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Banking in India originated in the last decades of the 18th century. The first banks were The
General Bank of India which started in 1786, and the Bank of Hindustan, both of which are now
defunct. The oldest bank in existence in India is the State Bank of India, which originated as the
Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one
of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all
three of which were established under charters from the British East India Company. For many
years the Presidency banks acted as quasi-central banks, as did their successors. The three banks
merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the
State Bank of India.
The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi
movement. The Swadeshi movement inspired local businessmen and political figures to found
banks of and for the Indian community. A number of banks established then have survived to the
present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and
Central Bank of India. The fervor of Swadeshi movement lead to establishing of many private
banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name
South Canara ( South Kanara ) district. Four nationalised banks started in this district and also a
leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of
Indian Banking".
The period during the First World War (1914-1918) through the end of the Second World War
(1939-1945), and two years thereafter until the independence of India were challenging for Indian
banking. The years of the First World War were turbulent, and it took its toll with banks simply
collapsing despite the Indian economy gaining indirect boost due to war-related economic
activities. At least 94 banks in India failed between 1913 and 1918.Post Independence in 1947,
The Government of India initiated measures to play an active role in the economic life of the
nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed
economy. This resulted into greater involvement of the state in different segments of the economy
including banking and finance. The major steps to regulate banking included the nationalization of
the Reserve Bank of India (RBI), India’s central banking authority. RBI became an institution
owned by the Government of India. In 1949, the Banking Regulation Act was enacted which
empowered the RBI "to regulate, control, and inspect the banks in India." The Banking Regulation
Act also provided that no new bank or branch of an existing bank could be opened without a license
from the RBI, and no two banks could have common directors. However, despite these provisions,
control and regulations, banks in India except the State Bank of India, continued to be owned and
operated by private persons.
By the 1960s, the Indian banking industry had become an important tool to facilitate the
development of the Indian economy. At the same time, it had emerged as a large employer, and a
debate had ensued about the possibility to nationalize the banking industry. Indira Gandhi, the-
then Prime Minister of India expressed the intention of the GOI in the annual conference of the All
India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalization." The paper
was received with positive enthusiasm. Thereafter, her move was swift and sudden, and the GOI
issued an ordinance and nationalized the 14 largest commercial banks with effect from the
midnight of July 19, 1969. Within two weeks of the issue of the ordinance, the Parliament passed
the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it received the
presidential approval on 9 August 1969.
A second dose of nationalization of 6 more commercial banks followed in 1980. The stated reason
for the nationalization was to give the government more control of credit delivery. With the second
dose of nationalization, the GOI controlled around 91% of the banking business of India. Later on,
the government merged New Bank of India with Punjab National Bank. It was the only merger
between nationalized banks and resulted in the reduction of the number of nationalised banks from
20 to 19. After this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to
the average growth rate of the Indian economy. In the early 1990s, the then Narsimha Rao
government embarked on a policy of liberalization, licensing a small number of private banks.
These came to be known as New Generation tech-savvy banks, and included Global Trust Bank
(the first of such new generation banks to be set up), which later amalgamated with Oriental Bank
of Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with
the rapid growth in the economy of India, revitalized the banking sector in India, which has seen
rapid growth with strong contribution from all the three sectors of banks, namely, government
banks, private banks and foreign banks.

The last decade has seen many positive developments in the Indian banking sector. The policy
makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related
government and financial sector regulatory entities, have made several notable efforts to improve
regulation in the sector. A few banks have established an outstanding track record of innovation,
growth and value creation. This is reflected in their market valuation. However, improved
regulations, innovation, growth and value creation in the sector remain limited to a small part of it.
The cost of banking intermediation in India is higher and bank penetration is far lower than in other
markets. India’s banking industry must strengthen itself significantly if it has to support the
modern and vibrant economy which India aspires to be. While the onus for this change lies mainly
with bank managements, an enabling policy and regulatory framework will also be critical to their
success. The failure to respond to changing market realities has stunted the development of the
financial sector in many developing countries. A weak banking structure has been unable to fuel
continued growth, which has harmed the long-term health of their economies. The future
performance for the industry will come at the back of reforms such as deeper penetration, better
norms for financial inclusion, technology initiatives, improving financial literacy etc. The policy
makers, Company managements and other participants have to work hand in hand to make the
banking sector realize its full potentiality.


DEMAND SUPPLY ANALYSIS-The banking industry is the driver force for the economy
of any country. The main function of banks constitutes of taking deposits from various sources of
savings in an economy and lending it to the various entities which are experiencing a demand for
funds. The demand supply scenario needs to be viewed in two different aspects policy environment
& general demand for credit. We try to look at these issues in a brief way.
Policy environment- India is on a contrary path to the rest of the world in terms of growth. The
focus of the policy makers are not only on growth, but on sustained growth. This requires a growth
rate which is accompanied by moderate levels of inflation and a manageable fiscal deficit. At
present, the growth in Domestic GDP for Q4FY10 came at 8.6% vs 6% YoY. This has come by a
contribution from all sectors of the economy, as per the eleventh survey of the Professional
forecasters conducted by RBI, the real GDP is expected to grow at 8.2 % in FY11, driven mainly by
increased private final consumption expenditure growth, stronger industrial activity in the first half
and further pick up in services in the second half. The sectoral growth rate forecast for 2010-11
suggests upward revision for agriculture and industry. For the year 2010-11, the forecast for
agriculture has been revised slightly upwards from 3.5 per cent to 4.0 per cent. For industry, the
forecasts have been revised upwards from 8.1 per cent to 9.0 per cent, whereas for the services
sector, the forecast value is 9.0 per cent, which is same as expected in the last survey. The main
concern however comes from rising inflationary pressures. The WPI inflation for May-10 stood at
10.16% vs 1.38%, a year ago. This is clearly a concern for the policy makers and they need to
react fast. This calls for the case of rate hikes in the coming times ahead. The key here is really
that of maintaining the balance between growth and monetary tightening. The baseline projection
of WPI for FY11 stands at 5.5%. This would require significant monetary tightening. However,
factors that could ease up the scenario are good monsoons-causing an ease to the supply side
problems and softening crude oil prices. The injection of fiscal stimulus and increased government
spending throughout the last year has had a substantial impact by the way of widening fiscal
deficits, the fiscal deficit for FY10 stood at 6.9% of GDP. It is expected that good collections from
the 3G and BWA auctions could help the cause of narrowing the fiscal deficit. As per the eleventh
survey of the Professional forecasters conducted by RBI, the deficit for FY11 is expected to be at
5.6% of GDP.

Mean probability pattern of real GDP growth forecasts-

Apart from the above discussed macroeconomic policies, structural reforms also do affect the
banking industry significantly, there were a number of key policy developments in the banking
sector during fiscal 2010. In continuation of the liberalization of the banking sector, in June
2009, banks were allowed to open offsite ATMs without prior approval from RBI. The branch
authorization policy was also liberalized in December 2009 and banks were allowed to open
branches in Tier III-VI cities without prior RBI approval. In August 2009, RBI also issued
guidelines relating to the issuance and operation of mobile phone based pre-paid payment
instruments. In July 2009, RBI issued a time schedule for the introduction of advanced approaches
of the Basel II framework in India whereby banks are required to apply to RBI for migration to
internal models approach for market risk band the standardized approach for operational risk
earliest by April 1, 2010 and for advanced measurement approach for operational risk and
internal ratings based approaches for credit risk earliest by April 1, 2012. RBI also initiated
several measures to increase systemic transparency and customer convenience. In April 2010, RBI
issued guidelines directing banks to replace the benchmark prime lending rate system with a
base rate system effective July 2010. The guidelines recommend calculating the base rate
taking into consideration cost elements that can be clearly identified and are common across
borrowers. RBI also issued guidelines revising the method of payment of interest on savings
accounts to a daily average basis effective April 1, 2010. During fiscal 2010, with an improvement
in market conditions, RBI also initiated several measures to maintain systemic stability. In
November 2009, the provisioning requirement for advances to commercial real estate classified as
standard assets was increased from 0.4% to 1.0%. In December 2009, RBI directed banks to
achieve a total provisioning coverage ratio of 70% by September 2010. In February 2010, in its
master circular on capital adequacy, RBI increased the capital requirements relating to
securitization exposures and provided enhanced guidance on valuation adjustments for illiquid
investments and derivatives. The guidelines also increased disclosure requirements for credit risk
mitigations and securitized exposures.

All this measures are a key to the efficient and vibrant functioning of the banking system. We
believe that the banking measures as far as structural policies are concerned will boost customer
transaction cost reductions, give banks a better de-risking in their business model and increase the
efficiency of the system. These steps are in line with the longer term objective of making Indian
banking industry comply with the highest global standards and thereby improving the demand
supply economics through structural reforms. However there is a need for the managements to
work on different lines like-
• PSBs need to fundamentally strengthen institutional skill levels especially in sales and
marketing, service operations, risk management and the overall organizational performance
ethic. The last, i.e., strengthening human capital will be the single biggest challenge, Old
private sector banks also have the need to fundamentally strengthen skill levels. However, even
more imperative is their need to examine their participation in the Indian banking sector and
their ability to remain independent in the light of the discontinuities in the sector.
• New private banks could reach the next level of their growth in the Indian banking sector by
continuing to innovate and develop differentiated business models to profitably serve segments
like the rural/low income and affluent/ HNI segments; actively adopting acquisitions as a means
to grow and reaching the next level of performance in their service platforms. Attracting,
developing and retaining more leadership capacity would be key to achieving this and would
pose the biggest challenge.
• Foreign banks committed to making a play in India will need to adopt alternative approaches to
win the “race for the customer” and build a value-creating customer franchise in advance of
regulations potentially opening up post 2009. At the same time, they should stay in the game
for potential acquisition opportunities as and when they appear in the near term. Maintaining a
fundamentally long-term value-creation mindset will be their greatest challenge.

The policy makers are also required to make coordinated efforts on the following fronts-
• Help shape a superior industry structure in a phased manner through “managed consolidation”
and by enabling capital availability. This would create 3-4 global sized banks controlling 35-45
per cent of the market in India; 6-8 national banks controlling 20-25 per cent of the market; 4-
6 foreign banks with 15-20 percent share in the market, and the rest being specialist players
(geographical or product/ segment focused).
• Focus strongly on “social development” by moving away from universal directed norms to an
explicit incentive-driven framework by introducing credit guarantees and market subsidies to
encourage leading public sector, private and foreign players to leverage technology to innovate
and profitably provide banking services to lower income and rural markets.
• Improve corporate governance primarily by increasing board independence and accountability.
• Accelerate the creation of world class supporting infrastructure (e.g., payments, asset
reconstruction companies (ARCs), credit bureaus, back-office utilities) to help the banking
sector focus on core activities.
• Enable labour reforms, focusing on enriching human capital, to help public sector and old
private banks become competitive.

General Demand and supply for credit- The general demand for credit is the most
important parameter that shapes the destiny of any banking system. The banking credit in India
has been steadily growing at a steady pace, registering a CAGR growth of 20.79% over the last
decade. The growth rate in credit was hit from the Q3FY09 and it declined steadily till Q2FY10. For
the last two quarters of FY10, the growth in credit has been rising again. This is clearly a signal of
recovery in demand. This is also supported by the fact that the IIP numbers are steadily growing
from March-09 and this has boosted the demand for credit. Going forward, the growth in credit is
likely to continue as there is a renewed demand from corporate sectors. As per the eleventh survey
of the Professional forecasters conducted by RBI, the growth rate in corporate profits in FY11 have
been revised from the earlier 18% and pegged at 20%. This will ensure a healthy demand for
credit and a good year ahead for the banks.

On the supply side, the fundamental force driving the supply of credit is the savings rate for the
economy. India has traditionally been a country exhibiting high savings to GDP ratio. As per the
eleventh survey of the Professional forecasters conducted by RBI, the savings to GDP ratio for FY11
is estimated at 35.30%. This could be further boosted, if we get better than expected monsoons
this year. Thus the supply of credit-capital will be robust to meet the rising demand. Although the
high inflation numbers are bound to increase pressure on the interest rates, but the inflation
numbers should cool off with good monsoons this year as the inflation is more of a supply side

Bank Credit in absolute terms and growth rate-

Non food credit as % of total credit:-

Savings to GDP ratio

Bank Deposit in absolute terms and growth rate-ASSET A

The asset qualities of the banks are judged based on the Non-performing asset portfolio of the
banking system as a whole. We look at the average of NPA as a percentage of net advances over
the last ten years to get a sense of the ensuing trend in the industry. The ratio has been steadily
declining over the period under consideration, especially from FY02. The ratio as at FY10 stands at
0.92, which is a very healthy one. The risk management focuses for the banking system and strict
monitoring by the apex bank has translated into such a performance. This is clearly a very good
trend as far as the health of the banking system is concerned.

Capital adequacy determines the capacity of the bank in terms of meeting the time liabilities and
other risks such as credit risk, operational risk, etc. In the simplest formulation, a bank's capital is
the "cushion" for potential losses, which protects the bank's depositors or other lenders. We look at
the average of capital adequacy ratio over the last ten years to get a sense of the ensuing trend in
the industry. The ratio have been rising from 2001-2003, steadied between 2004-2008, for the last
two years it has come down, taking a toll from the Global economic crisis. This has been well
addressed by RBI as they have made the provision coverage to be 70% from September-2010,
which will increase the Teir-II capital and enhance the capital adequacy ratio.

The main business of the banks is to take deposits from various sources of savings and then deploy
it to lend to those entities of the society who are in need of funds. In such a business, the cost at
which deposits are obtained really matters. The cheaper, the better. The current and savings
accounts are the least costly funds for the banking system, hence the ratio of these funds to total
deposits would indicate how cheap the funds intake by the system has been. The ratio has been
varying between 30-40% over the long term. The ratio was on a steady climb from 2003-2006 but
from then onwards, there has been a steady decline. This shows the overall trend of rising funding
costs. The declining share of CASA deposit in total deposits and the deceleration in their growth
may pose a challenge for the banking sector. This is because as mentioned above, the CASA
deposits constitute the cheapest source of funds for the banking sector. In case of drying up of this
source, alternate sources may be not only difficult but also prove expensive. In the context of
impending revival of economic growth, with commensurate increase in the credit needs of the
economy, the banking industry may require to take initiatives to attract more CASA deposits.

Profitability of the banking sector has been on a sound track. The banking sector has been one of
the most profitable sectors in the last ten years. The average growth rate for the past decade has
been at 25% on YoY basis. The financial reforms from the apex bank, increasing decontrol in the
private sector, allowing FDI in various sectors, increased thrust on infrastructure and a lot other
factors has contributed to such a performance. As shown by the trend line, the sector has been on
a stable growth phase in its life cycle, the other characteristics supporting the trend are the
probable signs of increasing competition as the policies are also directed towards increasing
competition (for details see the topic on Competition discussed later in the report), steady growth
in actual profits prior to the financial crisis which halted the trend. We expect the steady growth
phase to continue and the growth for the sector is expected to come between 25-30% in the next
few years. In FY10, the overall growth in profits for the sector stood at 15%.

One of the most important socio economic issues that need to be addressed is that of financial
inclusion. Financial inclusion is the availability of banking services at an affordable cost to
disadvantaged and low-income groups. Unfortunately, In India, the banking services has been
restricted amongst fewer sections of the society thereby causing a large scale of financial
exclusion. Though financial inclusion initiatives doesn’t present hugely profitable business for the
banking systems at large however they have a far reaching consequences in shaping up the future
of the economy and its banking system. Some of the possible causes of financial exclusion are:
Societal factors
• Demographic changes causing technological gap: the ageing population has difficulty in staying
up-to-date with all the new ways of dealing with money
• Labor market changes: more flexible meaning less stable incomes
• Income inequalities: bring difficulties of access to financial services Supply factors
• Risk assessment procedures: More and more tight risk assessment procedures create financial
• Marketing methods: they can be unclear and lead potential clients to abandon the request or to
mistrust financial institutions and look for other alternatives
• Geographical access: location of financial services providers are too far away from potential
• Product design: the terms and conditions are not clear and target public is not defined.
• Service delivery: the financial service is delivered by inadequate means for the target public,
e.g. Internet for older people
• Complexity of choice: can be an education issue, too many products proposed, target public has
trouble to choose.
Demand factors
• Belief that bank accounts are not for poor people or low self esteem
• Concern about costs: potential clients fear costs might be too high or lack information
• Fear of loss of financial control: bank account feels intangible compared to cold cash, also some
means are seen as “unsure” i.e. Internet hacking
• Mistrust of providers: fear of bankruptcy or lack of confidence with financial institutions.

Clearly these problems need to be addressed to make financial inclusion a reality. The
consequences of financial exclusion are-
Two main dimensions of financial exclusion consequences under the umbrella of socioeconomic
consequences on affected people can be determined.
First, financial exclusion can generate financial consequences by affecting directly or indirectly the
way in which the individuals can raise, allocate, and use their monetary resources. Secondly, social
consequences can be generated by financial exclusion.
We look at the consequences in the context of Banking. Credit, Savings and asset building.
Financial consequences
People with no bank account at all face difficulties dealing with cheques made out in their name by
a third party. Often they have to pay to have the cheque cashed. Lacking a transaction bank
account with payment facilities can make payment of bills. Moreover, the cost of banking services
bought separately is generally higher than those accessed within a stable relationship with the
bank. Consequently, occasional payments of utility bills, payment of taxes, bank transfers to third
persons, cashing cheques and money orders at the banking counter are more expensive for those
who are not customers of the bank. Therefore there are relevant negative economic consequences
of dealing occasionally with banks, not only of using alternative commercial profit-oriented financial
services providers.
Many utility companies offer discounted rates for people paying their bills electronically each
month, People lacking a payment card (debit or credit card) are also unable to take advantage of
the lower prices of goods and services bought in this way. It is also difficult to take employment in
countries where payment of wages is by electronic transfer into a bank account.
Social consequences
Not having access or not knowing how to use properly bank services can, depending on history,
status and life experience of people facing it, have an impact on self-esteem and lead to (self)-
isolation and depravation of social connections and social relationships with friends or family. In
some places, having to pay in cash generates the feeling that the money is not clean or has been
stolen. People concerned by this situation can feel humiliated by it and lose their self-esteem.

Financial consequences
People unable to get credit from banks or other mainstream financial providers often have to use
intermediaries or sub-prime lenders where the charges are higher and the terms and conditions
may be inferior. Customers can fall into greater financial difficulties and over-indebtedness as a
result of terms and conditions applied to some sub-prime products.

Social consequences
Evidently, the most negative consequences are experienced by those lending from illegal financial
service providers. One of the major risks associated with borrowing from illegal lenders arises when
borrowers find themselves in financial difficulties with lenders likely to use violence and


Financial & social consequences

Without savings, people have no means of coping with even small financial shocks or unexpected
expenses and those who keep savings in cash do not benefit from interest payments and are also
vulnerable to theft.

Thus Financial inclusion is as much a financial as social agenda. It is an absolute necessity in the
context of inclusive growth, increased per capita GDP, efficient capital allocation and overall a
much improved society.
With a view to increase banking penetration and promoting financial inclusion, domestic
commercial banks, both in the public and private sectors, were advised by RBI to take some
specific actions. First, banks were required to put in place a Board-approved Financial Inclusion
Plan (FIP) in order to roll them out over the next three years and submit the same to the Reserve
Bank by March 2010. Banks were advised to devise FIPs congruent with their business strategy and
to make it an integral part of their corporate plans. The Reserve Bank has deliberately not imposed
a uniform model so that each bank is able to build its own strategy in line with its business model
and comparative advantage. Second, banks were required to include criteria on financial inclusion
in the performance evaluation of their field staff. Third, banks were advised to draw up a roadmap
by March 2010 to provide banking services in every village having a population of over 2,000. The
Reserve Bank will discuss FIPs with individual banks and monitor their implementation.
These are the first round of steps taken by RBI and these steps would get more thrust once the
banks enter into the implementation phase of the FIP.

As is true for every growth sector, the huge potentiality in the banking space has been attracting
newer players to foray into the space. The reformative actions are also causing competition to rise.
In December 2009, RBI allowed domestic scheduled commercial banks (other than regional rural
banks) to open branches in Tier-III to Tier-VI centres (with population up to 49,999) without prior
permission. The impact acme in the form of Banks planning to open almost double the number of
branches this year, compared to last year.
Punjab National Bank plans to open close to 550 branches. It does not require a license for about
440, as they are in areas with a population of less than 50,000, according to Chairman and
Managing Director KR Kamath. Similarly, UCO Bank plans to open 140 branches this year, but
needs licences for only 89. The bank was hoping this would raise its market share to at least 3 per
cent from the existing 2.6 per cent, as per Chairman and Managing Director SK Goel.
The country’s largest lender, State Bank of India (SBI), spent about Rs 100 crore to open 286
branches and 2,521 automated teller machines in the fourth quarter of the last financial year. IDBI
Bank was planning to open about 300 branches this year, "substantially" higher than what it had
done over the past few years, said an executive.
Clearly, a liberalised policy has led banks to opt for branch expansion in a bid to gain market share.

Another important development came from the last Union Budget where the Finance Minister, in
his budget speech on February 26, 2010 announced that the Reserve Bank was considering giving
some additional banking licenses to private sector players. NBFCs could also be considered, if they
meet the Reserve Bank’s eligibility criteria. In line with the above announcement, it was proposed
by RBI in its annual policy 2010-11 to prepare a discussion paper marshalling the international
practices, the Indian experience as also the extant ownership and governance (O&G) guidelines
and place it on the Reserve Bank’s website by end-July 2010 for wider comments and feedback.
Thereafter, detailed discussions will be held with all stakeholders on the discussion paper and
guidelines will be finalized based on the feedback. All applications received in this regard would be
referred to an external expert group for examination and recommendations to the Reserve Bank for
granting licenses.

All this measures are driving the competition higher and going forward, margin sustainability will
be a direct function of greater penetration, excellent customer services, and sound strategy
combined with leadership. NSSO data reveal that 45.9 million farmer households in the country
(51.4%), out of a total of 89.3 million households do not access credit, either from institutional or
noninstitutional sources. Further, despite the vast network of bank branches, only 27% of total
farm households are indebted to formal sources (of which one-third also borrow from informal
sources). Farm households not accessing credit from formal sources as a proportion to total farm
households is especially high at 95.91%, 81.26% and 77.59% in the North Eastern, Eastern and
Central Regions respectively. The present situation depicts that the industry is clearly going to
grow in the years to come at a very fast pace but amidst increasing competition.

The banking sector of the Indian economy has been one of the brightest sectors. The sector has
gone through a lot of reforms and has changed both in its structure and function over the years.
The RBI has been instrumental in shaping the destiny for the sector. It has now positioned itself to
grow steadily in the next decade. The penetration of the banking system has been low so far,
however the Government and RBI are focused towards an inclusive growth which will not only
make the banking system grow steadily but also will prove vital to make India a global driver in
Growth in the next decade. For the short term, the challenges for the sector are, increasing sales
and marketing efforts to grow business per branch, increase the CASA base to become cost
efficient, reduce NPA’s. In the longer term, the goals are to improve on corporate governance,
increase financial inclusion and improving the banking infrastructure.