HISTORY OF BANKING

Wealth compressed into the convenient form of gold brings one disadvantage. Unless well hidden or
protected, it is easily stolen.

In early civilizations a temple is considered the safest refuge; it is a solid building, constantly
attended, with a sacred character which itself may deter thieves. In Egypt and Mesopotamia gold is
deposited in temples for safe-keeping. But it lies idle there, while others in the trading community or
in government have desperate need of it. InBabylon at the time of Hammurabi, in the 18th century
BC, there are records of loans made by the priests of the temple. The concept of banking has arrived.

Greek and Roman financiers: from the 4th century BC

Banking activities in Greece are more varied and sophisticated than in any previous society. Private
entrepreneurs, as well as temples and public bodies, now undertake financial transactions. They take
deposits, make loans, change money from one currency to another and test coins for weight and
purity.
They even engage in book transactions. Moneylenders can be found who will accept payment in one
Greek city and arrange for credit in another, avoiding the need for the customer to transport or transfer
large numbers of coins.
Rome, with its genius for administration, adopts and regularizes the banking practices of Greece. By
the 2nd century AD a debt can officially be discharged by paying the appropriate sum into a bank, and
public notaries are appointed to register such transactions.
The collapse of trade after the fall of the Roman empire makes bankers less necessary than before,
and their demise is hastened by the hostility of the Christian church to the charging of interest. Usury
comes to seem morally offensive. One anonymous medieval author declares vividly that 'a usurer is a
bawd to his own money bags, taking a fee that they may engender together'.

Religion and banking: 12th - 13th century AD

The Christian prohibition on usury eventually provides an opportunity for bankers of another
religion.European prosperityneeds finance. TheJews, barred from most other forms of employment,
supply this need. But their success, and their extreme visibility as a religious sect, brings dangers.

The same is true of another group, the knights Templar, who for a few years become bankers to the
mighty. They too, an exclusive sect with private rituals, easily fall prey to rumour, suspicion and
persecution (seeTemplarsin Europe). The profitable business of banking transfers into the hands of
more ordinary Christian folk - first among them the Lombards.

Bankers to Europe's kings: 13th - 14th century AD

During the 13th century bankers from north Italy, collectively

known as Lombards, gradually replace the Jews in their
traditional role as money-lenders to the rich and powerful. The
business skills of the Italians are enhanced by their invention
of double-entry book-keeping. Creative accountancy enables
them to avoid the Christian sin ofusury; interest on a loan is
presented in the accounts either as a voluntary gift from the
borrower or as a reward for the risk taken.
Siena and Lucca, Milan and Genoa all profit from the new trade.
But Florence takes the lion's share.

Florence is well equippped for international finance thanks to its

famous gold coin, the florin. First minted in 1252, the florin is
widely recognized and trusted. It is the hard currency of its day.
By the early 14th century two families in the city, the Bardi and
the Peruzzi, have grown immensely wealthy by offering financial
services. They arrange for the collection and transfer of money
due to great feudal powers, in particular the papacy. They
facilitate trade by providing merchants with bills of exchange, by
means of which money paid in by a debtor in one town can be
paid out to a creditor presenting the bill somewhere else (a
principle familiar now in the form of a cheque).

The ability of the Florentine bankers to fulfil this service is

shown by the number of Bardi branches outside Italy. In the
early 14th century the family has offices in Barcelona, Seville
and Majorca, in Paris, Avignon, Nice and Marseilles, in London,
Bruges, Constantinople, Rhodes, Cyprus and Jerusalem.

To add to Florence's sense of power, many of Europe's rulers are

heavily in debt to the city's bankers. Therein, in the short term,
lies the bankers' downfall.

In the 1340s Edward III of England is engaged in the expensive

business of war with France, at the start of the Hundred Years'
War. He is heavily in debt to Florence, having borrowed 600,000
gold florins from the Peruzzi and another 900,000 from the
Bardi. In 1345 he defaults on his payments, reducing both
Florentine houses to bankruptcy.
Florence as a great banking centre survives even this disaster.
Half a century later great fortunes are again being made by the
financiers of the city. Prominent among them in the 15th century
are two families, the Pazzi and the Medici.

Banks and cheques: from the 16th century AD

In 1587 the Banco della Piazza di Rialto is opened in Venice as a state initiative. Its purpose it to carry
out the important function of holding merchants' funds on safe deposit, and enabling financial
transactions in Venice and elsewhere to be made without the physical transfer of coins.

This was an accepted part of trade in ancientGreece, but it has previously been carried out by
individual moneylenders - involving a high risk of bankruptcy. The Venetian initiative, with the
expenses born by the state, is an attempt to provide a measure of security in this central aspect of the
risky business of trade.
Other Mediterranean trading centres (in particular Barcelona and Genoa) have possibly taken this
step before Venice, and it is soon followed in northern cities - Amsterdam in 1609, Hamburg in 1619,
Nuremberg in 1621.

A related development is that of the cheque, a device which depends on the existence of banks as
recognized institutions. A bill of exchange, the original method of transferring money without the use
of coins, is a complex contract between private parties and one or more moneylenders. A cheque is a
bill of exchange between banks, payable by one of the banks to whoever holds and presents the
cheque.

This much simplified version of a bill of exchange slowly gains acceptance from the late 17th century.
At the same time it is realized that the banking process has its own in-built potential for profit which
can more than cover the costs of processing cheques and transferring money.
The total of the money left on deposit by a bank's customers is a large sum, only a fraction of which is
usually required for withdrawals. A proportion of the rest can be lent out at interest, bringing profit to
the bank. When the customers later come to realize this hidden value of their unused funds, the bank's
profit becomes the difference between the rates of interest paid to depositors and demanded from
debtors.
The transformation from moneylenders into private banks is a gradual one during the 17th and 18th
centuries. In England it is achieved by various families of goldsmiths who early in the period accept
money on deposit purely for safe-keeping. Then they begin to lend some of it out. Finally, by the 18th
century, they make banking their business in place of their original craft as goldsmiths.
With private banking part of the fabric of commercial life, the next stage in the story is the
development of national banks.

National banks: 17th - 18th century AD

Venice, after being possibly the first city to found a bank for the keeping of money on safe deposit
and the clearing of cheques, is also a pioneer in the involvement of a bank with state finances. In 1617
the Banco Giro is established to solve problems encountered by the earlierBanco della Piazza di
Rialto, which has got into trouble through the making of unsecured loans.

Its debtors include the Venetian government. The Banco Giro is founded on the principle that the
government's creditors accept payment in the form of credit with the new bank. In solving an existing
problem, this also provides new opportunities. Venice now has a mechanism for raising public finance
on the basis of guaranteed credit.
The logical extension of this concept is a national bank, established in some form of partnership with
the state. The earliest example is the Bank of Sweden, founded in 1668 and today the world's oldest
surviving bank. It is followed before the end of the century by the Bank of England, originally ajoint-
stock companywhich begins its existence in 1694 by arranging a loan of £1,200,000 to the
government.

During the 18th century the Bank of England gradually undertakes many of the tasks now associated
with a central bank. It organizes the sale of government bonds when funds need to be raised. It acts as
a clearing bank for government departments, facilitating and processing their daily transactions.
The Bank of England also becomes the banker to other London banks, and through them to a much
wider banking community. The London banks act as agents in the capital for the many small private
banks which open around the country in the second half of the 18th century.
All these banks use the Bank of England as a source of credit in a crisis. For this purpose the national
bank needs a large reserve of gold, which it accumulates until almost the entire hoard of the nation's
bullion is stored in its vaults.

Bank notes: AD 1661-1821

Paper currencymakes its first appearance in Europe in the 17th century. Sweden can claim the
priority (as also, a few years later, in the first national bank).
In 1656 Johan Palmstruch establishes the Stockholm Banco. It is a private bank but it has strong links
with the state (half its profits are payable to the royal exchequer). In 1661, in consultation with the
government, Palmstruch issues credit notes which can be exchanged, on presentation to his bank, for a
stated number of silver coins.
Palmstruch's notes (the earliest to survive dates from a 1666 issue) are impressive-looking pieces of
printed paper with eight hand-written signatures on each. If enough people trust them, these notes are
genuine currency; they can be used to purchase goods in the market place if each holder of a note
remains confident that he can indeed exchange it for conventional coins at the bank.
Predictably, the curse of paper money sinks the project. Palmstruch issues more notes than his bank
can afford to redeem with silver. By 1667 he is in disgrace, facing a death penalty (commuted to
imprisonment) for fraud.
Another half century passes before the next bank notes are issued in Europe, again by a far-sighted
financier whose schemes come to naught. John Law, founder of the Banque Générale in Paris in 1716
(and later of the ill-fatedMississippi scheme) issues bank notes from January 1719. Public confidence
in the system is inevitably shaken when a government decree, in May 1720, halves the value of this
paper currency.
Throughout the commercially energetic 18th century there are frequent further experiments with bank
notes - deriving from a recognized need to expand the currency supply beyond the availability of
precious metals.

Gradually public confidence in these pieces of paper increases, particularly when they are issued by
national banks with the backing of government reserves. In these circumstances it even becomes
acceptable that a government should impose a temporary ban on the right of the holder of a note to
exchange it for silver. This limitation is successfully imposed in Britain during the Napoleonic wars.
The so-called Restriction Period lasts from 1797 to 1821.
With governments issuing the bank notes, the inherent danger is no longer bankruptcy but inflation.
When the Restriction Period ends, in 1821, the British government takes the precaution of introducing
the gold standard.

History of Banking in India

Without a sound and effective banking system in India it cannot have a healthy economy. The
banking system of India should not only be hassle free but it should be able to meet new challenges
posed by the technology and any other external and internal factors.

For the past three decades India's banking system has several outstanding achievements to its credit.
The most striking is its extensive reach. It is no longer confined to only metropolitans or
cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the
country. This is one of the main reasons of India's growth process.

The government's regular policy for Indian bank since 1969 has paid rich dividends with the
nationalisation of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for
withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank
transferred money from one branch to other in two days. Now it is simple as instant messaging or dial
a pizza. Money have become the order of the day.

The first bank in India, though conservative, was established in 1786. From 1786 till today, the
journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned
below:
• Early phase from 1786 to 1969 of Indian Banks
• Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector Reforms.
• New phase of Indian Banking System with the advent of Indian Financial & Banking Sector
Reforms after 1991.
To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase III.

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal
Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank
of Madras (1843) as independent units and called it Presidency Banks. These three banks were
amalgamated in 1920 and Imperial Bank of India was established which started as private
shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank
Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central
Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve
Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failures between
1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning
and activities of commercial banks, the Government of India came up with The Banking Companies
Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965
(Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of
banking in india as the Central Banking Authority.

During those day’s public has lesser confidence in the banks. As an aftermath deposit mobilisation
was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively
safer. Moreover, funds were largely given to traders.

Phase II

Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it
nationalised Imperial Bank of India with extensive banking facilities on a large scale especially in
rural and semi-urban areas. It formed State Bank of india to act as the principal agent of RBI and to
handle banking transactions of the Union and State Governments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July, 1969,
major process of nationalisation was carried out. It was the effort of the then Prime Minister of India,
Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalised.

Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven
more banks. This step brought 80% of the banking segment in India under Government ownership.

The following are the steps taken by the Government of India to Regulate Banking Institutions in the
Country:
• 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 core.
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%.

Banking in the sunshine of Government ownership gave the public implicit faith and immense
confidence about the sustainability of these institutions.
Phase III

This phase has introduced many more products and facilities in the banking sector in its reforms
measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name
which worked for the liberalisation of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a
satisfactory service to customers. Phone banking and net banking is introduced. The entire system
became more convenient and swift. Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from any crisis
triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all
due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet
fully convertible, and banks and their customers have limited foreign exchange exposure.

Nationalisation Of Banks In India

The nationalisation of banks in India took place in 1969 by Mrs. Indira Gandhi the then prime
minister. It nationalised 14 banks then. These banks were mostly owned by businessmen and even
managed by them.
• Central Bank of India
• Bank of Maharashtra
• Dena Bank
• Punjab National Bank
• Syndicate Bank
• Canara Bank
• Indian Bank
• Indian Overseas Bank
• Bank of Baroda
• Union Bank
• Allahabad Bank
• United Bank of India
• UCO Bank
• Bank of India
Befor the steps of nationalisation of Indian banks, only State Bank of India (SBI) was nationalised. It
took place in July 1955 under the SBI Act of 1955. Nationalisation of Seven State Banks of India
(formed subsidiary) took place on 19th July, 1960.

The State Bank of India is India's largest commercial bank and is ranked one of the top five banks
worldwide. It serves 90 million customers through a network of 9,000 branches and it offers -- either
directly or through subsidiaries -- a wide range of banking services.

The second phase of nationalisation of Indian banks took place in the year 1980. Seven more banks
were nationalised with deposits over 200 crores. Till this year, approximately 80% of the banking
segment in India were under Government ownership.

After the nationalisation of banks in India, the branches of the public sector banks rose to
approximately 800% in deposits and advances took a huge jump by 11,000%.
• 1955 : Nationalisation of State Bank of India.
• 1959 : Nationalisation of SBI subsidiaries.
• 1969 : Nationalisation of 14 major banks.
• 1980 : Nationalisation of seven banks with deposits over 200 crores.

Scheduled Commercial Banks In India

The commercial banking structure in India consists of:
• Scheduled Commercial Banks in India
• Unscheduled Banks in India
Scheduled Banks in India constitute those banks which have been included in the Second Schedule of
Reserve Bank of India(RBI) Act, 1934. RBI in turn includes only those banks in this schedule which
satisfy the criteria laid down vide section 42 (6) (a) of the Act.

As on 30th June, 1999, there were 300 scheduled banks in India having a total network of 64,918
branches.The scheduled commercial banks in India comprise of State bank of India and its associates
( , nationalised banks (19), foreign banks (45), private sector banks (32), co-operative banks and

regional rural banks.

"Scheduled banks in India" means the State Bank of India constituted under the State Bank of India
Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (Subsidiary Banks)
Act, 1959 (38 of 1959), a corresponding new bank constituted under section 3 of the Banking
Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of
the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980), or any
other bank being a bank included in the Second Schedule to the Reserve Bank of India Act, 1934 (2 of
1934), but does not include a co-operative bank".

"Non-scheduled bank in India" means a banking company as defined in clause (c) of section 5 of the
Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank".

The following are the Scheduled Banks in India (Public Sector):

• State Bank of India
• State Bank of Bikaner and Jaipur
• State Bank of Hyderabad
• State Bank of Indore
• State Bank of Mysore
• State Bank of Patiala
• State Bank of Saurashtra
• State Bank of Travancore
• Andhra Bank
• Allahabad Bank
• Bank of Baroda
• Bank of India
• Bank of Maharashtra
• Canara Bank
• Central Bank of India
• Corporation Bank
• Dena Bank
• Indian Overseas Bank
• Indian Bank
• Oriental Bank of Commerce
• Punjab National Bank
• Punjab and Sind Bank
• Syndicate Bank
• Union Bank of India
• United Bank of India
• UCO Bank
• Vijaya Bank
The following are the Scheduled Banks in India (Private Sector):
• Vysya Bank Ltd
• Axis Bank Ltd
• Indusind Bank Ltd
• ICICI Banking Corporation Bank Ltd
• Global Trust Bank Ltd
• HDFC Bank Ltd
• Centurion Bank Ltd
• Bank of Punjab Ltd
• IDBI Bank Ltd
The following are the Scheduled Foreign Banks in India:
• American Express Bank Ltd.
• ANZ Gridlays Bank Plc.
• Bank of America NT & SA
• Bank of Tokyo Ltd.
• Banquc Nationale de Paris
• Barclays Bank Plc
• Citi Bank N.C.
• Deutsche Bank A.G.
• Hongkong and Shanghai Banking Corporation
• Standard Chartered Bank.
• The Chase Manhattan Bank Ltd.
• Dresdner Bank AG.
Role of RBI

The central bank of the country is the Reserve Bank of India (RBI). It was established in April 1935
with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young
Commission. The share capital was divided into shares of Rs. 100 each fully paid which was entirely
owned by private shareholders in the begining. The Government held shares of nominal value of Rs.
2,20,000.

Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction
of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy
Governors, one Government official from the Ministry of Finance, ten nominated Directors by the
Government to give representation to important elements in the economic life of the country, and four
nominated Directors by the Central Government to represent the four local Boards with the
headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members
each Central Government appointed for a term of four years to represent territorial and economic
interests and the interests of co-operative and indigenous banks.

The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of 1934)
provides the statutory basis of the functioning of the Bank.

The Bank was constituted for the need of following:

• To regulate the issue of banknotes
• To maintain reserves with a view to securing monetary stability and
• To operate the credit and currency system of the country to its advantage.

Functions of Reserve Bank of India

The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank the
Reserve Bank of India.
Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of
all denominations. The distribution of one rupee notes and coins and small coins all over the country
is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate
Issue Department which is entrusted with the issue of currency notes. The assets and liabilities of the
Issue Department are kept separate from those of the Banking Department. Originally, the assets of
the Issue Department were to consist of not less than two-fifths of gold coin, gold bullion or sterling
securities provided the amount of gold was not less than Rs. 40 crores in value. The remaining three-
fifths of the assets might be held in rupee coins, Government of India rupee securities, eligible bills of
exchange and promissory notes payable in India. Due to the exigencies of the Second World War and
the post-was period, these provisions were considerably modified. Since 1957, the Reserve Bank of
India is required to maintain gold and foreign exchange reserves of Ra. 200 crores, of which at least
Rs. 115 crores should be in gold. The system as it exists today is known as the minimum reserve
system.

Banker to Government

The second important function of the Reserve Bank of India is to act as Government banker, agent
and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India
excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact Government
business, via. to keep the cash balances as deposits free of interest, to receive and to make payments
on behalf of the Government and to carry out their exchange remittances and other banking
operations. The Reserve Bank of India helps the Government - both the Union and the States to float
new loans and to manage public debt. The Bank makes ways and means advances to the Governments
for 90 days. It makes loans and advances to the States and local authorities. It acts as adviser to the
Government on all monetary and banking matters.

Bankers' Bank and Lender of the Last Resort

The Reserve Bank of India acts as the bankers' bank. According to the provisions of the Banking
Companies Act of 1949, every scheduled bank was required to maintain with the Reserve Bank a cash
balance equivalent to 5% of its demand liabilites and 2 per cent of its time liabilities in India. By an
amendment of 1962, the distinction between demand and time liabilities was abolished and banks
have been asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities. The
minimum cash requirements can be changed by the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or
get financial accommodation in times of need or stringency by rediscounting bills of exchange. Since
commercial banks can always expect the Reserve Bank of India to come to their help in times of
banking crisis the Reserve Bank becomes not only the banker's bank but also the lender of the last
resort.

Controller of Credit

The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of
credit created by banks in India. It can do so through changing the Bank rate or through open market
operations. According to the Banking Regulation Act of 1949, the Reserve Bank of India can ask any
particular bank or the whole banking system not to lend to particular groups or persons on the basis of
certain types of securities. Since 1956, selective controls of credit are increasingly being used by the
Reserve Bank.

The Reserve Bank of India is armed with many more powers to control the Indian money market.
Every bank has to get a licence from the Reserve Bank of India to do banking business within India,
the licence can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled.
Every bank will have to get the permission of the Reserve Bank before it can open a new branch.
Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and
liabilities. This power of the Bank to call for information is also intended to give it effective control of
the credit system. The Reserve Bank has also the power to inspect the accounts of any commercial
bank.

As supereme banking authority in the country, the Reserve Bank of India, therefore, has the following
powers:
(a) It holds the cash reserves of all the scheduled banks.

(b) It controls the credit operations of banks through quantitative and qualitative controls.

(c) It controls the banking system through the system of licensing, inspection and calling for
information.

(d) It acts as the lender of the last resort by providing rediscount facilities to scheduled banks.

Custodian of Foreign Reserves

The Reserve Bank of India has the responsibility to maintain the official rate of exchange. According
to the Reserve Bank of India Act of 1934, the Bank was required to buy and sell at fixed rates any
amount of sterling in lots of not less than Rs. 10,000. The rate of exchange fixed was Re. 1 = sh. 6d.
Since 1935 the Bank was able to maintain the exchange rate fixed at lsh.6d. though there were periods
of extreme pressure in favour of or against

the rupee. After India became a member of the International Monetary Fund in 1946, the Reserve
Bank has the responsibility of maintaining fixed exchange rates with all other member countries of the
I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of
India's reserve of international currencies. The vast sterling balances were acquired and managed by
the Bank. Further, the RBI has the responsibility of administering the exchange controls of the
country.

Supervisory functions

In addition to its traditional central banking functions, the Reserve bank has certain non-monetary
functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve
Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of
supervision and control over commercial and co-operative banks, relating to licensing and
establishments, branch expansion, liquidity of their assets, management and methods of working,
amalgamation, reconstruction, and liquidation. The RBI is authorised to carry out periodical
inspections of the banks and to call for returns and necessary information from them. The
nationalisation of 14 major Indian scheduled banks in July 1969 has imposed new responsibilities on
the RBI for directing the growth of banking and credit policies towards more rapid development of
the economy and realisation of certain desired social objectives. The supervisory functions of the RBI
have helped a great deal in improving the standard of banking in India to develop on sound lines and
to improve the methods of their operation.

Promotional functions

With economic growth assuming a new urgency since Independence, the range of the Reserve Bank's
functions has steadily widened. The Bank now performs a varietyof developmental and promotional
functions, which, at one time, were regarded as outside the normal scope of central banking. The
Reserve Bank was asked to promote banking habit, extend banking facilities to rural and semi-urban
areas, and establish and promote new specialised financing agencies. Accordingly, the Reserve Bank
has helped in the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in
1962, the Unit Trust of India in 1964, the Industrial Development Bank of India also in 1964, the
Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of
India in 1972. These institutions were set up directly or indirectly by the Reserve Bank to promote
saving habit and to mobilise savings, and to provide industrial finance as well as agricultural finance.
As far back as 1935, the Reserve Bank of India set up the Agricultural Credit Department to provide
agricultural credit. But only since 1951 the Bank's role in this field has become extremely important.
The Bank has developed the co-operative credit movement to encourage saving, to eliminate
moneylenders from the villages and to route its short term credit to agriculture. The RBI has set up the
Agricultural Refinance and Development Corporation to provide long-term finance to farmers.

Classification of RBIs functions

The monetary functions also known as the central banking functions of the RBI are related to control
and regulation of money and credit, i.e., issue of currency, control of bank credit, control of foreign
exchange operations, banker to the Government and to the money market. Monetary functions of the
RBI are significant as they control and regulate the volume of money and credit in the country.

Equally important, however, are the non-monetary functions of the RBI in the context of India's
economic backwardness. The supervisory function of the RBI may be regarded as a non-monetary
function (though many consider this a monetary function). The promotion of sound banking in India
is an important goal of the RBI, the RBI has been given wide and drastic powers, under the Banking
Regulation Act of 1949 - these powers relate to licencing of banks, branch expansion, liquidity of
their assets, management and methods of working, inspection, amalgamation, reconstruction and
liquidation. Under the RBI's supervision and inspection, the working of banks has greatly improved.
Commercial banks have developed into financially and operationally sound and viable units. The
RBI's powers of supervision have now been extended to non-banking financial intermediaries. Since
independence, particularly after its nationalisation 1949, the RBI has followed the promotional
functions vigorously and has been responsible for strong financial support to industrial and
agricultural development in the country

Imperial Bank of India

The Imperial Bank of India (IBI) was the oldest and the largest commercial bank of the Indian
subcontinent, and was subsequently transformed into State Bank of India in 1955.
The Imperial Bank of India came into existence on 27 January 1921 when the three Presidency Banks
of colonial India, were reorganized and amalgamated to form a single banking entity. The three
Presidency banks were the Bank of Bengal, established on 2 June 1806, the Bank of
Bombay (incorporated on 15 April 1840) and the Bank of Madras (incorporated on 1 July 1843).

Imperial Bank of India performed all the normal functions which a commercial bank was
expected to perform. In the absence of any central banking institution in India until 1935, the
Imperial Bank of India also performed a number of functions which are normally carried out
by a central bank.

 In 1924, at Apollo Street, currently called Mumbai Samachar Marg, Mumbai, a

magnificent stone structure [1] with fretted windows, was constructed to house a branch
of the Imperial Bank of India.

 In 1933, Sir Badridas Goenka, an important public figure and business tycoon of his
time, and a prominent member of Marwari community of Calcutta, became the first
Indian to be appointed as the Chairman of the Imperial Bank of India.

 The Reserve Bank of India, which is the central banking organization of India, in the year
1955, acquired a controlling interest in the Imperial Bank of India, and the Imperial Bank
of India was christened on 30 April 1955 as the State Bank of India, and this
transformation from the Imperial Bank of India to the State Bank of India was given legal
recognition in terms off an Act of the Parliament of India, which came into force from 1
July 1955. The day on which the Imperial Bank of India (IBI) became the State Bank of
India, IBI had 480 branches, sub-offices, and three local head offices; and had under its
control and command slightly more than a quarter of the resources of the Indian banking
industry. The branch network of State Bank of India has since grown to 9093 branches
as on 31 March 2004. In 2007 Reserve Bank of India transferred its stake in State Bank
of India to Government of India.

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 Bank of Hindustan, which started
in 1790; both 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 three banks merged in
1921 to form the Imperial Bank of India, which, upon India's independence, became
the State Bank of India.

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a
consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865
and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock Bank: A
company that issues stock and requires shareholders to be held liable for the company's
debt) It was not the first though. That honor belongs to the 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 Simla.

When the American Civil War stopped the supply of cotton to Lancashire from
the Confederate States, promoters opened banks to finance trading in Indian cotton. With
large exposure to speculative ventures, most of the banks opened in India during that period
failed. 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.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire
d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862;
branches in Madras and Puducherry, 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.

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 Lahorein 1895, which has survived to the present and is now one of the largest banks in
India.

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.

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.
This segmentation let Lord Curzon to observe, "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."

The period between 1906 and 1911, saw the establishment of banks inspired by
the 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.
The fervour 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. Four nationalised banks started in this district and also a
leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle
of Indian Banking".

During the First World War (1914-1918) through the end of the Second World War (1939-
1945), and two years thereafter until the independence of India were challenging for Indian
banking. The years of the First World War were turbulent, and it took its toll with banks
simply collapsing despite the Indian economy gaining indirect boost due to war-related
economic activities. At least 94 banks in India failed between 1913 and 1918 as indicated in
the following table:

Number of Authorised Paid-up

Yea
banks capital Capital
rs
that failed (Rs. Lakhs) (Rs. Lakhs)

191
12 274 35
3

191
42 710 109
4

191
11 56 5
5

191
13 231 4
6

191
9 76 25
7

191
7 209 1
8

Post-Independence

The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal,
paralyzing banking activities for months. India's independence marked the end of a regime
of the Laissez-faire for the Indian banking. 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 major steps to regulate banking included:

 The Reserve Bank of India, India's central banking authority, was nationalized on
January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public
Ownership) Act, 1948 (RBI, 2005b).[Reference www.rbi.org.in]

 In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank
of India (RBI) "to regulate, control, and inspect the banks in India."

 The Banking Regulation Act also provided that no new bank or branch of an existing
bank could be opened without a license from the RBI, and no two banks could have
common directors.
Nationalisation

Banks Nationalisation in India: Newspaper Clipping, Times of India, July, 20, 1969

Despite the provisions, control and regulations of Reserve Bank of India, banks in India
except the State Bank of India or SBI, continued to be owned and operated by private
persons. By the 1960s, the Indian banking industry had become an important tool to facilitate
the development of the Indian economy. At the same time, it had emerged as a large
employer, and a debate had ensued about the nationalization of the banking industry. Indira
Gandhi, then Prime Minister of India, expressed the intention of the Government of India in
the annual conference of the All India Congress Meeting in a paper entitled "Stray thoughts
on Bank Nationalisation." The meeting received the paper with enthusiasm.

Thereafter, her move was swift and sudden. The Government of India issued an ordinance
and nationalised the 14 largest commercial banks with effect from the midnight of July 19,
1969. Jayaprakash Narayan, a national leader of India, described the step as
a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance,
the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking)
Bill, and it received the presidential approval on 9 August 1969.

A second dose of nationalization of 6 more commercial banks followed in 1980. The stated
reason for the nationalization was to give the government more control of credit delivery.
With the second dose of nationalization, the Government of India controlled around 91% of
the banking business of India. Later on, in the year 1993, the government merged New Bank
of India with Punjab National Bank. It was the only merger between nationalized banks and
resulted in the reduction of the number of nationalised banks from 20 to 19. After this, until
the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average
growth rate of the Indian economy.

In the early 1990s, the then Narsimha Rao government embarked on a policy
of liberalization, licensing a small number of private banks. These came to be known as New
Generation tech-savvy banks, and included Global Trust Bank (the first of such new
generation banks to be set up), which later amalgamated with Oriental Bank of
Commerce, Axis Bank(earlier asUTI Bank), ICICI Bank and HDFC Bank. This move, along
with the rapid growth in the economy of India, revitalized the banking sector in India, which
has seen rapid growth with strong contribution from all the three sectors of banks, namely,
government banks, private banks and foreign banks.

The next stage for the Indian banking has been set up 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 74%
with some restrictions.

The new policy shook the Banking sector in India completely. Bankers, till this time, were
used to the 4-6-4 method (Borrow at 4%;Lend at 6%;Go home at 4) of functioning. 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.

Currently (2007), 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. The Reserve Bank of India is an autonomous body,
with minimal pressure from the government. The stated policy of the Bank on the Indian
Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been
true.
With the growth in the Indian economy expected to be strong for quite some time-especially
in its services sector-the demand for banking services, especially retail banking, mortgages
and investment services are expected to be strong. One may also expect M&As, takeovers,
and asset sales.

In March 2006, the Reserve Bank of India 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 since the RBI announced norms
in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by
them.

In recent years critics have charged that the non-government owned banks are too
aggressive in their loan recovery efforts in connection with housing, vehicle and personal
loans. There are press reports that the banks' loan recovery efforts have driven defaulting
borrowers to suicide.

Indian banking sector

NDIAN BANKING SECTOR
Banking in India has its origin as early as the Vedic period. It is believed that
thetransition from money lending to banking must have occurred even before Manu, thegreat
Hindu Jurist, who has devoted a section of his work to deposits and advances andlaid down
rules relating to rates of interest. During the Mogul period, the indigenousbankers played a
very important role in lending money and financing foreign trade andcommerce. During the
days of the East India Company, it was the turn of the agencyhouses to carry on the banking
business. The General Bank of India was the first JointStock Bank to be established in the
year 1786. The others which followed were the Bankof Hindustan and the Bengal Bank. The
Bank of Hindustan is reported to have continuedtill 1906 while the other two failed in the
meantime. In the first half of the 19thcenturythe East India Company established three
banks; the Bank of Bengal in 1809, the Bank ofBombay in 1840 and the Bank of Madras in
1843. These three banks also known asPresidency Banks were independent units and
functioned well. These three banks wereamalgamated in 1920 and a new bank, the Imperial
Bank of India was established on 27thJanuary 1921. With the passing of the State Bank of
India Act in 1955 the undertaking ofthe Imperial Bank of India was taken over by the newly
constituted State Bank of India.The Reserve Bank which is the Central Bank was created in
1935 by passing ReserveBank of India Act 1934. In the wake of the Swadeshi Movement, a
number of banks withIndian management were established in the country namely, Punjab
National Bank Ltd,Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of Baroda
Ltd, theCentral Bank of India Ltd. On July 19, 1969, 14 major banks of the country
werenationalised and in 15th April 1980 six more commercial private sector banks were
alsotaken over by the government.
Indian Banking: A Paradigm shift-A regulatory point of view
The decade gone by witnessed a wide range of financial sector reforms, withmany of
them still in the process of implementation. Some of the recently initiatedmeasures by the
RBI for risk management systems, anti money laundering safeguardsand corporate
governance in banks, and regulatory framework for non bank financialcompanies, urban
cooperative banks, government debt market and forex clearing andpayment systems are
aimed at streamlining the functioning of these instrumentalitiesbesides cleansing the
aberrations in these areas. Further, one or two all India developmentfinancial institutions
have already commenced the process of migration towards universalbanking set up. The
banking sector has to respond to these changes, consolidate andrealign their business
strategies and reach out for technology support to survive emergingcompetition. Perhaps
taking note of these changes in domestic as well as international arena
All of we will agree that regulatory framework for banks was one area which hasseen
a sea-change after the financial sector reforms and economic liberalisation andglobalisation
measures were introduced in 1992-93. These reforms followed broadly theapproaches
suggested by the two Expert Committees both set up under the chairmanshipof Shri M.
Narasimham in 1991 and 1998, the recommendations of which are by nowwell known. The
underlying theme of both the Committees was to enhance thecompetitive efficiency and
operational flexibility of our banks which would enable themto meet the global competition as
well as respond in a better way to the regulatory andsupervisory demand arising out of such
liberalisation of the financial sector. Most of therecommendations made by the two Expert
Committees which continued to be subjectmatter of close monitoring by the Government of
India as well as RBI have beenimplemented. Government of India and RBI have taken
several steps to :-(a)Strengthenthe banking sector,

(b) Provide more operational flexibility to banks,

(c) Enhance the competitive efficiency of banks, and

(d) Strengthen the legal framework governing operations of banks

The important measures taken to strengthen the banking sector are briefly, the
following:
•
Introduction of capital adequacy standards on the lines of the Basel norms,
•
prudential norms on asset classification, income recognition and provisioning,
•
Introduction of valuation norms and capital for market risk for investments
•
Enhancing transparency and disclosure requirements for published accounts ,
•
Aligning exposure norms – single borrower and group-borrower ceiling – with
inter-national best practices
•
Introduction of off-site monitoring system and strengthening of the supervisory
framework for banks.
(A) Some of the important measures introduced to provide more operational flexibility to
banks are:
•
Besides deregulation of interest rate, the boards of banks have been given theauthority to fix
their prime lending rates. Banks also have the freedom to offervariable rates of interest on
deposits, keeping in view their overall cost of funds.
•
Statutory reserve requirements have significantly been brought down.
•
The quantitative firm-specific and industry-specific credit controls were abolishedand banks
were given the freedom to deploy credit, based on their commercialjudgment, as per the
policy approved by their Boards.
•
The banks were given the freedom to recruit specialist staff as per their
requirements,
•
The degree of autonomy to the Board of Directors of banks was substantially
enhanced.
•
Banks were given autonomy in the areas of business strategy such as, opening ofbranches /
administrative offices, introduction of new products and certain otheroperational areas.
(b) Some of the important measures taken to increase the competitive efficiency of banks
are the following:
•
Opening up the banking sector for the private sector participation
The important measures taken to strengthen the banking sector are briefly, the
following:
•
Introduction of capital adequacy standards on the lines of the Basel norms,
•
prudential norms on asset classification, income recognition and provisioning,
•
Introduction of valuation norms and capital for market risk for investments
•
Enhancing transparency and disclosure requirements for published accounts ,
•
Aligning exposure norms – single borrower and group-borrower ceiling – with
inter-national best practices
•
Introduction of off-site monitoring system and strengthening of the supervisory
framework for banks.
(A) Some of the important measures introduced to provide more operational flexibility to
banks are:
•
Besides deregulation of interest rate, the boards of banks have been given theauthority to fix
their prime lending rates. Banks also have the freedom to offervariable rates of interest on
deposits, keeping in view their overall cost of funds.
•
Statutory reserve requirements have significantly been brought down.
•
The quantitative firm-specific and industry-specific credit controls were abolishedand banks
were given the freedom to deploy credit, based on their commercialjudgment, as per the
policy approved by their Boards.
•
The banks were given the freedom to recruit specialist staff as per their
requirements,
•
The degree of autonomy to the Board of Directors of banks was substantially
enhanced.
•
Banks were given autonomy in the areas of business strategy such as, opening ofbranches /
administrative offices, introduction of new products and certain otheroperational areas.
(b) Some of the important measures taken to increase the competitive efficiency of banks
are the following:
•
Opening up the banking sector for the private sector participation
Scaling down the shareholding of the Government of India in nationalised banks
and of the Reserve Bank of India in State Bank of India.
(c) Measures taken by the Government of India to provide a more conducivelegal
environment for recovery of dues of banks and financial institutions are:
•
Setting up of Debt Recovery Tribunals providing a mechanism for expeditious
loan recoveries.
•
Constitution of a High Power Committee under former Justice Shri Eradi to
suggest appropriate foreclosure laws.
•
An appropriate legal framework for securitisation of assets is engaging the
attention of the Government,
Due to this paradigm shift in the regulatory framework for banks had achieved the
desired results. The banking sector has shown considerable degree of resilience.
(a) The level of capital adequacy of the Indian banks has improved: the CRAR ofpublic
sector banks increased from an average of 9.46% as on March 31, 1995 to11.18% as on
March 31, 2001.
(b) The public sector banks have also made significant progress in enhancing their
asset quality, enhancing their provisioning levels and improving their profits.
•
The gross and net NPAs of public sector banks declined sharply from 23.2% and
14.5% in 1992-93 to 12.40% and 6.7% respectively, in 2000-01.
•
Similarly, in regard to profitability, while 8 banks in the public sector recordedoperating and
net losses in 1992-93, all the 27 banks in the public sector showedoperating profits and only
two banks posted net losses for the year ended March31, 2001.
•
The operating profit of the public sector banks increased from Rs.5628 crore as on
March 31, 1995 to Rs.13,793 crore as on March 31, 2001

The net profit of public sector banks increased from Rs.1116 crore to Rs.4317crore during
the same period, despite tightening of prudential norms onprovisioning against loan losses
and investment valuation.
 The accounting treatment for impaired assets is now closer to the international
bestpractices and the final accounts of banks are transparent and more amenable
tomeaningful interpretation of their performance.

16
THE INDIAN BANKING INDUSTRY
The origin of the Indian banking industry may be traced to the establishment ofthe
Bank of Bengal in Calcutta (now Kolkata) in 1786. Since then, the industry haswitnessed
substantial growth and radical changes. As of March 2002, the Indian bankingindustry
consisted of 97 Commercial Banks, 196 Regional Rural Banks, 52 ScheduledUrban Co-
operative Banks, and 16 Scheduled State Co-operative Banks.
The growth of the banking industry in India may be studied in terms of two
broadphases: Pre Independence (1786-1947), and Post Independence (1947 till date). The
postindependence phase may be further divided into three sub-phases:
•
Pre-Nationalisation Period (1947-1969)
•
Post-Nationalisation Period (1969-1991)
•
Post-Liberalisation Period (1991- till date)
The two watershed events in the postindependence phase are the nationalisationof
banks (1969) and the initiation of the economic reforms (1991). This section focuseson the
evolution of the banking industry in India post-liberalisation.
1. Banking Sector Reforms - Post-Liberalisation
In 1991, the Government of India (Gol) set up a committee under thechairmanship of
Mr. Narasimaham to make an assessment of the banking sector. Thereport of this
committee contained recommendations that formed the basis of the reforms
initiated in 1991.
The banking sector reforms had the following objectives:
1. Improving the macroeconomic policy framework within which banks operate;
2. Introducing prudential norms;
3. Improving the financial health and competitive position of banks;
4. Building the financial infrastructure relating to supervision, audit technology and legal
framework; and
5. Improving the level of managerial competence and quality of human resources.
1.Impact of Reforms on Indian Banking Industry

17
With the initiation of the reforms in the financial sector during the 1990s, theoperating
environment of banks and term-lending institutions has radically transformed.One of the fall-
outs of the liberalisation was the emergence of nine new private sectorbanks in the
mid1990s that spurred the incumbent foreign, private and public sectorbanks to compete
more fiercely than had been the case historically. Another developmentof the economic
liberalisation process was the opening up of a vibrant capital market inIndia, with both equity
and debt segments providing new avenues for companies to raisefunds. Among others,
these two factors have had the greatest influence on banksoperating in India to broaden the
range of products and services on offer. The reformshave touched all aspects of the banking
business. With increasing integration of theIndian financial markets with their global
counterparts and greater emphasis on riskmanagement practices by the regulator, there
have been structural changes within thebanking sector. The impact of structural reforms on
banks' balance sheets (both on theasset and liability sides) and the environment they
operate in is discussed in the following sections.

1.2 Reforms on the Liabilities Side

•
Reforms of Deposit Interest Rate
Beginning 1992, a progressive approach was adopted towards deregulating
theinterest rate structure on deposits. Since then, the rates have been freed
gradually.Currently, the interest rates on deposits stand completely deregulated (with the
exceptionof the savings bank deposit rate). The deregulation of interest rates has helped
Indianbanks to gain more control on the cost of their deposits, the main source of funding
forIndian banks. Besides, it has given more, flexibility to banks in managing their Asset-
Liability positions.

ncrease in Capital Adequacy Requirement

During the 1990s, the Reserve Bank of India (RBI) adopted a strategy aimed at
allbanks attaining a Capital Adequacy Ratio (CAR) of 8% in a phased manner. On
therecommendations of the Committee on Banking Sector Reforms, the minimum CAR
wasfurther raised to 9%, effective March 31, 2000.While the stipulation of a higher Capita!
Adequacy' Ratio has increased the capital requirement of banks; it has provided
morestability to the Indian banking system.
1.3 Reforms on the Asset Side
•
Reforms on the Lending Interest Rate
During 1975-76 to 1980-81, the RBI prescribed both the minimum lending rateand
the ceiling rate. During 1981-82 to 1987-88. The RBI prescribed only the ceilingrate. During
198889 to 1994-95, the RBI switched from prescribing a ceiling rate tofixing a minimum
lending rate. From 1991 onwards, interest rates have been increasinglyfreed. At present,
banks can offer loans at rates below the Prime Lending Rate (PLR) toexporters or other
creditworthy borrowers (including public enterprises), and have only toannounce the FLR
and the maximum spread charged over it. The deregulation of lendingrates has given banks
the flexibility to price loan products on the basis of their ownbusiness strategies and the risk
profile of the borrower. It has also lent a competitiveadvantage to banks with lower cost of
funds.
•
Lower Cash Reserve and Statutory Liquidity Requirements
During the early 1980s, statutory pre-emption in the form of Cash Reserve
Ratio(CRR) and Statutory Liquidity Ratio (SLR) accounted for 42% of the deposits. In
the1990s, the figure rose to 53.5%, which during the post-liberalisation period has
beengradually reduced. At present, banks are required to maintain a CRR of 4% of the
NetDemand and Time Liabilities (NDTL) (excluding liabilities subject to zero
CRRprescriptions). The RBI has indicated that the CRR would eventually be brought down
tothe statutory minimum level of 3% over a period of time.
The SLR, which was at a peak of 38.5% during September 1990 to December1992, now
stands lower at the statutory minimum of 25%.A decrease in the CRR andSLR requirements
implies an increase in the share of deposits available to banks for loansand advances. It also
means that bank's now have more discretion in the allocation of 19

funds, which if deployed efficiently, can have a positive impact on their profitability.
Byincreasing the amount of invisible funds available to banks, the reduction in the CRR
andSLR requirements has also enhanced the need for efficient risk management systems
inbanks.
•
Asset Classification and Provisioning Norms
Prudential norms relating to asset classification have been changed post-
liberalisation. The earlier practice of classifying assets of different quality into eight`health
codes" has now been replaced by the system of classification into four categories(in
accordance with the international norms): standard, sub-standard, doubtful, and lossassets.
On 1st April 2000, provisioning requirements of a minimum of 0.25% wereintroduced for
standard assets. For the sub-standard, doubtful and loss asset categories,the provisioning
requirements remained at 10%, 20-50% (depending on the duration forwhich the asset has
remained doubtful), and 100%, respectively, the recognition normsfor NPAs have also been
tightened gradually. Since March 1995, loans with interestand/or installment of principal
overdue for more than 180 days are classified as non-performing. This period will be
shortened to 90 days from the year ending 31st' March 2004.
1.4 Structural Reforms
•
Increased Competition
With the initiation of banking-sector reforms, a more competitive environmenthas
been ushered in. Now banks are not only competing within themselves, but also withnon-
banks, such as financial services companies and mutual funds. While existing bankshave
been allowed greater flexibility in expanding their operations, new private sectorbanks have
also been allowed entry. Over the last decade nine new private sector bankshave
established operations in the country. Competition amongst Public Sector Banks(PSBs) has
also intensified. PSBs are now allowed to access the capital market to raisefunds. This has
diluted Government's shareholding, although it remains the majorshareholder in PSBs,
holding a minimum 51% of their total equity. Although competitionin the banking sector has
reduced the share of assets and deposits of the PSBs, theirdominant positions, especially of
the large ones, continues.
Although the PSBs will remain major players in the banking industry, they are likelyto face
tough competition, from both private sector banks and foreign banks. Moreover,the banking
industry is likely to face stiff competition from other players like non-bank 20

finance companies, insurance companies, pension funds and mutual funds. Theincreasing
efficiency of both the equity and debt markets has also accelerated the processof financial
disintermediation, putting additional pressure on banks to retain theircustomers. Increasing
competition among banks and financial intermediaries is likely toreduce the Net Interest
Spread of banks.
•
Banks entry into New Business Lines
Banks are increasingly venturing into new areas, such as, Insurance and
MutualFunds, and offering a wider bouquet of products and services to satisfy the diverse
needsof their customers. With the enactment of the Insurance Regulatory and
DevelopmentAuthority (IRBA) Act, 1999, banks and NBFCs have been allowed to enter the
insurancebusiness. The RBI has also issued guidelines for-banks' entry into insurance,
according towhich, banks need to obtain prior approval of the RBI to enter the insurance
business. Sofar, the RBI has accorded its approval to three of the 39 commercial banks that
hadsought entry into insurance.
Insurance presents a new business opportunity for banks. The opening up of the
insurancebusiness to banks is likely to help them emerge as financial supermarkets like
theircounterparts in developed countries.
•
Increased thrust on Banking Supervision and Risk Management
 To strengthen banking supervision, an independent Board for FinancialSupervision
(BFS) under the RBI was constituted in November 1994. The Board isempowered to
exercise integrated supervision over all credit institutions in the financialsystem, including
select Development Financial Institutions (DFIs) and Non BankingFinancial Companies
(NBFCs), relating to credit management, prudential norms andtreasury operations. A
comprehensive rating system, based on the CAMELSmethodology, has also been instituted
for domestic banks; for foreign banks, the ratingsystem is based on CACS. This rating
system has been supplemented by a technology-enabled quarterly off- site surveillance
system.
To strengthen the Risk Management Process in banks, in line with proposed
Basel11 accord, the RBI has issued guidelines for managing the various types of risks
thatbanks are exposed to. To make risk management an integral part of the Indian
bankingsystem, the RBI has also issued guidelines for Risk based Supervision (RBS) and
Riskbased Internal Audit (RBIA)
Business per Employee
Since different employees in a bank contribute in different ways to the revenuesand
profits of a bank, it is difficult to come up with one universal metric that captures thebusiness
per employee accurately. For' this analysis, ICRA has used the amount ofdeposits mobilised
per employee as a measure of the business per employee. The Indianbanking industry on
an average mobilised Rs. 1-2 crore of deposits per employee for theyear ended March 2003.
In this respect, private sector banks lead the group of Indianbanks. The top bank in this
category showed a deposit per employee of Rs. 7.14 crore forthe year ended March 2003.
As for the global benchmark banks, business per employeefor HSBC was robust at USD9.71
million (Rs. 44.66 crore), while that for ABN AMROBank was EUR 4 million (Rs. 20 crore) for
the year ending December 2002.
Thus, deposit mobilisation per employee for the global benchmark banks is higher
than that of Indian banks.
•
Business per Branch
On an average, the banks showed a deposit of around Rs. 10-30 crore per branchfor
the year ended March 2003. In recent times, the deposit mobilisation for Indian Bankson a
branch basis has witnessed a steady increase. The new private sector banks in Indiahave
led the way in this regard, because of the better use of technology. The highestdeposit per
branch stood at Rs. 103.24 crore in 2003 for a new private sector bank, ascompared with
Rs, 68.71 crore in 2002. The global benchmark banks mobilised morebusiness per branch
as compared with their Indian counterparts. Bank of Americamobilised USD 88.9 million (Rs.
408.94 crores) for the financial year ended 2002, whileABN AMRO Bank mobilised EUR 140
million (Rs. 700 crores). The higher per-bankdeposit mobilisation for the global benchmark
banks may be attributed to their superiortechnology orientation and the higher gross
domestic products (GDP) of their respectivecountries. 3.5.5 Expenses per Employee
For this analysis, ICRA has used the employee expenses per employee as ameasure of the
expenses per employee. Indian banks, on an average, expensed Rs. 0.025crore per
employee in FY2002. For the new private sector banks, this figure was higher.The highest
expense per employee incurred by an Indian bank for the year 2002 was Rs.0.041 crore per
employee. 30

In the case of the global benchmark banks, the expenses per employee for Citi
GroupInc. was at USD 0.08 million (Rs. 0.36 crore), while for ABN AMRO Bank it was
EUR0.07 million Rs. 0.36 crore).
•

Expenses per Branch

For this analysis, ICRA has used operating expenses per branch as a measure ofthe
expenses per branch. The expense per branch for most Indian banks was Rs. 0.56crore for
FY2002. Over the years, Indian banks have reported a gradual increase in suchexpenses,
with competition-prompted upgrade being the primary reason for the same. Inthe case of the
global benchmark banks, expense per branch for Bank of America wasUSD 4.93 million
(amount in Rs. 22.68 crore), while for ABN AMRO Bank it was EUR4.6 million (Rs. 22.99
crore). 1.8 Structural Benchmarking

Since its inception in 1980s) BIS has issued several guidance notes for banks
andbank supervisors. These notes have sought to improve the integrity of the global
bankingsystem and propagate best practices in banking across the world. For issues related
toaccounting, BIS has relied on the International Accounting Standards (IAS) issued by
theInternational Accounting Standards Committee (IASC). Banks are supposed to
followthese accounting standards as part of best practices. For the structural
benchmarkingstudy of the Indian banking sector, ICRA has used primarily the guidance
notes issued byBIS and the relevant IAS as the benchmarks of best practices. ICRA has
also referred tostandards as mentioned under, US and UK. GAAP (Generally Accepted
AccountingPractices) where they provide a good understanding of international best
practices

40
MAJOR DEVELOPMENTS IN BANKING AND
FINANCE
•
Banking Developments
The RBI allowed resident Indians to maintain foreign currency accounts.
Theaccounts to be known as resident foreign currency (domestic) accounts, can be used
topark forex received while visiting any place abroad by way of payment for services,
ormoney received from any person not resident in India, or who is on a visit to India,
insettlement of any lawful obligations. These accounts will be maintained in the form
ofcurrent accounts with a cheque facility and no interest is paid on these accounts.With
aview to liberalise gold trading, the Reserve Bank has decided to permit authorised banksto
enter into forward contracts with their constituents like exporters of gold products,jewellery
manufacturers and trading houses, in respect of the sale, purchase and loantransactions in
gold with them. The tenor of such contracts should not exceed 6 months.The Reserve Bank
of India has told foreign banks not to shut down branches withoutinforming the central bank
well in advance. Foreign banks have been further advised bythe Reserve Bank of India to
furnish a detailed plan of closure to ensure that theircustomers’ interests and conveniences
are addressed properly.
The RBI has prohibited urban co-operative banks from acting as agents or sub-
agents of money transfer service schemes.The RBI has allowed banks to investundeployed
foreign currency non-resident (FCNR-B) funds in the overseas markets in thelong-term fixed
income securities with ratings a notch lower than highest safety. Earlier,banks were allowed
to invest only in long-term securities with highest safety ratings byinternational agencies.
The RBI has defined the term “willful defaulter” paving the way for banks toacquire
assets of defaulting companies through the Securitisation Ordinance and reducetheir NPAs
faster. According to the RBI a wilful defaulter is one who has not used bankfunds for the
purpose for which it was taken and who has not repaid loans despite havingadequate
liquidity.International credit rating agency Standard & Poor has estimated thatthe level of
gross problematic assets in India can move into the 35-70 per cent range inthe event of a
recession. It has also estimated that the level of non-performing assets(NPAs) in the system
to be at 25 per cent, of which only 30 per cent can be recovered.

41
The Reserve Bank of India has decided to extend operation of the guidelines forthe
one time settlement scheme for loans upto Rs.50,000 to small and marginal farmersby
public sector banks for another 3 months, i.e, upto March 31, 2003.
The Reserve Bank of India, as part of its policy of deregulating interest rates
onrupee export credit, has freed interest rates on the second slab - 181 to 270 days for pre-
shipment credit and 91 to 180 days for post-shipment credit with effect from May 1, 2003.
 The Cabinet cleared a financial package for IDBI and agreed to take over
thecontingent liabilities to the tune of Rs.2500 crore over five years. The IDBI Act will
berepealed during the winter session of the Parliament, paving the way for IDBI’sconversion
into a banking company.The IDBI would be given access to retail deposits, toenable it to
bring down the cost of funds, but will be spared from priority sector lendingand SLR
requirements for existing liabilities.
The RBI has issued guidelines for setting up of offshore banking units (OBUs)within
special economic zones (SEZs) in various parts of the country. Minimuminvestment of $10
million is required for setting up an OBU. All commercial banks areallowed to set up one
OBU each. OBUs have to undertake wholesale banking operationsand should deal only in
foreign currency. Deposits of the OBUs will not be covered bydeposit insurance. The loans
and advances of OBUs would not be reckoned as net bankcredit for computing priority
sector lending obligations. The OBUs will be regulated andsupervised by the exchange
control department of the RBI.
With a view to develop the derivatives market in India and making availablehedged
currency exposures to residents an RBI Committee headed by Smt. Grace
Koshie,recommended phased introduction of foreign currency-rupee (FC/NR)
options._ TheReserve Bank of India has notified the draft scheme for merging Nedungadi
Bank withPunjab National Bank. This is the first formal step towards bringing about a
mergerbetween the two Banks.
The Reserve Bank of India has agreed to allow capital hedging for foreign banks
in India. The guidelines pertaining to capital hedging will be issued by RBI soon.
The Reserve Bank of India has decided to allow foreign institutional investors
(FIIs) to enter into a forward contract with the rupee as one of the currencies, with an

42
authorised dealer (AD) in India to hedge their entire exposure in equities at a particularpoint
of time without any reference to the cut-off date. Further, the RBI has alsoincreased
Authorised Dealer’s overseas market investment limit to 50 per cent of theirunimpaired tier-I
capital or $ 25 million, whichever is higher.
The Reserve Bank of India doubled the foreign exchange available under thebasic
travel quota (BTQ) to resident individuals from US $5000 to US $10000, or itsequivalent.The
Government has decided to dispose of UTI Bank as part of restructuringUnit Trust of
India.Though the details in this regard is yet to be worked out, it has beendecided that the
bank will be disposed of during the course of the restructuring.
The RBI has allowed tour operators to sell tickets issued by overseas
traveloperators such as Eurorail and other rail/road and water transport operators in India,
inrupees, without deducting the paymentfrom the travellers’ basic travel quota.
 The Reserve Bank of India (RBI) has banned banks from offering swapsinvolving
leveraged structures, which can cause huge losses if the market moves the otherway.
The RBI constituted committee on payment system has recommended that
thecentral bank, as the regulator of payment and settlement systems, should be
empoweredto regulate non-banking systems.
•
Market Developments and New Products
The Hong Kong and Shanghai Banking Corporation will be bringing $150
million additional capital to India in the current fiscal.
The Reserve Bank of India has ordered a moratorium on the Nedungadi Bank.The
moratorium effective from the close of business will be in force upto February 1,2003. During
this period, the central bank is likely to finalise the plans for mergingNedungadi Bank with
Punjab National Bank.
ABN Amro Bank launched its Business Process outsourcing (BPO) operations,ABN
Amro Central Enterprise Services (ACES) in Mumbai. It has been set up with aninitial
investment of 4 million euros (Rs.19 crore) and has been capacitised at 650 seats ina single
shift.

CLASSIFICATION OF SCHEDULED BANKING

STRUCTURE IN INDIA
 The scheduled banks are divided into scheduled commercial banks and scheduledco
operative banks. Further scheduled commercial banks divided into the Public SectorBanks,
private sector banks, foreign banks, and regional rural banks. Whereas scheduledco-
operative banks are classified into scheduled urban co operative and scheduled stateco-
operative.RBI has further classified public sector banks into nationalized banks, statebank of
India and its subsidiaries. And private banks have been classified into old andnew private
sector banks. As far as the number is concerned, total public sector banksare 27, private
sector banks are 30, foreign banks are 36, and regional rural banks are196. Thus in
scheduled commercial bans, the regional rural banks are on the top number.In the
scheduled co-operative banks, there are 57 scheduled cooperatives and 16scheduled co-
operative banks. Today the overall commercial banking system in Indiamay be distinguished
into:

NTRODUCTION
After liberalization the Indian banking sector developed very appreciate. The RBIalso
nationalized good amount of commercial banks for proving socio economic servicesto the
people of the nation.
The Public Sector Banks have shown very good performance as far as thefinancial
operations are concerned. If we look to the glance of the financial operations,we may find
that deposits of public to the Public Sector Banks have increased from859,461.95crore to
1,079,393.81crore in 2003, the investments of the Public SectorBanks have increased from
349,107.81crore to 545,509.00crore, and however theadvances have also been increased to
549,351.16crore from 414,989.36crore in 2003.
The total income of the public sector banks have also shown good performancesince
the last few years and currently it is 128,464.40crore. The Public Sector Banks havealso
shown comparatively good result. The gross profits of the Public Sector Bankscurrently
29,715.26crore which has been doubled to the last to last year, and the net profitof the
Public Sector Banks is 12,295,47crore.
However, the only problem of the Public Sector Banks these days are theincreasing
level of the non performing assets. The non performing assets of the PublicSector Banks
have been increasing regularly year by year. If we glance on the numbers ofnon performing
assets we may come to know that in the year 1997 the NPAs were47,300crore and reached
to 80,246crore in 2002.
The only problem that hampers the possible financial performance of the
PublicSector Banks is the increasing results of the non performing assets. The non
performingassets impacts drastically to the working of the banks. The efficiency of a bank is
notalways reflected only by the size of its balance sheet but by the level of return on
itsassets. NPAs do not generate interest income for the banks, but at the same time
banksare required to make provisions for such NPAs from their current profits.

3
NPAs have a deleterious effect on the return on assets in several ways –
•
They erode current profits through provisioning requirements
•
They result in reduced interest income
•
They require higher provisioning requirements affecting profits and accretion to
capital funds and capacity to increase good quality risk assets in future, and
•
They limit recycling of funds, set in asset-liability mismatches, etc.
The RBI has also tried to develop many schemes and tools to reduce the nonperforming
assets by introducing internal checks and control scheme, relationshipmanagers as stated
by RBI who have complete knowledge of the borrowers, credit ratingsystem, and early
warning system and so on. The RBI has also tried to improve thesecuritization Act and
SRFAESI Act and other acts related to the pattern of the borrowings.
Though RBI has taken number of measures to reduce the level of the non
performingassets the results is not up to the expectations. To improve NPAs each bank
should bemotivated to introduce their own precautionary steps. Before lending the banks
mustevaluate the feasible financial and operational prospective results of the
borrowingcompanies. They must evaluate the business of borrowing companies by keeping
inconsiderations the overall impacts of all the factors that influence the business.

The biggest worry for indian banks…

Both the gross as well as net non-performing assets, or NPAs, of the Indian banking
industry are on the rise and things could get out of hand if the banks are not smart
enough to take prompt corrective actionThe Indian banking industry seems to be in pretty
good shape. At least that’s what the earnings of listed banks suggest. Barring six, all banks have
posted a higher net profit in the fiscal year that ended in March. Collectively, the net profit of 39
listed banks has risen by around 17% to Rs51,020 crore. Operating profit grew by almost an
identical margin. Only five banks have shown a drop in operating profit. The four banks that
feature in both lists are Dhanalakshmi Bank Ltd, Development Credit Bank Ltd, Indian Overseas
Bank and Bank of India.

Overall, the Indian banking industry is not only profitable, but also adequately capitalized. In fact,
some banks’ capital adequacy ratio—a measure of capital expressed as a percentage of risk-
weighted assets—is much above what they are required to maintain. For instance, Federal Bank’s
capital adequacy ratio is 17.27% and that of three others—Axis Bank Ltd, Development Credit
Bank and Corporation Bank —is at least 15%.

Also Read | Tamal Bandyopadhyay’s earlier columns

Is there any worry for the Indian banks at this point of time? A central banker tells me the biggest
worry is the quality of assets. Both the gross as well as net non-performing assets, or NPAs, of the
Indian banking industry are on the rise and things could get out of hand if the banks are not smart
enough to take prompt corrective action.

How bad is the situation? The gross NPAs of this set of banks have risen by 25.5% to Rs76,000
crore—around 50% more than the collective net profit of these banks. Net NPAs—excluding the
loans against which provisions have been made—have risen by around 26% to Rs35,400 crore.

Technically, there are three types of bad assets—substandard, doubtful and loss assets. While the
loss assets are to be provided for fully, the provisions for substandard and doubtful assets depend
on the age of the assets. The Indian central bank wants all banks to provide for 70% of bad
assets, irrespective of their age and classification, but most banks are resisting this move.

The most critical point to note is that 34 of the 39 listed banks have shown an increase in their
gross bad assets in absolute terms. In percentage terms, 24 banks have shown a rise. Similarly,
the net NPAs of 30 banks have risen in the past year in absolute terms even though in percentage
terms only 24 banks have shown a rise in net NPAs.

This is no consolation. In a growing economy, when banks lend money to consumers, bad assets
as a percentage of loans always decline. By setting aside more money, banks can also lower the
percentage of net NPAs, but an ominous sign is the growth of bad assets in absolute terms.

Bank of India’s gross NPAs have almost doubled from Rs2,470 crore to Rs4,883 crore and Indian
Overseas Bank’s gross NPAs have grown some 88%, from Rs1,923 crore to Rs3,611 crore. After
making hefty provisions, Bank of India’s net NPAs have grown some 251%, from Rs628 crore to
Rs2,207 crore. The growth in Punjab National Bank’s net NPAs is even higher—272%—from Rs264
crore to Rs982 crore. Union Bank of India’s net NPAs have almost doubled to Rs965 crore and that
of Bank of Maharashtra have grown 144% to Rs662 crore. Overall, State Bank of India has the
biggest book of gross and net NPAs—Rs19,535 crore and Rs10,870 crore, respectively, but their
growth in percentage term is not that high.

Not too long ago, barring a few exceptions, all Indian banks had less than 1% of net NPAs and
many of them even had zero net NPAs. They managed this feat by keeping a close eye on the
quality of assets and aggressively making provisions. That’s no more that case. There is no zero-
net NPA bank in India now. Eighteen of the 39 banks have at least 1% net NPAs, with
Development Credit Bank topping the list (3.11%), followed by Indian Overseas Bank (2.52%).
When it comes to gross NPAs as a percentage of loans, once again Development Credit Bank is the
worst performer (8.69%). Other prominent names in this list are ICICI Bank Ltd (5.06%), Indian
Overseas Bank (4.47%), Kotak Mahindra Bank Ltd (3.62%), United Bank of India (3.21%) and
State Bank of India (3.05%).

Things can get worse this year as many of the loans that were restructured in fiscal 2009 when
economic growth slowed and an unprecedented credit crunch hit the financial system in the wake
of the collapse of US investment bank Lehman Brothers Holdings Inc. are likely to turn bad.
The Reserve Bank of India allowed Indian lenders to restructure those loans where borrowers were
hit by the slowdown and could not service debt. That gave a temporary reprieve to the banks as
they were not required to classify many such loans as bad assets, but now they are being forced to
do so. State Bank of India had restructured around Rs16,800 crore worth of loans and around 10%
of such loans have already turned bad. Other banks, too, are feeling the heat.

Rising bad assets dent banks’ profitability as they need to set aside more money to cover them.
Besides, they do not earn any interest income from the bad assets. By aggressively growing their
loan books, banks can always distort the real picture of NPAs (as bad assets in percentage terms
decline) but this does not help in the long run. At least some of the banks now need to focus more
on bad loan recovery than on growing assets and the industry needs to be put on high alert.