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Indigenous Banking:
The exact date of existence of indigenous bank is not known. But, it is certain that
the old banking system has been functioning for centuries. Some people trace the
presence of indigenous banks to the Vedic times of 2000-1400 BC. It has
admirably fulfilled the needs of the country in the past.
However, with the coming of the British, its decline started. Despite the fast
growth of modern commercialbanks, however, the indigenous banks continue to
hold a prominent position in the Indian money market even in the present times.
It includes shroffs, seths, mahajans, chettis, etc. The indigenous bankers lend
money; act as money changers and finance internal trade of India by means of
hundis or internal bills of exchange.
Defects:
The main defects of indigenous banking are:
(i) They are unorganised and do not have any contact with other sections of
the banking world.
(ii) They combine banking with trading and commission business and thus have
introduced trade risks into theirbanking business.
(iii) They do not distinguish between short term and long term finance and also
between the purpose of finance.
(iv) They follow vernacular methods of keeping accounts. They do not give
receipts in most cases and interest which they charge is out of proportion to the
rate of interest charged by other banking institutions in the country.
Suggestions for Improvements:
(i) The banking practices need to be upgraded.
(ii) Encouraging them to avail of certain facilities from the banking system,
including the RBI.
(iii) These banks should be linked with commercial banks on the basis of certain
understanding in the respect of interest charged from the borrowers, the
verification of the same by the commercial banks and the passing of the
concessions to the priority sectors etc.
(iv) These banks should be encouraged to become corporate bodies rather than
continuing as family based enterprises.
Structure of Organised Indian Banking System:
The organised banking system in India can be classified as given
below:
Reserve Bank of India (RBI):
The country had no central bank prior to the establishment of the RBI. The RBI is
the supreme monetary and banking authority in the country and controls
the banking system in India. It is called the Reserve Bank as it keeps the reserves
of all commercialbanks.
Commercial Banks:
Commercial banks mobilise savings of general public and make them available to
large and small industrial and trading units mainly for working capital
requirements.
Commercial banks in India are largely Indian-public sector and private sector
with a few foreign banks. The public sector banks account for more than 92
percent of the entire banking business in Indiaoccupying a dominant position
in the commercial banking. The StateBank of India and its 7
associate banks along with another 19 banks are the public sector banks.
Scheduled and Non-Scheduled Banks:
The scheduled banks are those which are enshrined in the second schedule of the
RBI Act, 1934. These bankshave a paid-up capital and reserves of an aggregate
value of not less than Rs. 5 lakhs, hey have to satisfy the RBI that their affairs are
carried out in the interest of their depositors.
All commercial banks (Indian and foreign), regional ruralbanks, and state
cooperative banks are scheduled banks. Non- scheduled banks are those which
are not included in the second schedule of the RBI Act, 1934. At present these are
only three such banks in the country.
Regional Rural Banks:
The Regional Rural Banks (RRBs) the newest form ofbanks, came into existence
in the middle of 1970s (sponsored by individual nationalised commercial banks)
with the objective of developing rural economy by providing credit and deposit
facilities for agriculture and other productive activities of al kinds in rural areas.
The emphasis is on providing such facilities to small and marginal farmers,
agricultural labourers, rural artisans and other small entrepreneurs in rural
areas.
Other special features of these banks are:
(i) their area of operation is limited to a specified region, comprising one or more
districts in any state; (ii) their lending rates cannot be higher than the prevailing
lending rates of cooperative credit societies in any particular state; (iii) the paidup capital of each ruralbank is Rs. 25 lakh, 50 percent of which has been
contributed by the Central Government, 15 percent by State Government and 35
percent by sponsoring public sector commercial banks which are also responsible
for actual setting up of the RRBs.
These banks are helped by higher-level agencies: the sponsoring banks lend them
funds and advise and train their senior staff, the NABARD (National Bank for
Agriculture and Rural Development) gives them short-term and medium, term
loans: the RBI has kept CRR (Cash Reserve Requirements) of them at 3% and
SLR (Statutory Liquidity Requirement) at 25% of their total net liabilities,
whereas for other commercial banks the required minimum ratios have been
varied over time.
Cooperative Banks:
Cooperative banks are so-called because they are organised under the provisions
of the Cooperative Credit Societies Act of the states. The major beneficiary of the
Cooperative Banking is the agricultural sector in particular and the rural sector in
general.
The cooperative credit institutions operating in the country are mainly of two
kinds: agricultural (dominant) and non-agricultural. There are two separate
cooperative agencies for the provision of agricultural credit: one for short and
medium-term credit, and the other for long-term credit. The former has three tier
and federal structure.
At the apex is the State Co-operative Bank (SCB) (cooperation being a state
subject in India), at the intermediate (district) level are the Central
CooperativeBanks (CCBs) and at the village level are Primary Agricultural Credit
Societies (PACs).
Long-term agriculture credit is provided by the Land Development Banks. The
funds of the RBI meant for the agriculture sector actually pass through SCBs and
CCBs. Originally based in rural sector, the cooperative credit movement has now
spread to urban areas also and there are many urban cooperative banks coming
under SCBs.
It is necessary to encourage people to deposit their surplus funds with the banks.
These funds are used -for providing loans to the industries thereby making
productive investments.
A bank is a financial intermediary that accepts deposits and channels those
deposits into lending activities. They are the active players in financial market.
The essential role of a bank is to connect those who have capital with those who
seek capital. After the post economic liberalization and globalization, there has
been a significant impact on the banking industry.
Banking in India originated in the 18th century. The oldest bank in existence in
India is the State Bank of India, a government-owned bank in 1806. SBI is the
largest commercial bank in the country.
After the independence, Reserve Bank of India was nationalized and given wide
powers. Currently, India has 96 Scheduled Commercial Banks, 27 public
sector banks, 31 private banks and 38 foreign banks.
Today, banks have diversified their activities and are getting into new products
and services that include opportunities in credit cards, consumer finance, wealth
The popularity which virtual banking services have won among customers, owing
to the speed convenience and round-the-clock access they offer, is likely to
increase in the future.
Highlights of Narasimham Committee Recommendations
on Banking Reforms in India!
The main recommendations of Narasimham Committee (1991) on the Financial
(Banking) System are as follows;
(i) Statutory Liquidity Ratio (SLR) is brought down in a phased manner to 25
percent (the minimum prescribed under the law) over a period of about five years
to givebanks more funds to carry business and to curtail easy and captive finance.
(ii) The RBI should reduce Cash Reserve Ratio (CRR) from its present high level.
(iii) Directed Credit Programme i.e., credit allocation under government
direction, not by commercial judgement of banks under a free market
competitive system, should be phased out. The priority sector should be scaled
down from present high level of 40 percent of aggregate credit to 10 percent. Also
the priority sector should be redefined.
(iv) Interest rates to be deregulated to reflect emerging market conditions.
(v) Banks whose operations have been profitable is given permission to raise
fresh capital from the public through the capital market.
(vi) Balance sheets of banks and financial institutions are made more
transparent.
(vii) Set up special tribunals to help banks recover their debt speedily.
(viii) Changes be introduced in the bank structure 3-4 large banks with
international character, 8- 10 nationalbanks with branches throughout the
country, local banksconfined to specific region of the country,
rural banksconfined to rural areas.
(ix) Greater emphasis is laid on internal audit and internal inspection in
the banks.
Follow-up Action:
(i) Statutory Liquidity Ratio (SLR) on incremental Net Domestic and Time
Liabilities (NDTL) reduced from 38.5 percent in 1991-92 to 28 percent by
December 1996.
(ii) Effective Cash Reserve Ratio (CRR) on the NDTL reduced from 14 percent to
10 percent in January 1997.
(iii) In April, 1992 the RBI introduced a risk assets ratio system
for banks (including foreign banks) in India as a capital adequacy measure.
Under this banks will have to achieve a Capital to Risk Weighted Asset ratio
(CRAR) of 8 percent. By March, 1996 out of 27 public
sector banks19 banks (including SBI and all its subsidiaries) have attained 8
percent CRAR norm. In case of foreign banks, all of them have already attained
these norms.
(iv) New prudential norms for income recognition, classification of assets and
provisioning of bad debts introduced in 1992.
(v) In regard to regulated interest ratio structure: (i) considerable rationalisation
has been effected in banks lending rates with the number of concessive slabs
reduced and some of the ratio have been raised thereby reducing the element of
subsidy; (ii) regulated deposit late has been replaced by single prescription of not
exceeding 13 (revised to 11 percent) per annum for all deposit maturities of 46
days and above.
(vi) The SBI and some other nationalised banks have been allowed to seek capital
market access.
(vii) Less strong nationalised banks are being recapitalised by government
through budget provisions of Rs. 15000 crore till 1994-95.
(viii) Existing private sector banks given signal for expansion, more private
sector banks allowed to set up branches provided they confirms to the RBI
guidelines.
(ix) Supervision system of the RBI is being strengthened with establishment of
new board for Financial BankSupervision within the RBI.
(x) Banks given freedom to open new branches and upgrade extension counters
on attaining capital adequacy norms and prudential accounting standards. They
are permitted to close non-viable branches other than in rural areas.
(xi) Rapid computerization of banks being undertaken.
(xii) Agreement signed between the public sector bankand RBI to improve their
managerial and quality of performance.
(xiii) Recovery of debts due to banks and the Financial Institution Act 1993
recently passed to facilitate quicker recovery of loans and arrears. Accordingly 6
special Debt Recovery Tribunals were set up along with an Appellate Tribunal at
Mumbai to expedite the recovery of bankloan arrears.
(xiv) Under the Banking Ombudsmen Scheme 1995. Eleven Ombudsmen already
functioning out of a total of 15 to expedite inexpensive resolution of customers
complaints.
(xv) Ten new private banks have started functioning out of the thirteen in
principle approvals given for setting up new banks in private sector.
Direct Taxes:
Personal income-tax has been restructured with lower taxes, fewer slabs, a higher
exemption limit and reduced saving linked tax exemptions. The system of
taxation of firms has been rationalised by eliminating the distinction between
registered and unregistered firms and a flat rate of tax of 35 percent has been
prescribed on all partnerships.
Besides, the surcharges were abolished on Corporates and non Corporates in the
case of direct taxes and customs to affect trade cut to fuel growth. The emphasis
of the direct tax proposals in the budget was to continue with the policy of
stability in tax rates.
Widening the tax base, simplification of tax laws, provide incentives for
infrastructure development and promotion of capital market in particular. Tax
incentives in the form of tax holidays for development of infrastructure were
rationalised and enlarged. New measures to curb tax avoidance by transfer
pricing were introduced in the budget.
Indirect Taxes:
In the area of indirect taxes the process of rate reduction, rationalisation and
simplification of procedures were further carried forward. The peak level of
customs duty was scaled down to 35 percent with the abolition of 10 percent
surcharge.
They need more savings so as to increase the rate of capital formation and
thereby achieve higher rate of economic development. But in these countries the
general level of incomes of the people is low and their propensity to consume is
high and hence the rate of savings is small. The fiscal measures in these
countries, therefore, should aim at raising the rate of capital formation by
reducing consumption and encouraging propensity to save.
Our analysis of the problems connected with voluntary savings indicated that the
per capita incomes and savings are extremely low and as such capital formation
in underdeveloped economies cannot be left to voluntary savings.
According to an expert UN study, the annual per capita incomes in the Middle
East, in Asia and in Latin America are less than 200 US dollars or less than oneseventh of the US level and one-fourth of the Canadian level. It was revealed in
the I.M.F. staff papers that in India savings contributed only 2 percent of the
national income for development purpose.
The crucial determinant of economic growth is the rate of savings and, therefore
savings cannot be left to themselves to grow automatically. On the contrary, fiscal
measures have to be adopted to increase the savings of the people and to mobilise
them for productive purpose. In the words of Nurkse, fiscal policy, assumes a
new significance in the face of the problem of capital formation in underdeveloped countries.
The backward countries are caught in the vicious circle of low income, high
consumption, low savings, and low rate of capital formation and therefore, low
incomes. To get out of this vicious circle of poverty, the fiscal policy can play a
constructive and dynamic role for the economic development of the
underdeveloped countries.
To break out of this circle, apart from foreign aid, observes an expert UN study
calls for vigorous taxation and government development programmes. Thus in
poor countries, the importance of fiscal policy lies in raising the rate and volume
of savings and to divert them into the desired channels.
In this connection, the UN report on Taxes and Fiscal Policy says, Fiscal policy is
assigned the central task of wresting from the pitifully low output of under-
The fiscal policy can be employed effectively to divert savings of the people into
productive channels. It should aim at raising the incremental saving ratio
through taxation and forced loans and make funds available for investment
purposes in the public and private sectors of the economy.
This can be done by checking conspicuous consumption and preventing the flow
of funds for unproductive purposes. For this, high taxes on personal and
corporate incomes and commodity taxation on articles of widest use and
conspicuous consumption should be imposed to check the actual and potential
consumption of the people.
In this connection, report of the Taxation Enquiry Commissions, Government of
India, observes, A tax system, which on the whole, promotes capital formation in
is two aspects of saving and investment fulfills an essential desideration.
It should be borne in mind that the purpose of taxation should not be merely to
transfer funds from private to public use but to enlarge the total volume of
savings available for investments. This requires that the general emphasis should
be on curtailing and restraining consumption and thereby increasing the volume
of saving in the community.
In Japan, for example, agricultural productivity was doubled between 1885 and
1915 and the instruments of taxation was used effectively and much of the
increase was taken away from the farmers by imposing on them higher rents and
taxes and the resources thus collected were channelled into productive
investments.
Forced loans were also imposed on the business community to mop up surplus
funds for economic development. In USSR also, collective farms were heavilytaxed and agricultural surplus were siphoned off by raising the prices of
manufactures relating to farm products.
The Economic Bulletin for Asia and the Far East States observes, Taxation,
therefore, remains as the only effective financial instruments for reducing private
consumption and investment and transferring resources to the government for
economic development.
It will be essential for the purpose to relay on both direct and indirect taxes. Their
form and magnitude should be determined in the light of the requirements of
development.
We may discuss the role of Fiscal policy, in this connection, after Prof. Kurihara
regards Fiscal policy as a desiderate for underdeveloped countries, lacking in
private initiative, private voluntary saving and private innovation. He discusses
the fiscal roles of government as an additional saver, an investor, an innovator
and an income-redistributors.
As an additional saver, the government should, maintain a persistent budgetary
surplus through (a) a decrease in the government average propensity to spend,
(b) an increase in the average propensity to tax, or (c) a decrease in the
government average propensity to make transfer payments. Prof. Kurihara
observes, As for as under-developed economy is concerned, budgetary surplus is
the relevant position to be achieved and maintained. For it is as supplementing
deficient private saving that the fiscal role of government as a saver is to be
contemplated.
As an additional investor, the government can increases the productive capacity
of the economy and secure an accelerated rate of economic growth by changing
the pattern of investments and laying emphasis on capacity creating rather than
on income-generating aspects; by decreasing government consumption and
thereby increasing government investment and by raising the tax-rate which has
the effects of decreasing private consumption expenditure and hence of
increasing that part of real income which is available for government
investment.
As an innovator, the Government should spend on research and experimentation
and stimulate innovations and new techniques of production. This will reduce the
costs of production and encourage investment. Besides, the Government can
encourage innovations by giving subsidies and tax-relief to those firms and
industries which may introduce them of their own.
The government has an important role to play as an income redistributors and
for that fiscal measures can go a long way in reducing economic inequalities. A
broad-based and sleepy progressive tax structure can serve as a potent weapon in
the hands of the state to secure equitable distribution of income and wealth.
However, there is a limit to which taxation can be carried for resource
mobilisation. If the taxes are excessive they will adversely affect peoples desire
and ability to work, save and invest. This will obviously retard the pace of
economic development. To avoid such a situation, the gap in resources required
for economic development may be covered by mobilising savings through
voluntary loans.
Financing of economic development through borrowings is not harmful it loans
are used for productive projects. Further, unlike taxes, borrowing is not harmful
if loans are the public, does not adversely affect peoples desire to work, save and
invest as lending is voluntary and the lenders not only get back the amount lent
but also earn interest on it. Instead Public borrowing may add to the incentive of
the people to save and invest more as the lure of interest is there.
However, public borrowing is beset with certain limitations in under-developed
countries and as such much reliance cannot be placed on it. The general masses
are poor and their propensity to consume is very high and hence they have no
lending capacity. The rich generally do not like to lend to the government but
instead divert their invisible resources into speculative channels as they can earn
more from there.
Besides, the absence of organised money and capital markets
inadequate banking facilities and lack of confidence in the financial and political
stability in the governments of most of the underdeveloped countries are some of
the other obstacles in the way of public borrowing programme.
Therefore, steps may be taken to remove these and other obstacles and all out
efforts must be made to educate people and persuade them to save more in the
wider interest of the community.
But if inspite of all this, adequate resources are not forthcoming, the government
may resort to compulsory borrowing. For financing economic development. In
this connection, Nurkse says, since individuals are interested not only in their
consumption but also in the size of their asset holdings, there is a case for forced
loans as an alternative to taxation.
They may be little more than tax receipts and yet make a difference to the
incentive to work and to produce as was found during the war period when the
un-spendable cash reserves accumulated as a result of rationing made consumers
feel much better off. Forced loans in place of taxation would be a method of
forced saving in form as well in substance.
Those people who spend the major portion of their income on conspicuous
consumption and divert their resources into unproductive channels or those who
stand to be benefitted from particular development projects may be forced to
invest in government bonds.
But it may be noted that no democratic government can rely on forced loans
except for a short period and for certain specified projects. Ultimately, it is the
voluntary lending by the people that matters and the Government must be
prepared to increase its domestic borrowing when the income and saving of the
people increase as a result of economic development and make public borrowing
an important tool of resource mobilisation.
Under the policy of Laissez. Faire when state was regarded as police state, the
role of public expenditure in the economic life of the people and community
remained neglected. Its effects on production and distribution were not take
notice of and it was held that public expenditure should be kept at the minimum
level. But today, the pendulum has moved to the other side.
Public expenditure is one the most potent weapons in the hands of the state to
secure economic development of the underdeveloped. In underdeveloped
countries, there is lack of basic facilities such as transport, power, irrigation,
education etc. and also of basic and key industries.
The availability of such facilities and provides by the private sector for want of
resources and entrepreneurial ability. Thus, public expenditure should aim at
creating basic facilities and establishing basic and key industries and encourage
the development of agriculture and industry by giving loans, grants, subsidies etc.
Thus a carefully and wisely planned public expenditure by creating social and
economic overheads can go a long way in creating necessary environment for the
growth of the economy. But public expenditure can achieve its wider objective of
development only it conforms to certain well-defined principles of public
expenditure.
The expenditure on the armed forces must not be overdone and other wasteful
and excessive expenditure on administration must be avoided. Public enterprises
must conform to the principle of economic efficiency so that costs fall and profits
increase.
Care should be taken that public expenditure does not adversely affect peoples
desire to work, save and invest and for that people should not be provided with
direct money help but with goods and services in the form of free education, free
medical facilities etc. This will go a long way in increasing the efficiency and
productive capacity of the people. Thus public expenditure can play an important
role in economic development.
Dr. R.N. Tirpathy, in his book, Public Finance in Under-developed Countries has
suggested the following methods which the government may adopt to increase
the volume of domestic savings to meet the financial requirements of economic
development:
(i) Direct physical controls.
(ii) Increase in the rate of existing taxes.
(iii) Imposition of new taxes