Professional Documents
Culture Documents
VISHWAKARMA
BY.SUMANVISHWAKARMAUNDERTHEGUIDENCEOFPROF.
MR.SANJAYJADHAVDEPARTMENTOFLAW,UNIVERSITYOF
MUMBAI2012TO2013
04Sep13
The banks are the custodians of savings and powerful institutions to provide credit. They mobilize the
resources from all the sections of the community by way of deposits and channelize them to industries
and others by way of granting loans. In 1955 the Imperial Bank of India was nationalized and SBI was
constituted.
Background
The banks are the custodians of savings and
powerful institutions to provide credit. They mobilise the resources from all the
sections of the community by way of deposits and channelize them to industries
and others by way of granting loans. In 1955 the Imperial Bank of India was
nationalised and SBI was constituted.
It was observed that commercial banks were
directing their advances to the large and medium scale industries and the
priority sectors such as agriculture, small-scale industries and the exports were
neglected.
The chairmen and directors of banks were
mostly industrialists and many of them were interested in sanctioning large
amount of loans and advances to the industries with which they were connected.
To overcome these deficiencies found in the working of the banks, the Banking
Laws (Amendment) Act was passed in December 1968 and came into force on
1-2-1969. It is known as the scheme of 'social control' over the banks. The then
deputy Prime Minister, Mr. Morarji Desai made a statement in the Parliament
on the eve of introducing the bill to amend the banking laws Act.
He explained that the aim of social control was,
"to regulate our social and economic life so as to attain the optimum growth rate
for our economy and to prevent at the same time monopolistic trend,
concentration of economic power and misdirection of resources".
The following are the main provisions of this
amendment, Bigger banks had to be managed by whole time chairman
possessing special knowledge and practical experience of the working of a
banking company or of finance, economics or business administration.
The majority of directors had to be persons with special knowledge or practical
experience in any of the areas such as accountancy, agriculture and rural
economy, banking, co-operative, economics, finance, law, small scale industries
etc.The banks were also prohibited from making any loans or advances, secured
or unsecured to their directors or to any companies in which they have
substantial interest.
The growth of commercial banking during the
first three plan periods has been lopsided. Without demanding proper security
some banks were diverting funds to large and medium industries.
NATIONALIZATION.
Barely four months after the third meeting of the National Credit Council,
on 9 July 1969, Indira Gandhi sent a note to the Congress Working Committee
through Fakhruddin Ali Ahmed, who was the Minister for Industrial
Development, suggesting the nationalization of major banks. This came
as a complete surprise, for the prevalent belief in Congress circles was that
What was most disturbing for the Reserve Bank was the impression that was
created in the media that it was opposed to nationalization. This perhaps had to
do with the personality of Jha himself, and with the fact that the Bank had
striven hard to make a success of the social control experiment. As Vice
Chairman of the National Credit Council, Jha ensured that a large number of
documents were submitted on different aspects of social control.
The Bank had substantial inputs in the work of the groups formed by the
Council. It also helped to provide the secretariat for the Council, and to create in
March 1969 a cell attached to the Banking Commission. These actions by
themselves did not imply that Jha was opposed to nationalization of major
Indian banks. All the oral accounts point out that while Jha did not favour bank
nationalization, he did not openly articulate his personal view on the subject.
The real issue was summed up by I.G. Patel in his book,
Glimpses of Indian Economic Policy: An Insiders View: For me, one
consequence of nationalization was controversy once again about my
jurisdiction and that of my department. A new banking department was created
in the ministry under A. Bakshi from the RBI, an old leftist and acerbic friend
of Haksar who could obviously be more relied upon to run nationalized banks
than L.K. or I.G. (p. 137). As Patels quote shows, Jha was identified with
forces that did not figure in the leftist groups that considered social control as an
apology and a dilatory tactic to prevent the state from gaining the commanding
heights of Indian finances. After the legal tangle over nationalization was
temporarily sorted out, Jha convened a Rural Credit Survey Committee
commercial banks only provided 0.9% of the total volume of advances and
loans to the agricultural sector (Reserve Bank of India 2008a). Rural India
continued to rely mostly on moneylenders that charged them very high interest
rates on their loans.
THE SECOND ROUND
EVALUTION.
PRIVATE OWNERSHIP,
NATIONALIZATION AND
DISINVESTMENT
Effects of these reforms on the private and public banking
system
Credit structure and setting up of institutional framework
for providing longterm finance to agriculture and industry. Banking sector, which
during the preindependence India was catering to the needs of the government,
rich individuals and traders, opened its door wider and set out for the first time to
bring the entire productive sector of the economy large as well as small, in its
fold. During this period number of commercial banks declined remarkably. There
were 566 banks as on December, 1951; of this, number scheduled banks was 92 and
the remaining 474 were non-scheduled banks.
This number went down considerably to the level of
281 at the close of the year 1968. The sharp decline in the number of banks was due
to heavy fall in the number of non-scheduled banks which touched an all time low
level of 210. The banking scenario prevalent in the country up-tothe year 1968
depicted a strong stress on class banking based on security rather than on' purpose.
Before 1968, only RBI and Associate Banks of SBI were mainly controlled by
Government. Some associates were fully owned subsidiaries of SBI and in the rest,
there was a very small shareholding by individuals and the rest by RBI.
EXPANSION PHASE (1968-1984)
The motto of bank nationalization was to make
banking services reach the masses that can be attributed as "first- banking
revolution". Commercial banks acted as vital instruments for this purpose by way
of rapid branch expansion, deposits mobilization and credit creation. Penetrating
into rural areas and agenda for geographical expansion in the form of branch
expansion continued. The second dose of nationalization of 6 more commercial
banks on April 15, 1980 further widened the phase of the public sector banks and
therefore banks were to implement all the government sponsored programmes and
change their attitude in favour of social banking, which was given the highest
priority.
Rural Branches
1833
15105
35206
Semi-urban Branches
3342
8122
11,344
It can be seen from the Table 4.1 that the total number
of bank branches increased eight-fold between 1969 to 1991.
The bulk of the increase was on account of rural
branches which increased from less than 2000 to over 35000 during the period.
The percentage share of the rural and semi-urban branches rose from 22 and 4
respectively in 1969 to 45 percent and 25 percent in 1980 and 58 per cent and 18
percent in 1991.
The impact of this phenomenal growth was to bring
down the population per branch from 60,000 in 1969 to about 14,000. The banking
system thus assumed a broad mass-base and emerged as an important instrument of
social-economic changes. However, this success was neither unqualified nor
without costs.
While the rapid branch expansion, wider geographical
coverage has been achieved, lines of supervision and control had been stretched
beyond the optimum level and had weakened. Moreover, retail lending to more
risk-prone areas at concessional interest rates had raised costs, affected the quality
of assets of banks and put their profitability under strain.
PRIVATE OWNERSHIP
The underprovision of credit to small-scale industry
was one of the key reasons cited for nationalization in 1969: thus, it might in fact be
the case that while the public sector banks provide relatively little credit to SSI
firms, private banks are even worse. In the next sub-section we examine the effect
of bank ownership on bank allocation of credit.
Bank Ownership and Sectoral Allocation of Credit As
mentioned above, an important rationale for the Indian bank nationalizations was to
direct credit towards sectors the government thought were underserved, including
small scale industry, as well as agriculture and backward areas.
Ownership was not the only means of directing credit:
the Reserve Bank of India issued guidelines in 1974, indicating that both public and
private sector banks must provide at least one-third of their aggregate advances to
the priority sector by March 1979. In 1980, it was announced that this quota would
be increased to 40 percent by March 1985. Sub-targets were also specified for
lending to agriculture and weaker sectors within the priority sector. Since public
and private banks faced the same regulation, in this section we focus on how
ownership affected credit allocation.
The comparison of nationalized and private banks is
never easy: banks that fail are often merged with healthy nationalized banks, which
makes the comparison of nationalized banks and non-nationalized banks close to
meaningless.
The Indian nationalization experience of 1980
represents a unique chance to learn about the relationship between bank ownership
and bank lending behavior. The 1980 nationalization took place according to a
strict policy rule: all private banks whose deposits were above a certain cutoff were
nationalized.18 After 1980, the nationalized banks remained corporate entities,
retaining most of their staff, though the board of directors was replaced by
nominees of the Government of India.
Both the banks that got nationalized under this rule and
the banks that missed being nationalized, continued to operate in the same
environment, and face the same regulations and therefore ought to be directly
comparable .Even this comparison between banks just nationalized and just not
nationalized may be invalid, because policy rule means that banks nationalized in
1980 are larger than the banks that. remained private. If size influences bank
behavior, it would be incorrect to attribute all differencesbetween nationalized and
private sector banks to nationalization. In this section, based on Cole, we adopt an
approach in the spirit of regression discontinuity design, and compare banks
that were just above the 1980 cut off to those that were just below the 1980 cutoff,
while control- 18While the 1969 was larger, and also induced a discontinuity,
We do not use it because many of the banks just below the cut-off in 1969 were
nationalized in 1980.
One policy option that is being discussed is
privatization. The evidence from Cole, discussed above, suggests that privatization
would lead to an infusion of dynamism in to the banking sector: private banks
have been growing faster than comparable public banks in terms of credit, deposits
and number of branches, including rural branches, though it should be noted that
in our empirical analysis, the comparison group of private banks were the
relatively small old private banks.48 It is not clear that we can extrapolate from
this to what we could expect when the State Bank of India, which is more than an
order of magnitude greater in size than the largest old private sector banks. The
new private banks are bigger and in some ways would have been a better group
to compare with.
However while this group is also growing very fast,
they have been favored by regulators in some specific ways, which, combined
with their relatively short track record, makes the comparison difficult.
Privatization will also free the loan officers from the fear of the CVC and make
them somewhat more willing to lend aggressively where the prospects are good,
though, as will be discussed. Later, better regulation of public banks may also
achieve similar goals.
Historically, a crucial difference between public and
private sector banks has been their willingness to lend to the priority sector. The
recent broadening of the definition of priority sector has mechanically increased
the share of credit from both public and private sector banks that qualify as
priority sector. The share of priority sector lending from public sector banks was
42.5 percent in 2003, up from 36.6 percent in 1995.
Private sector lending has shown a similar increase
from its 1995 level of 30 percent. In 2003 it may have surpassed for the first time
ever public sector banks, with a share of net bank credit to the priority sector at
44.4 percent to the priority sector.49 Still, there are substantial differences
between the public and private sector banks.
Most notable is the consistent failure of private
sector banks to meet the agricultural lending subtarget, though they also lend
substantially less in rural areas. Our evidence suggests that privatization will make
it harder for the government to get the private banks to comply with what it wants
them to do.
PROTECTION OF DEPOSITORS
As stated earlier, financial intermediation by commercial banks has played a
key role in India in supporting the economic growth process. An efficient
financial intermediation process, as is well known, has two components:
effective mobilization of savings and their allocation to the most productive
uses. In this chapter, we will discuss one part of the financial intermediation
by banks: mobilization of savings. When banks mobilize savings, they do it in
the form of deposits, which are the money accepted by banks from customers to
be held under stipulated terms and conditions. Deposits are thus an instrument
of savings.
Since the first episode of bank nationalization
in 1969, banks have been at the core of the financial intermediation process in
India. They have mobilized a sizeable share of savings of the household sector,
the major surplus sector of the economy.
This in turn has raised the financial savings of
the household sector and hence the overall savings rate. Notwithstanding the
liberalization of the financial sector and increased competition from various
other saving instruments, bank deposits continue to be the dominant instrument
of savings in India. provides a description of the most standard instruments of
bank regulation: deposit insurance, capital adequacy requirements and lender of
last resort.
These three policies are linked one with the other.
Deposit insurance protects the smallest depositors from a bank bankruptcy and
prevents bank runs. Capital adequacy requirements are necessary in order to
make sure that bank managers follow a responsible credit policy, in the absence
of an effective control on the part of depositors. Lender of last resort policies
further reduce the risk of banks bankruptcies providing banks with Emergency
Liquidity Assistance facilities that are designed to avoid that temporary
situations
Safety of deposits
At the time of depositing money with the bank, a
depositor would want to be certain that his her money is safe with the bank and
at the same time, wants to earn a reasonable return.The safety of depositors'
funds, therefore, forms a key area of the regulatory framework for banking. In
India, this aspect is taken care of in the Banking Regulation Act, 1949 (BR
Act).
The RBI is empowered to issue directives/advices on
several aspects regarding the conduct of deposit accounts from time to time.
Further, the establishment of the Deposit Insurance Corporation in 1962
(against the backdrop of failure of banks) offered protection to bank depositors,
particularly small-account holders. This aspect has been discussed later in the
Chapter.
Deregulation of interest rates
The process of deregulation of interest rates started in
April 1992. Until then, all interest rates were regulated; that is, they were fixed
by the RBI. In other words, banks had no freedom to fix interest rates on their
deposits. With liberalization in the financial system, nearly all the interest rates
have now been deregulated.
Now, banks have the freedom to fix their own
deposit rates with only a very few exceptions. The RBI prescribes interest rates
only in respect of savings deposits and NRI deposits, leaving others for
individual banks to determine.
Deposit policy
The Board of Directors of a bank, along with its top
management, formulates policies relating
to the types of deposit the bank should have, rates of interest payable on each
type, special deposit schemes to be introduced, types of customers to be targeted
by the bank, etc. Of course, depending on the changing economic environment,
the policy of a bank towards deposit mobilization, undergoes changes.
Deposit Insurance:
Deposit insurance helps sustain public confidence
in the banking system through the protection of depositors, especially small
depositors, against loss of deposit to a significant extent. In India, bank deposits
are covered under the insurance scheme offered by Deposit Insurance and
Credit Guarantee Corporation of India (DICGC), which was established with
funding from the Reserve Bank of India.
The scheme is subject to certain limits and
conditions. DICGC is a wholly-owned subsidiary of the RBI.
1. Banks insured by the DICGC All commercial banks including branches of
foreign banks functioning in India, local area banks and regional rural banks are
insured by the DICGC.22
Further, all State, Central and Primary cooperative banks
functioning in States/Union Territories which have amended the local
Cooperative Societies Act empowering RBI suitably are insured by the DICGC.
Primary cooperative societies are not insured by the DICGC.
2 Features of the scheme
When is DICGC liable to pay?
In the event of a bank failure, DICGC protects bank deposits that are payable in
India. DICGC is liable to pay if (a) a bank goes into liquidation or (b) if a bank
is amalgamated/ merged with another bank.
Methods of protecting depositors' interest
There are two methods of protecting depositors' interest when
an insured bank fails:
by transferring business of the failed bank to another sound bank23
(i)
(in case of merger or amalgamation) and
(ii) where the DICGC pays insurance proceeds to depositors (insurance
pay-out method).
Safety:
Banks need to ensure that advances are safe and money lent out by
them will come back. Since the repayment of loans depends on the borrowers'
capacity to pay, the banker must be satisfied before lending that the business for
which money is sought is a sound one. In addition, bankers many times insist on
security against the loan, which they fall back on if things go wrong for the
business.
The security must be adequate, readily marketable and free
of encumbrances.
Liquidity:
To maintain liquidity, banks have to ensure that money lent out by
them is not locked up for long time by designing the loan maturity period
appropriately. Further, money must come back as per the repayment schedule. If
loans become excessively illiquid, it may not be possible for bankers to meet
their obligations vis--vis depositors.
Profitability:
To remain viable, a bank must earn adequate profit on its investment.
This calls for adequate margin between deposit rates and lending rates. In this
respect, appropriate fixing of interests rates on both advances and deposits is
critical. Unless interest rates are competitively fixed and margins are adequate,
banks may lose customers to their competitors and become unprofitable.
Risk diversification:
To mitigate risk, banks should lend to a diversified customer base.
Diversification should be in terms of geographic location, nature of business
etc. If, for example, all the borrowers of a bank are concentrated in one region
and that region gets affected by a natural disaster, the bank's profitability can be
seriously affected.
Loan Policy
Based on the general principles of lending stated
above, the Credit Policy Committee (CPC) of individual banks prepares the
basic credit policy of the Bank, which has to be approved by the Bank's Board
of Directors.
The loan policy outlines lending guidelines and
establishes operating procedures in all aspects of credit management including
standards for presentation of credit proposals, financial covenants, rating
standards and benchmarks, delegation of credit approving powers, prudential
limits on large credit exposures, asset concentrations, portfolio management,
loan review mechanism, risk monitoring and evaluation, pricing of loans,
provisioning for bad debts, regulatory/ legal compliance etc.
The lending guidelines reflect the specific bank's
lending strategy (both at the macro level and individual borrower level) and
have to be in conformity with RBI guidelines.
The loan policy typically lays down lending guidelines in the following areas:
1). Level of credit-deposit ratio
2).Targeted portfolio mix
3). Hurdle ratings
4). Loan pricing
5). Collateral security