GS-III : Economic Issues Banking

10 April, 2021
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India’s Banking Sector a brief Timeline – UPSC PRELIMS

GS Paper-3 Banking system – Prelims and Personality test

Banking is considered to be the “Backbone of a Nation’s Economy”. It is the most leading part of the financial sector of the country as it is responsible for more than 70 % of the funds that flow through the financial sector in the country.

The advancement of the Indian Banking System can be classified into 3distinct Phases:

1. The Pre-Independence Phase, i.e. before 1947

2. Second Phase from 1947 to 1991

3. Third Phase 1991 and beyond

First Phase - The Pre-Independence Phase

The Reserve Bank of India was set up on the basis of the recommendations of the Hilton Young Commission. The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the Bank, which commenced operations on April 1, 1935.

Originally it was a shareholder’s bank which was taken over by the Central Govt. under the Reserve Bank (Transfer of Public Ownership) Act1948 (paid up capital Rs.5cr).

This phase is characterized by the presence of a large number of banks most of them were small in size and suffered from a high rate of failures. While some others like the Bank of Bengal (est. 1806), Bank of Bombay (est. 1840), and Bank of Madras (est. 1843) merged into a single entity in 1921 which came to be known as Imperial Bank of India (later renamed in 1955 as the State Bank of India).

Why banks failed to survive during the pre-independence period:

Lack of machines and technology.
Human errors & time-consuming.
Fewer facilities.
Lack of proper management skills.
Indian account holders had become fraud-prone.

The Second Phase- from 1947 to 1991

The banking Structure of today evolved in this phase.

1949: Banking Regulation Act passed and RBI made Central Bank of the country.

Enacted to regulate the banks.
The Act is not applicable to primary agricultural credit societies, cooperative land mortgage banks & non-agricultural primary credit societies.

Fourteen commercial banks were nationalized in July 1969.
On the recommendation of the Narasimham Committee, Regional Rural Banks (RRBs) were formed on Oct 2, 1975. The objective behind the formation of RRBs was to serve the large unserved population of rural areas and to promote financial inclusion.
Six more commercial banks were nationalized in April 1980.
With a view to meet the specific requirement of the different sectors (i.e. agriculture, housing, foreign trade, and industry) some apex-level banking institutions were also set up like:
1. NABARD (est. 1982)
2. EXIM (est. 1982)
3. NHB (est. 1988)
4. SIDBI (est. 1990)

Why Nationalization?

The banks mostly catered to the needs of large industries, big business houses.
Sectors such as agriculture, small-scale industries and exports were lagging behind.
The poor masses continued reliance on moneylenders.
Planned economic structure.

Pros

Improved efficiency in the Banking system – since the public‘s confidence got boosted.
Sectors such as Agriculture, small and medium industries started getting funds which led to economic growth.
Increased penetration of Bank branches in rural areas.

Third phase 1991 and beyond-

This period saw remarkable growth in the process of development of banks with the liberalization of economic policies.
Even after nationalization and the subsequent regulations that followed, a large portion of the masses is untouched by the banking services.
In 1991, the Narasimham committee gave its recommendation i.e. to allow the entry of private sector players into the banking system. Therefore licenses were given to ICICI, HDFC, Axis Bank, IndusInd Bank, and DCB.
In 1998 Narsimham committee recommendation led to licensing of:

(a) Kotak Mahindra Bank (2001)

(b) Yes Bank (2004)

In 2013-14, the third round of bank licensing took place and in 2015, IDFC bank and Bandhan Bank emerged.
In order to further Financial Inclusion, RBI also proposed to set up 2 new kinds of banks i.e. Payment Banks and Small Banks.

In 2015, RBI gave in-principle licenses to 11 entities to launch Payments Bank and granted 'in-principle' approval to the 10 applicants to set up Small Finance Banks.

Series of Mergers

The SBI has merged its Associate banks and Bharatiya Mahila Bank into itself to create the largest Bank in India in 2017. With this merger SBI has a global ranking of 236 on Fortune 500 index.
Government of India proposed the amalgamation of Dena Bank and Vijaya Bank with erstwhile Bank of Baroda in April 2019

The government amalgamated three Regional Rural Banks -- Punjab Gramin Bank, Malwa Gramin Bank and Sutlej Gramin Bank -- into a single RRB with effect from January 1, 2019. New Gramin Bank is known as -Punjab Gramin Bank.

Why Merger?

To increase the global competitiveness of the Indian banks.
To protect them from losses and Slowdown

Pros and Cons of Merger:

Pros of Mergers:

Small banks can gear up to international standards
PSBs, which are geographically concentrated, can expand their coverage beyond their outreach.
Can offer more products and services and help in integrated growth of the sector.
Improves the professional standards and Technical Efficiency of the bank.
Mergers help end the unhealthy and intense competition going on even among public sector banks as of now.
In the global market, the Indian banks will gain greater recognition and higher rating.
The volume of inter-bank transactions will come down, resulting in saving of considerable time in clearing and reconciliation of accounts.
The size of each business entity after merger is expected to add strength to the Indian Banking System in general and Public Sector Banks in particular.
After mergers, bargaining strength of bank staff will become more and visible.
Customers will have access to fewer banks offering them wider range of products at a lower cost.
Mergers can diversify risk management.
This will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
From regulatory perspective, monitoring and control of less number of banks will be easier after mergers
The burden on the central government to recapitalize the public sector banks again and again will come down substantially.

Concerns with merger:

Mergers will result in shifting/closure of many ATMs, Branches and controlling offices, as it is not prudent and economical to keep so many banks concentrated in several pockets, notably in urban and metropolitan centres.
Mergers will result in job losses on account of large number of people taking VRS on one side and slow down or stoppage of further recruitment on the other.
Mergers will result in clash of different organizational cultures.
When a big bank books huge loss or crumbles, there will be a big jolt in the entire banking industry. Its repercussions will be felt everywhere.

By 2010, the supply, product range and reach of banking in India was generally fairly mature-even though reach in rural India still remains a challenge for the private sector and foreign banks.
Banks will be licensed as Small and Payments banks under Section 22 of the Banking Regulation Act, 1949, and will be registered as public limited company under the Companies Act, 2013.

Timeline of Structural and Technological Developments in Banking Sector

1955: SBI Act passed and Imperial Bank of India became State Bank of India

1959: State Bank of India (subsidiary banks) Act passed to create subsidiaries of SBI

1969: Government nationalized 14 major commercial banks

1975: Regional Rural Bank was conceptualized to serve the rural population

1987: HSBC first introduced ATM kiosk in Mumbai

1996: Local Area Banks were set up in the Union Budget to mobilize rural savings.

1991: Licenses given to 11 Private Sector Banks

1994: ICICI bank introduced net banking for retail customers in India

2000: Introduction of ATMs in India through countrywide BANCS network

2006: Cash Deposit Machines first introduced in India by ICICI bank, starting from western India

2008: Mobile banking through Mobile Apps introduced, pioneered by ICICI bank

2010: Cheque Truncation System (CTS) introduced, it eliminated a lot of paper and reduced cheque clearing time to a minimum

2014: Automatic Passbook Printing machines introduced in India

2015: Payments banks given license to operate in India

2016: Prime Minister announced demonetization of Rs. 1,000/- and Rs. 500/- currency notes, it led to a forced yet phenomenal increase in use of non-cash i.e. electronic payments.

2017: EMV chip cards made mandatory in ATM-cum-Debit cards to enhance security.

Expansion of banking infrastructure: Physical as well as virtual expansion of banking through mobile banking, internet banking, tele-banking, bio-metric and mobile ATMs etc. is taking place since last decade and has gained momentum in last few years.