The article is by Neelam Prusty of Madhusudan Law College, Cuttack. The article talks about the challenges faced by the Indian banking system.  

“Financial institutions must be able to deliver an easy to navigate, a seamless digital platform that goes for beyond a miniaturized online banking offering.”

–Jim Marous

Introduction

The banking sector in India has a huge canvas of history. It includes the traditional banking practices from the time of Zamindar to Independence of India, nationalization of banks to the privatization of banks and now the increasing numbers of foreign banks in India. The banking sector of India has been through a long journey of ups and downs. The banking sector in India has also reached a height with the changing times. The use of technology has brought a revolutionary change in the working of the banks. Still, the fundamental features of the banking sector in India i.e. trust, faith and the confidence of the people on the institution remain the same. The majority of the banks are successful in holding the assurance of the shareholders as well as stakeholders. However, a new kind of risk exposure is carried with the changing aspects of the banking sector.

In recent time, some complicated conditions such as bankruptcy of banking & financial institutions, the debt crisis in major economies of the world have been proved to be the major problems for the world economy which is seemingly a devastating problem for the recent future. The uncertain scenario caused the declination in the major economies like the US and Europe. It has turned into a global concern. This gives rise to some critical questions about the survival, growth and maintenance of sustainable development.

However, India’s Banking Industry has maintained its flexibility overtimes. The rhythm of development for the banking sector in India was outstanding over the past few years. From the advanced rate of credit expansion, expanding productivity and profitability to banks in developed markets, lower prevalence of non- performing assets and focus on financial inclusion, it is evident to have contributed to making Indian banking system vibrant and strong. Indian banks have started to revise their growth approach and re-evaluate the projections on hand to keep the economy rolling. 

Historical Background

The Bank of Hindustan was the first Indian bank to be set up in 1870. Later, three banks under Presidency Bank’s Act, 1876 i.e. Bank of Calcutta, Bank of Bombay and Bank of Madras laid the foundation for modern banking in India. In 1921, all presidency banks were merged to form the Imperial Bank of India. 

The Imperial bank carried out a limited number of functions of the central banking system before the establishment of RBI. It was engaged in all types of commercial banking business except for dealing with foreign exchange.

The Reserve Bank of India Act was approved and enacted in 1934. The Reserve Bank of India (RBI) was established as an apex body without major government ownership. Soon, the Banking Regulations Act was passed in 1949. This regulation brought RBI under government control. Under the act, RBI got a wide range of powers for supervision and control of banks. This Act also conferred licensing powers and the authority to conduct inspections in RBI.

In 1955, RBI acquired control on the Imperial Bank of India, which was renamed as the State Bank of India. Later, in 1959, SBI took over control of eight private banks floated in the earlier princely states, making them as its 100% subsidiaries. In 1960, the RBI was empowered to force the compulsory merger of weak banks with the strong ones. It substantially reduced the total number of banks from 566 in 1951 to 85 in 1969.

The nationalisation of banks was to make them play the role of catalytic agents for economic growth. The Narasimha Committee report proposed a wide range of reforms for the banking sector to introduce internationally accepted banking practices in 1992. The amendment of the Banking Regulation Act in 1993 permitted the entry of new private sector banks.

Banking sector is the backbone for the growth of the country’s economy. The journey of the banking Sector in India has faced many waves of economic crisis. Recently, there is an economic crisis of US in 2008-09 and later on in European countries. The general scenario of the world economy is in fact very critical. The framework of banking rules and regulation in India has played a dynamic role in preventing it from the world economic crisis.

General Banking Scenario in India

The general banking scenario in India has become very enthusiastic nowadays. Before the pre-liberalization era, the portrait of Indian Banking sector was completely different. Further, the Government of India introduced various measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution implemented by the Government of India in 1948 envisaged a mixed economy. This resulted in greater involvement of the state in different sectors of the economy including banking and finance.

The Reserve Bank of India was nationalized on January 1, 1949, under the terms and conditions of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. In 1949, the Banking Regulation Act was enacted which authorized the Reserve Bank of India (RBI) “to regulate, control, and scrutinize the banks in India.” The Banking Regulation Act also directed that no new bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could have common directors. 

By the 1960s, the banking sector had become a crucial tool to accelerate the speed of development of the Indian economy. The Government of India issued an ordinance and nationalised the 14 leading commercial banks with effect from the midnight of July 19, 1969. Due to this reason, the nationalization gave more control of credit delivery to the government. The Government of India controlled around 91% of the banking sector of India by 1980. 

Later, the new banking policy brought a sudden change in the banking sector in India. It was accompanied in a modern outlook and tech-savvy methods of working for traditional banks. This led to the retail expansion in India. People not only demanded more from their banks but also received more from them.

Structure of Indian Banking System 

The Banking Industry in India functions under the parasol of the Reserve Bank of India – the regulatory, supervisory and central bank. The Banking Industry mainly consists of:

• Commercial Banks.
• Co-operative Banks.

The commercial banks are further divided into two types. They are:

1. Scheduled Commercial Banks.
2. Unscheduled Bank.

Scheduled Commercial Banks are those banks which have been included in the Second Schedule of The Reserve bank of India (RBI) Act, 1934. The RBI includes only those banks in this schedule which satisfy the criteria laid down in Section 42 (60) of the Act. All public and private sector banks, The State Bank of India and its associates and other nationalised Bank comes under Scheduled Commercial Banks.

Unscheduled banks in India means a banking company as defined in clause (c) of Section 5 of the Banking Regulations Act,1949 which is not a scheduled bank.

The co-operative Banks in India are registered under the Co-operative Societies Act, 1904. The Co-operative banks are as well regulated by RBI. They are also governed under the Banking Regulations Act, 1949 and Banking Laws Act, 1956. It has a three-tier arrangement. The district co-operative bank operates at the district level and primary credit society works at the village level.

Challenges faced by Indian Banking system

Developing countries like India has a huge number of people, approximately about 1.3 billion, who do not have access to banking services due to dispersed and fragmented locations. But those people who are availing to the banking services, their expectations are rising as the level of services is increasing due to the development of Information Technology and competition. Since foreign banks are occupying Indian market, the services offered has increased due to which the banks have laid emphasis on meeting the customer expectations which needs to be fixed once and for all.

Now, the existing situation has created tremendous challenges and opportunity for Indian Banks. In order to encounter the general scenario of the business sector, we need to be aware of the visible challenges and opportunities lying with the banking sector of India. The major challenges faced by the Indian banking sector are as follows.

Rural Market

Approximately 69% of India’s population resides in rural areas. Recently, there have been some ambitious targets by the Government of India like access to bank accounts to all the households of the country. But even if everyone from all possible remote location gets access to a bank account, many villages do not have fairly adequate branches and ATMs to feed the market in rural areas. The lack of knowledge about the information and communication technologies, the illiteracy of rural folks and the unavailability of internet connection make the banking industry insignificantly inefficient in rural area.

Risks of Management 

The widely growing competition increases the competitiveness to a higher extent among the banks. But the existing global banking scenario is seriously posing threats for the banking sector in India. In recent times, a large number of employees are getting retired from the public sector banks. The younger employees are replacing the elder and more-experienced employees at junior levels. As a result, the work experience gap may emerge between the subordinates and superiors which would lead be a virtual vacuum. The absence of middle management could lead to adverse impact on the decision-making process of the banks. It can increase the time for tackling problems regarding the banking sectors.

Non-performing Assets (NPAs)

Presently, there is no such advanced equipment with the commercial banks to ensure that the loans and advances are going into productive use in the larger public interest. They are suffering from huge losses due to the high proportion of non-performing assets to banks from borrowers. Most of them are also unable to maintain capital competency ratio.

Only 12 companies constitute more than 25% NPAs in our country. Only 5 among these 12 companies have been settled after the strategic achievements.

Social and Ethical Aspects

The banks have to take on the responsibility to bear social and ethical aspects of the banking system in India. The banks have to accept these methods in order to operate themselves. Gaining trust of the people must be the top priority of the bank. Besides the maximization of profits, the banks have to support the social organisation to be successfully established in the society. The nature and operation of the banks in the general society help them to influence people to join them for loan, deposits and savings etc. These methods could be very much beneficial for the bank in coming future. 

Frauds

A fraud is an intentional act by the borrower where the scam of funds is involved. Such frauds include Accounting Frauds, Demand Draft Fraud, Uninsured Deposits, Bill Discounting Fraud, Fraudulent Loans, Cheque Kiting, and many more. The recent Punjab National Bank case where fake Letter of Undertakings worth Rs. 11,000 crores were issued is the most relevant example. 

Erstwhile, the scams in the Global Trust Bank (GBT) and the Bank of Baroda show the misuse of the freedom by the officials under the excuse of liberalisation for their personal benefit. These scams have badly damaged the image of these banks and consequently their profitability.

Growth of Banks

The growing number of banks in India is a serious problem. It sustains productivity growth due to technological development. The growth of foreign banks in India added to the competitive pressure in the banking market. The banks which improve its market share and customer base was successful in establishing themselves in the Indian market.  

Global Banking

It is practically impossible for any nation to exclude itself from the world economy. Therefore, for sustainable development, India’s merchandise trade, service exports and remittances are growing at a faster pace. As India is moving towards closer integration with the world economy, the impact of globalization becomes challenges for domestic enterprises as they are bound to compete with global players.

Financial Inclusion

Financial inclusion has become a necessity in today’s business environment. The production by the commercial organisations has to go through the verification from various perspectives like environmental concerns, corporate governance, social and ethical issues. Apart from this, it has to bridge the gap between rich and poor. The poor citizens of the country should be given proper attention to improving their financial condition.

Technological Risk

The most urgent concern for the global bankers is the risk of cyber-attacks which can result in significant loss to the banking sector. The modern world wants to meet their needs through modern technology. But unfortunately, it comes with a price. The application of technology like digital and mobile banking is not completely secure and are more prone to cyber-attacks. Eventually, the cybercriminals are coming up with new ways to breach cybersecurity which makes people insecure about the banking sector.

Reduced Profits 

The banking sector has recorded frequent declination in balance sheet growth. In the past few years, many banks have tried to suspend the reserved money by means of provisions for future bad loans. The only reason for which the chief executives of the bank have a short tenure, during which period they need to put up higher net profits and cheer investors.

Issue of Monetary Transmission

Due to short availability of financial resources against the background of high NPAs, the change in the policy rate was not reflected in lending rates as well as the banks were not willing to transmit the benefits of low-interest policy administration.

Transparency

According to the instruction of the Reserve Bank of India, it is compulsory for all commercial banks to reveal each and every information regarding the maturity pattern of loans, assets and liabilities, investment securities, capital provision like deposits and savings, foreign currency exchange, government shareholder, mutual funds, bonds, movements in Non-Performing Assets. So, the pressure upon the bank to be transparent in nature is the most important challenge for the bank because earlier, the vital information was not disclosed by the banks.

Advance to Priority Sector

As concern to the advance to the priority sectors, the progress has been slowed down. The fact is that the bank officials from top to bottom was unable to accept nationalisation with poise. This is attributable to the poor because of the unacceptable loan recovery rates from the agricultural and small sectors.

Competition from Non-Banking Financial Institution

Commercial banks are facing severe challenges from non-banking financial programmes like mutual funds, housing finance corporations, leasing and investment business. All these institutions compete meticulously with commercial banks in attracting public deposits and offering higher rates of interest than commercial banks.

Competition with Foreign Banks

Foreign banks and the smaller private sector banks have recorded an increase in deposits which is a potential threat for Indian banks. The reason is that non-nationalised banks offer better customer service. This creates the impression that a deviation of deposits from the nationalised banks to other banks has undoubtedly taken place.

The gap between Promise and Performance

A wide gap between promise and performance has been observed after the nationalisation of the banking system. The failure to withstand the desired credit pattern and fill in credit gaps in different sectors is one of the major weakness of the nationalised banking system in India. Even though the re-orientation of bank objectives has been conducted, the bank staff has remained practically inactive and the bank procedures and practices have continued to remain old and outdated. The bank staff doesn’t appreciate the new work philosophy and new social objectives.

Development of Human Resources

Human resource is the most important need of any sector of the country which plays an exponentially vital role in modern society. Human brains are the crucial demand to meet the challenges faced by the Indian banking system. A large investment was made on information technology and human resource development to keep the right pace with the fast-changing banking sector.

Bureaucratisation

The result of nationalisation is indeed the bureaucratisation of the commercial banks in the banking system. The smooth functioning of banks has been hampered by nepotism, long intervals, lack of initiative and failure to take quick decisions.

Political Pressures

The growing political pressures from the centre and the states hampers the smooth working of the nationalised banks in India. They often face lots of problems due to various political pressures. Such pressures are created in the selection of employees and grant of loans to particular parties without considering their capacity to pay back the amount.

Steps were taken to overcome the challenges faced by the Indian banking system 

It is obviously a terrible situation for a developing country like India to face such challenges regarding the economy. A number of calculated steps should be taken as soon as possible. It was the demand of the time to do something to restore the detouring situation of the economy of the country. At last, the Government of India including the Reserve Bank of India, the Supreme Court of India and each individual bank have taken many initiatives by themselves to address the challenges effectively. Some of the strategies coined by the Government of India to face the above challenges are as follows.

1. The Ministry of Finance suggested four R’s – Recognition, Recapitalization, Resolution, and Reform to address the problem of Non-Performing Assets in the year 2015-16.
2. The Union Government exposed its plans to infuse 70,000 crore rupees into different sectors in the next few years. But it came into the knowledge that the Public Sector Units (PSUs) banks would require at least 1.8 lakh crore rupees by 2019-20.
3. The Government announced Mission Indradhanush under which 7 key strategies were proposed to reform public sector banks (PSBs) in 2015.
4. In the same year, the RBI advised all PSBs to appoint internal supervisory body to boost the quality of customer service and to ensure that there is complete attention towards the resolution of customer complaints in banks.
5. The Government introduced ‘Insolvency and Bankruptcy Code’ in the Parliament with the recommendations of the Bankruptcy Law Reforms Committee (BLRC) in 2015.
6. In order to reduce corruption, the Supreme Court ordered that the higher officials and employees of private banks to be treated as public servants for the purposes of the Prevention of Corruption Act, 1988.
7. The RBI enabled modification of procedural flaws in the system through a number of ingenious initiatives like restricting additional non-performing assets through early detection, monitoring remedial action plans, shared information, disclosures, confessions etc.
8. The Government of India announced the implementation of PMJDY (Pradhan Mantri Jan Dhan Yojana) encouraging people to access bank services.
9. Kisan Credit Card scheme was launched for the farmers to assist them through loans from the banks.
10. The banks removed the fake accounts with the implementation of KYC verification policy for which money transaction can be easily monitored.

Besides the government of India, some practices were introduced worldwide to tackle problems faced by the banks like SWIFT was launched by Bank for International Settlements (BIS) to solve the problems of blockchain to transfer money between banks on international level.

Conclusion

The banking sector has been marked by high expectations values of the customers. Over the past years, the culture of fear and the small sector of development are two important phenomena of the global market, which has brought frequent changes in different situations. The pre- and post-liberalization period has observed innumerable environmental changes which directly affects the market. The post-liberalization period has spread new aspects of development in India, but at the same time, it has also established some challenges.

Banks are the heart of the economic system of any country. Basically, a scientifically advanced, transparent and efficient banking system is the need of the hour for the growth of the economy in developing countries like India. In our country, the conservative economy has been exceeded by the demand for qualitative banking as financial inclusion is still a distant dream. Besides the provision of traditional services, many social functions are included in the banking system. With the purpose of achieving the goal of faster and comprehensive growth, it is high time for the government and the banking sector to inclusively examine the existing policies, strategies and arrangements. The banks are struggling to fight back the competition with backs. The competition from global banks and technological innovation has forced other banks to reorganise their policies and strategies. At present, the banking sector is trying to improve its flaws to overcome the emerging challenges and become a profitable business in upcoming times. At last but not the least, we need to aware people regarding banking sectors and its different aspects to overcome the problems mentioned above.

---

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: