Banking System and Financial Inclusion in India Notes for UPSC

Banks are the heart of the economy. They collect the savings of the people and lend them for production, trade and consumption. A strong banking system supports growth, and an inclusive banking system brings the poor into the formal economy. In the UPSC Civil Services Examination, the banking system and financial inclusion is a part of the Indian Economy syllabus: Prelims asks about the structure of banks, NPAs, Basel norms and schemes like Jan Dhan and Mudra, while Mains asks about banking reforms, the NPA crisis and the challenges of financial inclusion. This note explains the Indian banking structure, key terms, reforms and financial inclusion schemes in simple language, with tables.

Structure of the Indian Banking System

The Reserve Bank of India (RBI) is at the top as the regulator and banker's bank. Below it are the following groups.

The Imperial Bank of India was converted into the State Bank of India in 1955. In 1969, the government nationalised 14 major banks, and in 1980, 6 more. The aim was to expand branches in rural areas, support priority sectors and reduce the concentration of credit. In 1991, the economic reforms (the Narasimham Committee recommendations) opened the sector to private banks, reduced the SLR and CRR, gave freedom in interest rates and introduced prudential norms. In 2019 and 2020, several public sector banks were merged, bringing their number down from 27 to 12.

Key Concepts in Banking

Non-Performing Asset (NPA): a loan on which interest or principal remains unpaid for more than 90 days. NPAs are classified as sub-standard (NPA for up to 12 months), doubtful (more than 12 months) and loss assets (that cannot be recovered). High NPAs reduce the profit of banks and their ability to lend. Capital Adequacy Ratio (CAR): the minimum capital that a bank must keep compared with its risk-weighted assets. Under the Basel III norms, the minimum CAR in India is 9 percent, plus a capital conservation buffer of 2.5 percent. Priority Sector Lending (PSL): banks must lend 40 percent of their credit to priority sectors such as agriculture, micro and small enterprises, education, housing and weaker sections. Deposit insurance: the DICGC (a subsidiary of the RBI) insures the deposits of each depositor in a bank up to 5 lakh rupees. Core Banking Solution (CBS) allows customers to operate their account from any branch.

NPA Crisis and the Reforms

Between 2012 and 2018, the NPAs of Indian banks rose sharply, particularly in public sector banks, because of the loans given to infrastructure, steel, power and other sectors during the boom, delays in projects, falling commodity prices, willful defaults and weak recovery. To deal with this, the government and the RBI adopted a series of measures, which are also called the "4Rs": recognition, resolution, recapitalisation and reforms.

• Insolvency and Bankruptcy Code (IBC), 2016: a time-bound process for resolving the insolvency of companies by creditors, with the National Company Law Tribunal (NCLT) and the Insolvency and Bankruptcy Board of India.
• SARFAESI Act, 2002: allows banks to take possession of the secured assets of defaulters without going to court, and set up Asset Reconstruction Companies (ARCs).
• Asset Quality Review (2015) and stricter recognition of stressed assets; Prompt Corrective Action (PCA) framework for weak banks.
• Recapitalisation of public sector banks by the government, and mergers to create stronger banks.
• Indradhanush plan (2015) for the revival of the public sector banks, with the Bank Board Bureau and the EASE reforms.
• National Asset Reconstruction Company Ltd (NARCL), known as the "bad bank", was set up in 2021 to take over large stressed assets.

As a result, gross NPAs have fallen to multi-year lows in recent years, and banks have become more profitable, though vigilance is still needed.

What Is Financial Inclusion?

Financial inclusion means making sure that all sections of society, especially the poor and the rural people, have access to basic financial services such as bank accounts, savings, credit, insurance, pensions and payments at an affordable cost. It reduces dependence on moneylenders, encourages savings, supports small businesses and helps the government deliver benefits directly. The Rangarajan Committee on Financial Inclusion (2008) and the National Strategy for Financial Inclusion (2019-2024) guide the policy. The RBI's Financial Inclusion Index measures the progress.

Major Financial Inclusion Schemes

The JAM trinity (Jan Dhan, Aadhaar and Mobile) made direct benefit transfers possible. Banking correspondents and the India Post Payments Bank take banking to the doorstep, while the Unified Payments Interface (UPI) has brought digital payments to the common man. The Account Aggregator framework allows safe sharing of financial data with consent, and the e-RUPEE (CBDC) is in the pilot phase.

Challenges

Despite great progress in opening accounts, many accounts remain inactive or have a low balance, so "access" has not always become "use". Other issues are the lack of financial literacy, poor connectivity in remote areas, gender gaps in account use, the high cost of serving small customers, rising cyber fraud, dependence on informal credit in rural areas, and the misuse of the digital platforms for fraud. Banks also face pressure from loan waivers, political interference in lending and the need to recover loans.

Way Forward

The way ahead includes more focus on the use of accounts and not just their opening, financial literacy campaigns, strong grievance redress and consumer protection, women-focused schemes, support to small businesses through credit guarantee schemes, the use of technology with strong cyber security, better governance and autonomy for public sector banks, and caution in the use of non-banking financial services. Linking bank accounts with micro-insurance and pensions is a key step towards social security for the poor.

Digital Banking and Fintech: The New Frontier

Technology has changed banking faster than any reform. A decade ago, a villager had to travel to a branch to open an account or send money. Today, with a mobile phone and Aadhaar, she can open an account, receive a subsidy and pay a shopkeeper in seconds. UPI has become the world's largest real-time payment system by volume, and fintech companies offer micro-loans, insurance and investment services on apps. Account aggregators allow loans based on cash flow rather than only collateral. These developments widen inclusion and reduce costs, but they bring new risks: fraud, loss of data, digital exclusion of the elderly and those without phones, and the danger of unregulated lending apps. The RBI has therefore issued rules on digital lending and customer protection, and it has asked banks to keep human and offline options. For the Mains, mention both the promise and the caution when you discuss digital finance and inclusion.

Quick Revision

• Nationalisation: 1969 (14 banks) and 1980 (6 banks); RRBs: 1975; Small finance and payments banks: from 2015.
• NPA: overdue more than 90 days; IBC 2016; SARFAESI 2002; NARCL in 2021; Basel III CAR 9 percent plus buffer.
• Jan Dhan (2014), PMJJBY, PMSBY, APY, Mudra (Shishu, Kishor, Tarun), Stand-Up India.
• DICGC insures deposits up to 5 lakh rupees; PSL target is 40 percent.

The banking system links money with development. Learn the structure, the terms and the schemes, connect them with current news on mergers, NPAs and digital payments, and you will find this chapter to be very scoring.

Related Notes to Read Next

Continue your preparation with these related notes from the same subject:

• Agriculture Economy Notes for UPSC
• External Sector: Balance of Payments, Forex Reserves
• Planning in India: Five-Year Plans to NITI Aayog Notes for UPSC
• All Indian Economy notes

Frequently Asked Questions (FAQ)

What is an NPA?

A Non-Performing Asset is a loan on which the principal or interest has remained unpaid for more than 90 days.

When were banks nationalised in India?

Fourteen major banks were nationalised in 1969 and six more banks were nationalised in 1980.

What are Regional Rural Banks?

Regional Rural Banks were set up in 1975 to provide credit to small farmers, artisans and rural workers, and are owned jointly by the Centre, State and a sponsor bank.

What is a payments bank?

A payments bank accepts deposits within a limit and provides payment services, but it cannot give loans. Examples include India Post Payments Bank.

What is the Insolvency and Bankruptcy Code?

The IBC, 2016 is a law that provides a time-bound process for resolving insolvency of companies and individuals, helping banks to recover their dues.

What is the SARFAESI Act?

The SARFAESI Act, 2002 allows banks to take possession of the secured assets of defaulting borrowers without court intervention.

What is the Basel III?

Basel III is an international set of banking regulations that requires banks to hold more and better quality capital and manage liquidity and risk.

What is priority sector lending?

Priority sector lending requires banks to give a fixed share of their loans, currently 40 percent, to sectors such as agriculture, small enterprises, housing and education.

What is financial inclusion?

Financial inclusion means providing access to affordable banking, credit, insurance, pension and payment services to all sections of society, especially the poor.

What is Pradhan Mantri Jan Dhan Yojana?

PMJDY, launched in August 2014, provides zero-balance bank accounts with a RuPay card and insurance cover to every household.

What is the Mudra Yojana?

The Pradhan Mantri Mudra Yojana gives collateral-free loans to micro and small businesses under the categories Shishu, Kishor and Tarun.

What is the deposit insurance cover in India?

The DICGC insures bank deposits up to 5 lakh rupees per depositor per bank.