88

Chapter II

Commercial Banking in India – Evolution, Growth and Development

2 . Introduction

2.1 Pre-Independence Phases (1720 to 1947)

2.2 Pre-Nationalization phase (1947 to 1968)

2.3 Nationalization-Phase (1969 to 1990)

2.4 Phase of Reforms (1991-92 onwards)

2.4.1 First Phase of Banking Sector Reforms (1991-92 to 1997)

2.4.2 Second phase of reforms (1998-99 and onwards)

2.5 Reforms and Public Sector Banks

2.6 Structure of Indian Banking

2.7 SWOT analysis

89

Chapter II

Commercial Banking in India – Evolution, Growth and Development

2. Introduction - This chapter gives comprehensive overview of the Indian

Banking Sector and its structural settings. An attempt has been made to reflect on

the evolution and development in the history of Indian banking system. This

chapter is divided into two sections. Section I deals with the evolution and

developments in the Indian banking sector. Section II exemplifies with the

universe of Indian banking and its structural settings.

Section –I

The saga of Indian Banking System can be segregated and described in four

distinct phases.

1. Pre-Independence Phase (1720 to 1947)

2. Pre-Nationalization phase (1948 to 1968)

3. Post - Nationalization-Phase (1969 to 1990)

4. Liberalized/Reforms Phase (1991 onwards)

2.1 Pre-Independence Phase (1720 to 1947)

90

The western type of joint stock banking was brought to India by the English

Agency House of Calcutta and Bombay. The first bank of the joint stock

variety was Bank of Bombay, established in 1720 in Bombay. This was

followed by Bank of Hindustan in Calcutta, which was established in 1770 by

an agency house. Since the agency was closed down, the bank was also closed.

The General Bank of Bengal and Bihar, which came into existence in 1773,

after a proposal by the then Governor Warren Hastings existed only for a short

while (RBI, 2008, p. 75)

The East India Company established Bank of Bengal in Calcutta on June 2,

1806 with a capital of Rs.50 lakh, followed by establishment of Bank of

Bombay (1840), with a capital of Rs.52 lakh, and Bank of Madras in July 1843

with a capital of Rs.30 lakh.

All three were independent units and called ―Presidency Banks‖ as they were

set in three Presidencies that were the units of administrative jurisdiction in the

country for the East India Company

The first formal regulation for banks was the enactment of the Companies Act

in 1850. This act stipulated unlimited liability for banking and insurance

companies until 1860. In 1860, the concept of limited liability was introduced

in banking. As a result several joint stock banks were floated. In 1865,

Allahabad Bank was established for the first time exclusively by Indians. The

second, Punjab National Bank Ltd. was set up in 1894 with headquarters at

Lahore, and the third, Bank of India was set up in 1906 in Bombay. All these

banks were founded under private ownership.

The Swadeshi Movement of 1906 provided a great momentum of joint stock

banks of Indian ownership and many Indian commercial banks such as Central

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

Mysore were established between 1906 and 1913. By the end of December

91

1913, the total number of reporting commercial banks in the country reached

to 56 comprising of 3 Presidency Banks, 18 class ‗A‘ banks (with capital

greater than 5 lakh), 23 class ‗B‘ banks (with capital of Rs.1 lakh to 5 lakh) and

12 foreign exchange banks (RBI, 2008, p. 76). The three presidency banks

were amalgamated into a single bank; as a result, The Imperial Bank of India

was established in 1921. The name Imperial Bank of India was suggested by

Lord John Maynard Keynes. The Imperial Bank of India functioned as a

central bank prior to the establishment of RBI in 1935 and performed three set

of functions, viz, commercial banking, central banking and the banker to the

government.

Exchange banks were foreign owned banks that engaged mainly in foreign

exchange business in terms of foreign bills of exchange and foreign

remittances for travel and trade. Class A and B were joint stock banks. The

banking sector during this period, however, was dominated by the Presidency

banks as was reflected in paid-up capital and deposits (RBI, 2008, p. 76). Table

(2.1) presents the details of capital and deposits 1870 to 1934.

The Swadeshi movement also provided momentum to the co-operative credit

movement and led to the establishment of a number of agricultural credit

societies and few urban co-operatives. The main objectives of such co-

operatives were to meet the banking and credit requirements of people with

smaller means to protect them from exploitation. An Act was passed in 1912

giving legal recognition to credit societies and the like. The Maclagan

Committee, set up to review the performance of co-operatives in India and to

suggest measures to strengthen them.

The world economy was gripped by the great depression during the pre World

War II period and this had an impact on the Indian banking Industry with the

92

number of banks failing sharply due to their loans going bad. Most of the

banks that failed had a low capital base.

The statistical data of bank failure during the period from 1913 to 1947 is

depicted in Table (2.2). Between 1936 and 1945 many small banks failed. The

decline was sharper in 1939 banks and 1940 with maximum bank failures.

Indian Central Banking Enquiry committee which was constituted by the

Government of India in 1929 to examine the relevance of establishing a central

banking authority for India, mentioned, in the course of its discussion some

important reasons responsible for the failure of the banks. They were; (a)

insufficient capital, (b) poor liquidity of assets, (c) combination of non-banking

activities with banking activities, (d)incompetent and inexperienced directors.

The Committee also noted that the commercial banks played a negligible role

in financing the requirements of agricultural production and co-operative credit

(RBI, 2008, p.79).

On the basis of major recommendations of the Central Banking Enquiry

committee, the Reserve Bank of India Act was passed in 1934 and the Reserve

Bank of India came into existence in 1935 as the central banking authority of

the country.

The RBI was empowered to regulate the issue of banknotes, maintain reserves

with a view to securing monetary stability, and to operate the credit and

currency system of the country to its advantage.

In 1939 the Reserve Bank submitted to Central Government its proposal for

banking legislation in India. Subsequently, RBI Companies (Inspection)

Ordinance, 1946, Banking Companies (Restriction of Branches) Act, 1946 and

The Companies (Control) Ordinance, 1948 were passed. Most of the provisions

93

in these enactments were subsequently embodied in the Banking Companies

Act in 1949.

The Second World War (1939-45), had far-reaching impact on the banking

sector, both on the expansion as well as failures. Table (2.3) depicts the

branch expansion during the World War. It can be observed that the total

number of branches increased from 1,964 in the year 1940 to 5,201 in 1945, a

2.7 fold increase during the war period.

Table 2.1 Number of banks, Capital and Deposits

(Rs. Lakh)

Year

end-

Dec

Number of reporting commercial

banks

Paid-up Capital and

Reserves Deposits

P/I

Bank

@

Class

A*

Exchange

bank

Class

B** Total

P/I

Bank

@

Class

A*

Class

B** Total

P/I

Bank

@

Class

A*

Exch

ange

bank

Class

B** Total

1870 3 2 3 - 8 362 12 - 374 1,197 14 52 - 1,263

1880 3 3 4 - 10 405 21 - 426 1,140 63 340 - 1,543

1890 3 5 5 - 13 448 51 - 499 1,836 271 754 - 2,861

1900 3 9 8 - 20 560 128 - 688 1,569 808 1,050 - 3,427

1910 3 16 11 - 30 691 376 - 1,067 3,654 2,566 2,479 - 8,699

1913 3 18 12 23 56 748 364 # 1,112 4,236 2,259 3,104 151 9,750

1920 3 25 15 33 76 753 1,093 8.1 1,927 8,692 7,115 7,481 233 23,458

1930 1 31 18 57 107 1,115 1,190 1.41 2,446 8,397 6,326 6,811 439 21,973

1934 1 36 17 69 123 1,128 1,267 1.49 2.54 8,100 7,677 7,140 511 23,428

P/I bank- Presidency/ Imperial bank

94

*Banks with capital and reserve of Rs. 5 lakh and over.

**Banks with capital of Rs.1 lakh and up to Rs.5 lakh

# Negligible

Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-

Table 2.2 Bank failures in India -1913 to 1947

Year

(Jan-

Dec)

No. of

banks

Year

(Jan-

Dec)

No. of

banks

Year

(Jan-

Dec)

No. of

banks

Year

(Jan-

Dec)

No. of

banks

1 2 3 4 5 6 7 8

1913 12 1922 15 1931 18 1940 107

1914 42 1923 20 1932 24 1941 94

1915 11 1924 18 1933 26 1942 50

1916 13 1925 17 1934 30 1943 59

1917 9 1926 14 1935 51 1944 28

1918 7 1927 16 1936 88 1945 27

1919 4 1928 13 1937 65 1946 27

1920 3 1929 11 1938 73 1947 38

1921 7 1930 12 1939 117

Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-08

95

Table 2.3 Branch Expansion during the period from 1940 to 1945

Year End

December Scheduled banks

Class 'A2' Non

Scheduled banks*

Class 'B' and 'C'

Non Scheduled

banks** All Banks

1940 1314 105 545 1964

1941 1414 204 678 2296

1942 1447 263 869 2579

1943 1878 400 996 3274

1945 2956 811 1434 5201

*: Banks with paid-up capital and reserves of above 5 lakhs

**: Banks with paid-up capital and reserves of above 50 thousand and up to 5 lakhs

Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-

08

96

In summary, the period preceding independence was a difficult one for Indian

banks. A large number of small banks sprang up with low capital base, although

their exact number was not known.

The organized sector consisted of the Imperial Bank of India, joint-stock banks

(which included both joint stock English and Indian banks) and the exchange

banks dealing in foreign exchange. During this period, a large number of banks

also failed. This was resultant of several factors. This period witnessed the two

World Wars and the Great Depression of 1930. Although global factors contributed

to bank failure in a large measure, several domestic factors were also at play. Low

capital base, insufficient liquid assets and inter-connected lending were some of

the major domestic factors. When the Reserve Bank was set up in 1935, the

predominant concern was that of bank failures and of setting up adequate

safeguards in the form of appropriate banking regulation. Yet, even after more than

twelve years following the establishment of the Reserve Bank, the issue of

strengthening the Reserve Bank through a separate legislation was not realized.

The major concern was the existence of non-scheduled banks as they remained

outside the purview of the Reserve Bank. Banking was more focused on urban

areas and the credit requirements of agriculture and rural sectors were neglected.

These issues were pertinent when the country attained independence.

2.2 Pre-Nationalization phase (1947 to 1968)

On the eve of Independence in 1947, there were 648 commercial banks

comprising 97 scheduled and 551 non-scheduled banks. The number of offices of

the banks stood at 2,987 with total deposits of Rs1,080 crore and advances at

Rs.475 crore.

97

When the country attained Independence, Indian banking was entirely

concentrated in the private sector. In addition to the Imperial Bank, there were five

big banks, each holding public deposits aggregating Rs.100 crore and more, viz.,

Central Bank of India Ltd., Punjab National Bank Ltd., Bank of India Ltd., Bank

of Baroda Ltd. and United Commercial Bank Ltd. All other commercial banks

were also in the private sector and had a regional character; most of them held

deposits of less than Rs.50 crore. Interestingly, the Reserve Bank was also not

completely State owned until it was nationalized in terms of the Reserve Bank of

India (transfer to Public Ownership) Act, 1948. The first task before the Reserve

Bank after independence was to develop a sound structure along contemporary

lines .The issue of bank failure in some measure was addressed by the Banking

Companies Act, 1949 (later renamed as the Banking Regulation Act), but to a

limited extent. The Banking Companies Act of 1949 conferred on the Reserve

Bank the extensive powers for banking supervision as the central banking

authority of the country. Bank failures continued in the period after independence

and after the enactment of the Banking Companies Act, although such failures

reduced considerably. In order to protect public savings, it was felt that it would be

better to wind up insolvent banks or amalgamate them with stronger banks.

Accordingly, in the 1950s, efforts were tuned towards putting in place an enabling

legislation for consolidation, compulsory amalgamation and liquidation of banks.

Accordingly, the Banking Companies (Amendment) Act 1961 was enacted that

sought, inter alia, to clarify and supplement the provisions under Section 45 of the

Banking Companies Act, which related to compulsory reconstruction or

amalgamation of banks. The Act enabled compulsory amalgamation of a banking

company with the State Bank of India or its subsidiaries. Until that time, such

amalgamation was possible with only another banking company.

98

Table 2.4 Number of banks failed , amalgamated and liquidated :1948-1968

Year

(Jan-

Dec)

Banks

failed

Banks

compulsorily

Amalgamated

Banks

Voluntarily

Amalgamat

ed

Banks ceased to

function/transferre

d their liabilities

and Assets

Banks

which went

into

compulsory

liquidation

Banks

which went

into

voluntary

liquidation

1948 45 - - - - -

1949 55 - - - - -

1950 45 - - - - -

1951 60 - - - - -

1952 31 - - - - -

1953 31 - - - - -

1954 27 - - - - -

1955 29 - - - - -

1956 - - - 6 6 16

1957 - - 1 10 3 16

1958 - - 4 10 5 9

1959 - - 4 20 7 7

1960 - - 2 15 5 4

1961 - 30 9 3 5

1962 - 1 3 22 3 4

1963 - 1 2 15 1 1

1964 - 9 7 63 3

1965 - 4 5 24 3 6

1966 - - - 7 3 7

1967 - - - 9 2 4

1968 - 1 - 2 1 3

Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume IV, 2006-

08

99

The legislation also enabled amalgamation of more than two banking companies

by a single scheme. Between 1954 and 1968, several banks were either

amalgamated or they otherwise ceased to function or their liabilities and assets

transferred to other banks. (Table 2.4)

The SBI was entrusted with the responsibility of expanding its rural branch

network within a time frame. This epoch making event marks the beginning of

inducing the banks into the field of rural credit which was formerly reserved for

co-operatives. Proactive measures like credit guarantee and deposit insurance

promoted the spread of credit and savings habits to the rural areas. Additionally,

there was a perception that banks should play a more prominent role in India‘s

development strategy by mobilizing resources for sectors that were seen as crucial

for economic expansion. As a consequence, in 1967 the policy of social control

over banks was introduced. Its aim was to cause changes in the management and

distribution of credit by commercial banks. Under social control the banking

system including the smaller banks started gaining strength as evidence by the

absence of voluntary or compulsory mergers of banks. National Credit Council

was set up in 1968 to assess the demand for credit by these sectors and determine

resource allocations. Both these policies brought momentous changes in the

banking system during this phase of banking evolution.

The decade of 1960s also witnessed significant consolidation in the Indian

banking industry with more than 500 banks functioning in the 1950s reduced to 89

by 1969.

2.3 Nationalization-Phase (1969 to 1990)

Although Indian banking system made considerable progress in the 1950s and

1960, its spread was mainly concentrated in the urban areas. The rapid increase in

the deposits in relation to their owned capital enabled the industrialist shareholders

100

to enjoy immense leverage. At this point, it was felt that if bank funds had to be

channeled for rapid economic growth with social justice, there was no alternative

to nationalization of at least the major segment of the banking system. Hence on

July1969, the Government of India nationalized 14 major Scheduled Commercial

Banks, each having a minimum aggregate deposit of Rs.50 crore. They were (i)

The Central Bank of India, (ii) Bank of India, (iii) The Punjab National Bank,

(iv) The Bank of Baroda, (v) The United Commercial Bank, (vi) The Canara

India, (vii) The United Bank of India, (viii) The Dena bank, (ix) The Syndicate

Bank,(x) The Union Bank of India, (xi) The Allahabad Bank (xii) The Indian

Bank , (xiii) The Bank of Maharashtra, and (xiv) The Indian Overseas Bank.

According to the Bank nationalization Act, 1969, the main objectives and reasons

for the nationalization, were: ―an institution such as the banking system, which

touches and should touch the lives of millions has been inspired by a larger social

purpose and has to serve the national priorities and objectives such as rapid growth

in agriculture, small industry and exports, raising employment levels,

encouragement of new entrepreneurs and the development of the backward areas.

For this purpose it was necessary for the Government to take direct responsibility

for expansion and diversification of banking services and of the working of

substantial part of the banking system. The acquisition and ownership of banks

was thus to enable banks as agents to play effective and key role for the economic

growth by extending banking facilities to the most deserving classes.

Again, in 1980, the Government of India nationalized six more banks, each having

deposits of Rs.200 crore or above. They were: (i) The Andhra Bank Ltd., (ii) The

Punjab and Sind Bank Ltd., (iii) The Corporation Bank Ltd., ( iv) The Oriental

Bank of Commerce Ltd., (v) The New Bank of India Ltd., (vi) The Vijaya Bank

Ltd.. Two significant aspects of nationalization were (i) rapid branch expansion

and (ii) channeling of credit according to plan priorities. To meet the broad

objectives, banking facilities were made available in hitherto uncovered areas, so

101

as to enable them to not only mop up potential savings and meet the credit gaps in

agriculture and small-scale industries, thereby helping to bring large areas of

economic activities within the organized banking system. The second wave of

nationalizations occurred because control over the banking system became

increasingly more important as a means to ensure priority sector lending, reach the

poor through a widening branch network and to fund rising public deficits. In

addition to the nationalization of banks, the priority sector lending targets were

raised to 40%.

In the wake of nationalization, the growth and development of the Indian banking

system was phenomenal. By the second decade of nationalization, Indian banking

was relatively sophisticated, with a wide network of branches, huge deposits

resources and far-reaching credit operations. In terms of branch licensing policy

laid down by RBI, the enunciation was on the opening of branches in rural and

semi-urban areas, backward regions and under-banked states so that the inter-

regional disparities could be reduced.

The progress of commercial banks in terms of branch expansion is exhibited in

Table 2.5. The statistical data reveals that commercial banks in India have

achieved tremendous progress in branch expansion during this phase (1969-91).

The number of bank offices in India increased from 8187 at the end of December

1969 to 60,597 at the end of March 1991, registering a trend growth rate of 8.6 per

cent. The progress indicates a more than 7.4 fold increase during the period. Rural

regions had registered the highest growth rate (12.4 per cent), while semi- urban

regions reported the lowest (5.1 per cent). Urban and Metropolitan regions

registered 6.3 and 5.5 per cent respectively.

102

Table 2.5 Branch Expansion of All Scheduled Commercial banks from 1969-1991

(In Numbers)

End of month/year Total Number of bank offices Rural Semi-Urban Urban Metropolitan

Dec-69 8187 1443 3337 1911 1496

Dec-70 12946 ---- ---- ---- ----

Dec-71 12890 ---- ---- ---- ----

Dec-72 14650 5274 4607 2637 2132

Dec-73 16503 6024 5012 2983 2484

Dec-74 17937 6447 5462 3332 2696

Dec-75 20049 7112 6156 3779 3002

Dec-76 23485 8588 7133 4413 3351

Dec-77 26958 10856 7702 4769 3631

Dec-78 29476 12534 8019 5037 3886

Dec-79 32219 14171 8295 5494 4259

Dec-80 34385 16111 8678 5462 4134

Dec-81 38018 19453 8718 5622 4225

Dec-82 40793 21626 8921 5511 4735

Dec-83 45385 23782 10115 6649 4839

Dec-84 48320 25541 10331 7347 5101

Dec-85 53899 29408 10745 8117 5629

Dec-86 53364 29700 10658 7649 5357

Dec-87 54431 30585 10731 7722 5393

Dec-88 56282 31641 11179 7929 5533

Dec-89 58568 33572 11263 8082 5651

Mar-90 59897 34867 11309 8065 5656

Mar-91 60597 35216 11379 8233 5769

TGR 8.6 12.4 5.1 6.3 5.5

Source: Special Statistics -19: A Statistical Profile of Commercial Banks in India. Economic and Political Weekly, Vol.32.No.42(Oct.18-24,1997),pp. 2753-2772

Trend Growth Rate – Calculated

103

The progress of commercial banks in terms of deposits, advances and business per

branch is exhibited in Table (1.6). The aggregate deposits increased from Rs.4822

crores at the end of 1969 to Rs. 219539 crore at the end of March 1991, registering

a trend growth rate of 17.6 per cent while the Advances increased from Rs.3467 in

1969 to Rs. 133745 at the end of March 1991 reporting a trend growth rate of 16.8

per cent. In case of Business per branch, it increased from Rs.1.01 crore at the end

of December, 1969 to Rs.5.83 at the end of March 1991 at a trend growth rate of

8.7 per cent.

Another important structural development during this period was the formation of

Regional Rural Banks (RRBs). In 1973, the government of India had set up a

Working group to study the credit availability at the rural areas. The Working

Group identified various weaknesses of the co-operative credit agencies and

commercial banks and came to a conclusion that they may not be able to fill the

regional and functional needs of the rural credit system. Therefore the Study group

recommended a new type of institution, which combined the rural touch and

experience of cooperatives with modernized outlook and capacity to mobilize the

deposits. The Government of India accepted this recommendation and permitted

the establishment of Regional Rural Banks (RRBs). The RRBs are state sponsored,

regional-based, rural oriented commercial banks, set up under the Regional Rural

Banks Act 1976. Their ownership vests with the sponsoring commercial bank, the

Central Government, and the Government of the State in which they are

geographically located. Under this approach 196 RRBs were set up.

104

Table 2.6 Growth of Deposits, advances and business per branch Commercial

Banking India from 1969-1991

Year/Indicators

No. of branches

( in numbers)

Aggregate

Deposits

(rupees in cores)

Advances

(rupees in

cores)

Business per

branch

(rupees in

cores)

Dec-69 8187 4822 3467 1.01

Dec-70 12946 5502 4298 0.76

Dec-71 12890 7243 5051 0.95

Dec-72 14650 8360 5614 0.95

Dec-73 16503 10084 7091 1.04

Dec-74 17937 11611 8246 1.11

Dec-75 20049 13711 10073 1.19

Dec-76 23485 17595 13553 1.33

Dec-77 26958 21365 15327 1.36

Dec-78 29476 26492 18310 1.52

Dec-79 32219 31275 21559 1.64

Dec-80 34385 36997 24760 1.80

Dec-81 38018 44260 30155 1.96

Dec-82 40793 52280 35679 2.16

Dec-83 45385 61149 40986 2.25

Dec-84 48320 71682 48931 2.50

Dec-85 53899 85922 53162 2.58

Dec-86 53364 102625 64677 3.14

Dec-87 54431 119023 72549 3.52

Dec-88 56282 141823 87746 4.08

Dec-89 58568 162036 104866 4.56

Mar-90 59897 184961 121984 5.12

Mar-91 60597 219539 133745 5.83

TGR 8.6 17.6 16.8 8.7

Source: Special Statistics -19: A Statistical Profile of Commercial Banks in India.

Economic and Political Weekly, Vol.32.No.42(Oct.18-24,1997),pp. 2753-2772

Trend Growth Rate – Calculated

105

The Lead bank scheme provided the blue-print of further bank branch expansion.

The course of evolution of the banking sector in India since 1969 has been

dominated by the nationalization of banks. However, the provisions made to help

spread institutional credit and nurture the financial system, also led to distortions

in the process. The administered interest rates and the burden of direct lending

constrained the banking sector. Operational flexibility was understated and

profitability occupied a back seat.

Besides the establishment of priority sector credits and the nationalization of

banks, the Government took further control over banks' funds by raising the

statutory liquidity ratio (SLR) and the cash reserve ratio (CRR). From a level of 2

per cent for the CRR and 25 per cent for the SLR in 1960, both witnessed a steep

increase until 1991 to 15 per cent and 38.5 per cent respectively (Joshi and Little,

1997, p. 112).

Through the CRR and the SLR more than 50% of savings had either to be

deposited with the RBI or used to buy government securities. Of the remaining

savings, 40% had to be directed to priority sectors that were defined by the

government. Besides these restrictions on the use of funds, the government had

also control over the price of the funds, i.e. the interest rates on savings and loans

(Mukherji, 2002, p. 39). This was about to change at the beginning of the 1990s

when a balance-of-payments crisis was a trigger for far-reaching reforms.

This phase in the banking sector was marked by a number of controls. The major

controls introduced during the period from 1969 to 1991 are specified in Table

(2.7).

106

Table 2.7 Major Controls during the period from 1969-91

1969 Fourteen banks with deposits of over Rs.50 crore were nationalized.

The Lead Bank Scheme was introduced with a view to mobilize deposits

on a massive scale throughout the country and also for stepping up

lending to weaker sections.

1972 Concept of Priority Sector was formalized. Specific targets were set out

in November 1974 for public sector banks and in November 1978 for

private sector banks.

The differential ratio of interest (DRI) Scheme was instituted to cater to

the needs of the weaker sections of the society and for their upliftment.

1973

A minimum lending rate was prescribed on all loans, except for the

priority sector.

The District Credit Plans were initiated.

1975 Banks were required to place all borrowers with aggregate credit limit

from the banking system in excess of Rs.10 lakh on the first method of

lending, whereby 25 per cent of the working capital gap, i.e., the

difference between current assets and current liabilities, excluding bank

finance, was required to be funded from long-term sources.

1976 The maximum rate for bank loans was prescribed in addition to the

minimum lending rates.

1980 The contribution from borrowers towards working capital out of their

long-term sources was placed in the second method of lending, i.e., not

less than 25 per cent of the current assets required for the estimated level

of production, which would give a minimum current ratio of 1.33:1 (as

against 25 per cent of working capital gap stipulated under the norms

prescribed in 1975).

Six Banks with demand and time liabilities greater than Rs.200 crore as

on March 14, 1980, were nationalized on April 15, 1980

1988 Service Area Approach (SAA) was introduced, modifying the Lead Bank

Scheme.

1989 The CRR was gradually raised from 5.0 per cent in June 1973 to 15.0 per

cent by July 1989.

1991 The SLR was raised by 12.5 percentage points from 26 per cent in

February 1970 to 38.5 per cent in September 1990.

107

Source: Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume

IV, 2006-08

As in other areas of economic policy-making, the emphasis on government control

began to weaken and even reverse in the mid-80s and liberalization set in firmly in

the early 90s. The poor performance of the public sector banks, which accounted

for about 90 per cent of all commercial banking, was rapidly becoming an area of

concern. The continuous escalation in non-performing assets (NPAs) in the

portfolio of banks posed a significant threat to the very stability of the financial

system. Banking reforms, therefore, became an integral part of the liberalization

agenda.

The process of expansion in the banking network in terms of geographical

coverage and heightened controls affected the quality of banks assets and strained

their profitability. In response to these developments, a number of measures were

undertaken in the mid 1980s for consolidation and diversification and, to some

extent, deregulation of the financial sector. The consolidation measures were

aimed at strengthening banks‘ structures, training, house-keeping, customer

services, internal procedures and systems, credit management, loan recovery, staff

productivity and profitability. Certain initiatives were also taken to impart

operational flexibility to banks.

Although nationalization of banks helped in the spread of banking to the rural and

hitherto uncovered areas, the monopoly granted to the public sector and lack of

competition led to overall inefficiency and low productivity. Excessive focus on

quantitative achievements had made many of the public sector banks unprofitable

and undercapitalized by international standards. Many banks were earning less

than reasonable rates of returns, had low capital adequacy and high non-

performing assets, and were providing poor quality customer service. By 1991 the

Indian financial system was saddled with an inefficient and unsound banking

108

system. Some of the reasons for this were i) High reserve requirements; ii)

administered interest rates; iii) directed credit; iv) lack of competition; and v)

political interference and corruption.

In summary, major issues faced at the beginning of this phase were the strong

nexus between banks and industry, as a result of which agriculture was ignored.

The focus in this phase was to break the nexus and improve the flow of credit to

agriculture. The main instruments used for this purpose were nationalization of

major banks in the country and institution of directed credit in the form of

priority sector lending. The achievements during the nationalization phase were

extensive, varied and widely acknowledged. The nationalization of banks in 1969

and again in 1980 brought a large segment of the banking business under

government ownership. In the post-nationalization phase, the country was able to

build up financial infrastructure geographically wide and financially diverse to

accelerate the process of resource mobilization to meet the growing needs of the

economy. The nationalization of banks in 1969 was a major step to ensure timely

and adequate credit to all the productive activities of the economy. It was

designed to make the system reach out to the small man and the rural and semi-

urban areas and to extend credit coverage to sectors then neglected by the

banking system, in place of what was regarded as a somewhat oligopolistic

structure where the system served mainly the urban and the industrial sectors

and where the grant of credit was seen as an act of patronage and receiving it as

an act of privilege. As at end-December 1990, there were 59,752 branches of

commercial banks (including RRBs) in the country, of which 34,791 (58.2 per cent)

were in rural areas. As a result of rapid branch expansion witnessed beginning

from 1969, the average population per bank office, which was 65,000 in 1969,

declined to 14,000 at end-December 1990 (Narasimham Committee Report,

1991). This reflected substantial efforts made towards spread of banking;

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particularly in unbanked rural areas. A notable feature of this expansion was that

there was a strong convergence across regions. Bank branches in unbanked

locations really accelerated after the 1:4 licensing rule of 1977, as between 1977

and 1990 more than three-fourths of the bank branches that were opened were

in unbanked locations.

Large branch expansion also resulted in increase in deposits and credit of the

banking system from 13 and 10 per cent of GDP, respectively, in 1969 to 38 per

cent and 24 per cent, respectively, by 1991. New branches opened helped

considerably in deposit mobilization and the evidence suggested that of the

incremental deposits a large proportion was from the branches opened after

1969. The share of rural deposits in total deposits increased from 3 per cent in

1969 to 16 per cent in 1990. The share of credit to the rural sector in total bank

credit increased from 3.3 per cent in 1969 to 14.2 per cent in 1990. The banking

sector met the credit needs of the economy subject to the requirements of

sectoral allocation and rendered support to the planning authority in efficient and

productive deployment of investible funds so as to maximize growth with stability

and social justice.

In the 1970s and the 1980s, the growing fiscal deficit and increased automatic

monetization, whereby the Government could borrow from the Reserve Bank

with the help of ad hoc Treasury Bills, resulted in a rise in reserve money and

money supply. To counter reserve money growth, the Reserve Bank was required

to raise the cash reserve ratio (CRR). Although resource mobilization by the

banking system increased sharply, the demands made on the banking system also

increased. In order to finance the increase in fiscal deficit of the Government, the

Reserve Bank was forced to increase the SLR of banks. At one point of time, 63.5

per cent of the resources of the banking sector were pre-empted by way of CRR

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and SLR and such deployments were not adequately remunerated. In view of

increased demand for funds from various quarters, attempts were made to bring

some financial discipline on the part of corporates. However, norms stipulated for

the purpose were found to be too rigid. The traditional sectors, in particular,

faced overall credit restrictions during periods of tight monetary policy. As a

result, the traditional sectors started seeking funds from sources other than the

banking system such as capital market and raising deposits directly from the

public, leading to disintermediation. On the other hand, in order to meet the

priority sector targets, credit appraisal standards were lowered. During this

period, the deposit and lending rate structure became very complex. Low return

on Government securities and priority sector loans meant that other sectors had

to be charged high interest rates. Interest rates differed as per type, size and

location of borrowers. Interest rates specified were cheaper for certain activities

such as food procurement, oil companies and certain key units in the public

sector. Various controls combined with the absence of adequate competition

resulted in decline in productivity and efficiency of the banking system and

seriously eroded its profitability. Banks’ capital position deteriorated and they

were saddled with large non-performing assets (RBI, 2008, p. 109).

In the mid-1980s, some efforts were made to liberalize and improve the

profitability, health and soundness of the banking sector, which by then had

transformed from a largely private owned system to the one dominated by the

public sector. However, these were small steps considering the kind and extent of

controls/regulations that came to prevail. Major reforms occurred in the next

phase following structural reforms initiated by the Government in the early

1990s.

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This phase although made significant progress in the banking system in terms of

geographical and functional coverage, resources mobilized and credit deployment,

but it is still an unexplained characteristics of repressed financial system. This

period also witnessed consolidation of the banking. At the launch of the first five

year plan in 1951, there were 566 commercial banks consisting of 92 scheduled

and 474 non-scheduled banks. In 1969, total number of banks declined to 89 out of

which 73 were scheduled and 16 were non scheduled. A major development

during this period was the enactment of the banking Regulation Act empowering

the RBI to regulate and supervise the banking sector.

To summarize, Indian financial system in the pre-reform period, i.e., upto the end

of 1980s, essentially catered to the needs of planned development in a mixed

economy framework where the government sector had a dominant role in

economic activity. The strategy of planned economic development required huge

development expenditures, which was met thorough the dominance of government

ownership of banks, automatic monetization of fiscal deficit and subjecting the

banking sector to large pre-emptions – both in terms of the statutory holding of

Government securities (statutory liquidity ratio, or SLR) and administrative

direction of credit to preferred sectors. Furthermore, a complex structure of

administered interest rates prevailed, guided more by social priorities,

necessitating cross-subsidization to sustain commercial viability of institutions.

These not only distorted the interest rate mechanism but also adversely affected

financial market development. All the signs of `financial repression‘ were found

in the system.

There is perhaps an element of commonality in terms of such a ‗repressed‘ regime

in the financial sector of many emerging market economies at that time. The

decline of the Bretton Woods system in the 1970‘s provided a trigger for financial

liberalization in both advanced and emerging markets. Several countries adopted a

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‗big bang‘ approach to liberalization, while others pursued a more cautious or

‗gradualist‘ approach. The East Asian crises in the late 1990s provided graphic

testimony as to how faulty sequencing and inadequate attention to institutional

strengthening could significantly derail the growth process, even for countries

with otherwise sound macroeconomic fundamentals.

India, in this context, has pursued a relatively more ‗gradualist‘ approach to

liberalization. The bar was gradually raised. Each year the Central Bank slowly,

in a manner of speaking, tightened the screws. Nevertheless, the transition to a

regime of prudential norms and free interest rates had its own traumatic effect. It

must be said to the credit of our financial system that these changes were absorbed

and the system has emerged stronger for this reason.

2.4 Phase of Reforms (1991-92) onwards:

This phase of the banking sector evolved to a significant extent in response to

financial sector reforms initiated as a part of structural reforms encompassing

trade, industry, investment and external sector, launched by the Central

Government in the early 1990s in the backdrop of a serious balance of payments

problem. A high-capacity Committee on the Financial System (CFS) under the

Chairmanship of Shri M. Narasimham was constituted by the Government of

India in August 1991 to examine all aspects relating to the structure, organization,

functions and procedures of the financial system. The Committee, which

submitted its report in November 1991, made comprehensive recommendations,

which formed the foundation of financial sector reforms relating to banks,

development financial institutions (DFIs) and the capital market in the years to

come. The Committee highlighted the commendable progress made by the

banking sector in extending its geographical spread and its functions/operations

and thereby promoting financial intermediation and growth in the economy.

However, at the same time, the Committee noted with concern the poor health of

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the banking sector. The Committee cautioned that unless the weakening in the

financial health of the system was treated quickly, it could further corrode the real

value of and return on the savings entrusted to it and even have an adverse impact

on depositor‘s and investor‘s confidence. Accordingly, financial sector reforms

were initiated as part of overall structural reforms to impart efficiency and

dynamism to the financial sector.

The country‘s approach to reform in the banking and financial sector was guided

by ‗Pancha Sutra’ or five principles. (Reddy, 1998):

1) Cautious and sequencing of reform measures – giving adequate time to the

various agents to undertake the necessary norms; e.g., the gradual reduction

of prudential norms,

2) Mutually reinforcing measures, that as a package would be enabling reform

but non-disruptive of the confidence in the system, e.g., combing reduction

in refinance with reduction in the cash reserve ratio (CRR) which obviously

improved bank profitability.

3) Complementary between reforms in the banking sector changes in fiscal,

external and monetary policies, especially in terms of co-ordination with

Government; e.g., recapitalization of Government owned banks coupled

with prudential regulation; abolition of ad-hoc treasury bill and its

replacement with a system of ‗ways and means‘ advances, coupled with

reforms in debt markets.

4) Development of financial infrastructure in terms of supervisory body, audit

standards, technology and legal framework; e.g., establishment of Board for

Financial Supervision, setting up of Institute for Development and Research

in Banking Technology, legal amendment to the RBI Act and Non Banking

Financial Companies (NBFCs).

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5) Taking initiative to nurture, develop and integrate money, debt and forex

markets, in a way that all major banks have an opportunity to develop skills,

participate and benefit; e.g., gradual reduction in the minimum period for

maturity of term deposits and permitting banks to determine the penalty

structure in respect of premature withdrawal, syndication in respect of loans,

flexibility to invest in money and debt market instruments, greater freedom

to banks to borrow from and invest abroad.

Some main features of the reform process worth mentioning are that, First,

financial sector reforms were undertaken early in the economic reform cycle.

Second, reform in the financial sector were initiated through own initiatives in a

well-structured, sequenced and phased manner and induced by a crisis, although

the balance-of-payment problems in 1991 did provide the wake-up call. Third, a

consultative approach towards policy formulation was adopted, which not only

enabled benchmarking the financial services against international standards in a

transparent manner, but also provided useful lead time to market players for

smooth adjustment to regulatory changes. Importantly, unlike the ‗stop-go‘

approach adopted in several Latin American and Asian economies, the Indian

approach to financial sector reforms has been marked by ‗gradualism‘ so as to

endure a gradual, non-disruptive and transparent approach to the

process.(Ahluwalia,2002)

Furthermore, the evolution of the banking sector in this phase could be divided

into two sub-phases, i.e., from 1991-92 to 1997-98 and 1997-98 onwards.

2.4.1 First Phase of Banking Sector Reforms

The main issues faced in the first sub-phase were the weak health of the banking

sector, low profitability, weak capital base and lack of adequate competition. The

Narasimham committee report I aimed at bringing about “operational autonomy”

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and “functional autonomy” so as to enhance, productivity, efficiency and

profitability. Major recommendation and accomplishments during first phase are

(a) Reduction in Statutory Liquidity Ration (SLR) and Cash Reserve Ratio

(CRR):

One of the major factors that affected banks‘ profitability was high pre-emptions in

the form of cash reserve ratio (CRR) and statutory liquidity ratio (SLR), which had

reached at the historically high level of 63.5 per cent in the early 1990s. Besides,

the administered structure of interest rates did not allow banks to charge the

interest rates depending on the credit worthiness of the borrower and, thus,

impinged on the allocative efficiency of resources. The Narasimham Committee

recommended that the SLR be brought down in a phased manner to 25 per cent

over a period of five years. Similarly, the Committee recommended phased

reduction of CRR to the statutory minimum.

Impact:

A phased reduction in the SLR and the CRR was undertaken beginning January

1993 and April 1993, respectively. The SLR was progressively brought down from

the peak rate of 38.5 per cent in February 1992 to the then statutory minimum of

25.0 per cent by October 1997. There was a sharp reduction in the Central

Government‘s fiscal deficit in the initial years of reforms. Accordingly, there was

less of a need to use the banking sector as a captive source of funds. Interest rates

on Government securities were also made more or less market determined. The

CRR of scheduled commercial banks (SCBs), which was 15 per cent of net

demand and time liabilities (NDTL) between July 1, 1989 and October 8, 1992,

was brought down in phases to 9.5 per cent by November 22, 1997. Between

November 1995 and January 1997, the CRR was reduced by as much as 5

percentage points. From its peak in 1991, it has declined gradually to a low of 4.5

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per cent in June 2003. In 2004 it was slightly increased to 5 per cent to counter

inflationary pressures (RBI, 2004, p 10))

(b) Deregulation of Interest rate:

Prior to reforms interest rates on both deposits and advances of banks were

administered by the RBI. These rates were usually unrelated to market realities.

For example, for long stretches banks offered negative returns on fixed deposits in

real terms (interest rate-inflation rate), on the assets side, the high interest rate on

corporate advances were used to cross subsidies government sponsored

employment generation programmes at low rates of interest determined by

political considerations.

As far as advances are concerned, there were as many as 20 administered rates in

1989-90. In regard to the regulated interest rate structure, the basic thrust of

Narasimham Committee was that real rates of interest should be positive and

concessional interest rates are a vehicle for subversion. Following reform

measures, the various rates of interest were market determined. Scheduled

Commercial Banks have been given the freedom to set interest rates on their

deposits subject to minimum floor rates and maximum ceiling rates.

Impact: The interest rates have been deregulated in a phased manner. All lending

rates have been deregulated except lending to small borrowers and a part of

export finance. Interest rates on deposits are now almost free except for

prescription in respect of savings deposits and foreign currency deposits. The

interest rate on Government borrowings is also now market determined. It

implied that banks were able to fix the interest rates on deposits and loans,

depending on the overall liquidity conditions and their risk perceptions (for

lending rates). Banks, over the years, developed a set of criteria for determining

the rate charged on individual borrowers. The deregulation of interest rates led to

innovations of various types, including fixed, floating and partly fixed and partly

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floating interest rates, among others. The four per cent differential interest scheme

has been officially withdrawn. Though the Committee recommended reduction

of target for priority sector advances from 40 per cent of total credit to 10 per

cent, the Government did not agree to it. But it diluted the concept of priority

sector considerably by including housing loans, educational loans, etc.,

subscription to bonds and debentures of the infrastructure and development

organization, etc., ―The sub-targets in the priority sector are 10 per cent for

weaker sections and 60 per cent credit – deposit ratio in the rural and semi –

urban areas have been conveniently forgotten by banks and regulatory authorities.

Selective credit controls have been totally abolished, thus giving banks freedom

to lend to even the sensitive sectors.‖ (Joshi, 2002,p 20)

(c) Measures to create Competitive Environment

The Indian banking sector over the years had become less competitive as no new

bank was allowed to be set up in the private sector after nationalization of 14

banks in 1969. Although a large number of players existed, there was no threat of

entry of new players. The lack of threat of entry of new players led to inefficiency

in the banking sector. Some other restrictions such as regulation of interest rates

and the system of financing working capital requirements also had an adverse

impact on the competitive environment. Banks were also constrained in their

operations due to restrictions on opening or closing of branches on the basis of

their commercial judgment. One of the major objectives of reforms was to bring

in greater efficiency by permitting entry of private sector banks, liberalize

licensing of more branches of foreign banks and the entry of new foreign banks

and increased operational flexibility to banks. Keeping these in view, several

measures were initiated to infuse competition in the banking sector (RBI, 2008,

p.115). In January 1993 the RBI announced guidelines for opening of private

sector banks as public limited companies. The criteria for setting up of new

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banks in private sector were: (a) capital of Rs. 100 crore, (b) most modern

technology, and (c) head office at a non-metropolitan centre.

Impact: Following liberalization of entry of new private sector banks, 10 new

banks were set up in the private sector by 1998. Besides, 22 foreign banks were

also set up. Times Bank was subsequently merged with HDFC Bank. The new

generation private sector banks have brought about a paradigm shift in service

standards and set new benchmarks in terms of application of technology, speed in

delivery of services, channels, décor and branch ambience, and a high order of

marketing orientation (Shenoy, 2000, p.44). These banks with their updated

technology have been providing stiff competition to public sector banks and old

private sector banks. The introduction of electronic banking by these banks

compelled the public sector banks and old private sector banks to fall in line with

them. Foreign banks have also been permitted to set-up subsidiaries, joint

ventures or branches. The number of foreign bank branches increased from 140

at end-March 1993 to 186 at end-March 1998. The share of new private sector

banks in total assets of scheduled commercial banks increased to 3.2 per cent by

end-March 1998. The share of foreign banks at 8.2 per cent at end-March 1998

was the same as at end-March 1993. That the impact on competition remained

muted was also evident from the limited number of mergers (four). (RBI, 2008,

p.116)

Liberalization of branch licensing policy

While banks could not close down branches in rural areas, in order to enable

them to rationalize their branch network in rural/semi-urban areas, they were

allowed to rationalize their existing branch network by relocating branches

within the same block and service area of the branch, shift their branches in

urban/metropolitan/port town, centres within the same locality/municipal ward,

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opening of specialized branches, spinning-off of business, setting up of

controlling offices/administrative units and opening of extension counters. Two

recommendation of the Narasimham Committee was to abolish the system of

branch licensing and allow foreign banks free entry.

(d) Prudential measures

Identifying the cause for the deterioration of financial health of banking system

over time, the Narasimham Committee recommended various remedial measures

which include inter alia prudential norm relating to income recognition, asset

classification, provisioning for bad debts and capital adequacy which have all been

implemented. In April 1992, the RBI issued detailed guidelines on a phased

introduction of prudential norms to ensure safety and soundness of banks and

impart greater transparency and accounting operations. The main objective of

prudential norms is the strengthening financial stability of banks.

Inadequacy of capital is a serious cause of concern. Hence, as per Basle

Committee norms, the RBI introduced capital adequacy norms. It was prescribed

that banks should achieve a minimum of 4 per cent capital adequacy ratio in

relation to risk weighted assets by March 1993, of which Tier I capital should be

achieved over a period of three years, that is, by March 1996. For banks with

international presence, it is necessary to reach the figure even earlier. Before

arriving at the capital adequacy ratio of each bank, it is necessary that assets of

banks should be evaluated on the basis of their realizable value.

Those banks whose operations are profitable and which enjoy reputation in the

markets are allowed to approach capital market for enhancement of capital. In

respect of others, the Government should meet the shortfall by direct subscription

to capital by providing loan.

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As per the recommendations of the Narasimham Committee banks cannot

recognize income (interest income on advances) on assets where income is not

received within two quarters after it is past due. The committee recommended

international norm of 90 days in phased manner by 2002.

In order to strengthen the capital base of banks, capital to risk-weighted assets

ratio (CRAR) system was also introduced for banks (including foreign banks) in

India in a phased manner. Indian banks having branches abroad were required to

achieve a capital adequacy norm of 8 per cent as early as possible and in any case

by March 31, 1994. Foreign banks operating in India were to achieve this norm of

8 per cent by March 31, 1993. Other banks were required to achieve a capital

adequacy norm of 4 per cent by March 31, 1993 and the 8 per cent norm by March

31, 1996 (RBI, 2008, p.111)

The assets are now classified on the basis of their performance into 4 categories:

(a) standard, (b) sub-standard, (c) doubtful, and (d) loss assets. Adequate

provision is required to be made for bad and doubtful debts (sub-standard assets).

Detailed instructions for provisioning have been laid down. In addition, a credit

exposure norm of 15 per cent to a single party and 40 per cent to a group has been

prescribed. Banks have been advised to make their balance sheets transparent

with maximum ‗disclosure‘ on the financial health of institutions. The Committee

recommended provisioning norms for non-performing assets. On outstanding sub-

standard assets 10 per cent general provision should be made (1992). On loss

assets the provision shall be 100 percent. On secured portion of doubtful asset, the

provision should be 20 to 50 per cent (GOI, 1999, pp 34-44).

Related to the improving financial soundness of banks are the other measures such

as recapitalization of public sector banks on a selective basis by the Government,

improving governance in banks and a certain amount of financial autonomy to the

managers of public sector banks.

Impact:

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The various measures initiated had a favorable impact on the quality of banks‘

balance-sheets. In a short span, banks were able to bring down their non-

performing assets significantly. Gross NPAs of public sector banks as percentage

of gross advances, which were 23.2 per cent at end-March 1993, declined to 16.0

per cent by end-March 1998. Despite increased provisioning, overall profitability

of the banking sector, in general, and public sector banks, in particular, improved

as detailed in the subsequent section. The soundness of the banking sector also

improved significantly. Of the 75 banks, 58 banks could achieve the stipulated

CRAR of eight per cent by end-March 2006. Eight nationalized banks, six old

private sector banks and three foreign banks could not attain the prescribed

capital to risk weighted assets ratio of eight per cent by end-March 1996. They,

therefore, were given one year extension to reach the prescribed ratio, subject to

certain restrictions such as modest growth in risk-weighted assets and

containment of capital expenditure and branch expansion, among others. At end-

March 1998, out of the 27 PSBs, 26 banks attained the stipulated 8 per cent

capital adequacy requirement. All banks, other than five banks (one public sector

bank and four old private sector banks) were able to achieve the stipulated CRAR

of eight per cent (RBI, 2008, p. 112)

(e) Supportive Measures

Revised format for balance sheet and profit and loss account reflecting and actual

health of scheduled banks were introduced from the accounting year 1991-92.

There have also been changes in the institutional framework. Commercial banks

were advised to make the increasing use of Lok Adalats (people‘s court), which

were conferred a judicial status and emerged as a convenient and low cost method

of settlement of dispute between banks and small borrowers. Further, ‗The

Recovery of Debts due to Banks and Financial Institutions Act‘ was enacted in

1993, which provided for the establishment of tribunals for expeditious

adjudication and recovery of such debts.

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Impact: The RBI evolved a risk-based supervision methodology with

international best practices. New Board of Financial Supervision was set-up in

the RBI to tighten up the supervision of banks. The system of external

supervision has been revamped with the establishment in November 1994 of the

Board of Financial Supervision with the operational support of the Department of

Banking supervision. In tune with international practices of supervision, a three-

tier supervisory model comprising outside inspection, off-site monitoring and

periodical external auditing based on CAMELS (Capital Adequacy, Asset quality,

Management, Earnings, Liquidity and System controls) had been put in place.

Special Recovery Tribunals are set-up to expedite loan recovery process.

Following the enactment of the Act, 29 Debt Recovery Tribunals (DRTs) and 5

Debt Recovery Appellate Tribunals (DRATs) were established at a number of

places in the country (RBI, 2008, p. 112).

To sum up, the main issues faced at the beginning of this sub-phase (1991-92 to

1997-98) were the poor financial performance, low asset quality, weak capital

position of banks and the absence of adequate competition. Several measures,

therefore, were initiated by the Government, the Reserve Bank and the banks

themselves to improve their profitability, financial health and capital position.

Major measures initiated included the introduction of objective prudential norms,

reduction in statutory pre-emptions and operational flexibility and functional

autonomy to public sector banks.

In view of various risks faced by the banking sector in a liberalized environment, a

special emphasis was also placed on strengthening the supervisory processes.

Various measures initiated had a profound impact. A significant improvement was

observed in the financial performance, asset quality and capital position by the end

of this sub-phase. The improvement in the financial performance was indeed

remarkable as the banks were subjected to the objective accounting norms. This,

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among others, was on account of improvement in asset quality and widening of net

interest margins. One of the objectives of reforms was to create competitive

conditions. Although several measures were initiated to create competitive

environment, competition remained muted. A major contribution of various reform

measures in this phase was that it led to a change in the behaviour of banks in that

they began to focus increasingly on improving their financial health and

profitability. Despite significant improvement, however, there were still some

concerns at the end of this sub-phase. First, the NPA level of public sector banks

was still very high by international standards. Second, some banks were not able

to achieve the stipulated capital adequacy ratio even after two years of the

stipulated time period. Third, although the banking sector, on the whole, turned

around during 1994-95 and made profits, some banks (including two public sector

banks) continued to incur losses at the end of this phase.

Fourth, competition did not penetrate enough and banks continued to enjoy high

net interest margins. Notwithstanding the improved credit flow to agriculture

before the onset of reforms, rural financial institutions such as RRBs suffered from

serious weaknesses. Efforts, therefore, were made to restructure them, which had a

desired impact on their financial health. In this phase, however, credit to the

agricultural sector decelerated.

A major achievement of this phase was significant improvement in the

profitability of the banking sector. However banks in this phase developed risk

aversion as a result of which credit expansions slowed down in general and to the

agriculture in particular.

2.4.2 Second phase of reforms: 1998-99 and onwards

The second phase of reforms laid emphasis on improvement in prudential norms in

a gradual move towards meeting the international standards. The framework for

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further strengthening the banking sector was provided by the Committee on

Banking Sector Reforms - CBSR (Chairman: Shri M. Narasimham), which

submitted its report in April 1998. However, while strengthening the prudential

norms, it was also necessary to ensure that some risk aversion by banks, which had

surfaced after application of prudential norms, did not aggravate.

In early 1997, Mr.Narasimham was again asked to chair another committee to

review the progress based on the 1st Committee report and to suggest a new

vision for Indian banking industry. In April, 1998, Narasimham Committee

submitted its report and recommended some major changes in the financial

sector. Many of these recommendations have been accepted and are under

process of implementation. Major recommendations and impact of the Second

phase of reforms are as follows:

2.4.2.1 Strengthening the Banking system

a) Capital adequacy

The committee recommended new and higher norms of capital adequacy. It

recommended that Minimum capital to risk assets ratio (CRAR) be increased from

the existing 8 per cent to 10 per cent; an intermediate minimum target of 9 per cent

be achieved by 2000 and the ratio of 10 per cent by 2002; RBI to be empowered to

raise this further for individual banks if the risk profile warrants such an increase.

Individual banks' shortfalls in the CRAR be treated on the same line as adopted for

reserve requirements, viz. uniformity across weak and strong banks. There should

be penal provisions for banks that do not maintain CRAR.

Impact: RBI has partially implemented the same by fixing CRAR at 9 per cent.

However, the ratio has not yet been increased to 10%. The CRR, which was

reduced to 4.5 per cent in March 2004, was gradually raised to 7.5 per cent

effective March 31, 2007.

The CRR was subsequently raised in stages to 8.75

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per cent effective July 19, 2008. These measures had a desired impact and the

credit growth moderated to 21.6 per cent in 2007-08. A sharp increase in credit

between 2004-05 and 2006-07 resulted in sharp increase in the risk weighted

assets. Despite this increase, however, banks were able to maintain their CRAR

significantly above the stipulated CRAR of 8 per cent (RBI, 2008, p. 112).

b) Asset quality

The Committee recommended that an asset be classified as doubtful if it is in

the substandard category for 18 months in the first instance and eventually for

12 months and loss if it has been identified but not written off. In June 2004, the

Reserve Bank advised banks further to adopt graded higher provisioning in

respect of (a) secured portion of NPAs included in ‗doubtful‘ for more than

three years category; and (b) NPAs which remained in ‗doubtful‘ category for

more than three years as on March 31, 2004. Provisioning was also increased

ranging from 60 per cent to 100 per cent over a period of three years in a phased

manner from the year ended March 31, 2005.These norms should be regarded

as the minimum and brought into force in a phased manner. For evaluating the

quality of assets portfolio, advances covered by Government guarantees which

have turned sticky, be treated as NPAs. For banks with a high NPA portfolio,

two alternative approaches could be adopted. One approach can be that, all loan

assets in the doubtful and loss categories should be identified and their realistic

value determined. These assets could be transferred to an Assets

Reconstruction Company (ARC) which would issue NPA Swap bonds.

Impact: Since March 2001, the assets are classified as doubtful if it is in the

substandard category for 18 months. As the asset quality began to improve,

credit growth, which had decelerated significantly between 1996-97 and 2003-

04 partly on account of risk aversion, began to pick-up from 2004-05. Credit

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growth, which was initially concentrated in retail segment, soon turned broad-

based encompassing agriculture, industry and small scale sector.

On the asset quality front, notwithstanding the gradual tightening of prudential

norms, non-performing loans (NPL) to total loans of commercial banks which

was at a high of 15.7 per cent at end-March 1997 declined to 3.3 per cent at

end-March 2006. Net NPLs also witnessed a significant decline and stood at 1.2

per cent of net advances at end-March 2006, driven by the improvements in

loan loss provisioning, which comprises over half of the total provisions and

contingencies. The proportion of net NPA to net worth, sometimes called the

solvency ratio of public sector banks has dropped from 57.9 per cent in 1998-99

to 11.7 per cent in 2006-07.(C.Rangarajan, 2007)

2.4.2.2 Systems and Methods in Banks

The international control systems which are internal inspection and audit,

including concurrent audit submission of controls returns by banks and

controlling offices to high level offices, risk management systems, etc. should

be strengthened there are recommendations for recruiting skilled manpower

from the open market, revision of remuneration to managerial positions taking

into account the market trends.

a) Structural Issues

Mergers

The Narsimham committee was of the view that the move towards this revised

system should be market driven and based on profitability considerations and

brought about through a process of mergers and acquisitions Merger between

banks and between banks and DFI‘s and NBFC‘s need to be based on

synergies, locational and business specific complimentary of the concerned

institutions and must obviously make sound commercial sense. Mergers of

127

public sector banks should emanate from the managements of banks with the

government as the common shareholder playing a supportive role. Such

mergers however can be worthwhile if they lead to rationalization of workforce

and branch network otherwise the mergers of public sector banks would tie

down the management with operational issues and distract attention from the

real issue. It would be necessary to evolve policies aimed at right sizing and

redeployment of the surplus staff either by the way of retraining them and

giving them appropriate alternate employment or by introducing a VRS with

appropriate incentives. This would necessitate the corporation and

understanding of the employees and towards this direction. Management

should initiate discussion with the representatives of staff and would need to

convince their employees about the intrinsic soundness of the idea, the

competitive benefits that would accrue and the scope and potential for

employees‘ own professional advancement in a larger institution. Mergers

should not be seen as a means of bailing out weak banks. Mergers between

strong banks/financial institutions would make for greater economic and

commercial sense and would be greater than the sum of its parts and have a

forced multiplier effect. Weak Banks' may be nurtured into healthy units by

slowing down on expansion, eschewing high cost funds / borrowings etc. The

Narasimham committee is seriously concerned with the rehabilitation of weak

public sector banks which have accumulated a high percentage of non-paying

assets (NPA), and in some cases, as high as 20 per cent of their total assets.

They suggested the concept of narrow banking to rehabilitate such weak banks.

It can hence be seen from the recommendations of Narsimham Committee that

mergers of the public sector banks were expected to emanate from the

management of the banks with government as common shareholder playing a

supportive role.. Merger should not be seen as a means of bailing out weak

banks. Mergers between strong banks/ financial institutions would make for

greater economic and commercial sense.

128

Impact: In this phase, two large development finance institutions (DFIs)

merged/converted into banks. After concessional sources of funding in the

form of Long-Term Operation (LTO) Fund of the Reserve Bank and

Government guaranteed bonds were withdrawn in the early 1990s, DFIs found

it difficult to sustain their operations. In January 2001, the Reserve Bank

permitted the reverse merger of ICICI with its commercial bank subsidiary.

ICICI Ltd. became the first DFI to convert itself into bank. The ICICI was the

second largest DFI, after Industrial Development Bank of India, and its reverse

merger led to a sharp increase in the market share of new private sector banks

in total assets of the banking sector. On October 1, 2004, Industrial

Development Bank of India, another large DFI, was converted into a banking

company. In April 2005, it merged its banking subsidiary (IDBI Bank Ltd.)

with itself. In all, during this phase, four new private sector banks and one new

public sector bank came into existence (including conversion of two major

DFIs, viz., ICICI and IDBI into banks). Besides, 16 foreign banks were also set

up. However, despite emergence of new domestic and foreign banks, the

number of banks gradually declined beginning from 100 at end-March 2000 to

82 by end-March 2007, reflecting the increased competitive pressures. The

number of branches set up by foreign banks increased from 181 in June 1997

to 273 by March 2007. Increased competition was also reflected in the sharp

increase in the sub-BPLR lending by banks. With a view to addressing the

downward stickiness of PLRs and the wide disparity in charging interest to

different category of borrowers, a scheme of benchmark PLRs (BPLRs) was

introduced by the Reserve Bank in 2003-04 for ensuring transparency in banks‘

lending rates as also for reducing the complexity involved in pricing of loans.

However, owing to increased competition, many banks introduced sub-BPLR

lending and the spreads between the minimum and maximum lending rates

increased significantly. The sub-BPLR lending enabled the corporate to raise

funds at competitive rates from banks. The share of sub-BPLR lending in total

129

lending increased gradually from 43 per cent in 2003-04 to 79 per cent by end-

March 2007 (RBI, 2008, p. 123)

f) Experiment With The Concept of Narrow Banking (Small Local

Banks): The Narasimham committee has suggested the setting up of small

local banks which should be confined to states or clusters of districts in

order to serve local trade, small industry etc.

g) Public Ownership and Real Autonomy: The Narasimham committee has

argued that government ownership and management of banks does not

enhance autonomy and flexibility in working of public sector banks.

Accordingly, the committee has recommended a review of functions of

banks boards with a view to make them responsible for enhancing

shareholder value through formulation of corporate strategy.

The Reserve Bank after a detailed consultative process released a

comprehensive policy framework of ownership and governance in private

sector banks in February 2005. The broad principles underlying the

framework were to ensure that (i) ultimate ownership and control was well

diversified; (ii) important shareholders were ‗fit and proper‘; (iii) directors

and CEO were ‗fit and proper‘ and observed sound corporate governance

principles; (iv) private sector banks maintained minimum net worth of

Rs.300 crore for optimal operations and for systemic stability; and (v)

policy and processes were transparent and fair.

Banks have been given greater autonomy in the areas like branch

rationalization, credit delivery, recruitment and creation of posts, etc,

subject to fulfillment of certain criteria.

h) Review And Updating Banking Laws: The Narasimham committee has

suggested the urgent need to review and amended the provisions of RBI

130

Act, Banking Regulation Act, State Bank of act etc., so as to bring them on

same line of current banking needs.

Keeping in view the importance of corporate governance even in public

sector banks, the Government of India at the Reserve Bank‘s initiative,

carried out amendments to the Banking Companies (Acquisition and

Transfer of Undertakings) Act, 1970/ 1980 and the State Bank of India

(Subsidiary Banks) Act, 1959 to include new sections providing for

applicability of ‗fit and proper‘ criteria for elected directors on the boards of

public sector banks. Necessary guidelines were issued to nationalized banks

in November 2007.

The banking sector has witness significant changes in the policy and legal reforms

during the post reforms era. See Table (2.8 )

Table 2.8 Banking Reform Measures

Year Reform measures

1992 Prudential norms relating to income recognition, asset classification,

provisioning and capital adequacy were introduced in a phased manner

in April 1992.

1993 Guidelines on entry of private sector banks were put in place in January

1993.

A phased reduction in the SLR was undertaken beginning January 1993.

The SLR was progressively brought down from the peak rate of 38.5

per cent in February 1992 to the then statutory minimum of 25.0 per

cent by October 1997.

The CRR was progressively reduced effective April 1993 from the peak

level of 15 per cent to 4.5 per cent by June 2003. The CRR was

subsequently raised in stages to 9.0 per cent effective August 30, 2008.

Rationalization of lending interest rates was undertaken beginning April

1993, initially by simplifying the interest rate stipulations and the

number of slabs and later by deregulation of interest rates.

131

1994 The Board for Financial Supervision (BFS) was set up in July 1994

within the Reserve Bank to attend exclusively to supervisory functions

and provide effective supervision in an integrated manner over the

banking system, financial institutions, non-banking financial companies

and other para-banking financial institutions

1995 The BFS instituted a computerized Off-site Monitoring and

Surveillance (OSMOS) system for banks in November 1995 as a part of

crisis management framework for ‗early warning system‘ (EWS) and as

a trigger for on-site inspections of vulnerable institutions.

The Banking Ombudsman Scheme was introduced in June 1995 under

the provisions of the BR Act, 1949

1997 The maximum permissible bank finance (MPBF) was phased out from

April 1997

2000 In order to strengthen the capital base of banks, the capital to risk-

weighted assets ratio for banks was raised to 9 per cent from 8 per cent,

from year ended March 31, 2000.

2001 With a view to liberalizing foreign investment in the banking sector, the

Government announced an increase in the FDI limit in private sector

banks under the automatic route to 49 per cent in 200.

2004 The FDI limit was further increased to 74 per cent in March 2004,

including investment by FIIs, subject to guidelines issued by the

Reserve Bank

2005 A comprehensive policy framework for governance in private sector

banks was put in place in February 2005 in order to ensure that (i)

ultimate ownership and control was well diversified; (ii) important

shareholders were ‗fit and proper‘; (iii) directors and CEO were ‗fit and

proper‘ and observed sound corporate governance principles; (iv)

private sector banks maintained minimum capital for optimal operations

and for systemic stability; and (v) policy and processes were transparent

and fair.

The roadmap for the presence of foreign banks in India was drawn up in

February 2005.

A mechanism of State level Task Force for Co-operative Urban Banks

(TAFCUBs) comprising representatives of the Reserve Bank, State

Government and federation/ association of UCBs was instituted in

March 2005 to overcome the problem of dual control over UCBs.

The Banking Codes and Standards Board of India (BCSBI) was set up

by the Reserve Bank as an autonomous and independent body adopting

the stance of a self-regulatory organization in order to provide for

voluntary registration of banks committing to provide customer services

132

as per the agreed standards and codes

Source: Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume

IV, 2006-08

133

Table 2.9 Legal reforms

1993 The Recovery of Debts Due to Banks and Financial Institutions Act was

enacted in 1993, which provided for the establishment of tribunals for

expeditious adjudication and recovery of non-performing loans. Following

the enactment of the Act, debt recovery tribunals (DRTs) were established

at a number of places.

In order to allow public sector banks to approach the capital market

directly to mobilize funds from the public, an Ordinance was promulgated

in October 1993 to amend the State Bank of India Act, 1955 so as to

enable the State Bank of India to enhance the scope of the provision for

partial private shareholding.

2002 The Securitization and Reconstruction of Financial Assets and

Enforcement of Security Interest (SARFAESI) Act, 2002 was enacted in

March, 2002.

2004 Risk based supervision (RBS) approach that entails monitoring according

to the risk profile of each institution was initiated on a pilot basis in April

2004.

In January 2006, banks were permitted to utilize the services of non-

governmental organizations (NGOs/ SHGs), micro-finance institutions and

other civil society organizations as intermediaries in providing financial

and banking services through the use of business facilitator and business

correspondent (BC) models.

2005 Banks were advised to introduce a facility of ‗no frills‘ account with nil or

low minimum balances in November 2005

2006 Section 42 of the RBI Act was amended in June 2006 to remove the

ceiling (20 per cent) and floor (3 per cent) on the CRR.

2007 Section 24 of the BR Act was amended in January 2007 to remove the

floor of 25 per cent on the SLR to be statutorily held by banks.

Amendments to the Banking Companies (Acquisition and Transfer of

Undertakings) Act, 1970/80 were also carried out to allow nationalised

banks to have access to the capital market, subject to the condition that the

Government ownership would remain at least at 51 per cent of equity of

nationalized bank.

134

Source: Source: Source: Report on Currency and Finance- Special Edition-RBI, Volume

IV, 2006-08

2.5 Reforms and Public sector banks

Enhancing the profitability of PSBs became necessary to ensure the stability of the

financial system. The restructuring measures for PSBs were threefold and

included recapitalization, debt recovery and partial privatization (Kamesam, 2002,

p.377; Reddy, 2002a, p. 358).

Owing to directed lending practices and poor risk management skills, India‘s

banks had accrued a significant level of NPAs. Prior to any privatization, the

balance sheets of PSBs had to be cleaned up through capital injection. In the fiscal

year 1991/92 and 1992/93 alone, the GOI provided almost Rs.40 billion to clean

up the balance sheets of PSBs. Between 1993 and 1999 another Rs120 billion

were injected in the nationalized banks. In total, the recapitalization amounted to

2 per cent of GDP (Deolakar, 1999, p. 66f.; Reddy, 2002a, p.359; Reserve Bank of

India, 2001, p.26).

Despite the suggestion of the Narasimham Committee to rationalize PSBs, the

Government of India decided against liquidation, which would have involved

significant losses accruing to either the government or depositors. It opted instead

to maintain and improve operations to allow banks to create a good starting basis

before a possible privatization (Shirai, 2002b, p. 26)

In 1993, the SBI Act of 1955 was amended to promote partial shareholding. The

SBI became the first PSB to raise equity in the capital markets. After the 1994

amendment of the Banking Regulation Act, PSBs were allowed to offer up to 49

per cent of their equity to the public. This led to the further partial privatization of

eleven PSBs. Despite those partial privatizations, the government is committed to

135

keep their public character by maintaining strong administrative control such as

the ability to appoint key personnel and influence corporate strategy (Ahluwalia,

2002, p.82; Arun and Turner, 2002b, p. 436-442; CASI, 2004, p. 33; Economist

Intelligence Unit, 2003, p. 9; Reddy, 2002a, p. 358; Shirai, 2002a, p. 54-56; Shirai,

2002b, p. 26).

To sum up, after nearly 10 years of the second phase of reforms, the complexion of

the Indian banking sector changed quite significantly. The main issues faced in this

sub-phase were to (i) strengthen the prudential norms in line with the international

best practices and at the same time ensure that the risk aversion did not aggravate;

(ii) increase the flow of credit to agriculture and SMEs; (iii) bring a large segment

of excluded population within the fold of the banking sector; (iv) strengthen the

corporate governance practices; (v) strengthen the urban cooperative banks and

resolve the issue of dual control; and (vi) improve the customer service. On almost

all the fronts, there was a significant improvement. Although efforts to strengthen

the banking sector had begun in the early 1990s, norms introduced were not in line

with the international best practices. Also, with the application of prudential

norms, banks had developed risk aversion. Therefore, while strengthening

prudential norms, institutional arrangements were put in place to enable banks to

expeditiously recover their past dues. Various measures initiated had a positive

impact as banks were able to recover large amounts locked up in NPLs. Banks,

therefore, gradually shed their risk aversion and credit began to grow sharply

beginning from 2004-05. Banks‘ NPLs level gradually declined to global level;

their gross NPAs declined from 15.4 per cent at end-March 1997 to 2.5 per cent at

end-March 2007. This was the most important achievement of this phase. The

profitability of scheduled commercial banks as reflected in their average return on

asset improved further, albeit marginally, from 0.8 per cent in 1997-98 to 0.9 per

cent in 2006-07. This was significant because competition intensified during this

phase as reflected in the acceleration of mergers and acquisitions (M&As) activity

136

and squeezing of net interest margins. The improved profitability, despite

increased competition, was, among others, on account of (a) sharp decline in

NPLs; and (b) increased credit volumes. In order to improve their profitability in a

competitive environment, banks also increasingly diversified their activities. This,

in turn, led to emergence of bank-led groups/financial conglomerates. The capital

adequacy ratio of banks also improved from 8.7 per cent at end-March 1997 to

12.9 per cent at end-March 2007. At individual bank level, the CRAR of most

banks was over 10 per cent, i.e., higher than the stipulated target which itself was

higher than the international norm. Thus, the impact of reforms initiated in the

early 1990s became clearly visible in this phase as the Indian banking sector had

become competitive, profitable and strong.

137

Source: RBI Bulletin 2004

A. Prudential Measures

Introduction and phase implementation of

international best practices and norms on risk-

weighted capital adequacy requirements,

accounting, income recognition, provisioning and

exposure.

Measures to strengthen risk management through

recognition of different components of risk,

assignment of risk-weighs to various asset classes,

norms on connecting lending, risk concentration,

application of market –to – market principle for

investment portfolio and limits on deployment of

fund sensitive activities.

B. Competition Enhancing Measures

Granting of operational autonomy to public sector

banks, reduction of public ownership in public

sector banks by allowing them to raise capital from

equity market up to 49 per cent of paid-up capital.

Transparent norms of entry of Indian private

sector, foreign and joint-venture banks and

insurance companies, permission for foreign

investment in financial sector in the form of

Foreign Direct Investment (FDI) as well as

portfolio investment, permission to banks to

diversify product portfolio and business activities.

C. Measures Enhancing role of Market forces

Sharp reduction of pre-emption through reserve

requirements, market determined pricing for

government securities, disbanding of administered

transparency and disclosure norms to facilitate

market discipline.

Introduction of pure inter-bank call money market,

auction-based repos-reserve repos fro short –term

liquidity management, facilitation of improved

payments and settlement mechanism.

D. Institutional and Legal Measures

Setting up of Lok Adalats (people‘s courts), debt

recovery tribunals, asset reconstruction companies,

settlement advisory committees, corporate debt

restructuring mechanism, etc for quick

recovery/restructuring. Promulgation of Securities and

Reconstruction of financial Assets and Enforcement of

Securities Interest (SARFAESI), Act, 2002 and its

subsequent amendment to endure creditor rights.

Setting up of Credit Information Bureau for

information sharing on defaulters as also other borrowers.

Setting up of clearing Corporation of India Limited

(CCIL) to act as central counter party for facilitating

payments and settlement system relating to fixed income

securities and money market instruments.

E. Supervisory Measures

Establishment of the Board for Financial Supervision

as the apex supervisory authority for commercial

banks, financial institutions and non-banking financial

companies.

Introduction of CAMELs supervisory rating system,

move towards risk-based supervision, consolidated

supervision of financial conglomerates, strengthening

of off- site surveillance through control returns.

Recasting of the role of statutory auditors, increased

internal control through strengthening of internal

audit.

Strengthening corporate governance, enhanced due

diligence on important shareholders, fit and proper

tests for directors.

F. Technology related Measures

Setting up of INFLINET as the communication

backbone for the financial sector, introduction of

Negotiated Dealing System(NDS) for screen-based

trading in government securities and Real Time Gross

Settlement(RTGS) System.

Table 2.10 The gist of reform measures aimed at strengthening the banks are given below

138

Table 2.11 Bank Mergers in the post reform period

Year of

Merger Target bank Acquirer

1993-94 New bank of India Punjab National Bank

1993-94 Bank of Karad Ltd. Bank of India

1995-96 Kashinath Seth Bank State Bank of India

1997 Punjab Co-operative Bank Ltd. Oriental Bank of Commerce

1997 Bari Doab Bank Ltd. Oriental Bank of Commerce

1999 Bareilly Bank Ltd. Bank of Baroda

1999 20th Century Finance Corporation Ltd. Centurion Bank

1999 British Bank of Middle East HSBC

1999-2000 Sikkim Bank Limited United Bank of India

1999-2000 Times Bank Ltd. HDFC Bank Ltd.

2001 Bank of Madura ICICI Bank

2002 Benaras State Bank Ltd. Bank of Baroda

2002 ICICI Ltd. ICICI Bank

2003 Nedungal Bank Ltd. Punjab National Bank

2004 South Gujrat Local Area Bank Bank of Baroda

2004 Bank Muscat SAOG Centurion Bank

2004 Global Trsut Bank Ltd. Oriental Bank of Commerce

2004 IDBI Bank IDBI Bank Ltd.

2006 Bank of Punjab Centurion Bank

2006 Ganesh bank of Kuranwad Federal Bank

2006 UFJ Bank Ltd. Bank of Tokyo-Mitsubishi Ltd.

2007 United Western Bank IDBI Ltd.

2007 Lord Krishna Bank Centurion Bnak of Punjab

2007 Sangli Bank ICICI Bank

2007 Bharat Overseas Bank Indian Overseas Bank

2008 Centurion bank of Punjab HDFC

2008 Amercan Express Bank Ltd. Standard Chartered Bank

2008 State Bank of Saurashtra State Bank of India

2008 South India Co-operative BankLtd.

The Saraswat Co-operative

bank Ltd.

2009 State Bank of Indore State Bank of India

Source: Indian Banking year book 2009,IBA

139

2.6 Structure of Indian Banking

The financial system in India has a very comprehensive structure. It represents a

variety of banks, financial institutions, capital market institutions, non-banks

indigenous banking and financial institutions,

The banking system in India consists of the Central Bank (RBI), commercial

banks, development banks, specialized banks and foreign banks. Banking

operating in India can be broadly classified into two categories viz., Commercial

Banks and Co-operative Banks.

(a) The Central Bank in the country is known as Reserve Bank of India, the

supreme monetary and banking authority in the country, has the

responsibility to control the banking system in the country.

(b) The Commercial banks are the joint stock companies dealing in the money

and credit. These banks mobilize savings and make them available to large

and small industrial and trading with mainly for working capital

requirements.

(c) Co-operative banks, organized on unit banking principle, are mainly rural

based, although, there are some banks operating in the urban areas. The

state funds for the agriculture are mainly routed through the state

cooperative banks and central cooperative banks. The Regional rural banks

came into being with the specific objective to agriculture laborers, small

and marginal farmers, artisans, small entrepreneurs in the rural area.

(d) A number of apex banks are working in specialized areas. They include

NABARD, IDBI, EXIM bank and National Housing Bank.

(e) Financial institutions like UTI, LIC, GIC and other subsidiaries such as

mutual funds, investments, loan, hire purchase and leasing companies are

also a part of the banking network in the boarder sense. All these

140

institutions undertake mobilization of resources, engage in long term

investment and provide financial services.

Within the category of Commercial banks, there are two types of banks namely

Scheduled Commercial Banks and Non- Scheduled Commercial Banks.

Scheduled Banks in India constitute those banks which have been included in the

Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI in turn includes

only those banks in this schedule which satisfy the criteria laid down vide section

42 (6) (a) of the Act.

"Scheduled banks in India" means the State Bank of India constituted under the

State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the

State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding

new bank constituted under section 3 of the Banking Companies (Acquisition and

Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of the

Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of

1980), or any other bank being a bank included in the Second Schedule to the

Reserve Bank of India Act, 1934 (2 of 1934), but does not include a co-operative

bank.

"Non-scheduled bank in India" means a banking company as defined in clause (c)

of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a

scheduled bank".

Depending on the pattern of ownership commercial banks can be classified into

three groups. They are (i) Public Sector banks which include State Bank of India,

its Associate Banks and Nationalized Banks and other Public Sector Banks, (ii)

Private Sector Banks consisting of Indian Private Sector Banks (which can be

divided into two i.e. banks existing prior to 1991 and the banks established after

141

1991) and Foreign Banks operating in India, (iii) Others comprising Regional

Rural banks and Local Areas banks.

Of these, public sector banks have a countrywide network of branches and

accounts for over 70 per cent of total banking business. They have a strong

presence in rural and semi-urban areas. Private sector banks and foreign banks are

more techno-savvy and have limited number of branches. Public sector banks

sponsor the RRBs and their activities are localized.

Figure 1 Structure of Scheduled Commercial Banks in India.

(Source: RBI)

RBI

Central Bank and Supreme Monetary Authority

Scheduled Co-operative Banks Scheduled Commercial

banks (79)

Public Sector

Banks (27) Private Sector

Banks (22) Foreign

Banks(30)

Regional Rural

banks

((((85)9999((((((

(Banks(95)

Nationalized

Banks (19)

Old Private Sector

Banks (15)

(Banks that existed

before 1991)

New Private Sector Banks

(7)

(Banks that came into

existence after 1991)

Scheduled Urban

Co-operative

Banks

Scheduled State

Co-operative Banks

State Bank of India

and Its Associates

(7)

Other Public

Sector Banks

(1)

142

Table 2.12 Structure of Indian Commercial Banks 2008-09

(Rs. Crores)

Sr. No.

Bank Group No. of Banks

No. of Branches

Staff Deposits Capital Reserves & Surplus

Total Assets Borrowings Investments Loans &

Advances

1 Public Sector Banks Markets Share (a+b+c)

27 34.18

56,109 85.8

734,661 78.0

3,112,748 76.79

13,536 30.74

194,760 60.27

3,766,716 72.02

158,305 60.85

1,012,666 70.02

2,260,156 75.48

1.a. State Bank Group Market Share

7 8.86

16,323 25.0

268,598 28.5

1,007,042 24.84

1,080 2.45

71,341 22.08

1,280,212 24.48

62,240 23.92

357,624 24.73

739,606 24.70

1.b. Nationalised Bank Group Market Share

19 24.05

39,340 60.1

455,862 48.4

1,993,305 49.17

11,731 26.64

114,721 35.50

2,314,102 44.24

51,647 19.85

604,994 41.83

1,417,121 47.33

1.c. Other Public Sector Bank Market Share

1 1.27

446 0.7

10,201 1.1

112,401 2.77

725 1.65

8,697 2.69

172,402 3.30

44,417 17.07

50,048 3.46

103,428 3.45

2

Indian Private Sector Banks Market Share 2 (a+b)

22 27.85

9,011 13.8

176,410 18.7

726,813 17.93

4,590 10.42

94,337 29.20

1,016,522 19.43

94,721 36.41

303,248 20.97

568,764 18.99

2.a. Old Pvt. Sector Banks Market Share

15 18.99

4,742 7.2

51,412 5.5

189,708 4.68

1,171 2.66

15,317 4.74

221,057 4.23

4,231 1.63

69,109 4.78

121,940 4.07

2.b. New Pvt. Sector Banks Market share

7 8.86

4,269 6.5

124,998 13.3

537,105 13.25

3,420 7.77

79,020 24.46

795,454 15.21

90,490 34.78

234,139 90.00

446,824 14.92

3 Foreign Banks in India Market Share

30 37.97

292 0.4

30,304 3.2

214,077 5.28

25,911 58.84

34,026 10.53

447,149 8.55

7127 2.74

130,354 9.01

165,415 5.52

4

Total Commercial Banks Total Market Share (1+2+3)

79 100.00

65,412 100.00

941,375 100.00

4,053,638 100.00

44,037 100.00

323,123 100.00

5,230,387 100.00

260,153 100.00

1,446,268 100.00

2,994,335 100.00

Source: Indian Banking Year Book, 2009, IBA, Mumbai

121

Table (2.12) presents the structure of India Commercial Banks during the year

2008-09. It can be observed that foreign banks group occupy a major share (37.97

per cent) in terms of number of banks followed by Public sector banks (34.18 per

cent) whereas other public sector banks (1 per cent) and new private sector banks

(7 per cent) the lowest.

With regard to branch expansion, public sector banks take up a major market

share of (85.8 per cent) where as foreign banks (0.4 per cent) the lowest. Group-

wise public sector banks have major share of employees (78.0 per cent) while

foreign banks (3.2 per cent).

With regard to deposits, public sector banks (76.79 per cent) whereas foreign

banks (5.2 per cent) the least. In terms of capital, foreign banks (58.84 per cent)

occupy major share while SBI group (2.45 per cent) the least. Public sector banks

capture a major share of (60.27 per cent) with respect to reserves and surplus

while foreign banks (10.53 per cent) the least.

It is pertinent to note that on all other parameters like total assets, borrowings,

investments, loans and advances, public sector banks capture a major share as

compared to its counterparts. On a whole public sector banks captured more than

50 per cent market share on almost seven parameters.

2.7 SWOT Analysis: Any organization operates within a framework of

environmental context. There is mutual demand and supply relationship that

prevails between the organization and large society. Owing to which, there is a

continuous response relationship between the organization and environment.

Social, economic, political aspects of the environment influence the operational

purviews of the organization. Interface is potential analyzed through the technique

of SWOT. i.e Strengths, Weakness, Opportunities and threats.

122

External environment poses two types of forces on the organization. They are

helping and hindering forces. The forces also can be positive and negative in

nature. These forces inherent strengths and weakness of the organization

Matrix I - SWOT Analysis of Indian Commercial Banking

Source: Business Monitor International, August, 2010

Strengths

In macro economics terms, India is

set to be a global outperformer in

the coming years.

India‘s highest savings rate and

efficacy of regulation by RBI has

provided stability.

Although loans have been growing

rapidly, there are few signs of the

kind of excess that have been seen

over the last few years in china.

The lack of links between Indian

banks and global financial system

means that they are relatively

immune to volatility in the global

market.

Weaknesses

A legacy of the state‘s protection of

the commercial banking sector,

which remains dominated by the

State bank of India, is that

efficiency levels and product

offerings are long way off the

world‘s best products.

The banking sector is held back by

low of GDP per capita.

The logistics involved in running a

bank in India can be daunting due

to prevalence of paper based

payment systems such as cheques.

Opportunities

India is still under banked. Per

capita deposits are low and people

with savings often keep their wealth

outside the formal banking system.

India‘s banking system is being

opened up to competition from

foreign banks.

Loan is growing quite rapidly from

a low, base and consumer finance is

developing quickly.

There are opportunities for mutual

funds, insurance companies and

organizations offering related

products.

Threats

The development of products, such

as mortgages, is hampered by

inefficiencies in housing market

(eg. cumbersome legal system and

bizarre planning regulations) that

need to be removed via reforms.

123

Matrix II - SWOT Analysis of Indian Public Sector Banks

Source: Compiled from the interactions with banking officials of various public sector

banks

Strengths

Being Custodians of Public Money,

Public sector banks enjoy public

trust, therefore have a good

franchise.

Has very good network of branches

Regulated by Government of India

and Scrutinized by RBI on their

portfolios.

Good Employee relations ( Number

of strikes reduced in the recent

years)

Are good gamekeepers.

Are adequately capitailized and

proved themselves in the crisis.

Upgraded their technology to meet

the market demands and consumer

expectations.

Cost to Income ratio is low

Weaknesses

Average age profile of the employees

is high as compared to its

counterparts

Compensation package is low, and

hence are not able to attract the best

talent.

Management not ascertaining their

rights.

Frequent transfer of banking heads.

Opportunities

Made their presence in II tier and

III tier cities and have good

franchise and has further scope for

expansion.

Has huge potential to contribute to

India‘s growth strategy

Threats

Competition from private and

foreign players

In terms of size they are not truly

international

124

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