Law And Policy

This post presents concise summaries of –
Reading- 1 | Historical Evolution of Banking in India – Najmi Shabbir
Reading-2 | A general introduction to the Banking Regulatory Regime in India– Extract from The Banking Regulation Review, 12th Edition

Reading- 1 | Historical Evolution of Banking in India – Najmi Shabbir

India’s banking system sits at the crossroads of financial inclusion policy, rapid digitalisation, and macro-prudential discipline. Over the past decade, public digital rails (Aadhaar e-KYC, UPI, IMPS, AEPS), inclusion programs (PMJDY), and stronger prudential norms (Basel III capital, tighter NPA recognition and provisioning) have collectively improved access, efficiency, and resilience. Banks exited the pandemic with cleaner balance sheets, healthier profitability, and adequate capital buffers, while non-bank lenders (NBFCs) faced closer RBI oversight after earlier liquidity episodes. The overarching policy trade-off is enabling innovation at population scale without compromising stability and consumer protection.

Institutional architecture

• Regulator: The Reserve Bank of India (RBI) is the monetary authority and primary banking regulator, setting licensing, capital, liquidity, governance, and supervisory norms; it also regulates payment systems.
• Other authorities: The Ministry of Finance (Department of Financial Services) oversees public sector banks (PSBs) and policy; DICGC provides deposit insurance; financial-sector coordination occurs via the Financial Stability and Development Council (FSDC).
• Core statutes: RBI Act 1934; Banking Regulation Act 1949; Payment and Settlement Systems Act 2007; SARFAESI 2002 for secured-credit enforcement; Prevention of Money Laundering Act 2002; Insolvency and Bankruptcy Code 2016 (banks excluded from insolvency but large borrowers are resolved under IBC); and the RBI’s Master Directions across risk, governance, and consumer protection.

Market structure

• PSBs and private banks dominate assets and deposits.
• Small Finance Banks (SFBs) focus on inclusion and micro/SME credit; Payments Banks provide deposit and payments services with lending restrictions.
• Regional Rural Banks (RRBs) and co-operative banks widen rural reach.
• NBFCs (investment/credit companies, HFCs, IFCs, MFIs, etc.) are systemically important in consumer and MSME credit; the RBI has shifted them to a scale-based regulatory (SBR) pyramid.

Licensing & ownership

Bank licensing now follows an “on-tap” regime for universal and SFB licenses, subject to “fit-and-proper” criteria, minimum paid-up capital, foreign shareholding caps aligned with FDI rules, promoter lock-ins, and governance requirements (independent directors, tenure/age norms for key managerial posts). Ownership transitions and mergers require RBI approval, and weak banks may be steered through moratoriums and amalgamations to protect depositors.

Prudential and supervisory framework

• Capital & liquidity: Basel III capital adequacy (CRAR), leverage ratio, Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) for larger institutions; statutory CRR/SLR requirements; ICAAP/SREP-style oversight through RBI’s Supervisory Program.
• Asset quality: 90-day NPA recognition, income recognition and provisioning norms, and quarterly disclosure.
• Early-warning & remediation: The Prompt Corrective Action (PCA) framework triggers restrictions based on capital, asset quality, and profitability thresholds; banks prepare time-bound turnaround plans.
• Risk & compliance: Comprehensive norms for credit concentration, connected lending, outsourcing, cyber security, operational risk events reporting, and stress testing.

Consumer protection & market conduct

RBI’s Integrated Ombudsman Scheme unifies grievance redress across banks, NBFCs, and payment operators. Clear KYC/AML/CFT standards (including CKYCR) coexist with tiered e-KYC for inclusion. Disclosure and transparency rules cover charges, product suitability (especially for retail and micro credit), and secure digital authentication. The DICGC insures deposits up to a statutory limit, improving depositor confidence.

Payments and public digital infrastructure

India’s payments stack blends public standards with private innovation. UPI enables instant, interoperable account-to-account transfers and has become the default interface for person-to-merchant and person-to-person transactions; IMPS is an alternative real-time rail; AEPS supports biometric transactions at banking correspondents; RuPay card rails complement international schemes. The government and RBI seeded Digital Banking Units (DBUs) to offer assisted digital services in semi-urban/rural areas, while Account Aggregators (AA) enable consented data-sharing for better underwriting. Cross-border linkages (e.g., UPI tie-ups) are expanding.

Inclusion and credit delivery

PMJDY catalyzed basic accounts with direct benefit transfers and RuPay cards, dramatically deepening formal access. The Business Correspondent model, RRBs, SFBs, and co-operatives extend last-mile presence; priority-sector lending (PSL) norms guide credit to agriculture, MSMEs, and weaker sections. Targeted refinance institutions (e.g., NABARD, SIDBI, NHB) support sectoral flows, while credit guarantee schemes crowd-in lending to small enterprises.

Emerging themes

• CBDC: RBI’s retail and wholesale central bank digital currency pilots explore programmable money, settlement efficiency, and financial inclusion use-cases.
• Fintech oversight: Regulatory sandboxes, stricter digital-lending guidelines (first-loss default guarantees, pass-through arrangements, FLDG caps), and data-protection alignment aim to curb predatory practices while preserving innovation.
• Climate & cyber: The supervisory agenda is adding climate-risk disclosures and enhanced cyber resilience testing as digital adoption rises.

India’s regime combines dense prudential guardrails with nation-scale digital pipes. The policy North Star low-cost access with high systemic resilience shows up in inclusion programs, standardized rails, tight supervision of asset quality and liquidity, and an increasingly data-driven supervisory approach. The near-term watch-list: NBFC-bank interconnectedness, governance in fast-growing lenders, responsible digital credit, and secure cross-border interoperability while continuing to compound the gains from UPI, DBUs, and account aggregation.

Reading-2 | A general introduction to the Banking Regulatory Regime in India– Extract from The Banking Regulation Review, 12th Edition

Indigenous finance and early experiments

Before modern banks, India’s commerce long relied on indigenous bankers such as sahukars, shroffs, and seths who issued hundis (bills of exchange) and provided trade finance across merchant networks. These institutions were flexible and reputation-based but localised, with limited capacity for large-scale intermediation or note issue. Colonial trade expansion in the eighteenth and nineteenth centuries brought European agency houses that mixed trading with banking and founded some of the earliest joint-stock banks; many were fragile and succumbed to trade shocks.

Presidency banks and currency centralisation

Three chartered Presidency Banks – Bank of Bengal (1806), Bank of Bombay (1840), and Bank of Madras (1843) became the pillars of formal banking in the nineteenth century. Initially permitted to issue banknotes, their privileges ended with the Paper Currency Act of 1861, which centralized note issuance in the Government. The Presidency banks increasingly acted as government bankers and anchors of formal finance, though their reach was urban and trade-centric. Company law gradually standardised joint-stock forms, but supervision remained weak.

Rise of Indian joint-stock banks and Swadeshi impulse

From the late nineteenth century, Indian-owned banks emerged – Allahabad Bank (1865), Punjab National Bank (1895), Bank of India (1906), accelerating during the Swadeshi movement (1905–1911). Nationalist sentiment and expanding indigenous enterprise produced a wave of banks: Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, Bank of Mysore, among others. By the early twentieth century, the sector comprised Presidency banks, a growing set of Indian joint-stock banks, and foreign “exchange banks” servicing trade settlements. In 1921, the three Presidency banks merged into the Imperial Bank of India, a quasi-central institution combining commercial banking with government business and limited lender-of-last-resort functions.

Cycles, crises, and institutional responses

World War I and subsequent commodity booms inflated deposits and credit, but the post-war slump (1918–21) exposed thin capital and risky connected lending in many small banks. Failures were common, aggravated by promoters mixing trading and banking, related-party exposures, and poor governance. The Central Banking Enquiry Committee (1931) documented systemic weaknesses and recommended a true central bank with supervisory powers. These culminated in the Reserve Bank of India Act, 1934; RBI began operations in 1935, assuming currency issuance, bankers’ bank responsibilities, management of reserves, and limited oversight of scheduled banks (those meeting capital/reserve criteria).

Cooperative credit and rural finance

Agriculture dominant in employment and output remained under-served by joint-stock banks that were urban-oriented. Inspired by European cooperative models, the Co-operative Credit Societies Acts (1904, 1912) encouraged Primary Agricultural Credit Societies (PACS), District Central Co-operative Banks, and State Co-operative Banks for short-term needs; long-term agricultural and land-improvement credit evolved via state-level land development banks. RBI, recognising agriculture as a special responsibility, provided refinance and guidance, yet the cooperative architecture struggled with governance, capital, audit, and professional management, limiting scale and reach. Moneylenders and traders thus continued to dominate rural credit, often at usurious rates.

Supervision, classification, and the long tail

Despite RBI’s creation, statutory supervision of commercial banks remained modest through the 1930s and early 1940s. New bank formation did not always require RBI approval; many small, local banks proliferated with minimal paid-up capital, opening far-flung branches to capture deposits. Banks were classified (A1, A2, B, C, D) by financial strength; while a few strong institutions grew, the long tail was vulnerable to shocks. High-profile collapses (e.g., Travancore National and Quilon Bank in 1938) unsettled public confidence and highlighted the need for tighter regulation, reforms that would only fully materialize with the Banking Regulation Act of 1949 (post-Independence).

World War II and wartime expansion

The Second World War transformed the deposit base. Defence spending, currency expansion, import compression, and rising incomes for certain segments swelled bank deposits. Scheduled and non-scheduled banks expanded branches rapidly between 1940 and 1945, sometimes without commensurate capital or risk management. The Imperial Bank and a few large joint-stock banks gained prominence, but fragmentation persisted. While deposit mobilisation improved, credit allocation remained skewed toward trade and urban commerce; rural and small-scale sectors continued relying on non-institutional sources.

Achievements and fault lines at Independence

By 1947, India possessed the essential scaffolding of a modern system, an embryonic central bank (RBI), a leading universal bank handling government business (Imperial Bank), and a cohort of Indian-owned joint-stock banks with national ambitions. Financial habits had shifted toward deposit banking in major towns, payments instruments (cheques, hundis) coexisted, and public familiarity with formal banking grew. Yet structural gaps loomed: weak prudential oversight for many banks, inadequate governance and capital, limited reach beyond cities, and enduring reliance on moneylenders for agriculture. The system had not yet internalised robust lender-of-last-resort protocols, deposit insurance, or comprehensive supervisory powers features that would be addressed only in the post-Independence legislative settlement.

Legacy and path to later reforms

The pre-Independence era thus bequeathed both institutional continuity (RBI, Imperial Bank/State Bank lineage, large Indian banks founded pre-1914/1911) and a reform agenda, professional supervision, depositor protection, rural credit expansion, and state-backed development finance. These priorities shaped the post-1949 trajectory: enactment of the Banking Regulation Act, social control and branch expansion, nationalisation waves to redirect credit, and much later post-1991 liberalisation with private bank entry and technology-led transformation. In that sense, the period up to 1947 was less a completed system than a launchpad for the twentieth-century project of building inclusive, stable, and nationally oriented banking in India.