Evolution on banking sector in India

The evolution of the banking sector in India can be divided into several key phases:

1. Pre-Independence Era (Before 1947):

Early Banking: Banking in India dates back to the 18th century with the establishment of the first bank,
the Bank of Calcutta (1806), later renamed the Bank of Bengal. Other major banks like the Bank of
Bombay and the Bank of Madras followed, eventually merging to form the Imperial Bank of India (later,
State Bank of India in 1955).

Colonial Influence: During British colonial rule, banking was largely limited to British interests, with only
a few indigenous banks. There was little regulation or government involvement.

2. Post-Independence Period (1947-1960s):

Nationalization Efforts: After independence in 1947, the Indian government recognized the need for
financial inclusion. The Reserve Bank of India (RBI) was established as the central bank in 1935, tasked
with regulating and controlling monetary policy.

State Control: In 1955, the first major step towards banking nationalization occurred when the State
Bank of India was formed, taking over the Imperial Bank. The government began promoting banking in
rural areas, and the sector remained largely under the control of private players.

3. Nationalization and Expansion (1960s-1980s):

Bank Nationalization (1969): In 1969, Prime Minister Indira Gandhi took a monumental step by
nationalizing 14 major commercial banks, increasing the state’s control over the sector. This aimed to
provide credit to priority sectors like agriculture, industry, and the weaker sections of society.

Rural Banking Initiatives: With nationalization, banks began focusing on rural and agricultural credit.
Schemes like the Priority Sector Lending (PSL) were introduced to promote economic equality and rural
development.

Opening of Branches: Banks were required to open branches in rural areas, thus expanding banking
services across the country.

4. Reforms and Liberalization (1990s):

Economic Reforms (1991): The 1991 economic reforms brought significant changes to the banking
sector. The liberalization of the economy opened the door to private sector participation and foreign
investment.

Entry of Private Banks: The government allowed the entry of private and foreign banks. This led to the
establishment of banks like ICICI Bank, HDFC Bank, and Uti Bank, which later became major players in
the banking sector.

RBI Reforms: The Reserve Bank of India introduced several reforms, including the introduction of
prudential norms, capital adequacy requirements, and the introduction of banking licenses for new
private sector banks.
5. Technological Advancements and Growth (2000s-Present):

Technological Integration: With the rise of technology, Indian banks started to incorporate digital
banking services. ATM networks, internet banking, and mobile banking became widespread. This
facilitated ease of banking, especially in urban areas.

Financial Inclusion: Programs like Jan Dhan Yojana aimed to bring the unbanked population into the
formal banking system, facilitating access to banking for the poor.

Growth of Private Banks and Foreign Investment: Private banks like ICICI, HDFC, and Axis Bank grew
exponentially. Foreign banks also began to establish a stronger presence in India.

The Rise of Digital Payments: The introduction of the Unified Payments Interface (UPI) by the National
Payments Corporation of India (NPCI) revolutionized payments in India, providing instant, cost-free
transactions.

6. 6. Recent Developments (2020s):

Digital Banking Surge: The COVID-19 pandemic accelerated the digital transformation of the banking
sector. There was a rise in contactless payments, mobile wallets, and digital loans.

Bank Consolidation: In recent years, the government has pushed for the consolidation of public sector
banks to improve efficiency. Mergers like those of SBI with Associate Banks and other PSU banks are
part of this strategy.

Financial Technology (Fintech): The fintech sector has grown significantly, offering innovative banking
solutions like peer-to-peer lending, insurtech, and robo-advisors.

Key Milestones in Indian Banking:

1991: Introduction of economic reforms and liberalization.

2005: Introduction of the Banking Ombudsman Scheme to address customer complaints.

2014: Launch of Pradhan Mantri Jan Dhan Yojana, expanding financial inclusion.

2016: Launch of Demonetization, encouraging digital payments.

2018: Introduction of the Banking Regulation (Amendment) Act, allowing RBI greater powers in
overseeing banks.

BANKING DEVELOPMENTS

1949-69
In the two decades following the enactment of the Banking Regulation Act, 1949, the Indian banking
system developed in many respects. It not only grew geographically, but also structurally and
functionally. The number of scheduled banks, however, decreased from 94 to 76 over the period. A
significant change that occurred in this period was a steady decline in the importance of the non-
scheduled commercial banks. The Banking Regulation Act provided extensive regulatory powers to the
RBI and with that it became possible for it to carry out various structural reforms in the banking system.

Judged on the basis of deposit mobilisation, commercial banks made considerable progress in this
period. Deposits of the scheduled banks registered spectacular increase. The other notable features in
deposit growth of the period were the higher rate of growth in time deposits relative to demand
deposits and the rise in the number of personal accounts relative to business accounts.

The establishment of the State Bank of India in 1955 and the creation of the State Bank group by
nationalising eight regional banks in 1960 allowed scope for a new experiment in the Indian banking.
Under a statutory obligation, these banks opened new offices in semi-urban and rural areas and
approached those sections of people which were hitherto never served by the modern banks.

The period also witnessed a change in the lending policy of commercial banks. For long the major part of
their credit had gone to commerce and large-and medium-scale industries. During the period under
reference not only the commercial bank credit to industries increased, the banks also developed an
interest in term lending.

Finally, in order to provide some protection to the depositors, an important step in the form of
establishment of the Deposit Insurance Corporation was undertaken on January 1, 1962. The deposit
insurance is very helpful in mobilisation of deposits, as it enhances confidence of the people in banks. Its
need was long felt in this country, particularly during the periods of large-scale bank failures.

Nationalisation of Banks

The nationalisation of 14 major banks with deposits of Rs 50 crores or more in July 1969 was a "historic"
and momentous event in the history of India. Nationalisation was resorted to on the ground that the
commercial banking system did not play its proper role in the planned development of the nation. It was
controlled by a coterie of industrialists and business magnates who had used bank funds to build up
private industrial empires. Small industrial and business units were continuously and consistently
ignored and starved of funds, even though the Government policy was to encourage small, tiny and
cottage and village industries. Agricultural credit never seriously considered by banks. Bank funds were
used to support anti-social and illegal activities against the interest of the general public. It was for these
reasons that the Government took over 14 top commercial banks in July 1969. In 1980 again the
Government took over another 6 commercial banks altogether there were 20 nationalised banks. These
were in addition to the State Bank of India and its associate banks-commonly called the State Bank of
India group which were taken over in 1955. Later on due to amalgamation of New Bank of India with
Punjab National Bank, number of Nationalised Banks is reduced to 19.

DATT N SUNDARAM PG 892 ONWARDS

Branch Expansion

Rapid economic development presupposes rapid expansion of commercial banks. Initially, the banks
were conservative and opened branches mainly in metropolitan cities and other major cities. Branch
expansion gained momentum after the nationalisation of major commercial banks and the introduction
of the Lead Bank Scheme. it is clear that in a matter of 43 years, after bank nationalisation, there was
over 1075 per cent increase in number of branches, but the most spectacular progress was in rural
branches increase was from about 1860 to nearly 35,850 bank branches. M. Gopalakrishnan,
professional banker states: "The single striking feature of the post-nationalisation banking scene is the
rapidity with which the branch network has multiplied itself. The rate of branch expansion has been
unparalleled anywhere else in the world. With the progress of branch expansion programmes, the
national average of population per bank office has progressively declined from 64,000 to 12,600. A rural
branch office frequently serves 15 to 25 villages within a radius of 16 kms. Some banks have started
mobile offices and satellite offices. Rapid expansion of branches of commercial banks after
nationalisation has led to integration of rural and urban areas as well as integration of organised and
unorganised money markets India. Bank nationalisation was hailed as a major instrument of social
change. But this is indeed doubtful. The massive branch banking, significant though it is shows the
magnitude of the problem before the commercialised banking system; at present only about 36,452
villages out of 5 lakh villages are covered by commercial banks directly. Expansion of bank facilities in
rural and backward areas and provision of bank credit to farmers and rural artisans and in most cases at
concessional rates of interest these have contributed to low profitability of public sector banks (Public
sector banks were tasked with providing cheap loans (often at lower-than-market interest rates) to
farmers, rural artisans, and small businesses. While this supported economic development, it limited
the interest income banks could generate from these loans, reducing overall profitability.)

Deposit Mobilisation

Expansion of bank deposits has been an important feature in recent years. Planned economic
development, deficit financing and increase in currency issue have led to increase in bank deposits. At
the same time, banks have contributed greatly to the development of banking habit among people
through sustained publicity, extensive branch banking and relatively prompt service to the customers.
Bank nationalisation gave a great fillip to deposit mobilisation, due partly to the expansion of a network
of bank branches and partly to the incentives given to savers.
Since 1950-51 deposit mobilisation and supply of credit by banks were growing at a rapid rate
particularly after bank nationalisation in 1969. For instance,

Growth of deposits in India of all scheduled com mercial banks was as follows

1951-1971 (20 years) 600% or 7 times

1971-1991 (20 years) 3,160% or 33 times

1991-2013 (22 years) 3,506% or 35 times

It is clear that the most rapid deposit expansion was during 1971-91 nearly 33 times. This was because
of nationalisation and the tremendous expansion of banking. In general, there has been regular and
continuous rise in bank deposits indicating clearly that banking habit is growing in India and more and
more people are keeping their cash with banks than with themselves

Even then, there are now 5 lakh villages waiting for banking services. In the banked areas also, new
depositors have to be attracted and the existing depositors have to be motivated to increase their
deposits

Expansion of Bank Credit

Side by side with the expansion of bank deposits, there has been continued expansion of bank credit
reflecting the rapid expansion of industrial and agricultural output. The banks are also meeting the
credit requirements of industry, trade and agriculture on a much larger scale than before. Just as bank
deposits have expanded, bank credit too has expanded tremendously particularly since July 1969, from
about 1,16,300 crores in 1990-91 to 27,70,012 crores during 2008-2009.

In recent years, bank credit has picked up smartly by around 20 to 21 per cent per year and many factors
have contributed to this:

(a) Rise in lendable resources of commercial banks as a result of large reduction in reserve requirements
(viz., CRR and SLR);

(b) Release of impounded cash balances under incremental cash reserve ratio (ICRR);

(c) Sharp increase in food credit mainly due to increased food procurement operations;
(d) Increased demand for credit from public sector undertakings and the large increase in export credit;
and

(e) Fall in the rates of interest due to RBI's chess money policy rapid expansion in bank lending for
industry, for housing, buying of cars etc.

In the sphere of bank credit, however, some of the old abuses regarding bank lending are still to be met
with. For instance, bank credit is freely available to well. established houses of industry and trade
without much difficulty while the tiny and small businessmen really find it difficult to get credit from
banks; even now, some powerful but unscrupulous spend bank funds to corner shares and acquire
control over companies. Finally, bank credit is not available to small and marginal farmers who are in the
clutches of rapacious money lenders.

Development-oriented Banking

Historically, there was close association of banks with commerce and with some traditional industries
cotton textiles in Western India and jute textiles in the East. For a long time, banks were unwilling to
venture into new fields of financing. The concentration of joint stock banks in large commercial areas to
the virtual neglect of non-commercial regions was due to the preference of banks for trading activities
and traditional industries After Independence, banking has moved away from the traditional pulls into
new directions. The concept of banking has widened from mere acceptance of deposits and lending of
funds to development-oriented banking Banks are increasingly catering to the needs of industrial and
agricultural sectors. From short term financing banks have been gradually shifting to medium and even
long-term lending. From well-established large industrial and business houses, banks are positively
assisting small and weak industrial units, small farmers, artisans and other hitherto neglected groups in
the country.

Priority Sector Lending by Banks

Before 1969, commercial banks had largely neglected agriculture on the ground that rural credit was be
undertaken by cooperative credit societies and Minks. Accordingly, they remained largely indifferent to
the credit needs of farmers for agricultural operations and for land improvement. This was regarded as a
basic reason for the failure of planning in the agricultural sector and consequently for the failure of
general planning. At the same time, as the banks were owned and controlled by big industrialists before
nationalisation, small industrial concerns and business units were ignored by banks. Soon after
nationalisation, the commercial banks were asked to be specially concerned with the financing of
priority sector of agriculture, small industry and business and small transport operators. In course of
time, other priority sectors were also added, such as retail trade, professional and self-employed
persons, education, housing loans for weaker sections and consumption loans.
 Neglect of priority sector lending was one of the causes for nationalisation of the top 14 banks in 1969.
However, it was the Working Group on the Priority Sector Lending and the 20-Point Economic
Programme chaired by Dr. K. S. Krishnaswami which clearly spelt out the concept:

"The concept of priority sector lending is mainly intended to ensure that assistance from the banking
sector flows in an increasing manner to those sectors of the economy which, though accounting for a
significant proportion of the national product, have not received adequate support of institutional
finance in the past."

Growth and structural changes in indian banking since 1991

Since 1991, the Indian banking sector has witnessed significant growth and structural changes,
primarily driven by economic liberalization, which included allowing private banks to operate,
deregulation of interest rates, and a focus on improving efficiency through consolidation and
technological advancements, leading to a more diverse and competitive landscape with
increased financial inclusion, especially through the introduction of small finance banks and
payments banks; all while reducing the dominance of public sector banks (PSBs) to some
extent.

● Narasimham Committee Reforms:

The pivotal change came with the establishment of the Narasimham Committee in
1991, which recommended major reforms like lowering statutory reserve ratios (CRR)
and SLR, allowing foreign banks to operate freely, and promoting bank mergers and
consolidation, paving the way for private sector participation in banking.
● Entry of Private Banks:
Following the reforms, several private banks like ICICI Bank, Axis Bank, and IndusInd
Bank were established, increasing competition within the banking sector.
● Focus on Financial Inclusion:
Initiatives like Jan Dhan Yojana and Aadhaar linking with bank accounts significantly
expanded financial access to previously unbanked populations.
● Digital Banking Adoption:
With advancements in technology, Indian banks rapidly adopted digital banking
solutions including internet banking, mobile banking, and UPI payments, leading to
increased accessibility and transaction volumes.
● Priority Sector Lending:
While the government still mandates priority sector lending to support agriculture and
small businesses, there has been a shift towards more flexible mechanisms to cater to
these sectors.
● Consolidation and Mergers:
To improve efficiency and strengthen balance sheets, several public sector banks were
merged, reducing the overall number of banks while creating larger entities.
● Governance Reforms:
Various committees like the PJ Nayak Committee focused on improving governance
practices within PSBs, advocating for greater board autonomy and professional
management.

The total number of bank branches increased from 45421 in the year
1990-91 to 89103 in 2012-13. The impact of this phenomenal growth
has been to bring down the population per branch from 14000 in the
year 1990-91 to 12000 in 2012-13. Indian banking industry is
composed of 152 scheduled commercial banks in all.
On the Structure of Interest Rates

The Narasimham Committee, (1991) recommended that the level and structure of interest rates in the
country should be broadly determined by market forces. All controls and regulations on interest rates on
lending and deposit rates of banks and financial institutions on debentures and company deposits, etc.
should be removed. Concessional rates of interest for priority sector loans of small sizes should be
phased out; and subsidies in IRDP loans should be withdrawn.

The Committee further proposed that RBI should be the sole authority to simplify the structure of
interest rates. The Bank rate should be the anchor rate and all other interest rates should be closely
linked to it.

On Structural Reorganisation of the Banking Structure

To bring about greater efficiency in banking operations, the Narasimham Committee (1991) proposed a
substantial reduction in the number of public sector banks through mergers and acquisitions. According
to the Committee, the broad pattern should consist of:

(a) 3 or 4 large banks (including the State Bank of India) which could become international in character;

(b) 8 to 10 national banks with a network of branches throughout the country engaged in general or
universal banking;

(c) Local banks whose operations would be generally confined to a specific region; and

(d) Rural banks including RRBs whose operations would be confined to the rural areas and whose
business would be predominantly engaged in financing of agriculture and allied activities.

Since the country had already a network of rural and semi-urban branches, the Narasimham Commitee
(1991) proposed that the present system of licensing of branches with the objective of spreading the
banking habit should be discontinued. Banks should have the freedom to open branches purely on
profitability considerations.

The Committee wanted the Government to make a positive declaration that there would be no more
nationalisation of banks. RBI should permit the setting up of new banks in the private sector, provided
they conform to the minimum start-up capital and other requirements. There should be no difference in
the treatment between public sector banks and private sector banks.

The Narasimham Committee (1991) recommended that the Government should allow foreign banks to
open offices in India either as branches or as subsidiaries. They should conform to or fulfil the same or
similar social obligations as the Indian banks. Foreign banks and Indian banks should be permitted to set
up joint ventures in regard to merchant and investment banking, leasing and other newer forms of
financial services.

Financial Sector Reforms and its Implications

Financial Sector Reforms are the steps taken to change the banking system, capital market, government
debt market, foreign exchange market, etc. An efficient financial sector enables the mobilization of
household savings and ensures their proper utilization in productive sectors.

What is the Financial Sector?

The financial sector constitutes the commercial banks, non-banking financial companies, investment
funds, money market, insurance and pension companies, real estate etc.

It forms the core of an economy which facilitates the mobilization and distribution of financial resources.

It is engaged in providing financial services to the customers of the commercial and retail segments.

Need for Financial Sector Reforms

After independence India inherited a colonial legacy that was full of various social and economic
deprivations.

The planned economic development strategy adopted based on the Mahalanobis model had its
limitations that started showing in the 1980s.

In order to achieve various economic goals, the government resorted to increased borrowings at
concessional rates which lead to weak and underdeveloped financial markets in India.

The nationalization of banks increased government control and decreased the role of market forces in
the financial sector

Increased bureaucratic control, issues of red-tapism increased the non-performing assets.

Turbulent international events such as the war in the Middle East and the fall of the USSR increased the
pressure on the Foreign Exchange Reserves of India.

Narasimham Committee report (1991)

It was established to give reforms pertaining to the financial sector of India including the capital market
and banking sector.

Some of its major recommendations have been mentioned below:

It recommended reducing the cash reserve ratio (CRR) to 10% and the statutory liquidity ratio (SLR) to
25% over the period of time.

It suggested fixing at least 10% of the credit for priority sector lending to marginal farmers, small
businesses, cottage industries, etc.

In order to provide required independence to the banks for setting the interest rates themselves for the
customers, it recommended de-regulating the interest rates

Financial Sector Reforms in India

Reforms in the Banking Sector

Reduction in CRR and SLR has given banks more financial resources for lending to the agriculture,
industry and other sectors of the economy.

The system of administered interest rate structure has been done away with and RBI no longer decides
interest rates on deposits paid by the banks.

Allowing domestic and international private sector banks to open branches in India, for example, HDFC
Bank, ICICI Bank, Bank of America, Citibank, American Express, etc

Issues pertaining to non-performing assets were resolved through Lok adalats, civil courts, Tribunals,
The Securitisation And Reconstruction of Financial Assets and the Enforcement of Security Interest
(SARFAESI) Act.

The system of selective credit control that had increased the dominance of RBI was removed so that
banks can provide greater freedom in giving credit to their customers.

Reforms in the Debt Market

The 1997 policy of the government that included automatic monetization of the fiscal deficit was
removed resulting in the government borrowing money from the market through the auction of
government securities.

Borrowing by the government occurs at market-determined interest rates which have made the
government cautious about its fiscal deficits.

Introduction of treasury bills by the government for 91 days for ensuring liquidity and meeting short-
term financial needs and for benchmarking.
To ensure transparency the government introduced a system of delivery versus payment settlement.

Reforms in the Foreign Exchange Market

Market-based exchange rates and the current account convertibility was adopted in 1993.

The government permitted the commercial banks to undertake operations in foreign exchange.

Participation of newer players allowed in rupee foreign currency swap market to undertake currency
swap transactions subject to certain limitations.

Replacement of foreign exchange regulation act (FERA), 1973 was replaced by the foreign exchange
management act (FEMA), 1999 for providing greater freedom to the exchange markets.

Trading in exchange-traded derivatives contracts was permitted for foreign institutional investors and
non-resident Indians subject to certain regulations and limitations.

Launch of Pradhan Mantri Jan Dhan Yojana (PMJDY) to promote financial inclusion.

Expansion of microfinance and digital banking.

Introduction of Unified Payments Interface (UPI) and fintech innovations.

Impact of Various Reforms in the Financial Sector

It increased the resilience, stability and growth rate of the Indian economy from around 3.5 % to more
than 6% per annum.

A resilient banking system helped the country deal with the Asian economic crisis of 1977-98 and the
Global subprime crisis.

The emergence of private sector banks and foreign banks increased competition in the banking sector
which has improved its efficiency and capability.

Better performance by stock exchanges of the country and adoption of international best practices.

Better budget management, fiscal deficit, and public debt condition have improved after the financial
sector reforms.

The financial sector forms the backbone of an economy and includes the sore sectors such as banking,
foreign exchange, insurance. In order to break the colonial hegemony of policies, various reforms in the
financial sector were carried out that enabled the strengthening of the banking sector, better
management of foreign reserves, etc enabled in economic growth and development.
Implications of Financial Sector Reforms

Improved Banking Efficiency

● Higher Profitability and Better Asset Quality:

Financial reforms introduced capital adequacy norms, risk management frameworks,
and non-performing asset (NPA) recognition guidelines, which strengthened the
banking system. Public sector banks were restructured, and private sector participation
increased competition, leading to higher profitability and better management of bad
loans.
● Increased Competition with the Entry of Private and Foreign Banks:
The liberalization of the banking sector allowed private and foreign banks to operate
more freely. This resulted in better customer service, innovative financial products,
and competitive interest rates. The presence of ICICI Bank, HDFC Bank, and
foreign banks like Citibank and HSBC has pushed traditional public sector banks to
modernize their operations.

Growth of Capital Markets

● Enhanced Transparency and Investor Confidence Due to SEBI Regulations:

The Securities and Exchange Board of India (SEBI) was empowered to regulate and
monitor stock market activities. Reforms such as electronic trading, stricter listing
norms, and corporate governance rules increased transparency. This built investor
confidence and reduced insider trading and market manipulation.

● Increased Domestic and Foreign Investments in Stock Markets:

The capital market reforms led to the rise of Foreign Institutional Investors (FIIs) and
Domestic Institutional Investors (DIIs), significantly increasing liquidity in stock
markets. The introduction of mutual funds, exchange-traded funds (ETFs), and Initial
Public Offerings (IPOs) created new investment opportunities, making the stock market
more dynamic and attractive.

3. Expansion of Insurance Sector

● Higher Insurance Penetration Due to Private Sector Participation:

Before the reforms, LIC and GIC dominated the insurance industry. With private
players like HDFC Life, ICICI Prudential, and Max Life entering the market,
insurance penetration improved. The Foreign Direct Investment (FDI) limit was
increased from 26% to 74%, attracting global insurers to India.

● Growth in Innovative Insurance Products:

Reforms encouraged the development of customized insurance plans, such as unit-
linked insurance plans (ULIPs), health insurance, microinsurance, and digital
 insurance platforms. This made insurance more accessible and tailored to individual
needs, particularly for middle- and lower-income groups.

4. Strengthened Financial Stability

● RBI’s Monetary Policy Reforms Have Led to Better Inflation Control:

The Reserve Bank of India (RBI) adopted inflation targeting under its monetary policy
framework. By keeping inflation within a defined range (4% ± 2%), the RBI has ensured
price stability and reduced economic volatility.

● Improved Foreign Exchange Reserves and Exchange Rate Stability:

The Liberalized Exchange Rate Management System (LERMS) introduced a market-
driven exchange rate, reducing forex market distortions. India’s foreign exchange
reserves have grown significantly, making the economy more resilient to external shocks.

5. Greater Financial Inclusion

● Rise in the Number of Bank Accounts and Access to Credit for the Poor:
The Pradhan Mantri Jan Dhan Yojana (PMJDY) led to the opening of over 500
million bank accounts, ensuring access to financial services for previously unbanked
populations. The Mudra Yojana provided microfinance loans to small businesses,
boosting entrepreneurship and employment.

● Increased Adoption of Digital Payments and Mobile Banking:

Digital financial services like Unified Payments Interface (UPI), Aadhaar-linked
payments, mobile banking, and fintech innovations have revolutionized transactions.
Cashless payments have surged, promoting financial literacy and reducing dependency
on physical cash transactions.

Challenges and the Way Forward

Despite these reforms, challenges such as non-performing assets (NPAs), regulatory issues, financial
frauds, and cyber security threats persist. Strengthening financial regulations, enhancing risk
management, and promoting financial literacy will be key to sustaining long-term growth in India’s
financial sector.
Financial sector reforms have significantly contributed to India's economic development, making the
financial system more resilient, competitive, and inclusive. However, continuous policy interventions are
necessary to address emerging challenges and ensure sustainable growth.

NBFCs and their role

In recent years, non-banking finance companies, variously called as "finance
corporations", "Loan Companies", "Finance Companies", etc., have mushroomed
all over the country. These finance companies, with very little capital of their own
oftes less than 1 lakh have been raising deposits from the public by offering
attractive rates of interest and other incentives. They advance loans to wholesale
and retail traders, small-scale industries and self-employed persons Bulk of their
loans are given to parties which do not either approach commercial banks or
which are denied credit facilities by the latter. The finance companies give loans
which are generally unsecured and the rate of interest charged by them may
range anywhere between 24 to 36 per cent per annum. Besides giving loans and
advances to the small sector, NBFCs, in coporated under the companies Act 1956,
run chit funds, purchase and discount hundis, and have also taken up merchant
banking, mutual funds, hire-purchase, leasing, etc.
Since NBFCs are not regarded as banking companies, they did not come under the
control of RBI, there is no minimum liquidity ratio or cash ratio, no specific ratio
between their owned funds and deposits. That the depositors of these companies
are subject to extreme insecurity is clear from the fact that:

(a) bulk of their loans are unsecured and are given to very risky enterprises and
hence their charging high rates of interest;

(b) the loans, though given for short periods, can be and are renewed frequently
and thus become long-term loans;
(c) as there is no exchange of communication between different companies, it is
possible for a person or party to borrow from more than one finance company;
and

(d) the deposits of the public with the finance companies are not protected by the
Deposit Insurance Corporation.

Financial Position of NBFCs

NBFCs provide a wide range of financial services such as leasing and merchant
banking. The financial services sector is teeming with over 40,000 NBFCs andtheir
number continued to grow by about 4,000 per year.

The RBI Report on Currency and Finance, (1997-98) gave some interesting
statistics regarding the financial position of NBFCs. For instance, during 1996-97,
the aggregate deposits of 13,970 NBFCs totalled upto 3,57,150 crores as
compared to 295,340 crores in the previous year - marked increase of nearly 21
per cent.
NBFCs do not have any specific legislation governing them. Instead, they come
under three different authorities:

(a) Being limited liability companies, NBFCs are governed by the Companies Act,
1956 which does even contain the definition of a finance company. Application of
general provisions of this Act, perforce, has invited avoidable violations by NBFCs.

(b) In the matter of deposits, NBFCs are governed by Non-banking Financial

Companies (Reserve Bank) Directions, 1997.

(c) NBFCs which engaged in merchant banking and portfolio management services
are governed by SEBI

Role of Non-Banking Financial Companies (NBFCs)

NBFCs play a significant role in financial systems worldwide by complementing
banks and improving credit accessibility, especially in underserved areas.

1. Financial Inclusion
NBFCs provide credit to individuals and businesses who may not qualify for bank
loans, such as small businesses, rural entrepreneurs, and low-income groups.
Microfinance Institutions (MFIs), a type of NBFC, offer small loans without
collateral to support self-employment and economic growth.
2. Credit and Loan Services
Provide personal, vehicle, home, and business loans.
Offer hire purchase and leasing options for assets like machinery, equipment, and
vehicles.
Housing Finance Companies (NBFC-HFCs) help in homeownership by providing
mortgage loans.
3. Infrastructure Development
Infrastructure Finance Companies (NBFC-IFCs) provide long-term funding for
roads, railways, airports, power, and other projects.
NBFCs play a key role in public-private partnerships (PPP) for infrastructure
financing.
4. Boosting Small and Medium Enterprises (SMEs)
NBFCs finance MSMEs (Micro, Small, and Medium Enterprises), which often
struggle to get bank loans due to strict credit requirements.
They offer flexible loan structures and faster approvals compared to banks.
5. Asset Financing and Leasing
Asset Finance Companies (NBFC-AFCs) help businesses acquire vehicles,
machinery, and equipment without high upfront costs.
They offer hire-purchase agreements, allowing businesses to use assets while
paying in installments.
6. Wealth and Investment Management
Investment NBFCs (NBFC-ICCs) invest in shares, bonds, and securities, helping
people and companies grow their wealth.
They provide portfolio management and financial advisory services.
7. Encouraging Digital and Fintech Growth
Many NBFCs collaborate with fintech startups to offer digital lending, mobile-
based credit, and online payment solutions.
They use AI and data analytics to assess creditworthiness and provide quick loans
8. Supporting Consumer Finance and Retail Credit
NBFCs offer loans for consumer durables, like electronics, furniture, and
appliances, making them more affordable through EMIs.
Many e-commerce companies partner with NBFCs to provide "Buy Now, Pay
Later" schemes.
9. Reducing Banking Burden
NBFCs share the financial load with banks by offering alternative credit channels.
They cater to sectors where banks might hesitate, such as real estate, startups,
and informal businesses.
10. Foreign Investments and Economic Growth
Many NBFCs attract Foreign Direct Investment (FDI), boosting capital flow into the
country.
Their flexibility in lending policies helps accelerate economic development and
entrepreneurship.

NBFCs bridge the gap between traditional banks and the unbanked population,
promoting financial inclusion and economic growth. Their ability to provide fast,
customized, and innovative financial solutions makes them essential in modern
economies.

Micro finance and financial inclusion initiatives

Microfinance first started in the 1970s in Bangladesh, pioneered by Dr.
Muhammad Yunus, who later founded Grameen Bank in 1983. Yunus introduced
small, collateral-free loans to poor rural women, proving that microcredit could
help lift people out of poverty.
Microfinance in India started in the 1970s and 1980s, inspired by global models
like Grameen Bank in Bangladesh. The Self-Help Group (SHG) model and
Microfinance Institutions (MFIs) played a major role in its expansion.
Key Developments in India
1974 – SEWA Bank (Ahmedabad)
The Self-Employed Women’s Association (SEWA) started providing small loans to
women workers.
1982 – NABARD (National Bank for Agriculture and Rural Development)
NABARD promoted microfinance through the Self-Help Group-Bank Linkage
Programme (SHG-BLP).
1992 – SHG-Bank Linkage Programme (SHG-BLP)

NABARD and Reserve Bank of India (RBI) officially launched this program to
connect SHGs with formal banks.
1997 – Microfinance Institutions (MFIs) Grow

Private institutions like SKS Microfinance (now Bharat Financial Inclusion),

Bandhan Bank, and Spandana Sphoorty started providing microloans.
2000s – Expansion & Regulations

Microfinance has significantly contributed to women’s empowerment, rural

entrepreneurship, and financial inclusion in India.The full form of SKS
Microfinance is Swayam Krishi Sangam Microfinance.

It was founded in 1997 by Vikram Akula in India and later rebranded as Bharat
Financial Inclusion Limited (BFIL). SKS was one of India's largest microfinance
institutions, providing small loans to low-income individuals, especially women, to
promote financial inclusion.
Microfinance refers to financial services provided to low-income individuals or
small businesses that lack access to traditional banking. It includes microloans,
savings, insurance, and financial literacy programs.
Features of Microfinance

1. Small Loans
Microfinance institutions (MFIs) primarily provide small-sized loans, also known as microloans,
to individuals or small businesses. These loans are usually given without collateral, making them
accessible to low-income individuals who do not own significant assets. The loan amounts vary
based on the borrower's needs but typically range from a few dollars to a few thousand dollars.

2. Group Lending Model

One of the unique aspects of microfinance is the group lending model. Instead of lending to
individuals, MFIs often lend to small groups of borrowers who act as guarantors for one another.
This ensures accountability, reduces the risk of default, and encourages timely repayment, as
group members support and monitor each other's progress.

3. Women Empowerment

Microfinance initiatives largely focus on empowering women, as they are more likely to reinvest
earnings into their families and communities. Many MFIs design programs specifically for
female entrepreneurs, helping them establish small businesses, improve household income, and
gain financial independence.

4. Financial Inclusion

Microfinance bridges the gap between the formal banking sector and the unbanked population. It
provides financial access to people who are often excluded from traditional banking services due
to a lack of credit history, low income, or geographical constraints, particularly in rural areas.

5. Low Interest Rates

Compared to informal moneylenders who charge exorbitant interest rates, microfinance

institutions offer loans at relatively lower interest rates. While these rates may still be higher than
conventional bank loans (due to the high operational costs of serving remote populations), they
are significantly more affordable than those of loan sharks.

6. Capacity Building

Microfinance is not just about providing loans—it also includes training and financial literacy
programs. Many MFIs offer skill-building workshops, entrepreneurship training, and guidance
on managing finances, helping borrowers make better use of their funds and sustain their
businesses.
Benefits of Microfinance

1. Poverty Alleviation

One of the primary goals of microfinance is to reduce poverty by providing financial resources to
small businesses and self-employed individuals. Access to credit enables low-income households
to invest in productive activities, generate income, and improve their standard of living.
2. Employment Generation

Microfinance supports self-employment and small startups, leading to job creation. When micro-
entrepreneurs receive funding, they can expand their businesses and hire more people,
contributing to local employment and economic stability.

3. Encourages Savings

Microfinance institutions often encourage borrowers to save money alongside borrowing. Many
MFIs offer savings accounts with low minimum balance requirements, helping people develop
financial discipline, build reserves, and prepare for future expenses or emergencies.

4. Economic Development

By increasing financial activity in rural and underserved regions, microfinance fosters economic
development. Small businesses contribute to local markets, enhance productivity, and stimulate
trade, leading to overall economic growth. Moreover, when communities have better financial
stability, there is an improvement in education, healthcare, and infrastructure.

Challenges of Microfinance
High-interest rates in some institutions.
Risk of over-indebtedness for borrowers.
Sustainability issues for Microfinance Institutions (MFIs).
Examples of Microfinance Institutions
Grameen Bank (Bangladesh) – Founded by Muhammad Yunus.
SKS Microfinance (India) – Supports small entrepreneurs.
BancoSol (Bolivia) – Provides small business loans.
Microfinance plays a crucial role in financial inclusion and economic development.
However, proper regulations and financial literacy programs are essential for its
sustainable success.
Financial Inclusion Initiatives
Financial inclusion ensures that individuals and businesses have access to
affordable financial services. Governments and financial institutions implement
various initiatives to promote inclusion.
Key Initiatives for Financial Inclusion

1. Digital Banking & Mobile Money

Digital banking has revolutionized financial inclusion by making banking services accessible via
mobile phones and the internet. Some successful global initiatives include:
Unified Payments Interface (UPI) – India

● A real-time digital payment system that enables easy and instant money transfers between bank
accounts using mobile applications.
● Popular apps using UPI include Google Pay, PhonePe, and Paytm.

● Has significantly boosted digital transactions, reducing dependency on cash.

2. Government-Led Financial Inclusion Programs

Governments worldwide have launched various financial inclusion strategies to provide banking
services to the unbanked population.
Pradhan Mantri Jan Dhan Yojana (PMJDY) – India

● Launched in 2014 to ensure every Indian household has access to a basic bank account.

● Offers zero-balance accounts, insurance coverage, and overdraft facilities.

● Over 500 million bank accounts have been opened under this scheme, promoting financial
stability.

3. Microfinance Support Programs

Microfinance plays a critical role in financial inclusion by providing small loans and financial
services to low-income individuals.
Self-Help Groups (SHGs) – India

● Community-based savings groups, primarily led by women in rural areas, that pool money for
lending among members.
● Encouraged by NABARD (National Bank for Agriculture and Rural Development).

● Helps women become financially independent and start small businesses.

Grameen Bank (Bangladesh)

● Founded by Muhammad Yunus, Grameen Bank pioneered microfinance lending to poor

individuals without requiring collateral.
● Has provided millions of small loans to rural entrepreneurs, especially women.

4. Entrepreneurship & Small Business Support

Several programs focus on supporting micro and small businesses through loans and financial
services.
Pradhan Mantri Mudra Yojana (PMMY) – India

● Provides collateral-free loans to micro and small businesses.

● Targets women entrepreneurs, startups, and self-employed individuals.

● Loans categorized as:

o Shishu (Up to ₹50,000)
o Kishor (₹50,000 – ₹5,00,000)
o Tarun (₹5,00,000 – ₹10,00,000)

Stand-Up India Scheme

● Encourages entrepreneurship among women and SC/ST communities.

● Offers bank loans from ₹10 lakh to ₹1 crore to support new business ventures.

5. Aadhaar-Enabled Payment System (AEPS) – India

● Uses biometric authentication for banking transactions, ensuring access for rural populations.
 ● Allows users to withdraw money, check balances, and transfer funds using their Aadhaar
number and fingerprint.
● Plays a key role in delivering government subsidies directly to beneficiaries (DBT – Direct
Benefit Transfer).

6. Digital Banking & Financial Literacy Campaigns

Financial literacy is essential for ensuring that people understand how to use banking services
effectively.
Digital India Program

● Promotes cashless transactions and encourages people to adopt digital banking, UPI, and
mobile wallets.
● Includes initiatives to educate rural communities about financial services.

Financial Literacy Programs

● Conducted by banks, NGOs, and government agencies to teach people about saving, budgeting,
credit management, and digital transactions.
● Helps rural and low-income individuals make informed financial decisions.

Impact of These Initiatives

Increased bank account ownership: Millions gained access to banking.
Boost to digital transactions: Cashless payments are more common.
Support for small businesses: Many entrepreneurs got funding
Women’s financial empowerment: More women engaged in banking and
entrepreneurship.
Impact of Microfinance & Financial Inclusion

1. Poverty Reduction

● Access to small loans and banking services helps low-income individuals start businesses,
increase their income, and escape poverty.
 ● Financial inclusion provides economic stability and social security.

2. Women Empowerment

● Many financial inclusion initiatives target female entrepreneurs, enabling them to start
businesses, manage finances, and become self-sufficient.
● Women-led SHGs and microfinance programs help improve financial decision-making within
households.

3. Economic Growth

● Increased financial activity in rural and underserved areas leads to higher productivity, more
business opportunities, and job creation.
● Countries with high financial inclusion experience stronger economic development.

4. Encouraging Savings & Investments

● Financial inclusion promotes saving habits and helps individuals build financial security.

● Access to insurance, pensions, and investment options ensures long-term stability.

Regulation and supervision of the financial sector

The Reserve Bank of India (RBI) started in April 1935 with ₹5 crores as its capital, divided into
₹100 shares. At first, private individuals owned most of it, while the Indian government had a
small portion. The RBI Act of 1934 allowed the government to appoint key leaders like the
Governor and two Deputy Governors.

In 1949, the government took full control of RBI (nationalized it). Today, the RBI is managed by
a team of 20 people called the Central Board of Directors, which includes the Governor, four
Deputy Governors, a Finance Ministry representative, ten government-nominated members, and
four directors representing different regions.

Apart from this, there are four Local Boards (in Mumbai, Kolkata, Chennai, and Delhi) to focus
on regional banking and financial matters. Each Local Board has five members appointed for
four years.

FUNCTIONS OF THE RESERVE BANK OF INDIA

By the Reserve Bank of India Act of 1934, all the important functions of a central
bank have been entrusted to the Reserve Bank of India.

(i) Bank of Issue. Under Section 22 of the Reserve Bank of India Act, the Bank has
the sole right to issue bank notes of all denominations. The distribution of one
rupee notes and coins and small coins all over the country is undertaken by the
Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue
Department which is entrusted with the issue of currency notes. The assets and
liabilities of the Issue Department are kept separate from those of the Banking
Department. Originally, the assets of the Issue Department were to consist of not
less than two-fifths of gold coin, gold bullion or sterling securities provided the
amount of gold was not less than 40 crores in value. The remaining three-fifths of
the assets might be held in rupee coins, Government of India rupee securities,
eligible bills of exchange and promissory notes payable in India. Due to the
exigencies of the Second World War and the post-war period, these provisions
were considerably modified. Since 1957, the Reserve Bank of India is required to
maintain gold and foreign exchange reserves of ₹ 200 crores, of which at least 115
crores should be in gold. The system as it exists today is known as the minimum
reserve system.

(ii) Banker to Government. The second important function of the Reserve Bank of
India is to act as Government banker, agent and adviser. The Reserve Bank is
agent of Central Government and of all State Governments in India excepting that
of Jammu and Kashmir. The Reserve Bank has the obligation to transact
Government business, viz., to keep the cash balances as deposits free of interest,
to receive and to make payments on behalf of the Government and to carry out
their exchange remittances and other banking operations. The Reserve Bank of
India helps the Government-both the Union and the States to float new loans and
to manage public debt. The Bank makes ways and means advances to the
Governments for 90 days. It makes loans and advances to the States and local
authorities. It acts as adviser to the Government on all monetary and banking
matters.
(iii) Bankers' Bank and Lender of the Last Resort. The Reserve Bank of India acts as
the bankers' Companies Act of 1949, every scheduled bank was required to
maintain with the Reserve Bank a cash balance equivalent to 5 per cent of its
demand liabilities and 2 per cent of its time liabilities in India. By an
amendmenper 1962, the distinction between demand and time liabilities was
abolished and banks have been asked to keep cash reserves equal to 3 per cent of
their aggregate deposit habilities. The minimum cash requirements can be
changed by the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the basis of
eligible securities or get financial accommodation in times of need or stringency
by rediscounting bills of exchange. Since commercial hanks can always expect the
Reserve Bank of India to come to their help in times of banking crisis, the Reserve
Bank becomes not only the bankers' bank but also the lender of the last resort.

(iv) Controller of Credit. The Reserve Bank of India is the controller of credit, i.e., it
has the power to influence the volume of credit created by banks in India. It can
do so through changing the Bank rate or through open market operations.
According to the Banking Regulation Act of 1949, the Reserve Bank of India can
ask any particular bank or the whole banking system not to lend to particular
groups or persons on the basis of certain types of securities. Since 1956, selective
controls of credit are increasingly being used by the Reserve Bank.

The Reserve Bank of India is armed with many more powers to control the Indian
money market. Every bank has to get a licence from the Reserve Bank of India to
do banking business within India, the licence can be cancelled by the Reserve
Bank if certain stipulated conditions are not fulfilled. Every bank will have to get
the permission of the Reserve Bank before it can open a new branch. Each
scheduled bank must send a weekly return to the Reserve Bank showing, in detail,
its assets and liabilities. This power of the Bank to call for information is also
intended to give it effective control of the credit system. The Reserve Bank has
also the power to inspect the accounts of any commercial bank.
TILL HERE DONE
(v) Custodian of Foreign Exchange Reserves.
The Reserve Bank of India (RBI) is responsible for maintaining the official
exchange rate of the Indian rupee and acting as the custodian of the country’s
foreign exchange reserves. Under the RBI Act of 1934, the Bank initially
maintained fixed exchange rates with the British sterling and later expanded this
role after India joined the International Monetary Fund (IMF) in 1946, ensuring
fixed exchange rates with other IMF member countries. Additionally, the RBI
manages India’s international currency reserves, oversees sterling balances, and
administers the country's exchange controls

Supervisory Functions
The Reserve Bank of India (RBI) performs supervisory functions to ensure sound banking practices in
India. Empowered by the Reserve Bank Act, 1934, and the Banking Regulation Act, 1949, the RBI
oversees commercial and co-operative banks in areas such as licensing, branch expansion, asset
liquidity, management practices, and restructuring or liquidation. It conducts periodic inspections and
collects necessary data from banks. The 1969 nationalization of 14 major banks added responsibilities
for guiding banking and credit policies to support economic development and social objectives.

Classification of RBI's Functions

The monetary functions also known as the central banking functions of the RBI
are related to control and regulation of money and credit, i.e., issue of currency,
control of bank credit, control of foreign exchange operations, banker to the
Government and to the money market. Monetary functions of the RBI are
significant as they control and regulate the volume of money and credit in the
country.

Credit Control
1. General Credit Controls
Since 1955-56 and particularly after 1973-74 the inflationary rise in prices has
been steadily mounting. Increased Government expenditure financed through
deficit spending has the direct effect of pushing up the prices, wages and
incomes. Shortfalls in production, and hoarding and speculation in essential
commodities have contributed to this inflationary pressure. RBI has various
weapons of control and, through using them, it hopes to achieve its monetary
policy. These weapons of control are broadly two: quantitative and qualitative
controls. Quantitative controls are used to control the volume of credit and,
indirectly, to control the inflationary and deflationary pressures caused by
expansion and contraction of credit. Quantitative controls are also known as
general credit controls and consist of bank rate policy, open market operations
and cash reserve ratio.

(a) Bank Rate. The bank rate is the rate at which the central bank (in India, the Reserve Bank of
India) lends money to commercial banks and financial institutions without requiring collateral.

 When the RBI increases the bank rate, borrowing becomes costlier for commercial banks,
leading to higher interest rates for loans provided by these banks to businesses and individuals.
This discourages borrowing, reduces money supply, and helps control inflation.
 When the RBI lowers the bank rate, borrowing becomes cheaper for commercial banks,
encouraging them to lend more. This increases money supply, boosts investment, and stimulates
economic growth, especially during deflation or economic slowdowns.

Cheap Money Policy (Easy/ expansionary Monetary Policy):

A cheap money policy, also known as an easy monetary policy, is implemented to increase the
money supply and stimulate economic growth, particularly during periods of economic
slowdown or deflation.

Dear Money Policy (Tight/contractionary Monetary Policy):

A dear money policy, also known as a tight monetary policy, is implemented by a central bank
to reduce the money supply in the economy. It is typically used to control inflation and stabilize
the currency.
As of 2025
 Repo Rate: 6.25%
 Reverse Repo Rate: 3.35%
 Bank Rate: 6.75%
(b) Cash Reserve Requirements (CRR). Another weapon available to RBI for credit
control is the use of variable cash reserve requirements. Under the RBI Act, 1934,
every commercial bank has to keep certain minimum cash reserves with RBI-
initially, it was 5 per cent against demand deposits and 2 per cent against time
deposits-these are known as the statutory cash reserves. Since 1962, RBI was
empowered to vary the cash reserve requirement between 3 per cent and 15 per
cent of the total demand and time deposits.

Apart from cash reserve requirements which commercial banks have to keep with
RBI (under RBI Act, 1934), all commercial banks have to maintain (under Section
24 of the Banking Regulation Act, 1949) liquid assets in the form of cash, gold and
unencumbered approved securities equal to not less than 25 per cent of their
total demand and time deposit liabilities. This is known as the statutory liquidity
requirement; this is in addition to statutory cash reserve requirements.

Open Market Operations of RBI

In economies with well-developed money markets, central banks use open
market operations - i.e. buying and selling eligible securities by the central bank in
the money market-to influence the volume of cash reserves with commercial
banks and thus influence the volume of loans and advances they can make to the
industrial and commercial sectors. RBI had not used this weapon for many years.

Since 1991, the enormous inflow of foreign funds into India created the problem
of excess liquidity with the banking sector and RBI undertook large scale open
market operations. When RBI sells Government securities in the market, it
withdraws a part of the cash reserves of commercial banks and, thereby, reduces
the ability of banks to lend to the industrial and commercial sectors. At any given
time, the banks' capacity to create credit-i.e., to give fresh loans depends upon
their surplus cash, that is, the amount of cash reserves in excess of their statutory
CRR. Once the surplus cash is eliminated and even part of the statutory CRR is
reduced, the banks have to contract their credit supply so as to generate some
cash reserves to meet their statutory CRR. As a result, the supply of bank credit
which involves the creation of demand deposits, falls and money supply contracts
The opposite will happen if RBI buys government securities from the market and
pays for them. The commercial banks will find that they have surplus cash-they
will create more credit and more bank deposits. The supply of money will expand.
Such a policy of buying Government securities will be adopted to reverse
economic recession in the country. It appears that RBI will actively use open
market operations as an instrument of monetary policy and not simply to support
the market for Government Bonds.

2. 2. Selective and Direct Credit Controls

Qualitative Measures of Credit Control

Qualitative measures, also known as selective credit controls, are tools used by the Reserve Bank
of India (RBI) to regulate the distribution and direction of credit in the economy. Unlike
quantitative measures (which focus on the overall money supply), qualitative measures target
specific sectors or uses of credit to influence economic priorities.
Key Qualitative Measures:
1. Credit Rationing:
o The RBI sets limits on the amount of credit that can be provided to specific sectors or
industries.
o This ensures that credit flows to priority sectors like agriculture, small-scale industries,
and infrastructure while discouraging excessive lending to speculative or non-essential
activities.
2. Regulation of Consumer Credit:
o The RBI regulates credit for consumer durables by setting limits on loan amounts and
increasing down payment requirements.
o This discourages over-borrowing and controls inflation caused by excessive consumer
demand.
3. Margin Requirements:
o Banks are required to maintain a margin (the difference between the loan amount and
the value of the collateral).
o By adjusting margin requirements, the RBI controls speculative activities in areas like the
stock market or real estate.
o Higher margins reduce speculative credit, while lower margins encourage borrowing.
4. Moral Suasion:
 o The RBI persuades or advises banks to follow its monetary policy objectives voluntarily.
o Through discussions, meetings, and directives, the RBI encourages banks to prioritize
specific sectors or adopt responsible lending practices.
5. Direct Action:
o The RBI may take punitive action against banks that do not comply with its credit control
measures.
o For instance, it can impose penalties, restrict operations, or withhold credit facilities to
non-compliant banks.
6. Publicity Measures:
o The RBI issues reports, guidelines, or public notifications to guide banks and borrowers
about economic conditions and desirable credit practices.
o This indirectly influences credit distribution by spreading awareness

Challenges and opportunities in the Indian banking sector

INDIAN BANKING: CONCERNS AND CHALLENGES FOR FUTURE

The decades of the 1980s and 1990s and the first decade of the present century
have witnessed several financial crises around the world. These crises were
sometimes country specific, often regional, and in the case of the current crisis,
global in scope. In each case, the banking sector became a drag on the real
economy, jeopardised public finances and hurt economic growth. It is noteworthy
that while other countries and regions went through banking upheavals, the
Indian banking remained safe. This was both due to cautious and prudent
regulation excercised by the Reserve Bank, on the one hand, and the relatively
lower globalization of our banking sector. The Indian banks have, in recent times,
registered higher credit growth, deposit growth, better return on assets, sound
capital-to-risk weighted assets ratio and an improvement in gross non-performing
assets ratio. However, certain concerns need to be addressed and challenges met
as would be clear from the discussion below

1. Ensuring financial inclusion. Despite its impressive progress, commercial

banking in India has not penetrated sufficiently to serve the large mass of rural,
illiterate and poor people in a meaningful way. Rough estimates indicate that of
the 60,000 habitation centres in the country, only about 30,000 centres are
covered by the commercial banks. The Reserve Bank has taken several steps
during the last few years to further financial inclusion. These include, encouraging
'no frills accounts to allow access to basic financial services, initiating and then
expanding the Business Correspondent model and the use of mobile phones, for
extending banking outreach. However, much more need to be done in the field of
financial inclusion.

2. Improving credit flow to rural areas. One disquieting feature in the present
business scenario of the Indian banking sector is the concentration of banking
business in a few metropolitan areas. Six top metropolitan centres account for
almost half of the total banking business of the Indian banking sector. More
alarmingly, rural areas account for only a small proportion of credit. Further, the
North-Eastern, Eastern and Central regions continue to display backwardness in
the availability as well as utilisation of banking services. Thus, efforts need to be
taken to improve credit flow to the rural areas as also to the North-Eastern,
Eastern and Central regions.

3. Conforming to the priority sector lending target. A number of banks have failed
to meet the target of credit

set for priority sector as a whole and also for agricultural credit. Non-adherence
to the agricultural lending target by

a large number of banks raises concern as still a large proportion of India's

population depends on the agricultural sector for livelihood.

4. Financing infrastructure. India is a supply constrained economy and the biggest

supply constraint is infrastructure. It is widely recognised that poor and
inadequate infrastructure is adding to production costs, adversely affecting the
productivity of capital, and eroding the competitiveness of our productive sectors.
Therefore, it is necessary to finance the huge infrastructure needs. However, as
pointed out by Subbarao, a big issue in bank financing of infrastructure is the
asset-liability mismatch. While infrastructure typically requires long-term
financing, the deposits of banks, their main source of funds, are relatively short-
term. This problem of asset-liability mismatch is not unique to India and exists in
other countries also. However, while in advanced countries, the long-term finance
space is filled by insurance companies and pension and provident funds, there is
no such provision in India. Thus, the burden of infrastructure financing has to be
borne by the banks. According to Subbarao, "Going forward, financing
infrastructure is going to be a big challenge for the banking sector. This huge and
growing demand for infrastructure finance will have to be met even as banks
wrestle with expanding their traditional banking services. Apart from finding the
resources, banks will also need to hone their skills in appraisal and management
of risks inherent in infrastructure financing."

5. Planning for better risk management. In the coming years, two big forces will
define the environment in which Indian banks will be called upon to operate: (1) a
rapidly globalising India, and (ii) a fiercely competitive industry. "This means in the
main that Indian banks will have to upgrade their risk management architectures.
In this regard, an important lesson thrown up by the crisis is that in addition to
managing more effectively the traditional roles such as credit risk, operational risk
and market risk, banks also need to manage some new risks that have proven to
be significant such as reputation risk, counterparty credit risk, liquidity risk,
interest rate risk in the banking book and incremental risk in the trading book."
Risk management will require pushing the frontiers of knowledge and
transforming that knowledge into practical policy.

6. Improving efficiency. The Indian banking sector has recorded an impressive

improvement in productivity during the period of the last decade and a half. In
fact, many of the productivity/efficiency indicators have moved closer to the
global levels. However, improvement is a never-ending business and several focus
areas in this context can be pointed out. For instance, the intermediation cost in
India is still high, due to high operating costs. Non-interest sources of income
constitute a very small share of total income of banks in India. Although overall
efficiency and productivity have improved, resources are not being utilised in the
most efficient manner. There is also a degree of stickiness and non-transparency
in bank lending rates. Subbarao points out that challenge for Indian banks,
therefore, is to reduce costs and pass on the benefits to both depositors and
lenders. "This will involve constantly reinventing business models and designing
products and services demanded by a rapidly growing and diversifying
economy.""

7. Monitoring high credit to a few sensitive sectors. In recent times, there has
been high growth of credit to a few sensitive sectors like NBFCs, personal loans
and real estate (particularty commercial real estate loans). This trend raises risk to
the banking sector as these loans may increase the asset-liability mismatches.
Therefore, careful monitoring of there loans is required.

8. Reviewing operations of foreign banks. According to Report on

Trend and Progress of Banking in India, 2010-11, it is necessary to
address at this juncture the concerns raised by operations of foreign
banks. It is a fact that these banks are mostly present in metropolitan
areas, and as such their role in furthering financial inclusion is
limited. It is alto a fact that even after having a lower priority sector
lending target, many of them have not been meeting this target.
Moreover, the target set for export credit has also not been met by
many of these banks. On the other side, their share in the sensitive
sector credit especially share in the real estate credit, has been
particularly high. Accordingly, there is an urgent need for a review of
the operations of foreign banks.

Opportunities in the Indian Banking Sector

1. Digital Transformation
○ The rapid adoption of technologies like Artificial Intelligence (AI), Machine
Learning (ML), blockchain, and data analytics is transforming banking
operations.
○ Digital payment platforms like Unified Payments Interface (UPI) and Bharat
Interface for Money (BHIM) have revolutionized the way people transact,
reducing dependency on cash.
 ○ Internet banking and mobile banking applications enable customers to perform
transactions anytime, creating new avenues for banks to enhance their reach and
efficiency.
○ Focus on cybersecurity is rising due to increased risks associated with digital
transactions.
2. Financial Inclusion
○ Government schemes like Pradhan Mantri Jan Dhan Yojana (PMJDY) aim to
provide every household with access to a bank account, fostering inclusion.
○ Banks are tapping rural and semi-urban markets with low-cost banking services
through microfinance, payment banks, and banking correspondents.
○ With rural development programs, banks have opportunities to expand their
services in untapped regions.
3. Corporate Banking and MSME Lending
○ The government’s emphasis on the growth of the MSME sector, which is a
significant contributor to employment and GDP, offers opportunities for banks to
lend to small businesses.
○ Initiatives like Mudra Loans under the Micro Units Development and Refinance
Agency (MUDRA) promote entrepreneurship.
○ With increasing demand for working capital, corporate banking is becoming more
competitive, and banks can leverage this to generate revenue through customized
services.
4. Green and Sustainable Banking
○ Banks are playing a vital role in financing renewable energy projects such as
solar, wind, and hydroelectric energy.
○ Green bonds, a form of debt instrument to fund eco-friendly projects, are gaining
traction in India.
○ Emphasis on sustainable banking practices and environmental risk assessments
aligns banks with global sustainability goals, creating new business opportunities.
5. Wealth Management and Investment Banking
○ The rising disposable income of India’s middle and upper classes has created
demand for wealth advisory services.
○ Banks are offering solutions for investment in mutual funds, stocks, insurance,
and retirement planning.
○ The growing popularity of Initial Public Offerings (IPOs) and mergers &
acquisitions (M&A) is providing opportunities in investment banking.
6. Foreign Direct Investment (FDI)
 ○ The government has eased FDI norms in the banking sector, encouraging foreign
investment and partnerships.
○ Entry of foreign banks brings global expertise, enhancing the competitiveness of
the Indian banking industry.
○ Collaboration between Indian and foreign banks leads to innovation in products
and services.
7. Non-Performing Assets (NPA) Resolution
○ High levels of NPAs in Indian banks have led to opportunities in asset
reconstruction and debt recovery businesses.
○ The Insolvency and Bankruptcy Code (IBC) provides a structured mechanism for
resolving bad debts, making it easier for banks to recover funds.
○ Banks are leveraging specialized agencies and technology to manage and reduce
their NPA burden effectively.
8. Expansion of Digital Financial Services
○ The rise of neo-banks (digital-only banks) is reshaping the banking landscape by
offering seamless, app-based financial services.
○ Collaborations between traditional banks and fintech companies create innovative
solutions for lending, payments, and investment.
○ With 5G and affordable smartphones, the reach of digital banking is expected to
grow significantly.
9. Increased Focus on Customer Experience
○ Banks are leveraging data analytics and AI to understand customer preferences
and offer personalized products and services.
○ Automation through chatbots and AI-powered systems is streamlining customer
interactions, making banking faster and more efficient.
○ User-friendly apps and portals improve customer satisfaction, helping banks
retain and attract clients.
10.Globalization of Indian Banks
● Indian banks are expanding to global markets to serve the Indian diaspora and tap
international business opportunities.
● Global trade and foreign exchange services provided by Indian banks help in boosting
cross-border transactions.
● Partnerships with foreign banks enable Indian banks to gain exposure to global banking
practices and bring those innovations back home.
The Indian banking sector is evolving rapidly, driven by technological advancements,
government initiatives, and changing customer preferences. By leveraging these opportunities,
banks can achieve growth, expand their customer base, and enhance their operational efficiency.