Evolution of Banking in India

Section 5 of the Banking Regulation Act, 1949 provides the definition of Banking as:

“Banking is the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise”

The financial sector of a country is very critical for the development of the economy, and banks are the most important institutions of the financial sector. Banks act as intermediaries between savers and investors. On the one hand, they collect funds from those who have surplus money and on the other they provide these funds to the investors that are the entrepreneur, firms and the companies.[1]

Chiefly, a Bank performs two primary functions, that is:

  1. Acceptance of deposits, and
  2. Lending of funds

The secondary functions of a Bank include agency and general utility functions such as underwriting of shares, dealing in foreign exchange, social welfare programs, etc.

Development of Banking in India

The development of banking happened in three phases in India:

  1. The Pre-Independence Phase (before 1947)
  2. The Post-Independence Phase (1947 – 1991)
  3.  The Phase after LPG (after 1991)

1. Pre-Independence Phase (before 1947)

The year 1770 marks the beginning of banking in India with the foundation of Bank of Hindustan at the then Capital, Calcutta. Thereafter, three presidency banks Bank of Bengal, Bank of Bombay and Bank of Madras were established in the 19th Century under the charter of the British East India Company. In 1935, these banks were merged and formulated into a single branch called the Imperial Bank of India which was later renamed as the State Bank of India.

The Swadeshi movement primarily provided a great thrust for the Indian Banks to be established in 1905. With the financing of foreign trade in the hands of foreign exchange banks, owned outside India, especially in the United Kingdom, the best medium for bank investment, namely trade bills, was not available to others. It was difficult for the Indian banks to get into this business. Further, the three Presidency Banks enjoyed the advantages that accrued from the use of the Government balances and Government business. In consequence, the Indian banks were “forced to seek profits on a class of business which appeared to be outside the sphere of operation of properly managed banks”[2]

In the year 1935, the Reserve Bank of India was established by the recommendation of the Hilton Young Commission. This phase was a failure because most of the banks were small in size and therefore, the confidence of the public was low and people were majorly engaged with unorganized moneylenders and indigenous bankers.

2. Post-Independence Phase (1947 – 1991)

This phase observed Nationalization of the Banking process where a large number of institutions emerged for providing finance to different sectors of the economy. The number of branches rose significantly between 1951 and 1967 but in spite of the increase in number of branches, the rural population could not avail banking services on account of concentration of branches in urban areas and a high credit flow directed to the industrial sector.

The Nationalization of Banks was carried on first in 1969 by Ms. Indira Gandhi. 14 banks were Nationalized in 1969 bringing 84 percent of the total number of branches under government control. Thereafter, in 1980, the Government of India carried out a second round of nationalization, placing 6 private banks under government control leaving approximately 10 percent of bank branches in private hands.

Nationalization had a great impact on the Banking process as whole in India. There was an improvement in the sector as the confidence of people in Banks was boosted and therefore, agriculture and other small industries started getting funds which led to economic growth. Moreover, there was also an increase in the number of branches in the rural areas.

3. Post LPG Phase (1992 – present)

In 1991, in order to improve financial stability and profitability of Public Sector Banks, the Government of India set up a committee under the chairmanship of Shri. M. Narasimham. The Narsimham committee gave its recommendation to allow the entry of private sector players into the Indian Banking system.

A number of small private banks were granted license by the government due to the policies of liberalization in the early 1990s. These banks included ICICI, Axis Bank, IndusInd Bank, etc. Due to Globalization more and more banks were receiving the benefits and also expanding at an incredible faster pace. Publicly owned Banks handled more than 80% of the Banking Business in India and rest in the hand of private sector Banks.[3]

In 1998, the Committee again recommended the entry of more private players following which there was an emergence of two new Banks – Kotak Mahindra Bank and Yes Bank. In 2013, there was yet another round of licensing where IDFC and Bandhan bank emerged.

Yet another phase was marked in the Indian Banking history when the new government in power in 2014 where Prime Minister of India Mr. Narendra Modi launched a new scheme for Financial Inclusion, the ‘Pradhan Mantri Jan Dhan Yojana’. Run by Department of Financial Services, Ministry of Finance opened 1.5 crores banks accounts on the inauguration day. By 10th January 2015, 11.5 crores accounts were opened with around Rs.8698 crores rupees deposited under the scheme. There was also an option for opening a bank account with zero balance. Physical as well as virtual expansion of banking through mobile banking, internet banking, tele banking, and bio metric and mobile ATMs took place in last decade and has gained a momentum in last few years.

A Brief Overview of the Evolution of Banking Laws in India

  • The Reserve Bank of India Act, 1934: It was enacted to constitute RBI with objectives to regulate the issue of bank notes, keeping reserves to ensure stability in the monetary system and operate the nation’s currency and credit system effectively. The Act mainly covers the constitution, powers and functions of the RBI. The Act does not deal with the regulation of the banking system except for Section 42 which is related to regulation of cash reserve ratio and Section 18 which mainly talks about direct discounting of bills of exchange and promissory notes.[4]
  • The Negotiable Instrument Act, 1881:- To manage the law identifying bills of exchange and promissory notes, the Legislature of India authorized Act 6 of 1840. In spite of the fact that Negotiable Instruments Bills was acquainted in 1866 with systematize the law in regards to negotiable instruments, it turned into a Demonstration in 1881 with a few changes.
  • The Banking Regulation Act, 1949: The Indian Companies Act, 1913 contained provisions regarding the regulation of banks but it was felt to be deficient and was later changed to the Banking Companies Act, 1949. This was eventually changed to the Banking Regulation Act, 1949. It was passed to merge and correct the law relating to money keeping and to accommodate the idea of exchange which can be carried on by the banks in India.
  • SARFAESI Act, 2002: The SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act allows banks and other financial institutions to auction residential or commercial properties for the purpose of recovering loans. It allows the banks to auction properties of the borrowers when they fail to repay their loan amount. Thus, the SARFAESI Act of 2002 enables the bank to reduce their non-performing assets by way of measures of recovery and reconstruction.

Conclusion

The Banking Sector in India has emerged into an efficient and far reaching sector of the economy and still continues to grow. With changing times, our banks have flourished and there have been dynamic reforms as the years went supported by the emergence of new technology. In the present scenario, the banking sector remains in yet another phase of transformation, the consequences of which are due. Nevertheless, the banking sector continues to contribute its share in the growth of the Indian Economy.


[1] Najmi Shabbir, Historical Evolution of Banking in India, IJMSS (2014) Vol.02 Issue-02

[2] Dhruba Narayan Ghosh, Banking Policy in India, Bombay, Allied, 1979

[3] Prashant Singh Rajput, Evolution Of Banking System In India, JCIL (2018) Vol. 4 Issue 3

[4] ‘All you need to know about Banking law and practise in India’ available at: https://blog.ipleaders.in/banking-law-india/

Riya Sharma from Vivekananda Institute of Professional Studies

“A law student, eager to look for opportunities to learn and grow. I believe in taking life as it comes

EDITOR: SANSKRITI SOOD

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