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  • 8/11/2019 Black Book Sies


    An Overview Of Indian Banking Sector




    1.1 The role of bank in economy

    Banking if we equate it with money lending, is perhaps as old as civilization

    itself. When money in its modern form was not in existence, people in order

    to obtain goods or services offered other goods or services in return. This was

    barter, a clumsy and inconvenient system in many ways. Nevertheless could

    people and did lend or borrow in the form of specific goods which they received

    back or rapid in the same form or any other mutually acceptable form. Modern

    banking is something radically different from mere lending. It is far more

    sophisticated and complicated. Banking institution today form the heart of the

    financial structure of any country, whether it is developed or developing, rich or

    poor, advanced or backward in the fields of science and technology.

    In a developing economy the role of banks is more creative and purposeful than

    in a developed one. This observation is, however, subject to the assumption that

    banks are operating in a free-enterprise economy and not a totalitarian economy

    where all factors of production are under state control and all authority is vested

    in the state. In such a centrally planned economy the problem of economic

    development is relatively simpler in sense that the course of development is laid

    out and the economy is expected to move along that course.

    The primary task of banks in a free-enterprise economy is to mobilize the

    saving of the people and direct them into productive channels. In a developing

    country, where people are not in the habit of depositing their savings with

    banks, the task of creating and spreading the banking habit and of mobilizing

    the countrys resources becomes a challenging one. It is true that finance cannot

    take the place of real resources. But it is not lack of resources alone that retards

  • 8/11/2019 Black Book Sies


    An Overview Of Indian Banking Sector


    or hinders the process of economic development. An equally important cause is

    the lack of effective utilization of available resources. It is here that banks plays

    a crucial role because they act as a bridge between those who require finance

    (which enables them to acquire the necessary resources) and those who have

    finance(in the form of savings) but are unable to make an effective and

    productive use of it. Banks thus become an instrument of a more efficient use of

    available savings. An important outcome of this process is a rise in the rate of

    savings and investment and there by in the rate of growth.

    1.2 Banking & its Evolution

    The word 'Bank' is said to be derived from French word Bancusor Banque,

    i.e., a bench. It is believed that the early bankers, the Jews in Lombardy,

    transacted their business on benches in the market place. Others think it is

    derived from German word "Back" meaning a Joint stock fund.

    The first modern bank was founded in Italy in Genoa in 1406; its name was

    Banco di San Giorgio (Bank of St. George).

    Many other financial activities were added over time. For example banks are

    important players in financial markets and offer financial services such as

    investment funds. In some countries such as Germany, banks are the primary

    owners of industrial corporations while in other countries such as the United

    States banks are prohibited from owning non-financial companies. In Japan,

    banks are usually the nexus of cross share holding entity known as zaibatsu .In

    France "Bancassurance" is highly present, as most banks offer insurance

    services (and now real estate services) to their clients.

    The concept of banking was first introduced in medieval Florence in 1397. A

    powerful merchant family named Medici established a network of shops that

    allowed patrons to place money on account and withdraw the money in anothercity that had a Medici representative. Many powerful families and even the

  • 8/11/2019 Black Book Sies


    An Overview Of Indian Banking Sector


    Church kept their money in Medici banks. This allowed rich people to travel

    without the need to carry large sums of money and risk of robbery while

    traveling. Banking continued to gain popularity throughout Europe by 1700.

    Nearly every country in Europe had some form of established banking. Modern

    banking has come a very long way from those humble beginnings in Florence.

    Banking today covers the entire spectrum of finance from simple savings to

    credit cards and home loans. Typically, a bank generates profits from

    transaction fees on financial services or the interest spread on resources it holds

    in trust for clients while paying them interest on the asset. Banks today are

    connected electronically so that banking transactions can be made globally in a

    split second.

    1.3 Overview of Banking

    The banking system in India is significantly different from that of other Asian

    nations because of the countrys unique geographic, social, and economic

    characteristics. India has a large population and land size, a diverse culture, and

    extreme disparities in income, which are marked among its regions. There are

    high levels of illiteracy among a large percentage of its population but, at the

    same time, the country has a large reservoir of managerial and technologically

    advanced talents. Between about 30 and 35 percent of the population resides in

    metro and urban cities and the rest is spread in several semi-urban and rural

    centers. The countrys economic policy framework combines socialistic and

    capitalistic features with a heavy bias towards public sector investment. India

    has followed the path of growth-led exports rather than the export-led growth

    of other Asian economies, with emphasis on self-reliance through import


    These features are reflected in the structure, size, and diversity of the countrys

    banking and financial sector. The banking system has had to serve the goals of

    economic policies enunciated in successive five year development plans,

  • 8/11/2019 Black Book Sies


    An Overview Of Indian Banking Sector


    particularly concerning equitable income distribution, balanced regional

    economic growth, and the reduction and elimination of private sector

    monopolies in trade and industry. In order for the banking industry to serve as

    an instrument of state policy, it was subjected to various nationalization

    schemes in different phases (1955, 1969, and 1980). As a result, banking

    remained internationally isolated (few Indian banks had presence abroad in

    international financial centers) because of preoccupations with domestic

    priorities, especially massive branch expansion and attracting more people to

    the system. Moreover, the sector has been assigned the role of providing support

    to other economic sectors such as agriculture, small-scale industries, exports,

    and banking activities in the developed commercial centers (i.e., metro, urban,

    and a limited number of semi-urban centers). The banking systems

    international isolation was also due to strict branch licensing controls on foreign

    banks already operating in the country as well as entry restrictions facing new

    foreign banks. A criterion of reciprocity is required for any Indian bank to open

    an office abroad. These features have left the Indian banking sector withweaknesses and strengths. A big challenge facing Indian banks is how, under

    the current ownership structure, to attain operational efficiency suitable for

    modern financial intermediation. On the other hand, it has been relatively easy

    for the public sector banks to recapitalize, given the increases in nonperforming

    assets (NPAs), as their Government dominated ownership structure has reduced

    the conflicts of interest that private banks would face.

  • 8/11/2019 Black Book Sies


    An Overview Of Indian Banking Sector




    2.1 History of Indian Banking System

    The first bank in India, called The General Bank of India was established in the

    year 1786. The East India Company established The Bank of Bengal/Calcutta

    (1809), Bank of Bombay (1840) and Bank of Madras (1843). The next bank

    was Bank of Hindustan which was established in 1870. These three individual

    units (Bank of Calcutta, Bank of Bombay, and Bank of Madras) were called as

    Presidency Banks. Allahabad Bank which was established in 1865 was for the

    first time completely run by Indians. Punjab National Bank Ltd. was set up in

    1894 with head quarters at Lahore. Between 1906 and 1913, Bank of India,

    Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of

    Mysore were set up. In 1921, all presidency banks were amalgamated to form

    the Imperial Bank of India which was run by European Shareholders. After that

    the Reserve Bank of India was established in April 1935.

    At the time of first phase the growth of banking sector was very slow. Between

    1913 and 1948 there were approximately 1100 small banks in India. To

    streamline the functioning and activities of commercial banks, the Government

    of India came up with the Banking Companies Act, 1949 which was later

    changed to Banking Regulation Act 1949 as per am