There is a difference of opinion as to whether the French word ‘Banque’ or the Italian word ‘Banca’ is the genesis of the English word “Bank”. Nevertheless, both these words point to some kind of a bench or a counter where money exchange transactions used to take place historically.
Charles Woelfel’s Encyclopedia of Banking and Finance more comprehensively defines a bank as “… an organisation engaged in any or all of the various functions of banking i.e. receiving, collecting, transferring, paying, lending, investing, dealing, exchanging and servicing (safe deposit, custodianship, agency, trusteeship) money and have claims to money both domestically or internationally.” In India, Section 5(b) of Banking Regulation Act, 1949, which was the first state act to control and regulate the activities of banking companies, defines banking as “Accepting, for the purpose of lending and investment, of deposits of money from the public, repayable on demand or otherwise.” Importance of bank in the modern age cannot be overemphasised since finance is the life blood of trade, commerce and industry of a nation. Today, we come across broadly, three types of banks: commercial/ retail banks, investment banks and the central bank. Banks, in most countries, are regulated by the national government or its central bank. Commercial banks are those that typically are involved in receiving deposits and managing withdrawals as well as supplying short-term credit to individuals and small businesses. Investment banks are those that provide corporate clients with investment services like underwriting and merger and acquisition (M&A) assistance. Central banks are chiefly regulatory bodies working for ensuring currency stability, overseeing money supply, controlling inflation and devising monetary policy. The Federal Reserve in the US, Bank of England in the UK and Reserve Bank of India are examples of a central bank.
Banking in India:
History of banking system in India is as old as the early Vedic period. References regarding deposits, advances, pledging for loan, and interest rates are found in Manusmriti the book of Manu, the great Hindu jurist. There is mention in ‘Manusmriti’ of terms like Rnapatra, Rnalekhya, Kusidin (soodhkhor: kind of usurer in English) etc. This clearly indicates that banking did exist during the ancient Vedic civilization. During the Mauryan period, we find quotes in Kautilya’s (or Chanakya’s) Arthashastra (300 B.C.) about banking products like “adesha” which was equivalent to Bill of Exchange of current times. It also referred to ‘merchant’ bankers who used to receive deposits, advance loans and carried out other functions akin to those of modern day banking. Since ancients times Shroffs, Seths, Mahajans, Chettis, Sahukars etc. belonging to the Vaishya community have been carrying on banking business by accepting deposits and lending money for interest on the amount loaned to people. They even advanced loans to kings and managed the currency of the kingdom. These were indigenous bankers, primarily money lenders who did play some role in the economy of the then kingdoms by lending money and financing trade and commerce including foreign trades.
During the Muslim rule, particularly in the Mughal period there was some decline in the money lending business as Islam forbids taking of interest. However, with enhanced use of metallic money called Sicca with names of rulers and governors stuck on them and appointment of more revenue collectors, bankers, money changers and mint officers, the economy gained momentum. 18th century India was one of the most attractive centres for trade and commerce in the world. Flourishing trade centres developed in Peshawar, Lahore, Agra, Surat, Ahmedabad and Daulatabad in the north & west; Benares, Patna, Berhampore (Qassimbazar), Dhaka in the east and Golconda and Bijapur in the south. Trade boomed in fine muslin (textile), silk, saltpetre and indigo. From Central Asia came gorgeous carpets, lavish dress, dry fruits, horses and also slaves. Principal instrument of trade was the Hundi (a kind of IOU) which could be customised according to need to be used in trade and credit transactions. The men who engaged themselves in all these transactions of money transfers, issuance of letters of exchange were called Shroffs and Sahukars. These indigenous bankers by their extraordinary ‘power of purchase’ were not only centres of wealth, but also the epicentre of power during the Mughal Empire as it was presumed that they could even purchase thrones with their money power. However for agricultural loans the peasants continued to depend on the small village money lenders charging high interest rates.
With the advent of the British East India Company there was major transformation in banking ideas. The western concept of banking made its appearance in the country with the founding of ‘The Bank of Hindustan’ in 1770 by M/s Alexander & Company but it is said, it did not follow some of the basic tenets of banking as per modern definition of banking. The first joint stock bank established in 1786 was The General Bank of India. Subsequently, the East India Company founded the first Presidency bank, namely Bank of Calcutta in 1806 which later in 1809 was renamed Bank of Bengal. This was followed by establishment of two other presidency banks, The Bank of Bombay in 1840 and Bank of Madras in 1843. The 3 presidency banks which started functioning as quasi-central bankers of issue, bankers to the Government and Bankers’ bank were later merged in 1921 to form the Imperial Bank of India. The oldest surviving joint stock bank in India is Allahabad Bank founded in 1865 by some Europeans in Allahabad. The first commercial bank in India having limited liability and entirely managed by Indians was Oudh Commercial Bank established in 1881 in Faizabad (in Uttar Pradesh). This bank which failed in 1958, served only local customers with no branches. The Punjab National Bank Limited was registered under the Indian Companies Act in 1894, with its office in Lahore, now in Pakistan. In the wake of the freedom struggle, the Swadeshi movement inspired some Indian entrepreneurs to venture into banking which saw founding of Bank of India Limited (1906), Canara Bank Limited (1906), Indian Bank Limited (1907) Bank of Baroda Limited (1908), Central Bank of India Limited (1911). The boom period of 1906-1913 helped the growth of these banks along with some others which did not survive in later years. The period between 1913 and 1917 was one of crisis as some 100 odd banks failed during these years. The Reserve Bank of India (RBI) was established in 1935 with private shareholders. The need for a central bank was met with its establishment. It took over the functions involving government transactions, hitherto carried out by the Imperial Bank.
By the time of independence in 1947, India inherited an extremely weak banking structure with a large urban centre bias; loans and advances were made available mostly to relatives of promoters and directed primarily to the trading sector only. Most of the smaller towns and almost all villages in the country were devoid of any banking facility. Certain geographical locations had a skewed presence of branches with no bank having a true all India network. Weak banks continued to fail till 1948 due to a variety of reasons ranging from inadequate capital structure, poor liquidity of assets due to injudicious advancing, lack of regulatory control and mismanagement. This underlined the need to regulate and control commercial banks. With the passing of the Banking Regulations Act, 1949, RBI was conferred with more powers of supervision, control and licensing of banks and the authority to conduct periodic inspections. The Act provided the legal framework for regulation of the banking system by RBI. In 1955 the State Bank of India (SBI) was constituted when the RBI acquired controlling interest in the Imperial Bank to form the largest commercial bank in the country. The nationalisation of the Imperial Bank of India became part of a wider objective to direct the funds of the banking system into certain neglected, but important, sectors of the economy such as agriculture, and to spread banking facilities in rural areas. In 1959, State Bank of India (subsidiary) act was passed to nationalise the seven subsidiary banks of the State Bank of India. These seven banks were the erstwhile banks of the princely states which merged into the union of India after independence.
Since 1951 Government of India embarked upon planned economic development of the country with social justice. The government sought to play an active role in the economic life of the nation by introducing 5-year plans. As in other sectors of the economy, the government introduced several important reforms in the banking sector for its transformation. The aim was to bring in structural changes in commercial banking by bringing in certain banking legislations. To avert bank failures, the government in 1960 added a new section (Sec. 45) in the Banking Companies Act, 1949 which empowered the RBI to seek consent of the government to prepare a scheme of amalgamation of weak banks with strong and well-managed banks. Since the government opted for a socialist pattern of economy, it set a goal for itself to achieve a society where wealth shall be distributed as equitably as possible without government playing a totalitarian role. Accordingly, government adopted a model of mixed economy with the private and the public sectors functioning independently of each other. It preferred a scenario where the means of production, distribution and exchange would be owned by the state on behalf of the people and the working class, for consolidation of resources to build a controlled economy. Towards this direction the government enacted the Banking Laws (Amendment) Act, 1968 which envisaged a scheme of ‘social control over banks’. The immediate objective was to remove certain deficiencies in the functioning of scheduled commercial banks whereby the banks were directing their advances to the large and medium scale industries only and the priority sectors such as agriculture, small-scale industries and exports stood neglected. Large industrialists who monopolised the board of directors in these banks were only interested in sanctioning large amount of loans and advances to the industries they were connected with. However, this scheme of social control over banks was tried for only 168 days and the government decided to go for full nationalisation of 14 major commercial banks of the country on July 19, 1969. The motives for nationalization were both political and economic. Subsequently, in 1980, another six banks were nationalised bringing the total number of nationalised commercial banks to 20. The reasons that led the government to take this drastic measure can be outlined in the following points.
- Bank deposits mobilised by commercial banks were largely lent out to security based borrowers in trade and industry.
- Since the banks were controlled by business houses, sectors of the economy such as agriculture, small and village industries, which the government called priority sector, though were in need of funds for their expansion, were actually starved of funds.
- It was necessary to spread banking across the country through expansion of banking network (by opening new bank branches) in the un-banked areas.
- In order to reduce the regional imbalance in respect of existing branch network of banks, it was necessary for banks to go into the rural and semi-urban areas where the banking facilities were unavailable.
- Agriculture and its allied activities despite being the largest contributor to the national income were deprived of their due share in bank credit.
- It was felt necessary to develop banking habit among a large section of population as more than 70% of Indian population lived in villages.
Post nationalisation, the banks were given quantitative targets to achieve the twin main objectives of nationalisation namely, expansion of branch network and directing a certain percentage of total disbursed credit into the priority sector. The target for priority sector lending for nationalised banks was fixed at 40% of net advances.
There were arguments for and against the act of nationalisation of banks. The principal arguments in favour was attaining a socialistic society, directing more credit to the priority sector of the economy and lowering of interest rates for credit extended to weaker sections, backward areas and the export sector. Those arguing against bank nationalisation believed that the reasons for nationalisation were more political than economic, existing set of evils of the sector would be substituted by another set of evils, inefficiencies inherent in public sector will result in financial losses, customer service will be affected and corruption and nepotism will creep in.
However, the positive impact of nationalisation was quite evident on the ground especially in respect of significant expansion of branch network, especially in rural areas; breaking of social barriers between bankers and customers with massive expansion of customer base; increase in direct and indirect employment opportunities; huge jump in the quantum of deposits and advance in reaching 90% of population. All these made nationalised banks a driving force of the Indian economy. Hence, positives of nationalisation far outweighed its negative impacts.
Narsimhan Committee Reports:
Looking back at the Indian banking system after nearly five decades since nationalisation, there are reasons to be concerned about the health of the banking institutions. The Narasimhan committee instituted by the government of India under former RBI Governor M. Narasimham in 1991, made significant discoveries about the health of Indian banks and the areas of concern for the banking sector from a regulatory perspective.
Important recommendations of Narasimhan Committee Report-I (Committee on Financial System) of 1991 are summarised below:
- It advocated easing of available liquidity with banks by lowering of SLR to the minimum level of 25% allowed by law and also lowering the CRR from its high level.
- It advocated gradual phasing out of government directed lending as against lending by commercial judgement. It suggested capping of directed lending to the priority sector at 10% from the existing 40% to increase profitability of banks in a competitive environment.
- It recommended reduction in number of public sector banks by mergers. It envisaged three or four banks including SBI to be developed as international banks; eight to ten banks with national spread to be positioned as universal banks and Regional Rural Banks concentrating on rural and agricultural finance.
- It recommended interest rate deregulation for benefit in emerging market conditions.
- It advocated healthier banks to raise more capital from the capital market.
- It recommended more transparency in banks’ balance sheets.
- It suggested internal audit and inspection.
- It wanted government to commit that there would be no further nationalisations and open the sector to newer private banks subject to compliance of regulations.
- It advocated setting up of debt recovery tribunals for speedy recovery of sticky non-performing assets (NPAs).
- It also recommended establishment of a special financial institution called Asset Reconstruction Fund (ARF) which would purchase debts from banks at a discount to pursue their recovery. This would ease the fund situation of banks burdened with doubtful debts.
Important recommendations of Narasimhan Committee Report-II of 1998 were:
- Strengthening of banks: It recommended merger of stronger banks to have multiplier effects on industry.
- Autonomy to banks: Greater autonomy was recommended for public sector banks in order to function with professionalism at par with their international counterparts.
- Narrow banking: Rehabilitating weak banks having heavier burden of NPAs by allowing them to invest their funds in short term risk-free assets.
- Capital adequacy ratio: For improving the inherent strength of banks, the committee recommended that the government should raise the prescribed capital adequacy ratio to 9% by 2000 and to 10% by 2002.
Implementation of many of Narasimhan committee recommendations in the aftermath of 1990s was a kind of watershed in reforming the Indian banking system. For determining true health of banks, RBI mandated adoption of Prudential Accounting Norms for (a) Recognition of Income; (b) Classification of Assets; and (c) Provision for Loans & Advances.
On income recognition RBI wanted banks to account for income from performing assets on accrual basis and on non-performing assets on cash basis.
On classification of assets RBI proposed classifying assets as (a) Standard/ Performing assets and (b) Non-Performing Assets (NPAs). NPAs were to be further classified as (i) Sub-Standard Assets; (ii) Doubtful Assets; and (iii) Loss Assets on the basis of their vintage in respect of non recovery of interest/ instalments.
On Provisioning on Loans & Advances, RBI directed banks to make appropriate accounting provisions on consideration of the quality of assets (depending on credit standing status), the value of collateral security and its erosion.
Diversity in the Indian Banking scenario:
Besides commercial banks the country has developed specialised banks catering to various financial needs of the country. These banks are ―
1) Co-operative Banks: These banks mainly serve the needs of agriculture and allied activities, rural-based industries and to a lesser extent, trade and industry in urban centres. Indian co-operative bank structure is one of the largest in the world.
2) National Bank for Agricultural and Rural Development (NABARD): Promoted by RBI and Government of India in 1982, NABARD is India’s specialized bank working in the field of agriculture and rural development by providing refinance credit to other credit providers in rural areas, regulates them and optimises the agricultural processes.
3) EXIM Bank (Export Import Bank of India): It was established in 1982 with the object to provide Marketing Advisory Service, Export Advisory Service to exporters & importers and also to offer financial products like Lines of Credit, Project Export Finance and Buyer’s Credit.
4) Payment Bank: It is a special category bank which can offer selective banking services to their customers like acceptance of deposit up to Rupees 1 Lac from a customer, provide payment and remittance services, offer internet/ phone banking, issue debit/ ATM card but cannot issue credit card nor can offer loans. They can also function as business correspondents for other banks.
Challenges ahead of the Indian Banking Industry:
Deregulation of the banking sector has thrown open new opportunities for banks to increase revenue earnings by diversifying their activities into investment banking, insurance, credit cards, depository services, mortgage financing, securitisation, etc. At the same time, liberalisation in the sector has introduced greater competition among banks, both domestic and foreign, as well as competition from mutual funds, NBFCs and small savings organisations like the post office, etc. Competition will be tougher by the day as Indian banks will have to benchmark themselves against the best in the world addressing substantial issues like improvement in profitability, efficiency and technology. The Indian banking industry still has a long road ahead.