An Overview of Banking Sector in India

Till the end of late 18th century, Banks in India, in the modern sense of the term, weren’t there. During the time of the American Civil War, the supply of cotton to Lancashire (The textile hub of UK) stopped from the Americas. At that time some banks were opened, which functioned as entities to finance industry, including speculative trades in cotton. Most of the banks opened in India during that period could not survive and failed because of the high risk which came with large exposure to speculative ventures. It was a disaster for depositors who lost money and therefore lost interest in keeping deposits with banks. In the year 1786, The General Bank of India was the first bank to come into existence in India. And then, almost a century later, in the year 1870, The Bank of Hindustan became the 2nd bank in India. Unfortunately, both these banks are now defunct.1

The Bank of Bengal which later became the State Bank of India The oldest bank to be still in existence, that too as the largest bank in India, is the State Bank of India. Albeit, the name was not the same as today rather was "The Bank of Bengal” which started its operations in Calcutta in June, 1806. Interestingly, if people think that the entry of foreign banks in India is only a post-reform phenomenon, they are absolutely incorrect. In fact, in as early as 1850s, foreign banks like Credit Lyonnais started their Calcutta (now Kolkata) operations. At that point of time, Calcutta was the most active trading port, thanks to the trade of the British Empire, and due to which banking activity took roots there and prospered. The first fully Indian owned bank was the Allahabad Bank, which was established in 1865. By the 1900s, the market expanded with the establishment of banks such as Punjab National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai - both of which were founded under private ownership. The Reserve Bank of India formally took on the responsibility of regulating the Indian banking sector from 1935. At least 94 banks in India failed during the years 1913 to 1918. This was really a turbulent time for the world as a whole and the banking sector in India specially. This was the period which witnessed the First World War (1914-1918). Since then through the end
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of the Second World War (1939-1945), and two years thereafter until India achieved independence, were very challenging period for Indian banking. The years of the First World War were turbulent, and it took toll on many banks which simply collapsed despite the Indian economy gaining indirect boost due to war-related economic activities. There were at least 106 numbers of banks which downed shutters during that period. Following is a table giving year wise closed banks’ detail during the period;2

Years

Number of banks Authorised capital Paid-up Capital that failed (Rs. Lakhs) (Rs. Lakhs)

1913 1914 1915 1916

12 42 11 13 9

274 710 56 231 76 209

35 109 5 4 25 1

1918

7

Post-independence The partition of India bought about a social unrest throughout India in 1947. Riot and chaos ruled. The most adversely impacted provinces were the Punjab and West Bengal. So did the economies of both these provinces. As a result, the banking activities had remained paralyzed for months. Till then the banking sector was wide open and there were almost no regulation. Most of the promoters were private players. With Independence, things started changing. Rather the independence marked the end of a regime of the Laissez-faire for the Indian banking. The new government initiated a process of playing an active role in the economy of the nation. The Industrial Policy Resolution adopted by the government in 1948 was the first step towards it. The resolution opted for a mixed economy. This resulted into greater control and involvement of the state in different segments of the economy, more so, in the sensitive sectors including banking and finance. The important banking regulatory steps were as follows: • In 1948, India's central banking authority the Reserve Bank of India got nationalized, and it became an institution owned by the Government of India.

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• •

With the enactment of the Banking Regulation Act in 1949, the Reserve Bank of India (RBI) got empowered "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 may be opened without a license from the RBI, and no two banks could have common directors.

Interestingly, despite these provisions, control and regulations, almost all banks in India except the State Bank of India, continued to be owned and operated by private persons. However, the situation changed dramatically with the nationalization of major banks in India on 19th July, 1969. Nationalisation From Independence, it took some years for the banking sector to mature. By 1960s, the Indian banking industry did occupy an important position to facilitate the development of the Indian economy. Moreover, it did employ a quantum volume which could affect national economy. It resulted in a debate about the possibility to nationalize the banking industry. At that point, during the annual conference of the All India Congress Meeting, in a paper entitled "Stray thoughts on Bank Nationalisation", Indira Gandhi, the-then Prime Minister of India expressed the intention of the GOI favouring nationalisation. The paper was received with positive enthusiasm. Thereafter, in a swift and sudden move, the GOI issued an ordinance and nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. The decision was even termed as a "masterstroke of political sagacity" by non other than a leader of the stature of Jaypraksh Narayan. Then, within the next fortnight of issuing the ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill. The bill finally received the presidential approval on 9th August, 1969. In 1980, there came the second phase of nationalisation of 6 more commercial banks. The reason forwarded for this was to have more control of credit delivery by the government. By the time, GOI effectively got hold of 91% control of the total banking business of India. Till 1990s, all nationalised banks grew at a pace of around 4%, similar to the average growth rate of the Indian economy. Post-liberalisation In the early 1990s, with the Narsimha Rao government embarking on a policy of liberalisation the situation started changing. Licenses were issued to a small number of private banks, such as Global Trust Bank (the first of such new generation banks to be set up)which later amalgamated with Oriental Bank of Commerce, UTI Bank(now re-named as Axis Bank), ICICI Bank and HDFC Bank. These banks also came to be known as New Generation tech-savvy banks because of their improved service condition and their extensive use of IT in the operations.

This move instigated competition, resulting increased efficiency and performance and did a lot of good to the banking sector. The rapid growth in the economy of India, again as a result of liberalisation, also did help transform the sector to this new look. The new situation shifted many goal posts. Till then, the widely used method of 4-6-4 (Borrow at 4%; Lend at 6%; Go home at 4) of functioning by the banks become redundant. Technology, competition, change in customer behaviour, macro-economic conditions, government policies, resultant of all together ushered a new modern, efficient and innovating banking environment in India. People started receiving more from the banks and also constantly started demanding more. Retail banking boom can be attributed to this phenomenon. With the second phase of economic reforms, the next stage for the Indian banking has been setup 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%. It’s notable that FDI permissible limit, at present, has gone up to 49% with some restrictions. Current situation Today, the banking sector in India is fairly mature in terms of supply, product range and reach. As far as private sector and foreign banks are concerned, the reach in rural India still remains a challenge. 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. Till now, there is hardy any deviation seen from this stated goal which is again very encouraging. With passing time, Indian economy is further expected to grow and 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 grow stronger. Therefore, it is not hard to forecast few M&As, takeovers, and asset sales in the sector. Consolidation is going to be another order of the day. The significant change in the policy and attitude that is currently being seen is encouraging for the banking sector growth. In March 2006, the Reserve Bank of India allowed Warburg Pincus, a private foreign investor, to increase its stake in Kotak Mahindra Bank to 10%. Notably, this is the first time that a foreign individual investor has been allowed to hold more than 5% in a private sector bank since 2000. Earlier, The RBI in 2005 announced that any stake exceeding 5% by foreign individual investors in the private sector banks would need to be vetted by them. “Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks

hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.”3 Despite the current global slowdown, despite the fear of US economic recession, despite the volatility of Indian stock markets, every informed observer is more or less optimistic about the 8% to 10% growth per annum for the Indian economy till the next few years. Therefore, it can safely be said that the banking industry in India will only surge ahead in coming years. We can also expect to see many other sea changes in terms of their operations, funding and structures. As they say, this is just the beginning!

Written by: Jagadish Nath Faculty Member Icfai National College, Guwahati

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