Indian Banking System: Evolution and Bank Classifications

Posted on Aug 23, 2025 in Business Administration and Management (BAM)

Evolution of Banking in India

Phase 1: Pre-Independence Era (Before 1947)

The roots of banking in India trace back to ancient times, with references to money lending and financial transactions in Vedic texts. However, the formal banking system began during the British colonial period.

  • Early Banks: The first bank in India, the Bank of Hindustan, was established in 1770 in Calcutta but ceased operations in 1832. Subsequently, the General Bank of India was set up in 1786.
  • Presidency Banks: The East India Company established three presidency banks: the Bank of Bengal (1806), the Bank of Bombay (1840), and the Bank of Madras (1843). These banks were later merged in 1921 to form the Imperial Bank of India, which became the State Bank of India in 1955.
  • Proliferation of Banks: By the early 20th century, India had over 600 banks. However, many were small and unstable, leading to frequent failures. The lack of regulation and supervision contributed to this instability.
  • Need for Regulation: The frequent bank failures highlighted the necessity for a central regulatory authority, paving the way for the establishment of the Reserve Bank of India (RBI) in 1935.

Phase 2: Post-Independence and Nationalization (1947-1991)

After gaining independence in 1947, India aimed to build a banking system that would support its planned economic development.

  • Establishment of RBI: The Reserve Bank of India was nationalized in 1949, granting it the authority to regulate the banking sector and ensure monetary stability.
  • Banking Regulation Act, 1949: This act provided a framework for the regulation and supervision of banks in India, empowering the RBI to license banks, regulate their activities, and ensure their solvency.
  • Nationalization of Banks: In 1969, the government nationalized 14 major private banks to align the banking sector with national priorities, such as poverty alleviation and rural development. In 1980, six more banks were nationalized. This move aimed to extend banking services to rural and underserved areas.
  • Regional Rural Banks (RRBs): Established in 1975, RRBs were created to provide credit and other banking facilities to the rural population, especially small and marginal farmers, agricultural laborers, and artisans.
  • Lead Bank Scheme: Launched in 1969, this scheme assigned specific banks to districts to coordinate banking activities and ensure adequate banking facilities throughout the country.

Phase 3: Liberalization and Technological Advancements (1991-2010)

The economic liberalization of the early 1990s brought significant changes to the Indian banking sector.

  • Narasimham Committee Reports: The government appointed two committees (1991 and 1998) under M. Narasimham to recommend banking sector reforms. Key recommendations included reducing the statutory liquidity ratio (SLR) and cash reserve ratio (CRR), allowing private sector banks, and improving asset quality.
  • Entry of Private Banks: The RBI granted licenses to new private sector banks, leading to the emergence of banks like HDFC Bank, ICICI Bank, and Axis Bank. These banks introduced modern banking practices and customer-centric services.
  • Technological Integration: Banks began adopting technology to enhance efficiency and customer service. The introduction of Automated Teller Machines (ATMs), Electronic Fund Transfer (EFT), and Core Banking Solutions (CBS) revolutionized banking operations.
  • Financial Inclusion Initiatives: The government and RBI launched various initiatives to promote financial inclusion, such as the Self-Help Group (SHG)-Bank Linkage Programme and the Kisan Credit Card scheme.

Phase 4: Digital Transformation and Financial Inclusion (2010-Present)

The last decade has witnessed a digital revolution in the Indian banking sector, aiming to enhance accessibility and efficiency.

  • Digital Payment Systems: The introduction of the Unified Payments Interface (UPI) in 2016 revolutionized digital transactions, allowing instant money transfers through mobile devices. Other platforms like Bharat Interface for Money (BHIM) and Aadhaar-enabled Payment Systems (AePS) further facilitated digital payments.
  • Jan Dhan Yojana: Launched in 2014, this financial inclusion program aimed to provide universal access to banking facilities. It led to the opening of millions of bank accounts, especially in rural areas, promoting savings and direct benefit transfers.
  • Emergence of Small Finance and Payments Banks: To cater to the underserved segments, the RBI introduced differentiated banking licenses, leading to the establishment of small finance banks and payments banks. These banks focus on financial inclusion by providing basic banking services.
  • Cybersecurity and Regulatory Measures: With the rise in digital transactions, the RBI has emphasized strengthening cybersecurity frameworks. Banks are investing in robust IT infrastructure to prevent fraud and ensure secure banking experiences.
  • Green and Sustainable Banking: Banks are increasingly adopting environmentally sustainable practices, such as paperless banking, green loans, and financing renewable energy projects, aligning with global sustainability goals.

Indigenous Bankers in India

Meaning

Indigenous bankers are traditional money lenders and financial intermediaries who operate outside the modern, organized banking system. They are individuals or private firms who provide banking services like lending money, accepting deposits, and helping in fund transfers, especially in rural and semi-urban areas. Common examples of indigenous bankers are Shroffs, Seths, Sahukars, Mahajans, and Chettiars.

History

Indigenous banking has been a part of India since ancient times. Before the entry of British and modern banks, these bankers were the main source of finance for traders, farmers, and small businesses. They helped in promoting trade, agriculture, and even government finances during earlier times. After the British introduced modern banking institutions, the importance of indigenous bankers started declining, but they still continue to exist, mainly in rural areas.

Functions of Indigenous Bankers

  1. Accepting Deposits: They accept savings from individuals and businesses. People trust them for safekeeping of money.
  2. Lending Money: They give loans to farmers, traders, shopkeepers, and small businesses. Loans are usually given without strict formalities or heavy paperwork.
  3. Discounting Hundis: Hundis are traditional financial instruments, similar to today’s cheques or bills of exchange. Indigenous bankers help in discounting hundis to facilitate trade.
  4. Remittance Services: They help people send money from one place to another through their personal networks, especially before banks became common.
  5. Other Services: Some indigenous bankers also work as money changers (foreign currency exchange) and engage in trading activities.

Characteristics of Indigenous Bankers

  • Operate mostly in personal capacity or small firms.
  • Services are based on personal trust and relationships.
  • Formal rules and regulations are limited or absent.
  • Operate more flexibly compared to modern banks.
  • Interest rates on loans are usually higher.

Advantages of Indigenous Bankers

  • Accessibility: They are easily available in remote areas where modern banks do not reach.
  • Quick Service: Loans and money transfers happen faster without much paperwork.
  • Flexible Terms: Loan repayment terms can be adjusted depending on the borrower’s condition.
  • Relationship-Based: Decisions are often made based on personal relationships and trust.

Disadvantages or Limitations

  • High Interest Rates: They usually charge very high rates of interest compared to banks.
  • Lack of Regulation: Their activities are not regulated by government rules, which sometimes leads to exploitation.
  • Limited Resources: They have limited money compared to banks, so they can only support small financial needs.
  • Mixing of Business: Many indigenous bankers also trade in goods, which can lead to conflict of interest and risks.

Role Today

Even today, indigenous bankers are important in rural India. Many farmers, small traders, and shopkeepers still depend on them when formal banks are unavailable or procedures are too difficult. However, with financial inclusion schemes and expansion of banking services, their role is slowly reducing. Government policies aim to bring more people into the formal banking system to ensure fair and regulated financial services for all.

Types of Banks in India

The Indian banking system comprises various types of banks, each serving distinct purposes and segments of the economy. These include:

  • Central Bank
  • Commercial Banks
  • Cooperative Banks
  • Payment Banks
  • Small Finance Banks
  • Development Banks

Commercial Banks in India

Commercial banks are financial institutions that accept deposits from people and businesses and provide loans to those who need funds. Their main goal is to earn profit through lending, investments, and providing various financial services. In India, commercial banks are a very important part of the financial system and are regulated mainly by the Reserve Bank of India (RBI). Commercial banks in India are classified into four main types:

  • Public Sector Banks
  • Private Sector Banks
  • Regional Rural Banks
  • Foreign Banks

Public Sector Banks (PSBs)

Meaning: Public Sector Banks are those banks where the Government of India holds more than 50% of the shareholding. These banks are owned and controlled by the government.

Features:

  • Majority Ownership: More than half of the bank’s shares are owned by the central government.
  • Wide Network: They have branches in cities, towns, and even remote rural areas.
  • Social Responsibility: They aim not only for profits but also to serve the public by promoting financial inclusion.
  • Government Schemes: They are key players in implementing government programs like Jan Dhan Yojana, Mudra Loans, and Priority Sector Lending.
  • Safety: Customers often see public sector banks as safe because of government backing.

Examples: State Bank of India (SBI), Bank of Baroda, Punjab National Bank, Canara Bank, Union Bank of India.

Important Points: In 2020, many smaller public sector banks were merged to form larger, stronger entities (e.g., Allahabad Bank merged with Indian Bank).

Private Sector Banks

Meaning: Private Sector Banks are banks where most of the ownership is with private individuals, corporations, or institutions rather than the government.

Features:

  • Private Ownership: The majority of shares are held by private players.
  • Customer Service Focus: They focus a lot on personalized customer service and better banking experiences.
  • Technology Use: They quickly adopt modern technologies like mobile banking, internet banking, and digital wallets.
  • Profit Motive: They are mainly profit-driven and compete aggressively with each other.
  • Innovation: They introduce new financial products, credit cards, loans, and investment options.

Types of Private Sector Banks:

  1. Old Private Sector Banks – Established before 1969 (e.g., Karur Vysya Bank, South Indian Bank).
  2. New Private Sector Banks – Established after the 1990s liberalization reforms (e.g., HDFC Bank, ICICI Bank, Axis Bank).

Examples: HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank.

Important Points: Private sector banks are known for better efficiency, faster services, and offering many new types of loans and investment products.

Regional Rural Banks (RRBs)

Meaning: Regional Rural Banks are special types of banks set up to provide banking facilities to the rural and semi-urban areas, especially to small farmers, artisans, and agricultural workers.

Establishment: RRBs were established in 1975 based on the recommendations of the Narasimham Committee.

Ownership Structure: 50% owned by the Central Government, 15% owned by the concerned State Government, 35% owned by a sponsoring Public Sector Bank.

Features:

  • Rural Focus: Their main goal is to support agriculture, small industries, and rural development.
  • Limited Area: They work within a limited number of districts.
  • Low-Cost Loans: They provide loans at cheaper rates to farmers, laborers, and small businessmen.
  • Government Support: They get financial and operational support from their sponsoring banks and the government.

Examples: Maharashtra Gramin Bank, Kerala Gramin Bank, Andhra Pragathi Grameena Bank.

Important Points: RRBs help in increasing rural credit and making the rural economy stronger. In recent years, many RRBs have been merged to make them stronger and more efficient.

Foreign Banks

Meaning: Foreign Banks are banks that have their headquarters outside India but operate through branches or wholly-owned subsidiaries within India. They bring global banking practices and cater to multinational corporations, large businesses, and high-net-worth individuals.

Features:

  • Global Expertise: They bring international experience and global banking standards.
  • Limited Presence: Mostly have branches in metro cities like Mumbai, Delhi, Chennai, and Bengaluru.
  • Corporate Services: They focus more on corporate banking, trade finance, and wealth management rather than retail banking.
  • High-End Services: They offer specialized financial products to multinational companies, exporters, and wealthy individuals.
  • Regulation: They are regulated by the RBI just like Indian banks but also follow the rules of their home countries.
  • Specialized Services: Offer specialized services like foreign exchange, trade finance, and international remittances.
  • Advanced Technology: Introduce advanced technology and banking practices.

Examples: Standard Chartered Bank, HSBC, Citibank, Deutsche Bank, Barclays Bank.

Advantages:

  • Enhance competition and efficiency in the banking sector.
  • Facilitate international trade and investment.
  • Introduce innovative financial products and services.

Important Points: Foreign banks contribute to bringing in foreign investment, international banking practices, and competition into the Indian banking system.

Cooperative Banks

Meaning: Cooperative Banks are financial institutions that operate on a cooperative basis. They are owned and controlled by their members, who are also the customers. The main aim of cooperative banks is not just to make profits but to promote financial assistance and welfare of their members, especially people from the weaker sections of society. Cooperative banks are registered under the Cooperative Societies Act and are also regulated by the Reserve Bank of India (RBI) and the respective State Governments.

Key Features of Cooperative Banks

  • Member Ownership: Owned and operated by members (customers themselves).
  • Democratic Control: Each member has equal voting rights (“one member, one vote”) regardless of their shareholding.
  • Social Objective: Focus on the financial upliftment of rural and urban people.
  • Dual Regulation: Supervised by both the RBI and State Government Authorities.
  • Credit Focus: Provide easy and low-cost loans for agriculture, housing, small businesses, and personal needs.

Cooperative banks are mainly classified into three types:

State Cooperative Banks (SCBs)

Meaning: State Cooperative Banks are apex (top-level) cooperative banks at the state level. They coordinate the activities of all the district and central cooperative banks within the state.

Functions:

  • Act as a link between district cooperative banks and the Reserve Bank of India (RBI).
  • Provide financial resources and guidance to the lower levels of the cooperative banking system.
  • Offer short-term and medium-term loans for agricultural and rural development activities.
  • Help in the distribution of funds under government-sponsored schemes like crop loans, farmer development schemes, etc.
  • Perform banking functions like accepting deposits, lending money, and discounting bills for district-level cooperatives.

Structure: State Cooperative Banks usually have:

  • A central office in the state capital.
  • Branches in major cities and towns of the state.

Sources of Funds:

  • Share capital contributed by member societies and the state government.
  • Deposits from the public and cooperative institutions.
  • Borrowings from the Reserve Bank of India and NABARD (National Bank for Agriculture and Rural Development).

Example: Maharashtra State Cooperative Bank, Gujarat State Cooperative Bank, Punjab State Cooperative Bank.

Important Points: State Cooperative Banks help strengthen the cooperative credit system by ensuring that rural and agricultural needs for money are properly met through a chain of cooperative societies and banks.

Urban Cooperative Banks (UCBs)

Meaning: Urban Cooperative Banks are cooperative banks that operate in urban and semi-urban areas. They cater mainly to the financial needs of small businesses, retail traders, salaried individuals, and professionals. Earlier, these banks were meant only for limited banking activities, but now they provide almost all modern banking services like savings accounts, loans, debit cards, and internet banking.

Functions:

  • Accept deposits from members and the general public.
  • Provide loans for personal use, business expansion, housing, vehicle purchase, and small industry operations.
  • Promote saving habits among middle-class and low-income people living in cities and towns.
  • Support small businesses and self-employed persons through easy loans.

Structure:

  • Registered under the State Cooperative Societies Act.
  • Regulated by the RBI since 1966 for banking operations.
  • Can be either single-state or multi-state banks depending on their area of operation.

Sources of Funds:

  • Member contributions (share capital).
  • Deposits from the public.
  • Borrowings from higher financial institutions (if needed).

Examples: Saraswat Cooperative Bank (Mumbai), Shamrao Vithal Cooperative Bank (SVC Bank), Abhyudaya Cooperative Bank.

Important Points: Urban Cooperative Banks often focus on community welfare rather than maximizing profits. RBI has introduced reforms to strengthen UCBs and improve governance to ensure better customer service and financial soundness.

District Central Cooperative Banks (DCCBs)

Meaning: DCCBs operate at the district level. They act as a link between State Cooperative Banks and Primary Agricultural Credit Societies (PACS). Their main customers are PACS and other cooperative societies, not individual customers directly.

Functions:

  • Provide short-term and medium-term loans to PACS.
  • Accept deposits from PACS and member cooperative societies.
  • Help in the distribution of crop loans to farmers through PACS.
  • Support rural development and agriculture at the district level.

Structure:

  • Every district generally has one DCCB.
  • They are funded by SCBs and offer financial services to PACS, which further help farmers and rural people.

Example: Ahmednagar District Central Cooperative Bank (Maharashtra), Krishna District Central Cooperative Bank (Andhra Pradesh), Nashik District Central Cooperative Bank (Maharashtra).

Development Banks in India

Meaning: Development banks are specialized financial institutions established to provide long-term capital for economic development projects. Unlike commercial banks that focus on short-term lending, development banks finance large-scale infrastructure, industrial, and agricultural projects.

Objectives

  • Promote industrial growth.
  • Support infrastructure development.
  • Provide financial assistance to agriculture and rural sectors.
  • Encourage entrepreneurship and innovation.

Types and Examples

Industrial Development Banks
  • Industrial Development Bank of India (IDBI): Established in 1964 to provide financial support to large industries.
  • Industrial Finance Corporation of India (IFCI): Founded in 1948 to offer medium and long-term finance to industrial projects.
Agricultural Development Banks
  • National Bank for Agriculture and Rural Development (NABARD): Set up in 1982 to finance agriculture and rural development projects.
Export-Import Banks
  • Export-Import Bank of India (EXIM Bank): Established in 1982 to promote international trade by providing financial assistance to exporters and importers.
Housing Development Banks
  • National Housing Bank (NHB): Founded in 1988 to promote housing finance institutions and provide financial support for housing projects.

Functions

  • Provide long-term loans for industrial and infrastructure projects.
  • Offer refinancing facilities to other financial institutions.
  • Support modernization and technological upgrades in industries.
  • Assist in project planning and development.

Small Finance Banks

Meaning: Small Finance Banks are niche banks established to provide financial inclusion by offering basic banking services to underserved and unbanked segments, including small businesses, farmers, and low-income households.