From nationalisation to reform: evolution and structure of Indian banking

Detail

1. Why banks need rules at all: the core idea

• A bank borrows short-term and lends long-term.
• Deposits can be taken out on demand. Loans are paid back over years.

• This is called maturity transformation: the bank turns short-term money into long-term loans.

• NCERT example (Class 12, Money and Banking): the goldsmith Lala.

• People leave their gold with Lala for safe keeping.
• Lala lends part of this gold to others. He is betting that not all depositors will come back for their gold on the same day.

• A modern bank works the same way. It keeps only a small part of deposits as cash and lends out the rest.

• So a bank is a leveraged business (it runs mostly on borrowed money, not its own capital). It transforms maturities, and it depends on trust.

• Leverage in numbers: Suppose a bank has Rs 100 of assets (loans). Rs 8 is its own capital and Rs 92 is deposits.
• If Rs 8 of loans go bad, all of the bank's own capital is gone.

• After that, any further loss falls on depositors.

• Every banking rule deals with one of three failures:

Failure	What goes wrong	Rules that handle it
Hidden bad loans	Loans that will not be repaid still show as healthy in the books	Classification and provisioning (Sections 4-7)
Too little capital	The bank's own money is not enough to absorb losses	Basel norms, Prompt Corrective Action (PCA) (Sections 8-9)
A run on liquidity	Many depositors want their cash back at the same time	LCR/NSFR, deposit insurance, lender of last resort (Section 9)

2. Foundations (1935-1955)

• RBI set up in 1935. It started as a shareholder-owned bank and was nationalised in 1949.
• Banking Regulation Act 1949. This is the main banking law. It gave RBI powers to:
• license banks (no one can run a bank without RBI's permission)

• supervise banks (inspect them, give directions and remove managers)

• Imperial Bank of India became the State Bank of India (SBI) in 1955. This was the first big step towards public ownership of commercial banking.

3. Bank nationalisation (1969 and 1980)

• 19 July 1969: 14 banks were nationalised. Each had deposits of at least Rs 50 crore.
• The cut-off was deposits "not less than Rs 50 crore as on the last Friday of June 1969" [8].

• The stated aim was to serve development needs "in conformity with national priorities and objectives" [8][9].

• 1980: 6 more banks were nationalised. Each had deposits of at least Rs 200 crore.

• The gap nationalisation tried to fill (1969):
• 617 of about 2,700 towns had no commercial bank [9].

• Of about 6 lakh villages, only about 5,000 had a bank [9].

• Gains, known as "social banking":

• Bank branches spread quickly into rural areas.
• Credit reached farmers and small industry, which private banks had largely ignored.

• A large share of credit went to priority sectors, meaning sectors the government wants banks to lend to, such as agriculture, small firms and weaker sections [9].

• Costs, known as "financial repression":

• Financial repression means the government holds down interest rates and pushes savings towards itself and towards chosen sectors, at below-market rates. It worked through three tools:
  • Interest-rate caps. RBI fixed deposit and loan rates.
  • Directed lending. Banks were told whom to lend to.
  • High compulsory holdings of government bonds, through a high SLR.
• CRR (Cash Reserve Ratio): the share of deposits a bank must keep as cash with RBI. It earns nothing.
• SLR (Statutory Liquidity Ratio): the share of deposits a bank must keep in safe liquid assets, mainly government securities.
• Peak levels around 1990-91: SLR 38.5% and CRR 15%.
• Worked example (1990-91): a bank receives deposits of Rs 100.
  • CRR: Rs 15 goes to RBI as cash and earns no interest.
  • SLR: Rs 38.50 must go into government bonds at low, fixed rates.
  • Only Rs 46.50 (100 − 15 − 38.5) is left for commercial loans, and part of that is directed lending too.
• Result: low bank profits, weak asset quality and poor credit judgement.
  • Lending was often decided by targets, not by whether the borrower could repay.
  • This planted the roots of the later NPA (non-performing asset) problem. An NPA is a loan on which interest or principal has not been paid for a set period, 90 days for most loans.

4. The 1991 turn: Narasimham Committee I

• It was set up during the 1991 balance-of-payments crisis. It had three main recommendations.
• 1. Reduce pre-emptions. It asked for lower SLR and CRR. This freed deposits for lending to businesses.
• 2. Deregulate interest rates. Banks began to set their own deposit and loan rates in steps.
• 3. Introduce prudential norms. These are safety rules that make a bank's books show its true health.
• Income recognition: a bank may count interest as income only when it is actually received, not just when it falls due. This stops bad loans from showing false profits.
• Asset classification: loans are sorted by health: standard, sub-standard, doubtful and loss.
• Provisioning: the bank sets aside money from its profits against loans that may not be repaid.

• Capital adequacy: the bank must keep a minimum amount of its own capital against its risky assets. This is measured by the CRAR:

  CRAR = (Tier I capital + Tier II capital) ÷ Risk-weighted assets × 100

  • Risk-weighted assets means each loan is counted according to its risk. A government bond gets a 0% weight. Riskier loans get higher weights.
  • Example: a bank has Rs 1,000 crore of risk-weighted assets and Rs 90 crore of capital. CRAR = 90 ÷ 1,000 × 100 = 9%.
  • These norms link to the Basel norms, the international capital standards covered in Section 8.

• 4. Allow new private banks. Licences were issued in rounds:

Round	Year
First wave of new private banks	1993-94
Second round	2001
Third round	2014
On-tap licensing: apply any time, no fixed window	2016 onward

5. NCERT view of financial-sector reform (Class 11, LPG chapter)

• The goal was to change RBI's role "from regulator to facilitator". RBI would set broad rules instead of controlling every decision.
• Private Indian banks and foreign banks were allowed to enter.
• Banks that met set conditions could open new branches without RBI approval.
• Correction to NCERT: NCERT says the "foreign investment limit in banks was raised to around 74 per cent".
• Correct position: 74% is the FDI cap for private-sector banks.
• The FDI cap for public sector banks (PSBs) is 20%.

6. Narasimham Committee II (1998)

• Higher CRAR. Banks should hold more capital against risk.
• Narrow banking for weak banks. A weak bank should put its deposits only into safe, liquid assets such as government securities.
• It then carries little credit risk (the risk that borrowers do not repay).

• Weak banks stop adding new bad loans while they recover.

• Mergers of strong banks to build large banks able to compete globally.

• It advised against merging a strong bank with a weak one, because that drags the strong bank down.

7. Universal banking and Islamic banking

• Universal banking: one institution offers commercial banking, investment banking, insurance and other financial services.
• Examined by the Khan Working Group (1997).
• Development finance institutions (DFIs) are lenders that give long-term loans for industry and infrastructure. Two of them became banks:
  • ICICI became a bank in 2002
  • IDBI became a bank in 2004

• Why convert? DFIs had lost their cheap government funding. As banks, they could raise low-cost public deposits.

• Islamic banking: interest-free banking. It works through profit-and-loss sharing and asset-backed contracts, such as the bank buying an asset and selling it to the customer at a mark-up.

• RBI considered it and dropped the proposal in 2017.

8. Structure of Indian banking today

Scheduled vs non-scheduled banks

• Scheduled bank: a bank listed in the Second Schedule of the RBI Act, 1934.
• It must keep CRR with RBI.

• It can use RBI refinance and liquidity windows, meaning it can borrow from RBI when short of cash.

• Non-scheduled bank: a bank outside this list. It cannot use these RBI facilities in the same way.

Segments

Segment	Key facts
Public sector banks (PSBs)	Government stake above 50%. Merged down from 27 to 12: SBI associates (2017), Bank of Baroda-Vijaya-Dena (2019), April 2020 mega-merger
Private banks	Old private banks (never nationalised) and new private banks (licensed from 1993-94)
Foreign banks	Work in branch mode or as a wholly owned subsidiary (WOS), a separate Indian company fully owned by the foreign bank
Small finance banks (SFBs), payments banks	Differentiated banks: licensed for a limited set of activities (Section 2 of the parent note)
Regional Rural Banks (RRBs)	Being merged under "One State One RRB". Status below
Local area banks	Small, few in number

RRBs: "One State One RRB" (current status)

• The scaffold says RRBs were "being merged … 2025 (verify current)". The merger is now complete:
• Fourth phase: 26 RRBs in 11 States/UTs were merged, effective 1 May 2025 [6].
• Overall, 43 RRBs became 28 [5].
• 28 RRBs now have more than 22,000 branches in more than 700 districts, with one common logo [7].
• In FY 2025-26, RRBs made a record net profit of ₹10,176 crore. Their total business crossed ₹13.5 lakh crore [10].

Cooperative banks

• Urban cooperative banks (UCBs): cooperative societies licensed to do banking in urban and semi-urban areas.
• RBI regulates their banking functions.
• The Banking Regulation (Amendment) Act 2020 widened RBI's powers over them.
• A four-tier regulatory framework came in 2022. UCBs are grouped by size, and bigger tiers face stricter rules.
• NUCFDC (National Urban Co-operative Finance and Development Corporation) was set up as the umbrella organisation for UCBs in 2024.

• Dual control is still a problem.

  • RBI regulates banking, but state Registrars of Cooperative Societies handle registration, management and elections.
  • So no single authority can fully fix a failing bank. The PMC Bank failure (2019) is the usual example.

• Rural cooperatives have a three-tier short-term credit structure:

• StCBs: State Cooperative Banks, at the state level
• DCCBs: District Central Cooperative Banks, at the district level
• PACS: Primary Agricultural Credit Societies, at the village level

9. PSB governance reform

Each step came out of the one before it:

• P.J. Nayak Committee (2014) found weak governance in PSBs: government interference, short CEO tenures and weak boards.
• Indradhanush (2015) was a 7-point plan: appointments, a Bank Board Bureau, capitalisation, less stress on banks, empowerment, a framework of accountability and governance reforms.
• Banks Board Bureau (BBB, 2016) was set up to select heads of PSBs.
• FSIB (2022), the Financial Services Institutions Bureau, replaced the BBB. It recommends heads of PSBs and public-sector financial institutions, such as insurers.

10. Privatisation

• Budget 2021-22 announced the privatisation of two PSBs. It has not been done yet.
• The strategic sale of IDBI Bank is under way (verify current). A strategic sale means selling a controlling stake together with management control.

11. Banking Laws (Amendment) Act 2025

• Five Acts amended [2]:
• RBI Act 1934
• Banking Regulation Act 1949
• SBI Act 1955

• Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980

• Passage in Parliament [2]:

• Introduced in Lok Sabha: 9 August 2024
• Passed by Lok Sabha: 3 December 2024

• Passed by Rajya Sabha: 26 March 2025

• Up to four nominees per account, named simultaneously or successively [2][4].

• Simultaneous nomination: the depositor fixes each nominee's percentage share, and the shares must add up to 100% [4].

• Successive nomination: the next nominee is recognised only if the one before them has died.

• "Substantial interest" threshold raised from Rs 5 lakh to Rs 2 crore [2][3].

• "Substantial interest" is the shareholding level above which a person counts as having a big stake in a company. This matters for rules on loans to connected parties.

• The old limit had not changed since 1968 [3].

• Tenure of cooperative bank directors extended from 8 to 10 years [2].

• Reporting fortnight for banks' regulatory returns redefined [2].
• Old: Saturday to Friday.

• New: the 1st to the 15th, and the 16th to the last day of each month.

• Unclaimed dividends, shares, interest and bond redemption amounts that stay unpaid for 7 years go to the Investor Education and Protection Fund (IEPF) [2].

• Auditors' pay: the power to decide it moves from RBI to the banks [2].
• Came into force in stages [3][4]:
• Stage 1: 1 August 2025
• Stage 2 (nomination provisions): 1 November 2025

Prelims Hooks

• 1969: 14 banks with deposits of at least Rs 50 crore. 1980: 6 banks with deposits of at least Rs 200 crore. A common trap swaps these two thresholds.
• RBI: set up in 1935, nationalised in 1949. The Imperial Bank became SBI in 1955. The Banking Regulation Act is from 1949.
• Peak pre-emption around 1990-91: SLR 38.5%, CRR 15%. Deposits left for commercial lending: 100 − 38.5 − 15 = 46.5%.
• FDI cap: 74% in private banks, 20% in PSBs. NCERT's "around 74 per cent for banks" is only half the story.
• Narrow banking came from Narasimham II (1998), not Narasimham I (1991). It means a weak bank putting its deposits only into government securities.
• DFIs that became universal banks: ICICI (2002), IDBI (2004). Report on universal banking: Khan Working Group (1997). RBI dropped Islamic banking in 2017.
• Scheduled bank = listed in the Second Schedule of the RBI Act, 1934.
• RRBs: 43 merged into 28 under "One State One RRB". The fourth phase took effect on 1 May 2025 [5][6].
• Order of PSB governance reforms: Nayak Committee (2014) → Indradhanush (2015) → BBB (2016) → FSIB (2022).
• Banking Laws (Amendment) Act 2025: up to 4 nominees; "substantial interest" Rs 5 lakh → Rs 2 crore (unchanged since 1968); cooperative bank director tenure 8 → 10 years [2][3].

Mains Points

• Social banking vs commercial viability (GS-III):
• Nationalisation took banking to villages. In 1969, only about 5,000 of about 6 lakh villages had a bank [9].
• But financial repression (SLR 38.5%, CRR 15%, directed lending, capped rates) weakened profits and credit discipline. The 1991 prudential norms then brought hidden bad loans into the open.

• Lesson: financial inclusion (bringing everyone into the banking system) works best through incentives and differentiated banks, not through forced lending.

• Ownership vs governance:

• The Nayak Committee argued that PSBs underperform because of how they are governed, not simply because the government owns them.
• The response so far has been BBB, then FSIB, plus mergers (27 → 12 PSBs). Full privatisation (Budget 2021-22) has moved slowly.

• Useful GS-II/III debate: privatise PSBs, or make their boards professional and give them real freedom (autonomy)?

• Consolidation as a reform tool:

• PSB mergers (2017-2020) and RRB mergers (43 → 28) [5] aim at scale, lower costs and a stronger capital base.

• Risks: mergers can hide weak banks inside strong ones, reduce local lending, and create too-big-to-fail banks (banks so large that the government feels it must rescue them).

• Cooperative banking and dual control:

• The 2020 amendment, the four-tier framework (2022), NUCFDC (2024) and the 2025 Act all strengthen oversight.
• But dual control by the state Registrar and RBI still weakens supervision. This links to depositor protection and cooperative federalism (the Centre and states working together, since cooperatives are a state subject).