History of Banking in India

© Research Paper by - Tariq Mumtaz

The Beginning The English traders that came to India in the 17th century could not make much use of the indigenous bankers, owing to their ignorance of the language as well the inexperience indigenous people of the European trade. Therefore, the English Agency 1 Houses in Calcutta and Bombay began to conduct banking business, besides their commercial business, based on unlimited liability. The Europeans with aptitude of commercial pursuit, who resigned from civil and military, organized these agency houses. A type of business organisation recognizable as managing agency took form in a period from 1834 to 1847. The primary concern of these agency houses was trade, but they branched out into banking as a sideline to facilitate the operations of their main business. The English agency houses, that began to serve as bankers to the East India Company had no capital of their own, and depended on deposits for their funds. They financed movements of crops, issued paper money and established joint stock banks. Earliest of these was Hindusthan Bank, established by one of the agency houses in Calcutta in 1770. Banking in India originated in the last decades of the 18th century. The first bank in India, though conservative, was established in 1786 in Calcutta by the name of bank of Bengal. Indian banking system, over the years has gone through various phases. For ease of study and understanding it can be broken into four phases

These phases are based upon personal study and understanding and many experts may ir may not agree this chronological segmentation. Prof K.V. Bhanu Murthy2 has also segregates the Indian banking periods into four eras. These are

1. Early historical and formative era: 1770-1905

2. Pre-independence era: 1906-1946

3. Post independence regulated era: 1947-1993

4. Post independence deregulated era from 1993 onwards

1 1 A type of business organization recognizable as managing agency took form in a period from 1834 to 1847. Managing agency system came into existence when an agency house first promoted and acquired the management of a company. This system, with no counterpart in any other country functioned as an Indian substitute for a well-organized capital market and an industrial banking system of western countries. 2 Professor in Department of Commerce, Delhi School of Economics

Early Phase (1786 to 1935) Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India, which started in 1786, and the Bank of Hindustan, both of which are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The East India Company established Bank of Bengal, Bank of Bombay and Bank of Madras as independent units and called it Presidency Banks. The three banks merged in 1925 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India. Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire d’Escompte de Paris opened a branch in Calcutta in 1860 and another in Bombay in 1862; branches in Madras and Pondichery, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, and so became a banking center. Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 because of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India.

Joint Stock Banks American Civil War played a major role in the development of banking in India. The next big thing unfolded in the early phase of banking was formation of joint stock companies, with limited liability. The American Civil War cut off the supply of American cotton to England caused an unprecedented boom in India’s cotton trade with England. The first joint stock bank was Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Shimla. The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India

Stability & Growth Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities.

The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally under capitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe,

Swadeshi Movement The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. Ammembal Subba Rao Pai founded “Canara Bank Hindu Permanent Fund” in 1906. Central Bank of India was established in 1911 by Sir Sorabji Pochkhanawala and was the first commercial Indian bank completely owned and managed by Indians. In 1923, it acquired the Tata Industrial Bank.

"In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments."

The fervor of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Canara (South Kanara ) district. Four nationalized banks started in this district and also a leading private sector bank. Hence, undivided Dakshina Kannada district is known as "Cradle of Indian Banking". Banks with Year of Start

Bank of Bengal 1809

Bank of Bombay 1840

Bank of Madras 1843

Allahabad Bank 1865

Punjab National Bank Ltd. 1894

Canara Bank 1906

Indian Bank 1907

Bank of Baroda 1908

Central Bank of India 1911

Bank of Mysore 1913

Union Bank if India 1922

Failures in Early Phase During the first phase, the growth was very slow and banks experienced periodic failures during the Early Phase between. There were approximately 1100 banks, mostly small which failed within the early phase The first major bank failure took place in 1791, when General Bank of India was voluntarily liquidated, due to inability to earn profits following the currency difficulties in 1787. Bengal Bank failed around 1791, due to a run on it caused by emergence of difficulties of a related firm. A large number 14 of banks failed within a short time, and public confidence in banks was destroyed. The currency confusion during 1873-1893 caused trade uncertainties and also played its role in creating an atmosphere unfavorable to establishment of new banks. Due to war and uncertainty in Europe let to speculative activity, which eventually caused bank failures. The depositors lost money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century.

Development of banking, during this period, was mostly because very deregulated (laissez faire policy). This also played a major role in failures. The deficiency of capital made newly established banks almost wholly dependent on deposits. Keen rivalry among them to attract deposits led to luring of depositors, with rates of interest much higher than they could really afford. During 1913, Indian Companies Act3 was passed. It contained a few sections related to joint sector banks. While this act is significant, being the first legislation related to banks, it was not adequate for regulation of banking activity. Many banks were left altogether free from regulation. The boom during the later part of World War I and after it gave another impetus to the starting of new banks. A number of banks were established, some specially for financing industries. But from 1922, the bank failures increased once again due to economic depression

3 http://www.vakilno1.com/bareacts/companiesact/s3.htm

Pre Nationalization Phase (1935 to 1969) Organized banking in India is more than two centuries old. Until 1935 all, the banks were in private sector and were set up by individuals and/or industrial houses, which collected deposits from individuals and used them for their own purposes. In the absence of any regulatory framework, these private owners of banks were at liberty to use the funds in any manner, they deemed appropriate and resultantly, the bank failures were frequent. For many years the Presidency banks acted as quasi-central banks, as did their successors. Bank of Bengal, Bank of Bombay and Bank of Madras merged in 1925 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India. Even though consolidation in banking was building trust among the investors but a central regulatory, authority was much needed. British Government in India passed many trade and commerce laws but acted little on regulating the banking industry.

Reserve Bank of India Another breakthrough happened in this phase, which was Reserve Bank of India. The Reserve Bank of India was set up on the recommendations Royal Commission on Indian Currency and Finance 4 also known as the Hilton-Young Commission. The commission submitted its report in the year 1926, though the bank was not set up for nine years.

Reserve Bank of India (RBI) was created with the central task of maintaining monetary stability in India. The Government on December 20, 1934 issued a notification and on January 14, 1935, the RBI came into existence, though it was formally inaugurated only on April 1, 1935. Main functions of RBI were

1. Regulate the issue of banknotes

2. Maintain reserves with a view to securing monetary stability and

3. To operate the credit and currency system of the country to its advantage

The Bank began its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India. Offices of the Banking Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon. Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank continued to act as the Central Bank for Burma until Japanese Occupation of Burma and later unto April 1947. After the partition of India, the Reserve Bank served as the central bank of Pakistan up to June 1948 when the State Bank of Pakistan commenced operations. 4 http://hansard.millbanksystems.com/lords/1926/nov/18/indian-currency-and-finance

India Wins Freedom I think the second milestone in history of Indian banking was India becoming a sovereign republic. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy5. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The banking sector also witnessed the benefits; Government took major steps in this Indian Banking Sector Reform after independence.

First major step in this direction was nationalized of Reserve Bank in 1949.

Enactment of Banking Regulation Act in 19496

Reserve Bank of India Scheduled Banks' Regulations, 1951.

Nationalization of Imperial Bank of India in 1955, with extensive banking facilities on a large scale especially in rural and semi-urban areas.

Nationalization of SBI subsidiaries in 1959

Government of India took many banking initiatives. These were aimed to provide banking coverage to all section of the society and every sector of the economy. -

1955 The Industrial Credit and Investment Corporation of India Limited (ICICI) was incorporated at the initiative of World Bank, the Government of India and representatives of Indian industry, with the objective of creating a development financial institution for providing medium-term and long-term project financing to Indian businesses.

Industrial Development Bank of India Limited (IDBI) was established in 1964 by an

Act of Parliament to provide credit and other facilities for the development of the fledgling Indian industry. Some of the institutions built by IDBI are The National Stock Exchange of India (NSE), The National Securities Depository Services Ltd. (NSDL) and the Stock Holding Corporation of India (SHCIL) IDBI BANK, as a private bank after government policy for new generation private banks.

This phase of Indian banking was eventful and was a phase of restructuring, regulation. However, despite these provisions, control and regulations, banks in India except the State Bank of India, continued to be owned and operated by private persons.

5 http://en.wikipedia.org/wiki/Mixed_economy 6 http://www.bankingindiaupdate.com/bra.html

Post Nationalization Phase (1969 to 1990) I think nationalization7 of banks in India was an important phenomenon. On July 19, 1969 - the erstwhile government of India nationalized 14 major private banks. Nationalization of bank in India was not new or happening first time. From 1955 to 1960, State Bank of India and other seven subsidiaries were nationalized under the SBI Act of 1955.

List of Nationalized Banks in 1969

1 Central Bank of India 8 Indian Overseas Bank

2 Bank of Maharashtra 9 Bank of Baroda

3 Dena Bank 10 Union Bank

4 Punjab National Bank 11 Allahabad Bank

5 Syndicate Bank 12 United Bank of India

6 Canara Bank 13 UCO Bank

7 Indian Bank 14 Bank of India

It was not a step taken at random or because of the whims of the leadership of the time, but reflected a process of struggle and political change which had made this an important demand of the people. Nationalisation took place in two phases, with a first round in 1969 covering 14 banks followed by another in 1980 covering seven banks. Currently there are 27 nationalized commercial banks.

Reasons for Nationalization

1. The need for the nationalization was felt mainly because private commercial banks were not fulfilling the social and developmental goals of banking, which are so essential for any industrializing country. Despite the enactment of the Banking Regulation Act in 1949 and the nationalization of the largest bank, the State Bank of India, in 1955, the expansion of commercial banking had largely excluded rural areas and small-scale borrowers.

2. The developmental goals of financial intermediation were not being achieved other than for

some favored large industries and established business houses. Whereas industry’s share in credit disbursed by commercial banks almost doubled between 1951 and 1968, from 34 per cent to 68 per cent, agriculture received less than 2 per cent of total credit.

3. The stated purpose of bank nationalization was to ensure that credit allocation occur in

accordance with plan priorities.

4. Reduce the hold of moneylenders and make more funds available for agricultural development. Nationalization of bank was to actively involve in poverty alleviation and employment generation programs.

7 What is Nationalization: Nationalization, also spelled nationalisation, is the act of taking an industry or assets into the public ownership of a national government or state. Nationalization usually refers to private assets, but may also mean assets owned by lower levels of government, such as municipalities, being state operated or owned by the state. The opposite of nationalization is usually privatization or de-nationalization. The motives for nationalization are political as well as economic.

Advantages of Nationalization

1. Nationalized banks had to provide 18 per cent of their net credit to the agricultural sectors. This was targeted to reduce the hold of moneylenders and make more funds available for agricultural development. This has substantially helped farmers.

2. The reach of banking widened; the entry barriers that existed for customers to bank, social economic and political were lowered. This resulted in a massive quantitative expansion of the bank customer base as well as in the nature of services provided. Absence of concern for profitability and targeting made banks to expand rapidly in un-banked areas thereby the entire country was linked to banking activity.

3. Enhanced bank credit to the farm sector became instrumental for the success of green revolution and the increase of aggregate food grain production in north and northwest India in the 1970s and in the eastern region in the 1980s.

4. Increase in exports by small-scale manufacturers over the 1980s and 1990s, such that they accounted for around two-third of the total value of all exports, was strongly related to access to bank credit provided by priority sector norms.

5. Collection of saving: Private banks were not that good in attracting more saving. However, with nationalization banks were now backed by Government of India, which tremendously improved their credibility. This helped in more deposits, more savings hence more supply of money.

Disadvantages of Nationalization

1. State intervention to some extent distorted the banking sector. The domination of the State has had a negative effect on the contribution of the banking sector as a whole to the economy. Absence of profitability, non-realization of its potential as a business and the deterioration in service has all affected citizens.

2. The intervention by the State and excessive domination and intervention by the bureaucracy and polity into the functioning of banks has led to deterioration on economic efficiency, which runs counter to the principles of a good Government.

3. Low Profitability: When the ownership is in public sector, the employs do not work for profit and do not there performance and efficiency of the employs remains poor. Competition is necessary for development and increasing the production. Nationalization has decreased the spirit of competition

This phase of Indian banking not so happening for entry of new banks. Undoubtedly, it was a phase of expansion, consolidation and increment in many ways. The banking sector grew at a phenomenal rate, fruits of nationalization were evident, and common person was now banking with great trust. National Bank for Agricultural and Rural Development (NABARD) was set up in 1982, as an apex institution for agricultural and rural credit, though primarily, a refinance extension institution. Board for Industrial & Financial Reconstruction (BIFR) came into existence under Sick Companies (Special Provisions) Act 1985 and started its operations wef May 15, 1987. It is meant to deal with sick companies or potential sick companies as defined under the Act. BIFR, based on a reference by the concerned sick company, takes a decision whether the company should be rehabilitated or wound up.

Modern Phase from 1991 till date This is the phase of “New Generation” tech-savvy banks. This phase can be called as “The Reforms Phase”. Starting of the modern and current phase of Indian Banking is marked by two important events.

Narasimhan Committee The Committee on Banking Sector Reforms Committee8 headed by Mr. M. Narasimhan, it is also known as Narasimhan Committee. The Committee, headed by former Reserve Bank of India governor M Narasimhan, was appointed by the United Front government to review the progress in banking sector reforms. The committee submitted its recommendations to union Finance Minister Yashwant Sinha in November of 1991. The Committee was required to review the progress in the reforms in the banking sector over the past six years with and to chart a programme on Financial Sector Reforms necessary to strengthen the India's financial system and make it internationally competitive taking into account the vast changes in the international and financial markets, technogical advances. Some of the recommendations offered by the committee are:

1. A reduction, phased over five years in the Statutory Liquidity Ratio (SLR) to 25 percent, synchronized with the planned contraction in Fiscal Deficit.

2. A progressive reduction in the Cash Reserve Ratio (CRR).

3. Gradual deregulation of interest rates.

4. All banks to attain Capita Adequacy 8% in a phased manner.

5. Banks to make substantial provisions for bad and doubtful debts.

6. Profitable and reputed banks be permitted to raise capital from the public.

7. Instituting an Assets Reconstruction Fund to which the bad and doubtful debts of banks and Financial Institutions could be transferred at a discount.

8. Facilitating the establishment of new private banks, subject to RBI norms.

9. Banks and financial institutions to classify their assets into four broad groups, viz, Standard, Sub-standard, Doubtful and Loss.

10. RBI to be primarily responsible for the regulation of the banking system.

11. Larger role for Securities Exchange Board of India (SEBI), particularly as a market regulator rather than as a controlling authority.

8 http://pib.nic.in/focus/fomore/narsim.html

Economic Liberalization in India The second major turning point in this phase was Economic Liberalization in India. After Independence in 1947, India adhered to socialist policies. The extensive regulation was sarcastically dubbed as the "License Raj". The Government of India headed by Narasimha Rao decided to usher in several reforms that are collectively termed as liberalization in the Indian media with Manmohan Singh whom he appointed Finance Minister. Dr. Manmohan Singh, an acclaimed economist, played a central role in implementing these reforms. New research suggests that the scope and pattern of these reforms in India's foreign investment and external trade sectors followed the Chinese experience with external economic reforms.

Reasons for the Reforms A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF bailout, gold was transferred to London as collateral, the Rupee devalued and economic reforms were forced upon India. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy. Controls started to be dismantled, tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment, private sector enterprise and competition were encouraged and globalisation was slowly embraced.

Impact of Economic Liberalization on Finance & Banking Post nationalization now Indian banking sector was unshackled, and along with the government banks a thick layer of private and foreign banks was taking shape. The first of such new generation banks to be set up was Global Trust Bank, which later amalgamated with Oriental Bank of Commerce, ICICI Bank, HDFC Bank and Axis Bank. This move, along with the rapid growth in the economy of India, revitalized the banking sector in India. The next stage for the Indian banking has been setup with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights, which could exceed the present cap of 10%, at present it has gone up to 49% with some restrictions. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to the retail boom in India. People not just demanded more from their banks but also received more.

Banking Sector Reforms since 1992 The first type of reforms mainly based on Narasimhan Committee recommendations and the principals of new liberalized Indian economy.

Out of the 27 public sector banks (PSBs), 26 PSBs achieved the minimum capital to risk assets ratio (CRAR) of 9 per cent by March 2000. To enable the PSBs to operate in a more competitive manner, the Government adopted a policy of providing autonomous status to these banks, subject to certain benchmarks.

The Reserve Bank advised banks in February 1999 to put in place an ALM system, effective April 1, 1999 and set up internal asset liability management committees (ALCOs) at the top management level to oversee its implementation. Banks were expected to cover at least 60 per cent of their liabilities and assets in the interim and 100 per cent of their business by April 1, 2000.

Interest rate deregulation has been an important component of the reform process. The

interest rates in the banking system have been largely deregulated except for certain specific classes; these are savings deposit accounts, non-resident Indian (NRI) deposits, small loans up to Rs.2 lakh and export credit.

In 1994, a Board for Financial Supervision (BFS) was constituted comprising select members

of the RBI Board with a variety of professional expertise to exercise 'undivided attention to supervision'. The BFS, which generally meets once a month, provides direction on a continuing basis on regulatory policies including governance issues and supervisory practices. It also provides direction on supervisory actions in specific cases.

The share of the public sector banks in the aggregate assets of the banking sector has come

down from 90 per cent in 1991 to around 75 per cent in 2004. The share of wholly Government-owned public sector banks has declined from about 90 per cent to 10 per cent of aggregate assets of all scheduled commercial banks during the same period. Diversification of ownership has led to greater market accountability and improved efficiency. Current market value of the share capital of the Government in public sector banks has increased manifold and as such, what was perceived to be a bailout of public sector banks by Government seems to be turning out to be a profitable investment for the Government.

A Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) has also

been recently constituted to prescribe policies relating to the regulation and supervision of all types of payment and settlement systems, set standards for existing and future systems, authorize the payment and settlement systems and determine criteria for membership to these systems. Both the Houses of the Parliament have passed the Credit Information Companies (Regulation) Bill, 2004.

Consolidation in the banking sector has been another feature of the reform process. This also

encompassed the Development Financial Institutions (DFIs), which have been providers of long-term finance.

Since 1993, twelve new private sector banks have been set up. As already mentioned, an element of private shareholding in public sector banks has been injected by enabling a reduction in the Government shareholding in public sector banks to 51 per cent. As a major step towards enhancing competition in the banking sector, foreign direct investment in the private sector banks is now allowed up to 74 per cent, subject to conformity with the guidelines issued from time to time. Currently, banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. Reserve Bank of India in March 2006 allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank.

Current Banking Structure Banks in India can be categorized into Scheduled and Non-scheduled Banks Scheduled Banks Scheduled Banks in India constitute those banks, which have been included in the Second Schedule of Reserve Bank of India(RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the Act. As on 30th June 1999, there were 300 scheduled banks in India having a total network of 64,918 branches. The scheduled commercial banks in India comprise of State bank of India and its associates (8), nationalized banks (19), foreign banks (45), private sector banks (32), co-operative banks and regional rural banks Non-Schedule Banks Non-scheduled bank in India" means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank". Banks in India can also be classified in a different way.

Public Sector Banks

Private Sector Banks

Foreign Banks

Regional Rural Banks (RRBs)

The above mentioned classification overlaps with the previous one. Public Sector, Private Sector and Foreign Banks fall the category of scheduled banks. Currently, India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government of India holding a stake), 31 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 38 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75% of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

Industry Data

Banks in India RBI List http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=A%20Profile%20of%20Banks

Statistical Tables Relating to Banks of India http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Statistical%20Tables%20Relating%20to%20Banks%20of%20India

Trend and Progress of Banking in India http://www.rbi.org.in/Scripts/AnnualPublications.aspx?head=Trend%20and%20Progress%20of%20Banking%20in%20India

Bibliography

Bagchi, A. K. (1972) Private Investment in India 1900-39. New Delhi: Orient Longman Ltd.

Concept of Deregulation - Lessons from banking history in India by Prof K.V. Bhanu Murthy, Delhi University.

http://finance.indiamart.com/investment_in_india/banking_in_india.html

RECENT HISTORY OF INDIAN BANKING at http://www.bankingindiaupdate.com/general.html

RBI Publications at http://www.rbi.org.in/scripts/publications.aspx

The Economic Journal, Vol. 37, No. 146. Published by: Blackwell Publishing for the Royal Economic Society.

C.P.I.M, Vol. XXIX - July 31, 2005 - Jayati Ghosh