An Overview of the Banking Sector of India

An Overview of the Banking Sector of India

Background

Decades ago, the Indian Government strictly regulated the allocation of credit. The government introduced lending rate controls, imposed high liquidity requirements, and established state banks for industry and agriculture. The government over regulated and discriminated against risk capital, financial markets, and non bank financial institutions. Consequently, foreigners played a limited role in India's financial markets.

However, in recent years, the limited success of banking institutions urged governments to reform the current financial sector and move from bank financed development to equity financed development. The Indian Government began financial market reform in the mid 80s. The progress was slow at first but later we see a prominent outcome (Subitha, 1997, p.10-13)

Introduction

India, a booming country with its financial sector beginning to open up in the 90s, has attracted significant amount of investments from foreign banks and companies. The liberalization movement of the banking industry of India and financial reform in 1993 provided valuable opportunities for foreign investments. "Citigroup said last February that it will invest more than half a billion dollars in its Indian operations in 2006; in 2005, it pumped $415 million into its operations there. Others writing expansion checks in India include HSBC, Bank of America, Standard Chartered Bank and Deutsche Bank" (Kingsbury, 20th September, 2007). In the followings, we will discuss the present structure of the banking system in India by looking into different types of banks operating in India, their functions and their recent activities.

The Central Bank

The Reserve Bank of India (RBI) is the Central Bank of India. It forms, implements and monitors the monetary policy such as controlling the money supply, credit and interest rates, to maintain price stability and ensure adequate flow of credit to productive sectors. It acts as the regulator and supervisor to the financial system so as to maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. It manages the Foreign Exchange Management Act, 1999 to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. It is responsible for issuing currency and performs a wide range of promotional functions to support national objectives. It also acts as the banker to the governments and provides commercial banking services to the central and state governments. Under the aegis of the RBI, a Board for Financial Supervision was set up in 1994 to supervise banks the activities of all banks, including domestic, foreign and non-banking finance companies (NBFCs). It requires banks to submit consolidated financial statements annually and consolidated prudential reports half-yearly.

Domestic Banks

There are currently 28 private domestic banks operating in India. The State Bank of India, the Bank of India and the Bank of Baroda operate most of the country's bank branches in financial centres abroad. The State Bank of India is by far the largest bank which controlled 15.04% of the lending market in the fiscal year 2005/06. ICICI Bank, the largest private-sector bank, was a public-sector financial institution that was corporatized and later merged with its commercial-bank subsidiary. It is now jointly owned by Indian and foreign banks. It has a joint-venture asset-management company and a life insurance company, both in partnership with Prudential of the UK. It also has a non-life-insurance joint venture with Lombard Canada and numerous other subsidiaries, including a venture-capital arm.

The domestic banking system includes 19 "old" private-sector banks, which accounted for 5.4% of the total commercial bank assets in 2006. Some are publicly listed and their small capital bases make them attractive takeover targets. The net profits of these private domestic banks have doubled in 2006 compared with the previous year.

The RBI has issued revised guidelines for the entry of private banks into the market in 2001. A new bank needs an initial paid-up capital of Rs2 bn, rising to Rs3 bn within three years of the beginning of business. The Increased competition causes banks to consider forming alliances. For example, ICICI merged with the old, traditional private-sector Bank of Madura in March 2001; the public-sector Punjab National Bank took over the old private-sector Nedungadi Bank in February 2003.

On the other hand, savings, mortgage and co-operative banks are small and do not constitute a significant source of funds for most companies. Co-operative banks and regional rural banks tend to finance relatively small scale rural sectors the rural and are restricted to geographic locations. Co-operative banks are subject to multiple regulators, including the RBI and the state governments

Foreign Banks

Foreign banks play a small but increasingly significant role in India's banking sector. By 2006, it accounted for 7.2% of total commercial-bank assets. They are established mainly to meet financial needs of foreign companies operating in the country. They provide services not only to large Indian companies but the medium-sized ones as well. Currently, there are 39 foreign banks operating in India.

The most active foreign banks are those from the US and the UK, for example, Standard Chartered Bank, Citibank and HSBC. They offer borrowing terms similar to those in domestic banks, but their benchmark prime lending rates and the rate charged to standard borrowers are relatively higher.

Since foreign banks are aggressive in treasury operations, Financial liberalization has given foreign banks opportunities to introduce new products, including personalized retail banking, consumer-durables financing, electronic banking, currency and interest-rate swaps etc.

The RBI issues licences for bank branches. Since 1992 it has been gradually permitting foreign banks to expand their networks. The government has promised the World Trade Organisation to grant a minimum of 12 new branch licences to new and existing foreign banks a year. Since 2005, the RBI has issued an average of 18 branch licences per year. Most branches of foreign banks are in Mumbai, Delhi, Chennai, Kolkata and Bangalore, but in recent years foreign banks have begun branching off in industrial and trade centres, such as Ahmedabad and Hyderabad. Foreign banks without a branch presence can still conduct business through representative offices. These banks concentrate on providing