The Evolution of Banking in India

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The banking system is considered almost as old as civilization and has existed in varied forms. Before we deep-dive into the evolution of banking in India, let’s take a look at the banking scene in the world. Here’s a short video that captures the evolutionary process of banking, with a few pre-historic and mythological elements thrown in as a homage to our curious and imaginative ancestors.

The banking system of a country upholds its economic development. Considering the economic condition of people, the need for financial services, and the advancements in technology that followed, the Indian banking industry has gone through major transformations over the past five centuries. 

 

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It’s interesting to track the history of banking in India. 

TImeline of the Indian banking industry

Let’s take a look at the evolution of banking in India from the time the first bank was established in India to the current mobile banking era–what happened in between. The history of banking in India can be broadly classified as:

  1. Pre-independence Phase (1770-1947)
  2. Post-independence Phase (1947-till date): To understand this phase better, we’ll break it down further into:
    1. Pre-nationalisation Phase (1947-1969)
    2. Post-nationalisation Phase (1969-1991)
    3. Liberalisation Phase (1991-till date)

Let’s deep dive into each one of these eras.

The Pre-independence Phase (1770-1947)

The organized banking sector in India dates back to more than a century before independence when the Bank of Hindustan–the first bank of India was established in 1770 in the then Indian capital, Calcutta. It failed in due course and was liquidated in 1832. Subsequently, several banks like General Bank of India (1786-1791), and the Oudh Commercial Bank (1881-1958) established during the pre-independence era didn’t last very long either.

The Bank of Bengal, Bank of Bombay, and Bank of Madras established by the East India Company during the early to mid-1800s–together known as the Presidential Banks were later merged in 1921 to form the Imperial Bank of India. It was later nationalised in 1955 and named the State Bank of India (SBI). In 1959, the SBI was given charge of 7 subsidiary banks making it India’s largest Public Sector Bank (PSB).

Subsidiary banks of SBI

As many as 600 banks were founded during this period. While many major banks failed to work due to a lack of proper management skills, machines, and technology which led to time-consuming processes and human errors leaving the Indian account holders fraud-prone. A few banks survived the test of time and exist even today:

Pre-independence banks currently operating in India

Between 1906 and 1911, inspired by the Swadeshi movement several local businessmen and political figures established banks for the Indian community. Many of these are still operational.

During the First World War (1914-1918), till the end of the Second World War (1939-1945), and until two years later until the independence of India, the banking system witnessed turbulent times leading to the collapse of a large number of banks.

The Post-independence Phase (1947-1991)

Post-independence, the evolution of the Indian banking system continued when the Government of India (GOI) adopted the approach of a mixed economy in 1948 with an extensive intervention into markets to strengthen the economy. The Reserve Bank of India (est. 1935) was nationalised in 1949 and it was empowered to regulate, control, and inspect the banks in India.

Nationalisation in 1969

In the 1960s the RBI had become a large employer and the Indian banking industry had begun playing an important role in supporting economic development. Yet, except for SBI, most banks continued to be run by private entities.

The Government of India issued the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969 and nationalized the 14 largest commercial banks at that time.

Nationalization in 1969
Nationalisation in 1980

The second wave of Nationalisation followed in 1980 with 6 more commercial banks.

Nationalisation in 1980
Reasons for nationalisation of banks in India

The nationalisation of Indian banks was a major development in the course of the evolving Indian banking industry. To understand the impact it caused and played a major role in shaping the industry, let’s deep-dive into the scenarios that led to it. There was a dire need to:

  • Promote the economic development of the country
  • Develop confidence in the banking system of India
  • Prevent the concentration of economic power in the hands of a select few
  • Improve the efficiency of the banking industry
  • Create a socio-economic balance
  • Mobilize the national savings and channel them into productive purposes
  • Sectors such as exports, agriculture, and small-scale industries were lagging behind
  • Serve the large masses of the rural population.
Positive impacts of nationalisation

The nationalisation of the Indian banks was a major milestone in the evolution of banking in India that played a major role in guiding its future course. Currently, there are 19 nationalised banks in India. Here’re a few benefits that made a difference:

  • Better outreach: The penetration of banks increased when branches were opened in the remotest corners of the country
  • Increased savings: With the opening of new branches, since more people had access to banks, the average domestic savings increased twofold
  • Surged public deposits: The increased reach of banks helped small industries, agriculture, and the export sector grow leading to a proportionate increase in public deposits
  • Increased efficiency: The added accountability led to improved efficiency and increased public confidence
  • Empowered small scale industries (SSIs): The SSIs received a boost resulting in considerable growth in the economy
  • Provided employment opportunities: RBI, post its nationalisation had already set a precedence of becoming one of the largest employers. This continued further with more banks following the lead.
  • Improved agricultural sector: Marginal farmers could receive credit from banks at economic rates which gave a massive boost to India’s agricultural sector
Liberalisation in 1991

In 1991, the GOI adopted economic liberalisation that brought about a massive change in its economic policies to enhance the participation of private and international investments. The RBI approved 10 private banks:

Foreign banks that opened in 1993 following liberalisation in India

In a few years, Kotak Mahindra Bank (2001), Yes Bank (2004), IDFC (2015), and Bandhan (2015) banks joined the league.

Positive impacts of liberalisation

Here’s how liberalisation revolutionised the Indian banking picture:

  • Revitalized the banking sector and led to the rapid and strong growth of government banks, private banks and foreign banks
  • A modern and tech-based approach started setting into traditional banks
  • Paved path for Payments banks
  • Small finance banks came into existence
  • The digitalisation of bank transactions and operations became a norm
  • Foreign banks such as Bank of America, Citibank, HSBC, etc. set up branches in India. Currently, there are 46 international banks in the country.
  • Nationalisation of banks took a pause, instead, the Indian banking sector witnessed several mergers in the public sector banks in the following years:
Bank mergers in India post-liberalisation
Different types of banks in India

So far, we discussed at length the evolution of the Indian banking system. To sum it up, your bank is bound to fall in one of the above categories. Let’s take a closer look at the key features of these banks:

Commercial banks

Commercial banks function solely to generate profits by accepting deposits and giving out loans. They can be owned by the government or by private entities and are grouped into 4 categories:

  • Public sector banks: These are the banks in which the GOI owns the majority of the stock
  • Private sector banks: In these banks, a private entity, an individual, or a group of people owns the majority of the stock
  • Regional rural banks: These are unique commercial banks that lend at a reduced rate for agriculture purposes in the rural areas to boost the rural economy
  • Foreign banks: These are banks that are headquartered overseas with branches in India
Co-operative banks

Co-operative banks were set up to enhance social welfare by providing short-term low-interest loans to agriculture and related industries. Co-operative banks are financial entities established on a co-operative basis and belong to their members. This means that the customers of a co-operative bank are also its owners. These can be further categorised as:

  • Rural co-operative banks: These mainly finance agriculture-based activities including farming, dairy, fish culture, along with small scale industries and self-employment activities
  • Urban co-operative banks: These banks finance people for self-employment, industries, small scale units and home finance.
Specialized banks

Between 1982-1990, the government established several specialised banking institutions with specific requirements of sectors like agriculture, foreign trade, housing, and small scale industries. And the evolution of financial services in India began with noteworthy financial institutions like:

  • NABARD (National Bank for Agriculture and Rural Development,1982) to support agricultural activities
  • EXIM Bank (Export-Import Bank of India, 1982) to promote export and import
  • National Housing Bank (1988) to finance housing projects
  • SIDBI (Small Industries Development Bank of India, 1990) to fund small-scale industries
Payments banks

Payments banks is a newer genre of banks conceptualised by the RBI in 2014 to operate on a smaller scale with minimal credit risk. The main objective was to advance financial inclusion by offering banking and financial services to the unbanked and underbanked segments.

Payments banks come with certain limitations like they can accept deposits of only up to 2 lakh per customer and can’t issue loans or credit cards. However, they can offer both current and savings accounts, issue ATM and debit cards, and offer net banking and mobile banking. The convenience of making online payments through mobile apps marked the evolution of e-banking in India.

India currently has 6 Payments banks:

Payments banks in India
Small finance banks

Small finance banks were granted approval by the RBI in 2016 to extend financial inclusion to people who are not served by the regular banks. It’s a niche category of banks that provides savings facilities and credit to small businesses, small and marginal farmers, and micro and small industries through modern technology at low-cost operations.

Here’re some of the operational small finance banks in India:

Small finance banks in India
Digital banking in India

Digital banking basically means digitization of all banking activities that were traditionally available only by visiting a bank branch–opening an account, transferring funds, making payments, etc.

In 2016, the GOI launched the UPI (Unified Payment Interface) System and BHIM by the National Payments Corporation of India (NPCI) setting off the digital payments revolution with what we popularly know as mobile banking.

Following the advancements in technology, several fintechs in the country have taken digital banking to the next level in partnership with traditional banks to bring an array of financial services.

In 2021, Niti Aayog proposed setting up full-stack ‘digital banks’, which will entirely rely on the internet to offer their services and not on their physical branches. This is expected to revolutionize digital banking in India.

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