1

CHAPTER -1
INTRODUCTION

The development of 'Banking' is evolutionary in nature. There is no
single answer to the question of what is banking, because a bank performs a
multitude of functions and services which cannot be comprehended into a
single definition. For a common man, a bank means a storehouse of money,
for a businessman it is an institution of finance and for a worker it may be a
depository for his savings.
It may be explained in brief as "Banking is what a bank does." But it is
not clear enough to understand the subject in full. The Oxford Dictionary
defines a bank as "an establishment for the custody of money which it pays
out on a customer's order ". But this definition is also not enough, because it
considers the deposit accepting and repayment functions only. The meaning
of the bank can be understood only by its functions just as a tree-is, known by
its fruits. As any other subjects, it has its own origin, growth and development.
Let us briefly trace the evolution of Banking.


1.1 EVOLUTION OF BANK

It is interesting to trace the origin of the word 'bank' in the modern
sense, to the German word "Banck" which means, heap or mound or joint
stock fund. From this, the Italian word "Banco" meaning heap of money was
coined.
Some people have the opinion that the word "bank" is derived from
the French words " bancus" or "banque" which means a 'bench' . Initially, the
bankers, the J ews in Lombardy, transacted their business on benches in the
market place and the bench resembled the banking counter. If a banker failed,
his' banque' (bench) was broken up by the people, hence the Word "bankrupt"
has come. In simple term, bankrupt means a person who has lost all his
Money, wealth or financial resources.


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Thus, the origin of the word bank can be traced as follows:

Banck German (J oint stock fund)

Banco Italian (Heap of money)

Bancus/ French (Bench/chest a place where valuables are kept)

Bank English (Common meaning prevalent today, i.e., as an institution
accepting money as deposit for lending
In India, the Banking Regulation Act, 1949, under which banks are
regulated by the Reserve Bank of India, defines a banking company and
banking as under:

1.2 DEFINITION OF BANK
Section 5(b) defines bank as accepting for the purpose of lending or
investment of deposits of money from the public, repayable on demand or
otherwise and withdrawal by cheque, draft, and order or otherwise. Section
49A of the Act prohibits any institution other than a banking company to
accept deposit money from public withdrawal by cheque. Students may note
that the essence of banking business is the function of accepting deposits
from public with the facility of withdrawal of money by cheque. In other words,
the combination of the functions of acceptance of public deposits and
withdrawal of the money by cheques by any institution cannot be performed
without the approval of Reserve Bank.
A bank is an institution which deals in money and credit. Thus, bank
is an intermediary which handles other people's money both for their
advantage and to its own profit. But bank is not merely a trader in money but
also an important manufacturer of money. In other words, a bank is a factory
of credit.


3

Let us see the definitions of bank and banking, given by various
authorities.
Crowther defines a bank as, "one that collects money from those
who have it to spare or who are saving it out of their income and lends the
money so collected to those who require it".
Dr. L. Hart, says that the bankers are "one who in the ordinary
course of business ; honours cheques drawn upon him by persons from and
for whom he receives money on current accounts".
Sir Jhon Paget says that, "no person or body corporate otherwise
can be a banker who does not, (i) take deposit accounts, (ii) take current
accounts, (iii) issue and pay cheques, and (iv) collect cheques, for his
customers".
Sir Ki nley, "A bank is an establishment which makes to individuals
such advances of money as may be required and to which individuals entrust
money when not required by them for use".
Prof. Sayers says that "Banks are not merely purveyors of money
but also in an important sense, manufacturers of money".
Although the above definitions have described the meaning of bank,
none of them precisely defined, 'Banking' incorporating its entire functions.
However, an attempt has been made in Section 5(1) (b&c) of the Banking
Regulation Act, 1949 to define 'Banking' and 'Banking Company'.
According to Section 5(1) (b), "Banking means accepting for the
purpose of lending or investment, of deposits of money from the public,
repayable on demand or otherwise and withdrawal by cheques, draft, order or
otherwise".
Section 5(1)(c) defines banking company as, "any company which
transacts the business of banking in India".





4

SCHEDULED BANKS
Scheduled Banks are those banks which are listed in the Second
Schedule to the Reserve Bank of India Act, 1934. The Banks satisfying the
following conditions are only included in the Second Schedule.
(a) That the Banks paid up capital plus free reserves are not less than Rs. 5.00
lakh, and
(b) That the affairs of the Bank are not conducted to the detrimental interest of
the depositors.
The Reserve Bank also has powers to deschedule a bank, when the
abovementioned conditions are not satisfied. It may be noted presently, the
RBI has prescribed a minimum capital of Rs. 100 crores for starting a new
commercial bank.

DEFINITION OF BANKING COMPANY
The Banking Regulation Act, 1949 defines a banking company as a
company which transacts the business of banking in India [Section 5(c)].
The development of 'Banking' is evolutionary in nature. There is no single
answer to the question of what is banking, because a bank performs a
multitude of functions and services which cannot be comprehended into a
single definition. For a common man, a bank means a storehouse of money,
for a businessman it is an institution of finance and for a worker it may be a
depository for his savings.
It may be explained in brief as "Banking is what a bank does." But it is
not clear enough to understand the subject in full. The Oxford Dictionary
defines a bank as "an establishment for the custody of money which it pays
out on a customer's order ". But this definition is also not enough, because it
considers the deposit accepting and repayment functions only. The meaning
of the bank can be understood only by its functions just as a tree-is, known by
its fruits. As any other subjects, it has its own origin, growth and development.
Let us briefly trace the evolution of Banking.



5

1.3. ORIGIN OF BANKING IN INDIA:
Banking in India is indeed as old as Himalayas. But, the banking
functions became an effective force only after the first decade of 20th century.
Banking is an ancient business in India with some of oldest references in the
writings of Manu. Bankers played an important role during the Mogul period.
During the early part of the East India Company era, agency houses were
involved in banking. Modern banking (i.e. in the form of joint-stock companies)
may be said to have had its beginnings in India as far back as in 1786, with
the establishment of the General Bank of India. Three Presidency Banks were
established in Bengal, Bombay and Madras in the early 19th century. These
banks functioned independently for about a century before they were merged
into the newly formed Imperial Bank of India in 1921. The Imperial Bank was
the forerunner of the present State Bank of India. The latter was established
under the State Bank of India Act of 1955 and took over the ImperialBank.

The Swadeshi movement witnessed the birth of several indigenous banks
including the Punjab National Bank, Bank of Baroda and Canara Bank. In
1935, the Reserve Bank of India was established under the Reserve Bank of
India Act as the central bank of India. In spite of all these developments,
independent India inherited a rather weak banking and financial system
marked by a multitude of small and unstable private banks whose failures
frequently robbed their middle-class depositors of their lifes savings. After
independence, the Reserve Bank of India was nationalized in 1949 and given
wide powers in the area of bank supervision through the Banking Companies
Act (later renamed Banking Regulations Act). The nationalization of the
Imperial bank through the formation of the State Bank of India and the
subsequent acquisition of the state owned banks in eight princely states by
the State Bank of India in 1959 made the government the dominant player in
the banking industry. In keeping with the increasingly socialistic leanings of
the Indian government,
To understand the history of modern banking in India, one has to refer to the
"English Agency Houses" established by the East India Company. These
Agency Houses were basically trading firms and carrying on banking business


6

as part of their main business. Because of this dual functions and lack of their
own capital (Agency Houses depend entirely on deposits for their capital
requirements) they failed and vanished from the scene during the third
decade of 18th century, The East India Company laid the foundations for
modern banking in the first-half of the 19
th
century with the establishment of
the following three banks:
(i) Bank of Bengal in 1809
(ii) Bank of Bombay in 1840
(iii) Bank of Madras in 1843
These banks are also known as "Presidency Banks" and they
functioned well as independent units.
During the last part of 19th century and early phase of 20th century,
the 'Swadeshi Movement' induced the establishment of a number of banks
with Indian Management.
For example, Punjab National Bank Ltd. in 1895, The Bank of India
Ltd. in 1906, The Canara Bank Ltd. in 1906, The Indian Bank Ltd. in 1907,
The Bank of Baroda Ltd. in 1908, The Central Bank of India Ltd. in 1911 and
many other banks were established on the same line. But most of the weak
banks went bankrupt due to wrong policy decisions taken by the management
and due to severe banking crisis during 1913-18, the period of World War I.
However, the stronger and well managed banks like those mentioned above
survived, the crisis.
In 1920, the "Imperial Bank of India Act" was passed for
amalgamating the three Presidency Banks. As such, the 'Imperial Bank of
India' was established in 1921. It was given power to hold government funds
and manage the Public debt. The branches of the bank were functioning as
clearing houses (Agency for effecting settlement of funds among banks).
However, it was not authorized to issue currency.
Even though the need for a Central Bank was felt in the 18th century,
it could be materialized only in the 20th century. On the basis of the
recommendations of the Banking Enquiry Committee, the Reserve Bank of


7

India Act was passed in 1934. Accordingly the Reserve Bank of India was
constituted in 1935 to regulate the issue of Bank notes, securing monetary
stability in India and to operate the currency and credit system of the country
to its economic development. Initially, it was constituted as a private
shareholders' bank with a fully paid up capital of Rs. 5 crores. . After
independence, there was a general attitude towards its nationalization. Thus,
the 'Reserve Bank of India' (Transferred to public ownership) Act was passed
in 1948. Accordingly, the entire Share Capital of the bank was acquired by the
Central Government from the private shareholders against compensation and
it was nationalised on J anuary 1, 1949.
In 1955, the 'State Bank of India Act' was passed. Accordingly the
'Imperial Bank' was nationalized and 'State Bank of India' emerged with the
objective of extension of banking facilities on a large scale, specifically in the
rural and semi-urban areas and for various other public purposes.
In 1959, the 'State Bank of India' (Subsidiary Banks) Act was passed
by which the public sector banking was further extended. The following banks
were made the subsidiaries of State Bank of India:
(i) The State Bank of Bikaner
(ii) The State Bank of J aipur
(iii) The State Bank of Indore
(iv) The State Bank of Mysore
(v) The State Bank of Patiala
(vi) The State Bank of Hyderabad
(vii) The State Bank of Saurashtra
(viii) The State Bank of Travancore
In 1963, the first two banks were amalgamated under the name of
"The State Bank of Bikaner and J aipur". In 1969, fourteen major Indian
commercial banks were nationalized. These banks are Allahabad Bank, Bank
of Baroda, Bank of India, Canara Bank, Central Bank of India, Dena Bank,
Indian Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank,


8

Union Bank of India, United Bank of India, United Commercial Bank and
Vijaya Bank. And in 1980 six more banks were nationalized. These banks
constitute the public sector banks while the other scheduled banks and non-
scheduled banks are in the private sector.
1.4. FEATURES OF BANKING:
From the views of above authorities, we can derive the following
basic characteristics of Banking:
(i) Dealing in money: The banks accept deposits from the public and advancing
them as loans to the needy people. The deposits may be of different types
current, fixed, saving etc. accounts. The deposits are accepted on various
terms and conditions.
(ii) Deposits must be withdraw able: The deposits (other than fixed deposits)
made by the public can be withdraw able by cheques, draft on otherwise, i.e.
the bank issue and pay cheques. The deposits are usually withdraw able on
demand.
(iii) Dealing with credit: The banks are the institutions that can create i.e., creation
of additional money for lending. Thus, creation of credit is the unique feature
of banking.
(iv) Commercial in nature: Since all the banking functions are carried on with the
aim of making profit, it is regarded as commercial institutions.
(v) Nature of agent: Besides the basic functions of accepting deposits and
lending money as loans, banks possess the character of an agent because of
its various agency services.

1.5. CLASSIFICATION OF BANKS :
Today is the age of specialization and we can find specialization in all
fields including banking. The banks have specialized in a particular line of
finance. Various types of banks have developed to suit the economic
development and requirements of the country. The principal banking
institutions of a country may be classified into following types:
(1) Central Banks


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(2) Commercial Banks
(3) Industrial Or Development Banks
(4) Exchange Banks (authorized dealers in foreign exchange)
(5) Co-operative Banks
(6) Land-mortgage Banks
(7) Indigenous Banks
(8) Savings Banks
(9) Supranational Banks
(10) International Banks
Central Banks: Central Bank is the bank of a country a nation. Its
main function is to issue currency known as Bank Notes. This bank acts as
the leader of the banking system and money market of the country by
regulating money and credit. These banks are the bankers to the government,
they are bankers banks and the ultimate custodian of a nations foreign
exchange reserves. The aim of the Central Bank is not to earn profit, but to
maintain price stability and to strive for economic development with all round
growth of the country.
Commercial Banks: A bank, which undertakes all kinds of ordinary
banking business, is called a commercial bank.
Industrial Banks or Financial Institutions: An Industrial Bank is
one which specializes by providing loans and fixed capital to industrial
concerns by subscribing to share and debenture issued by public companies.
Exchange Banks (Authorised Dealers in Foreign Exchange):
These types of banks are primarily engaged in transactions involving foreign
exchange. They deal in foreign bills of exchange import and export of bullion
and otherwise participate in the financing of foreign trade.
Co-operative Banks: They are organized on co-operative principles
of mutual help and assistance. They grant short-term loans to the
agriculturists for purchase of seeds, harvesting and for other cultivation
expenses. They accept money on deposit from and make loans to their
members at a low rate of interest.


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Land-mortgage Banks (Presently known as Agriculture and
Rural Development Banks): They are agriculture development banks. The
Land-mortgage banks supply long-term loans for a period up to 15 years for
development of land to improve agricultural yields. They grant loan for
permanent improvements in agricultural lands. The National Bank for
Agriculture and Rural Development (NABARD) was constituted by the
Government to promote rural development.
Indigenous Banks: The Central Banking Enquiry Commission
defined an indigenous banker as an individual or film accepting deposits and
dealing in indigenous lending of money to the needy. They form unorganized
part of the banking structure, i.e., these are unrecognized operators in
receiving deposits and lending money.
Savings Banks: These are institutions which collect the periodical
savings of the general public. Their main object is to promote thrift and saving
habits among the middle and lower income sections of the society.
Supranational Banks: Special Banks have been created to deal with
certain international financial matters. World Bank is otherwise known as
International Bank for Reconstruction and Development (IBRD) which gives
long-term loans to developing countries for their economic and agricultural
development. Asian Development Bank (ADB) is another Supranational Bank
which provides finance for the economic development of poor Asian countries.
International Banks: International Banks are those which are
operating in different countries. While, the registered office/head office is
situated in one country, they operate through their branches in other
countries. They specialize in Banking business pertaining to foreign trade like
opening of letters of credit, providing short-term finance in foreign currency,
issue of performance guarantee, arranging foreign currency credits, etc. They
are the main traders in International Currencies like US 'dollars', J apanese
'Yen', the new-born European Currency 'Euro', etc.
1.6. BANKING SYSTEM :
The structure of banking system differs from country to country
depending upon their economic conditions, political structure and financial


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system. Banks can be classified on the basis of volume of operations,
business pattern and areas of operations. They are termed as system of
banking. The commonly identified systems are,
1. Unit banking
2. Branch Banking
3. Correspondent Banking System
4. Group Banking
5. Chain Banking
6. Pure Banking
7. Mixed Banking
8. Relationship banking
9. Narrow Banking
10. Universal Banking
11. Retail Banking
12. Wholesale Banking
13. Private Banking:
Unit banking: Unit banking is originated and developed in U.S.A. In
this system, small independent banks are functioning in a limited area or in a
single town i.e., the business of each bank is confined to a single office, which
has no branch at all. It has its own board of directors and stockholders. It is
also called as "localized Banking".
Branch Banking: The Banking system of England originally offered
an example of the branch banking system, where each commercial bank has
a network of branches spread throughout the country.
Correspondent Banking: Correspondent banking system is
developed to remove the difficulties in unit banking system. It is the system
under which unit banks are linked with bigger banks. The big correspondent
banks are linked with still bigger banks in the financial centers. The smaller
banks deposit their cash reserve with bigger banks. The bigger banks with
whom such deposits are so made are called correspondent banks.
Therefore, correspondent banks are intermediaries through which all
unit banks are linked with bigger banks in financial centers. Through


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correspondent banking, a bank can carry-out business transactions in another
place where it does not have a branch.
Group Banking: Group Banking is the system in which two or more
independently incorporated banks are brought under the control of a holding
company. The holding company may or may not be a banking company.
Under group banking, the individual banks may be unit banks, or banks
operating branches or a combination of the two.
Chain Banking: Chain banking is a system of banking under which a
number of separately incorporated banks are brought under the common
control by a device other than holding company. This may be:
(a) Through some group of persons owning and controlling a number of
independent banks. (b) Each bank retains its separate identity. (c) Each one
carries out its operations without the intervention of any central organisation.
Pure Banking and Mixed Banking: On the basis of lending
operations of the bank, banking is classified into :
(a) Pure Banking
(b) Mixed Banking
(a) Pure Banking: Under pure Banking, the commercial banks give only
short-term loans to industry, trade and commerce. They specialize in short-
term finance only. This type Of banking is popular in U.K.
(b) Mixed Banking: Mixed banking is that system of banking under which the
commercial ban s perform the dual function of commercial banking and
investment banking, i.e., it combines deposit and lending activity with
investment banking. Commercial banks usually offer both short-term as well
as medium term loans. The German banking system is the best example of
mixed Banking.
Relati onshi p banking: Relationship banking refers to the efforts of a
bank to promote personal contacts and to keep continuous touch with
customers who are very valuable to the bank. In order to retain such profitable
accounts with the bank or to attract new accounts, it is necessary for the bank
to serve their needs by maintaining a close relationship with such customers.


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Narrow Banking: A bank may be concentrating only on collection of
deposits and lend or invest the money within a particular region or certain
chosen activity like investing the funds only in Government Securities. This
type of restricted minimum banking activity is referred to 'Narrow Banking.
Universal Banking: As Narrow Banking refers to restricted and
limited banking activity Universal Banking refers to broad-based and
comprehensive banking activities. Under this type of banking, a bank will deal
with working capital requirements as well as term loans for developmental
activities. They will be dealing with individual customers as well as big
corporate customers. They will have expanded lines of business activity
combining the functions of traditional deposit taking, modern financial
services, selling long-term saving products, insurance cover, investment
banking, etc.
Regional banking: In order to provide adequate and timely credits to
small borrowers in rural and semi-urban areas, Central Government set up
Regional Banks, known as Regional Rural Banks all over India jointly with
State Governments and some Commercial Banks. As they are permitted to
operate in particular region, it may help develop the regional economy.
Local Area Banks: With a view to bring about a competitive
environment and to overcome the deficiencies of Regional Banks,
Government has permitted establishment of a one type of regional banks in
rural and semi-urban centers under private sector known as Local Area
Banks.
Wholesal e Banking: Wholesale or corporate banking refers to
dealing with limited large-sized customers. Instead of maintaining thousands
of small accounts and incurring huge transaction costs, under wholesale
banking, the banks deal with
large customers and keep only large accounts. These are mainly corporate
customer.
Private Banking: Private or Personal Banking is banking with people
rich individuals instead of banking with corporate clients. Private or
Personal Banking attends to the need of individual customers, their


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preferences and the products or services needed by them. This may include
all round personal services like maintaining accounts, loans, foreign currency
requirements, investment guidance, etc.
Retail Banking: Retail banking is a major form of commercial
banking but mainly targeted to consumers rather than corporate clients. It is
the method of banks' approach to the customers for sale of their products.
The products are consumer-oriented like offering a car loan, home loan
facility, financial assistance for purchase of consumer durables, etc. Retail
banking therefore has large customer-base and hence, large number of
transactions with small values. It may therefore be cost ineffective in a highly
competitive environment. Most of the Rural and semi-urban branches of
banks, in fact, do retail banking. In the present day situation when lending to
corporate clients lead to credit risk and market risk, retail banking may
eliminate market risk. It is one of the reasons why many a wholesale bankers
like foreign banks also prefer to go for consumer financing albeit for
marginally higher net worth individual.

1.7 RATIONALE
We have seen the evolution and development of banking sector in
india and found that the Indian Banking system has undergone tremendous
changes since the nationalization of major commercial banks. Nowhere in the
history of the world, the banking system has grown in similar dimensions as in
India in the past 25 years. Following the two phases of nationalization, there has
been considerable increase in the number of bank offices, quantum of deposits
and advances and number of transactions. Simultaneously, the banking system
has also shifted its focus from Class Banking to Mass Banking from
Traditional Banking to Innovative Banking and from Asset-nexus lending to
Production-nexus lending. They have also done a commendable job in the
field of societal banking. These are, no doubt, great achievements of the
countrys banking system. But on the other side of the coin, it has to be
conceded that the Indian banking system today is confronted with many
problems. Deteriorating customer service in banks is a mater causing serious
concern. Due to increased social responsibilities and obligations and mounting


15

over dues, there has been considerable decline in the profitability of some of the
banks. Further, they are facing stiff competition not only from the non-banking
companies but also from the corporate giants in mobilizing deposits. The recent
stock and other financial scams which have raised some doubts about the
integrity of the banking system have also added fuel to fire.
Bank customers are becoming more choosy in their preferences. The
intense competition among banks, other financial institutions, and the corporate
sector and greater awareness among bank customers have resulted in a
buyers market for banking products/services. This has aggravated the problem
of fierce competition and now banks face difficulties in attracting clientele. The
broad thrust of reforms in the banking sector has been clear enough to ease
norms that have weighted down profitability in the banking system to introduce
greater competitiveness; and to introduce greater operational efficiency. In the
first category are included those measures such as reduction of SLR and
simplification of administered interest rate belong to the second category. The
third category envelops the new capital adequacy norms as well as norms of
income recognition, freedom to close non-viable branches, mergers and tapping
the capital market to augment banks resources base.
It is evident to note that the banking sector is moving towards a market
driven pattern wherein efficiency, profitability and customer orientation have
become the watchwords. The complexion of the banking sector has undergone
a significant change in terms of their overall attitude towards products, services,
technology etc. Suddenly, banks find themselves in a market where the buyer
has more options than ever before and the seller (i.e. bank) has to constantly
review his package of services to suit the customers expectations. If
deregulation of interest rates was one fact of change, another has been the
introduction of various new instruments like certificate of Deposits, Commercial
Paper Money Mutual Fund. These are supposed to help the corporate and
individual investors in a variety of ways.
1.8 SPREAD OF BANKING IN INDIA
The Indian banking system has done extremely well in the past 25
years. There has been a spectacular spread of banking with an increase in the


16

number of branches from 8,262 in J une, 1969 to 74,852 at the end of March,
2010. The population per branch has come down from 64,000 to 11,000 during
this period. There has been an impressive growth of rural branches, the number
rising from 1,833 in J une, 1969 to 55,379 at the end of March, 2010. The
number of semi urban branches has risen from 3,342 to 24,320 of urban
branches from 1,584 to 38,324 and or metropolitan branches from 1,503 to
18,929. The number of scheduled commercial banks has gone up from 73 to
381 during the period.
However, with the progress on various fronts, Indian banks had also
developed several weaknesses during the past nationalization period. The
deposit and lending rates were controlled, a large portion of bank resources was
steadily pre-empted through statutory liquidity ratio by way of low yielding
Government and other securities and high cash and reserve ratios. Banks have
had to operate under several constraints dictated by socio-economic objectives,
which have had a bearing of their profitability. These relate primarily to the rapid
and vast expansion of banking facilities with its associated costs, the allocation
of credit for priority needs and the element of class subsidization to asset
preferred sectors.
LIBERALIZATION
Liberalization (or liberalization) refers to a relaxation of previous government
restrictions, usually in areas of social or economic policy. In some contexts this
process or concept is often, but not always, referred to as deregulation. In the
arena of social policy it may refer to a relaxation of laws restricting. Most often,
the term is used to refer to economic liberalization, especially trade liberalization
or capital market liberalization.

LIBERALIZATION IN INDIAN BANKING SECTOR
Liberalization in Indian banking sector was begun since 1992, following the
Narsimham Committee Report (December 1991). The 1991 report of the
Narsimham Committee served as the basis for the initial banking sector reforms
.In the following years, reforms covered the areas of interest rate deregulation,
directed credit rules, statutory pre-exemptions and entry deregulation for both
domestic and foreign banks. The objective of banking sector reforms was in line


17

with the overall goals of the 1991 economic reforms of opening the economy,
giving a greater role to markets in setting prices and allocating resources, and
increasing the role of the private sector. The Narsimham Committee was first
set up in 1991 under the chairmanship of Mr. M. Narsimham who was 13th
governor of RBI. Only a few of its recommendations became banking reforms of
India and others were not at all considered. Because of this a second committee
was again set up in 1998.As far as recommendations regarding bank
restructuring, management freedom, strengthening the regulation are
concerned, the RBI has to play a major role.
1.9 BACKDROP OF REFORMS

Despite this commendable progress, serious problems have emerged
resulting in a decline in productivity and efficiency, and erosion of profitability
of the banking sector. While nationalization achieved the widening of the
banking industry in India, the task of deepening their services was still left
unattended. By the beginning of 1990, the social banking goals set for the
banking industry made most of the public sector banks unprofitable. The
Narsimham Committee attributed this state to: (a) directed investments (SLR
and CRR obligations), and (b) directed credit programmes (Priority sector
lending). By 1991 the administered interest rates have become highly
complex and rigid. Further, the inadequacy of capital in the banking system
was a cause for concern. Income recognition, asset classification and
provisioning were faulty. Since income was recognized on accrual basis, it
inflated profits. The balance sheets of banks did not therefore disclose the
true health of banks. Non-Performing Assets accumulated which has an
impact on income on the one hand and capital on the other. While the
quantitative restrictions on credit led to credit rationing for the private sector,
interest rate controls led to sub optional use of credit and low levels of
investment and growth. The resultant 'financial repression' led to the decline
in productivity and efficiency and erosion of profitability of the banking sector
in general.






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1.10 THEME OF THE STUDY

It is against the background of these circumstances, that the
development of a sound banking system was considered essential for the
future growth of the financial system. Financial sector reforms were initiated in
the country in 1992 with a view to improving the efficiency in the process of
financial intermediation, enhancing the effectiveness in the conduct of
monetary policy and creating conducive environment for the integration of
domestic financial sector with the global system
.The first phase of banking sector reforms was guided by the report of
the committee on the Financial System (presided over by M. Narsimham,
Governor of RBI), which was submitted to the Government in November
1991. The approach of the Committee was to ensure that the financial
services industry operates on the basis of operational flexibility and functional
autonomy with a view to enhancing efficiency, productivity and profitability of
the banking sector.

PROBLEMS IDENTIFIED BY THE NARASIMHAM COMMITTEE

i. Directed Investment Program : The committee objected to the system of
maintaining high liquid assets by commercial banks in the form of cash, gold
and unencumbered government securities. It is also known as the Statutory
Liquidity Ratio (SLR). In those days, in India, the SLR was as high as 38.5
percent. According to the M. Narasimham's Committee it was one of the
reasons for the poor profitability of banks. Similarly, the Cash Reserve Ratio-
(CRR) was as high as 15 percent. Taken together, banks needed to maintain
53.5 percent of their resources idle with theRBI. .
ii. Directed Credi t Program : Since nationalization the government has
encouraged the lending to agriculture and small-scale industries at a
confessional rate of interest. It is known as the directed credit programme.
The committee opined that these sectors have matured and thus do not need
such financial support. This directed credit programme was successful from
the government's point of view but it affected commercial banks in a bad
manner. Basically it deteriorated the quality of loan, resulted in a shift from the
security oriented loan to purpose oriented. Banks were given a huge target of


19

priority sector lending, etc. ultimately leading to profit erosion of banks..
iii. Interest Rate Structure : The committee found that the interest rate
structure and rate of interest in India are highly regulated and controlled by
the government. They also found that government used bank funds at a
cheap rate under the SLR. At the same time the government advocated the
philosophy of subsidized lending to certain sectors. The committee felt that
there was no need for interest subsidy. It made banks handicapped in terms
of building main strength and expanding credit supply.
iv. Additional Suggesti ons : Committee also suggested that the
determination of interest rate should be on grounds of market forces. It further
suggested minimizing
The slab of interest. Along with these major problem areas M. Narasimham's
Committee also found various inconsistencies regarding the banking system
inIndia.
The first phase of reforms have been well calibrated and timed to
ensure smooth transition of the system from a highly regulated regime with
administered interest rate structure, quantitative requirements and preemption
of a significant proportion of lendable resources for the priority sector and
government sectors (Statutory Liquidity Requirements) to a market-based
system. The gradual scaling down of cash reserves and statutory liquidity
requirements (SLR) has afforded flexibility to banks to manage their asset
portfolios in time. The implementation of prudential norms relating to income
recognition, asset classification and provisioning capital adequacy
requirements characterized the first phase of banking reforms.

The second generation of banking sector reforms was guided by the
report of the Committee on Banking Sector Reforms (again presided over by
M. Narasimham) 1998. The reform measures focused on strengthening the
foundations of the banking system, streamlining procedures, upgrading
technology and human resources development and further structural
changes.
The norms of BASEL I and BASEL II committee:
The Basel I framework was confined to the prescription of only minimum
capital requirements for banks, the Basel II framework expands this approach


20

not only to capture certain additional risks in the minimum capital ratio but
also includes two additional areas, viz. Supervisory Review Process and
Market Discipline through increased disclosure requirements for banks. Thus,
Basel II framework rests on the following three mutually- reinforcing pillars:

Pill ar 1: Minimum Capital Requirements prescribes a risk-sensitive
calculation of capital requirements that, for the first time, explicitly includes
operational risk along with market and credit risk.

Pill ar 2: Supervisory Review Process (SRP) envisages the establishment
of suitable risk management systems in banks and its review by the
supervisory authority.
Pill ar 3: Market Discipline seeks to achieve increased transparency
through expanded disclosure requirements for banks.
The process of implementing Basel II norms in India is being carried out in
phases. Phase I has been carried out for foreign banks operating in India and
Indian banks having operational presence outside India with effect from March
31,2008.
In phase II, all other scheduled commercial banks (except Local Area Banks
and RRBs) will have to adhere to Basel II guidelines by March 31, 2009. With
the deadline of March 31, 2009 for full implementation of Basel II norms fast
approaching, banks are looking to maintain a cushion in their respective
capital reserves. The minimum capital to risk-weighted asset ratio (CRAR) in
India is placed at 9%, one percentage point above the Basel II requirement.
All the banks have their Capital to Risk Weighted Assets Ratio (CRAR) above
the stipulated requirement of Basel guidelines (8%) and RBI guidelines (9%).
As per Basel II norms, Indian banks should maintain tier I capital of at least
6%.
The Government of India has emphasized that public sector banks should
maintain CRAR of 12%. For this, it announced measures to re-capitalize most
of the public sector banks, as these banks cannot dilute stake further, as the
Government is required to maintain a stake of minimum 51% in these banks.


21

1.11 NEED FOR THE STUDY

A sea change has taken place in the banking environment since the
initiation of reform process in 1992-93. The period of almost two decades
witnessed remarkable changes in perceptions, policies and practices of
banks. In the light of sweeping changes that have taken place in banking
policies and practices during the last nineteen years of reform period, it is
thought appropriate to evaluate the impact of reform measures on the
efficiency, profitability and overall performance of banks vis-a-vis bank groups
in the public and private sector since 1992-93 and also to make a comparative
analysis of performance of bank groups in both quantitative and qualitative
aspects.
Though recently a large number of studies evaluating the performance
of commercial banks in the reform period have come up, yet certain important
aspects remain untouched. These studies by and large confined to economic
aspects of their performance i.e., profits alone and socio-economic
dimensions of their working are altogether ignored. Moreover, in most of these
studies, analysis is passed upon very limited number of indicators, limited
number of years and for limited banks and bank groups. Not even a single
study seems to cover sufficiently large time span after the initiation of reforms
by taking the required number of indicators and incorporating all the public
and private sector banks and bank groups. Therefore against this
background, it is thought desirable to take up a comprehensive study
evaluating and comparing the performance of different aspects of the
domestic commercial banks in India.
Banks should discard old practices/ethos that act as constraints and
indicate modern methods of management/operation to stand up to the
challenges. This re-engineering process aims at reviewing the current business
practices and elimination of non value-added services in pursuit of total
customer satisfaction. In fact, many international management consultants have
developed strategies for banks which adopt the re-engineering strategies. The
re-engineering takes the focus on customer one step further and combines risk
analysis, market research, business analysis and cost-cutting strategies as
components of the process. Good banking needs healthy competition and not


22

war among banks. The underlying force for healthy competition should come
from effective marketing strategies. In fact, marketing has become an
inseparable portion of successful banking.
Banks in future have to take recourse to effective marketing strategies
on account of;
(1) Compulsion in the area of profitability of banking business;
(2) Resource crunch and poor recovery;
(3) Efforts to globalize our economy and integrate it with the rest of the
world;
(4) Need for effective product development;
(5) Emergence of new range of banking services; and
(6) Ensuring optimum use of vast banking infrastructure.
Given the above scenario one can conclude that practicing the
marketing concept is the only way left to the banks for their survival. Hence,
marketing of banking services has a crucial role to play and greater efforts are
to be made to make the banks market oriented.
Accepting deposits and granting loans and advances are the primary
functions of a banker. Schemes designed to accept various types of deposits
and sanction advances for different purposes are the products for the banker.
Merchant banking services, mutual funds, credit cards, factoring and
investment counseling services are some of the innovative products of the
banking industry. Banks are desirous of devising new schemes/products
without violating RBI norms. For the successful marketing of such
schemes/products a few tips are given below-
1. Knowing its own strengths and weaknesses is equally an important
element in bank marketing. Wide net-work of branches, regional
concentration, strong metropolitan base and possession of good
counter staff with acumen and enthusiasm are the strengths of a bank.
On the other hand, poor customer services, absence of national
network of branches and stiff resistance of personnel to changes are
some of the weaknesses of a bank. Banks have to design schemes to


23

popularize their products in the market by availing the strengths of the
organisation and by circumventing the weakness.
2. Effective bank marketing requires a well co-ordinate effort at all levels
of the organisation. Ideas to launch new products may emanate from
the planning and development department. But this department has to
design pragmatic schemes. It is high time Indian banks created an
exclusive department for marketing as in western countries.
3. Banking is basically a person to person business. In an environment
where major components of marketing mix like place, product and
price are regulated by the RBI, the quality of service alone determines
the effectiveness of marketing. Bank personnel involved in launching a
new product have to educate the field staff about the special features
of the proposed product. An attempt in this direction will help the
people at the branch level to render quality services to improve the
quantum of business in the new product lines.
4. Timing is yet another important factor in marketing a new
product/service. Every product has a life cycle and the bank has to
enter the market at the right time. Introduction of the instrument stock-
invest is timely in the sense the primary market of corporate securities
is buoyant in India.
5. Though the banks corporate office is responsible for the anticipation
and identification of customers requirements and design
schemes/products to suit their different needs, it is only at the branch
level that schemes/products are being marketed. Hence, the success
of the scheme/product mostly depends on the marketing strategy
adopted by branch personnel. To start with, the branch has to give
wide publicity to the new schemes in the service area. This may be
done through hoardings, wall paintings, posters and exhibition of slides
in cinema theaters. Effective publicity should ever be followed by direct
marketing for better results. The branch has to prepare a list of
potential customers and the manager has to address a personal letter
to everyone of them highlighting the salient features of the proposed


24

scheme/product. This has to be reinforced through personal contact
either by the branch manager or by the branch staff possessing
influence in the society. In short, the branch manager has to articulate
the marketing strategies and communicate them effectively to his team
of staff for percolation to prospective customers.
6. Promotional campaigns have a stellar role to play in the successful
launching and marketing of banking products. Media support is a must
to make promotional campaigns more effective. But the public sector
banks in India have limited freedom in this regard since they have
largely to confine their publicity campaigns through the joint publicity
committee. As the banks are facing stiff competition and they are
periodically launching investor friendly products/schemes, they should
be permitted to use the popular audiovisual medium-TV, to create
awareness among the general public about the implications of the
proposed schemes/products.
7. Effective marketing requires enough care in designing the product.
Market segmentation facilities the banker to locatemarket opportunities
and market opportunities ,in turn assist to design marketable products.
8. As mentioned above the financial system in India has built, over time, a
vast network of financial institutions and markets. A strong and
efficient financial system is crucial to the attainment of our objectives
of creating a market-driven, productive and competitive economy and
to support higher investment levels and accentuate growth. The
creation of such a system has been the objective that has inspired the
process of financial sector reform since 1992 as part of the broader
programme of structural economic reforms.
As part of this process, reform of the banking sector is now under way.
The banking system is, by far, the most dominant segment of the financial
sector accounting for about two third of the assets of the organized financial
sector and it is appropriate that reform in this sector has been receiving major
emphasis. The reform measures taken in this area have followed the
recommendations of the Committee on the Financial System (CFS), which


25

submitted its report in November 1991. The Report had made a number of
recommendations aimed at improving the productivity, efficiency and profitability
of the banking system on the one hand, and providing it greater operational
flexibility and functional autonomy in decision-making, on the other. It covered
policy aspects, accounting practices, institutional and structural issues and
matters relating to organizational development.
Following the recommendations of the Committee on Financial System
which reported in 1991 and the second Report of the Narasimham Committee in
1998, a considerable ground has been covered in putting in place a financial
system which can meet the requirements of a more competitive and open
economy. By and large, financial reforms in India have proceeded in four major
directions.
First, setting the policy conditions right and removing the operational
constraints of the financial system.
What the reform process has tried to achieve is to lower the share of pre-
empted resources in the total resources of the banking system through gradual
liberalization of the cash reserve ratio and the statutory liquidity ratio.
The second directional change has been in the area of creating a more
competitive environment in financial sector through reform measures such as
relaxation of entry and exit norms, reduction in public ownership in banking
industry and letting banks access capital market for meeting their fund
requirement. The objective is to bring out the best result in terms of pricing and
quality of banking services over a period of time.
The third important direction of reform has been the strengthening of
market institutions and allowing greater freedom to financial intermediaries.
These reforms have taken the form of gradual liberalization of interest rates,
development of money, capital and debt and giving operational flexibility to
banks in the management of their assets and liabilities subject, of course, to
prudential guidelines
The fourth important element of reform concerns the safety aspects of
the financial system. This is the core of the challenges facing the financial
system at present. When the reform process was started in 1992, there was a


26

massive problem of cleaning the balance sheets of banks which had
deteriorated over the years. Successive reform initiatives in this area gave been
aimed at prescribing certain prudential standards for the financial system and
addressing certain structural weaknesses which could minimize their recurrence
in future. Measures such as income recognition norms, asset classification,
meeting minimum capital adequacy standards through re-capitalization and
devising a supervisory framework are steps in the direction of ensuring the
safety of the financial system.
The Report of the Narasimham Committee (April 1998) provides a
framework for the current phase of reforms-the second generation of reforms-
which could be conveniently looked at in terms of three broad inter-related
issues:
(i) Actions that need to be taken to strengthen the foundations of the
banking system;
(ii) Related to this, streamlining procedures, upgrading technology and
human resource development Structural changes in the system.
The reforms including the important aspects of banking policy, institutional,
supervisory and legislative dimensions, which have been studied in this study.
Considering the financial reforms banking organizations have changes
their policies, procedures, systems and also operations, to cope with the new
banking policies and to serve the customers in better way and also make
sustainable development.
In this chapter the introduction and evolution of banking sector and its
development has been explained. .The present study is concerned with
Impact of Banking sector Reforms in the post liberalization period. Now in the
coming chapter, I will explain the details of the research methodology.