Evolution of Banking in India from Hundis to Liberalisation

Banking law in India is the product of a long history. Lending and deposit taking existed here for centuries before any statute governed them, and the modern framework grew out of repeated crises: bank failures that ruined depositors, a currency system that needed a central bank, and a political judgment that credit should serve development. Each phase left behind a statute or an institution that is still in force, so the history of banking in India is the quickest route to understanding the shape of the present law.

Figure 1: Seven turning points in Indian banking

1. Banking in Ancient and Medieval India

• Early practice: deposit taking, lending on interest and the transfer of money by written instrument are described in the Vedic texts, in Manusmriti, which deals with rates of interest and pledges, and in Kautilya's Arthashastra, which discusses deposits, loans and the rate of return.
• Indigenous bankers: shroffs, sahukars, seths and mahajans financed trade, accepted deposits and remitted money across long distances, operating on reputation and community networks rather than on statute.
• Hundis: the hundi, an indigenous bill of exchange, allowed value to move between cities without transporting coin. Its use is expressly preserved by Section 1 of the Negotiable Instruments Act, 1881, which does not affect any local usage relating to an instrument in an oriental language.
• Limits: the system had no central bank, no uniform currency and no legal protection for depositors. It financed trade well, but could not support an industrial economy.

2. The First Western-style Banks

• Agency houses: European trading firms in Calcutta and Bombay began accepting deposits and lending as a sideline to trade, and their failures taught the first lesson about mixing banking with commerce.
• Bank of Hindustan (1770): generally treated as the earliest bank in India on the Western model, founded at Calcutta; it failed in the early nineteenth century.
• General Bank of India (1786): established soon after, and it failed in 1791.

3. The Presidency Banks and the Imperial Bank

• Bank of Bengal (1806): established as the Bank of Calcutta and later renamed, the first of three presidency banks incorporated by charter.
• Bank of Bombay (1840) and Bank of Madras (1843): completed the group.
• Quasi-central functions: the presidency banks held government balances, issued notes for a period and acted as bankers to the government, performing some central banking functions before a central bank existed.
• Imperial Bank of India (1921): the three presidency banks were amalgamated into the Imperial Bank, which conducted government business until the Reserve Bank was established, and which became the State Bank of India under the State Bank of India Act, 1955.

4. Indian Joint Stock Banks and the Swadeshi Movement

• Indian ownership: from the later nineteenth century, banks promoted by Indians were established, including Allahabad Bank (1865), Punjab National Bank (1894), Bank of India (1906), Bank of Baroda (1908) and Central Bank of India (1911).
• Swadeshi impulse: the swadeshi movement encouraged Indian-owned banking as part of economic self-reliance, and several banks of this era survive today among the public sector banks.
• Instability: hundreds of small banks were also promoted and failed, particularly in the crises of the 1910s and the 1940s. The absence of licensing, capital norms and inspection was the direct cause of the regulatory statute that followed.

5. The Reserve Bank of India

• Hilton Young Commission: the Royal Commission on Indian Currency and Finance (1926) recommended a central bank that would separate the management of currency and credit from commercial banking.
• Reserve Bank of India Act, 1934: gave effect to the recommendation, and the Reserve Bank commenced operations on 1 April 1935.
• Nationalisation of the Reserve Bank: it began as a shareholders' bank and was nationalised with effect from 1 January 1949 under the Reserve Bank of India (Transfer to Public Ownership) Act, 1948.

6. The Banking Regulation Act, 1949

• Enactment: passed as the Banking Companies Act, 1949, which came into force on 16 March 1949, and was renamed the Banking Regulation Act, 1949 with effect from 1 March 1966.
• Purpose: to consolidate the law relating to banking after the scattered provisions of company law proved unable to prevent bank failures.
• Core scheme: a definition of banking, a licensing requirement, minimum capital and reserves, restrictions on the business a bank may do and on its lending, powers of inspection and direction, and a special regime for amalgamation and winding up.
• Cooperative banks: brought within the Act by the amendment of 1965, which inserted Section 56, and brought more fully under Reserve Bank supervision by the Banking Regulation (Amendment) Act, 2020.

7. Social Control and Nationalisation

• Social control (1968): an attempt to direct bank credit towards agriculture, small industry and exports through changes in bank management and lending, without transferring ownership.
• Nationalisation of 1969: fourteen banks with deposits of ₹50 crore or more were taken over, first by ordinance and then by the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.
• Nationalisation of 1980: six more banks, with deposits of ₹200 crore or more, were acquired under a further Act of the same title.
• Effect: the great majority of Indian banking came into public ownership, and credit was directed to priority sectors and to rural branch expansion.

Parliament responded by re-enacting the measure with a revised compensation scheme in the Act of 1970, and the Constitution (Twenty-fifth Amendment) Act, 1971 later replaced the word compensation in Article 31(2) with the word amount.

8. Liberalisation and the Modern Phase

Figure 2: Four phases of banking regulation in India

• Narasimham Committee I (1991): chaired by M. Narasimham, it recommended reducing the statutory liquidity ratio and the cash reserve ratio, deregulating interest rates, introducing capital adequacy and prudential norms, creating tribunals for debt recovery, and licensing new private banks.
• New private banks (from 1993): licences were issued under Reserve Bank guidelines, bringing competition to the public sector banks.
• Narasimham Committee II (1998): addressed capital adequacy, non-performing assets, consolidation of weak banks and the Reserve Bank's shift from direct control to prudential supervision.
• Recovery statutes: the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (renamed the Recovery of Debts and Bankruptcy Act, 1993 in 2016), the SARFAESI Act, 2002 and the Insolvency and Bankruptcy Code, 2016 progressively strengthened creditor rights.
• Differentiated banks: payments banks and small finance banks were licensed from 2015 to deepen financial inclusion.
• Consolidation: the associate banks merged into the State Bank in 2017, Vijaya Bank and Dena Bank merged into Bank of Baroda in 2019, and ten public sector banks were merged into four with effect from 1 April 2020, leaving twelve public sector banks.
• Digital phase: the Payment and Settlement Systems Act, 2007, the growth of UPI, digital lending and the digital rupee have made payment and technology regulation a central part of banking law.

9. Quick Revision

10. Frequently Asked Questions

Which was the first bank established in India?

The Bank of Hindustan, founded at Calcutta in 1770, is generally regarded as the first bank in India on the Western model. It did not survive. The oldest surviving institution in the line of descent is the State Bank of India, which traces back to the Bank of Bengal (1806) through the Imperial Bank (1921).

Why were banks nationalised in 1969?

The stated objects were to break the concentration of economic power, to direct credit to agriculture, small industry and exports, and to expand banking into rural areas. Social control in 1968 had been judged insufficient to achieve these ends without a transfer of ownership.

Did the Supreme Court hold bank nationalisation unconstitutional?

Not in principle. In R.C. Cooper (1970) the Court upheld Parliament's competence to acquire banking undertakings and accepted that the State may create a monopoly. It struck down the particular measure because the compensation provisions were invalid and the selection of banks was discriminatory. Parliament then re-enacted the measure in a valid form.

When did the Banking Regulation Act get its present name?

It was enacted as the Banking Companies Act, 1949 and came into force on 16 March 1949. It was renamed the Banking Regulation Act, 1949 with effect from 1 March 1966.

What is the significance of the Hilton Young Commission?

The Royal Commission on Indian Currency and Finance (1926), commonly called the Hilton Young Commission, recommended that the management of currency and credit be separated from commercial banking and placed in a central bank. That recommendation produced the RBI Act, 1934 and the Reserve Bank itself.

How many public sector banks are there after the mergers?

Twelve. The number fell from twenty seven through three rounds of consolidation: the associate banks and Bharatiya Mahila Bank merged into the State Bank in 2017, Vijaya Bank and Dena Bank into Bank of Baroda in 2019, and ten banks into four with effect from 1 April 2020.

11. Related Topics and Provisions

• Meaning of banking, banker and bank
• Constitutional and legislative framework of banking
• Structure of the Indian banking system
• Nationalisation and the Acquisition and Transfer Acts
• Committees and reforms in Indian banking