I.

EVOLUTION OF BANKING IN INDIA

Modern banking in India could be traced back to the establishment of Bank of
Bengal (Jan 2, 1809), the first joint-stock bank sponsored by Government of
Bengal and governed by the royal charter of the British India Government. It was
followed by establishment of Bank of Bombay (Apr 15, 1840) and Bank of Madras
(Jul 1, 1843). These three banks, known as the presidency banks, marked the
beginning of the limited liability and joint stock banking in India and were also
vested with the right of note issue.
In 1921, the three presidency banks were merged to form the Imperial Bank of
India, which had multiple roles and responsibilities and that functioned as a
commercial bank, a banker to the government and a bankers bank. Following the
establishment of the Reserve Bank of India (RBI) in 1935, the central banking
responsibilities that the Imperial Bank of India was carrying out came to an end,
leading it to become more of a commercial bank. At the time of independence of
India, the capital and reserves of the Imperial Bank stood at Rs 118 mn, deposits
at Rs 2751 mn and advances at Rs 723 mn and a network of 172 branches and 200
sub offices spread all over the country.
In 1951, in the backdrop of central planning and the need to extend bank credit to
the rural areas, the Government constituted All India Rural Credit Survey
Committee, which recommended the creation of a state sponsored institution that
will extend banking services to the rural areas. Following this, by an act of
parliament passed in May 1955, State Bank of India was established in Jul, 1955.
In 1959, State Bank of India took over the eight former state-associated banks as
its subsidiaries. To further accelerate the credit to fl ow to the rural areas and the
vital sections of the economy such as agriculture, small scale industry etc., that are
of national importance, Social Control over banks was announced in 1967 and a
National Credit Council was set up in 1968 to assess the demand for credit by these
sectors and determine resource allocations. The decade of 1960s also witnessed
significant consolidation in the Indian banking industry with more than 500 banks
functioning in the 1950s reduced to 89 by 1969.
For the Indian banking industry, Jul 19, 1969, was a landmark day, on which
nationalization of 14 major banks was announced that each had a minimum of Rs
500 mn and above of aggregate deposits. In 1980, eight more banks were
nationalised. In 1976, the Regional Rural Banks Act came into being, that allowed
the opening of specialized regional rural banks to exclusively cater to the credit
requirements in the rural areas. These banks were set up jointly by the central
government, commercial banks and the respective local governments of the states
in which these are located.
The period following nationalisation was characterized by rapid rise in banks
business and helped in increasing national savings. Savings rate in the country
leapfrogged from 10-12% in the two decades of 1950-70 to about 25 % post
nationalisation period. Aggregate deposits which registered annual growth in the

range
credit
in the
in the

of 10% to 12% in the 1960s rose to over 20% in the 1980s. Growth of bank
increased from an average annual growth of 13% in the 1960s to about 19%
1970s and 1980s. Branch network expanded significantly leading to increase
banking coverage.

Indian banking, which experienced rapid growth following the nationalization,

began to face pressures on asset quality by the 1980s. Simultaneously, the banking
world everywhere was gearing up towards new prudential norms and operational
standards pertaining to capital adequacy, accounting and risk management,
transparency and disclosure etc. In the early 1990s, India embarked on an
ambitious economic reform programme in which the banking sector reforms formed
a major part. The Committee on Financial System (1991) more popularly known as
the Narasimham Committee prepared the blue print of the reforms. A few of the
major aspects of reform included (a) moving towards international norms in income
recognition and provisioning and other related aspects of accounting (b)
liberalization of entry and exit norms leading to the establishment of several New
Private Sector Banks and entry of a number of new Foreign Banks (c) freeing of
deposit and lending rates (except the saving deposit rate), (d) allowing Public
Sector Banks access to public equity markets for raising capital and diluting the
government stake,(e) greater transparency and disclosure standards in financial
reporting (f) suitable adoption of Basel Accord on capital adequacy (g) introduction
of technology in banking operations etc. The reforms led to major changes in the
approach of the banks towards aspects such as competition, profitability and
productivity and the need and scope for harmonization of global operational
standards and adoption of best practices. Greater focus was given to deriving
efficiencies by improvement in performance and rationalization of resources and
greater reliance on technology including promoting in a big way computerization of
banking operations and introduction of electronic banking.
The reforms led to significant changes in the strength and sustainability of Indian
banking. In addition to significant growth in business, Indian banks experienced
sharp growth in profitability, greater emphasis on prudential norms with higher
provisioning levels, reduction in the non performing assets and surge in capital
adequacy. All bank groups witnessed sharp growth in performance and profitability.
Indian banking industry is preparing for smooth transition towards more intense
competition arising from further liberalization of banking sector that was envisaged
in the year 2009 as a part of the adherence to liberalization of the financial services
industry.
II. STRUCTURE OF THE BANKING INDUSTRY
According to the RBI definition, commercial banks which conduct the business of
banking in India and which (a) have paid up capital and reserves of an aggregate
real and exchangeable value of not less than Rs 0.5 mn and (b) satisfy the RBI that
their affairs are not being conducted in a manner detrimental to the interest of their
depositors, are eligible for inclusion in the Second Schedule to the Reserve Bank of
India Act, 1934, and when included are known as Scheduled Commercial Banks.

Scheduled Commercial Banks in India are categorized in five different groups

according to their ownership and/or nature of operation. These bank groups are (i)
State Bank of India and its associates, (ii) Nationalised Banks, (iii) Regional Rural
Banks, (iv) Foreign Banks and (v) Other Indian Scheduled Commercial Banks (in
the private sector). All Scheduled Banks comprise Schedule Commercial and
Scheduled Co-operative Banks. Scheduled Cooperative banks consist of Scheduled
State Co-operative Banks and Scheduled Urban Cooperative Banks.
Banking Industry at a Glance
In the reference period of this publication (FY06), the number of scheduled
commercial banks functioning in India was 222, of which 133 were regional rural
banks. There are 71,177 bank XIV offices spread across the country, of which 43 %
are located in rural areas, 22% in semi-urban areas, 18% in urban areas and the
rest (17 %) in the metropolitan areas. The major bank groups (as defined by RBI)
functioning during the reference period of the report are State Bank of India and its
seven associate banks, 19 nationalised banks and the IDBI Ltd, 19 Old Private
Sector Banks, 8 New Private Sector Banks and 29 Foreign Banks.
Table 1: Indian Banking at a Glance

Source: Reserve Bank of India

Table 2: Number of Banks, Group Wise

Source: Indian Banks Association/ Reserve Bank of India.

* Includes Industrial Development Bank of India Ltd.
Table 3: Group Wise: Comparative Average

Source: Reserve Bank of India.

Table 4: Bank Groups: Key Indicators

Source: Reserve Bank of India.

Mergers & Acquisitions
During FY06, two domestic banks were amalgamated - Ganesh Bank of Kurundwad
with Federal Bank Ltd and Bank of Punjab Ltd with Centurion Bank Ltd to become
Centurion Bank of Punjab Ltd, while one Foreign bank UFJ Bank Ltd merged with
Bank of Tokyo-Mitsubishi Ltd. ING Bank NV closed its business in India. In Sept,
2006, The United Western Bank Ltd was placed under moratorium leading to its
amalgamation with Industrial Development Bank of India Ltd. in Oct, 2006. On Apr
1, 2007, Bharat Overseas Bank an old private sector bank was taken over by Indian
Overseas Bank and on Apr 19, 2007, Sangli Bank, another old private sector bank
was merged with ICICI Bank, a new private sector bank.
Shareholding Pattern
As of Mar 2006, only four Nationalised Bank had 100% ownership of the
Government. These are Central Bank of India, Indian Bank, Punjab and Sind Bank
and United Bank of India. As of Mar 2006, the government shareholding in the
State Bank of India stood at 59.7% and in between 51-77% in other nationalised
banks. In Feb 2007, Indian Bank came out with a public issue thus leaving only
three nationalised banks having 100% government ownership. Foreign institutional
holding up to 20% of the paid up is allowed in respect of Public Sector Banks
including State Bank of India and many of the banks have reached the threshold
level for FII investment. In respect of Private Sector Banks where higher FII holding
is allowed, threshold limit has been reached in the leading banks.

III. INDIAN BANKING AND INTERNATIONAL TRENDS

When compared to other emerging markets, the growth of Indian banking has been
impressive and compares favorably on several counts. A recent study by Bank for
International Settlements on the progress and the prospects of banking systems in
emerging countries highlights the following features of the performance of Indian
banks:
Average growth rate of real aggregate credit in India rose from 6.1% during
the period 1995- 99 to 14.6 % in 2000-04.
The average growth rate of real aggregate credit in India during 2000-04 in
India is higher as compared to major countries and regions in the emerging
markets, such as China (13.3%), Other Asia (4.7%), Latin America (4.5%),
and Central Europe (9.6%).
Commercial banks in India account for a major share of the bank credit
(97%) as compared to Latin America (68%), Other Asia (74%) and Central
Europe (83%).
Real bank credit to the private sector has shown sustained growth in India,
and has moved from 3.9% a year in 1990-94 to 6.9% a year in 1995-99 to
13.5 % a year in 2000-04. In 2005, real bank credit to the private sector in
India showed a growth of 30% year-on-year as against 9.4% in China and
15.8% in emerging markets.
In India, during the period 1999 and 2004, non-performing loans as a
percentage of total commercial bank assets came down from 6.1% to 3.3%,
capital asset ratios moved up from 11.3% to 12.9% and operating costs as a
percentage of total assets reduced from 2.4% to 2.3%. NPAs in China in
2004 stood at 6%.
In India, return on assets of banks during the period 1999-2004 moved up
from 0.4% to 1.1%, and return on equity from 8.5% to 20.9% where as in
China the former rose from 0.1% to 0.3%.
IV. BUSINESS OF COMMERCIAL BANKS
1. Balance Sheet Growth
In FY06, the aggregate balance sheet of the scheduled commercial banks
increased by 18.4%, over a 19.3 % growth registered in FY05. The ratio of
bank assets to GDP rose to 86.9% as compared to 82.8% in FY05. Banking
industry gained from the by rapid rise in the real economy, leading to surge
in several areas of business.
2. Capital and Reserves
The capital of the scheduled commercial banks as on Mar 31, 2006 stood at

Rs 252040 mn. During FY06, reserves and surplus of all scheduled

commercial banks rose by 27.6%. Revenue and other reserves nearly
doubled for the banks as a whole, with SBI reporting four fold increase in
this regard.
3. Deposits and Advances
Deposits of SCBs grew by 17.8 % in FY06 as against 16.6% in FY05, but the
advances growth outstripped this pace with a rise of 31.8% in FY06, over a
33.2% growth in FY05. As per a recent RBI report, FY06 was the second
consecutive year, when increase in credit in absolute terms was more than
the absolute increase in aggregate deposits.
Table 5: Deposits/Advances/Investments of Bank Groups in India
(In Rs mn)

Source: Reserve Bank of India

4. Group-wise Performance
The growth in deposits across the different bank groups showed substantial
variation. Public Sector Banks with a deposit growth of 12.9% and Old
Private Sector Banks with 11.4% showed a relatively subdued growth in
deposits where as the New Private Sector Banks with 50.7% and Foreign
Banks with 31.7% showed a sharp rise. Borrowings of the Public Sector
Banks grew at 24%, but that of the Foreign Banks was much higher (30%).
Due to redemption of the India Millennium Deposits in Dec 2005, banks
non-resident foreign currency deposits showed a sizeable decline. Loans and
advances growth too was on similar trends. For Public Sector Banks, loan
growth was 29.5% as compared to 34.9% in FY05, for Old Private Sector
Banks, it was 21.5% as against 22.7% in the previous year, for New Private
Sector Banks it was 50.2 % as against 33% in FY05, and for Foreign Banks it
was 29.5% as against 24 % in FY05. In the non-food credit, apart from
retail credit which grew at 40.9%; infrastructure (24%), basic metals

(14.1%) and textiles (11.2%) were the other major sectors that received
higher levels of incremental credit.
5. Growth in Retail Lending
While total credit of the SCBs grew at 31% in FY06, credit to the new
segments in the retail banking showed still higher growth rates. In FY06,
loans to housing rose by 33.4%, credit card receivables by 47.9%, auto
loans by 75%, and other personal loans by 39.1% taking the growth of retail
loans during the FY06 to 40.9%. Retail loans in FY06 constituted 25.5% of
the total loans and advances of scheduled commercial banks. Lending to
sensitive sectors also rose significantly. Loans to capital market rose by
39.2%, to real estate markets by 81.78% and to commodities by 85.56%
with the growth in these three segments reaching to 77.65% in FY06.
Table 6: Advances to Sensitive Sectors as a percentage to Total
Loans

Source: Reserve Bank of India

6. Priority Sector Advances
Credit to priority sector increased at a robust rate of 33.7% in FY06 on the
top of 40.3% in the previous year. A major portion of the credit growth in
the priority sector is accounted by agriculture and housing. Credit to SSI also
grew sizeably.

Table 7: Priority Sector Lending

Source: Reserve Bank of India.

Figures in brackets are annual growth rate in %
7. Market Share
The share of Public Sector Banks showed deceleration in respect of major
areas of business, where as that of the new private sector and Foreign Banks
earned higher share of business. The market share of the Old Private Sector
Banks too came under pressure. Public Sector Banks hold 75% market share
in major areas of business.
Table 8: Major Components of Business, Bank GroupWise (in %)

Source: Reserve Bank of India

* Industrial Development Bank of India Ltd
** Includes Industrial Development Bank of India Ltd
8. Access to Equity Markets
Banks have been increasingly accessing primary equity capital markets for
raising resources. In FY06, resource mobilization of banks through public

equity markets rose by 24%. Resources raised by banks from public equity
markets showed continuous increase, from Rs 24560 mn in FY04 to Rs
89220 mn in FY05 to Rs 110670 mn in FY06. Encouraged by the response to
banks stocks, eleven banks, six in the public sector and five in the private
sector, raised Rs 110670 mn from the equity markets. The Public Sector
Banks which raised equity from the capital markets included Allahabad Bank,
Oriental Bank of Commerce, Syndicate Bank, Andhra Bank, Bank of Baroda
and Union Bank of India. The five Private Sector Banks were Lakshmi Vilas
Bank Ltd, Yes Bank Ltd, ICICI Bank Ltd., The South Indian Bank Ltd and The
United Western Bank Ltd. The size of the share issue of these banks was Rs
6270 mn where as the premium was at Rs 104400 mn. Banks also tapped
private placement market for resource mobilization in a big way by raising
Rs 301510 mn of which Public Sector Banks accounted for 74%.
Bank stocks also emerged as an important portfolio for investment giving
significant returns. Returns from bank stocks as measured through BSE
Bankex rose from 28.6% in FY05 to 36.8 % in FY06 as compared to the
benchmark index. Bank stocks still have scope for further growth with lower
valuation prevailing at present in many banks.

Source : Bombay Stock Exchange.

9. Asset Quality
There is a perceptible increase in the quality of bank assets. Standard assets
as percent of all assets for scheduled commercial banks moved from 94.9%
in FY05 to 96.7% in FY 06, with decline in reported sub standard, doubtful
and loss assets. The proportion of standard assets rose across all the bank
groups in FY06, showing improved management of assets by banks.
According to a report of the Reserve Bank of India, the gross non performing
assets of the scheduled commercial banks declined by Rs 73090 mn over
and above the decline of Rs 65610 mn in FY05.
As on 31 Mar 2006, gross NPAs of scheduled commercial banks stood at Rs
518150 mn of which 26.4% are with State Bank group, 53% with the

nationalised banks, 7.1% with the Old Private Sector Banks, 7.3% with the
New Private Sector Banks and 3.7% with the Foreign Banks.
Scheduled commercial banks stepped up recovery efforts through numerous
methods. In addition to their own internal recovery processes, banks
recovered to the tune of Rs 6080 mn through one-time settlement and
compromise schemes, Rs 2230 mn though Lok Adalats, Rs 47100 mn
through Debt Recovery Tribunals and Rs 34230 mn through SARFAESI Act.
Asset Reconstruction Company of India Ltd (ARCIL) acquired 559 cases
amounting to Rs 211260 mn from banks.
Table 9: Asset Classification in Banks (as % of Total Assets)

Source: Reserve Bank of India

10.Distribution of Network
The expansion in the distribution network of the banks is increasingly
evident from the growth of the automated teller machines. There is a surge
in the growth of off-site ATMs with their share in the total ATMs rising to
32% in respect of Public Sector Banks, 67% in State Bank group, 32% in Old
Private Sector Banks, 63% in New Private Sector Banks and 73% in Foreign
Banks. Computerisation of public sector bank branches is also moving at
rapid pace. In 2007 the pace of computerization progressed much further.
Public Sector Banks have 93 branches operating abroad in 26 countries. All
scheduled commercial banks together have 106 branches abroad.

Table 10: Branches/ATMs/Staff in Banks (Number)

Source: Reserve Bank of India

11.Major Trends in Business
Indian banking, in addition to improvements in performance and efficiency,
has also experienced significant changes in the structure of asset and
liabilities. The major changes on the liabilities side include relatively higher
growth of demand deposits over time deposits, and also, within time
deposits, greater preference for short term over the longer term deposits.
The share of demand deposits in total deposits increased from 14.7% in
FY01 to 17% in FY06. The share of short term deposits in total time deposits
increased from 43.8% in FY00 to 58.2% in FY06. The narrowing of interest
rate spread between short and long term deposits has reduced the
preference for long term deposits.
Banks are moving away from investments to loans due to more lending
opportunities offered by the higher economic growth. The rate of bank credit
growth which was at 14.4% in FY03 rose sharply to reach 30% each in the
FY05 and FY06. Bank credit has picked up momentum on the back of rising
growth of real economy. A period of low interest rates induced banks to shift
their preference from investments to advances, which led to the share of
gross advances in total assets of all commercial banks reaching 54.7% in
FY06 from 45% in two years prior to that.

The sectors towards which the bank credit was directed has also shown
significant changes. Retail loans witnessed growth of over 40% in the last
two years, and began driving the credit growth to a significant extent. Retail
loans as a percentage of Gross Advances rose from about 22% in FY04 to
25.5% in FY06. Within the retail loans, housing segment showed the highest
growth of 50% in FY05 and 34% in FY06. As per the RBI data, banks direct
exposure to commercial real estate more than doubled in FY06.
Despite sharp rise in the credit growth, improved risk management
processes and procedures of banks contained the surge in bad debts which is
evident from the lower levels of incremental nonperforming assets reported
by the banks as also the rise in the proportion of standard assets. Further
improvement in risk management systems could provide banks with more
opportunities in expanding credit and pursuing higher levels of growth in
retail lending.