Professional Documents
Culture Documents
COMMERCIAL BANK
A commercial bank is a type of financial institution that accepts deposits, offers checking
account services, makes various loans, and offers basic financial products like certificates of
deposit (CDs) and savings accounts to individuals and small businesses.
They generally finance trade and commerce with short-term loans. They charge high rate
of interest from the borrowers but pay much less rate of Interest to their depositors with the result
that the difference between the two rates of interest becomes the main source of profit of the
banks. Most of the Indian joint stock Banks are Commercial Banks such as Punjab National
Bank, Allahabad Bank, Canara Bank, Andhra Bank, Bank of Baroda, etc
The two most distinctive features of a commercial bank are borrowing and lending, i.e.,
acceptance of deposits and lending of money to projects to earn Interest (profit). In short, banks
borrow to lend. The rate of interest offered by the banks to depositors is called the borrowing rate
while the rate at which banks lend out is called lending rate.
The difference between the rates is called ‘spread’ which is appropriated by the banks.
Mind, all financial institutions are not commercial banks because only those which perform dual
functions of (i) accepting deposits and (ii) giving loans are termed as commercial banks. For
example post offices are not bank because they do not give loans. Functions of commercial
banks are classified in to two main categories—(A) Primary functions and (B) Secondary
functions.
Primary Functions:
It accepts deposits:
A commercial bank accepts deposits in the form of current, savings and fixed deposits. It
collects the surplus balances of the Individuals, firms and finances the temporary needs of
commercial transactions. The first task is, therefore, the collection of the savings of the public.
The bank does this by accepting deposits from its customers. Deposits are the lifeline of banks.
Such deposits are payable on demand and are, therefore, called demand deposits. These
can be withdrawn by the depositors any number of times depending upon the balance in the
account. The bank does not pay any Interest on these deposits but provides cheque facilities.
These accounts are generally maintained by businessmen and Industrialists who receive and
make business payments of large amounts through cheques.
Fixed deposits have a fixed period of maturity and are referred to as time deposits. These
are deposits for a fixed term, i.e., period of time ranging from a few days to a few years. These
are neither payable on demand nor they enjoy cheque facilities.
They can be withdrawn only after the maturity of the specified fixed period. They carry
higher rate of interest. They are not treated as a part of money supply Recurring deposit in which
a regular deposit of an agreed sum is made is also a variant of fixed deposits.
These are deposits whose main objective is to save. Savings account is most suitable for
individual households. They combine the features of both current account and fixed deposits.
They are payable on demand and also withdraw able by cheque. But bank gives this facility with
some restrictions, e.g., a bank may allow four or five cheques in a month. Interest paid on
savings account deposits in lesser than that of fixed deposit.
The second major function of a commercial bank is to give loans and advances
particularly to businessmen and entrepreneurs and thereby earn interest. This is, in fact, the main
source of income of the bank. A bank keeps a certain portion of the deposits with itself as reserve
and gives (lends) the balance to the borrowers as loans and advances in the form of cash credit,
demand loans, short-run loans, overdraft as explained under.
i) Cash Credit:
An eligible borrower is first sanctioned a credit limit and within that limit he is allowed to
withdraw a certain amount on a given security. The withdrawing power depends upon the
borrower’s current assets, the stock statement of which is submitted by him to the bank as the
basis of security. Interest is charged by the bank on the drawn or utilised portion of credit (loan).
A loan which can be recalled on demand is called demand loan. There is no stated
maturity. The entire loan amount is paid in lump sum by crediting it to the loan account of the
borrower. Those like security brokers whose credit needs fluctuate generally, take such loans on
personal security and financial assets.
Short-term loans are given against some security as personal loans to finance working
capital or as priority sector advances. The entire amount is repaid either in one instalment or in a
number of instalments over the period of loan.
Investment:
(i) Government securities, (ii) Other approved securities and (iii) Other securities. Banks
earn interest on these securities.
Apart from the above-mentioned two primary (major) functions, commercial banks
perform the following secondary functions also.
3. Discounting bills of exchange or bundles:
Suppose, A buys goods from B, he may not pay B immediately but instead give B a bill
of exchange stating the amount of money owed and the time when A will settle the debt.
Suppose, B wants the money immediately, he will present the bill of exchange (Hundi) to the
bank for discounting. The bank will deduct the commission and pay to B the present value of the
bill. When the bill matures after specified period, the bank will get payment from A.
4. Overdraft facility:
In other words, depositors of current account make arrangement with the banks that in
case a cheque has been drawn by them which are not covered by the deposit, then the bank
should grant overdraft and honour the cheque. The security for overdraft is generally financial
assets like shares, debentures, life insurance policies of the account holder, etc.
The bank acts as an agent of its customers and gets commission for performing agency
functions as under:
It provides facility for cheap and easy remittance of funds from place-to-place through
demand drafts, mail transfers, telegraphic transfers, etc.
(ii) Collection of funds:
It collects funds through cheques, bills, bundles and demand drafts on behalf of its
customers.
It makes payment of taxes. Insurance premium, bills, etc. as per the directions of its
customers.
It buys sells and keeps in safe custody securities and shares on behalf of its customers.
(v) Collection of dividends, interest on shares and debentures is made on behalf of its
customers.
(iv) Acts as Trustee and Executor of property of its customers on advice of its customers.
It gives information about economic position of its customers to traders and provides
similar information about other traders to its customers.
The banks provide many general utility services, some of which are as under:
(i) Traveller’s cheques .The banks issue traveler’s cheques and gift cheques.
(ii) Locker facility. The customers can keep their ornaments and important documents in
lockers for safe custody.
Scheduled banks are those banks which are included in Second Schedule of Reserve
Bank of India. A scheduled bank must have a paid-up capital and reserves of at least Rs 5 lakh.
RBI provides special facilities including credit to scheduled banks. Some of important scheduled
banks are State Bank of India and its subsidiary banks, nationalised banks, foreign banks, etc.
Non-scheduled Banks:
The banks which are not included in Second Schedule of RBI are known as
non-scheduled banks. A non-scheduled bank has a paid-up capital and reserves of less than Rs 5
lakh. Clearly, such banks are small banks and their field of operation is also limited.
A bank is a financial institution that provides banking and other financial services to their
customers. A bank is generally understood as an institution which provides fundamental banking
services such as accepting deposits and providing loans. There are also nonbanking institutions
that provide certain banking services without meeting the legal definition of a bank. Banks are a
subset of the financial services industry.
Indian banking industry has been divided into two parts, organized and unorganized
sectors. The organized sector consists of Reserve Bank of India, Commercial Banks and
Cooperative Banks, and Specialized Financial Institutions (IDBI, ICICI, IFC etc).
1. Reserve banks of India.
3.Foreign banks
4. Non-scheduled banks.
5. Co-operative banks.
Banking in India is indeed as old as the Himalayas. But, the banking functions became an
effective force only after the first decade of 20th century. Banking is an ancient business in India
with some of oldest references in the writings of Manu. Bankers played an important role during
the Mogul period. During the early part of East India Company era, agency houses were
involved in banking. Modern banking (i.e. in the form of joint-stock companies) may be said to
have had its beginnings in India as far back as in 1786, with the establishment of the General
Bank of India.
Banking System
The structure of banking system differs from country to country depending upon their
economic conditions, political structure, and financial system. Banks can be classified on the
basis of the volume of operations, business pattern and areas of operations. They are termed as a
system of banking. The commonly identified systems are:
Unit Banking
Unit banking is originated and developed in the U.S.A. In this system, small independent
banks are functioning in a limited area or in a single town . It has its own board of directors and
stockholders. It is also called as “localized Banking”.
Branch Banking
The Banking system of England originally offered an example of the branch banking
system, where each commercial bank has a network of branches spread throughout the country.
Correspondent Banking
The correspondent banking system is developed to remove the difficulties in the unit
banking system. The smaller banks deposit their cash reserve with bigger banks.
Therefore, correspondent banks are intermediaries through which all unit banks are
linked with bigger banks in financial centers. Through correspondent banking, a bank can
carry-out business transactions in another place where it does not have a branch.
Group Banking
Group Banking is the system in which two or more independently incorporated banks are
brought under the control of a holding company. The holding company may or may not be a
banking company. Under group banking, the individual banks may be unit banks, or banks
operating branches or a combination of the two.
Relationship Banking
It refers to the efforts of a bank to promote personal contacts and to keep continuous
touch with customers who are very valuable to the bank. In order to retain such profitable
accounts with the bank or to attract new accounts, it is necessary for the bank to serve their needs
by maintaining a close relationship with such customers.
Narrow Banking
A bank may be concentrating only on the collection of deposits and lend or invest the
money within a particular region or certain chosen activity like investing the funds only in
Government Securities. This type of restricted minimum banking activity is referred to as
‘Narrow Banking’.
Universal Banking
As Narrow Banking refers to restricted and limited banking activity Universal Banking
refers to broad-based and comprehensive banking activities.
Regional Banking
In order to provide adequate and timely credits to small borrowers in rural and
semi-urban areas, Central Government set up Regional Banks, known as Regional Rural Banks
all over India jointly with State Governments and some Commercial Banks.
Wholesale Banking
Private Banking
Private or Personal Banking is banking with people — rich individuals instead of banking
with corporate clients. It attends to the need of individual customers, their preferences and the
products or services needed by them. This may include all-around personal services like
maintaining accounts, loans, foreign currency requirements, investment guidance, etc.
Retail Banking
Retail banking is a major form of commercial banking but mainly targeted to consumers
rather than corporate clients. It is the method of banks’ approach to the customers for sale of
their products
Exposure limits
Lending to a single borrower is limited to 15% of the bank’s capital funds (tier 1 and tier
2 capital), which may be extended to 20% in the case of infrastructure projects. For group
borrowers, lending is limited to 30% of the bank’s capital funds, with an option to extend it to
40% for infrastructure projects. The lending limits can be extended by a further 5% with the
approval of the bank's board of directors. Lending includes both fund-based and non-fund-based
exposure.
Over and above the CRR, a minimum of 22% and a maximum of 40% of NDTL, which
is known as the SLR, needs to be maintained in the form of gold, cash or certain approved
securities. The excess SLR holdings can be used to borrow under the Marginal Standing Facility
(MSF) on an overnight basis from the RBI. The interest charged under MSF is higher than the
repo rate by 100 bps, and the amount that can be borrowed is limited to 2% of NDTL. (To learn
more about how interest rates are determined, particularly in the U.S., consider reading more
about who determines interest rates.)
Provisioning
Non-performing assets (NPA) are classified under 3 categories: substandard, doubtful and
loss. An asset becomes non-performing if there have been no interest or principal payments for
more than 90 days in the case of a term loan. Substandard assets are those assets with NPA
status for less than 12 months, at the end of which they are categorized as doubtful assets. A loss
asset is one for which the bank or auditor expects no repayment or recovery and is generally
written off the books.
For substandard assets, it is required that a provision of 15% of the outstanding loan
amount for secured loans and 25% of the outstanding loan amount for unsecured loans be made.
For doubtful assets, provisioning for the secured part of the loan varies from 25% of the
outstanding loan for NPAs that have been in existence for less than one year, to 40% for NPAs in
existence between one and three years, to 100% for NPA’s with a duration of more than three
years, while for the unsecured part it is 100%.
Provisioning is also required on standard assets. Provisioning for agriculture and small
and medium enterprises is 0.25% and for commercial real estate it is 1% (0.75% for housing),
while it is 0.4% for the remaining sectors. Provisioning for standard assets cannot be deducted
from gross NPA’s to arrive at net NPA’s. Additional provisioning over and above the standard
provisioning is required for loans given to companies that have unhedged foreign exchange
exposure.
The amount that is disbursed as loans to the agriculture sector should either be the credit
equivalent of off-balance-sheet exposure, or 18% of ANBC – whichever of the two figures is
higher. Of the amount that is loaned to micro-enterprises and small businesses, 40% should be
advanced to those enterprises with equipment that has a maximum value of 200,000 rupees, and
plant and machinery valued at a maximum of half a million rupees, while 20% of the total
amount lent is to be advanced to micro-enterprises with plant and machinery ranging in value
from just above 500,000 rupees to a maximum of a million rupees and equipment with a value
above 200,000 rupees but not more than 250,000 rupees.
The total value of loans given to weaker sections should either be 10% of ANBC or the
credit equivalent amount of off-balance sheet exposure, whichever is higher. Weaker sections
include specific castes and tribes that have been assigned that categorization, including small
farmers. There are no specific targets for foreign banks with less than 20 branches.
The private banks in India until now have been reluctant to directly lend to farmers and
other weaker sections. One of the main reasons is the disproportionately higher amount of NPA’s
from priority sector loans, with some estimates indicating it to be 60% of the total NPAs. They
achieve their targets by buying out loans and securitized portfolios from other non-banking
finance corporations (NBFC) and investing in the Rural Infrastructure Development Fund
(RIDF) to meet their quota.
The foreign shareholding is limited to 49% for the first five years of its operation, after
which RBI approval would be needed to increase the stake to a maximum of 74%. The board of
the bank should have a majority of independent directors and it would have to comply with the
priority sector lending targets discussed earlier. The NOFHC and the bank are prohibited from
holding any securities issued by the promoter group and the bank is prohibited from holding any
financial securities held by the NOFHC. The new regulations also stipulate that 25% of the
branches should be opened in previously unbanked rural areas.
Willful defaulters
A willful default takes place when a loan isn’t repaid even though resources are available,
or if the money lent is used for purposes other than the designated purpose, or if a property
secured for a loan is sold off without the bank's knowledge or approval. In case a company
within a group defaults and the other group companies that have given guarantees fail to honor
their guarantees, the entire group can be termed as a willful defaulter.
Willful defaulters (including the directors) have no access to funding, and criminal
proceedings may be initiated against them. The RBI recently changed the regulations to include
non-group companies under the willful defaulter tag as well if they fail to honor a guarantee
given to another company outside the group.
Though the regulatory structure of India's banking system seems a bit conservative, this
has to be seen in the context of the relatively under-banked nature of the country. The excessive
capital requirements that have been set are required to build up trust in the banking sector while
the priority lending targets are needed to provide financial inclusion to those to whom the
banking sector would not generally lend given the high level of NPA’s and small transaction
sizes.
Since the private banks, in reality, do not directly lend to the priority sectors, the public
banks have been left with that burden. A case could also be made for adjusting how the priority
sector is defined, in light of the high priority given to agriculture, even though its share of GDP
has been going down. (For more insight, read about how India may be eclipsing china's
economy.)
Wholesale banking
Large Scale Operations: Wholesale banking majorly meets the enormous financial
requirements of the large scale companies and the government.
Low Operational Cost: The cost of carrying out transactions and other banking
operations is quite low due to a limited customer base and few numbers of transactions.
High Risk Involved: The risk level involved in wholesale banking is very high since
the failure of the borrower company can lead to the collapse of all the parties associated with it.
Control Over Financial Transaction Monitoring and Recovery: Due to limited
customers, it becomes convenient for the banks to monitor the financial transactions and recover
the loans and advances.
High Cost of Deposit: The interest rates paid by the banks on the deposits made by
the substantial business entities is high
Primary Functions: Some of the major services performed by wholesale banks are as
follows:
Making Advances: The principal purpose of wholesale banks is to provide loans and
advances of high value to the large scale business entities.
Accepting Deposits: These banks also receive deposits from the big companies and
provides high interest on the deposited funds.
Credit Creation: The wholesale banks increase the flow of funds in the economy by
initiating loans and deposits by the government and large scale companies.
Secondary Functions: The banks have some additional responsibilities which are
mentioned below:
Underwriting: The wholesale bank raises capital for the projects of large business
organizations by issuing debt or equity shares to the investors on behalf of the respective
companies.
● Mergers and Acquisitions: Through operations like currency conversion, these banks
facilitate the merger of two or more companies across the globe and also the acquisition
of one business unit by the other organization.
● Trust and Consultancy Services: The merchant banks provide various other services like
investment advice and trust building to the client companies.
● Fund Management: The merchant banks continuously function towards managing and
handling of the funds deposited by the clients wisely.
● Finance wholesaling
● Underwriting
● Market making
● Consultancy
● Mergers and acquisitions
Wholesale financing
Underwriting
Following are the different adjustments and updations made by the merchant banks in this
context:
● Global Expansion: Wholesale banks expand to the places where the multinational client
companies have branches.
● Wholesale Credit Transformation: A wholesale bank focus on consistent client’s
experience, processes, roles and technology used in the credit product and bank’s
operations.
● Client Onboarding: The primary concern is enhancing the information, transparency,
service speed and experience of the client companies.
● Data Management: The banks control and enhance the security, governance and quality
of the confidential data.
● Monetize Mobile Capabilities: These banks facilitate customers with self-service
operations and information related to various products and services through mobile
channels.
● Platform Modernization, Simplification and Migration: The wholesale banks function
to simplify and modernize the business operations, accepting of deposits and providing
loans and advances.
● Relationship Management: Building up long term relationship with the clients is
essential for the merchant banks.
● High Risk: As we know that the lumpsum transactions take place in wholesale banking,
there is a high level of risk involved.
● Expensive Business Accounts: Maintaining accounts and records is a costly affair in
wholesale banking when compared to traditional bank accounts.
● High-Interest Rates and Processing Fees: The borrower company is liable to pay off
high interest and processing fees on loans and advances to the banks.
● Relies on Stability of Location: When the company deposits a large amount at a single
location, i.e. the wholesale bank, there is a risk of loss if the bank faces a situation of
downfall.
● Payment for Unused Services: In wholesale banking, there is always a complaint that
the client companies have to pay even for those services which are not used by them.
● May Lead to Client’s Exploitation: When the borrowed sum is of high value, there are
chances that the borrower company may be exploited by the bank.
We know that India is a developing country and with the increasing globalization, Indian
firms are converting into multinational companies. These companies operate across the globe
and therefore requires enormous funds to serve the working capital requirements, investment
needs and other financial obligations.
Even the Indian government promotes medium scale industries to build reliable
infrastructure, facilitate sound market conditions, minimize deficits and for overall economic
development. All these factors result in the need for business finance.
In fact in India, the revenue generated from the banking industry comprises majorly of
wholesale banking services. Since, these banks fulfil major corporate requirements such as
merchant banking services, project finance, working capital needs, investment banking services,
leasing finance, facilitates mergers and acquisitions, etc.
Wholesale banking is a whole sole solution to all the banking requirements of the
companies with huge turnover and high net worth facilitating easy transfer of funds, proper
allocation and investment of excess capital, internal stock transfer, etc.
There is a vast scope for wholesale banking in the Indian banking industry, and it is
flourishing rapidly with the increase in globalization and industrialization.
RETAIL BANKING
Retail banking refers to banking that directly deals with individual customers by
providing them basic banking services like savings bank accounts, mortgages, personal loans,
debit cards, credit cards, and safe deposit boxes. Retail banks usually have a head office, coupled
with a large number of branches in different locations to target a wide spectrum of customers.
However, in addition to the above it also acts as providing services to retail customers, these
banks often serve commercial businesses, as well
A retail banking which acts as a comprehensive financial service provider for retail clients,
allowing them to purchase multiple financial instruments, under one roof. For a multiplicity of
services like opening a savings account, taking a loan, applying for a credit card and may also
inquire about potential banking products that they may need at a future date, which the bank can
offer all the retail customers can approach the bank.
A retail bank is a bank that works with consumers, offering basic banking services like checking
accounts, savings accounts, loans, and more. Retail customers are members of the general public
taking care of personal needs as opposed to organizations such as governments and businesses
that might need more complex services. In short, one can say that Retail banking refers to the
consumer-oriented services offered by commercial banks.
While some of the retail banks also venture into other services such as wealth management,
private banking, retirement and brokerage accounts, which are often linked to core retail banking
accounts for transactional ease.
Retail banks use the depositors’ funds to give loans. They make money by charging higher
interest rates on loans than they pay on deposits. The banking system in India is regulated by
the Reserve Bank of India (RBI), through the provisions of the Banking Regulation Act, 1949.
Except for the smallest banks, it requires all other banks to keep around 10 percent of their
deposits.
They are free to lend out the rest. At the end of each day, banks that are short of the Fed’s
reserve requirement borrow from other banks to make up for the shortfall. This amount borrowed
is called the fed funds.
From an economic standpoint, all three types of retail banks exist to:
2. Reduce the probability of default on loans by pooling together the risks of lending money
The institutions are also in better positions to cope with defaults due to
federally-mandated reserve ratios. The ratio ensures that banks always have a minimum amount
of cash on hand that is a percentage of total consumer deposits.
● Retail banks handle financial needs for everyday spending as well as life events like
buying a home. Local community banks and credit unions offer many of the same
services as the big banks. Online-only banks are also an option, especially for keeping
fees to a minimum.
● Bank accounts like checking accounts, savings accounts, and retirement accounts.
Checking accounts often come with a debit card for making purchases and the ability to
pay bills online or electronically. Money market accounts pay marginally high, with a few
limitations on how often one can spend the money.
● Certificates of Deposit (CDs) pay more than savings accounts, but you usually need to
leave your money untouched for at least several months to avoid early withdrawal
penalties.
● Small valuable safe within the bank’s walls kept as Safe so they can’t be stolen or
destroyed while in your home.
● Home loans help people buy a home, and second mortgages allow borrowers to
refinance existing loans or take cash out of home equity.
● Auto loans help people buy a car, and can also be refinanced.
● Unsecured personal loans can be used for any purpose and do not require you to pledge
collateral. Revolving lines of credit (including credit cards) allow borrowers to spend and
repay repeatedly without applying for a new loan.
Such amenities make it easier for individuals to handle their finances. It is possible to live
without a bank account, but life is more difficult. Without banks and credit unions, you might
end up spending more time on routine tasks and paying more fees for one-off transactions.
The rising attention in retail banking in the developing economies can be illuminated on
account of a few major developments. The first of them is the transitioning of the economies into
the intermediate phase. In the early phase of the development of banking, the policymakers
focused on ensuring the flow of bank credit to the productive sectors of the economy.
But over time, as the credit demand from the basic industrial and infrastructure sectors
have somewhat, the regulators have become more accommodating in allowing the banks to lend
even for consumption purposes. The additional development that has provided an enhancement
to retail banking aspiration of banks is the availability of enabling technology.
Since retail banking requires mass production techniques, the advent of technology has
enabled the banks to design appropriate technology-based delivery channels. Retail banking has
also received a push from the regulators for inclusive growth in the wake of the global financial
crisis.
The Governments across the worldview banks as the key component in furthering the
cause of financial inclusion. India has also been endorsing a bank-led financial inclusion model
and views retail mass banking as the stepping stone towards the achievement of universal
financial inclusion.
The last, but not the least of the reasons for the growing interest in retail banking is the
banks’ quest for new sources of revenue and new channels for profit. Slowly but surely, the
banks have realized that the commerce for the poor anywhere in the world is more viable than
the commerce for the rich and hence they view the excluded masses as a potential source of
profit in the long-run. Commercial banks cannot ignore the adage that the “Future of Banking is
Retail Banking.”