Banking system in india

BANKING SYTEM IN INDIA

INTRODUCTION:

All the modern economies are money economies .The process of growth and expansion of banking sector has been evolutionary in nature .There is no solitary answer to the query of what banking is? This is because a bank performs a multitude of functions and services, which cannot be comprehended into a single definition. For a common man, a bank means a storehouse or lumber room of money ; for a businessman it is an institution of finance and for a worker it may be a depositary for his savings.

Etymologically, the word ‘bank’ is derived from the Greek word ‘banque’ or the Italian word ‘banco’ both meaning – a bench at which money-lenders and money-changers used to display their coins and transact business in the market place. The origin of modern banking in India can be traced back to the English Agency Houses in Kolkata and Mumbai which used to serve as bankers to the East India Company . The Hindustan Bank established in 1779 was the first banking institutions of its kind in India.

Definition of Bank:

“A bank is defined as one which transacts the business of banking which means accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawals by cheque ,draft, order, or otherwise.”- The Banking Companies Act, 1949

Need of the Banks:

Before the establishment of banks, the financial activities were handled by money lenders and individuals. At that time the interest rates were very high. Again there were no security of public savings and no uniformity regarding loans. So as to overcome such problems the organized banking sector was established, which was fully regulated by the government. The organized banking sector works within the

financial system to provide loans, accept deposits and provide other services to their customers. The following functions of the bank explain the need of the bank and its importance:• To provide the security to the savings of customers.• To control the supply of money and credit• To encourage public confidence in the working of the financial system, increasesavings speedily and efficiently.• To avoid focus of financial powers in the hands of a few individuals andinstitutions.• To set equal norms and conditions (i.e. rate of interest, period of lending etc) to alltypes of customers

Establishment of Reserve Bank of India (1935)

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The establishment of this central bank of the country ended the quasi-central banking role of the Imperial Bank. The latter ceased to be bankers to the Government of India and instead became agent of the Reserve Bank for the transaction of government business at centre at which the central bank was not established. Even after the formation as well as nationalization of RBI the growth of economy & banks was very slow and banks still experienced periodic failure. Therefore in order to streamline the functioning and activities of the 1100 commercial banks present then, the Government of India came up with in March 1949, a special legislation, called the Banking Companies Act,1949.

The Banking Regulation Act

The Banking Act 1949 was a special legislation, applicable exclusively to the banking companies. This Act was later renamed as the Banking Regulation Actfrom March 1966. The Act vested in the Reserve Bank of India the responsibility relating to licensing of banks, branch expansion, and liquidity of their assets, management and methods of working, amalgamation, reconstruction and liquidation. Thus giving RBI authority along with responsibility & igniting the first part of banking transformation in India. The second path braking & transformation effort took place in 1955 with the establishment of the Indian Banking Sector' State Bank of India.

Nationalization

The need for nationalization was felt because government believed that private commercial banks were lacking in fulfilling the social & developmental goals of banking. This was evident from the fact that the industries' share in loans almost doubled between1951 and 1968, from 34% to 68%. On the other hand, agriculture which was a major occupation (and still is) received less than 2% of total credit Thus with a view to serve the mass Government of India Nationalized14 banks (refer table 1) in 1969 bringing the total number of branches under government control to 84.Once again in April of 1980, the Government of India undertook a second round of nationalization, placing under government control the six private banks whose nationwide deposits were above R s. 2 billion, leaving approximately 10 percent of bank branches in private hands.

Banks Nationalized

S.No 1969 S.No 19801. Allahabad Bank 1. Andhra Bank

2. Bank of Baroda 2. Corporation Bank New Bank

3. Bank of India 3. Punjab & Sind Bank

4. Bank of Maharashtra 4. Vijaya Bank

5. Canara Bank 5. Oriental Bank of Commerce

6. Central Bank of India 6. UTI Bank

7. Syndicate Bank

8. UCO Bank

9. United Bank of India

10. Union Bank

11. Punjab National Bank

12. Indian Overseas Bank

13. Indian Bank

14. Dena Bank

Major recommendations by the NarasimhamCommittee

The Committee was set up under the chairmanship of M. Narasimham. They submitted their recommendations in the 1990s in reports widely known as the Narasimham Committee-I (1991) report and the Narasimham Committee-II (1998) Report. It was the recommendations of the two Narasimham Committees that actually turned around the destiny of Indian Banking. The year 1991 which is also called as the year of'Banking Sector Reforms' opened the gates to the private sector & to foreign banks which in turn significantly increased the level of competition . Seven new private banks entered the market between 1994 and 2000. In addition, over 20 foreign banks started operations in India since 1994. By March 2004, the new private sector banks and the foreign banks had a combined share of almost 20% of total assets. In addition to above recommendation the other major contributors to the revamping of the banking sector was the progressive lowering of SLR & CRR, introduction of Basel Norms, , deregulation of interest rate, redefining of priority sectors, Golden Handshake Scheme & merger of the week banks with the strongerbanks.

Functions of RBI

Bank of Issue Regulator-Supervisor of the financial system Manager of exchange control Issuer of currency Developmental role Controller of Credit Supervisory Functions Promotional Functions

Functions of Banks

Classification of Banking Industry in India

Indian banking industry has been divided into two parts, organized and unorganized sectors. The organized sector consists of Reserve Bank of India, Commercial Banks and Co-operative Banks, and Specialized Financial Institutions (IDBI, ICICI, IFC etc). The 28 unorganized sector, which is not homogeneous, is largely made up of money lenders and indigenous bankers.An outline of the Indian Banking structure may be presented as follows:-1. Reserve banks of India.2. Indian Scheduled Commercial Banks.a) State Bank of India and its associate banks.b) Twenty nationalized banks.c) Regional rural banks.d) Other scheduled commercial banks.3. Foreign Banks4. Non-scheduled banks.5. Co-operative banks.

Banking Structure in India

Profile of Scheduled Commercial Banks in India

Category Numberof banks

Number of offices

Totaladvances(crore)

TotalDeposits(crore)

NetNPARatio

TotalNumber ofEmployees

SBI &Associate

6 18,772 994154 1245862 1.49 2,82,453

NationalizedBanks(IDBI)

20 45,640 2311478 3127122 .92 4,75,082

Private Banks

21 11,968 797534 1002759 .56 2,18,679

Foreign Banks

33 316 195539 240689 .67 27,968

total 80 76,696 4298704 5616432 .97 10,04,182Source- Profile of Banks 2010-2011, RBI

Private Sector Banks:

In this type of banks, the majority of share capital is held by private individuals and corporate. Not all private sector banks were nationalized in 1969, and 1980. The private banks which were not nationalized are collectively known as the old private sector banks and include banks such as The Jammu and Kashmir Bank Ltd., Lord Krishna Bank Ltd etc. Entry of private sector banks was however prohibited during the post-nationalization period. In July 1993, as part of the banking reform process and as a measure to induce competition in the banking sector, RBI permitted the private sector to enter into the banking system. This resulted in the creation of a new set of private sector banks, which are collectively known as the new private sector banks.

Foreign Banks:

Foreign Banks have their registered and head offices in a foreign country but operate through their branches in India. The RBI permits these banks to operate either through branches; or through wholly-owned subsidiaries. Foreign banks in India are required to adhere to all banking regulations, including priority-sector lending norms as applicable to domestic banks. In addition to the entry of thenew private banks in the mid-90s, the increased presence of foreign banks in India has also contributed to boosting competition. There are a total 33 foreign banks with 316 offices across India.. (Profile of Indian Banks, RBI 2011). Citibank is the largest Foreign Bank in India followed by Standard Chartered

Largest foreign Banks in India are CITI BANK, STANDARD CHARTERED, HSBC,DEUTSCHE BANK,RBS,BARCLAYS

India’s Ten largest Banks are STATE BANK OF INDIA, PUNJAB NATIONAL BANK, BANK OF BARODA, ICICI, BANK OF INDIA, CANARA BANK, HDFC, IDBI, AXIS BANK, CENTRAL BANK OF INDIA

The Credit Composition of Financial Sector Entities

Perspectives on Banking in IndiaIndia is a bank dominated financial sector: commercial banks account for over 60 per cent of the total assets of the financial system comprising banks, insurance companies, non-banking financial companies, cooperatives, mutual funds and other smaller financial entities.4 Banking expansion as reflected in the growth of total assets of banks was rapid till the intensification of the global financial crisis which affected the Indian economy through trade, finance and confidence channels. Bank assets as a percentage of gross domestic product (GDP) rose from 60 per cent in 2000-01 to 93 per cent by 2008-09, but there after it has plateaued. Bank credit to GDP ratio more than doubled from 24 per cent to 53 per cent during this period but has remained around that level in the following years

The growth of the banking sector was influenced by the performance of the economy, reflected in a co-movement between the growth in banking business and real GDP growth (Chart 2). It is noteworthy that the period up to 2007-08 was also a period of fiscal consolidation, with combined fiscal deficit of the centre and the states falling from over 9 per cent of GDP in early 2000s to 4 per cent by 2007-08 (Chart 3). The consequent reduction in government borrowing requirement opened up the space for expansion of credit to the commercial sector in a non-inflationary manner.

While the financial expansion has slowed down in the post-crisis period, the Indian banking sector has shown remarkable resilience and stability. During the global financial crisis, the timely recourse to counter-cyclical prudential and monetary policy measures helped the banking sector in transiting through this challenging period largely unscathed. Most of the indicators of soundness bear out the stability of the Indian banking sector. The capital to risk-weighted assets ratio (CRAR) at the aggregate and bank group-levels have remained above the statutory minimum requirement of 9 per cent and international norm of minimum 8 per cent since 2001 (Chart 4).

There was a steady improvement in the asset quality through the 2000s. For instance the gross non-performing assets (NPAs) as per cent of gross advances had declined from 12.0 per cent in 2000-01 to 2.4 per cent in 2007-08. Thereafter it has increased to 3.7 per cent by December 2012, first with higher NPAs in foreign and private sector banks and more recently in public sector banks (Chart 5).

Banking Efficiency: It has been a key objective of financial sector reforms to improve the

efficiency and profitability of the banking sector. In this regard, the interest rate structure has been fully deregulated. The statutory pre-emptions of bank resources through statutory liquidity ratio (SLR) and cash reserve ratio (CRR) have been substantially reduced. Banks’ access to central bank liquidity through export credit refinance, marginal standing facility (MSF) and liquidity adjustment facility (LAF) has been enhanced. Furthermore, branch licensing norms have been relaxed and prudential norms have been strengthened. In addition, banks have increasingly adopted technology and accorded greater focus to human resource management. These changes have helped improve efficiency as borne out by various indicators. The profitability of the Indian banking sector has been maintained at about 1.0 per cent in terms of Return on Assets (RoA), even in the post-crisis period. The banks have also shown significant improvement in other efficiency indicators such as cost to income ratio, business per employee and business per branch. However, net interest margin (NIM) has gone up indicating deterioration in allocative efficiency.

Financial Inclusion:In order to sustain a higher economic growth, it is important to bring the

excluded segment of the society into the fold of the formal financial sector. In recognition of this, the Reserve Bank has taken a number of steps to take formal banking to door steps of habitations with population over 2000 through the business correspondent (BC) model where the BCs provide basic banking functions acting as agents of banks. Simultaneously, a number of initiatives such as incentivisation of branch authorization scheme for banks to open branches in unbanked centres, simplification of Know Your Customer (KYC) norms, technological interventions and financial literacy-oriented programmes to increase awareness have been taken. While the initial impact of these initiatives has been positive, it has created a huge potential for expansion in banking business once the level of activity is scaled up and government social benefit transfers increasingly take place through the banking sector. While we have our own data source to gauge financial inclusion, the Census of India provides useful information on access to banking. It shows that about 59 per cent of households had access to banking services in 2011 as compared with only 35 per cent in 2001. Increase in access for the eastern-region has also gone up significantly from about 29 per cent in 2001 to 47 per cent in 2011, though the region still lags behind the all-India average.

Conclusion:The Indian Banks have managed to grow with resilience during the post reform era. However the Indian banking sector still has a large market unexplored. With the Indian households being one of the highest savers in the world accounting for 69% of India gross national saving of which only 47% is accessed by the banks more than half of the Indian population still unbanked with only 55 per cent of thepopulation have a deposit account and 9 per cent have credit accounts with banks. India has the highest number of households (145 million) excluded from Banking &has only one bank branch per 14,000 people. On the other hand, Indian banking industry has to face challanges like financial inclusion, deregulation of interest rates on saving deposits, slow industrial growth, management of asset quality, increased stress on some sectors, transition to the International Financial Reporting System, implementation of Basel II & so on. Nevertheless seeing the credentials of the Indian Banks one can safely conclude that the industry might have many stumbling blocks in the 'Road Ahead' but when ever encountered with such blocks in the past it has used them as a stepping stone & has always'Transformed' itself ( for the better) and 'Evolved' as a winner.