(IGP) GS Paper 1 – Economic & Social Development – “Banking System In India”

Integrated Guidance Programme of
General Studies for IAS (Pre)

Subject – Economic and Social Development
Chapter – Banking System In India

Commercial Bank

  • A commercial bank is a type of financial intermediary. It is a financial
    intermediary because it mediates between the savers and borrowers. It does so by
    accepting deposits from the public and lending money to businesses and
    consumers. Its primary liabilities are deposits and primary assets are Ioan and
    bonds.
  • The commercial banking system in, India consists of
    public sector banks; private sector banks and cooperative banks.

Public Sector Banks

They are owned by the Government- either totally or as a majority stake holder.

  • State Bank of India and its five associate banks called the State Bank group
  • 19 nationalised banks
  • Regional Rural Banks mainly sponsored by Public Sector Banks

Development Banks

Development Banks are those financial institutions which provide long term
capital for industries and agriculture: Industrial Finance Corporation of India
(IFCI), Industrial Development Bank of India (IDBI), Industrial Credit and
Investment Corporation of India (ICICI) that was merged with the ICICI Bank in
2000, Industrial Investment Bank of India (JIBI), Small Industries Development
Bank of India (SIDBI), National Bank for Agriculture and Rural Development (NABARD),

Bank Nationalization

In 1969 and again in 1980, Government nationalized private
commercial banking units for channelizing banking capital into rural sectors;
checking misuse of banking capital for speculative purposes; to shift from
‘class banking’ to ‘mass banking’ (social banking); and to make banking into an
integral part of the planning process of socio economic development in the
country. Today, no other developing country can boast of a banking system
comparable to India’s in terms of geographic coverage, operational capabilities,
range of services and technological prowess.

Cooperative Banks

  • Co-operative Banks are organised and managed on the
    principle of co-operation, self-help, and mutual help. They function with
    the rule of “one member, one vote” and on “no profit, no loss” basis.
    Co-operative banks as a principle do not pursue the goal of profit
    maximisation.

  • Co-operative bank performs all the main banking functions
    of deposit mobilisation, supply of credit and provision of remittance
    facilities.

Narasimhan Committee

Banking sector reforms in India were conducted on the basis of Narasimhan
Committee reports I and 11(1991 and 1998 respectively). The recommendations of
Narsimham Committee 1991 are:

  • No more nationalization
  • create a level playing field between the public sector, private sector
    and foreign sector banks.
  • select few banks like SBI for global operations.
  • reduce Statutory Liquidity Ratio (SLR) as that will leave more resources
    with banks for lending.
  • reduce Cash Reserve Ratio (CRR) to increase lendable resources of banks.
  • rationalize and better target priority sector lending as a sizeable
    portion of it is wasted and also much of it turning into nonperforming
    asset.
  • introduce prudential norms for better risk management and transparency
    in operations
  • deregulate interest rates

NPAs (Non Performing Assets)

  • Non-performing assets are those accounts of borrowers who
    have defaulted in payment of interest or installment of the principal or
    both for more than 90 days.

  • NPAs are largely a fallout of banks’ credit appraisal
    system, monitoring of end usage of funds and recovery procedures. It also
    depends on the overall economic environment, the business cycle and the
    legal environment for recovery of defaulted loans. Wilful default, priority
    sector problems among the poor etc are also responsible.

The following are the RBI guidelines for NPAs classification
and provisioning:

  • Sub Standard Assets — These are those accounts which have
    been classified as NPAs for a period less than or equal to 18 months.

  • Doubtful Assets — These are those accounts which have
    remained as NPAs for a period exceeding 18 months.

  • Loss Assets — In other words, such an asset is considered
    uncollectable and of such little value that its continuance as a bankable
    asset is not warranted although there may be some salvage or recovery value.
    But a loss asset has not been written off, wholly or partly.

SARFAESI Act 2002

To expedite recovery of loans and bring down the
non-performing asset level of the Indian banking and financial sector, the
government in 2002 made a new law that promises to make it much easier to
recover bad loans from willful defaulters. Called the Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002
(SARFAESI), the law has given unprecedented powers to banks, financial
institutions and asset reconstruction securitization companies to take over
management control of a loan defaulter or even capture its assets.

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Basel Norms

  • Banks lend to different types of borrowers and each carries its own risk. They
    lend the deposits of public as well as money raised from the market- equity and
    debt.
  • The intermediation activity exposes the bank to a variety of risks. Cases of big
    banks collapsing due to their inability to sustain the risk exposures are
    readily available.
  • Therefore, banks have to-keep aside a certain percentage of capital as security
    against the risk of non-recovery.
  • Basel committee provided the norms called Basel norms to tackle the risk.

In 1988 Basel committee gave the first set of norms (Basel I) and presently
the Basel II norms are being complied with by Indian banks as follows:

  • by 2008- foreign banks and Indian banks with overseas operation and
  • by 2009 other Indian banks except local area banks and RRBs.

Shadow Banks

NBFCS are largely referred to as shadow banking system or the
shadow financial system. They have become the major financial intermediaries. As
seen in the note on NBFCS elsewhere, shadow institutions do not accept demand
deposits and therefore are not subject to the same regulations.

Financial Inclusion

  • Many people, particularly those living on low incomes, cannot access
    mainstream financial products such as bank accounts and low cost loans.
  • This financial exclusion forces them to borrow from the moneylenders at
    high cost. Therefore, financial inclusion has been the goal of governments’
    policy since late sixties.

Banking Stability Index

It has been devised by the RBI in 2009. This index is simple average of five
sub indices chosen for banking stability map that RBI has constructed. Banking
Stability Map has used five key risk dimensions like operational efficiency,
asset- quality, liquidity and profitability. These are based on capital adequacy
ratio, cost-to-income ratio, nonperforming loans to total loans ratio, liquid
assets to total assets ratio and net profit to total assets ratio.

How Indian Banks Survived the Global Crisis

Even though many banks failed and some survived on huge bailouts in the west due
to the global financial crisis, Indian banking is almost unscathed for the
following reasons.

  • Public sector banks- 27- dominate.
  • FDI is 74% in private-banks but voting rights are only 10%.
  • We adopted capital account convertibility in a measured manner.
  • RET has been conservative and regulated the banks well. Banks were not
    allowed to invest in risky instruments like credit default swaps (CDS).
  • Basel norms, SER and CRR levels were well maintained.
  • Prudential norms also saved the Indian banks from recklessness.

Recommendations of the Rangarajan Panel on Financial inclusion

The Committee on Financial Inclusion headed by Shri C. Rangarajan, submitted its
report in 2008 and recommended that the semi-urban and rural branches of
commercial banks and Regional Rural Banks may set for themselves a minimum
target of covering 250 new cultivator and non-cultivator households per branch
per annum with an emphasis on financing marginal farmers and poor non-
cultivator households for achieving financial inclusion.

Base Rate

It is the minimum rate of interest that a bank is allowed to charge from its
customers. Unless mandated by the government, RBI rule stipulates that no bank
can offer loans at a rate lower than BR to any of its customers.

ULIP

United Linked Invest Plans (ULIPs) are the insurance products in which payment
is made partly for premium (insurance) and rest of it invested in the capital
market like a Mutual Fund investment it led to jurisdictional disputes between
SEBI and IRDA. SEBI says that a huge amount of ULIP is invested in stock market.
Government promulgated an ordinance to set up a mechanism to regulate such
jurisdictional disputes.

Swabhimaan 2011

  • The government has launched ‘Swabhimaan’-a programme to ensure banking
    facilities in habitation with a population in excess of 2,000, by March
    2012. The programme will use various models and technologies, including
    branchless banking through business correspondents. The government has
    decided to pay banks Rs 140 for every no frills account they open as part of
    the financial inclusion plan.
  • The initiative would enable small and marginal farmers obtain credit at
    lower rates from banks and other financial institutions. This would insulate
    them from exploitation of the money lenders.

FSDC (Financial Stability & Development Council)

Financial Stability and Development Council is apex-level body constituted by
government of India on an Act of Parliament in 2010. The idea to create such a
super regulatory body was first mooted by Raghuram Rajan Committee and Deepak
Parekh Committee. The recent global economic meltdown has put pressure on
governments and institutions across globe to regulate the economic assets. This
council is seen as an India’s initiative to be better prepared to prevent such
incidents in future. The new body envisages to strengthen and institutionalise
the mechanism of maintaining financial stability, financial sector development.

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