Chapter 1 Introduction

 
INTRODUCTION
Banking system plays an important role in building of the modern-day economic
world. The growth of trade and industry, which contributes significantly towards
overall economic growth, depends crucially upon the smooth flow of money through
banks. The presence of effective banking system thus is essential for the economic
progress of a country; and the Indian economic growth story amply highlights the
significance of a sound banking system.
The concept of flow of money or banking is mirrored in references available in our
old scriptures. The business of money lending was quite common during the Vedic
period (Barasara, 2013) and during the time of Mughal period indigenous bankers
played a fundamental role by lending money for promoting foreign trade and
commerce (Dharamsi, 2015). Further, the traders of East India Company set up their
own agency houses at the ports of Bombay, Calcutta and Madras (now Mumbai,
Kolkata and Chennai respectively) in seventeenth century to perform trade and
commerce activities, under which they also carried on the banking businesses.

The first bank in India, the General Bank of India was established in 1786 followed
by the formation of Bank of Hindustan and the Bengal Bank. The most considerable
achievement of this period was the formation of Bank of Bengal (1806), Bank of
Bombay (1840) and Bank of Madras (1843); which were acknowledged as Presidency
Banks (RBI, 2008). In 1921, the merger of these three presidency banks led to the
formation of the new bank known the Imperial Bank of India. The further growth in
banking sector took place with the formation of Reserve Bank of India on 1st April
1935 under the Reserve Bank of India Act, 1934 (Gauba, 2012). A reduction in
customer base and performance of banks was felt when many small banks went into
liquidation during the time of crises, (1913-17, 1939-45 and 1948-53) as the banking
sector was not developed to meet the requirements of the economy (Barasara, 2013).

1.1 Bank Nationalization Era

A major step to control banking system happened in 1948, when the RBI was
nationalized and became the establishment fully owned by the GOI. Further, the
Banking Regulation Act was passed during 1949 which brought RBI under the control
of the government and vested it with wide range of powers to administer and manage
commercial banks (Goyal and Joshi, 2012). Under this Act, it was ensured that none

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of the banks can open a new branch and no new bank can be established without due
permission and license from RBI (Rajesh and Sivagnanasithi, 2009).
Further, with an objective of extending banking services, especially into rural areas,
the Imperial Bank of India was nationalized and was renamed as State Bank of India
(SBI) in 1955. This bank was given powers to operate as the principal representative
to keep control over the banking transactions throughout the country and offer wide
range of services to rural and semi-urban areas. As the objective was expansion of the
bank, hence seven other banks which were part of princely states were nationalized
and made subsidiaries of the State Bank of India (Rajyaguru, 2016). Thereafter, as the
demands of priority sectors, small scale industries (SSIs) were not being fulfilled, the
GOI by passing an ordinance nationalized other fourteen main commercial banks on
July 19, 1969. From 1969 to 1979, the 14 nationalized banks opened more than
twenty-one thousand new bank offices raising the number from 8262 to 30202
respectively (Shehar, 1986).

Subsequently, six more commercial banks were given nationalized status in 1980
(Saini and Lodha, 2014) and by the end of 1980 about 80% of the banks were under
the control of the government (Tulasirao et.al. 2013). The primary aim of bank
nationalization was to give priority to meeting the credit requirements of the
borrowers from backward sector, small scale industries, agriculture and export sector.
The lending target of 33.3% of total advances was defined for priority sector lending
(Karmakar, 2014). Throughout the duration from 1969-1984, banks provided large
number of services to its customers in rural areas and made extensive efforts to spread
bank branches for mobilizing the deposits of customers and lending it to borrowers
from weaker section of the society (Shehar, 1986).

After the second phase of nationalization the government of India had the control over
91% of the banking business of the country. The banks were now capable of serving
the large section of the people for socio-economic growth of the country (Zacharias,
1995). Nationalization of banks resulted into the inclusive programme of branch
expansion, opening of saving accounts and priority sector lending (Thomas, 1996).
Banking sector showed significant results during the seventies and eighties in
accomplishing the objectives set by the government. Nationalized banks were
working in less competitive environment, with very few private and foreign banks at
that time, and hence, during late eighties, social banking and customer service became

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the matter of concern as a result of the un-empathetic attitude of bank staff and
traditional style of working of the banks. Long queues at bank counters, delay in
cheque clearance, and non-availability of forms were also some of the issues which
continuously troubled the customers. Also, the banks were lending to privileged class
in the name of social banking, instead of helping the under-privileged (Thomas,
1996).

During late eighties the share of deposits with nationalized banks started declining; till
1984 the nationalized banks had a share of 63.30% of total deposits, which dropped
down to 62.75% by March 31st 1991 (Indian Banks Association, 1994). Moreover,
some internal as well as external constraints of banks led to low operational
efficiency, inadequate capital base, increase in NPAs, decrease in profits and
unsatisfactory customer service (Nathwani, 2004). The recommendations made by
Narsimham Committee in 1991, highlighted that Indian commercial banks were
encumbered with large amount of NPAs and as a result banks went financially weak.
Emphasis on priority sector lending, bank branch expansion, increase in establishment
expenses, decrease in non-interest income and deposit composition were some other
factors which affected the profitability of nationalized banks (Amandeep, 1991). The
RBI took several measures to ensure safety and consistency of banks and encouraged
them to play a lead role in accelerating the economic growth. Although banks had
been contributing significantly towards the advancement of national economy, yet
still after the fast growth of deposits, the financial condition of banks was found to be
unprofitable, inefficient and unproductive. Hence, the RBI slowed down the rapidity
of branch expansion and laid emphasis on strengthening of existing branches and
customer base (Joshi and Little, 1997). In 1990s, the government came up with the
plan of liberalizing and licensing small private sector banks. The foremost focus of
bank reforms was to promote operational independence, flexibility, competition in
banking system and to raise the standards of banks in the country, at par with
international standards (Dwivedi, 2011).

1.2 Post Reform Era

With reference to these backdrops, Narasimham Committee-I introduced economic
and financial sector reforms in 1991 with an aim to make Indian banking sector more
efficient, strong and vibrant. The fundamental reform measures recommended by the

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Committee changed the appearance and prospects of banking industry. The period
between 1992-97 witnessed numerous reform measures like reduction in reserve
requirements, capital adequacy norms, and deregulation of interest rates, improving
competitiveness and strengthening of bank supervision (Ramasastri and Samuel,
2006).
In 1993, the government gave licenses to seven new private sector banks to promote
the spirit of competition and to extend the reach of banking in thus far excluded areas.
The prominent among these banks were ICICI (Industrial Credit and Investment
Corporation of India), GTB (Global Trust Bank), HDFC (Housing Development
Finance Corporation) and IDBI (Industrial Development Bank of India) bank (Gauba,
2012). This development and swift growth in Indian economy rejuvenated the
banking system of the country. The major contributor towards this growth was the
banking sector; all sector banks namely public sector banks, private sector banks and
foreign banks. In addition to 27 public sector banks, 24 new private sector banks were
added during 1993-1998. The total of commercial banks, excluding RRBs increased
from 75 in 1992 to 99 in 1998 (Malli, 2011). Private sector banks, which were
popularly known as New Generation tech-savvy banks, made banking more
competitive and customer friendly. Emergence of these banks brought public sector
banks out of self-satisfaction and made them more competitive (Vohra, 2011). Public
sector banks were superior in case of customer loyalty, image and customer
orientation, whereas new private sector banks were seen as more customer friendly
(Sobti, 1997).

Further, in 1997, the GOI set up Narasimham Committee-II to review the record of
first generation financial sector reforms and draw the blue print of the future reforms
necessary to make India’s banking sector stronger and better equipped to meet global
competition (Nandy, 2010). The report submitted by the committee in April 1998
made wide range of recommendations covering various aspects of banking policy,
institutional, supervisory and legislative dimensions in the view of capital adequacy,
asset quality, non-performing assets, directed credit, prudential norms, transparency,
asset-liability management, earnings and profitability, policies and procedures,
restructuring including mergers and amalgamations, reduction of government and RBI
shareholding to 33% in the public sector banks, devising effective regulatory norms
and the review of banking sector laws (Reddy and Rao, 2016).

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Liberalization and globalization of the Indian economy, with respect to increase in the
entry of foreign banks and private sector banks opened new vistas for the growth of
banking system in the country (Anita and Singh, 2013). Despite of progressive
developments, after banking sector reforms and entry of tech-savvy banks, significant
proportions of underprivileged were still excluded from formal financial services net.
Keeping in view this scenario it had become essential for banks to work for retaining
the existing customer base (Mandal and Bhattacharya, 2013) and improve the level of
credit delivery system for enhancing the intensity of financial inclusion (Laha and
Kuri, 2011). Since independence the government had been taking various measures to
expand banking in rural and unbanked areas to prevent people borrowing from private
money lenders. Social banking policies were developed to shift the focus of
commercial banks from selective banking to mass banking (Vasudevan and Ghaisas,
2013) with the focus to establish new bank branches and spread banking facilities to
include the unbanked into banking. In 2005, the Reserve Bank of India, with the
successful pilot project in union territory of Pondicherry, formally introduced the plan
of financial inclusion. Mangalam village was the first village in India to get a
opportunity to have all banking facilities. In addition to this RBI relaxed KYC (Know
Your Customer) norms for the customers to open bank account with annual deposit of
less than `0.05 million (Chhabra, 2014). While discussing financial inclusion, the
Rangarajan Committee (2008) identified savings, loans, insurance, credit, and
payments as the factors which determining financial inclusiveness.

Even after the impact of global crises on the productivity and competence of banks,
the GOI and RBI kept the ball rolling to provide necessary financial services to those
who were unbanked. The Reserve Bank of India (2010) reported the increase in
number of credit accounts to `118.6 million and total deposit accounts to `734.8
million in 2010. Many more initiatives like permission given to commercial banks for
establishing off-site ATMs and white label ATMs (WLAs) by non-bank entities were
taken to even include the villages below the population of 2000 under the umbrella
banking system. Substantial progress have been made by providing accessibility of
banking services to the people through Jan Dhan Yojana programme which was
launched with a vision achieving 100% financial inclusiveness by opening 600
million accounts by 2020 (RBI, 2015).

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1.3 Current Scenario
Currently, banking in India is fairly mature to provide wide product range and reach;
even though the reach in some regions of rural India is still a challenge for the private
sector and foreign banks. As of now at least 80% of the business is still under the
control of public sector banks (Singh and Arora, 2011). The public and private sector
banks of India provide extensive range of banking services namely opening a savings
account, internet banking, granting loans, selling insurance, providing locker facilities
to transferring money abroad etc. (Virk and Mahal, 2012). Every bank has to work for
satisfying the customers who come from different classes of the society. Since last
couple of decades, due to increasingly competitive, saturated and vigorous business
environment, retail banks in many countries have adopted customer friendly
philosophies to bridge the gap between bank and the customer (Walker et.al. 2008).

Currently, there are 93 scheduled commercial banks in India and these include 27
public sector banks, 20 private sector banks and 46 foreign banks. Private sector
banks have around 19975 branches and around 51490 ATMs in the country. Over the
period of time tremendous growth and achievements have been witnessed by present
banking system of India. These have been attributed to the procedure of expansion,
re-organization, consolidation, and advent of internet and most importantly to the
technological changes which have changed the complete scenario (Bisht et.al. 2002).
Extensive outreach has been a striking achievement in Indian banking for the last few
decades. Banking is now not only limited to cities; rather the banking services are
reaching even the remote areas of the country. Banking services have also shown
enormous improvement by offering extensive range of services.

In such an environment, it has become compulsory for banks to measure their

financial performance on continuous basis as survival in the present competitive
environment will depend upon overall efficiency of banks. It has been witnessed that
now-a-days banks are trying to adopt the change and improve their performance for
survival in the changing economies. The competence of the banking sector also
depends upon as how best the services are delivered to its target customers or how far
the expectations of customers are met. Any service to be provided to the customers
can be differentiated by the service provider from that of its competitors if it possesses
some unique selling proposition. The customers compare the service with the
expected service. The customers perceive the services provided by banks to be high

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quality only if these are as per their expectations; and this perception leads to
customer satisfaction.

Customer satisfaction is a dynamic concept and at present it is an important issue to

be addressed by the banks. Customers, at present, are more demanding and expect
prompt services and thus a customer centric view has replaced the earlier product
centric view in banking. Keeping in view the above scenario, present study was
conducted to measure the performance of public and private sector banks taking into
consideration the three major aspects viz. financial performance, financial
inclusiveness and customer satisfaction with regard to services provided by banks. An
attempt was made to compare the public and private sector banks on the selected
aspects as briefly discussed hereunder.

1.4 Financial Performance

Productivity is a vital indicator of economic performance and it shows relationship
between the output and the inputs used to produce it (Bansal, 2010). Productivity of
banking sector, as pointed out earlier, is important for economic growth of a country.
It is believed that strong and well organized banking system leads to faster economic
growth (Singla, 2013). Although the banking sector has made good progress in
tangibles but there still are challenges and banks would have to continuously take note
of the same. Therefore, evaluation of performance has become important for the
banks because it helps in protecting the banking operations from the continuous risk
associated with capital market (Hays et.al. 2009). Today, keeping an eye on bank
performance has become a preferred topic for many stakeholders such as customers,
investors and the general public (Jha and Hui, 2012). A number of financial indicators
are available to assess the financial performance. But some of the most important
criteria to determine the compatibility and health of a financial organization are
various ratio measures like credit deposit ratio, return on assets ratio, net NPA to net
advances ratio, capital adequacy, asset quality, quality of management etc. In this
study the ratio measures have been used. These rating are largely accepted for
evaluating performance of banks and other financial institutions (Nimalathasan,
2008).

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1.5 Financial Inclusion
Financial inclusion may be defined as the “process of ensuring access to financial
services and timely and adequate credit where needed by vulnerable groups such as
weaker sections and low income groups at an affordable cost” (Rangarajan
Committee, 2008). The Reserve Bank of India (2011) gave a wider definition stating
that “financial inclusion is the process of ensuring access to appropriate financial
products and services needed by all sections of the society in general and vulnerable
groups such as weaker sections and low income groups in particular at an affordable
cost in a fair and transparent manner by mainstream institutional players”. Despite the
financial inclusion drive being the pivot in development of financial system, regional
disparities are still observed. For example, financial inclusion is very low in the North
Eastern Region of the country. The regional average is only 37.3 percent of the
population which comes under the domain of financial inclusion; this is significantly
low as compared to the national average of 59.2 percent.

The way forward in financial inclusion was defined in June 2012, when it was
decided that banks have to develop a strategy to bring all financially excluded under
the umbrella of financial inclusion by covering the unbanked villages with population
of less than 2000 with banking services. Even after extensive outreach huge
proportions of poor and disadvantageous population remain excluded from the formal
financial system in India (Dixit and Ghosh , 2013) and thus the RBI came out with a
policy containing sequence of events for including the unbanked under the purview of
banking. Since 2006 many measures like financial education, leveraging technology
and creating awareness have been taken to improve the access to affordable financial
services.

1.6 Customer Satisfaction

Customer satisfaction is said to be the measure of how products and services provided
by any organization meet the expectation of a customer. The efficiency of the banking
sector depends on how it delivers the services to its customers. To survive in this
competitive environment, it is important for banks to provide fast and efficient
services to its customers. People working in banks are the first ones to know about the
specific needs of the customer and act as a bridge between the bank and customer. In
the present competitive environment it has become a challenge for especially public

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sector banks to keep hold of the existing customers and attract new ones (Bhatt,
1990). However, even after offering ample range of services there exists a gap
between the services provided by the banks and the expectations of the customers. In
this fast changing scenario it is important that banks go for customer segmentation
and provide reliable, independent, impartial opinion and tailored treatment that
customers now expect. In view of the increasing competition among banks it is the
customer’s satisfaction that will act as a sole differentiating factor to stay in this
business (The Hindu, 2012). The idea of customer satisfaction is a theoretical concept
with the state of satisfaction varying from person to person and service to service; as
the state of satisfaction depends on the both psychological and physical variables
(Kanojia and Yadav, 2012).

The above discussion and various studies indicate that the private and public sector
banks have made significant progress during the reform period. At the same time, in
the present scenario Indian banking system is facing huge challenges and stiff
competition due to advancement of technology. The competitive character has further
been promoted by facilitating the entry of foreign banks also. Hence, it was thought to
be imperative to study the financial performance of private and public sector banks
vis-a-vis the new developments and also to understand the factors which determine
the financial performance of the banks. It has been brought out by many studies that
there have been improvements in tangibles in banking sector over the past years.
However, not all sections of the society are getting benefited from this and hence
looking at the financial inclusiveness gains importance. Hence, financial inclusiveness
was taken as an objective to address such questions in this research. Also, in order to
keep the momentum on and to survive in the aggressive competitive environment and
keep the customer satisfied, it is required to persistently improve the services
provided to its customers. It had been revealed that 5% rise in customer retention can
increase profits of the banks by 35%. Therefore, banks have been continuously
working to retain the customers and in order to increase its market share (Chothani
et.al. 2004). Hence, the issue of customer satisfaction with regard to the services
provided by public and private sector banks has also been addressed in this research.
Against this backdrop, a comparative study on performance of private and public
sector banks in India was conducted with following as the specific objectives of the
study.

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1.7 Objectives of the Research
 To compare the financial performance of public and private sector banks.
 To study and compare the financial inclusiveness of public and private banks.
 To compare customer satisfaction with respect to services provided by the
public and private sector banks.
 To provide suggestions and recommendations to the banks for further
improvements.

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