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November 15, 2009

Banking Sector In India

Banking Industry – Funding the Economy

Banking Industry is an essential part of any economy. In fact, banks are the single most important supplier of credit. The banking industry has the capital and commitment to support the financial needs of individuals, businesses and all levels of government. In each of these roles, banks support the creation of jobs and the growth of our economy. India has 79 scheduled commercial banks with 28 public sector banks, 23 private banks and 28 foreign banks. They have a combined network of over 67,000 branches and 914,241 employees, according to a release by Reserve Bank of India published on Sep 24, 2008.According to a report by ICRA Limited, a rating agency, the public sector banks hold around 75.3 per cent of total assets of the banking industry and the private and foreign banks hold of 18.2 per cent and 6.5 per cent respectively.

The Indian banking industry is presently in a situation of great flux. There are various developments, changes within the Indian economy and deregulations occurring that have the potential to drastically change the way this industry functions in the future. As per the changes envisaged by the Reserve Bank of India (RBI), a roadmap has been laid down to gradually deregulate this sector to the foreign banks. Banking Industry is the most dominant sector of the financial system in India, and with good valuations and increasing profits, the sector has been among the top performers in the markets. But currently worldwide the banking industry is facing a tough time due to the failure of financial system in the biggest economy i.e. United State of America. The problem arose due to default in sub-prime mortgage lending clubbed with rising national debt, current account deficit, and fiscal policies of US. This has led to the failure of some big investment banking firm leading to filing bankruptcy. Financial Institutions are the one to face challenge because of liquidity crunch.

Indian Industries have been witnessing today is an indirect, knock-on effect of the global financial situation and is a reflection of the uncertainty and anxiety in the global financial markets. While no country in today’s globalizing world can remain completely insulated from the global financial crisis, Indian banking industry is better placed to cope with the adverse consequences of the financial turmoil. India is relatively better placed due to its robust policy framework, stricter prudential regulations with respect to capital and liquidity and strong growth performance (a growth of ~9 per cent) in recent years. An added obstacle to the sustained improvement of the banking system is the fact that banks are mandated to provide funding to government-defined priority sectors dominated by small-scale business and agriculture. Loans to these sectors are at high risk of becoming non-performing. Private-sector banks must ensure that 25 per cent of their loans are directed towards these priority sectors; for state-owned banks, the figure is 40 per cent. These thresholds restrict the level of credit available to more efficient companies in non-priority sectors. The level of bad loans has been falling in recent years as a result of the creation of asset-reconstruction companies and a rapid expansion in lending. Non-performing assets (NPA) fell to 1.0 per cent for the fiscal year 2007-08, according to the latest data from the Reserve Bank of India. In the near future, for a stint, we expect to see an increase in Non-performing Assets.

Evolution and contours of banking reforms in India

The indigenous system of banking had existed in India for many centuries, and catered to the credit needs of the economy of that time. The famous Kautilya Arthashastra, which is ascribed to be dating back to the 4th century, contains reference to creditors and lending. During the period of modern history, however, the roots of commercial banking in India can be traced back to the early 18th century when the Bank of Calcutta was established in June 1806. This was followed by Bank of Madras in 1843 and the Bank of Bombay in 1868. The three presidency banks were amalgamated in 1921 to form Imperial Bank of India. The Reserve Bank of India was established in 1935 and the State Bank of India in 1955.

Regulation of Banking in India

In the very early phase of commercial banking in India, the regulatory framework was somewhat diffused and the Presidency banks were regulated by their royal charter, the East India company and the government of India at that time. The recommendations of the Indian Central Banking Enquiry Committee (1929-1931) paved the way for legislation for banking regulation in the country. Under the RBI Act 1934 and later the banking Companies Act 1949 the responsibilities relating to licensing of banks, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction and liquidation were vested on the RBI.

Bank Nationalization: The nationalisation of banks in India took place in 1969 by Mrs. Indira Gandhi the then prime minister. It nationalised 14 banks then. These banks were mostly owned by businessmen and even managed by them. Before the steps of nationalisation of Indian banks, only State Bank of India (SBI) was nationalised. It took place in July 1955 under the SBI Act of 1955. Nationalisation of Seven State Banks of India (formed subsidiary) took place on 19th July, 1960. The second phase of nationalisation of Indian banks took place in the year 1980. Seven more banks were nationalised with deposits over 200 crores. Till this year, approximately 80% of the banking segment in India was under Government ownership.

The financial reform process is often thought of as comprising two stages – the first phase guided broadly by the Narasimham Committee I report while the second is based on the Narasimham Committee II recommendations. The aim of the former was to bring about “operational flexibility” and “functional autonomy” so as to enhance “efficiency, productivity and profitability”. The latter focused on bringing about structural changes so as to strengthen the foundations of the banking system to make it more stable.

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