Evolution of Banking in India

Points to Ponder in This Article – Just read how banking system evolved in India & how was it before and after the independence. Also look at the committees which led to setting up of new banks, decrease in CRR, SLR etc. & evolution of banking system.

Banking in India, in the modern sense, originated in the last decades of the 18th century. Among the first banks were the Bank of Hindustan, which was established in 1770 and liquidated in 1829–32; and the General Bank of India, established in 1786 but failed in 1791.

East India Co. established three presidency banks viz.

• Bengal 1806
• Bombay 1840
• Madras 1842

1861 : All 3 were given right to issue currency

1921 : Formation of Imperial Bank of India by merging all above 3 banks

1955 : Nationalization of imperial bank → Birth of SBI

Pre Independence banks in India

Foreign Banks (Pre independence)

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

Indian Banks (Pre independence)

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

Birth of RBI

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

Post Independence banks in India

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

Bank Nationalization problems

• Administered interest rate by government
• Political interference→ loan for government nepotism →Rise in NPA → Burden on Civil Courts
• High reserve requirement → CRR 15%, SLR 40%
• Hard to get loans for business → Balance of Payment crisis

• High cost (interest rates) for credit (loans)
• Business expansion decreased → Jobs creation decreased
• Tax-Collection decreased → Government borrowing: Fiscal deficit increased
• Exports decreased → Current Account Deficit increased

Narsimhan Committee I – 1991

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

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

Benchmark Prime Lending Rate (BPLR) → Base Rate system

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

Bank licences → 1^st Round (1993)

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

Narsimhan Committee II – 1998

• Introduced Voluntary retirement scheme (VRS) in public sector banks.
• Legal reforms for loan recovery → SARFAESI act 2002
• Computerization, electronic fund transfer, legal framework

• Payment and Settlement Act
• Retail Transaction → ECS, NEFT, Credit Card
• Wholesale Transaction → RTGS

• Permit new private / foreign banks

New Bank licenses 2^nd round (2001)

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

• Kotak Mahindra
• Yes Bank

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

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

RBI – Bimal Jalan Committee

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

• Bandhan Microfinance
• IDFC

Bandhan Microfinance → Chandra Shekhar Ghosh

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

IDFC (Infrastructure Development and Financial Corporation) → Rajiv Lal

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

These two are given only “in-principle” approval which means

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

Once they fulfill above conditions, RBI will give them license under Banking Regulation Act, 1949 to open current account, savings account etc.

RBI has also prohibited the promoters (Ghosh and Lal) to hold CEO position in their respective banks to prevent conflict of interest.