Banking through the Ages: Tracing the Evolution of Banking in

India

Banking is a crucial aspect of societies worldwide and has been present in many cultures
independently. India is no exception and has a rich history of banking before modern banking
took hold.
In ancient and medieval periods, banking was informal and based on local community
practices. Wealthy individuals and temples acted as storage for deposits and financial
services. They protected valuables and acted as custodians of wealth. Banking also included
facilitating trade and lending money.
During British rule, modern banking institutions emerged with the primary aim of managing
government finances and facilitating trade and commerce.
Presidency Banks: The Bank of Bengal (1809), Bank of Bombay (1840), and Bank of Madras
(1843) were established under royal charters to manage the British East India Company's
finances and support its commercial activities.
The Presidency Banks were merged into one to become the Imperial Bank, which later
became the State Bank of India and laid the foundation for the modern banking system in
India.
 Indian Banking Sector: 1950–1990—From Laissez Faire to
Government Control
India had 97 scheduled private banks, 557 "non-scheduled" private banks constituted as joint
stock companies, and 395 cooperative banks at the time of independence in 1947. Thus, at the
time of India's independence, there were three primary categories of actors in the organized
banking sector: the Imperial Bank of India, joint-stock banks, and foreign-owned exchange
banks.
The 1950s and 1960s were marked by limited access to productive sector funding and a high
number of bank failures. Because of this unhappiness, the government of left-wing Prime
Minister (and then Finance Minister) Mrs Indira Gandhi nationalized fourteen private sector
banks on July 20, 1969, and six additional commercial banks in 1980.

Thus, by the early 1980s, the Indian banking sector had been substantially nationalized and
displayed classic symptoms of financial repression, such as high pre-emption of banks'
investible resources (with associated effects of crowding out of credit to the private sector),
subject to an intricate web of administered interest rates, and accompanied by quantitative
ceilings on sectoral credit imposed by the Reserve Bank of India.
Aside from commercial banks, the Indian financial industry included four additional types of
financial organizations: development financing institutions (DFIs), co-operative banks,
regional rural banks, and post offices.
 Banking in India since the 1990s: Towards Modern Competitive
Banking

The initial foundation of the banking sector reforms in India came from two official reports:
i. The Report of the Committee on Financial System (Reserve Bank of India, 1991)
ii. The Report of the Committee on Banking Sector Reforms (Government of India,
1998), both chaired by former Governor of the RBI, M Narasimham.
The Narasimham Committee 1991 was primarily concerned with improving operational
freedom in the commercial banking sector, and it recommended measures such as reducing
pre-emption of banks' investible resources (via a reduction in the cash reserve ratio (CRR)
and the statutory liquidity ratio (SLR)) and gradually eliminating the administered interest
rate structure. The Narasimham Committee suggested further steps for modernizing the
banking system in 1998, including improved regulation and supervision, as well as the
implementation of prudential rules. It also advised that the bank ownership structure in India
be reviewed.
Other elements of financial sector reforms in India include:
i. significant reduction of financial repression (including removal of automatic
monetization); dismantling of the complex administered interest rate structure to
enable the process of price discovery;
ii. providing operational and functional autonomy to public sector institutions;
iii. preparing the financial system for increasing international competition;
iv. opening the external sector in a calibrated manner;
v. and promoting financial stability in the wake of domestic and external shocks
All these measures, which were designed to create an efficient, productive and profitable
financial sector, between the early 1990s and the mid-2010s, have made a huge improvement
to the availability of lendable resources to the banking sector.
In the mid-1990s, for the first time since bank nationalisation, a slew of new private sector
commercial banks were licensed in order to increase competition, improve efficiency, and
spur innovation in the banking system.
In this transforming journey of Indian banking, information technology has played a critical
role. Through the construction of a contemporary payments system, technology has enabled
more effective, lower-cost, and real-time delivery of financial services. Some of the major
technological initiatives implemented include the establishment of the Indian Financial
Network (INFINET) as the financial sector's communication backbone, the implementation
of a Real Time Gross Settlement System (RTGS), and core banking solutions across banks
encompassing the majority of their branches across India.
The Reserve Bank's establishment of the Institute for creation and Research in Banking
Technology (IDRBT) in 1996 has tremendously aided in boosting connectivity among all
banks through the creation and dissemination of common IT standards throughout the sector.
With no legacy concerns to restrain them, the new private sector banks rapidly adopted
modern information technology from their beginning, functioning as a competitive incentive
to promote comparable adoption by public sector banks.
The amount of financialization of the Indian economy has grown dramatically over the years.
This may be seen in the rising trend of aggregate deposit and credit as a proportion of GDP.

All of the reform initiatives implemented after the 1990s resulted in the formation of a
modern banking industry in India, as well as improvements in many of the profitability,
efficiency, and stability metrics of commercial banking in India. Beginning in the late 1990s,
the new private sector banks, along with the home finance corporation HDFC, heralded the
era of retail lending and housing financing in India. With a lag, public sector banks followed
suit. This adjustment significantly increased demand for autos, two-wheelers, and other
consumer durables, promoting general economic growth in the country and diversifying
banks' asset bases.
While experiencing strong balance sheet growth of the banks, commensurate with the
impressive growth of the liberalizing Indian economy, the financial health of banks also
improved significantly, in terms of both capital adequacy and asset quality.
Illustratively, gross non-performing loans as a percentage of gross advances came down
steadily from 15.7 percent in 1996 to 2.4 percent in 2009. Notwithstanding recent stress, the
capital to risk-weighted assets ratio of scheduled commercial banks in India was 12.7 percent
while Tier-I leverage ratio stood at 6.5 percent in September 2015.13 These are impressive by
standards of comparator economies. While improved capitalisation of public sector banks
was initially brought through infusion of funds by government to recapitalise these banks,
subsequently, public sector banks were allowed to raise funds from the market through equity
issuance subject to the maintenance of 51 percent public ownership.
Along with divestiture in the public sector banks, and their subsequent listing in stock
exchanges, a significant number of private sector banks were allowed entry; consequently,
the share of public sector banks continued to decline gradually in banking business and a
private sector bank emerged as the second largest bank in India over the last ten years or so.
In terms of adoption of technology, the share of electronic payments has been increasing
continuously.
Notwithstanding such trends, the Indian banking sector continued to remain predominantly
public in nature, with the public sector banks still accounting for more than 70 percent of
total banking sector assets.
A recent official report argued for reduction in government shareholding to below 50 percent
to allow more autonomy to banks as well as to create distance between the government and
governance of banks (RBI, 2014). However, during 2014–15, despite their substantive share
in total assets, public sector banks accounted for only 42 percent in total profits (RBI, 2015),
down from 74 percent in 2003–04.
Are the public sector banks inherently less efficient than the private banks? Or, is their less
impressive performance an outcome of an inefficient governance structure subject to
bureaucratic interference? Do Indian banks continue to suffer from the imperatives of societal
concerns and thus, torn between the dilemmas of efficiency and equity?

The fact that the performance of public sector banks had converged to that of the new private
sector banks by 2008–09, before deteriorating subsequently poses a further puzzle, raises
further questions about the determinants of their performance. The issue of recent
deterioration of asset quality in public sector banks has emerged as the key concern
surrounding the banking sector today.
Earlier, gross non-performing assets (GNPAs) of the Indian banking sector, as a percentage
of gross advances, had come down from 15 percent in 1998 to 3.3 percent in 2009: since then
GNPAs have increased steadily to 5.1 percent by the end of 2015 (Figure 6). Taking a wider
definition, the stressed assets (i.e., gross NPA plus restructured standard assets plus written
off accounts) for the banking system as a whole increased from 9.8 percent in 2012 to 14.5
percent in 2015; stressed assets in public sector banks increased from 11.0 percent to 17.7
percent during the same period.
How can we summarize the story of the Indian banking sector in recent times? At the risk of
oversimplification, the following trends can be highlighted.
First, while commercial banks have seen an all-round improvement in key financial
indicators, particularly in areas of capital adequacy, asset quality and earnings, their recent
trends raise some disquieting developments.
Second, “the financial results of the co-operative banking structure however, show some
degree of vulnerability, though they may not be systemically very large” (RBI, 2009).
Third, the new entrants in the financial sector, viz., payments banks and small savings banks
are at this juncture are really unknown unknowns.
Finally, while various efforts towards financial inclusion seemed to have bear fruit, there is
much to achieve.