Scenario of Indian Banking Sector in Pre and Post Reform Period

Scenario of Indian Banking Sector in Pre Reform Period

Banking is an ancient business in India. Initially, the growth of Indian banks was very slow and also experienced periodic failures between 1913 and 1948. 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).

During those days, public had lesser confidence in the banks. As an aftermath deposit mobilization was slow. Government took major steps in Indian banking sector reform after independence. On 19th July 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. Fourteen major commercial banks were nationalized.

Second phase of nationalization of Indian banking sector reform was carried out in 1980 with seven more banks having deposits over 200 crore. This step brought 80 percent of the banking segment in India under Government ownership. After the nationalization, the branches of the public sector bank in India rose to approximately 800 percent and deposits and advances took a huge jump by 11,000 percent. Thus, the Indian banking system became predominantly government owned by the early 1990s.

Banking sector in pre reform period was facing very poor performance due to excessive loans in comparison to total deposits having a ratio more than 50 percent consisting of about 90 percent of all commercial banking and continuous escalation in non-performing assets (NPAs) in the portfolio of banks also posed a significant threat to the very stability of the financial system.

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Scenario of Indian Banking Sector in Post Reform Period

As the Indian banking system had become predominantly government owned by the early 1990s, banking sector reforms essentially took a two pronged approach. First, the level of competition was gradually increased within the banking system while simultaneously introducing international best practices in prudential regulation and supervision tailored to Indian requirements. In particular, special emphasis was placed on building up the risk management capabilities of Indian banks while measures were initiated to ensure flexibility, operational autonomy and competition in the banking sector. Second, active steps were taken to improve the institutional arrangements including the legal framework and technological system. The supervisory system was revamped in view of the crucial role of supervision in the creation of an efficient banking system. . ‘Measures to improve the health of the banking system had included (i) restoration of public sector banks’ net worth through recapitalization where needed; (ii) streamlining of the supervision process with combination of on-site and off-site surveillance along with external auditing; (iii) introduction of risk based supervision; (iv) introduction of the process of structured and discretionary intervention for problem banks through a prompt corrective action (PCA) mechanism; (v) institutionalization of a mechanism facilitating greater coordination for regulation and supervision of financial conglomerates; (vi) strengthening creditor rights (still in process); and (vii) increased emphasis on corporate governance.

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. 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 in 2000 identified Indian Bank, 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 percent came from the public sector banks.

Financial liberalization has, however, had a predictable effect in the distribution of scheduled commercial banking in India. Between 1969 and 1991 for instance, the share of the rural branches increased from about 22 percent to over 58 percent. 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 percent to less than 23 percent. In the years since it has crawled back up to over 31 percent.