Role of Indian Banks and the Reserve Bank in the Development Process for RBI Grade B ESI
Last updated: 2026-11-11 · MockMentor
"Role of Indian banks and Reserve Bank in the development process" is a syllabus line written for an exam that recruits officers of the central bank. It asks how banks and RBI have shaped India's development: by spreading branches to villages, directing credit to farmers and small firms, building development institutions, and now by driving financial inclusion and digital payments. This chapter covers the history of Indian banking, its developmental role, the institutions built for development, the bad loan cycle, and RBI's role beyond monetary policy.
In one line: in India, banks and RBI have been tools of development as well as finance, spreading credit to sectors and people that markets neglected, and the challenge today is to keep that reach while keeping banks safe and efficient.
Basic concepts
- Scheduled commercial bank: a bank included in the Second Schedule of the RBI Act, 1934, eligible to borrow from RBI and bound by its regulations.
- Financial inclusion: access for all individuals and businesses, especially the poor, to affordable financial services: savings, credit, insurance, pensions and payments.
- Development Finance Institution (DFI): a specialised institution that provides long-term finance for sectors such as industry, agriculture, housing and infrastructure, where commercial banks are reluctant to lend.
- Non-Performing Asset (NPA): a loan on which interest or principal has remained overdue for more than 90 days.
- Priority Sector Lending (PSL): the requirement that banks direct a fixed share of their credit to sectors such as agriculture, small enterprises, education and housing.
- Business correspondent: an agent (a shopkeeper, a self-help group member or a retired official) who provides basic banking services on behalf of a bank in places without a branch.
Why in News?
- On its 12th anniversary in August 2026, the Pradhan Mantri Jan Dhan Yojana had over 59 crore accounts with deposits of about ₹3.17 lakh crore.
- RBI's Financial Stability Report of June 2026 put the gross NPA ratio of scheduled commercial banks at 1.8% at the end of March 2026, a multi-decade low, against a peak of over 11% in March 2018.
- The Union Budget 2026-27 announced a High Level Committee on Banking for Viksit Bharat to review the banking sector for India's next phase of growth.
How Indian banking evolved
| Phase | Key events |
|---|---|
| Before 1947 | Bank of Hindustan (1770), the Presidency Banks of Bengal, Bombay and Madras, merged into the Imperial Bank of India in 1921; Allahabad Bank (1865) and Punjab National Bank (1894) among the first Indian-run banks; RBI set up in 1935. Frequent bank failures. |
| 1947 to 1969 | Banking Regulation Act, 1949; RBI nationalised (1949); the Imperial Bank became the State Bank of India (1955) on the recommendation of the All India Rural Credit Survey Committee (A.D. Gorwala). Banks mostly lent to industry and trade in cities. |
| 1969 to 1991 | Nationalisation of 14 major banks (1969) and 6 more (1980); lead bank scheme (1969); priority sector targets; Regional Rural Banks (1975); NABARD (1982). Massive branch expansion into rural areas. |
| 1991 to 2014 | Narasimham Committee reforms; new private banks from 1994; prudential norms; Basel capital standards; technology and core banking. |
| 2014 onwards | Jan Dhan accounts; payments banks and small finance banks (2015 to 2016); the Insolvency and Bankruptcy Code (2016); recapitalisation and the merger of public sector banks (10 banks merged into 4 in 2020); UPI and digital banking. |
Why banks were nationalised
On 19 July 1969, the government nationalised 14 banks with deposits above ₹50 crore. Six more were nationalised in 1980. The stated reasons were:
- Banks were controlled by large business houses and lent mainly to their own firms.
- Agriculture, small industry and exports received little credit.
- Rural areas had very few branches.
- The government wanted to direct savings to plan priorities.
Results
| Achievements | Problems that followed |
|---|---|
| Bank branches rose from about 8,000 in 1969 to over 60,000 by 1991, most of the new ones in rural and semi-urban areas | Directed lending and interest rate controls reduced profitability |
| Rural savings mobilised into the formal system | Loan waivers and political pressure hurt credit discipline |
| Credit to agriculture and small industry rose sharply | Low productivity, overstaffing and weak technology |
| Moneylenders' share of rural debt fell | Rising bad loans by the late 1980s |
The developmental role of banks
1. Mobilising savings
Banks collect small savings from millions of households and turn them into loans for investment, raising the saving and investment rates of the economy.
2. Directing credit to priority sectors
Under PSL rules, domestic banks must lend 40% of their Adjusted Net Bank Credit to priority sectors, including 18% to agriculture and 7.5% to micro enterprises. Regional Rural Banks have a target of 75%. Our chapter on monetary policy explains the categories and Priority Sector Lending Certificates.
3. Lead bank scheme
Introduced in 1969 on the Gadgil Study Group's recommendation and the Nariman Committee's advice, the scheme gives one bank in each district the lead role in coordinating credit planning with the government and other banks, through a District Consultative Committee and an annual credit plan.
4. Credit for small firms and the self-employed
| Scheme | What it does |
|---|---|
| Pradhan Mantri MUDRA Yojana (2015) | Collateral-free loans to micro businesses in four categories: Shishu (up to ₹50,000), Kishore (up to ₹5 lakh), Tarun (up to ₹10 lakh) and Tarun Plus (up to ₹20 lakh, added in 2024) |
| Stand-Up India (2016) | Loans of ₹10 lakh to ₹1 crore to women and Scheduled Caste and Scheduled Tribe entrepreneurs |
| Credit Guarantee Fund Trust for Micro and Small Enterprises | Guarantees that let banks lend without collateral |
| PM SVANidhi (2020) | Small working capital loans to street vendors |
5. Financial inclusion
| Step | Detail |
|---|---|
| Self-help group (SHG) bank linkage (1992) | Pioneered by NABARD; groups of 10 to 20 women save together and borrow from banks |
| No-frills accounts (2005) and business correspondents (2006) | Basic accounts with low or no minimum balance; agents to serve villages |
| Pradhan Mantri Jan Dhan Yojana (2014) | Universal bank accounts with a RuPay debit card, accident insurance and an overdraft facility; over 59 crore accounts by August 2026 |
| Social security schemes (2015) | PM Jeevan Jyoti Bima Yojana (life cover), PM Suraksha Bima Yojana (accident cover) and Atal Pension Yojana |
| Payments banks and small finance banks (2015 to 2016) | New types of banks for small savers, migrant workers and small borrowers |
| Direct Benefit Transfer | Subsidies and welfare payments sent directly to Jan Dhan accounts linked to Aadhaar |
| National Strategy for Financial Inclusion 2019-24 and RBI's Financial Inclusion Index | A plan and a measure (on a scale of 0 to 100) of access, use and quality |
6. Digital payments
The Unified Payments Interface (UPI), launched by the National Payments Corporation of India (NPCI) in 2016, handled over 24,162 crore transactions worth more than ₹314 lakh crore in 2025-26. Digital payments have brought millions of small merchants and customers into the formal system and created a record of transactions that can support lending.
Development Finance Institutions
| Institution | Year | Role |
|---|---|---|
| Industrial Finance Corporation of India (IFCI) | 1948 | First DFI; long-term loans to industry |
| Industrial Credit and Investment Corporation of India (ICICI) | 1955 | Industrial finance; converted into a commercial bank in 2002 |
| Industrial Development Bank of India (IDBI) | 1964 | Apex industrial DFI; became a bank in 2004 |
| National Bank for Agriculture and Rural Development (NABARD) | 1982 | Apex body for rural credit; refinance, Rural Infrastructure Development Fund, supervision of RRBs and cooperative banks |
| Export-Import Bank of India (EXIM Bank) | 1982 | Finance for exports and imports and lines of credit to other countries |
| National Housing Bank (NHB) | 1988 | Refinance for housing finance |
| Small Industries Development Bank of India (SIDBI) | 1990 | Finance and development of micro, small and medium enterprises |
| National Bank for Financing Infrastructure and Development (NaBFID) | 2021 | A new DFI for long-term infrastructure finance |
After 1991, the large industrial DFIs lost access to cheap funds and most became commercial banks. This left a gap in long-term finance that banks tried to fill, especially for infrastructure, contributing to the bad loan crisis. NaBFID was set up to fill this gap again.
The bad loan cycle and the clean-up
From 2008 to 2014, banks, especially public sector banks, lent heavily to infrastructure, power, steel and telecom projects. Many projects stalled because of delays in land, environment clearances and fuel supply, and because of the slowdown after 2011. RBI's Asset Quality Review of 2015 forced banks to recognise these loans as NPAs. The gross NPA ratio of scheduled commercial banks peaked at over 11% in March 2018.
The government and RBI responded with what became known as the 4R strategy:
- Recognition: the Asset Quality Review and strict classification norms.
- Resolution: the Insolvency and Bankruptcy Code (2016) and new rules for restructuring.
- Recapitalisation: over ₹3 lakh crore of government capital in public sector banks.
- Reforms: governance changes, the Bank Board Bureau, Prompt Corrective Action for weak banks and the merger of public sector banks.
By March 2026, the gross NPA ratio had fallen to 1.8%, and banks were well capitalised and profitable.
RBI's role in development
Beyond monetary policy, RBI has played a direct role in building India's financial system:
- Building institutions: RBI set up or helped set up the Agricultural Refinance Corporation (later part of NABARD), the Unit Trust of India (1964), IDBI, the Deposit Insurance and Credit Guarantee Corporation (DICGC), NABARD, the National Housing Bank, the Clearing Corporation of India and NPCI.
- Rural credit: the All India Rural Credit Survey (1954) shaped decades of policy on cooperative and rural credit.
- Directed credit: the priority sector framework, the lead bank scheme and interest subvention for farmers.
- Financial inclusion: licensing small finance and payments banks, business correspondent rules, and the Financial Inclusion Index.
- Payment systems: the Payment and Settlement Systems Act (2007), Real Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT), and support for UPI.
- Consumer protection: the Integrated Ombudsman Scheme (2021) and digital lending rules (2022).
- Financial literacy: financial literacy centres, Financial Literacy Week and the National Centre for Financial Education with other regulators.
- Innovation: the regulatory sandbox, the digital rupee (Central Bank Digital Currency pilots from 2022) and the Unified Lending Interface.
Challenges
- Public sector banks still hold a large share of deposits but have lower valuations and higher costs than private banks.
- Credit to small firms remains short of their needs, and collateral requirements exclude many.
- Many Jan Dhan accounts are little used, and access to credit and insurance has grown more slowly than access to accounts.
- Rapid growth of unsecured personal loans and microfinance has raised stress in some segments.
- Digital fraud and cyber risks are growing.
- Long-term infrastructure finance still depends heavily on banks.
Way forward
- Strengthen the governance and autonomy of public sector banks, and consider further consolidation or privatisation as recommended in earlier reviews.
- Use data from UPI, GST and account aggregators for cash-flow based lending to small firms.
- Deepen the bond market and DFIs for long-term finance.
- Move from access to use: credit, insurance and pensions for Jan Dhan account holders.
- Expand financial literacy and strong protection against fraud and mis-selling.
- Build climate risk into bank lending and supervision, and finance the green transition.
Possible exam and interview questions
- Evaluate the role of bank nationalisation in India's development. Is there still a case for public sector banks? (420 words)
- Discuss the role of RBI in the development process of India beyond its function as a monetary authority. (620 words)
- What is financial inclusion? Assess the success of the Pradhan Mantri Jan Dhan Yojana.
- Explain the causes of the bad loan crisis in Indian banks and the steps taken to resolve it.
- Interview: Should priority sector lending targets be continued in a market economy?
Related reading: money and financial markets, monetary policy, and our RBI Grade B Phase 2 Finance guide.
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