Banking and Insurance - Laws and Practice · Overview of Indian Banking System

Evolution and Structure of the Indian Banking System

Updated 11 October 2026

The Indian banking system grew from early joint-stock banks and the Presidency banks through the RBI (1935), nationalisation and the 1991 reforms. Today the RBI is at the top, with scheduled and non-scheduled banks (commercial and cooperative) below it, and development institutions as a separate long-term finance category. Trace the phases, then classify banks with one feature each.

Understand Evolution and Structure of Indian Banking System

Banking in India did not appear at once. It grew in phases, and each phase fixed a gap in the one before. If you know the phases, you can answer almost any history question in the exam.

Pre-independence phase. Early banks were private joint-stock banks, and many failed. The three Presidency Banks (Bengal, Bombay, Madras) were later merged into the Imperial Bank of India. The Reserve Bank of India was set up under the RBI Act, 1934 and began work in 1935 as the central bank. The Imperial Bank later became the State Bank of India.

Post-independence phase. The state took a larger role in banking. The Banking Regulation Act, 1949 gave RBI wide control over banking companies. Major commercial banks were nationalised in 1969 and more in 1980, to push credit to agriculture, small industry and weaker sections. Regional Rural Banks were created to serve rural areas.

Reforms phase (from 1991). Reforms opened the sector to private banks, reduced controls on interest rates and strengthened prudential norms such as capital adequacy and asset classification. Later steps include payment banks, small finance banks and consolidation of public sector banks through mergers.

Present structure. RBI is the regulator and central bank. Below it, banks are classed as scheduled banks and non-scheduled banks. A scheduled bank is one included in the Second Schedule to the RBI Act. Both groups are made up of commercial banks (public sector, private sector, foreign, small finance, payment, regional rural) and cooperative banks (urban and state/district/rural cooperatives). Be careful with the legal basis for cooperative banks. Among cooperative banks, Section 42(6)(a)(iii) expressly provides for State co-operative banks to be included in the Second Schedule. Do not say that this clause covers every kind of cooperative bank. Development banks and similar institutions, such as NABARD and SIDBI, provide long-term finance. Treat them as a separate category, outside the scheduled and non-scheduled classification of commercial and cooperative banks.

The key difference between commercial and cooperative banks: commercial banks are companies or statutory bodies run for business, while cooperative banks are owned by members and run on cooperative principles, with a state-level and local structure.

Key rules to remember

Cash reserve duty of scheduled banks: Average daily balance with RBI ≥ such per cent of the total of the demand and time liabilities in India as RBI notifies in the Gazette of India; Section 42(1) of the RBI Act: every bank in the Second Schedule must maintain it. The Act uses the words 'total of the demand and time liabilities in India' as shown in the return. The Explanation excludes items such as paid-up capital and reserves, and nets inter-bank liabilities. 'NDTL' is only a commonly used regulatory shorthand, not the wording of Section 42(1). The exact percentage is notified by RBI, so do not quote a fixed figure.
Fortnight under Section 42: Fortnight = Saturday to the second following Friday, both days inclusive; Average daily balance is the average of the balances at close of business on each day of the fortnight.
Return by scheduled banks: Return at close of business on each alternate Friday, sent within 7 days of the date it relates to; Section 42(2). The return is signed by two responsible officers.
Inclusion in Second Schedule (capital test): Paid-up capital and reserves ≥ ₹5,00,000 in real or exchangeable value; Section 42(6)(a). This is one of three tests. 'Value' means real or exchangeable value, not the nominal value shown in the books, and if a dispute arises in computing it, RBI's determination is final. RBI must also be satisfied that affairs are not conducted to depositors' detriment. The bank must also be a State co-operative bank, a company as defined in the Act, an institution notified by the Central Government, or a corporation or company incorporated by or under any law in force outside India.

How to solve Evolution and Structure of Indian Banking System questions

Use this method for history, classification and comparison questions on the structure of Indian banking.

1Read the question and mark the task: trace evolution, classify, compare, or explain a legal term.
2For evolution questions, give phases in date order: pre-independence, RBI 1935, post-independence and nationalisation, reforms from 1991, recent changes.
3For each phase, give the cause and the effect, not just the event.
4For classification questions, draw the tree: RBI, then scheduled and non-scheduled banks, each made up of commercial and cooperative banks. Show development financial institutions as a separate category, not under scheduled banks.
5Give one defining feature for each category, such as ownership, regulator or purpose.
6For scheduled bank questions, cite the Second Schedule of the RBI Act and the duties under Section 42.
7Close with a one-line conclusion linking structure to RBI's regulatory control.

Quickest way: Phase and tree shortcut

When to use it: Use it when you have 5 to 8 minutes for a short note or a comparison.

Write four labels: Pre-1935, 1935 to 1968, 1969 to 1990, 1991 onwards.
Add one event and one reason against each label.
Draw the tree: commercial and cooperative banks under scheduled and non-scheduled banks. Show development financial institutions as a separate box.
Add a two-line comparison on ownership and purpose.
Add the Section 42 reserve duty as a legal point.

Common mistakes in Evolution and Structure of Indian Banking System

Treating scheduled bank as a bank that is government owned.
Students confuse scheduled with public sector.
Fix: Scheduled means included in the Second Schedule to the RBI Act. Private, cooperative and foreign banks can be scheduled.
Quoting a fixed cash reserve percentage as the law.
Memorised figures from news or notes.
Fix: Section 42(1) leaves the percentage to RBI's notification. Say it is such per cent of demand and time liabilities as RBI notifies.
Placing RBI's founding in 1949.
Mixing the RBI Act, 1934 with the Banking Regulation Act, 1949.
Fix: RBI Act, 1934; RBI began operations in 1935. The 1949 Act regulates banking companies.
Calling development banks commercial banks.
Both lend money.
Fix: Development banks give long-term finance for sectors like agriculture and industry and do not mainly take retail deposits.
Writing the history as a list of dates with no reasons.
Rote learning.
Fix: Add why each phase happened, for example nationalisation aimed at wider credit reach.
Mixing up fortnight with calendar two weeks.
Ignoring the Explanation to Section 42.
Fix: A fortnight runs Saturday to the second following Friday, both included.

Worked examples

Example 1

Explain what a scheduled bank is and state its main statutory obligations under Section 42 of the RBI Act, 1934.

Show the solution

Definition: a scheduled bank is a bank included in the Second Schedule to the RBI Act.
Inclusion under Section 42(6)(a) needs three things. First, paid-up capital and reserves of not less than ₹5,00,000. Here 'value' means real or exchangeable value, not the nominal book value, and RBI's determination of it in a dispute is final. Second, RBI's satisfaction that affairs are not conducted to depositors' detriment. Third, the bank must be a State co-operative bank, a company as defined in the Act, an institution notified by the Central Government, or a corporation or company incorporated by or under any law in force outside India.
Reserve duty: it must keep an average daily balance with RBI of not less than the notified per cent of the total of its demand and time liabilities in India.
Average daily balance is measured over a fortnight, Saturday to the second following Friday.
Return duty: it sends a return signed by two responsible officers at close of business on each alternate Friday, within seven days.
Default on the reserve: if the average daily balance in a fortnight is below the minimum, the bank pays penal interest at 3% above bank rate on the shortfall. If the balance is still short in the next fortnight, the rate rises to 5% above bank rate for that fortnight and each later fortnight of continuing default. Once the 5% rate has become payable, if the balance in the next succeeding fortnight is still below the minimum, Section 42(3A) applies. Every director, manager or secretary who is knowingly and wilfully a party to the default is punishable with fine up to ₹500, and a further fine up to ₹500 for each subsequent fortnight of default. RBI may also prohibit the bank from receiving any fresh deposit after that fortnight.
Default on the return: failure to send the return under Section 42(2) is not a case of penal interest. The bank is liable to pay a penalty of ₹100 for each day the failure continues, under Section 42(4).

Answer: A scheduled bank is one in the Second Schedule. It must maintain the notified cash reserve with RBI as an average daily balance over each fortnight and file alternate-Friday returns. A reserve shortfall attracts penal interest (3% above bank rate, then 5% above bank rate for continuing default). If the shortfall continues in the next fortnight after the 5% rate applies, Section 42(3A) brings fines on the responsible directors, managers or secretaries (up to ₹500, plus up to ₹500 per later fortnight) and allows RBI to bar fresh deposits. Failure to send returns attracts a penalty of ₹100 per day.

Example 2

Distinguish between commercial banks and cooperative banks in the Indian banking structure.

Show the solution

Ownership: commercial banks are public sector, private sector or foreign banks; cooperative banks are owned by their members.
Purpose: commercial banks work for business and wide credit; cooperative banks serve members, often farmers, small borrowers and local communities.
Structure: commercial banks are in public, private, foreign, small finance, payment and regional rural groups; cooperative banks have urban banks and a state, district and primary tier in rural credit.
Scheduled status: a bank is scheduled only if it is included in the Second Schedule. Among cooperative banks, Section 42(6)(a)(iii) expressly names State co-operative banks as eligible for inclusion. Do not say that this clause covers all cooperative banks.
Regulation: RBI regulates both, but cooperative banks also have state-level cooperative law.

Answer: Commercial banks are business-oriented institutions with varied ownership, while cooperative banks are member-owned and community-focused. Either type is a scheduled bank only if it is included in the Second Schedule. For cooperative banks, the Act expressly provides for State co-operative banks.

Exam tips

Write the phases in a time order with a heading for each. It scores better than a long paragraph.
Always connect structure to the regulator: RBI Act for scheduled status, Banking Regulation Act for banking companies.
Do not quote a cash reserve percentage as fixed. Refer to RBI's notification.
A neat tree diagram is quick and earns marks. Show commercial and cooperative banks under scheduled and non-scheduled banks, and show development institutions separately.
In case-based questions, apply the facts: check if the bank is in the Second Schedule before concluding it is scheduled.

Practice questions from Overview of Indian Banking System

Evolution and Structure of Indian Banking System: frequently asked questions

What is the difference between scheduled and non-scheduled banks?

A scheduled bank is included in the Second Schedule to the RBI Act, 1934. A non-scheduled bank is not included. Scheduled banks must maintain a reserve with RBI under Section 42 and file returns.

What are the types of banks in India?

Broadly, RBI is the central bank. Commercial banks and cooperative banks are each classed as scheduled or non-scheduled, depending on whether they are in the Second Schedule. Commercial banks include public, private, foreign, small finance, payment and regional rural banks. Among cooperative banks, Section 42(6)(a)(iii) expressly provides for State co-operative banks. Development banks, such as NABARD and SIDBI, are long-term finance institutions treated as a separate category, outside this scheduled and non-scheduled classification.

When did RBI start working?

The RBI Act was passed in 1934 and RBI began operations in 1935. It was nationalised after independence.

Do I need to remember exact dates for evolution questions?

Remember the key milestones: 1935 for RBI, 1949 for the Banking Regulation Act, 1969 and 1980 for nationalisation, and 1991 for reforms. Reasons and effects matter more than minor dates.