A bank is a financial institution licensed to receive deposits and make loans. In the Indian economy, banking acts as the “financial intermediary” that facilitates the mobilization of savings from surplus units (savers) and channels them into deficit units (investors/borrowers). Under the Banking Regulation Act, 1949, banking is defined as the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise.
The Structure of Indian Banking
The Indian banking system is a multi-layered structure regulated primarily by the Reserve Bank of India (RBI).
Scheduled vs. Non-Scheduled Banks
- Scheduled Banks: Banks included in the Second Schedule of the RBI Act, 1934. To qualify, a bank must have a paid-up capital and reserves of at least ₹5 lakhs and satisfy the RBI that its affairs are not conducted in a manner detrimental to the interests of its depositors.
- Non-Scheduled Banks: Banks not included in the Second Schedule. They are subject to fewer regulations but do not have the same access to RBI’s liquidity facilities.
Classification by Ownership and Mandate
- Public Sector Banks (PSBs): Banks where the majority stake (more than 50%) is held by the Government of India (e.g., State Bank of India, Punjab National Bank).
- Private Sector Banks: Banks where the majority of share capital is held by private individuals or corporations (e.g., HDFC Bank, ICICI Bank).
- Foreign Banks: Banks incorporated outside India but operating through branches or subsidiaries within the country.
- Regional Rural Banks (RRBs): Formed under the RRB Act, 1976, to provide credit to rural areas. Ownership is shared: Central Government (50%), State Government (15%), and Sponsor Bank (35%).
- Cooperative Banks: Organized on a cooperative basis, these are governed by both the Banking Regulation Act and State Cooperative Societies Acts. They follow a three-tier structure: Primary Credit Societies (Village level), Central Cooperative Banks (District level), and State Cooperative Banks (State level).
Key Banking Operations and Concepts
Assets and Liabilities of a Bank
The balance sheet of a bank is inverted compared to a manufacturing firm:
- Liabilities: Deposits (Demand and Time) are liabilities because the bank owes this money to the public.
- Assets: Loans, advances, and investments (like G-Secs) are assets because they generate income for the bank in the form of interest.
Net Demand and Time Liabilities (NDTL)
NDTL is the total demand and time liabilities (deposits) of a bank with the public and other banks, minus the deposits held by other banks in this bank. It is the base on which CRR and SLR are calculated.
- Demand Liabilities: Deposits payable on demand (Current Account, Savings Account – CASA).
- Time Liabilities: Deposits payable after a fixed period (Fixed Deposits, Recurring Deposits).
Spread and Net Interest Margin (NIM)
- Spread: The difference between the interest rate a bank charges on loans and the interest rate it pays on deposits.
- Net Interest Margin (NIM): A performance metric that examines how successful a bank’s investment decisions are compared to its debt situations. It is calculated as (Interest Income – Interest Expense) / Productive Assets.
Specialized Banking Models in India
Differentiated Banks
Unlike universal banks, differentiated banks are niche players with specific remits.
- Payments Banks: Can accept deposits up to ₹2 lakh but cannot issue credit cards or give loans (e.g., Airtel Payments Bank, India Post Payments Bank).
- Small Finance Banks (SFBs): Focus on high-volume, low-value lending to unserved and underserved sections, including small business units and micro-industries.
Shadow Banking (NBFCs)
Non-Banking Financial Companies (NBFCs) provide banking services without holding a banking license. They cannot accept demand deposits (only term deposits in some cases) and do not form part of the payment and settlement system (cannot issue cheques drawn on themselves).
Regulatory Framework and Essential Facts
| Act/Requirement | Description |
| RBI Act, 1934 | Established the RBI and provides the framework for currency management and credit control. |
| Banking Regulation Act, 1949 | Empowers RBI to license banks, regulate shareholding, and oversee liquid reserves. |
| Priority Sector Lending (PSL) | Banks are mandated to direct 40% of their Adjusted Net Bank Credit (ANBC) to sectors like Agriculture, MSMEs, Education, and Housing. |
| Basel Accords | International regulatory standards (Basel I, II, III) aimed at ensuring banks have enough capital to absorb losses. |
Trivia for Prelims
- CASA Ratio: The ratio of deposits in Current and Savings Accounts to total deposits. A higher CASA ratio indicates a lower cost of funds for the bank, as interest on these accounts is lower than on FDs.
- Narrow Banking: A concept where banks invest customer deposits only in very safe, liquid government securities rather than lending to the private sector.
- Universal Banking: A system where banks provide a wide range of financial services, including commercial banking, investment banking, and insurance, under one roof.
- The First Bank in India: The Bank of Hindustan, established in 1770 in Calcutta (now defunct).
- The Largest Public Sector Bank: State Bank of India (SBI), which originated from the Bank of Calcutta (1806) and later the Imperial Bank of India (1921).