CHAPTER – 4
REFORMS IN INDIAN BANKING SECTOR: AN OVERVIEW
4.1 RELEVANCE AND NEED FOR REFORMS
The Committee on the Financial System (1991) had observed that the Indian Banking
System have made appreciable progress in having geographical reach and functional
strength. Inspite of this commendable progress, several issues had emerged which had
resulted in decline of productivity, efficiency and erosion of profitability of the
Banking Sector. Social Banking agenda of the Government had made most of the
PSBs unprofitable. The Narasimham Committee had described the reasons as –
a. Meeting the SLR and CRR obligations by the Banks.
b. Directed credit disbursement through Priority Sector lending.
Interest rate regime was rigid and complex followed by inadequacy of capital
requirements and faulty income recognition, asset classification and provisioning
norms. The Banks’ Balance Sheet did not reflect their true health since income was
recognized on accrual basis resulting in reporting of inflated profits. Quantitative
restrictions for credit squeeze/rationing coupled with regulated interest regime had led
to sub optimal use of credit resulting in low level of investments and thus lower
economic growth.
All this finally resulted into the financial repression which ultimately led to decline in
productivity, efficiency and erosion of the profitability of the Indian Banks.
4.2 GROWTH AND DEVELOPMENT OF BANKING
4.2.1 Pre-Reform Period
Post-Independence – Foundation Phase
The first phase covers the period from 1948- 1969, i.e. till the nationalisation of
Banks in 1969.
37
, The Indian Banking System is regulated by the RBI and the major steps to regulate
Indian Banking included:
I. The Reserve Bank of India, India's Central Banking Authority, was nationalized
on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to
Public Ownership) Act, 1948 (RBI, 2005b).
II. In 1949, the Banking Regulation Act was enacted which empowered the
Reserve Bank of India (RBI) "to regulate, control, and inspect the Banks in
India."
III. The Banking Regulation Act also provided that no new Bank or Branch of an
existing Bank could be opened without a license from the RBI, and no two
Banks could have common Directors.
Despite the above regulations, the Banking System in India was under private control
except for SBI, which was renamed on 1st July 1955, as a part of reorganisation of
rural credit structure. 8 Banking Companies functioning in former princely states were
also converted into subsidiaries of SBI, later known as Associate Banks of SBI.
The Banking System at the time of independence was largely urban oriented and
remained out of reach of rural population. Commercial Banks mostly confined their
lending to trade, commerce and industry and treated agriculture as a non priority.
Security- oriented lending was the order of the day. Banks did not pay any attention to
the farming community, the Agriculturist was forced to borrow from money lenders,
who charged exorbitant rates of interest and imposed onerous conditions. To
overcome these issues, ‘Social Control measures’ were initiated by then Prime
Minister Smt. Indira Gandhi in 1968 to help the Indian masses in poverty alleviation.
Nationalisation – Expansion Phase
The second phase, which had, began in early 60’s gained momentum after the
nationalisation of 14 major Banks on 19th July 1969 by then Prime Minister Mrs.
Indira Gandhi. The statement of objectives and reasons of the Banking Companies
(Acquisition and Transfer of Undertakings) Act says: ‘That the Banking System
touches the lives of millions and has to be inspired by a large social purpose and has
to sub-serve national priorities and objectives such as rapid growth of agriculture,
38
, small industries, exports, raising employment levels, encouragement of new
entrepreneurs and development of backward areas.’
On 15th April 1980, 6 more Private Sector Banks were nationalised, making the
number of Public Sector Banks as 27.The 15 years after the nationalisation of Banks
in 1969 have to be described as a period of distinct transformation of far reaching
significance occurring in the Indian Banking System. This period saw the provision of
credit facilities to hitherto neglected Sectors and sections of the society, participation
in employment generation and poverty elevation programmes etc. Therefore, the
important development after nationalisation was the emergence of ‘Social Banking’
i.e. the use of Banking as an instrument for promoting socio-economic objectives,
thereby converting ‘Class Banking’ to ‘Mass Banking’.
The ‘Mass Banking’ philosophy led to swift branch expansion, massive recruitment,
increased lending at concessional interest rates, declining quality of assets etc. To
summarize, all these have added costs to the Banks, eroded profitability and
weakened control, thus, lowering competitive efficiency of Indian Banks.
Outcome of Nationalisation
The progress of Commercial Banking during the period 1951 -2012 could be
evidenced from the following.
Table 4.1 - Progress of Commercial Banking during the period 1951 - 2012
Sl. Indicator/Year 1951 1969 1987 1991 2012
no.
1 No. Commercial Banks(Incl. RRBs) 566 89 279 276 237
a. Scheduled Banks 92 73 275 272 237
b. Non – scheduled Banks 474 16 4 4
2 No .of Bank offices 4,151 8,262 53,840 60,220 101,261
3 Total deposit of scheduled Banks 9.08 46.46 1,073.45 2,011.99 60,777.93
(Rs in Billion)
4 Total credit of scheduled Banks (Rs 5.47 35.99 642.13 1,218.65 47,537.83
in Billion)
Source: RBI (1998) – Banking Statistics: 1972-95
RBI (2012) - Statistical Tables relating to Banks of India, 2011-12
39
REFORMS IN INDIAN BANKING SECTOR: AN OVERVIEW
4.1 RELEVANCE AND NEED FOR REFORMS
The Committee on the Financial System (1991) had observed that the Indian Banking
System have made appreciable progress in having geographical reach and functional
strength. Inspite of this commendable progress, several issues had emerged which had
resulted in decline of productivity, efficiency and erosion of profitability of the
Banking Sector. Social Banking agenda of the Government had made most of the
PSBs unprofitable. The Narasimham Committee had described the reasons as –
a. Meeting the SLR and CRR obligations by the Banks.
b. Directed credit disbursement through Priority Sector lending.
Interest rate regime was rigid and complex followed by inadequacy of capital
requirements and faulty income recognition, asset classification and provisioning
norms. The Banks’ Balance Sheet did not reflect their true health since income was
recognized on accrual basis resulting in reporting of inflated profits. Quantitative
restrictions for credit squeeze/rationing coupled with regulated interest regime had led
to sub optimal use of credit resulting in low level of investments and thus lower
economic growth.
All this finally resulted into the financial repression which ultimately led to decline in
productivity, efficiency and erosion of the profitability of the Indian Banks.
4.2 GROWTH AND DEVELOPMENT OF BANKING
4.2.1 Pre-Reform Period
Post-Independence – Foundation Phase
The first phase covers the period from 1948- 1969, i.e. till the nationalisation of
Banks in 1969.
37
, The Indian Banking System is regulated by the RBI and the major steps to regulate
Indian Banking included:
I. The Reserve Bank of India, India's Central Banking Authority, was nationalized
on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to
Public Ownership) Act, 1948 (RBI, 2005b).
II. In 1949, the Banking Regulation Act was enacted which empowered the
Reserve Bank of India (RBI) "to regulate, control, and inspect the Banks in
India."
III. The Banking Regulation Act also provided that no new Bank or Branch of an
existing Bank could be opened without a license from the RBI, and no two
Banks could have common Directors.
Despite the above regulations, the Banking System in India was under private control
except for SBI, which was renamed on 1st July 1955, as a part of reorganisation of
rural credit structure. 8 Banking Companies functioning in former princely states were
also converted into subsidiaries of SBI, later known as Associate Banks of SBI.
The Banking System at the time of independence was largely urban oriented and
remained out of reach of rural population. Commercial Banks mostly confined their
lending to trade, commerce and industry and treated agriculture as a non priority.
Security- oriented lending was the order of the day. Banks did not pay any attention to
the farming community, the Agriculturist was forced to borrow from money lenders,
who charged exorbitant rates of interest and imposed onerous conditions. To
overcome these issues, ‘Social Control measures’ were initiated by then Prime
Minister Smt. Indira Gandhi in 1968 to help the Indian masses in poverty alleviation.
Nationalisation – Expansion Phase
The second phase, which had, began in early 60’s gained momentum after the
nationalisation of 14 major Banks on 19th July 1969 by then Prime Minister Mrs.
Indira Gandhi. The statement of objectives and reasons of the Banking Companies
(Acquisition and Transfer of Undertakings) Act says: ‘That the Banking System
touches the lives of millions and has to be inspired by a large social purpose and has
to sub-serve national priorities and objectives such as rapid growth of agriculture,
38
, small industries, exports, raising employment levels, encouragement of new
entrepreneurs and development of backward areas.’
On 15th April 1980, 6 more Private Sector Banks were nationalised, making the
number of Public Sector Banks as 27.The 15 years after the nationalisation of Banks
in 1969 have to be described as a period of distinct transformation of far reaching
significance occurring in the Indian Banking System. This period saw the provision of
credit facilities to hitherto neglected Sectors and sections of the society, participation
in employment generation and poverty elevation programmes etc. Therefore, the
important development after nationalisation was the emergence of ‘Social Banking’
i.e. the use of Banking as an instrument for promoting socio-economic objectives,
thereby converting ‘Class Banking’ to ‘Mass Banking’.
The ‘Mass Banking’ philosophy led to swift branch expansion, massive recruitment,
increased lending at concessional interest rates, declining quality of assets etc. To
summarize, all these have added costs to the Banks, eroded profitability and
weakened control, thus, lowering competitive efficiency of Indian Banks.
Outcome of Nationalisation
The progress of Commercial Banking during the period 1951 -2012 could be
evidenced from the following.
Table 4.1 - Progress of Commercial Banking during the period 1951 - 2012
Sl. Indicator/Year 1951 1969 1987 1991 2012
no.
1 No. Commercial Banks(Incl. RRBs) 566 89 279 276 237
a. Scheduled Banks 92 73 275 272 237
b. Non – scheduled Banks 474 16 4 4
2 No .of Bank offices 4,151 8,262 53,840 60,220 101,261
3 Total deposit of scheduled Banks 9.08 46.46 1,073.45 2,011.99 60,777.93
(Rs in Billion)
4 Total credit of scheduled Banks (Rs 5.47 35.99 642.13 1,218.65 47,537.83
in Billion)
Source: RBI (1998) – Banking Statistics: 1972-95
RBI (2012) - Statistical Tables relating to Banks of India, 2011-12
39
