BANKING SYSTEM IN INDIA

Chapter two

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Bank of Hindustan was the first bank to be established in 1770. The earliest institutions that undertook banking business in

India under the British Regime were agency houses that carried on banking business in addition to their normal trading activities.Most of these agency houses were closed down during 1929-32. Three Presidency banks known as Bank of Bengal, Bank of Bombay and Bank of Madras were opened in 1809,1840 and 1843 respectively. They later on merged into the Imperial Bank of India in 1919 following a banking crises.

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The first bank of limited liability managed by Indians was the Oudh Commercial Bank started in 1881. Earlier between 1865 and 1870 only one bank Allahabad Bank Ltd was established. Subsequently the Punjab National Bank was established in 1894 having its headquarters in Lahore.

The Swadesi Movement that began in 1906 prompted the formation of a large number of commercial banks.

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A series of banking crisis between 1913-1917 witnessed the failure of 588 banks. The Banking Companies Act was passed in February 1946 which was later amended to be known as the Banking Regulation Act 1949.

The RBI Act 1934 was passed and the Reserve Bank of India became the first Central Bank of this country w.e.f. 01.04.1935. it took over the central banking activities from Imperial Bank of India.

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The RBI was nationalized in 1949. The Imperial Bank was nationalized to form the State Bank of India in 1955. Subsidiaries of the State Bank of India were introduced in 1959.

On July 19,1969 the nationalization of 14 commercial banks by Mrs Indira Gandhi took place folllowed by nationalization of another 6 banks on 15.04.1980.

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The Banking system in India consists of 27 banks in the public sector. The major objective behind nationalization was to ensure mass banking and extension of bank credit to all sectors of the economy.

Private sector got a fillip in 1994 with the Government relaxing the conditions for opening of private sector banks as a part of the liberalization process.

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The HDFC Bank was the first to get an in principle approval from the RBI to set up a bank in the private sector. As on March 31,2005 there are 30 private sector banks operating in the country.

Private banks have been playing a crucial role in enhancing customer oriented products. The Reserve Bank of India has issued guidelines on ownership and governance in private banks.

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The guidelines require that Important shareholders with shareholding of 5% and

above are fit and proper as per RBI guidelines in respect of ownership and transfer of shares.

The directors and CEOs are fit and proper in respect of observance of sound corporate principles.

The banks have minimum capital/net worth in line with their operational requirements.

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Policy and processes are transparent and fair.

Some additional requirements are Banks maintain a net worth of Rs.300 crores

at all times. Shareholding of more than 10% by one

person or group of related entities requires RBI prior approval.

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Banks(including foreign banks having branches in India) are not allowed to exceed equity holding of 5% of the equity capital of the investee bank.

Large industrial houses are allowed to acquire shares not exceeding 10% of the paid up capital of the bank subject to approval by RBI.

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The Reserve Bank would permit a higher level of shareholding on a case to case basis for restructuring of problem/weak banks or in the interest of consolidation in the banking sector.

In case the net worth comes to below Rs.300 crores, a time bound program to augment the capital should be submitted to the Reserve Bank.

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On the issue of foreign participation in private banks from allsources(FDI,FII,NRI) the guidelines stipulate that it cannot exceed 74% of the paid up capital of the bank. The aggregate limit for FII investments is restricted to 24% which can be increased to 49% with the approval of the Board/Shareholders.

The aggregate limit for NRI investments is 24% with individual investment being a limit of 5% subject to approval of the board/shareholders.

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Indian Banks operations abroad As on October 20,2005 14 Indian banks-nine from

the public sector and five from the private sector had overseas operations spread across 42 countries with a network of 101 branches (including 6 offshore units), 6 joint ventures,17 subsidiaries and 30 representative offices. The Bank of Baroda had the highest overseas presence followed by State Bank of India and Bank of India.

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Local Area Banks The concept of local area banks was launched by

the RBI on 24/08/1996 with the purpose of developing backward and less developed districts. In order to facilitate its formation,the RBI prescribed a minimum capital of Rs.500 lakhs for its formation by individuals,trusts,societies/corporates. RBI has also laid down guidelines for this purpose which are given below :-

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The promoters of LAB are required to approach the Registrar of Companies only after the in principle approval is given by RBI for the purpose of setting up the LAB

If the promoters have selected a name for the LAB, the proposed name may be indicated.

The composition of the Board of Directors for the proposed LAB as well as the name and bio data of the proposed managing director shall have to be submitted to RBI for approval after the local area bank is given the in principle approval.

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The proposed LAB has to submit a detailed project report with business plan and projections for five years as well as the projected Profit and Loss Account for 5 future years.

LAB has to operate only in backward and less developed districts.

Promoters have to bring in the entire minimum capital of Rs.5 crores from their own verifiable sources of funds. The promoters have to submit their net worth statements duly authenticated by a Chartered Accountant. The promoters have to submit documentary evidence along with Auditors Certificate in support of their having mobilized the minimum initial capital of Rs.5 crore before issue of the licence to the LAB.

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The entire promoters contribution inclusive of contribution of relatives and friends shall have a lock in period of three years from the date of issue of the licence and at least 40% will be locked in for a further period of two years.

The LAB shall operate in rural and semi urban areas of their area of operation. One urban branch (center with population above one lakh) will be allowed.

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Four LABs were functional at end March 2005

Coastal Area Bank Ltd Vijayawada Andhra Pradesh

Capital Local Area Bank Ltd Navsari Gujarat Krishna Bhima Samruddhi Local Area Bank

Ltd Mehboobnagar Subhadra Local Area Bank Ltd Kolhapur.

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Lead Bank Scheme Lead Bank Scheme was introduced in December

1969 on the recommendations of FKF Nariman Committee.

Under the scheme the country is divided into 338 districts and were distributed among major scheduled banks mostly in the public sector to play a lead role in coordinating the efforts of all credit institutions in the district for planned growth in branch network and credit deployment in the district.

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The Lead Bank prepares a District Credit Plan and subsequently an Annual Action Plan which stipulates targets to provide credit to priority sectors, weaker sectors etc. The performance of the branches within the lead area is monitored by Block Level Bankers Committee at the block level, District Consultative Committee at the District Level and State level Banker’s Committee at the State Level.

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The progress of the branches in the lead area are monitored by a well designed MIS. The returns to be submitted by the branches to the Lead Bank are

Lead Bank Return 1 (service area credit plan) Annual Return submitted by branch to the BLBC before February 26 every year giving details of the annual credit plan of the branch.

Lead Bank Return 2 (service area operation scroll) A monthly return submitted by all rural and semi urban branches giving details of priority sector credit disbursement each day during the month. It is to be submitted by the branch to the District Lead Manager.

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Lead Bank Return U2 It is a modified version of LBR 2 and is required to be submitted by semi urban/urban branches once in a quarter.

Lead Bank Return 3 (Service area recovery and outstanding statement) This statement consists of three parts

Part A Deposit and Advance Position to be submitted on a quarterly basis

Part B Outstanding under Priority Sector Advances to be submitted on a half yearly basis.

Part C Statement of Priority Sector Advances to be submitted on an annual basis.

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Cooperative Banks Cooperative Banks mobilize deposits and serve

agricultural as well as rural credit with a view to uplift the rural poor.

The RBI regulates these banks since March 1,1966. In view of the liquidity and insolvency problems in 2001 RBI took some stern measures related to lending against shares, borrowings in the call market as well as term deposits placed with urban cooperative banks.

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Regional Rural Banks This concept was introduced on the basis of the

Narasimhan Committee. Each RRB has a maximum authorised capital of

Rs.5 crore and an issued capital of minimum Rs.25 lakhs and maximum Rs,1 crore. The share capital of the RRB is subscribed by the Central Government, State Government and the sposoring bank in the ratio 50:15:35 respectively. RRBs are specialized rural financial institutions providing credit to the rural sector.

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Some important financial institutions National Bank for Agriculture and Rural Development Established on July 12,1982 as an apex bank for

agriculture and rural development in accordance with the recommendations of the Committee for Review Arrangements for Institutional Credit for Agriculture and Rural Development. NABARD had a paid up capital of Rs.1000 crores.

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Functions of NABARD Credit Planning Promotion and Development Financial services NABARD plays a supervisory role in conducting

inspections of State Cooperative banks, District Credit Cooperative Banks and Regional Rural Banks and has also been conducting periodic inspections of state level cooperative and rural agricultural development banks.

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EXIM Bank Set up by an Act of Parliament in 1981and commenced

operations in March 1982 It coordinates the activities of all financial institutions involved in

financing exports. The objective of the EXIM Bank it to finance commercial viable

relationships with a target set of externally oriented companies by offering them a comprehensive range of products and services

Exim Bank provides financial assistance to Indian companies for export capability by way of a variety of programs.

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Services It provides a range of analytical information

and services.The bank’s fee based services help industry identify new business propositions,source trade and investment related information, create and enhance presence thro a network of institutional linkages