Role of Banks in Indian Economy

Macroeconomics Research Paper Prepared by : Sourabh Kumar SahaPGDM : 2008-2010Calcutta Business School , West Bengal , IndiaEmail : souravsaha86@gmail.com Abstract: Banks play an important role in development of Indian economy. After liberalization, the banking industry under went major changes. The economic reforms totally have changed thebanking sector. RBI permitted new banks to be started in the private sector as per therecommendation of Narasimham committee. The Indian banking industry was dominated bypublic sector banks. But now the situations have changed. New generation banks with used of technology and professional management has gained a reasonable position in the bankingindustry. In this paper we look at the type of banks , their role and functioning , Establishment and Role of Indias Central Bank - RBI and the recent banking reforms .We perform a comparative data analysis between GDP and total advances & deposits .We also check whether the Credit Deposit Ratio has any relationship with the GDP . We thenperform a regression analysis to check whether there is any relationship between GDP and Bank lending interest rates. We also compare the Flow of credit to Agricultural Sector with the Growthof Agriculture Sector. We conclude the analysis by an overview and analysis of the sectorialdeployment of gross bank credit over the last two financial years.

Index Title Page1. Introduction 31.1. Motivation 31.2. Hypothesis 41.3. What is a Bank 41.4 Functions of a Bank 41.5. T ypes of Banks 61.6. Banking Sector in India 72.0 Role of Banks 82.1. Role of Banks in Indian Economy 92. 2. Role of Central Bank (RBI) 92.3. Evolution of Indian Banking 102.4. Narasimham Committee Banking Reforms 102.5. Performance of Indian Banking Sector Post Reforms 123.0. Methodology 153.1. Data Analys is 153.2. Remarks 253.3. The challenges Ahead 263.4. Conclusion 26References 27Acknowledgement 28

Introduction

Banks over the years, have become a significant aspect of an economy. With the on going financial depression, the position of banks have become all the more important in the course of working of the money market and hence the economy of a nation. The banking sector forming aportion of the financial sector primarily

works as a financial intermediary generating money supply. From the different macro economic models , banks have been found to be a part of the supply side of the economy . However, over time banks have transformed from merely moneyg enerating organizations to a multi tasking entity. In this paper, we shall deal with the role of banks in the context of the world economy as well as the Indian economy . The first section willillustrate the functions of a bank along with its classification. In the second section, we shalldiscuss the role of a banks as a major component of the service sector rendering to the economyas a whole. In the third section, we would like to empirically validate our hypothesis with acomprehensive data analysis.
1.1Motivation The recession in the US market and the global meltdown termed as Global recession haveengulfed complete world economy with a varying degree of recessional impact. World over theimpact has diversified and its impact can be observed from the very fact of falling Stock market,recession in jobs availability and companies following downsizing in the existing available staff and cutting down of the perks and salary corrections.Various steps taken by RBI to curb the present recession in the economy and counter act theprevailing situation. The sudden drying-up of capital inflows from the FDI which were investedin Indian stock markets for greater returns visualizing the Potential Higher Returns flying back iscontinuing to challenge liquidity management. At the heart of the current liquidity tightening isthe balance of payments deficit, and this NRI deposit move should help in some small way.To curb the liquidity crises the RBI will continue to initiate liquidity measures as long as thecurrent unusually tight domestic liquidity environment prevails. The current step to curb thesebeing lowering of interest rates and reduction of PLR . The BOP- Balance of Payment deficit ata time when domestic credit demand is very high is resulting in a vicious loop of reducedaccess to liquidity, slowing growth, and increased risk-aversion in the financial system.In present situation down fall in one sector one day leads to a negative impact on the other sectorthus all together everyone feel the impact of the Financial crises with the result of the currentrecession which started in US and slowly and gradually due to linked global world haveimpacted everyone.Solution for the problem still remain at the top of the mind of every one, still everyone facing theimpact of recession but how long is the major question which is of great importance.

Hypothesis In this research paper , I am trying to give an overview of the whole banking sector in India andthe kind of financial functions they perform which help in the growth of the economic growthand progress of the country . I have tried to look for relationship if any between GDP and thefollowing : Total advances/Total deposits , Credit Deposit Ratio , Lending interest rates , and thesectors in India which got more advances from the banks over the last 3 years .

1.3What is a Bank While the question may seem elementary, the answer can be quite complex. Understanding whatbanking is all about will help the paper to illustrate the role of banks better.A bank is a financial institution where an individual can deposit money. Banks provide a systemfor easily transferring money from one person or business to another. Using banks and the manyservices they offer saves an incredible amount of time, and ensures that the funds of micro aswell as macroeconomic agents "pass hands" in a legal and structured manner. There are alsoother types of financial institutions that operate just like banks. 1.4Functions of a Bank Functioning of a Bank is among the more complicated of corporate operations. SinceBanking involves dealing directly with money, governments in most countries regulatethis sector rather stringently. In India, the regulation traditionally has been very strict andin the opinion of certain quarters, responsible for the present condition of banks, whereNPAs are of a very high order. The process of financial reforms, which started in 1991 hascleared the cobwebs somewhat but a lot remains to be done. The multiplicity of policy andregulations that a Bank has to work with, makes its operations even more complicated,sometimes bordering on illogical. This section attempts to give an overview of thefunctions in as simple manner as possible.Banking Regulation Act of India, 1949 defines Banking as "accepting, for the purpose of lending or investment of deposits of money from the public, repayable on demand orotherwise and withdraw able by cheques, draft, order or otherwise". Deriving from thisdefinition and viewed solely from the point of view of the customers, Banks essentially perform the following functions :

1.Accepting Deposits from public/others (Deposits) 2.Lending money to public (Loans) 3.Transferring money from one place to another (Remittances) 4.Credit Creation 5.Acting as trustees 6.Keeping valuables in safe custody 7.Investment Decisions and analysis 8.Government business 9.Other types of lending and transactions. In addition to providing a safe custodian of money, banks also loan money to businesses andconsumers. A large portion of a bank's business is lending. How do banks get the money theyloan? The money comes from depositors

who intend to save a portion of their wealth. Banksacting as intermediaries, use these deposits as loans to prospective borrowers.The objective of commercial banks like any other organization is profit maximisation. This profitgenerally originates from the interest differential between borrowers and lenders. In the presentday, however, the banking operation has extended much beyond simple lending exercise. Sothere are other different channels of profit ensuing from other investment programmes as well.However, it should be mentioned in this context that the entire deposit held by a bank cannot begiven as loans as the Central Bank retains a portion of this money in the form of cash-reserve forunforeseen circumstances.Banks create money in the economy by making loans. The amount of money that banks canlend is directly affected by the reserve requirement set by the Federal Reserve. The reserverequirement is currently 3 percent to 10 percent of a bank's total deposits. This amount can beheld either in cash on hand or in the bank's reserve account with the Fed. To see how this affectsthe economy, think about it like this. When a bank gets a deposit of $100, assuming a reserverequirement of 10 percent, the bank can then lend out $90. That $90 goes back into the economy,purchasing goods or services, and usually ends up deposited in another bank. That bank can thenlend out $81 of that $90 deposit, and that $81 goes into the economy to purchase goods orservices and ultimately is deposited into another bank that proceeds to lend out a percentage of it.In this way, money grows and flows throughout the community in a much greater amount thanphysically exists. That $100 makes a much larger ripple in the economy than you may realize! Other Services Offered by Banks

Credit Cards Personal Loans Home and Car Loans Mutual Funds Business Loans Safe Deposit Boxes Debit Cards Trust Services Signature Guarantees and many other investment services.

1.5Types of Banks Central Bank: A central bank, reserve bank, or monetary authority is the entity responsible forthe monetary policy of a country or of a group of member states. Its primary responsibility is tomaintain the stability of the national currency and money supply, but more active duties includecontrolling subsidized-loan interest rates, and acting as a lender of last resort to the bankingsector during times of financial crisis (private banks often being integral to the national financialsystem). It may also have supervisory powers, to ensure that banks and other financialinstitutions do not behave recklessly or fraudulently. Commercial Banks : A commercial Bank performs all kinds of banking functions such asaccepting deposits, advancing loans, credit creation & agency functions. They generally advanceshort term loans to their customers, in some cases they may give medium term loans also Industrial Banks : Ordinarily , the industrial banks perform three main functions : Firstly ,Acceptance of Long term deposits : Since the industrial bank give long term loans , they cannotaccept short term deposits from the public . Secondly, Meeting the credit requirements of companies : Firstly the industries require to purchase land to erect buildings and purchase heavymachinery . Secondly the industries require short term loans to buy raw materials & to makepayment of wages to workers . Thirdly it does some Other Functions - The industrial bankstender advice to big industrial firms regarding the sale & purchase of shares & debentures Agricultural Banks : As the commercial & the industrial Banks are not in a position to meet thecredit requirements of agriculture , there arises the need for setting up special types of banks tofinance agriculture. Firstly, the farmers require short term loans to buy seeds, fertilizers, ploughsand other inputs . Secondly, the farmers require long term loans to purchase land, to effectpermanent improvements on the land to buy equipment & to provide for irrigation works . Foreign Exchange Banks

: Their main functions is to make international payments through thepurchase and sale of exchange bills . As is well known , the exporters of a country prefer toreceive the payment for their exports in their own currency . Hence their arises the problem of converting the currency of one country into the currency of another . The foreign exchange bankstry to solve this problem . These banks specialize in financing foreign trade .

Indigenous Banks

: According to the Indian Enquiry Committee , Indigenous banker is a person or a firm which accepts deposits , transacts business in hundies and advances loans etc . 1.6Banking Sector in India Central Bank :The Reserve Bank of

India is the central Bank that is fully owned by the Government. Itis governed by a central board (headed by a Governor) appointed by the Central Government. Itissues guidelines for the functioning of all banks operating within the country. Public Sector Banks a.State Bank of India and its associate banks called the State Bank Group b.20 nationalized banks c.Regional rural banks mainly sponsored by public sector banks Private Sector Banks Old generation private banks New generation private banks Foreign banks operating in India Scheduled co-operative banks Non-scheduled banks

Co-operative Sector The co-operative sector is very much useful for rural people. The co-operative banking sector is divided into the following categories.

State co-operative Banks

Central co-operative banks

Primary Agriculture Credit Societies Development Banks/Financial Institutions IFCI,IDBI, ICICI Bank , IIBI SCICI Ltd .NABARD Export-Import Bank of India National Housing Bank Small Industries Development Bank of India North Eastern Development Finance Corporation

Role of Banks A proper financial sector is of special importance for the economic growth of developing andunderdeveloped countries. The commercial banking sector which forms one of the backbones of the financial sector should be well organized and efficient for the growth dynamics of a growingeconomy. No underdeveloped country can progress without first setting up a sound system of commercial banking. The importance of a sound system of commercial banking for a developingcountry may be depicted as follows : Capital Formation : The rate of saving is generally low in an underdeveloped economy due tothe existence of deep-rooted poverty among the people . Even the potential savings of thecountry cannot be realized due to lack of adequate banking facilities in the country . To mobilizedormant savings and to make them available to the entrepreneurs for productive purposes , thedevelopment of a sound system of commercial banking is essential for a developing economy . Monetization

: An underdeveloped economy is characterized by the existence of a large nonmonetized sector , particularly , in the backward and inaccessible areas of the country . Theexistence of this non monetized sector is a hindrance in the economic development of thecountry . The banks , by opening branches in rural and backward areas , can promote the processof monetization in the economy . Innovations : Innovations are an essential prerequisite for economic progress . Theseinnovations are mostly financed by bank credit in the developed countries . But the entrepreneursin underdeveloped countries cannot bring about these innovations for lack of bank credit in anadequate measure . The banks should , therefore , pay special attention to the financing of business innovations by providing adequate and cheap credit to entrepreneurs . Finance for Priority Sectors : The commercial banks in underdeveloped countries generallyhesitate in extending financial accommodation to such sectors as agriculture and small scaleindustries , on account of the risks involved there in . They mostly extend credit to trade andcommerce where the risk involved is far less .But for the development of these countries it isessential that the banks take risk in extending credit facilities to the priority sectors , such asagriculture and small scale industries . Provision for Medium and Long term Finance : The commercial banks in underdevelopedcountries invariably give loans and advances for a short period of time . They generally hesitateto extend medium and long term loans to businessmen. As is well known , the new business needmedium and long term loans for their proper establishment . The commercial banks should ,therefore , change their policies in favor of granting medium and long term accommodation tobusiness and industry . Cheap Money Policy : The commercial banks in an underdeveloped economy should followcheap money policy to stimulate economic activity or to meet the threat of business recession. In fact , cheap money policy is the only policy which can help promote the economic growth of anunderdeveloped country . It is heartening to note that recently the commercial banks havereduced their lending interest rates considerably . Need for a Sound Banking System : A sound system of commercial banking is an essential prerequisite for the economic development of a backward country . 2.1 Role of Banks in Indian Economy In India , as in many developing countries , the commercial banking sector has been the dominant element in the countrys financial system . The sector has performed the key functions of providing liquidity and payment services to the real sector and has accounted for the Bulk of the financial

intermediation process. Besides institutionalizing savings, the banking sector has contributed to the process of economic development by serving as a major source of credit to households, government, and business and to weaker sectors of the economy like village and small-scale industries and agriculture. Over the years, over 30-40% of gross household savings, have been in the form of bank deposits and around 60% of the assets of all financial institutions accounted for by commercial banks. An important landmark in the development of banking sector in recent years has been the initiation if reforms following the recommendations of the first Narasimham Committee on Financial System. In reviewing the strengths and weaknesses of these banks, the Committee suggested several measures to transform the Indian banking sector from a highly regulated to amore market oriented system and to enable it to compete effectively in an increasingly globalised environment. Many of the recommendations of the Committee especially those pertaining to Interest rate, an institution of prudential regulation and transparent accounting norms were in line with banking policy reforms implemented by a host of developing countries since 1970s .

2.2 Role of Central Bank ( RBI ) The main objectives for the establishment of the Central Bank were as follows :To manage the monetary and credit system of the country.To stabilizes internal and external value of rupeeFor balanced and systematic development of banking in the countryFor the development of organized in the money market in the country .For proper arrangement of agriculture finance.For proper arrangement of Industrial Finance .To establish monetary relations with other countries of the world & internationalfinancial institutions.For proper management of public debts .For centralization of cash reserves of commercial banks . To maintain balance between the demand and supply of currency . 2.3 Evolution of Indian Banking Prior to 1969 , all banks , except State Bank of India and its seven associate banks were privately owned /. However there was a perception among policy makers that under private ownership ,too many rural and semi urban-areas remained un-served by banks , whereas the banking industry has to be developed to touch the lives of millions. Further as India became anincreasing planned economy , policy makers felt that It would be difficult to undertake creditplanning unless the link control of industry and banks in the same (private) banks is snapped by the nationalization of banks (Hazari Report , 1967) . These considerations led to the Nationalization Act of 1969 which caused 14 largest privately owned domestic banks to benationalized. In 1980 under the same Act , the Government of India acquired ownership of 6more private banks , bringing the total number of nationalized banks to 20 .Notwithstanding the positive role played by the banking sector since nationalization ininstitutionalizing savings and becoming a source of credit to the small borrower , the cumulativeeffect of excessive focus on quantitative achievement and social obligations took a toll onprofitability and efficiency . Rates of return became low by international standards , the capital base was eroded, NPSs were on the rise, and customer service was below expectation . Theseconditions led to gradual liberalization of banking sector operations since

the mid 1980s and culminated in the initiation of fundamental banking sector reforms of 1992 with the acceptanceof key recommendations of the Narasimham Committee . 2.4Narasimham Committee Banking Reforms Restructuring of the banking system : The committee recommended 4-tier structure of thebanking system consisting of : (a) : Three of Four Large (international) banks . (b) : Eight to tennational banks with a network of branches throughout the country . (c) : Local works withoperations confined to a specific region. (d) : Rural Banks with operations confined to rural areasand business confined to

agricultural and allied activities . Enhancement of Capital Base of Bank : The committee recommended that the banks shouldbe allowed to raise fresh capital from the public . Mutual Funds , profitable public sector unitsand employees can also subscribe to these issues . Deregulation of Interest Rates : The committee recommended deregulation of interest rate onloan so that they reflect the actual market conditions . The interest rate on governmentborrowings may also be gradually deregulated to bring it in line with market rates . Howeverinterest rate on bank deposits may continue to be regulated .The first step was taken in October 1994 , when rates were deregulated for advances more than 2lakh . In April 1998, under new regulations interest on credit limits up to Rs 25,000 was prescribed at 12% and for credit limit between Rs 25,000 and Rs 2 lakh , the rate was not toexceed 13.5% per annum . Abolition of Licensing : The committee proposed no further nationalization of banks . Itproposed abolition of branch licensing. It said that the banks should be allowed to decide forthemselves. The foreign banks, private banks should be allowed to open branches in the country Cut in SLR , CRR : The committee recommended bringing down the SLR of banks in a phasedmanner period of five years . It also recommended reducing of CRR from its present high level .Trends in Cash Reserve Ratio (CRR) and statutory liquidity ratio (SLR) 1991-92 to 199798Year CRR (As % of NDTL*) Base SLR (as % of NDTL*)1991-2 15 38.51992-3 15 37.7519934 14 34.751994-5 15 33.7519956 14 31.5April 1996 13 31.5July 1996 12 31.5October 1996 11.5 31.5January 1997 10 31.5October 1997 9.75 2 5January 1998 10.5 25April 1998 10 25Note: *Net demand and time liabilitiesSource : RBI , Annual Report, Various issues and RBI Credit Policy October 97, April 98The committee favoured of putting on end to dual control over banks by RBI and Bankingdivision. It suggested that RBI should be the primary

agency for regulations . Supervisoryfunctions over banks and financial institutions should be given to a new quasi autonomous bodyunder RBI .The committee favoured scrapping of prior approval of Government or Securities ExchangeBoard of India for any issue in the market . The issuing company should be free to decide on thenature of the instrument , its terms and lending.Foreign banks should be subject to same requirements as applicable to Indian banks . Theyshould be permitted to open offices in India as branches or as subsidiaries .Computerization of Bank Operations needs to be stepped up . The committee also proposed that its directed credited programme should be phased out . Thepriority sector should be redefined to comprise small and marginal farmers , the tiny sector of theindustry , village and cottage industries , small business and other weak sections .A special tribunal should be set up to speed up the process of recovery of overdue loans .An asset reconstruction fund should be set up to speed up the process of recovery of overdueloans. 2.5 Performance of Indian Banking Sector Post Reforms

We now look into the different aspects of bank performance which have been targeted by thereforms. These are :1.

Deposit mobilization2.

Portfolio Choice3.

Competition4.

Profitability5.

Efficiency6.

Capital Adequacy7.

NPAs

Deposit Mobilization : Estimates of trends in real deposit growth post reforms reveal that the rateof growth has fluctuated, slackening between 1994-5 and 1995-6 but picking up during 1996-7 .Growth rates of key banking Variables (1981)Item 1980-81 to1989-901990-91 to1995-961993-94 to1994-1995199495 to1995-961995-96 to199697AggregateDeposits9.8 6.8 10.7 4.1 6.3Timedeposits10.2 6.5 8.1 5.8 7.2Bank Credit 8.7 4.2 -1.6 9.3 1.9Investmentsin GovtSecurities10.5 10.3 22.9 4.3 9.6 Note : Compound annual growth rates. All estimates are in real terms . Given in % forms . Sources : RBI annual report 1996-97 and RBI Bulletin Different issuesIn a nutshell , the present banking scenario with respect to deposits and advances can beobserved from the following table : Year % Increase in Deposits % Increase in Advances % Growth in GDP1999-0019.23 31.5 9.5920000117.2 30.93 7.532001-0214.26 23.6 7.82002-0313.02 15.12 10.942003-0416.47 16.93 13.620040539.96 30.99 13.882005-069.11 32.3 15.152006-0723.88 30.93 14.47 Source : RBI Trend and progress of banking in India various issuesBank credit consists of food and non food credit and bank investments comprise of investment inGovernment securities, bonds, debentures , shares issued by public sector undertakings andprivate corporate sector and commercial paper . The rate of growth on non food credit between1995-96 and 1996-07 was a negative 0.7 compared to a growth rate off 11.6% between 1994-95and 1995-96 . A comparison of growth Rate on investment in government securities in real termsover the pre-reform and post-reform years does not reveal substantial differences . Competition :With the entry of new private banks , the market shares of public sector banks havedeclined by close to 4% points from around 90% in 1991-92 to around 85% in 1995-96 . Thiskind of competition has led to adoption of newer banking practices like ATM , Onlinetransactions and others to fit in the global competitive market . Profitability :Estimates for 1996-97 show public sector banks turning a net profit of 30.95 billionwiping out the loss of 3.71 billion in 1995-96 . Efficiency :An increase in competitive pressures is expected to improve efficiency levels. Howeverin this regard , there has been marginal improvement except the state bank group and olddomestic private banks .

Capital Adequacy :In 1996-97 , out of the 27 public sector banks, 25 have attained the BIS norm of an 8%risk waited capital to asset ratio . Non performing Assets :In 199394 , the average percentage of NPAs to total advances for 27 public sector banks was 21.89 which declined to 9.8% of total advances in 1996-97 .

3.3The Challenges Ahead Let me now turn to the major challenges facing the banking system in the country, particularly inthe wake of the global financial crisis.

The First Challenge: Maintaining the Credit Flow There was a noticeable decline in the credit demand in the month of November2008 but it is not yet clear if it was a one off episode or it reflects a trend. If it is indicative of slowing economic activity, it would be a major challenge for the banks to ensure healthy flow of credit to the productive sectors of the economy. As you know, economic growth, even in normaltimes, requires efficient financial intermediation. An economic downturn, therefore, requireseven more efficient financial intermediation and this is a major challenge that the bankingcommunity has to address. The Second Challenge: How to Reform Financial Sector Regulation? Several issues have come to the fore. I will mention just a few. How can complexderivative products, which transmitted risks across the system, be made more transparent? Whatare the financial stability implications of structured products like credit derivatives? Areexchange traded derivatives better than over-the-counter (OTC) derivatives? How do weeliminate the drawbacks of the 'originate-todistribute' model? Is universal banking, the modelthat the United States has now turned to, appropriate? Can we apply the same regulatory regimefor both wholesale and retail banks? The Third Challenge: Effective Implementation of Basel II Framework As you are aware, a part of the Indian banking system has already migrated to the BaselII Framework effective March 31, 2008 and the remaining commercial banks are slated to do soby March 31, 2009. However, having regard to the state of preparedness of the system, we have,for the present, adopted only the simpler approaches available under the Framework. The RBI isyet to announced the timeframe for adoption of the Advanced Approaches in the Indian bankingsystem but the migration to these Approaches is the eventual goal for which the bankingsystem will need to start its preparations in all earnestness. 3.4Conclusion Going forward, developments in the real economy, financial markets and global commodityprices point to a period of moderation in growth with declining inflation. What is hearteningthough is that the fundamentals of our economy continue to be strong. Once calm andconfidence are restored in the global markets, economic activity in India will recover sharply.But a period of painful adjustment is inevitable. It is our collective challenge for you, thebankers, and for us at the RBI

to respond to this extraordinary situation effectively and returnIndia to its path of growth and poverty reduction.

References Trend and Progress of Banking in India ( Different issues from 1990 2007)Annual Report RBI ( Different issues )Economic Survey of India 2008 Handbook of Indian statisticswww.IMF.orgwww.RBI.org.inwww.wikipedia.orgwww.Google.com

Acknowledgement I am grateful to Prof. Tamal Datta Chaudhuri for giving me the project idea and guided me allalong with his suggestions. The Role of Banks is very apt in the current financial scenario .I also extend my

gratitude to Dr. Basudeb Sen for his expert consultation and for guiding me inanalyzing the data for this project .I am also thankful to the institute for technical support and for providing the necessary softwares which helped me in data analysis. Lastly I would also like to thank RBI Calcutta for providing me the necessary data for theproject, some of which was otherwise not available online .

ROLE OF BANKS AND FINANCIAL INSTITUTIONS IN ECONOMY Money lending in one form or the other has evolved along with the history of the mankind. Even in the ancient times there are references to the moneylenders. Shakespeare also referred to Shylocks who made unreasonable demands in case the loans were not repaid in time along with interest. Indian history is also replete with the instances referring to indigenous money lenders, Sahukars and Zamindars involved in the business of money lending by mortgaging the landed property of the borrowers. Towards the beginning of the twentieth century, with the onset of modern industry in the country, the need for government regulated banking system was felt. The British government began to pay attention towards the need for an organised banking sector in the country and Reserve Bank of India was set up to regulate the formal banking sector in the country. But the growth of modern banking remained slow mainly due to lack of surplus capital in the Indian economic system at that point of time. Modern banking institutions came up only in big cities and industrial centres. The rural areas, representing vast majority of Indian society, remained dependent on the indigenous money lenders for their credit needs.

Independence of the country heralded a new era in the growth of modern banking. Many new commercial banks came up in various parts of the country. As the modern banking network grew, the government began to realise that the banking sector was catering only to the needs of the well-to-do and the capitalists. The interests of the poorer sections as well as those of the common man were being ignored. In 1969, Indian government took a historic decision to nationalise 14 biggest private commercial banks. A few more were nationalised after a couple of years. This resulted in transferring the ownership of these banks to the State and the Reserve Bank of India could then issue directions to these banks to fund the national programmes, the rural sector, the plan priorities and the priority sector at differential rate of interest. This resulted in providing fillip the banking facilities to the rural areas, to the underprivileged and the downtrodden. It also resulted in financial inclusion of all categories of people in almost all the regions of the country. However, after almost two decades of bank nationalisation some new issues became contextual. The service standards of the public sector banks began to decline. Their profitability came down and the efficiency of the staff became suspect. Non-performing assets of these banks began to rise. The wheel of time had turned a full circle by early nineties and the government after the introduction of structural and economic reforms in the financial sector, allowed the setting up of new banks in the private sector. The new generation private banks have now established themselves in the system and have set new standards of service and efficiency. These banks have also given tough but healthy competition to the public sector banks. Modern Day Role Banking system and the Financial Institutions play very significant role in the economy. First and foremost is in the form of catering to the need of credit for all the sections of society. The modern economies in the world have developed primarily by making best use of the credit availability in their systems. An efficient banking system must cater to the needs of high end investors by making available high amounts of capital for big projects in the industrial, infrastructure and service sectors. At the same time, the medium and small ventures must also have credit available to them for new investment and expansion of the existing units. Rural sector in a country like India can grow only if cheaper credit is available to the farmers for their short and medium term needs. Credit availability for infrastructure sector is also extremely important. The success of any financial system can be fathomed by finding out the availability of reliable and adequate credit for infrastructure

projects. Fortunately, during the past about one decade there has been increased participation of the private sector in infrastructure projects. The banks and the financial institutions also cater to another important need of the society i.e. mopping up small savings at reasonable rates with several options. The common man has the option to park his savings under a few alternatives, including the small savings schemes introduced by the government from time to time and in bank deposits in the form of savings accounts, recurring deposits and time deposits. Another option is to invest in the stocks or mutual funds. In addition to the above traditional role, the banks and the financial institutions also perform certain new-age functions which could not be thought of a couple of decades ago. The facility of internet banking enables a consumer to access and operate his bank account without actually visiting the bank premises. The facility of ATMs and the credit/debit cards has revolutionised the choices available with the customers. The banks also serve as alternative gateways for making payments on account of income tax and online payment of various bills like the telephone, electricity and tax. The bank customers can also invest their funds in various stocks or mutual funds straight from their bank accounts. In the modern day economy, where people have no time to make these payments by standing in queue, the service provided by the banks is commendable. While the commercial banks cater to the banking needs of the people in the cities and towns, there is another category of banks that looks after the credit and banking needs of the people living in the rural areas, particularly the farmers. Regional Rural Banks (RRBs) have been sponsored by many commercial banks in several States. These banks, along with the cooperative banks, take care of the farmer-specific needs of credit and other banking facilities. Future Till a few years ago, the government largely patro-nized the small savings schemes in which not only the interest rates were higher, but the income tax rebates and incentives were also in plenty. The bank deposits, on the other hand, did not entail such benefits. As a result, the small savings were the first choice of the investors. But for the last few years the trend has been reversed. The small savings, the bank deposits and the mutual funds have been brought at par for the purpose of incentives under the income tax. Moreover, the interest rates in the small savings schemes are no longer higher than those offered by the banks. Banks today are free to determine their interest rates within the given limits prescribed by the RBI. It is now easier for the banks to open new branches. But the banking sector reforms are still not complete. A lot more is required to be done to revamp the public sector banks. Mergers and amalgamation is the

next measure on the agenda of the government. The government is also preparing to disinvest some of its equity from the PSU banks. The option of allowing foreign direct investment beyond 50 per cent in the Indian banking sector has also been under consideration. Banks and financial intuitions have played major role in the economic development of the country and most of the credit- related schemes of the government to uplift the poorer and the under-privileged sections have been implemented through the banking sector. The role of the banks has been important, but it is going to be even more important in the future.