Indian Financial System

The Indian Financial System plays a vital role in the Indian Economy. It has several components that are explained in detail in this article.

In India, there are primarily two types of financial institutions: Banks and Non-Banking Financial Institutions (NBFIs).

The main distinction between a bank and an NBFI is that banks accept demand deposits, whereas NBFIs do not. Banks issue Cheques, however, NBFIs are not permitted to do so.

Also read: Nidhi Company

Indian Financial System

Under the Indian Financial System, there are two types of banks: commercial and cooperative banks.

While cooperative banks function on cooperative principles like serving their members and the community/society, commercial banks operate according to commercial (profit) principles.

Compared to commercial banks, cooperative banks offer a higher rate of interest on deposits.

Also read: Financialization of Indian Economy

Commercial Banks

There are two types of commercial banks: scheduled commercial banks and non-scheduled commercial banks.

A bank is referred to as a scheduled bank because it is listed in the second schedule of the RBI Act of 1934.

Other requirements for a scheduled bank include corporate status and a minimum paid-up share capital of 500 crores of rupees.

On the other hand, limited operations may be performed by a non-scheduled bank; for instance, non-scheduled banks are not permitted to transact in foreign exchange.

According to the Banking Regulation Act of 1949, non-scheduled banks must maintain reserve requirements but may not be with the RBI and according to the RBI Act of 1934, Scheduled Banks must maintain reserve requirements with the RBI.

For Commercial Banks, a license from RBI is required to

• To commence banking operations
• Opening of a New Bank Branch
• Closing of an existing Branch
• Change in location of existing branch

Read: Banking Laws Amendment Bill 2024

Scheduled Commercial Banks

Scheduled commercial banks are divided into:

Public Sector Banks

Banks where the government owns more than 51% of the bank, either at the central or state level.

For example, SBI and its affiliates, Punjab National Bank, Bank of India, etc.

Government ownership of more than 51%, which were private banks earlier that the government took over in 1969 and the 1980s during bank nationalization, makes them part of the public sector.

Private Sector Banks

Banks that are privately held, such as ICICI Bank, Axis Bank, etc.

Foreign Banks

Banks that are established in India but are owned by a foreign firm or entities, like Citi Bank. These are essentially private banks with foreign ownership.

Regional Rural Banks (RRB)

Under the provisions of the Regional Rural Banks Act of 1976, Regional Rural Banks were created in 1975 with the goal of boosting the rural economy by offering loans and other facilities, particularly to small and marginal farmers, agricultural laborers, artisans, and small businesses owners, for the growth of agriculture, trade, commerce, industry, and other productive activities in rural areas.

• RRBs are held by the Central government, the concerned State government, and the sponsor bank in the proportion of 50:15:35.
• Each RRB is sponsored by a particular bank.
• RRBs need to provide 75% of the lending to priority sectors. RRBs are under the supervision of NABARD.

Payment Banks

In August 2015, RBI approved licenses to 11 applicants as Payment Banks. The RBI has set a limit of Rs. 1 lakh on the amount of deposits that payment banks may accept from one customer. Only businesses that are really committed to serving the underprivileged and poor will be able to apply for a payment bank.

Therefore, migrant workers, independent contractors, low-income households, etc. will be the main target of payment banks.

Payment banks are not allowed to lend money or issue credit cards. Payment banks will only accept demand deposits i.e., only current and savings account options will be offered.

Small Finance Banks

• The RBI awarded licenses to numerous applications for Small Finance Banks in September 2015, which is a step toward advancing financial inclusion.
• The small finance banks will largely engage in basic banking activities, such as accepting deposits and lending to underserved and unserved groups, such as unorganized sector entities, small business units, small and marginal farmers, and micro and small businesses.
• There won’t be any limitations on the area of operation of small financing institutions.
• The small finance banks must lend 75% of their total credit to sectors that the RBI has designated as priority sectors for lending (PSL).
• Its lending portfolio should consist of at least 50% loans and advances under Rs. 25 lakhs.

A Government of India Scheme announced in 1996 led to the establishment of Local Area Banks (LAB). The purpose of establishing local area banks was to make it possible for local institutions to mobilize rural savings and make them available for investments in the local regions.

Also read: Microfinance Institutions

Cooperative Banks

Under the Indian Financial System, Urban Co-operative Banks (UCB) and Rural Co-operative Banks are the two subcategories of cooperative banks. UCBs come under the supervision of RBI.

Urban Co-operative Banks

Urban Co-operative Banks, also known as Primary Co-operative Banks, are found in urban and semi-urban regions. They essentially made loans to small enterprises and borrowers. They now have a far wider range of operations.

UCBs are further classified into Scheduled and Non-scheduled categories, which are then further divided into single-state and multi-state.

Single State UCBs are governed by the Registrar of Cooperative Societies (RCS) of the state concerned and are registered as cooperative societies under the State Government Cooperative Societies Act.

Multi-State UCBs are governed by the Central Registrar of Cooperative Societies (CRCS) and are registered as cooperative societies under the requirements of the Multi-State Cooperative Societies Act of 2002.

Rural Cooperative Banks

India’s rural cooperative credit system is primarily responsible for ensuring credit flow to the agricultural sector. Both short-term and long-term cooperative credit systems are included in it.

State Cooperative Banks (StCBs) at the state level, (District) Central Cooperative Banks (DCCBs) at the district level and Primary Agricultural Credit Societies (PACS) at the village level make up the three-tier system that governs the short-term cooperative credit framework.

Long-term cooperative credit systems include the State Cooperative Agriculture and Rural Development Bank (SCARDB) and the Primary Cooperative Agricultural and Rural Development Bank (PCARDB).

About Non-Banking Financial Institutions (NBFIs)

Under the Indian Financial System, the Non-Banking Financial Institutions (NBFIs) industry is a key sector that is governed and regulated by the RBI.

All India Financial Institutions (AIFIs), Non-Banking Financial Companies (NBFCs), and Primary Dealers (PDs) fall under NBFIs in the Indian Financial System.

Credit Information Companies (CIC) are also a category of non-banking financial institutions that are subject to RBI regulation.

All India Financial Institutions (AIFIs)

AIFIs are an institutional mechanism entrusted with providing sector-specific long-term financing. Currently, the RBI regulates and supervises several AIFIs, also known as Development Financial Institutions (DFIs). Such AIF institutions are mentioned below.

a) NABARD

By the National Bank for Agriculture and Rural Development Act of 1981, NABARD was established in 1982.

NABARD offers credit to promote rural areas’ linked economic activities, including small-scale enterprises, cottage industries, handicrafts, and rural crafts.

NABARD oversees and coordinates the activities of rural credit institutions like RRBs and Rural Cooperative Banks (RBI has delegated its supervisory powers in the case of the rural sector to NABARD while retaining its regulatory powers)

When it comes to issues of rural development, NABARD offers help to the government, RBI, and other organizations.

provides training and research facilities for banks, cooperatives, and organizations in areas related to rural development.

Although it does not offer direct credit to specific individuals, it does offer indirect financial help through refinancing (NABARD finances the organizations that offer financial assistance to the rural sector). Institutions that are approved by the central government may receive direct financing from NABARD.

b) National Housing Bank (NHB)

Under the National Housing Bank Act of 1987, NHB was founded in 1988. The main purpose of NHB’s operations is to assist and promote housing finance institutions through financial and other means at both the local and regional levels.

Although it does not provide direct credit to individuals, it does provide indirect financial help through refinancing (i.e. NHB finances those institutions that provide finance to individual borrowers, builders, etc.)

c) EXIM bank

The Export-Import Bank of India Act of 1981 led to the establishment of the EXIM bank in 1982.

The goal of the EXIM bank is to help exporters and importers with financial support and serve as the main financial institution for coordinating the operations of institutions engaged in financing the export and import of products and services to promote the nation’s international trade.

It offers direct financial support to exporters and importers as well as indirect support through refinancing.

d) Small Industries Development Bank of India (SIDBI)

Under the provisions of the Small Industries Development of India Act 1989, SIDBI was established in 1990.

SIDBI serves as the primary financial institution for the development, financing, and promotion of the Micro, Small, and Medium-Sized Enterprise (MSME) sector as well as for coordination of the operations of the institutions involved in related activities.

SIDBI primarily provides banking institutions with indirect financial support (via refinancing) to enable them to continue lending to MSMEs.

e) MUDRA Bank

The Government of India established MUDRA (Micro Units Development and Refinance Agency Ltd.) as a financial organization for the development and refinancing of micro-unit firms.

Under the Indian Financial System, a Non-Banking Finance Company named MUDRA Ltd has been established as a subsidiary of SIDBI.

The goal of MUDRA is to provide funding to the non-corporate (informal sector) small business sector, including small manufacturing units, store owners, fruit and vegetable vendors, hair salons, and craftsmen in both rural and urban areas with financial requirements up to Rs. 10 lakhs.

There are three different types of MUDRA loans. Loans up to Rs. 50,000 are available for small businesses under the “Shishu” category; loans beyond Rs. 50,000 and up to Rs. 5 lakhs are available under the “Kishor” category, and loans between Rs. 5 lakhs and Rs. 10 lakhs are available under the “Tarun” category.

Non-Banking Financial Companies (NBFCs)

Non-Banking Financial Companies (NBFCs), commonly referred to as Non-Banking Financial Institutions (NBFIs), are organizations that offer some financial services that resemble those offered by banks but do not have a banking license.

Under the Indian Financial System, a non-banking financial company (NBFC) is a company registered under the Companies Act of 1956 that engages in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by the government or a local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, and chit business.

It excludes institutions whose main line of business is that of agriculture activity, industrial activity, and the purchase or sale of immovable property.

According to the RBI Act of 1934, no NBFC may operate without a certificate of registration from RBI. However, certain kinds of NBFCs that are subject to regulation by other agencies are free from the requirement of registration with the RBI, for example:

• Venture Capital Funds, Merchant Banking Institutions, and Stock broking companies registered with SEBI.
• Insurance Company with a current Certificate of Registration by IRDA.
• Chit firms, as outlined in the 1982 Chit Funds Act and governed by the respective State governments.

Micro Financial Institutions (MFIs) are also a type of NBFC, however, the amount of credit they can extend is restricted. The upper limit is Rs. 1.25 lakh for those living in rural areas, and Rs. 2 lakhs for those in urban and semi-urban areas.

Primary Dealers (PDs)

The RBI has granted primary dealers the right to buy and sell government securities. They are organizations that have registered with the RBI. As RBI releases these government securities on behalf of the government, PDs purchase them directly from the government in the primary market to resell them to other customers in the secondary market. As a result, they are essential in developing the primary and secondary markets for government securities.

Peer to Peer (P2P) Lender

Under the Indian Financial System, P2P intermediaries are a new class of NBFCs that offer a platform that connects independent lenders and borrowers. P2P lending allows borrowers to borrow money from private investors who are willing to lend their own funds at an agreed interest rate. Social lending or crowd lending are other names for peer-to-peer lending.

There are limits on how much a lender can lend (up to a total of Rs. 50 lakhs), how much a borrower can borrow, and for how long they can borrow it (limit on period).

• serve as an intermediary by offering a platform or online market to those taking part in peer-to-peer lending;
• not raise deposits and not end on its own
• not offer any sort of credit guarantee
• conduct a thorough investigation of the participants;
• carry out risk profiling and credit assessment of the borrowers and disclose the information to potential lenders;
• require the participant’s prior consent before accessing their credit information;
• provide aid with loan disbursement and repayment of the amount;

Credit Information Companies (CIC)

A CIC is an autonomous company that enlists banks, NBFCs, and financial institutions as members. From these members, the CIC collects data and identifying information for specific customers and companies. Based on a prospective borrower’s past payment history, CICS can tell banks whether or not he is creditworthy. The level of information determines how well lenders can assess risk and how easily consumers can get loans at affordable rates.

By the Credit Information Companies (Regulation) Act of 2005, the RBI regulates and issues licenses to CICs. TransUnion Credit Information Bureau of India Limited (CIBIL), Equifax, Experian, and High Mark Credit Information Services are the four CICS currently operating in India.

Article Written By: Priti Raj