I.

EVOLUTION OF BANKING IN INDIA

Modern banking in India could be traced back to the establishment of Bank of Bengal (Jan 2,
1809), the first joint-stock bank sponsored by Government of Bengal and governed by the royal
charter of the British India Government. It was followed by establishment of Bank of Bombay
(Apr 15, 1840) and Bank of Madras (Jul 1, 1843). These three banks, known as the presidency
banks, marked the beginning of the limited liability and joint stock banking in India and were
also vested with the right of note issue.
In 1921, the three presidency banks were merged to form the Imperial Bank of India, which had
multiple roles and responsibilities and that functioned as a commercial bank, a banker to the
government and a bankers bank. Following the establishment of the Reserve Bank of India
(RBI) in 1935, the central banking responsibilities that the Imperial Bank of India was carrying
out came to an end, leading it to become more of a commercial bank. At the time of
independence of India, the capital and reserves of the Imperial Bank stood at Rs 118 mn,
deposits at Rs 2751 mn and advances at Rs 723 mn and a network of 172 branches and 200 sub
offices spread all over the country.
In 1951, in the backdrop of central planning and the need to extend bank credit to the rural areas,
the Government constituted All India Rural Credit Survey Committee, which recommended the
creation of a state sponsored institution that will extend banking services to the rural areas.
Following this, by an act of parliament passed in May 1955, State Bank of India was established
in Jul, 1955. In 1959, State Bank of India took over the eight former state-associated banks as its
subsidiaries. To further accelerate the credit to fl ow to the rural areas and the vital sections of the
economy such as agriculture, small scale industry etc., that are of national importance, Social
Control over banks was announced in 1967 and a National Credit Council was set up in 1968 to
assess the demand for credit by these sectors and determine resource allocations. The decade of
1960s also witnessed significant consolidation in the Indian banking industry with more than 500
banks functioning in the 1950s reduced to 89 by 1969.
For the Indian banking industry, Jul 19, 1969, was a landmark day, on which nationalization of
14 major banks was announced that each had a minimum of Rs 500 mn and above of aggregate
deposits. In 1980, eight more banks were nationalised. In 1976, the Regional Rural Banks Act
came into being, that allowed the opening of specialized regional rural banks to exclusively cater
to the credit requirements in the rural areas. These banks were set up jointly by the central
government, commercial banks and the respective local governments of the states in which these
are located.

The period following nationalisation was characterized by rapid rise in banks business and
helped in increasing national savings. Savings rate in the country leapfrogged from 10-12% in
the two decades of 1950-70 to about 25 % post nationalisation period. Aggregate deposits which
registered annual growth in the range of 10% to 12% in the 1960s rose to over 20% in the 1980s.
Growth of bank credit increased from an average annual growth of 13% in the 1960s to about
19% in the 1970s and 1980s. Branch network expanded significantly leading to increase in the
banking coverage.
Indian banking, which experienced rapid growth following the nationalization, began to face
pressures on asset quality by the 1980s. Simultaneously, the banking world everywhere was
gearing up towards new prudential norms and operational standards pertaining to capital
adequacy, accounting and risk management, transparency and disclosure etc. In the early 1990s,
India embarked on an ambitious economic reform programme in which the banking sector
reforms formed a major part. The Committee on Financial System (1991) more popularly known
as the Narasimham Committee prepared the blue print of the reforms. A few of the major aspects
of reform included (a) moving towards international norms in income recognition and
provisioning and other related aspects of accounting (b) liberalization of entry and exit norms
leading to the establishment of several New Private Sector Banks and entry of a number of new
Foreign Banks (c) freeing of deposit and lending rates (except the saving deposit rate), (d)
allowing Public Sector Banks access to public equity markets for raising capital and diluting the
government stake,(e) greater transparency and disclosure standards in financial reporting (f)
suitable adoption of Basel Accord on capital adequacy (g) introduction of technology in banking
operations etc. The reforms led to major changes in the approach of the banks towards aspects
such as competition, profitability and productivity and the need and scope for harmonization of
global operational standards and adoption of best practices. Greater focus was given to deriving
efficiencies by improvement in performance and rationalization of resources and greater reliance
on technology including promoting in a big way computerization of banking operations and
introduction of electronic banking.
The reforms led to significant changes in the strength and sustainability of Indian banking. In
addition to significant growth in business, Indian banks experienced sharp growth in profitability,
greater emphasis on prudential norms with higher provisioning levels, reduction in the non
performing assets and surge in capital adequacy. All bank groups witnessed sharp growth in
performance and profitability. Indian banking industry is preparing for smooth transition towards
more intense competition arising from further liberalization of banking sector that was envisaged
in the year 2009 as a part of the adherence to liberalization of the financial services industry.
II. STRUCTURE OF THE BANKING INDUSTRY
According to the RBI definition, commercial banks which conduct the business of banking in
India and which (a) have paid up capital and reserves of an aggregate real and exchangeable

value of not less than Rs 0.5 mn and (b) satisfy the RBI that their affairs are not being conducted
in a manner detrimental to the interest of their depositors, are eligible for inclusion in the Second
Schedule to the Reserve Bank of India Act, 1934, and when included are known as Scheduled
Commercial Banks. Scheduled Commercial Banks in India are categorized in five different
groups according to their ownership and/or nature of operation. These bank groups are (i) State
Bank of India and its associates, (ii) Nationalised Banks, (iii) Regional Rural Banks, (iv) Foreign
Banks and (v) Other Indian Scheduled Commercial Banks (in the private sector). All Scheduled
Banks comprise Schedule Commercial and Scheduled Co-operative Banks. Scheduled
Cooperative banks consist of Scheduled State Co-operative Banks and Scheduled Urban
Cooperative Banks.
Banking Industry at a Glance
In the reference period of this publication (FY06), the number of scheduled commercial banks
functioning in India was 222, of which 133 were regional rural banks. There are 71,177 bank
XIV offices spread across the country, of which 43 % are located in rural areas, 22% in semiurban areas, 18% in urban areas and the rest (17 %) in the metropolitan areas. The major bank
groups (as defined by RBI) functioning during the reference period of the report are State Bank
of India and its seven associate banks, 19 nationalised banks and the IDBI Ltd, 19 Old Private
Sector Banks, 8 New Private Sector Banks and 29 Foreign Banks.
Table 1: Indian Banking at a Glance

Source: Reserve Bank of India

Table 2: Number of Banks, Group Wise

Source: Indian Banks Association/ Reserve Bank of India.

* Includes Industrial Development Bank of India Ltd.
Table 3: Group Wise: Comparative Average

Source: Reserve Bank of India.

Table 4: Bank Groups: Key Indicators

Source: Reserve Bank of India.

Mergers & Acquisitions

During FY06, two domestic banks were amalgamated - Ganesh Bank of Kurundwad with
Federal Bank Ltd and Bank of Punjab Ltd with Centurion Bank Ltd to become Centurion Bank
of Punjab Ltd, while one Foreign bank UFJ Bank Ltd merged with Bank of Tokyo-Mitsubishi
Ltd. ING Bank NV closed its business in India. In Sept, 2006, The United Western Bank Ltd was
placed under moratorium leading to its amalgamation with Industrial Development Bank of India
Ltd. in Oct, 2006. On Apr 1, 2007, Bharat Overseas Bank an old private sector bank was taken
over by Indian Overseas Bank and on Apr 19, 2007, Sangli Bank, another old private sector bank
was merged with ICICI Bank, a new private sector bank.
Shareholding Pattern
As of Mar 2006, only four Nationalised Bank had 100% ownership of the Government. These
are Central Bank of India, Indian Bank, Punjab and Sind Bank and United Bank of India. As of
Mar 2006, the government shareholding in the State Bank of India stood at 59.7% and in
between 51-77% in other nationalised banks. In Feb 2007, Indian Bank came out with a public
issue thus leaving only three nationalised banks having 100% government ownership. Foreign
institutional holding up to 20% of the paid up is allowed in respect of Public Sector Banks
including State Bank of India and many of the banks have reached the threshold level for FII
investment. In respect of Private Sector Banks where higher FII holding is allowed, threshold
limit has been reached in the leading banks.
III. INDIAN BANKING AND INTERNATIONAL TRENDS
When compared to other emerging markets, the growth of Indian banking has been impressive
and compares favorably on several counts. A recent study by Bank for International Settlements
on the progress and the prospects of banking systems in emerging countries highlights the
following features of the performance of Indian banks:

Average growth rate of real aggregate credit in India rose from 6.1% during the period
1995- 99 to 14.6 % in 2000-04.

The average growth rate of real aggregate credit in India during 2000-04 in India is
higher as compared to major countries and regions in the emerging markets, such as
China (13.3%), Other Asia (4.7%), Latin America (4.5%), and Central Europe (9.6%).

Commercial banks in India account for a major share of the bank credit (97%) as
compared to Latin America (68%), Other Asia (74%) and Central Europe (83%).

Real bank credit to the private sector has shown sustained growth in India, and has
moved from 3.9% a year in 1990-94 to 6.9% a year in 1995-99 to 13.5 % a year in 200004. In 2005, real bank credit to the private sector in India showed a growth of 30% yearon-year as against 9.4% in China and 15.8% in emerging markets.

In India, during the period 1999 and 2004, non-performing loans as a percentage of total
commercial bank assets came down from 6.1% to 3.3%, capital asset ratios moved up
from 11.3% to 12.9% and operating costs as a percentage of total assets reduced from
2.4% to 2.3%. NPAs in China in 2004 stood at 6%.

In India, return on assets of banks during the period 1999-2004 moved up from 0.4% to
1.1%, and return on equity from 8.5% to 20.9% where as in China the former rose from
0.1% to 0.3%.

IV. BUSINESS OF COMMERCIAL BANKS

1. Balance Sheet Growth
In FY06, the aggregate balance sheet of the scheduled commercial banks increased by
18.4%, over a 19.3 % growth registered in FY05. The ratio of bank assets to GDP rose to
86.9% as compared to 82.8% in FY05. Banking industry gained from the by rapid rise in
the real economy, leading to surge in several areas of business.
2. Capital and Reserves
The capital of the scheduled commercial banks as on Mar 31, 2006 stood at Rs 252040
mn. During FY06, reserves and surplus of all scheduled commercial banks rose by
27.6%. Revenue and other reserves nearly doubled for the banks as a whole, with SBI
reporting four fold increase in this regard.
3. Deposits and Advances
Deposits of SCBs grew by 17.8 % in FY06 as against 16.6% in FY05, but the advances
growth outstripped this pace with a rise of 31.8% in FY06, over a 33.2% growth in FY05.
As per a recent RBI report, FY06 was the second consecutive year, when increase in
credit in absolute terms was more than the absolute increase in aggregate deposits.

Table 5: Deposits/Advances/Investments of Bank Groups in India (In Rs mn)

Source: Reserve Bank of India

4. Group-wise Performance
The growth in deposits across the different bank groups showed substantial variation.
Public Sector Banks with a deposit growth of 12.9% and Old Private Sector Banks with
11.4% showed a relatively subdued growth in deposits where as the New Private Sector
Banks with 50.7% and Foreign Banks with 31.7% showed a sharp rise. Borrowings of the
Public Sector Banks grew at 24%, but that of the Foreign Banks was much higher (30%).
Due to redemption of the India Millennium Deposits in Dec 2005, banks non-resident
foreign currency deposits showed a sizeable decline. Loans and advances growth too was
on similar trends. For Public Sector Banks, loan growth was 29.5% as compared to
34.9% in FY05, for Old Private Sector Banks, it was 21.5% as against 22.7% in the
previous year, for New Private Sector Banks it was 50.2 % as against 33% in FY05, and
for Foreign Banks it was 29.5% as against 24 % in FY05. In the non-food credit, apart
from retail credit which grew at 40.9%; infrastructure (24%), basic metals (14.1%) and
textiles (11.2%) were the other major sectors that received higher levels of incremental
credit.
5. Growth in Retail Lending
While total credit of the SCBs grew at 31% in FY06, credit to the new segments in the
retail banking showed still higher growth rates. In FY06, loans to housing rose by 33.4%,
credit card receivables by 47.9%, auto loans by 75%, and other personal loans by 39.1%
taking the growth of retail loans during the FY06 to 40.9%. Retail loans in FY06
constituted 25.5% of the total loans and advances of scheduled commercial banks.
Lending to sensitive sectors also rose significantly. Loans to capital market rose by

39.2%, to real estate markets by 81.78% and to commodities by 85.56% with the growth
in these three segments reaching to 77.65% in FY06.
Table 6: Advances to Sensitive Sectors as a percentage to Total Loans

Source: Reserve Bank of India

6. Priority Sector Advances
Credit to priority sector increased at a robust rate of 33.7% in FY06 on the top of 40.3%
in the previous year. A major portion of the credit growth in the priority sector is
accounted by agriculture and housing. Credit to SSI also grew sizeably.
Table 7: Priority Sector Lending

Source: Reserve Bank of India.

Figures in brackets are annual growth rate in %
7. Market Share
The share of Public Sector Banks showed deceleration in respect of major areas of
business, where as that of the new private sector and Foreign Banks earned higher share

of business. The market share of the Old Private Sector Banks too came under pressure.
Public Sector Banks hold 75% market share in major areas of business.
Table 8: Major Components of Business, Bank GroupWise (in %)

Source: Reserve Bank of India

* Industrial Development Bank of India Ltd
** Includes Industrial Development Bank of India Ltd
8. Access to Equity Markets
Banks have been increasingly accessing primary equity capital markets for raising
resources. In FY06, resource mobilization of banks through public equity markets rose by
24%. Resources raised by banks from public equity markets showed continuous increase,
from Rs 24560 mn in FY04 to Rs 89220 mn in FY05 to Rs 110670 mn in FY06.
Encouraged by the response to banks stocks, eleven banks, six in the public sector and
five in the private sector, raised Rs 110670 mn from the equity markets. The Public
Sector Banks which raised equity from the capital markets included Allahabad Bank,
Oriental Bank of Commerce, Syndicate Bank, Andhra Bank, Bank of Baroda and Union
Bank of India. The five Private Sector Banks were Lakshmi Vilas Bank Ltd, Yes Bank
Ltd, ICICI Bank Ltd., The South Indian Bank Ltd and The United Western Bank Ltd. The
size of the share issue of these banks was Rs 6270 mn where as the premium was at Rs
104400 mn. Banks also tapped private placement market for resource mobilization in a
big way by raising Rs 301510 mn of which Public Sector Banks accounted for 74%.
Bank stocks also emerged as an important portfolio for investment giving significant
returns. Returns from bank stocks as measured through BSE Bankex rose from 28.6% in
FY05 to 36.8 % in FY06 as compared to the benchmark index. Bank stocks still have
scope for further growth with lower valuation prevailing at present in many banks.

Source : Bombay Stock Exchange.

9. Asset Quality
There is a perceptible increase in the quality of bank assets. Standard assets as percent of
all assets for scheduled commercial banks moved from 94.9% in FY05 to 96.7% in FY
06, with decline in reported sub standard, doubtful and loss assets. The proportion of
standard assets rose across all the bank groups in FY06, showing improved management
of assets by banks. According to a report of the Reserve Bank of India, the gross non
performing assets of the scheduled commercial banks declined by Rs 73090 mn over and
above the decline of Rs 65610 mn in FY05.
As on 31 Mar 2006, gross NPAs of scheduled commercial banks stood at Rs 518150 mn
of which 26.4% are with State Bank group, 53% with the nationalised banks, 7.1% with
the Old Private Sector Banks, 7.3% with the New Private Sector Banks and 3.7% with the
Foreign Banks.
Scheduled commercial banks stepped up recovery efforts through numerous methods. In
addition to their own internal recovery processes, banks recovered to the tune of Rs 6080
mn through one-time settlement and compromise schemes, Rs 2230 mn though Lok
Adalats, Rs 47100 mn through Debt Recovery Tribunals and Rs 34230 mn through
SARFAESI Act. Asset Reconstruction Company of India Ltd (ARCIL) acquired 559
cases amounting to Rs 211260 mn from banks.
Table 9: Asset Classification in Banks (as % of Total Assets)

Source: Reserve Bank of India

10. Distribution of Network
The expansion in the distribution network of the banks is increasingly evident from the
growth of the automated teller machines. There is a surge in the growth of off-site ATMs
with their share in the total ATMs rising to 32% in respect of Public Sector Banks, 67% in
State Bank group, 32% in Old Private Sector Banks, 63% in New Private Sector Banks
and 73% in Foreign Banks. Computerisation of public sector bank branches is also
moving at rapid pace. In 2007 the pace of computerization progressed much further.
Public Sector Banks have 93 branches operating abroad in 26 countries. All scheduled
commercial banks together have 106 branches abroad.

Table 10: Branches/ATMs/Staff in Banks (Number)

Source: Reserve Bank of India

11. Major Trends in Business
Indian banking, in addition to improvements in performance and efficiency, has also
experienced significant changes in the structure of asset and liabilities. The major
changes on the liabilities side include relatively higher growth of demand deposits over
time deposits, and also, within time deposits, greater preference for short term over the
longer term deposits. The share of demand deposits in total deposits increased from
14.7% in FY01 to 17% in FY06. The share of short term deposits in total time deposits
increased from 43.8% in FY00 to 58.2% in FY06. The narrowing of interest rate spread
between short and long term deposits has reduced the preference for long term deposits.
Banks are moving away from investments to loans due to more lending opportunities
offered by the higher economic growth. The rate of bank credit growth which was at
14.4% in FY03 rose sharply to reach 30% each in the FY05 and FY06. Bank credit has
picked up momentum on the back of rising growth of real economy. A period of low
interest rates induced banks to shift their preference from investments to advances, which
led to the share of gross advances in total assets of all commercial banks reaching 54.7%
in FY06 from 45% in two years prior to that.

The sectors towards which the bank credit was directed has also shown significant
changes. Retail loans witnessed growth of over 40% in the last two years, and began
driving the credit growth to a significant extent. Retail loans as a percentage of Gross
Advances rose from about 22% in FY04 to 25.5% in FY06. Within the retail loans,
housing segment showed the highest growth of 50% in FY05 and 34% in FY06. As per
the RBI data, banks direct exposure to commercial real estate more than doubled in
FY06.
Despite sharp rise in the credit growth, improved risk management processes and
procedures of banks contained the surge in bad debts which is evident from the lower
levels of incremental nonperforming assets reported by the banks as also the rise in the
proportion of standard assets. Further improvement in risk management systems could
provide banks with more opportunities in expanding credit and pursuing higher levels of
growth in retail lending.