Development of Commercial Banking 1950–1990
DEVELOPMENT OF COMMERCIAL BANKING 1950–1990
DEVELOPMENT OF COMMERCIAL BANKING 1950–1990 When India attained independence in 1947, it inherited a weak and unwieldy banking structure. The rudimentary nature of the legal framework had allowed the haphazard growth of indigenous banking institutions, with the number of banks mushrooming in some periods, followed by sizable numbers of bank failures, especially during World War II. The structure of banking underwent a significant change during the war, with the semiofficial Imperial Bank of India and the foreign-controlled exchange banks yielding ground to the new Indian joint stock banks. With the preponderance of banks with miniscule capital and rampant unhealthy business practices, banking development during this period was considered uncontrolled and indiscriminate.
The stresses and strains faced by the Indian banking system during the immediate postwar years were compounded by the postpartition travails, particularly in West Bengal and Punjab, the provinces that suffered the worst impact. Two hundred and five banks went out of business from 1947 to 1951; of them, 83 were in West Bengal, with outside liabilities of 260 million rupees, and 24 were in Punjab, with much larger outside liabilities of 620 million rupees. Of 194 nonscheduled banks listed with the Reserve Bank of India at the end of March 1953, 146 were defunct or untraceable.
The subject of the inadequacy of banking laws had received probing attention in the report of the Central Banking Enquiry Committee (1931), which recommended a full-fledged bank act, but this could be implemented only with the passage of a regular Banking Companies Act (1949). After these early steps, the Indian banking system experienced far-reaching changes in the post-1950 period. These changes have been primarily influenced by public policies that evolved over different phases, which may be broadly described as: consolidation of banking and strengthening of banking regulations (1950–1967); credit initiatives and social control over banking (1955–1967); bank nationalization and significant structural and institutional changes (1969–1990); and the current period of banking reforms (1991 onward).
The task of consolidation and strengthening of the banking system, which the Reserve Bank of India took up in earnest after 1950, required multilayered actions. Toward this end, even the new law was found to be insufficient; it was amended ten times between 1950 and 1967. The multilayered processes of consolidation and strengthening first required the execution of a wide set of measures of supervision and control over banking
|Number of all commercial banks||566||85||276||290||298|
|Scheduled banks including regional rural banks||92||71||273||287||294|
|Regional rural banks||—||—||194||196||196|
|Nonscheduled commercial banks||474||14||3||2||4|
|Share in bank deposits (in percentages)|
|Publics sector banks||—||84.5||91.9||90.8||79.0|
|SOURCE: Reserve Bank of India.|
companies, including control over management, board membership, and voting rights; there followed varied attempts at amalgamations, mergers, transfers, reconstructions, and even liquidations of fragile banks. The process of consolidation through amalgamation—voluntary until 1960—was slow. The failure of two major banks in 1960 brought home the inherent risks involved in allowing substandard banks to continue to function. An amendment to the banking law enacted that year facilitated the compulsory reconstruction and amalgamation of banks considered to be unviable and reluctant to enter into voluntary merger arrangements. During this phase, efforts were made to reorganize fifty-four state-associated banks in the erstwhile princely states.
As a result, between 1960 and the end of 1969, there were 48 compulsory mergers, in addition to 20 voluntary amalgamations, 17 mergers with the State Bank of India, and 125 transfers of assets and liabilities. These various measures of consolidation drastically reduced the number of banks from 566 in 1951 to 295 in 1961 and finally to 85 in 1969 (see Table 1). The process brought an end to the institutions that had been called nonscheduled banks, with limited capital size and unsustainable banking practices.
To encourage the growth of regional and functional banking, the social orientation of commercial banking was conceived in the founding law of the Reserve Bank of India itself, which was entrusted with the responsibility of enlarging the supply of agricultural finance through scheduled commercial banks or cooperative institutions. Until the early 1950s, the cooperative movement was considered appropriate for this purpose. But, on the basis of the recommendations of the Rural Banking Enquiry Committee (1950) for involving commercial banks in rural credit, the former Imperial Bank of India agreed to open 114 offices in rural and semiurban areas (against 274 branches recommended); it opened only 63 branches in the five years following July 1951. It was concluded, therefore, that without government intervention, banking facilities would not be extended to such areas. Hence, the Imperial Bank of India was brought under public ownership as the State Bank of India from July 1955, with the central bank of the country holding 92 percent of its shares and with a statutory responsibility to establish at least 400 additional branches within a five-year period; it fulfilled these and other branch expansion targets it set for itself. In September 1959 major state-associated banks of the former princely states were taken over and vested with the State Bank of India as subsidiaries.
Even so, many perceived weaknesses of the commercial banking system, such as poor population coverage of bank branches, vast sectoral credit gaps, excess control over banks by industrial and commercial interests, and a poor capital base, came to be aired in political circles, suggesting reorientation of the banking system. This led to the adoption of several measures, during the period from 1965 to 1969, that have been described as establishing "social control" over commercial banks. They included introduction of the credit authorization plan (1965) requiring scheduled banks to obtain prior authorization for granting new credit limits of 10 million rupees or over to any single party; initiation of a social control plan in 1968, with the objectives of achieving a wider spread of bank credit, preventing its misuse, and directing a larger volume of credit to priority sectors; and the statutory reconstitution of commercial bank boards with a majority representation to informal sectors.
The sociopolitical undercurrent of the second half of the 1960s was one of disenchantment with the functioning of the commercial banking system, even after the initiation of social control over banks. Two major institutional developments took place during the period that followed. First, effective 19 July 1969, fourteen major Indian scheduled banks having public deposits of 500 million rupees or over were nationalized. On 15 April 1980 six more Indian banks of the same size were nationalized. In 1975 a new type of commercial bank, the regional rural bank, was established in underbanked districts of the country as an institution that could combine local familiarity with modern banking methods. By the end of December 1983, 150 regional rural banks had come into existence, covering 265 districts out of the country's then 400-odd districts. These were set up with central government, state government, and commercial bank partnership.
|(percent of total)||(22.2)||(58.2)||(49.1)|
|(percent of total)||(40.5)||(19.0)||(22.2)|
|(percent of total)||(100.0)||(100.0)||(100.0)|
|SOURCE: Courtesy of author.|
By the middle of the 1980s, public policies began to focus on facilitating banks to undertake diversification into "parabanking" and other financial service activities. Many banks had set up specialized subsidiary companies and asset-liability management companies, and either through these entities or on their own, they entered into new activities, such as merchant banking, mutual funds, hire-purchase, housing finance, venture capital, equipment leasing, factoring, securities broking and trading, and other financial services.
These institutional developments have brought, along with the State Bank of India and its subsidiaries, commercial banks with over 90 percent of deposits into public ownership (see Table 1). At the same time, a series of policy initiatives brought about many other structural changes, such as the fast growth of bank branches, the spread of branches to rural, semiurban, and underdeveloped regions, and a higher proportion of bank credit extended to agriculture, small-scale industries, and other defined priority sectors. By the end of March 1990, over 46,000 bank branches (or 77 percent) were located in rural and semi-urban areas (see Table 2). A large number of these branches were opened in underbanked and underdeveloped eastern, northeastern, and central regions of the country. Over 93 percent of bank branches represented public sector banks, including regional rural banks; the balance belonged to Indian private banks (6.5 percent) and foreign banks (0.2 percent). An equally sharp change occurred in the sectoral distribution of bank credit, with the share of agriculture, small-scale industries, and other informal sectors rising significantly, from less than 10 percent in March 1968 to about 40 percent in March 1990 (see Table 3); the share of medium and large-scale industry declined from about 60 percent to 37 percent during the same period.
Even as the postnationalization policies for commercial banks were underway, many efforts were made to examine their functioning (James Raj Committee, 1978); to undertake their restructuring (Banking Commission, 1972, and James Raj Committee,1978);
|Sector||March 1951||March 1968||March 1980||March 1990||March 2002|
|SOURCE: Reserve Bank of India.|
to enhance productivity, efficiency, and profitability (PEP Committee, 1997); and to improve customer service in banks (Varadachary Working Group, 1977). In retrospect, many of their substantive recommendations remained unimplemented or were implemented half-heartedly. As a result, the deterioration in the working of commercial banks persisted.
As various studies and committee reports have demonstrated, the vast quantitative progress of commercial banking with a directed and forced pace was accompanied by growing problems of deterioration in the quality of loan portfolios, resulting in sizable nonperforming assets, declines in productivity and profitability, serious management weaknesses, and trade union pressures, giving rise to overstaffing, weaknesses in organizational structures, inadequate internal controls, deterioration in "housekeeping," and poor customer service. These issues of deterioration in financial health called for urgent remedial measures, which the two versions of the Narasimham Committee (1991 and 1998) subsequently proposed. Almost all of the committee's recommendations, except that to reduce the 40 percent target for directed credit to 10 percent, have been under implementation since the beginning of the 1990s; these, along with other reform measures, have served as a check on the postnationalization structural changes and have overall contributed to an improvement in the working of the commercial banking system.
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