Banking General Awareness History of Banking History of Banking - Its Evolution and Development

INTRODUCTION

Banking history dates back to 2000 years which involved grain loans to farmers and traders who carried goods between cities in Mesopotamia and Babylonia. Later/ it was in ancient Greece and Roman Empire, who added two important innovations: acceptance of deposits and changed money.

 

Bank - A financial institution which accepts different forms of deposits and lends them to the prospective borrowers as well as allows the depositors to withdraw their money from the accounts by cheque is a bank.

 

BANKING IN ANCIENT INDIA

Archaeological evidences in India suggest that references to banking and regulations were even found in our scriptures and ancient texts. Debt is even mentioned in our Vedic literature. The Vedas (2000-1400 BCE) are earliest Indian texts to mention the concept of usury whereby the lender lends money at excessive rate of interest. It was also found to contain Loan deed forms which are called rnapatra or rnalekhya which also contained the details related to name of the debtor & creditor, amount of loan, rate of interest, condition of repayment and time of repayment.

Later the concept of Modern day banking system was conceptualised by the people of Italy under the name Banco.

The period of Mauryan era (321-185 BCE) saw an instrument called adesha, which was an order on a banker directing him to pay the sum on the note to a third person, which corresponds to the definition of a modern bill of exchange.

 

Indigenous Banking:

The indigenous bankers lend money; act as money changers and finance internal trade of India by means of hundis or internal bills of exchange. It is certainly one of the oldest banking systems which have been functioning for centuries. However, with the coming of the British, its decline started. Despite the fast growth of modern commercial banks, however, the indigenous banks continue to hold a prominent position in the Indian money market even in the present times. It includes shroffs, seths, mahajans, chettis, etc.

 

Defects of Indigenous Banking

(i) Indigenous banking is unorganized and does not sensitize the need and working of the different sectors of the economy, including banking sector.

(ii) They only do business for trade and commerce and work on commission basis resulting in trade risk in their financial business.

(iii) They did not distinguish between short term and long term finance purposes.

(iv) Methods of accounting were based on local practices and hence could not match with modern methods of financial accounting.

(v) Many of the indigenous bankers charged very high rate of interest.

 

BANKING IN MEDIEVAL ERA

The use of loan deeds continued into the Mughal era and were called dastawez.

Two types of loan deeds have been recorded.

Dastawez-e-indultalab - payable on demand

Dastawez-e-miadi - payable after a stipulated time.

The use of payment orders by royal treasuries/ called barattes have also been recorded. The evolution of hundis, a type of credit instrument,, also occurred during this period and remained in use.

 

BANKING IN MODERN ERA

The period of coming of Europeans (15th Century) till Indian independence in 1947, laid the real foundation of Modem Banking system in India. This period was also characterized by the   presence of a large number of banks (more than 600).

 

First Bank of India

Modem banking system commenced in India with the foundation of Bank of Hindustan in Calcutta (now Kolkata) in 1770 by M/s Alexander and co, which ceased to operate in 1832.

 

Presidency Banks

The British East India Company had setup various trading posts and factories in India. They needed funds to fulfil their Administrative, Economic needs and also Military ambitions. So they setup Three Presidency Banks under the charters from the British East India Company.

 

IMPERIAL BANKS
Date	Bank Name	Features
June 2,1806	Bank of Calcutta in Calcutta (Now Kolkata)	• 1st Presidency Bank in collaboration with British East India Company and Government of Bengal. • Total capital was ` 50 lakh of which ` 10 lakh was share of East India Company. • On January 2, 1809, Bank of Calcutta was renamed as Bank of Bengal. • At Cawnpore in 1862, amalgamation of Dacca Bank (established in 1846) with the Bank of Bengal.
April 15,1840	Bank of Bombay in Bombay (Now Mumbai)	• 2nd Presidency Bank • It undertook all the normal activities which a commercial bank was expected to undertake.
July 1, 1843	Bank of Madras in Madras (Now Chennai)	• 3rd Presidency Bank • Established through the amalgamation of a number of existing regional banks and headquartered in Madras.
January 27, 1921	Imperial Bank of India - was formed by amalgamation of the Bank of Bengal, the Bank of Bombay and the Bank of Madras. • It was a private entity till that time. • In 1955, this Imperial Bank of India was nationalised and renamed as State Bank of India. • Thus, State Bank of India is the oldest bank of India among the banks that exist today.

 

Joint Stock Banks

A Bank that has many shareholders is called as joint stock Bank. In 1860, concept of limited liability was introduced in India leading to the establishment of Joint Stock Banks. Indian joint stock banks were generally undercapitalized and lacked the experience and maturity to compete with the presidency.

 

In 1863, the oldest Joint stock Bank called as Bank of Upper India was established which became defunct in 1913. On April 24, 1865 a group of British founded Allahabad Bank in Allahabad. The Bank is considered as one of the oldest joint stock bank which is still working and also one of the oldest public sector banks in India.

 

Other Notable Banks (Still Operating):

1865	Allahabad Bank	·      One of the oldest public sector banks in India still functioning in India.
1895	Punjab National Bank	·      Established in Lahore in Punjab province by Lala Lajpat Rai, Babu Purshotam Lal Tandon, S. Dayal Singh and others. ·      It was the first bank purely managed by Indians. ·      It was established by Indian nationalist people
1911	Central Bank of India,	·      First Indian commercial bank wholly owned and managed by Indians. ·      The bank also known as the First Truly Swadeshi bank of India. ·      It was founded by Sir Sorabji Pochkhanawala and its First Chairman was Sir Pherozeshah Mehta.

 

Other Notable Banks (Now defunct):

In 1839, Indian merchants established a Bank called Union Bank but it failed within a decade.

The Bank of Upper India established in 1863, was the oldest joint stock bank of India but the bank failed in 1913.

In 1881, Oudh Commercial Bank was established at Faizabad. It was the first Bank of India with Limited Liability to be managed by Indian Board. After Independence, in 1958 this bank failed.

 

First Indian Bank to open a Foreign Branch was Bank of India founded as private entity in 1906 - London in 1946

 

RESERVE BANK OF INDIA

In 1926, Royal Commission on Indian Currency and Finance popularly known as the Hilton-Young Commission submitted its report and made recommendations to the British Government of India for creation of a central Bank.

 

Objectives:

• To separate the control of currency and credit from the government
• To augment banking facilities throughout the country

Finally, on April 1, 1935, Reserve Bank of India was established via the RBI Act of 1934 as the banker to the central government.

 

Post-Independence Period

After independence, in order to serve the economy better, the All India Rural Credit Survey Committee was set up by RBI. This Committee recommended that Imperial Bank of India be taken over and with it are merged / integrated former state-owned and state- associate banks.

The Government of India (GOI) adopted planned economic development which basically aimed at social ownership of the means of production. However, commercial banks were in the private sector those days. It was considered that banks were controlled by business houses and thus failed in catering to the credit needs of poor sections such as cottage industry, village industry, farmers, craft men, etc. In 1950-51, there were 430 commercial banks.

 

1951	India implemented its First Five Year Plan for overall development of the nation
1955	State Bank' of India (SBI) was  constituted in 1955 under the State  Bank of India Act (1955)
1959	State Bank of India (subsidiary bank) Act was passed, enabling the SBI to take over five major former state-   associate banks as its subsidiaries. These were - • State Bank of Patiala • State Bank of Hyderabad • State Bank of Travancore • State Bank of Bikaner & Jaipur • State Bank of Mysore After creating a subsidiary of SBI, arrangement made was that 55 per cent of the capital will be owned by the SBI and rest 45 per cent remain with old shareholders. However, this arrangement also saw some weaknesses like reduced bank profitability, weak capital base, and banks getting / burdened with large amounts of bad loans (unrecovered loans).
1966	• Cooperative Banks came within the regulations of the RBI. • Rupee was devaluated for the first time.
1969	Nationalization of 14 Banks happened.
1973	Foreign Exchange Regulation act was amended and exchange control was strengthened
1974	Priority Sector Advance Targets started getting fixed
1975	In 1975 five Regional Rural banks were established on 2.10.1975 through an Ordinance. The ordinance was replaced by Regional Rural Banks Act, 1976, with the main objective to extend banking facilities to the un-banked rural areas along with commercial banks and cooperative banks.

 

NATIONALISATION OF BANKS

The Government of India had some social objectives like ensuring social welfare, credit availability to the needy sectors such as Agriculture, Small and Village Industries, checking private monopolies, Reducing Regional Imbalance and so on. These commercial banks failed helping the government in attaining these objectives. Thus, the government decided to nationalize 14 major commercial banks on 19th July, 1969. All commercial banks with a deposit base over `50 crores were nationalized.

 

List of 14 Banks Nationalized in 1969 (1st Phase)

1. Central Bank of India

2. Bank of Maharashtra

3. Dena Bank

4. Punjab National Bank

5. Syndicate Bank

6. Canara Bank

7. Indian Bank

8. Indian Overseas Bank

9. Bank of Baroda

10. Union Bank

11. Allahabad Bank

12. United Bank of India

13. UCO Bank

14. Bank of India

 

2nd Phase of Nationalization

This process was followed again in 1980 when another lot of six banks were nationalized under Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980. The stated reason for the nationalization was to give the government more control of credit delivery. With the second phase of nationalisation, the Government of India controlled around 91% of the banking business in India.

The 6 banks nationalized in 1980 are as follows:

 

List of 6 Banks Nationalized in 1980 (2nd Phase)

1. Punjab & Sind Bank

2. Oriental Bank of Commerce

3. New bank of India (now merged with Punjab National Bank)

4. Vijay Bank

5. Andhra Bank

6. Corporation Bank

 

Impact of Nationalisation

After the two major phases of nationalization in India, the 80% of the banking sector came under the public sector / government ownership. The nationalization of banks imparted major impetus to branch expansion in un-banked, rural and semi-urban areas, which in turn resulted in huge deposit mobilization, thereby giving boost to the overall savings rate of the economy. It also resulted in scaling up of lending to agriculture and its allied sectors. After the nationalization of banks, the branches of the public sector banks in India rose to approximately 800 per cent in deposits, and advances took a huge jump by 11,000 per cent. Government ownership gave the public implicit faith and immense confidence in the sustainability of public sector banks.

 

Demerits of Nationalisation of Banks in India

Though the nationalisation of commercial banks was undertaken with tall objectives, in many senses it failed in attaining them. In fact it converted many of the banking institutions in the loss making entities. The reasons were obvious lethargic working, lack of accountability, lack of profit motive, political interference, etc. Under this backdrop, it is necessary to have a critical look at the whole process of nationalisation in the period after nationalisation.

The major limitations of the nationalisation of banks in India are:-

Inadequate banking facilities: Even though banks have spread across the country, still many parts of the country are unbanked. Especially in the backward states such as the Uttar Pradesh, Bihar, Madhya Pradesh, Chhattisgarh and north-eastern states of India.

 

Limited resources mobilized and allocated: The resources mobilized after the nationalisation is not sufficient if we consider the needs of the Indian economy. Sometimes the deposits mobilized are enough but the resource allocation is not as per the expansions.

 

Lowered efficiency and profits: After nationalisation, banks fell into the government sector. Many times political forces pressurized them. Banking was not done on professional and ethical grounds. It resulted in lower efficiency and poor profitability of banks.

 

Increased expenditure: Due to huge expansion in a branch network, large staff administrative expenditure, trade union struggle, etc. banks expenditure increased to a dangerous levels.

 

Political and Administrative Interference: Many public sector banks badly suffered due to the political interference. It was seen in arranging loan melas. It ultimately resulted in huge non-performing assets (NPA) of these banks and inefficiency.

 

Apart from these, there are certain other limitations as well, such as weak infrastructure, poor competitiveness, etc.

But after Economic Reforms of 1991, the Indian banking industry has entered into the new horizons of competitiveness, efficiency and productivity. It has made Indian banks more vibrant and professional organizations, removing the bad days of bank nationalisation.

 

BANKING REFORM PHASE

Commercial banks in India have traditionally focused on meeting the short-term financial needs of industry, trade and agriculture but long term financial needs were left for other agencies or government to meet. There was no coordination between commercial banks and long term lending organizations. Hence when one was available the other was not available.

 

As such with the growing need for long term funds for financing industrial projects. Government established Industrial Development Bank of India (IDBI) in 1964 to help industrial sector with long term financial resources to boost industrial growth.

 

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 economy. This resulted in greater involvement of the state in different segments of the economy including banking and finance. The major steps to regulate banking included:

 

The Reserve Bank of India, India's central banking authority, was established in April 1935, but was nationalised on 1 January 1949 under the terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. 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." 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.

 

One important feature of the reforms of the 1990s was the permission to open new private sector banks. Following this decision, new banks such as ICICI Bank, HDFC Bank, IDBI Bank, Development Credit Bank (DCB), Kotak Mahindra Bank, Indusind Bank, Yes Bank, UTI Bank (now Axis bank), Bandhan Bank, RBL(Ratnakar Bank Limited) were set up.

 

From 1991 onwards till today, banking industry has seen the reforms in terms of their management and business policies. The main aim of reforms is to create a vibrant financial sector that is efficient, competitive and responsive to the needs of the economy and the people at large.

 

Main focus of the reforms was: Strengthening of financial institutions, and integration of domestic financial system with global system of banking and economic system.

 

Policies were made in such a way that it could provide banks with:

(a) Greater flexibility in banking operations (b) Greater accountability to shareholders, and

(c) Greater control over bank functions, and

(d) Safety through prudential norms and supervision.

The government commenced a comprehensive reform process in the financial system in 1992-93 after the recommendations of a high level committee on Financial System (CFS) was set up on August 14, 1991 to examine all aspects relating to structure, organisation, function and procedures of the financial system— based on its recommendations, a comprehensive reform of the banking system was introduced in the fiscal 1992-93.

In December 1997 the government did set up another committee on the banking sector reforms under the chairmanship of M. Narasimham. The objective of the committee was-

"To review the progress of banking sector reforms to date and chart a programme of financial sector reforms necessary to strengthen India's financial system and make it internationally competitive"

The Narasimham Committee-II (popularly called by the Government of India) handed over its reports in April 1998 which included the following major suggestions:

 

(i) Need for a stronger banking system for which mergers of the PSBs and the financial institutions (AlFIs) were suggested— stronger banks and the DFIs (development financial institutions, i.e., AlFIs) to be merged while weaker and unviable ones to be closed.

(ii) A 3-tier banking structure was suggested after mergers:

(a) Tier-1 to have 2 to 3 banks of international orientation;

(b) Tier-2 to have 8 to 10 banks of national orientation; and

(c) Tier-3 to have large number of local banks.

(iii) Higher norms of Capital-to-Risk— Weighted Adequacy Ratio (CRAR) suggested— increased to 10 per cent.

(iv) Budgetary recapitalisation of the PSBs is not viable and should be abandoned.

(v) Legal framework of loan recovery should be strengthened (the government passed the SARFAESI (Act, 2002).

(vi) Net NPAs for all banks suggested to be cut down to below 3 per cent by 2000 and 3 per cent by 2002.

(vii) Rationalisation of branches and staffs of the PSBs suggested.

(viii) Licencing to new private banks (domestic as well as foreign) was suggested to continue with.

(ix) Banks' boards should be depoliticized under RBI supervision.