The first bank of limited liability managed by Indians was Oudh Commercial Bank founded in 1881. Subsequently, Punjab National Bank was established in 1894. Rao Bahadur T.M. (Thalakodi Madathil) Appu Nedungadi, who was famous as the first Malayalam novelist, established Nedungadi Bank in 1899 at Calicut in Kerala. It was the first private sector commercial bank set up in South India.
Swadeshi movement, which began in 1906, encouraged the formation of a number of commercial banks. The banking crisis during 1913-1917 and the failure of 588 banks in various parts of the country during the decade ended 1949 underlined the need for regulating and controlling commercial banks. The Banking Companies Act was passed in February 1949, which was subsequently amended to read as Banking Regulation Act, 1949. This Act provided the legal framework for the regulation of the banking system in India. The largest bank – Imperial Bank of India – was nationalized in 1955 and renamed as State Bank of India, followed by the formation of its 7 Associate Banks in 1959. With a view to bringing commercial banks into the mainstream of economic development with definite social obligations and objectives, the Government of India issued an ordinance on 19 July 1969 acquiring ownership and control of major banks in the country. Six more commercial banks were nationalized from April 1980.
Ascertain rigidities and weaknesses were found to have developed in the banking system during the late eighties, the Government of India felt that there had to be addressed to enable the financial system to play its role in ushering in a more efficient and competitive economy Accordingly, a high-level Committee on the Financial System (CFS) was set up on 14 August 1991 to examine all aspects relating to the structure, organization, functions and procedures of the financial systems. Based on the recommendations of the Committee (Chairman: Shri M.Narasimham), a comprehensive reform of the banking system was introduced in 1992-93.
To review the record of implementation of financial system reforms recommended in 1991 by the Committee on Financial System and chart the path of reforms in the years ahead, a high-level committee on Banking Sector Reforms, under the Chairmanship of Shri M.Narasimham was constituted by the Government of India in December 1997. The Committee submitted its report in April 1998. Some of the recommendations of the Committee, on prudential norms, Capital Adequacy Ratio, classification of Government guaranteed advances, provisioning requirements on standard advances and more disclosures in the Balance Sheets of banks were accepted and implemented. Recent major initiatives undertaken for strengthening the financial sector in pursuance to the recommendations of the above Committee relate to guidelines to banks on Asset-Liability Management and integrated risk management systems, compliance with Accounting Standards, consolidated accounting and supervision, fine-tuning of prudential norms for income recognition, asset classification and provisioning for NPAs, etc. The guidelines on setting-up of Off-shore Banking Units in Special Economic Zones, Fair Practices Code for Lenders, Corporate Governance, Anti-Money Laundering measures, Know Your Customer (KYC) norms, Corporate Debt Restructuring (CDR) derivatives, guidance notes on Credit Risk, Market Risk, Operational Risk, etc., are other important developments introduced in the banking sector in recent years. RBI has also issued revised guidelines on migration to the Basel II Framework on Capital Adequacy. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 has facilitated NPA management by banks more effectively.
In 1993, in recognition of the need to introduce greater competition, new private sector banks were allowed to be set up. Licenses were issued to 10 banks which had satisfied the necessary regulatory requirements. Subsequently, in 2001, fresh guidelines for setting up new private sectors were issued and two banks were issued a license under those guidelines. A draft comprehensive policy framework for ownership and governance in private sector banks was put in the public domain on 2 July 2004 for discussion and feedback. After taking into consideration the feedback received from all concerned and in consultation with the Government of India, RBI issued detailed Guidelines on ownership and governance in private sector banks on 28 February 2005. The underlying principles of the guidelines inter alia are to ensure that the all banks in the private sector have a net worth of 300 crore, ultimate ownership and control of private sector banks is well-diversified, important shareholders (i.e., the shareholding of 5 percent and above) conform to the ‘fit and proper’ criteria. The directors and the CEO who manage the affairs of the bank should also satisfy the ‘fit and proper’ criteria. The guidelines also provide for restrictions on cross-holding above 5 percent by one bank/Financial Institution (FI) in another bank/FI and observance of sound corporate governance principles.
On a review of corporate governance practices in Banks in 2007, RBI advised banks in the private sector to ensure that their Memorandum and Articles of Association conform to the above-mentioned stipulations. Banks in the private sector were also advised to split the posts of Chairman/MD/CEO and have a part-time Chairman of the Board of Directors and a separate Chief Executive Officer /Managing Director who would be responsible for day-to-day management/activities of the bank.
Reserve Bank of India issued guidelines on May 11, 2005, for merger/ amalgamation of private sector banks for consolidation in the banking sector. The guidelines are applicable where the merger takes place between two banking companies or between a banking company and a non-banking financial company.