Commercial Banks and Industrial Finance in India: The Pre-Liberalisation Scenario Subhamoy Das Professor, Department of Commerce University of Kalyani, Kalyani, Nadia e-mail: [email protected] Abstract: Development of industry is an essential prerequisite for the development of the economy of a country. Needless to say that it is absolutely imperative to have a proper supply of ·finance for the industrial sector to develop and prosper. Commercial banks, inter alia, of a country have to play a pivotal role in this respect, especially when the economy is a budding one. The economy of India has grown at a rapid pace since the economic liberalisation process took off in 1991-92. With the onset of this process, the capital market in India snowballed and has become a major source of industrial finance. But one must not forget that in the pre-liberalisation era, the underpinning in this respect was provided mainly by the commercial banks. With this in view, this paper attempts to analyse in-depth their contribution prior to the incipience of economic liberalisation since the infancy of modem day banking in India. Key-words: Commercial banking, sectoral deployment, bank advances, underwriting. 1. Introduction It is a known fact that from very early times there existed in India a reasonably developed mechanism of banking and credit by contemporary standards, capable of fulfilling the needs of the then Indian society. The Vedas, Manusmriti and Kautilya's Arthashastra bear testimony to the existence and efficient functioning of banking in ancient India. "From all this it is obvious that India possessed for all times known to history a system of banking which admirably fulfilled her needs and proved very beneficial to her, although its methods were different from those of modem Western banking" (Garg, /964). The method of banking that existed in India in those days consisted of money lending and transfer of monetary cl_aims through Hundis from one place to another. "The use of credit instruments is also quite old in India and Hundi, the indigenous credit instrument, has been in vogue for a very long time. In our early history one comes across referenc~ to bankers whose Hundis were honoured throughout the length and breadth of the country" (Ghosha/ and Sharma. /965). The banking system carried on by individuals known as 'Shresthis' and 'Sahukars' served the needs of primitive and medieval agriculture, industry and trade. These bankers were also the bankers of the native rulers. The house of Jagat Seths, the hereditary bankers of the Nawab of Bengal, was founded as early as in 1715 (Sinha, 1927). With the arrival of the East India Company in India the modem era of trade and commerce commenced. The British businessmen, conversant with the banking system that was in existence in their country at that time, found it inconvenie11:t to carry on their activities in India as the Business stndle&-Vol: XXXV & XXXVI, 2014 & 2015 indigenous bankeis were either incapable or unwilling to extend banking or credit facilities to them. Thus, in order to meet the requirements of English businessmen, the Managing Agency houses of Calcutta and Bombay gradually extended their horizon of operation to include banking. In filct, the entry of the Managing Agency Houses into the arena of banking marked the eme,gence of the practice of British commercial banking in India. The earliest example of such banks in India was the Bank of Hindostan, established in Calcutta by Mess111. Alexander & Co. in 1770 and that was also the fi111t public bank of the country. The second wave of banking development came at the beginning of the nineteenth century with the establishment of the fi111t Presidency Bank, the Bank of Calcutta, in 1806. Two more Presidency Banks, the Bank of Bombay and the Bank of Madras were established in 1840 and 1843 respectively. The Presidency Banks acted as the banke111 of the Government and had the right of issuing currency notes till 1862. These banks also served the interest of the East India Company and British businessmen till their merger and the formation of the Imperial Bank of India in I 921. Modern joint stock banking in India may be said to have begun from 1860 when the concept of limited liability was made applicable to the banking business by the Companies Act of 1860, which followed the English Act of 1858 (Rungta, 1970). Since the passing of the Companies Act of 1860, large number of banking and loan companies were established. In 1895-96 there existed 299 such banking and loan companies, but most of those companies were so small that they were no more than small savings and loan societies. Thus, the progress of modem organised banking was not very satisfactory; by the end of the century there were three Presidency Banks, eight Exchange Banks and nine Indian Joint Stock Banks, besides a number of small savings and loan societies. The Presidency Banks, as has already been mentioned, were semi-Government iostibltions. The Exchange Banks, owned by foreigneis, engaged themselves primarily in the inlemational trade of India and the Joint Stock Banks, owned mainly by the Indians, confined themselves primarily to the internal trade. 2.. State of lndnstrial Finance in India The modem banking system, developed in India under the initiative and enterprise of those who were cooveisant with the British counterpart, oablrally followed the orthodox British ~ The banking system arose out of the requirements of foreign investo111 who transacted business in India, mainly foreign trade, and remitted money to their country. ''They needed a modem banking system to carry out the processes of foreign trade-most important, to transfer foreign exchange or to supply it, and also to meet credit requirerneiits between order and payment. ...T he English investo111 normally invested their own resources and ploughed back d,eir earnings. . .. There was little demand for long-term credit under such circumstances; the .,.._ amintaincd their English character as instibltions for the supply of short-term credit" ("-, /962). Subhamoy Das Indian businessmen, who began to shift from commerce to industry under the stimuli of examples set by the foreigners or self-recognised opportunities, also experienced inconvenience in financing their ventures without support from the banking system. In the absence of issue houses and investment banks, the Indian entrepreneurs were neither in a position to get their shares and debentures underwritten nor was there any supply of finance specially for meeting the long-term needs. The Indian entrepreneurs, however, did not Jag behind. A number of Indian owned banks were set up, in some cases, by the entrepreneurs themselves for ensuring the supply of fund to the ventures owned or patronised by them. "Many of the banking, insurance, and finance companies were under the domination or influence of particular business houses, giving rise to a system of what may be called 'captive' financial institutions which were integral parts of financial and industrial complexes" ( Gupta, I 969). Such chain holding of financial and industrial companies gave birth to a system of individual or family control over a number of industries, which ultimately paved the way for investment of profits of industries· under the same ownership among themselves. Thus, the long-term financial needs of the industries under the big business houses were met to a considerable extent from the internal sources and the banks were ultimately allowed to follow the British system of supplying only short-term working capital. The Indian-owned banks, modelled on the British, thus performed a similar function the supply of short-term credit against tangible, rapidly turned over assets in the form of stocks of raw materials and finished products. Demand for fostering indigenous industries, however, gained momentum with the onset of the twentieth century under the influence of the Swadeshi Movement. Ambition of industrial development, strengthened by the spirit of the Swadeshi Movement, led to the establishment of a number of banks in different parts of the country particularly for meeting the needs of indigenous industries. Attempts at such industrial financing were made for the first time by a number of commercial banks, mostly in the Punjab, during the Swadeshi movement of I 906- 13. Instead of pursuing the orthodox system of commercial banking, these banks freely subscribed to the shares and debentures of the industrial companies set up by the Indians and also granted loans and advances against the mortgage of real estates and capital goods. The new Joint Stock Banks undertook varied types of business, including industrial financing and developed an unmistakable tendency to provide long-term finance to industry. But these banks, popularly known as Swadeshi Banks, had a very brief history of operation. A large number of these banks failed during the crisis of 1913-15. The founders of these banks were mos\ly enthusiastic Indians without any experience in banking or industrial finance, nor did they pay due regard to known principles and practices of investment banking. They were primarily deposit banks and the policy oflocking up almost the whole of their resources in long-term industrial investments, unrealisable at the time of a crisis, was inevitably followed by disastrous consequences. During the boom that followed the First World War, a number of commercial banks were promoted to provide long-term finance to the companies set up by the Indian entrepreneurs. The promoters of these banks were moved by the role played by the Japanese and German 3 Business Studies-Vol : XXXV & XXXVI, 2014 & 2015 industrial banks in the spectacular industrial development of those countries. But whatever might have been there in the minds of the promoters, these banks were far. from well-conceived industrial banks. A perusal of their Memoranda and Articles of Association shows that they intended to pursue every variety of ordinary banking business and couple with it issue, investment trust and real estate mortgage business. Undaunted by the massive periodic failures, the search for an appropriate system of industrial financing institutions continued. Formation of the Imperial Bank oflndia in 1921 and the establishment of the Reserve Bank of India in I 934 failed to provide any solution to the problem in the absence of a definite policy for industrial development and a plan for realising the goal. Thus, at the start of the programme of industrialisation after independence, India had a large unorganized money market which met the demands for funds on the part of the niral and poor urban population; an almost unrelated modem banking system, the main purpose of which was to supply the short-term capital needs of firms whose longer term requirements were largely met from the internal sources of the firm or the ownership group; and a security market which contributed to meeting the longer term investment needs of only a few firms. 3. Commercial Banking in India since Independence: Trends and Progress An analysis of the policy of commercial banks with respect to the financing of industrial development in the period since the independence of India must be preceded by a brief account of the various types of commercial banks, their relative importance and their lending practices. In India there are scheduled banks and non-scheduled banks. Scheduled banks are banks that are included in the Second Schedule of the RBI Act, I 934 having paid-up capital and reserves of an aggregate value of Rs. 5 lakh and above. Such banks must maintain a minimum reserve with the Reserve Bank of India and have the right to borrow from it under different circumstances. The non-scheduled banks, on the other hand, are smaller banks with paid-up capital and reserve below Rs. 5 lakh. These banks are not required to maintain any reserve with the Reserve Bank of India, but can borrow from it only under special circumstances. Both the scheduled and non-scheduled banks are under the control of the Reserve Bank of India. The control of the Reserve Bank of India has been strengthened by tho Banking Companies Act of I 949 and the nationalisation of the Reserve Bank of India in the preceding year. In this context, it may be noted that since May I 997 there does not exist any non-scheduled commercial bank in India, although there are some non-scheduled cooperative banks. From the point of view of the number of banks and the volume of business transacted, the non-scheduled banks occupy a very insignificant position. From Table I it can be found that over the years from 1951 onwards, the non-scheduled banks have lost their significance steadily both in terms of attracting deposits and extending credit. In I 970, the non-scheduled banks attracted only 0.45 per cent of the deposits and extended 0.27 per cent of credit of both the categories of banks taken together. 4 Subhamoy DIS Table-I : Commercial Banking Trends at a Glance (As on the last Friday of June) (Rs. Crore) 1951 1961 1967 1970 No. of Banks: i) Scheduled Banks 92 84 74 72 ii) Non-Scheduled Banks 474 249 24 14 Deposits: i) Scheduled Banks 918.1 1775.8 3517.0 5239.8 ii) Non-Scheduled Banks 69.9 43.4 24.5 23.5 Bank Credit: i) Scheduled Banks 545.1 1282.8 2631.1 4227.6 ii) Non-Scheduled Banks 45.8 27.6 IS.I 11.3 Sources: I) Reserve Bank of India: Annual Report on the Working of the Reserve Bank of India and Trend amt Progress of Banking in India, June 30, 1970, Bombay. 2) Reserve Bank of India: Statistical Tables Relating to Banks in India, 19S3, Bombay. The scheduled banks also include the branches of foreign banka which were centred in and around the port cities for facilitating the financing of foreign trade. Since 1947, the situation hlS changed considerably. Now the branches of foreign banks are taking part in internal banking business as well and the Indian scheduled banks are also taking an interest in foreign trade. Thus, side by side, with expansion in the volume of business, the scheduled banks have also extended the scope of their operations. The non-scheduled banks, on the other hand, serve mainly the rural and unorganised sector. In the context of the above analysis, our examination of the role of commercial banks in the supply of industrial finance would naturally include only the scheduled commercial banks. Indian banking made considerable progress during and after the Second World War. But it was not sufficient to meet the requirements of a VIS! country like India. A small number of big banka concentrated their operations mostly in the urban areas, wherelS the VIS! rural areas remained either completely unbanked or were banked by a few smaller banks with meagre financial resources. Hence, in order to consolidate the banking system, a policy of merging the non-viable units with the viable ones WIS followed. This led to a reduction in the number of banks in the subsequent years. Simultaneously, however, the branches of scheduled commercial banks were opened in the unbanked or meagrely banked rural areas. The twin policy of strengthening the banking system and extending the area of operation of the organised banking WIS successfully pursued, through the formation of the State Bank of India in 1955 and the nationalisation of the fourteen major commercial banka in July, 1969. 5 Business Studies-Vol : XXXV & XXXVI, 2014 & 2015 From Table 2 it would appear that since nationalisation in 1969, the commercial banking recorded an all-round progress. Through the opening of new branches, the commercial banks were able to go nearer to the people and mobilise their precious savings for use in productive purposes. While the deposits of commercial banks during the period increased by more than 51 times, the number of people served by each office of commercial banks decreased from 64,000 to 14,000 only. This necessarily means that there was also qualitative improvement in the services of the commercial banks. Increase in per capita deposits by more than 31 times conclusively proves the ability of nationalised banks in mobilising the savings of the people by going nearer to them. In fact, the all-round progress of the commercial banks since nationalisation demonslillted the confidence of the society in the economic philosophy which did away with the domination and control of banks by large business houses. Table-2 : Progress of Commercial Banking at a Glance Important June June June March Indicators 1969 1984 1988 1992 I. No. of Commercial Banks of which 89 247 278 276 a) Non-Scheduled 16 4 4 4 b) Scheduled 73 243 274 272 of which (RRBs) (-) (162) (196) (196) 2. No. of Bank Offices in India 8262 45332 55410 60570 3. Population per office (in thousands) 64 16 14 14 4. Deposits of Scheduled Comm. Banks in India of which (Rs. Crore) 4646 64620 126323 237566 a) Demand 2104 12195 21936 48893 b) Time 2542 52425 104387 188672 5. Credit of Scheduled Comm. Banks in India (Rs. Crore) 3599 43613 72436 131520 6. Deposits of Scheduled Comm. Banks per office (Rs. Laich) 56 143 228 392 7. Credit of Scheduled Comm. Banks per office (Rs. Lakh) 44 96 131 217 8. Per Capita Deposits of Scheduled Comm. Banks (Rs.) 88 878 1586 2738 S-U: R<serve Bank of India: Ban/ring Statistics: Basic Statistical Returns, Vol. 20, March 1991, Published in February 1993, Bombay. 6 Subbamoy Das 4. Financial Practice of Indian Commercial Banks: Emerging Trends Toward Industrial Financing in India Commercial banks are a major source of finance to industry and trade. During the period from 1969 to 1992, the volume of bank credit increased by 36.54 times from Rs. 3599 crore to Rs. 131520 crore. Banks in India mainly provide short-term credit for meeting the working capital needs of the borrowers. This is mainly because of the fact that a substantial portion of the resources of these banks consists of demand and short-term deposits. In actual practice, however, a considerable portion of the short-term bank credit is always renewed and therefore, serves as a substitute for long-term finance. Moreover, quite in tune with the changing practice of commercial banking from 'real bills doctrine' to the 'anticipated income theory', the Indian commercial banks extended the scope of their operations in order to meet the requirements of planned economic development. S.K. Basu wrote in 1980: "Commercial banking today presents a new picture-a picture of innovations in practice, of wider horizons and of new enterprises." Supply of credit for packing, advances against export and import bills, foreign currency loans and cash incentives for export were examples of such innovations. While there were development banks and other financial intermediaries for supplying term loans, the commercial banks also enlianced the supply of term loans to industry. While participation in long term industrial financing has taken place through clearly distinct financial intermediaries and has therefore been indirect, there appears to be a broad trend towards a shift of commercial banks' interest in favour of direct term loans on American lines to trade and industry. From Table 3 it can be seen that during the period from 1972 to 1991, the composition of outstanding credit of commercial banks i:nderwent very meaningful changes. In the first place, cash credit, the most popular form of bank credit, lost much of its importance and the term loans gained considerable prominence. In 1972, cash credit constituted as much as 50.4 per cent of the outstanding bank credit whereas in 1991, it came down to 35.7 per cent. During the same period, the share of term loans increased from 11.9 per cent to 30.5 per cent of the outstanding bank credit. Again, during the same period, the shares of overdrafts and demand loans declined slightly, but those declines were made good by the addition of new forms of credit granted for specific purposes such as those against foreign currency cheques, etc. and advances against Export Cash Incentives and Duty Drawback claims. Over the period of twenty years, as shown in Table 3, the ·volume of bank credit increased by more than nineteen times. Corporate sector of India, the centre of all industrial and business activities, is a deficit sector in the sense that its requirements for new investments cannot be met from its internal sources. Thus, for meeting the deficit, the corporate sector draws upon the surplus of other sectors, particularly the household sector, the commercial banks and other financial institutions. 7 Business Studl.,._Vol: XXXV & XXXVI, 2014 & 2015 Tllble-3 : Distrlutlon of Outstanding Credit of S~heduled Commercial Banks according to Type of Account (Amount outstanding as on the last Friday) (Rs. Crore) Type of Account Dec. Dec. Dec. March 1972 1980 1988 1991 I. Cash Credit 2544.7 8578.3 22613.2 34554.6 (50.4) (42.4) (38.0) (35.7) 2. Overdrafts 479.7 1345.2 4387.8 7505.0 (9.5) (6.7) (7.4) (7.8) 3. Demand Loans 330.9 981.1 2259.3 3363.8 (6.6) (4.9) (3.8) (3.5) 4. Term Loans 601.1 4492.4 17204.3 29615.6 (11.9) (22.2) (28.9) (30.5) 5. Packing Credit 209.6 754.5 2726.4 4255.6 (4.1) (3.7) (4.6) (4.4) 6. Export Bills Purchased/ Discounted / Advanced against 212.4 795.7 1944.6 3642.1 (4.2) (3.9) (3.3) (3.8) 7. Inland Bills Purchased/ 631.9 3056.8 7718.0 10847.9 Discounted (12.5) (15.1) (12.9) (11.2) 8. Advances against Import Bills 30.3 217.0 545.2 1269.3 (0.6) (I.I) (0.9) (1.3) 9. Foreign Currency Cheques / - - 124.8 1608.3 TCs / DDs / TTs / MTs purchased (0.2) (1.7) 10. Advances against Export Cash - - - 218.2 Incentives & Duty Drawback claims (0.2) II. Unclassified 10.8 - - - (0.2) TOTAL: 5051.4 20221.0 59523.7 96880.4 Nair. Figura in brackelS indicate pen:entage to total. s.rcr. Racrve Bank oflndia: Banking Statistics: Basic Statistical Returns, Vol. I, 1972; Vol. II, 1980; Vol. 17, 1988; Vol.20, 1991. B Subbamoy Das Table 4 depicts the composition and the volume of flow of fund to the private corporate sector from various sources from the beginning of the First Five Year Plan to 1990-91. The table indicates that during the First Plan period, about IS per cent of the fund required by the private corporate sector had come from the Banking sector. Flow of fund from the banking sector to the private corporate sector increased to 61 per cent in 1966-69 and reached a low point of 23 per cent of its requirements in 1980-81. Since 1981-82, the share of the Banking sector began to increase and by I 988-89 it accounted for the next all-time high of SS per cent of the total flow of fund to the private corporate sector. Overall proportionate decline in the flow of fund from the Banking sector to the private corporate sector since 1969-70 is attributable to the nationalisation of fourteen major commercial banks in I 969 and the adoption of the policy of providing greater financial support to the priority sector. It is also very interesting to note that the flow of funds from the other financial institutions, which include mainly development banks, increased appreciably during the period. In fact, decline in the flow of fund from the Banking sector during the period was made good, at least to a considerable extent, by increase in the flow of funds from the other financial institutions. Barring the First Five Year Plan period and early 1980s, flow of funds to the private corporate sector from banking and other financial institutions taken together varied between S4 per cent and even one hundred per cent during the period covered by the study. Table-4 : Flow of Fund to Private Corporate Sector (Rs. Crore) Year Banking Other Govt. Households Rest of Others Total Financial the Institutions World 19Sl-S6 63 40 29 27S 8 I 416 (IS) (10) (7) (66) (2) (-) (100) 19S6-61 363 82 9S 281 61 -S8 824 (44) (10) (12) (34) (7) (-7) (JOO) 1961-66 813 3S4 IIS 2S3 62 - IS97 (SI) (22) (7) (16) (4) (-) (100) 1966-67 69S 226 68 89 60 -4 1134 to (61) (20) (6) (8) (S) (-) (100) 1968-69 1969-70 4S0 211 143 292 -60 21 I0S7 to (43) (20) "(13) (28) (-6) (2) (100) 1971-72 9 Business Studl0$-Vol : XXXV & XXXVI, 2014 & 2015 Tahle-4 : Flow of Fund to Private Corporate Sector ( Contd.) (Rs. Crore) Year Banking Other Govt. Households Rest of Otben Total Financial the Institutions World 1980-81 637 686 134 1017 2 328 2804 (23) (24) (5) (36) (-) (12) (100) 1981-82 1641 1056 150 1481 40 1579 5947 (28) (18) (2) (25) (1) (26) (100) 1982-83 1464 1175 171 1716 48 1220 5794 (25) (20) (3) (30) (I) (21) (100) 1983-84 1053 1320 IOI 519 37 1026 4056 (26) (32) (3) (13) (I) (25) (100) 1984-85 1625 1406 -164 1178 76 904 5025 (32) (28) (-4) (24) (2) (18) (100) 1985-86 2311 . 1642 -35 1827 - 789 6534 (35) (25) (-) (28) (-) (12) (100) 1987-88 2886 3238 -69 1035 86 -892 6284 (46) (52) (-1) (16) (1) (-14) (100) 1988-89 7107 5502 -446 1362 451 -937 13039 (55) (42) (-3) (10) (3) (-7) (100) 1989-90 6373 8196 71 1807 788 -2798 14437 (44) (57) (-) (12) (5) (-19) (100) 1990-91 6067 8393 165 1423 1029- -2245 14832 (41) (56) (1) (10) (7) (-15) (100) N*' Figures in brackels indicate percentage (in rounded figure) to total. s.na: a) V. V. Divatia & T.R. Venkatachalam: "Flow of Funds Accounts" in Reserve Bank of India Slaff Occasionol Papers, Vol. No. 2, Dec. 1976, p.129; b) Reserve Bank of hK!ia: Reserve Bank of India Bulletin, Bombay, January 1991 and June 1993. Having mwysed the pattern of flow of funds from different sectors to the private corporate -· ii would now be pertinent to analyse the relative importance of the different sources 'Jf fimd fiam the point of view of die users of fund, that is, the c01porate sector. 10