Banking and Financial Institution by: Abbas Vattoli
Syllabus
Unit—rx
Banking and Financial Institution
 Importance Of Banking to Business, types of Banks
and Their Functions,
 Reserve Bank of India, NABARD and Rural Banking
 Banking Sector Reforms in India, NPA, Capital
adequacy norms
 E,banking
 Development Banking IDBI, IFCI, SFCst tm, SIDBI
Origin of the term Bank
Italian word — 'banco'
Latin word — 'bancus'
Greek word — 'banque'
French word — 'banque'
Which mean bench
German word — 'banc' or 'banck' which means a joint
stock fund.
Definition
 Sec 5(1) (c ) of Indian Banking regulation Act 1949
defines
 The term banking company as any company which
transacts the business of banking in India.
 Sec 5(1) (b) defines the term banking as accepting,
for the purpose of lending or investment, of
deposits of money from the public, repayable on
demand or otherwise and withdrawable by
cheques, draft, order or otherwise.
 In sec 6 various activities included in banking are
listed such as lending, borrowing, accepting and
discounting of bills, dealing in foreign currency,
deposit lockers, transfer of money, etc.
 Sec 8 prohibits a bank from buying and selling
goods
 Sec 9 prohibits from holding immovable property
Evolution of banking
 Banking existed in Babylonia as early as in 2000 BC
 Temples were used a place for money lending
Banking confined money lending
 Bank of England established in 1694
 In India banking was in existence during Vedic
period
 Modern banks emerged only during industrial
revolution(1750 to 1850 )
Ancestors of modern banks
 Merchant banks- traders become financiers
 Money lenders- only lends money
 Goldsmiths- for safe keeping of valuables and
money
Role and Importance of Banks
 Deposit mobilization
 Granting of credit
 Creation of credit
 Channalize funds into productive investments
 Provision of finance to the government
 Protecting the funds of depositors
 Provision of remittance facilities
 Provision of medium of exchange
 Discharge of social responsibility
 Innovative services
Classification of banks based on functions
 Commercial banks or deposit banks
 Industrial banks or investment banks
 Agricultural banks- (agricultural cooperative banks
and land mortgage or development banks)
Exchange banks(export/import)
 Savings banks (small savings- not found in India)
 Central banks (banker’s bank)
Nature of commercial banking
 They are the intermediaries between lenders and
borrowers
 They are not merely purveyors of money, but also
manufacturers of money
 It renders variety of services to the depositors and
general public
 They are the oldest banking institution and hold lien
share in the total banking operation
Commercial banking principles
 Profitability
 Liquidity
 Security of safety
 Principle of social responsibility of social good
 Purpose of advances
 Mass banking
Functions of commercial banks
 Primary functions
 Accepting deposits
 Lending money
 Investment of funds Creation of money
Type of deposits account
• Current Accounts-by business people,
numerous transactions, no interest, overdraft facility
• Savings bank account- for promoting savings
among people, low rate of interest, restrictions on no
and size withdrawals.
• Fixed deposits account- fixed amt for fixed
period at fixed interest. Time liability and get high
interest.
• Recurring deposits account
Type of advances
Loans
Overdrafts
Cash credits
Discounting of bills
Subsidiary or secondary functions
Agency services( as an agent of the customer)
Collection of money
Making of payments
Purchase and sale of securities
Advising customers regarding stock exchange
investments
Arranging for remittances of funds(Bank draft,
mail transfers, telegraphic transfer)
Acting as trustee, executor, administrator or
attorney of customers
 Serving as correspondents and representatives
of customers
General Utility serivices
Safe custody of valuables(accepting valuables
for safe custody or hiring out safe deposit lockers)
Dealing in foreign exchange business (export
finance, import credit, deffered payment guarantee,
forward contracts, issue of solvency certificates, letter
of introduction, provision of trade information)
Issue of traveler's letter of credit, circular note,
travelers cheques
Acting as refereee
Collecting information about other business
men for customers
New lines of activities of commercial banks
Rendering of merchant banking services
Underwriting of shares and debentures
Factoring services
Lease financing
Housing finance
Issue of credit and debit cards
Consultancy services
Setting up of mutual funds
Classification of commercial banks
On the basis of lending practices
Pure banking — lend only for short period to
industries and commerce
Investment banking — provide medium and
long term funds to industries and commerce
Mixed banking — provides both short term and
long term finance to industries and commerce
Classification of commercial banks
On the basis of structure of commercial banking
• Group banking — a group of banks separately
incorporated are brought under the control of a holding
company. It was popular in USA during
1930s
• Chain banking — a number of separately
incorporated banks are brought under common control
by a device other than holding company. (inter locking
of directors)
• Correspondent banking — Unit banks in small
towns are linked with big correspondent banks situated
in nearby bigger towns so the correspondent banks are
the intermediaries through which all the unit banks are
linked with the banks in the very important financial
centers
• Branch banking — an individual bank carries on
banking business with a network of branches Unit
banking — an individual bank carries on banking
business through a single office or through few offices
Other systems of commercial banking
Universal banking — a commercial bank offers a
wide variety of banking and financial services beyond
those offered by a traditional bank.
Narrow banking — a bank which provides only
limited banking activities in a particular region
Functions of Central bank
Issuing currency notes
Principle of Note issue —
Currency principle(100% gold backing) and
banking principle Systems of note issue —
Fixed fiduciary system (central bank can issue
notes up to a limit call fiduciary limit with out any gold
backing.
Maximum fiduciary system
Proportional fiduciary system (since 1956 india
is on this system) Minimum reserve system
acting as a banker to the state or government
> Central bank as the bankers bank
Controller of credit
Acting as the custodian of the nations gold and foreign
exchanges reserves
Developmental functions of central bank
Credit control
• Credit control means regulating credit(expansion and
contraction) according to the requirements of the
economy channelizing the credit into productive uses
Objectives credit control/monetary policy
• Internal price stability Economic stability
• Full employment
• Economic growth
• Stability in money market
• Stability of foreign exchange rates
• International economic equilibrium
Methods of credit control
Quantitative of general methods
• Bank rate policy — bank rate or discount rate is
the official minimum rate at which the central bank
rediscounts eligible bills of exchange offered by
commercial banks and other financial institutions.
(lending rate of the CB)
• Open market operation — purchase and sale of
govt securities in the open market
• Variable cash reserve ratio(CRR)
• Variation of statutory liquidity ratio(SLR) 
Current rates
Policy rates
Bank rate- 9%
Repo rate- 8%
Reverse repo- 7%
Reserve ratios
CRR- 4-75%
SLR- 24%
Lending/ Deposit rates Base rate — 10 -10.75%
Deposit rate — 8.5- 9.25
Qualitative or selective credit control
Which control the quality or uses of credit. In
other words it encourages credit to essential uses and
discourages credit to non essential uses
Types of qualitative credit contol
Fixation of margin requirement on secured
loans
Regulation of consumer credit
Control of bank advances through directives
Rationing of credit — central bank limit the
total amount of loans or specific catogories loans
granted by commercial banks
Moral suasion (persuade)
Direct Action (punishment against violating
banks)
Publicity(educating and influencing public
openion)
History of development of indian banking system
Banking in the form of money lending was in
existance during vedic period
 During pre independence period banking was
mainly carried out by
Indigenous bankers and money lenders
Indigenous bankers are individuals or firms
dealing in hundies and some times accepts deposits
Money lenders are persons who lend their own
money mainly for consumption.
Bank of hindustan, the first bank in india started
by britishers in 1770.
Presidency bank of bengal 1806
Presidency bank of bombay 1840
Presidency bank of madras 1846
The first joint stock bank in india is Oudh
commercial bank in 1881 followed by PNB 1895
Imperial bank was formed in 1921 through the
presidency banks of bengal bombay and madras RBI
was established in 1 st april 1935
Post independence
RBI nationalised 1st jan 1949
The banking regulation act 1949 passed
The imperial bank nationalised and converted
into state bank of india in 11th july 1955
14 major banks were nationalized I on 19th jul
1969 and 6 more banks in 15th april 1980
Several RRBs and developmental banks
established
Today there are 27 public sector banks
30 private sector scheduled commercial banks
2 private sector non scheduled commercial banks
31 foreign banks
196 Regional rural banks
Non performing aseets
NPA is an asset which ceases to generate income for
the bank. It mean an advance or credit facility in respect
of which the interest or installment of principal remains
overdue for a period of more than 90 days with effect
from 31st march 2004.
Impact of NPA
They do not generate income
They enhance the administrative, legal and
recovery costs of loans
They reduce profitability of the lending bank
They affect banks credibility and image
They adversely affect decision making for fresh
loans
Early indicators of NPA
• Financial warning signal — default in
repayment, falling profits, rising level of bad debts,
decliainign sales
• Operational warning signal- under utilisation of
capacity, frequent labour problems, over stocking
Banking warning signals- frequent requests for further
loans, delay in payment of interest or install ment due,
reduction in transactions, dishonour of cheques, opeing
account with other banks, etc
• Managerial warning signal- poor financial
control, frequent change in ownership, undertaking of
undu risks, window dressing External warning signal —
economic recession, change in govt policies, new
competition
Factors responsible for NPA
> Internal factors
Diversion of funds by the borrowers
Delay and consequent increase in cost of the
project
Business failure External factors
Recession
Shortage of input/power Rise in prices of
inputs
Techniques for managing NPA
Ensure that loans are diversified across sectors
Loans are granted to credit worthy borrowers
Improving its monitoring system
React to early warning signals
Knowing clients profile thoroughly
Adapting credit rating system
Banking legislations in india
The Negotiable instruments Act 1881
The banking regulation act 1949
The reserve bank of india act 1934
Banking ombudsman scheme
A banking ombudsman is a person appointed by
the reserve bank of india to redress customer
complaints against certain deficiencies in banking
services
It is to resolve and settle complaints relating to
the provisions of banking services
E Banking
E banking means conduct of banking operations
through electronic means of devices, such as
computers, telephones, mobile phones, ATMs, etc
Forms of e banking
Internet banking
Mobile banking
Telephone banking
Home banking
Credit card
A credit card is an instrument which provides
instantaneous credit facilities to its holder to purchase
goods or services from business establishments enrolled
as members of the credit card system Debit cards
It also a payment card. It is used to obtain cash, goods
or services automatically deviting the payments to the
card holders bank account instantly upto the credit
balance which exists in the customers bank accoun
Electronic Fund Transfer
• It is a scheme of RBI introuduced in 1996. It helps
banks to offer their customers money transfer service
from one account to another account of a bank branch
both intercity and intra city and also from one account
of one bank to
another account of another bank in the same city or
different cities