Banking History in India

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Commercial Banking in India in Post 1990 PeriodParadigm Shifts Achievements... 61

Vol. VI, No. 1; June, 2010

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COMMERCIAL BANKINGIN INDIAIN POST 1990 PERIOD

PARADIGM SHIFTS, ACHIEVEMENTSAND THREATS

B. K. Singh*

ABSTRACT

The paper has made an attempt to map the reforms in the Indian banking system in its definingbackground. The paper notes that more than a decade and a half has gone by since the reform

process was enunciated in the Indian banking system and during this span of time the reformmeasures have changed the Indian banking environment significantly. They are still leading crucialchanges of far reaching impact. In this direction, the paper maps the new financial regime and the

new rules of the game which have shifted the paradigms of the Indian banking system. It is in thislight, the paper has made an attempt to identify the impact of reforms in terms of achievements

and failures of the Indian banking system in the post 1990 period.

The achievements certainly reflect a pleasing turnaround in the Indian banking system. While thereforms have successfully arrested the deterioration of the Indian banking system, they have also

extended a new strength and business orientation to Indian banks. As such, the Indian bankingsystem is now reflecting a better profitability and a significantly improved financial health.

However, at the same time, the changed environment of the Indian banking system has given riseto certain threatening challenges. The paper has taken note of such threatening challenges and

has offered suggestions thereof with a view to tackle them effectively before they grow out ofproportion and go beyond control.

* Associate Professor, Faculty of Commerce, Banaras Hindu University, Varanasi

1. CONTEXT BUILDING

The late 1980s is recorded in theIndian economic history as the time-framein which the most awesome and dangerouseconomic problem was in the making.While the Indian people were largelyunaware of the problem in the making, theeconomy managers and policy plannerswere well aware of the same. Even whenthey were aware of the problem, they

allowed it to grow. Soon the problem wentout of their control leaving them awed andhelpless.1 By the year 1991 the problemsurfaced in its full blown form and took theentire economy into its frightening grip.2

Thus, triggered by the gulf crisis, a severe

balance of payment crisis had to be facedin 1991 that made introduction ofcomprehensive programme of reformsinevitable.

The economic crisis led to economicreforms and the economy received a newdirection with the new economic policy inplace.3 The reform measures undertakenwere all pervasive and the financial andbanking sector also witnessed a series of

reforms of far reaching impact.4

In order tointroduce reforms in financial and bankingsector so as to support the reforms in realeconomy, a high powered committee wasconstituted by the Government of Indiaunder the chairmanship of Shri M.


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Narsimham. The Committee submitted itsreport in November 1991 and suggested

wide ranging reforms relating to thestructure, organisation, functions andprocedures of the financial and bankingsystem. The reforms led by the report ofthe Narsimham Committee are termed asFirst Phase of Reforms, which mark their

beginning since 1991-92 and extend to

1997-98.

Even though the reform measuresintroduced in this phase were a majorattempt towards strengthening of theIndian banking system, these reformmeasures fell short of internationalstandards and practices on several counts.

Therefore, it was deeply felt by theGovernment and the policy planners tostrengthen the reform measures further. It

was realised that a weak banking systemcould not withstand any internationaleconomic turmoil. Accordingly, again inthe Chairmanship of Shri M. Narsimham,a Committee on Banking Sector Reforms(CBSR) was set up to suggest measures forfurther strengthening of the Indian

banking sector.5

The CBSR submitted its report in April1998 and marked the beginning of thesecond phase of banking sector reforms.Based on the recommendations of the twoCommittees under the chairmanship of SriNarsimham, several reform measures offar reaching impact were introduced in theIndian banking system. Some crucialreform measures introduced in the Indian

banking system include the following:6

i. Reforms relating to prudential norms

for capital adequacy,

ii. Reforms relating to prudential normsfor income recognition,

iii. Reforms relating to prudential normsfor asset classification and provisioningthereof,

iv. Enactment of the Recovery of DebtsDue to Banks and FinancialInstitutions Act leading toestablishment of Debt Recovery

Tribunals (DRTs),

v. In October 1993 the public sectorbanks were given access to capitalmarket to directly mobilise funds frompublic. An Ordinance was promulgatedto amend the State Bank of India Act,1955 enabling it to enhance its scope ofpartial private shareholding,

vi. In the year 1993, entry for new privatebanks was allowed and guidelines forentry of new private sector banks in the

Indian banking sector werepromulgated,

vii. Creation of a computerised Off-siteMonitoring and Surveillance (OSMOS)system for banks,

viii Phased reduction in the SLR and CRRsince January 1993,

ix. Deregulation of interest rates,

x. Enactment of The Securitisation andReconstruction of Financial Assets and

Enforcement of Security Interest(SARFAESI) Act, 2002,

xi. In February 2005, the roadmap for theentry and operations of foreign banksin India was laid down, and

xii. In June 2006, the ceiling of 20 percentand floor of 3 percent on the CRR wasremoved with the amendment of theSection 42 of the RBI Act. Similarly, in

January 2007, the floor of 25% on theSLR was removed with the amendment

of the Section 24 of the RBI Act.More than a decade and a half has

gone by since the reforms in Indianbanking system were enunciated. Duringthis span of time, the reform measureshave changed and are still leading changein the Indian banking environment. They


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have put in place a new financial regimeand new rules of the game shifting theparadigms of the Indian banking.Therefore, it would be interesting toidentify and analyse the paradigm shiftswhich have taken place in the Indianbanking system. It would be equallyinteresting to analyse the impact of reformmeasures on banking operations andfinancial soundness of banks. Further, itwould be in the fitness of the basic purposeof the present paper to offer suggestionsfor future policy directions.

2. PARADIGM SHIFTS IN INDIAN BANKING

SYSTEM

In any economy, the banking systemassumes significance in at least threeimportant ways. First, the banking systemin any economy performs a cruciallyimportant function of transformation offunds by offering intermediation servicesto saving-surplus and saving deficient-units. Second, it works like a mirror of themacro-economy and provides the mirrorimage of the same. And, thirdly, the

banking system in itself is an industry thatworks like the hub of all industries and

industrial activities of the economy. It is anindustry which functions and operatespredominantly on public trust, and in

which the entire industrial scenario of aneconomy finds its expression and remainsunderpinned to. Precisely, the success orfailure of the banking industry writes thesuccess or failure story of other industriesin the economy.7

The strength of the inter-linkagebetween the banking system and the

economy, and between the banking systemand industrial activities depends on theinter-linkage between banking system andthe people in general. It is the people ingeneral who determine the financial

viability and stability of banking system.Therefore, for any economys growth

agenda, it becomes all the more essentialthat its banking system as a whole enjoys ahigh degree of public confidence andthereby remains sound and stable. It isonly then the banking system succeeds indelivering the much needed growthimpulses to the economy.

Ever since the Indian economy andthe financial and banking sector of theeconomy were put on reform track, thedriving and the guiding force has always

been the idea of strengthening the abovenoted inter-linkages between the bankingsystem and the economy, banking systemand the industry, and the banking systemand the peoples trust. In the earlier

section, we have noted the background ofreforms and the crucial reform measuresundertaken in the banking sector in Indiain the post 1990 period. The reformmeasurers undertaken have given rise tonew paradigms for banking business andaccordingly have given new directionalchanges to the Indian banking system. At

this juncture, it would be pertinent to mapthe paradigm shifts which have takenplace in the Indian banking system.

(i)The most important directional shiftin the Indian banking sector is visible interms of increased competition. In the post1990 period several reform measures wereundertaken to make the Indian bankingsector more competitive. Entry and exitnorms for banks have been relaxed, publicownership in banking industry has beensignificantly reduced, and banks have

been permitted to access capital market formeeting their fund requirement. The

impact of these reform measures arereflected in the Indian banking system interms of increased number of banks. Notonly a good number of new private bankshave entered the Indian market, thenumber of foreign banks has also swelledsignificantly. The new private banks and


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foreign banks are relatively stronger thantheir predecessors. Even they comparestronger than their counterparts in thepublic sector except the SBI. All this hasheightened the competition in the Indian

banking sector.

(ii) In the post 1990 period,under the influence of reform measures,another important directional shift hastaken place in the Indian banking systemin terms of increased interdependence

between the banking sector and the microand macro level economic policies. Withthe rising globalization of the Indianeconomy and with the economies of the

world becoming more and more

interactive, the banking sector isdeveloping new dimensions and assumingmore complex new roles. Because of theheightened intensity and increasedinterdependence between micro andmacro level economic policies and the

banking sector, the two-way interactionbetween the economy and the bankingsector are becoming more and morecomplex and of crucial significance. Thereforms in the larger Indian economy have

increased the domestic and the foreignmarket exposure and competition to theIndian banks. This has further increasedthe vulnerability of Indian banks to microand macro economic shocks emanatingeither from the domestic market or fromthe world market.

(iii) In the earlier Para, we havenoted an important directional shift in thename of increased interdependence of the

banking sector and the micro and macrolevel economic policies. As a corollary of

the same, when the banking system andthe economy become moreinterdependent, they at the same time

become more open to systemicpsychological laws and behave more onemotional inputs than on reason andrational inputs. In an environment of

rising globalization, the Indian economy isbecoming more and more interactive withother economies of the world. This hasinfused a great deal of financial and non-financial complexities in the Indianfinancial and banking system. Ineconomies like the Indian economy, whichare characterized by rising financial andeconomic complexities, perceptions andexpectations play major role in controllingand shaping fear causing events in theeconomy. This consideration getsaccentuated if the financial system isperceived to be weak, unstable, andunsound. In this perspective, it becomesall the more crucial to devise strategic

mechanism to control such events fromtaking place, for if they take place theytake the cascading and snowballingimpact and thus ultimately take the entireeconomy in its grip. The directional shift inthis regard has thrown open a newchallenge towards strategic considerationsof ensuring continued sustainability andstability of the financial system.

(iv) The economy managers andthe RBI in India have been following a

policy of high reliance on Cash ReserveRatio (CRR) and Statutory Liquidity Ratio(SLR) in the name of managing inflation,other related economic problems, and theneeds of monetary policy operations. Theexcessive and unduly high reliance on CRRand SLR in the past had inhibited the freeand competitive operations in the bankingsector in India. However, because of thechange in philosophy of economymanagers and of the RBI, the situation inthis regard has witnessed a marked shift in

post 1990 period. In order to better developthe banking sector, to make financialmarkets more efficient, and to allow for agreater role for the interest rate in theeconomy, the unduly high dependence onCRR and SLR as instruments of monetarypolicy was gradually reduced in the post


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1990 period. The lowering of CRR and SLRhas increased the availability of resourcesin the hands of banks for increasedlending in the economy.

(v) Giving of greater operationalflexibility to banks is leading to greaterexposure of individual banks to turbulenteconomic environment and highly volatilemarket forces. In this context, it would beappropriate to discuss a very crucialeconomy oriented paradigm shift whichhas serious implications for the bankingsystem. This paradigm shift is visible inthe form of more crucial and intenseimpact of macro economy market forces ofinterest rate, exchange rate, and prices of

other assets on the profitability andfinancial health of the banks. Thisparadigm shift is pressing for a change inmanagerial orientation of banks. Thebanks are required to be managedstrategically so as to withstand thefluctuations in interest rates, foreignexchange rate, and prices of other assets inthe economy. If banks fail to anticipatechanges in interest rates, exchange rateand prices of other assets in the economy,

they quite naturally will fail in taking pre-emptive actions as also in formulating asuitable strategic response well in time tocounter the adverse impact of suchchanges. This then will put such banks ina difficult situation. This danger issomething that could not be well dealt withany reform measure for this is an offshootof the reform process itself. As such, whatis needed is a better management ofuncertain and furious future with strategicintent.

(vi) Increasing globalisation ofthe Indian economy is giving rise to a newparadigm shift in terms of greaterexposure of Indian banks to turbulentglobal economic environment. Somethinghappening somewhere in the worldtransmits its impact on the Indian

economy immediately. As such, the highlyvolatile American economy and theturbulence in the American banking sectorare having their toll on the Indian economyand on the banking sector. Slowdown inAmerican economy and failure of bankslike Leehman Brothers in USA haveresulted into slowdown of the Indianeconomy and have landed Indian banksinto deep sea. The worry and panic relatingto the ICICI Bank, the largest andstrongest private sector bank in India,reveals this fact. In fact, not only themanagement of the ICICI Bank had tocome forward with tall claims andreassurances on their financial strength,

the Government of India also had toreaffirm the claims made by the ICICIBank management in order to prevent theslide into ocean of problems. The point isthat the paradigm shift in the form ofincreasing exposure of Indian banks toglobal economic environment calls for amore prudent and strategic managementof banks in India so that the Indian banksare not caught unprepared by the globalevents, whether favourable orunfavourable.

(vii) Another very crucialparadigm shift is emanating from freemarket developments in India. The freemarket developments are giving rise to apressing need for Indian banks to shuntheir earlier practice of concentrationlending. The Indian banks cannot afford tocontinue with high concentration oflending to one or two booming sectors ofthe economy. High concentration of banklending, as was the practice of Indian

banks in the pre 1990 period, is bound tolead to asset price bubbles, which if burstsunder the impact of adverse changestaking place in the domestic economy orthe world economy would land such banksin quagmire of crisis. And, it would then bevery difficult for such banks to come out


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from that crisis. It is pertinent to note herethat the Reserve Bank has prescribedregulatory limits on banks exposure toindividual and group borrowers in India toavoid concentration of credit, and hasadvised the banks to fix limits on theirexposure to specific industries or sectors(real estate, capital market, etc.) forensuring better risk management.8

However, the rules are not very exact, theygo with several exemptions, and they areleft to banks for adherence and practice.That is why the banks will have to becautious enough in identifying group orindividuals who may seek lendingexceeding the limits prescribed in the

disguised identity. Similarly, there is everypossibility that the bank officialsthemselves intend to flout the rulesdeliberately and grant concentratedlending in their personal interest ofreporting higher business so as to maketheir performance look better.

(viii) We know that after thenationalization of 14 banks in 1969 andthen 6 banks in 1980, the policy of theGovernment of India was predominantly

focused on social banking. The efforts ofthe Government of India in this regardwere double pronged. On one hand, theGovernment came out with the policy ofpriority sector lending. And, on the otherhand, the Government policy directed the

Indian banks to reach out to entire India sothat the earlier unbanked areas andunbanked people start getting bankingfacilities. Accordingly, the Indian banksfollowed a policy of spreading their branch

network with an inherent favour towardsrural India and rural people. The effortsand achievements of Indian banks in thisregard were commendable. They didsucceed in extending banking facilities tounbanked areas and unbanked people ofIndia. But, at the same time, because of

the over emphasis on social banking andbranch expansion, the Indian banksignored the profitability and safetyprinciple and accordingly they gatheredsome filth and dirt in their incomestatements and balance sheets. The profitsand profitability of Indian banksdeteriorated in general. The situationbecame very gruesome for certain banks.They were incurring losses over the yearsand they had become financially veryweak. In the mean time, as we have alreadynoted, India was caught in the quagmire ofeconomic crisis. To bail the economy outfrom the quagmire of crisis, a neweconomic policy was laid down and a host

of reform measures of far reaching impactwere enunciated. We have noted that bythe year 1991, when the reform processwas started, the income statements andbalance sheets of the Indian banks werefull of filth and dirt. The reform measuresin the larger economy and the filth and dirtin the income statements and balancesheets of the Indian banks together gaverise to the most challenging paradigmshift. This paradigm shift emerged in the

form of concerns for profitability andsafety principle of the banking system.The banks under the changed scenariohad to change their earlier direction andcome out from the social bankingphilosophy. The paradigm shift in theeconomic philosophy of the Government ofIndia caused this paradigm shift in thebanking philosophy of Indian banks. In thenew environment of liberalized, privatized,and globalised market economy, theIndian banks realized that they can

continue to exist if they are working on freemarket principles and earning profit.Norms relating to income recognition,asset classification, and minimum capitaladequacy standards are accentuating thisparadigm shift.


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3. IMPACT OF PARADIGM SHIFTS ON

BANKING OPERATIONS- IDENTIFYING

ACHIEVEMENTS:

While building the context for the

paper we discussed the background ofreforms and important reform measuresenunciated in the Indian banking sector asan extension of reforms in the Indianeconomy. In the second section, thediscussion was devoted to identify theshifting paradigms of commercial bankingin India in post 1990 period. Thediscussion there has identified crucialparadigm shifts in banking philosophy andin rules of game which abound thebanking business in India.

The changed banking philosophy andthe changed rules of game are forcing and

moving the Indian banks to operate onmarket principles and to capitalise onopportunities which are emanating fromthe changes in the banking environment. Itis in this light, it would be pertinent toexplore the impact of reforms on bankingoperations. In order to explore the impactof reforms on banking operations, thesimplest and the most revealing way is to

identify the achievements of the Indianbanking system in the post 1990 period.Therefore, in the present section, thediscussion and analysis is devoted to dig

out the achievements of the Indianbanking system.

3.1 Impact on Branch Expansion Policy of the

Pre 1990 Period:

At the dawn of independence, thecommercial banks in India were mostly

private banks. Most of them were small insize and they had closely held privateshareholding. Being private banks andlargely having closely held shareholding,the banks of the time were largely localisedto industrially-developed urban areas ofthe economy. As such, the industrially

backward areas and the rural India werelargely unbanked.

Realising the aspirations of theindependent India to develop at a faster

pace and understanding the importance ofbanks in spurring the cycle of economicdevelopment, the Government of India andthe RBI accepted the onus of extending thebanking facilities to the rural areas of theIndian economy. Accordingly, theGovernment and the RBI took severalsteps. In the year 1951, the Governmentand the RBI asked the Imperial Bank ofIndia to extend its branches to suchTaluka and Tehsil towns where thebusiness potential and the Governmenttransactions were high enough to warrantsuch opening of branches. In the year1955, Government of India converted theImperial Bank of India into State Bank ofIndia with the enactment of the State Bank

of India Act, 1955. Having formed the SBI,the Government and the RBI asked the SBIto open 400 branches within 5 years inunbanked areas. Then, the Governmentcame forward with the concept of socialcontrol through the Banking Laws

(Amendment) Act 1968, which wasenforced on February 1, 1969. In the verysame year, the Government promulgatedthe Banking Companies (Acquisition andTransfer of Undertakings) Ordinance,1969 and nationalised 14 banks with

deposits of over Rs.50 Crore.

Having 14 banks nationalised, theGovernment and the RBI adopted a doublepronged strategy for making bankingfacilities available in the then unbanked

areas. A new branch licence policy wasdesigned and with that a new scheme inthe name of Lead Bank Scheme (LBS) wasintroduced. Encouraged by the progressmade, the branch licence policy waschanged in the year 1977. Banks weregiven the incentive of opening one branch


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in metropolitan area and one in urban areaif they wanted to open four branches inrural areas. Finally, in the year 1980 sixmore banks were nationalised and thepolicy of branch expansion to rural areaswas continued even in the 1980s.

Because of the continued emphasis onpolicy of branch expansion, the Indianbanking system developed an appreciableextension and reach. There has beenphenomenal incremental increase in thenumber of bank branches during theperiod 1975-1985. Given thenationalisation of banks, the 1:4incentivised branch licensing policy, andthe lead bank scheme, there has been an

addition of 13689 and 18966 new bankbranches during the periods 1975-1980and 1980-1985. The incremental increasepercentage in number of bank branchescomes out to be 73.09% and 58.50%during the same periods. With thismassive growth the Indian banking systemdeveloped an appreciable extension andreach as it covered the areas which wereunbanked at the time of independence.The per branch population coverage came

down significantly from a high of 65000persons in the year 1969 to a pleasing lowof 14000 persons in the year 1985.

Similarly, there has been aremarkable improvement in area breakupof Indian banks. The Indian banks are nolonger confined only to metropolitan citiesand large towns. In fact, they have reachedout extensively to cover the rural areas andthe remote corners of the economy. Therural areas which were unbanked earlier

are now receiving banking facility. Thepercentage of bank branches in rural areawas a meagre 17.63% in the year 1969.This improved remarkably to about 59% bythe year 1985.

As such, in terms of the number ofbranches and its rural spread, the Indian

banking system became one of the largestbanking systems in the world. But, at thesame time, when the Government wasplacing over emphasis on branchexpansion policy, it was giving rise to avery serious problem. Since the problemwas in the making beneath the surface, itwas not in the awareness domain.Approaching the year 1990, when theIndian economy was caught in the worstever economic crisis, the problem came tosurface. The excessively increased numberof bank branches, the consequentexcessive increase in number of bankemployees, the spread of bank branches inrural areas, and the excessive lending to

priority sector started taking their toll onprofit and financial health of the banks.Together they caused a serious dent inbank profits. The erosion in profits wasrendering Indian banks weak and sick.Several banks were incurring losses andmost of the nationalised banks developed aweak capital base.

In order to stop the ill impacts of thepolicy of branch expansion and ruralspread of branches, it became all the more

necessary to withdraw the emphasis fromthe policy. Accordingly, the Governmentintroduced several reform measures whichmoved Indian banks to operate on marketprinciples. The bank branches are nowseen as profit centres and therefore theyare opened only if they present a profitablyviable prospect. From the perusal of theTable 1 and Table 2, it is evident that thetrend of increasing increase in the numberof bank branches and the trend of ruralspread of bank branches slowed down

significantly. The rate of increase in thenumber of branches came down to about4.38% in the year 1995 from a high of58.50% in the year 1985. Similarly, thetrend of rural spread of bank branchestook a reverse turn by the year 1990 whenthe share of rural branches in the total


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number of branches started declininginstead of increasing. From a high of58.74% share in the year 1985, the shareof rural branches declined to 42.53% inthe year 2007. New rural branches arebeing opened only if they present a viableand profitable picture.

While discussing the paradigm shifts,we have already noted that the bankingphilosophy has drifted from socialconcerns to viability, performance andprofitability. Accordingly, the bankingphilosophy now shows a predominant tilttowards market and business principles.In May 1992, the banks were given greaterfreedom in decisions relating to opening or

not opening of branches in a particular

area. As such, the earlier policy of forcingbanks to open rural branches was shownthe exit route. However, still the banks arenot allowed to close down rural brancheseven if such branches are loss making andnon-viable. But, they are allowed torationalise their branch network in ruraland semi-urban areas. They are allowed to:(i) relocate branches within the same blockand service area, (ii) shift their urban/metropolitan/port town centre brancheswithin the same locality, (iii) openspecialised branches, (iv) spin-offbusiness, (v) set up controlling offices oradministrative units, and (vi) openextension counters. This flexibility has

enabled banks to rationalise their lossmaking rural and semi-urban branches.

Table 1 : Trends in Branch Expansion

Total Number Increase Over the Population

Year of Branches Previous Period Coverage

Increase Incremental Increase Percentage

1969 8187 _ _ 65000

1970 13622 5435 66.39 41000

1975 18730 5108 37.50 32000

1980 32419 13689 73.09 20000

1985 51385 18966 58.50 14000

1990 59752 8367 16.28 14000

1995 62367 2615 4.38 15000

2000 65412 3045 4.88 15000

2005 68355 2943 4.50 16000

2007 71839 3484 5.10 15000

Source: 1. Statistical Tables Relating to Banks in India, RBI

2. Banking Statistics, 1972, RBI

3. Report on Currency and Finance, RBI, Various Issues


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Table 2 : Area Breakup of Bank Branches

Year Rural Semi-Urban Urban Metropolitan Total

1969 1443(17.63) 3337(40.76) 1911(23.34) 1496(18.27) 8187(100)

1970 4817(35.36) 4401(32.31) 2504(18.38) 1900(13.95) 13622(100)

1975 6807(36.34) 5598(29.89) 3489(18.63) 2836(15.14) 18730(100)

1980 15105(46.59) 8122(25.06) 5178(15.97) 4014(12.38) 32419(100)

1985 30185(58.74) 9816(19.11) 6578(12.80) 4806(9.35) 51385(100)

1990 34791(58.23) 11324(18.95) 8042(13.46) 5595(9.36) 59752(100)

1995 33004(52.92) 13341(21.39) 8868(14.22) 7154(11.47) 62367(100)

2000 32734(50.04) 14407(22.03) 10052(15.37) 8219(12.56) 65412(100)

2005 32082(46.94) 15403(22.53) 11500(16.82) 9370(13.71) 68355(100)

2007 30551(42.53) 16361(22.78) 12970(18.05) 11957(16.64) 71839(100)

Note: Figures in parenthesis are percentage to total.

Source: 1. Statistical Tables Relating to Banks in India, RBI

2. Banking Statistics, 1972, RBI

3. Report on Currency and Finance, RBI, Various Issues

3.2 Impact on Deposit Mobilisation:

Since the reform measures wereintroduced in the Indian banking sector in

the year 1991, the Indian banks haveassumed the core place in financialintermediation process. The spread andreach of Indian banks and their various

deposit schemes have helped themmobilise the savings of the Indians inwhopping proportions. Doing so they have

made available huge funds for productivepurposes and thereby have spurred andaccentuated the growthprocess. The datain this regard is presented in Table 3.

Table 3 : Average Growth Rate of Bank Deposits

Deposit Scheme Time Span

1951-52 to 1969-70 to 1984-85 to 1995-96 to

1968-69 1983-84 1994-95 2004-05

Demand Deposit 7.1 13.3 19.5 12.6

Time Deposit 13.1 22.7 18.2 16.4

Aggregate of Deposits 9.5 19.2 18.4 15.7

Source: Handbook of Statistics on the Indian Economy, RBI.

The Table 3 presents the data onaverage growth rate of bank deposits over

different time spans. A perusal of the Table3 reveals that the average growth rate of


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aggregate of bank deposits increasedremarkably from a low of 9.5% in postindependence pre nationalisation timespan (1951-52 to 1968-69) to a very high of19.2% in the post nationalisation timespan (1969-70 to 1983-84). Whilediscussing the extension and reach ofIndian banks we have seen the concertedefforts of the RBI and the Government ofIndia in spreading and developing a strongnetwork of banks and thereby in makingavailable banking facilities even in ruraland other areas which were unbanked atthe time of independence. The efforts of theRBI as an extended arm of the Governmentof India paid rich dividends. The banking

network increased enormously and soincreased the mobilisation of deposits. It ispleasing to note that the aggregatedeposits continued to increase at a veryhigh rate of 18.4% during the time spanranging in most near years of pre and post1990 period; the period in which theeconomy faced crisis and the reforms wereintroduced. The reform measures helpedthe Indian banks to maintain their highdeposit growth rate. This becomes all themore pleasing because the base

denominator (aggregate deposits in earliertime span) was very high. Even though thegrowth rate of aggregate deposits dippedslightly from 18.4% of the previous timespan, it still maintained its high growthrate at 15.7%. The slight dip in growth ratedoes not indicate anything negative orpoor. The rise in aggregate deposits inabsolute amount terms was there in thesame pleasing way. The rate of growthshows a slight decline for the obvious

reason that the base denominator in theform of aggregate deposits of earlier periodwas very high because of the enormousrise of deposits during that period.

3.3 Impact on Resource Mobilisation:

The post 1990 period has resulted intoa very laudable achievement of Indian

banks. This laudable achievement is morepleasing one because this has averted avery frightening problem that was presentin the system like a volcano and wasgaining strength beyond manageable

proportions. Analysis of component wisedata on total resource mobilisation byIndian banks digs out and unearths thislaudable and interesting achievement ofIndian banks in post 1990 period. Let uslook into and analyse the component wisedata on total resource mobilisation whichis presented in Table 4.

The components through whichIndian banks mobilise resources includecapital and reserves, deposits,

borrowings9, and other resources10. Thesein fact constitute the liability side of thebalance sheet of Indian banks. A perusal ofthe Table 4 reveals that deposits have beenthe main source of bankable funds forIndian banks until 1990. The share ofdeposits constituted a whopping 88.81%in total resources of Indian banks. Theshare of capital and reserves was a meagre1.59% of the total resources. The poorcapital base of Indian banks was indicativeof a very grim situation. A very high

proportion of deposits and a very poorcapital and reserves base were in factculminating into a very serious healthproblem of liquidity, solvency and overallstability of the Indian banking system.But, perhaps the RBI, the policy plannersand the economy managers failed to takenote of this grim situation. What was moreworrisome was the fact that by the year1980 the share of capital and reservesdeclined to 0.88% of the total liabilities.This amply reveals the serious healthproblem of the Indian banks that wasdormant and was in the simmering like asilent volcano. Had that silent volcano offinancial ill health of Indian banks burst atthat point of time, the situation would havegone beyond control of the RBI and theGovernment of India.


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The problem was serious and wasgaining strength day by day as theproportion of deposits continued to be veryhigh with a very low proportion of capitaland reserves. Even though the share ofdeposits in total resources of banks camedown slightly from 88.81% in the year1970 to 81.69% in the year 1990, there

was no improvement in capital andreserves base. The share of capital andreserves remained just 1.94% of the totalresources of the banks. The major chunkof the decline in deposits was replaced by

borrowings; a resource item which is morerisky than the deposits.11 The proportion of

borrowings that was 6.22% in the year

1970, increased to 9.70% of the totalresources of banks.

Thanks to God that the frighteningvolcano of financial ill health of Indianbanks did not burst. The Indian economyfaced a balance of payment crisis whichassumed serious proportions by the year1990. This economic crisis forced the

Government and the economy managers tointroduce massive reforms. With economicreforms came the reforms in Indian

banking system. Under the impact ofcapital adequacy and Basel I reformmeasures which were introduced in the

year 1992-93, the problem of liquidity,solvency and overall stability of the Indian

banking system started reversing in thepost 1990 period. By the year 1995, theshare of capital and reserves increased to5.89% from a frightening low of 0.88% ofthe year 1980. The proportion of capitaland reserves continued to increase overthe years. Rising from a low of 0.88% of the

year 1980, it increased to 7.29% by the

year 2008. Similarly, there has been awelcome decline in the share ofborrowings. The share of borrowingswhich had risen to 9.70% in the year 1990,declined to 6.87% with intermittent periodups and downs. This undoubtedly is a very

welcome achievement of Indian bankingsystem in the post 1990 period.

Table 4 : Resource Base of Indian Banks

(Amount In Rs. Crore)

Year Capital and Reserve Deposits Borrowings Other Total

1970 115.99(1.59) 6,479.31(88.81) 453.88(6.22) 246.34(3.38) 7,295.52(100)

1975 211.29(1.21) 15,666.51(89.37) 1,003.72(5.73) 647.63(3.69) 17,529.15(100)

1980 511(0.88) 42,653(73.79) 2,475(4.28) 12,161(21.04) 57,800(100)

1985 1,789(1.33) 1,00,205(74.61) 7,886(5.87) 24,432(18.19) 1,34,312(100)

1990 4,814(1.94) 2,02,414(81.69) 24,025(9.70) 16,536(6.67) 2,47,789(100)

1995 30,263(5.89) 4,06,119(79.10) 25,452(4.96) 51,565(10.04) 5,13,399(100)

2000 59,927(5.41) 9,00,307(81.27) 45,360(4.09) 1,02,257(9.23) 11,07,851(100)

2005 1,45,570(6.19) 18,37,559(78.15) 1,68,351(7.16) 1,99,989(8.50) 23,51,469(100)

2008 3,15,554(7.29) 33,20,052(76.74) 2,97,349(6.87) 3,93,520(9.10) 43,26,475(100)

Note:Figures in parenthesis are percentage to total.

Source:Statistical Tables Relating to Banks in India, RBI, Various Issues


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3.4 Impact on Capital Market Activities:

Prior to 1990, the Indian bankingsystem was made to remain cut off fromthe Indian capital market as it was not

allowed to raise capital from the capitalmarket. The public sector banks, whichwere predominantly the largest player ofthe Indian banking system, were notallowed to access the capital market toraise funds by issuing shares and othersecurities so that the exclusive control andownership of the government was notdiluted. As such, a very importantfinancial sector player was kept aloof fromplaying a very crucial role in the financialsystem. This caused dual loss to the

system. While it deprived the public sectorbanks to get resources from the capitalmarket, at the same time, it also deprivedthe financial system to get the advantagethat would have come to its fold frombanking sector share issues andconsequent trading of such shares in thestock market. While discussing theresources base of Indian commercialbanks, we have had the glimpse of thisproblem. We have seen that the share ofdeposits constituted a whopping 88.81%in total resources of Indian banks and theshare of capital and reserves was a meagre1.59% of the total resources. By the year1980 the share of capital and reservesdeclined to 0.88% of the total liabilities. Assuch, the Indian banks developed a verypoor capital base because they were deniedto access the capital market for raisingcapital and were made to depend ongovernment for capital support.

In October 1993, realising the

seriousness of the problem of liquidity,solvency and overall stability of the Indianbanking system, the Government of Indiapermitted the public sector banks toaccess the capital market for directlyraising funds from public. Since then,many public sector banks, including the

SBI, have come out with several capitalissues. The capital issues by them havestarted yielding positive results. Ouranalysis of table 4 has revealed that in thepost 1990 period the capital base of banksin relation to deposits has improvedsignificantly. This has given enoughcushion, liquidity, and stability to banks.Further, the capital issues by Indian bankshave fostered capital formation in theeconomy. Capital issues by public sectorbanks reflect mopping up of the savings ofIndian public and then channelling of thesame to productive avenues.

Further, as the private sector in Indiahas been allowed to open bankingcompanies, a host of new private sectorbanks have come into existence. The newprivate sector banks by offering publicissues have raised capital from the capitalmarket and thus have given a fillip to

capital formation in the economy. Up tillend-March 1999, eight public sectorbanks and nine new private sector bankshad raised capital through equity issuesfrom the new issues market. Opening up ofnew private sector banks and the

permission to public sector banks toaccess capital market has not onlybenefited the new issue market. Thebenefit is being received by the secondarymarket also. The number of banks listedon recognised stock exchanges registered

a welcome increase. It increasedsignificantly from a paltry 6 scheduledcommercial banks in 1994-95 to 28scheduled commercial banks in 1998-99.By the end March 1999, the shares of 8

public sector banks and of 17 privatesector banks were listed for secondarymarket trading on the National StockExchange of India.

The data on resources raised by banksfrom the primary market in recent years isgiven in Table 5. The table reveals that


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barring the year 2006-07, the resourcesraised by banks from the primary markethave registered a continuous increase.

While in the year 2004-05 the scheduledcommercial banks, both in the public andprivate sectors, raised in total Rs. 8,922Crore, the resources raised by themincreased significantly to Rs. 11,067 Croreduring the year 2005-06. However, duringthe year 2006-07 the banks did not showmuch appetite for resources as they raisedonly Rs. 1,066 Crore from the market. But,during the year 2007-08, the banksaccessed the Indian primary market with a

bigger appetite and demand for funds.During the year 2007-08, the banks raised

a whopping Rs.30,455 Crore from themarket as against Rs.1,066 Crore raisedduring the year 2006-07. It is pleasing tonote that banks are not only strengtheningtheir capital base in keeping with the BaselII norms, they are also giving a fillip todomestic primary market by raising fundsfrom there.

Another equally significant trend isvisible from the table 5. The Table showsthat the banks and the subscribing public

both favoured the equity issue. Moppingup over 80% funds through equity issuesloudly speaks about the rising confidenceof Indian public in Indian banks. This factis also vindicated by the share of bankstocks in market capitalisation. In recentpast, the bank stocks have constitutedabout 7% of market capitalisation of theIndian equity market. During the year2008 the share of bank stocks had evengone beyond 8% of the total marketcapitalisation. Similarly, if we look into

turnover of bank stocks the same pictureis revealed. The share of turnover of bankstocks in total turnover has shown a risingtrend in the recent past. It has increasedfrom 5.3% of the year 2006-07 to 6.6%during 2007-08. The data up to December2008 shows that the share of turnover of

bank stocks has even gone up to 11.5% ofthe total turnover of all stocks.

Table 5: Resources Raised by Banks from

Primary Market

(Rs. Crore)

Year Total Grand Total

Equity Debt

2004-05 7,444 1,478 8,922

2005-06 11,067 _ 11,067

2006-07 1,066 _ 1,066

2007-08 29,955 500 30,455

Source:Report on Trend and Progress

of Banking in India, RBI, Various Issues

Table 6: Share of Bank Stocks in Total Turnover

and Market Capitalisation

(in %)

Share of

Year Share of turnover capitalisation

of bank stocks in of bank stocks

total turnover in total market

Capitalisation

2005-06 6.8 7.1

2006-07 5.3 6.8

2007-08 6.6 7.2

2008-09 11.5 8.8

(Up to

December

3, 2008)

Source: Report on trend and Progress

of Banking in India, RBI.

3.5 Impact on Lending Activity of Banks:Prior to reforms in banking sector in

India, the lending by banks was highlycontrolled and regulated. The interestrates were administered, lendingresources of banks were subjected to a

very high level of pre-emption, and


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allocation freedom was limited to directedflow of credit to certain sectors. As such,the Indian banks did not enjoy the decisionfreedom in allocation of their bankableresources among different sectors of theeconomy as also among different assetclasses.

However, the situation in this regardstarted changing under the impact ofreforms in banking sector. The reforms aremoving the banking sector towards an eraof choice and decision making; away froma controlled and directed regime. Underthe influence of reforms banks are now freeto select lending opportunities to a greaterextent. They are free to decide their lending

rates and to determine the price of theirbanking products. This decision freedomin allocation of resources is impartingefficiency to the Indian banking system.

This is evident from the data given in theTable 7.

A perusal of the data given in the table7 reveals that under the forced anddirected financial regime the total creditextended by scheduled commercial banksgrew at a faster pace during the period

1972-1980 and 1980-1990. The totallending by banks increased 3.84 fold and4.90 fold during the periods 1972-1980and 1980-1990 respectively. This high rateof growth of forced lending during thecontrolled and directed financial regimedid serve the purpose of policy planners ofmaking credit available to various sectorsof the economy. But, at the same time thisinflicted losses on Indian banks andresulted into erosion of their financial

health. It was because of this, the trendwitnessed a slowdown immediately afterthe year in which the reforms wereintroduced in the Indian banking system.

Introduction of prudential normsrelating to income recognition, assetclassification and provisioning resulted

into shrinkage of lending capacity ofbanks. These norms on being applied onbanks brought to surface the losses andthe large size of gross non-performingassets (NPAs) of banks. During the years1992-93 and 1993-94, the yearsimmediately after the implementation ofprudential norms of income recognitionand asset classification, the Indian banksreported a total loss of Rs. 4150 Crore andof Rs 3624 Crore respectively. Banks,therefore, became over cautious and waryof expanding the lending. They startedpaying more weight to safety and returnpotential of loan proposals. This resultedinto slight slowdown in lending. While the

increase in lending was 2.09 fold duringthe period 1985-1990, it dropped downslightly to 2.02 fold during the period1990-1995.

The slowdown in lending activity wasreversed during the next period of five

years as the banks got attuned toparadigm shifts and changed businessscenario. They became strategically moreastute in doing business and thereforethey started reporting profit and their

NPAs started declining. Accordingly,during the period 1995-2000 and 2000-05, the credit from banks increased 2.18fold and 2.51 fold respectively.

Apart from analysing the trends inlending by banks, the sectoral breakup oflending has also been analysed. Whilediscussing the trends in lending it wasobserved that having incurred loss duringthe years 1992-93 and 1993-94, the banksstarted reporting profit thereafter. Banksstarted earning profit not only because

they were given freedom to decide lendingrate, but also because they shifted theirlending focus to more lucrative lendingoptions, i.e. to professional and personallending. A perusal of the Table 7 revealsthat the Indian banks increased personaland professional lending. In the year 1990,


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personal and professional lendingaccounted for just 9.39% of the totallending by banks. In years after theintroduction of prudential norms, theshare of personal and professional lending

by banks increased continuously. Risingfrom 9.39% in the year 1990, the share ofpersonal and professional lendingincreased to 28.51% in the year. Theincreased share of personal andprofessional lending by banks helped themearn returns at higher rates.

Analysis of lending by banks onsectoral breakup reveals anotherimportant change. This change came as adecline in the share of agriculture in total

bank lending. The Table reveals thatduring first half of 1980s, the share ofagriculture in total bank credit increased.

This increased from 14.79% in the year1980 to 17.64% in the year 1985. Thenafter, the share of agriculture came downto 15.94% in the year 1990. The share of

agriculture continued to decline and camedown sharply to 9.92% by the year 2000. Itis interesting to look to this decline in theshare of agriculture in total bank lending.If we look to it from banks point of view, thedecline in the share of agriculture becomesa pleasing change. Lending to agriculturehas always been viewed as high risklending because agriculture is a vagary ofmonsoon in India. Decline in the share ofagriculture in total bank lending thusreflects a reduction in risk proposition for

banks.

Contrary to the above, if we look todecline in share of agriculture in total

bank lending from nations point of view,

this becomes a displeasing change.Agriculture is an economic activity in Indiawhich employs and absorbs the largestnumber of people in India. A majority ofthe people who depend on agriculture aresmall and marginal farmer who need thecredit support from banks on easy terms.

Table 7: Lending to Various Sectors of the Economy

(Amount In Rs. Crore)

Year Agriculture Industry, Professional Various Total

Trade and and LendingTransport Personal

1968 0.67(3.14) 20.68(96.86) 21.35(100)

1972 500.91(9.02) 4308.92(77.60) 275.59(4.96) 467.65(8.42) 5553.07(100)

1975 968.70(10.75) 6968.68(77.34) 484.81(5.38) 588.83(6.53) 9011.02(100)

1980 3152.04(14.79) 15891.95(74.57) 1171.55(5.50) 1096.07(5.14) 21311.61(100)

1985 8820.24(17.64) 34743.67(69.50) 3208.53(6.42) 3222.13(6.44) 49994.57(100)

1990 16626.07(15.94) 68618.16(65.78) 9791.28(9.39) 9276.44(8.89) 104311.95(100)

1995 24948.02(11.83) 136294.74(64.61) 23810.54(11.29) 25885.80(12.27) 210939.10(100)

2000 45638.27(9.92) 293471.96(63.79) 66291.59(14.41) 54678.86(11.88) 460080.68(100)2005 124384.87(10.79) 590191.44(51.21) 311246.92(27.01) 126644.70(10.99) 1152467.93(100)

2007 230191.08(11.82) 972831.72(49.96) 555018.11(28.51) 189058.71(9.71) 1947099.62(100)

Note: Figures in Parenthesis denote percentage share in total lending by banks.

Source: Statistical Tables, Banking Statistics, and Report on Trend and Progress ofBanking in India


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Banks shifting away from lending toagriculture caused hardships to small andmarginal farmers and to certain extentsuicides committed by farmers may beattributed to it. This necessitated policyintervention on the part of the Governmentand RBI to direct credit to the agriculturalsector. Interventions from the Governmentand the RBI reversed the trend back infavour of agriculture. Accordingly, theshare of agriculture in total bank lendingstarted increasing. It increased from 9.92% in the year 2000 to 10.79% in the year2005 and to 11.82% in the year 2007.

3.6 Impact on Profit Position of Banks:

The data on total profit of banks ispresented in Table 8. A perusal of the tablereveals that the profits of Indian banks

vanished immediately after theimplementation of prudential norms ofincome recognition and assetclassification. It is surprising to note thatthe Indian banking system that wasreporting increasing profits up till 1990-91, reported a loss all of a sudden whennew prudential norms were introduced. Infact, the reality lies in reading in between

the lines. The total profit as reported bybanks was not profit at all. It was in fact aloss that appeared as profit in the absenceof prudential norms. Therefore, with theimplementation of prudential norms, theprofit of Indian banks vanished and in the

year 1992-93 and 1993-94 banks reporteda huge loss of Rs 4150 Crore and of Rs.3624 Crore respectively.

At this juncture, it would beinteresting to dig out the reasons which

caused loss in the disguise of profit tobanks. In the pre reform period, theprudential norms of asset classificationand income recognition were not there. Assuch, banks in India not only calculatedincome on NPAs, but they also countedthem in their profit. This income vanished

immediately with the implementation ofprudential norms as banks were asked notto calculate and count income on NPAs. Atthe same time, not only the income onNPAs vanished, the provisioningrequirements ate up the huge portion ofthe income of the banks. This convertedthe profit of banks into loss and therebyexposed the reality of profits reported by

banks in pre-reform period.

Apart from the prudential norms ofasset classification, provisioning thereof,and income recognition, there were tworoot-cause reasons responsible for lossesincurred by the Indian banks. Thesereasons included a very high and stringent

pre-emption of funds in the form of CRRand SLR, and flow of credit to directedsectors at concessional rates. So far as theflow of credit to directed sectors atconcessional rates is concerned, the samehas already been examined in terms of itshidden impact on profit/loss of banks.

Therefore, the discussion here is focusedon examining the impact of reserverequirements on profit/loss of banks.

The Indian banking system requires

Indian banks to maintain two reserves inthe name of Cash reserve Ratio (CRR) andStatutory Liquidity ratio (SLR). CRR is areserve requirement that forces Indian

banks to hold a portion of their deposits(net demand and time liabilities DTL) inthe form of cash balances with the RBI.

While in the past the CRR balances beyondthe 3 percent basic statutory reservesreceived a high interest rate, the gradualincrease to higher levels of such balances

did not get any interest. Obviously, a veryhigh portion of deposits of banks did notearn any return, whereas on these the

banks incurred cost as interest paid todepositors. Ultimately this reflected itselfin deteriorating profit performance of

banks.


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SLR is a reserve requirement thatforces Indian banks to invest a portion oftheir net DTL in Central and StateGovernment and other approvedsecurities. Initially the SLR levels werereasonable. With the passage of time, asthe fiscal deficits in India increased, theGovernment was forced to borrow largeamounts from non-RBI sources. In order tomake resources easily available, theGovernment increased SLR repeatedly tohigher levels. This is how the banks weregradually made to invest an increasinglyhigh proportion of their bankableresources in low yield Governmentsecurities.

In late 1980s, the two reserverequirements in the form of CRR and SLRconsumed about 55% to 60% of deposits ofbanks as the same was to be depositedwith the RBI or invested in Governmentsecurities.12 As a consequence, the bankswere left with residue funds (about 45% to40%) to invest profitably. The banks wereforced to recover the cost of total depositsfrom the residue of bankable resources attheir disposal. Banks therefore did chargea very high interest rate on residue portionof the funds that they lent. But this policyof banks went against them as theborrowers finding the cost of capital toohigh from banks switched over to othercheaper sources of finance. As such, thehigh levels of CRR and SLR ultimatelyreflected themselves in deteriorating profitposition of banks and when the prudentialnorms were introduced the loss of bankssurfaced.

The prudential norms served the

purpose and delivered the great good bybringing to surface the loss that wasbuilding up and accumulating in thedisguise of profit. Accumulation of loss inthe garb of profit would have become aproblem beyond manageable proportions,had the same was not defused by the

prudential norms well in time. Theprudential norms not only defused thedangerous problem of disguised loss, theyalso resulted into making Indian banksmore business oriented and profit focused.Accordingly, after the loss years (1992-93and 1993-94) the Indian banks startedearning profit. The banks reported a totalprofit of Rs. 2122.81 Crore in the year1994-95. Registering a 3.41 fold increaseover the profit of the year 1994-95, thebanks reported a total profit of Rs. 7245.25Crore in the year 1999-2000. The totalprofit of banks again registered a 5.89 foldincrease and touched a high of Rs.42725.87 Crore in the year 2007-08.

The reversal in loss scenario andcontinuous improvement in total profit ofbanks may be attributed to lowering downof reserve requirements and shifting oflending focus to professional and personallending at higher interest rates. Loweringdown of CRR and SLR requirements hasalready been examined earlier in this verysection. It clearly emerged from thediscussion that low reserve requirementshave made larger bankable funds available

to banks to invest and lend at profitablerates. Similarly, while examining thesector breakup of lending by banks, it isrevealed there that directed lending toagriculture at concessional rates has gonedown and the share of personal andprofessional lending by banks hasincreased from 9.39% in the year 1990 to28.51% in the year 2007. The increasedshare of personal and professional lendingby banks helped them earn returns athigher rates.

3.7 Impact on Financial Health of Banks:

The starting point for discussion inthis section finds its logical underpinningin the fact that financial health is a matterof profit and therefore financially soundbanks need to be profitable. Under the


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framework of prudential norms, profitsvindicate that banks have low NPAs andmaximum of their assets are performingassets. Profits also ensure that interestand other earnings of banks have fullycovered the total expenses after due

provisioning for loss and doubtful assets,for tax liabilities, and for depreciation invalue of investments. Contrary to this, lossmaking banks imply erosion in capital andreserves. Once the losses of banks eat upand exhaust their capital and reserves,they begin to erode deposits.

Seen in above perspective, thefinancial health of Indian banks hascertainly improved with steady profitsbeing reported by them in years after the

implementation of prudential norms. Inthe earlier section, we have seen that theprudential norms and lowering down ofreserve requirements have helped theIndian banking system in wiping off thelosses and then in earning profit. Afterreporting loss in years 1992-93 and 1993-

94, the Indian banks reported a total profitof Rs. 2122.81 Crore in the year 1994-95.However, the profit of banks dipped to Rs.832.16 Crore in the year 1995-96. The dipin profit was caused primarily by the heavyprovisioning requirements for NPAs as the

RBI asked all Indian banks to provideadequately for uncovered NPAs. Sincethen, the Indian banks are reportingincreasing profit except for the years 1998-99, 2000-01, and 2004-05 when theprofits instead of increasing dippedslightly. Once the backlog provisioning forNPAs was achieved, the profit of banksstarted increasing. This is evident from a3.41 fold and 5.89 fold escalations in profitof banks during the periods 1994-95 to

1999-2000 and 1999-2000 to 2007-08.Banks earning profit and profit of

banks increasing many folds over the yearsindicate that the financial health of Indianbanks has improved and is improvingcontinuously. Larger profits earned bybanks over the years are indicative of the

Table 8: Trends in Total Profit

Year Total Profit (Rs. Crore) Year Total Profit (Rs. Crore)

1970 139.63 1997-98 6501.84

1975 31.2 1998-99 4659.50

1980 51.28 1999-2000 7245.25

1985 123.55 2000-01 6424.10

1990-91 743 2001-02 11576.06

1991-92 1200 2002-03 17077.22

1992-93 -4150 2003-04 22270.94

1993-94 -3624 2004-05 21320.16

1994-95 2122.81 2005-06 24581.77

1995-96 832.16 2006-07 31202.61

1996-97 4504.24 2007-08 42725.87

Source: Banking Statistics, RBI.


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fact that the financial assets (loans,advances, and investments) of banks arenow predominantly performing assets.This implies a welcome decline in NPAs ofbanks.13 Decline in NPAs also signifies animprovement in the financial health ofbanks.

Further, the profit earned by bankshas enabled them to develop a fullprovision cover for loss asset category ofNPAs, and a stipulated provision cover forother asset categories of NPAs.14 Theproper provisioning cover for various assetcategories of NPAs is again a testimony tothe fact that the Indian banks are nowfinancially more healthy and sound.

Another fact which reveals theimproving financial health of banks is thefact that most of the banks have nowachieved the minimum capital adequacynorm of 8%.15 Minimum capital adequacyensures that the banks have sufficientcapital and reserves to protect theirdepositors and creditors from the businessrisk that the banks in general bear in thecourse of banking business. In the startinglines of this section we have seen that loss

making banks eat up their capital andreserves and once the capital and reservesare fully eaten up, the losses incurred bybanks start inflicting their damagingimpact on depositors by eroding thedeposits. Erosion in deposits shakes theconfidence of general public and therebybreeds an environment of disbelief anddistrust. The environment of disbelief anddistrust spreads faster and engulfs theentire economy in no time. The present

banking crises and turbulence in UnitedStates of America is an evidence enough toprove this point. Even the Indian economywas heading towards this quagmire in late1980s.

This issue we have already analysedwhile discussing the composition of

resource base and mobilisation ofresources by Indian banks. Our analysisthere (Table 4) has revealed that in late1970s and early 1980s a very highproportion of deposit against the very poorcapital and reserves base was breeding themost serious health problem of liquidity,solvency and overall stability of the Indianbanking system. By the year 1980 theshare of capital and reserves had declinedto 0.88% of the total liabilities. Thisserious health problem of the Indian bankswas dormant and was in the simmeringlike a silent volcano. Remaining dormantthe problem was gaining strength day byday. India was fortunate enough that the

frightening volcano of financial ill health ofIndian banks did not burst. In the meantime the economy was caught in balance ofpayment crisis and to tackle the problemthe economy managers resorted toeconomic reforms. As a natural corollary toeconomic reforms, came the reforms inIndian banking system. The bankingsystem received massive doses of reformmeasures in the name of prudential normsand capital adequacy.16 Under the impactof these reform measures the problem ofliquidity, solvency and overall stability ofthe Indian banking system startedreversing in the post 1990 period. We haveseen that by the year 1995, the share ofcapital and reserves increased to 5.89%from a frightening low of 0.88% of the year1980. The proportion of capital andreserves continued to increase over theyears and it increased to 7.29% by the year2008. This undoubtedly has been a verywelcome achievement of Indian banking

system in the post 1990 period.

4. IDENTIFYING THREATS AND

SUGGESTIONS THEREOF:

In the earlier section we haveidentified and discussed the achievementsof Indian banks under the impact of


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reforms in the post 1990 period. Theachievements certainly reflect a pleasingturnaround. While they have arrested thefurther deterioration of the Indian bankingsystem, they have also extended a newstrength and business orientation toIndian banks. But the paradigm shifts andthe changes taking place in the currentmacro-economic environment in nationaland international arena are giving rise tonew threats and challenges. As such, it

becomes all the more necessary to identifythe threats and challenges being thrown

by paradigm shifts and environmentalchanges in the Indian banking system. Themajor threat issues and challenges being

faced by the Indian banking system couldbe identified and drawn out from ourdiscussion in earlier section on paradigmshifts in Indian banking system. Thethreat issues and challenges emanatingfrom the paradigm shifts are as follows:

4.1 In the post 1990 period andparticularly in the recent past, the Indianeconomy has surged ahead on to a highgrowth trajectory under the impact ofreform measures. The growth rate of the

Indian economy during the period 2003-04to 2007-08 on an average has been above8%. This was made possible by a welcomeincrease in the investment and savingsrate. The investment rate has gone up fromabout 22% in 2001-02 to about 35.9% in2006-07. The rise in investment rate wasfacilitated by the rise in saving rate whichincreased from 23.5% in 2001-02 to 34.8%in 2006-07. In our analysis of loans andadvances extended by banks, we have seenthat the same has registered a rise of 2.18

fold during the period 1995-2000 andagain a rise of 2.51 fold during the period2000-05. It becomes evident here that theIndian economy succeeded in maintainingits growth momentum because the Indian

banking sector moved in tandem with andextended the support demanded by the

growth momentum. This fact also brings tosurface the hidden challenge before the

banking system. The Indian bankingsystem will have to be on toes in keeping

with the high growth demands of theIndian economy. In order to fuel andsustain the growth momentum, the

banking system will have to acceleratesavings mobilisation and credit extension.

This critically calls for a more efficientintermediation between savers andinvestors.

4.2 For a high trajectory growtheconomy, investments demand forfinancial savings; and not the physicalsavings. The physical savings of the

economy largely remain unproductive asthey cannot be channelled to productiveavenues. As such, the Indian banks arefacing a new challenge of enhancing andfostering the mobilisation of financialsavings in the economy. Even though thefinancial savings have increased over the

years in the economy, but the investmentdemand would certainly require asubstitution of unproductive physicalsavings into financial savings. Similarly,

the enormous untapped savings potentialof rural and semi-urban areas requires tobe tapped for financing the high trajectorygrowth of the economy. Transformation ofunproductive physical savings intofinancial savings and mobilisation of yetuntapped savings potential of rural andsemi-urban areas requires a moreinnovative banking system which couldoffer innovative and cost effective productsas per the need of the holders of suchsavings.

4.3 While discussing the reformmeasures and paradigm shift, we haveseen that easing of governmental controland giving of greater operational flexibilityare exposing Indian banks to a highlyuncertain and rapidly changing marketenvironment. This in turn is pressing for a


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change in managerial orientation of banks.The banks, now in the changed paradigm,need to be managed strategically so thatthey can withstand the changes in marketforces of interest rates, foreign exchangerate, and prices of other assets in theeconomy. If banks fail to anticipatechanges in interest rates, exchange rateand prices of other assets in the economy,they quite naturally will fail in taking pre-emptive actions as also in formulating asuitable strategic response well in time tocounter the adverse impact of suchchanges. This danger is something thatcould not be well dealt with any reformmeasure for this is an offshoot of the

reform process itself. Therefore, what isneeded is a better management ofuncertain and furious future with strategicintent.

4.4 We have seen that increasingglobalisation of the Indian economy hasgiven rise to a new paradigm shift in termsof greater exposure of Indian banks toglobal financial system and economicenvironment. Any financial and economichappening in any part of the world

transmits its impact on the Indianeconomy immediately. It was because ofthis the recessionary economic conditionsand the turbulence in the Americanbanking sector had its toll on the Indianeconomy and on the Indian bankingsector. The turbulence in the Americanbanking system as caused by the Failure ofLeehman Brothers has transmitted its illimpact to the Indian banking system andhas landed Indian banks into deep sea.The worry and panic relating to the ICICI

Bank, the largest and strongest privatesector bank in India, amply reveals thisfact. Not only the management of the ICICIBank had to come forward with tall claimsand reassurances on their financialstrength, the Government of India also hadto reaffirm the claims made by the ICICI

Bank management in order to prevent theslide into ocean of problems. The point isthat the paradigm shift in the form ofincreasing exposure of Indian banks toglobal economic environment calls fordeveloping a strong battery ofprofessionally educated and trainedbanking experts who are capable andprudent enough to read the globaleconomic and financial events well in time.For ensuring the supply of professionallyeducated and trained banking experts, theGovernment of India should think forestablishing specialised academicinstitutions for banking education at parwith IITs and IIMs.

4.5 Another very crucial threat isemanating from free market developmentsin India. Under the impact of free marketdevelopments, the Indian banks cannotafford to continue with high concentrationof lending to one or two booming sectors ofthe economy. High concentration of banklending, as was the practice of Indianbanks in the pre 1990 period, is bound tolead to asset price bubbles, which if burstsunder the impact of adverse changes

taking place in the domestic economy orthe world economy would land such banksin quagmire of crisis. And, it would then bevery difficult for such banks to come outfrom that crisis. Thus, there is a pressingneed for Indian banks to take note of thisparadigm shift in their lending andinvestment activities. While constructingtheir lending and investment portfolio,they should construct a well diversifiedinvestment portfolio instead ofconcentration of lending in boom led one

or two sectors of the economy.4.6 A very serious threat is emanating

from an increased interdependence of theIndian banking system on the micro andmacro level economic activities andcorresponding economic policies. This ismaking Indian banking system more open


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to systemic psychological swings leadingto a threat of reactive-response behaviouron emotional inputs than on reason andrational inputs. In the Indian economy,which is characterized by rising financialand economic complexities, perceptionsand expectations have started playingcrucial role in controlling and shaping theaction response of people in general. Inthis perspective, it becomes all the morenecessary to devise such mechanismswhich could be used to preventpsychological reaction response fromcausing a landslide erosion of publicconfidence in banking system. If such amechanism is not in place and the

psychological reaction response behaviourof people is ignited by any fear causingevent, then the same fear causing eventwill become the general behaviour ofpeople with cascading and snowballingimpact. Ultimately the same will take theentire banking system into its grip. Therecent fear psyche crisis that the ICICIBank faced amply reveals the threateningpropositions of this fact. Therefore, thepolicy planners should read the writing onthe wall and think for devising amechanism which could be used toprevent psychological reaction responsefrom causing a landslide erosion of publicconfidence in banking system.

4.7 Even though the profit position ofIndian banks has improved under theimpact of reforms, banking in India is stilla high-cost banking. What is moreworrisome is the fact that expenditure ofIndian banks in recent past has shown arising trend in absolute terms. It increased

by 33.9% during 2007-08 as comparedwith 24.1% in the previous year. The non-interest or operating expenses of banksincreased by 16.4% during 2007-08 ascompared with the 12% in the last year.Similarly, the Wages bill of banksincreased at a somewhat higher rate of

10.1% in 2007-08 as compared with 8% inthe previous year. 17 The point of worry isthe fact that these expenses are increasingin the face of computerization of banks anduse of ATMs. The guiding logic forcomputerization of banks and use of ATMswas underpinned in registering asubstantial reduction in wage bill andother operating costs of banks. Byspending heavily a wide spread network ofATMs have been created and the bankshave been computerized to a greaterextent, but still the expected reduction inwage bill and other operating costs ofbanks is not visible. In the absence of afocused study on the issue nothing could

be said conclusively. But still whatappears on the face is not a welcomesituation. The Indian banking is still a highcost banking which leads to anuneconomical banking wherein the profitsare suppressed by the operating expenses.The pressure of suppressed profits leads toanother problem. The banks are thenforced to earn a relatively high interestincome by charging a high lending rate. Ahigh interest rate on lending has itsadverse impact on financial intermediationand as also on the economic growth. Assuch, there is an urgent need to have adeeper look into cost composition ofbanking in India. The RBI should think interms of constituting an expert committeeto have a focused study on costcomposition of banking in India.

4.8 While discussing the paradigmshift we have seen that competition inIndian banking sector has increasedtremendously. We have seen that entry

norms for banks have been relaxed. Assuch, a good number of new private bankshave entered the Indian market. Similarly,the number of foreign banks has alsoswelled significantly. All this is furtherheightening competition in the Indianbanking sector. The heightening


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competition is giving rise to a very seriouschallenge for Indian banks. Let us considerthe case of structural spread of ourbanking system. Extending from remoterural corners to semi-urban, urban andhighly developed areas of India, thestructural spread of the Indian bankingsystem is far and wide. What is worrisomein this is the fact that such a vaststructural spread of banking system inIndia yet operates without the scaleeconomies. The banking network is vastbut the banks and their branches are notreceiving the scale economies due to theirsmaller size in general as also due tofragmented organisational structure of

banks. In heightened competitive businessenvironment, size is becoming strategicallymore important for Indian banking system.The issue of scale economy is furthermarred by the multi-tier multi-bankbanking system. The multi-bankingsystem has resulted into several banksoperating their branches in the sameareas. This makes them incur heavy costin creating and running a branch for athinner share in business of the area.Similarly, the multi-tier banking system inthe form of commercial banks, co-operative banks, regional rural banks,non-bank financial companies, and specialfinancial institutions entails unnecessaryorganizational, structural, and systemiccosts. Therefore, in order to eliminate theunnecessary organizational, structural,and systemic costs and to make thebanking system more efficient, the RBI andthe Government of India should think interms of doing away the multi-tier system

of banking by developing a unified system.Further, the number of banks which runoverlapping branches should also bereduced by merging them. This will helpincrease the size of banks as also will helpconsolidate the business to a few strongerplayers. This is absolutely necessary for

enabling banks to get scale economies andwithstand the rising competition.

SELECT REFERENCES:

1. Ahluwalia, Isher and I.M.D. Little (1998)

Indias Economic Reforms and DevelopmentOxford University Press, Delhi.

2. Another Money Rate Cut, Indian

Management, April 2002.

3. Balachandran, G. (1998), The Reserve Bank

of India, 1951-1967, Oxford University

Press, Delhi.

4. Business Today, January 20, 2002.

5. Government of India (1998), Report of the

Committee on Banking Sector Reforms

(Chairman: Shri M. Narasimham),

Government of India, New Delhi.

6. Indian Economy 1950-2000-2020, Y. V.Reddy, in Indias Economy in the 21st

Century, 2nd Edition, Academic Foundation,

New Delhi.

7. Memorandum of Economic Policies Sent to

International Monetary Fund for 1991-92 &

1992-93 (The memorandum as sent to IMF

by the Finance Minister, Dr Manmohan

Singh, on August 27, 1991, and circulated in

Parliament on December 16, 1991.

8. Mohan, R. (2002), A Decade After 1991: New

Challenges Facing the Indian Economy, 28th

Frank Moraes Memorial Lecture organised by

United Writers Association and the Frank

Moraes Foundation., Website Copy, RBI.

9. Mohan, R. (2002). Transforming Indian

Banking: In Search of a Better Tomorrow,

Valedictory address at the Twenty-Fourth

Bank Economists Conference, Bangalore,

RBI Bulletin, January 2003.

10. Rangarajan, C. (1993), Autonomy of Central

Banks, Fifty Years of Central Banking

Governors Speak, RBI

11. Rangarajan C (1998) Indian Economy:

Essays on Money and Finance, UBS

Publishers, New Delhi.

12. Reasonable Proposition, Business India,

April 29 to May 12, 2002.

13. Reserve Bank of India (1991), Report of the

Committee on the Financial System

(Chairman: Shri M.Narasimham), RBI,

Mumbai.


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14. RBI, Handbook of Statistics on Indian

Economy, Various Issues.

15. RBI, Trend and Progress of Banking in India,

Various Issues.

16. RBI, Report on Currency and Finance,

Various Issues.

17. Saggar, S. (2005), Commercial Banks in

India, Deep & Deep Publications, New Delhi.

18. Statistical Tables Relating to Banks in India,

1947, RBI.

Footnote1 The new Government that took office on June 21,

1991 inherited an economy in deep crisis. The balance

of payments situation was precarious, with reserves at

a low level and the weakening of international

confidence having resulted in a sharp decline in

capital inflows through commercial borrowing and

nonresident deposits. The origins of these problems are

directly traceable to large and persistent macro-

economic imbalances, most notably the unsustainably

large fiscal deficits, and to the low productivity of past

investments.

Memorandum of Economic Policies Sent to

International Monetary Fund for 1991-92 & 1992-93

(The memorandum as sent to IMF by the Finance

Minister, Dr Manmohan Singh, on August 27, 1991,

and circulated in Parliament on December 16, 1991.),

p.1.2 Thus, triggered by the gulf crisis, a severe balance of

payment crisis had to be faced in 1991 that madeintroduction of comprehensive programme of reforms

inevitable.

Indian Economy 1950-2000-2020, Y. V. Reddy, in

Indias Economy in the 21stCentury, 2ndEdition, 2002,

Academic Foundation, p. 60.3 Ahluwalia, Isher and I.M.D.Little (1998), Indias

Economic Reforms and Development, Oxford

University Press, Delhi.4 We have accordingly gone through a wide ranging

reform process covering the areas of macro economic

and fiscal stabilisation. In all these areas the effort has

been to eliminate existing controls that had distorted

resource allocation and inhibited entrepreneurship.

A Decade After 1991: New Challenges Facing the

Indian Economy, 28th Frank Moraes Memorial Lecture

delivered by Rakesh Mohan at Chennai on July 26,

2002 organised by United Writers Association and the

Frank Moraes Foundation., Website Copy, RBI.5 Mohan, R. (2002). Transforming Indian Banking: In

Search of a Better Tomorrow, Valedictory address at

the Twenty-Fourth Bank Economists Conference,

Bangalore, RBI Bulletin, January 2003.6 The reform measures as introduced in the Indian

banking system are drawn out from Report on Trend

and Progress of Banking in India, Relevant Issues.7 Saggar, S. (2005), Commercial Banks in India, Deep &

Deep Publications, New Delhi, pp. 1-27.8 Report on Trend and Progress of Banking in India,

2003-04 , RBI, p.26.9 Indian banks supplement their resources by borrowing

in terms of refinance and rediscounting facilities from

NABARD, EXIM Bank, other similar financial

institutions and also from the Reserve Bank of India.10 Other liabilities in the form of various provisions, like

provisions for various bad and doubtful debts and

NPAs.

11 Deposits go with statutory pre-emption and haveinsurance to a threshold limit by the Government.

Thus they allow more safety not only to depositors but

to banks also. On the other hand, borrowings do not

provide this safety. More so, the low perception of risk

by depositors enables banks to mobilise deposits at

lower rates relative to borrowings.12 The CRR had increased steadily to its legal upper limit

of 15% in early 1991. Similarly, the SLR increased to

38.5% (almost equal to its legal upper limit of 40%) in

1991.

13 The level of gross and net NPAs of banks as a

percentage of gross and net advances have declined

over the years. Gross NPAs as a percentage of gross

advances declined from 23.18% in 1992 to 12.40% in

2000-01, and Net NPAs as a percentage of net

advances declined from 14.46% in 1994 to 6.74% in

2001. By the year 2004-05 the gross NPAs declined to

5.2% of gross advances, and net NPAs as percentage

of net advances declined to 2% of net advances.

During 2007-08, the gross NPAs declined to 2.3% of

gross advances, and net NPAs as percentage of net

advances declined to 1% of net advances.

Business Today, January 20, 2002, and Report on

Trend and Progress of Banking in India, RBI, Relevant

Issues.14 The banks are required to make 100% provision for

loss assets and 100% of the unsecured portion of the

doubtful asset, plus, depending on the period for

which the account is doubtful, 20% to 50% of the


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secured portion. In respect of sub-standard assets, the

banks are required to make a general provision of

10%.

15 Capital adequacy ratio of banks in India has

registered a welcome improvement over the years. The

CRAR of all banks, taken together, has gone up to 13%

by the end-March 2008. The CRAR of the banking

system at 13% is significantly above the stipulated

minimum of 9%.

Report on Trend and Progress of Banking in India,

2007-08, RBI.16 In keeping with the Basle Committees

recommendations, the RBI had asked Indian banks to

comply with the new capital adequacy norms over a

three year period. All Indian banks were required to

achieve a 4% capital to risk-assets ratio (CRAR) by

31st March 1993 and 8 per cent by 31st March 1996.

Indian banks with branches overseas were asked to

achieve the 8% standard by 31st

March 1994. Theseminimum capital levels were required to be achieved

with simultaneous adoption prudential norms of

income recognition, asset classification, and

provisioning.

RBI, Report of the Committee on the Financial

System, (Chairman: Shri M. Narasimham), 1991.18 Report on Trend and Progress of Banking in India,

RBI, p. 113.

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