Commercial Banks in India

In the previous chapter, we explored how the Reserve Bank of India (RBI) sits at the very top of the country's financial system, pulling the macroeconomic levers of money supply and interest rates. But the RBI is a central bank; it does not deal directly with you, me, or the local grocery store.

The institutions that actually connect the RBI's grand policies to the daily lives of citizens and businesses are the Commercial Banks. If the RBI is the heart pumping blood through the economy, commercial banks are the arteries and veins that deliver it to every town, village, and corporate headquarters.

In this chapter, we are going to break down exactly what commercial banks do, how they make their money, and how the Indian banking sector is divided into public, private, foreign, regional rural, and cooperative banks.

The Core Business Model: How Banks Make Money

Before we categorize banks, we must understand what a bank actually is. At its simplest, a bank is a financial intermediary—a middleman.

Imagine you have ₹50,000 saved up. Keeping it under your mattress is risky and earns you nothing. So, you deposit it in a bank. The bank promises to keep it safe and pays you, say, 4% interest per year.

Meanwhile, a local entrepreneur needs ₹50,000 to buy new machinery for her factory. She goes to the same bank for a loan. The bank lends her your deposited money, but charges her 9% interest per year.

The bank pays you 4%, collects 9% from the borrower, and keeps the 5% difference. This difference is the lifeblood of the banking industry.

Primary Functions of Commercial Banks

No matter whether a bank is owned by the government or private investors, its primary functions are always the same: accepting deposits and granting loans.

1. Accepting Deposits

Banks offer different types of accounts to suit the different needs of the public. These are broadly divided into two categories: Demand Deposits and Time Deposits.

Demand Deposits These are deposits that you can withdraw "on demand" at any time, without giving the bank prior notice. Because the bank must keep this money ready for you at a moment's notice, they cannot easily lock it up in long-term loans. Therefore, demand deposits pay very little or no interest.

• Current Accounts: Designed for businesses that make dozens of transactions a day. There are no limits on withdrawals or deposits. Because of the high volatility of the balance, banks pay zero interest on current accounts.
• Savings Accounts: Designed for individuals to encourage the habit of saving. They offer limited numbers of withdrawals per month and pay a modest rate of interest.

Time Deposits (Term Deposits) These are deposits locked in for a specific period (a "term"). Because the bank knows exactly how long it has the money, it can confidently lend it out for long-term projects. In return, the bank pays a higher interest rate.

• Fixed Deposits (FD): A lump sum deposited for a fixed period (e.g., 1 year, 5 years). You cannot withdraw it early without paying a penalty.
• Recurring Deposits (RD): Instead of a lump sum, you deposit a fixed amount every month for a specific period. It is ideal for salaried individuals saving for a future goal.

2. Granting Loans and Advances

The second primary function is lending out the pooled deposits. Banks do this in several ways:

• Term Loans: A lump sum given to a borrower, which is repaid in regular installments (EMIs) over a fixed period. Examples include home loans, car loans, and corporate infrastructure loans.
• Cash Credit (CC): A facility given to businesses to meet their daily working capital needs (like buying raw materials). The bank sets a borrowing limit based on the value of the business's inventory. The business can withdraw money as needed up to that limit, and interest is charged only on the amount actually withdrawn, not the total limit.
• Overdraft (OD): Similar to cash credit, but usually offered to individuals or businesses against their existing assets (like a Fixed Deposit or a Current Account). It allows the customer to withdraw more money than they actually have in their account, up to a sanctioned limit.
• Discounting of Bills of Exchange: If a manufacturer sells goods on credit and receives a bill (an IOU) payable after 90 days, they can take this bill to the bank. The bank buys the bill at a slight discount (giving the manufacturer immediate cash) and then collects the full amount from the buyer after 90 days.

Secondary Functions of Commercial Banks

Beyond deposits and loans, modern banks perform a host of secondary functions to make financial life easier for their customers.

Agency Functions The bank acts as an agent on behalf of the customer.

• Collecting cheques and dividends.
• Paying utility bills, insurance premiums, and loan EMIs automatically.
• Buying and selling securities (shares, mutual funds) on the customer's instructions.

General Utility Functions Services provided to the general public for a fee.

• Providing safe deposit lockers for valuables.
• Issuing Letters of Credit and Bank Guarantees (crucial for international trade).
• Dealing in foreign exchange (converting Rupees to Dollars for travelers or importers).
• Underwriting shares (guaranteeing to buy unsold shares when a company issues new stock).

The Grand Classification: Scheduled vs. Non-Scheduled

Before we look at public and private banks, you need to understand the master categorization of all banks in India.

To be included in this schedule, a bank must satisfy the RBI that its affairs are not being conducted in a manner detrimental to the interests of its depositors, and it must have a minimum paid-up capital and reserves of ₹5 lakhs (a historical figure, though actual capital requirements today are in the hundreds of crores).

Being a Scheduled Bank is a mark of legitimacy. It gives the bank the right to borrow money from the RBI at the bank rate and grants it automatic membership in the clearing house. Almost every bank you have ever heard of is a Scheduled Commercial Bank (SCB). Non-scheduled banks are practically non-existent in the modern commercial space.

Now, let us break down the Scheduled Commercial Banks into their main types based on ownership.

1. Public Sector Banks (PSBs)

Public Sector Banks are banks where the Government of India holds the majority stake (more than 50%). Because the government is the majority shareholder, these banks are effectively state-owned.

Why do we have them? In the early decades after India's independence, all commercial banks were privately owned. They focused almost entirely on lending to large industries in big cities, ignoring agriculture, small-scale industries, and rural areas. To fix this, the Government of India took a historic step: it nationalized 14 major private banks in 1969, and another 6 in 1980. Overnight, the government took ownership of these banks to ensure that credit flowed to the rural and agricultural sectors.

How they operate today: Today, PSBs are the backbone of the Indian banking system. They have the largest branch networks, especially in rural and semi-urban areas. They are the primary vehicles for the government's financial inclusion schemes (like the Pradhan Mantri Jan Dhan Yojana).

In recent years, the government has merged several smaller PSBs into larger ones to create globally competitive "mega-banks." For example, Oriental Bank of Commerce and United Bank of India were merged into Punjab National Bank.

Examples:

• State Bank of India (SBI) — The largest commercial bank in India.
• Punjab National Bank (PNB)
• Bank of Baroda (BoB)
• Canara Bank

2. Private Sector Banks

Private Sector Banks are banks where the majority of the share capital is held by private individuals, corporations, or institutional investors, not the government.

Old vs. New Private Banks:

• Old Private Sector Banks: These are banks that existed before the major economic reforms of 1991. They were not large enough to be nationalized in 1969 or 1980, so they remained private. They often have strong regional roots. Examples include Federal Bank, South Indian Bank, and Jammu & Kashmir Bank (which has a unique structure where the UT government is the majority shareholder, but it operates and is classified as an old private sector bank).
• New Private Sector Banks: After the economic liberalization of 1991, the RBI issued guidelines in 1993 to allow new private players to set up banks. These banks brought in modern technology, ATMs, internet banking, and aggressive customer service. Examples include HDFC Bank, ICICI Bank, and Axis Bank.

Private banks are highly competitive, heavily technology-driven, and generally focus on urban and semi-urban areas, though regulatory requirements force them to expand into rural areas as well.

3. Foreign Banks

Foreign Banks are banks that are headquartered in a foreign country but operate branches or subsidiaries in India.

They bring international banking practices, advanced technology, and global connectivity to the Indian market. They are particularly useful for multinational corporations operating in India and Indian companies doing business abroad.

Foreign banks can operate in India in two ways:

1. 1As Branches: They simply open a branch of their foreign parent company in India.
2. 2As Wholly-Owned Subsidiaries (WOS): They create a legally separate Indian company that is 100% owned by the foreign parent. The RBI prefers this route because it makes it easier to regulate the bank locally and protects Indian depositors if the foreign parent company goes bankrupt.

Examples:

• Standard Chartered Bank (UK)
• Citibank (USA)
• HSBC (UK)

4. Regional Rural Banks (RRBs)

While Public Sector Banks expanded into rural areas after nationalization, they still carried an urban, corporate culture. Their staff often struggled to understand the specific, seasonal needs of local farmers. On the other hand, local cooperative societies understood the farmers but lacked professional management and financial muscle.

To bridge this gap, the government created Regional Rural Banks (RRBs) in 1975, following the recommendations of the Narasimham Working Group.

The vision was simple: create a bank that has the "local feel and familiarity" of a cooperative, but the "professionalism and financial strength" of a commercial bank.

The Unique Ownership Structure of RRBs: RRBs are jointly owned by three entities. This specific shareholding pattern is fixed by law and is a highly tested concept.

Role and Functions: RRBs are restricted to operating within a specific region (a few districts within a state). Their primary mandate is to provide credit and banking facilities to small and marginal farmers, agricultural laborers, artisans, and small entrepreneurs in rural areas.

Example: J&K Grameen Bank is an RRB. It is sponsored by J&K Bank, and its ownership is divided between the Central Government (50%), the J&K UT Government (15%), and J&K Bank (35%).

5. Cooperative Banks

Cooperative Banks are fundamentally different from commercial banks in their philosophy. While commercial banks are driven by profit, cooperative banks are driven by the principle of "no profit, no loss" and mutual help.

They are organized on a cooperative basis, meaning the customers (depositors and borrowers) are also the owners of the bank.

The Core Difference: Voting Rights In a commercial bank (like HDFC or SBI), voting power is based on the number of shares you own. One share = one vote. In a cooperative bank, the principle is "One Member, One Vote." Whether a farmer deposits ₹100 or ₹1,00,000, they have exactly one vote in electing the bank's management. This prevents wealthy individuals from taking over the bank.

Dual Regulation: Cooperative banks face a unique regulatory setup.

1. 1Their banking operations (interest rates, capital adequacy) are regulated by the Reserve Bank of India (RBI).
2. 2Their management, elections, and audits are regulated by the Registrar of Cooperative Societies (either of the State Government, or the Central Government if they operate in multiple states).

The Structure of Rural Cooperative Credit

The rural cooperative credit system in India is designed in a three-tier structure to channel funds from the RBI and NABARD down to the village level.

(Note: There are also Urban Cooperative Banks (UCBs) that operate in towns and cities, providing credit to small businesses, artisans, and middle-class individuals, but the three-tier structure above is specific to rural agricultural credit).

Quick Revision

• Commercial Banks act as intermediaries, borrowing money from depositors at a lower rate and lending it to borrowers at a higher rate. The difference is their profit margin, known as the Spread.
• CASA Ratio refers to the proportion of Current and Savings Account deposits. A higher CASA ratio means cheaper funds for the bank.
• Scheduled Banks are those listed in the Second Schedule of the RBI Act, 1934.
• Public Sector Banks (PSBs) are majority-owned (>50%) by the Government of India (e.g., SBI, PNB). They were largely created through the nationalization waves of 1969 and 1980.
• Private Sector Banks are majority-owned by private entities. They are divided into Old (pre-1993) and New (post-1993) private banks.
• Foreign Banks are headquartered abroad but operate in India, often through Wholly-Owned Subsidiaries (WOS).
• Regional Rural Banks (RRBs) were created in 1975 to serve rural areas. Their ownership is strictly divided: Central Govt (50%), State Govt (15%), and Sponsor Bank (35%).
• Cooperative Banks operate on a "One Member, One Vote" principle rather than maximizing profit. Rural cooperatives follow a three-tier structure: State (Apex) -> District (Central) -> Village (Primary).
• Cooperative banks are subject to dual regulation by the RBI (for banking functions) and the Registrar of Cooperative Societies (for management and administration).