socialistic pattern of society. In 1980 six
more banks were nationalized taking the total nationalized banks to twenty.

BANKING SECTOR REFORMS

INTRODUCTION:In India, commercial banks are the oldest, largest and fastest growing financial
intermediaries. They have been playing a very important role in the process of
development. In 1949 RBI was nationalized followed by nationalization of
Imperial Bank of India (New State Bank of India) in 1995. In July 1969, 14 major
commercial banks were nationalized and in April 1980, 6 more were nationalized.
Reforms in banking sector have led to the setting up of new private sector banks as
well as entry of more foreign banks.
STRUCTURE OF BANKING IN INDIA :Banking system in India is classified in to scheduled and Non-scheduled banks.
Scheduled banks consist of State co-operative banks and Commercial banks. Nonscheduled consist of Central Co-operative Banks and primary credit society and
Commercial Banks.
STRUCTURE OF BANKING IN INDIA
Scheduled Bank
Non Scheduled Bank
State co-op bank
Commercial bank
Central Co-op Banks
Commercial and
Primary credit society.

1.

Scheduled Banks :Under RBI Act of 1934, banks were classified as scheduled and non-scheduled
banks. The scheduled banks are those which are entered in second schedule of RBI
Act of 1934. They are eligible for certain facilities. All commercial banks (India
and foreign, regional rural banks) and state co-operatives are scheduled banks.
A scheduled bank must have a paid up capital and reserves of not less than Rs. 5
lakhs. It must also satisfy RBI that it affairs are not conducted in a manner
detrimental to the interest of its depositors.
2. Non-Scheduled Banks :Non-scheduled Banks are those which have not been included in the second
Schedule of RBI Act. The number of non-scheduled banks is declining as many of
them are attaining the status of scheduled banks in 2008.
STRUCTURE OF SCHEDULED COMMERCIAL BANKS
Public Sector
Banks (27)
-

Private Sector
Bank (22)

Foreign
Banks (31)

State Bank Group (08)

- Old Private Sector Banks (15)
Nationalised banks (19) - New Private Sector Banks (07)
Regional Rural Banks (86)
The scheduled commercial banks consist of public sector banks, private sector
Banks and Foreign Banks.
As on march 2009, there are 27 public sector banks consisting of SBI and its 8
associated banks, 19 nationalised banks and IDBI Ltd. There are 7 new private
sector banks, 15 old private sector banks in India. Besides there are 86 RRBs in
2008-09.
I.
Public Sector Banks :Public sector Banks have a dominant position in terms of business. They accounted
for 71.9% of assets, 76.6% of deposits, 75.3% of advances and 69.9% of
investments of all scheduled commercial banks as at end of March 2009.
Among the public sector banks, the state Bank of India and associates had about
16,294 branches and nationalized banks had about 39,703 branches as on June 30,
2009.

a)

State Bank Of India And Its Associate Banks :On 1st July, 1955, on the recommendation of Rural Credit Survey Committee, the
Imperial Bank of India was converted in to State Bank of India. RBI acquired its
92% shares, thus SBI had the distinction of becoming the first state owned
commercial bank in the country.
The State Bank of India (Associate banks) Act was passed in 1959 and this paved
the way for creating State Bank Group. Besides functioning as a commercial bank,
SBI ushered a new era of mixed banking system in the country. It proved that
financing to agriculture and other priority sectors could be a viable commercial
activity.
On 19th July, 1969, 14 major commercial banks were nationalized and 6 more were
nationalized in 1980. Over the years SBI and its associates have expanded their
business. On June 30, 2009, they accounted for 20% of total branches of all
commercial banks. The share of banking business with them was roughly 30%. In
1993, SBI Act was amended to enable it to have access to capital market.
b) Other Nationalised Banks :The second category of public sector is 19 commercial banks, of which 14 were
natioalised on July 19, 1969. This changed the banking structure. Each one of these
14 banks had deposits of Rs. 50 crore or more. The nationalization was justified by
government because major banks have a larger social purpose. In December 1969,
Lead bank Scheme was formulated which played an important role in transforming
these profit maximizing institutions in to catalysts of local development.
On April 15, 1980 six more private owned commercial were nationalized. The
purpose was to promote the welfare of the people in conformity with the policy of
the state. With nationalisation, The share of private sector in the entire banking
declined to just 9%. In 1993 New Bank of India merged with Punjab National
Bank. As a result, the no. of public sector banks (other than state Bank and its
associates) declined to 19. As on June 30, 2009, the total number of branches of 19
nationalised banks was 39,661.
c) Regional Rural Banks (RRBs) :The RRBs came to be set up under the act of 1976. They were set up to save the
poor rural people from the grip of money lenders and traders. The Working Group
on Rural Banks recommended the setting up of RRBs as part of multi-agency
approach to rural credit. A RRB is sponsored by a public sector bank which also
subscribes to its share capital. As on June 30, 2006, there were 196 RRBs with a
network of 14,500 branches.
The RRBs meet the credit requirements of weaker sections, small and marginal
farmers , landless labourers, artisians and small entrepreneurs. RRBs have been
excellent in meeting the credit needs of rural poor. RRBs 95% of total direct
advances goes to weaker sections. RRBs are facting organizational and

management problems. In 1995-96 they incurred losses of Rs. 426 crore. As a

result of Amalgamation the number of RRBs have come down to 86 and their
branches were 15,144 as on June 30, 2009. In 2009-10 their number still declined
to 82.
II.
Private Sector Banks :In Private sector small scheduled commercial banks and seven newly established
banks with a network of about 8,965 branches are operating. To encourage
competitive efficiency, the setting up of new private bank is now encouraged.
Presently, the total number of banks in private sector is approx. 22 (15 old and 7
new). In 2008-09 new private sector banks accounted for 19.6% of total banking
assets.
III.
Foreign Banks :For a long time a majority of foreign banks have been operating in India. On
30th June 2009, the country had 32 foreign banks with 295 branches located mainly
in big cities. Apart from financing of foreign trade, these banks have performed all
functions of commercial banks and they have an advantage over Indian banks
because of their vast resources and superior management. In 2008-09, foreign
banks accounted for 8.5% of total banking assets. At the end of September, 2010,
34 foreign banks were operating in India.
In India, foreign banks practices have been held in suspicion. The unfair
competition with Indian banks, their practice of drawing funds from London
Money Market for financing Indias foreign trade and their gross irregularities
in securities scam have been a cause of concern. With growing strength of Indian
banks have improved their practices and have stopped discriminatory policies.
A) BANKING SECTOR REFORMS :Since nationalisation of banks in 1969, the banking sector had been
dominated by the public sector. There was financial repression, role of technology
was limited, no risk management etc. This resulted in low profitability and poor
asset quality. The country was caught in deep economic crises. The Government
decided to introduce comprehensive economic reforms. Banking sector reforms
were part of this package. In august 1991, the Government appointed a committee
on financial system under the chairmanship of M. Narasimhan.

B) FIRST PHASE OF BANKING SECTOR REFORMS / NARASIMHAN

COMMITTEE REPORT 1991 :To promote healthy development of financial sector, the
Narasimhan committee made recommendations.
I)
RECOMMENDATIONS OF NARASIMHAN COMMITTEE :1. Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks
(including SBI) at top and at bottom rural banks engaged in agricultural activities.
2. The supervisory functions over banks and financial institutions can be assigned to
a quasi-autonomous body sponsored by RBI.
3. Phased reduction in statutory liquidity ratio (SLR).
4. Phased achievement of 8% capital adequacy ratio.
5. Abolition of branch licensing policy.
6. Proper classification of assets and full disclosure of accounts of banks and
financial institutions.
7. Deregulation of Interest rates.
8. Delegation of direct lending activity of IDBI to a separate corporate body.
9. Competition among financial institutions on participating approach.
10. Setting up asset Reconstruction fund to take over a portion of loan portfolio of
banks whose recovery has become difficult.
II) Banking Reform Measures Of Government :On the recommendations of Narasimhan Committee, following measures were
undertaken by government since 1991 :1. Lowering SLR And CRR
The high SLR and CRR reduced the profits of the banks. The SLR has been
reduced from 38.5% in 1991 to 25% in 1997. This has left more funds with banks
for allocation to agriculture, industry, trade etc.
The Cash Reserve Ratio (CRR) is the cash ratio of a banks total deposits to be
maintained with RBI. The CRR has been brought down from 15% in 1991 to 4.1%
in June 2003. The purpose is to release the funds locked up with RBI.
2. Prudential Norms :Prudential norms have been started by RBI in order to impart professionalism in
commercial banks. The purpose of prudential norms include proper disclosure of
income, classification of assets and provision for Bad debts so as to ensure that the
books of commercial banks reflect the accurate and correct picture of financial
position.
Prudential norms required banks to make 100% provision for all Non-performing
Assets (NPAs). Funding for this purpose was placed at Rs. 10,000 croresphased
over 2 years.

3.

4.

a)
b)
c)
d)
e)
5.

6.

7.

8.

9.

Capital Adequacy Norms (CAN) :Capital Adequacy ratio is the ratio of minimum capital to risk asset ratio. In April
1992 RBI fixed CAN at 8%. By March 1996, all public sector banks had attained
the ratio of 8%. It was also attained by foreign banks.
Deregulation Of Interest Rates :The Narasimhan Committee advocated that interest rates should be allowed to be
determined by market forces. Since 1992, interest rates has become much simpler
and freer.
Scheduled Commercial banks have now the freedom to set interest rates on their
deposits subject to minimum floor rates and maximum ceiling rates.
Interest rate on domestic term deposits has been decontrolled.
The prime lending rate of SBI and other banks on general advances of over Rs. 2
lakhs has been reduced.
Rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled.
The interest rates on deposits and advances of all Co-operative banks have been
deregulated subject to a minimum lending rate of 13%.
Recovery Of Debts :The Government of India passed the Recovery of debts due to Banks and
Financial Institutions Act 1993 in order to facilitate and speed up the recovery of
debts due to banks and financial institutions. Six Special Recovery Tribunals have
been set up. An Appellate Tribunal has also been set up in Mumbai.
Competition From New Private Sector Banks :Now banking is open to private sector. New private sector banks have already
started functioning. These new private sector banks are allowed to raise capital
contribution from foreign institutional investors up to 20% and from NRIs up to
40%. This has led to increased competition.
Phasing Out Of Directed Credit :The committee suggested phasing out of the directed credit programme. It
suggested that credit target for priority sector should be reduced to 10% from 40%.
It would not be easy for government as farmers, small industrialists and
transporters have powerful lobbies.
Access To Capital Market :The Banking Companies (Acquisition and Transfer of Undertakings) Act was
amended to enable the banks to raise capital through public issues. This is subject
to provision that the holding of Central Government would not fall below 51% of
paid-up-capital. SBI has already raised substantial amount of funds through equity
and bonds.
Freedom Of Operation :Scheduled Commercial Banks are given freedom to open new branches and
upgrade extension counters, after attaining capital adequacy ratio and prudential

accounting norms. The banks are also permitted to close non-viable branches other
than in rural areas.
10. Local Area banks (LABs) :In 1996, RBI issued guidelines for setting up of Local Area Banks and it gave Its
approval for setting up of 7 LABs in private sector. LABs will help in mobilizing
rural savings and in channeling them in to investment in local areas.
11. Supervision Of Commercial Banks :The RBI has set up a Board of financial Supervision with an advisory Council to
strengthen the supervision of banks and financial institutions. In 1993, RBI
established a new department known as Department of Supervision as an
independent unit for supervision of commercial banks.

A) SECOND PHASE OF REFORMS OF BANKING SECTOR (1998) /

NARASIMHAN COMMITTEE REPORT 1988 :To make banking sector stronger the government appointed Committee on banking
sector Reforms under the Chairmanship of M. Narasimhan. It submitted its report
in April 1998. The Committee placed greater importance on structural measures
and improvement in standards of disclosure and levels of transparency. Following
are the recommendations of NarasimhanCommittee :1) Committee suggested a strong banking system especially in the context of capital
Account Convertibility (CAC). The committee cautioned the merger of strong
banks with weak ones as this may have negative effect on stronger banks.
2) It suggested that 2 or 3 large banks should be given international orientation and
global character.
3) There should be 8 to10 national banks and large number of local banks.
4) It suggested new and higher norms for capital adequacy.
5) To take over the baddebts of banks committee suggested setting up of Asset
Reconstruction Fund.
6) A board for Financial Regulation and supervision (BFRS) can be set up to
supervise the activities of banks and financial institutions.
7) There is urgent need to review and amend the provisions of RBI Act, Banking
Regulation Act, etc. to bring them in line with current needs of industry.
8) Net Non-performing Assets for all banks was to be brought down to 3% by 2002.
9) Rationalization of bank branches and staff was emphasized. Licensing policy for
new private banks can be continued.
10) Foreign banks may be allowed to set up subsidiaries and joint ventures.

On the recommendations of committee following reforms have been

taken :1) New Areas :New areas for bank financing have been opened up, such as :- Insurance, credit
cards, asset management, leasing, gold banking, investment banking etc.
2) New Instruments :For greater flexibility and better risk management new instruments have been
introduced such as :- Interest rate swaps, cross currency forward contracts, forward
rate agreements, liquidity adjustment facility for meeting day-to-day liquidity
mismatch.
3) Risk Management :Banks have started specialized committees to measure and monitor various risks.
They are regularly upgrading their skills and systems.
4) Strengthening Technology :For payment and settlement system technology infrastructure has been
strengthened with electronic funds transfer, centralized fund management system,
etc.
5)
6)
7)
8)

9)

Increase Inflow Of Credit :Measures are taken to increase the flow of credit to priority sector through focus on
Micro Credit and Self Help Groups.
Increase in FDI Limit :In private banks the limit for FDI has been increased from 49% to 74%.
Universal banking :Universal banking refers to combination of commercial banking and investment
banking. For evolution of universal banking guidelines have been given.
Adoption Of Global Standards :RBI has introduced Risk Based Supervision of banks. Best international practices
in accounting systems, corporate governance, payment and settlement systems etc.
are being adopted.
Information Technology :Banks have introduced online banking, E-banking, internet banking, telephone
banking etc. Measures have been taken facilitate delivery of banking services
through electronic channels.

10) Management Of NPAs:RBI and central government have taken measures for management of nonperforming assets (NPAs), such as corporate Debt Restructuring (CDR), Debt
Recovery Tribunals (DRTs) and LokAdalts.
11) Mergers And Amalgamation :-

In May 2005, RBI has issued guidelines for merger and Amalgamation of private
sector banks.
12) Guidelines For Anti-Money Laundering :In recent times, prevention of money laundering has been given importance in
international financial relationships. In 2004, RBI revised the guidelines on know
your customer (KYC) principles.
13) Managerial Autonomy :In February. 2005, the Government of India has issued a managerial autonomy
package for public sector banks to provide them a level playing field with private
sector banks in India.
14) Customer Service:In recent years, to improve customer service, RBI has taken many steps such as :Credit Card Facilities, banking ombudsman, settlement off claims of deceased
depositors etc.
15) Base Rate System Of Interest Rates:In 2003 the system of Benchmark Prime Lending Rate (BPLR) was introduced to
serve as a benchmark rate for banks pricing of their loan products so as to ensure
that it truly reflected the actual cost. However the BPLR system tell short of its
objective. RBi introduced the system of Base Rate since 1 st July, 2010. The base
rate is the minimum rate for all loans. For banking system as a whole, the base
rates were in the range of 5.50% - 9.00% as on 13th October, 2010.