A Commercial Bank is a financial institution that performs the twin functions of accepting deposits from the public and providing loans for investment or consumption. Under the Banking Regulation Act, 1949, these institutions act as intermediaries that facilitate the flow of capital in the Indian economy. Unlike the central bank, commercial banks are profit-seeking entities that generate income through the “interest spread.”
Structural Classification of Commercial Banks in India
Commercial banks in India are categorized based on their inclusion in the RBI’s regulatory schedule and their ownership patterns.
Scheduled Commercial Banks (SCBs)
These are banks included in the Second Schedule of the RBI Act, 1934. To be an SCB, a bank must have a paid-up capital and reserves of at least ₹5 lakhs and must satisfy the RBI that its operations do not jeopardize the interests of depositors.
- Public Sector Banks (PSBs): Banks where the Government of India holds a majority stake (e.g., State Bank of India, Bank of Baroda).
- Private Sector Banks: Banks where the majority of share capital is held by private individuals or entities (e.g., HDFC Bank, ICICI Bank, Axis Bank).
- Foreign Banks: Banks incorporated outside India but operating through branches or wholly-owned subsidiaries within India (e.g., HSBC, Citibank, Standard Chartered).
- Regional Rural Banks (RRBs): Special institutions created under the RRB Act, 1976, to cater to rural credit needs. The equity is held by the Central Govt (50%), State Govt (15%), and Sponsor Bank (35%).
Non-Scheduled Banks
Banks not included in the Second Schedule of the RBI Act. They have limited access to the RBI’s liquidity facilities and are primarily local in nature, such as certain Local Area Banks (LABs).
Functional Mechanics of Commercial Banks
The operations of a commercial bank are reflected in its balance sheet, where the relationship between assets and liabilities is the reverse of a typical manufacturing company.
Balance Sheet Dynamics
- Liabilities (Sources of Funds): Primarily consist of Demand Deposits (Current and Savings Accounts) and Time Deposits (Fixed and Recurring Deposits). These are liabilities because the bank must repay the depositor.
- Assets (Uses of Funds): Consist of Loans and Advances (Cash Credit, Overdrafts, Term Loans) and Investments (Government Securities, Bonds). These are assets because they generate interest income for the bank.
The Interest Spread
The “Spread” is the difference between the interest rate charged to borrowers and the interest rate paid to depositors. This serves as the primary source of gross profit for the bank.
Mandatory Regulatory Reserves
To ensure financial stability, the RBI mandates that commercial banks maintain specific portions of their Net Demand and Time Liabilities (NDTL) as reserves.
| Reserve Requirement | Regulatory Provision | Form of Maintenance | Purpose |
| Cash Reserve Ratio (CRR) | Section 42(1), RBI Act, 1934 | Cash with the RBI | Controlling inflation and liquidity. |
| Statutory Liquidity Ratio (SLR) | Section 24, BR Act, 1949 | Gold, Cash, or G-Secs with the bank | Ensuring solvency and funding govt debt. |
Priority Sector Lending (PSL)
The RBI mandates that SCBs direct a portion of their lending to sectors that are vital for the country’s development but often lack adequate credit.
- Target: Domestic SCBs and Foreign banks with 20+ branches must lend 40% of their Adjusted Net Bank Credit (ANBC) to priority sectors.
- Sectors Included: Agriculture, MSMEs, Export Credit, Education, Housing, Social Infrastructure, Renewable Energy, and Weaker Sections.
- Small Finance Banks (SFBs): They have a higher PSL target of 75% of ANBC.
Performance Metrics and Asset Quality
The health of a commercial bank is assessed using several key indicators essential for economic stability.
- Capital Adequacy Ratio (CAR): Also known as Capital to Risk-Weighted Assets Ratio (CRAR). It ensures the bank has enough “cushion” to absorb losses. Under Basel III norms, Indian banks are required to maintain a specific CAR.
- Non-Performing Assets (NPAs): An asset becomes an NPA when it ceases to generate income for the bank. Generally, a loan is classified as an NPA if interest or principal remains overdue for more than 90 days.
- Provisioning Coverage Ratio (PCR): The ratio of provisioning to gross NPAs, indicating how much of the bad loans are covered by the bank’s reserves.
Evolution of Commercial Banking: Key Facts
- Bank Nationalization: 14 major banks were nationalized in 1969, and another 6 in 1980, to align banking with socialistic objectives and rural development.
- Narasimham Committee (1991 & 1998): These reports laid the foundation for banking sector reforms, including the reduction of CRR/SLR and the entry of new private sector banks.
- Prompt Corrective Action (PCA): A framework under which the RBI monitors banks with weak financial metrics (high NPAs or low capital) to prevent them from failing.
- DICGC: The Deposit Insurance and Credit Guarantee Corporation provides insurance for bank deposits. Each depositor in a bank is insured up to a maximum of ₹5 lakhs for both principal and interest amount.
- Indradhanush Plan: A seven-pronged strategy launched by the government in 2015 to revamp Public Sector Banks, covering Appointments, Board of Bureau, Capitalization, De-stressing, Empowerment, Framework of Accountability, and Governance Reforms.