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An efficient and effective financial system is a prerequisite to any country for its overall industrial development. A financial system is said to be efficient and effective only when there is a mix of financial institutions, financial markets and financial instruments to suit the needs of both the savers and users. Indian economy has been witnessing financial liberalization after the responsibility of development of financial system was taken up by the government.
Banks play the vital role of intermediation between the small investors and the deficit borrowers particularly the corporate and help channelize the resources from surplus holders to deficit holders. Prior to 1955, all banks in India were private sector banks. The Banking Regulation Act was passed in the year 1949, to direct and regulate the functioning of the commercial banks during the early years of independence of the nation. After independence State Bank of India in the year 1955, and its seven subsidiaries in 1959 were nationalized. Thereafter, on July 19, 1969, 14 major banks with a deposit base of over 50 cr, and a further six banks in April 1980, were nationalized. This paved the way for social banking. Banks have become the extended wings of the government for the development of backward areas. State Bank of India and its associate banks, nationalized banks and IDBI Bank constitute Public Sector Banks (PSBs). Earlier, these banks were confined to short-term loans and working capital finance, while the financial institutions were extending the long-term loans. The seed capital and margin money was provided by the government and its arms in the form of specialized institutions like IDBI, SIDBI, ICICI, SCICI, SFCs, IICs, SIDCs, etc.
The new economic policy, 1991, initiated reforms in all the areas of the Indian economy. It is widely known as ‘Stabilization and Structural Adjustment Program’, in the financial sector. In this process, The Comptroller of Capital Issues was replaced with Securities Exchange Board of India, the Development Financial Institutions like ‘Industrial Credit and Investment Corporation of India’ and ‘Housing Development Finance Corporation’ were transformed into ICICI Bank and HDFC Bank respectively and were made independent and autonomous institutions with responsibility to lend and accountability for the money invested by the people.
The process of liberalization in our country since 1990s has brought in an array of savings instruments in the financial market. Companies which hitherto were borrowing loans from banks started raising resources directly from the public in the form of equity or debt or quasi-equity instruments. This paved way for financial disintermediation and has thrown a vast challenge to banks, who in their urge to retain their position have adapted to changing environment by devising various strategies.
The financial sector reforms initiated in the year 1991 led to the emergence of the New-Generation Private Sector Banks (NGPSBs)—HDFC, ICICI, AXIS, YES, IndusInd, Kotak Mahindra, and DCB. These banks are tech-savvy and 100% computerized. Consequently, these banks are manned by young, energetic and dynamic staff, with lean organizational structures. These banks, along with the then existing foreign banks in India, gave a stiff competition to the banking industry, especially the PSBs, which were operating till then as extended hands of government, and catering to social banking activities.
The advent of new-generation banks brought greater change in the operation and functioning of PSBs. Deregulation of interest rates, disintermediation and disinvestment policies pushed up competition in the banking sector. Technology-based innovative financial products and services swept the market. The lending too witnessed a paradigm shift from security-oriented lending to purpose-oriented lending. Inclusive growth has become the watch word. Income recognition and asset classification norms, capital adequacy norms, warranted banks to be viable to survive. RBI commenced reviewing the performance of banks in terms of CAMELS rating. CAMELS stands for Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Systems and procedures. It necessitated the banks to improve their performance in terms of return on assets, return on equity, operating expenses to total assets, net interest margin to total assets, earnings per employee, profit per employee, etc. RBI cautioned the banks to be viable as business units, to avoid prescription of narrow banking, in the event of their falling under the category of weak banks.
Thus, the competitive environment made all the banks strive to increase their productivity and profitability, while complying with the stipulations of RBI from time to time.
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