Get Even More Visitors To Your Blog, Upgrade To A Business Listing >>

The long road to an Indian banking union

The Banking Regulation Act, 1949, gave the Reserve Bank of India (RBI) supreme powers to license and inspect banks. Photo: Abhijit Bhatlekar/Mint

In European economics, every discussion is about some manner of union. It started with coal and steel (sharing common resources), then it was customs (one border) and finally monetary (one currency). After the 2008 financial crisis, there were demands for a fiscal union (one tax policy). The common objective behind all of these is to transfer powers from nations to a central European body.

The ongoing European banking crisis has led to a demand for a Banking Union too, with a similar objective. This is trickier, given the different levels of non-performing assets (NPAs) amidst members ranging from 45.3% in Greece to 1.7% in Germany. A banking union would have three pillars: single supervisory mechanism (SSM), single resolution mechanism (SRM) and European deposit insurance scheme (EDIS). Of these, the first two are already in place. The SSM enables a single authority to supervise all European banks and SRM helps in resolution in case of failure.

Currently, the focus is on the third pillar, which will provide an equal level of depositor protection across members, boosting the confidence of small depositors. Here, the scope becomes more complex, given that different member states already have their own deposit insurance schemes.

This discussion about a banking union has some interesting lessons for monetary and financial historians. One can apply these ideas from Europe to study the evolution of monetary and banking systems in other countries as well.

Take the case of India. Pre-1861, India had “free banking” as seen in other countries where banks could issue their own currency notes. In 1861, the British implemented one currency across the country, forming the so-called monetary union. Thus, post-1861, banking became “relatively free”, where banks could not issue their own notes, but anyone could still open banks without any restrictions on capital, ownership or branching. This led to British mercantile houses opening their “banking departments” and other industrialists/traders starting banks that also engaged in real activity. Apart from commercial banks, exchange banks, cooperative banks and indigenous banks were also established.

Banking was even freer in some of the princely states. First, we saw a spate of princely states opening their own banks; in its history volume (1951-67), the Reserve Bank of India (RBI) counts 54 of them. Just like British India, the banks differed when it came to ownership. In some instances, the states held entire/majority share. Other banks were private. There was the unique case of the Gwalior-based Krishna Ram Baldeo Bank, which was a private bank owned by the ruler. The banks also differed on operations, with the State Bank of Hyderabad issuing its own currency (Osmania state rupee which had an exchange rate with the Indian rupee), and others offering treasury services. The incorporation rules differed with some banks opened via an Act (Baroda) and others by mere fiat of the ruler (Patiala and Dungarpur).

After the establishment of RBI in 1935, efforts towards a so-called Indian banking union began. RBI defined a bank for the first time as a “company which carries on as its principal business the accepting of deposits of money on current account or otherwise, subject to withdrawal by cheque, draft or order”. Only companies doing this business could use the terms “bank”, “banker” or “banking” and minimum capital and reserves were kept at ₹ 50,000. There was a ban on a managing agency system owning a bank.

Just after the RBI’s formation, a major bank—Travancore and Quilon Bank—failed in the princely state of Travancore. The RBI was found wanting in banking supervision given the differences in banking systems across the country. A need was felt for a comprehensive banking legislation, but it was delayed due to World War II and India winning independence. Just as is seen in Europe today, in India too there was a need to have a common set of banking regulations.

The Banking Regulation Act was finally enacted in 1949, giving RBI supreme powers to license and inspect banks. The scope of banking was expanded in the definition, minimum capital and reserves for banks were increased to ₹ 5 lakh and a statutory liquidity ratio was imposed. Seven of the princely state banks were made associates of the State Bank of India whereas the rest merged, liquidated or continued as private commercial banks.

Amidst all these developments, banks continued to fail in large numbers. In 1913-34, 1935-48 and 1948-60, the number of banks that failed were 341 (average number of failures per year; 16), 869 (62) and 415 (35), respectively. Thus, it was not enough to standardize the banking code; other options also needed to be considered.

The US had implemented a deposit insurance scheme in 1934 to address its large-scale banking failures. Taking a cue, by the late 1940s, Indian policymakers started discussing the need for deposit insurance. The plan got delayed as consolidation was given preference over insurance. Finally, the closure of Palai Central Bank in Kerala led to the advent of the Deposit Insurance Corporation (DIC) in 1962. This in itself led to chaos as cooperative banks were not covered under the scheme. The RBI had no powers to regulate cooperative banks, and it was only after changes in the Banking Regulation Act, 1949, that cooperatives were included in DIC in 1968.

The path to the Indian banking union was, demonstrably, not linear. New fixes were constantly needed in response to ongoing banking challenges. We still do not have a resolution framework. However, if there is anything Europe can learn from India (and others), it is that a banking union will never be complete. It will always be a work in progress, with banking troubles surfacing from time to time, calling for new institutional fixes and revisiting old ones.

Amol Agrawal teaches at Ahmedabad University and blogs at mostlyeconomics.wordpress.com

Comments are welcome at [email protected]



via LiveMint

The post The long road to an Indian banking union appeared first on CommentWise.



This post first appeared on CommentWise, please read the originial post: here

Share the post

The long road to an Indian banking union

×

Subscribe to Commentwise

Get updates delivered right to your inbox!

Thank you for your subscription

×