April 26, 2023

The Evolution of Banking in India

Banking in India has evolved remarkably, , undergoing significant changes in its structure, operations and services, over the years. From its humble beginnings in the colonial era to the modern digitally-connected banks with a glocal footprint, the Indian banking sector is vital to the nation’s economy. We’ll glance at the journey of banking in India, through public and private sector banks including:
  • Significance of banks in the Indian economy
  • Different types of banks
  • Key milestones in the evolution of public and private sector banks

Significance of banks in the Indian economy

The significance of the banking sector to the Indian economy can be understood from the seven aspects listed below.
  • Financial Intermediation: At its core, banking refers to the process of financial intermediation. Banks are intermediaries between depositors and borrowers. Banks mobilise savings from individuals and businesses through various deposit products such as savings accounts, fixed deposits and recurring deposits.
  • Safety of deposits: Among the foundations of banking, is the assurance of safety for depositors. The Reserve Bank of India (RBI), the central banking institution, regulates and supervises banks to maintain the stability of the financial system. The Deposit Insurance and Credit Guarantee Corporation (DICGC) provides deposit insurance in the unlikely event of a bank failure. The DICGC insures principal and interest up to a maximum amount of ₹5 lakh per account holder.
  • Credit and capital formation: Banks facilitate credit creation, which stimulates economic activity and capital formation. By extending loans to individuals, businesses, and industries, banks facilitate investment and entrepreneurship. Banks also provide financial support for various purposes, such as setting up a business, purchasing a home or funding an education. This credit creation mechanism helps enhance economic growth.
  • Payment and Settlement System: Banking includes a payment and settlement system that enables smooth transactions and commerce. From the issuance of cheques and demand drafts to the development of digital payment systems, such as Real-Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT) and Unified Payments Interface (UPI), banks ensure the secure transfer of funds between participants.
  • Financial inclusion: In recent years, banking has expanded its scope to focus on financial inclusion. The Government of India (GOI) and banks together have undertaken several initiatives to provide banking services to the unbanked and under-served sections of society. Schemes like the Pradhan Mantri Jan Dhan Yojana (PMJDY), Direct Benefit Transfer (DBT) and other microfinancing programs have helped include a marginalised population into the formal banking system.
  • Customer services: Banking experienced a paradigm shift with the integration of technology. This resulted in enhanced customer services and convenience. Internet banking, mobile banking and digital wallets completely changed the way in which individuals access and manage their finances. Most banks now offer a wide array of services, including: online account management, fund transfers, bill payments. and investment options. This enables convenience in financial transactions.
  • Corporate governance and regulatory compliance: Banks are expected to maintain high standards of governance, risk management and transparency. Regulatory bodies such as the RBI and Securities and Exchange Board of India (SEBI) monitor bank operations and mandate compliance with guidelines. This is done in order to safeguard the interests of depositors, investors and stakeholders.
Banking is the cornerstone of any financial system. A laser-sharp focus of the above listed aspects helps Indian banks foster economic growth and financial stability of individuals, businesses and consequently, the economy.

The evolution of banking in India - key milestones

Banking in India can be traced back to the early 19th century to the Presidency Banks that functioned during the British rule. These marked the beginning of formal banking in pre-independence India.
1806: The Bank of Bengal is established
1840: The Bank of Bombay is established
1843: The Bank of Madras is established
These three Presidency Banks primarily catered to European businesses and the colonial government.

Nationalisation and public sector banks

Post-independence, many reforms swept through the Indian banking sector. To consolidate the banking sector and establish a central banking authority, the Reserve Bank of India (RBI) was established in 1935 and nationalised in 1949. The RBI is India’s central bank, responsible for monetary policy, currency circulation and supervisory activities.
Another landmark moment was in 1969 when the GOI nationalised 14 major banks to enhance credit flow and promote economic development. The establishment of large public sector banks, such as State Bank of India (SBI), Punjab National Bank (PNB) and Bank of India (BOI) then helped expand banking across the country.

Expansion

The nationalisation of banks led to a significant expansion of banking services across India. New banking products and services were introduced, including savings accounts, fixed deposits, loans and remittance facilities.

Liberalisation and the entry of private banks

The 1990s witnessed another paradigm shift in Indian banking with economic liberalisation opening up the sector to private players. The move aimed at bringing efficiency and modernisation to the banking landscape. This marked the entry of private sector banks including ICICI Bank, HDFC Bank and Axis Bank, among others.

Digital transformation

21st century technologies again completely changed banking in India, largely for the better. Banks began online banking services, giving customers the convenience of “anytime-anywhere” banking.
The introduction of Electronic Funds Transfer (EFT) systems like National Electronic Funds Transfer (NEFT) and Real-Time Gross Settlement (RTGS) enabled swift and secure fund transfers. Automated teller machines (ATMs) made banking services more accessible. The Aadhaar biometric identification system facilitated the opening process for a bank account via a simplified KYC (know your customer) procedure.
Smartphones and the internet led to mobile banking applications and digital wallets. Customers could access financial services through their mobile devices.

Financial inclusion and government Initiatives

The growth of digital banking catalysed financial inclusion which aimed to bring the unbanked population into the formal banking system. The ideal was for every household to have access to a bank account and financial services. This is being achieved through a mix of policy initiatives like the Jan Dhan Yojana and the efforts of the banking sector. This era also saw the growth of microfinance institutions (MFIs) whose target customers were the unbanked like daily wage labourers, micro farmers etc.
Additionally, the National Bank for Agriculture and Rural Development (NABARD) was alsoinstrumental in driving rural development through initiatives such as microfinance and farmer producer organisations. NABARD's efforts have helped promote sustainable agriculture and catalysed rural prosperity.

Regulatory reforms

To enhance stability and efficiency of the banking sector, various regulatory reforms were introduced. The RBI is tasked with maintaining financial stability. The implementation of Basel norms (Basel I, II, and III) strengthened capital adequacy requirements and risk management practices. The Insolvency and Bankruptcy Code (IBC) in 2016 addressed the issue of non-performing assets (NPAs) and provided a framework for the timely resolution of stressed assets.

Conclusion

Banking in India has constantly evolved to cater to the dynamic needs of a growing economy. The evolution has seen many transitions, but has resulted in a transformative and technology-driven ecosystem with a strong focus oninclusive economic growth.

Disclaimer

The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.

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