Money and Banking

History of Indian Banking and Reforms. Modern banking in India began in the 18th Century, with the founding of the English Agency Houses in Calcutta and Bombay. Then in the first half of the 19th Century three presidency banks viz. Bank of Bengal (1806), Bank of Bombay (1840) and Bank of Madras (1843) were established. After the introduction of limited liability in 1860, private and foreign banks entered into the market. The beginning of 20th century saw the introduction of Joint stock banks. In 1921, the three presidency banks were merged to create Imperial Bank of India. Imperial Bank of India performed all the normal functions which a commercial bank was expected to perform. In the absence of any Central Bank in India till 1935, the Imperial Bank of India also performed a number of functions which are normally carried out by a Central Bank.

At the time of Independence in 1947, the banking system in India was fairly well developed 

with over 600 commercial banks operating in the country. However soon after 

independence, the view that the banks from the colonial heritage were biased in favour of 

working capital loans for trade and large firms and against extending credit to small scale 

enterprises, agriculture and commoners, gained prominence. To ensure better coverage of 

banking needs of larger parts of economy and the rural constituencies, the Government of 

India nationalized the Imperial bank which was established in 1921 and transformed it into 

the State Bank of India (SBI) with effect from 1955.

Despite the progress in 1950s and 1960s, it was felt that the creation of SBI was not far 

reaching enough since the banking needs of small-scale industries and the agricultural 

structure was still not covered sufficiently. This was partially due to the existing close ties 

commercial and industry houses maintained with the established commercial banks, which 

give them an advantage in obtaining credit. Additionally, there was a perception that banks 

should play a more prominent rule in India’s development strategy by mobilizing resources 

for sectors that were seen as crucial for economic expansion. As a result, the policy of social 

control over banks was announced. Its aim was to cause changes in the management and 

distribution of credit by commercial banks.

The post war development strategy was in many ways a socialist one and Indian 

Government felt that banks in private hands didn’t lend enough to those who needed it 

most. In July 1969, the Government nationalized all 14 banks whose nation wise deposits 

were greater than Rs. 50 crores. The bank nationalization in July 1969 with its objective to 

‘Control the commanding heights of the economy and to meet progressively the needs of 

development of the economy in conformity with the national policy and objectives’ served to 

intensify the social objective of ensuring that financial intermediaries fully met the credit 

demands for the productive purposes. Two significant purposes of nationalization were 

rapid branch expansion and channelling of credit according to the plan priorities.

The Indian banking system progressed by leaps and bounds after Nationalization and bank 

branches expanded rapidly both in rural and urban areas.

In the period of 1969 to 1991, bank branches increased a lot but banks remained 

unprofitable, inefficient, and unsound owing to their poor lending strategy and lack of 

internal risk management under government ownership.The major factors that contributed to deteriorating bank performance included: 

 Too stringent regulatory requirements of CRR and SLR that required banks to hold a 

certain amount in government and eligible securities 

 Low interest rates charged on government bonds as compared to commercial advances 

 Directed and concessional lending 

 Administrated interest rates and 

 Lack of competition.

The Government of India felt towards the end of 1997 that the time was ripe to look ahead 

and chart the reforms necessary in the years ahead so that India’s banking system can 

become stronger and better equipped to compete effectively in a fast-changing international 

economic environment. Another committee specifically called Committee on banking Sector 

Reforms was accordingly constituted in 1997 under the chairmanship of the same M. 

Narasimhan (Narasimhan Committee - II). Following were the major recommendations of 

Narasimhan Committee - 

 Autonomy in Banking: Greater autonomy was proposed for the public sector banks in 

order for them to function with equivalent professionalism as their international 

counterparts. For this the panel recommended that recruitment procedures, training 

and remuneration policies of public sector banks be brought in line with the best-

market-practices. Secondly, the committee recommended GOI equity in nationalized 

banks be reduced to 33% for increased autonomy.

 Stronger Banking System: The committee recommended for merger of large Indian 

banks to make them strong enough for supporting international trade.

 Capital Adequacy Norms: In order to improve the inherent strength of the Indian 

banking system the committee recommended that the Government should raise the 

prescribed capital adequacy norms. This would also improve their risk-taking ability.

 Reform in the role of RBI: The committee recommended that the Reserve Bank as a 

regulator of the monetary system should not be the owner of a bank in view of a 

possible conflict of interest. Pursuant to the recommendations, RBI has transferred its 

shareholdings of public banks like SBI, NHB and NABARD to government of India.