When India woke up to independence in 1947, the banking system was never this vast, digitally efficient, financially inclusive network like it is today. It was small, urbanized, and built for a purpose which was never our own. It was built for the colonials, not for a country which was trying to industrialise, feed farmers, and bring millions out of poverty.

What has come up in these 75 years? It was nothing close to a linear growth curve, but a rollercoaster!

A wave of nationalisation, years of lending, painful periods of crisis, infinite boom and bust cycles and faulty credits which were at peak during the 2010s, and then finally a digital reassured system which has made Indian banking one of the most closely watched stories in the emerging financial markets. This article aims to look into the arc of the evolution of the Indian Banking system, which has not only grown traditionally but has also set the benchmark for digital payments.

At Independence, India’s formal banking system was thin and urbanised. The Reserve Bank of India (RBI)  had been functioning since April 1, 1935 as a privately-owned “shareholders bank” under the RBI Act, 1934. It was not yet a public institution, which it managed to become later (post-independence). Commercial banking was in itself dominated by a few major powerful players like the Imperial Bank of India, along with foreign “exchange banks” whose primary purpose was financing the export-import trade with Britain. It did not support the Indian households or farmers.

Three major features of the Indian banks before Independence:

1. Urban concentration: Bank branches were concentrated in the urban cities, which majorly had ports; Bombay, Madras, and Calcutta which served as the largest industrial houses for the trading firms.
2. Rural Credit Gap: The British Bank made sure that credit was given with the purpose of making profits, which made the agriculture workers and rural population (where most of the population resided in) devoid of the credit facility. To their rescue were the village money-lenders who filled the gap at exploitative rates, a problem which the colonials never solved.
3. Privitized: All banks in the country were working at a private level, without any interference of the government or any regulatory body monitoring their activities.

To sum, the banking system till 1947 was only for the elite business class of the urban areas, there was no access or awareness amongst the rural people towards the countryside.

Post-Independence

Independent India’s first task at hand was to bring the privatized system under the control of the government. The Reserve Bank of India Act, 1948 transferred its entire ownership to the government, under the RBI Act, 1948 which nationalised the RBI effect from January 1, 1949! RBI was now a fully government-owned central bank. This gave the state, for the first time, control over its monetary policy and currency issuance in line with the upcoming development goals of the country.

That same year, the Banking Regulation Act, 1949 gave RBI the real power! The power to govern the commercial banks, licensing powers, control over branch expansion, capital requirements, liquidity maintenance, authority to inspect and removal of top management. This was a direct action towards the failing, chaotic and untrusted banking sector in India.

The next major change came in 1955, when the government nationalised the Imperial Bank of India and merged it with several princely-state-associated banks to create the State Bank of India (SBI). These princely banks were now associate banks of RBI. The reason for the government controlled banks was the lack of ability of the private banks to reach rural and semi-rural areas, which could also be used as a tool for planning development. Along with SBI, India also built certain banks which were specialised for development. ICICI (1955) for industrial development and IDBI (1964) as an apex development bank to fill gaps that commercial banks were not addressing.

India’s Era of Social Control

By the 1960s, the government concluded that these reforms had not delivered as they were supposed to. Private commercial banks were still giving out loans largely towards industrial borrowers and urban centres, while agriculture, a small industry, and exports remained devoid of institutional credit.

On the night of 19 July, 1969, the government nationalized 14 major private banks (deposits of each exceeding Rs. 50 crore), which accounted for roughly 75-80% of the country’s bank deposits. Another round during 1980 got sex more banks under state ownership, taking the control of these banking businesses to roughly 91%. The rationale behind, in the language of 1969 ordinance, was “to better serve the needs of development of the economy in conformity with national policy objectives”.

This period produced a genuine, measurable expansion of the banks. People started gaining trust and depositing their money in banks. The Lead Scheme assigned individual public sector banks (PSBs) the responsibility for planning credit in specific districts, branch networks and giving out

loans to priority sectors which included agriculture, small scale industry and the weaker sections. For the first time, institutional credit became an option for the rural section of India.

The Cost of the Social Control:

But this model came with a heavy price tag that became increasingly visible through the 1970-80s. Reasons which possibly pushed the nation towards a financial crisis:

1. Direct lending without commercial discipline: Because branch expansion, credit targets, and interest rates were mostly given by the government policy rather than market signals, banks had little incentive to assess the risk of the borrowing properly.
2. Political inference in lending decisions: Loans were extended based on political reasons rather than the credit repayment ability, which created a culture of loan waivers and resulted in a situation of poor financial health of the banks.
3. Poor profitability and thin capital buffers: When the entire banking system was under the government, banks did not have the incentive to control their costs, reduce burden and create assets for themselves.

These structural weaknesses collided with India’s 1991 balance of payments crisis , when the country came close to defaulting on its external obligations and had to pledge gold reserves to secure an IMF loan. The fragility of the banking sector was no longer a side issue, but a macroeconomic emergency,

The Narasimham Committees analysis: Liberalized banking

The government’s response was the Committee on the Financial System, chaired by the former Governor M. Narasimham, constituted in August 1991 and submitted its report that December. Known as the Narasimham Committee-I, its recommendations reshaped the Indian Banking system. The recommendations were as follows:

1. Introduce income recognition, asset classification and provisioning (IRAC) norms. Fir the first time defining what counted as a non-performing asset, and forcing banks to set aside capital against bad loans.
2. Sharply reduce the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) both of which were extraordinarily high (38.5% and 15% respectively) which choaked banks ability to give out loans commercially.
3. Deregulate interest rates rather than have them fixed by the government.
4. Open the door to new-private-sector and foreign banks, ending the effective monopoly public sector banks had enjoyed since 1969.
5. Give banks greater operational autonomy.

Apart from this, a second Narasimham Committee in 1998 pushed further on capital requirement, technology, and governance. Together, these reforms prompted the entry of new

private banks including HDFC, ICICI, Axis which brought retail banking technology into more commercially disciplined culture which had been dominated by the government for the past three decades.

The rollercoaster of Non-Performing Assets: Three phases of the Last 30 years

The worst number captures of Indian Banking since the 1990s, was the gross NPA ratio, the share of total bank advances that have turned bad. A research done by Rakesh Mohan and Partha Ray at the Centre for Social and Economic Progress identifies a three-phase pattern:

Phase 1: The great clean-up (1992-93 to 2008-09): The time period where the Indian Banking sector performed its best. Guided by the Narasimham reform, and a period of high-GDP growth, banks became notably more conservative, built up capital and reduced the amount of bad loan ratios every single year. It is worth noting and Mohan and Ray make this point forcefully that this improvement happened despite India tightening its own definition of a bad loan (from a 180-day to a 90-day overdue norm in 2004), which should have made the number look worse, not better.

Phase 2 (2008-2018) is where the rollercoaster took its steepest drop. In the aftermath of the 2008 global financial crisis, the RBI and the government unleashed a large monetary and fiscal stimulus, and critically introduced “regulatory forbearance”, allowing banks to restructure stressed loans without downgrading their asset classification. This bought short-term breathing room but effectively hid the true scale of stress on bank balance sheets for years. Layered onto this were a sharp fall in global commodity prices (particularly steel), the collapse of several public-private-partnership infrastructure projects (in power, telecom, and roads) after cost overruns and regulatory reversals such as the 2012 cancellation of 2G telecom licences and coal-block allocations. When the RBI finally forced the banks to reveal their balance sheets in 2015 for a thorough Asset Quality Review (AQR), the true extent of hidden bad loans was exposed overnight, pushing NPA’s from public sector banks to a peak of 15.6% by March 2018.

Phase 3 (2018-2020) was the recovery driven by the Insolvency and Bankruptcy Code, 2016 (IBC), which for the first time gave India a time-bound legal mechanism to resolve corporate insolvency (cutting the average time to resolve a bankruptcy from 4.3 years in 2013 to 1.6 years by 2019 better than China or France), the Prompt Corrective Action (PCA) framework that restricted the operations of weak banks, and a wave public sector bank mergers that reduced the number of PSBs from 27 in 2017 to 12 by April 2020.

Major Setback Along the Way

No 75-year long journey can come without setbacks or roadblocks which hampered the growth of the journey:

1. The Twin Balance Sheet Problem (2011-2018). Simultaneously over-leveraged and stressed banks caused an issue: corporates couldn’t service debt and banks couldn’t recover it, neither could invest that amount in new growth.
2. The 2G Spectrum and coal-block cancellation (2012-2014). Judicial rulings cancelling licences that banks had financed left public sector banks holding large volumes to these under worthless exposures.
3. High-profile bank frauds. The 2018 Punjab National Bank Nirav-Modi fraud (roughly Rs. 14,000 crore) became the most visible symbol of weak internal controls and governance failures at public sector banks, part of a longer list of larger borrowers, several of which left the country.
4. The IL&FS (Infrastructure leasing & financial services) and NBFC crisis (2018-2019). The collapse of the infrastructure financier IL&FS triggered a liquidity shortage across India’s shadow banking (NBFC) sector, which had itself become deeply linked with bank balance sheets.
5. The Yes Bank collapse (2020). A private-sector bank failure, which was revived and rescued by the RBI via SBI-led joint-financing showed that governance failures were not confirmed to public sector banks alone.

Where the growth has delivered: Indian Banking System

Along with the shortcomings, the banks have also delivered genuine growth, creating a system of digital payments which is one of the strongest in the world. A comparison:

Just like economies, this sector also had a flip side. Even as the NPA crisis was unfolding in corporate lending books, the Jan-Dhan-Aadhaar-Mobile (JAM) trinity was building the most successful financial inclusion move in modern economic history. Later, UPI, a zero-cost, real-time payments method, is now studied in places, and is tried to be replicated by other developing economies.

The Way forward of the Indian Banking System

1. Indian banking’s next phase should shift from reacting to crises to preventing them. This means moving past the public-versus-private ownership debate toward incentivising good governance wherever it exists, building real-time credit monitoring so stress is taken care of early on rather than hidden for a prolonged period of time and letting the credit ecosystem mature with faster NCLT timelines.
2. Deepen the corporate bond market which would reduce the burden of banks’ financing long term infrastructure.
3. Digital lending and fintech need smarter regulation that protects consumers without stifling innovation.
4. Financial inclusion must evolve from account-opening to actual usage of savings, insurance and credit.
5. And with the energy transition under-way, banks should build climate-risk frameworks now, before stressed green-transition assets become the next crisis.