Learning Unit BOB LU1_SLU1.1-1.

2
Sub LU Title Evolution of Money & Evolution of
Banking
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Introduction:

1. Money has a long and interesting history. In the distant past, money was very different from what
we now see and perceive it to be. The changes happened with time, dictated by the needs of the
people of each era.
Let us understand the evolution and journey of money over the years.

2. Banking is a commercial activity India has known from ancient times. But banks as
commercial institutions came into existence only in the second half of the eighteenth
century. Since then, banks have grown in number and have evolved, creating a banking
system with different types of banks. The creation of a central bank – RBI – and the policies
of RBI and the Government of India have shaped the evolution of the banking industry.
Initially, all banks were initially privately owned. But after independence, the Government
of India felt key sectors of the economy were starved of bank credit. This led to the
nationalisation of many major banks in the private sector. Two decades later, it was found
that the government-run banks enjoyed an unhealthy monopoly. To bring in an element of
competition and modern practices, new banks were encouraged to be set up in the private
sector. To increase rural lending, Regional Rural Banks, were set up in the public sector in
1975. In 2015, to strengthen financial inclusion and lending to micro and small units,
privately-owned Small Finance Banks were given licences. And for the first time, in the
same year, licences were issued for a special type of banks in the private sector that could
undertake banking operations but were barred from lending. Clearly, evolution in the
banking industry is a continuous process, and with changing needs of the economy, the
banking system will only further evolve.

Let us further understand the evolution of banking in India in detail.

Learning Objective
At the end of this unit, you will be able to
 Outline the evolution of money
 List the history of metal coins and paper money
 Explain how the Central Bank‘s prerogative in issuing paper currency
 Explain the evolution of banking in India
 Identify the segments of the Indian banking system
Knowledge
 Definition of Money
 Money is best defined by its function or what it does.
 It is ‘anything that is widely used for making payments and accounting’.
 Money has substituted the earlier barter system where one item was exchanged for the other.
 Money slowly evolved as ‘store of value’, ‘common measure of value’, ‘means of payment’, ‘medium
of exchange’ etc.
 Money was identified through various metallic coins, animal skins and later through the paper.
 Now, the Government of India issues coins and the Reserve Bank of India issues notes.
These notes are called currencies which were backed by silver and later by gold and now by the
assurance of the Central Banks to pay an equivalent amount in the same paper money.

 Evolution of Money

 Long ago, ownership of cattle represented wealth. The social need for gifting led to cattle being used
for the transfer of wealth. Commerce or exchange of goods and services was through means of
“barter system” – exchange of one commodity for the other. Suppose, someone had cattle and
desired to have food grains, the only means was to exchange his cattle for food grains. The English
words “capital”, “chattel” and “cattle” appear to have a common root. This also indicates that cattle
were viewed as capital or wealth and used as money.
 This system was found to be advantageous initially. But it suffered from certain fundamental
disadvantages. The main disadvantages were valuation and easy transferability. Arriving at an
acceptable valuation for each transaction was a herculean task under the barter system. Once these
disadvantages were noticed and identified, there was a fresh impetus for the development of money,
as a commonly accepted measure of value. There is ample evidence to suggest that many other
things (apart from cattle), like beads, shells, eggs, ivory, nails, pigs, yarn etc. were used as money
from time to time. With crop cultivation making its advent as a means of livelihood, food grain also
came to be regarded as wealth and gained acceptability as a “medium of exchange” or popularly
known as “money”. The greatest advantage of grains as a common “measure of value” was because
of their measurability, storability, high value and easy transferability.

1. Metal Coins

 When precious metals were discovered, people began using them as money.
 The credit of using the metal coins first goes to the Lydians in Asia Minor.
 The metal coins, an amalgam of gold and silver, were first used by them as money in 687 BC. Then
this spread to Greece. Persia also followed suit in 550 BC when it captured Lydia. In 390 BC, the Gauls
attacked Rome. Rome was alerted by the cackling of geese and was able to defeat the Gauls and
protect their cash reserve.
 As thanksgiving, they built a temple to worship the “Goddess of Warning” – Moneta. This term
“Moneta” led to the evolution of terms like “Mint” and “Money”. The history of Greek cities tells us
that coinage was a civic emblem and to emboss the coins with the city’s badge proclaimed one’s
political independence or dominance. The monetary uniformity over much of the known world can
be attributed to the conquests of Alexander the Great, to a large extent.
 When Alexander captured Persia during 336 to 323 BC, in order to pay his soldiers, large stocks of
gold were converted into coins. He promulgated an order that 10 silver coins were equal to one gold
coin, bringing in the first “official exchange rate”.
 Convenience was the chief reason for coins gaining huge acceptability. They were accepted at their
nominal value and transactions involved counting rather than weighing.

 Paper Currency - Prerogative of Central Banks

 In the year 1694, Bank of England had been established as a Joint Stock Company, to arrange a loan
to the King. Due to his patronage, the Bank of England, during the 18th Century, emerged as the
Central Bank of the country. The other banks in the UK (which hitherto also had the authority of
issuing bank notes) surrendered this authority to the Bank of England. Their action stemmed from
their inability to manage the frequent “runs” on them. Thus, the issue of paper currency became the
prerogative of the Central Banks. In India too, RBI (which is the Central Bank) has the sole and
exclusive authority to issue currency notes.
 As paper does not have any intrinsic value, these paper notes (currency notes) were dependent upon
an underlying valuable commodity, to derive value. Initially, this valuable commodity was silver,
which backed the paper notes. In 1816, the world saw the birth of “gold standard” as Britain adopted
gold as the backing for paper currency in lieu of silver. The “gold standard” meant that the Bank of
England promised to exchange every currency (paper) note for a specified quantity of gold. Gold
Coins and Currency (Paper) Notes were in circulation.
 The gold standard was subsequently adopted by Germany (1871), France and Japan (1878) and also
by the USA (1900). This “gold standard” lasted till 1914 (outbreak of the First World War). In 1914,
Britain withdrew gold coins from circulation, and this sounded the death knell for the “gold
standard”. Britain abandoned the Gold Standard. Soon other European Countries which had adopted
“gold standard” also followed suit and only the USA continued to link its dollar to gold till 1973.
 The USA was the last to abandon the “gold standard”. Now, the currency (paper) notes are backed by
just a promise of the Central Banks to pay an equivalent amount in the same paper currency.
The coins and currency (paper) notes are also known as intangible money. This is because once the coins
and paper notes are deposited in a Bank account, they get converted into book entry, remaining intact,
backed by the bank’s assurance to return the same when demanded by the depositor.

2. Evolution of Banking

Banking in some form was present in ancient India. But it was confined to money lending and
safekeeping of cash and valuables. Later pawnbroking, nidhis and chit funds came into existence. But a
commercial bank as an institution came much much later in 1770 when Bank of Hindustan was
established in Kolkata. Subsequently, three Presidency banks were set up by the British East India
Company.

1. Bank of Calcutta in 1806 (renamed Bank of Bengal in 1809)

2. Bank of Bombay in 1840
3. Bank of Madras in 1843

In 1921, the above three banks were amalgamated, under the Imperial Bank of India Act, to form the
Imperial Bank of India. In 1935, RBI started its operations as a central bank of the country and as a
regulator. Let us now look at the other milestones in the evolution of banking in India.
 In 1904, the Cooperative Societies Act was passed, which led to the creation of cooperative banks
primarily for dealing with rural credit. This has a three-tier structure – primary credit society at
the village level, central cooperative banks at the district level and state cooperative banks at the
state level
 In 1955, with the passing of the SBI Act, the Imperial Bank of India became State Bank of India
with RBI acquiring a controlling interest.
 In 1959, the Government passed the State Bank of India (Subsidiary Banks) Act. This made eight
banks that had belonged to the princely states into subsidiaries of SBI. These were merged with
SBI by March 2017.
 Development financial institutions were set up to provide long term finance for infrastructure
projects and industries. In 1948, IFCI or the Industrial Finance Corporation of India was set up. In
1951, State Financial Corporations were set up in different states. In 1955, ICICI or the Industrial
Credit and Investment Corporation of India was set up followed by IDBI or the Industrial Bank of
India in 1964.
 In 1969, 14 major banks, which were privately owned, were taken over by the Government of
India to give greater thrust to all-round economic development. The next two decades witnessed
a huge expansion of the branch network in rural and semi-urban areas.
 In 1975, to increase lending in the rural areas, RRBs or Regional Rural Banks were set up. Each of
these banks is jointly owned by the Government of India, a public sector bank and a state
government.
 In 1980, another six privately owned banks were nationalised. The other banks in the private
sector continue to this day, except those of which got merged and are referred to as old
generation private sector banks.
 In 1994, RBI decided to permit setting up of banks in the private sector to inject an element of
competition in the banking industry which had come to be monopolised by public sector banks.
This resulted in the emergence of ‘new generation banks’ such as HDFC Bank, ICICI Bank, IDBI
Bank, UTI Bank (later renamed Axis Bank). These banks changed the face of the industry by
embracing technology in a big way and by being both customer and profit-oriented.
 In the years 1999 to 2001, Local Area Banks, with a mandate to set up branches in only 2-3
contiguous districts, came up in the private sector. Only four Local Area Banks are functioning
now. Coastal Local Area Bank, Vijayawada and Capital Local Area Bank, Phagwara are among
them.
 In 2002, ICICI was merged with ICICI Bank, and in 2004, IDBI was merged with IDBI Bank for
business reasons.
 In 2003, Kotak Mahindra Finance got a licence to convert itself into a bank, Kotak Mahindra Bank.
This was the first case of an NBFC becoming a bank. In 2004, another bank, Yes Bank, was set up
in the private sector.
 In 2015, Bandhan, which was into MFI business, got a licence to set up a bank. IDFC, now known
as IDFC First Bank, also got a licence in the same year.
 In 2015, RBI issued licences to 10 Small Finance Banks with the aim to strengthen financial
inclusion and to promote the financing of small business units, small and marginal farmers, micro
and small industries and entities in the unorganised sector. These banks are required to extend
75% of their lending to the priority sector.
 In 2015, RBI also issued licences to Payment Banks. Six of them, including Paytm Payments Bank,
India Post Payments Banks, Airtel Payments Bank, are operational. Payment banks can only
 accept deposits of up to Rs 1 lakh per customer in a savings/current account. They can issue
cheque books and debit cards. They cannot lend money or issue credit cards
 Foreign banks have been functioning in India since 1858 wen Standard Chartered Bank opened its
first branch in Kolkata. Over the years, many others set up branches in India. As of 31st May 2019,
46 foreign banks are present. Standard Chartered Bank has 100 branches, Citibank 35, HSBC 26
and Deutsche Bank 17.

3. Segments of Indian Banking Industry

The Indian Banking Industry can be classified as under

- Public sector banks
- Private sector banks
- Cooperative banks
- Foreign banks
- Regional Rural Banks
- Local Area Banks
- Small Finance Banks
- Payment banks

How Do You Apply?

1. Look at the currency note in your wallet. Place it in context with the evolution of money story.
Solution:
The currency note is paper money, which was first introduced in China. Bank of England became the first
Central Bank to issue paper currency. It was initially backed by gold, and subsequently, the gold standard
was dropped. Other Central Banks also took the same route. In India, RBI issues the currency notes.

2. A customer has a savings account in a payment bank as well as a commercial bank. What are the
differentiating factors between the two banks?

Solution –
The customer cannot keep more than ₹ 1 lakh in the payment bank, while there is no upper limit for
deposits in the commercial bank. The former cannot accept an FD, while the latter can. The former
cannot provide any loans while the latter can.

Check your understanding

1. Gold standard refers to
a. Money in the form of gold
b. Gold in monetary terms
c. Issue of currency notes backed by gold holding
d. High quality
Justification: Paper money derived its value from the gold against which it was issued.
 2. Currency notes do not have an intrinsic value.
a. True
b. False
Justification: It is just paper. Its value comes from the promise given by the central bank to pay
3. In India, coins are issued by
a. RBI
b. Government of India
c. State government
d. None of the above
Justification: As per Sec RBI Act Sec 22 the coins are issued by the Government of India

Summary
1. Money is ‘anything that is widely used for making payments and accounting’. Many things like beads,
shells, eggs, ivory, nails, pigs, yarn etc. were used as money across the ages.
2. Years ago, ownership of cattle represented wealth or money. Then came the barter system;
exchange of one commodity for the other. When precious metals were discovered, people began
using them as money.
3. China was the first country to introduce paper money. The next development was paper money
issued by a central bank against the backing of gold, called the gold standard.
4. The coins and currency (paper) notes are also known as intangible money. This is because once the
coins and paper notes are deposited in a Bank account, they get converted into book entry,
remaining intact, backed by the bank’s assurance to return the same when demanded by the
depositor.
5. Banking in India started with money lending and safekeeping.
6. Banking started in 1770, with the establishment of Bank of Hindustan. The Presidency Banks were set
up between 1806 and 1843. These were merged to form the Imperial Bank of India in 1921 and later
became State Bank of India.
7. Cooperative banks have been functioning since 1904 to meet rural credit needs. 14 private banks
were nationalised in 1969 and another 6 in 1980.
8. In 1994 and later, new generation banks - HDFC Bank, ICICI Bank, Axis Bank etc. – came into
existence. These Banks changed the face of the industry by embracing technology in a big way and by
being both customer and profit-oriented.
9. In 2015, 6 payment banks and 10 Small Finance Banks received licences.
10. Foreign banks have been functioning in India since 1858. There are 46 foreign banks as of 31 st May
2019.

Subject: Basics of Banking

Title of the SLU: 1.2

Evolution of banking and
Indian banking system