Banking Sector in India

BANKING SECTOR IN INDIA

History of Indian Banking and Reforms

• The banking system has existed in many different forms for almost as long as civilization, and India’s financial system is no different. This business has seen many changes over the ages, from the development of technology to the diversification of financial services and goods. At the moment, Commercial Banks, Small Finance Banks, Regional Rural Banks and Cooperative Banks make up India’s banking sector. Banks that operate within the borders of India are subject to the Banking Regulation Act 1949. India’s banking history can be roughly categorized as follows:

• Pre-independence Phase (1770-1947)

• Post-independence Phase (1947-till date):

• Pre-nationalisation Phase (1947-1969)

• Post-nationalisation Phase (1969-1991)

• Liberalization Phase (1991-till date)

The Pre-independence Phase (1770-1947)

• The Bank of Hindustan, the country’s first bank, was founded in 1770 in Calcutta, the then-capital of India. This marked the beginning of the structured banking industry in India, which began more than a century before the country gained its freedom. After eventually failing, it was liquidated in 1832. Following this, a number of banks that had been founded during the pre- independence era, such as the General Bank of India (1786–1791) and the Oudh Commercial Bank (1881–1958), also failed to survive for very long.

• The East India Company founded the Bank of Bengal, Bank of Bombay, and Bank of Madras in the early to mid-1800s; these banks were together referred to as the Presidential Banks. In 1921, they amalgamated to become the Imperial Bank of India. Later, in 1955, it was nationalized and given the name State Bank of India (SBI). When the SBI assumed control of seven subsidiary banks in 1959, it became the largest Public Sector Bank (PSB) in India.

• Inspired by the Swadeshi movement, a number of prominent local politicians and merchants opened banks specifically for the Indian community between 1906 and 1911. Many of these are still in use.

• The establishment of an Indian central bank was suggested in 1926 by the Royal Commission on Indian Currency and Finance. A law to put this into effect was introduced in 1927 but was later withdrawn because of disagreements. A Reserve Bank was suggested in the 1933 White Paper on Indian Constitutional Reforms, and a bill for the same was presented in the Legislative Assembly. The bill was passed in 1934 and was endorsed by the Governor General.

• On April 1, 1935, the Reserve Bank of India opened for business. The Reserve Bank of India Act, 1934 (Section II of 1934) established the legal framework that governs the RBI’s operations.

The Post-independence Phase (1947-1991)

• It is among the most significant periods in Indian banking history. The Indian banking sector saw further development after independence when the Government of India (GOI) decided to implement a mixed economy in 1948, involving significant market intervention to boost the economy. After being nationalized in 1949, the 1935-founded Reserve Bank of India gained the authority to oversee, manage and inspect all Indian banks.

• The Indian government acknowledged that a number of communities were being financially excluded in 1975. It established banking entities with specialized roles between 1982 and 1990 to keep pace with the development of financial services in India, such as NABARD (1982), EXIM (1982), National Housing Board, and SIDBI.

Nationalisation in 1969

• By the 1960s, the RBI had grown to be a significant employer and the Indian banking sector had started to contribute significantly to the country’s economic growth. However, the majority of banks remained privately owned, with the exception being SBI.

• In 1969, the 14 biggest commercial banks in India were nationalized by the Government of India through the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance.

Nationalisation in 1980

• Six additional commercial banks were included in the second wave of nationalisation that began in 1980 and went on to play a significant role in Indian banking history.

Liberalisation in 1991

• The Government of India (GOI) implemented economic liberalisation in 1991, resulting in a significant shift in its economic policies to increase the involvement of private and foreign investments. The RBI approved ten private banks in India. Among the well-known brands that have survived this liberalization are ICICI, Axis Bank and HDFC.

• During this time, there were also the following noteworthy advancements and changes:

International banks that have branches in India include Bank of America, HSBC and Citibank.

There was a halt to the nationalization of banks.

Payments banks came into existence.

Small finance banks were allowed to open branches all over India.

Banks began to digitalise transactions and various other related banking operations.

Reasons Why Banks were Nationalised in India

• To Energise Priority Sectors: The number of bank failures was rapidly increasing; from 1947 to 1955, 361 institutions failed or almost 40 banks annually. Clients lost their deposits and had no possibility of getting them back.

• A Neglected Agricultural Sector: Banks disregarded the rural area in favor of big firms and industries. Nationalization was linked with promises of support for the agricultural sector.

• Expansion of Branches: Nationalization made it easier for new branches to open, ensuring that banks were fully covered across the nation.

• Mobilisation of Savings: Nationalising the banks would allow people more access to banks and encourage them to save, injecting additional revenue into a cash-strapped economy.

• Economic and Political Factors: The economy had been severely impacted by the two conflicts in 1962 and 1965. The economy would benefit from a rise in deposits resulting from the nationalisation of Indian banks.

The Positive Effects of Nationalisation:

• The following are some of the ways that nationalization helped the economy:

• Increased Savings: With the creation of new branches, savings increased dramatically. Gross domestic savings nearly doubled throughout the 1970s as the country’s income increased.

• Improved Efficiency: More accountability increased the efficiency of banks. Additionally, it raised public trust.

• Empowering SSIs: An increase in small-scale industries (SSIs) led to a commensurate improvement in the economy.

• Financial Inclusion: The Indian economy’s and the banking industry’s overall statistics demonstrated a noticeable improvement. It was based on metrics such as the percentage of bank deposits to GDP, the gross savings rate, the percentage of advances to GDP, and the gross investment rate between 1969 and 1991.

• Better Outreach: The banking industry was no longer confined to large cities. In the most remote regions of the nation, branches were opened.

• A Surge in Public Deposits: Expanded banking networks facilitated the growth of exports, small businesses

and agriculture. An equivalent rise in public deposits coincided with this growth.

• Elevating the Green Revolution: Support for the agricultural sector from the recently nationalized banks contributed to the Green Revolution, one of the highest priorities on the government’s agenda.

Drawbacks of Nationalisation

• Socio-Economic Challenges: The banks were unable to assist the grassroots levels of society with sufficient funding or to completely eradicate poverty. In India’s rural areas, this was especially clear.

• Competition from Private Banks: Public sector banks never achieved performance levels higher than private banks, even with government support and additional stimulus from rising deposits.

• Failure to Achieve Financial Inclusion: The primary goal of nationalizing banks was financial inclusion, although it was not sufficiently facilitated.

Consolidation among Public Sector Banks

• India’s banking sector is currently developing, with a variety of bank types catering to various economic sectors. A number of new bank types and their introduction into the system in recent years have emerged, catering to specific societal segments. However, Public Sector Banks (PSBs), which still hold a market share of more than 70% of the banking system’s assets, continue to dominate the banking industry.

• There has long been a recommendation that PSBs should combine. In 1991, the Narasimhan Committee Report (NC-I) proposed a three-tier banking system in India, involving the creation of three major global banks, eight to ten national banks, and several regional and local banks.

• The suggestions on NC-I were also reaffirmed in the 1998 Narasimhan Committee Report (NC-II).

Current Imperatives

• Currently, a number of consistent criteria suggest that the Indian banking sector is ready for consolidation. Following is the order in which they are listed:

• The necessity for consolidation is particularly apparent at this time since, despite the fact that the Indian economy is the fifth largest in the world, State Bank of India, our top bank, is only ranked 55th in the world and is the only bank in the global top 100.

• Additionally, a larger bank is thought to be less dangerous than a smaller bank because its portfolio will be more diversified, resulting in less volatility in its profitability. As a result, a bigger bank could be able to get a better credit rating than a smaller one.

• The need for large-scale loans will rise as Indian businesses expand and become more global in scope.

In order to accommodate the increased demand for loans, banks must likewise expand in size. It will be necessary for the banking sector to increase its ability to lend to bigger businesses and projects.

Consolidation in the Indian banking system in past

• Bank consolidation in India has taken two forms. Banks have voluntarily merged, which is the most notable example of the desire for operational efficiency, growth, and synergy. An instance of this type of consolidation is the union of Kotak Mahindra Bank and ING Vysya Bank.

• Under Section 44A of the Banking Regulation Act of 1949, the Reserve Bank is authorized to accept these voluntary mergers.

• A weak bank’s resolution has been the focus of the other kind of bank merger.

• The Reserve Bank is authorized by Section 45 of the Banking Regulation Act 1949 to devise a plan for the merger of one bank with another, provided that it serves the interests of depositors and the banking system as a whole.

• One example of this type of merger was the 2004 combination of Global Trust Bank and Oriental Bank of Commerce.

• Vijaya and Dena banks were recently bought by Bank of Baroda, and Oriental Bank of Commerce and United Bank of India was recently acquired by Punjab National Bank. Andhra Bank and Corporation Bank were bought by and Union Bank of India.

Caveats in Consolidation of PSBs

• The banking sector and the economy as a whole do not always benefit from enormous sizes. Up to a certain threshold size, the benefits of size are evident. Any expansion above this point could be detrimental to the economy. Significant moral hazard costs for the system as a whole could also result from the existence of excessively large banks.

• PSBs have not been doing well collectively during the past few years. The amount of non-performing assets (NPAs) has increased significantly.

• It must be made sure that bank mergers are not viewed as a temporary solution to issues that particular PSBs are experiencing. Only a strategic strategy driven by synergy and producing value for both institutions may make a merger beneficial. If a weak bank and a strong bank merge, the resultant entity may become weak if the merger procedure is not managed correctly.

Consolidation beyond Mergers

Most of the time, we presume that consolidation means acquisitions and mergers. This isn’t need to be the case. The merging of enterprises is an additional form consolidation. An entity consolidation is not the same as this.

• In this kind of bank consolidation, a bank voluntarily chooses to participate in specific business ventures and exits or sells some business ventures.

• Our PSBs can learn from this model and assess if they can all decide to be unique banks in their respective markets or areas of expertise, or if they can all decide to be universal banks.

• For example, a few PSBs are primarily active, strong and knowledgeable in the agricultural and rural markets. A few PSBs primarily serve the SME market with their assets and reach. Small finance banks are an option available to these PSBs. By doing this, they may preserve capital and avoid wasting their energy in the extremely intricate and specialized corporate and project finance sector.