Commercial Banking I

Dr. Priyanka Zala

Evolution of banking
• Innovations in the fields of transport and
communications, development of energy and
manufacturing
 Evolution of banking (Cont…)
“Opinion about the word Bank”

• The early bankers, the Jews in Italy transacted their business

Bancus
on benches

• German word meaning joint stock fund

Pack

• As per European history, the babylonians developed

systematised banking
Babylonians • Temples of babylon were used as banks
Evolution of banking (Cont…)
• In 12th Century that some banks were established in
Venice and Genoa
• These banks were simply receiving deposit and lending
money to the people
Evolution of banking (Cont…)

The Bank of England

It started its business in 1694, with a view to
finance the government to carry on its war with
France
Evolution of Modern Banking
• The growth of banking in England in the nineteenth
century paved the way for modern banking in the world
Banking
According to Banking Regulation Act, “Banking means the
accepting for the purpose of lending or investment of
deposits of money from the public, repayable on demand or
otherwise and withdrawable by cheque, draft and an order
or otherwise.
Banking in India
1786- The General Bank of India

1809- Bank of Bengal, 1840- Bank of Bombay, 1843-

Bank of Madras (Presidency Banks)

1870- Bank of Hindustan

1865-Allahbad Bank

1894- PNB

1906- 1913 – BOI, CBI, BOB, CB, IB, BOM

1921- Imperial Bank of India

1935- Reserve Bank of India

Steps taken by the government during pre-
liberalisation era to promote banking

1935: Starting of Reserve Bank of India

1949: Enactment of Banking Regulation Act
1955: Nationalisation of State Bank of India
1959: Nationalisation of SBI subsidiaries
1961: Insurance cover extended to deposits
1969: Nationalisation of 14 major banks
1971: Creation of credit guarantee corporation
1975: Creation of regional rural banks
1980: Nationalisation of seven banks with deposits over Rs. 200
crores
Banking Sector Reforms
in Post Liberalization Era
Banking Sector Reforms in Post liberalization Era
(Cont…)

Two expert committees were set up to make Indian banking

sector more effective, competitive and efficient.
1. Narasimham Committee I (1991)
2. Narasimham Committee II (1998)
1. Narasimham Committee I (1991)
• It was appointed by Manmohan Singh as India’s Finance
Minister

Objectives:
• The purpose was to study all aspects relating to structure,
organisation, functions and procedures of the financial
systems
• To recommend improvements in their efficiency and
productivity
2. Narasimham Committee II (1998)
• It was appointed by P. Chidambaram as Finance Minister

Objectives:
• It was tasked with the progress review of the
implementation of the banking reforms since 1992 with
the aim of further strengthening the financial institutions
of India.
• It focussed on issues like size of banks and capital
adequacy ratio among other things.
1. Autonomy in Banking
Recommendation :
 Greater autonomy was proposed for the public sector
banks
 To perform equivalent professionalism as their
international counterparts
 GOI equity reduced to 33%
Action taken:
 Criteria for autonomous status was identified by March
1999
 17 banks were considered eligible for autonomy
2. Reforms in the Role of RBI
Recommendation:
 RBI withdraw from the 91 day treasury bills market and
that interbank call money and term money markets
 Segregation of the roles of RBI as a regulator of banks
and owner of bank
Action Taken:
 RBI introduced a Liquidity Adjustment Facility (LAF)
operated through Repo and Reverse Repos
 In April 1999, an Interim Liquidity Adjustment Facility
(ILAF) was introduced for up gradation in technology
 RBI decided to transfer its respective shareholding of
public banks like SBI, NHB, and NABARD to GOI.
3. Stronger Banking System:
Recommendation :
 Merger of large Indian banks to make them strong
enough for supporting international trade

Action taken:
 There were a string of mergers in banks of India during
the late 90s and early 2000s.
4. Non-Performing Assets
Recommendation:
 Highlighted the need for zero NPA
 NPAs to be brought down to 3% by 2002
Action Taken:
 Introduction of Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest
Act, 2002
5. Capital Adequacy and Tightening of Provisioning Norms
Recommendation:
 The Govt. should raise the prescribed capital adequacy
norms
 The committee targeted raising the capital adequacy ratio
to 9% by 2000 and 10% by 2002
Action Taken:
 RBI targeted to bring the capital adequacy ratio to 9% by
March 2001.
6. Entry of Foreign Banks
Recommendation:
 Minimum start up capital of $25 million as against the
existing requirement of $10 million
 Foreign banks can be allowed to set up subsidiaries and
joint venture
Action Taken:
The government has allowed the foreign banks to operate in
India
Some of the other recommendation made by
Narsimhan Committee are given below:
1. Reduction in the SLR and CRR:
The SLR was recommended to reduce from 38.5% to 25%
and CRR from 15% to 3 to 5%
2. Phasing out Directed Credit Programme:
 The committee recommended phasing out of this
programme.
 It was reducing the profitability of banks
 Committee recommended the stopping of this programme
3. Interest Rate Determination
 Interest rate in India are regulated and controlled by the
authorities.
 Committee suggested that it should be on the ground of
market forces such as the demand for and the supply of
fund
4. Establishment of the ARF Tribunal:
 Proportion of bad debts and NPA was very alarming in
those days
 Establishment of ARF (Asset Reconstruction Fund)
 This fund will take over the proportion of the bad and
doubtful debts from the banks
5. Removal of dual control
 Those days banks were under the dual control of the
Reserve Bank of India and the Banking Division of the
Ministry of Finance
 It was recommended that the RBI should be the only
main agency to regulate banking in India
Types of Banks in India
Role of Commercial Banks

• It encourages savings habit amongst people and thereby

makes funds available for productive use
• It acts as an intermediary between people having surplus
money and those requiring money for various business
activities
• It facilitates business transactions through receipts and
payments by cheques instead of currency
• It provides loans and advances to businesses for short term
and long term purposes
• It also facilitates import export transactions
• It helps in national development by providing credit to
farmers, small scale industries and self employed people
and large business scale industries
• It helps in raising standard of living of people in general
by providing loans for purchase of consumer durable
goods
Functions of Commercial Banks
Primary Functions
1. Accepting Deposits from the
Public
• Fixed Deposits
• Savings Deposits
• Current Deposits
• Recurring Deposits
2. Making Loans and Advances
• Call money advances
• Cash Credits
• Overdrafts
• Discounting Bills of
Exchange
• Term Loans
• Personal loans
3. Credit Creation
Secondary Functions
1. Collection and Payment of
Cheque
2. Undertaking the payment
subscriptions, insurance
premium, rent, utility bills
etc.
3. Buying and Selling of
Securities
4. Representative of the
customers, banks and
financial institutions
5. Acts as a trustee,
administrator and an attorney
Structure of commercial Banks
Group Banking

Chain Banking

Unit Banking

Branch Banking

Correspondent bank
1. Group Banking

• A plan offered by banks designed to be used by groups

rather than individuals. A common example is a company
plan offered to employees.
• Usually, the bank will offer incentives such as discounts,
lower fees, and interest rates, as well as other benefits not
available to individual customers.
2. Chain Banking
• Chain banking is a situation in which three or more banks
that are independently chartered are controlled by a small
group of people.
3. Unit Banking
Banking systems encourage either small, independent banks
or banks that are theoretically independent but are in fact
owned by a bank holding company.
4. Branch Banking
• Branch banking refers to a single bank which operates
through various branches in a city or in different
locations or out of the cities. It offers a wide array of face
to face service to its customers.
5. correspondent bank
• A correspondent bank is a bank in one country that is
authorized to provide services for another bank or
financial institution in a foreign country. The most
common services provided by a correspondent bank are
currency exchange, handling business transactions and
trade documentation, and money transfers.
BANKER CUSTOMER RELATIONSHIP
1. Debtors-Creditors Relationship

2. Banker as a Trustee

3. Banker as an agent

4. Banker as a Bailee

5. Banker as Lessor
Rights and Obligations of the Banker
Rights
1. Banker’s right of general lien
2. Right to change interest, commission, incidental
charges, commitment charges
3. Right to set off or right to combine bank accounts
4. Right to appropriate payments
5. Right under Garnishee order
1. Banker’s Right of General Lien
Lien is a right of the person who can retain the goods of
another in his position until a debt due to him is paid

1. Particular Lien
2. General Lien
• Particular lien – Section 170 of Indian Contract Act) the
creditor gets the right to retain only goods or securities
for which the dues have arisen and not for other dues
• General lien- A general lien (Section 171) gives the rights
to the creditor to retain the goods or securities till all
amounts due from debtors are paid or discharged
• General lien is available to bankers and factors
• Reasonable Notice must be given before selling securities
under General Lien
2. Right to charge interest, commission, incidental charges,
commitment charges
a. Interest : Bank calculate interest and debit the same to
the loan account
b. Commission: Commission for the services he renders to
the customers
c. Incidental Charges: Most of the banks are charging
incidental charges for not maintaining minimum
balance
d. Commitment Charges: This is a charge made by the
banker on overdraft and cash credit accounts
3. Right to Set- off
 The right of set off facilities the banker to know the net
amount due to him from the customer
 The banker as a debtor has the right of set off
4. Right to Appropriate Payments (Indian Contract Act, 1872)

 When a payment is made by a debtor to his creditor with an

express or implied instruction that the payment should be
applied towards the discharge of a particular debt, the creditor
(banker) should apply the payment according to the debtor’s
instruction.

 If debtor does not take any decision regarding appropriation at

the time of payment, then the creditor (banker) has the choice
5. Right under Garnishee Order

The obligation of a banker to honour his customer’s cheque is extinguished

(not accepted or clear) on receipt of an order of the Court, known as the
Garnishee order, issued under Order 21, Rule 46 of the Code of Civil
Procedure, 1908.
 A court order instructing a garnishee (a bank) that funds
held on behalf of a debtor (the judgement debtor) should
not be released until directed by the court.

 The order may also instruct the bank to pay a given sum
to the judgement creditor (the person to whom a debt is
owed by the judgement debtor) from these funds
 If the debtor fails to pay the debt owned by him to his
creditor, the latter may apply to the court for the issue of
a garnishee order on the banker of his debtor.

 The account of the customer with the banker, thus,

becomes suspended and the banker is under an obligation
not to make any payment thereof.
The creditor at whose request the order is issued is called
the judgment creditor; the debtor whose money is frozen is
called judgment debtor and the banker who is the debtor of
the judgment debtor is called the Garnishee.
 In case of order nisi the banker is prohibited from paying
the amount due to the customer in the date of receipt of
order nisi.
 Bank should in such a case immediately inform the
customer so that dishonour of any cheque issued by him
may be avoided.
Obligations

1. To honour customer’s cheques

2. To maintain secrecy of customer’s account
Disclosure as per law
Disclosure at the will of customer
Disclosure in public interest
Disclosure in the interest of bank
Disclosure as common courtesy
3. Receive cheques and other instruments for collection
4. Honour the cheques of customers across the counter
5. Give reasonable notice before closing the customer’s
account
6. Obligation to provide all banking services to customer
Asset Structure of Commercial Banks
1. Cash
2. Money at Call and Short Notice
3. Investments
4. Bills Discounted
5. Loans Advances and Cash Credit
6. Bills Receivables
7. Building, Furniture and Equipment
ASSET STRUCTURE OF COMMERCIAL BANKS
Liabilities & Capital
1. Capital
a. Authorized Capital
b. Issued Capital
c. Subscribed Capital
d. Paid up Capital
2. Reserve Funds
3. Deposits
4. Borrowings from other banks
5. Bills Payable
6. Acceptance & Endorsements
7. Contingent Liabilities
8. P & L A/c
9. Bills for collection
Assets
1. Cash
a. Cash on hand
b. Cash with central banks and other banks
2. Money at Call & Short Notice
3. Bills Discounted
4. Bills for collection
5. Investments
6. Loans and advances
8. Fixed Assets
Investment Policy of Commercial Banks
Principles to be observed in Investment Policy
(a) Liquidity
(b) Profitability
(c) Shiftability
(d) Security
(e) Principle of Productivity
(f) Principle of Diversity
(g) Principle of Saleability of Securities
SOURCES OF FUNDS OF COMMERCIAL BANKS
Share Capital

Reserve Fund and other Reserves

Deposits

Borrowing from RBI and Other Banks

Bills Receivable

Acceptances and Endorsements