Banking History

Banking in India forms the base for the economic development of the country. Major changes in the banking system and management have been seen over the years with the advancement in technology, considering the needs of people. The History of Banking in India dates back to before India got independence in 1947 and is a key topic in terms of questions asked in various Government exams. In this article, we shall discuss in detail the evolution of the banking sector in India.

What is Banking?

Banking is defined as the management and administration of money, credit, banking transactions and other financial transactions of a corporation or a business firm. It allows you to take out loans at low interest rates and provides funds for investments that can help in increasing your profits. Banks are also called as commercial banks which are operating on a financial basis. They offer services such as banking products, managing deposits of individuals and providing loans to companies, individuals and other organizations.

Banking in Pre-Independence Period

The first bank of the country was known as Bank of Hindustan, started in South India.  The British colonial government took over control of the banking sector and set up the banking system in India on the pattern of those formed in Britain. The Banking Companies Act 1909 was passed to regulate banking business in India.

The Pre-independence Era saw a fair degree of growth in the Indian economy and this also brought an increase in banking activities, which were mainly confined to areas such as trade finance, small scale industries and trading, bullion trading and imports/ exports. At the time of independence, the economy was in a good state and many reforms were carried out. The Indian Banks Act,1935 brought all banks under one umbrella and the Reserve Bank of India was formed.

The Banking system in India after Independence

The Reserve Bank of India took control of all banking activities in India. The Reserve Bank set up a statutory bank (Government of India) to deal with trade finance activities and bank deposits. In 1956, the Banking Companies Act gave rise to new commercial banks (private sector) and also provided for setting up new regional rural banks. However, in 1959, most private commercial banks were nationalized as banks (State Owned Banks) through Banking Regulation Act 1960.

The Banking sector of India witnessed a phenomenal growth between the years 1950 and 2009. In terms of deposits, deposits nearly doubled from Rs. 112 billion in 1970 to Rs. 251 billion in 1980 and the Indian banking system was able to lend nearly 30% of the GDP on average during that period. In financial year 1980-81, total loans increased by 50%, resulting in a growth rate of 6% for public sector banks (PSBs) and 13% for private sector banks (PSBs). During this period, 59 state-owned banks were formed under the controls of Public Sector Banks, whereas 10 new private bank branches were opened.

Impact of Nationalization on Banking Sector

Nationalization of banks has brought considerable changes in the banking sector. A wide range of banking activities were transferred to public sector banks. The Private Sector Banks (PSBs) dominated the private sector until nationalization, but with the advent of nationalization, their role was restricted to commercial banking and non-banking financial services such as life insurance, mutual funds and other securities.

Nationalization raised a number of issues

Nationalized banks extend more direct credit than modern commercial banks, but are primarily engaged in rediscounting commercial paper. Thus, they have little opportunity for making profits from market interest rate spreads or from dealing in securities held on their own account. As a result of nationalization, banks have found it difficult to secure capital against deposits. Profits are not distributed among shareholders and institutional investors who hold banking shares.

Since the nature of the bank is changed from a commercial financial institution to an agricultural development bank, stock portfolio management has been given priority over individual savings accounts. Thus, public sector banks have lost their most important source of long-term income — interest on saving deposits.

Banking Sector in Liberalisation Period (1991-Till Date)

In 1991, economic liberalisation was introduced. With this change, the banking sector was opened to private sector as well. This gave a boost to the growth of banking market and also saw several new commercial banks being formed. The globalization of economy brought about widespread use of technology in all sectors and also in banking sector, which increased competition between banks. In the process, many domestic banks were able to expand their business through foreign funding from foreign institutions along with domestic capital.

However, with the introduction of Mobile Banking (now called as Internet Banking) in 2002 which allowed people to deposit and withdraw funds from their bank account by using mobile phones or personal digital assistants such as Blackberries, it is expected that this will transform Indian banking system drastically.

Conclusion

The banking sector in India is growing faster than countries like China, Germany, and the UK. However, this growth has been very challenging for the Indian banking system. The major reason for this growth is the presence of large number of private players who have done well in this sector as compared to Indian public sector banks. Moreover, we can also see from present scenario that private banks are also putting pressure on public sector banks through increasing lending rates and non-sufficient deductions from savings deposits. Further, research needs to be done on the technologies such as Internet Banking etc. which will make the banking system more efficient and more profitable.