Banking in India
- The earliest evidence of Banking in India is found in Vedic texts where concept of “usury” is mentioned. Usury is defined as the practice of making unethical or Immoral monetary loans that unfairly enrich the lender. Originally, usury meant interest of any kind. A loan may be considered usurious because of excessive or abusive interest rates or other factors.
- The Modern banking system has its origin in the Western world to which India was introduced by the British rulers, way back in the 17th century.
- The first bank in India was ‘Bank of Hindustan” started in 1770 and liquidated in 1829 – 32. First successful bank in India was bank of Calcutta set up on 2 January 1806, mainly to fund General Wellesley’s wars against Tipu Sultan and the Marathas. It was renamed as Bank Of Bengal on 2 January 1809.
- The bank of Bengal and two other presidencies banks the Bank of Bombay and the Bank of Madras amalgamated on 27 Jan 1921 and the reorganized banking entity asumed the name “Imperial Bank of India”
- The Reserve Bank of India, which is the central banking Organisation of India,in the year 1955, acquired a controlling interest in the Imperial Bank of India and the Imperial Bank of India was renamed on 30 April 1955 as the State Bank of India followed by the formation of its 07 associates in 1959.
- Oudh commercial bank was established in 1881 in Faizabad. It was the first commercial bank in India having limited liability and an entirely Indian board of directors.
- The two important steps taken after Independence in 1949 which changed the complete picture of Banking sector of India are:-
- Nationalisation of Reserve Bank of India with effect from 1st Jan 1949 on the basis of RBI Act, 1948.
- Enactment of Banking Regulation Act, 1949 which empowered RBI to regulate banking sector in country.
- The Punjab National Bank, established in Lahore in 1895, has survived to the present and is now one of the largest banks in India.
- The step toward social banking was taken with the nationalization of 14 commercial banks were nationalised on August 15, 1980.
- In general, bank refers to a financial institution where we deposit our savings, withdraw our money in case of emergency and take loans. But a bank can be better defined by the various functions performed by it.
- Definition of a bank given by the Banking Regulation Act, 1949. Sec 5(b) of the Banking Regulation Act, 1949 define banking as “Accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheques, drafts, orders or otherwise”.
- From this definition it is clear that a bank accepts deposits from the public and its main purpose is to invest this money in profitable avenues. The banker is under obligation to repay the money to the depositor as and when demanded by the depositor. The depositor can withdraw his money through cheques, drafts etc.
Reserve Bank of India
- The Reserve Bank of India was established on the basis of Hilton Young Commission recomme-ndation on 1st April, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.
- The RBI is the apex Bank or Central Bank of the country. It is entrusted with the control, supervision, promotion, development and planning of the financial system.
- The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937.
- The RBI’s main function is to control the monetary base and through this route influence the supply of money, depending on the economic conditions of the nation. Its objectives are to maintain price stability and ensure an adequate flow of credit to the productive sectors. The RBI commenced its operations with effect from 1 April 1935, with a share capital of rupees 5 crore. It was later nationalized in January 1949. It became a member of Bank of International Settlements (BIS) in September 1996.
- The RBI is not only the Central Bank of India; it is also the principal regulatory authority in the Indian money market. It derives its powers from two principal enactments, namely the Reserve Bank of India Act, 1934, and the Banking Regulation Act, 1949.
- RBI continued to serve as the Central Bank to Burma (Myanmar), until Japanese occupation of Myanmar in April, 1947.
- RBI also continued to serve as Central Bank to Pakistan, until June, 1948.
- RBI was nationalised in 1949 and its first Indian Governor was CD Deshmukh.
- RBI is the representative of government in IMF.
Functions of RBI
- The RBI regulates and supervises commercial banks and non-banking finance companies in the money market. It has two distinct roles to play: monetary control and bank supervision. As the nation's financial regulator, the RBI handles a range of activities or functions which are discussed below:
- Monetary Management: One of the most important functions of the RBI is formulation and execution of monetary policy. It formulates, implements and monitors monetary policy to achieve the basic objectives of monetary stability. Over time, the objectives of monetary policy in India have evolved to include maintaining price stability, ensuring adequate flow of credit to productive sectors of the economy for supporting economic growth, and achieving financial stability.
- Banker and Debt Manager to Government: The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and the management of its public debt. The Government also deposits its cash balances with the Reserve Bank. The Reserve Bank may also, by agreement, act as the banker to a State Government. Currently, the Reserve Bank acts as banker to all the State Governments in India, except Jammu & Kashmir and Sikkim. It has limited agreements for the management of the public debt of these two State Governments. The Reserve Bank manages the public debt and issues new loans on behalf of the Central and State Governments. It involves issue and retirement of rupee loans, interest payment on the loan and operational matters about debt certificates and their registration.
- Issuer of Currency: Management of currency is one of the core central banking functions of the Reserve Bank. Along with the Government of India, the Reserve Bank is responsible for the design, production and overall management of the nation’s currency. The Paper Currency Act of 1861 conferred upon the Government of India the monopoly of note issues but in 1935, when the Reserve Bank began operations, it took over the function of note issue from the Office of the Controller of Currency, Government of India. RBI issues all the currency notes except one rupee notes. One rupee notes and coins are issued by the Governmnet of India but put into circulation by the RBI.
- Banker to Banks: Banks are required to maintain a portion of their demand and time liabilities as cash reserves with the Reserve Bank, thus necessitating a need for maintaining accounts with the Bank. As a Banker to Banks, the Reserve Bank also acts as the ‘lender of last resort’. It can come to the rescue of a bank that is solvent but faces temporary liquidity problems by supplying it with much needed liquidity when no one else is willing to extend credit to that bank.
- Financial Regulation and Supervision: The Reserve Bank’s regulatory and supervisory domain extends not only to the Indian banking system but also to the development financial institutions (DFIs), non-banking financial companies (NBFCs), primary dealers, credit information companies and select segments of the financial markets. In respect of banks, the Reserve Bank derives its powers from the provisions of the Banking Regulation Act, 1949, while the other entities and markets are regulated and supervised under the provisions of the Reserve Bank of India Act, 1934. The credit information companies are regulated under the provisions of Credit Information Companies (Regulation) Act, 2005. As the regulator and the supervisor of the banking system, the Reserve Bank has a critical role to play in ensuring the system’s safety and soundness on an ongoing basis. The objective of this function is to protect the interest of depositors through an effective prudential regulatory framework for orderly development and conduct of banking operations, and to maintain overall financial stability through various policy measures. India’s financial system includes commercial banks, regional rural banks, local area banks, cooperative banks, financial institutions and non-banking financial companies.
- Foreign Exchange Reserves Management: To keep the foreign exchange rates stable, the RBI buys and sells foreign currencies. It maintains and protects the country's foreign exchange funds.
- Controller of Credit: The RBI is the controller of credit. It has the regulatory power to influence the amount of credit created by the banks, by changing the bank rate, repo rate, reverse repo rate and through open market operations. Recently, repo and reverse repo rates are used, rather than the bank rate, which has become a conventional tool.
Credit control in India
- Credit controlis an important function of Reserve Bank of India.
- It is a major weapon of the monetary policy used to control the demand and supply of money (liquidity) in the economy.
- Central Bank administers control over the credit that the commercial banks grant.
- Such a method is used by RBI to bring "Economic Development with Stability".
Need for credit control
- Credit control policy is just an arm of economic policy which comes under the purview of Reserve Bank of India, hence, its main objective being the attainment of high growth rate while maintaining the reasonable stability of the internal purchasing power of money.
- The basic and important needs of credit control in the economy are-
- To encourage the overall growth of the "priority sector" i.e. those sectors of the economy which is recognized by the government as "prioritized" depending upon their economic condition or government interest. These sectors broadly totals to around 15 in number.
- To keep a check over the channelization of credit so that credit is not delivered for undesirable purposes.
- To achieve the objective of controlling inflation as well as deflation.
- To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors.
- Stability in exchange rate and money market of the Country.
Methods of credit control
- There are two methods that the RBI uses to control the money supply in the economy-
- Quantitative method
- Qualititative method
- During the period of inflation Reserve Bank of India tightens its policies to restrict the money supply, whereas during deflation it allows the commercial bank to pump money in the economy.
- Quantitative credit control is used to control the volume of credit and indirectly to control the inflationary and deflationary pressures caused by expansion and contraction of credit. The quantitative credit control; consist of:
- Bank Rate
- Repo Rate
- Reverse Repo Rate
- Cash Reserve Ratio
- Statutory Liquidity Ratio
- Open Market Operations
- Bank Rate refers to the official interest rate at which RBI lends loans to other bank or financial institution which includes commercial/ cooperative banks, development banks etc.
- In other words, bank rate is the rate at which banks borrow money from the central bank, without any sale of securities. This is similar to borrowing money from someone, without security, and paying interest on that amount.
- Such loans are given out either by direct lending or by rediscounting (buying back) the bills of commercial banks and treasury bills. Thus, bank rate is also known as discount rate. Bank rate is used as a signal by the RBI to the commercial banks on RBI’s thinking of what the interest rates should be.
- Central banks make changes in the bank rate to control the money supply in the market.
- Repo (Repurchase) rate is the rate, at which RBI lends short-term money to the banks against securities.
- It is the rate at which commercial banks have to sell securities to RBI with an agreement to repurchase them on a future date at a predetermined price. It is a means of short-term borrowing.
- When the Repo rate increases, borrowing from the RBI becomes more expensive and when the repo rate decreases, borrowing becomes cheaper.
- Repo rate injects liquidity in the market.
- It was introduced in December, 1992, by RBI.
Difference between Bank Rate and Repo Rate
- Both Bank rate and repo rate are the rates at which RBI makes funds available to the commercial banks. This is the similarity between the two. Though both are meant for the same purpose. There are certain basic differences between the bank rate and repo rate. These are:
- The first difference is in respect of collateral security for borrowing. To have funds at repo rate, commercial banks have to sell the securities to RBI with an agreement to ‘repurchase’ them on a future date at a predetermined price. The repurchase agreement (Repo) associated with the repo rate is collateralized by a security. The bank rate, on the other hand, is not collateralized. It takes place as mere lending of money to commercial banks at a fixed rate, i.e. bank.
- Repo rate is short-term while bank rate is long-term both in outlook and impact.
- Bank rate is more than the repo rate as the former has no collateral security.
- Bank rate is used to levy a penalty on the shortfalls in reserves required to be maintained by commercial banks with RBI, while repo rate governs the borrowings made by commercial banks from the RBI.
Reverse Repo Rate
- Reverse Repo rateis the short term borrowing rate at which RBI borrows money from banks. It is the opposite of Repo Rate.
- The Reserve bank uses this tool when it feels there is too much money floating in the banking system. An increase in the reverse repo rate means that the banks will get a higher rate of interest from RBI. As a result, banks prefer to lend their money to RBI which is always safe instead of lending it others (people, companies etc) which is always risky.
- Reverse Repo Rate withdraws liquidity from the market.
- Hence Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse Repo rate signifies the rate at which the central bank absorbs liquidity from the banks.
- Repo rate and Reverse Repo Rate are the parts of Liquidity Adjustment Facility (LAF) of RBI.
Cash Reserve Ratio (CRR)
- Cash Reserve Ratio (CRR) is the average daily balance that a bank is required to maintain with the Reserve Bank as a share of such percent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
- CRR is the slice of deposits banks must mandatorily park with RBI.
- The CRR (percent of NDTL) requires banks to maintain a current account with the RBI with liquid cash.
- While ensuring some liquid money against deposits is the primary purpose of CRR, its secondary purpose is to allow the RBI to control liquidity and rates in the economy.
- The amount specified as the CRR is held in cash and cash equivalents, is stored in bank vaults or parked with the Reserve Bank of India.
- CRR is a crucial monetary policy tool and is used for controlling money supply in an economy.
- The RBI (Amendment) Bill, 2006, empowers RBI to prescribe CRR without any floor rate or ceiling rate.
Statutory Liquidity Ratio (SLR)
- Apart from Cash Reserve Ratio (CRR), all commercial banks are also required to maintain a stipulated proportion of their net demand and time liabilities (NDTL) in the form of liquid assets like cash, gold and unencumbered securities which are called the statutory liquidity ratio (SLR).
- In simple terms it is the ratio of liquid assets to net demand and time liabilities (NDTL).
- Treasury bills, dated securities issued under market borrowing programme and market stabilisation schemes (MSS), etc also form part of the SLR. Banks have to report to the RBI every alternate Friday their SLR maintenance
- The SLR requires banks to invest in safe and quickly saleable assets such as government securities.
- The institutions which are required to keep SLR are: All Commercial Banks (Scheduled and non scheduled), Primary (Urban) Co-operative Banks (UCBs), State and Central Cooperative Banks.
Difference between SLR and CRR
- Cash Reserve Ratio is the percentage of the deposit (NDTL) that a bank has to keep with the RBI. CRR is kept in the form of cash and no interest is paid on such reserves. On the other hand, SLR is the percentage of deposit that the banks have to keep as liquid assets in their own vault.
- The CRR is a more active and useful monetary policy weapon compared to the SLR.
- SLR rate = (liquid assets / (demand + time liabilities)) × 100%
- This percentage is fixed by the Reserve Bank Of India. The maximum limit for the SLR was 40% in India. Following the amendment of the Banking regulation Act (1949) in January 2017, the floor rate of 20.75% for SLR was removed.
- A higher statutory liquidity ratio compels the banks to divert funds from loans and advances to investment in the Government and approved securities.
Open market operations (OMO)
- OMOs are the market operations conducted by the Reserve Bank of India by way of sale or purchase of government securities to adjust money supply conditions. The RBI sells government securities to suck out liquidity from the system and buys back government securities to infuse liquidity into the system.
- The two traditional type of OMO’s used by RBI:
- Outright purchase (PEMO): Is outright buying or selling of government securities. (Permanent).
- Repurchase agreement (REPO): Is short term, and are subject to repurchase.
- Open market operations role as a credit control instrument emerged after economic reforms of 1991, when Indian economy was flushed with excessive inflow of foreign funds.
Qualitative Credit Control
- Qualitative measures are used by the RBI for selective purposes. Some of them are
- Margin requirements: This refers to difference between the securities offered and amount borrowed by the banks.
- Consumer Credit Regulation: This refers to issuing rules regarding down payments and maximum maturities of installment credit for purchase of goods.
- RBI Guidelines: RBI issues oral, written statements, appeals, guidelines, and warnings etc. to the banks.
- Rationing of credit: The RBI controls the Credit granted/allocated by commercial banks.
- Moral Suasion: Psychological means and informal means of selective credit control.
- Direct Action: This step is taken by the RBI against banks that don’t fulfill conditions and requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit.
- Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act.
- The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
- The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
- Since 1952, Monetary Policy of the RBI emphasises on twin goals. These are:
- Economic growth
- Inflation Control
Instruments of Monetary Policy
- There are several direct and indirect instruments that are used for implementing monetary policy.
- Repo Rate
- Reverse Repo Rate
- Open Market Operations (OMOs)
- Bank Rate
- Cash Reserve Ratio (CRR)
- Liquidity Adjustment Facility (LAF)
- Marginal Standing Facility (MSF)
- Statutory Liquidity Ratio (SLR)
- Market Stabilisation Scheme (MSS)
Liquidity Adjustment Facility (LAF)
- The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
Marginal Standing Facility (MSF)
- RBI has introduced a new mechanism-Marginal Standing Facility(MSF) under which banks are permitted to borrow short-term funds(overnight) upto 2 per cent of their respective net demand and time liabilities outstanding at the end of the second preceding fortnight. Banks can borrow for an overnight period from RBI through this emergency funding window under exceptional circumstances when all other avenues are exhausted. MSF allows banks to borrow money from the central bank at a higher rate when there is a significant liquidity crunch.
- This new instrument has been introduced by RBI in its monetary policy, announced in May 2011. This instrument is likely to reduce the volatility in overnight rates and improved monetary transmission.
- Banks can access MSF only when all other avenues (like repo and CBLO) are exhausted for overnight money. That is why it is meant to be exceptional.
- The purpose of MSF is to provide an additional window to bridge gaps in overnight liquidity, always above the repo rate.
- This provides a safety valve against unanticipated liquidity shocks to the banking system.
Market Stabilisation Scheme (MSS)
- This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank.
- The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
Difference between MSF and Repo rate
- Banks can borrow under the LAF-Repo rate, by pledging Govenrment securities, over and above the statutory liquidity requirement. Under the MSF, banks can borrow funds within the statutory liquidity ratio. They do not need to pledge government securities under MSF, while such a pledge is required when availing of the Repo rate. However, MSF can be used only when all other avenues are exhausted, at an extra cost of 3 per cent above Repo rate.
- Fiscal policy means the use of taxation and public expenditure by the government for stabilisation or growth.
- Objectives of Fiscal Policy:
- To maintain and achieve full employment.
- To stabilise the price level.
- To stabilise the growth rate of the economy.
- To maintain equilibrium in the balance of payments.
- To promote economic development.
Scheduled Commercial Banks
- Commercial Banksrefer to both scheduled and non-scheduled commercial banks which are regulated under Banking Regulation Act, 1949.
- All banks which are mentioned in the Second Schedule of RBI Act, 1934 are known as Scheduled Banks.
- The Banking Companies Act was passed in February 1949, which was subsequently amended to read as Banking Regulation Act, 1949. This Act provided the legal framework for regulation of the banking system in India.
- The Scheduled bank comprises Scheduled Commercial Banks and Scheduled Cooperative Banks.
- Scheduled Commercial Banks can be further divided into four groups:
- Public Sector Banks. This includes:
- State Bank of India
- Nationalized Banks
- Other Public Sector Banks
- Private Banks
- Old private-sector banks
- New private-sector banks
- Private-sector Foreign banks
- Regional Rural Banks
- Public Sector Banks. This includes:
- At present, there are 21 Public Sector Banks in India including SBI and 19 nationalized banks. Further, there is one banks which have been categorized by RBI as “Other Public Sector Banks”. IDBI come under this category.
- 19 nationalized banks in India are as follows:
- Allahabad Bank
- Andhra Bank
- Bank of Baroda
- Bank of India
- Bank of Maharashtra
- Canara Bank
- Central Bank of India
- Corporation Bank
- Dena Bank
- Indian Bank
- Indian Overseas Bank
- Oriental Bank of Commerce
- Punjab & Sind Bank
- Punjab National Bank
- Syndicate Bank
- UCO Bank
- Union Bank of India
- United Bank of India
- Vijaya Bank
Functions of Banks
Primary Functions of Banks
- The primary functions of a bank are also known as banking functions. They are the main functions of a bank. These primary functions of banks are explained below.
- Accepting Deposits: The bank collects deposits from the public. These deposits can be of different types, such as:-
- Saving Deposits
- Fixed Deposits
- Current Deposits
- Recurring Deposits
- Saving Deposits: This type of deposits encourages saving habit among the public. The rate of interest is low. At present it is about 4% p.a. Withdrawals of deposits are allowed subject to certain restrictions. This account is suitable to salary and wage earners. This account can be opened in single name or in joint names.
- Fixed Deposits: Lump sum amount is deposited at one time for a specific period. Higher rate of interest is paid, which varies with the period of deposit. Withdrawals are not allowed before the expiry of the period. Those who have surplus funds go for fixed deposit.
- Current Deposits: This type of account is operated by businessmen. Withdrawals are freely allowed. No interest is paid. In fact, there are service charges. The account holders can get the benefit of overdraft facility.
- Recurring Deposits: This type of account is operated by salaried persons and petty traders. A certain sum of money is periodically deposited into the bank. Withdrawals are permitted only after the expiry of certain period. A higher rate of interest is paid.
- Granting of Loans and Advances: The bank advances loans to the business community and other members of the public. The rate charged is higher than what it pays on deposits. The difference in the interest rates (lending rate and the deposit rate) is its profit.The types of bank loans and advances are :-
- Cash Credits
- Discounting of Bill of Exchange
- Overdraft: This type of advances is given to current account holders. No separate account is maintained. All entries are made in the current account. A certain amount is sanctioned as overdrafts which can be withdrawn within a certain period of time say three months or so. Interest is charged on actual amount withdrawn. An overdraft facility is granted against a collateral security. It is sanctioned to businessman and firms.
- Cash Credits: The client is allowed cash credit upto a specific limit fixed in advance. It can be given to current account holders as well as to others who do not have an account with bank. Separate cash credit account is maintained. Interest is charged on the amount withdrawn in excess of limit. The cash credit is given against the security of tangible assets and / or guarantees. The advance is given for a longer period and a larger amount of loan is sanctioned than that of overdraft.
- Loans: It is normally for short term say a period of one year or medium term say a period of five years. Now-a-days, banks do lend money for long term. Repayment of money can be in the form of installments spread over a period of time or in a lumpsum amount. Interest is charged on the actual amount sanctioned, whether withdrawn or not. The rate of interest may be slightly lower than what is charged on overdrafts and cash credits. Loans are normally secured against tangible assets of the company.
- Discounting of Bill of Exchange: The bank can advance money by discounting or by purchasing bills of exchange both domestic and foreign bills. The bank pays the bill amount to the drawer or the beneficiary of the bill by deducting usual discount charges. On maturity, the bill is presented to the drawee or acceptor of the bill and the amount is collected.
- Credit Creation: Another function of banks is to create credit. Creation of credit is the natural outcome of the process of advancing loans that we have discussed above. In advancing loan to the borrower, the bank opens an account in his name and credits the loan amount to that account instead of giving cash to him. The borrower can withdraw the money from the account. Thus, in the process of advancing loans, the bank creates bank deposits which results in increasing the money supply in the economy. This is known as credit creation function of commercial banks.
- Accepting Deposits: The bank collects deposits from the public. These deposits can be of different types, such as:-
Secondary Functions of Banks
- The bank performs a number of secondary functions, also called as non-banking functions. These important secondary functions of banks are explained below.
- Agency Functions: The bank acts as an agent of its customers. The bank performs a number of agency functions which includes:-
- Transfer of Funds
- Collection of Cheques
- Periodic Payments
- Portfolio Management
- Periodic Collections
- Other Agency Functions
- General Utility Services: The banks provide general utility services not only to the customers but also to the general public against a fee. Some of these services are –
- Providing locker facility
- Providing business information
- Issuing travelers’ cheques
- Issuing letter of credit
- Issuing credit cards
- Agency Functions: The bank acts as an agent of its customers. The bank performs a number of agency functions which includes:-
- By the early 1960s, the Government of India realized that a significant share of deposits coming from the masses of India was controlled by 14 privately owned commercial banks. Indian agriculture and industries were booming and the need for finance was high.
- Financial regulations were also very important at that time since those would help shape the nature of the country’s economy for decades to come.
- With Mrs. Indira Gandhi taking over as the Prime Minister of India, the Indian National Congress rallied for a state takeover of some of the major banks in the country.
- In what can be deemed a rather hasty move, the government promulgated an ordinance - the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969 - thereby nationalising all the 14 banks that were under consideration and having deposits of more than rupees 50 Crore, with effect from the midnight of 19 July 1969.
- As a follow-up to passing the ordinance, the Banking Companies (Acquisition and Transfer of Undertaking) Bill was taken up by the Parliament for discussion. It received a clear majority as well as the assent of the President within a month of issuing the ordinance.
- In 1980, when Mrs. Gandhi was re-elected as the Prime Minister for her third term at the PMO, she initiated a second spate of bank nationalization. This time about six banks were nationalised and the Government of India controlled over 90 percent of the banking business in the country. Of the 20 banks that were nationalised, New Bank of India was later (in 1993) merged with Punjab National Bank.
Public Sector Bank
- After 1969 Commercial Banks are broadly classified into Nationalised or Public Sector Banks and Private Sector Banks.
- These Public Sector Banks are now managed by the Government of India through the Board of Directors appointed by it.
State Bank of India
- The State Bank of India was founded as the Imperial Bank of India in January 1921 through the merger of Bank of Calcutta, Bank of Bombay and Bank of Madras. In 1955, the Reserve Bank of India bought a 60-percent stake in the bank and renamed it State Bank of India (SBI Act, 1955).
- During the nationalisation of banks in 1969, and again in 1980, SBI was not added to the list of the ‘nationalised banks’ since it was already a state-owned financial institution. In 2008, the Government of India took over the RBI's stake in the bank to avoid any conflict of interests within the RBI (which both owned and regulated the SBI).
- Now though the SBI and its subsidiaries are often referred to as a nationalised bank, it is a Public Sector Undertaking (PSU) and not one of the nationalised banks of India. It is India's largest banking and financial services enterprise as of now.
- Similarly, IDBI Bank Ltd. is also a public sector bank but not one of the nationalised banks of India. IDBI Bank was established in 1964 (IDBI Act, 1964) to aid developmental finance in the country. Initially, it was a financial institution and did not participate in core banking activities. IDBI Bank was inducted into banking in 2003 and was merged with IDBI Ltd. - a company, in which the Government of India holds about 70-percent stake, in 2005.
- After nationalization in 1969, the Government imposed Social control on banks by introducing certain provisions in the Banking Regulation Act,1949. It imposed severe restrictions on the composition of the board of directors and internal management and administration of Banking Companies. It also introduced restrictions on advances by banking companies.
- These were intended to ensure that the bank advances were not confined to large scale industries and big business houses, but were also directed, in due proportion to other important sectors like agriculture, small scale industries and exports.
Benefits of the Nationalisation of Banks
- The nationalization of banks was a significant move undertaken by the government for the development of the country.
- It instilled public confidence in the banking system encouraging the masses to save and invest.
- It allowed for the elimination of regional bias and promoted opening up of branches in the remote areas of the country as well, thus strengthening the banking network.
- By elimination of monopoly or credit competition, nationalization streamlined banking practices in the country, thereby directing funds where it was most necessary – towards industrial and sectoral development – as planned by the RBI and the Indian government.
- All those banks where greater parts of Stake or equity are held by the private shareholders are called as Private Sector Banks. They are divided into
- Old Private Sector Banks
- New Private Sector Banks
- The banks which were not nationalised at the time of nationalisation of banks that took place during 1969 and 1980 are known as the Old Private Sector Banks. These were not nationalised, because of their small size and regional focus.
- The banks which came in operation after 1991, with the introduction of economic reforms and financial sector reforms are known as New Private Sector Banks. Banking regulation Act was then amended in 1993, which permitted the entry of new Private Sector Banks in the Indian banking sector.
- Foreign Banks are banks from a foreign country working in India through branches.
- Foreign Banks are allowed to operate in India through branches and representative offices. A new foreign Bank desirous of opening a branch in India is required to apply to Reserve Bank of India giving relevant information about its shareholders, financial position and the dealing with Indian parties. Foreign Banks applying for branch in India should met several condition which is mentioned below:
- Economic stability should be proved by the bank
- Bank must have a very good financial soundness
- The bank must provide necessary documents to show the proper ownership.
- The bank must be rated by any International rating agency
- Bank must have a risk management team.
- The largest branch network of foreign banks in India was that of Standard Chartered Bank (96) followed by HSBC Limited (50), Citibank (42) and the Royal Bank of Scotland (31).
Regional Rural Bank
- The nationalization of the banks in 1969 boosted the confidence of the public in the Banking system of the country. However, in the early 1970s, there was a feeling that even after nationalization, there were cultural issues which made it difficult for commercial banks, even under government ownership, to lend to farmers. This issue was taken up by the government and it set up Narasimham Working Group in 1975. On the basis of this committee’s recommendations, a Regional Rural Banks Ordinance was promulgated in September 1975, which was replaced by the Regional Rural Banks Act 1976.
- Regional Rural Banks Act, 1976 was enacted by Parliament to provide for the incorporation, regulation and winding up of Regional Rural Banks
- Regional Rural Banks came into existence on Gandhi Jayanti in 1975 with the formation of a Prathama Grameen Bank. The rural banks had the legislative backing of the Regional Rural Banks Act 1976. This act allowed the government to set up banks from time to time wherever it considered necessary.
- The RRBs were owned by three entities with their respective shares as follows:
- Central Government → 50%
- State government → 15%
- Sponsor bank → 35%
- Regional Rural Banks are regulated by National Bank for Agriculture and Rural Development (NABARD). On the recommendation of M.Narasimham committee, first RRB was Prathama bank in Moradabad (Uttar Pradesh), sponsored by Syndicate Bank ,established on 2nd October, 1975 with capital of Rs. 5 crore .
- The states and UTs, where there is no presence of RRbs are Goa, Sikkim, Delhi, Chandigarh, Andaman and Nicobar Islands, Lakshadweep, Dadra and Nagar Haweli, Daman and Diu.
- The objective of the RRBs is to develop the rural economy by providing for the purpose of development of agriculture, trade, commerce, industry and other productive activities in the rural areas, credit and other facilities, particularly to the small and marginal farmers, agricultural labourers, artisans and small entrepreneurs and for matters connected therewith and incidental thereto.
- A Regional Rural Bank seeking permission of the Reserve Bank for opening branches has to obtain the recommendation of NABARD.