Overview of India financial system

By Vipin Agnihotri

Financial intermediation in the organized sector of India is conducted by a wide array of institutions functioning under the overall surveillance of the Reserve Bank of India (RBI).

Reserve Bank of India-

The Reserve Bank of India as the central banking authority is at the apex of the Indian financial system. Established in 1935, it became a government owned institution from 1949 under the Reserve Bank Act of 1948. Under this Act, the Indian government is empowered to issue directions to RBI, after consulting with RBI’s governor.

RBI performs the following traditional functions of the central banking authority:

• It formulates and implements monetary and credit policies

• It functions as the banker’s bank

• It manages the liquidity reserves of the credit institutions and supervises their operations

• It plays an important role in maintaining the exchange value of the rupee

• It controls payments and receipts for international trade and regulates other foreign exchange transactions.

In addition to the traditional functions of the central banking authority, RBI performs number of functions aimed at developing the Indian financial system.

• It seeks to integrate the unorganized financial sector with the organized financial sector

• It encourages the extension of the commercial banking system in the rural areas

• It influences the allocation of credit

• It supports innovation in cooperative banks

• It promotes the development of new institutions (for example, it set up the Unit Trust of India, the Industrial Development Bank of India and the National bank for Agriculture and Rural development)

Commercial banks-

After RBI, commercial banks represent the most important institutions in the financial system of India. Public sector commercial banks dominate the commercial banking scene in the country. The changes in banking structure and controls in the last few years have resulted in

• Wider geographical spread and deeper penetration of rural areas

• Higher mobilization of deposits

• Reallocation of bank credit policy to priority activities

• Lower operational autonomy for bank management

One of the major activities of the commercial banks is to provide working capital advance to industry. “In recent years, RBI has been monitoring closely the credit extended by commercial banks to industry, which traditionally relied heavily on commercial banks and were the primary beneficiaries of the banking system,” pointed out Shalabh Saxena, business journalist based at India.

Number of committees – the Dehejia Committee, the Tandon Committee has been set up to look into the problem of working capital credit and make suggestions. The major recommendations of these committees have been two fold: reduction in bank credit to industry and inculcation of a greater sense of financial discipline in industrial borrowers. By and large, RBI has accepted the recommendations of these committees.

A major problem faced by commercial banks in India is that their profitability is low. This is largely because of over staffing, inefficient procedures, subsidized lending to the priority sector and high incidence of bad debts.