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Manual on Concurrent Audit of Banksincluding. insufficient capital, poor liquidity of assets, combination of non-bankingactivities with banking activities, irrational credit policy, incompetent andinexperienced directors, etc.1.4The Reserve Bank of India (RBI) Act was passed in 1934 and theReserve Bank of India came into existence in 1935 on the basis of majorrecommendations of Central Banking Enquiry Committee. In 1949, the BankingRegulation Act was passed which gave wide powers to the RBI with regard toestablishment of new banks, mergers and amalgamation of banks, opening ofnew branches, closing of existing branches, shifting of existing branches to otherlocations, etc., including inspection of banks. The Banking Regulation Act, 1949gave wide powers to RBI to regulate, supervise and develop the banking system.The period after 1949 was marked by the efforts of RBI towardsinstitutionalization of savings, to adapt the credit system that was suitable to theemerging needs of the economy.The Banking Regulation Act,1949 was landmark legislation. The Act, thus,provided framework for RBI's supervision of banks. In 1947, India gotindependence and the partition thereafter affected Indian banking system.1.5 1950-1969: This period in history of banking industry in India was markedby important events including constitution of the State Bank of India (the StateBank of India (SBI) became successor to the Imperial Bank of India under theState Bank of India Act, 1955), the creation of a state partnered/state sponsoredBank, in order to have effective control over the Imperial Bank of India andintegrating it with the former state owned banks of princely states. Later, theState Bank of India (Subsidiary Banks) Act was passed in 1959 enabling the SBIto take over eight state-associated banks as its subsidiaries. State Bank ofBikaner and State Bank of Jaipur were merged into one Bank, viz. State Bank ofBikaner and Jaipur and the other state owned banks were, the State Bank ofIndore, the State Bank of Mysore, the State Bank of Patiala, the State Bank ofSaurashtra, the State Bank of Hyderabad, and the State Bank of Travancore.The conversion of Imperial Bank of India into the State Bank of India and thereconstitution of Associate Bank in 1959, were intended to accelerate the pace ofextension of banking facilities all over the country.1.6 1969-1990: To bring about a wider diffusion of banking facilities and tochange the uneven distribution of pattern of lending, schemes for social control4

Banking in Indiafor banks was announced in the Parliament in December 1967, to ensure anequitable and purposive distribution of credit within the resources available,keeping in view the relative priorities of developmental needs. The social controlmeasures were designed to achieve a social orientation of banking within theframework of existing ownership. National Credit Council was set up in 1968 toassess the demand for bank credit from various sectors of the economy and todetermine the priorities. In July 1969, the Government of India nationalized 14major banks, which became one of the important events in the history of IndianBanking. Banks were nationalized to achieve social objectives so that theyeffectively played the role of catalytic agents for economic growth by extendingbanking facilities in all parts of the country. Six more Banks were nationalizedthereafter termed as “Corresponding New Bank” (the body corporate specifiedagainst an existing Bank in column 2 of the First Schedule of BankingCompanies Act, 1980). With a view to develop the rural economy withdevelopment of agriculture, trade, commerce, industry and all other productiveactivities in the rural area RRBs were established under the Regional RuralBanks Act, 1976.Today’s Era1.7 “Report on Trend and Progress of Banking in India 2014-151” issued bythe Reserve Bank of India states that the operations of banking sector and theNBFC sector for the year 2014-15, exhibited several week spots. However, whencompared with the global banking trends in profitability, asset quality and capitalpositions, the Indian banking sector did not appear to be an exceptional underperformer. Furthermore, the regulatory steps initiated in 2014-15 as well as inearlier years are expected to address many of short-term concerns afflicting thesector, while paving way for medium to long-term reforms in this sector.1.8 Some of the major regulatory steps taken during the year and theperspective about how these steps would help in reforming the Indian Bankingsector are as follows:(a)De-stressing the banking sector(b)Reforming the public sector banks (PSBs)(c)Improving monetary policy transmission1Refer RBI website for full text of Report.5

Manual on Concurrent Audit of Banks(d)Strengthening the liquidity standards of banks(e)Monitoring the build-up of leverage in the banking system(f)Dealing with the concern of too-big-to-fail(g)Convergence with the international accounting standards(h)Minimising the regulatory arbitrage between banks and non-banks(i)Reviving the licensing and expansion of urban co-operative banks(j)Making the banking sector more inclusive1.9Presently, the following types of banking institutions prevail in India: Commercial Banks Regional Rural Banks Co-Operative Banks Development Banks more commonly known as ‘term-lendinginstitutions’ Payment banks Small finance banksCommercial Banks1.10 Commercial banks are by far the most widespread banking institutions inIndia. Commercial bank is a financial institution, i.e., authorized by law to receivemoney from businesses and individuals and lend money to bank. Commercialbanks are open to the public and serve individuals institutions businesses andcorporations, etc. A commercial bank is also regularized through Reserve bankof India. The major products and services rendered by Commercial Banks aregiven in Chapter 2.1.11 A number of commercial banks were nationalized with an attempt to shiftthe focus of commercial bank lending to a large extent. RBI propagated theconcept of lending to priority sector and laid down corresponding guidelines.Every commercial bank is required to provide credit to certain important sectorsof the Indian economy.This inaugurated the era of direct credit flows to specified sectors. The financialinclusion of the under-privileged in the banking system started with thenationalization of Banks. According to RBI directives, the scheduled commercial6

Banking in Indiabanks are required to ensure that priority sector advances constitute a prescribedminimum level of net bank credit and that a substantial portion is directedtowards the weaker sections of the society.1.12 Credits provided by the commercial banks are an important driver ofnational economy. During the post-independence period, a phenomenal growthin industrialization has been possible largely due to enhance credit off-take frombanks and financial institutions.Public Sector and Private Sector Banks1.13 Commercial banks operating in India can be divided into two categoriesbased on their ownership – public sector banks and private sector banks.However, irrespective of the pattern of ownership, all commercial banks in Indiafunction under the overall supervision and control of the RBI.1.14 Public sector banks comprise the State Bank of India, its fivesubsidiaries (also called ‘associate banks’ of State Bank of India; these are StateBank of Bikaner and Jaipur, State Bank of Hyderabad, State Bank of Mysore,State Bank of Patiala, and State Bank of Travancore), IDBI Bank Ltd. and thenationalised banks.While the majority stake in the Share Capital of all Public Sector Banks is withthe Government of India, there are private individual/institutional shareholdersalso. The majority stake in the share capital of associate banks of State Bank ofIndia has been subscribed to by the parent, i.e., State Bank of India.1.15 The ownership of private sector banks is with institutional shareholders,private individuals and bodies corporate. Private Sector Banks are of thefollowing types:(a)Indian scheduled commercial banks other than public sector banks.These include the ‘old’ private banks which were in existence before theguidelines for floating new private banks were issued in 1993, the ‘new’generation private banks, and the two banks that were granted licensesby RBI in March 2014.(The term ‘scheduled commercial banks’ refers to commercial bankswhich are included in the Second Schedule to the Reserve Bank of IndiaAct, 1934.)7

Manual on Concurrent Audit of BanksUnder Section 2(e) of the RBI Act, a scheduled bank is conferred twomain privileges (a) availing of refinance from RBI and (b) permission toparticipate in the call/notice money market.It may be noted that all scheduled banks are not commercial banks; someco-operative banks are also scheduled banks. Commonly known as‘banking companies’, these banks are ‘companies’ registered under theCompanies Act, 1956 (now the Companies Act, 2013),or an earlier IndianCompanies Act.(b)Non-scheduled banks(c)Indian branches of banks incorporated outside India, commonly referredto as ‘foreign banks’.Some of the banks have set up subsidiaries – wholly-owned or partly-owned – tooperate in some specialised spheres of activity, such as, merchant banking,funds management, housing finance, primary dealership, pension fundmanagement, insurance business, stock broking, credit card activity, factoring,etc. These subsidiaries do not carry on all the principal functions of a commercialbank.Regional Rural Banks1.16 These banks have been established “with a view to develop the ruraleconomy by providing, for the purpose of development of agriculture, trade,commerce, industry and other productive activities in the rural areas, credit andother facilities, particularly to the small and marginal farmers, agriculturallabourers and artisans and small entrepreneurs. While regional rural banks cancarry on any business in which a bank is legally permitted to engage. Section 18of the Regional Rural Banks Act, 1976, specifically lists the following businesseswhich such a bank may undertake:(a)the granting of loans and advances, particularly, to small and marginalfarmers and agricultural labourers, whether, individually, or in groups, andto co-operative societies, including agricultural marketing societies,agricultural processing societies, co-operative farming societies, primaryagricultural credit societies or farmers’ service societies, for agriculturalpurposes or agricultural operations or for other purposes connectedtherewith;8

Banking in India(b)the granting of loans and advances, particularly to artisans, smallentrepreneurs and persons of small means engaged in trade, commerceor industry or other productive activities, within the notified area in relationto the RRB.1.17 In order to strengthen and consolidate RRBs, the government in 2005initiated the process of amalgamation of RRBs in a phased manner.Consequently, the total number of RRBs has reduced from 196 to 562. Further,the Government of India has issued a notification dated May 17, 2007 specifying‘Regional Rural Bank’ as ‘bank’ for the purpose of the Securitisation andReconstruction of Financial Assets and Enforcement of Security Interest(SARFAESI) Act, 2002.1.18 In recent years, in an attempt to strengthen the regional rural banks,several measures have been taken by the Central Government and the RBI.These banks are no longer required to confine their lending to the weakersections and are permitted to lend to non-target groups also up to specifiedlimits. They can also undertake various types of business, such as, issuance ofguarantees, demand drafts, travellers’ cheques, etc. Moreover, RRBs are nolonger required to confine their operations only within local limits notified by theCentral Government; they are now permitted, subject to fulfilling service areaobligations, to lend monies outside their service area. In the wake of thesedevelopments, the distinction between commercial banks and RRBs has becomesomewhat blurred.1.19 Each RRB has a public sector bank as its ‘sponsor bank’. Capital in eachsuch bank is contributed by the Central Government, the sponsor bank and theState Government concerned in proportion of 50, 35 and 15 per cent,respectively.1.20 Apart from subscribing to the share capital of a RRB sponsored by it, thesponsor bank is also required to train personnel of the RRB as also to providemanagerial and financial assistance to such bank during the first five years of thelatter’s functioning (this period can, however, be extended by the CentralGovernment).2As per the information available from the website of the Reserve Bank of India at the following spx?pg RegionalRuralBanks.htm.9

Manual on Concurrent Audit of Banks1.21 Like commercial banks, regional rural banks also function under theoverall supervision and control of the RBI. Some of the regulatory functions ofthe RBI in relation to RRBs have been delegated to the National Bank forAgriculture and Rural Development (NABARD).Co-operative Banks1.22 These are banks in the co-operative sector which cater primarily to thecredit needs of the farming and allied sectors. Co-operative banks include centralco-operative banks, state co-operative banks, primary co-operative banks andland development banks. Of these, primary co-operative banks operate inmetropolitan cities, urban and semi-urban centres to cater principally to the creditneeds of small industrial units, retail traders, etc. Due to their existence primarilyin urban areas, primary co-operative banks are more commonly known as ‘UrbanCo-operative Banks’ (UCB). Land development banks provide long-term financefor agriculture and have a two-tier structure – State Land Development Banksand the Primary Land Development Banks.1.23 Each co-operative bank operates within a specific geographic jurisdictionas determined by its bye-laws. Co-operative banks can lend monies only to theirmembers or to registered societies. The single most important regulatory andsupervisory feature in the co-operative banking sector is the prevalence of dualcontrol. While incorporation/registration and management related activities areregulated in the states by the Registrar of Co-operative Societies or the CentralRegistrar of Co-operative Societies (for multi-state cooperative banks), bankingrelated activities are under the regulatory/supervisory purview of the ReserveBank of India or NABARD (in the case of rural cooperatives).Foreign Banks1.24 Foreign banks operate in India through a network of branches and do nothave a separate legal entity existence in India. However, the RBI regulates thefunctioning of these banks in India, with regard to scale and nature of businessthey undertake in India.Almost all foreign banks are technologically advanced and use a high level of ITintegration into their operations. These systems, in most instances, are similar tothose being used by their branches globally. Due to cost-benefit and otherconsiderations, in some instances, foreign banks, get certain financial or other10

Banking in Indiainformation processed at one of their global centres. This processing of data outof the country is generally with specific consent from the RBI.1.25 In the aftermath of the global financial crisis and building on the lessonsthere from, RBI issued a Discussion Paper in January 2011 on the mode ofpresence of foreign banks in India. Taking into account the feedback received onthe Discussion Paper, a Scheme for setting up of locally incorporated WhollyBanking in India Owned Subsidiary (WOS) by foreign banks in India wasfinalized in November 2013.,The scheme provided, as hitherto, allowing foreign banks to operate in Indiaeither through branch presence or setting up a wholly owned subsidiary (WOS)with near national treatment. The foreign banks in India have to choose one ofthe above two modes of presence and shall be governed by the principle ofsingle mode of presence. The policy is guided by the two cardinal principles of (i)reciprocity and (ii) single mode of presence. As a locally incorporated bank, theWOS will be given near national treatment which will enable them to openbranches anywhere in the country at par with Indian banks (except in certainsensitive areas where RBI’s prior approval would be required). They would alsobe able to participate fully in the development of the Indian financial sector. Thepolicy incentivises the existing foreign bank branches which operate within theframework of India’s commitment to the World Trade Organisation (WTO) toconvert into WOS due to the attractiveness of near national treatment. Suchconversion is also desirable from the financial stability perspective. To providesafeguards against the possibility of the Indian banking system being dominatedby foreign banks, the framework has certain measures to contain their expansionif the share of foreign banks exceeds a critical size. Certain measures fromcorporate governance perspective have also been built in so as to ensure thatthe public interest is safeguarded.Payment Banks1.26 Payment Banks have been introduced in the Indian financial systemsince November 2014, with the basic objective of furthering financial inclusion byproviding (i) small savings accounts and (ii) payments/remittance services tomigrant labour workforce, low income households, small businesses, otherunorganised sector entities and other users. Their scope of ac

operation. The Indian banks did not undertake foreign exchange business, and the monopoly remained with foreign banks. In 1921, the Presidency banks were merged and the Imperial Bank of India was created. Subsequently, the same Bank was converted into the State Bank of India. The period of 1900 to 1925, however, saw failure of many banks.