BANKING SYSTEM IN INDIA
Economics
INTRODUCTION TO BANKING
A bank is a financial institution that accepts deposits from the public and creates credit. Banks play a crucial role in economic development by mobilising savings, providing credit to productive sectors, facilitating payments, and supporting financial stability. Lending activities of banks are carried out either directly through loans or indirectly through capital markets.
In India, the banking system is the backbone of the financial system and is closely regulated to ensure safety, inclusion, and economic growth.
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CLASSIFICATION OF BANKS IN INDIA
CENTRAL BANK
The central bank of India is the Reserve Bank of India (RBI).
Functions:
- Issuance of currency notes
- Formulation and implementation of monetary policy
- Regulation and supervision of banks and financial institutions
- Banker to the government
- Custodian of foreign exchange reserves
- Controller of credit and liquidity in the economy
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COOPERATIVE BANKS
Cooperative banks are financial institutions owned and managed by their members, who are both owners and customers.
Features:
- Operate on cooperative principles
- Serve local communities
- Important for rural credit delivery
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COMMERCIAL BANKS
Commercial banks are organised under the Banking Regulation Act and operate on a profit motive.
Features:
- Accept deposits
- Provide loans
- Offer payment and remittance services
- Have a unified and nationwide structure
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REGIONAL RURAL BANKS (RRBs)
RRBs are special types of commercial banks established to provide concessional credit to agriculture and rural sectors.
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LOCAL AREA BANKS (LABs)
- Set up by the private sector
- Registered under the Companies Act
- Operate in limited geographical areas
- Profit-oriented
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SPECIALISED BANKS
These banks are established for specific purposes such as industrial development.
Example: SIDBI
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SMALL FINANCE BANKS
- Focus on micro industries, small farmers, and unorganised sector
- Promote financial inclusion through lending and deposit services
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PAYMENTS BANKS
- Accept deposits up to Rs 2 lakh per customer
- Cannot provide loans or credit cards
- Focus on payments and remittance services
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HISTORY OF BANKING IN INDIA
PRE-INDEPENDENCE PERIOD
- Earliest evidence of banking found in Vedic period in the form of loan deeds called rnalekhya
- First bank set up in Madras in 1683
- First joint stock bank: Bank of Bombay (1720)
- First presidency bank: Bank of Bengal (1806)
- First Indian owned bank: Allahabad Bank (1865)
- In 1921, presidency banks merged to form Imperial Bank of India
- Imperial Bank was nationalised in 1955 and renamed State Bank of India
Impact of Great Depression:
- Failure of many small banks
- RBI Act, 1934 enacted
- RBI established in 1935 to regulate banking sector
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POST-INDEPENDENCE EVOLUTION
- Banking Companies Act, 1949 enacted (later renamed Banking Regulation Act)
- State Bank of India nationalised in 1955
- Major bank nationalisation in 1969 (14 banks)
- Further nationalisation in 1980 (6 banks)
Objectives of nationalisation:
- Expand banking services in rural and semi-urban areas
- Promote priority sector lending
- Support socio-economic development
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BANKING REGULATION ACT
Powers of RBI:
- Issue banking licences
- Approve branch expansion
- Prescribe CRR and liquidity norms
- Regulate mergers and closures of banks
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SCHEDULED COMMERCIAL BANKS
Definition:
Banks listed in the Second Schedule of the RBI Act, 1934.
Conditions:
- Paid-up capital and reserves of at least Rs 5 lakh
- Eligible for RBI facilities
- Membership of clearing house
Types:
- Public Sector Banks
- Private Sector Banks
- Foreign Banks
- Regional Rural Banks
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PUBLIC SECTOR BANKS
- State Bank of India and its associates
- Nationalised banks
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PRIVATE SECTOR BANKS
- Established as per Narasimham Committee recommendations
- Examples: ICICI Bank, HDFC Bank
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FOREIGN BANKS
- Entered India mainly after 1991 reforms
- Can operate through branches or subsidiaries
- Allowed limited shareholding in Indian banks
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REGIONAL RURAL BANKS
Establishment:
- Set up under RRB Act, 1976
Ownership:
- Central Government: 50%
- State Government: 15%
- Sponsor Bank: 35%
Functions:
- Rural banking services
- Government scheme implementation
- Para-banking services
Regulation:
- RBI as regulator
- NABARD as supervisory authority
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COOPERATIVE BANK STRUCTURE
URBAN COOPERATIVE BANKS:
- Banking functions regulated by RBI
- Management regulated by Registrar of Cooperative Societies
RURAL COOPERATIVE BANKS:
Short-term structure:
- State Cooperative Banks
- District Central Cooperative Banks
- Primary Agricultural Credit Societies
Long-term structure:
- State Cooperative Agriculture and Rural Development Banks
- Primary Cooperative Agriculture and Rural Development Banks
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TYPES OF BANK ACCOUNTS
Savings Account:
- Low interest
- No withdrawal penalty
Current Account:
- Mainly for businesses
- No interest
- Overdraft facility
Fixed Deposit:
- Higher interest
- Penalty on premature withdrawal
- Can be used as collateral
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TYPES OF DEPOSITS
Demand Deposits:
- Withdrawable on demand
- Low interest
Fixed Deposits:
- Tenure from 7 days to 10 years
Recurring Deposits:
- Fixed monthly deposits
- Encourages savings habit
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BASIC SAVINGS BANK DEPOSIT ACCOUNT (BSBDA)
Features:
- No minimum balance
- For economically weaker sections
- Jan Dhan accounts fall under this
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NARASIMHAM COMMITTEE ON BANKING REFORMS
NARASIMHAM COMMITTEE I (1991):
- Four-tier banking structure
- Reduction in SLR
- Capital adequacy norms
- Deregulation of interest rates
- Asset classification reforms
NARASIMHAM COMMITTEE II (1998):
- Bank mergers
- Narrow banking
- Greater autonomy
- Review of banking laws
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PRIVATISATION OF BANKS
- UTI Bank became Axis Bank in 2007
- IDBI Bank acquired by LIC in 2018
- PJ Nayak Committee recommended Banking Investment Company
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PRIVATE BANK LICENSING
- On-tap licensing introduced in 2016
- Continuous application process
- Strict eligibility norms
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PAYMENTS BANKS
Features:
- Deposit limit Rs 2 lakh
- No lending
- Investment of deposits largely in government securities
- Minimum capital Rs 100 crore
- Capital adequacy ratio 15%
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SMALL FINANCE BANKS
Features:
- Focus on priority sector
- 75% lending to priority sector
- 50% loans below Rs 25 lakh
- Minimum capital Rs 200 crore
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BASEL NORMS
Basel norms are global regulatory standards for banking stability framed by Basel Committee on Banking Supervision.
CAMELS framework:
- Capital adequacy
- Asset quality
- Management
- Earnings
- Liquidity
- System control
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KEY BASEL TERMS
Risk Weighted Assets:
- Assets adjusted for credit risk
CRAR:
- Measure of bank safety
Tier I Capital:
- Core capital
Additional Tier I:
- Perpetual bonds
Tier II Capital:
- Supplementary capital
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LIQUIDITY NORMS
Liquidity Coverage Ratio:
- High quality liquid assets for 30-day stress
Net Stable Funding Ratio:
- Stable funding for long-term assets
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BASEL I, II AND III
Basel I:
- Focus on credit risk
- Minimum capital 8%
Basel II:
- Risk sensitivity and disclosure
- Implemented in India from 2009
Basel III:
- Post-2008 crisis reforms
- Higher capital and liquidity standards
- Capital conservation buffer
- Counter-cyclical buffer
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BASEL III AND INDIA
- RBI mandates higher capital norms
- Minimum CAR: 9%
- CET 1 requirement higher than Basel III
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DOMESTICALLY SYSTEMICALLY IMPORTANT BANKS (D-SIBs)
- Banks too big to fail
- Classified into buckets
- Additional capital requirements
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COINAGE ACT AND RBI
- Government issues coins and Rs 1 note
- RBI circulates currency as agent
- RBI manages public debt
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RBI BALANCE SHEET
Liabilities:
- Currency notes and coins
Assets:
- Foreign securities
- Gold
- Government bonds
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TYPES OF BORROWERS
Prime Borrower:
- High repayment capacity
Subprime Borrower:
- Low repayment capacity
Zombie Lending:
- Weak banks lending to stressed borrowers
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NON-PERFORMING ASSETS (NPAs)
Standard Assets:
- Regular repayment
NPA:
- Interest or principal overdue beyond 90 days
Gross NPA:
- Total NPA value
Net NPA:
- Gross NPA minus provisioning
Substandard Asset:
- NPA up to 12 months
Doubtful Asset:
- Substandard beyond 12 months
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STRESSED ASSETS
Includes:
- NPAs
- Restructured loans
- Written-off loans
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RBI MECHANISMS FOR NPA RESOLUTION
Rectification:
- Asset quality review
Restructuring:
- Loan restructuring schemes
Recovery:
- SARFAESI Act, 2002
- Insolvency and Bankruptcy Code, 2016
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Subject: Economics
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