Evolution of banks in India, growth of banking in pre and post-independence period, nationalization of banks, diversification of banking activities, banking sector reforms, RBI and its functions

1. BANKING AND INSURANCE

2. Development of Banking in India
• The first banking institution in India was the Bank of Bengal in 1809
that did not last long.
• Many of the surviving banks were started by Indian businessmen
during the Swadeshi Movement between 1906 and 1913.
• The Imperial Bank of India was started by the government in 1921.
• It was renamed as the State Bank of India (SBI) in 1955.
• Issues of shares of the bank to the general public in 1955 resulted in it
being not fully owned by the government, but it continued to be
recognized as the government bank and had monopoly over the
banking business of the government till 2003.

3. Development of Banking in India
• Soon after India’s independence, the Industrial Development Bank of
India (IDBI) and Industrial Credit and Investment Corporation of India
(ICICI) were promoted by the Government of India to provide long
term (up to 10 years) financial assistance to industries as there was
dearth of capital for setting up industries and the existing banks
specialized in providing short term finance.
• The government and international development institutions like the
World Bank (WB) provided them funds which they lent to Indian
industries. Both these institutions have been converted a commercial
banks after 2002

4. Development of Banking in India
• Banks being commercial institutions, were reluctant to finance new
and small business ventures that were risky and to set up branches in
rural areas because the business potential was low.
• The Government of India felt that providing banking services and
financial assistance to all sections and sectors of the society was
necessary to promote economic growth and welfare of the people.
• Hence the Government of India nationalized all large banks in 1969 by
paying off the owners.
• The banks that were allowed to continue in the private sector,
through many in number, had insignificant market share

5. Development of Banking in India
• As owners of the banks, the government could influence the policies of
nationalized banks.
• The orientation of the banks was changed from profit to development and
the next two decades saw unprecedented expansion of banks into rural
and semi urban areas, and bank financing to the agriculture, small
industries, and small business sectors multiplied manifold.
• In 1980 another set of banks were also nationalized.
• Subsequent to 2000 the government’s share holding has been diluted as
the banks have raised capital from the market, but the management of the
banks is firmly controlled by the government.
• The government banks continue to control over 80 per cent of banking
business in India.

6. Development of Banking in India
• It was in 1994 that the Government of India decided to permit setting up of
banks in the private sector to inject an element of competition in the
banking industry as virtual monopoly had made the public sector banks
rather complacent.
• Eight new banks, including ICICI Bank, HDFC Bank, IDBI Bank and UTI Bank
were set up in the next three years.
• The new banks revolutionized the banking industry by embracing modern
technology and management practices and by being customer- and profit-
oriented.
• The rapid growth of the private sector banks has promoted the public
sector banks to mend their ways and many of them, especially the SBI,
have transformed themselves in a big way.

7. Development of Banking in India
• In 2002, ICICI was merged with the ICICI Bank and in 2004 IDBI was
merged with the IDBI Bank.
• While some foreign banks have been operating in India for over 100
years, it is only since 2004 that some of them have started expanding
aggressively.
• Their conservative attitude and reluctance to bring in capital has
prevented them from growing as fast as private sector banks, which
have stolen a march over them.
• Since 2005 foreign banks have been evincing renewed interest in the
Indian market.

8. Development of Banking in India
• The co-operative banks form another group of important players in
the Indian banking scene.
• They originated well before independence but after 1947 a large
number of co-operative banks were set up with the active
encouragement of the government.
• While their financial health is poor due to mismanagement, they
continue to play a significant role, especially in the rural areas.

9. List of Public Sector Banks in India

10. List of Private Sector Banks in India

11. Role of Banks
Intermediation
Continuous economic growth is a necessity as population grows
continuously and ever-increasing production of goods and services
are required to meet the needs of the people and also to keep the
people productively engaged.
This calls for large investments, as even the smallest enterprise like
that of a vegetable vendor requires investment of money for buying
the pushcart and the stock of vegetables.
While small businesses may be financed with own money,
businessmen or entrepreneurs need financial assistance to start any
business of reasonable size.

12. Role of Banks
• In any society, the number of people with entrepreneurial inclinations
is few because the majority of people are not capable or willing to
take the risks involved in running a business.
• While money is available with the savers of the society, the
entrepreneurs are unable to access it as the savers would be unwilling
to lend it to the entrepreneurs because of the following risks:
• Credit Risk
• Liquidity Risk
• Interest Rate Risk

13. Credit Risk
• Credit risk refers to the risk of default by the borrower for any reason.
It is possible that the business does not generate sufficient income to
repay the loan or the borrower is not honest enough to honour his
commitment.
• Credit risk is the most serious risk any lender faces and individuals
savers cannot afford to take such risk.

14. Liquidity Risk
• The borrower may have every intension to repay the loan and the
business too may be doing well. However, there could be occasions
when the borrower is not able to withdraw funds from the business
when the lender demands repayment or the repayment is due.
• There could be many types of temporary problems, which may or
may not be in the control of the borrower that stands in the way of
repayment of the loan

15. Interest Rate Risk
• Another risk in lending money is the possibility of loss due to change
in the rate of interest in the market.
• At the time of the transaction the borrower may have agreed to give
interest at the prevailing rate of, say, 10 per cent.
• Subsequently, he may ask for a reduction in the rate of interest rate or
repay the loan before the due date, quoting the terms of the original
contract.
• Both situations are to the detriment of the lender and individuals
with savings would like to insulate themselves from such risk of loss
due to movement in interest rates.

16. Role of Banks
• The risk-averse nature of normal savers and the risks inherent in any
entrepreneurial activity necessitates intermediaries who have the
ability to insulate the savers from the risks inherent to business and
make available the funds to entrepreneurs by managing the risks in
an effective manner to minimize the chances of loss.
• The process of transferring the funds from the savers to the
entrepreneurs is called intermediation the essence of which is risk
management.

17. Role of Banks
• Money, to be productive, needs to circulate. If all savings are hoarded,
the surpluses of the community will not be available for investments
and this would lead to economic stagnation.
• Financial intermediaries play an important economic function by
facilitating productive use of the surpluses of the community to
generate employment and promote economic welfare by enabling
production of goods and services required by the community. Thus
intermediation is a very important economic function.

18. Role of Banks
• All institutions in the financial sector do or enable some form of
intermediation. Banks—because of their reach, trust of the people they
enjoy, and the other rules they play by—have emerged as the largest
intermediaries across the world.
• Consequently, banking has become a business with great social relevance.
• The economic prosperity of the economy as a whole and of different
regions and industries depend upon the banks. If the banks choose not to
lend to a particular industry it is unlikely that the industry will flourish.
• For instance, in the early days of the Information Technology (IT) industry,
banks were reluctant to lend to the industry because banks did not
understand the nuances of the IT business. As a result, the growth of the IT
industry was lackluster.

19. Role of Banks
• Once the banks understood the business and its potential, they
started supporting the IT industry in a big way and played a decisive
role in the spectacular growth of the industry.
• Similarly, till the 1970s, banks were reluctant to lend to the
agricultural sector and India continued to be a net importer of food
grains.
• The adoption of improved methods of agriculture which led to the
green revolution and food self sufficiency, needed liberal doses of
investments and it is the banks which provided the credit support
necessary to make the green revolution a success.

20. Payment System
• Apart from being the largest intermediary, two unique features
differentiate banks from other intermediaries.
• The second part of the definition of banking points to this feature.
• Banks accept ‘deposits of money, repayable on demand…. and
withdrawable by cheque…’. Banks are only the institutions that can
accept demand deposits or deposits repayable as and when
demanded by the depositor.
• All other financial institutions can only take fixed deposits or deposits
repayable after a specific period at time.

21. Payment System
• Secondly, banks are the only institutions on which a depositor can
issue a cheque to withdraw his deposits.
• By its very definition, a cheque is an instruction issued to a bank to
pay a certain sum of money to the person whose name is written on
the cheque.

22. Payment System
• The difficulty in transporting and exchanging large volumes of currency notes and
coins to settle transactions have led to the growth of cheques as the most
preferred instrument for settlement of transactions.
• Cheques have effectively assumed the role of money, and the volume of money
in circulation represented by cheques is much more than the volume of money in
the form of currency notes and coins. In the process of handling cheques to settle
transactions, banks also move money from place to place.
• For instance, when a resident of Mumbai issues a cheque to a resident of Delhi
and the payee’s bank in Delhi credits the money from the payer’s bank in
Mumbai, money would have moved from place to place and from the payer’s
account to the payee’s account.
• As the only institutions that can complete transactions involving cheques, and
also move money from place to place, banks collectively, have evolved into the
payment system of the economy

23. Financial Services
• From ancient times, banks have played the roles of safekeeper,
financial intermediary, and payment system constituent. As times
changed, banks have provided additional services to meet the
changing needs of the people.
• Today, banks take pride in positioning themselves as financial services
providers rather than as just banks.
• The financial services offered by banks include selling products of
mutual funds and insurance companies, collection of utility bill
payments, sale of gold coins, and many more

24. Banking Regulation
• Banking is more than just a business.
• Therefore, the great social and economic importance of banks makes
regulation of their activities highly important.
• Banking regulation seeks to ensure that banks:
• Maintain adequate liquid resources at all times.
• Manage all risks adequately and ensure that the funds under their management are
safe.
• Run their business in a profitable manner and the profits are used prudently to
strengthen the banks and not freely distributed to please the investors.
• Take their duty of secrecy seriously and at the same time not let anti-social elements
use the banking system to subvert the economy.
• Maintain certain minimum levels of service quality and not discriminate between the
members of the public in making available banking services, which have assumed the
nature of essential services.

25. Banking Regulation in India
• Banks in India are regulated by and through the RBI using the powers
conferred on them primarily by the RBI Act of 1934; the Banking
Regulations (BR) Act of 1949; the FEMA of 1999, among others.
• Respective state governments regulate cooperative banks under respective
State Cooperative Societies Acts.
• Multistate Cooperative Banks are regulated by the central government
under the Multiunit Cooperative Societies Act. Cooperative banks are
subject to dual regulation—both by the government and the RBI.
• The need for closer regulation of cooperative banks has led to several state
governments signing memorandum of understandings (MoUs) with the RBI
giving them greater control over the cooperative banks.

26. Regulation by the RBI
• RBI regulates the banks through statutory prescriptions, guidelines issued
by the RBI, onsite inspections, and offsite supervision.
• RBI issues important regulations and guidelines related to the following,
which are of relevance in the day-to-day functioning of banks:
1. Nature of business
2. Licensing
3. Capital requirements
4. Appointment of whole-time and part-time directors
5. Know Your Customer (KYC) and Anti Money Laundering (AML)
6. Banking ombudsman scheme
7. Non-Performing Assets (NPA) norms
8. Rate of interest
9. CRR
10. SLR, etc.

27. Functions of the Reserve Bank of India
• The RBI controls the entire financial sector of the economy.
• It regulates the activities of the money market, acts as the custodian
of the money market, tries to execute the monetary policy of the
government, uses its powers to promote economic development of
the country and so on.
• Various functions performed by the RBI may be conveniently divided
into two categories.
They are as follows:
(i) Traditional functions
(ii) Promotional functions