15th Finance Commission

15th Finance Commission

This article deals with ‘National Incomes.’ This article is part of our series on ‘Economics’ which is an important pillar of the GS-3. For more articles, you can click here.


15th Finance Commission came up with two reports due to the sudden creation of the Union Territory of Jammu and Kashmir and Ladakh as more time was required to analyse the impact of these developments.

  • 1st Report: Recommendations from 1/April 2020 to 31/ March/2021
  • 2nd Report: Recommendations from 1/April/2021 to 31/March/2026

Composition of 15th Finance Commission

It consists of 5 members, including the Chairman (according to the provisions of the Indian Constitution)

NK Singh Chairman
Shantikanta Das (Member) RBI Governor
Dr. Anoop Singh (Member) Professor
Dr. Ashok Lahiri  (Member) Senior Executive of Bandhan Bank
Prof. Ramesh Chand (Member) Agriculture Economist

Terms of Reference of 15th Finance Commission

Terms of Reference for all Finance Commissions mentioned in the Indian Constitution are as follows.

  1. Distribution of the net proceeds of the divisible pool of taxes to be shared between Centre and states (Vertical Distribution), and the allocation between states (Horizontal Distribution) 
  2. Principles that should govern the grants-in-aid to the states by the Centre.
  3. Measures needed to augment the consolidated fund of a state to supplement the resources of Panchayats and municipalities. 
  4. Any other matter referred to it by the President in the interests of sound finance.
  5. Constitution also allows Finance Commission to make broader recommendations in the interests of sound finance. 

President referred the following additional matters. 

  1. For population, use data of Census of 2011 instead of Census of 1971.
  2. Keep New India 2022 vision in mind (i.e. Smart City, Swachh Bharat Scheme etc.).
  3. Keep Union’s Defence and Internal Security responsibilities in mind.
  4. Recommend whether Union should continue to give Revenue Deficit Grants or not along with the additional conditions that Union can impose on states while borrowing from external sources.
  5. Finance Commission should propose performance-based incentives (PBI) in areas such as
    • Steps taken by particular state towards expanding and deepening GST.
    • Steps taken to achieve population replacement rate.
    • Improvement in ease of doing business.
    • Sanitation
    • Reign in populist measures 
    • Promoting savings through the adoption of direct benefit transfers.
    • Promoting a digital economy.

States are apprehensive on the additional terms of references

Issue 1: Using 2011 census for population

  • 14th Finance Commission had used both Census of 1971 and 2011 for horizontal distribution of taxes among states. 17% weightage was given to the 1971 population, and 10% weightage was given to the 2011 population.
  • But 15th Finance Commission was ordered to use the Census data of 2011 only. Hence, the Southern States and states like Punjab who have reduced their fertility rate between 1971 to 2011, are bound to lose some share in favour of states like UP, Bihar, etc. who have performed worse in reducing their fertility rate. Therefore, Commission is punishing the states for performing better in the initiative started on the directions of the Union government to reduce population growth in the 1970s-80s.

Counter Argument: 12.5% weightage is also given to demographic performance to appreciate the work of states that have performed well to reduce the Total Fertility Rate in their states (shown below)

Issue 2: Issues with keeping New India-2022 vision in mind

  • States are apprehensive that this can reduce the percentage of devolved funds to states.
  • Along with that, another apprehension is that Local Governments will get more grants with tied objectives. Hence, their independence and the ability to start area-specific schemes will be curtailed.

Issue 3: Issues with keeping Union’s defence responsibilities in mind

  • This will also reduce the share of the state’s in the devolved funds as defence is the Union’s responsibility.
  • In the final report, the 15th Finance Commission has reduced the vertical distribution to 41% (i.e. 1% less than 14th Finance Commission), keeping Jammu and Kashmir’s security concerns in mind.

Issue 4: Debt and Grants

  • 15th Finance Commission will examine whether revenue deficit grants given to the states should be abolished.
  • Article 293: States can’t borrow without consent of the Union. Terms of Reference includes suggestion on additional conditions that Union could impose on the states when states borrow from external sources?  States fear that this will reduce their autonomy in raising loans from the market.

Issue 5: Issues with performance-based incentives

States are apprehensive about them because

  • Small states like Mizoram, Manipur etc., due to their geographical constraints, can’t deepen their GST tax net in the same way as can be done by states like Punjab, Haryana or Maharashtra. 
  • Northern states are apprehensive that due to higher Fertility rates, they will lose money.
  • The southern States have apprehensions that they will have to stop their populist schemes like Amma Canteens (Tamil Nadu).

Recommendations of 15th Finance Commission

1. Vertical Devolution

All the money collected by the Union government through direct and indirect taxes is shared by the Union government with the states on the formula suggested by the Finance Commission, which is to be constituted by the President every five years (under the provisions of Article 280 of Indian Constitution).

Such arrangement has been made because

  • Taxation powers of State governments are low. 
  • The Union government collects all the important direct taxes like Income and corporate taxes.

Previous Finance Commissions have suggested the following percentage of Union Government’s devisable taxes to be shared with states.

15th Finance Commission

Presently, the 15th Finance Commission has recommended that for the financial year 2020-21, Union should share 41% of devisable taxes with the states.

15th Finance  Commission

Why 15th Finance Commission reduced the percentage of taxes to be devolved?

15th Finance Commission headed by NK Singh believed that, because of the creation of new Union Territories of Jammu and Kashmir and Ladakh, Union’s responsibilities have increased.

2. Horizontal Devolution

  • Horizontal devolution means how to distribute the devolved taxes horizontally between the individual States.
  • 15th Finance Commission considered the following criteria to divide the devolved taxes between the states.
    • 45% weightage to Income distance (states with lesser per capita GSDP (Gross State Domestic Product), i.e. poorer states will get more share)
    • 15% weightage to the area (states with more area will get more share)
    • 15% weightage to the population as per 2011 census (more population means more share)
    • 12.5% weightage to demographic performance (states that have reduced Total Fertility Rate will get more share)
    • 10% weightage to forest and ecology (states with more area under forest will get more share)
    • 2.5% weightage to tax efforts (States who have improved their per capita (State) tax collection in the last three years will get more share).
  • After doing calculations based on the above formula, the final list is as follows
Rank State %age
1 UP 17.93%
2 Bihar 10.06%
3 MP 7.89%
—- —– —–
6 Rajasthan 5.979%
—– —– —–
16 Kerala 1.943%
17 Punjab 1.788%
—- —- —-
26 Mizoram 0.51%
27 Sikkim 0.39%
28 (last) Goa 0.39%
Note Any Union Territory 0%

3. Grants from Union to States

Apart from the tax devolution, Finance Commission also suggest Union to give some grants to the states. These grants are as follows:-

3.1 Grants to Local Bodies

  • Union Government should give ₹4.36Lcr  for 2021-26 to local bodies.

3.2 Post devolution Revenue Deficit Grant

Some states like Andhra Pradesh and Punjab, which have revenue deficits even after devolved taxes from the Union, will get this grant to cover that deficit. Union government will give ₹ 2.94 lakh crore to such states in the form of Revenue Deficit Grants.

There are 14 such states eligible for this: Assam, Himachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Uttarakhand, Andhra, Kerala, Punjab, Tamil Nadu, West Bengal.


3.3 Special Grants

  • If any state receives less money than earlier getting under 14th Finance Commission, it will be compensated through Special Grants.
  • Under the 15th Finance Commission, there are three such states, i.e. Telangana, Karnataka and Mizoram. 

3.4 Disaster Management Grants

Under Disaster Management Act 2005, four funds have been created (two at the union level and two at the state level, respectively). 15th Finance Commissions recommendations have been explained in the infographic given below.

Disaster Management Grant

3.5 Sector-Specific Grants

  • 15th Finance Commission has recommended special grants for seven sectors mentioned in its Terms of Reference, i.e. health, pre-primary education, judiciary, rural connectivity, railways, statistics and housing. 
  • For example, 
    1. Health Sector has been given 1.06 lakh crore for upgrading the PHCs, building new hospitals, training doctors and healthcare workers. 
    2. State-specific grants of ₹ 49599 cr have been allocated for developing tourism, historical monuments, infrastructure, water etc.
    3. ₹ 2.38 lakh crore has been given to the Union for Defense and Internal Security Fund.
    4. ₹45,000 crores have been allocated for the implementation of agricultural reforms.
    5. ₹27,000 crores have been allocated to maintain Pradhan Mantri Gram Sadak Yojana (PMGSY) roads.
    6. ₹10,000 crores have been allocated for the judiciary to set up infrastructure to settle the property cases pending for five years or more, civil cases of marginalized people, POSCO cases (child sex abuse) & heinous crimes. 
    7. ₹6,000 crores have been allocated for developing online learning and translating medical engineering courses in regional languages.

3.6 Performance-based Incentives

  • Finance Commission will also propose performance-based incentives (PBI) in areas such as
    1. Efforts made by the states in expansion and deepening of the tax net under GST.
    2. Efforts and progress made in moving towards replacement rate of population growth.
    3. Improvement in ease of doing business.
    4. Sanitation 
    5. Reign in populist measures.
    6. Promoting savings through adoption of direct benefit transfers.
    7. Boosting a digital economy; etc.
  • If States perform well in the above areas, they will get more money in grants.
  • 15th Finance Commission hasn’t decided the amount yet.

4. Other Recommendations by Finance Commission

  • Government should reform the direct tax system to increase tax collection.
  • Government should review the outcomes of all Government schemes and abolish non-essential schemes.
  • Government should follow FRBM Act in letter and spirit. It should avoid off-budget borrowings through para-statal entities.
  • Union and State Government should together spend 2.5% of their GDP on Healthcare sector by 2025.
  • Form All India Medical and Health Service as 4th All India Service and IAS, IPS and IFS.
  • Some States have requested special category status. But Finance Commission has refrained from commenting on this matter as it wasn’t part of their Terms of Reference.

Digital Banking

Digital Banking

This article deals with ‘Digital Banking / Cashless Economy.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

More Cash in Circulation

  • India uses too much cash for transactions . Ratio of Cash to GDP is one of the highest in the world
    • India = 12.4% (2014)
    • Whereas – China = 9.4% or Brazil =  4%

Pros and Cons of Cashless Economy

Pros of Cashless Economy

  • It will be very difficult to evade taxes as all transactions can be tracked in cashless economy . Money laundering, black money and terrorist financing can be easily controlled .
  • No fear of physical theft : In Sweden , where 50%  transactions have gone cashless robberies have fallen to 30 years low because people don’t have any cash with them .
  • Cash transactions in small denominations can happen easily  . One can pay even single paisa (or cent)  .
  • No issue of counterfeit currency and wearing and tearing of currency notes  .
  • Working fine in Sweden & Norway where 50% transactions have gone cashless.
  • Ratan Watal Committee (in December2016) quoted that the dependency on cash costs the country about ₹1 Lakh crore on account of cost of printing new currency, operating currency chests, maintaining supply to ATM networks etc.
  • If small vendors start to take payment via digital means in Bank Accounts, their credit history will develop and he can use this to get credit from institutional lenders .

Cons of Cashless Economy

  • Extreme Surveillance – every payment you make will be traceable. The power this would hand banks & governments is enormous and the potential scope for Orwellian levels of surveillance is terrifying.
  • It can lead to exclusion of segments of the population who are slow to embrace new technologies especially the elderly.
  • Problem of electronic frauds increases  and whole system can be hacked .
  • Cashlessness may produce a peculiar human problem as people are sentimental about coins and notes.
  • For payment to happen cashlessly , infrastructure is required at point of sale destinations which small business cant afford.
  • Costs of digital payment, ultimately, are borne by consumers even when they are charged from producers or vendors. Charges can range from 0.1 per cent to as much as 4 per cent of the value of the transaction.

International Examples

In Kenya, M-PESA in partnership with Vodafone’s local operator Safaricom has ushered Cashless Revolution.

Digital Banking

Problems in adoption of Digital Payment in India

As seen by Chandrababu Naidu Committee & Ratan Watal Committee , problems associated with Digital Payment in India are

1 . Lesser Points of Sale

  • India has 160 ATMs per million (UK = 1000 / million) .
  • India has 1000 Point of Sale (PoS) per million (UK = 30,000 / million) .

2. MDR Issue

  • MDR = Merchant Discount Rate
  • Banks charge  around 2% from Merchant for providing Cashless Payment Services. Due to this , profit margin of merchants decrease . This restrict adoption of digital payment by Merchants .

3. KYC norms for Point of Sale Devices

  • Vendors cant buy Point of Sale devices as they don’t have any permanent address .

4. Interoperability

  • There is no interoperability between different payment systems (Eg : PayTM to FreeCharge) and also between different Financial Institutions (Eg: SBI to PayTM) .

5. Regulatory Problems

  • Banking Ombudsman doesn’t have required powers  to deal with Internet Banking Frauds.
  • IT Act is not comprehensive enough to deal with such financial frauds.

6. Government doesn’t act as Role Model

  • Although government is promoting Cashless economy but one cant pay taxes via mobile wallets like PayTM and bidding fees for various e-Tenders is to be paid in Cash (only)  . Hence, government doesn’t act as role-model.

7. Low Digital Financial Literacy

  • People aren’t aware enough that they can handle cashless system of payment .

8. Behavioural Issue

  • Changing behaviour to use cashless transactions is a complex process .

Issue : Interoperability

  • Interoperability is the ability of customers to transact across commercially and technically independent payment platforms.
  • Due to Legal  complications under Payment & settlement system act 2007,  we don’t have full interoperability ie
    • we can’t transfer money between one wallet to another (cant transfer money from Paytm to Phonepe) .
    • can’t use wallet to pay all types of taxes, fees, insurance premiums etc  .
  • This is an obstacle to ‘cashless-economy’.

In 2018, RBI issued guidelines for interoperability with Know Your Customer check, customer grievances redressal  mechanism etc. so that transactions can be made between different platforms.

Issue analysis : Regulation over Payment Settlement

Digital Banking
  • 1998: Banking Reforms / Narsimham-II Committee suggested regulatory framework for e- banking, card payment etc.
  • 2007: Payment & Settlement Systems Act enacted in accordance with Narsimha, II under which  RBI supervises e-banking, card payment and other digital money related issues through Board for Regulation and Supervision of Payment and Settlement Systems (BPSS).
  • All Payment system providers have to register with RBI’s BPSS – Whether bank, non-bank, wallet-PPI etc.
  • 2016: Ratan Watal Committee on digital payment suggested replacing this BPSS with a Payments Regulatory Board (PRB) in RBI, to look after Interoperability, Consumer protection, Innovation, R&D in digital payments (as BPSS looks after only Payment and Settlement).
  • 2018: RBI opposed formation of Payments Regulatory Board due to differences with Government over issue of who should be Chairman, how many members should be from Government side etc.

RBI made Ombudsman Scheme for Digital Transactions (OSDT) in 2019 with following functions

  • To look into matters of Digital Payment like Consumer Protection  .
  • Consumer can make free complaint for matters upto Rs 20 lakh against Mobile Wallets, Payment Payment Instruments (PPI) and other digital transactions.
  • It can charge penalty of upto Rs 1 lakh to be paid to victim for his mental agony , loss of time etc.

Issue analysis  : Merchant Discount Rate

  • MDR is the fee that a merchant must pay to a bank for every credit / debit card transaction.
  • MDR hurts merchants’ profit margin, discourages them from adopting Point of Sale terminals, digital payment system.
  • 2017-18: RBI put ceilings on MDR fees to encourage digital economy.
  • WEF 1/1/18: Government of India started 100 % MDR-subsidy on payments made via Debit card, BHIM or Aadhar enabled payment system for bills upto Rs.2,000. Scheme was valid for 2 years. This will encourage digital payments ecosystem.
  • Budget 2019 : No MDR will be charged from firm whose annual turnover is less than Rs 50 crore . RBI and Bank will absorb this burden for not handling so much money.
Merchant Discount Rate

Developments Related to Cashless/Less Cash Economy

1 . Committees

1.1 Ratan Watal Committee

  • Formed in Dec 2016.
  • To suggest Medium Term Recommendations to strengthen digital payment eco-system in India .


  • Separate Regulator for Digital Payments under RBI known as Payments Regulatory Board .
  • Envisaged a prominent role for Aadhaar as the primary identification for (KYC) purposes  .
  • Government departments should levy a cash-handling charge to discourage cash transactions.
  • Give incentives like discounts to consumers to make cashless payments  .
  • It had also suggested interoperability between banks and non-bank digital payment gateways .
  • Rewards for government departments, state governments, districts and Panchayats for promoting  digital payments.
  • Create a fund proposed as DIPAYAN from savings generated from cash-less transactions to expand digital payments.
  • Reduce or eliminate  import duty on import of ATMs & Point of Sale machines  .

1.2 Chandra Babu Naidu Committee

  • Formed in Nov 2016 & submitted report in Jan 2017
  • Chief Minister’s Committee to promote Digital Payment in India  by NITI Aayog.


  • Tax incentives should be given for domestic production of Point of Sale machines & ATMs .
  • Banks should charge 0% MDR from Government Bodies like Railways, Electricity etc. .
  • Develop Common QR based payment system for Vendors (led to formation of BHARAT QR).

1.3 Nandan Nilekani Committee

  • Jan 2019 : RBI appointed Nandan Nilekani Committee for suggesting ‘how to deepen the digital payments.
  • It’s main recommendations were
    1. Government should extend MDR subsidy for two more years .
    2. Give tax incentives to companies using digital payments.
    3. Reduce the taxes on devices required for digital payments .
    4. Raise awareness about BHIM-UPI .
    5. Setup Computer Emergency Response Team for Finances (CERT-Fin).
    6. Prepare area-wise ‘Digital Financial Inclusion Index’ to monitor progress.

2. Schemes

2.1 Rupay Card

  • RuPay is the Payment Gateway started by National Payment Corporation of India (NPCI) .
  • It will help in financial inclusion indirectly by decreasing the operating cost of Banks to service their customers using Debit & Credit Cards .

How Payment Gateway system work ?

Case 1 : If there is no payment gateway

  • Each bank has to separately tie up with merchants .
  • It leads to duplication of effort . 
Digital Banking

Case 2 : In presence of payment gateways

  • Each bank can tie up with payment gateway & payment gateway will tie up with merchant.
  • Banks are paying ₹300 cr per year to payment gateways   (Banks charge them from Merchants as Merchant Discount Rate (MDR) per transaction)

What Rupay will do ?

  • Rupay will  do the same work at 40% lower rates
  • Hence, User will have to pay lower Credit/ Debit card charges and Merchants will have to pay lower Merchant Discount rates to the banks.
  • Rupay is the 7th payment gateway in world .
  • 3 channel payment can be done using this :ATM, PoS(point of sale) and Online
  • They can tie up with any organisation : prepaid card by milk/ grain procurement agencies in Punjab.
  • Under Jan Dhan Scheme, Rupay Debit Card is given to the customers.

2.2. FastTag

  • FASTags are prepaid rechargeable tags  for automatic toll collection at  toll collection booths using RFID technology.
  • It helps in faster mobility by solving the issue of Jams at toll booths. Along with that it is issue in the direction of cashless economy.
  • From 15th January 2020, it shall be mandatory for all vehicles passing through tolls to have FASTags. Otherwise , vehicles have to pay double the normal rates .

2.3 NEFT System

  • Using bank, person can settle amount with other person even if he/she is having bank account in other bank. To settle these payments, NEFT (National Electronic Funds Transfer) system is used in the backend .
  • NEFT settles the net amount between banks at the interval of 30 minutes . It means , after interval of 30 minutes , it will check the  lakhs of transactions which were made between particular two banks throughout the country and will settle the remaining amount between two banks.
  • This system is operated by RBI.
  • Using this system, transactions of upto ₹10 lakhs can be made .
NEFT System

2.4 White Label ATMs

  • White Label ATMs are operated by private non-banking companies that own & operate their own brand of ATMs .
  • All the other Bank ATMs can use these White Label ATMs & get service but on nominal charge .
  • It is step towards Financial inclusion . ATM penetration will increase because of this  (present = 160/1million compared to US=  1400/1Million)
  • Eg Tata have Indicash , Muthoot Finance , Srei Infra, Vakrangee Software ,  Prizm Payments

2.5 Schemes by NPCI

NPCI is a not for profit company , made by 10 promoter banks in 2008 to provide cost-effective payment solutions for banks


NPCI is running various initiatives related to high end technology in Banking &  Payment Systems .

a. UPI

  • UPI = Unified Payment Interface
  • Started in 2016
  • It is  a technology for building digital payment apps (ie UPI is not an app but technology made by NPCI which is used by banks to make their apps) .
  • Features provided by UPI
    • Scan QR Code and pay directly to merchant’s account.
    • Link your bank account for direct transfer of money from your bank account without storing in e-wallet first. (unlike PayTM).
    • Facility of Push transaction (e.g. Sending Remittances to family).
    • Facility of Pull Transaction (e.g. Cable operator sending request for monthly bill within the app).
    • Bill sharing among friends.
  • Examples of UPI based app:  SBI Pay,  AxisPay and NPCi’s own BHIM.

b. UPI 2.0

  • Upgraded version launched in Oct 2018 with following additional features:
    1. Overdraft facility 
    2. Cash on Delivery
    3. User mandate for future date e.g. DTH 
    4. Invoice in the inbox.


  • BHIM = Bharat Interface for Money
  • It is app for ios & Android based on UPI (this is app in which UPI technology is used).
  • Made by NPCI
  • Benefits
    • No need to install multiple apps for each bank account (SBI Pay, AxisPay etc) . Single BHIM app can be used for using all  bank accounts.
    • App has 3 factor authentication system.
    • Your money stays in bank account . It is not stored in e-wallet outside bank like PayTM.  Hence, person can earn interest on his money.
    • No cards involved . Hence, no MDR or such hidden charges need to be payed.

d. Bharat QR Code

  • Started in Feb 2017
  • Bharat QR code has been developed jointly by National Payments Corporation of India (NPCI), Visa, MasterCard and  American Express under instructions from Reserve Bank of India (RBI).
  • Note – QR is two dimensional machine readable matrix. QR Code can store up to 7089 digits as compared to conventional bar codes which can store max 20 digits. 

Advantages of Bharat QR Code

  • It eliminates the need of using card swiping machines for digital payments. There is no need to have ‘Swiping Machines’ on shops. Just have QR printed & payments can be easily done via that.
  • Interoperability- Using BharatQR code, the merchants will be required to display only one QR code instead of multiple ones.
  • For buyer, there is no need to carry Card. Payment can be done via mobile.

Bharat QR


e. Aadhar Enabled Payment System  (AePS)

  • Customer simply has to tell  Aadhar number and name to the merchant or Bank Business Correspond who in return authenticate it using customer’s fingerprint .  Following this simple step, his transaction is completed.

f. Cheque Truncation System (CTS)

  • If somebody from Delhi gives Cheque of Delhi Bank Branch to person in say Chandigarh. Earlier that cheque was physically sent through post to Delhi Branch for settlement.
  • Under CTS, Scanned image of Cheque can be send to Delhi Branch and settlement can be done rapidly.

g. National Financial Switch (NFS)

  • ATM Card of one Bank can be used in other Bank too.  System that is working in the backend to make this possible is NFS .
  • NFS helps in re-routing transactions to Core Banking Solution Network of the Bank whose ATM card is being used.

h. NACH (National Automated Clearing House)

  • They help in Automated Payments which are to be paid periodically like each month or year like salaries, bills  etc. .
  • NACH is finding great attraction among Customers, Companies and Government Departments for payment of bills ,EMIs , salaries, pension etc.


  • IMPS = Immediate Payment Settlement System
  • It is available 24X7 . 
  • It is used for realtime Settlement of all  the Online  Payments  from Rs 1 to 2 lakh .
  • It is not free .  Service fee is charged on the transactions.

Side Topic : ATM security features introduced to prevent frauds

1. ATM Card Technology changed


Magnetic Technology 60s technology.
Data is stored on magnetic strip. Data can be duplicated, cloned, skimmed while swiping the card = increased chances of fraud.
So, RBI stopped such cards from 1/1/2019 using powers from Payment & Settlement Act.
EMV Technology Full form: Europay + Mastercard+ Visa 
Based on chip infrastructure with encryption.
RBI had ordered migration in 2013 => finally effective from 1/1/2019.
Two sub-types
1. EMV-Contact: cards must remain in Point of Sale (PoS) Terminal during transaction.
2. EMV-contactless cards: simply tap the card on terminal using RFID technology.
EMV Technology in ATM Cards

2. Card Tokenisation

  • When we do shopping on sites like Amazon, Flipkart etc. or pay bills using PayTM, they allow us to store our Debit or Credit Card information like Card Number, Expiry date etc. for future convenience. But this thing has security implications in case server of such company is hacked and user information is leaked.
  • To prevent such incidents, Card Tokenization has been introduced by RBI in Jan 2019
    • Tokenization = Token number is generated for a given credit/debit card.
    • Card customer gives the token number during any type of online / physical shop transaction  so that his original card number, its expiry date etc. remains hidden from the third party seller  .

Schemes for Digital Financial Literacy

1.Vitiya Shaksharta Abhiyan

  • Under MHRD
  • Encouraging students of University and Colleges to spread the message of moving towards digital payments going home to home.

2. Digishala TV Channel

  • MEITY has launched a TV channel named ‘DigiShala’
  • It is 24X7 Channel to increase Financial Literacy

Financial Inclusion

Financial Inclusion

This article deals with ‘Financial Inclusion.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

What is Financial Inclusion ?

As defined by Rangarajan Committee on Financial Inclusion in 2008 , Financial inclusion means everyone is given access to financial services ie Banking, Credit, Insurance & Investment at affordable cost  & in appropriate time frame .

Importance of Financial Inclusion

  • Helps family to cope with unforeseen circumstances like death of breadwinner.
  • Helps in converting savings to investments which in turn helps in nation building. Japan, USA etc. have earlier followed same path.
  • Protect common people from exploitation of informal money lenders who charge exorbitant interest rate .
  • By providing good investment schemes, it can protect people from falling into traps like Ponzi Schemes like Saradha & Rose Valley Chit Fund Schemes  .
  • E – Payment : Cashless subsidies & salaries can save government ₹1 Lakh crore according to McKinley study .


  • In rural areas, there is problem of accessibility . Number of branches in rural areas are low .
  • Geographically Hilly and desert areas don’t have large bank penetration .
  • Gender : Access of women to banks is low . Women have disproportionately less number of accounts than men .
  • 55% rural Dalits borrow from money lenders at exorbitant rates .
  • MSMEs are given low value of loans compared to big industrial houses .

New steps taken by Government for Financial Inclusion

Government is very much concerned to increase the Financial Inclusion and taking various steps in this regard

1 . Committees

  • Various committees have been formed like
    • Nachiket Mor Committee : Suggested various measures like Payment Banks, Small Banks etc. .
    • Deepak Mohanty Committee for Mid Term Path to Financial Inclusion : Suggested various measures like (1)  Use USSD on simple mobiles , (2)  Scrap Interest Subvention Scheme for farmers and concentrate on Insurance instead , (3) promote Sukanya Samridhi Scheme to cultivate saving habit in girls etc. .

2. New types of Differential Banks started

  • Payment Banks : 11 Licenses given .
  • Small Banks : 10 Licenses given .

3. Schemes

  • Jan Dhan Yojana is the main one (we are going to read in detail below).

4. Digital Schemes

  • Various initiatives have been taken by the government in this regard like
    1. Introduction of Rupay Card
    2. UPI, UPI2.0 & BHIM
    3. Bharat pay

5. Small Investment Schemes

  • Launched to promote the habit of savings among the poor and  save them from Ponzi scams
  • Main schemes include
    1. Kisan Vikas Patra (doubles money in 8 year 4 months)
    2. Indira Vikas Patra
    3. Public Provident Fund
    4. Sukanya Samridhi Yojana (component of Beti Bachao, Beti Padhao): Scheme for small girl children in which money can be deposited by the parents (between Rs 250 to 1.5 lakh per annum)  till girl reaches age of 14 years and can be later withdrawn by girl when she reaches age of 18 years for her studies or marriage. Government offers higher interest than normal rates on such deposits (In 2020 : interest rate = 8.5%)

Earlier Schemes for Financial Inclusion

  • Bank Nationalisation was done in 1969 and 1980 .
  • Regional Rural Banks  & Cooperative Banks have been opened .
  • Micro Finance Institutions have been promoted by the government .
  • No frills accounts  (i.e. accounts with zero balance) scheme has been started by various banks .
  • 25%  rural bank mandate : Banks have to open 25% of their branches in rural unbanked areas.
  • Post Office Schemes to deposit money.

Jan Dhan Yojana

Works on following pillars pillars

  • Free Bank Account for every family  along with Rupay Card , 1 lakh accident insurance & 10,000 overdraft facility .
  • Banking outlet for each household within 5 km .
  • Imparting financial literacy .
  • Direct Benefit Transfer (DBT) of government schemes and subsidies through Jan Dhan Accounts  .
Financial Inclusion


  • According to Global Findex Report, 80% adults in India now have Bank accounts due to Jan Dhan Scheme .
  • It has helped in Women empowerment as large number of women accounts have been opened .
  • It has helped government in implementing Direct Benefit Transfers and prevent leakage of subsidies .
  • It has helped in breaking hold of local moneylenders .
  • + All benefits of Financial inclusion


  1. Account Dormancy (72% accounts opened under scheme are  dormant according to Microsave (think tank survey) .
  2. Account Duplication (33% duplicate accounts have been opened due to attraction of insurance & overdraft facility) .
  3. Rupay cards not given to 70% Jan Dhan Account holders . Overdraft facility cant be used without that .
  4. Jan Dhan Account Holders are being used as money mules by Hawala Agents  .
  5. Operating cost of Banks is increasing because they have to keep on servicing dormant account . It costs ₹100 to 150 / annum to banks to maintain each account .

2016 : Indian Express Report -> Bank Officials made one ₹ deposit to Jan Dhan accounts to hide their zero balance status . This shows that these can be used in money laundering too .

Priority Sector Lending

Priority Sector Lending

This article deals with ‘Priority Sector Lending .’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .


  • Basic principle in Economics = No Risk No Reward & High Risk High Reward .
  • Hence, Banks will charge high rate of interest from farmers, students , small entrepreneurs etc. or they will never get loans . To tackle this, RBI in 1980s came with PSL norms .

Who are covered under Priority Sector Lending (PSL) ?

Priority Sector Lending
  • Domestic Scheduled Commercial Bank (Public and Private) = 40%
  • Foreign Scheduled Commercial Bank (SCB) = 40%
  • RRB = 75 %
  • Small Finance Banks – 75%
  • Cooperative Banks = No Requirement

What includes PSL ?

Category % SCB  
Weaker Sections 10%  
Agriculture & Allied Activities 10%  
Marginal Farmer & Small farmer 8% – Added as new category in April 2016 .
– Earlier Agriculture and Allied Activities was given 18% but due to broad category, small & marginal farmers weren’t getting anything.  
Micro Enterprise – Khadi-Village industry 7.50%  
All other PSL categories 4.5% These include
1. Small & Medium Enterprises
2. Affordable housing loans to beneficiaries under PMAY
3. Food processing companies
4. Vermi compost, biofertilizer, seed production
5. Student-Education loans (upto Rs.10 lakh)
6. Social Infrastructure (schools, health care, drinking water, sanitation facilities)
7. Renewable Energy Projects (wind mills,  solar  etc.)  
Total PSL 40%  

Note : For Foreign Banks with less than 20 branches , 40% PSL is there  but there is no internal classification. Their consolidated PSL should be 40%.

Benefits of Priority Sector Lending

  • It helps in channelising credit to the Vulnerable Section .
  • PSL helps in Financial Inclusion .
  • PSL provides higher Social Returns on lending .
  • It helps in diversification  of Credit Portfolio of government
  • Credit Formalisation : It helps in breaking the hold of non-institutional lenders especially in rural areas.

Issues with Priority Sector Lending

  • Rising NPA : Second Narsimham Committee (1998 )  observed that  47% of all NPA  have come from PSL . It also recommended to end the system of PSL for the betterment of Banking Sector.
  • Lethargy in Lending: Most bank seem reluctant to lend to the priority sectors .
  • Not used for intended purpose especially in Agriculture sector. Loan given to farmers under PSL is to increase productivity, but it is used for unproductive purposes like marriages and other social obligations.
  • Targeting issues : Suitcase farmers benefitted instead of poor farmers .
  • Deter banks from  expanding their scale of lending as more they lend, more they will have to contribute in PSL .

What if PSL quota is not met ?

Mostly banks aren’t able to meet their PSL quotas. In this case, they have to invest the remainder in RIDF or SIDF as the case may be

Indian Banks + Foreign banks (with 20 or more branches) RIDF =Rural infra. Development fund
Managed by NABARD
For funding rural infrastructure projects  
Foreign bank with less than 20 branches. SEDF = Small Enterprises development fund
– Managed by SIDBI  

But  problem with both of the above is , money is given for long term ie around 20 years. Hence,  banks money is gone for long time which they cant use & as a result , they suffer in the meantime

To Address this, RBI came with Priority Sector Lending Certificates:-

Priority Sector Lending Certificates

  • In this arrangement, the overachieving Banks can sell their excess PSL in form of ‘certificates’ to underachieving banks without transferring the loan assets or its risk.
Priority Sector Lending Certificates
  • Four kinds of PSLCs are traded through RBI’s e-Kuber Portal, viz
    • Agriculture (PSLC-A)
    • Small and Marginal Farmers (PSLCSM)
    • Micro Enterprises (PSLC-ME)
    • General (PSLC-G). 

(Note – In future , one of the work of wholesale Banks would be to give large loans in PSL sector and then sell PSL certificates through this facility. )

Rural Banking

Rural Banking

This article deals with ‘Rural Banking.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Steps taken to promote Rural Banking

Various steps have been taken to penetrate Banking into Rural Areas

1 . Before Independence

  • During British Raj & initial years of independence , Banks (& insurance companies) operated in Urban Areas only .
  • Result :  villagers used to rely on money lenders , who lend money at exorbitant rates & they remained in debt & poverty .

2. After Independence

1950s Cooperative Banks/societies
1955 Birth of SBI & ICICI
1960s Bank Nationalisation (1960 & 1969)
1969 Lead Bank Scheme
1975 Regional Rural Banks (RRB) setup
1980s NABARD setup + Bank Nationalisation(2nd Round)
Early 90s Self Help Group & Bank linking
Late 90s Kisan Credit Card
Mid 2000s No Frills Account Banking Business Correspondent Interest Subvention Schemes on crop loans
Present RRB Amendment + Payment Banks

Lead Bank Scheme

  • 1960s :  Narsimham Committee recommended that responsibility of development should be given to banks & there should be integrated approach  . Hence, this  scheme was launched .
  • 1969 : State Bank of India + its subsidiaries + 14 national banks + 3 Private banks selected under this . Every district was given to specific bank making it responsible for development of Banking in that district called Lead Bank .
  • 1975: these banks were asked to setup subsidiary banks in their districts which are known as Regional Rural Banks .

Rural Infrastructure Development Fund (RIDF)

  • Started in mid 90s .
  • NABARD operates RIDF.
  • This fund provides cheap loans to state & state owned corporations so that they can complete projects related to
Medium & minor irrigation Community Irrigation Wells
Soil conservation Village Knowledge centres
Watershed Management Desalination plants in coastal areas
Flood Protection Building schools & Anganwadi centres
Forest development Building toilet blocks
Cold storage Rural roads & bridges
  • Banks who don’t meet their Priority sector lending requirements provide money to RIDF .

Regional Rural Banks

Cooperative Banks

  • Dealt below

Priority Sector Lending

Cooperative Banks

Cooperative Banks
  • Co-operative bank is a financial entity which belongs to its members, who are at the same time the owners and the customers of their bank.
  • These Banks on the principle of NO PROFIT & NO LOSS + ONE MEMBER ONE VOTE .
  • They are subjected to CRR & SLR requirements , however the requirements are less than commercial banks.
  • PSL requirements are not applicable on them.
  • They can be Scheduled or Non Scheduled.
  • Western Concept & came into being in beginning of 1900s.
  • Regulators : RBI, NABARD & State Registrar of Cooperative Society .
  • They were  instrumental in dismantling hegemony of money lenders in rural finance .
  • Before nationalisation drive took place in 1960s , Cooperative banks constituted 80% of institutional credit . But after nationalisation of banks, due to  stiff competition from commercial Banks , their share decreased significantly .
  • Due to One Member One Vote , they suffer from Caste Politics .
  • These banks don’t have all India presence & are present in selected regions like Gujarat, Maharashtra, Andhra Pradesh and  Tamil Nadu where cooperative movement was strong.
  • 2018 Update : RBI allowed Urban Cooperatives to voluntarily transform into Small Finance Banks, with conditions .


Type Commercial Cooperative
Banking Regulation Act Yes Yes (Since 1966)
CRR, SLR Yes Yes ( but lesser than Commercial Banks)
Who can borrow Anyone Only Members
Vote Power Proportionate to Shareholding One Member One Vote
Profit Motive Yes No Profit No Loss
Presence All India Mainly concentrated in Gujarat, Maharashtra , Andhra & TN

Rural Co-Operative Banks

Structure and Funding  of Rural Co-operative banks is as follows

Rural Co-Operative Banks


  • Rural Cooperatives suffer from huge NPAs . NPA level in these banks was around 25% in 2015 (very high) .
  • Due to 1 person 1 vote , they suffer from Casteism during voting . After that, they serve people belonging to their caste only.
  • Although SARFAESI Act powers are given to these banks but due to political backing , these banks don’t take action on defaulters.
  • Deposits are very low because rates are not competitive against Scheduled Commercial Banks & Post Office Deposits. Hence, they have to depend on NABARD Funding .
  • Large scale manipulation goes on in District Central Cooperative Banks (DCCBs) and PACS as their operations are not digitalised and they aren’t connected to Core Banking Solution . During demonetisation, District Cooperative Banks were involved in changing black money in back-date.
  • They are under the dual supervision of   RBI and the Registrar of Co-operative Societies (RCS) of the respective states . This has led  to poor supervision and control .


  • Close down PACS & form LAMPS (LArge Sized Multipurpose Society) in their place. Their operations will not be restricted to giving loans  . Apart from banking, LAMPS   will also be involved in food processing , supplying fertilisers and seeds etc. . 
  • Budget 2017 : Core Banking Solution introduced in PACS & District Central Cooperative Banks to check manipulation of accounts.

Urban Cooperative Banks (UCBs)

  • Traditionally, the area of operation of the UCBs was confined to metropolitan, urban or semi urban centres and catered to the needs of small borrowers including MSMEs, retail traders, small entrepreneurs, professionals and the salaried class. However, there is no formal restriction as such and today UCBs can conduct business in the entire district in which they are registered, including rural areas.
  • UCBs too are suffering from losses.

Reasons for losses

  • UCBs are dominated by builders and manipulators. They indulge in Zombie-lending. Eg: Punjab and Maharashtra Cooperative Bank kept on doing zombie-lending to weak company called HDIL due to corrupt nexus between directors and HDIL owners. When HDIL failed, NPA of the bank increased exponentially and depositor’s money was stuck in the bank .
  • Although, they are given powers under SARFAESI Act but officials of the bank don’t use these powers because debtors are their friends and relatives .

Steps taken

  • RBI has offered all Urban Cooperative Banks to convert to Small Finance Banks so that RBI can have more regulation over these Banks. But most of UCBs are least interested to convert because of the benefits accruing from present loopholes.
  • RBI is forcing shutdowns (reduced from 1900 (2004) to 1500 (2018)) and mergers (Maharashtra = 72 mergers between 2004 to 2018) due to frauds and scams.
Urban Cooperative Banks

Differential Banks

Differential Banks

This article deals with ‘Differential Banks (Payment Banks, Small Area Banks, Local Area Banks etc.).’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Differential Banks vs. Universal Banks

Difference Universal Banks Differential Banks
Branches Can open Branch anywhere: example SBI, ICICI Geographical Restrictions on branch opening for Local Area Bank (LAB), Regional Rural Banks (RRB) etc.
Money acceptance Both Time & Demand Deposits of any amount can be accepted. Restrictions are there . Eg Payment Bank : Can accept maximum amount of Rs 1 lakh only in deposit.
Give Loans to Anyone Restrictions present. Eg : Small Finance Bank, Regional Rural Bank : must give 75% to Priority Sector  . Payment Bank can’t give loans .

1. Regional Rural Banks  (RRB)

Need of RRBs

  • In 1975 , Government appointed MM Narsimham Committee to look into rural banking .
  • Observations of the Narsimham Committee were as follows :-
    • Staff of Banks has expertise in banking & financial matters but are not aware of the problems of rural people .
    • Primary Agriculture Credit Societies (PACS) have members from villages & are aware of needs and problems of the villagers .
  • As a result of this , Regional Rural Banks (RRBs) were first set up on 2 October, 1975 (only 5 in numbers) under RRB Act.

Client of RRBs

RRB provide loan & saving facilities to villagers & they include

Farmers Rural Entrepreneurs
Agricultural Labourers Cooperative societies
Rural Artisans Primary Agricultural Credit Societies


  • RRBs are sponsored by Commercial Banks
    • Sponsor Bank provides training to staff of RRB.
    • Sponsor Bank also provides initial capital to setup RRB.
  • RRB operates in selective districts & don’t have all India presence .
  • According to original RRB Act, paid up capital ( ownership) of RRBs was as follows .
Central govt State govt Sponsor Bank 
50 % 15 % 35 %
  • Priority Sector Lending (PSL) is applicable to RRB (75% loans should be PSL)   .
Regional Rural Banks

Failure of RRBs

  • Due to excessive lending towards social Banking & catering highly weaker sections , these banks started to incur huge losses by early 1980s .
  • Private & Public banks too started to operate in rural areas , which resulted in low deposits in RRBs . As a result, RRBs had to depend on NABARD for credit .
  • Debt waiver to farmers & NPA also created lot of problems .

Subsequently , following the suggestions of the Kelkar Committee, the government stopped opening new RRBs in 1987—by that time their total number stood at 196.

Steps to revive

  • RRB Amendment Act , 2015 
    • Earlier shareholding requirements  – Central : State : Sponsor Bank = 50:15:35 .
    • After Amendment – Centre, State & Sponsor Bank’s cumulative share holding can reduce upto 51% .
RRB Amendment Act , 2015
  • From 2005, amalgamation process of RRBs with their ‘Parent Banks’ was initiated so that these banks can become more viable (As of April 2020, there are only 53 RRBs ) .
  • Obligation of concessional loans has been abolished & RRBs have started to charge commercial interest rates on lending .
  • Target client restrictions have been ended & RRBs can now serve anybody.
  • Dr KC Chakrabarty Committee has recommended that CAR /CRAR for RRBs should also be 9% & to achieve this, government should recapitalise RRBs as well.

Note – Recently launched Priority Sector Lending Certificates (PSLC) are going to help them because they do a lot of PSL.

2 . Local Area Banks (LAB)

  • In 1996, Manmohan Singh (as FM) mooted to start Local Area Bank (LAB) .
  • They are licensed under Banking Regulation Act but not included in 2nd Schedule of RBI Act. 
  • Vision was  to increase financial inclusion .


  • They can operate only in Rural & Semi-Urban Areas .
  • Can operate in Max 3 geographically contiguous districts .
  • Can open only 1 branch in Urban / District city  .
  • PSL norms apply=> 40% loans should go to Priority Sector.
  • They are not Scheduled Commercial Banks because their names are not mentioned in RBI Act.

Problems with Local Area Banks

  • MSME loans given by LABs aren’t covered under Credit Guarantee Scheme of the Governments .
  • Farm loans arent covered under Interest Subvention Scheme .
  • State/Central PSUs/Institutes don’t open account in them.
  • Branch expansion heavily restricted in rural & semi-urban areas.
  • Cant get loans from RBI at Bank Rate /MSF .
  • Don’t get refinance from NABARD /SIDBI .

Operating Banks

  • 10 Licenses were given at that time & only 4 are operating presently .
  • Was in news in 2016 when applications for Small Financial Banks were called. Usha Thorat Committee  allowed them to apply for Small Finance Banks    & one out of them ie Capital Local Area Bank based in Punjab got license to open Small Finance Bank
Differential Banks

3. Payment Banks

Side Topic : Prepaid  Payment Instrument (PPI)

  • Airtel Money is an example of PPI .
  • You give them money from your account &  they transfer that money in Digital Wallet . Later, you can use it to pay bills, shopping, movie tickets etc .

Problems  with PPI

  • Doesn’t offer any interest. Hence, not good for financial inclusion .
  • PPI is nested payment model ie they deposit your money in account of some bank .  This increases contagion risk  .
  • There are issues related to security and KYC norms.

What are Payment Banks ?

  • PPI aren’t good due to above mentioned reasons. But their idea as a whole is good  .
  • Payment Banks are new stripped-down type of banks (Differential Banks), which are expected to reach customers mainly through mobiles rather than traditional bank branches .
  • These are under the recommendations of Nachiket Mor Committee  that RBI should give license to new type of banks i.e. Payment Banks under Banking Regulation Act .
  • Sept 2015 : RBI  granted ‘in principle’ approval for payment banks to 11 entities.  Later, 3  backed out of the business . Hence , 8 in market now
    1. Aditya Birla Nuvo Ltd.
    2. Airtel M Commerce Services Ltd.
    3. Department of Posts
    4. Fino PayTech Ltd.
    5. National Securities Depository Ltd
    6. Reliance Industries Ltd. (Jio)
    7. Vijay Shekhar Sharma  (Pay TM)
    8. Vodafone m-pesa Ltd.
    9. Cholamandalam Distribution Services Ltd (withdrew later)
    10. Dilip Shantilal Shanghvi (withdrew later)
    11. Tech Mahindra Ltd. (withdrew later)

Characteristics of Payment Banks

Target Audience Small businessman , poor (domestic) immigrant workers and rural population .
Potential candidate to run Mobile  companies, consumer goods companies, post office system, agri/dairy type cooperatives and Corporate Business correspondents.   
CRR Have to keep CRR just as Scheduled Commercial Banks .
Entry Capital Require ₹ 100 crore as entry capital .
Features Payment Banks can hold upto ₹ 1 Lakh  in an account and pay interest on these balances just like a savings bank account.
But they cant involve in any credit risk i.e. can’t give loan to others . However, they can invest in SLR approved securities & earn about 8% interest .
– They can issue debit cards (but not Credit Cards) and ATM cards usable on ATM networks of all banks.
They can enable transactions , transfers and remittances through a mobile .
– Since , Payment Banks can become Banking Correspondents of Universal Banks, hence customer can use same account as that of Universal Bank and take services of Payment Bank from that account.
Payment bank will enjoy all the rights and responsibilities of a Scheduled commercial banks .
Payments Banks are required to use the word ‘Payments’ in its name to differentiate it from other banks.  

Working of Payment Banks

Payment Banks

Case Study of m-Pesa : Why India should get Payment Banks (case study)

  • M-Pesa is Kenya’s Payment bank .
  • M = mobile & Pesa = Money in Swahili .
  • It provides banking services through mobile and works in same way as Payment Banks. Nachiket Mor Committee recommended to start Payment Banks based on the success story of m-Pesa innKenya.

Benefits of Payment Banks

  • Help in financial inclusion : It is uneconomical for traditional banks to open branches in every village but mobile  coverage is a promising low-cost platform  .
  • Remittances at Zero Cost : Their main target is migrant labourers . It will tap India’s domestic remittance market  .
  • Increase in disposable income of poor migrant families : Since Remittances will happen at zero cost , it will  increase disposable income in the hands of low income migrant families  .
  • They  will help in easy implementation of Direct Benefit Transfer.
  • They will help in moving India towards less cash society . 
  • They will create job opportunities in form of Payment Bank’s Agents.

Problems with Payment Banks

  • Low revenue: can’t undertake any lending businesses + can invest in SLR approved securities only  .
  • Banks are already offering most services that payments banks can offer  . Hence, for payments banks to offer a new and differentiated proposition will not be easy.
  • RBI has launched Unified Payment Interface (UPI) giving blow to business plans of Payment banks .

As a result, after initial enthusiasm in applying for payment banks, companies like Tech Mahindra, Sanghvi’s, Cholamandalam Investment have opted out.

Started till now

Jan 2017  (1) Airtel (first to start)
May 2017 (2) PayTM
2018 (3) Reliance Jio , (4) Fino, NSDL and (5) Birla launched their Payment Banks
September 2018 (6) India Post Payment Bank

Side Topic : Indian Post

September 2018 : India Post Payment Bank was launched

  • All 1.55 Lakh Post Offices  linked to Payment Bank System .
  • 3 lakh Post men and Grameen Dak Sewaks will provide on the door banking facilities  .
  • Upto 1 lakh deposit | 4% interest Rate | Debit Card facility | Free withdrawls from own ATMs and Punjab National Bank’s ATMs | No minimum balance .
  • India Post Payment Bank has all the features & benefits of Payment Banks (with additional benefit that they already have post office infrastructure) .
  • They have also partnered with Bajaj Alliance Life Insurance (BALIC) to sell insurance policies.

Post office as Financial Intermediary

  • Indian Post is the oldest & largest organisation involved in resource mobilisation in India .
  • It has huge network of 1.55 lakh post offices , 3 Lakh postmen & 5 Lakh employees .
  • 90% of Post-Offices present in Rural areas . 
  • Earlier too, it was providing  wide array of ‘financial services’  such as saving and other time deposit accounts, Public provident fund, Monthly Investment schemes, National saving certificates. 
  • It comes to rescue government when banking system is not able to deliver cash benefits such as under MGNREGA, Old age/disability Pension Schemes etc.
  • Post offices around the world have gone through this transformation in many countries & experience was quite successful there. Most notable is Royal Post in UK  which apart from Banking services , is also providing mobile and broadband services . US is also considering such plans.
  • It can free bigger commercial banks to concentrate on competitive commercial operations leaving social security works to be handled by Postal Bank.
India Post

4. Small Finance Banks

  • The purpose of the small banks will be to provide a whole suite of basic banking products such as deposits and supply of credit, but in a limited area of operation (contiguous districts in a homogenous cluster of states or union territories) .
  • These are modelled on Community Banks of USA .
  • In Community Bank, Employees of banks know almost every family and therefore is well aware of their assets, credit history, financial position and business. As a result,  MSME Industry, Retail Business men and Farmers can take loans from them without any problem.

Indian Parallels of Community Banks

  • Old Private Banks like Catholic Syrian Bank of Kerala, Nainital Bank etc.
  • Local Area Banks
  • Regional Rural Banks
  • Microfinance Institutions

Their employees know their customers very well unlike big PSBs (like SBI) and New Private Banks (like Axis, ICICI Bank).

Hence, Nachiket Mor recommended creation of Small Financial Banks based on Community Banks of USA  . They should focus on unserved, underserved , small and marginal farmers along with MSMEs . Even Indian parallels can get SFB license . Atlast, 10 contenders got license . eg : Capital Area Bank (Punjab) , Au Financiers (Jaipur) etc

Small Finance Banks

Prelims related information regarding Small Finance Banks 

  • They are licensed  under Banking Regulation Act .
  • PSL requirement = 75% (40% category wise (as Universal Banks) + 35% into PSL with competitive edge)   .
  • They are Scheduled Banks under RBI Act.
  • CRR and SLR requirements are similar to existing Commercial Banks.
  • CRAR/CAR requirements – 15% (ordinary Banks – 9%) .
  • FDI – upto 74% allowed.
  • They can open bank branches with condition that 25% branches should be in rural unbanked areas.
  • The maximum loan size and investment limit exposure to single/group borrowers/issuers would be restricted to 15% of capital funds.
  • Loans and advances of up to ₹25 lakhs, primarily to micro enterprises, should constitute at least 50 per cent of the loan portfolio.
  • They can evolve into Universal Banks after 5 years subject to RBI’s discretion .

5. Wholesale Bank

It has not formed yet . RBI proposed it in 2017.

  1. Wholesale Bank will be regulated under Banking regulation Act
  2. They can only accept deposits larger than Rs.10 crore from big investors. Apart from that, they will raise money by issuing bonds.
  3. It will not give loan to retail /common person . It will only lend in wholesale markets such as infrastructure sector or to corporates.
  4. PSL norms are applicable but at wholesale level. They will finance big projects in Priority Sector and can sell extra PSL certificates to Scheduled Banks to fulfil their targets.
Wholesale Bank

Why we need Wholesale Banks?

  • India need huge investments in Infrastructure Sector ( ₹40 trillion in next decade) . But there are issues
    • Till now , government is the biggest spender in infrastructure sector (45% of total infrastructure spending). But  government cant invest more  because of Fiscal Deficit problems .
    • Next biggest investor are banks . But they too cant invest more due to NPA Problem.

To get more investment in infrastructure , government is planning to come up with Wholesale Banks.

  • Tenor of the infrastructural loans is very long and therefore it does not incentivize institutions like Banks. Therefore there is a need of separate infrastructure banks. Wholesale Banks will perform that work.
  • Right now NBFC are not under supervision of RBI (and act somewhat like Shadow Banks) and are not covered under SARFAESI to recover their Bad Loans .  It is not in our interest to let them continue as this because they don’t have protection cover of CRR& SLR . By making Wholesale Banks, bigger NBFCs can be made to come under RBI’s regulatory supervision.
  • Apart from that , they will help Banks to achieve their PSL Targets . They will invest huge amounts in PSL Projects and then issue their PSL Certificates which can be bought by Banks 
Wholesale Bank

Merger and Consolidation of Public Sector Banks

Merger and Consolidation of Public Sector Banks

This article deals with ‘Merger and Consolidation of Public Sector Banks.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Bank Mergers

  • 2016 : At Gyan Sangam II , it was decided that since Public Sector Banks aren’t performing well, there is need to consolidate banks by merging small banks with State Bank of India, Punjab National Bank , Bank of Baroda , Canara Bank etc. as Anchor Banks.
  • Crux : government is working on a consolidation of public sector banks with a view to creating 3-4 global-sized banks and reducing the number of state-owned banks to about 10-12.

Mergers happened till now

  • 2017 : SBI’s 5 Associated Banks & Bhartiya Mahila Bank merged with SBI .
  • 2019 : Vijaya & Dena Bank merged with Bank of Baroda . 
  • 2019 : Oriental Bank of Commerce and United Bank of India merged into Punjab National Bank .
  • 2019 : Syndicate Bank merged with Canara Bank .
  • 2019 : Andhra Bank and Corporation Bank merged with Union Bank of India .
  • 2019 : Allahabad Bank merged with Indian Bank .
Merger and Consolidation of Public Sector Banks
Merger and Consolidation of Public Sector Banks

Points in favour of Merger of Banks

  • (Economic Survey 2020) It will help to place more Indian Banks in the top 100 banks of the world  . It is sine quo none to have atleast 6-8 top-100 banks of the world in India, if we want to make India a financial hub of Asia and channelize global savings towards India to make India $ 5 trillion economy. Currently , India has just one bank in top 100 banks of the world (SBI = 55 Rank) while China has 18.
Number of top 100 banks in countries

India needs atleast 6-8 global 
banks in Top-100 to make India 
a $ 5 Trillion economy. 
(Economic Survey 2020)
  • Earlier State Bank of Saurashtra (2008) & Indore (2010) merger into SBI was successful . Hence, previous experience is pleasant.
  • Larger banks provide financial stability and act as engines of growth in times of trouble. Eg Chinese Banks in 2008 .
  • It will lead to  branch rationalisation and reduce operating costs .
  • Larger Public Sector Banks can support the corporate sector better in overseas acquisitions  as done by Chinese Banks.
  • For compliance with BASEL III Norms, if big bank like Consolidated SBI issue shares , they can fetch good response .
  • Enhanced geographical reach: For example, Vijaya Bank has strength in the South while Bank of Baroda and Dena Bank had a stronger base in Western India. That would mean wider access for both the proposed new entity and its customers.
Merger of Banks

Points against Merger of Banks

  • Mergers eat up a lot of top management time . At a time when Public Sector Banks  need razor focus to deal with NPA menace , mergers will be very distracting .
  • Large banks aren’t necessarily efficient banks : The quest to create an Indian banking giant is old one when world looked  in awe at the Japanese banking giants . But their big size emboldened them to do excessive lending and ultimately they  had to be bailed out by taxpayers money  .
  • The merged State Bank of India is likely to be five times larger than its nearest competitor and can stifle the competition .
  • Setback to corporate governance :The merger sends out a poor signal of a dominant shareholder (the government) dictating decisions that impact the minority shareholders .
  • Banks will lose their regional identities .
  • Political Implications : Kerala Legislative Assembly has passed resolution that State Bank of Travancore’s merger with SBI will affect state’s economic growth negatively.
  • Protests: Addressing the concerns of unions and shareholders will be challenging.
  • Harmonization of Technology: It is a big challenge as various banks are currently operating on different technology platforms.

Best way to Merge : Merge banks that are complementary . Eg : Bank of Baroda with Dena and Vijaya Bank so that lay offs aren’t large .

Privatisation of Banks

  • Government is also reducing its shareholding to less than 50% in a Public Sector Banks .
  • Eg :
    • Government owned UTI Mutual Fund applied for UTI Bank License in 90s => Scam => UTI Bank privatised into Axis Bank
    • 2018 : IDBI Bank  Privatisation

IDBI Privatisation

Present Structure

  • Government had 81% ownership in IDBI Bank Limited. But Unlike in the other public sector banks, the government could reduce its stake in IDBI Bank  below 50%, because this bank is not governed by the Bank Nationalisation Act, 1969 .
  • June 2018 : Government was unable to find suitable private sector buyer for IDBI Bank. Hence, Government has started discussions with LIC to pick up a controlling stake of 51% (from  around 11% ) in a  deal of around Rs 10,000 crore .
  • March 2019 : RBI changed categorisation of IDBI to private sector lender following acquisition of majority stake by LIC
  • Budget 2020 : Finance Minister announced that Government will sell remainder 41% shares of IDBI Bank as well.
IDBI Privatisation
Positive Government  has not to  worry about BASEL-recapitalization of IDBI.
LIC can market its insurance policies to IDBI consumers (using bancassurance model) .
Negative IDBI Bank is the worst performing state-owned lender with NPAs as on March 31, 2018 of 28% .
– IRDAI do not permit LIC to raise its shareholding in a single listed entity beyond 15% to ensure that the Corporation does not put policyholders’ money at risk, and has a diversified portfolio.
Funds at the disposal of LIC are  policyholders’ money. Using those funds to buy a badly performing bank will deprive them from optimal returns .

History of Banking System

History of Banking System

This article deals with ‘History of Banking System.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Financial Intermediaries

  • Institutions that channel funds between surplus and deficit agents are called financial intermediaries.
Financial Intermediaries
  • These include Banks, Insurance companies , pension funds, mutual funds etc. .
Financial Intermediaries

Banking System

Type of Banks

Type of Banks

Scheduled Commercial Banks

When RBI is satisfied that a bank has (Paid Up Capital + Reserves =) Minimum 5 Lakhs  & it is not conducting business in a manner harmful to its depositors, then such bank is listed in the 2nd Schedule of RBI Act, and it is known as a Scheduled Bank.

Scheduled Banks Non-Scheduled Banks
Are bound to maintain CRR with RBI and maintain SLR as mandated by the RBI . Not required to maintain SLR and CRR .
As a benefit , they are eligible to borrow  funds via Liquidity Adjustment Facility (Repo and Bank Rates) It depends on RBI’s discretion to allow them to borrow via this mechanism .
Can be subdivided into two parts 1) Scheduled Commercial Banks e.g. SBI, Axis , PNB, ICICI Bank etc. 2) Schedule Cooperative Banks like Haryana Rajya Sahakari Bank  etc. Hundreds of cooperative banks are non-Schedule Banks.

Topic : History of Banking System in India

History of Banking System in India before Independence

  • Present Banking System was introduced in the western world and was later introduced in India during the British Raj.
  • History of  Banking system in India goes to 19th century (then known as Agency Houses ).
  • During British Times, there were two type of Banks
British Banks East India Company established Banks in 3 Presidencies
1. Bengal : 1806
2. Bombay : 1840
3. Madras : 1843
1921 : These three merged to form  Imperial Bank of India . Later, it was nationalised and became SBI . It targeted British  Army officers , Civil Servants & Judges.  
Swadeshi Banks These were setup by the Indians , parallel to the British Banks.
First Indian Bank was Allahabad Bank(1856).
Other – Bank of Baroda (backed by Gaekwads of Baroda) , Punjab National Bank (role  was played by Lala Lajpat Rai in it’s formation) , Punjab & Sind Bank (by Bhai Vir Singh) .
These banks targeted big merchants particularly raw material exporters  

But neither helped in financial inclusion .

Birth of RBI

  • By the early 1930s,  there were large number of banks operating in India . They were registered under the Company Law and regulations on this sector were not present. But problem arose during The Great Depression(1929) which started in USA . Due to this, demand of Indian exports in the foreign market  decreased and Indian merchants started to default .  Consequently , large number of Indian banks collapsed.
  • To deal with such situation and bring banking sector under regulation,  British Indian government setup Reserve Bank of India in 1934 under the recommendations of Hilton Young Royal Commission.

History after Independence

Two important steps were taken by Government of India

  • Nationalisation of RBI
  • Banking Regulation Act,1949 : It empowered RBI to control & regulate Banking sector in India .

Nationalisation of Banks

Nationalisation of banks :  SBI Case (1st Round )

1955 Imperial Bank was nationalised & renamed SBI . (At the same time, Nationalisation of Insurance Companies also done)
1960 8 Banks were nationalised & made subsidiaries to State Bank of India
1963 Two subsidiary Banks were merged  (State Bank of Bikaner & State Bank of Jaipur) leading to the formation of  State Bank of Bikaner & Jaipur
2008 State Bank of Saurashtra merged  with Parent Bank .
2010 State Bank of Indore merged with Parent Bank .
Till recent times There were  5 subsidiaries of SBI
1. State Bank of Bikaner & Jaipur
2. State Bank of Hyderabad
3. State Bank of Mysore
4. State Bank of Patiala
5. State Bank of Travancore  
2017 All subsidiaries merged into Parent Bank
History of Banking System

Nationalisation of Banks :  Except SBI (2nd Round)

  • 1969 :  14 Banks having deposits of more than ₹ 50 Crore were nationalised (2019 : 50 years have passed i.e. Golden Jubilee of Nationalisation.)
  • 1980 : 6 more banks Nationalised having deposits more than ₹200 Crore .
Nationalised in 1969 Punjab National Bank, Canara Bank etc .
Nationalised in 1980 Punjab & Sind Bank, Vijaya Bank, Oriental Bank of Commerce etc.

Reasons of Nationalisation

  • To remove control & concentration of economic power in the hands of few industrialists .
  • Due to misuse of funds by owners .
  • Due to tendency of banks to ignore the needs of small scale industrial sector & agriculture .
  • To remove concentration of banking sector mostly in Urban areas .

Objectives after Nationalisation

  • To open more banks in rural & semi urban areas & to collect saving from these areas .
  • To provide credit facilities to areas defined as Priority Sector in economy.

Has the nationalisation of private banks benefitted India?

  • According to Economic Survey (2020) , due to nationalisation of banks ,  allocation of banking resources to rural areas, agriculture, and priority sectors have increased. For example in the period from 1969-1980
    • Number of rural Bank branches increased ten-fold.
    • Credit to rural areas increased twenty-fold.
    • Credit to agriculture expanded forty-fold, reaching 13% of GDP from a starting point of 2% of GDP .
  • But Economic Survey (2020) doubts  whether these benefits were entirely caused by Nationalization as the period also saw various other events like green revolution, anti-poverty programmes (like Integrated Rural Development Programme) and policies of RBI (such as RBI’s 4:1 formula).

Issues faced by Public Sector Banks due to Bank Nationalisation

  • Since government was the majority shareholder of the banks, it started to give loans at populistic ‘Government Administered Interest Rates’  which decreased the profitability of the banks.
  • Banks were forced to give loans to fund unviable projects based on political considerations which increased the NPAs of Public Banks as the recovery of such loans was low. In 2019 public sector banks reported NPAs of Rs. 7.4 lakh crore amounting to about 80 per cent of the NPAs of India’s banking system.
  • Public Sector Banks account for 92.9% of the cases of bank fraud, a large majority (90%) were related to advances, suggesting poor quality of screening and monitoring processes for corporate lending adopted by Public Sector Banks.
  • PSBs perform poorly on Return-on-Assets (RoA), Return-on-Equity (RoE) etc when compared with  Private Banks. Public Sector Banks are having negative RoA presently.   
performance of Public Sector Banks
  • Politicisation of Bank Boards happened with government placing it’s favourites in the Board of Directors irrespective of their knowledge and talent. This reduced the professionalism in the banks.
  • Due to above reasons, RBI feared that banks can collapse. Hence, it mandated high Cash Reserve Ratio (CRR)  , reducing the funds at the disposal of bank for loan purposes.
  • Large staff was hired in banks , even more than what was required, to create government jobs. This led to unionization of staff and inefficient customer services. Frequent hartals of bank employees were observed in the period after nationalization.

Side Topic : Number of Public Sector Banks Today

  • Public Sector Banks = 13 ( on July 2020 including Post Payment Bank).

Old Private Banks

  • All the Big Private Banks were nationalised.
  • But there were Small Private Banks whose deposits were less than limits and they were not nationalised.
  • These Banks are now called Old Private Banks .
  • There are 12 such banks in India .
  • These are Scheduled Banks and have to maintain Cash Reserve Ratio & Statutory Liquidity Ratio .
  • Examples : Catholic Syrian Bank, Dhanlaxmi Bank, Federal Bank, Jammu and Kashmir Bank etc. .

Narsimham Committee and (Rise of ) New Private Sector Banks

After the 1980 nationalization, Public Sector Banks had a 91% share in the national banking market which has reduced to 70% in recent times. Reduced stake has been absorbed by New Private Banks (NPBs) which came up in early 1990s after liberalization. This brings us to the topic of New Private Banks .

Share of different banks in India

Private Sector Banks

1991: Balance of Payment crisis finally forced Govt. to set up a Committee for Banking Sector Reforms under the former RBI Governor M Narsimham . He recommended :

  • Government should decrease its shareholding in Public Sector Banks.
  • The resources of the banks come from the general public and are held by the banks in trust that they are to be deployed for maximum benefit of the depositors.  Even the government had no business to endanger the solvency, health and efficiency of the nationalised banks under the pretext of using banks, resources for economic planning, social banking, poverty alleviation, etc.
  • RBI should decrease CRR and SLR .
  • Priority Sector Lending (PSL) given to agriculture and Small Scale Industries (SSIs) should be phased out gradually as they had already grown to a mature stage . They don’t require any special support; two decades of interest subsidy were enough.
  • Govt. should not dictate interest rates to Banks .
  • Liberalize the branch expansion policy .
  • Allow entry of New Private Banks and New Foreign Banks.

This led to 3 Rounds of Banking Licenses

1st Round (1993-95) 10 licenses were given to open following banks.
3. Indus
4. DCB
5. UTI => later Axis bank
6. IDBI => now owned by LIC
7. Global Trust Bank => Merged with Oriental Bank
#8-9-10: Bank of Punjab, Centurion Bank, Times Bank were merged into HDFC  
2nd Round (2001-04)  2 licenses were given in 2nd Round
1. Kotak Mahindra
2. Yes Bank   
3rd Round (2013) Bimal Jalan Committee made selections:
1. Bandan Microfinance  (A Microfinance company based in West Bengal) 
2. IDFC (An infra finance NBFC based in Maharashtra). Later on, another NBFC “Capital First” merged so renamed into IDFC-First

Side Topic : Number of Private Banks in India

  • 22 Presently ( after IDBI is privatised)

On Tap System of Banking License

  • Present System : Start & Stop System
    • RBI issues notification and interested entities can apply at that time only..
    • Till now , 3 such rounds have happened
  • New Proposed : On Tap System
    • In this system , there will be no deadline for application. No need to wait for notification.
    • When entity thinks that it is fit to become Bank , they can approach RBI with application.
    • RBI has issued guidelines regarding this too.

No one has applied for Banking License through this route yet .

Foreign Commercial Banks

  • In Nehruvian Socialist Economy there was disdain & apprehensions about Foreign Banks. Only a handful of them were allowed to open branches. But, Post-Narasimham-Reform, foreign banks approval policy was liberalized.
  • 1991 : M Narsimham Committee recommended to allow Foreign Banks on reciprocal basis . Government accepted this proposal.
  • There are 44 Foreign Banks in India
Foreign Commercial Banks in India
  • Foreign Bank has to first open Indian Subsidiary registered in India under Companies Act .

Core Banking Solution

  • Core Banking Solution (CBS) is networking of branches, which enables Customers to operate their accounts, and avail banking services from any branch of the Bank on CBS network, regardless of where he maintains his account. The customer is no more the customer of a Branch. He becomes the Bank’s Customer.
  • It has helped in converting Branch Banking to Branchless Banking .

This marks end of article on “History of Banking System.’