UNIT-I

▪ Introduction
▪ Banks are the important segment in Indian Financial System.
▪ An efficient banking system helps the nation’s economic
development.
▪ Various categories of stakeholders of the Society use the banks for
their different requirements.
▪ Banks are financial intermediaries between the depositors and the
borrowers.
▪ Apart from accepting deposits and lending money, banks in today’s
changed global business environment offer many more value added
services to their clients.
▪ LEARNING OBJECTIVES

▪ To enable the reader

▪ To Understand the features of Indian Banking System
▪ To Know the significant contribution of different types of banks
▪ To Appreciate how important banking services for the economy

▪ Evolution of Indian banking may be traced through four distinct

phases
▪ 1. Evolutionary phase (Prior to 1947)
▪ 2. Foundation phase (1947-1969)
▪ 3. Expansion phase (1969-1990)
▪ 4. Consolidation and Liberalization phase (1990 to till)
▪ THE POST-INDEPENDENCE PHASE MAY BE FURTHER DIVIDED INTO
THREE SUB phases such as
▪ pre-nationalization period (1947-1969).
▪ Post nationalization period (1969 to 1991) and
▪ Post-liberalization period (1991 till date).
▪ EVOLUTION OF BANKING
▪ Banking is as old as the authentic history. The banking has it’s origin
as early as 2000 B.C., when Babylonians developed the system of
banking using their temples as banks (Khubchandani, 2000).
▪ One finds a reference to the money changers in the New Testament
(Hajela, 1987).
▪ The ‘rudimentary bank practices’ found in the Egyptian and
Phoenician history (Harish Chand
▪ Sharrma, 1969 and Vaish, 1991).

▪ Thus, the origin of the word bank can be traced as follows

▪ Banck — German (Joint stock fund)
▪ Banco — Italian (Heap of money)
▪ Bancus/ — French (Bench/chest a place where valuables are kept)
▪ Bank – English (Common meaning prevalent today, i.e., as an
institution
▪ accepting money as deposit for lending

▪ In ancient Rome also, banking was developed on the lines of Greek

system (Vaish, 1991 and Anil Gupta, 1998).
▪ When Romans conquered the Greeks, the Temple Priests no longer
acted as financial agents.
▪ The Romans introduced the rules and regulations for the conduct
of private banking.
▪ The growth of banking was seen only in 12th Century A.D in Venice
and Geneva.

▪ Some people opined that the word ‘banking’ is originated

▪ from the German word (Johnson, Iran and Roberts, William, 1982
and Suresh & Sachdeva, 1998) meaning ‘a mound or heap of money’
 (Parameswaran and Natarajan, 2001) which was Italianised into
“Banco” (Seth, 1987).
▪ Some other opined that the word “Bank” is derived from the French
word ‘banque’ which means a ‘Bench’ where business is transacted
(Ajit Singh, 1986; Parameswaran and Natarajan, 2001).
▪ Thus, it is understood that there is no unanimity among
▪ the economists about the origin of the word ‘Banking’ .
▪ Evolution of Banking in India
▪ There are plenty of evidences to show that even prior to the
advent of accidental ideas, the concept of banking was practiced in
India and well understood in those days.
▪ It’s origin can be traced to a time as early as 500 B.C., in one or
another form.
▪ Sir. Richard Temple testified to the fact that banking business was
carried on in ancient India
▪ The Vedas, Manusmiriti and Kautilya’s Arthashastra bear testimony
to the existence and efficient working of a banking system in India
by a section of people early in the history

▪ According to the Central Banking Enquiry Committee (1931), money

lending activity in India could be traced back to the Vadic period,
i.e., 2000 to 1400 BC.
▪ The existence of professional banking in India could be traced to the
500 BC. Kautilya‟s Arthashastra, dating back to 400 BC contained
references to creditors, lenders and lending rates.
▪ Banking was fairly varied to the credit needs for the trade,
commerce, agriculture as well as individuals in the economy, Mr.
W.E. Preston, member, Royal Commission on India
▪ Currency and finance set up in 1926, observed “….. it may be
accepted that a system of banking that was extremely suited to
India‟s then requirements was in force in that country many
countries before the science of banking become an accomplished
fact in England.
▪ They had their own inland bills of exchange or Hundis which were
the major instruments of transactions.
▪ The dishonoring of hundis was a rare at that time as most banking
worked on mutual trust, confidence and without securities.

▪ Banking in India has also been referred to Manu, the great Hindu
Jurist and others in the early vedic literatures.
▪ The banking was carried on by the members of the Vaisha
community and Manu speaks of earning through interest as the
business of Vaishyas.
▪ During the Buddhist period, business of banking was further refined
and decentralized.
▪ Till the Buddhist period, banking was practiced only by ‘Vaishyas’.

▪ Then, Brahmins and Kshatriyas entered in to the lucrative business

of banking.
▪ Thus, the transition from money-lending to banking must have
occurred before Manu developed a special section to the subject of
deposits and Pledges .
▪ During Ramayana and Mahabharata eras, banking was a part-time
business.
▪ Where as, during the Vedic period it became a full-time business
and banking remained the most crude form

▪ The banker in the Smriti period (which followed the vedic period)
performed most of the functions of the modern banker.
▪ During the early period of Muslim and Moghul rule in India,
indigenous bankers known as ‘Seth maneekchand’ were Prominent
in performing number of banking functions both for granting loans
both for domestic and foreign countries.
▪ During the Moghul period, in the reign of Jahangir and Shah Jahan
Hundies came into existence and large banking houses came to be
established.
▪ The indigenous bankers had great opportunities for developing the
very profitable business of money changing

▪ During the long reign of Aurangazeb bankers received a great

setbacks (Desai Vasanth, 1981) due to instable political situation
and muslim rulers believed that charging interest on money is a
great sin.
▪ By the arrival of Britishers in India, revolutionary changes took
place in the Indian banking system.
▪ The first joint stock bank was established at Calcutta known as "the
Bank in Hindustan” in 1770 under the European management
promoted by an Agency House M/S Alexander & Co. These agency
houses were very much similar

▪ to the indigenous bankers and this combination of trading with

banking proved fatal and collapsed in 1832,.
▪ Non-existence of banking legislation resulted in speculation, fraud
and mismanagement.
▪ The agency houses disappeared from the scene in the 18th Century
due to the difficulties encountered.
▪ They established the East India company which lead to the down fall
of Indian banking.
▪ In the meantime, Industrial Revolution (IR) took place which
resulted in worst position of the banking system.
▪ The bankers found difficulties to suit the changed economic
conditions.
▪ The ‘Sahukars’ and ‘Seths too reluctant in changing their methods
in tune to the changed environment.
▪ The French traveller J.B.Tavemier wrote in the 17th Century that
every village in India had a money changer, called the “Shroff’, acted
as a banker.
▪ But with the gradual increase of British trade and power in India,
many agency houses started commercial banks and time was thus
set for the decline of indigenous bankers.
▪ However, the need was felt for the modem banking system.

▪ The first western bank of a joint stock verity was Bank of Bombay,
establishing 1720 in Bombay.
▪ This was followed by bank of Hindustan in Calcutta, which was
established in 1770 by an agency house.
▪ This agency house and banks were close down in 1932.
▪ The first „Presidency Bank‟ was the Bank of Bengal established in
Calcutta on June 2, 1806 with a capital of Rs.50 Lakh.
▪ The Government subscribed to 20 percent of its share capital and
shared the privilege of appointing directors with voting rights.
▪ The bank had the task to discounting the treasury bills to provide
accumulation to the Government

▪ The bank was given powers to issue notes in 1823.

▪ The Bank of Bombay was the second presidency bank set up in 1840
with a capital of Rs. 52 Lakh, and the Bank of Madras the third
Presidency bank established in July 1843 with a capital of Rs. 30
Lakh.
▪ The presidency banks were governed by Royal charters.
▪ The presidency banks issued currency notes until the passing of the
paper currency Act, 1861, when this right to issue currency notes by
the presidency banks was taken over and that function was given to
the Government.

▪ Thus, the seed of modern banking on British pattern were sown

during the last decade of 18th century.
▪ In the beginning of 19th century, special efforts were made to
develop modern banking institutions.

▪ The bank of Calcutta’ the first presidency bank was established in

1806 marked the beginning of modern banking era in India and it
was renamed as the 'The Bank of Bengal’ in 1809.

▪ Then two more Presidency banks namely, The Bank of Bombay’ in

1840 and The bank of Madras’ in 1843 were set-up through a
Charter of East India Company with the financial Participation of
government

▪ To have a proper control over the banking industry the joint stock
banks forced to enact legislations.
▪ Accordingly, the joint stock companies Act was passed in 1850.
▪ The year 1860 was considered to be a ‘landmark’ in the banking
history of India because of the acceptance of limited liability to
number of joint stock banks.
▪ During 1862-65, the Bank of Bombay was tightened with
speculation crisis and was subsequently liquidated.
▪ Despite the set backs, the need for such a bank continued to be
felt.
▪ Then a new bank with the same name was established in 1868
without government’s participation.

▪ The presidency banks were amalgamated into a single bank, the

Imperial Bank of India, in 1921.
▪ The Imperial Bank of India was further reconstituted with the
merger of a number of banks belonging to old princely states such
as Jaipur, Mysore, Patiala and Jodhpur.
▪ The Imperial Bank of India also functioned as a central bank prior to
the establishment of the Reserve Bank in 1935.
▪ Thus, during this phase, the Imperial Bank of India performed three
set of functions via commercial banking, central banking and the
banker to the government.

▪ The three banks merged in 1925 to form the Imperial 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.
▪ Bank of Upper India was established in 1863 but failed in 1913.
▪ The Allahabad Bank, established in 1865 , is the oldest survived Joint
Stock bank in India .
▪ Oudh Commercial Bank, established in 1881 in Faizabad, failed in
1958.
▪ The next was the Punjab National Bank, established in Lahore in
1895, which is now one of the largest banks in India.

▪ Towards the end of 19th Century, the early phase of 20th century,
the ‘Swadeshi Movement’ (1906) gave a great stimulus to the
establishment of a number of banks with Indian management.
▪ The first purely Indian bank was “The Oudh commercial bank”,
established in 1881, followed by ‘The Punjab National Bank’ in 1894,
and The People’s Bank of India' in 1901 (Panadikar, 1963). But these
banks were started by Indians with meager capital, moreover they
had no knowledge and experience relating to banking Practices and
Principles

▪ In 1899, ‘the Flower Currency Committee’ advocated for the

establishment of a ‘Central Bank’.
▪ But ‘the Lord Curzon’ did not favour this scheme. The public in India
strongly demanded for creation of a ‘Central bank’.
▪ The 'Chamberlin Currency Commission’ in 1913 examined the whole
issue.
▪ Consequently, the Presidency banks were amalgamated into a single
bank in January 1921 namely “The Imperial Bank of India”, now the
‘State Bank of India’ with the intention of creating a Central bank in
the Country

▪ The first Indian owned bank was the Allahabad Bank set up in
Allahabad in 1865, the second, Punjab National Bank was set up in
1895 in Lahore, and the third, Bank of India was set up in 1906 in
Mumbai.
▪ All these banks were founded under private ownership.
▪ The Swadeshi Movement of 1906 provided a great momentum to
joint stock banks of Indian ownership and many more Indian
commercial banks such as Central Bank of India, Bank of Baroda,
Canara Bank, Indian Bank, and Bank of Mysore were established
between 1906 and 1913.

▪ By the end of December 1913, the total number of reporting

commercial banks in the country reached 56 comprising 3
Presidency banks, 18 Class „A‟ banks (with capital of greater than
Rs.5 lakh), 23 Class „B‟ banks (with capital of Rs.1 lakh to 5 lakh) and
12 exchange banks.
▪ Exchange banks were foreign owned banks that engaged mainly in
foreign exchange business in terms of foreign bills of exchange and
foreign remittances for travel and trade.
▪ Class A and B were joint stock banks.
▪ The banking sector during this period, however, was dominated by
the Presidency banks as was reflected in paid-up capital and
deposits

▪ ‘The Hilton Young Currency Commission’ (l921) had suggested and

strongly recommended for the establishment of a Central bank to
be called ‘the Reserve Bank of India’ (RBI) in 1926 (Anil Gupta,
1988).
▪ The government of India decided to establish a separate Central
bank with the task of controlling the issue of money and regulating
all other banks in the country on the recommendations of ‘Central
Banking Enquiry Committee’ in 1929-31.

▪ World War I and its Impact on Indian banking sector

▪ The World War I (1913-1918) has affected badly the Indian economy
and created many problems like high Inflation, low productive of
agriculture sector.
▪ During the war period, a large number of banks failed.
▪ Some banks that failed were also doing trading function with
banking function.
▪ Most of the banks that failed during war period had low capital
base.
▪ Several exchange banks also failed during this period mainly due to
global reasons.

▪ Prior to the 1st World war, the pace of growth of the banking sector
was very low more particularly in 1930s due to the economic
depression, the unhelpful internal as well as the external financial
policies of the government and the low level of interest rate.
▪ The banking industry suffered many set-backs resulted to failure of
a large number of commercial banks due to great World war held in
1913-17.
▪ The year 1935 opened a new era in the history of Indian banking,
when the Reserve Bank of India was established under the Reserve
Bank of India Act, 1934 to act as a central bank of the country.
▪ It started functioning from 1st April, 1935

▪ Reserve Bank of India was setup in 1935, as bank failure and

neglecting of agriculture sector were the main reasons for the
establishment of Reserve Bank of India.
▪ Yet, even after so many years of the Reserve Bank establishment,
bank failure did not stop.
▪ The major concern was the existence of non-scheduled banks as
they remained outside the preview of the Reserve Bank.
▪ Banking was more focused on urban areas and the credit
requirements of agriculture and rural sectors were neglected.
▪ These issues were solved when the country attained independence.

▪ Foundation Phase (1947-1969)

▪ When the country became independent in 1947, India banking was

entirely in the private sector.
▪ In addition to the Imperial Banks, there were five big banks, each
holding public deposits aggregating Rs.100 Cr. and more, Central
Bank of India Ltd., Punjab National Bank Ltd, Bank of India Ltd, Bank
of Baroda Ltd. and United Commercial Bank Ltd.
▪ At the time of independence, the banking structure was domestic
scheduled commercial banks.
▪ Non- scheduled banks, though large in number but constituted a
small share of the banking sector

▪ The banking system at the time of independence was largely urban-

oriented and remained beyond the reach of the rural population.
▪ A large percentage of the rural population had to depend on the
money lenders as their main source of credit banks.
▪ Rural access was grossly inadequate, as agriculture was not
considered as an economic proposition by banks in these days.
▪ Thus, the rural economy, in general, and agriculture sector in
particular, which is the crucial segment of the Indian economy was
not supported by the banking system in any form
▪ Further in 1948-53, due to the partition of the country into India
and Pakistan (Sethi, 1987 and Anil Gupta, 1998), the banking
industry faced failures.
▪ But, the post-Independence era registered a tremendous
advancement in the field of banking. It paved way to change the
whole approach towards commercial banking and government
came to recognize banking as a positive instrument to foster
economic development (Lall Nigam, 1988).
▪ The Reserve Bank of India (Transferred to public ownership) Act was
passed in 1948 (Chandraseker, 1986) led to the nationalization of
Reserve Bank of India by the enactment of Banking Regulation Act,
1949

▪ The Reserve Bank of India was private share holders’ institution till
the enactment of Banking Regulation Act, 1949.
▪ This Act empowered the central government to issue directions to
commercial and co-operative banks and even to the non-banking
institutions who receive deposits from the public (Khan Masood
Ahmad, 1992).
▪ In 1955, 'the Imperial bank of India’ was nationalized and renamed
as ‘State Bank of India’ (Anil Gupta, 1998).
▪ In 1959, Subsidiary banks’ Act was passed for further extension of
banking activities in rural and semi-urban areas
▪ Establishment of State Bank of India

▪ At the time of Independence, the Imperial Bank of India and all

other commercial banks were urban oriented.
▪ Therefore it is the need of the hour, to provide the banking facility
to the rural area. It was suggested that the Imperial Bank of India
should extent its branches to Taluka or Tehsil to provide the banking
services for the neglected area.
▪ The Imperial Bank of India was given a target of opening 114 offices
within a period of five years commencing from 1st July, 1951.
▪ But Imperial Bank of India could open only 63 branches till June 20,
1955.
▪ Imperial Bank of India was taken over by the Government under the
State Bank of India Act, 1955, effective from July 1, 1955.
▪ Under the State Bank of India (Subsidiary Banks) Act, 1959, eight
state owned/sponsored banks were taken over by State Bank of
India as its subsidiaries, now called Associate Banks.
▪ With amalgamation of two of them (State Bank of Bikaner and
Jaipur), the number of these associate banks has come down to
seven.

▪ 'State Bank of India' (Subsidiary Banks) Act

(i) The State Bank of Bikaner
(ii) The State Bank of Jaipur
(iii) The State Bank of Indore
(iv) The State Bank of Mysore
(v) The State Bank of Patiala
(vi) The State Bank of Hyderabad
▪ (vii) The State Bank of Saurashtra
▪ (viii) The State Bank of Travancore

Expansion Phase (1969-1990):

▪ Although the banking system had made some progress in terms of
deposit growth in the 1950s and the 1960s, its spread was mainly
concentrated in the urban areas.
▪ It was felt that if bank funds had to be channeled for rapid economic
growth with social justice, then most of the banks should be
nationalized.
▪ Accordingly, the Government nationalized 14 banks with deposits of
over Rs.50 Cr. by the Banking Companies (Acquisition and Transfer
of Undertakings) Ordinance, 1969
▪ These banks were the:
➢ Central Bank of India
➢ Bank of Maharashtra,
➢ Dena Bank,
➢ Punjab National Bank,
➢ Syndicate Bank,
➢ Canara Bank,
➢ Indian Overseas Bank,
➢ Indian Bank,
➢ Bank of Baroda,
➢ Union Bank,
➢ Allahabad bank,
➢ United Bank of India, UCO Bank and Bank of India.
▪ The main objectives behind the nationalization of the banks were
as follows:

➢ Reduction in the regional imbalance of economic activities.

➢ To make the banking system reaches in hand of rural and semi-urban
people.
➢ The aim was to bring a large area of economic activity within the
organized banking system.

▪ Although banks penetrated in rural areas, but amount of credit

extended to the weaker section of society was not satisfactory.
▪ In 1974 the Narasimhan Committee went into these problems and
recommended the establishment of regional Rural Banks (RRB)
under the „Regional Rural Banks Act, 1975‟.
▪ Banking in collaboration with central and State Governments, set up
Regional Rural Banks in selected regions where the cooperative
system was weak and where commercial banks were not very
active.
▪ On April 15, 1980 six more private sector banks were nationalized,
making the number of public sector banks 27.
▪ THE BANKS THAT WERE NATIONALIZED:
➢ 1. ANDHRA BANK
➢ 2. PUNJAB & SINDH BANK
➢ 3. NEW BANK OF INDIA
➢ 4. VIJAYA BANK
➢ 5. CORPORATION BANK
➢ 6. ORIENTAL BANK OF COMMERCE

Consolidation &liberalization Phase (1990 to till):

▪ In order to improve the financial strength and the profitability of the
public sector banks and tone up the overall Indian financial system
by examining all aspects relating to structure, organisation, function
and procedures, the Government of India set up two high level
committees with M. Narasimham, a former Governor of RBI, as their
Chairman.
▪ The first Committee submitted its report in 1991 and the second
committee, which was set up a few years later, submitted Report in
1998.

▪ These reports made certain recommendations for introducing

radical measures.
▪ The major thrust of the recommendations was to make banks
competitive and strong and conducive to the stability of the
financial system.
▪ The Government was advised to make a policy declaration that
there would be no more nationalization of banks.
▪ Foreign banks would be allowed to open offices in India either as
branches or as subsidiaries.
▪ In order to promote competitive culture in banking, it was
suggested that there should be no difference in the treatment
between public sector banks and private sector banks.
▪ Narasimham Committee Report I - 1991

▪ The Narsimham Committee was set up in order to study the

problems of the Indian financial system and to suggest some
recommendations for improvement in the efficiency and
productivity of the financial institution.

▪ The Committee consist of the followings.

▪ 1. Shri M. Narasimham Chairman
▪ 2. Deputy Governor, RBI Member (Banking Operations)
▪ 3. Chairman, State Bank of India Member
▪ 4. Chairman, IDBI Member
▪ 5. Chairman, ICICI Member
▪ 6. Shri Manu Shroff Member
▪ 7. Shri Y.M Malegam Member
▪ 8. Shri Mrinal Datta-Chaudhuri Member
▪ 9. Additional Secretary (Banking) Member Secretary
▪ Problems Identified By The Narasimham Committee
▪ Directed Investment Programme
▪ system of maintaining high liquid assets by commercial banks in
the form of cash, gold and unencumbered government securities.
▪ Directed Credit Programme
▪ lending to agriculture and small-scale industries at a confessional
rate of interest.
▪ The committee opined that these sectors have matured and thus
do not need such financial support.

▪ Interest Rate Structure

▪ The committee found that the interest rate structure and rate of
interest in India are highly regulated and controlled by the
government
▪ Additional Suggestions
▪ the determination of interest rate should be on grounds of market
forces.
▪ It further suggested minimizing the slabs of interest.

▪ The committee has given the following major recommendations

▪ Reduction in the SLR Statutory Liquidity Ratio and CRR Cash
Reserve Ratio
▪ Phasing out Directed Credit Programme
▪ Interest Rate Determination
▪ structural Reorganizations of the Banking sector
▪ Establishment of the ARF (Asset Reconstruction Fund) Tribunal
▪ Removal of Dual control
▪ Banking Autonomy
▪ Some of these recommendations were later accepted by the
Government of India and became banking reforms.

▪ Narasimham Committee Report II - 1998

▪ In 1998 the government appointed yet another committee under

the chairmanship of Mr. Narsimham. It is better known as the
Banking Sector Committee. It was told to review the banking reform
progress and design a programme for further strengthening the
financial system of India. The committee focused on various areas
such as capital adequacy, bank mergers, bank legislation, etc.

▪ It submitted its report to the Government in April 1998 with the

following recommendations.

▪ Strengthening Banks in India (it recommended the merger of

strong banks which will have 'multiplier effect' on the industry.)
▪ Narrow Banking [Non-performing assets] (NPAs)
▪ Capital Adequacy Ratio [Government should raise the prescribed
capital adequacy norms].
▪ Bank ownership
▪ Review of banking laws
▪ Apart from these major recommendations, the committee has also
recommended faster computerization, technology upgradation,
training of staff, depoliticizing of banks, professionalism in banking,
reviewing bank recruitment, etc.

▪ Evaluation of Narsimham Committee Reports

▪ The Committee was first set up in 1991 under the chairmanship of

Mr. M. Narasimham who was 13th governor of RBI. Only a few of its
recommendations became banking reforms of India and others
were not at all considered. Because of this a second committee was
again set up in 1998.

▪ As far as recommendations regarding bank restructuring,

management freedom, strengthening the regulation are concerned,
the RBI has to play a major role. If the major recommendations of
this committee are accepted, it will prove to be fruitful in making
Indian banks more profitable and efficient.

▪ The Government of India accepted all major recommendations of

Narasimhan Reports and started implementing them straightway,
despite stiff opposition from banks unions and political parties in
the country.
▪ It is primarily because of the financial sector reforms initiated during
the last two decades or so that the Indian financial system is
acquiring fast the shades of a vibrant, dynamic, globalized, complex
system today, creating new opportunities and challenges.
▪ But it still continues to be largely dominated by the presence of a
giant public sector particularly in banking and insurance even
though the private sector has been growing at a much faster rate in
the recent years, out-playing the public sector in the matter of
efficiency and performance.

Recent development in Indian Banking Sector:

▪ In the recent year, the banking Industry has been under going rapid
changes which is reflecting in banking reforms.
▪ Telecommunication and Information technology are the most
significant areas which have changed rapidly.
▪ It has accelerated the broadcasting of financial information which
lowering the costs of many financial activities.
▪ In the last few year banking sector has introduce new products:
Credit Cards, ATM, Tele-Banking, Electronic Fund Transfer (EFT),
Internet Banking, Mobile Banking etc.
▪ These new products increase the efficiency of banks by reducing
transactions cost

▪ Electronic funds transfer at point of sale (EFTPOS )

▪ is an electronic payment system involving electronic funds transfers
based on the use of payment cards,
▪ such as debit or credit cards,
▪ at payment terminals located at points of sale.
▪ EFTPOS technology originated in the United States in 1981 and was
adopted by other countries