CHAPTER - 4

BANKING SCENARIO IN WORLD & BANKING IN INDIA

4.1 Indian Banking

4.2 Need of Banking

4.3 Meaning of Banking

4.4 Features of Banking

4.5 Banking Scenario in World

4.5.1 The Italian banking scenario

4.5.2 Islamic Banking

4.6 History of Indian Banking

4.6.1 Co-operative Banking

4.7 Phases of Indian Banking

4.7.1 Nationalization

4.7.2 Liberalization

4.7.3 Privatization

4.8 Government Policy on Banking Industry

4.8.1 Classification of Banking Industry in India

4.8.2 Problems of Indian Banking System

4.9 Processes of Banking Reform

4.10 Narasimham Committee Reforms

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 CHAPTER - 4
BANKING SCENARIO IN WORLD & BANKING IN INDIA

4.1 Indian Banking – a background :

Banking is an ancient business in India with some of oldest references in the writings of
Manu. Bankers played an important role during the Mogul period. During the early part of the
East India Company era, agency houses were involved in banking. Modern banking (i.e. in the
form of joint-stock companies) may be said to have had its beginnings in India as far back as in
1786, with the establishment of the General Bank of India. Three Presidency Banks were
th
established in Bengal, Bombay and Madras in the early 19 century. These banks functioned
independently for about a century before they were merged into the newly formed Imperial Bank
of India in 1921. The Imperial Bank was the forerunner of the present State Bank of India. The
latter was established under the State Bank of India Act of 1955 and took over the Imperial
Bank. The Swadeshi movement witnessed the birth of several indigenous banks including the
Punjab National Bank, Bank of Baroda and Canara Bank. In 1935, the Reserve Bank of India
was established under the Reserve Bank of India Act as the central bank of India.
In spite of all these developments, independent India inherited a rather weak banking and
financial system marked by a multitude of small and unstable private banks whose failures
frequently robbed their middle-class depositors of their life’s savings. After independence, the
Reserve Bank of India was nationalized in 1949 and given wide powers in the area of bank
supervision through the Banking Companies Act (later renamed Banking Regulations Act). The
nationalization of the Imperial bank through the formation of the State Bank of India and the
subsequent acquisition of the state owned banks in eight princely states by the State Bank of
India in 1959 made the government the dominant player in the banking industry. In keeping with
the increasingly socialistic leanings of the Indian government, 14 major private banks, each with
deposits exceeding Rs. 50 crores, were nationalized in 1969. This raised the proportion of
scheduled bank branches in government control from 31% to about 84%. In 1980, six more

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private banks each with deposits exceeding Rs 200 crores, were privatized further raising the
proportion of government controlled bank branches to about 90%.
As in other areas of economic policy-making, the emphasis on government control began
to weaken and even reverse in the mid-80s and liberalization set in firmly in the early 90’s. The
poor performance of the public sector banks, which accounted for about 90% of all commercial
banking, was rapidly becoming an area of concern. The continuous escalation in non-performing
assets (NPAs) in the portfolio of banks posed a significant threat to the very stability of the
financial system. Banking reforms, therefore, became an integral part of the liberalization
agenda. The first Narasimham Committee set the stage for financial and bank reforms in India.
Interest rates, previously fixed by the Reserve Bank of India, were liberalized in the 90’s and
directed lending through the use of instruments of the Statutory Liquidity Ratio was reduced.
While several committees have looked into the ailments of commercial banking in India, three of
them – the Narasimham committee I (1992) and II (1998) and the Verma committee – have
aimed at major changes in the banking system. Nevertheless, more than a decade since the
beginning of economic reforms, the banking sector is still struggling under the burden of
considerable NPAs and the poor performance of public sector banks continues to be a major
issue.
The financial reform process is often thought of as comprising two stages – the first
phase guided broadly by the Narasimham Committee I report while the second is based on the
Narasimham Committee II recommendations. The aim of the former was to bring about
“operational flexibility” and “functional autonomy” so as to enhance “efficiency, productivity
and profitability”. The latter focused on bringing about structural changes so as to strengthen the
foundations of the banking system to make it more stable.
During the 90’s quite a few new private sector banks made their appearance,
predominantly floated by public sector or quasi-public sector financial institutions. Among the
completely private sector banks that made their debut during this period, the Global Trust Bank
ended in a major failure in 2004 and its depositors had to be bailed out by the RBI through a
merger with the Oriental Bank of Commerce. Several foreign banks also made their entry into
the Indian banking scenario while the existing foreign banks expanded their operations.
Meanwhile, the performance of public sector banks continued to be saddled with operational and
lending inefficiencies. The Verma Committee identified three public sector banks – Indian Bank,

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UCO Bank and United Bank of India – as the weakest of the twenty-seven public sector banks,
in terms of NPAs and accumulated losses. In March 2002, the gross NPAs of scheduled
commercial banks amounted to Rs. 71,000 crores out of which Rs. 57,000 crores or roughly 80%
came from the public sector banks. The following year witnessed a marginal improvement in the
situation. Financial liberalization has, however, had a predictable effect in the distribution of
scheduled commercial banking in India. The reforms era growth in banking have focused on the
more profitable urban and metro areas of the country. Between 1969 and 1991 for instance, the
share of the rural branches increased from about 22% to over 58%. In 2004, the corresponding
figure stood at a much lower 46%. The number of rural bank branches actually declined from the
1991 figure of over 35,000 branches by about 3000 branches. Between 1969 and 1991 the share
of urban and metro branches fell from over 37% to less than 23%. In the years since it has
crawled back up to over 31%. (Gangwar, May 2011)

4.2 Need For Banking :

Before the establishment of banks, the financial activities were handled by money lenders
and individuals. At that time the interest rates were very high. Again there were no security of
public savings and no uniformity regarding loans. So as to overcome such problems the
organized banking sector was established, which was fully regulated by the government.
A sound banking system is necessary to achieve the following objectives:
1) Savings and capital formation Bank plays a vital role in mobilizing the savings of the
people and promoting the capital formation for the economic development of the country.
2) Canalization of savings The mobilized savings are allocated by the banks for the
development of various fields such as agriculture, industry, communication, transport etc.
3) Implementation of Monetary Policy A well-developed banking system can easily
implement the monetary policy because development of the economy depends upon the
control of credit given by the banks. So, banks are necessary for the effective
implementation of monetary policy.
4) Encouragement of Industries Banks provide various types of financial services such as
granting cash credit loans, issuing letter of credit, and bill discounting etc., which
encourages the development of various industries in the country.

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 5) Regional development Banks, by transferring surplus money from the developed regions
to the fewer developed regions reduces regional imbalances.
6) Development of Agriculture and other neglected sectors Banks are necessary for the
farmers. It also encourages the development of small-scale and cottage industries in rural
areas.

4.3 Meaning of Bank:

In simple words bank is an institution, which deals in money and credit.
1) According to Herbert L. Hart “A banker is one who in the ordinary course of his
business honors cheques drawn upon him by persons from and for whom he receives
money on current accounts”.
2) According to Banking Regulation Act “Banking means the accepting for the purpose of
lending or investment of deposits of money from the public, repayable on demand or
otherwise and withdrawal by cheque, draft, order or otherwise”.

4.4 Features of Banks :

From the above definitions the features of a bank may be listed as follows:
1) Acceptance of deposits of money from the public.
2) Obligation to refund deposits on demand.
3) Lending or investing money for promotion and development of business.
4) Profitable employment of funds received as deposits from the public.
5) Money is withdrawal by cheque or draft.

4.5 Banking Scenario in the world :

4.5.1 The Italian banking scenario :
“Widespread crises and scandals affected the credibility of the Italian banking sector,
lessening Italian investor’s sentiments” says Claudia Segre, UBM – Head of Emerging & New
Europe DCM.
“The general situation of crisis can be seen as one of the causes leading the banking
sector to seek new solutions supporting increasing flexibility on investment-grade rated paper
supply in order to cover the new needs of ethnic communities with special financial

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requirements, such as the Islamic community. Apart from increasing the level of market shares,
this operation hit new customers meet the clients’ needs and renew the market image of banks
consolidating a stable business confidence relationship with banks in contrast with recent
disaffection tendencies. On the other hand, institutions are aware of the profit opportunities
offered by capital flows to the Euro area. In conclusion, is seems as if we are at an important
turning point, particularly for Latin cultures, like the Italian one”. Though at an early stage, a
new wave of interest for unconventional modes of finance is arising in the Italian banking sector.
In the occasion of the “Investing in microfinance, the role of commercial banks” conference,
organized at Milan’s Stock exchange in 2004 to celebrate the opening of the international year of
microcredit ABI (the Italian Banking Association), underlined the changing needs of new
segments of clientele such as migrants, microenterprises, young entrepreneurs, no profit sector
organizations and low income families. Through these efforts, banks can play a pivotal role in
fostering the financial inclusion and integration1 of more than nine million people who don’t
even hold a bank account2. Though Italian Banks’ interest for microfinance should not only be
regarded in a welfare policy perspective channeled through Foundations or charities but as part
of the core responsibility of the sector for new stakeholders.
In order to promote and effectively support the role of banks in microfinance, ABI
engaged in a preliminary assessment on microfinance with the support of Fondazione Giordano
Dell’Amore, a centre for financial growth and development assistance on microfinance projects.
The pros and cons of introducing Islamic banking services in Italy were attentively weighted
during the Conference on Islamic Banking organized by ABI, with the support of the Islamic
Development Bank, Islamic Research and Training Institute and the Arab-Italian Chamber of
Commerce, in December 2002.
Doubts over the readiness of the Italian banking system to welcome Islamic products
have been stigmatized by Hamza Piccardo, Secretary General of the Islamic Communities and
Organizations in Italy (UCOII): “There have been several attempts to establish Islamic friendly
banking services in Italy over the last decade, but they have all failed because of lack of
investment guarantees. The time for Islamic finance in Italy has not jet come, since Muslim
communities have arrived within the past ten years and are still facing problems with settlement.
Their focus is on sending remittances to their home country in order to economically support
their families or to purchase a home. (Ferro, June 2005)

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4.5.2 Islamic Banking :
Islamic finance is a mode of finance inspired by the provisions set forth by the Qu’uran,
the holy book setting Islamic Law (Sharia law). While secular societies generally propose a
system of ethics divorced from religion and law, Sharia law governs religious as well as civil
life, including business life.
Considered from this perspective, Islam convictions on the responsibility of business go
well beyond mere profitability goals and coincide with the renewed perception on business
recently at stake within the most advanced sectors of western business and civil societies. Far
from the limits imposed by neo-classical thought, this new wave implies new sorts of
responsibilities on behalf of the company falling under the rubric of corporate social
responsibility.
The essential feature of Islamic finance is the prohibition of interest (Riba) on money.
Banks resort to an alternative mechanism based on profit and loss sharing, and become a prime
actor, and not only an intermediary, in investments. Islamic law, also regulates the direction
investments take, strictly forbidding areas such as pornography, tobacco, gambling, weapons,
pork and alcohol industries. Although there are some differences, the overlap with socially
responsible investments highly diffused in Western countries has an appeal for non Muslims
seeking ethically- driven investments.
A further distinguishing element of banking based on Islamic beliefs is the religious
obligation to pay Zakat, a fee with the two fold purpose of redistributing wealth among the poor
and achieving purification. Conclusively, to ensure that the products offered by the bank meet
the requirements set by Sharia, an independent Supervisory Committee of scholars is needed,
possibly in accordance with the standards set by the Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI).
Islamic Finance developed primarily in those Islamic countries where increased revenues
from oil created a new middle wealth segment of clientele in need of banking services and
investment facilities. Nowadays, besides the huge market represented by Eastern countries,
Muslim communities living in the West are increasingly attracted by Islamic products and
services. Great Britain’s long tradition of immigration (about 1.8 million Muslims are currently
living in the country, including second and third generations of Muslims), has made London the
centre for the dissemination of Islam banking in Europe. The first bank operating wholly in

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accordance with Islamic precepts ever created in Europe is the Islamic Bank of Britain, which
was opened in London. Great potentiality for Islam banking can also be found in the U.S due to
its 6 to 12 million Muslim population.
Western banks waking up to Islamic finance in the mid 90’s operate through two main
channels. The first consists of including Sharia compliant products in the bank’s conventional
products and services through special facilities called “Islamic windows”, also available at
Western banks such as Abn-Amro, Citibank, and the German Dresdner Bank. While the financial
systems of some countries underwent a complete Islamization, making Islamic windows no
longer necessary, many western banks preferred to open ad hoc, owned subsidiary divisions
totally devoted to Islamic Finance, and operating in countries such as Bahrain and UAE where
the flows are particularly high, as they are considered the two main important financial hubs for
the Middle East followed by Qatar and Dubai. City Islamic Investment Corp. as an owned
subsidiary division of Citigroup was created in 1996 and paved the way to a major involvement
of international banks in Islamic finance. The protagonists of this newly established trend are
more or less the same banks that are turning their interest to microfinance. Just to name a few:
HSBC with its Amanah unit established in 1998, as well as Barclays, Deutsche Bank.
Emirates Bank is a good example of the appeal Islamic products can have on the markets,
even in the West. As a matter of fact, the bond was very well received by the market with good
cover ratios of subscriptions, and over 80%, was sold to investors outside the Middle East,
recording the highest ever proportion of non regional buyers of any Middle Eastern Eurobonds.
Another reason of this success is the rarity of investment-grade rated paper paying a generous
return. European and Asian issuers of this grade do not feel compelled to offer investors such an
incentive. (Ferro, June 2005)

4.6 History of Indian Banking System: The story so far :

The Indian Banks are the backbone of Indian financial sector and Indian economy.
Presently, the Indian financial system is in a process of rapid transformation. There are about
67,000 branches of Scheduled banks spread across India. During the first phase of financial
reforms, there was a nationalisation of14majorbanks in1969.This crucial step led to a shift from
Class banking to Mass banking. Since then the growth of the banking industry in India has been
a continuous process.

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 Banks in India can be categorized in to non-scheduled banks and scheduled banks.
Scheduled banks Constitute of commercial banks and co-operative banks. There are about
67,000 branches of Scheduled banks spread across India. During the first phase of financial
reforms, there was a nationalization of14major banks in 1969. This crucial step led to a shift
from Class banking to Mass banking. Since then the growth of the banking industry in India has
been a continuous process. Banking today has transformed into a technology intensive and
customer friendly model with a focus on convenience. The sector is set to witness the emergence
of financial supermarkets in the form of universal banks providing a suite of services from retail
to corporate banking and industrial lending to critical areas. Technology, customer focus, quality
of service, etc, which aware the distinguishing features of private sector banks, during their early
years, have now become part and parcel of the public sector banks as well. By adopting the
voluntary retirement scheme and streamlining their recruitment process, public sector banks have
not only eliminated the excess workforce, but also tuned themselves up to compete better. In the
arena of product innovations too, public sector banks are not far behind. From an era when
banking products remained the same for decades, we have come to an age where new product
innovations, particularly those targeted at specific groups, have become the norm of the day. The
winds of change are refreshing and the private sector banks also making more innovative value
added and beyond banking products to attract their customers.
4.6.1 Cooperative Banking :
The cooperative banking sector is one of the small Partner of Indian banking structures in
terms of volume of business, but it has more reach than any public sector bank or private sector
bank. In our country, the cooperative banks have more reach to the rural India, through their
huge network of credit societies in the institutional credit structure. There are 31 State
Cooperative Banks with 450 branches working for the development of cooperative sector in our
country. A wide network of 361District Central Cooperative Banks (DCCBs) with over 7000
branches and 112000 Primary Agriculture Cooperative Credit Societies are serving the rural
population and particularly farmers of our country.
Apart from the DCCBs There are more than 350 Agriculture Cooperative and Rural
Development Banks (formerly known as Land Development Banks). If we include the Urban
Cooperative Banks and Urban Credit Societies, then the numbers of cooperative credit
institutions cross the figure of 150000. The overall market share of cooperative credit system in

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the Indian banking system, in terms of volume of business may be less than 10%,
butitis35%intermsofagriculturecredit (65% in terms of financing to small and marginal farmers).
It is more significant to note that; the cooperative credit system has the only system, which has
coverage of more than 90 % of populace in rural India. The cooperative credit structure is
serving the Indian society since 1889 and since then it has seen several ups and downs. Despite
of several limitations such as restriction of area of operations, limited clients, small volume of
business, political interference, this movement is standing since last 104 years and serving the
societies. The general perception of the public about the cooperative banks is not much
encouraging, because of the frequent failures of cooperative banks and credit societies. But, the
truth is that, the cooperative credit system is the most important Critical Evaluation of Banking
Sector.
The first bank in India, called The General Bank of India was established in the year
1786. The East India Company established The Bank of Bengal/Calcutta (1809), Bank of
Bombay (1840) and Bank of Madras (1843). The next bank was Bank of Hindustan which was
established in 1870. These three individual units (Bank of Calcutta, Bank of Bombay, and Bank
of Madras) were called as Presidency Banks. Allahabad Bank which was established in 1865 was
for the first time completely run by Indians. Punjab National Bank Ltd. was set up in 1894 with
head quarters at 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. In 1921, all presidency
banks were amalgamated to form the Imperial Bank of India which was run by European
Shareholders. After that the Reserve Bank of India was established in April 1935.
At the time of first phase the growth of banking sector was very slow. Between 1913 and
1948 there were approximately 1100 small banks in India. 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 Banking Regulation Act 1949 as per amending Act of
1965 (Act No.23 of 1965). Reserve Bank of India was vested with extensive powers for the
supervision of banking in India as a Central Banking Authority.
After independence, Government has taken most important steps in regard of Indian
Banking Sector reforms. In 1955, the Imperial Bank of India was nationalized and was given the
name "State Bank of India", to act as the principal agent of RBI and to handle banking
transactions all over the country. It was established under State Bank of India Act, 1955. Seven

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banks forming subsidiary of State Bank of India was nationalized in 1960. On 19th July, 1969,
major process of nationalization was carried out. At the same time 14 major Indian commercial
banks of the country were nationalized. In 1980, another six banks were nationalized, and thus
raising the number of nationalized banks to 20. Seven more banks were nationalized with
deposits over 200 Crores. Till the year 1980 approximately 80% of the banking segment in India
was under government’s ownership. On the suggestions of Narasimham Committee, the Banking
Regulation Act was amended in 1993 and thus the gates for the new private sector banks were
opened. (Dr.S.P.Jadhao, June 2010)

4.7 Phases of Indian Banking :

4.7.1 Nationalisation:
By the 1960s, the Indian banking industry has become an important tool to facilitate the
development of the Indian economy. At the same time, it has emerged as a large employer, and a
debate has ensured about the possibility to nationalize the banking industry.
Indira Gandhi, the-ten Prime Minister of India expressed the intention of the Government
of India (GOI) in the annual conference of the All India Congress Meeting in a paper entitled
"Stray thoughts on Bank Nationalisation". The paper was received with positive enthusiasm.
Thereafter, her move was swift and sudden, and the GOI issued an ordinance and nationalized
the 14 largest commercial banks with effect from the midnight of July 19, 1969. Jayaprakash
Narayan, a national leader of India, described the step as a "Masterstroke of political sagacity"
Within two weeks of the issue of the ordinance, the Parliament passed the Banking Companies
(Acquisition and Transfer of Undertaking) Bill, and it received the presidential approval on 9
August, 1969.
A second step of nationalisation of 6 more commercial banks followed in 1980. The
stated reason for the nationalisation was to give the government more control of credit delivery.
With the second step of nationalisation, the GOI controlled around 91% of the banking business
in India. Later on, in the year 1993, the government merged New Bank of India with Punjab
National Bank. It was the only merger between nationalized banks and resulted in the reduction
of the number of nationalized banks from 20 to 19. After this, until the 1990s, the nationalized
banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy. The

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nationalized banks were credited by some; including Home minister P. Chidambaram, to have
helped the Indian economy withstand the global financial crisis of 2007-2009.
4.7.2 Liberalisation :
In the early 1990s, the then Narsimha Rao government embarked on a policy of
liberalization, licensing a small number of private banks. These came to be known as New
Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation
banks to be set up), which later amalgamated with Oriental Bank of Commerce, Axis
Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move along with the rapid growth
in the economy of India revolutionized the banking sector in India which has seen rapid growth
with strong contribution from all the three sectors of banks, namely, government banks, private
banks and foreign banks. The next stage for the Indian banking has been setup with the proposed
relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may
be given voting rights which could exceed the present cap of 10%, at present it has gone up to
49% with some restrictions.
The new policy shook the banking sector in India completely. Bankers, till this time,
were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. The
new wave ushered in a modern outlook and tech-savvy methods of working for the traditional
banks. All this led to the retail boom in India. People not just demanded more from their banks
but also received more.
Currently (2007), banking in India is generally fairly mature in terms of supply, product
range and reach-even though reach in rural India still remains a challenge for the private sector
and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are
considered to have clean, strong and transparent balance sheets as compared to other banks in
comparable economies in its region. The Reserve Bank of India is an autonomous body, with
minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to
manage volatility but without any fixed exchange rate-and this has mostly been true. With the
growth in the Indian economy expected to be strong for quite some time-especially in its services
sector-the demand for banking services, especially retail banking, mortgages and investment
services are expected to be strong. In March 2006, the Reserve Bank of India allowed Warburg
Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the
first time an investor has been allowed to hold more than 5% in a private sector bank since the

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RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would
need to be voted by them. In recent years critics have charged that the non-government owned
banks are too aggressive in their loan recovery efforts in connection with housing, vehicle and
personal loans. There are press reports that the banks' loan recovery efforts have driven
defaulting borrowers to suicide.
4.7.3 Privatization :
Privatization has become a popular measure for solving the organizational problems of
governments by reducing the role of the state and encouraging the growth of the private sector
enterprises. However, privatization takes a number of forms and has been approached in various
ways during the move away from government control to other forms of ownership in developing
countries. Privatization has leaded the corporate world into the new world of dynamic
competition with the search of new resources, global markets, expanded global networking. The
consequences of privatization have focused onto the fields of economics, international relations,
management and sociology. The scope of the privatization aspect is different for different fields
of business and different sectors.
Privatization is the process of transferring ownership of a business, enterprise, agency,
public service or public property from the public sector (a government) to the private sector,
either to a business that operates for a profit or to a non-profit organization. Privatization is both
a challenge and an opportunity for Indian banks to gain strength in the domestic market and
increase presence in the global market. On the basis of various parameters, paper finds that there
is a fast penetration of foreign banks in India and public sector banks, particularly SBI is
intensively entering in foreign countries, same is the case of ICICI Bank as this bank is capturing
foreign markets at a fast pace. At the end, the present paper finds some challenges and also
explores the future opportunities. On the basis of the experience of already global went banks,
paper suggests some strategies that how Indian banks can make their presence effective in the
global market. Globalization refers to widening and Deeping of international flow of trade,
capital, labour, technology, information and services.
Privatization has led to an overall economic, political and technological integration of the
world. In our country, first economic reforms (1991) gave birth to globalization and second
phase of banking sector reforms strengthened the globalization. Various reform measures
introduced in India have indeed strengthened the Indian banking system in preparation for the

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global challenges ahead. The banking sector in India has remained regulated since
nationalisation in 1969. Private bank entry was restricted after nationalization to prevent unfair
competition, urban concentration and lending to rich and well known firms. This resulted in
elimination of competition among public sector banks, public-private sector banks. India is the
largest country in South Asia with a huge financial system characterized by many and varied
financial institutions and instruments. The Indian financial sector was well-developed even prior
to the political independence of the country in 1947. However, privatization takes a number of
forms and has been approached in various ways during the move away from government control
to other forms of ownership in developing countries. (PRIYANKA RANI, 2013)

4.8 Government Policy on Banking Industry:

Banks operating in most of the countries must contend with heavy regulations, rules
enforced by Federal and State agencies to govern their operations, service offerings, and the
manner in which they grow and expand their facilities to better serve the public. A banker works
within the financial system to provide loans, accept deposits, and provide other services to their
customers. They must do so within a climate of extensive regulation, designed primarily to
protect the public interests. The main reasons why the banks are heavily regulated are as follows:
1) To protect the safety of the public’s savings.
2) To control the supply of money and credit in order to achieve a nation’s broad economic
goal.
3) To ensure equal opportunity and fairness in the public’s access to credit and other vital
financial services.
4) To promote public confidence in the financial system, so that savings are made speedily
and efficiently.
5) To avoid concentrations of financial power in the hands of a few individuals and
institutions.
6) Provide the Government with credit, tax revenues and other services.
7) To help sectors of the economy that they have special credit needs for eg. Housing, small
business and agricultural loans etc
4.8.1 Classification of Banking Industry in India :

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 Indian banking industry has been divided into two parts, organized and unorganized
sectors. The organized sector consists of Reserve Bank of India, Commercial Banks and Co-
operative Banks, and Specialized Financial Institutions (IDBI, ICICI, IFC etc). The unorganized
sector, which is not homogeneous, is largely made up of money lenders and indigenous bankers.
An outline of the Indian Banking structure may be presented as follows:-
1) Reserve banks of India.
2) Indian Scheduled Commercial Banks.
a) State Bank of India and its associate banks.
b) Twenty nationalized banks.
c) Regional rural banks.
d) Other scheduled commercial banks.
3) Foreign Banks
4) Non-scheduled banks.
5) Co-operative banks.
(Source:-The federal Reserve Act 1913 and The Banking Act 1933)
4.8.2 Problems of Indian Banking System :
1) Interest rates and non-performing assets - The best indicator of the health of the
banking industry in a country is its level of NPAs. Given this fact, Indian banks seem to
be better placed than they were in the past. A few banks have even managed to reduce
their net NPAs to less than one percent (before the merger of Global Trust Bank into
Oriental Bank of Commerce, OBC was a zero NPA bank). But as the bond yields start to
rise the chances are the net NPAs will also start to go up. This will happen because the
banks have been making huge provisions against the money they made on their bond
portfolios in a scenario where bond yields were falling.
2) Deregulation - This continuous deregulation has made the Banking market extremely
competitive with greater autonomy, operational flexibility and decontrolled interest rate
and liberalized norms for foreign exchange. The deregulation of the industry coupled
with decontrol in interest rates has led to entry of a number of players in the banking
industry. At the same time reduced corporate credit off take thanks to sluggish economy
has resulted in large number of competitors batting for the same pie. 3. Steps to improve
Indian banking system - We have made considerable progress in implementing banking

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 and financial sector reforms. There is also some improvement in the financial
performance of the banking system in terms of various indicators of operating efficiency.
Nevertheless, there are several areas regarding the efficiency of our banking system –
rather than its stability – that raise concerns.
3) Prudential Norms - A strong and resilient financial system and the orderly evolution of
financial markets are key prerequisites for financial stability and economic progress. In
keeping with the vision of an internationally competitive and sound banking system,
deepening and broadening of prudential norms to the best internationally recognized
standards have been the core of our approach to financial sector reforms. This has been
supported concurrently by heightened market discipline, pro-active and comprehensive
supervision of the financial system and the orderly development of financial market
segments. (Gangwar, May 2011)

4.9 Processes of Banking Reform :

The processes adopted for bringing about the reforms in India may be of some interest to
this audience. Recalling some features of financial sector reforms in India would be in order,
before narrating the processes. First, financial sector reform was undertaken early in the reform-
cycle in India.
In order to ensure timely and effective implementation of the measures, RBI has been
adopting a consultative approach before introducing policy measures. Suitable mechanisms have
been instituted to deliberate upon various issues so that the benefits of financial efficiency and
stability percolate to the common person and the services of the Indian financial system can be
benchmarked against international best standards in a transparent manner. Let me give a brief
account of these mechanisms.
First, on all important issues, workings group are constituted or technical reports are
prepared, generally encompassing a review of the international best practices, options available
and way forward. The group membership may be internal or external to the RBI or mixed. Draft
reports are often placed in public domain and final reports take account of inputs, in particular
from industry associations and self-regulatory organizations. The reform-measures emanate out
of such a series of reports, the pioneering ones being: Report of the Committee on the Financial
System (Chairman: Shri M. Narasimham), in 1991; Report of the High Level Committee on

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Balance of Payments (Chairman: Dr. C. Rangarajan) in 1992; and the Report of the Committee
on Banking Sector Reforms (Chairman: Shri M. Narasimham) in 1998.
Second, Resource Management Discussions meetings are held by the RBI with select
commercial banks, prior to the policy announcements. These meetings not only focus on
perception and outlook of the bankers on the economy, liquidity conditions, credit flow,
development of different markets and directions of interest rates, but also on issues relating to
developmental aspects of banking operations.
Third, we have formed a Technical Advisory Committee on Money, Foreign Exchange
and Government Securities Markets (TAC). It has emerged as a key consultative mechanism
amongst the regulators and various market players including banks. The Committee has been
crystallizing the synergies of experts across various fields of the financial market and thereby
acting as a facilitator for the RBI in steering reforms in money, government securities and
foreign exchange markets.
Fourth, in order to strengthen the consultative process in the regulatory domain and to
place such a process on a continuing basis, the RBI has constituted a Standing Technical
Advisory Committee on Financial Regulation on the lines similar to the TAC. The Committee
consists of experts drawn from academia, financial markets, banks, nonbank financial institutions
and credit rating agencies. The Committee examines the issues referred to it and advises the RBI
on desirable regulatory framework on an on-going basis for banks, non-bank financial
institutions and other market participants.
Fifth, for ensuring periodic formal interaction, amongst the regulators, there is a High
Level Co-ordination Committee on Financial and Capital Markets (HLCCFCM) with the
Governor, RBI as the Chairman, and the Heads of the securities market and insurance regulators,
and the Secretary of the Finance Ministry as the members. This Coordination Committee has
authorized constitution of several standing committees to ensure co-ordination in regulatory
frameworks at an operational level.
Sixth, more recently a Standing Advisory Committee on Urban Co-operative Banks
(UCBs) has been activated to advise on structural, regulatory and supervisory issues relating to
UCBs and to facilitate the process of formulating future approaches for this sector. Similar
mechanisms are being worked out for non-banking financial companies.

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 Seventh, the RBI has also instituted a mechanism of placing draft versions of important
guidelines for comments of the public at large before finalization of the guidelines. To further
this consultative process and with a specific goal of making the regulatory guidelines more user-
friendly, a Users' Consultative Panel has been constituted comprising the representatives of
select banks and market participants. The panel provides feedback on regulatory instructions at
the formulation stage to avoid any subsequent ambiguities and operational glitches.
Eighth, an extensive and transparent communication system has been evolved. The
annual policy statements and their mid-term reviews communicate the RBI's stance on monetary
policy in the immediate future of six months to one year. Over the years, the reports of various
working groups and committees have emerged as another plank of two way communication from
RBI. An important feature of the RBI's communication policy is the almost real-time
dissemination of information through its web-site. The auction results under Liquidity
Adjustment Facility (LAF) of the day are posted on the web-site by 12.30 p.m the same day,
while by 2.30 p.m. the 'reference rates' of select foreign currencies are also placed on the
website. By the next day morning, the press release on money market operations is issued. Every
Saturday, by 12 noon, the weekly statistical supplement is placed on the web-site providing a
fairly detailed, recent data-base on the RBI and the financial sector. All the regulatory and
administrative circulars of different Departments of the RBI are placed on the web-site within
half an hour of their finalization.
Ninth, an important feature of the reform of the Indian financial system has been the
intent of the authorities to align the regulatory framework with international best practices
keeping in view the developmental needs of the country and domestic factors. Towards this end,
a Standing Committee on International Financial Standards and Codes was constituted in 1999.
The Standing Committee had set up ten Advisory Groups in key areas of the financial
sector whose reports are available on the RBI website. The recommendations contained in these
reports have either been implemented or are in the process of implementation. (Malli, 2011)

4.10 Narasimham Committee Reforms :

To restore the financial health of commercial banks and to make their functioning
efficient and profitable, the Government of India appointed a committee called 'The Committee
on Financed System' under the chairmanship of Sri M. Narasimham, ex-Governor of Reserve

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Bank of India which made recommendations in November 1991. The Committee laid down a
blue print of financial sector reforms, recognized that a vibrant and competitive financial system
was central to the wide ranging structural reforms. In order to ensure that the financial system
operates on the basis of operational flexibility and functional autonomy, with a view to enhance
efficiency, productivity and profitability, the Committee recommended a series of measures
aimed at changes according greater flexibility to bank operations, especially in Pointing out
statutory stipulations, directed credit program, improving asset quality, institution of prudential
norm, greater disclosures, better housekeeping, in terms of accounting practices. In the words of
Bimal Jalan, ex-Governor of RBI, "the central bank is a set of prudential norm that are aimed at
imparting strength to the financial institutions, and inducing greater accountability and market
discipline. The norms include not only capital adequacy, asset classifications and provisioning
but also accounting standards, exposure and disclosure norms and guidelines for investment, risk
management and asset liability management." These recommendations are a landmark in the
evolution of banking system from a highly regulated to more market-oriented system.
The reforms introduced since 1992-93 breathed a fresh air in the banking sector.
Deregulation and liberalization encouraged banks to go in for innovative measures, develop
business and earn profits. These reforms, the Narasimham Committee-I felt, will improve the
solvency, health and efficiency of institutions.
The measures were aimed at
1) Ensuring a degree of operational flexibility,
2) Internal 'autonomy for public sector banks in their decision-making process, and
3) Greater degree of professionalism in banking operations.
The Reserve Bank of India grouped the first phase of reform measures into three main
areas: Enabling measures, Strengthening measures and Institutional measures. In other way, they
can also be classified into five different groups
1) Liberalization measures,
2) Prudential norms,
3) Competition directed measures,
4) Supportive measures, and
5) Other measures.

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1) LIBERALIZATION MEASURES: Statutory Liquidity Ratio (SLR) /Cash Reserve Ratio
(CRR): The SLR and CRR measures were originally designed to give the RBI two additional
measures of credit control, besides protecting the interests of depositors. Under the SLR,
commercial banks are required to maintain with the RBI minimum 25 per cent of their total
net demand and time liabilities in the form of cash, gold and unencumbered eligible
securities (under the Banking Regulation Act, 1949).
2) PRUDENTIAL NORMS: In April 1992, the RBI issued detailed guidelines on a phased
introduction of prudential norms to ensure safety and soundness of banks and impart greater
transparency and accounting operations. The main objective of prudential norms is the
strengthening financial stability of banks. Inadequacy of capital is a serious cause for
concern. Hence, as per Basle Committee norms, the RBI introduced capital: adequacy norms.
It was prescribed that banks should achieve a minimum of 4 per cent capital adequacy ratio
in relation to risk weighted assets by March 1993, of which Tier I capital should not be less
than 2 per cent. The BIS standard of 8 per cent should be achieved over a period of three
years, that is, by March 1996, For banks with international presence, it is necessary to reach
the figure even earlier. Before arriving at the capital adequacy ratio of each bank, it is
necessary that assets of banks should be evaluated on the basis of their realizable value.
Those banks whose operations are profitable and which enjoy reputation in the markets are
all over to approach capital market for enhancement of capital. In respect of others, the
Government should meet the shortfall by direct subscription to capital by providing loan.
As per the recommendations of the Narasimham Committee banks cannot recognize income
(interest income on advances) on assets where income is not received within two quarters
after it is past due. The committee recommended international norm of 90 days in phased
manner by 2002.
The assets are now classified on the basis, of their performance into 4 categories:
a) Standard
b) Sub-standard
c) Doubtful &
d) Loss assets
Adequate provision is required to be made for bad and doubtful debts (substandard assets).
Detailed instructions for provisioning have been laid down. In addition, a credit exposure

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 norm of 15 per cent to a single party and 40 per cent to a group has been prescribed. Banks
have been advised to make their balance sheets transparent with maximum 'disclosure' on the
financial health of institutions.
The Committee recommended provisioning norms for nonperforming assets. On outstanding
substandard assets 10 percent general provision should be made (1992). On loss assets the
permission shall be 100 percent. On secured portion of doubtful assets, the provision should
be 20 to 50 per cent.:"
3) COMPETITION DIRECTED MEASURES: Since 1969 none bank had allowed to be
opened in India. That policy changed in January 1 1993 when the RBI announced guidelines
for opening of private sector banks public limited companies. The criteria for setting up of
new banks in private sector were: (a) capital of Rs. 100 crore, (b) most modern technologic,
and (c) head office at a non-metropolitan centre, In January' 2001, paid-up capital of these
banks was increased to Rs. 200 crore which has to be raised to Rs. 300 crore within a period
of 3 years after the commencement of business, The promoters share in a bank shall not be
less than 40 per cent. After the issue of guidelines in 1993, 9 new banks have been set up in
the private sector. Foreign banks have also been permitted to set-up subsidiaries, joint
ventures or branches, Their number have increased from 24 in 1991 to 42 in 2000 and their
branch network increased from 140 to 185 over the same period. Banks have also been
permitted to rationalize their existing branches, spinning off business at other centers,
opening of specialized branches, convert the existing non-urban rural branches into satellite
offices. Banks have also been permitted to close down branches other than in rural areas.
Banks attaining capital adequacy norms and prudential accounting standards can set-up new
branches without the prior approval of RBI. Two recommendation of the Narasimham
Committee was to abolish the system of branch licensing and allow foreign banks free entry.
4) SUPPORTIVE MEASURES: Revised format for balance sheet and profit and loss account
reflecting and actual health of scheduled banks were introduced from the accounting year
1991-92.
There have also been changes in the institutional framework. The RBI evolved a risk-based
supervision methodology with international best practices. New Board of Financial
Supervision was set-up in the RBI to tighten up the supervision of banks. The system of
external supervision has been revamped with the establishment in November 1994 of the

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 Board of Financial Supervision with the operational support of the Department of Banking
supervision. In tune with international practices of supervision, a three-tier supervisory
model comprising outside inspection, off-site monitoring and periodical external auditing
based on CAMELS (Capital Adequacy, Asset quality, Management, Earnings, Liquidity and
System controls) had been put in place. Special Recovery Tribunals are set-up to expedite
loan recovery process. The recent Securitization and Reconstruction of Financial; Assets and
Enforcement of Security Interests (SARFAAESI) Act, 2002 enables the regulation of
securitization of and reconstruction of financial assets and enforcement of security interests
by secured creditors. The Act will enable banks to dispose of securities of defaulting
borrowers to recover debt.
5) OTHER MEASURES: The Banking Companies (Acquisition and Transfer of Undertaking)
Act was amended with effect from July 1994 permitting public sector banks to raise capital
up to 49 per cent from the public. There are number of other recommendations of the
Narasimham Committee such as reduction in priority sector landings, appointment of .special
tribunals for speeding up the process of loan recoveries, and reorganization of the rural credit
structure, all of which need detailed examination as these recommendations have far-
reaching implications both in terms of the structure of the financial system and also the
financing required to implement them. The Committee proposed structural reorganization of
the banking sector which involves a substantial reduction of public sector banks through
mergers and acquisitions. It proposed a pattern of
a) 3 or 4 large banks of international character,
b) 8 to 10 national banks engaged in "general or universal banking
c) Local banks whose operation be confined to a specific areas, and
d) RRBs financing permanently agriculture I and allied activities. The Government had not
taken any decision regarding this suggestion.

4.10.1 RECOMMENDATIONS OF NARASIMHAM COMMITTEE – I

The main recommendations of the Committee were: -
1) Reduction of Statutory Liquidity Ratio (SLR) to 25 percent over a period of five years
2) Progressive reduction in Cash Reserve Ratio (CRR)
3) Phasing out of directed credit programmes and redefinition of the priority sector

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4) Deregulation of interest rates so as to reflect emerging market conditions
5) Stipulation of minimum capital adequacy ratio of percent to risk weighted assets by
March 1993, 8 percent by March 1996, and 8 percent by those banks having international
operations by March 1994.
6) Adoption of uniform accounting practices in regard to income recognition, asset
classification and provisioning against bad and doubtful debts
7) Imparting transparency to bank balance sheets and making more disclosures
8) Setting up of special tribunals to speed up the process of recovery of loans
9) Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of
their bad and doubtful advances at a discount
10) Restructuring of the banking system, so as to have 3 or 4 large banks, which could
become international in character, 8 to 10 national banks and local banks confined to
specific regions. Rural banks, including Regional Rural Banks (R.RBs), confined to rural
areas.
11) Setting up one or more rural banking subsidiaries by Public Sector Banks
12) Permitting RRBs to engage in all types of banking business
13) Abolition of branch licensing
14) Liberalizing the policy with regard to allowing foreign banks to open offices in India.
15) Supervision of merchant banks, mutual funds, leasing companies etc., by a separate
agency to be set up by RBI and enactment of a separate legislation providing appropriate
legal framework for mutual funds and laying down prudential norms for these
institutions, etc. Several recommendations have been accepted and are being
implemented in a phased manner. Among these are the reductions SLR/CRR, adoption of
prudential norms for asset classification and provisions, introduction of capital adequacy
norms, and deregulation of most of the interest rates, allowing entry to new entrants in
private sector banking sector, etc.

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Summary:

Banking is an ancient business in India with some of oldest references in the writings of
Manu. Bankers played an important role during the Mogul period. In spite of all these
developments, independent India inherited a rather weak banking and financial system marked
by a multitude of small and unstable private banks whose failures frequently robbed their
middle-class depositors of their life’s savings. After independence, the Reserve Bank of India
was nationalized in 1949 and given wide powers in the area of bank supervision through the
Banking Companies Act (later renamed Banking Regulations Act). The first Narasimham
Committee set the stage for financial and bank reforms in India. Interest rates, previously fixed
by the Reserve Bank of India, were liberalized in the 90’s and directed lending through the use of
instruments of the Statutory Liquidity Ratio was reduced.
The financial reform process is often thought of as comprising two stages – the first
phase guided broadly by the Narasimham Committee I report while the second is based on the
Narasimham Committee II recommendations. The aim of the former was to bring about
“operational flexibility” and “functional autonomy” so as to enhance “efficiency, productivity
and profitability”. The latter focused on bringing about structural changes so as to strengthen the
foundations of the banking system to make it more stable.
This chapter is mainly focuses on the Basic structure of Indian Banking system like Types of
Banking, Banking Scenario in India as well as World, Phases of Indian Banking like
Nationalisation, Liberalisation & Privatization. Along with this chapter also includes the
Recommendation Narasimham Committee on Banking Sector.

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