1. Introduction to Banking HISTORICAL PERSPECTIVE Topics: Historical perspective, Banking Sector Reforms in India and recent developments - an overview, Structure of banking Reading Materials: 1. Reserve bank of India: Report on Currency & Finance - III EVOLUTION OF BANKING IN INDIA 2. Notes on Banking Structure
Banking – Definition • The banker has three ancestors • Merchants, • Goldsmiths and • Money lenders - GeofferyCrowther • “Accepting for the purpose of lending or investment, of deposits of money from the public repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise” -Banking Regulation Act 1949, Sec. 5 (b).
Brief History • The first public banking institution was The Bank of Venice, founded in 1157. • The Bank of Barcelona and the bank of Genoa were established in 1401 and 1407 respectively. • The Bank of England was established in 1694. • The joint stock commercial banking started functioning in 1833. • 13th C – Bill of exchange was used in India. • Vedic literature records the details of banking Transactions (2000 -1400 BC) • Manusmrithi speaks of deposits, pledge, loans, interest rates etc. • ‘Pious obligation’ – Sons to discharge the loan of their father • Modern concept of banking was brought by European agency houses. • Earlier to that the concept of ‘banking’ was synonymous with lending
History of Modern Banking in India • 1720: Bank of Bombay. • 1806: The first ‘Presidency bank’ - The Bank of Bengal in Calcutta. • 1823: The bank was given powers to issue notes in. • 1861: The Paper Currency Act - Currency Notes issue only by Govt. • 1860: The concept of limited liability extended to Banks. • 1865: Allahabad Bank, exclusively by Indians for the first time. • 1876: Merger of Presidency banks - The Presidency Bank Act • 1906: The Swadeshi Movement – more Banks of Indians till 1913. • 1913: No. of Banks increased to 56 (13 A Class, 23 B ,12 ex. Banks.) • The Swadeshi Movement also provided impetus to the co-operative credit movement and led to the establishment of a number of agricultural credit societies and a few urban co-operatives.
History and Developments 2 • During the World War I years (1913 to 1918) many banks failed. • imprudence, mismanagement, fraudulent manipulation by directors and managers, incompetence and inexperience were the causes. • Flight of deposits to urban co-operative banks. • The presidency banks amalgamated into the Imperial Bank of India, in 1921. Few other banks were also merged with Imperial Bank. It also functioned as a central bank prior to the establishment of the Reserve Bank in 1935. • By 1930, the number of commercial banks increased to 107. 158 co-operative banks also existed. Including the indigenous Banks, Nidhis and loan companies, the total number of Banking institutions registered under companies Act 1913 were 1528. • Rural indebtedness to money lenders increased which ultimately resulted in the transfers of land from farmers to moneylenders. • The Reserve Bank of India Act, 1934 and subsequent enactments gave RBI , powers of supervision and control over the entire banking system.
History and Developments 2 • Far-reaching effects of the Second World War (1939 to 1944). • Government expenditure on defence and supplies to the Allies led to a rapid expansion of currency. • Surplus in the hands of few and a large pool of bank deposits. • The number of branches increased sharply between 1940 and 1945 and most of this branch expansion was accounted for by scheduled commercial banks. • A large number of small banks sprang up with low capital base. • During this period, a large number of banks also failed. • Global factors and domestic factors - Low capital base, insufficient liquidity and inter-connected lending - caused the failures. • Banking was more focused on urban areas and the credit requirements of agriculture and rural sectors were neglected.
Developments – early years of independence • The first regulatory step by the Government of independent India, was the enactment of The Banking Companies Act, 1949 (later renamed as the Banking Regulation Act) to streamline the functioning and activities of commercial banks in India. • The Banking Companies (Amendment) Act 1961 - compulsory reconstruction or amalgamation of banks. • Reduction in the number of non-scheduled banks from 474 in 1951 to 210 in 1961 and further to 20 in 1967. Their branch offices declined from 1504 in 1951 to 622 in 1961 and to 203 in 1967 • In order to ensure the safety of deposits of small depositors in banks in India, the Deposit Insurance Corporation Act, 1961 was enacted. Accordingly, Deposit Insurance Corporation of India was established in January 1962. • RBI was given power to inspect the Banks, to restrict credit dispensation and to control the appointment and removal of Bank’s executive personnel.
Nationalisation of Imperial Bank • At the time of independence, the bulk of the Bank credit went to commerce and industry, mostly to the controlling entities of the concerned Banks and Agriculture was neglected. • The Imperial Bank of India was nationalised with the enactment of the State Bank of India Act, 1955 • Eight banks, the then subsidiaries of SBI were nationalised in 1960. This brought one-third of the banking segment under the direct control of the Government, which concentrated in branch expansion. • All India Rural Credit Survey Committee (AIRCS) survey in 1951 made suggestions regarding the Reserve Bank’s development role. • In 1966, the banking sector was increasingly subjected to selective credit controls. the focus was on effective use of credit in the overall context of national priorities as enunciated over the years. • The population per bank branch declined from 1,36,000 in 1951 to 92,000 in 1960 and further to 65,000 in 1967. Still, Banking did not reach the rural areas and agriculture as desired.
SOCIAL CONTROL - 1967 TO 1991 • Concentration of credit to individual firms and neglect of agriculture continued to cause concern • Hence the concept of social control over banking was introduced in December 1967 through the Banking Laws (Amendment) Act 1968. • The following provisions of the act are noteworthy: • Not less than 51 per cent of the board of directors of a bank were to consist of persons who had special knowledge or practical experience in various fields. • every bank to have a whole-time chairman who was a professional banker and his term was not to exceed 5 years at a time. • The RBI was vested with the powers of appointment, removal or termination of the services of the chairman director, CEO etc. • The National Credit Council (NCC) was set up in February 1968 to assist the Reserve Bank and the Government to allocate credit according to plan priorities. • Despite the system of social control on banks, a large segment of the population remained outside the purview of the organised sector credit.
Nationalisation of Banks • On the eve of nationalisation, the banks had a definite urban orientation as about 44 per cent of total deposits and 60 per cent of total credit were accounted for by the five centres • In order that bank funds be channelled for rapid economic growth with social justice, the Government nationalised 14 banks with deposits of over Rs.50crore, in 1969. • The immediate tasks set for the nationalised banks were mobilisation of deposits on a large scale and on-lending those funds for all productive activities,, particularly to weaker sections of the society. • To make banking facilities available in the then unbanked areas, a branch licence policy was evolved along with initiating specific schemes like the Lead Bank Scheme (LBS). • The ‘lead bank’ designated for the district was responsible for taking lead role in surveying the credit needs of the population, development of banking and of credit facilities in the district allotted to it.
Progress in 23 years • The branch network which was 8262 in June 1969 expanded to 60000 by 1992 with major expansion (80%) in rural areas. • The average number of people served by a branch came down from 60000 to 11000. • In 1969 deposits amounted to 13% of GDP and advances to 10%. By 1990 deposits grew to 30% and advances to 25% of the GDP • Deposits grew from a figure of Rs. 4669 Crores in July 1969 to Rs. 2,75,000 crores on 31.3.1993. • More than 45% of the total credit was directed to the priority sector. • More than 45% of the total deposits were used by the government to fund its five year plans
Nationalisation - signs of Positive impact. • In 5 years of nationalisation, the branch network expanded by 129 per cent. The population per bank office declined to 31,660 per bank office in December 1975 from 65,000 in June 1969. • The share of rural branches in total bank branches increased from 17.6 % in 1969 to 36.3 % in 1975. • One of the objectives of nationalisation of banks was to ensure that no productive endeavour fell short of credit support. • Banks were directed that each rural and semi-urban bank should maintain a credit-deposit ratio of at least 60 per cent. • The credit-deposit ratios for the banks were carefully monitored. • Immediately after the nationalisation, confidence in the banking sector increased, which was reflected in the sharp increase in the share of bank deposits in household savings and financial savings of households in their total saving.
Setting up of Regional rural Banks • From 1974, National targets were set for Lending to Priority Sector. Banks were directed to provide 30% of their total credit to Priority sector. The ratio was raised to 40% later. • The establishment of the Credit Guarantee Corporation of India Ltd. in 1971 encouraged Banks for this type of lending. • The Differential Rate of Interest (DRI) Scheme was instituted in 1972 for upliftment of the weaker sections of the society. • The share of agricultural credit in total bank credit increased from 2.2 % 1967 to 8 % in 1970-71 and further to 9.1 per cent in 1974-75. However, this improvement was not upto the expectations. • In order to develop the rural economy by providing credit for the purpose of development of agriculture, trade, commerce, industry and other facilities, Regional Rural Banks (RRBs) were set up. They were expected to ‘combine the rural touch and local feel with the modern business organisation’.
Further improvement • In 1978, commercial banks and RRBs were directed to charge a flat rate of 9 per cent on all priority sector loans, irrespective of size. The policy was to free the vulnerable rural population from the local moneylenders by enhancing the spread of organised credit. • The results of nationalisation of banks and introduction of directed credit programmes and other initiatives were extremely encouraging. The share of rural branches increased sharply from 17.6 per cent in 1969 to 58.2 per cent in 1990. • The credit-deposit ratio in rural areas increased from 37.6 per cent in 1969 to 60.6 per cent in 1981 and remained at that level in 1990. • While RBI continued in its role of administering the interest rate for deposits and advances with focus on easy credit to Priority sector and exports, excess demand for credit for the industry was controlled by stipulating inventory norms for industries. • In 1980 six Banks with deposits of over Rs. 200 Cr were nationalised.
Financial and banking sector Reforms • Introduction of Prudential norms relating to income recognition, asset classification, provisioning & capital adequacy n 1992 • Guidelines on entry of private sector banks in January 1993. • The SLR reduced to the then statutory minimum of 25 % by Oct 97. • The CRR progressively reduced from the peak level of 15 % to 4.5 % by June 2003; subsequently raised in stages to 9 % in Aug 08. • Deregulation of interest rates except for Savings Bank Deposits. • The Banking Ombudsman Scheme introduced in June 1995. • MPBF was phased out from April 1997. • The CRAR raised to 9 % from 8 % from year ended March 31, 2000. • increase in the FDI limit in private sector banks. • The Banking Codes and Standards Board of India (BCSBI) was set up
Financial and banking sector Reforms - 2 • A risk based supervision (RBS) approach was initiated in April 2004. • ‘No frills’ account with nil or low minimum balances. Nov 05. • In Jan 2006, banks were permitted to utilise the services of NGOs/SHGs, micro-finance institutions and other civil society organisations as intermediaries. • The Recovery of Debts Due to Banks and Financial Institutions Act 1993. • Partial private shareholding in SBI and nationalised banks permitted. • The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 enacted. • Section 42 of the RBI Act amended in 2006 to remove the ceiling (20 % and 3%) on the CRR. Floor of 25 per cent on the SLR also removed.
Indian Banking system • All banks which are included in the Second Schedule to the Reserve Bank of India Act, 1934 are Scheduled Banks. These banks comprise Scheduled Commercial Banks and Scheduled Co-operative Banks. • Public Sector banks comprise of Nationalised Banks and IDBI bank. • There are no non- scheduled commercial banks in India at present.
Regional Rural Bank (RRB) • Started to strengthen the banking system in rural areas • Combination of the following:- • Rural atmosphere • Local feeling • Knowledge of cooperative institutions • Modern banking practices • First RRB – October 1975 • RRB Act – 1976
NATIONALISED BANKS SCHEDULED BANKS PUBLIC SECTOR BANKS OTHER PUBLIC SECTOR BANKS SBI AND ASSOCIATES OLD PRIVATE BANKS SCHEDULED COMMERCIAL BANKS PRIVATE SECTOR BANKS NEW PRIVATE BANKS FOREIGN BANKS IN INDIA SCHEDULED BANKS REGIOLAL RURAL BANKS URBAN COOPERATIVE BANKS SCHEDULED COOPERATIVE BANKS STATE COPERATIVE BANKS
2. Regulatory framework Topics: Government Regulations for Banks, Reserve bank of India, Credit policcies, SLR, CRR requirements. Study Materials: Introduction to Banking- VijayaragavanIyengar Chapter 2, 8,9
Central bank • “The Central Bank is an institution charged with the responsibility of managing the expansion and contraction of the volume of money in the interest of the general public welfare…” - R. P. Kent, Money and Banking, p. 351 • Almost all nations in the globe have their ‘Central Banks’ • The idea of having central bank attained popularity during 20th century (although some central banks in existence earlier as well) • International Monetary Conference held in Brussels (1929) – strongly emphasized the need of central banking unit
Necessity of Central bank • Control of credit in any nation • monopoly power of currency issue • Friend, philosopher & guide to commercial banks • Implementation of government’s monetary policies
Reserve Bank of India • Established in 1935 - Reserve Bank of India Act, 1934. • Initially functioned as private bank with share capital of 5 crores. • Nationalised in 1948 by RBI (transferred to public ownership) Act. • Private share holders were paid @ 118.10 per share. • Operation – (Bombay, Calcutta, Madras, Delhi and Rangoon) – (Myanmar) • 1947 – Rangoon office was closed.
Reserve Bank of India • Preamble to the Reserve Bank of India Act: • “Whereas it is expedient to constitute a RBI to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; • And whereas in the present disorganization of the monetary systems of the world it is not possible to determine what will be suitable as permanent basis for the Indian monetary system; • But whereas it is expedient to make temporary provision on the basis of the existing monetary system, and to leave the question of the monetary standard best suited to India to be considered when the international monetary position has become sufficiently clear and stable to make it possible to frame permanent measures”
Main Functions of RBI • Price Stability: to formulate implement and monitor appropriate monetary policy which shall address the requirements of the economy.