Banking- Theory & Practice - History & Evolution of Indian Banking System

We have studied about recent developments in banking from the onset of Economic Reforms of the year 1991-92, under the project titled "Indian Banking Today & Tomorrow" and also about ongoing developments from year 2000 onwards in the project, "Banking in the New Millenium". These resources are intended for practising bankers to update their knowledge with regards to recet developments in Indian Banking. The Learning Circle is intended to gain basic knowledge about banking theory and practice for students of Management studies in India with Banking as a subject for specialisation and as a reference source for new entrants to the banking organization.

"India's banking system has several outstanding achievements to its credit, the most striking of which is its reach. An extensive banking network has been established in the last thirty years, and India's banking system is no longer confined to metropolitan cities and large towns: in fact, Indian banks are now spread out into the remote corners of our country. In terms of the number of branches, India's banking system is one of the largest, if not the largest in the world today. An even more significant achievement is the close association of India's banking system with India's development efforts. The diversification and development of our economy, and the acceleration of the growth process, are in no small measure due to the active role that banks have played in financing economic activities in different sectors." [ Dr.Bimal Jalan, Governor RBI in a speech delivered at the 22nd Bank Economists' Conference, New Delhi,15th February, 2001 ]

We can identify three distinct phases in the history of Indian Banking.

1. Early phase from 1786 to 1969

2. Nationalisation of Banks and up to 1991 prior to banking sector Reforms

3. New phase of Indian Banking with the advent of Financial & Banking Sector Reforms after 1991.

The first phase is from 1786 to 1969, the early phase up to the nationalisation of the fourteen largest of Indian scheduled banks. It was also the traditional or conservative phase of Indian Banking. The advent of banking system of India started with the establishment of the first joint stock bank, The General Bank of India in the year 1786. After this first bank, Bank of Hindustan and Bengal Bank came to existence. In the mid of 19th century, East India Company established three banks The Bank of Bengal in 1809, The Bank of Bombay in 1840, and bank of Madras in 1843. These banks were independent units and called Presidency banks. These three banks were amalgamated in 1920 and a new bank, Imperial Bank of India was established. All these institutions started as private shareholders banks and the shareholders were mostly Europeans. The Allahabad Bank was established in 1865. The next bank to be set up was the Punjab National Bank Ltd. which was established with its headquarters at Lahore in 1894 for the first time exclusively by Indians. Most of the Indian commercial banks, however, owe their origin to the 20th century. Bank of India, Central Bank of India, Bank of Baroda, the Canara Bank, the Indian Bank, and the Bank of Mysore were established between 1906 and 1913. The last major commercial bank to be set up in this phase was the United Commercial Bank in 1943. Earlier the establishment of Reserve Bank of India in 1935 as the central bank of the country was an important step in the development of commercial banking in India.

The history of joint stock banking in this first phase was characterised by slow growth and periodic failures. There were as many as 1100 banks, mostly small banks, failed during the period from 1913 to 1948. The Government of India concerned by the frequent bank failures in the country causing miseries to innumerable small depositors and others enacted The Banking Companies Act, 1949. The title of the Act was changed as "Banking Regulation Act 1949", as per amending Act of 1965 (Act No.23 of 1965). The Act is the first regulatory step undertaken by the Government to streamline the functioning and activities of commercial banks in India. Reserve Bank of India as the Central Banking Authority of the country was vested with extensive powers for banking supervision. Salient features of the Act are discussed in a separate page/article

At the time of Independence of the country in 1947, the banking secor in India was relatively small and extremely weak. The banks were largely confined to urban areas, extending loans primarily to trading sector dealing with agricultural produce. There were a large number of commercial banks, but banking services were not available at rural and semi-urban areas. Such services were not extended to different sectors of the economy like agriculture, small industries, professionals and self-employed entrepreneurs, artisans, retail traders etc.

Commercial banks, as they were privately owned, on regional or sectarian basis resulted in development of banking on ethnic and provincial basis with parochial outlook. These Institutions did not play their due role in the planned development of the country. Deposit mobilisation was slow. Public had less confidence in the banks on account of frequent bank failures. The savings bank facility provided by the Postal department was viewed a comparatively safer field of investment of savings by the public. Even the deficient savings thus mobilised by commercial banks were not channeled for the development of the economy of the country. Funds were largely given to traders, who hoarded agricultural produce after harvest, creating an artificial scarcity, to make a good fortune in selling them at a later period, when prices were soaring. The Reserve Bank of India had to step in at these occasions to introduce selective credit controls on several commodities to remedy this situation. Such controls were imposed on advances against Rice, Paddy, Wheat, Other foodgrains (like jowar, millets, ragi etc.) pulses, oilseeds etc.

When the country attained independence Indian Banking was exclusively in the private sector. In addition to the Imperial Bank, there were five big banks each holding public deposits aggregating Rs.100 Crores and more, viz. the Central Bank of India Ltd., the Punjab National Bank Ltd., the Bank of India Ltd., the Bank of Baroda Ltd. and the United Commercial Bank Ltd. Rest of the banks were exclusively regional in character holding deposits of less than Rs.50 Crores.

Government first implemented the exercise of nationalisation of a significant part of the Indian Banking system in the year 1955, when Imperial Bank of India was Nationalised in that year for the stated objective of "extension of banking facilities on a large scale, more particularly in the rural and semi-urban areas, and for diverse other public purposes" to form State Bank of India. SBI was to act as the principal agent of the RBI and handle banking transactions of the Union & State Governments throughout India. The step was in fact in furtherance of the objectives of supporting a powerful rural credit cooperative movement in India and as recommended by the "The All-India Rural Credit Survey Committee Report, 1954". State Bank of India was obliged to open an accepted number of branches within 5 years in unbanked centres. Government subsidised the bank for opening unremunerative branches in non-urban centres. The seven banks now forming subsidiaries of SBI were nationalised in the year 1960. This brought one-third of the banking segment under the direct control of the Government of India.

But the major process of nationalisation was carried out on 19th July 1969, when the then Prime Minister of India, Mrs.Indira Gandhi announced the nationalisation of 14 major commercial banks in the country. One more phase of nationalisation was carried out in the year 1980, when seven more banks were nationalised. This brought 80% of the banking segment in India under Government ownership. The country entered the second phase, i.e. the phase of Nationalised Banking with emphasis on Social Banking in 1969/70.

1. 1949 : Enactment of Banking Regulation Act.

2. 1955(Phase I) : Nationalisation of State Bank of India

3. 1959(Phase II) : Nationalisation of SBI subsidiaries

4. 1961 : Insurance cover extended to deposits

5. 1969(Phase III) : Nationalisation of 14 major banks

6. 1971 : Creation of credit guarantee corporation

7. 1975 : Creation of regional rural banks

8. 1980(Phase IV) : Nationalisation of seven banks with deposits over 200 crores.

The government's banking policy has paid rich dividends over the last three decades in terms of the objectives set up, after 1969 when 14 major private banks were nationalised .

Apart from the nationalisation process, the other features of the policy include enactment of the Banking Regulation Act in 1949, and the creation of the first state-owned State Bank of India in 1955. The policy has resulted in the creation of the massive network of the banking structure in the country. The major chunk of the structure was contributed by the nationalised banks, which number 27 at present. According to bank economists, during the last 28 years of nationalisation, the branches of the public sector banks rose 800 per cent from 7,219 to 57,000, with deposits and advances taking a huge jump by 11,000 per cent and 9,000 per cent to Rs 5,035.96 billion and Rs 2,765.3 billion respectively.(statistics as at 1993)

Contrary to the popular belief, employee productivity has been rising in the nationalised banks over the period, as per studies conducted by economists. Productivity per employee in respect of business volume (both deposits and advances) has gone up from Rs 250,000 in 1969 to Rs 4,780,000 in 1993. Accordingly, profits of these banks went up to Rs 30 billion in 1993 as against Rs 90 million at the time of the nationalisation. These banks also contributed to the generation of employment. Their staff strength increased by 300 per cent over the period to 900,000. The growth of the banking sector after the nationalisation was unprecedented anywhere in the world. It is particularly true of branch expansion to every nook and corner of the country. While there were hardly any branch in the rural areas in 1969, 35,000 bank branches are operating there at present (1993).

However Nationalised banks in their enthusiasm for development banking, looking exclusively to branch opening, deposit accretion and social banking, neglected prudential norms, profitability criteria, risk-management and building adequate capital as a buffer to counter-balance the ever expanding risk-inherent assets held by them. They failed to recognise the emerging non-performing assets and to build adequate provisions to neutralise the adverse effects of such assets. Basking in the sunshine of Government ownership that gave to the public implicit faith and confidence about the sustainability of Government-owned institutions, they failed to collect before hand whatever is needed for the rainy day. And surfeit blindly indulged is sure to bring the sick hour. In the early Nineties after two decades of lop-sided policies, these banks paid heavily for their misdirected performance in place of pragmatic and balanced policies. The RBI/Government of India have to step in at the crisis-hour to implement remedial steps. Reforms in the financial and banking sectors and liberal recapitalisation of the ailing and weakened public sector banks followed. These developments are discussed in detail in the project on "Indian Banking Today & Tomorrow". The history of Indian Banking in the current period (Post Reform period) is discussed in the project "Indian Banking in the New Millenium". These are not therefore included here. However it is relevant to mention here that the advent of banking sector reforms brought the era of modern banking of global standards in the history of Indian banking. The emphasis shifted to efficient, and prudential banking linked to better customer care and customer service. The old ideology of social banking was not abandoned, but the responsibility for development banking is blended with the paramount need for complying with norms of prudency and efficiency.