Banking System in India: Structure, History, Laws and Challenges for RBI Grade B Finance
Last updated: 2026-11-13 · MockMentor
"Banking System in India: Structure and Developments" is a core line of the Financial System unit in the RBI Grade B Phase 2 Finance syllabus. Banks hold the largest share of India's financial assets, carry out monetary policy and fund most of the economy, so questions on them appear every year: the types of banks, the provisions of the banking laws, the modes of creating a charge on security, and the challenges facing public sector banks. This chapter covers the history, structure, functions and legal framework of Indian banking. Recent reforms are covered in a separate chapter on banking reforms and developments.
In one line: India has a bank-dominated financial system led by scheduled commercial banks (public, private, foreign, small finance, payments and regional rural banks) and cooperative banks, all regulated by RBI under the RBI Act, 1934 and the Banking Regulation Act, 1949.
Basic concepts
- Bank: under Section 5(b) of the Banking Regulation Act, 1949, banking means accepting deposits of money from the public for lending or investment, which are repayable on demand or otherwise and can be withdrawn by cheque, draft or order.
- Scheduled bank: a bank listed in the Second Schedule of the RBI Act, 1934. It must have paid-up capital and reserves of at least ₹5 lakh and satisfy RBI that its affairs are not run against depositors' interests. Scheduled banks can borrow from RBI and must keep CRR with it.
- Net Demand and Time Liabilities (NDTL): a bank's deposits and other liabilities to the public and other banks, after netting interbank items. CRR and SLR are calculated on NDTL.
- CASA ratio: the share of current and savings account deposits in total deposits. A higher CASA ratio means cheaper funds for the bank.
- Net Interest Margin (NIM): the difference between interest earned and interest paid, as a share of earning assets.
- Non-performing asset (NPA): a loan on which interest or principal has been overdue for more than 90 days.
Why in News?
- The Banking Laws (Amendment) Act, 2025 allowed up to four nominees for a bank account, raised the "substantial interest" limit for directors from ₹5 lakh to ₹2 crore and extended the maximum tenure of directors of cooperative banks from 8 to 10 years. The nomination provisions came into force on 1 November 2025.
- Under the "One State, One RRB" policy, the number of regional rural banks fell from 43 to 28 with effect from 1 May 2025.
- RBI's final rules on expected credit loss (ECL) provisioning and on the revised Basel III standardised approach for credit risk will apply to banks from 1 April 2027.
- The gross NPA ratio of scheduled commercial banks has stayed around a multi-year low, reflecting a decade-long clean-up of bank balance sheets.
History of banking in India
Early and colonial period
Indigenous bankers such as shroffs, mahajans and chettiars lent money and dealt in hundis (bills of exchange) for centuries. Modern banking began with agency houses in the late eighteenth century.
| Year | Development |
|---|---|
| 1770 | Bank of Hindostan, the first bank on modern lines, set up in Calcutta (failed in 1832) |
| 1806, 1840, 1843 | The three Presidency Banks: Bank of Bengal, Bank of Bombay and Bank of Madras |
| 1865 | Allahabad Bank, the oldest joint stock bank, set up |
| 1894 | Punjab National Bank, the first bank fully managed by Indians |
| 1921 | Presidency Banks merged into the Imperial Bank of India |
| 1935 | RBI started operations |
| 1949 | Banking Regulation Act passed; RBI nationalised |
| 1955 | Imperial Bank became the State Bank of India (SBI), on the advice of the All India Rural Credit Survey Committee (A. D. Gorwala) |
After independence
| Year | Development |
|---|---|
| 1959 | Eight state-associated banks became subsidiaries of SBI |
| 1969 | Nationalisation of 14 banks with deposits above ₹50 crore |
| 1975 | Regional Rural Banks set up, on the advice of the Narasimham Working Group |
| 1980 | Nationalisation of 6 more banks with deposits above ₹200 crore |
| 1991 and 1998 | Narasimham Committee reports on the financial system and banking sector reforms |
| 1993 to 1994 | New private sector banks licensed, such as HDFC Bank, ICICI Bank and Axis Bank (then UTI Bank) |
| 2015 to 2016 | Payments banks and small finance banks licensed |
| 2017 | SBI merged its associate banks and Bharatiya Mahila Bank with itself |
| 2019 to 2020 | Big mergers of public sector banks; their number fell from 27 to 12 |
Structure of the Indian banking system
Scheduled and non-scheduled banks
All banks in India are either scheduled or non-scheduled. Nearly the entire banking business is with scheduled banks.
| Category | Types |
|---|---|
| Scheduled commercial banks | Public sector banks, private sector banks, foreign banks, regional rural banks, small finance banks, payments banks |
| Scheduled cooperative banks | Scheduled urban cooperative banks, state cooperative banks |
| Non-scheduled banks | Local area banks, many smaller urban cooperative banks, district central cooperative banks |
Commercial banks
| Type | Features |
|---|---|
| Public sector banks (PSBs) | The government holds more than 50%. There are 12: SBI, Bank of Baroda, Punjab National Bank, Canara Bank, Union Bank of India, Bank of India, Indian Bank, Central Bank of India, Indian Overseas Bank, UCO Bank, Bank of Maharashtra and Punjab & Sind Bank |
| Private sector banks | Owned mainly by private shareholders; include old private banks (before 1993) and new private banks (licensed after 1993) |
| Foreign banks | Banks incorporated abroad operating through branches or a wholly owned subsidiary in India, such as SBM Bank (India) and DBS Bank India, which are subsidiaries |
| Regional rural banks (RRBs) | Set up under the Regional Rural Banks Act, 1976 to lend in rural areas; owned by the central government (50%), sponsor bank (35%) and state government (15%) |
| Small finance banks (SFBs) | Licensed from 2015 to serve small units and the unbanked; must lend 60% of adjusted net bank credit to the priority sector (75% until 2024-25), and half of their loans must be of up to ₹25 lakh |
| Payments banks | Licensed from 2015; can take deposits of up to ₹2 lakh per customer and offer payments and remittances, but cannot lend |
Public sector banks were created by nationalisation under the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980, and SBI by the SBI Act, 1955. They are not companies under the Companies Act, which is why their governance rules differ from those of private banks.
Cooperative banks
Cooperative banks are owned by their members and work on the principle of "one member, one vote".
| Tier | Institution |
|---|---|
| Urban | Urban Cooperative Banks (UCBs), which serve small businesses and households in towns |
| Rural short-term (three tier) | State Cooperative Bank at the top, District Central Cooperative Banks in the middle, and Primary Agricultural Credit Societies (PACS) at the village level |
| Rural long-term | State and primary cooperative agriculture and rural development banks |
Cooperative banks are registered under state Cooperative Societies Acts or the Multi-State Cooperative Societies Act, 2002. Their banking functions are regulated by RBI, while their registration and elections fall under the Registrar of Cooperative Societies. NABARD supervises state and district cooperative banks and RRBs.
Other bank types
- Local area banks: small private banks allowed from 1996 to operate in three contiguous districts. Only a few survive, and RBI stopped licensing them.
- Universal banks: banks offering a wide range of services, including commercial banking, investment banking and insurance distribution, usually through subsidiaries.
- Development banks: institutions that give long-term finance, now covered in the chapter on development financial institutions.
Basic banking terms
| Term | Meaning |
|---|---|
| Demand deposits | Repayable on demand: current and savings deposits |
| Time deposits | Fixed and recurring deposits repayable after a fixed period |
| Retail banking | Banking for individuals: deposits, home and personal loans, cards |
| Wholesale or corporate banking | Services for large firms and institutions |
| Branch banking | A bank works through many branches under one head office, as in India |
| Unit banking | Each bank has a single office, as was common in the United States |
| Relationship banking | Banks build long-term ties with customers, selling many products to each |
| Narrow banking | Banks invest deposits only in very safe assets such as government securities |
| Bancassurance | Banks sell insurance products of insurance companies to their customers |
Functions of banks
Primary functions
- Accepting deposits: current, savings, fixed and recurring deposits.
- Lending: cash credit, overdrafts, term loans, demand loans and the discounting of bills.
- Credit creation: when a bank lends, it creates a new deposit. Because only part of deposits is kept as reserves, the banking system as a whole can expand money by a multiple of new reserves, called the money multiplier.
Secondary functions
- Agency functions: collecting cheques, paying bills, insurance premiums and taxes, buying and selling securities for customers, acting as trustee or executor.
- Utility functions: issuing letters of credit and bank guarantees, lockers, foreign exchange, remittances, debit and credit cards, and digital banking.
Types of loans and advances
| Type | Meaning |
|---|---|
| Cash credit | A borrower can draw up to a limit against stock or receivables; interest is paid only on the amount used |
| Overdraft | Permission to withdraw more than the balance in a current account, up to a limit |
| Term loan | A loan for a fixed period, usually to buy fixed assets, repaid in instalments |
| Bill discounting | The bank pays the value of a bill before it is due, after deducting a discount |
| Letter of credit (LC) | The bank undertakes to pay a seller if the buyer's documents meet the terms; common in trade |
| Bank guarantee | The bank promises to pay a third party if its customer fails to perform an obligation |
Securities for bank loans and modes of creating a charge
Banks protect themselves by taking security. The way a bank gets rights over a security is called creating a charge.
| Mode | Asset | How it works |
|---|---|---|
| Pledge | Movable goods, gold, shares | The borrower hands over possession of goods to the bank, which can sell them on default after notice (Section 172, Indian Contract Act, 1872) |
| Hypothecation | Movable goods such as vehicles, stock or machinery | The goods remain with the borrower, but the bank has a charge on them and can take possession on default |
| Mortgage | Immovable property such as land and buildings | Transfer of an interest in property to secure a loan (Section 58, Transfer of Property Act, 1882); types include simple, English, usufructuary and equitable mortgage (by deposit of title deeds) |
| Assignment | Book debts, insurance policies, receivables | The borrower transfers a right to receive money to the bank |
| Lien | Goods or securities already in the bank's possession | The right to retain property until a debt is paid; a banker's lien is a general lien over all securities of a customer |
| Set-off | Deposits of the same customer | The right of a bank to adjust a customer's credit balance against a debt owed by the same customer |
Secured lenders can enforce their security without a court order under the SARFAESI Act, 2002 (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act), for loans above a limit. The Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI) records charges, to prevent the same asset being pledged to many lenders.
Banking laws
RBI Act, 1934
The RBI Act sets up RBI, gives it the sole right to issue notes, provides for CRR (Section 42), the Second Schedule of scheduled banks, regulation of NBFCs (Chapter III-B) and the Monetary Policy Committee (Chapter III-F).
Banking Regulation Act, 1949
| Section | Subject |
|---|---|
| Section 5 | Definitions of banking and banking company |
| Section 6 | Forms of business a bank may carry on |
| Section 10A, 10B | Board composition and chairman of a bank |
| Section 12 | Capital structure and voting rights |
| Section 18 and 24 | Cash reserve for non-scheduled banks and the Statutory Liquidity Ratio |
| Section 20 | Restrictions on loans to directors and their relatives |
| Section 22 | Licensing of banks by RBI |
| Section 23 | Opening of new branches |
| Section 35 | Inspection by RBI |
| Section 35A | RBI's power to give directions |
| Section 35AA and 35AB | Directions to start insolvency proceedings against defaulters (added in 2017) |
| Section 36 | Further powers and functions of RBI, including removal of directors |
| Section 45 | Moratorium and amalgamation of a bank |
The Act applies to cooperative banks through Section 56, which was widened in 2020 to give RBI more powers over their management, capital and audit.
Banking Laws (Amendment) Act, 2025
| Change | Detail |
|---|---|
| Nominees | Up to four nominees for deposits, lockers and safe custody articles, either all at once (in set shares) or one after another |
| Substantial interest | Threshold raised from ₹5 lakh, fixed in 1968, to ₹2 crore |
| Cooperative banks | Maximum tenure of directors raised from 8 to 10 years; a central cooperative bank director may sit on the board of the state cooperative bank |
| Reporting | Banks report for each fortnight ending on the 15th and the last day of a month, instead of alternate Fridays |
| Unclaimed amounts | Unclaimed dividends, shares and bond interest can move to the Investor Education and Protection Fund |
| Audit | Public sector banks may decide the pay of their statutory auditors |
Other important laws
- Negotiable Instruments Act, 1881: cheques, bills of exchange and promissory notes; Section 138 makes cheque bouncing a criminal offence.
- Recovery of Debts and Bankruptcy Act, 1993: Debt Recovery Tribunals.
- SARFAESI Act, 2002: enforcement of security and asset reconstruction companies.
- Insolvency and Bankruptcy Code, 2016: time-bound resolution of insolvent companies.
- Prevention of Money Laundering Act, 2002: KYC and reporting of suspicious transactions.
- Deposit Insurance and Credit Guarantee Corporation Act, 1961: deposit insurance of up to ₹5 lakh per depositor per bank, with payment within 90 days if a bank is placed under restrictions.
Banker and customer relationship
The relationship between a bank and its customer changes with the service.
| Relationship | When it applies |
|---|---|
| Debtor and creditor | When a customer deposits money, the bank is the debtor and the customer the creditor; when the bank lends, the roles reverse |
| Trustee and beneficiary | When the bank holds money or securities for a specific purpose |
| Agent and principal | When the bank collects cheques, pays bills or buys securities for the customer |
| Bailee and bailor | When the customer keeps valuables in safe custody |
| Lessor and lessee | In safe deposit locker services |
Duties and rights of a banker
- Duty of secrecy: a bank must keep customers' information confidential, except when required by law, in the public interest, for the bank's own protection or with the customer's consent.
- Duty to honour cheques: if there are sufficient funds and the cheque is in order.
- Right of general lien: to retain securities of the customer until debts are paid.
- Right of set-off: to adjust a credit balance against a debt of the same customer.
- Right to charge interest and fees.
- Right of appropriation: to decide how a payment is applied when the customer does not specify.
Garnishee order
A garnishee order is a court order directing a bank to hold, and later pay to a creditor, the money in a customer's account to satisfy a debt. The bank must stop payments from the account to the extent of the order.
Types of accounts and KYC
| Account | Features |
|---|---|
| Savings account | For individuals; interest paid; limits on some withdrawals |
| Current account | For businesses; no interest; unlimited transactions; overdraft facility possible |
| Fixed deposit | A sum kept for a fixed period at a fixed rate; premature withdrawal allowed with a penalty |
| Recurring deposit | A fixed amount deposited every month for a set period |
| Basic Savings Bank Deposit Account (BSBDA) | Zero minimum balance account with basic services, as under Jan Dhan |
| Small account | Opened with simplified KYC, with limits on balance and transactions |
| NRI accounts | NRE, NRO and FCNR-B accounts for non-residents |
Know Your Customer (KYC) rules under the Prevention of Money Laundering Act and RBI's master direction require banks to verify each customer's identity and address, assess their risk and update KYC periodically: every two years for high-risk, eight years for medium-risk and ten years for low-risk customers. Officially valid documents include the passport, driving licence, voter ID card, Aadhaar (with consent) and the job card issued under the rural employment guarantee scheme.
Negotiable instruments
| Instrument | Meaning |
|---|---|
| Promissory note | A written unconditional promise by one person to pay a sum to another (Section 4, Negotiable Instruments Act) |
| Bill of exchange | A written unconditional order by one person directing another to pay a sum to a third person (Section 5) |
| Cheque | A bill of exchange drawn on a specified bank and payable on demand (Section 6); includes electronic cheques and truncated cheque images |
Crossing of cheques
| Type | Effect |
|---|---|
| Open (uncrossed) cheque | Can be paid in cash at the counter |
| General crossing (two parallel lines) | Must be paid into a bank account, not in cash |
| Special crossing (bank's name between the lines) | Can be paid only through the named bank |
| Account payee crossing | Must be credited only to the payee's account |
| Not negotiable crossing | The holder cannot get a better title than the person who gave it |
A cheque is valid for three months from its date. A post-dated cheque cannot be paid before its date, and a stale cheque (over three months old) will not be paid. Dishonour of a cheque for lack of funds is an offence under Section 138, with up to two years' imprisonment or a fine of up to twice the amount.
Endorsement
An endorsement is the signature of the holder on the back of an instrument to transfer it. It can be blank (only a signature, making it payable to the bearer), full or special (naming the new payee), restrictive (limiting further transfer) or conditional.
Priority sector lending
Priority sector lending (PSL) directs a share of bank credit to sectors that may not get enough loans on commercial terms.
| Category | Target for domestic commercial banks (share of adjusted net bank credit) |
|---|---|
| Total priority sector | 40% |
| Agriculture | 18%, of which 10% for small and marginal farmers |
| Micro enterprises | 7.5% |
| Weaker sections | 12% |
Regional rural banks have a higher total target of 75% of adjusted net bank credit. Small finance banks have a target of 60%, reduced from 75% from 2025-26, and urban cooperative banks also have a target of 60%. Eligible categories include agriculture, MSMEs, export credit, education, housing (within limits), social infrastructure, renewable energy and others.
Banks that fall short must deposit the shortfall in funds such as the Rural Infrastructure Development Fund with NABARD at low interest. They can also meet targets by buying Priority Sector Lending Certificates (PSLCs) on RBI's e-Kuber platform from banks that have surplus priority sector loans, which lets each bank specialise in what it does best.
How banks earn money
| Income | Source |
|---|---|
| Net interest income | Interest earned on loans and investments minus interest paid on deposits and borrowings; the largest source |
| Fee income | Processing fees, card fees, commissions on third-party products such as insurance and mutual funds, remittance and locker charges |
| Treasury income | Gains on trading in bonds, foreign exchange and derivatives |
| Recoveries | Amounts recovered from written-off loans |
Expenses include staff costs, technology, rent and provisions for bad loans. A bank's return on assets of about 1% and above, and return on equity of 15% and above, are generally seen as healthy.
Number and reach of banks
India's scheduled commercial banks run well over 1.5 lakh branches, and a large network of ATMs and business correspondents. The share of branches in rural and semi-urban areas has risen since nationalisation, and RBI's branch authorisation policy requires banks to open at least 25% of new banking outlets each year in unbanked rural centres. Public sector banks still hold the largest share of deposits and loans, but private banks have grown much faster in the last two decades and now hold a share close to that of public sector banks in credit.
Performance of Indian banks
After a decade of stress and repair, Indian banks are in their best shape in many years. Gross NPAs, which peaked above 11% of advances in March 2018, are around 2% to 2.5%. Capital ratios are well above the regulatory minimum, and public sector banks have returned to strong profits, paying dividends to the government. Credit growth was in the high teens in 2023 and 2024, cooled after RBI's tightening of risk weights on unsecured loans, and has since moved with economic activity. Deposit growth has lagged credit growth at times, as households moved savings to mutual funds and markets.
Challenges in the Indian banking system
- Deposit mobilisation: low-cost deposits are harder to attract, and the credit-deposit ratio of several banks is high, which pushes up funding costs.
- Asset quality risks: unsecured personal loans, credit cards and microfinance have shown stress, even as corporate loans look healthy.
- Governance of public sector banks: government ownership limits flexibility in pay, hiring and strategy, and boards are not always independent.
- Frauds and cyber risk: digital frauds have grown with the shift to online banking.
- Competition from fintech and NBFCs, which offer faster service in payments and small loans.
- Low credit penetration in many states and among small businesses.
- Weak cooperative banks: several urban cooperative banks have failed because of poor governance and connected lending.
- Climate risk: loans to sectors exposed to climate change and to the energy transition may face losses.
- Skills and technology: banks need data, risk and cyber skills that are scarce.
Way forward
- Strengthen the deposit base through better products, digital outreach and competitive rates.
- Give public sector bank boards more autonomy, as the P. J. Nayak Committee (2014) suggested, through a holding company or reduced government stake.
- Improve risk management through the ECL framework, stress testing and early warning systems.
- Expand credit to MSMEs using cash-flow data from GST and the Account Aggregator framework.
- Consolidate and professionalise cooperative banks, with umbrella organisations and stricter fit and proper rules.
- Invest in cyber security and fraud prevention, and protect customers.
Possible exam and interview questions
- Explain the structure of the Indian banking system. How has it changed since bank nationalisation in 1969? (620 words)
- Distinguish between pledge, hypothecation and mortgage with examples. Which is most common for vehicle loans and why? (420 words)
- What are the main provisions of the Banking Laws (Amendment) Act, 2025?
- Why have payments banks struggled to become profitable, while small finance banks have grown?
- Interview: Should the government reduce its stake in public sector banks below 51%?
Related reading: banking reforms and recent developments, functions of RBI, and banks and RBI in the development process.
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