Chapter II Commercial Banking in India – Evolution, Growth and ...
Transcript of Chapter II Commercial Banking in India – Evolution, Growth and ...
88
Chapter II
Commercial Banking in India – Evolution, Growth and Development
2 . Introduction
2.1 Pre-Independence Phases (1720 to 1947)
2.2 Pre-Nationalization phase (1947 to 1968)
2.3 Nationalization-Phase (1969 to 1990)
2.4 Phase of Reforms (1991-92 onwards)
2.4.1 First Phase of Banking Sector Reforms (1991-92 to 1997)
2.4.2 Second phase of reforms (1998-99 and onwards)
2.5 Reforms and Public Sector Banks
2.6 Structure of Indian Banking
2.7 SWOT analysis
89
Chapter II
Commercial Banking in India – Evolution, Growth and Development
2. Introduction - This chapter gives comprehensive overview of the Indian
Banking Sector and its structural settings. An attempt has been made to reflect on
the evolution and development in the history of Indian banking system. This
chapter is divided into two sections. Section I deals with the evolution and
developments in the Indian banking sector. Section II exemplifies with the
universe of Indian banking and its structural settings.
Section –I
The saga of Indian Banking System can be segregated and described in four
distinct phases.
1. Pre-Independence Phase (1720 to 1947)
2. Pre-Nationalization phase (1948 to 1968)
3. Post - Nationalization-Phase (1969 to 1990)
4. Liberalized/Reforms Phase (1991 onwards)
2.1 Pre-Independence Phase (1720 to 1947)
90
The western type of joint stock banking was brought to India by the English
Agency House of Calcutta and Bombay. The first bank of the joint stock
variety was Bank of Bombay, established in 1720 in Bombay. This was
followed by Bank of Hindustan in Calcutta, which was established in 1770 by
an agency house. Since the agency was closed down, the bank was also closed.
The General Bank of Bengal and Bihar, which came into existence in 1773,
after a proposal by the then Governor Warren Hastings existed only for a short
while (RBI, 2008, p. 75)
The East India Company established Bank of Bengal in Calcutta on June 2,
1806 with a capital of Rs.50 lakh, followed by establishment of Bank of
Bombay (1840), with a capital of Rs.52 lakh, and Bank of Madras in July 1843
with a capital of Rs.30 lakh.
All three were independent units and called ―Presidency Banks‖ as they were
set in three Presidencies that were the units of administrative jurisdiction in the
country for the East India Company
The first formal regulation for banks was the enactment of the Companies Act
in 1850. This act stipulated unlimited liability for banking and insurance
companies until 1860. In 1860, the concept of limited liability was introduced
in banking. As a result several joint stock banks were floated. In 1865,
Allahabad Bank was established for the first time exclusively by Indians. The
second, Punjab National Bank Ltd. was set up in 1894 with headquarters at
Lahore, and the third, Bank of India was set up in 1906 in Bombay. All these
banks were founded under private ownership.
The Swadeshi Movement of 1906 provided a great momentum of joint stock
banks of Indian ownership and many 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
91
1913, the total number of reporting commercial banks in the country reached
to 56 comprising of 3 Presidency Banks, 18 class ‗A‘ banks (with capital
greater than 5 lakh), 23 class ‗B‘ banks (with capital of Rs.1 lakh to 5 lakh) and
12 foreign exchange banks (RBI, 2008, p. 76). The three presidency banks
were amalgamated into a single bank; as a result, The Imperial Bank of India
was established in 1921. The name Imperial Bank of India was suggested by
Lord John Maynard Keynes. The Imperial Bank of India functioned as a
central bank prior to the establishment of RBI in 1935 and performed three set
of functions, viz, commercial banking, central banking and the banker to the
government.
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 (RBI, 2008, p. 76). Table
(2.1) presents the details of capital and deposits 1870 to 1934.
The Swadeshi movement also provided momentum to the co-operative credit
movement and led to the establishment of a number of agricultural credit
societies and few urban co-operatives. The main objectives of such co-
operatives were to meet the banking and credit requirements of people with
smaller means to protect them from exploitation. An Act was passed in 1912
giving legal recognition to credit societies and the like. The Maclagan
Committee, set up to review the performance of co-operatives in India and to
suggest measures to strengthen them.
The world economy was gripped by the great depression during the pre World
War II period and this had an impact on the Indian banking Industry with the
92
number of banks failing sharply due to their loans going bad. Most of the
banks that failed had a low capital base.
The statistical data of bank failure during the period from 1913 to 1947 is
depicted in Table (2.2). Between 1936 and 1945 many small banks failed. The
decline was sharper in 1939 banks and 1940 with maximum bank failures.
Indian Central Banking Enquiry committee which was constituted by the
Government of India in 1929 to examine the relevance of establishing a central
banking authority for India, mentioned, in the course of its discussion some
important reasons responsible for the failure of the banks. They were; (a)
insufficient capital, (b) poor liquidity of assets, (c) combination of non-banking
activities with banking activities, (d)incompetent and inexperienced directors.
The Committee also noted that the commercial banks played a negligible role
in financing the requirements of agricultural production and co-operative credit
(RBI, 2008, p.79).
On the basis of major recommendations of the Central Banking Enquiry
committee, the Reserve Bank of India Act was passed in 1934 and the Reserve
Bank of India came into existence in 1935 as the central banking authority of
the country.
The RBI was empowered to regulate the issue of banknotes, maintain reserves
with a view to securing monetary stability, and to operate the credit and
currency system of the country to its advantage.
In 1939 the Reserve Bank submitted to Central Government its proposal for
banking legislation in India. Subsequently, RBI Companies (Inspection)
Ordinance, 1946, Banking Companies (Restriction of Branches) Act, 1946 and
The Companies (Control) Ordinance, 1948 were passed. Most of the provisions
93
in these enactments were subsequently embodied in the Banking Companies
Act in 1949.
The Second World War (1939-45), had far-reaching impact on the banking
sector, both on the expansion as well as failures. Table (2.3) depicts the
branch expansion during the World War. It can be observed that the total
number of branches increased from 1,964 in the year 1940 to 5,201 in 1945, a
2.7 fold increase during the war period.
Table 2.1 Number of banks, Capital and Deposits
(Rs. Lakh)
Year
end-
Dec
Number of reporting commercial
banks
Paid-up Capital and
Reserves Deposits
P/I
Bank
@
Class
A*
Exchange
bank
Class
B** Total
P/I
Bank
@
Class
A*
Class
B** Total
P/I
Bank
@
Class
A*
Exch
ange
bank
Class
B** Total
1870 3 2 3 - 8 362 12 - 374 1,197 14 52 - 1,263
1880 3 3 4 - 10 405 21 - 426 1,140 63 340 - 1,543
1890 3 5 5 - 13 448 51 - 499 1,836 271 754 - 2,861
1900 3 9 8 - 20 560 128 - 688 1,569 808 1,050 - 3,427
1910 3 16 11 - 30 691 376 - 1,067 3,654 2,566 2,479 - 8,699
1913 3 18 12 23 56 748 364 # 1,112 4,236 2,259 3,104 151 9,750
1920 3 25 15 33 76 753 1,093 8.1 1,927 8,692 7,115 7,481 233 23,458
1930 1 31 18 57 107 1,115 1,190 1.41 2,446 8,397 6,326 6,811 439 21,973
1934 1 36 17 69 123 1,128 1,267 1.49 2.54 8,100 7,677 7,140 511 23,428
P/I bank- Presidency/ Imperial bank
94
*Banks with capital and reserve of Rs. 5 lakh and over.
**Banks with capital of Rs.1 lakh and up to Rs.5 lakh
# Negligible
Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-
Table 2.2 Bank failures in India -1913 to 1947
Year
(Jan-
Dec)
No. of
banks
Year
(Jan-
Dec)
No. of
banks
Year
(Jan-
Dec)
No. of
banks
Year
(Jan-
Dec)
No. of
banks
1 2 3 4 5 6 7 8
1913 12 1922 15 1931 18 1940 107
1914 42 1923 20 1932 24 1941 94
1915 11 1924 18 1933 26 1942 50
1916 13 1925 17 1934 30 1943 59
1917 9 1926 14 1935 51 1944 28
1918 7 1927 16 1936 88 1945 27
1919 4 1928 13 1937 65 1946 27
1920 3 1929 11 1938 73 1947 38
1921 7 1930 12 1939 117
Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-08
95
Table 2.3 Branch Expansion during the period from 1940 to 1945
Year End
December Scheduled banks
Class 'A2' Non
Scheduled banks*
Class 'B' and 'C'
Non Scheduled
banks** All Banks
1940 1314 105 545 1964
1941 1414 204 678 2296
1942 1447 263 869 2579
1943 1878 400 996 3274
1945 2956 811 1434 5201
*: Banks with paid-up capital and reserves of above 5 lakhs
**: Banks with paid-up capital and reserves of above 50 thousand and up to 5 lakhs
Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-
08
96
In summary, the period preceding independence was a difficult one for Indian
banks. A large number of small banks sprang up with low capital base, although
their exact number was not known.
The organized sector consisted of the Imperial Bank of India, joint-stock banks
(which included both joint stock English and Indian banks) and the exchange
banks dealing in foreign exchange. During this period, a large number of banks
also failed. This was resultant of several factors. This period witnessed the two
World Wars and the Great Depression of 1930. Although global factors contributed
to bank failure in a large measure, several domestic factors were also at play. Low
capital base, insufficient liquid assets and inter-connected lending were some of
the major domestic factors. When the Reserve Bank was set up in 1935, the
predominant concern was that of bank failures and of setting up adequate
safeguards in the form of appropriate banking regulation. Yet, even after more than
twelve years following the establishment of the Reserve Bank, the issue of
strengthening the Reserve Bank through a separate legislation was not realized.
The major concern was the existence of non-scheduled banks as they remained
outside the purview 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 pertinent when the country attained independence.
2.2 Pre-Nationalization phase (1947 to 1968)
On the eve of Independence in 1947, there were 648 commercial banks
comprising 97 scheduled and 551 non-scheduled banks. The number of offices of
the banks stood at 2,987 with total deposits of Rs1,080 crore and advances at
Rs.475 crore.
97
When the country attained Independence, Indian banking was entirely
concentrated in the private sector. In addition to the Imperial Bank, there were five
big banks, each holding public deposits aggregating Rs.100 crore and more, viz.,
Central Bank of India Ltd., Punjab National Bank Ltd., Bank of India Ltd., Bank
of Baroda Ltd. and United Commercial Bank Ltd. All other commercial banks
were also in the private sector and had a regional character; most of them held
deposits of less than Rs.50 crore. Interestingly, the Reserve Bank was also not
completely State owned until it was nationalized in terms of the Reserve Bank of
India (transfer to Public Ownership) Act, 1948. The first task before the Reserve
Bank after independence was to develop a sound structure along contemporary
lines .The issue of bank failure in some measure was addressed by the Banking
Companies Act, 1949 (later renamed as the Banking Regulation Act), but to a
limited extent. The Banking Companies Act of 1949 conferred on the Reserve
Bank the extensive powers for banking supervision as the central banking
authority of the country. Bank failures continued in the period after independence
and after the enactment of the Banking Companies Act, although such failures
reduced considerably. In order to protect public savings, it was felt that it would be
better to wind up insolvent banks or amalgamate them with stronger banks.
Accordingly, in the 1950s, efforts were tuned towards putting in place an enabling
legislation for consolidation, compulsory amalgamation and liquidation of banks.
Accordingly, the Banking Companies (Amendment) Act 1961 was enacted that
sought, inter alia, to clarify and supplement the provisions under Section 45 of the
Banking Companies Act, which related to compulsory reconstruction or
amalgamation of banks. The Act enabled compulsory amalgamation of a banking
company with the State Bank of India or its subsidiaries. Until that time, such
amalgamation was possible with only another banking company.
98
Table 2.4 Number of banks failed , amalgamated and liquidated :1948-1968
Year
(Jan-
Dec)
Banks
failed
Banks
compulsorily
Amalgamated
Banks
Voluntarily
Amalgamat
ed
Banks ceased to
function/transferre
d their liabilities
and Assets
Banks
which went
into
compulsory
liquidation
Banks
which went
into
voluntary
liquidation
1948 45 - - - - -
1949 55 - - - - -
1950 45 - - - - -
1951 60 - - - - -
1952 31 - - - - -
1953 31 - - - - -
1954 27 - - - - -
1955 29 - - - - -
1956 - - - 6 6 16
1957 - - 1 10 3 16
1958 - - 4 10 5 9
1959 - - 4 20 7 7
1960 - - 2 15 5 4
1961 - 30 9 3 5
1962 - 1 3 22 3 4
1963 - 1 2 15 1 1
1964 - 9 7 63 3
1965 - 4 5 24 3 6
1966 - - - 7 3 7
1967 - - - 9 2 4
1968 - 1 - 2 1 3
Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-
08
99
The legislation also enabled amalgamation of more than two banking companies
by a single scheme. Between 1954 and 1968, several banks were either
amalgamated or they otherwise ceased to function or their liabilities and assets
transferred to other banks. (Table 2.4)
The SBI was entrusted with the responsibility of expanding its rural branch
network within a time frame. This epoch making event marks the beginning of
inducing the banks into the field of rural credit which was formerly reserved for
co-operatives. Proactive measures like credit guarantee and deposit insurance
promoted the spread of credit and savings habits to the rural areas. Additionally,
there was a perception that banks should play a more prominent role in India‘s
development strategy by mobilizing resources for sectors that were seen as crucial
for economic expansion. As a consequence, in 1967 the policy of social control
over banks was introduced. Its aim was to cause changes in the management and
distribution of credit by commercial banks. Under social control the banking
system including the smaller banks started gaining strength as evidence by the
absence of voluntary or compulsory mergers of banks. National Credit Council
was set up in 1968 to assess the demand for credit by these sectors and determine
resource allocations. Both these policies brought momentous changes in the
banking system during this phase of banking evolution.
The decade of 1960s also witnessed significant consolidation in the Indian
banking industry with more than 500 banks functioning in the 1950s reduced to 89
by 1969.
2.3 Nationalization-Phase (1969 to 1990)
Although Indian banking system made considerable progress in the 1950s and
1960, its spread was mainly concentrated in the urban areas. The rapid increase in
the deposits in relation to their owned capital enabled the industrialist shareholders
100
to enjoy immense leverage. At this point, it was felt that if bank funds had to be
channeled for rapid economic growth with social justice, there was no alternative
to nationalization of at least the major segment of the banking system. Hence on
July1969, the Government of India nationalized 14 major Scheduled Commercial
Banks, each having a minimum aggregate deposit of Rs.50 crore. They were (i)
The Central Bank of India, (ii) Bank of India, (iii) The Punjab National Bank,
(iv) The Bank of Baroda, (v) The United Commercial Bank, (vi) The Canara
India, (vii) The United Bank of India, (viii) The Dena bank, (ix) The Syndicate
Bank,(x) The Union Bank of India, (xi) The Allahabad Bank (xii) The Indian
Bank , (xiii) The Bank of Maharashtra, and (xiv) The Indian Overseas Bank.
According to the Bank nationalization Act, 1969, the main objectives and reasons
for the nationalization, were: ―an institution such as the banking system, which
touches and should touch the lives of millions has been inspired by a larger social
purpose and has to serve the national priorities and objectives such as rapid growth
in agriculture, small industry and exports, raising employment levels,
encouragement of new entrepreneurs and the development of the backward areas.
For this purpose it was necessary for the Government to take direct responsibility
for expansion and diversification of banking services and of the working of
substantial part of the banking system. The acquisition and ownership of banks
was thus to enable banks as agents to play effective and key role for the economic
growth by extending banking facilities to the most deserving classes.
Again, in 1980, the Government of India nationalized six more banks, each having
deposits of Rs.200 crore or above. They were: (i) The Andhra Bank Ltd., (ii) The
Punjab and Sind Bank Ltd., (iii) The Corporation Bank Ltd., ( iv) The Oriental
Bank of Commerce Ltd., (v) The New Bank of India Ltd., (vi) The Vijaya Bank
Ltd.. Two significant aspects of nationalization were (i) rapid branch expansion
and (ii) channeling of credit according to plan priorities. To meet the broad
objectives, banking facilities were made available in hitherto uncovered areas, so
101
as to enable them to not only mop up potential savings and meet the credit gaps in
agriculture and small-scale industries, thereby helping to bring large areas of
economic activities within the organized banking system. The second wave of
nationalizations occurred because control over the banking system became
increasingly more important as a means to ensure priority sector lending, reach the
poor through a widening branch network and to fund rising public deficits. In
addition to the nationalization of banks, the priority sector lending targets were
raised to 40%.
In the wake of nationalization, the growth and development of the Indian banking
system was phenomenal. By the second decade of nationalization, Indian banking
was relatively sophisticated, with a wide network of branches, huge deposits
resources and far-reaching credit operations. In terms of branch licensing policy
laid down by RBI, the enunciation was on the opening of branches in rural and
semi-urban areas, backward regions and under-banked states so that the inter-
regional disparities could be reduced.
The progress of commercial banks in terms of branch expansion is exhibited in
Table 2.5. The statistical data reveals that commercial banks in India have
achieved tremendous progress in branch expansion during this phase (1969-91).
The number of bank offices in India increased from 8187 at the end of December
1969 to 60,597 at the end of March 1991, registering a trend growth rate of 8.6 per
cent. The progress indicates a more than 7.4 fold increase during the period. Rural
regions had registered the highest growth rate (12.4 per cent), while semi- urban
regions reported the lowest (5.1 per cent). Urban and Metropolitan regions
registered 6.3 and 5.5 per cent respectively.
102
Table 2.5 Branch Expansion of All Scheduled Commercial banks from 1969-1991
(In Numbers)
End of month/year Total Number of bank offices Rural Semi-Urban Urban Metropolitan
Dec-69 8187 1443 3337 1911 1496
Dec-70 12946 ---- ---- ---- ----
Dec-71 12890 ---- ---- ---- ----
Dec-72 14650 5274 4607 2637 2132
Dec-73 16503 6024 5012 2983 2484
Dec-74 17937 6447 5462 3332 2696
Dec-75 20049 7112 6156 3779 3002
Dec-76 23485 8588 7133 4413 3351
Dec-77 26958 10856 7702 4769 3631
Dec-78 29476 12534 8019 5037 3886
Dec-79 32219 14171 8295 5494 4259
Dec-80 34385 16111 8678 5462 4134
Dec-81 38018 19453 8718 5622 4225
Dec-82 40793 21626 8921 5511 4735
Dec-83 45385 23782 10115 6649 4839
Dec-84 48320 25541 10331 7347 5101
Dec-85 53899 29408 10745 8117 5629
Dec-86 53364 29700 10658 7649 5357
Dec-87 54431 30585 10731 7722 5393
Dec-88 56282 31641 11179 7929 5533
Dec-89 58568 33572 11263 8082 5651
Mar-90 59897 34867 11309 8065 5656
Mar-91 60597 35216 11379 8233 5769
TGR 8.6 12.4 5.1 6.3 5.5
Source: Special Statistics -19: A Statistical Profile of Commercial Banks in India. Economic and Political Weekly, Vol.32.No.42(Oct.18-24,1997),pp. 2753-2772
Trend Growth Rate – Calculated
103
The progress of commercial banks in terms of deposits, advances and business per
branch is exhibited in Table (1.6). The aggregate deposits increased from Rs.4822
crores at the end of 1969 to Rs. 219539 crore at the end of March 1991, registering
a trend growth rate of 17.6 per cent while the Advances increased from Rs.3467 in
1969 to Rs. 133745 at the end of March 1991 reporting a trend growth rate of 16.8
per cent. In case of Business per branch, it increased from Rs.1.01 crore at the end
of December, 1969 to Rs.5.83 at the end of March 1991 at a trend growth rate of
8.7 per cent.
Another important structural development during this period was the formation of
Regional Rural Banks (RRBs). In 1973, the government of India had set up a
Working group to study the credit availability at the rural areas. The Working
Group identified various weaknesses of the co-operative credit agencies and
commercial banks and came to a conclusion that they may not be able to fill the
regional and functional needs of the rural credit system. Therefore the Study group
recommended a new type of institution, which combined the rural touch and
experience of cooperatives with modernized outlook and capacity to mobilize the
deposits. The Government of India accepted this recommendation and permitted
the establishment of Regional Rural Banks (RRBs). The RRBs are state sponsored,
regional-based, rural oriented commercial banks, set up under the Regional Rural
Banks Act 1976. Their ownership vests with the sponsoring commercial bank, the
Central Government, and the Government of the State in which they are
geographically located. Under this approach 196 RRBs were set up.
104
Table 2.6 Growth of Deposits, advances and business per branch Commercial
Banking India from 1969-1991
Year/Indicators
No. of branches
( in numbers)
Aggregate
Deposits
(rupees in cores)
Advances
(rupees in
cores)
Business per
branch
(rupees in
cores)
Dec-69 8187 4822 3467 1.01
Dec-70 12946 5502 4298 0.76
Dec-71 12890 7243 5051 0.95
Dec-72 14650 8360 5614 0.95
Dec-73 16503 10084 7091 1.04
Dec-74 17937 11611 8246 1.11
Dec-75 20049 13711 10073 1.19
Dec-76 23485 17595 13553 1.33
Dec-77 26958 21365 15327 1.36
Dec-78 29476 26492 18310 1.52
Dec-79 32219 31275 21559 1.64
Dec-80 34385 36997 24760 1.80
Dec-81 38018 44260 30155 1.96
Dec-82 40793 52280 35679 2.16
Dec-83 45385 61149 40986 2.25
Dec-84 48320 71682 48931 2.50
Dec-85 53899 85922 53162 2.58
Dec-86 53364 102625 64677 3.14
Dec-87 54431 119023 72549 3.52
Dec-88 56282 141823 87746 4.08
Dec-89 58568 162036 104866 4.56
Mar-90 59897 184961 121984 5.12
Mar-91 60597 219539 133745 5.83
TGR 8.6 17.6 16.8 8.7
Source: Special Statistics -19: A Statistical Profile of Commercial Banks in India.
Economic and Political Weekly, Vol.32.No.42(Oct.18-24,1997),pp. 2753-2772
Trend Growth Rate – Calculated
105
The Lead bank scheme provided the blue-print of further bank branch expansion.
The course of evolution of the banking sector in India since 1969 has been
dominated by the nationalization of banks. However, the provisions made to help
spread institutional credit and nurture the financial system, also led to distortions
in the process. The administered interest rates and the burden of direct lending
constrained the banking sector. Operational flexibility was understated and
profitability occupied a back seat.
Besides the establishment of priority sector credits and the nationalization of
banks, the Government took further control over banks' funds by raising the
statutory liquidity ratio (SLR) and the cash reserve ratio (CRR). From a level of 2
per cent for the CRR and 25 per cent for the SLR in 1960, both witnessed a steep
increase until 1991 to 15 per cent and 38.5 per cent respectively (Joshi and Little,
1997, p. 112).
Through the CRR and the SLR more than 50% of savings had either to be
deposited with the RBI or used to buy government securities. Of the remaining
savings, 40% had to be directed to priority sectors that were defined by the
government. Besides these restrictions on the use of funds, the government had
also control over the price of the funds, i.e. the interest rates on savings and loans
(Mukherji, 2002, p. 39). This was about to change at the beginning of the 1990s
when a balance-of-payments crisis was a trigger for far-reaching reforms.
This phase in the banking sector was marked by a number of controls. The major
controls introduced during the period from 1969 to 1991 are specified in Table
(2.7).
106
Table 2.7 Major Controls during the period from 1969-91
1969 Fourteen banks with deposits of over Rs.50 crore were nationalized.
The Lead Bank Scheme was introduced with a view to mobilize deposits
on a massive scale throughout the country and also for stepping up
lending to weaker sections.
1972 Concept of Priority Sector was formalized. Specific targets were set out
in November 1974 for public sector banks and in November 1978 for
private sector banks.
The differential ratio of interest (DRI) Scheme was instituted to cater to
the needs of the weaker sections of the society and for their upliftment.
1973
A minimum lending rate was prescribed on all loans, except for the
priority sector.
The District Credit Plans were initiated.
1975 Banks were required to place all borrowers with aggregate credit limit
from the banking system in excess of Rs.10 lakh on the first method of
lending, whereby 25 per cent of the working capital gap, i.e., the
difference between current assets and current liabilities, excluding bank
finance, was required to be funded from long-term sources.
1976 The maximum rate for bank loans was prescribed in addition to the
minimum lending rates.
1980 The contribution from borrowers towards working capital out of their
long-term sources was placed in the second method of lending, i.e., not
less than 25 per cent of the current assets required for the estimated level
of production, which would give a minimum current ratio of 1.33:1 (as
against 25 per cent of working capital gap stipulated under the norms
prescribed in 1975).
Six Banks with demand and time liabilities greater than Rs.200 crore as
on March 14, 1980, were nationalized on April 15, 1980
1988 Service Area Approach (SAA) was introduced, modifying the Lead Bank
Scheme.
1989 The CRR was gradually raised from 5.0 per cent in June 1973 to 15.0 per
cent by July 1989.
1991 The SLR was raised by 12.5 percentage points from 26 per cent in
February 1970 to 38.5 per cent in September 1990.
107
Source: Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume
IV, 2006-08
As in other areas of economic policy-making, the emphasis on government control
began to weaken and even reverse in the mid-80s and liberalization set in firmly in
the early 90s. The poor performance of the public sector banks, which accounted
for about 90 per cent of all commercial banking, was rapidly becoming an area of
concern. The continuous escalation in non-performing assets (NPAs) in the
portfolio of banks posed a significant threat to the very stability of the financial
system. Banking reforms, therefore, became an integral part of the liberalization
agenda.
The process of expansion in the banking network in terms of geographical
coverage and heightened controls affected the quality of banks assets and strained
their profitability. In response to these developments, a number of measures were
undertaken in the mid 1980s for consolidation and diversification and, to some
extent, deregulation of the financial sector. The consolidation measures were
aimed at strengthening banks‘ structures, training, house-keeping, customer
services, internal procedures and systems, credit management, loan recovery, staff
productivity and profitability. Certain initiatives were also taken to impart
operational flexibility to banks.
Although nationalization of banks helped in the spread of banking to the rural and
hitherto uncovered areas, the monopoly granted to the public sector and lack of
competition led to overall inefficiency and low productivity. Excessive focus on
quantitative achievements had made many of the public sector banks unprofitable
and undercapitalized by international standards. Many banks were earning less
than reasonable rates of returns, had low capital adequacy and high non-
performing assets, and were providing poor quality customer service. By 1991 the
Indian financial system was saddled with an inefficient and unsound banking
108
system. Some of the reasons for this were i) High reserve requirements; ii)
administered interest rates; iii) directed credit; iv) lack of competition; and v)
political interference and corruption.
In summary, major issues faced at the beginning of this phase were the strong
nexus between banks and industry, as a result of which agriculture was ignored.
The focus in this phase was to break the nexus and improve the flow of credit to
agriculture. The main instruments used for this purpose were nationalization of
major banks in the country and institution of directed credit in the form of
priority sector lending. The achievements during the nationalization phase were
extensive, varied and widely acknowledged. The nationalization of banks in 1969
and again in 1980 brought a large segment of the banking business under
government ownership. In the post-nationalization phase, the country was able to
build up financial infrastructure geographically wide and financially diverse to
accelerate the process of resource mobilization to meet the growing needs of the
economy. The nationalization of banks in 1969 was a major step to ensure timely
and adequate credit to all the productive activities of the economy. It was
designed to make the system reach out to the small man and the rural and semi-
urban areas and to extend credit coverage to sectors then neglected by the
banking system, in place of what was regarded as a somewhat oligopolistic
structure where the system served mainly the urban and the industrial sectors
and where the grant of credit was seen as an act of patronage and receiving it as
an act of privilege. As at end-December 1990, there were 59,752 branches of
commercial banks (including RRBs) in the country, of which 34,791 (58.2 per cent)
were in rural areas. As a result of rapid branch expansion witnessed beginning
from 1969, the average population per bank office, which was 65,000 in 1969,
declined to 14,000 at end-December 1990 (Narasimham Committee Report,
1991). This reflected substantial efforts made towards spread of banking;
109
particularly in unbanked rural areas. A notable feature of this expansion was that
there was a strong convergence across regions. Bank branches in unbanked
locations really accelerated after the 1:4 licensing rule of 1977, as between 1977
and 1990 more than three-fourths of the bank branches that were opened were
in unbanked locations.
Large branch expansion also resulted in increase in deposits and credit of the
banking system from 13 and 10 per cent of GDP, respectively, in 1969 to 38 per
cent and 24 per cent, respectively, by 1991. New branches opened helped
considerably in deposit mobilization and the evidence suggested that of the
incremental deposits a large proportion was from the branches opened after
1969. The share of rural deposits in total deposits increased from 3 per cent in
1969 to 16 per cent in 1990. The share of credit to the rural sector in total bank
credit increased from 3.3 per cent in 1969 to 14.2 per cent in 1990. The banking
sector met the credit needs of the economy subject to the requirements of
sectoral allocation and rendered support to the planning authority in efficient and
productive deployment of investible funds so as to maximize growth with stability
and social justice.
In the 1970s and the 1980s, the growing fiscal deficit and increased automatic
monetization, whereby the Government could borrow from the Reserve Bank
with the help of ad hoc Treasury Bills, resulted in a rise in reserve money and
money supply. To counter reserve money growth, the Reserve Bank was required
to raise the cash reserve ratio (CRR). Although resource mobilization by the
banking system increased sharply, the demands made on the banking system also
increased. In order to finance the increase in fiscal deficit of the Government, the
Reserve Bank was forced to increase the SLR of banks. At one point of time, 63.5
per cent of the resources of the banking sector were pre-empted by way of CRR
110
and SLR and such deployments were not adequately remunerated. In view of
increased demand for funds from various quarters, attempts were made to bring
some financial discipline on the part of corporates. However, norms stipulated for
the purpose were found to be too rigid. The traditional sectors, in particular,
faced overall credit restrictions during periods of tight monetary policy. As a
result, the traditional sectors started seeking funds from sources other than the
banking system such as capital market and raising deposits directly from the
public, leading to disintermediation. On the other hand, in order to meet the
priority sector targets, credit appraisal standards were lowered. During this
period, the deposit and lending rate structure became very complex. Low return
on Government securities and priority sector loans meant that other sectors had
to be charged high interest rates. Interest rates differed as per type, size and
location of borrowers. Interest rates specified were cheaper for certain activities
such as food procurement, oil companies and certain key units in the public
sector. Various controls combined with the absence of adequate competition
resulted in decline in productivity and efficiency of the banking system and
seriously eroded its profitability. Banks’ capital position deteriorated and they
were saddled with large non-performing assets (RBI, 2008, p. 109).
In the mid-1980s, some efforts were made to liberalize and improve the
profitability, health and soundness of the banking sector, which by then had
transformed from a largely private owned system to the one dominated by the
public sector. However, these were small steps considering the kind and extent of
controls/regulations that came to prevail. Major reforms occurred in the next
phase following structural reforms initiated by the Government in the early
1990s.
111
This phase although made significant progress in the banking system in terms of
geographical and functional coverage, resources mobilized and credit deployment,
but it is still an unexplained characteristics of repressed financial system. This
period also witnessed consolidation of the banking. At the launch of the first five
year plan in 1951, there were 566 commercial banks consisting of 92 scheduled
and 474 non-scheduled banks. In 1969, total number of banks declined to 89 out of
which 73 were scheduled and 16 were non scheduled. A major development
during this period was the enactment of the banking Regulation Act empowering
the RBI to regulate and supervise the banking sector.
To summarize, Indian financial system in the pre-reform period, i.e., upto the end
of 1980s, essentially catered to the needs of planned development in a mixed
economy framework where the government sector had a dominant role in
economic activity. The strategy of planned economic development required huge
development expenditures, which was met thorough the dominance of government
ownership of banks, automatic monetization of fiscal deficit and subjecting the
banking sector to large pre-emptions – both in terms of the statutory holding of
Government securities (statutory liquidity ratio, or SLR) and administrative
direction of credit to preferred sectors. Furthermore, a complex structure of
administered interest rates prevailed, guided more by social priorities,
necessitating cross-subsidization to sustain commercial viability of institutions.
These not only distorted the interest rate mechanism but also adversely affected
financial market development. All the signs of `financial repression‘ were found
in the system.
There is perhaps an element of commonality in terms of such a ‗repressed‘ regime
in the financial sector of many emerging market economies at that time. The
decline of the Bretton Woods system in the 1970‘s provided a trigger for financial
liberalization in both advanced and emerging markets. Several countries adopted a
112
‗big bang‘ approach to liberalization, while others pursued a more cautious or
‗gradualist‘ approach. The East Asian crises in the late 1990s provided graphic
testimony as to how faulty sequencing and inadequate attention to institutional
strengthening could significantly derail the growth process, even for countries
with otherwise sound macroeconomic fundamentals.
India, in this context, has pursued a relatively more ‗gradualist‘ approach to
liberalization. The bar was gradually raised. Each year the Central Bank slowly,
in a manner of speaking, tightened the screws. Nevertheless, the transition to a
regime of prudential norms and free interest rates had its own traumatic effect. It
must be said to the credit of our financial system that these changes were absorbed
and the system has emerged stronger for this reason.
2.4 Phase of Reforms (1991-92) onwards:
This phase of the banking sector evolved to a significant extent in response to
financial sector reforms initiated as a part of structural reforms encompassing
trade, industry, investment and external sector, launched by the Central
Government in the early 1990s in the backdrop of a serious balance of payments
problem. A high-capacity Committee on the Financial System (CFS) under the
Chairmanship of Shri M. Narasimham was constituted by the Government of
India in August 1991 to examine all aspects relating to the structure, organization,
functions and procedures of the financial system. The Committee, which
submitted its report in November 1991, made comprehensive recommendations,
which formed the foundation of financial sector reforms relating to banks,
development financial institutions (DFIs) and the capital market in the years to
come. The Committee highlighted the commendable progress made by the
banking sector in extending its geographical spread and its functions/operations
and thereby promoting financial intermediation and growth in the economy.
However, at the same time, the Committee noted with concern the poor health of
113
the banking sector. The Committee cautioned that unless the weakening in the
financial health of the system was treated quickly, it could further corrode the real
value of and return on the savings entrusted to it and even have an adverse impact
on depositor‘s and investor‘s confidence. Accordingly, financial sector reforms
were initiated as part of overall structural reforms to impart efficiency and
dynamism to the financial sector.
The country‘s approach to reform in the banking and financial sector was guided
by ‗Pancha Sutra’ or five principles. (Reddy, 1998):
1) Cautious and sequencing of reform measures – giving adequate time to the
various agents to undertake the necessary norms; e.g., the gradual reduction
of prudential norms,
2) Mutually reinforcing measures, that as a package would be enabling reform
but non-disruptive of the confidence in the system, e.g., combing reduction
in refinance with reduction in the cash reserve ratio (CRR) which obviously
improved bank profitability.
3) Complementary between reforms in the banking sector changes in fiscal,
external and monetary policies, especially in terms of co-ordination with
Government; e.g., recapitalization of Government owned banks coupled
with prudential regulation; abolition of ad-hoc treasury bill and its
replacement with a system of ‗ways and means‘ advances, coupled with
reforms in debt markets.
4) Development of financial infrastructure in terms of supervisory body, audit
standards, technology and legal framework; e.g., establishment of Board for
Financial Supervision, setting up of Institute for Development and Research
in Banking Technology, legal amendment to the RBI Act and Non Banking
Financial Companies (NBFCs).
114
5) Taking initiative to nurture, develop and integrate money, debt and forex
markets, in a way that all major banks have an opportunity to develop skills,
participate and benefit; e.g., gradual reduction in the minimum period for
maturity of term deposits and permitting banks to determine the penalty
structure in respect of premature withdrawal, syndication in respect of loans,
flexibility to invest in money and debt market instruments, greater freedom
to banks to borrow from and invest abroad.
Some main features of the reform process worth mentioning are that, First,
financial sector reforms were undertaken early in the economic reform cycle.
Second, reform in the financial sector were initiated through own initiatives in a
well-structured, sequenced and phased manner and induced by a crisis, although
the balance-of-payment problems in 1991 did provide the wake-up call. Third, a
consultative approach towards policy formulation was adopted, which not only
enabled benchmarking the financial services against international standards in a
transparent manner, but also provided useful lead time to market players for
smooth adjustment to regulatory changes. Importantly, unlike the ‗stop-go‘
approach adopted in several Latin American and Asian economies, the Indian
approach to financial sector reforms has been marked by ‗gradualism‘ so as to
endure a gradual, non-disruptive and transparent approach to the
process.(Ahluwalia,2002)
Furthermore, the evolution of the banking sector in this phase could be divided
into two sub-phases, i.e., from 1991-92 to 1997-98 and 1997-98 onwards.
2.4.1 First Phase of Banking Sector Reforms
The main issues faced in the first sub-phase were the weak health of the banking
sector, low profitability, weak capital base and lack of adequate competition. The
Narasimham committee report I aimed at bringing about “operational autonomy”
115
and “functional autonomy” so as to enhance, productivity, efficiency and
profitability. Major recommendation and accomplishments during first phase are
(a) Reduction in Statutory Liquidity Ration (SLR) and Cash Reserve Ratio
(CRR):
One of the major factors that affected banks‘ profitability was high pre-emptions in
the form of cash reserve ratio (CRR) and statutory liquidity ratio (SLR), which had
reached at the historically high level of 63.5 per cent in the early 1990s. Besides,
the administered structure of interest rates did not allow banks to charge the
interest rates depending on the credit worthiness of the borrower and, thus,
impinged on the allocative efficiency of resources. The Narasimham Committee
recommended that the SLR be brought down in a phased manner to 25 per cent
over a period of five years. Similarly, the Committee recommended phased
reduction of CRR to the statutory minimum.
Impact:
A phased reduction in the SLR and the CRR was undertaken beginning January
1993 and April 1993, respectively. The SLR was progressively brought down from
the peak rate of 38.5 per cent in February 1992 to the then statutory minimum of
25.0 per cent by October 1997. There was a sharp reduction in the Central
Government‘s fiscal deficit in the initial years of reforms. Accordingly, there was
less of a need to use the banking sector as a captive source of funds. Interest rates
on Government securities were also made more or less market determined. The
CRR of scheduled commercial banks (SCBs), which was 15 per cent of net
demand and time liabilities (NDTL) between July 1, 1989 and October 8, 1992,
was brought down in phases to 9.5 per cent by November 22, 1997. Between
November 1995 and January 1997, the CRR was reduced by as much as 5
percentage points. From its peak in 1991, it has declined gradually to a low of 4.5
116
per cent in June 2003. In 2004 it was slightly increased to 5 per cent to counter
inflationary pressures (RBI, 2004, p 10))
(b) Deregulation of Interest rate:
Prior to reforms interest rates on both deposits and advances of banks were
administered by the RBI. These rates were usually unrelated to market realities.
For example, for long stretches banks offered negative returns on fixed deposits in
real terms (interest rate-inflation rate), on the assets side, the high interest rate on
corporate advances were used to cross subsidies government sponsored
employment generation programmes at low rates of interest determined by
political considerations.
As far as advances are concerned, there were as many as 20 administered rates in
1989-90. In regard to the regulated interest rate structure, the basic thrust of
Narasimham Committee was that real rates of interest should be positive and
concessional interest rates are a vehicle for subversion. Following reform
measures, the various rates of interest were market determined. Scheduled
Commercial Banks have been given the freedom to set interest rates on their
deposits subject to minimum floor rates and maximum ceiling rates.
Impact: The interest rates have been deregulated in a phased manner. All lending
rates have been deregulated except lending to small borrowers and a part of
export finance. Interest rates on deposits are now almost free except for
prescription in respect of savings deposits and foreign currency deposits. The
interest rate on Government borrowings is also now market determined. It
implied that banks were able to fix the interest rates on deposits and loans,
depending on the overall liquidity conditions and their risk perceptions (for
lending rates). Banks, over the years, developed a set of criteria for determining
the rate charged on individual borrowers. The deregulation of interest rates led to
innovations of various types, including fixed, floating and partly fixed and partly
117
floating interest rates, among others. The four per cent differential interest scheme
has been officially withdrawn. Though the Committee recommended reduction
of target for priority sector advances from 40 per cent of total credit to 10 per
cent, the Government did not agree to it. But it diluted the concept of priority
sector considerably by including housing loans, educational loans, etc.,
subscription to bonds and debentures of the infrastructure and development
organization, etc., ―The sub-targets in the priority sector are 10 per cent for
weaker sections and 60 per cent credit – deposit ratio in the rural and semi –
urban areas have been conveniently forgotten by banks and regulatory authorities.
Selective credit controls have been totally abolished, thus giving banks freedom
to lend to even the sensitive sectors.‖ (Joshi, 2002,p 20)
(c) Measures to create Competitive Environment
The Indian banking sector over the years had become less competitive as no new
bank was allowed to be set up in the private sector after nationalization of 14
banks in 1969. Although a large number of players existed, there was no threat of
entry of new players. The lack of threat of entry of new players led to inefficiency
in the banking sector. Some other restrictions such as regulation of interest rates
and the system of financing working capital requirements also had an adverse
impact on the competitive environment. Banks were also constrained in their
operations due to restrictions on opening or closing of branches on the basis of
their commercial judgment. One of the major objectives of reforms was to bring
in greater efficiency by permitting entry of private sector banks, liberalize
licensing of more branches of foreign banks and the entry of new foreign banks
and increased operational flexibility to banks. Keeping these in view, several
measures were initiated to infuse competition in the banking sector (RBI, 2008,
p.115). In January 1993 the RBI announced guidelines for opening of private
sector banks as public limited companies. The criteria for setting up of new
118
banks in private sector were: (a) capital of Rs. 100 crore, (b) most modern
technology, and (c) head office at a non-metropolitan centre.
Impact: Following liberalization of entry of new private sector banks, 10 new
banks were set up in the private sector by 1998. Besides, 22 foreign banks were
also set up. Times Bank was subsequently merged with HDFC Bank. The new
generation private sector banks have brought about a paradigm shift in service
standards and set new benchmarks in terms of application of technology, speed in
delivery of services, channels, décor and branch ambience, and a high order of
marketing orientation (Shenoy, 2000, p.44). These banks with their updated
technology have been providing stiff competition to public sector banks and old
private sector banks. The introduction of electronic banking by these banks
compelled the public sector banks and old private sector banks to fall in line with
them. Foreign banks have also been permitted to set-up subsidiaries, joint
ventures or branches. The number of foreign bank branches increased from 140
at end-March 1993 to 186 at end-March 1998. The share of new private sector
banks in total assets of scheduled commercial banks increased to 3.2 per cent by
end-March 1998. The share of foreign banks at 8.2 per cent at end-March 1998
was the same as at end-March 1993. That the impact on competition remained
muted was also evident from the limited number of mergers (four). (RBI, 2008,
p.116)
Liberalization of branch licensing policy
While banks could not close down branches in rural areas, in order to enable
them to rationalize their branch network in rural/semi-urban areas, they were
allowed to rationalize their existing branch network by relocating branches
within the same block and service area of the branch, shift their branches in
urban/metropolitan/port town, centres within the same locality/municipal ward,
119
opening of specialized branches, spinning-off of business, setting up of
controlling offices/administrative units and opening of extension counters. Two
recommendation of the Narasimham Committee was to abolish the system of
branch licensing and allow foreign banks free entry.
(d) Prudential measures
Identifying the cause for the deterioration of financial health of banking system
over time, the Narasimham Committee recommended various remedial measures
which include inter alia prudential norm relating to income recognition, asset
classification, provisioning for bad debts and capital adequacy which have all been
implemented. In April 1992, the RBI issued detailed guidelines on a phased
introduction of prudential norms to ensure safety and soundness of banks and
impart greater transparency and accounting operations. The main objective of
prudential norms is the strengthening financial stability of banks.
Inadequacy of capital is a serious cause of concern. Hence, as per Basle
Committee norms, the RBI introduced capital adequacy norms. It was prescribed
that banks should achieve a minimum of 4 per cent capital adequacy ratio in
relation to risk weighted assets by March 1993, of which Tier I capital should be
achieved over a period of three years, that is, by March 1996. For banks with
international presence, it is necessary to reach the figure even earlier. Before
arriving at the capital adequacy ratio of each bank, it is necessary that assets of
banks should be evaluated on the basis of their realizable value.
Those banks whose operations are profitable and which enjoy reputation in the
markets are allowed to approach capital market for enhancement of capital. In
respect of others, the Government should meet the shortfall by direct subscription
to capital by providing loan.
120
As per the recommendations of the Narasimham Committee banks cannot
recognize income (interest income on advances) on assets where income is not
received within two quarters after it is past due. The committee recommended
international norm of 90 days in phased manner by 2002.
In order to strengthen the capital base of banks, capital to risk-weighted assets
ratio (CRAR) system was also introduced for banks (including foreign banks) in
India in a phased manner. Indian banks having branches abroad were required to
achieve a capital adequacy norm of 8 per cent as early as possible and in any case
by March 31, 1994. Foreign banks operating in India were to achieve this norm of
8 per cent by March 31, 1993. Other banks were required to achieve a capital
adequacy norm of 4 per cent by March 31, 1993 and the 8 per cent norm by March
31, 1996 (RBI, 2008, p.111)
The assets are now classified on the basis of their performance into 4 categories:
(a) standard, (b) sub-standard, (c) doubtful, and (d) loss assets. Adequate
provision is required to be made for bad and doubtful debts (sub-standard assets).
Detailed instructions for provisioning have been laid down. In addition, a credit
exposure norm of 15 per cent to a single party and 40 per cent to a group has been
prescribed. Banks have been advised to make their balance sheets transparent
with maximum ‗disclosure‘ on the financial health of institutions. The Committee
recommended provisioning norms for non-performing assets. On outstanding sub-
standard assets 10 per cent general provision should be made (1992). On loss
assets the provision shall be 100 percent. On secured portion of doubtful asset, the
provision should be 20 to 50 per cent (GOI, 1999, pp 34-44).
Related to the improving financial soundness of banks are the other measures such
as recapitalization of public sector banks on a selective basis by the Government,
improving governance in banks and a certain amount of financial autonomy to the
managers of public sector banks.
Impact:
121
The various measures initiated had a favorable impact on the quality of banks‘
balance-sheets. In a short span, banks were able to bring down their non-
performing assets significantly. Gross NPAs of public sector banks as percentage
of gross advances, which were 23.2 per cent at end-March 1993, declined to 16.0
per cent by end-March 1998. Despite increased provisioning, overall profitability
of the banking sector, in general, and public sector banks, in particular, improved
as detailed in the subsequent section. The soundness of the banking sector also
improved significantly. Of the 75 banks, 58 banks could achieve the stipulated
CRAR of eight per cent by end-March 2006. Eight nationalized banks, six old
private sector banks and three foreign banks could not attain the prescribed
capital to risk weighted assets ratio of eight per cent by end-March 1996. They,
therefore, were given one year extension to reach the prescribed ratio, subject to
certain restrictions such as modest growth in risk-weighted assets and
containment of capital expenditure and branch expansion, among others. At end-
March 1998, out of the 27 PSBs, 26 banks attained the stipulated 8 per cent
capital adequacy requirement. All banks, other than five banks (one public sector
bank and four old private sector banks) were able to achieve the stipulated CRAR
of eight per cent (RBI, 2008, p. 112)
(e) Supportive Measures
Revised format for balance sheet and profit and loss account reflecting and actual
health of scheduled banks were introduced from the accounting year 1991-92.
There have also been changes in the institutional framework. Commercial banks
were advised to make the increasing use of Lok Adalats (people‘s court), which
were conferred a judicial status and emerged as a convenient and low cost method
of settlement of dispute between banks and small borrowers. Further, ‗The
Recovery of Debts due to Banks and Financial Institutions Act‘ was enacted in
1993, which provided for the establishment of tribunals for expeditious
adjudication and recovery of such debts.
122
Impact: The RBI evolved a risk-based supervision methodology with
international best practices. New Board of Financial Supervision was set-up in
the RBI to tighten up the supervision of banks. The system of external
supervision has been revamped with the establishment in November 1994 of the
Board of Financial Supervision with the operational support of the Department of
Banking supervision. In tune with international practices of supervision, a three-
tier supervisory model comprising outside inspection, off-site monitoring and
periodical external auditing based on CAMELS (Capital Adequacy, Asset quality,
Management, Earnings, Liquidity and System controls) had been put in place.
Special Recovery Tribunals are set-up to expedite loan recovery process.
Following the enactment of the Act, 29 Debt Recovery Tribunals (DRTs) and 5
Debt Recovery Appellate Tribunals (DRATs) were established at a number of
places in the country (RBI, 2008, p. 112).
To sum up, the main issues faced at the beginning of this sub-phase (1991-92 to
1997-98) were the poor financial performance, low asset quality, weak capital
position of banks and the absence of adequate competition. Several measures,
therefore, were initiated by the Government, the Reserve Bank and the banks
themselves to improve their profitability, financial health and capital position.
Major measures initiated included the introduction of objective prudential norms,
reduction in statutory pre-emptions and operational flexibility and functional
autonomy to public sector banks.
In view of various risks faced by the banking sector in a liberalized environment, a
special emphasis was also placed on strengthening the supervisory processes.
Various measures initiated had a profound impact. A significant improvement was
observed in the financial performance, asset quality and capital position by the end
of this sub-phase. The improvement in the financial performance was indeed
remarkable as the banks were subjected to the objective accounting norms. This,
123
among others, was on account of improvement in asset quality and widening of net
interest margins. One of the objectives of reforms was to create competitive
conditions. Although several measures were initiated to create competitive
environment, competition remained muted. A major contribution of various reform
measures in this phase was that it led to a change in the behaviour of banks in that
they began to focus increasingly on improving their financial health and
profitability. Despite significant improvement, however, there were still some
concerns at the end of this sub-phase. First, the NPA level of public sector banks
was still very high by international standards. Second, some banks were not able
to achieve the stipulated capital adequacy ratio even after two years of the
stipulated time period. Third, although the banking sector, on the whole, turned
around during 1994-95 and made profits, some banks (including two public sector
banks) continued to incur losses at the end of this phase.
Fourth, competition did not penetrate enough and banks continued to enjoy high
net interest margins. Notwithstanding the improved credit flow to agriculture
before the onset of reforms, rural financial institutions such as RRBs suffered from
serious weaknesses. Efforts, therefore, were made to restructure them, which had a
desired impact on their financial health. In this phase, however, credit to the
agricultural sector decelerated.
A major achievement of this phase was significant improvement in the
profitability of the banking sector. However banks in this phase developed risk
aversion as a result of which credit expansions slowed down in general and to the
agriculture in particular.
2.4.2 Second phase of reforms: 1998-99 and onwards
The second phase of reforms laid emphasis on improvement in prudential norms in
a gradual move towards meeting the international standards. The framework for
124
further strengthening the banking sector was provided by the Committee on
Banking Sector Reforms - CBSR (Chairman: Shri M. Narasimham), which
submitted its report in April 1998. However, while strengthening the prudential
norms, it was also necessary to ensure that some risk aversion by banks, which had
surfaced after application of prudential norms, did not aggravate.
In early 1997, Mr.Narasimham was again asked to chair another committee to
review the progress based on the 1st Committee report and to suggest a new
vision for Indian banking industry. In April, 1998, Narasimham Committee
submitted its report and recommended some major changes in the financial
sector. Many of these recommendations have been accepted and are under
process of implementation. Major recommendations and impact of the Second
phase of reforms are as follows:
2.4.2.1 Strengthening the Banking system
a) Capital adequacy
The committee recommended new and higher norms of capital adequacy. It
recommended that Minimum capital to risk assets ratio (CRAR) be increased from
the existing 8 per cent to 10 per cent; an intermediate minimum target of 9 per cent
be achieved by 2000 and the ratio of 10 per cent by 2002; RBI to be empowered to
raise this further for individual banks if the risk profile warrants such an increase.
Individual banks' shortfalls in the CRAR be treated on the same line as adopted for
reserve requirements, viz. uniformity across weak and strong banks. There should
be penal provisions for banks that do not maintain CRAR.
Impact: RBI has partially implemented the same by fixing CRAR at 9 per cent.
However, the ratio has not yet been increased to 10%. The CRR, which was
reduced to 4.5 per cent in March 2004, was gradually raised to 7.5 per cent
effective March 31, 2007.
The CRR was subsequently raised in stages to 8.75
125
per cent effective July 19, 2008. These measures had a desired impact and the
credit growth moderated to 21.6 per cent in 2007-08. A sharp increase in credit
between 2004-05 and 2006-07 resulted in sharp increase in the risk weighted
assets. Despite this increase, however, banks were able to maintain their CRAR
significantly above the stipulated CRAR of 8 per cent (RBI, 2008, p. 112).
b) Asset quality
The Committee recommended that an asset be classified as doubtful if it is in
the substandard category for 18 months in the first instance and eventually for
12 months and loss if it has been identified but not written off. In June 2004, the
Reserve Bank advised banks further to adopt graded higher provisioning in
respect of (a) secured portion of NPAs included in ‗doubtful‘ for more than
three years category; and (b) NPAs which remained in ‗doubtful‘ category for
more than three years as on March 31, 2004. Provisioning was also increased
ranging from 60 per cent to 100 per cent over a period of three years in a phased
manner from the year ended March 31, 2005.These norms should be regarded
as the minimum and brought into force in a phased manner. For evaluating the
quality of assets portfolio, advances covered by Government guarantees which
have turned sticky, be treated as NPAs. For banks with a high NPA portfolio,
two alternative approaches could be adopted. One approach can be that, all loan
assets in the doubtful and loss categories should be identified and their realistic
value determined. These assets could be transferred to an Assets
Reconstruction Company (ARC) which would issue NPA Swap bonds.
Impact: Since March 2001, the assets are classified as doubtful if it is in the
substandard category for 18 months. As the asset quality began to improve,
credit growth, which had decelerated significantly between 1996-97 and 2003-
04 partly on account of risk aversion, began to pick-up from 2004-05. Credit
126
growth, which was initially concentrated in retail segment, soon turned broad-
based encompassing agriculture, industry and small scale sector.
On the asset quality front, notwithstanding the gradual tightening of prudential
norms, non-performing loans (NPL) to total loans of commercial banks which
was at a high of 15.7 per cent at end-March 1997 declined to 3.3 per cent at
end-March 2006. Net NPLs also witnessed a significant decline and stood at 1.2
per cent of net advances at end-March 2006, driven by the improvements in
loan loss provisioning, which comprises over half of the total provisions and
contingencies. The proportion of net NPA to net worth, sometimes called the
solvency ratio of public sector banks has dropped from 57.9 per cent in 1998-99
to 11.7 per cent in 2006-07.(C.Rangarajan, 2007)
2.4.2.2 Systems and Methods in Banks
The international control systems which are internal inspection and audit,
including concurrent audit submission of controls returns by banks and
controlling offices to high level offices, risk management systems, etc. should
be strengthened there are recommendations for recruiting skilled manpower
from the open market, revision of remuneration to managerial positions taking
into account the market trends.
a) Structural Issues
Mergers
The Narsimham committee was of the view that the move towards this revised
system should be market driven and based on profitability considerations and
brought about through a process of mergers and acquisitions Merger between
banks and between banks and DFI‘s and NBFC‘s need to be based on
synergies, locational and business specific complimentary of the concerned
institutions and must obviously make sound commercial sense. Mergers of
127
public sector banks should emanate from the managements of banks with the
government as the common shareholder playing a supportive role. Such
mergers however can be worthwhile if they lead to rationalization of workforce
and branch network otherwise the mergers of public sector banks would tie
down the management with operational issues and distract attention from the
real issue. It would be necessary to evolve policies aimed at right sizing and
redeployment of the surplus staff either by the way of retraining them and
giving them appropriate alternate employment or by introducing a VRS with
appropriate incentives. This would necessitate the corporation and
understanding of the employees and towards this direction. Management
should initiate discussion with the representatives of staff and would need to
convince their employees about the intrinsic soundness of the idea, the
competitive benefits that would accrue and the scope and potential for
employees‘ own professional advancement in a larger institution. Mergers
should not be seen as a means of bailing out weak banks. Mergers between
strong banks/financial institutions would make for greater economic and
commercial sense and would be greater than the sum of its parts and have a
forced multiplier effect. Weak Banks' may be nurtured into healthy units by
slowing down on expansion, eschewing high cost funds / borrowings etc. The
Narasimham committee is seriously concerned with the rehabilitation of weak
public sector banks which have accumulated a high percentage of non-paying
assets (NPA), and in some cases, as high as 20 per cent of their total assets.
They suggested the concept of narrow banking to rehabilitate such weak banks.
It can hence be seen from the recommendations of Narsimham Committee that
mergers of the public sector banks were expected to emanate from the
management of the banks with government as common shareholder playing a
supportive role.. Merger should not be seen as a means of bailing out weak
banks. Mergers between strong banks/ financial institutions would make for
greater economic and commercial sense.
128
Impact: In this phase, two large development finance institutions (DFIs)
merged/converted into banks. After concessional sources of funding in the
form of Long-Term Operation (LTO) Fund of the Reserve Bank and
Government guaranteed bonds were withdrawn in the early 1990s, DFIs found
it difficult to sustain their operations. In January 2001, the Reserve Bank
permitted the reverse merger of ICICI with its commercial bank subsidiary.
ICICI Ltd. became the first DFI to convert itself into bank. The ICICI was the
second largest DFI, after Industrial Development Bank of India, and its reverse
merger led to a sharp increase in the market share of new private sector banks
in total assets of the banking sector. On October 1, 2004, Industrial
Development Bank of India, another large DFI, was converted into a banking
company. In April 2005, it merged its banking subsidiary (IDBI Bank Ltd.)
with itself. In all, during this phase, four new private sector banks and one new
public sector bank came into existence (including conversion of two major
DFIs, viz., ICICI and IDBI into banks). Besides, 16 foreign banks were also set
up. However, despite emergence of new domestic and foreign banks, the
number of banks gradually declined beginning from 100 at end-March 2000 to
82 by end-March 2007, reflecting the increased competitive pressures. The
number of branches set up by foreign banks increased from 181 in June 1997
to 273 by March 2007. Increased competition was also reflected in the sharp
increase in the sub-BPLR lending by banks. With a view to addressing the
downward stickiness of PLRs and the wide disparity in charging interest to
different category of borrowers, a scheme of benchmark PLRs (BPLRs) was
introduced by the Reserve Bank in 2003-04 for ensuring transparency in banks‘
lending rates as also for reducing the complexity involved in pricing of loans.
However, owing to increased competition, many banks introduced sub-BPLR
lending and the spreads between the minimum and maximum lending rates
increased significantly. The sub-BPLR lending enabled the corporate to raise
funds at competitive rates from banks. The share of sub-BPLR lending in total
129
lending increased gradually from 43 per cent in 2003-04 to 79 per cent by end-
March 2007 (RBI, 2008, p. 123)
f) Experiment With The Concept of Narrow Banking (Small Local
Banks): The Narasimham committee has suggested the setting up of small
local banks which should be confined to states or clusters of districts in
order to serve local trade, small industry etc.
g) Public Ownership and Real Autonomy: The Narasimham committee has
argued that government ownership and management of banks does not
enhance autonomy and flexibility in working of public sector banks.
Accordingly, the committee has recommended a review of functions of
banks boards with a view to make them responsible for enhancing
shareholder value through formulation of corporate strategy.
The Reserve Bank after a detailed consultative process released a
comprehensive policy framework of ownership and governance in private
sector banks in February 2005. The broad principles underlying the
framework were to ensure that (i) ultimate ownership and control was well
diversified; (ii) important shareholders were ‗fit and proper‘; (iii) directors
and CEO were ‗fit and proper‘ and observed sound corporate governance
principles; (iv) private sector banks maintained minimum net worth of
Rs.300 crore for optimal operations and for systemic stability; and (v)
policy and processes were transparent and fair.
Banks have been given greater autonomy in the areas like branch
rationalization, credit delivery, recruitment and creation of posts, etc,
subject to fulfillment of certain criteria.
h) Review And Updating Banking Laws: The Narasimham committee has
suggested the urgent need to review and amended the provisions of RBI
130
Act, Banking Regulation Act, State Bank of act etc., so as to bring them on
same line of current banking needs.
Keeping in view the importance of corporate governance even in public
sector banks, the Government of India at the Reserve Bank‘s initiative,
carried out amendments to the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970/ 1980 and the State Bank of India
(Subsidiary Banks) Act, 1959 to include new sections providing for
applicability of ‗fit and proper‘ criteria for elected directors on the boards of
public sector banks. Necessary guidelines were issued to nationalized banks
in November 2007.
The banking sector has witness significant changes in the policy and legal reforms
during the post reforms era. See Table (2.8 )
Table 2.8 Banking Reform Measures
Year Reform measures
1992 Prudential norms relating to income recognition, asset classification,
provisioning and capital adequacy were introduced in a phased manner
in April 1992.
1993 Guidelines on entry of private sector banks were put in place in January
1993.
A phased reduction in the SLR was undertaken beginning January 1993.
The SLR was progressively brought down from the peak rate of 38.5
per cent in February 1992 to the then statutory minimum of 25.0 per
cent by October 1997.
The CRR was progressively reduced effective April 1993 from the peak
level of 15 per cent to 4.5 per cent by June 2003. The CRR was
subsequently raised in stages to 9.0 per cent effective August 30, 2008.
Rationalization of lending interest rates was undertaken beginning April
1993, initially by simplifying the interest rate stipulations and the
number of slabs and later by deregulation of interest rates.
131
1994 The Board for Financial Supervision (BFS) was set up in July 1994
within the Reserve Bank to attend exclusively to supervisory functions
and provide effective supervision in an integrated manner over the
banking system, financial institutions, non-banking financial companies
and other para-banking financial institutions
1995 The BFS instituted a computerized Off-site Monitoring and
Surveillance (OSMOS) system for banks in November 1995 as a part of
crisis management framework for ‗early warning system‘ (EWS) and as
a trigger for on-site inspections of vulnerable institutions.
The Banking Ombudsman Scheme was introduced in June 1995 under
the provisions of the BR Act, 1949
1997 The maximum permissible bank finance (MPBF) was phased out from
April 1997
2000 In order to strengthen the capital base of banks, the capital to risk-
weighted assets ratio for banks was raised to 9 per cent from 8 per cent,
from year ended March 31, 2000.
2001 With a view to liberalizing foreign investment in the banking sector, the
Government announced an increase in the FDI limit in private sector
banks under the automatic route to 49 per cent in 200.
2004 The FDI limit was further increased to 74 per cent in March 2004,
including investment by FIIs, subject to guidelines issued by the
Reserve Bank
2005 A comprehensive policy framework for governance in private sector
banks was put in place in February 2005 in order to ensure that (i)
ultimate ownership and control was well diversified; (ii) important
shareholders were ‗fit and proper‘; (iii) directors and CEO were ‗fit and
proper‘ and observed sound corporate governance principles; (iv)
private sector banks maintained minimum capital for optimal operations
and for systemic stability; and (v) policy and processes were transparent
and fair.
The roadmap for the presence of foreign banks in India was drawn up in
February 2005.
A mechanism of State level Task Force for Co-operative Urban Banks
(TAFCUBs) comprising representatives of the Reserve Bank, State
Government and federation/ association of UCBs was instituted in
March 2005 to overcome the problem of dual control over UCBs.
The Banking Codes and Standards Board of India (BCSBI) was set up
by the Reserve Bank as an autonomous and independent body adopting
the stance of a self-regulatory organization in order to provide for
voluntary registration of banks committing to provide customer services
132
as per the agreed standards and codes
Source: Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume
IV, 2006-08
133
Table 2.9 Legal reforms
1993 The Recovery of Debts Due to Banks and Financial Institutions Act was
enacted in 1993, which provided for the establishment of tribunals for
expeditious adjudication and recovery of non-performing loans. Following
the enactment of the Act, debt recovery tribunals (DRTs) were established
at a number of places.
In order to allow public sector banks to approach the capital market
directly to mobilize funds from the public, an Ordinance was promulgated
in October 1993 to amend the State Bank of India Act, 1955 so as to
enable the State Bank of India to enhance the scope of the provision for
partial private shareholding.
2002 The Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest (SARFAESI) Act, 2002 was enacted in
March, 2002.
2004 Risk based supervision (RBS) approach that entails monitoring according
to the risk profile of each institution was initiated on a pilot basis in April
2004.
In January 2006, banks were permitted to utilize the services of non-
governmental organizations (NGOs/ SHGs), micro-finance institutions and
other civil society organizations as intermediaries in providing financial
and banking services through the use of business facilitator and business
correspondent (BC) models.
2005 Banks were advised to introduce a facility of ‗no frills‘ account with nil or
low minimum balances in November 2005
2006 Section 42 of the RBI Act was amended in June 2006 to remove the
ceiling (20 per cent) and floor (3 per cent) on the CRR.
2007 Section 24 of the BR Act was amended in January 2007 to remove the
floor of 25 per cent on the SLR to be statutorily held by banks.
Amendments to the Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970/80 were also carried out to allow nationalised
banks to have access to the capital market, subject to the condition that the
Government ownership would remain at least at 51 per cent of equity of
nationalized bank.
134
Source: Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume
IV, 2006-08
2.5 Reforms and Public sector banks
Enhancing the profitability of PSBs became necessary to ensure the stability of the
financial system. The restructuring measures for PSBs were threefold and
included recapitalization, debt recovery and partial privatization (Kamesam, 2002,
p.377; Reddy, 2002a, p. 358).
Owing to directed lending practices and poor risk management skills, India‘s
banks had accrued a significant level of NPAs. Prior to any privatization, the
balance sheets of PSBs had to be cleaned up through capital injection. In the fiscal
year 1991/92 and 1992/93 alone, the GOI provided almost Rs.40 billion to clean
up the balance sheets of PSBs. Between 1993 and 1999 another Rs120 billion
were injected in the nationalized banks. In total, the recapitalization amounted to
2 per cent of GDP (Deolakar, 1999, p. 66f.; Reddy, 2002a, p.359; Reserve Bank of
India, 2001, p.26).
Despite the suggestion of the Narasimham Committee to rationalize PSBs, the
Government of India decided against liquidation, which would have involved
significant losses accruing to either the government or depositors. It opted instead
to maintain and improve operations to allow banks to create a good starting basis
before a possible privatization (Shirai, 2002b, p. 26)
In 1993, the SBI Act of 1955 was amended to promote partial shareholding. The
SBI became the first PSB to raise equity in the capital markets. After the 1994
amendment of the Banking Regulation Act, PSBs were allowed to offer up to 49
per cent of their equity to the public. This led to the further partial privatization of
eleven PSBs. Despite those partial privatizations, the government is committed to
135
keep their public character by maintaining strong administrative control such as
the ability to appoint key personnel and influence corporate strategy (Ahluwalia,
2002, p.82; Arun and Turner, 2002b, p. 436-442; CASI, 2004, p. 33; Economist
Intelligence Unit, 2003, p. 9; Reddy, 2002a, p. 358; Shirai, 2002a, p. 54-56; Shirai,
2002b, p. 26).
To sum up, after nearly 10 years of the second phase of reforms, the complexion of
the Indian banking sector changed quite significantly. The main issues faced in this
sub-phase were to (i) strengthen the prudential norms in line with the international
best practices and at the same time ensure that the risk aversion did not aggravate;
(ii) increase the flow of credit to agriculture and SMEs; (iii) bring a large segment
of excluded population within the fold of the banking sector; (iv) strengthen the
corporate governance practices; (v) strengthen the urban cooperative banks and
resolve the issue of dual control; and (vi) improve the customer service. On almost
all the fronts, there was a significant improvement. Although efforts to strengthen
the banking sector had begun in the early 1990s, norms introduced were not in line
with the international best practices. Also, with the application of prudential
norms, banks had developed risk aversion. Therefore, while strengthening
prudential norms, institutional arrangements were put in place to enable banks to
expeditiously recover their past dues. Various measures initiated had a positive
impact as banks were able to recover large amounts locked up in NPLs. Banks,
therefore, gradually shed their risk aversion and credit began to grow sharply
beginning from 2004-05. Banks‘ NPLs level gradually declined to global level;
their gross NPAs declined from 15.4 per cent at end-March 1997 to 2.5 per cent at
end-March 2007. This was the most important achievement of this phase. The
profitability of scheduled commercial banks as reflected in their average return on
asset improved further, albeit marginally, from 0.8 per cent in 1997-98 to 0.9 per
cent in 2006-07. This was significant because competition intensified during this
phase as reflected in the acceleration of mergers and acquisitions (M&As) activity
136
and squeezing of net interest margins. The improved profitability, despite
increased competition, was, among others, on account of (a) sharp decline in
NPLs; and (b) increased credit volumes. In order to improve their profitability in a
competitive environment, banks also increasingly diversified their activities. This,
in turn, led to emergence of bank-led groups/financial conglomerates. The capital
adequacy ratio of banks also improved from 8.7 per cent at end-March 1997 to
12.9 per cent at end-March 2007. At individual bank level, the CRAR of most
banks was over 10 per cent, i.e., higher than the stipulated target which itself was
higher than the international norm. Thus, the impact of reforms initiated in the
early 1990s became clearly visible in this phase as the Indian banking sector had
become competitive, profitable and strong.
137
Source: RBI Bulletin 2004
A. Prudential Measures
Introduction and phase implementation of
international best practices and norms on risk-
weighted capital adequacy requirements,
accounting, income recognition, provisioning and
exposure.
Measures to strengthen risk management through
recognition of different components of risk,
assignment of risk-weighs to various asset classes,
norms on connecting lending, risk concentration,
application of market –to – market principle for
investment portfolio and limits on deployment of
fund sensitive activities.
B. Competition Enhancing Measures
Granting of operational autonomy to public sector
banks, reduction of public ownership in public
sector banks by allowing them to raise capital from
equity market up to 49 per cent of paid-up capital.
Transparent norms of entry of Indian private
sector, foreign and joint-venture banks and
insurance companies, permission for foreign
investment in financial sector in the form of
Foreign Direct Investment (FDI) as well as
portfolio investment, permission to banks to
diversify product portfolio and business activities.
C. Measures Enhancing role of Market forces
Sharp reduction of pre-emption through reserve
requirements, market determined pricing for
government securities, disbanding of administered
transparency and disclosure norms to facilitate
market discipline.
Introduction of pure inter-bank call money market,
auction-based repos-reserve repos fro short –term
liquidity management, facilitation of improved
payments and settlement mechanism.
D. Institutional and Legal Measures
Setting up of Lok Adalats (people‘s courts), debt
recovery tribunals, asset reconstruction companies,
settlement advisory committees, corporate debt
restructuring mechanism, etc for quick
recovery/restructuring. Promulgation of Securities and
Reconstruction of financial Assets and Enforcement of
Securities Interest (SARFAESI), Act, 2002 and its
subsequent amendment to endure creditor rights.
Setting up of Credit Information Bureau for
information sharing on defaulters as also other borrowers.
Setting up of clearing Corporation of India Limited
(CCIL) to act as central counter party for facilitating
payments and settlement system relating to fixed income
securities and money market instruments.
E. Supervisory Measures
Establishment of the Board for Financial Supervision
as the apex supervisory authority for commercial
banks, financial institutions and non-banking financial
companies.
Introduction of CAMELs supervisory rating system,
move towards risk-based supervision, consolidated
supervision of financial conglomerates, strengthening
of off- site surveillance through control returns.
Recasting of the role of statutory auditors, increased
internal control through strengthening of internal
audit.
Strengthening corporate governance, enhanced due
diligence on important shareholders, fit and proper
tests for directors.
F. Technology related Measures
Setting up of INFLINET as the communication
backbone for the financial sector, introduction of
Negotiated Dealing System(NDS) for screen-based
trading in government securities and Real Time Gross
Settlement(RTGS) System.
Table 2.10 The gist of reform measures aimed at strengthening the banks are given below
138
Table 2.11 Bank Mergers in the post reform period
Year of
Merger Target bank Acquirer
1993-94 New bank of India Punjab National Bank
1993-94 Bank of Karad Ltd. Bank of India
1995-96 Kashinath Seth Bank State Bank of India
1997 Punjab Co-operative Bank Ltd. Oriental Bank of Commerce
1997 Bari Doab Bank Ltd. Oriental Bank of Commerce
1999 Bareilly Bank Ltd. Bank of Baroda
1999 20th Century Finance Corporation Ltd. Centurion Bank
1999 British Bank of Middle East HSBC
1999-2000 Sikkim Bank Limited United Bank of India
1999-2000 Times Bank Ltd. HDFC Bank Ltd.
2001 Bank of Madura ICICI Bank
2002 Benaras State Bank Ltd. Bank of Baroda
2002 ICICI Ltd. ICICI Bank
2003 Nedungal Bank Ltd. Punjab National Bank
2004 South Gujrat Local Area Bank Bank of Baroda
2004 Bank Muscat SAOG Centurion Bank
2004 Global Trsut Bank Ltd. Oriental Bank of Commerce
2004 IDBI Bank IDBI Bank Ltd.
2006 Bank of Punjab Centurion Bank
2006 Ganesh bank of Kuranwad Federal Bank
2006 UFJ Bank Ltd. Bank of Tokyo-Mitsubishi Ltd.
2007 United Western Bank IDBI Ltd.
2007 Lord Krishna Bank Centurion Bnak of Punjab
2007 Sangli Bank ICICI Bank
2007 Bharat Overseas Bank Indian Overseas Bank
2008 Centurion bank of Punjab HDFC
2008 Amercan Express Bank Ltd. Standard Chartered Bank
2008 State Bank of Saurashtra State Bank of India
2008 South India Co-operative BankLtd.
The Saraswat Co-operative
bank Ltd.
2009 State Bank of Indore State Bank of India
Source: Indian Banking year book 2009,IBA
139
2.6 Structure of Indian Banking
The financial system in India has a very comprehensive structure. It represents a
variety of banks, financial institutions, capital market institutions, non-banks
indigenous banking and financial institutions,
The banking system in India consists of the Central Bank (RBI), commercial
banks, development banks, specialized banks and foreign banks. Banking
operating in India can be broadly classified into two categories viz., Commercial
Banks and Co-operative Banks.
(a) The Central Bank in the country is known as Reserve Bank of India, the
supreme monetary and banking authority in the country, has the
responsibility to control the banking system in the country.
(b) The Commercial banks are the joint stock companies dealing in the money
and credit. These banks mobilize savings and make them available to large
and small industrial and trading with mainly for working capital
requirements.
(c) Co-operative banks, organized on unit banking principle, are mainly rural
based, although, there are some banks operating in the urban areas. The
state funds for the agriculture are mainly routed through the state
cooperative banks and central cooperative banks. The Regional rural banks
came into being with the specific objective to agriculture laborers, small
and marginal farmers, artisans, small entrepreneurs in the rural area.
(d) A number of apex banks are working in specialized areas. They include
NABARD, IDBI, EXIM bank and National Housing Bank.
(e) Financial institutions like UTI, LIC, GIC and other subsidiaries such as
mutual funds, investments, loan, hire purchase and leasing companies are
also a part of the banking network in the boarder sense. All these
140
institutions undertake mobilization of resources, engage in long term
investment and provide financial services.
Within the category of Commercial banks, there are two types of banks namely
Scheduled Commercial Banks and Non- Scheduled Commercial Banks.
Scheduled Banks in India constitute those banks which have been included in the
Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI in turn includes
only those banks in this schedule which satisfy the criteria laid down vide section
42 (6) (a) of the Act.
"Scheduled banks in India" means the State Bank of India constituted under the
State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the
State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding
new bank constituted under section 3 of the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of the
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of
1980), or any other bank being a bank included in the Second Schedule to the
Reserve Bank of India Act, 1934 (2 of 1934), but does not include a co-operative
bank.
"Non-scheduled bank in India" means a banking company as defined in clause (c)
of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a
scheduled bank".
Depending on the pattern of ownership commercial banks can be classified into
three groups. They are (i) Public Sector banks which include State Bank of India,
its Associate Banks and Nationalized Banks and other Public Sector Banks, (ii)
Private Sector Banks consisting of Indian Private Sector Banks (which can be
divided into two i.e. banks existing prior to 1991 and the banks established after
141
1991) and Foreign Banks operating in India, (iii) Others comprising Regional
Rural banks and Local Areas banks.
Of these, public sector banks have a countrywide network of branches and
accounts for over 70 per cent of total banking business. They have a strong
presence in rural and semi-urban areas. Private sector banks and foreign banks are
more techno-savvy and have limited number of branches. Public sector banks
sponsor the RRBs and their activities are localized.
Figure 1 Structure of Scheduled Commercial Banks in India.
(Source: RBI)
RBI
Central Bank and Supreme Monetary Authority
Scheduled Co-operative Banks Scheduled Commercial
banks (79)
Public Sector
Banks (27) Private Sector
Banks (22) Foreign
Banks(30)
Regional Rural
banks
((((85)9999((((((
(Banks(95)
Nationalized
Banks (19)
Old Private Sector
Banks (15)
(Banks that existed
before 1991)
New Private Sector Banks
(7)
(Banks that came into
existence after 1991)
Scheduled Urban
Co-operative
Banks
Scheduled State
Co-operative Banks
State Bank of India
and Its Associates
(7)
Other Public
Sector Banks
(1)
142
Table 2.12 Structure of Indian Commercial Banks 2008-09
(Rs. Crores)
Sr. No.
Bank Group No. of Banks
No. of Branches
Staff Deposits Capital Reserves & Surplus
Total Assets Borrowings Investments Loans &
Advances
1 Public Sector Banks Markets Share (a+b+c)
27 34.18
56,109 85.8
734,661 78.0
3,112,748 76.79
13,536 30.74
194,760 60.27
3,766,716 72.02
158,305 60.85
1,012,666 70.02
2,260,156 75.48
1.a. State Bank Group Market Share
7 8.86
16,323 25.0
268,598 28.5
1,007,042 24.84
1,080 2.45
71,341 22.08
1,280,212 24.48
62,240 23.92
357,624 24.73
739,606 24.70
1.b. Nationalised Bank Group Market Share
19 24.05
39,340 60.1
455,862 48.4
1,993,305 49.17
11,731 26.64
114,721 35.50
2,314,102 44.24
51,647 19.85
604,994 41.83
1,417,121 47.33
1.c. Other Public Sector Bank Market Share
1 1.27
446 0.7
10,201 1.1
112,401 2.77
725 1.65
8,697 2.69
172,402 3.30
44,417 17.07
50,048 3.46
103,428 3.45
2
Indian Private Sector Banks Market Share 2 (a+b)
22 27.85
9,011 13.8
176,410 18.7
726,813 17.93
4,590 10.42
94,337 29.20
1,016,522 19.43
94,721 36.41
303,248 20.97
568,764 18.99
2.a. Old Pvt. Sector Banks Market Share
15 18.99
4,742 7.2
51,412 5.5
189,708 4.68
1,171 2.66
15,317 4.74
221,057 4.23
4,231 1.63
69,109 4.78
121,940 4.07
2.b. New Pvt. Sector Banks Market share
7 8.86
4,269 6.5
124,998 13.3
537,105 13.25
3,420 7.77
79,020 24.46
795,454 15.21
90,490 34.78
234,139 90.00
446,824 14.92
3 Foreign Banks in India Market Share
30 37.97
292 0.4
30,304 3.2
214,077 5.28
25,911 58.84
34,026 10.53
447,149 8.55
7127 2.74
130,354 9.01
165,415 5.52
4
Total Commercial Banks Total Market Share (1+2+3)
79 100.00
65,412 100.00
941,375 100.00
4,053,638 100.00
44,037 100.00
323,123 100.00
5,230,387 100.00
260,153 100.00
1,446,268 100.00
2,994,335 100.00
Source: Indian Banking Year Book, 2009, IBA, Mumbai
121
Table (2.12) presents the structure of India Commercial Banks during the year
2008-09. It can be observed that foreign banks group occupy a major share (37.97
per cent) in terms of number of banks followed by Public sector banks (34.18 per
cent) whereas other public sector banks (1 per cent) and new private sector banks
(7 per cent) the lowest.
With regard to branch expansion, public sector banks take up a major market
share of (85.8 per cent) where as foreign banks (0.4 per cent) the lowest. Group-
wise public sector banks have major share of employees (78.0 per cent) while
foreign banks (3.2 per cent).
With regard to deposits, public sector banks (76.79 per cent) whereas foreign
banks (5.2 per cent) the least. In terms of capital, foreign banks (58.84 per cent)
occupy major share while SBI group (2.45 per cent) the least. Public sector banks
capture a major share of (60.27 per cent) with respect to reserves and surplus
while foreign banks (10.53 per cent) the least.
It is pertinent to note that on all other parameters like total assets, borrowings,
investments, loans and advances, public sector banks capture a major share as
compared to its counterparts. On a whole public sector banks captured more than
50 per cent market share on almost seven parameters.
2.7 SWOT Analysis: Any organization operates within a framework of
environmental context. There is mutual demand and supply relationship that
prevails between the organization and large society. Owing to which, there is a
continuous response relationship between the organization and environment.
Social, economic, political aspects of the environment influence the operational
purviews of the organization. Interface is potential analyzed through the technique
of SWOT. i.e Strengths, Weakness, Opportunities and threats.
122
External environment poses two types of forces on the organization. They are
helping and hindering forces. The forces also can be positive and negative in
nature. These forces inherent strengths and weakness of the organization
Matrix I - SWOT Analysis of Indian Commercial Banking
Source: Business Monitor International, August, 2010
Strengths
In macro economics terms, India is
set to be a global outperformer in
the coming years.
India‘s highest savings rate and
efficacy of regulation by RBI has
provided stability.
Although loans have been growing
rapidly, there are few signs of the
kind of excess that have been seen
over the last few years in china.
The lack of links between Indian
banks and global financial system
means that they are relatively
immune to volatility in the global
market.
Weaknesses
A legacy of the state‘s protection of
the commercial banking sector,
which remains dominated by the
State bank of India, is that
efficiency levels and product
offerings are long way off the
world‘s best products.
The banking sector is held back by
low of GDP per capita.
The logistics involved in running a
bank in India can be daunting due
to prevalence of paper based
payment systems such as cheques.
Opportunities
India is still under banked. Per
capita deposits are low and people
with savings often keep their wealth
outside the formal banking system.
India‘s banking system is being
opened up to competition from
foreign banks.
Loan is growing quite rapidly from
a low, base and consumer finance is
developing quickly.
There are opportunities for mutual
funds, insurance companies and
organizations offering related
products.
Threats
The development of products, such
as mortgages, is hampered by
inefficiencies in housing market
(eg. cumbersome legal system and
bizarre planning regulations) that
need to be removed via reforms.
123
Matrix II - SWOT Analysis of Indian Public Sector Banks
Source: Compiled from the interactions with banking officials of various public sector
banks
Strengths
Being Custodians of Public Money,
Public sector banks enjoy public
trust, therefore have a good
franchise.
Has very good network of branches
Regulated by Government of India
and Scrutinized by RBI on their
portfolios.
Good Employee relations ( Number
of strikes reduced in the recent
years)
Are good gamekeepers.
Are adequately capitailized and
proved themselves in the crisis.
Upgraded their technology to meet
the market demands and consumer
expectations.
Cost to Income ratio is low
Weaknesses
Average age profile of the employees
is high as compared to its
counterparts
Compensation package is low, and
hence are not able to attract the best
talent.
Management not ascertaining their
rights.
Frequent transfer of banking heads.
Opportunities
Made their presence in II tier and
III tier cities and have good
franchise and has further scope for
expansion.
Has huge potential to contribute to
India‘s growth strategy
Threats
Competition from private and
foreign players
In terms of size they are not truly
international
124
References
1. Ahluwalia, M S.(2002) : ―Economic reforms in India since 1991: Has
Gradualism worked?‖, Journal of Economic Perspectives, Vol.16(3),pp.67-
88.
2. Arun,T.G.,Turner,J.D (2002), ―Financial Sector Reforms in Developing
Countries: The Indian Experience‖, The World Economy, Volume 25 (3),pp.
429-445.
3. Business Monitor International, August, 2010
4. C. Ranagarajan (2007), ―The Indian Banking System – Challenges ahead‘,
Lecture delivered at Institute of Banking and Finance on 31st July, 2007,
Mumbai.
5. CASI (2004), Doing Business in India- Ideology, Politics and Economics
Reforms, The National Democratic alliance 1999-2004.
6. Chandavarkar, A.2005, ―Money and Credit-1858-1947.‖ The Cambridge
Economic History of India Volume II 1757-2003, New Delhi, Orient
Longman Private Limited
7. Deolakar,G.H (1999), ―The Indian Banking Sector; On the road of
Progress‖, in (ed) Rising to the Challenge in Asia: A study of Financial
Markets – India, Manila, pp.59-109
8. Economic Intelligence Unit (2003), Country Commerce, India
9. EPW Research Foundation,(1997) ―Special Statistics -19: A Statistical
Profile of Commercial Banks in India‖ Economic and Political Weekly,
Vol.32.No.42 (Oct.18-24, 1997), pp. 2753-2772
10. Government of India, 1998. ―Report of the Committee on Banking Sector
Reforms (Chairman: Shri M. Narasimham) April.
11. Indian Banking Year Book (2009), Indian Banks Association, Mumbai.
125
12. Joshi P.N. (2002), Financial Sector Reforms and Weaker Section of the
society, The Journal of the Institute of Bankers, Vol.13, No.2, April-June,
pp 10
13. Joshi,Vijay., Little,I.M.D (1997), India‘s Economic Reforms 1991-2001,
Delhi.
14. Kamesam Vepa(2002), ‗Indian Economy- Financial Sector reforms and
Role of RBI‖, RBI Bulletin, May, pp. 375-391
15. Mukherji, Joydeep, (2002), ―India‘s Long March to Capitalism‖, India
Review.
16. Narasimham,M (1991), Report of the Committee on Financial System,
,RBI, November.
17. Rakesh, Mohan, (2004), ―Financial Sector Reforms in India: Policies and
Performance Analysis.‖ RBI Bulletin, October 2004
18. RBI (2001), Report on Trend and Progress of Banking in India, ,2000-01
19. RBI (2004), Report on Trends and Progress Banking in India, 2003-04.
20. RBI (2008), ―Evolution of banking in India‖ in Report on Currency and
Finance, Special Edition-, Volume IV, 2006-08
21. Reddy, Y.V. (1998), ―Financial Sector Reforms: Review and Prospects‖.
RBI Bulletin, December
22. Reddy, Y.V. (2002), ―Monetary and Financial Sector Reforms in India: A
Practitioner‘s Perspective‖. RBI Bulletin, May, pp. 337-356.
23. Shenoy.P.S(2000), Public Sector Banks: Remarkable Turnaround, the Hindu
Survey of Indian Industry, Chennai,p 44
24. Shirai, Sayuri 2002 a), ―Banking Sector Reforms in India and China: Does
India‘s experience offer lessons for China‘s future reforms agenda?‖, Asia-
Pacific Development Journal, Volume 9 (2),pp 51-82.
25. Shirai, Sayuri 2002 b), ―Road from State to Market – Assessing the Gradual
Approach to Banking Sector Reforms in India‖, Asian Development Bank
Institute Research Paper, No.32, pp. 1-