Role of Banking in Building a Society

When we talk about a nation, we discuss its infrastructure, economic growth and stability, innovation, constitution, and human capital. When we talk about failed nations, we tend to focus on a lack of legitimate government, economic mismanagement, and weak institutions, such as legal enforcement and social factors.

Rarely do banks figure into these conversations.

Banks are the lifeblood of any economy. A functioning banking system is key to a nation’s economic growth and development. It funds evolution, creates opportunities, provides jobs, and facilitates exchange.

To ensure steady growth, governments need a mechanism to stabilize the economy from internal and external shocks. That’s where banks come in.

Origins of Banks

The word Bank is speculated to have come from the ancient Roman Empire, where money lenders set up stalls on a bench called Bancu. Some trace it to the French word banque, which refers to the benches in marketplaces where bankers conducted business.

Banking as a practice, though, was prevalent centuries before these events. Temples, palaces, and wealthy individuals served as pseudo-bankers. The history of banking began with merchants across the world who gave grain loans to farmers and traders who carried goods between cities. The earliest traces were around 2000 BC in Assyria - India and Sumer.

The Mauryan period (321–185 BCE) used adesha, an order on a banker directing him to pay the sum on the note to a third person. This corresponds to the definition of a modern bill of exchange.

The first Public Bank, the Bank of Venice, was founded in Italy in 1157 A.D.

Role of Banks in Societies

Historically, and even now, banks perform three principal functions for every society:

• Lending and borrowing
• Money exchange
• Safekeeping of valuables

As societies evolved, so did the complexities of monetary transactions. Banks gained trust as institutions and, over time, evolved from simple custodians of valuables to complex financial entities.

Key developments that shaped their evolution include:

1. The rise of central banks: Regulation of the money supply, maintaining financial stability, and acting as lenders of last resort.
2. The emergence of commercial banks: Expansion of services to individuals and businesses, including deposits, loans, exchange, and investment products.
3. The Industrial Revolution: The growth of industries increased the demand for banking services, leading to the expansion of the banking sector.
4. Banking crises: Events like the Great Depression exposed vulnerabilities in the banking system, leading to reforms and stricter regulations.
5. Government Intervention: Governments took a more active role in regulating the banking sector to prevent crises.

With their increasing involvement in all monetary activities, banks have been entrusted with more responsibilities, such as channeling investments into economic growth, creating jobs, promoting financial inclusion, and more.

Banks worldwide generally share the same goals, but their banking systems are diverse, reflecting the unique economic, historical, and cultural contexts of different countries. While there are commonalities, significant variations exist in structure, ownership, regulation, and the range of services offered.

__Brief History of Indian Banking __

In India, banking has existed in some form or another since ancient times, as reflected in Kautilya’s Arthashastra. The first official bank was the Bank of Hindustan, established in 1770, but it failed within a decade. Allahabad Bank was established in 1865, Alliance Bank of Shimla in 1875, Oudh Commercial Bank in 1881, and Punjab National Bank in 1894.

Over the years, the banking industry flourished, with many commercial and cooperative banks becoming operational in India.

The Imperial Bank of India, a quasi-central bank, was established in 1921 through the amalgamation of the three presidency banks of Madras, Bombay, and Bengal. To finance specialized sectoral activities, the Industrial Development Bank was set up in 1964. The Export-Import Bank of India and the National Bank for Agriculture and Rural Development were established in 1982.

The Reserve Bank of India (RBI) was established in 1935, marking a significant milestone. It was nationalized in 1949 and officially became the central bank responsible for monetary policy, banking regulation, and supervision.

Indian Banking Structure in Developing Economy

At independence, Indian economy had two major concerns – all the major banks of the country were led privately and people in rural areas were heavily dependent on money lenders for credit. There were also concerns about bank failures, soundness of banking, and stability of banking sector in India.

As India embarked upon planned economic growth, it needed a strong and efficient financial system to meet credit and development requirements.

In 1955 the government of India and the Reserve Bank of India, assumed joint ownership of Imperial Bank, which was renamed the State Bank of India. The key objective of the new bank was to ensure the extension of banking facilities at a much greater scale than before, particularly in the neglected rural and semi-urban areas.

To further achieve economic growth with social inclusion, the Government nationalized 14 banks in 1969 and 6 banks later in 1980.

In March 1969, when nationalization became effective, there were only 1,833 rural and 3,342 semi-urban bank offices out of 8,262. This implied one bank branch for 3 lakhs of the population. In such a situation, Indians were leaning on money lenders, specifically in the rural sector, as agriculture was not covered by bank credit facility

The banking system grew rapidly in terms of presence as well as penetration over the two decades immediately following the nationalization. By the 1990s, the public sector banks had a 90% share in the country’s banking business.

Since 1972, there have been a series of revisions in the scope and extent of priority sector lending. One objective was financial inclusion, which included extending financial services to a large portion of the country's unserved or underserved population and removing dependencies on non-institutional credit.

Since then, the Indian banking system has undergone a structural transformation. The emphasis has been on making formal banking facilities available in unbanked areas. The government has been successful in directing credit to the agricultural sector, micro, small, and medium enterprises, and industry. The spread of branch network is now extensive, increasing access to formal credit.

Role of PSUs in Indian Economy

In India, banks have played an important role in economic growth and development. As of Nov ‘23, the Indian Banking system consists of 12 public sector banks, 21 private sector banks, 46 foreign banks, 43 regional rural banks, 1,534 urban cooperative banks, and 96508 rural cooperative banks.

RBI - The apex bank of India, responsible for regulating the entire banking system

Commercial Banks - Primarily focused on profit-making activities, offering various banking services to individuals and businesses.

Cooperative Banks - Serve specific geographic areas or groups, such as farmers, artisans, or small-scale industries.

Regional Rural Banks (RRBs) - Established to serve primarily the rural and agricultural sectors.

Public Sector Banks (PSBs), though commercial in nature, played the most crucial role in financial inclusion and development. Since the 1970s, PSBs have been at the forefront of mobilizing resources from far-flung rural areas and extending banking services in the remotest parts of the country. PSBs have largely shouldered the burden of social agenda and economic development,

• Financial Inclusion: PSBs have been championing the expansion of banking services to rural and underserved areas, which has led to increased financial inclusion
• Priority Sector Lending: They play a crucial role in providing credit to agriculture, small-scale industries, and other priority sectors, contributing to inclusive growth
• Infrastructure Financing: PSBs are instrumental in financing large infrastructure projects, such as power plants, roads, and railways.
• Economic Stability: By acting as custodians of public savings, PSBs contribute to macroeconomic stability
• Social Welfare: They actively participate in government schemes like affordable housing, education loans, and rural development programs

Despite the heavy focus on social objectives, Public Sector Bankss are competing well with PVBs (private sector banks) on various financial parameters. Many PSBs feature in the top banks by AUM.

Key Public Sector Banks (PSBs) of India:

• State Bank of India (SBI): SBI is India's largest public sector bank. It has 22,405 branches in India, holds a 23 percent market share, and has a strong presence abroad, with more than 233 foreign branches in 36 countries. The largest public lender in the country, its market capitalization surpassed ₹7 trillion in April 2024. It played a crucial role in rural credit, infrastructure financing, and foreign exchange management.
• Canara Bank: Originating from South India, Canara Bank is a significant player with 10,391 branches, 12,829 ATMs, and a business size of over ₹16 trillion. The bank is well known for its customer-centric approach; it has been a significant player in retail banking and rural credit.
• Punjab National Bank: It is the second-largest public sector bank in India in terms of business volumes, with over 180 million customers, 12,248 branches, and 13,000+ ATMs. With a strong presence in northern India, it has been instrumental in agricultural credit and SME financing. These banks are not without challenges or areas for improvement—managing non-performing assets (NPAs), enhancing financial inclusion, adapting to technological advancements, strengthening cybersecurity, etc.

The opportunity is tremendous. If the current challenges are addressed, India has the potential to build one of the world’s biggest domestic banking sectors.

Conclusion

The success that the Indian Banking system achieved through PSBs, particularly in taking banking to the masses and making the banking system a potent vehicle for furthering public policy, has few parallels in the world.

India's aspiration to become a $5 trillion economy is inextricably linked to the performance of public sector banks, as highlighted in the Economic Survey 2017. The economy wants the PSU Banks to perform at their best and support economic growth. India should at least have six banks in the global top 100 rather than just the current largest PSU Bank, the State Bank of India.

The Indian banking sector is poised for further growth and innovation, driven by the increasing financial aspirations of the population and the government's focus on financial inclusion.

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References:

1. https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=60
2. https://www.ijrar.org/papers/IJRAR19D1334.pdf
3. https://www.iimb.ac.in/sites/default/files/2018-07/WP%20No.%20530.pdf
4. https://core.ac.uk/download/pdf/234110792.pdf
5. https://en.wikipedia.org/wiki/Banking_in_India
6. https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Monetary-Policy
7. https://www.madhyam.org.in/50-years-of-bank-nationalization-a-peek-into-social-and-development-banking/
8. https://www.drishtiias.com/daily-news-editorials/50-years-of-nationalization-of-banks

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