• Chapter20

Chapter 20 -- (Module
(Module – –C)C)

INDIAN
FINANCIAL
SYSTEM - AN
OVERVIEW
Further, Financial Institutions can be classified into three categories:
• Regulatory - Institutes that regulate the financial markets like
RBI, IRDA, SEBI, etc.
• Intermediates - Commercial banks which provide loans and other
financial assistance such as SBI, BOB, PNB, etc.
• Non Intermediates - Institutions that provide financial aid to
corporate customers. It includes NABARD, SIBDI, etc.
▪ Financial Instruments are in the nature of financial products and services,
include instruments on the asset as well as on the liability side of the
financial institution's balance sheet. They can also be in the form of
intangible value-added services, which can facilitate financial
development.
▪ Financial instruments on the asset side of the balance sheet
include loans and advances, investments, placements, derivatives,
etc.,
▪ Financial instruments on the liabilities side of the balance sheet
include deposits, money accepted from customers for remittances,
insurance policies and mutual funds units issued and contribution
received for building up a corpus for payment of pension.
➢ A financial market is a market where buyers and sellers trade
money, commodities, financial securities, foreign exchange and
derivatives, at low transaction costs and at prices that are
determined by forces of demand and supply.
 The financial market has four major segments, viz.,
• Money market,
• Foreign exchange (forex) market,
• Capital market and,
• Insurance market.
 PHASES OF DEVELOPMENT OF FINANCIAL SYSTEM
History has recorded that the first commercial bank set up in India was Bank of Hindustan in
the year 1770. Similarly, the first insurance company to be set up in India was National
Insurance Company, in the year 1906, and the Company is still in existence.
Development of the financial system in India can be segmented into the following phases:
1. Pre-independence (prior to 1947)
2. Post-independence (1947 to 1991)
3. Post-liberalisation (1991 to 2010)
4. Post-Global Financial Crisis (2010 to present)
 PHASE I-PRE-INDEPENDENCE (PRIOR TO 1947)
• The reminisce of banking in India can be traced back to the 4th century BC, in
the "Kautilya Arthashastra", which contains references to creditors and
lenders.
During the pre-independence phase, a large number of banks were present in
India - which was around 600.
• Bank of Hindustan 1770, in Calcutta (marked the starting of the formal Indian
financial system). This bank, however, discontinued its services in 1832.
General Bank of India (1786-1791) Oudh Commercial Bank (1881-1958)
 PHASE I-PRE-INDEPENDENCE (PRIOR TO 1947)
• Bank of Calcutta 1806. This was later renamed to Bank of Bengal in 1809.
Bank of Bombay 1840. The Bank of Madras 1843. All these three banks
merged in 1921, to form the Imperial Bank of India, which was subsequently
converted into the country's first Public Sector Bank, i.e., State Bank of India
on 1st July 1955.
• Punjab National Bank, which was formed in 1894.
• During this phase, the BSE also established in 1875 and it was Asia's first
stock exchange. The BSE played a yeomen role (supporter’s role) in
development of India's capital markets, including the retail capital market,
and has enabled the Indian corporate sector to grow.
• The pre-independence phase was marked by extreme turbulence in the
financial market, which led to the closing down of a number of banks.
This spurred the establishment of a banking regulator. The setting up of a
central bank, was recommended by the Hilton Young Commission in
1926.
• The regulation of the foreign exchange market also originated during this
phase, with implementation of the Defense of India Rules (DIR) on 3rd
September, 1939, which coincided with the commencement of World War II.
These draconian regulations were superseded by an equally tough legislation in
1947 , FERA.
• The pre-independence phase was one in which majority of small-sized banks
failed to function properly and were unable to gain people's confidence. People
were more associated with money lenders and unregulated players, for meeting
their savings and borrowing needs.
 PHASE II - POST-INDEPENDENCE (1947 TO 1991)
• Post-Independence, India launched into a stage for social development
and development of the country's infrastructure and the organisation of
the Indian financial system during this period evolved in response to
the imperatives of planned economic development.
• Economic growth with social justice was enshrined in the Indian
Constitution, under the Directive Principles of State Policy and the
scheme of planned economic development was initiated in 1951, with
the launch of the First Five-Year Plan.
 PHASE II - POST-INDEPENDENCE (1947 TO 1991)
• This led to adoption of mixed economy, as the pattern of industrial
development, in which a complementary role was conceived for the
public and private sectors. This commenced with the nationalisation of
RBI in 1949, followed by that of State Bank of India in 1955.
• In the succeeding year, on 1st September 1956, 245 private insurance
companies were nationalised to form the LIC.
 PHASE II - POST-INDEPENDENCE (1947 TO 1991)
• In an attempt to bring in tight social control over the banking
sector, the Government nationalised the largest 14 private banks
on 19th July 1969. Each of these banks had deposits over Rs 50
crores.
• The socialised banking sector was enlarged with the
nationalisation of 6 more banks, each with deposits exceeding
Rs 200 crores, on 16th April, 1980.
NATIONALIZATION OF BANKS
• In the meanwhile, another measure which was taken by the Government was the setting up of
the General Insurance Corporation (GIC) in 1972, as a result of the nationalisation of 55
private general insurance companies and simultaneous formation of four 4 public sector
general insurance companies, namely, National Insurance Co. Ltd., Oriental Insurance Co.
Ltd., The Oriental Insurance Co. Ltd. and The New India Assurance Co. Ltd.
• A major step taken during this phase was the setting up of Regional Rural Banks (RRBs) in
1975.
• This phase of development of the Financial System was also marked by establishment of
Development Financial Institutions (DFIs) and the setting up of the Industrial Finance
Corporation of India (IFCI) in 1948, marked the beginning of the era of development banking
in India.
• Under the State Financial Corporations Act, 1951, as counterpart of the IFCI at the
state level, regional institutions, State Financial Corporations (SFCs), were
organised to assist the small/medium enterprises.
• The establishment of the Industrial Credit and Investment Corporation of India
(ICICI) Ltd, in 1955, represented a landmark in the diversification of
development banking in India, as it was a pioneer in many respects like
underwriting of issues of capital, channelisation of foreign currency loans from the
World Bank to private industry, etc.
• One of the important roles of Reserve Bank of India has been the setting up of
institutions that fostered economic development.
These were institutions that had been hived off from different departments of
RBI. Institutions that were so set up include the Industrial Development Bank of India
(IDBI) in 1964, National Bank for Agriculture and Rural Development (NABARD)
and Export Import Bank (EXIM), both set up in 1982, the National Housing Bank
(NHB) set up in 1988 and the Small Industries Development Bank of India (SIDBI),
which was set up in 1990.
• In the arena of Mutual Funds, a significant step was the setting up of the Unit
Trust of India (UTI), UTI was established in 1963, by an Act of Parliament. It was
set up by the Reserve Bank of India and functioned under the Regulatory and
administrative control of the Reserve Bank of India. In 1978, UTI was de-linked
from the RBI and the Industrial Development Bank of India (IDBI) took over the
regulatory and administrative control in place of RBI.
• The first scheme launched by UTI was Unit Scheme 1964.
• The confidence of depositors was also required to be maintained - especially since
there had been a number of bank failures, in the past. It was in 1960 that the
failure of Laxmi Bank and the subsequent failure of the Palai Central Bank which
catalyzed the introduction of deposit insurance scheme in India.
• The Deposit Insurance Corporation (DIC) Bill received the assent of the President
on December 7, 1961 and the Deposit Insurance Corporation commenced
functioning on January 1, 1962, providing an insurance cover of Rs 1 lakh (now 5
lakh) for every deposit customer.
• It was during this phase, in 1986, that BSE first launched its equity index-the
Sensex-which was built up of the top 100 shares, based on market capitalisation.