Banking Evolution in India


  • Need of banking system in India
    • Merchants at the colonial time feel difficult to carry the money due to pirates.
    • The origin of western type commercial Banking in India dates back to the 18th century.
    • The story of banking starts from Bank of Hindustan established in 1770 and it was first bank at Calcutta under European management. It was liquidated in 1830-32.

From Bank of Hindustan in 1770, the evolution of banking in India can be divided into three different periods as follows:

  • Phase I: Early phase of primitive Indian banks to Nationalization of Banks in 1969
  • Phase II: From Nationalization of India banks in 1969 up to advent of liberalization and banking reforms in 1991
  • Phase III: From Indian Financial and Banking Sector Reforms 1991 onward

Phase I –

  • In 1786 General Bank of India was set up.
  • Since Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, it became a banking center.
  • Three Presidency banks were set up under charters from the British East India Company- Bank of Calcutta, Bank of Bombay and the Bank of Madras. These worked as quasi central banks in India for many years.
    • Bengal 1806
    • Bombay 1840
    • Madras 1842
  • The Bank of Calcutta established in 1806 immediately became Bank of Bengal.
  • In 1921 these 3 banks merged with each other and Imperial Bank of India got birth. Imperial Bank of India was later renamed in 1955 as the State Bank of India. Thus, State bank of India is the oldest Bank of India.
  • In 1839, there was a fruitless effort by Indian merchants to establish a Bank called Union Bank. It failed within a decade.
  • Next came Allahabad Bank which was established in 1865 and working even today.
    • The oldest Public Sector Bank in India having branches all over India and serving the customers for the last 145 years is Allahabad Bank. 
    • Allahabad bank is also known as one of India’s Oldest Joint Stock Bank.
    • However, the Oldest Joint Stock bank of India was Bank of Upper India established in 1863 and failed in 1913.
  • The first Bank of India with Limited Liability to be managed by Indian Board was Oudh Commercial Bank.
    • It was established in 1881 at Faizabad.
    • This bank failed in 1958.
  • The first bank purely managed by Indians was Punjab National Bank, established in Lahore in 1895.
    • The Punjab national Bank has not only survived till date but also is one of the largest banks in India.

  • However, the first Indian commercial bank which was wholly owned and managed by Indians was Central Bank of India which was established in 1911. So, Central Bank of India is called India’s First Truly Swadeshi bank.

Pre Independence banks in India

Foreign Banks (Pre independence)

  • Bombay, Bengal, Madras Presidency Banks Imperial Bank’ 21 SBI’ 55
  • Catered British Army, Bureaucrats, Judges, merchants

Indian Banks (Pre independence)

  • Allahabad Bank, PNB, BoB, Canara Bank
  • Focus was majorly on Foreign trade
  • Catered Merchants, Shroff & Moneylenders

Birth of RBI

  • By 1930 India had more than 1000 banks working solely on companys law
  • In October 24, 1929, the stock market bubble finally burst, as investors began dumping shares en masse.
  • A record 12.9 million shares were traded that day, known as Black Thursday.
  • Finally in 1934, to check this kind of situation in future RBI as bankers bank was institutionalized.

Phase II-

  • The Second Phase of banking in India starts from 1935 when Reserve Bank of India was established.
  • Between the period of 1911-1948, there were more than 1000 banks in India, almost all small banks.
  • The Reserve Bank of India was constituted in 1934 as an apex Bank, however without major government ownership.
  • Immediately after the independence, the Government of India came up with the Banking Companies Act 1949.
    • This act was later changed to Banking Regulation (Amendment) Act 1949.
    • Further, the Banking Regulation (Amendment) Act of 1965 gave extensive powers to the Reserve Bank of India and via this act, the Reserve Bank of India was made the Central Banking Authority.

Post-Independence banks in India

  • SBI, ICICI, PNB, BOB
  • Catered Merchant & industrial houses
  • Bank branches increases but only to cater industrial markets
  • No expansion in rural areas No
  • No Financial inclusion No help in five year plans achievement
  • Hence to cater the needs of rural banks Government began nationalizing the banks

Bank Nationalization problems

  • Administered interest rate by government
  • Political interference loan for government nepotism Rise in NPA Burden on Civil Courts
  • High reserve requirement CRR 15%, SLR 40%
  • Hard to get loans for business Balance of Payment crisis
    • High cost (interest rates) for credit (loans)
    • Business expansion decreased Jobs creation decreased
    • Tax-Collection decreased Government borrowing: Fiscal deficit increased
    • Exports decreased Current Account Deficit increased

The banking sector reforms started immediately after the independence. These reforms were basically aimed at improving the confidence level of the public because in those days, most banks were not trusted by the majority of the people. Instead, the deposits with the Postal department were considered rather safe.

  • The first major step was Nationalization of the Imperial Bank of India in 1955 via State Bank of India Act.
  • State Bank of India was made to act as the principal agent of RBI and handle banking transactions of the Union and State Governments.
  • After that, in a major process of nationalization, seven subsidiaries of the State Bank of India were nationalized via the State Bank of India (Subsidiary Banks) Act, 1959.
  • In 1969, fourteen major private commercial banks were nationalized. These 14 banks Nationalized in 1969 are as follows:
  • List of 14 Banks Nationalized in 1969

1.

Central Bank of India

2.

Bank of Maharashtra

3.

Dena Bank

4.

Punjab National Bank

5.

Syndicate Bank

6.

Canara Bank

7.

Indian Bank

8.

Indian Overseas Bank

9.

Bank of Baroda

10.

Union Bank

11.

Allahabad Bank

12.

United Bank of India

13.

UCO Bank

14.

Bank of India

  • The above was followed by a second phase of nationalization in 1980, when Government of India acquired the ownership of 6 more banks, thus bringing the total number of Nationalised Banks to 20.
  • The private banks at that time were allowed to function side by side with nationalized banks and the foreign banks were allowed to work under strict regulation.
  • After the two major phases of nationalization in India, the 80% of the banking sector came under the public sector / government ownership.
  • After the nationalisation of banks, the branches of the public sector banks in India rose to approximately 800 per cent in deposits, and advances took a huge jump by 11,000 per cent.
  • Government ownership gave the public implicit faith and immense confidence in the sustainability of public sector banks.

Phase III

Narsimhan Committee I 1991

Narsimhan Committee I was formed to overhaul banking sector of India & to overcome its problems viz.

  • Rising NPA
  • Lack of Rural Expansion
  • Bank Nationalization
  • Lack of Financial inclusion
  • High Interest Rates

Recommendation

Result

Government / RBI must not regulate the banks loan interest rates. Banks should be allowed to decide that by themselves.

 RBI adopted Benchmark Prime Lending Rate (BPLR) Now days Base Rate system (2010)

 Setup Debt recovery tribunals, so loan defaulters cannot get stay orders from courts.

Debt recovery tribunal setup in 1993 Later came SARFAESI act in 2002 with more powers

Liberate Branch expansion policy.

Banks can open branches anywhere. Only condition 25% of branches in rural areas.

Reduce CRR and SLR so banks are left with more money to lend.

Gradually reduced from (15,40) → (4, 21.5)

NBFC regulatory framework

Implemented

Government should reduce its shareholding from public sector banks.

Done, SBI shares sold, nowadays government owns ~ 60%. (this facilitates entry of professionals in the board of directors)

Allow entry of private sector banks and foreign banks.

Done, leads to first round of bank licenses

Benchmark Prime Lending Rate (BPLR)Base Rate system

  • RBI does NOT fix the base rate.  It has issued broad guidelines to bank as to how they should arrive at the base rate.
  • Thus, individual bank itself fixes its own base rate.
  • The calculations of the BPLR by various banks were not transparent.
  • In case of BPLR, Banks normally used to take into consideration the factors like cost of funds, administrative costs and a margin over it.
  • However, such parameters were neither disclosed by banks nor were same for all the banks
  • Result Base Rate system (2010)

Lets Say Base rate of SBI is 10%

Base Rate +

Result

Car Loan

0.75 %

10.75 %

Two Wheeler Loan

8.25 %

18.25 %

Education Loan

3.50 %

13.50 %

Home Loan (< 75 L)

0.15 %

10.15 %  (10.10 W)

Home Loan (> 75 L)

0.30 %

10.30 %  (10.25 W)

Bank licences 1st Round (1993)

  • Total 10 private banks given licenses 6 still running + 4 closed down
  • 6 Running ICICI, HDFC, UTI (became Axis bank (2007)), IDBI, Indusind, DCB (Development Credit Bank)
  • 4 Closed Global Trust Bank merged with Oriental bank of Commerce, Bank of Punjab merged with Centurion bank, Centurion bank merged with HDFC bank, Times Bank merged with HDFC bank

Narsimhan Committee II 1998

  • Introduced Voluntary retirement scheme (VRS) in public sector banks.
  • Legal reforms for loan recovery SARFAESI act 2002
  • Computerization, electronic fund transfer, legal framework
    • Payment and Settlement Act
    • Retail Transaction ECS, NEFT, Credit Card
    • Wholesale Transaction RTGS
  • Permit new private / foreign banks

Older Classification 

  • Banks
  • NBFI
  • DFI (Development Financial institutions) ICICI, IDBI, IFCI etc.

New Classification 

  • Banks
  • NBFI

New Bank licenses 2nd round (2001)

  • This time RBI gave license only two strongest contenders viz.

  • Kotak Mahindra
  • Yes Bank

New Bank licenses 3rd Round (2013 14) RBI conditions

  • 10 years successful work-ex with minimum capital Rs. 5 billion
  • Get its shares listed on stock exchange within 3 years; bring down voting rights to 15% within 12 years.
  • foreign shareholding must not be more than 49% (for the first five years)
  • 50% of directors should be independent & such bank must not invest in shares/bonds of its parent group.
  • Must open at-least 25% branches in the unbanked rural areas & Have to comply with PSL norms

RBI Bimal Jalan Committee

  • Based on committees recommendations RBI gave license only two strongest contenders viz.
    • Bandhan Microfinance
    • IDFC

Bandhan Microfinance Chandra Shekhar Ghosh

  • Micro-finance company at West Bengal
  • Net worth 1100 Cr., 45% branches in rural areas

IDFC (Infrastructure Development and Financial Corporation) Rajiv Lal

  • Infrastructure finance company at Mumbai
  • Net worth 21000 cr., but rural presence low

These two are given onlyin-principle approval which means

  • Within 18 months must get net worth Rs. 1000 crore
  • Must open 25% branches in unbanked rural areas

Once they fulfill above conditions, RBI will give them license under Banking Regulation Act, 1949 to open current account, savings account etc. RBI has also prohibited the promoters (Ghosh and Lal) to hold CEO position in their respective banks to prevent conflict of interest.

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