2.

1 Milestones in Indian banking industry

1949: Enactment of Banking Regulation Act.

1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
1969: Nationalization of 14 major Banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of six banks with deposits over 200 Cores.

2.2 Reform measures in indian banking

5.3.1 Interest rate liberalization

 Prior to the reforms, interest rates were a tool of cross-subsidization between

different sectors of the economy.
 Interest rate structure had grown increasingly complex with both lending and
deposit rates set by RBI.
 At present, RBI is only setting the interest rates for NRI deposits.

5.3.2 Statutory Pre-emptions

 Major problem faced by the banking system was on account of statutory pre-
emption of banks resources to finance Government’s budgetary resources to
finance Government’s budgetary needs.
 Removal of these constraints meant a planned reduction in statutory pre-emption.
 Effective CRR reduced from 15% in 1991 to 4.75% at present.
 SLR reduced from 38.5% in 1992 to 24% at present.

5.3.3 Priority sector lending

 Identified as one of the major reasons for the below average profitability of Indian
banks.
 The Narasimham Committee recommended a reduction from 40% to 10%
 While nominal targets have remained unchanged, the effective burden of priority
sector advances has been reduced by expanding the definition of priority sector
lending

5.3.4 Stabilization
 Due to directed lending practices and poor risk management skills, India's banks
had accrued a significant level of NPLs.
 Prior to any privatization, the balance sheets of PSBs had to be cleaned up through
capital injections.

5.3.5 Credit Controls

 Selective credit controls have been dispensed with and there is a greater freedom
to both banks and borrowers in matters relating to credit

5.3.6 Privatization
 In 1993 partial private shareholding of the SBI was allowed, which made it the
first SOB to raise, equity in the capital markets.
 After the 1994 amendment of the Banking Regulation Act, PSBs were allowed to
offer up to
 49% of their equity to the public
 This led to the partial privatization of 11 PSBs

5.3.6 Prudential Norms

 Starting with the guidelines on income recognition, asset classification,
provisioning and capital adequacy the RBI issued in 1992/93, there have been
continuous efforts to enhance the transparency and accountability of the banking
sector introduced gradually to meet the international standards
 Basle Accord capital standards were adopted in April 1992
 Income Recognition & Asset Classification norms of 90 days as per international
standards
 Prudential liquidity management guidelines and Operational risk management
guidelines for Systems and Control
 5.3.7 Competition and Transparency
 Competition is sought to be fostered by permitting new private sector banks, and
more liberal entry of branches of foreign banks.

5.3.8 Supervision
 An independent Board for Financial Supervision under aegis of the RBI has been
established, and consistent with international practice, focus is also on offsite
inspections and on control systems internal to the banks.

5.3.9 Structural changes

 Before the start of the 1991 reforms, there was little effective competition in the
Indian banking system due to strict entry restrictions for new banks, which
effectively shielded the incumbents from competition
 The guidelines for licensing of new banks in the private sector were issued by RBI
in January 1993
 RBI granted licenses to 10 banks in the private sector during 1993 to 2000
 By March 2005, the new private sector banks and the foreign banks had a
combined share of almost 20% of total assets.

2.3 Future reforms in banking industry

 Licensing of New Banks in Private Sector
 Presence of Foreign Banks in India Holding Companies Structure for Indian Banks
 Compensation Policy
 Credit Information Companies
 Costs and risks in using technology to change the face of banking
 Migration to Advanced Approaches under Basel II
 Preparing Indian banks migrate to Basel III regime
 Indian banks transition to IFRS
 Improving efficiency parameters of Indian Banks
  Challenges to further strengthening inclusive growth
 Need for effective corporate governance in banks
 Review of laws governing Indian banking sector
The Structure of Indian Banking

Diagram no1

RBI

Scheduled Banks/ Organized sector Unorganized sector

Commercial banks Cooperative banks

Foreign Regional
banks Rural Banks
40 196 Urban
cooperatives State
cooperatives
Private 52
Public sector 16
sector Banks
Banks
27
30

New
Old
State bank of Other 8
22
India and nationalized
associates banks

8 19
 The structure of the Indian banking system can be categorized in
two ways. The first divides the banks into three categories: the Reserve Bank of
India, commercial banks and cooperative banks. The second divides the banks into
two categories: scheduled banks and non-scheduled banks. In both of these systems
of categorization, the Reserve Bank of India, or RBI, is at the center of the banking
structure. It holds the reserve capital of all commercial and scheduled banks in the
country.
1. RBI
RBI is the central Bank of India and controls the entire money
issue, circulation the entire money issue, circulation and control by its monetary
policies and lending policies by periodical updates or corrections to discipline the
economy. It is also known as the bank of last resort.
Establishment: The reserve bank of India was established on April 1, 1935 in
accordance with the provisions of the Reserve Bank of India Act, 1934. The Central
Office of the Reserve Bank of India was initially established in Calcutta but was
permanently moved to Mumbai in 1937. Though originally privately owned, since
nationalization in 1949, the Reserve Bank is fully owned by the Government of
India.

1.1 Main Functions

 Monetary Authority: Formulate implements and monitors the monetary

policy.
 Regulator and supervisor of the financial system: Prescribes broad
parameters of banking operations within which the country‘s banking and
financial system functions.
 Manager of Foreign Exchange: Manages the Foreign Exchange
Management Act, 1999.
 Issuer of Currency: Issues and exchanges or destroys currency and coins
not fit for circulations.
  Development role: Performs a wide range of promotional functions to
support national objectives.
 Bankers to the Government: performs merchant banking function for the
central and the state governments; also acts as their banker.
 Bankers to banks: maintains banking accounts of all scheduled banks.
 Formulating the monetary policy: controls the supply of money in the
economy by its control over interest rates in order to maintain price stability
and achieve high economic growth.

1.2 Components of Monetary policy:

1.2.1 Repo Rate

Repo rate is the rate of interest which is levied on Short-Term
loans taken by commercial banks from RBI. Whenever the banks have any
shortage of funds they can borrow it from RBI. A reduction in the repo rate will
help banks to get money at a cheaper rate. When the repo rate increases, borrowing
from RBI becomes more expensive.

1.2.2 Reverse Repo Rate

This is exact opposite of Repo rate. Reverse repo rate is the
rate at which commercial banks CHARGE on their surplus funds with RBI. RBI
uses this tool when it feels there is too much money floating in the banking system.
Banks are always happy to keep money with RBI since their money is in the safe
hands with a good interest. An increase in Reverse repo rate can cause the banks to
transfer more funds to RBI due to these attractive interest rates.

1.2.3 CRR Rate

Cash reserve Ratio (CRR) is the amount of cash funds that the
banks have to maintain with RBI. If RBI decides to increase the percent of this, the
available amount with the banks comes down. RBI is using this method (increase
of CRR rate), to drain out the excessive money from the banks.

1.2.4 SLR Rate

 SLR (Statutory Liquidity Ratio) is the amount a commercial
bank needs to maintain in the form of cash, or gold or government approved
securities (Bonds) before providing credit to its customers. SLR is determined and
maintained by the RBI in order to control the expansion of bank credit. SLR is
determined as the percentage of total demand and time liabilities. Time Liabilities
are the liabilities a commercial bank is liable to pay to the customers after a
specific time period. SLR is used to control inflation and proper growth. Through
SLR tuning, the money supply in the system can be controlled efficiently.

1.2.5 Bank Rate

Bank rate is the rate of interest which is levied on Long Term
loans and Advances taken by commercial banks from RBI. Changes in the bank
rate are often used by central banks to control the money supply.

1.2.6 MSF Rate:-

MSF (Marginal Standing Facility Rate) is the rate at which
banks can borrow overnight from RBI. This was introduced in the monetary policy
of RBI for the year 2011-2012. Banks can borrow funds through MSF when there
is a considerable shortfall of liquidity. This measure has been introduced by RBI to
regulate short-term asset liability mismatches more effectively.

1.2.7 Base Rate:-

The Base Rate is the minimum interest rate of a Bank below
which it cannot lend, except for DRI advances, loans to bank's own employees and
loan to banks' depositors against their own deposits. (I.e. cases allowed by RBI).

2. SCHEDULED BANKS OR THE ORGANISED SECTOR:

The eligibility criteria exist for scheduled banks:
a) The first of which entails carrying on the business of banking in India.
b) All scheduled banks must maintain a reserve capital of 5 lakhs rupees in the
Reserve Bank of India.
c) These are registered under the second schedule of RBI Act, 1934.
Scheduled banks in India fall into two categories:

2.1 COMMERCIAL BANKS

Commercial banks constitute those banks driven by profit. These banks
exist for no other reason than generating capital. Commercial banks in India have
traditionally focused on meeting the short-term financial needs of industry, trade and
agriculture. They may be categorized as Scheduled Commercial Banks (“SCBs”) and
non-scheduled commercial banks.
SCBs are banks that are listed in the second schedule to the RBI Act,
and may further be classified as public sector banks, private sector banks and foreign
banks. SCBs have a presence throughout India, with nearly 66.5 per cent of the bank
branches located in rural or semi-urban areas of the country. A large number of these
branches belong to the public sector banks.

2.1.1 Public Sector Banks

Public sector banks make up the largest category of banks in the
Indian banking system. There are 28 public sector banks in India. They include
the SBI and its seven associate banks and 19 nationalized banks and one other
public sector. Nationalized banks are governed by the Banking Companies
(Acquisition and Transfer of Undertakings) Acts of 1970 and 1980. The banks
nationalized under the Banking Companies (Acquisition and Transfer of
Undertakings) Acts of 1970 and 1980 are referred to as “corresponding new
banks”.

2.1.2 Private Sector Banks

After bank nationalization was completed in 1969 and 1980, the
majority of Indian banks were public sector banks. Some of the existing private
sector banks, which showed signs of an eventual default, were merged with
state-owned banks. In July 1993, as part of the banking reform process and as a
measure to induce competition in the banking sector, the RBI permitted entry by
the private sector into the banking system. This resulted in the emergence of
nine private sector banks. These banks are collectively known as the “New
Private Sector Banks”. There are eight New Private Sector Banks operating as
on June 30, 2006. In addition, 19 private sector banks existing prior to July 1993
 were operating as on June 30, 2006. These are collectively known as the “Old
Private Sector Banks”. With 6,543 branches, as on June 30, 2006, these banks
accounted for 20.0 per cent of aggregate deposits and 20.3 per cent of the gross
bank credit outstanding of the SCBs in India.

2.1.3 Foreign Banks

As on June 30, 2006, there were 29 foreign banks with 242
branches operating in India and these banks accounted for 5.4 per cent of
aggregate deposits and 6.90 per cent of the gross bank credit outstanding of the
SCBs in India.
The GoI permits foreign banks to operate through (i) branches;
(ii) a wholly owned subsidiary; or (iii) a subsidiary with aggregate foreign
investment of up to 74 per cent in a private bank. The foreign direct investment
limit in private sector banks is 74 per cent under the automatic route, including
investment by FIIs.

2.1.4 Regional Rural Banks

Regional Rural Banks (“RRBs”) were established by the GoI, state
governments and sponsoring commercial banks with a view to develop the rural
economy. RRBs mainly provide credit to small farmers, artisans, small
entrepreneurs and agricultural labourers. There were 109 RRBs as on June 30,
2006, with 14,369 branches and they accounted for 3.20 per cent of aggregate
deposits and 2.6 per cent of the gross bank credit outstanding of the SCBs in
India.

2.2 COOPERATIVE BANKS

Cooperative banks technically constitute cooperative
institutions with an elected managing committee, provisions for the protection of
members' rights and a set of communally developed and approved by laws and
amendments.

Three tier structures exist in the cooperative banking:

a. State cooperative bank at the apex level.

 b. Central cooperative banks at the district level.

c. Primary cooperative banks and the base or local level.

3. UNORGANIZED SECTOR OR NON SHEDULED BANKS

The unorganized sector comprising individual or family owned

indigenous bankers or money lenders and non-banking financial companies (NBFCs).
And are those commercial banks, which are not included in the second schedule of RBI
Act 1934.

2.4 Regulations for Indian banks

Currently in most jurisdictions commercial banks are regulated by
government entities and require a special bank license to operate. Usually the
definition of the business of banking for the purposes of regulation is extended to
include acceptance of deposits, even if they are not repayable to the customer's order
—although money lending, by itself, is generally not included in the definition.
Unlike most other regulated industries, the regulator is typically also a participant in
the market, i.e. a government-owned (central) bank. Central banks also typically have
a monopoly on the business of issuing banknotes. However, in some countries this is
not the case. In UK, for example, the Financial Services Authority licenses banks, and
some commercial banks (such as the Bank of Scotland) issue their own banknotes in
addition to those issued by the Bank of England, the UK government's central bank.
Some types of financial institutions, such as building societies and credit unions, may
be partly or wholly exempted from bank license requirements, and therefore regulated
under separate rules. The requirements for the issue of a bank license vary between
jurisdictions but typically include:
a. Minimum capital
b. Minimum capital ratio
c. 'Fit and Proper' requirements for the bank's controllers, owners, directors,
and/or senior officers
d. Approval of the bank's business plan as being sufficiently prudent and
plausible.