Banking System in India: Overview, Regulation & Cooperative Banks

Introduction

The banking system in India, which evolved over several decades, is well established and has been serving the credit and banking needs of the economy. The banking ecosystem is providing impetus to the economic growth and development of the country and catering to the specific and varied financial requirements of different customers and borrowers.

Banks play a crucial role in efficiently channeling resources from depositors to lenders, mutually benefiting parties and promoting economic growth by optimizing resource utilization.

Banking Sector Landscape in India

• Scheduled Commercial Banks: 137 scheduled commercial banks operate in India, providing banking services nationwide.
• Co-operative Banks and Local Area Banks: also contribute to the banking sector, serving various segments in different regions.
• NBFC and AIFI: For targeted lending to specific sectors or segments, approximately 9,516 Non-Banking Financial Companies (NBFCs) and  All India Financial Institutions play a role in meeting borrowers’ needs.
• Banking Correspondents: Efforts to enhance banking accessibility have led to the establishment of banking outlets, branches, or business correspondents in every village, ensuring coverage within a 5-kilometer radius.
• Enhanced Banking Accessibility in Rural Areas: This initiative has resulted in 99.97% coverage of inhabited mapped villages across the country, improving access to banking services for rural populations.

  Landscape of Commercial Banks in India

• Governed under Banking Regulations Act, 1949. Commercial Banks can be categorized into two segments: Scheduled Commercial Banks (SCBs) and Non-Scheduled Commercial Banks.
• Scheduled Commercial Banks: These are officially listed in the Second Schedule of the RBI Act, 1934 and fall under the regulatory framework of the Banking Regulation Act, 1949.
• Two primary factors determine an SCB’s status: 
  • A minimum paid-up capital and reserves of 5 lakh, ensuring the bank’s resilience and ability to manage deposits responsibly.
  • Maintaining operations that prioritize the welfare of depositors, as determined by the Reserve Bank of India (RBI).
• SCBs in India are categorized into following different groups as follows: (Classification Based on the data of the Department of Financial Services)
  • Public Sector Banks: Public Sector Banks are constituted under the State Bank of India Act, 1955 and Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980. 
    • Presently, there are 12 public sector banks.
  • Private Banks: These are banking companies licensed to operate under Banking Regulation Act, 1949.
  • Private Sector Foreign Banks: These are banks that have their headquarters outside India but run their offices as a private entity at any other location in India. 
    • Such banks are under an obligation to operate under the regulations provided by the Reserve Bank of India as well as the rules prescribed by the parent organization located outside India.
  • Regional Rural Banks (RRBs): Established on recommendations of the Narasimham Working Group (1975), 
    • Established under the Regional Rural Banks Act of 1976; 
    • The aim is to ensure sufficient institutional credit for agriculture and other rural sectors.
    • The area of operation of RRBs is limited to the area notified by the Central Government.
    • Ownership: 50% by the Central Government, 35% by the Sponsor Bank, and 15% by the State Government.
  • Small Finance Bank: Llicensed under Banking Regulation Act, 1949.
    • Created to further financial inclusion by primarily undertaking basic banking activities to un-served and underserved sections including small business units, small and marginal farmers, micro and small enterprises and other underserved sections.
  • Payment Banks: Public limited companies licensed under Banking Regulation Act, 1949.
    • Specific licensing conditions restricting its activities mainly to acceptance of demand deposits and provision of payments and remittance services.

Evolution and Regulation of Cooperative Banks

• Co-operative Societies are governed by the Co-operative Societies Act, 1904.
• Four distinct tiers: 
  • Central Cooperative Banks: Operate at the district level, providing loans primarily to affiliated primary societies.
  • State Cooperative Banks: Operate at state level. 
  • Primary Cooperative Banks: Serve urban and semi-urban areas, focusing on non-agricultural businesses.
  • Land Development Banks: Cater specifically to farmers’ needs, offering credit for development purposes. Comprise three tiers: Primary, State, and Central.
• Regulatory Authority: Recently came under the regulatory purview of the National Bank for Agricultural and Rural Development (NABARD) instead of just RBI and state governments.
• Urban Cooperative banks: After the Banking Regulation (Amendment) Act 2020 was passed, all the powers were transferred to RBI from the Registrars of the cooperative societies. 
  • Even some powers are left with the registrar but RBI powers will override them.
• RBI allows  cooperative banks to raise funds through the issuance of equity shares, preference shares and debt instruments; Large cooperative banks with paid-up share capital and reserves of Rs.1 lakh were brought under the purview of the Banking Regulation Act 1949 with effect from 1st March 1966. [UPSC 2021]

Differentiated Banks

• Nachiket Mor Committee: The Concept of differentiated banking was introduced in 2013 following recommendations from the Nachiket Mor Committee; Catering to specific customer segments.
• Small Finance Bank: Established on recommendations of the Nachiket Mor Committee; Licensed by the RBI under the Banking Regulation Act, 1949 and governed by the RBI Act, 1934.
  • Individuals, corporates, trusts, societies, existing NBFCs, Micro Finance Institutions (MFIs), and Local Area Banks (LABs) can all become promoters of SFBs.
  • 75% of SFBs’  loans must be directed towards priority sectors and at least 50% of their loans and advances must be below  25 lakh.
  • Allowed to take deposits of any amount.
  • Can provide remittance services as well as credit cards; Allowed to issue ATM or debit cards.
  • Can accept NRI deposits.
• Payment Banks: Established on the recommendations of Nachiket Mor Committee;  Licensed under Banking Regulation Act, 1949 [UPSC 2016]
  • Minimum paid up capital required is  100 crore and the promoter’s stake should remain at least 40% for the first five years.
  • Existing Prepaid Payment Instrument (PPI) issuers or businesses like mobile telephone companies, Microfinance Institutions (MFIs) and Small Finance Banks (SFBs) can also establish Payments Banks.
  • Do not provide credit services like loans and credit cards; Provide both current accounts and savings accounts; Allowed to issue ATM /debit cards.
  • They accept demand deposits (Only up to 2 lakh per individual customer) but cannot accept time deposits and Non-Resident Indian (NRI) deposits.
  • Can distribute products like mutual funds, insurance, third party loans.
  • Can apply for conversion into small finance banks (SFBs) after five years of operation.
  • FDI is allowed in payment banks. 
  • They cannot set up subsidiaries to undertake non-banking activities.

Differentiated Banking Landscape in India:

• Development Financial Institutions: Financial entities that cater to the economy’s needs by providing long-term financial assistance, especially to sectors crucial for economic growth and infrastructure development.
• NABARD: Born in 1982 following the recommendations of the B. Sivaraman Committee; fully owned entity of the Government of India.
• Small Industries Development Bank of India (SIDBI): Established in 1990; owned by Government of India. 
• Export-Import Bank (EXIM Bank): Established in 1982;  wholly-owned subsidiary of the Central Government.
• National Housing Bank: Instituted in 1988 under the National Housing Bank Act, 1987; wholly owned by the Government of India (GOI).
• MUDRA Bank: Set up under the Pradhan Mantri MUDRA Yojana scheme; Offer low-interest loans to Micro Finance Institutions (MFIs) and non-banking financial institutions.
• National Bank for Financing Infrastructure and Development (NaBFID): Established in 2021 through the enactment of The National Bank for Financing Infrastructure and Development (NaBFID) Act, 2021.

Deposit Insurance and Credit Guarantee Corporation

• Establishment: Under the DICGC Act 1961, is one of the wholly owned subsidiaries of the RBI. 
• Insurance Coverage: DICGC insures all bank deposits, such as savings, fixed current, and recurring deposits for up to the limit of Rs 500,000 for each depositor in a bank. (If one has multiple accounts in a single bank, one will be given a maximum of ` 500000 only in case of bank failure).
• Premium Payment Responsibility: The bank (not the customer) pays the premium amount for insurance.
• Mandatory Entities for Deposit Insurance: It is mandatory to take deposit insurance cover from DICGC by the following entities
  • All Scheduled Commercial Banks
  • Local Area Banks
  • Foreign banks with branches in India
  • At present all co-operative banks are covered by the DICGC.
• No Insurance Cover: Includes following:
  • Deposits of Foreign Governments.
  • Deposits of Central/State Governments.
  • Inter-bank deposits.
  • Any amount due on account of any deposit received outside India.
  • Deposits of the State Land Development Banks with the State co-operative banks.
  • Any amount that the corporation has specifically excluded with the RBI’s prior approval. 
  • Primary cooperative societies are not insured by the DICGC

Difference Between NBFCs and Banks

• Micro Finance Institutions: Specialized financial institutions dedicated to providing services like micro-loans, micro-savings and microinsurance to low-income individuals and groups at lower interest rates; . 
  • In India, all loans that are below Rs.1 lakh can be considered microloans. [UPSC 2011]

• Neo Banks: Completely online-based digital banking platforms that lack any physical presence. 
  • Example: Yono by SBI, RazorpayX
• Lead Bank Scheme: Envisages assignment of lead roles to individual banks (both in public sector and private sector) for the districts allotted to them; 
  • On the recommendation of the Gadgil Study Group and Banker’s Committee, the Scheme was introduced by RBI.
• Nidhi 
  • Included in the definition of NBFCs.
  • Registered under the Companies Act, 1956 and are regulated by the Ministry of Corporate Affairs.
  •  It receives deposits from, and lends to its members only, for their mutual benefit. 

• Chit Funds: It is a type of savings scheme where a specified number of subscribers contribute payments in installments over a defined period. 
  •  Covered in the Concurrent List.
  • RBI does not regulate the chit fund business and SEBI Act specifically excludes chit funds.
  • Chit fund business is regulated under the Central Chit Funds Act, 1982 and the rules framed under this Act by the various state governments for this purpose.

• Ponzi Schemes: These schemes promise high returns with little or no risk.The Ponzi scheme generates returns for older investors by acquiring new investors. example – Sarada Scam

Automated Teller Machine

• The ATM network operates on NPCI – National Financial Switch.
• National Financial Switch (NFS) is the largest network of shared Automated Teller Machines (ATMs) in India facilitating interoperable cash withdrawal, card to card funds transfer and interoperable cash deposit transactions etc.
• Bank ATMs: Owned, managed and installed by banks.
• Brown label ATMs
  • Owned by banks and banks outsourced the ATM operations to a third party (a nonbanking firm).
  • The concerned banks only handle part of the process that is cash handling and back – end server connectivity. 
  • They carry the logo of the bank which outsources their service.
• White label ATMs
  • Owned and operated by a third party (a non – banking firm).
  • They do not bear the logo of the banks they serve (that is why such a name).
  • In place, they carry the logo of the firm which owns them

Digital Payment

• Digital Payments grew significantly in recent years, driven by government initiatives, an increase in internet and smartphone penetration, and the rise of e-commerce. 
• The digital payment ecosystem is supported by private players who offer a range of digital payment services. 
• The future of digital payments in India looks bright with the expected growth in the number of internet users and e-commerce market size.
• Digital Payment Dashboard has been integrated with 118 public sector, private sector, payments, regional rural and foreign banks. 
• In FY 2021-22, 8,840 Crores of Digital Payment Transactions were achieved with 87.20% Current & Savings Accounts seeded with Aadhaar Numbers, and 81.05% Current & Savings Accounts seeded with Mobile Numbers (According to NIC data)

Recent Status of Digital Payment in India.

Overview of Banking System and Financial Infrastructure in India

Conclusion

• The banking system in India is robust and diverse, comprising scheduled commercial banks along with cooperative banks, local area banks, Non-Banking Financial Companies (NBFCs), and All India Financial Institutions.
• This widespread coverage not only facilitates financial inclusion but also contributes to economic growth by ensuring that banking services are available to rural populations.
• Continued efforts to innovate and expand banking services will be crucial for sustaining this momentum and driving further progress in India’s financial landscape.

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