The period from 1951 to the mid-1980s marks the second phase of the Indian Financial System, which evolved in line with India’s planned economic development strategy. After Independence, the government adopted a socialistic pattern of society, and the financial system was reorganised to support Five-Year Plans, industrialisation, agriculture, and infrastructure development. During this phase, the role of the State and public sector institutions became dominant, and financial institutions were structured to mobilise savings and direct credit towards priority sectors rather than profit maximisation.
Overall Nature of Financial System During Phase II
In this phase, the Indian financial system was highly regulated, institution-centric, and bank-dominated. The emphasis was on developmental banking, where financial institutions were expected to promote economic growth, reduce regional imbalances, and support weaker sections of society. Market forces played a limited role, and interest rates, credit allocation, and investment priorities were largely controlled by the government and the Reserve Bank of India (RBI).
The organisational structure of the financial system during this period can be broadly understood under banking institutions, development financial institutions, non-banking institutions, and regulatory authorities.
Role of the Reserve Bank of India (RBI)
The Reserve Bank of India acted as the central authority and regulator of the financial system. During this phase, RBI’s role expanded significantly beyond traditional central banking functions.
RBI was responsible for:
- Regulating and supervising banks and financial institutions
- Controlling credit through selective and quantitative credit controls
- Directing credit to priority sectors such as agriculture, small-scale industries, and exports
- Acting as banker to the government and managing public debt
RBI also played a developmental role, helping establish new financial institutions and promoting rural credit and cooperative banking. The central bank thus acted as both regulator and development catalyst.
Commercial Banking System
Commercial banks formed the core of the financial system in this phase. A major milestone was the nationalisation of banks in 1969 and 1980, which brought a large part of banking under government control.
The objectives of commercial banking were redefined to:
- Expand banking facilities to rural and semi-urban areas
- Mobilise household savings
- Provide institutional credit to agriculture, small industries, and weaker sections
- Reduce dependence on moneylenders
Branch expansion increased rapidly, and banking became a tool of financial inclusion, even though efficiency and profitability were secondary concerns.
Cooperative Banking Structure
The cooperative banking system was developed mainly to support agriculture and rural credit. It operated on a three-tier structure:
- Primary Agricultural Credit Societies at the village level
- District Central Cooperative Banks at the district level
- State Cooperative Banks at the state level
Cooperative banks were designed to provide short-term and medium-term credit to farmers and rural borrowers. Though their outreach was wide, issues like poor governance, political interference, and weak financial discipline limited their effectiveness.
Development Financial Institutions (DFIs)
A defining feature of this phase was the creation of specialised Development Financial Institutions (DFIs) to meet the long-term credit needs of industry and infrastructure, which commercial banks were not equipped to handle.
Important DFIs included:
- Industrial Finance Corporation of India (IFCI) – provided long-term finance to large industries
- Industrial Development Bank of India (IDBI) – acted as the apex development institution for industry
- Industrial Credit and Investment Corporation of India (ICICI) – promoted private sector industrial development
- State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs) – focused on state-level industrial growth
These institutions played a crucial role in building India’s industrial base, especially in heavy industries and core sectors.
Agricultural and Rural Financial Institutions
To strengthen agricultural credit, several specialised institutions were created. The most important among them was the National Bank for Agriculture and Rural Development (NABARD), established in 1982.
NABARD functioned as:
- An apex refinancing institution for rural credit
- A supervisor of cooperative banks and regional rural banks
- A promoter of rural development and institutional finance
The establishment of Regional Rural Banks (RRBs) in 1975 further strengthened the organisational structure by combining the local familiarity of cooperatives with the banking expertise of commercial banks.
Non-Banking Financial Institutions
Non-banking institutions such as insurance companies, provident funds, and mutual savings institutions also formed part of the financial system. However, they operated under strict government control.
- Life Insurance Corporation of India (LIC) was nationalised in 1956 to mobilise long-term savings
- General Insurance Corporation (GIC) was nationalised in 1972
- Provident and pension funds were major sources of long-term funds for the government
These institutions helped in mobilising household savings and channelising them into planned development.
Capital Market Organisation
During this phase, the capital market remained underdeveloped and tightly regulated. The government controlled:
- Issue of securities
- Pricing of shares
- Access to capital
Stock exchanges existed, but their role was limited. The focus was more on institutional finance rather than market-based finance. As a result, equity culture among investors remained weak.
Characteristics and Limitations of Organisational Structure
The organisational structure of the Indian financial system during this phase had several strengths, such as:
- Wide institutional network
- Strong focus on development and social objectives
- Expansion of banking and rural credit
However, it also suffered from:
- Excessive regulation and bureaucratic control
- Poor efficiency and low profitability of institutions
- Limited competition and innovation
- Weak capital markets
These limitations eventually led to the need for financial sector reforms, which began in the early 1990s.