Banking and financial sector development in India: Banks and

other constituents of Indian financial markets and related

developments

A bank is a type of financial institution that primarily deals with deposit collection
and loan distribution. Banking sector in India truly reflects a mixed economy, with
public, private, and foreign banks.
In accordance with the liberalisation policy, reforms in the banking sector were
launched concurrently in 1991, based on the recommendations of the Narasimham
Committee.
Prior to 1991, banking, like the industrial sector, was heavily regulated and
sheltered by the RBI. It became critical to reform the banking sector in order to
support the liberalisation policy and allow for the growth of the private sector.

Historical Background

• The development of the banking sector can be divided into three stages:
• Phase I – Early Phase (1770 to 1969) which can be subdivided into Pre
Independence Period (1786-1947) and Post Independence Period (1947-
1969)
• Phase II – Nationalisation Phase (1969 to 1991)
• Phase III – Liberalisation or Banking Sector Reforms Phase (1991 – till date)

Pre-Independence Period (1786-1947)

 • The "Bank of Hindustan," established in 1770 in the then-Indian capital of
Calcutta, was the country's first bank. However, this bank did not succeed
and closed its doors in 1832.
• Over 600 banks were registered in the country during the pre-independence
period, but only a few survived.
• During British rule in India, the East India Company established three banks
known as the Presidential Banks: The Bank of Bengal, the Bank of Bombay,
and the Bank of Madras.
• These three banks were eventually merged into a single bank in 1921, which
was known as the “Imperial Bank of India.”
• The Imperial Bank of India was later nationalised and renamed The State
Bank of India, which is now the largest public sector bank in India.

Post-Independence Period (1947-1991)

• At the time of India's independence, all of the country's major banks were
privately led, which was a source of concern because people in rural areas
were still reliant on money lenders for financial assistance.
• To address this issue, the then-Government decided to nationalise the banks.
The Banking Regulation Act of 1949 was used to nationalise these banks.
• The Reserve Bank of India, on the other hand, was nationalised in 1949.
• Following the formation of the State Bank of India in 1955, another 14 banks
were nationalised between 1969 and 1991. These were the banks with more
than 50 crores in national deposits.
• Another six banks were nationalised in 1980, bringing the total to twenty.
• Aside from the aforementioned 20 banks, seven SBI subsidiaries were
nationalised in 1959.
• Except for the State Bank of Saurashtra, which was merged in 2008, and the
State Bank of Indore, which was merged in 2010, all of these banks were
merged with the State Bank of India in 2017.

Liberalisation Period (1991-Till Date)

 • Once the banks have been established in the country, regular monitoring and
regulations must be followed in order to maintain the profits generated by
the banking sector.
• The final or ongoing phase of the banking sector's development is critical.
• To ensure the stability and profitability of the Nationalised Public Sector
Banks, the Government decided to form a committee led by Shri. M
Narasimham to oversee the various banking reforms in India.
• The introduction of private sector banks in India was the most significant
development. The Reserve Bank of India granted licences to ten private
sector banks to establish themselves.

Banking Structure in India

The Indian banking system is divided into "Scheduled Banks" and "Non-scheduled
Banks."
• Schedule banks are those that are listed in the Second Schedule of the RBI
Act, 1934 and thus meet the following requirements:
• a bank must have a paid-up capital and reserve of at least Rs. 5 lakh and
• a bank must satisfy the Reserve Bank of India (RBI) that its affairs are not
conducted in a manner that is detrimental to the interest of its deposits.
• Non-scheduled banks are those that are not listed in the second schedule of
the RBI Act, 1934 and thus do not meet the requirements outlined in that
schedule.
• The term "scheduled banks" refers to both "scheduled commercial banks"
and "scheduled cooperative banks."
• The Scheduled commercial banks are further subdivided into four groups:
• Public sector banks (also known as "nationalised banks" and "State Bank of
India (SBI) banks");
• Private sector banks (divided into "Old Private Sector Banks" and "New
Private Sector Banks" that emerged after 1991);
• Foreign banks in India; and
 • Regional Rural Banks (that operate exclusively in rural areas to provide
credit and other facilities to small and marginal farmers, agricultural workers,
and small entrepreneurs).
• Foreign banks are present in the country either through full
branch/subsidiary presence or through representative offices.
• Except for foreign banks, these scheduled commercial banks are registered
in India under the Companies Act.

Role of RBI

• The RBI is the country's supreme monetary and banking authority, and it
controls the Indian banking system. It is known as the Reserve Bank because
it holds the reserves of all commercial banks.
• In accordance with the provisions of the Reserve Bank of India Act, 1934,
the Reserve Bank of India was established on April 1, 1935.
• The Reserve Bank's Central Office was initially located in Calcutta, but was
permanently relocated to Mumbai in 1937. The Governor sits in the Central
Office, where policies are developed.
• Though originally privately owned, the Reserve Bank has been wholly owned
by the Government of India since its nationalisation in 1949.
• The RBI Nationalisation Act of 1949 has been amended several times by the
government in response to changing needs, and its functions have been
expanded.
• Its current functions can be objectively summarised as:
• Monetary policy formulation, implementation, and monitoring are all part
of it. The overarching goal is to maintain price stability while pursuing
growth.
• It issues new currency notes and coins (except for rupee one or its
denominations, which are issued by the Ministry of Finance) as well as
exchanging or destroying those that are no longer fit for circulation.
• This function also includes the responsibility for currency and coin
distribution (of those ones also which are issued by the Ministry of Finance).
• The overarching goal is to maintain adequate supplies of quality currency and
coins.
• Itestablishesbroad parameters for banking operations within which the
banking and financial system operates.
• This function's overarching goal is to maintain public trust in the system,
protect depositors' interests, and provide cost-effective banking services to
the public.
• Itmanagesthe FEMA (Foreign Exchange Management Act, 1999), keeping
the country's Forex (foreign exchange) reserves, stabilising the rupee
exchange rate, and representing the Government of India at the IMF and
World Bank (and other international financial agencies of which India is
member).
• The goal of this function is to facilitate external trade and payments, as well
as to promote the orderly development and maintenance of the country's
foreign exchange market.
• It introducesand upgradessafe and efficient payment systems in the country
to meet the needs of the general public. The goal is to keep the public's trust
in the payment and settlement system.
• As a banker of the Government and the banks, it consists of three categories
of functions:
• first, performing Merchant Banking functions for the central and state
governments; second, acting as their Bankers; and third, maintaining
banking accounts of the SCBs (scheduled commercial banks) operating in
the country (domestic, foreign, public, and private).
• The broad objectives are to enable governments and banks to mobilise
enough liquidity for their operations, under which it lends or manages
government borrowing plans and provides short-term and long-term loans
to banks (as Lender of Last Resort).
• As part of its developmental responsibilities, the RBI established
developmental banks such as IDBI, SIDBI, NABARD, NEDB (North Eastern
Development Bank), Exim Bank, and NHB.
• The ownership of these banks is gradually being transferred from the RBI to
the Government of India.
Types of Banks
There are many types of banks in India, such as:

Commercial Banks

• Any banking organisation that deals with the deposits and loans of
businesses is referred to as a commercial bank.
• Commercial banks issue bank checks and drafts and accept term deposits.
• Through instalment loans and overdrafts, commercial banks also serve as
moneylenders.
• Commercial banks also provide a variety of deposit accounts, including
checking, savings, and time deposits.
• These institutions are run for profit and are owned by a group of people.

Commercial Banks are further divided into the following:

• Public Sector Banks - These are banks in which the Government of India
owns a majority stake. SBI, Bank of India, Canara Bank, and other public
sector banks are examples.
• Private Sector Banks - The majority of a bank's share capital is held by private
individuals. These banks are set up as limited-liability corporations. Private
sector banks include ICICI Bank, Axis Bank, HDFC, and others.
• Regional Rural Banks - Regional Rural Banks were established in accordance
with the provisions of an Ordinance promulgated on September 26, 1975,
and the RRB Act, 1976, with the goal of ensuring adequate institutional
credit for agriculture and other rural sectors.
• RRBs can only operate in the areas that have been designated by Gol as
covering one or more districts in the state.
• RRBs are jointly owned by Gol, the relevant State Government, and Sponsor
Banks; the issued capital of an RRB is divided among the owners in the
proportions of 50%, 15%, and 35%, respectively.
 • Foreign Banks - These banks are registered and have their headquarters in
another country, but they have branches in our country. Foreign banks in
India include HSBC, Citibank, Standard Chartered Bank, and others.

Small Finance Banks

• The Small Finance Bank (SFB) is a private financial institution that primarily
undertakes basic banking activities such as deposit acceptance and lending
to unserved segments such as small business units, small and marginal
farmers, micro and small industries, and unorganised sector entities, but
without any geographical restrictions, unlike Regional Rural Banks or Local
Area Banks.

Payment Banks

• A payment bank is a distinct type of bank that performs only the limited
banking functions permitted by the Banking Regulation Act of 1949.
• Acceptance of deposits, payments and remittance services, internet banking,
and acting as a business correspondent for other banks are examples of
some oftheactivities.
• They are initially permitted to collect deposits of up to Rs 1 lakh per
individual.
• They can help with money transfers as well as sell insurance and mutual
funds. Furthermore, they can only issue ATM/debit cards, not credit cards.
• They are not permitted to establish subsidiaries to provide non-banking
financial services. More importantly, they are not permitted to engage in any
lending activities.

Co-operative Banks

• A cooperative bank is a financial entity that is owned and operated by its

members, who are also its customers.
 • Co-operative banks are frequently formed by people who belong to the same
local or professional community or who share a common interest.
• Co-operative banks typically offer a wide range of banking and financial
services to their members (loans, deposits, banking accounts, etc).
• It is further divided into:
• Urban Cooperative Banks
• Rural Cooperative Banks

Non Banking Financial Institutions

• A Non-Banking Financial Company (NBFC) is a company registered under the

Companies Act, 1956.
• A non-banking financial company, also known as a non-banking financial
institution, provides financial services and products but is not recognised as
a bank with a full banking licence.
• NBFCs are not banks, but their activities include lending and other activities
such as providing loans and advances, credit facilities, savings and
investment products, trading in the money market, managing stock
portfolios, money transfers, and so on.
• NBFC Registration is required before NBFC activities can begin.
• Their activities include hiring, leasing, infrastructure finance, venture capital
finance, housing finance, and so on.
• Deposits can be accepted by NBFC, but only term deposits and deposits
repayable on demand are not accepted.
• Some examples of well-known NBFCs are Kotak Mahindra Finance, SBI
Factors, Sundaram Finance, and ICICI Ventures.

Conclusion

Banks play an important role in an economy's overall growth by lending to various

sectors of the economy for expansion, diversification of existing businesses, and
support of new businesses.
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Financial Market
The financial market serves as a link between fundraisers and investors. It involves
the sale and purchase of treasury securities such as banknotes, bonds, securities,
foreign currency, and contracts. It is a mechanism that facilitates the movement of
equity and debt money by bringing together financial institutions (banks, etc.),
financial products (bonds, stocks, etc.), associations (investment banks), and
regulatory authorities (RBI, SEBI, etc.). In addition, the financial market provides a
marketplace where market participants can trade resources at prices established
by producers and consumers.

Financial Market Functions

• The financial market facilitates the transfer of funds between savers and
investors, besides helping them determine the prices of securities.
• It aids in determining the prices of different financial products (bonds, stocks,
etc) based on demand and supply.
• It allows investors to sell their holdings and convert assets to cash within a
short time frame, thereby making the financial commodity market more
dynamic.
• It also offers a platform for producers and consumers to find each other
easily.
• It facilitates the flow of new savings by investors into the country, which
contributes to capital formation.

Financial Market Types

The financial market is classified into two categories: money market and capital
market.
Money Market
The money market deals with short-term financial instruments with a high liquidity
level. The primary function of the money markets is to provide an outlet for
balancing the short-term supply of and demand for funds. It also helps facilitate
monetary policy decisions. The key instruments of the money market are call
money, Treasury bills, commercial paper, deposit certificates, banker’s
acceptances, and inter-corporate funds. Due to the high liquidity of the securities,
the money market is considered a safe investment option.

Capital Market

The capital market is a term used to describe the channels through which medium
and long-term funds are collected and invested. Commercial banks, development
banks, and stock exchanges make up the capital market. The main capital market
instruments are equity shares, bonds, debentures, preference shares, and so on.

Difference between Money Market and Capital Market

• Money market participants are largely institutional players, such as the

Reserve bank of India, banks, financial institutions, etc. Among the
participants in the capital market are banks, financial institutions, foreign
investors, corporations, and retail investors.
• It is possible to issue money market instruments for one day or one year. In
contrast, capital market securities include debentures and equity shares,
which are medium- and long-term investment vehicles.
• As the money market has a short term, it does not yield high returns. On the
other hand, the returns on investments in capital markets are typically higher
than those in money markets. Securities held for an extended period have a
greater possibility of generating higher earnings.

Capital Market and its Types

Primary market: Primary markets are the places that issue securities. First-time
stock and bond offerings take place in this market. IPOs, or initial public offerings,
are examples of primary markets. Primarily, the primary market is responsible for:
(a) Origination: It is the process of analysing and evaluating new proposals
submitted to the primary market.
(b) Underwriting: Underwriting companies assist in launching new issues by
ensuring a minimum subscription. They also purchase unsold issues.
(c) Distribution: Distribution is carried out primarily by the dealers and brokers who
deal directly with the investors to ensure the success of the issue.
Secondary market: Secondary markets are capital markets where existing securities
are traded. Also known as the stock market, it is the place where investors can buy
and sell securities. Moreover, the secondary market provides investors with regular
information about the value of securities. Additionally, it provides investors with
liquidity for their assets.

Stock Exchanges Role in the Financial Market

Stock exchange markets play an important role in the financial market. The system
facilitates transactions between traders of financial instruments and their
prospective buyers. India’s stock exchanges are regulated by the Securities and
Exchange Board of India or SEBI.
The stock market in India enables investors to trade investment instruments, such
as stocks, bonds, securities, and currencies. This is an online platform for buyers
and sellers to trade financial tools at specific hours during the day while adhering
to the rules that are laid out by SEBI. Nevertheless, only companies that are listed
on a stock exchange are allowed to trade on it.
However, stocks that are not registered on a reputable securities exchange can still
be traded via over-the-counter (OTC) derivatives. In OTC derivatives, two
counterparties arrange a financial contract with minimal regulations. Moreover,
these can be tailored to the needs of the parties involved. However, these shares
are not highly valued on the stock exchange.
Following are the recognised stock exchanges according to the Securities and
Exchange Board of India (SEBI):

• Calcutta Stock Exchange

• Bombay Stock Exchange
• International India Exchange (India INX)
• Indian Commodity Exchange Limited
• India’s Multi Commodity Exchange Limited
• National Commodity & Derivatives Exchange Ltd.
• The National Stock Exchange of India (NSE)
 • NSE IFSC Ltd.

Financial Market Indices (Stock Indices)

A stock index is a statistical metric that indicates how the values of stocks in publicly
traded corporations have changed over time. Moreover, it shows the general
market sentiment and the direction of price movements in financial, commodities,
or any other market. The following are also some of the major stock market indices:

• NIFTY 50: It is an index consisting of 50 stocks representing 13 economic

sectors
• BSE SENSEX: It is a free-floating market-weighted stock market index
comprising 30 reputable and financially secure businesses listed on the
Bombay Stock Exchange.
• S & P CNX 500: It is India’s first broad-based stock market index. S&P CNX
500 makes up almost 96% of total market capitalisation.
• MSX-SX: Multi Commodities Market Exchange ranks third among India’s
national stock exchanges after Bombay Stock Exchange and National Stock
Exchange. The exchange allows trading in the shares of 1,116 listed
companies
• Other stock indices include NIFTY India Consumption, NSE Midcap, etc.

Financial Market Regulatory Bodies

Financial markets and institutions in India, like banks, insurance companies, etc.,
are regulated by autonomous regulatory agencies. Such as:

• The money market is regulated via the Reserve Bank of India.

• The capital market and mutual fund market is regulated via the Securities
Exchange Board of India (SEBI)
• The insurance marketplace is regulated via the Insurance Regulatory and
Development Authority (IRDA); and
• The pension fund is regulated through the Pension Fund Regulatory and
Development Authority (PFRDA).
Conclusion

The Indian Capital Market is a place for buyers and sellers to buy and sell financial
instruments such as stocks, bonds and other securities. The financial market
provides a platform for buyers and sellers to trade assets at prices based on supply
and demand. However, only corporations that are authorised on a stock market are
permitted to trade on it. Nevertheless, stocks not listed on a reputable securities
exchange can be bought and sold on over-the-counter derivatives. However, these
securities might not have a high market value.

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