Commercial Banking, NPAs & Financial Inclusion
Commercial banks are the most visible part of the Indian financial system and act as the bridge between savers and borrowers. The story of Indian banking includes nationalisation, the growth of branch networks, the problem of non-performing assets, the reform of recovery laws and the effort to bring every household into the formal banking fold. This topic is a favourite in competitive examinations because it links economic policy with institutions and with current schemes. These notes explain the meaning of scheduled banks, the rounds of nationalisation, the definition and resolution of bad loans, the international capital standards known as Basel norms, and the main instruments of financial inclusion.
Scheduled commercial banks and nationalisation
A scheduled commercial bank is a bank included in the Second Schedule of the Reserve Bank of India Act, 1934. Inclusion in the schedule requires a paid-up capital and reserves of a minimum prescribed level and the satisfaction of the Reserve Bank that the bank's affairs are not conducted in a manner detrimental to the interests of its depositors. Scheduled status makes a bank eligible for facilities such as liquidity support from the Reserve Bank and membership of clearing houses. The State Bank of India was formed in 1955 by taking over the Imperial Bank of India. The first round of nationalisation took place on 19 July 1969, when fourteen major commercial banks were nationalised, and a second round in 1980 brought six more banks under public ownership, making twenty in all. In April 2017 five associate banks and the Bharatiya Mahila Bank were merged into the State Bank of India, creating one of the largest banks in the world by branch network.
Non-performing assets and their resolution
A non-performing asset, or NPA, is a loan or advance on which the interest or the principal instalment remains overdue for more than ninety days. Loans are classified as sub-standard, doubtful and loss assets depending on how long they have remained non-performing and on the security available. A high level of NPAs weakens a bank because it stops earning interest on those loans and must make provisions that reduce its profits and capital. India has built a set of legal instruments to deal with bad loans. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002, known as SARFAESI, allows banks to enforce their security interest and sell the mortgaged assets of defaulters without going to court. The Insolvency and Bankruptcy Code of 2016 provides a time-bound, unified framework for resolving insolvency, and it followed the report of the Bankruptcy Law Reforms Committee chaired by T. K. Vishwanathan. An asset reconstruction company is a specialised firm that buys bad loans from banks at a discount and tries to recover them.
Basel norms and capital adequacy
Basel norms are international standards on capital adequacy and risk management issued by the Basel Committee on Banking Supervision, which works under the Bank for International Settlements. They require banks to maintain a minimum amount of capital against their risk-weighted assets so that depositors are protected and the financial system remains stable. The Indian banking system follows the Basel III framework and the Reserve Bank requires banks to maintain a minimum capital to risk-weighted assets ratio of nine per cent, which is higher than the international minimum. Capital adequacy therefore expresses how much cushion a bank has to absorb unexpected losses.
Financial inclusion and new bank models
Financial inclusion means ensuring that all sections of society, especially the poor and those in rural areas, have access to affordable financial services such as savings, credit, insurance and payments. The Pradhan Mantri Jan Dhan Yojana, launched on 28 August 2014, is the flagship financial inclusion mission, with the slogan Mera Khata, Bhagya Vidhata, and it opened zero-balance accounts with RuPay cards. Two new categories of banks were created to deepen inclusion. Payment banks accept demand deposits up to a limit, provide payment and remittance services, but cannot lend. Airtel Payments Bank was the first payment bank to begin operations. Small finance banks focus on small farmers, micro and small industries and the unorganised sector, and they can lend. The Bharat Bill Payment System, run by the National Payments Corporation of India, provides interoperable bill payment services.
Priority sector lending and the lead bank scheme
The Reserve Bank directs commercial banks to lend a specified share of their credit to sectors that need support but may not attract enough private finance. Commercial banks have to lend forty per cent of their adjusted net bank credit to the priority sector, which includes agriculture, micro and small enterprises, education, housing and weaker sections. The Lead Bank Scheme, introduced in 1969 on the recommendation of the Nariman Committee, designates one bank in each district as the lead bank, responsible for coordinating credit and banking development in that district. Regional Rural Banks were established under the Regional Rural Banks Act of 1976 to serve rural areas, and Prathama Bank, sponsored by Syndicate Bank and set up on 2 October 1975, was the first such bank. RRBs are jointly owned by the central government, the state government and the sponsor bank in the ratio of fifty, fifteen and thirty-five per cent respectively.
Regulation and supervision
The Reserve Bank of India regulates commercial banks and urban cooperative banks, while rural cooperative banks are supervised mainly through the National Bank for Agriculture and Rural Development and the state governments. NABARD, established in 1982, is the apex institution for rural credit. Banks that are weak in capital, burdened with high NPAs or poor in profitability are placed under the Prompt Corrective Action framework, which imposes restrictions on their business until they recover. This framework protects depositors and the wider financial system from the failure of weak banks.
Key facts at a glance
- Scheduled commercial banks are those included in the Second Schedule of the RBI Act, 1934.
- First nationalisation: 14 banks on 19 July 1969.
- Second nationalisation: 6 banks in 1980; total 20 banks.
- SBI was formed in 1955 from the Imperial Bank of India.
- In 2017 five associate banks and Bharatiya Mahila Bank merged into SBI.
- An NPA is a loan overdue for more than 90 days.
- SARFAESI Act was passed in 2002.
- IBC was enacted in 2016 on the recommendation of the Bankruptcy Law Reforms Committee.
- Minimum CRAR for Indian banks is 9 per cent.
- PMJDY was launched on 28 August 2014; its slogan is Mera Khata, Bhagya Vidhata.
- Payment banks can accept deposits up to Rs 2 lakh per customer and cannot lend.
- Airtel Payments Bank was the first payment bank to start operations.
- Priority sector lending target is 40 per cent of adjusted net bank credit.
- RRBs were established under the RRB Act of 1976; Prathama Bank was the first.
- RRB ownership ratio is 50:15:35 among the centre, state and sponsor bank.
- NABARD, the apex rural credit institution, was established in 1982.
Quick revision points
- Scheduled status comes from the RBI Act and brings liquidity support.
- Nationalisation happened in two rounds, in 1969 and 1980.
- An NPA is defined by ninety days of overdue, and its resolution rests on SARFAESI and the code of 2016.
- Basel norms are about capital, and India requires a higher CRAR than the global minimum.
- Payment banks cannot lend; small finance banks can.
- The lead bank scheme and priority sector lending are the main instruments for directing credit.
How to prepare this topic
- Learn the two nationalisation rounds with the number of banks in each.
- Memorise the ninety-day rule for an NPA and the acts of 2002 and 2016.
- Remember the CRAR, the PMJDY date and slogan, and the payment bank deposit limit.
- List the priority sector components and the forty per cent target.
- Note the RRB Act year, the first RRB and the ownership ratio.
- Understand NABARD, the Lead Bank Scheme and the PCA framework in one line each.
Common exam traps
- Confusing the 1969 round of 14 banks with the 1980 round of 6 banks.
- Saying an NPA is created after 180 days; the rule is more than 90 days.
- Mixing up SARFAESI and the Insolvency and Bankruptcy Code.
- Believing payment banks can lend; they cannot.
- Getting the RRB ownership ratio wrong.
- Confusing NABARD with the Reserve Bank, which are different institutions.
Frequently Asked Questions
What is a scheduled commercial bank?
A scheduled commercial bank is a bank included in the Second Schedule of the Reserve Bank of India Act, 1934. To be included, a bank must have a minimum paid-up capital and reserves and must satisfy the Reserve Bank that its affairs are not conducted in a manner harmful to depositors. Scheduled banks become eligible for liquidity support from the Reserve Bank and for membership of clearing houses.
What is an NPA and how is it resolved?
A non-performing asset is a loan on which the interest or principal instalment has remained overdue for more than ninety days. Banks resolve bad loans through legal instruments such as the SARFAESI Act of 2002, which allows them to sell the mortgaged assets of defaulters without going to court, and the Insolvency and Bankruptcy Code of 2016, which provides a time-bound framework. Asset reconstruction companies also buy bad loans and attempt recovery.
What are Basel norms and what is the CRAR requirement in India?
Basel norms are international standards on capital adequacy and risk management issued by the Basel Committee on Banking Supervision under the Bank for International Settlements. They require banks to hold a minimum amount of capital against risk-weighted assets. Indian banks follow Basel III and are required by the Reserve Bank to maintain a minimum capital to risk-weighted assets ratio of nine per cent, which is above the international minimum.
What is the difference between payment banks and small finance banks?
Payment banks accept demand deposits up to two lakh rupees per customer and provide payment and remittance services, but they cannot lend. Small finance banks focus on financial inclusion by giving loans and savings services primarily to small farmers, micro and small industries and the unorganised sector, and they can lend. Airtel Payments Bank was the first payment bank to begin operations in India.
What is the priority sector lending target and what does it cover?
Commercial banks in India must lend forty per cent of their adjusted net bank credit to the priority sector. The priority sector includes agriculture, micro and small enterprises, education, housing and weaker sections. The idea is to ensure that sectors important for employment and development receive adequate credit even though they may not always attract private finance on their own.