The story of India’s banking industry has been intertwined with the country’s nationalization. The government considered nationalizing selected private banks in India after the Reserve Bank of India (RBI) was nationalized in 1949 and a central banking system was established for the following major reasons:
- Because banks were owned and managed by the private sector, banking services were limited—the general public had no access to banking services.
- The government needed to allocate resources in a way that provided a greater public benefit. The economy’s planned development necessitated some government control over the capital generated by the economy. The following stages of bank nationalization occurred in India.
The emergence of the SBI
With the passage of the SBI Act in 1955, the Indian government partially nationalized the three Imperial Banks (which had 466 branches and mostly operated in the three previous Presidencies) and renamed them the State Bank of India, the country’s first public sector bank. In this partial nationalization, the RBI purchased 92 percent of the shares.
Satisfied with the experiment, the government used the SBI (Associates) Act, 1959 to partially nationalize eight more private banks (with strong regional presence) and rename them the Associates of the SBI—the RBI had also purchased a 92 percent stake in them. The State Bank of Bikaner & Jaipur was established later (by merging the State Bank of Jaipur and State Bank of Bikaner, as they used to operate in the same region). By 2017-18, the SBI and its Associates (7+1) had been merged into one bank, the SBI, as part of the banking consolidation process.
The emergence of Nationalised Banks
Following the success of partial nationalization, the government decided to pursue complete nationalization. The government nationalized 20 private banks with the help of the Banking Nationalisation Act of 1969:
- 14 banks with deposits were more than Rs. 50 crore nationalized in July 1969, and
- 6 banks with deposits were more than Rs. 200 crores were nationalized in April 1980.
The total number of nationalized banks fell to 19 after the loss-making New Bank of India merged with the Punjab National Bank (PNB) in September 1993. India will have 18 public sector banks (PSBs) by April 2020. The government began a process of merger and amalgamation of the PSBs in 2020 with the goal of streamlining their operation and size—after this process is completed, the number of PSBs will be reduced to only 12.
The government prohibited the establishment of private banks
Following bank nationalization, the government prohibited the establishment of private banks, though some foreign private banks were permitted to operate in the country to provide foreign currency loans. In the fiscal year 1992-93, India began a comprehensive banking system reform after ushering in the era of economic reforms. Three related developments allowed the banking industry in the country to expand further:
- In 1993 the SBI was allowed access to the capital market with permission given to sell its share to the tune of 33 percent through the SBI (Amendment) Act, 1993.
The government of India currently owns 59.73 percent of the SBI. (The Government of India acquired the RBI’s entire equity stake on July 9, 2007.) As a result, the RBI is no longer the SBI and its Associates’ holding bank.)
On October 10, 2007, the government announced its intention to sell SBI shares and reduce its stake in the bank to 53%, allowing the bank to pursue capitalization.
- In 1994 the government allowed the nationalized banks to have access to the capital market with a ceiling of 33 percent sale of shares through the Banking Companies (Amendment) Act, 1994.
Nationalized banks have used the capital market to boost their capital
Since then, many nationalized banks have used the capital market to boost their capital, the first being the Indian Overseas Bank. Despite the fact that such banks are better referred to as public sector banks (because the Indian government owns more than 50% of them), they are still referred to as nationalized banks.
- In 1994 itself the government allowed the opening of private banks in the country. The first private bank of the reform era was the UTI Bank. Since then dozens of Indian and foreign private banks have been opened in the country.
As a result, we’ve seen a shift in the country’s banking policies from 1993-to 94. The public sector and nationalized banks are to be converted into private sector entities as a general rule. What would be the bare minimum of government holdings in them is still up for debate and decision. 24 The government continues to pursue a bank consolidation policy in order for these institutions to broaden their capital bases and become significant players in the global banking market. Experts believe that any delay will harm their interests.
Regional Rural Banks
The Regional Rural Banks (RRBs) were established for the first time on October 2, 1975 (with only five branches) with the goal of bringing banking services to the rural masses, particularly in remote areas where there was no access to banking services, and with dual responsibilities to fulfill:
- to provide credit to the weaker sections of the society at concessional rate of interest who previously depended on private money lending, and
- to mobilize rural savings and channel them for supporting productive activities in the rural areas.
The Government of India, the concerned state government, and the sponsoring nationalized bank each contribute 50%, 15%, and 35% of the RRBs’ share capital, respectively. The RRB’s jurisdiction is limited to a few notified districts in each state.
The government stopped opening new RRBs in 1987, based on the Kelkar Committee’s recommendations; there were 196 at the time. By the early 1980s, these banks had incurred massive losses as a result of their excessive inclinations toward social banking and catering to the economically disadvantaged. The governments established two committees to restructure and strengthen banks: the Bhandari Committee (1994-95) and the Basu Committee (1996). (1995-96). From 1998-to 99, 171 of them were losing money when the government made some important decisions:
- The obligation of concessional loans was abolished and the RRBs started charging commercial interest rates on their lendings.
- The target clientele (rural masses, weaker sections) was set free now to lend to anybody.
RRBs began to emerge from the red/losses after the above-mentioned policy changes. The CFS recommends that they be merged with their managing nationalized or public sector banks, and that they eventually become part of India’s proposed three-tier banking structure. According to the RBI, there were 53 RRBs operating in the country by April 2020 (over 13 of them were in the process of amalgamation with their parent PSBs), which will be completely replaced by Small Banks in the future.
Commercial banks and cooperative banks are the two broad categories of banks in India. Commercial banks (nationalized banks, State Bank group, private sector banks, foreign banks, and regional rural banks) account for the vast majority of banking transactions, but cooperative banks play an important role as well. Founded to replace indigenous sources of rural credit, particularly money lenders, they now primarily serve the needs of agriculture and related activities, rural-based industries, and, to a lesser extent, urban trade and industry. A three-tiered structure exists in cooperative banks-
- Primary Credit Societies-PCSs (agriculture or urban),
- District Central Co-Operative Banks-DCCBs, and
- State Co-Operative Banks-SCBc (at the apex level).
UCBs & PCSs
UCBs & PCSs in urban areas that meet certain criteria can apply to the RBI for a banking license to operate as urban co-operative banks (UCBs). They are governed and registered under the respective states’ cooperative societies acts, as well as the Banking Regulation Act of 1949, putting them under dual regulatory control.
State governments control the administrative aspects of these banks, such as registration, management, administration, recruitment, amalgamation, and liquidation, while the RBI regulates banking matters.
UCBs have traditionally limited their operations to metropolitan, urban, or semi-urban areas, catering to the needs of small borrowers such as MSMEs, retail traders, small entrepreneurs, professionals, and salaried workers. However, there is no formal restriction, and UCBs can now operate throughout the district in which they are registered, including rural areas. Primary UCBs with deposits of over X50 crore are also permitted to operate in multiple states, subject to certain restrictions.
They have certain rights and obligations under the RBI Act, 1934 (2nd Schedule), including the ability to obtain refinance and loans from the RBI, as well as obligations such as maintaining cash reserves and filing returns with the RBI. There are currently 29 UCBs.
DCCBs & SCBs
They work at the district and state levels, as their names suggest. There can only be one DCCB per district, with multiple DCCBs reporting to the SCB. They were initially supervised by the RBI, which was later delegated to the NABARD.
Problems of these Banks
Cooperative banks play an important role in India’s financial system, but they have also faced some long-standing issues, which we will briefly examine:
- The UCBs are regulated by the RBI and the Registrar of Co-operative Societies (RCS) of their respective states, while the DCCBs and SCBs are regulated by NABARD, the RBI, and the RCSs. Given the close ties that exist between politicians and co-operatives, and the fact that the RCS is run by the state government, the dual (or triple) custody of co-operative banks has resulted in poor oversight and control. Furthermore, most cooperative banks lack expertise and skill.
- Recruitments are politicized as are appointments at most levels.
- Income recognition and prudential norms that were introduced for commercial banks in the early 1990s (under the process of banking reforms) are still to be this sector.
Cooperative banks have been in the news recently due to fraudulent transactions. Due to the multiplicity of federal regulatory controls, it is extremely difficult to hold these banks to prudential standards. Meanwhile, the Indian government announced (in the Union Budget 2017-18) that cooperative banks will be brought under the ‘core banking’ structure. Customers who use the core banking solution (CBS) can use the bank’s services across all branches rather than just the one where their account is held, making them bank customers rather than branch customers.
The Government introduced a Bill (Banking Regulation Amendment Bill, 2020) in Parliament in March 2020 to give the RBI more powers to regulate cooperative banks. The initiative was launched in the aftermath of the PMC Bank fraud, and it aims to strengthen cooperative banks by increasing professionalism, improving governance, and ensuring sound banking through the RBI.
Previous Year Questions for UPSC Prelims
Ques 1: With reference to India, consider the following : (UPSC Prelims 2010)
1. Nationalization of Banks
2. Formation of Regional Rural Banks
3. Adoption of villages by Bank Branches
Which of the above can be considered as steps taken to achieve “financial inclusion” in India?
a. 1 and 2 only
b. 2 and 3 only
c. 3 only
d. 1, 2 and 3
Answer: Option D
- Nationalization of Banks – It is a kind of action through which an entity of the private sector is transferred to the public sector. Hence the statement 1 is correct.
- Formation of Regional Rural Banks – Regional Rural Banks (RRBs) was established under the provisions of the Ordinance of 26 September 1975 and the RRB Act of 1976. Hence the statement 2 is correct.
- It was done so that banking and loan services can be provided for agriculture and other rural areas. It was started on 2 October 1975.
- Adoption of villages by Bank Branches – In India, the village adoption scheme was launched by the banks in 1960. Hence statement 3 is correct.
Ques 2: How many associate banks merged with the State Bank of India (SBI) in 2017?
Answer: Option C
Explanation: Five SBI associate banks along with Bhartiya Mahila Bank merged with SBI in April 2017.
Quick Questions on Nationalization of Banks for UPSC Preparation
What is Banking?
Banking is an industry that is known for handling financial activities such as cash, credit, deposits, investment, loans, and other kinds of financial transactions. It is important for the Indian economy as it provides safeguard to normal citizens by providing cash security, and credit security.
When was the first nationalization of banks done in India?
The First Bank in India to be Nationalized was Reserve Bank of India in 1949. The State Bank of India was nationalized in year 1955.
How many banks were nationalized in 1969?
14 banks that were nationalised banks in 1969: Allahabad Bank, Canara Bank, United Bank of India, UCO Bank, Syndicate Bank, Indian Overseas Bank, Bank of Baroda, Punjab National Bank, Bank of India, Bank of Maharashtra, Central Bank of India, Indian Bank, Dena Bank and Union Bank.
Where were 6 Banks Nationalized?
In 1980, 6 commercial banks were nationalized. These were Vijaya Bank Limited, Punjab and Sind Bank Limited, Oriental Bank of Commerce Limited, New Bank of India Limited, Corporation Bank Limited, Andhra Bank Limited.