The Indian Banking Structure
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented” Josiah Stamp. The object of this report is to understand in depth the concept of what are banks, history of the Indian banking system, structure of banking in India, types of banks and the key statutes and regulations.
What are Banks
Banks are in presence since dating back to the 14th century, banks furnish a safe haven for the consumers as well as the business owners to stow their cash and it is also a source of loans for personal purchases and business ventures. Consecutively, the banks use the deposited cash to make loans and collect interest on them.
The basic business plan structure has not changed much since the Medici Family started to dabble in banking during the Renaissance period. Though over the course of time the range of services that banks offer have increased.
Oxford dictionary defines a bank as “an organization that provides various financial services, for example keeping or lending money”. A bank in a simplified manner can be defined as a financial institution which executes the deposit as well as lending function. A bank permits a person with excess money to deposit his money in the bank and also earn an interest rate.
On the other hand, bank lends money to a person who needs it at an interest rate. Hence, banks act as an intermediary between the saver and the borrower. Banks take a deposit from the public at a lower rate which is called a deposit rate and further lends the money to the borrower at a much higher rate which is called lending rate. The difference between the deposit and the lending rate is called as the net interest spread and this interest spread constitutes as the banks income.
History of Indian Banking
The modern banking in India began in the 18th century with the establishment of the English Agency Houses in Calcutta and Bombay. In the first half of the 19th century three presidency banks namely Bank of Bengal (1806), Bank of Bombay (1840) and Bank of Madras (1843) were established. After the introduction of limited liability in 1860 the private banks and foreign banks entered into the market. The beginning of the 20th century saw the introduction of Joint Stock Banks.
In 1921, the three presidency banks were merged to create the Imperial Bank of India. The Imperial Bank of India performed all the normal functions which a commercial bank was expected to perform. In the absence of any Central Bank in India till 1935, the Imperial Bank of India also performed a number of functions which are normally carried out by a Central Bank.
At the time of Independence in 1947, the banking system in India was fairly well developed with over 600 commercial banks operating in the country. However soon after independence the view that the banks from the colonial heritage were biased in favour of the working capital loans for trade and large firms and against extending credit to small scale enterprise, agriculture and commoners gained prominence.
To ensure better coverage of banks the needs of larger parts of economy and the rural constituencies, the Government of India nationalised the Imperial Bank which was established in 1921 and transformed it into the State Bank of India (SBI) with effect from 1955.
Despite the progress in 1950’s and 1960’s it was felt that the creation of SBI was not far reaching enough since the banking needs of the small scale industries and the agricultural structure was still not covered sufficiently. This was partially due to the existing close ties commercial and industry houses maintained with the established commercial banks which give them an advantage in obtaining credit.
Additionally, there was a perception that banks should play a more prominent rule in India’s development strategy by mobilising resources for sectors that were seen as crucial for the economic expansion. As a result, the policy of social control over banks was announced and its aim was to cause changes in the management and distribution of credit by commercial banks.
The post war development strategy was in many ways a socialist one and the Indian Government felt that banks in private hands did not lend enough to those who needed it most. In July 1969, the Government nationalised all 14 banks whose nation wise deposits were greater than Rs.50 crores.
The bank nationalisation in July 1969 with its objective to control the commanding heights of the economy and to meet progressively the needs of development of the economy in conformity with the national policy and objectives served to intensify the social objective of ensuring that financial intermediaries fully met the credit demands for the productive purposes. Two significant purposes of nationalisation were the rapid branch expansion and channelling of credit according to the plan priorities.
The Indian banking system progressed by leaps and bounds after nationalisation and bank branches expanded rapidly both in rural and urban areas. There was a rapid growth in deposits mobilised by the banks. Besides credit expansions, especially in the areas designated as priority sector. After nationalisation, the breadth and scope of Indian banking sector expanded at a rate perhaps unmatched by any other country.
In April 1980, the government undertook a second round of nationalisation, placing under government control the six private banks whose nationwide deposits were above Rs.200 crores which increased the public sector banks share of deposits to 92%. The second wave of nationalisations 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 government deficits.
Structure of Banking in India
The Reserve Bank of India (RBI) is the central bank of the country. Central banks are a relatively recent innovation and most central banks as we know them today were established around the early twentieth century. The RBI was set up on the basis of the recommendations of the Hilton Young Commission.
The Reserve Bank of India Act, 1934 provides the statutory basis of the functioning of the bank which commenced operations on April 1, 1935. The structure of banking system in india can be divided into Scheduled Banks, Non-Scheduled Banks and Development Banks.
The banks which are included in the second schedule of the RBI Act, 1934 are considered to be scheduled banks. All scheduled banks enjoy the following facilities, as such a bank becomes eligible for debts/loans on bank rate from the RBI and such a bank automatically acquires the membership of a clearing house.
All banks which are not included in the second section of the RBI Act, 1934 are Non-scheduled banks. These banks are not eligible to borrow from the RBI for normal banking purposes except for emergencies. Scheduled banks are further divided into Commercial Banks and Cooperative Banks.
Commercial banks are the banks which accept deposits from the general public and advance loans with the purpose of earning profits. Commercial banks can be broadly divided into public sector banks, private sector banks, foreign banks and regional rural banks.
Public sector banks, the majority stake is held by the government and after the recent amalgamation of smaller banks with larger banks there are 12 public sector banks in india as of now, a perfect example of public sector banks is State Bank of India.
Private sector banks, the major stakes in the equity are owned by private stakeholders or business houses and a few major private sector banks in india are ICICI bank, HDFC bank and Kotak Mahindra bank.
Foreign banks, a bank which has its headquarters outside the country but runs its offices as a private entity at any other location outside the country and such banks are under an obligation to operate under the regulations provided by the central bank of the country as well as the rule prescribed by the parent organisation located outside india.
Citi Bank is an great example of a foreign bank in India. Regional rural banks (RRB), these banks were established under the Regional Rural Banks Ordinance, 1975 with the aim of ensuring sufficient institutional credit for agriculture and other rural sectors.
The area of operation of RRBs is limited to the area notified by the government and RRBs are owned jointly by the government of India and the state government as well as the sponsor banks. Arunachal Pradesh Rural Bank is an great example of RRB in India.
Cooperative bank is a financial entity that belongs to its members who are also the owners as well as the customers of their banks, they provide their members with numerous banking and financial services. Cooperative banks are the primary supporters of agricultural activities, small scale industries and self employed workers.
Mehsana Urban Co-operative Bank is an example of cooperative bank in India. Cooperative banks are divided into two categories urban and rural, rural cooperative banks are either short term or long term. Short term cooperative banks can be subdivided into State co-operative banks, District central co-operative banks and Primary agricultural credit societies.
Long term banks are either State Cooperative Agriculture and Rural Development Banks (SCARDBs) or Primary Cooperative Agriculture and Rural Development Banks (PCARDBs). Urban Co-operative Banks (UCBs) refer to primary cooperative banks located in urban and semi-urban areas.
Development Banks the chief development banks in India are, Industrial Finance Corporation of India (IFCI Ltd) 1948, Industrial Development Bank of India (IDBI) 1964, Export-Import Banks of India (EXIM) 1982, Small Industries Development Bank of India (SIDBI) 1989, National Bank for Agriculture and Rural Development (NABARD) 1982.
Types of Banks
1 Commercial Banks
Commercial banks are of two categories namely Scheduled Commercial Banks and Non-scheduled Commercial Banks. A scheduled bank is called as such because it has been included in the second schedule of the RBI Act, 1934.
The other conditions for a scheduled bank are that it must be a corporation and the paid up share capital should be at least Rs.500 crores. The difference between scheduled and non-scheduled banks is the type of banking activity that they are allowed to carry out in india.
A Non-scheduled bank can carry out limited operations for example non-scheduled banks are not allowed to deal in foreign exchange. Non-scheduled banks need to maintain reserve requirements as per the Banking Regulation Act, 1949 but may not be with RBI. Scheduled banks are required to maintain reserve requirements with RBI as per the RBI Act, 1934.
2 Scheduled Banks
– Public Sector Banks:
Banks owned by the central or state governments having more than 51% ownership with the government. For example SBI and its associates, Punjab National Bank, Bank of India. Nationalised banks (private banks taken over by the government) which were nationalised in 1969 and 1980s are also public sector banks as government owns more than 51% in these banks.
State Bank of India
Bank of Baroda
Bank of India
Central Bank of India
Bank of Maharashtra
– Private Sector Banks:
Banks where the majority stakes are owned by a private organization or an individual or a group of people. For example ICICI Bank, Axis Bank.
City Union Bank
Kotak Mahindra Bank
– Foreign Banks:
Banks with their headquarters in a foreign country and branches in our country fall under this category. Banks established in India but owned by foreign entity and these are basically private banks only owned by foreign entities. For example Citi Bank.
United Overseas Bank Ltd
Westpac Banking Corporation
National Australia Bank
DBS Bank Ltd
– Regional Rural Banks (RRB):
This bank was established in 1975 under the provisions of the Regional Rural Banks, 1976 with a view 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 small and marginal farmers, agricultural labourers, artisans as well as small entrepreneurs. RRBs are owned by the central government, concerned state government and the sponsor bank in proportion of 50:15:35 (each RRB is sponsored by a particular bank). RRBs need to provide 75% of the lending to priority sectors. RRBs are under the supervision of NABARD.
– Payment Banks:
In August 2015 RBI granted license to 11 applicants for Payment Banks. RBI has put a cap of Rs.2 lakh on deposits that payment banks can receive from individual customers. This restriction will allow only those companies to seek for payment bank license who are really interested in targeting the poor.
Hence, the main target for payment banks will be migrant labourers, self employed, low income, households etc. as they will offer low cost savings accounts and remittance services so that those who now transact only in cash can take their first step into the formal banking system.
Payment banks will not be allowed to lend and issue credit cards. Payment banks will accept only demand deposits eg: only savings account and current account facility will be available. The payment banks will be cashing in on mobile technology and applications to cater to the various services they will be offering and with the use of technology they can be cost efficient. Payment banks will be acting as add-on to the already established banks, rather than their competitors.
Paytm Payments Bank
NSDL Payments Bank
Jio Payments Bank
Fino Payments Bank
India Post Payments Bank
Airtel Payments Bank
– Small Finance Banks:
In September 2015 RBI granted license to 10 applicants for Small Finance Banks which in a step in the direction of furthering the financial inclusion. The small finance banks shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganised sector entities.
There will not be any restriction in the area of operations of small finance banks. The small finance banks will be required to extend 75% of its total credit to the sectors eligible for classification as priority sector lending (PSL) by the RBI.
At least 50% of its loan portfolio should constitute loans and advances of up to Rs.25 lakhs. Both payment banks and small finance banks are niche or differentiated banks eg: specialised in certain banking functions and not universal.
Capital Small Finance Bank
Esaf Small Finance Bank
AU Small Finance Bank
Utkarsh Small Finance Bank
Fincare Small Finance Bank
Equitas Small Finance Bank
Jana Small Finance Bank
3 Non-Scheduled Banks
– Local Area Banks (LAB):
They were set up as per a government of India scheme announced in 1996. The intention of the government was to set up new private local banks with jurisdiction over two or three contiguous districts. The objective of establishing the local area banks was to enable mobilisation of the rural savings by local institutions and make them available for investments in local areas. There are only four Local Area Banks in india which exist in the form of Non-scheduled banks. Eg: Coastal Local Area Bank in Vijayawada, Andhra Pradesh.
4 Co-operative Banks
The co-operative banks are of two categories namely Urban Co-operative banks (UCB) and Rural Co-operative banks. The urban coco-operative banks (UCB) also called Primary Co-operative banks are located in urban and semi urban areas and were traditionally entered around communities, localities work place groups. They essentially lent to small borrowers and businesses, today their scope of operations has widened considerably.
UCBs are again classified into scheduled and non-scheduled categories which are then further classified into single state and multi state. Single state UCBs are registered as cooperative societies under the provisions of the State Government Cooperative Societies Act and are regulated by the Registrar of Cooperative Societies (RCS) of state concerned.
Multi-State UCBs registered as cooperative societies under the provisions of Multi-State Cooperative Societies Act, 2002 and are regulated by the Central Registrar of Cooperative Societies (CRCS). UCBs come under the supervision of RBI. The rural co-operative credit system in india is primarily mandated to ensure flow of credit to the agriculture sector. It comprises short term and long term co-operative credit structures.
The short term co-operative credit structure operates with a three tier system, State Cooperative Banks (StCBs) at the State level, (District) Central Cooperative Banks (DCCBs) at the District level and Primary Agricultural Credit Societies (PACS) at the Village level.
A PACS is organised at the grass roots level of a village or a group of small villages. It is this basic unit which deals directly with the rural (agricultural) borrowers, gives them loans and collects repayments of loans given. PACS are outside the purview of the Banking Regulation Act, 1949 and hence not regulated by the RBI.
SCBs/DCCBs are registered under the provisions of State Cooperative Societies Act of the State concerned and comes under the dual regulation of state government and RBI. All rural cooperative banks are supervised by NABARD.
Key Statutes and Regulations
The key statutes and regulations which govern the banking industry in india are the Reserve Bank of India Act, 1934 (RBI Act), the Banking Regulation Act, 1949 (BR Act), The Foreign Exchange Management Act, 1999 and the rules and regulations issued thereunder (FEMA).
RBI Act was enacted to establish and set out functions of the RBI. The RBI Act empowers the RBI to issue rules, regulations, directions and guidelines on a wide range of issues relating to the banking and financial sectors.
BR Act provides a framework for supervision and regulation of all banks and it also gives the RBI the power to grant licenses to banks and regulate their business operations. The BR Act also sets out details of the various businesses that a bank in india is permitted to engage in.
FEMA is the primary legislation in India that regulates cross-border transactions and related activities. FEMA and the rules made thereunder are administered by the RBI. In addition the following regulations also govern banking in India, The Bankers Books Evidence Act, 1891, The Recovery of Debts Due to Banks and Financial Institutions Act, 1993, The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, The Payment and Settlement Systems Act, 2007 and various guidelines, directions and regulations issued by the RBI from time to time.
A efficiently functioning financial system is fundamental to a modern economy and banks perform important functions for the society therefore they must be secure. Banks play an extremely important role in our lives today as technology has developed and continues too we will be seeing many more changes in time to come.
Banks have an vital part as they act as an intermediary between people having surplus money and those requiring money for various business activities as well as they help the national development by providing credit to the farmers, small scale industries and self employed people as well as to the large business houses which leads to a balanced economic development in the country.
The deposits accepted by the banks are converted into loans and advances for industrial and trading activities to business organisations, this way banking converts savings into investment leading to capital formation and development of the economy.
Banking helps business through a variety of services like providing long term and short term finance, arranging remittance of money, collection of cheques and bills as well Helps in raising of capital by acting as the underwriters.