Banking Sector Part – I

By admin August 1, 2019 15:28

Banking in India

In India, the “Bank” is defined in the Banking Regulation Act, 1949 as ‘a banking company is a company which transacts the business of banking in India; accepting, for the purpose of lending or investing, of  deposits of money from the public, repayable on demand or otherwise, and withdrawal, by cheque, draft, order or otherwise.’

The main functions of commercial banks are accepting deposits from the public and advancing them loans.

However, besides these functions there are many other functions which these banks perform. All these functions can be divided under the following heads:

  1. Accepting deposits
  2. Giving loans
  3. Overdraft
  4. Discounting of Bills of Exchange
  5. Investment of Funds
  6. Agency Functions
  7. Miscellaneous Functions
  8. Accepting Deposits

Various sections of society, according to their needs and economic condition, deposit their savings with the banks. It may be as

  1. Current Deposits
  2. Fixed Deposits
  3. Saving Deposits

(a) Current Deposits:

  • The depositors of such deposits can withdraw and deposit money whenever they desire.
  • Since banks have to keep the deposited amount of such accounts in cash always, they carry either no interest or very low rate of interest.
  • These deposits are called as Demand Deposits because these can be demanded or withdrawn by the depositors at any time they want.

(b) Fixed Deposits:

  • These are the deposits which are deposited for a definite period of time.
  • This period is generally not less than one year and, therefore, these are called as long term deposits.
  • These deposits cannot be withdrawn before the expiry of the stipulated time and, therefore, these are also called as time deposits.
  • These deposits generally carry a higher rate of interest because banks can use these deposits for a definite time without having the fear of being withdrawn.

(c) Saving Deposits:

  • In such deposits, money upto a certain limit can be deposited and withdrawn once or twice in a week.
  • On such deposits, the rate of interest is very less.
  • As is evident from the name of such deposits their main objective is to mobilise small savings in the form of deposits.
  1. Giving Loans:
  • The second important function of commercial banks is to advance loans to its customers.
  • Banks charge interest from the borrowers and this is the main source of their income.
  • Banks advance loans not only on the basis of the deposits of the public rather they also advance loans on the basis of depositing the money in the accounts of borrowers.
  • In other words, they create loans out of deposits and deposits out of loans. This is called as credit creation by commercial banks.
  • Modern banks give mostly secured loans for productive purposes.
  • In other words, at the time of advancing loans, they demand proper security or collateral.
  • Generally, the value of security or collateral is equal to the amount of loan.
  • This is done mainly with a view to recover the loan money by selling the security in the event of non-refund of the loan.
  • At limes, banks give loan on the basis of personal security also. Therefore, such loans are called as unsecured loan.

Types of loans and advances:

(a) Cash Credit:

  • In this type of credit scheme, banks advance loans to its customers on the basis of bonds, inventories and other approved securities.
  • Under this scheme, banks enter into an agreement with its customers to which money can be withdrawn many times during a year.

(b) Demand loans:

  • These are such loans that can be recalled on demand by the banks.
  • The entire loan amount is paid in lump sum by crediting it to the loan account of the borrower, and thus entire loan becomes chargeable to interest with immediate effect.

(c) Short-term loan:

  • These loans may be given as personal loans, loans to finance working capital or as priority sector advances.
  • These are made against some security and entire loan amount is transferred to the loan account of the borrower.

3 Over-Draft

  • Banks advance loans to its customer‘s upto a certain amount through over-drafts, if there are no deposits in the current account.
  • For this banks demand a security from the customers and charge very high rate of interest.
  1. Discounting of Bills of Exchange
  • This is the most prevalent and important method of advancing loans to the traders for short-term purposes.
  • Under this system, banks advance loans to the traders and business firms by discounting their bills.
  • In this way, businessmen get loans on the basis of their bills of exchange before the time of their maturity.
  1. Investment of Funds
  • The banks invest their surplus funds in the following types of securities—
  • Government securities
  • Other securities
  • Government securities include both, central and state governments, such as treasury bills, national savings certificate etc.
  • Other securities include securities of state associated bodies like electricity boards, housing boards, debentures of Land Development Banks units of UTI, shares of Regional Rural banks etc.
  1. Agency Functions
  • Banks function in the form of agents and representatives of their customers. The important functions of these types are as follows:
  • Banks collect cheques, drafts, bills of exchange and dividends of the shares for their customers.
  • Banks make payment for their clients and at times accept the bills of exchange of their customers for which payment is made at the fixed time.
  • Banks pay insurance premium of their customers. Besides this, they also deposit loan installments, income-tax, interest etc. as per directions.
  • Banks purchase and sell securities, shares and debentures on behalf of their customers.
  • Banks arrange to send money from one place to another for the convenience of their customers.
  1. Miscellaneous Functions

Besides the functions mentioned above, banks perform many other functions of general utility which are as follows:

  • Banks make arrangement of lockers for the safe custody of valuable assets of their customers such as gold, silver, legal documents etc.
  • Banks give reference for their customers.
  • Banks collect necessary and useful statistics relating to trade and industry.
  • For facilitating foreign trade, banks undertake to sell and purchase foreign exchange. \
  • Banks advise their clients relating to investment decisions as specialist
  • Banks does the under-writing of shares and debentures also.
  • Banks issue letters of credit.
  • During natural calamities, banks are highly useful in mobilizing funds and donations.
  • Banks provide loans for consumer durables like Car, Air-conditioner, and Fridge etc.

Banking Structure in India

India’s banking system mainly consists of

  1. Scheduled
  2. Non-scheduled banks

Scheduled banks consist of

  1. Scheduled commercial banks
  2. Scheduled cooperative banks

The scheduled commercial banks are divided into following categories:

  1. Public sector banks (which are further classified as nationalised banks and State Bank of India [SBI] banks);
  2. Private sector banks (which are further classified as old private sector banks and new private sector banks that emerged after 1991);
  3. Foreign banks in India; and,
  4. Regional rural banks (which operate exclusively in rural areas to provide credit and other facilities to small and marginal farmers, agricultural workers, artisans, and small entrepreneurs).

Scheduled Bank

  • All banks which are included in the Second Schedule to the Banking Regulation Act of 1965 are scheduled banks.
  • These banks comprise Scheduled Commercial Banks and Scheduled Cooperative Banks.
  • These banks are eligible for certain facilities such as financial accommodation from RBI and are required to fulfill certain statutory obligation.
  • The Banks satisfying the following conditions are only included in the Second Schedule


  1. That the Bank’s paid up capital plus free reserves are not less than Rs. 5.00 lakh, and
  2. That the affairs of the Bank are not conducted to the detrimental interest of the depositors.

The RBI is empowered to exclude any bank from the schedule whose:

  1. Aggregate value of paid up capital and reserves fall below Rs 5 lakh
  2. Affairs are conducted in a manner detrimental to the interests of depositors
  3. Goes into liquidation and ceases to transact banking business

It may be noted presently, the RBI has prescribed a minimum capital of Rs. 100 crores for starting a new commercial bank.

Non-scheduled banks

  • Non-scheduled banks are those banks which does not come under the Schedule of the Banking Regulation Act of 1965 and, thus, do not satisfy the conditions laid down by that schedule.
  • At present, there are few Non-scheduled Local Area Banks present, such as:

Coastal Local Area Bank Ltd

Capital Local Area Bank Ltd

Krishna Bhima Samruddhi Local Area Bank Ltd

Subhadra Local Area Bank Ltd.

  • Non-scheduled banks are further divided into two classifications
    1. Non-scheduled cooperative banks
    2. Non-scheduled commercial banks
  • Difference between Scheduled and Non-scheduled banks
Scheduled Banks Non-Scheduled Banks
Scheduled banks follow the rules made by the RBI Non-scheduled banks do not follow the rules made by the RBI.
Non-scheduled banks are listed under second schedule to the Reserve Bank of India Act, 1934. Scheduled banks are not listed under Reserve Bank of India Act, 1934.
Scheduled banks are allowed to borrow money from RBI for their day to day needs. Non-Scheduled banks do not have such facility.
Scheduled Banks need to maintain the Cash Reserve Ratio (CRR) with RBI. Non-Scheduled banks also need to maintain the Cash Reserve Ratio but with themselves only (not with RBI).


Commercial Banks

  • Commercial banks are financial institutions that accept demand deposits from the general public, transfer funds from the bank to another, and earn profit..
  • Commercial banks play a significant role in fulfilling the short-term and medium- term financial requirements of industries.
  • Commercial banks also act as moneylenders, by way of installment loans and overdrafts.
  • Commercial banks also allow for a variety of deposit.
  • These institutions are run to make a profit and owned by a group of individuals.

Cooperative Banks

  • Beginning of cooperative banks was provided by the establishment of cooperative credit societies “to encourage thrift, self-help and cooperation among agriculturists, artisans and persons of limited means.”
  • These banks are Run by the elected members of a managing committee and registered under the Cooperative Societies Act, 1912.
  • These are no-profit, no-loss banks and mainly serve entrepreneurs, industries, small businesses, and self-employment.
  • Co-operative banks operate in both urban and non-urban areas.
  • In the urban centers, they mainly finance entrepreneurs, small businesses, industries, and self-employment and cater to home buying and educational loans.
  • Co-operative banks in the rural areas primarily cater to agricultural-based activities, which include farming, livestock’s, dairies and hatcheries etc.
  • They also extend loans to small scale units, cottage industries, and self-employment activities like artisanship.

 Difference between Cooperative Banks and commercial banks

Co-operative Banks Commercial Banks
Cooperative banks are governed by Co-operative Societies Act of respective state and Banking regulation act, 1949. Commercial banks are governed by Banking Regulation Act, 1949.
Goal of these banks is self help and mutual benefit Main goal of these banks is profit generation.
Borrowers of these banks get the status of  its shareholders. Borrowers of these banks only gets the status of account holders.
Loans provided by these banks are relatively cheaper than commercial banks. Commercial banks provide loans on the basis of market sentiments and competition
Cooperative banks have a 3-tier model i.e. state Co-operative at the apex level, central/district co-operative  banks at the middle level and primary co-operative banks at the lower level. Commercial banks have no such tiers, they have branch system to increase their reach.
Cooperative banks functions within the boundary of the allocated region Commercial banks are not tied to any regional boundary line.


Examples of commercial banks are: SBI, PNB, BOB, ICICI and HDFC etc.

Examples of Co-operative banks are: Andhra Pradesh State Co-operative Bank Ltd, The Bihar State Co-operative Bank Ltd, Chhatisgarh Rajya Sahakari Bank Maryadit,The Goa State Co-operative Bank Ltd, The Gujarat State Co-operative Bank Ltd, Haryana Rajya Sahakari Bank Ltd etc.

Private Sector Banks

  • These are banks majority of share capital of the bank is held by private individuals.
  • These banks are registered as companies with limited liability.
    • There are two types of private sector banks in India viz.
    • Old Private Sector Banks such as ING Vysya Bank, Federal Bank, Dhanlaxmi Bank Etc.
    • New Private Sector Banks such as HDFC Bank, IndusInd Bank, Bandhan Bank Etc.

Foreign Banks

  • These banks are registered and have their headquarters in a foreign country but operate their branches in our country.
  • As on January 31, 2018, there were 45 foreign banks with branch present in India.

Wholly Owned Subsidiary (WOS) model

In 2013, RBI released the roadmap for foreign banks operating in India. At that time all foreign banks in India were operating through the branch model. This road map provided following guidelines:

  • Those foreign banks which have commenced banking business in India through a branch mode after August 2010 shall convert into a wholly owned subsidiary.
  • In case of foreign banks which are operating in India before August 2010 shall have the option either to continue their banking business through the branch mode or to convert those branches into a WOS?
  • New foreign bank can enter into Indian market in the form of a Company, which shall be wholly owned subsidiary (WOS) of the foreign bank.
  • WOS looking to enter into mergers and acquisition transactions with any private sector bank in India would be permitted, subject to regulatory approvals, to the overall foreign investment limit of 74%.
  • RBI said it will treat foreign banks operating in the country on nearly equal terms with local lenders if they move to a wholly owned subsidiary structure.

Challenges faced by foreign banks in India

Despite the rush of deposits after demonetisation, foreign banks’ deposits grew only 1.4 per cent against industry growth of 11.8 per cent. Foreign banks are also reducing their branch count, or at least, not opening new ones, due to the following reasons.

  • By 2019, all foreign banks have to give 40 per cent of their loans to the priority sector, at par with locally incorporated lenders.
  • Bank’s shareholding has to be diversified in India, and no individual shareholder can hold more than 10 per cent.
  • Licenses for foreign banks are harder to come by due to the complexities involved. Apart from regulatory issues, licenses to foreign banks are issued on the basis of relations between India and the home country of the foreign bank, and reciprocal arrangements between the banking regulators of both countries. This results in a wide time gap from applying for and eventually getting the license.

Public Sector Banks

  • Public sector banks are the ones in which the government has a major holding.
  • They are divided into two group’s i.e.
  1. Nationalized Banks
  2. State Bank of India and its associates.
  • Among them, there are 19 nationalized banks and State Bank of India and its 6 associates that has now merged into a single umbrella unit SBI in April, 2017.
  • Public Sector Banks dominate about 75% of deposits and more than 70% of advances in the banking industry.
  • The banks were also intended to mobilise and channelize rural savings for supporting productive activities in the rural areas. However, with effect from 22 March 1997, the RRBs were allowed to lend outside the target group by classifying their advances into Priority Sector and others.
  • In general, RRBs are commercial banks but they adopt some of the principles of cooperatives such as location in areas, work for rural population in a limited area etc.
  • Thus they are hybrid institutes. RRBs operate under the control of two institutions,
  1. National Agricultural Bank and Rural Development (NABARD)
  2. Reserve Bank of India (RBI)

Emergence of Nationalised Banks in India

  • Public sector in the banking industry emerged with the nationalization of Imperial Bank of India (1921) and creating the State Bank of India (1955) as a part of integrated scheme of rural credit proposed by the All India Rural Credit Survey Committee (1951).
  • In 1959, eight banking companies functioning in formerly princely states were acquired by the SBI, which later came to be known as Associate Banks.
  • Later, two of the subsidiary banks, viz., the State Bank of Bikaner and Jaipur were merged to form the State Bank of Bikaner and Jaipur (SBBJ), thus form eight banks in the SBI group.
  • State Bank of Bikaner and Jaipur(SBBJ), State Bank of Hyderabad (SBH). State Bank of Mysore (SBM), State Bank of Patiala (SBP) and State Bank of Travancore (SBT), besides Bharatiya Mahila Bank (BMB), merged with SBI with effect from April 1,2017.
  • With this merger, SBI has joined the league of top 50 banks globally in terms of assets.

The Public sector in the Indian banking got widened with two rounds of nationalization-

  1. First in July 1969 of 14 major private sector banks each with deposits of Rs.50 crore or more, and thereafter
  2. Second in April 1980, 6 more banks with deposits of not less than Rs. 2 Crore each.

Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank.

It was the only merger between nationalised banks and resulted in the reduction of the number of nationalised banks from 20 to 19.

Therefore, currently there are following 19 nationalised banks in India as per the RBI website.

  1. Allahabad Bank
  2. Andhra Bank
  3. Bank of Baroda
  4. Bank of India
  5. Bank of Maharashtra
  6. Canara Bank
  7. Central Bank of India
  8. Corporation Bank
  9. Dena Bank
  10. Indian Bank
  11. Indian Overseas Bank
  12. Oriental Bank of Commerce
  13. Punjab & Sind Bank
  14. Punjab National Bank
  15. Syndicate Bank
  16. UCO Bank
  17. Union Bank of India
  18. United Bank of India
  19. Vijaya Bank

Objectives of Nationalisation of Banks

  • The main aim of nationalizing the banks in India was to make it reach its clients in rural areas and be able to provide them with quality services.
  • The stated reason for the nationalisation was to give the government more control of credit delivery. With the second step of nationalisation, the GOI controlled around 91% of the banking business in India.
  • Since 1969, PSBs began to play a large and dominant supplementary role to the government programmes in alleviating poverty, employment creation and generation of fresh resources for development.

Branch Expansion

  • After nationalization of major banks, there had been massive branch expansion, primarily with the objective of covering the unbanked centres in rural and semi-urban centres, coupled with intensive branch network in metro urban centres to sustain profitability.
  • In the decade that followed 1990 (reform period) it was felt that haphazard growth should be contained and there should be qualitative network in branch banking.
  • The Narasimham Committee-I recommended that branch licensing be abolished and the matter of opening and closing branches are left to commercial judgment of individual banks.

This recommendation was partly implemented.

  • Although branch licensing has not been abolished, greater operational freedom has been given to individual banks to open certain specialized branches as well as expanding branches in a more systematic way in its geographical spared.
  • Of late, the banking system has been increasingly looking towards technology-based delivery channels and progressive reduction of physical branches to the extent possible.

Why nationalization was necessary?

Nationalization of banks in India generated a controversy that can be understood as follows;

  • The public deposits in the banks have increased so much that it is unsafe to leave them in the private hands.
  • Banks by advancing loans to the speculators and non- priority sectors can play havoc with the economy of the country.
  • Furthur, banks are the custodians of the public money but they were in private hands.
  • Some directors of the banks used to utilize funds for their personal benefit by entering into partnership with some business they would sanction loans and get profits. Thus public money was used for personal profit.
  • More importantly, agriculture and cottage industries were to be financed in order to give a fillip to them. This could be done if the government had a control over the disbursement of Banks’ loans.
  • Hence, in a welfare state a government cannot left over the matters that is not in the public interest and harmful to the national development.
  • Banks, thus, used to advance loans to the individuals or non- priority sectors. So banks were nationalized in the larger interests of the nation.
  • And nationalization is in accordance with our national policy of adopting socialistic pattern of society.
  • But the objection raised against nationalization is that it has resulted in inefficient working of the banks.
  • No denying the fact the initiative which the private entrepreneur can take is not possible in a nationalized organization.
  • But can government risk the economy of the country and the public money for the sake of efficiency?
  • Rather it is imperative to make the banking system more efficient and strong to fulfill the need of all the section of society, especially the weaker section.
  • Also currently, banking sector is not performing as it was aspired but government have taken many initiatives to reform the banking sector.

Finally, there are 6 key reasons on why the nationalisation of banks was necessary:

  1. Social Welfare

Sectors such as agriculture, small and village industries were in need of funds for their expansion and further economic development

  1. Controlling Private monopolies

It was necessary to check the private monopolies in order to ensure a smooth supply of credit to socially desirable sections.

  1. Expansion of Banking

It was necessary to spread banking across the country.

It could be done through expanding the banking network (by opening new bank branches) in the un-banked areas. 

  1. Reduce Regional Imbalance

With an urban-rural divide, it was necessary for banks to go in the rural areas where banking facilities were not available.

  1. Priority Sector lending

Nationalisation was urgently needed for catering funds to the agriculture sector and its allied activities.

  1. Developing Banking Habits

In India, more than 70 % of the population used to stay in rural areas. It was necessary to develop a banking habit among such a large population

Cooperative Banks in India

  • Cooperative bank is an institution established on the cooperative basis and dealing in ordinary banking business.
  • While commercial banks accounts for overwhelming share of the banking business, cooperative banks also play an important role.
  • Initially set up to supplant indigenous sources of rural credit, particularly money lenders, today they mostly serve the needs of agriculture and allied activities, rural-based industries and to a lesser extent, trade and industry in urban centres.
  • The history of Indian cooperative banking started with the passing of Cooperative Societies Act in 1904. The objective of this Act was to establish cooperative credit societies “to encourage thrift, self-help and cooperation among agriculturists, artisans and persons of limited means.”
  • The Cooperative Societies Act, 1912 recognised the need for establishing new organisations for supervision, auditing and supply of cooperative credit.

Structure of Cooperative Banking in India

Short term credit structure of Cooperative Banking

In rural India, there exists a 3-tier short-term rural cooperative structure.

  1. Tier-I includes State Cooperative Banks (SCBs) at the state level;
  2. Tier-II includes Central Cooperative Banks (CCBs) at the district level; and
  3. Tier- III includes Primary Agricultural Credit Societies (PACSs).

In majority of states this 3 tier structure exists whereas in many states only 2 tier structure exists i.e. SCBs and PACSs.

State cooperative banks

State cooperative banks are the apex institutions in this 3-tier structure of Cooperative credit.

  • It provides a link between RBI and cooperative at the lower level, ultimately facilitating the rural financing.
  • They finance, control and supervise the central cooperative banks, and primary credit societies through them.
  • Their main source of deposit are cooperative societies and central cooperative banks, individuals, local bodies and others
  • Their source of borrowing is mainly from Reserve Bank and the remaining from state governments and others.
  • Their major part of lending is to cooperative societies for the purpose of agricultural purposes.

Central Cooperative Banks (CCBs)

CCBs are at the mid-level of cooperative structure.

  • Their major source of funds include own funds, deposits, borrowings and other sources.
  • Deposits largely come from individuals and cooperative societies.
  • Their lending consists of 98% loans to cooperative societies mainly for the purpose of agriculture.
  • About 80 per cent loans given to the cooperative societies are unsecure and the remaining loans are given against the securities

Primary agricultural societies

  • It is a village-level institution, providing assistance directly to the rural society.
  • It accepts deposits in rural areas, gives loans to the needy borrowers and collects repayments.
  • A primary agricultural credit society may be started with 10 or more persons of a village. The membership fee is nominal so that even the poorest agriculturist can become a member.
  • The working capital of the primary credit societies comes from their own funds, deposits, borrowings and other sources.
  • Deposits are received from both members and non- members. Borrowings are mainly from central cooperative banks.

Long term cooperative banking

Land Development Banks (LDBs) or Cooperative Agricultural and Rural Development Banks (CARDBs)

Land development banks were established for the purpose of satisfying the long-term capital needs of the rural society for repaying old debts, for purchasing agricultural machinery and other implements.

It has a 2 tier structure:

  1. state cooperative agricultural and rural development banks (SCARDBs) at state level
  2. Primary cooperative agricultural and rural development banks (PCARDBs) at local level.

In few states there are no PCARDBs.

Funds: Land development banks raise their funds from share capital, reserves, deposits, loans and advances, and debentures.

Loans: LDBs provides loans for (a) for redemption of old debt, (b) for improvement of land and methods of cultivation, (c) purchasing costly machinery, and (d) in special cases, for purchasing land.

Challenges ahead of cooperative banking

  • Technology adoption is slow and not uniform across the country. In some District Central Cooperative Banks (DCCBs)/State Cooperative Banks (StCBs), the gains from implementing Core Banking Solutions( CBS) are yet to be realised by way of introduction of new technology enabled products and services
  • Cooperative are facing the challenges of inadequately qualified manpower and are lacking customer grievance resolution mechanism.
  • Recruitment of youth in 18-35 years is minimal.
  • Due to personnel not being tech savvy with high age profile and lower qualifications, changing the orientation of the Human Resource Development is becoming more challenging for delivering new age banking facilities in a sustainable manner.
  • The Board of Directors are often not effective in taking prudent business decisions in the interest of banks.

Regional Rural Banks (RRBs)

  • Regional Rural Banks (RRBs) had been established in 1975 to take the banking services to the doorsteps of rural masses especially in remote rural areas with no access to banking services.
  • The main objective were to meet the financial and banking needs of weaker sections of the rural areas with a special attention on small and marginal farmers, agricultural labourers, artisans, landless farmers, small traders, tint enterprises etc.
  • These banks were originally intended to provide institutional credit to those weaker sections of the society at concessional rate of interest, who depend on private money-lenders.
  • They are regulated by the Reserve Bank and supervised by the NABARD.
  • The area of operation of RRBs is limited to the area as notified by Government of India covering one or more districts in the State.
  • By end-March 2018, 90 per cent of the loan portfolio of RRBs comprised priority sector loans, with agriculture accounting for 76.1 per cent, followed by micro, small and medium enterprises (14.0 per cent).
  • There is a network of 21,747 branches with 56 Regional Rural banks at end-March 2018.

Government measures for Regional Rural Banks (RRBs)

Recapitalisation of RRBs

  • Union Cabinet has approved extension of scheme of recapitalization of Regional Rural Banks (RRBs) for next three years (up to 2019-20).
  • The scheme was started in 2010-11 and was extended twice in the year 2012-13 and 2015-16.
  • Total amount of Rs. 1107.20 crore, as Central Government share, out of Rs. 1450 crore, was released to RRBs up to March, 2017 under recapitalisation.
  • The remaining amount of Rs.342.80 crore will be utilized to provide recapitalization support to RRBs whose CRAR is below 9%, during the extended three years period.
  • It will ensure strong capital structure and minimum required level of CRAR.

Consolidation of RRBs

Government initiated consolidation of regional rural banks along with the public sector lenders and intends to bring down their number to 36 from the existing 56.

Consolidation of RRBs has been taken to:

  • Minimise their overhead expenses
  • Optimise the use of technology
  • Enhance the capital base and area of operation
  • Better scale-efficiency and higher productivity

Small Finance Banks in India

Small Finance Banks (SFBs) have been set up to deepen financial inclusion by catering to clientele such as migrant labourers, low income households, small businesses and other unorganised sector entities.


  • Resident individuals/professionals with 10 years of experience in banking and finance;
  • Companies and societies owned and controlled by residents
  • Existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) that are owned and controlled by residents can also opt for conversion into small finance banks.
  • Promoters should have asound track record of professional experience or of running their businesses for at least a period of five years.


  • The small finance bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganised sector entities.
  • There will not be any restriction in the area of operations of small finance banks.

Promoter’s capital

The promoter’s minimum initial contribution to the paid-up equity capital of such small finance bank shall at least be 40 per cent and gradually brought down to 26 per cent within 12 years from the date of commencement of business of the bank.

Some of the operational Small Finance Banks in India are as follows.

  • Ujjivan Small Finance Bank.
  • Janalakshmi Small Finance Bank.
  • Equitas Small Finance Bank.
  • A U Small Finance Bank.
  • Capital Small Finance Bank.

So far, three SFBs have listed on the stock markets—Equitas Financial Holdings Ltd, Ujjivan Financial Services Ltd and AU Small Finance Bank

Payment banks

  • Payment Banks (“PB”) are to be registered as public limited companies under the Companies Act, 2013 and are to be licensed under Sec 22 of the Banking Regulation Act, 1949.
  • PBs are to be given the status of scheduled banks under the section 42 (6) (a) of the Reserve Bank of India Act, 1934.


PBs can accept demand deposit but maximum allowed limit is Rs. 1 Lakh per customer.

They can

  • Issue ATM/debit cards but not credit cards.
  • Provide Payments and remittance services through various channels
  • act as Business Correspondents (“BCs”) of another bank
  • Undertake utility bill payments etc. on behalf of its customers and the general public.

Difference between Payment banks and Small Finance Banks

Why banks are highly regulated in India?

The main reasons why the banks are heavily regulated are as follows:

  • To protect the safety of the public‘s savings.
  • To control the supply of money and credit in order to achieve a nation‘s broad economic goal.
  • To ensure equal opportunity and fairness in the public‘s access to credit and other vital financial services.
  • To promote public confidence in the financial system, so that savings are made speedily and efficiently.
  • To avoid concentrations of financial power in the hands of a few individuals and institutions.
  • Provide the Government with credit, tax revenues and other services.
  • To help sectors of the economy that they have special credit needs for e.g. Housing, small business and agricultural loans etc.

Decline in Efficiency of PSBs

  • Over a period of time, the financial health of PSBs continually to deteriorate resulting in decline in their efficiency.
  • Since so many obligations, economic and social, are imposed on PSBs, it was thought, that their performance should not be judged merely in terms of profits.
  • During 1992-93 and 1993-94 these banks actually posted huge losses to the amount of Rs. 3,513 crore and Rs. 4,705 crore respectively.
  • It is possible to defend the low profitability by referring to their commitment to social obligations imposed by the Government.
  • That were as for instance, opening rural branches in large numbers, financing poverty alleviation programmes at concessional rates of interest, priority sector lending to the extent of 40 per cent huge NPAs, etc.
  • As a result of their involvement in social banking and other factors such as directed investment, the state of health of these banks left much to be desired.
  • It can also assume that prior to reform period, profitability was not considered as the prime objectives of PSBs.

Role of Banks in Indian Economy

  • According to joint report prepared by KPMG-Confederation of Indian Industry (CII), Indian banking sector is poised to become fifth largest by 2020.
  • The report also states that bank credit is expected to grow at a compound annual growth rate of 17 per cent in coming years.
  • Today, the banking sector is one of the biggest service sectors in India.
  • The focus of banks has shifted from customer acquisition to customer retention by providing various products like internet banking, ATM services, telebanking and electronic payment etc.

Banks can contribute to a country’s economic development in the following ways:

  1. Removing the deficiency of capital formation
  • In any economy, economic development is not possible unless there is an adequate amount of capital formation.
  • A sound banking system mobilizes small savings of the community and makes them available for investment in productive enterprises.
  1. Helps in generating employment opportunity
  • While revenue and employment generation are two very important contributions, successfully maintaining healthy credit line to industrial sector as well as to overall economy is another important contribution of financial sector.
  1. Financial assistance to Industries
  • The commercial banks provide short-term, medium-term and long-term loans to industry.
  • The Industrial Development Bank of India is the main institution in India providing financial assistance to the industrial sector.
  • Moreover, Micro Units Development & Refinance Agency (MUDRA) Ltd. was also established to refinance all Micro-finance Institutions (MFIs).
  1. Promote saving Habits of the people
  • Bank attracts depositors by introducing attractive deposit schemes and providing higher rates of interest. It enables to create saving habits among people.


  1. Financial assistance to Consumer Activities
  • The commercial banks advance loans to consumers for the purchase of such items as houses, furniture, refrigerators, etc.
  • In this way, they also help in raising the standard of living of the people in developing countries by providing loans for consumption activities.
  1. Helps in implementing Monetary Policy
  • RBI depends upon the commercial banks for the success of its policy of monetary management in keeping with requirements of a developing economy.
  • Thus the commercial banks contribute much to the growth of a developing economy by granting loans to agriculture, trade and industry, by helping in capital formation and by following the monetary policy of the country
  1. Financial facilities for Trade
  • The commercial banks help in financing both internal and external trade.
  • Banks provide all types of facilities such as discounting and accepting bills of exchange, providing overdraft facilities, issuing drafts, etc. for promoting the trade.
  • Moreover, they finance both exports and imports of developing countries by providing foreign exchange facilities to importers and exporters of goods.
  • Exim Bank of India and the Government of Andhra Pradesh has signed a Memorandum of Understanding (MoU) to promote exports in the state.
  1. Foreign Currency Loans
  • Foreign currency loans are meant for setting up of new industrial projects.
  • Banks also helps in providing loans for expansion, diversification, modernization or renovation of existing units.
  • Banks also helps in financing import of equipment from abroad and/or technical knowhow
  1. Promotion of New Entrepreneurs
  • Development banks in India have also achieved a success in creating a new class of entrepreneurs and spreading the industrial culture.
  • Special capital and seed Capital schemes have been introduced to provide equity type of assistance to new and technically skilled entrepreneurs who lack financial resources of their own.
  1. Balanced Development
  • A developed banking system enables the country to attain balanced development without any special consideration of rich and poor, cities and rural areas etc.
  • It helps a country to spread banking activities in rural and semi urban areas.
  • With the spreading of banking operations all over the country, helps to attain balanced regional development by promoting rural areas.
  • They transfer surplus capital from the developed regions to the less developed regions, where it is scarce and most needed.
  • Modern banks spreading its operations throughout the world,like Citibank, SBI, PNB, Baroda bank etc.
  1. Financial assistance to agriculture sector
  • Agriculture is the backbone of economy of any country like India. They provide loans to traders in agricultural commodities.
  • They open a number of branches in rural areas to provide agricultural credit.
  • They provide finance directly to agriculturists for the marketing of their produce, for the modernisation and mechanisation of their farms, for providing irrigation facilities, for developing land, etc.
  • The small and marginal farmers and landless agricultural workers, artisans and petty shopkeepers in rural areas are provided financial assistance through the regional rural banks in India.
  1. Government Spending
  • Commercial banks also support the role of the federal government as an agent of economic.
  • Generally, commercial banks help fund government spending by purchasing bonds issued by the Department of the Treasury.

Consolidation of Banks

  • Mergers and acquisitions in India were initiated as per recommendations of the Narasimham committee II. Recommendations of the committee were based on the idea that one single entity is better than many bits and parts.
  • The merger must enable better economical and commercial growth of institutions and in turn should serve the nation more efficiently.
  • The state-run Bank of Baroda has become India’s second largest commercial bank after Vijaya Bank and Dena Bank amalgamated with Bank of Baroda.

Benefits of merger

Merging of banks help in:

  • strengthening the bargaining power of banks
  • reduce operational expenditure
  • improve supervision
  • enhancing  capital efficiency,
  • recover bad debts


Challenges of merger

  • The biggest challenge in PSB merger is to cut costs, bring efficiencies, improve profit per branch and profit per employee.
  • The merged entity would not necessarily get benefit of efficiencies. The PSBs have a very high-cost structure. Take for example, in the BoB-Dena and Vijaya Bank, the Dena Bank has a very high cost to income ratio, which is an indicator of cost efficiency, of 67.52 per cent as against BoB’s 45.56 per cent.
  • There are issues with hierarchy of the organization and employee benefit schemes in the merged or consolidated structure. For example, it is necessary to consider the provision of adequate system in order to define seniority levels of employees of merging banks in the consolidated system.
By admin August 1, 2019 15:28