The banking history of the Indian started in 1870, the year that Bank of Hindustan was founded. Until 1921, the first central bank Imperial Bank of India was found. However, it was only provide limited central bank functions.
The first fully functioned central bank in India, Reserve Bank of India ("RBI") was formed not until in 1934. Interestingly it was not a state owned bank at the time of formation. The India Government gained the control of RBI in 1949 under the Banking Regulations Act after the independence of India. From 1960s to 1980s, RBI had taken over more than 30 non-state owned banks. As a result, the Indian Government was under the domination of the banking industry in India, even in today. The nationalization at that time was aiming at building up confidence for the Indian citizens and foreign investors under the unstable economy condition.
In view of the recession in the industrial, import and export sectors in the 1990s, the Indian government has reformed the banking sector. New banking products and facilities were allowed in the market and trade policies and banking practices were evolved. One of the notable new policies was the introduction of market-driven exchange rate system. In mid 1990s, new private bank sectors was approved to be set up in the market as to promote a healthy competition. Later, advanced facilities in modern banking, such as electronic funds transfer, debit and credit clearing through e-banking, were also brought to India Banks.
Types of Financial Institutions in India Nowadays
The Indian banking system comprises of five major institutions namely, (1) the Reserve Bank of India, (2) Commercial Banks, (3) Co-operative Banks, (4) Development Financial Institutions and (5) Non-Bank Financial Companies [1] , in which commercial Banks and co-operatives Banks can be sub-divided into scheduled and non-scheduled types.
Scheduled Bank vs Non-Scheduled Bank
A commercial bank or a cooperative bank can be classified as scheduled bank if it can comply with the two requirements provided by section 42 of the Reserve Bank of India Act. A scheduled bank must have at least 500 thousand Rupees in both its share capital account and reserves account. It also has to prove to the satisfaction that the interest of the depositors will be protected by the bank. [2]
A scheduled bank can enjoy the following preferential treatments:-
Eligible for obtaining debts/loans on bank rate from the RBI [3]
Become a member of the clearing house [4]
A scheduled bank could often be treated as a goodwill for a bank operating in the India.
The Central Bank of India, Reserve Bank of India ("RBI")
The Preamble of the Reserve Bank of India describes the basic functions of the RBS as:-
"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." [5]
In general terms, RBI has the following six functions [6] :-
Holding the monetary authority by formulating, implementing and monitoring the monetary policy and also stabilize the price of the Indian currency. RBI maintains a healthy flow of credit to productive sectors.
Being the Regulator and supervisor of the financial system. RBI sets the broad parameters of banking operations for India's banking and financial system functions. It assures the creditability of the Indian banks and protects the creditors and the depositors. It also provides quality banking service
Monitoring the foreign exchange market pursuant to Foreign Exchange Management Act. RBI facilitates promote foreign trade and transaction executions. It develops and maintains the foreign exchange market for India.
Issue the Indian currency, Rupees.
Develop the banking section or India. Arranging promotion.
Provide financial facilities or banking services to the Indian Government
Maintains banking accounts for the scheduled banks.
Currently, RBI also has controlling interest in a numerous of commercial banks business.
Commercial Banks in India
Commercial banks mainly serve corporate clients. They provide wide spectrum of financial services ranging from saving and time deposits, long and short term financing (loans or bond), to letters of credit, etc. There is no exhaustive definition for the term commercial bank. Having said that, it is a normal business term referring to a banking business which is not a retail banking or investment banking.
Currently more than 80% of the bank assets in the Indian banking sector are owned by the scheduled commercial banks. The definition of the term "scheduled banks" is discussed in the early section of this memo.
Commercial banks in India are generally categorized with reference to the origin of investments. They are categorized into public sector banks, private sector banks, foreign banks and regional rural banks.
Public sector banks are the banks with the Indian Government or the RBI holding the controlling interest. It is the biggest sector in terms of assets and having approximately 75% of the total assets in the Indian Banking industry.
Though public sector banks are the major banking in India, they are often blamed for old fashioned corporate governance, poor risk management, weak financial position as appeared in the face of the financial statements, having large amount of unrecoverable debts / bad assets. Their percentage of net profitable asset has been declining since the nineteen centaury without any indication of rebound.
In 1990s, partial privatization was started to be allowed and has been used to raise fund for the public sector banks. After the pass of the Banking Regulation Act, the privatized interest must not be larger than 49% of the total equity of the public sector banks. Therefore, the Indian Government or the RBI still can keep at least 51% controlling interest in the each public sector banks.
Private sector banks are owned by local private investors. Private sector banks had existence since the pre-independence era of India. At present, private sector banks in India include leading banks like ICICI Banks, ING Vysya Bank, Jammu & Kashmir Bank, Karnataka Bank, Kotak Mahindra Bank, SBI Commercial and International Bank, etc. [7]
Compared with the public sector banks, private sector banks have better management and more advanced banking technologies. As a result, private sector banks are more efficient and are often commented as more customer friendly. However, private sector banks are only confined to operate in certain regions of India. [8]
Foreign banks are banks with foreign controlling interest. Their entering has been injecting the latest banking technology and culture to India and was one of the greatest impacts in the Indian banking history.
Development of the foreign bank sector in India is currently one of the most important policies of the Indian Government. The Indian Government has been releasing sets of new policies to facilitate the expansion of the foreign bank sector in India. The expansion plan includes two phases. [9] The first phase was already over and was in the period from March 2005 to March 2009. In this period, foreign banks were allowed to set up wholly owned subsidiaries in India. They also might consider transforming their existing Indian branch to wholly owned subsidiaries. The second phase commenced right after the first phase and is in fact a health check review of the first phase which emphasis on reviewing (1) the possibility of extension setup period of the wholly owned subsidiaries, (2) dilution of stake and (3) possibilities of M&A activities of the private sector banks in India by a foreign bank.
Regional Rural Banks mainly provide banking services to the rural population. The rural population is often the less affluent class in India and mainly is small and marginal farmers, agricultural workers, artisans and small entrepreneurs, who are engaged in trade, commerce or other productive activities.
Regional rural banks are often fund by the RBI or some public sector banks. RBI also provides several preferential policies to the regional rural banks such as lower interest rates, lower cash ratio, lower statutory liquidity ratio, lower rate of interest on loans taken from sponsoring banks etc as a concession to the lower income class [10] .
Co-operative Banks
Co-operative banks are banks provide services to their members and can be viewed as big credit union organizations. RBI can only exert limited control on the co-operative banks. They are important banks in the rural areas of India, especially important to the lower income class population which normal bank may not provide credit to them. Co-operative banks are sub-grouped into (1) urban co-operative banks and (2) rural co-operative credit institutions. The former mainly provide banking services to middle and lower income class including small scale business and self-employment in urban and semi-urban areas. The latter provide banking services to agricultural industry.
Development Financial Institutions
Development financial institutions provide strategic financial services to special classes. For instance, Export Import Bank of India provides banking services to exporters and importers whilst National Housing Bank provides housing financing services.
Conclusion
As a foreign investor, this is the appropriate time to enter the Indian market as other major competitors in the foreign bank sector still do not have a long history in India. We can consider first setting up a wholly foreign owned subsidiary / branch in India and following by take over a local private bank sector aiming at localize our client base at the fastest pace. Our action should be taken as soon as possible or otherwise our international based client will choose to t as most of them have the expansion plan in India in this decade.
