History of banking in India

There are three different phases in the history of banking in India.

  • Pre-Nationalization Era.
  • Nationalization Stage.
  • Post Liberalization Era.

1. Pre-Nationalization Era:

In India the business of banking and credit was practices even in very early times. The remittance of money through Hundies, an indigenous credit instrument, was very popular. The hundies were issued by bankers known as Shroffs, Sahukars, Shahus or Mahajans in different parts of the country.

The modern type of banking, however, was developed by the Agency Houses of Calcutta and Bombay after the establishment of Rule by the East India Company in 18th and 19th centuries.

During the early part of the 19th Century, ht volume of foreign trade was relatively small. Later on as the trade expanded, the need for banks of the European type was felt and the government of the East India Company took interest in having its own bank. The government of Bengal took the initiative and the first presidency bank, the Bank of Calcutta (Bank of  Bengal) was established in 180. In 1840, the Bank of Bombay and IN 1843, the Bank of Madras was also set up.

These three banks also known as “Presidency Bank”. The Presidency Banks had their branches in important trading centers but mostly lacked in uniformity in their operational policies. In 1899, the Government proposed to amalgamate these three banks in to one so that it could also function as a Central Bank, but the Presidency Banks did not favor the idea. However, the conditions obtaining during world war period (1914-1918) emphasized the need for a unified banking institution, as a result of which the Imperial Bank was set up in1921. The Imperial Bank of India acted like a Central bank and as a banker for other banks.

The RBI (Reserve Bank of India) was established in 1935 as the Central Bank of the Country. In 1949, the Banking Regulation act was passed and the RBI was nationalized and acquired extensive regulatory powers over the commercial banks.

In 1950, the Indian Banking system comprised of the RBI, the Imperial Bank of India, Cooperative banks, Exchange banks and Indian Joint Stock banks.

2. Nationalization Stages:

After Independence, in 1951, the All India Rural Credit survey, committee of Direction with Shri. A. D. Gorwala as Chairman recommended amalgamation of the Imperial Bank of India and ten others banks into a newly established bank called the State Bank of India (SBI). The Government of India accepted the recommendations of the committee and introduced the State Bank of India bill in the Lok Sabha on 16th April 1955 and it was passed by Parliament and got the president’s assent on 8th May 1955. The Act came into force on 1st July 1955, and the Imperial Bank of India was nationalized in 1955 as the State Bank of India.

The main objective of establishing SBI by nationalizing the Imperial Bank of India was “to extend banking facilities on a large scale more particularly in the rural and semi-urban areas and to diverse other public purposes.”

In 1959, the SBI (Subsidiary Bank) act was proposed and the following eight state-associated banks were taken over by the SBI as its subsidiaries.

Name of the Bank                                      Subsidiary with effect from

1.  State Bank of Hyderabad                                      1st October 1959

2.  State Bank of Bikaner                                             1st January 1960

3.  State Bank of Jaipur                                               1st January 1960

4.  State Bank of Saurashtra                                      1st May 1960

5.  State Bank of Patiala                                              1st April 1960

6.  State Bank of Mysore                                             1st March 1960

7.  State Bank of Indore                                              1st January 1968

8. State Bank of Travancore                                       1st January 1960

With effect from 1st January 1963, the State Bank of Bikaner and State Bank of Jaipur with head office located at Jaipur. Thus, seven subsidiary banks State Bank of India formed the SBI Group.

The SBI Group under statutory obligations was required to open new offices in rural and semi-urban areas and modern banking was taken to these unbanked remote areas.

On 19th July 1969, then the Prime Minister, Mrs. Indira Gandhi announced the nationalization of 14 major scheduled Commercial Banks each having deposits worth Rs. 50 crore and above. This was a turning point in the history of commercial banking in India.

Later the Government Nationalized six more commercial private sector banks with deposit liability of not less than Rs. 200 crores on 15th April 1980, viz.

  • Andhra Bank.
  • Corporation Bank.
  • New Bank if India.
  • Oriental Bank of Commerce.
  • Punjab and Sind Bank.
  • Vijaya Bank.

In 1969, the Lead Bank Scheme was introduced to extend banking facilities to every corner of the country. Later in 1975, Regional Rural Banks were set up to supplement the activities of the commercial banks and to especially meet the credit needs of the weaker sections of the rural society.

Nationalization of banks paved way for retail banking and as a result there has been an alt round growth in the branch network, the deposit mobilization, credit disposals and of course employment.

The first year after nationalization witnessed the total growth in the agricultural loans and the loans made to SSI by 87% and 48% respectively. The overall growth in the deposits and the advances indicates the improvement that has taken place in the banking habits of the people in the rural and semi-urban areas where the branch network has spread. Such credit expansion enabled the banks to achieve the goals of nationalization, it was however, achieved at the coast of profitability of the banks.

Consequences of Nationalization:

  • The quality of credit assets fell because of liberal credit extension policy.
  • Political interference has been as additional malady.
  • Poor appraisal involved during the loan meals conducted for credit disbursals.
  • The credit facilities extended to the priority sector at concessional rates.
  • The high level of low yielding SLR investments adversely affected the profitability of the banks.
  • The rapid branch expansion has been the squeeze on profitability of banks emanating primarily due to the increase in the fixed costs.
  • There was downward trend in the quality of services and efficiency of the banks.

3. Post-Liberalization Era—Thrust on Quality and Profitability:

By the beginning of 1990, the social banking goals set for the banking industry made most of the public sector resulted in the presumption that there was no need to look at the fundamental financial strength of this bank. Consequently they remained undercapitalized. Revamping this structure of the banking industry was of extreme importance, as the health of the financial sector in particular and the economy was a whole would be reflected by its performance.

The need for restructuring the banking industry was felt greater with the initiation of the real sector reform process in 1992. the reforms have enhanced the opportunities and challenges for the real sector making them operate in a borderless global market place. However, to harness the benefits of globalization, there should be an efficient financial sector to support the structural reforms taking place in the real economy. Hence, along with the reforms of the real sector, the banking sector reformation was also addressed.

The route causes for the lackluster performance of banks, formed the elements of the banking sector reforms. Some of the factors that led to the dismal performance of banks were.

  • Regulated interest rate structure.
  • Lack of focus on profitability.
  • Lack of transparency in the bank’s balance sheet.
  • Lack of competition.
  • Excessive regulation on organization structure and  managerial resource.
  • Excessive support from government.

Against this background, the financial sector reforms were initiated to bring about a paradigm shift in the banking industry, by addressing the factors for its dismal performance.

In this context, the recommendations made by a high level committee  on financial sector, chaired by M. Narasimham, laid the foundation for the banking sector reforms. These reforms tried to enhance the viability and efficiency of the banking sector. The Narasimham Committee suggested that there should be functional autonomy, flexibility in operations, dilution of banking strangulations, reduction in reserve requirements and adequate financial infrastructure in terms of supervision, audit and technology. The committee further advocated introduction of prudential forms, transparency in operations and improvement in productivity, only aimed at liberalizing the regulatory framework, but also to keep them in time with international standards. The emphasis shifted to efficient and prudential banking linked to better customer care and customer services.

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