India cannot have a healthy economy without a sound and effective banking system. The banking system should be hassle free and able to meet the new challenges posed by technology and other factors, both internal and external.

In the past three decades, India's banking system has earned several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to metropolises or cities in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main aspects of India's growth story.

The government's regulation policy for banks has paid rich dividends with the nationalization of 14 major private banks in 1969. Banking today has become convenient and instant, with the account holder not having to wait for hours at the bank counter for getting a draft or for withdrawing money from his account.

History of Banking in India

The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases:

  • Early phase of Indian banks, from 1786 to 1969
  • Nationalization of banks and the banking sector reforms, from 1969 to 1991
  • New phase of Indian banking system, with the reforms after 1991

Phase 1
The first bank in India, the General Bank of India, was set up in 1786. Bank of Hindustan and Bengal Bank followed. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840), and Bank of Madras (1843) as independent units and called them Presidency banks. These three banks were amalgamated in 1920 and the Imperial Bank of India, a bank of private shareholders, mostly Europeans, was established. Allahabad Bank was established, exclusively by Indians, in 1865. Punjab National Bank was set up in 1894 with headquarters in Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. The Reserve Bank of India came in 1935.

During the first phase, the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1,100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with the Banking Companies Act, 1949, which was later changed to the Banking Regulation Act, 1949 as per amending Act of 1965 (Act No. 23 of 1965). The Reserve Bank of India (RBI) was vested with extensive powers for the supervision of banking in India as the Central banking authority. During those days, the general public had lesser confidence in banks. As an aftermath, deposit mobilization was slow. Moreover, the savings bank facility provided by the Postal department was comparatively safer, and funds were largely given to traders.

Phase 2
The government took major initiatives in banking sector reforms after Independence. In 1955, it nationalized the Imperial Bank of India and started offering extensive banking facilities, especially in rural and semi-urban areas. The government constituted the State Bank of India to act as the principal agent of the RBI and to handle banking transactions of the Union government and state governments all over the country. Seven banks owned by the Princely states were nationalized in 1959 and they became subsidiaries of the State Bank of India. In 1969, 14 commercial banks in the country were nationalized. In the second phase of banking sector reforms, seven more banks were nationalized in 1980. With this, 80 percent of the banking sector in India came under the government ownership.

Phase 3
This phase has introduced many more products and facilities in the banking sector as part of the reforms process. In 1991, under the chairmanship of M Narasimham, a committee was set up, which worked for the liberalization of banking practices. Now, the country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking are introduced. The entire system became more convenient and swift. Time is given importance in all money transactions.

The financial system of India has shown a great deal of resilience. It is sheltered from crises triggered by external macroeconomic shocks, which other East Asian countries often suffered. This is all due to a flexible exchange rate regime, the high foreign exchange reserve, the not-yet fully convertible capital account, and the limited foreign exchange exposure of banks and their customers.

The Banking Structure in India
The commercial banking structure in India consists of scheduled commercial banks and unscheduled banks. Scheduled banks constitute those banks that are included in the Second Schedule of Reserve Bank of India (RBI) Act, 1934.

As on June 30, 1999, there were 300 scheduled banks in India having a total network of 64,918 branches. The scheduled commercial banks in India comprise State Bank of India and its associates (8), nationalised banks (19), foreign banks (45), private sector banks (32), co-operative banks, and regional rural banks. Before the nationalization of Indian banks, the State Bank of India (SBI) was the only nationalized bank, which was nationalized on July 1, 1955, under the SBI Act of 1955. The nationalization of seven State Bank subsidiaries took place in 1959.
After the nationalization of banks in India, the branches of the public sector banks rose to approximately 800 percent in deposits and advances took a huge jump by 11,000 percent.

Nationalization Process

  • 1955: Nationalization of State Bank of India
  • 1959: Nationalization of SBI subsidiaries
  • 1969: Nationalization of 14 major banks
  • 1980: Nationalization of seven banks with deposits over Rs 200 crore

Banks in India

In India, banks are segregated in different groups. Each group has its own benefits and limitations in operations. Each has its own dedicated target market. A few of them work in the rural sector only while others in both rural as well as urban. Many banks are catering in cities only. Some banks are of Indian origin and some are foreign players.

Banks in India can be classified into:

  • Public Sector Banks
  • Private Sector Banks  
  • Cooperative Banks
  • Regional Rural Banks
  • Foreign Banks

One aspect to be noted is the increasing number of foreign banks in India. The RBI has shown certain interest to involve more foreign banks. This step has paved the way for a few more foreign banks to start business in India.

Reserve Bank of India (RBI)
The central bank of the country is the Reserve Bank of India (RBI). It was established in April 1935 with a share capital of Rs 5 crore on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into fully paid shares of Rs 100 each, which was entirely owned by private shareholders in the beginning. The government held shares of nominal value of Rs 220,000.

The RBI commenced operation on April 1, 1935, under the Reserve Bank of India Act, 1934. The Act (II of 1934) provides the statutory basis of the functioning of the Bank. The Bank was constituted to meet the following requirements:

  • Regulate the issue of currency notes
  • Maintain reserves with a view to securing monetary stability
  • Operate the credit and currency system of the country to its advantage

Functions of the RBI
The Reserve Bank of India Act of 1934 entrusts all the important functions of a central bank with the Reserve Bank of India.

Bank of Issue: Under Section 22 of the Act, the Bank has the sole right to issue currency notes of all denominations. The distribution of one-rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as an agent of the government.

Banker to the Government: The second important function of the RBI is to act as the government’s banker, agent, and adviser.

Bankers' Bank and Lender of the Last Resort: The RBI acts as the bankers' bank.  Since commercial banks can always expect the RBI to come to their help in times of banking crisis, the RBI becomes not only the banker's bank but also the lender of the last resort.

Controller of Credit: The RBI is the controller of credit, i.e., it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations.

Custodian of Foreign Reserves: The RBI has the responsibility to maintain the official rate of exchange. Besides maintaining the rate of exchange of the rupee, the RBI has to act as the custodian of India's reserve of international currencies.

Supervisory Functions: In addition to its traditional central banking functions, the RBI has certain non-monetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949, have given the RBI wide powers of supervision and control over commercial and co-operative banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction, and liquidation.

Indian Banks’ Association (IBA)
The Indian Banks’ Association (IBA) was formed on September 26, 1946, with 22 members. Today, IBA has more than 156 members, such as public sector banks, private sector banks, foreign banks having offices in India, urban co-operative banks, developmental financial institutions, federations, merchant banks, mutual funds, housing finance corporations, etc.

The IBA has the following functions:

  • Promote sound and progressive banking principles and practices.
  • Render assistance and to provide common services to members.
  • Organize co-ordination and co-operation on procedural, legal, technical, administrative, and professional matters.
  • Collect, classify, and circulate statistical and other information.
  • Pool expertise towards common purposes such as cost reduction, increased efficiency, productivity, and improving systems, procedures, and banking practices.
  • Project good public image of banking through publicity and public relations.
  • Encourage sports and cultural activities among bank employees.

 Banking Activities

  • Retail banking, dealing directly with individuals and small businesses
  • Business banking, providing services to mid-market businesses
  • Corporate banking, directed at large business entities
  • Private banking, providing wealth management services to high networth individuals
  • Investment banking, activities in the financial markets, such as "underwrite" (guarantee the sale of) stock and bond issues, trade for their own accounts, make markets, and advise corporations on capital market activities like mergers and acquisitions
  • Merchant banking is the private equity activity of investment banks
  • Financial services, global financial institutions that engage in multiple activities such as banking and insurance

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