🏦 JAIIB · IE & IFS · Module C · Chapter 20
Indian Financial System — An Overview
From Bank of Hindustan (1770) to UPI and Digital Rupee — 250 years of Indian financial history compressed into four phases. Formal vs informal systems, financial institutions, instruments, markets, and how two Narasimham Committees transformed Indian banking.
⏱ 18 min read🎯 High Exam Weightage📅 4 Phases of Development⚡ 5 PYQs Inside
Sections 1–3 — What, Why, and Overview
The financial system is the bloodstream of the economy
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Sir, what exactly IS a financial system?
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Simple, Banky. Wealth flows from where it is surplus to where it is deficit. Savers have money → they give it to the financial system → the system gives it to borrowers/investors who need it. Without this flow, no business can operate, no infrastructure gets built, no economy grows. The financial system is three things: Financial Institutions (your bank, LIC, SEBI), Financial Instruments (loans, bonds, deposits, mutual funds) and Financial Markets (money market, capital market, forex market). YOU are part of financial institution — now understand the whole system.
Informal = unregulated (money lenders, mahajans) | Formal = regulated (banks, NBFCs, insurance) | Q1 PYQ: Mutual fund = Formal, NOT informal
Section 4 — Key Concepts
Components of formal financial system + four phases of development
Three Components of Formal Financial System
| Component | What it is | Examples | Sub-types |
|---|---|---|---|
| Financial Institutions | Entities that transfer wealth from savers to investors. Cater to both surplus entities and those needing capital. | RBI, SBI, LIC, NABARD, SIDBI, Mutual Funds, Pension Funds | Banking (depository) — collect deposits, lend | Non-banking (non-depository) — insurance, mutual funds, brokerages | Regulatory (RBI, SEBI, IRDA) | Intermediates (SBI, PNB) | Non-intermediates (NABARD, SIDBI) |
| Financial Instruments | Financial products and services — on asset side (loans, investments, derivatives) and liability side (deposits, insurance policies, mutual fund units) | Loans, Bonds, Deposits, Insurance Policies, MF Units, Derivatives | Asset side: loans, advances, investments, placements | Liability side: deposits, remittances, insurance policies |
| Financial Markets | Where buyers and sellers trade money, commodities, securities, forex and derivatives at prices determined by demand and supply | NSE, BSE, Money Market, Forex Market | Four major segments: Money market | Forex (foreign exchange) market | Capital market | Insurance market |
Four Phases of Development of Indian Financial System
Phase I — Pre-Independence (Prior to 1947)
“Foundation of formal banking — mostly chaotic”
- Roots in Kautilya’s Arthashastra (4th century BC)
- First formal bank: Bank of Hindustan, 1770, Calcutta — discontinued 1832
- Bank of Calcutta (1806) → renamed Bank of Bengal (1809)
- Bank of Madras (1843), Bank of Bombay (1843)
- All three merged in 1921 to form Imperial Bank of India → became SBI on 1st July 1955
- Punjab National Bank formed in 1874
- BSE established 1875 — Asia’s first stock exchange
- Hilton Young Commission (1935) recommended setting up RBI
- Defense of India Rules (DIR) Sep 3, 1939 — forex regulation started
- Most banks failed; people relied on money lenders
Phase II — Post-Independence (1947–1991)
“Nationalisation and institution building era”
- First Five-Year Plan 1951 → mixed economy adopted
- RBI nationalised: 1st January 1949
- SBI established: 1st July 1955
- LIC formed 1st September 1956 — 245 private insurance companies nationalised
- 14 banks nationalised 19th July 1969 (deposits > Rs 50 crores)
- 6 more banks nationalised 16th April 1980 (deposits > Rs 200 crores)
- GIC set up 1972 — 55 private general insurance companies nationalised + 4 PSU cos formed
- RRBs established 1975 (Narasimham Committee recommendation)
- UTI set up 1963 | First scheme: Unit Scheme 1964
- IFCI 1948, ICICI 1955, IDBI 1964, NABARD and EXIM 1982, NHB 1988, SIDBI 1990
- Deposit Insurance Corporation: Jan 1, 1962 (Rs 1 lakh cover)
- BSE Sensex launched 1986
- Lead Bank Scheme December 1969
Phase III — Liberalisation (1991–2010)
“Narasimham Committees + private banks + capital market reforms”
- 1991 crisis: forex reserves crashed to USD 1.1 billion (3 weeks imports)
- July 1, 1991: INR devalued 9%; July 3: another 11%
- India pledged 67 tonnes of gold to IMF for USD 3.9 bn loan
- Narasimham Committee I (1991): 4-tier banking hierarchy, SLR/CRR reduction, 8% CAR, deregulate interest rates, open banking to private sector
- SLR reduced from 38.5% (1991) to 25% (1997) | CRR from 15% to 4.1% (2003)
- CAR fixed at 8% from April 1992
- Recovery of Debts Act 1993 — 6 Debt Recovery Tribunals set up
- ICICI Bank licensed June 1994 | HDFC Bank August 1994
- NSE established — screen-based trading 1992
- Depositories Act 1996 → NSDL and CDSL (99% dematerialisation)
- Settlement cycle: T+5 (2001) → T+3 (2002) → T+2 (2003)
- FIIs permitted 1992 under Portfolio Investment Scheme (PIS)
- Credit rating agencies: CRISIL, ICRA, CARE established
- Narasimham Committee II (1998): Strong banks, narrow banking for weak banks, CAR 9%, DFIs → Universal Banks
Phase IV — Post-GFC (2010–Present)
“Financial inclusion + consolidation + digital revolution”
- Global Financial Crisis 2007-08: originated in US sub-prime mortgage market
- India relatively protected but took measures: repo reduced 9%→4.75%, CRR 9%→5%
- PM Jan Dhan Yojana (PMJDY) — JAM Trinity (Jan-Dhan + Aadhaar + Mobile)
- Nachiket Mor Committee (Sep 2013) → Payments Banks and Small Finance Banks licensed (2015)
- P J Nayak Committee (2014) — governance of bank boards
- PSU bank consolidation: 27 banks → 12 banks
- Insolvency and Bankruptcy Code (IBC) — speedy NPA resolution
- NaBFID (2021) — apex DFI for infrastructure financing
- NARCL (“Bad Bank”) — take over Rs 2 lakh crore impaired assets
- Cooperative banks brought under Banking Regulation Act (2020 amendment)
- Deposit insurance cover: Rs 1 lakh → Rs 5 lakhs
- UPI, NEFT 24×7, RTGS 24×7 introduced
- FDI in insurance: 49% → 74%
- LIC IPO launched
Banks Nationalised in 1969 and 1980
| 1969 — 14 Banks (deposits > Rs 50 crores) — 19th July | 1980 — 6 Banks (deposits > Rs 200 crores) — 16th April |
|---|---|
| Allahabad Bank, Bank of Baroda, Bank of India, Bank of Maharashtra, Canara Bank, Central Bank of India, Syndicate Bank, UCO Bank, United Bank of India, Union Bank, Punjab National Bank, Indian Overseas Bank, Indian Bank, Dena Bank | Andhra Bank, Corporation Bank, Punjab & Sind Bank, Vijaya Bank, Oriental Bank of Commerce, New Bank of India |
Section 5 — Exam Angle Points
All 5 PYQ answers plus high-frequency facts
✅ Must-Know Facts — Verified from PDF
- Mutual fund is NOT part of informal financial system — it is formal (Q1 PYQ: answer = Mutual fund)
- Association (mahajan) is NOT part of formal financial system — it is informal (Q2 PYQ: answer = Association)
- Financial system has three parts: Financial market + Financial instrument + Financial institution = ALL three (Q3 PYQ: answer = All of the above)
- First bank established in India: Bank of Hindustan, 1770, Calcutta (Q4 PYQ: answer = Bank of Hindustan)
- DFIs established in Phase II — Post-Independence 1947-1991 (Q5 PYQ: answer = Phase II)
- Bank of Hindustan: First formal bank, 1770, Calcutta, discontinued 1832
- BSE established: 1875 — Asia’s first stock exchange | Sensex launched: 1986
- 14 banks nationalised: 19th July 1969 | deposits > Rs 50 crores
- 6 more banks nationalised: 16th April 1980 | deposits > Rs 200 crores
- LIC formed: 1st September 1956 | 245 private insurance companies nationalised
- RRBs established: 1975 (Narasimham Committee recommendation)
- UTI established: 1963 | First scheme: Unit Scheme 1964 | De-linked from RBI: 1978 (IDBI took over)
- Deposit Insurance Corporation commenced: January 1, 1962 | Cover: Rs 1 lakh (now Rs 5 lakhs)
- 1991 crisis: Forex reserves = USD 1.1 billion (3 weeks imports) | India pledged 67 tonnes gold to IMF
- ICICI Bank: First new private bank after liberalisation | Licensed June 1994 in Vadodara
- HDFC Bank: Second new private bank | August 1994
- NSE: National Stock Exchange | Screen-based trading from inception 1992
- Settlement cycle: T+5 (July 2001) → T+3 (April 2002) → T+2 (April 2003)
- Narasimham Committee I (1991): CAR 8% | SLR reduction | Deregulate interest rates | Allow private banks
- Narasimham Committee II (1998): CAR 9% | Narrow banking for weak banks | DFIs → Universal Banks
📝 All 5 PYQ Answers from PDF
Q1: Which is NOT part of the informal financial system? (a) Money lender (b) Mutual fund (c) Relatives (d) Mahajan
Answer: (b) Mutual fund — mutual funds are part of the FORMAL financial system
Q2: Which is NOT part of the formal financial system? (a) Association (b) Banks (c) NBFCs (d) Insurance company
Answer: (a) Association — associations/mahajans are informal, not formal
Q3: Which of the following is/are part of the financial system? (a) Financial market (b) Financial instrument (c) Financial institution (d) All of the above
Answer: (d) All of the above
Q4: Which was the first bank to be established in India? (a) Bank of India (b) State Bank of India (c) Bank of Hindustan (d) Punjab National Bank
Answer: (c) Bank of Hindustan — established 1770, Calcutta
Q5: In which phase was focus laid on setting up of Development Financial Institutions? (a) Phase I (b) Phase II (c) Phase III (d) Phase IV
Answer: (b) Phase II — Post-Independence (1947 to 1991)
Section 6 — Memory Tricks
Trick 1 — First Bank and First Exchange
Bank of Hindustan 1770 | BSE 1875
“Hindustan Handled Banking in 1770, Bombay Stock Exchange in 1875!”
First bank = Bank of Hindustan, 1770, Calcutta (discontinued 1832). BSE = 1875 = Asia’s first stock exchange. Sensex launched = 1986. The Presidency Banks (Bank of Calcutta 1806, Bank of Madras 1843, Bank of Bombay 1843) merged in 1921 → Imperial Bank → SBI on 1st July 1955. Q4 PYQ answer: Bank of Hindustan. Common wrong answer: SBI (which came later from Imperial Bank).
Trick 2 — Nationalisations 1969 and 1980
14 banks July 19, 1969 | 6 more April 16, 1980
“1969: Fourteen banks at Fifty crores. 1980: Six banks at Two hundred crores!”
First nationalisation: 19th July 1969 — 14 banks with deposits > Rs 50 crores. Second nationalisation: 16th April 1980 — 6 banks with deposits > Rs 200 crores. LIC formed = 1st September 1956 (245 insurance companies). GIC set up = 1972 (55 general insurance companies → 4 PSU cos). Total after both nationalisations = 20 nationalised banks (before mergers).
Trick 3 — Key Institution Years
DFI founding years — frequently tested
“IFCI first (1948), UTI 1963, IDBI 1964, NABARD/EXIM 1982, NHB 1988, SIDBI 1990”
Memory order: IFCI 1948 (first DFI), ICICI 1955, LIC 1956, UTI 1963, IDBI 1964, NABARD and EXIM 1982, NHB 1988, SIDBI 1990. UTI Unit Scheme 1964 = first MF scheme. UTI de-linked from RBI in 1978 (IDBI took over). Deposit Insurance Corporation started January 1, 1962. These dates are classic JAIIB exam targets.
Trick 4 — Formal vs Informal (PYQs Q1 and Q2)
Formal = regulated institutions | Informal = unregulated social finance
“Formal = has Form (registration, license). Informal = no Form (just social trust)!”
Formal financial system = banks, NBFCs, insurance cos, mutual funds, pension funds, DFIs — all REGULATED. Informal = money lenders, mahajans, associations, relatives, chit fund companies (unregulated). Q1 PYQ trap: Mutual fund seems informal but it’s FORMAL. Q2 PYQ trap: Association seems like a formal org but in financial system context, associations (mahajans) = INFORMAL. Banks, NBFCs, insurance = all formal.
Sections 7–9 — Visual, Flash Cards and Summary
Four phases of Indian Financial System development — key events and institutions in each phase
First Bank in India
Bank of Hindustan, 1770, Calcutta
Discontinued 1832 | Q4 PYQ answer
1969 Nationalisation
14 banks on 19th July 1969
Deposits > Rs 50 crores | Led by Indira Gandhi
1980 Nationalisation
6 banks on 16th April 1980
Deposits > Rs 200 crores
BSE Established
1875 — Asia’s first stock exchange
Sensex launched 1986 | Built on top 100 market cap shares
Informal Financial System
Money lenders, mahajans, associations, chit funds
No regulations | Low transaction cost | Unstructured
Three Parts of Financial System
Financial Institutions + Instruments + Markets
Q3 PYQ: All of the above
DFI Phase
Phase II — Post-Independence 1947–1991
IFCI 1948 = first DFI | Q5 PYQ answer
1991 Triggers
Forex = USD 1.1 bn | 67 tonnes gold pledged
INR devalued 9% (July 1) + 11% (July 3) | IMF USD 3.9 bn loan
⚡ Chapter 20 Complete — Indian Financial System Overview
- Financial system transfers wealth from surplus entities (savers) to deficit entities (investors) — essential for capital formation
- Two types: Informal (money lenders, mahajans — unregulated) and Formal (banks, NBFCs, insurance — regulated)
- Three components of formal system: Financial Institutions + Financial Instruments + Financial Markets
- Four major financial market segments: Money market + Forex market + Capital market + Insurance market
- Phase I (Pre-1947): Bank of Hindustan 1770 (first bank) | BSE 1875 | RBI set up 1935 | Most banks failed
- Phase II (1947-1991): RBI nationalised 1949 | SBI 1955 | LIC 1956 | 14 banks 1969 | 6 banks 1980 | IFCI, ICICI, IDBI, NABARD, NHB, SIDBI set up | Sensex 1986
- Phase III (1991-2010): 1991 crisis → Narasimham I → private banks | ICICI Bank 1994 | NSE 1992 | T+2 settlement 2003 | Narasimham II 1998 → DFIs → Universal banks
- Phase IV (2010-present): PMJDY, Payments Banks, SFBs | PSU banks 27→12 | IBC | NaBFID 2021 | UPI | Deposit cover Rs 5 lakh
Banky says: “Now I know the entire 250-year history of the system I work in!” 🎉
All 5 PYQs answered, four phases with key dates and events memorised, formal vs informal distinction locked in! 💪