MODULE – 1

Banking is defined as “Accepting of deposits of money from public for the purpose of

Lending or Investment, repayable on demand or otherwise and withdrawable by cheque, draft,

or otherwise”

Banking can be defined as the business activity of accepting and safeguarding money owned

by other individuals and entities, and then lending out this money in order to earn a profit.

However, with the passage of time, the activities covered by banking business have widened

and now various other services are also offered by banks. The banking services these days

include issuance of debit and credit cards, providing safe custody of valuable items, lockers,

ATM services and online transfer of funds across the country / world.

Objective of Bank
 Business objectives.
 Social objectives.
Business objectives
 Making profits.
 Providing services.
 Currency issue.
 Creation of transaction media.
 Receiving deposit.
 Making loan.
 Ensuring safety.
 Investment.
Social objectives
 Creating savings.
 Capital formation.
 Industrialization.
 Employment.
 Developing living standard.
 Economic development.
Features of Banking
 Deals with money
The bank accept deposits from the public and advancing them as loans to the needy people.
The deposits may be current, fixed saving etc.
 Provide loans
The banks are the institutions that can create credit i.e. creation of additional money for
lending Thus ‘creation of credit is the unique features of banking.

Banks make extra money by providing loans for different Product to the loan. The bank makes
the extra money by lending money to the eligible person at certain rates. Nowadays, banks
provide loans for various requirements such as study loan, car loan, home loan, personal loans,
etc. Different banks provide different loans at different interest rates. You can compare the
interest rates of different banks to get a loan at minimum interest rates
 Middle man
Banks serve as a middle man from the money surplus unit to be money deficit unit. They are
intermediaries, who transfer funds from savers to investors through grants for business,
commerce, education, housing etc.
 Deposits must be withdrawable
The deposits are usually withdrawable on demand. it may be withdrawable by cheque, draft or
otherwise.

Phase 1: The Pre-Independence Phase

There were almost 600 banks present in India before independence. The first bank to be
established as the Bank of Hindustan was founded in 1770 in Calcutta. It closed down in
1832. The Oudh Commercial Bank was India’s first commercial bank in the history of the
evolution of banking in India.
A few other banks that were established in the 19th century, such as Allahabad Bank (Est.
1865) and Punjab National Bank (Est. 1894), have survived the test of time and exist even
today.
Some other banks like the Bank of Bengal, Bank of Madras, and Bank of Bombay –
established in the early to mid-1800s – were merged as one to become the Imperial
Bank, which later became the State Bank of India.

Phase 2: The Post-Independence Phase

After independence, the evolution of the banking system in India continued pretty much
the same as before. In 1969, the Government of India decided to nationalise the banks
under the Banking Regulation Act, 1949. A total of 14 banks were nationalised, including
the Reserve Bank of India (RBI).
In 1975, the Government of India recognised that several groups were financially
excluded. Between 1982 and 1990, it created banking institutions with specialised
functions in line with the evolution of financial services in India.
 NABARD (1982) – to support agricultural activities
 EXIM (1982) – to promote export and import
 National Housing Board – to finance housing projects
 SIDBI – to fund small-scale industries

Phase 3: The LPG Era (1991 Till Date)

From 1991 onwards, there was a sea change in the Indian economy. The government
invited private investors to invest in India. Ten private banks were approved by the RBI. A
few prominent names which exist even today from this liberalisation are HDFC, Axis
Bank, ICICI, DCB and IndusInd Bank.
In the early to mid-2000s, two other banks, Kotak Mahindra Bank (2001) and Yes Bank
(2004), received their licenses. IDFC and Bandhan banks were also given licenses in 2013-
14.
Other notable changes and developments during this era were:
 Foreign banks like Citibank, HSBC and Bank of America set up branches in
India.
 The nationalisation of banks came to a standstill.
 RBI and the government treated public and private sector banks equally.
 Payments banks came into existence.
 Small finance banks were permitted to set up their branches throughout
India.
 Banks began to digitalise transactions and various other related banking
operations.

Types of Banking
Common types of banks prevalent in India include the following:

Scheduled and Non-Scheduled Banks

The banking sector is divided into scheduled and non-scheduled banks.

 Scheduled Banks are listed in the second schedule of the Reserve Bank of India
(RBI) Act, 1934. The paid-up capital and collected funds of scheduled banks must be
5 Lakh and above. The RBI grants loans at the bank rate, and these banks are
eligible to become clearing house members.
 Non-Scheduled Banks are banks not listed in the second schedule of the RBI Act,
1934. The paid-up capital and collected funds are less than INR 5 Lakh. Such banks
need not borrow funds from the RBI.
Commercial Banks
Commercial banks can be scheduled or non-scheduled and are regulated under the
Banking Regulation Act, 1949. These banks accept deposits and grant loans to the
general public, businesses, and even the Government. Commercial types of banking
systems are:

 Public Sector Banks: More than 75% of the total banking business in India comes
under the public sector, also known as nationalised banks. The Indian Government
and RBI are the major stakeholders in this sector.
 Private Sector Banks: Most stakeholders of Private Sector Banks are individual
investors, not the RBI or Indian Government. Nevertheless, these banks must adhere
to all the RBI regulations for their operations.
 Foreign Banks: Foreign Banks have their headquarters in a foreign country but
operate as a private entity in India. They abide by the regulations of their home
country and the country in which they operate.
 Regional Rural Banks: These scheduled commercial banks serve the economically
weaker sections, such as marginal farmers, agricultural labourers, and small
 businesses. Operating at regional levels, RRBs offer banking facilities like debit
cards, bank lockers, complimentary insurance etc.
Small Finance Banks
Licensed under section 22 of the Banking Regulation Act, 1949, these types of
banking systems cater to sections of societies not usually served by large banks.
They serve micro and cottage industries and small business units.

Payments Banks
RBI restricts these banks to offer deposit facilities only, with a deposit limit of INR 1
Lakh per customer. You can avail of debit cards and e-banking facilities.

Cooperative Banks
These banks are registered under the Cooperative Societies Act, 1912, and function
on a no-profit no-loss basis. They offer banking services to entrepreneurs, small
businesses, and industries.

BANKER CUSTOMER RELATIONSHIP

It means that to become a customer account relationship is a must.

Account relationship is a contractual relationship. Banking is a trust-based
relationship. There are numerous kinds of relationships between the bank
and the customer. The relationship between a banker and a customer
depends on the type of transaction. Thus the relationship is based on
contract, and certain terms and conditions.

These relationships confer certain rights and obligations both on the part
of the banker and on the customer. However, the personal relationship
between the bank and its customers is long-lasting. Some banks even say
that they have a generation-to-generation banking relationship with their
customers.

MODULE – 2

Central banks are responsible for the monetary policy implemented in a

country, which includes decisions about interest rates, liquidity control,
reserve requirements, and open market operations. When the monetary
policy is effective, the centralized bank manages to keep the unemployment
rate at low levels, and it stabilizes inflation and interest rates to stimulate
economic growth. Although most centralized banks are governed by a board
of member banks, they act independently. Also, the decisions of a
centralized bank have a strong impact on every aspect of the economy,
seeking to meet the nation’s long-term goals.

Functions of Central Bank:

The central bank does not deal with the general public directly. It performs its functions with
the help of commercial banks. The central bank is accountable for protecting the financial
stability and economic development of a country.

Apart from this, the central bank also plays a significant part in avoiding the cyclical
fluctuations by controlling money supply in the market. As per the view of Hawtrey, a central
bank should primarily be the “lender of last resort.”

On the other hand, Kisch and Elkins believed that “the maintenance of the stability of the
monetary standard” as the essential function of central bank. The functions of central bank
are broadly divided into two parts, namely, traditional functions and developmental functions.

Need of Central Banking

The central bank is the apex institution which facilitates the working of commercial banks
and regulates the monetary decisions for the economy. The central bank controls money
supply and interest rates by using the monetary policies. Central bank is the bank of the
commercial banks. It is the lender of the last resort. For a developing country, central bank is
a significant body which accelerates the growth of the economy. Here are a few important
roles played by the central bank in a developing country:

 Money Control: Any change in the money supply affects the price level of the
economy. If the money supply is increased, there will be an increase in the price level
and vice-versa. Hence, central bank has a major role in maintaining the equilibrium
between the demand and supply of money. Central bank directly controls the supply
of money and can influence the demand for money for various purposes by using
appropriate monetary policy.
 Interest rate: Interest rates are an important determinant of the investment demand in
the economy. Central bank by regulating the money supply, can change the interest
rates and thus can stimulate investment. For example, if the central bank wants to
increase the investment demand it will increase the money supply. An increase in the
money supply will reduce the interest rate and borrowings will be cheaper. People
will borrow and invest these funds. Therefore, investment in the economy has been
increased.
 Balance of payments: The central bank controls the foreign exchange reserves and
helps to solve the balance of payments problem faced by the government. When the
imports exceed the exports i.e. expenditure exceeds the income, central bank uses its
foreign currency reserves to pay the balance. The central bank also maintains the
 stability of the domestic currency. It avoids fluctuations in the currency by a process
of buying and selling of foreign reserves.
 Economic growth: Central bank facilitates the working of the commercial banks and
encourages new banks to come up. It helps in rural development by extending the
commercial bank branches to rural areas. It helps in the establishment of various
financial institutions which helps in the country’s growth.

CENTRAL BANKING AND COMMERCIAL BANKING

S.NO. CENTRAL BANK COMMERCIAL BANK

1. A Central Bank is defined as a On the other hand, a Commercial Bank

financial institution that looks after is a financial institution that receives
the country's economic and people's deposits in order to earn
financial stability. profits.

2. A Central Bank is of the highest A Commercial Bank is the richest bank

authority in the country. in the nation.

3. A Central Bank devises new policies A Commercial Bank has no such

and rules which have to be followed authority of making policies or rules.
by the other banks.

4. The Central Bank acts as a banker to A Commercial Bank serves as a dealer

several other banks and the to the citizens of the nation.
government.

5. The Central Bank came into being The Commercial Bank came into being
under the Reserve Bank Act of India, in the year 1949 under the Banking
1934. Regulation Act.

6. A Central Bank is owned by the A Commercial Bank is owned by both

public sector/ government. the public and private sectors.

7. A Central Bank does not make Commercial Banks are solely made for
profits out of the deposits. earning profits through people's
deposits.

8. A Central Bank is the highest A Commercial Bank has no authority

Monetary authority. This bank has like this.
many powers to exercise.

9. The main purpose of the Central The primary objective of the

Bank is the welfare of the citizens Commercial Bank is to earn profits.
 and bringing economic stability in
the country.

10. Central Banks are the ultimate Commercial Banks do not perform
money supply sources in the nation. such monetary functions.

11. The right to print currency notes Commercial Banks have no such right.
and issue them lies with the Central
Bank.

12. Central Bank deals with the Commercial Banks deal with the
government and several other general public.
banks.

13. There is only one Central Bank in There are many Commercial Banks in
every nation. the country.

14. Examples: Examples:

o Federal Reserve Bank o Dena Bank
o Bank of Japan o Punjab National Bank
o European Central Bank o State Bank of India

ESTABLISHMENT OF RBI

The Reserve Bank of India is the central bank of the country. Central banks are a relatively
recent innovation and most central banks, as we know them today, were established around
the early twentieth century.

The Reserve Bank of India was set up on the basis of the recommendations of the Hilton
Young Commission. The Reserve Bank of India Act, 1934 (II of 1934) provides the statutory
basis of the functioning of the Bank, which commenced operations on April 1, 1935.

The Bank was constituted to

* Regulate the issue of banknotes
* Maintain reserves with a view to securing monetary stability and
* To operate the credit and currency system of the country to its advantage.

The Bank began its operations by taking over from the Government the functions so far being
performed by the Controller of Currency and from the Imperial Bank of India, the
management of Government accounts and public debt. The existing currency offices at
Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Cawnpore (Kanpur) became
branches of the Issue Department. Offices of the Banking Department were established in
Calcutta, Bombay, Madras, Delhi and Rangoon.
Burma (Myanmar) seceded from the Indian Union in 1937 but the Reserve Bank continued to
act as the Central Bank for Burma till Japanese Occupation of Burma and later upto April,
1947. After the partition of India, the Reserve Bank served as the central bank of Pakistan
upto June 1948 when the State Bank of Pakistan commenced operations. The Bank, which
was originally set up as a shareholder's bank, was nationalised in 1949.

An interesting feature of the Reserve Bank of India was that at its very inception, the Bank
was seen as playing a special role in the context of development, especially Agriculture.
When India commenced its plan endeavours, the development role of the Bank came into
focus, especially in the sixties when the Reserve Bank, in many ways, pioneered the concept
and practise of using finance to catalyse development. The Bank was also instrumental in
institutional development and helped set up insitutions like the Deposit Insurance and Credit
Guarantee Corporation of India, the Unit Trust of India, the Industrial Development Bank of
India, the National Bank of Agriculture and Rural Development, the Discount and Finance
House of India etc. to build the financial infrastructure of the country.

With liberalisation, the Bank's focus has shifted back to core central banking functions like
Monetary Policy, Bank Supervision and Regulation, and Overseeing the Payments System
and onto developing the financial markets.

Functions and Department of RBI

The Reserve Bank of India influences the management of commercial banks

through its various policies, directions and regulations. Its role in bank
management is quite unique. It performs the four basic functions such as planning,
organizing, directing and controlling in laying a strong foundation for the
functioning of commercial banks.
RBI is the central bank of India and regulates the supply of money in the country.
To regulate this supply and various other policies, RBI has dedicated various
departments.

Various Departments and their Functions:

1. Banking Department: The Banking Department is responsible for rendering

the bank’s services as a banker to the Government and to the banks. Thus,
there are 4 sub-divisions to this department
2. Issue Department: The Issue department is concerned with the proper and
efficient management of the note issue.
3. Currency Management Department: This department is responsible for
forecasting the long-term requirements of the currency and subsequently
allocating it to the various other branches.
4. Government and Bank Accounts Department: The main task of this
department is to handle and maintain the various bank’s accounts in the
banking and issuing departments.
5. Budgetary Control and Expenditure Department: Under this department,
the bank’s budget and various expenditures are monitored for the different
units.
6. Department of Exchange Control: This department is responsible for
maintaining the exchange rate and controlling the foreign exchange. Also,
they try to stabilize the exchange rate.
 7. Department for Industrial Credit: This department as the name suggests is
related to the credit-related activities of the industries. So, their primary
task is to provide various credit guarantee schemes for the small-scale
industries and looking after their administration.
8. Banking Operations and Development Department: This department
looks after the commercial banks in India. They control, supervise, develop
these banks. Earlier it was also related to bank credit and lead bank scheme
for the priority sectors.
9. Agriculture Credit Department : Under this department, the care is taken
for various credit schemes in rural financing, providing financial resources
to various co-operative banks.
10. Non-banking Companies Department: The primary task of this department
is to regulate the deposits related to non-banking financial companies.
Further, it also controls and administers companies.
11. Credit and Rural Planning Department: This is one of the oldest
departments in the RBI. Also, it was established in the year 1982 and is
concerned with the issues like lead bank scheme, credit plans for the district,
provision for the expert assistance, processing the credit line for short -term
loans the NABARD, and putting forward the policies for reserve bank
regarding rural India.
12. Economic Policy and Analysis Department: This department handles the
economic reviews and research for banking and financial conditions of the
country.
13. Computer Services and Statistical Analysis Department: This department
as the name suggests collects, generates, process, and compiles the
statistical data related to the financial and banking sectors.
14. Legal and Inspection Department: The inspection department carries out
the inspections of the various departments and offices of the RBI. For the
legal advice on various issues referred by the RBI, the legal department is
responsible.
15. Department of Administration and Personnel: It looks after the general
administration and personnel policy, such as recruitment, training,
placements, promotions, transfers, discipline, appeals, service conditions,
wage structure, etc.
16. Premises Department: It is mainly concerned with the construction of
buildings for the Bank’s offices, training institutions and staff quarters.
17. Management Services Department: It is basically concerned with
organisational analysis, systems research and development, work procedure
studies and codification, manpower planning, costing studies, etc.
18. Reserve Bank of India Service Board: Its functions involve conducting of
examinations/interviews for the selection and promotion of staff in the
Reserve Bank.

MODULE – 3

FUNCTIONS OF COMMERCIAL BANK

Broadly speaking, the functions are of two categories – primary and secondary.

Primary Functions of Commercial Banks

The primary functions of a commercial bank are as follows:

1. Accepting Deposits
Commercial banks accept deposits from people, businesses, and other entities in the form of:

 Savings deposits – The commercial bank accepts small deposits, from households
or persons, in order to encourage savings in the economy.

 Time deposits – The bank accepts deposits for a fixed time and carries a higher
rate of interest as compared to savings deposits.

 Current deposits – These accounts do not offer any interest. Further, most
current accounts offer overdrafts up to a pre-specified limit. The bank, therefore,
undertakes the obligation of paying all cheques against deposits subject to the
availability of sufficient funds in the account.
Browse more Topics under Money And Banking

 Functions of Money and its Demand

 Supply of Money

 Instruments of Monetary Policy and the Reserve Bank of India

2. Lending of Funds
Another important activity is lending funds to customers in the form of loans and advances, cash
credit, overdraft and discounting of bills, etc.

Loans are advances that a bank extends to his customers with or without security for a specified
time and at an agreed rate of interest. Further, the bank credits the loan amount in the customers’
account which he withdraws as per his needs.

ROLE OF COMMERCIAL BANKS IN ECONOMIC DEVELOPMENT

Commercial banks are a source of finance for small businesses. The role of commercial
banks in economic growth depends on their role as financial intermediaries. In this capacity,
commercial banks help drive the flow of investment capital across the market. The main
method of allocating this capital in the economy is through the lending process which helps
commercial banks.

 Risk: The most important role of commercial banks in economic growth is to act as a risk
mediator. This is mainly when banks lend to businesses or individuals. For example, when
individuals apply for a loan from a bank, the bank examines the borrower's financing, among
other factors, including income, credit score, and loan level. The results of this analysis help
the bank determine the borrower's predetermined probability. Eliminating risky borrowers
reduces the risk of financial losses to commercial banks.

 Small Business: Commercial banks also finance business loans in a variety of ways. A
business owner can ask for a loan to finance the start-up costs of a small business. After
providing financial support, small businesses can start work and implement development
plans. The overall impact of small business activity creates a significant portion of
employment across the country.

 Wealth: Commercial banks also offer different types of accounts to hold or generate
individual wealth. As a result, it is used to lend and invest in commercial banks attracted with
account services. For example, commercial banks typically attract deposits by offering a
traditional savings menu and checking the accounts of businesses and individuals. Similarly,
banks offer other types of deposit accounts, such as money market accounts and certificates
of deposit.

 Government Expenditure: Commercial banks also support the role of the federal
government as an agent of economic growth. Typically, commercial banks help fund
government spending by purchasing bonds issued by the Treasury Department. Both long-
term and short-term treasury bonds support government operations, programs and deficit
spending.

MERCHANT BANKING

Introduction to Merchant Banking

Merchant banking is a professional service provided by the merchant banks to their
customers considering their financial needs, for adequate consideration in the form of fee.
Merchant banks are banks that conduct fundraising, financial advising and loan services to
large corporations.

These banks are experts in international trade, which makes them experts in dealing with
large corporations and industries. Merchant banking provides funds to the multinational
businesses and large business entities in the country which helps to boost the country’s
economic strength.

Merchant banks do not provide services to the general public; their services are limited to
business entities and large business corporations.

Merchant banker is a person who provides assistance for the subscription of securities. The
merchant banker plays an important role and carries a lot of responsibilities like, private
placement of securities, managing public issue of securities, stock broking, international
financial advisory services, etc.

Functions of Merchant Banking

The functions of merchant banking in India are governed by Securities and Exchange Board
of India (SEBI) regulations, 1992.

Portfolio Management
Merchant banking provides investment advice to the investors to make the investment
decisions. The merchant bank provides portfolio managing assistance to the investors
by trading securities on their behalf.
Raising funds for clients
Merchant banks assist clients in raising funds from the domestic and international market by
buying securities.

Promotional activities
The merchant bank also helps in the promotion of the business institute in its initial stages. It
helps the organisation to work on their business idea and to get the approval from the
government.

Loan Syndication
This is the service provided by merchant banks to its clients for raising credit from banks and
financial institutions.

Leasing Services
Merchant banks also provide leasing services to their customers.

Merchant banking provides a lot of support and opportunities for new businesses. This in turn
also has a positive effect on the country’s economic growth.

Role and activities of Merchant Bankers

Raising finance- Merchant Bankers (MB) assist their clients in fund raising by way of issue
of a debenture, shares, bank loans, etc.

Promotional activities– In India, Activities of Merchant Banker play a very vital role of

promoter of industrial enterprises. They assist entrepreneurs in the matter of conceiving ideas,

identifying projects, preparation of feasibility reports, getting Government approvals as well

as incentives, etc.

Brokers in stock exchanges– Merchant bankers also buy and sell shares in the stock exchange

on behalf of their clients. They also additionally conduct researches on equity shares.

Project management- Merchant bankers offer their service to clients in several ways in the

process of project management also.

What Is Investment Banking?

Investment banking is a type of banking that organizes large, complex financial transactions
such as mergers or initial public offering (IPO) underwriting. These banks may raise money
for companies in a variety of ways, including underwriting the issuance of new securities for
a corporation, municipality, or other institution. They may manage a corporation's IPO.
Investment banks also provide advice in mergers, acquisitions, and reorganizations.
In essence, investment bankers are experts who have their fingers on the pulse of the current
investment climate. They help their clients navigate the complex world of high finance.

Understanding Investment Banking

Investment banks underwrite new debt and equity securities for all types of corporations, aid
in the sale of securities, and help facilitate mergers and acquisitions, reorganizations, and
broker trades for institutions and private investors. Investment banks also provide guidance
to issuers regarding the offering and placement of stock.

Venture Capital Funds

Venture capital funds(VCFs) are investment instruments through which individuals can park
their money in newly-formed start-ups as well as small and medium-sized companies. These
are types of investment funds that primarily target firms that have the potential to deliver high
returns. Nonetheless, investing in these companies also involves considerable risk.

VCFs are somewhat similar to mutual funds – these constitute a pool of money collected
from several investors. Here investors can refer to individuals with high net worth,
companies, or even other funds. Instead of an asset management company, a VCF is managed
by a venture capital firm.

How Does a Venture Capital Fund Work?

VCFs are some of the ways to avail financing for entrepreneurs and small business owners.
However, a VCF will only invest in firms that project significant growth potential and the
ability to generate high ROI in the long run. As investments are made in new ventures, the
risk associated is also comparatively high.

That’s why VCFs invest in multiple companies at once. This is done by having confidence
that at least a few among the lot will be able to produce high returns and assuage the losses, if
any, incurred by the others.

What Does a Venture Capital Firm Do?

A venture capital firm identifies investment areas that can generate lucrative returns. It not
only acts as the fund manager but also as an investor. Generally, a venture capital firm will
also invest its own money as a form of commitment and assurance to its clients.

In lieu of investment, a venture capital firm may seek a chair amongst the directors at the
company, and offer expertise and intelligence for better management.

Non-Performing Assets (NPA)

NPA expands to non-performing assets (NPA). Reserve Bank of India defines NPA as any
advance or loan that is overdue for more than 90 days. “An asset becomes non-performing
when it ceases to generate income for the bank,” said RBI in a circular form 2007. To be
more attuned to international practises, RBI implemented the 90 days overdue norm for
identifying NPAs has been made applicable from the year ended March 31, 2004. Depending
on how long the assets have been an NPA, there are different types of non-performing
assets as well.

What is an asset for a bank?

Asset means anything that is owned. For banks, a loan is an asset because the interest we pay
on these loans is one of the most significant sources of income for the bank. When customers,
retail or corporates, are not able to pay the interest, the asset becomes ‘non-performing’ for
the bank because it is not earning anything for the bank. Therefore, RBI has defined NPAs as
assets that stop generating income for them.

Categories of NPA

There are different types of non-performing assets depending on how long they remain in the
NPA category.

a) Sub-Standard Assets

An asset is classified as a sub-standard asset if it remains as an NPA for a period less than or
equal to 12 months.

b) Doubtful Assets
An asset is classified as a doubtful asset if it remained as an NPA for more than 12 months.

c) Loss Assets

An asset is considered as a loss asset when it is “uncollectible” or has such little value that its
continuance as a bankable asset is not suggested. However, there may be some recovery
value left in it as the asset has not been written off wholly or in parts.

NPA Provisioning

Keeping aside the technical definition, provisioning means an amount that the banks set aside
from their profits or income in a particular quarter for non-performing assets; such assets that
may turn into losses in the future. It is a method by which banks provide for bad assets and to
maintain a healthy book of accounts.

Provisioning is done according to which category the asset belongs to. The categories have
been mentioned in the above section. Not only the type of asset, but provisioning also
depends on the type of bank. Like, Tier-I banks and Tier-II banks have different provisioning
norms.

GNPA and NNPA

Banks are required to make their NPAs numbers public and to the RBI as well from time to
time. There are primarily two metrics that help us to understand the NPA situation of any
bank. NPA numbers for a bank will be mentioned in the standalone financial statements of a
bank.

NPA in Absolute Numbers

GNPA: GNPA stands for gross non-performing assets. GNPA is an absolute amount. It tells
you the total value of gross non-performing assets for the bank in a particular quarter or
financial year as the case may be.

NNPA: NNPA stands for net non-performing assets. NNPA subtracts the provisions made by
the bank from the gross NPA. Therefore, net NPA gives you the exact value of non-
performing assets after the bank has made specific provisions for it.
NPA Ratios

NPAs can also be expressed as a percentage of total advances. It gives us an idea of how
much of the total advances is not recoverable. The calculation is pretty simple:

GNPA ratio is the ratio of the total GNPA of the total advances.

NNPA ratio uses net NPA to find out the ratio to the total advances.

Preventive Measures

 Taking a person/corporation’s Credit Information Bureau (India) Limited (CIBIL)

score into consideration before lending.
 Compromise or use various settlement schemes.
 Use alternative dispute resolution mechanisms for faster settlement of dues such as
use Lok Adalats and Debt Recovery Tribunals.
 Actively circulate information of defaulters.
 Take strict action against large NPAs.
 Use Asset Reconstruction Company.
 Legal Reforms such as implementation of the Insolvency and Bankruptcy Code have
already taken place.
 Corporate Debt Restructuring (CDR).
 Propose guidelines on wilful defaults/diversion of funds.
 Special Mention Accounts – Additional Precaution at the Operating Level.

MODULE – 4

What are Loans?

Finance is the blood of any business. It is the best and very popular financial facility provided
by a bank or other financial institutes to help businesses at the time of money requirement.
So, when it becomes difficult to arrange finance by the owner, the businesses can use this
option to arrange funds for their business. This financing option is provided for the long term.
Loans are a type of debt and have a repayment schedule for longer.

What are Advances?

Advance is a credit facility provided by banks or financial institutes to cover daily fund
requirements or as working capital. It is cheaper and more convenient to arrange short-term
finance as banks charge very low interest and charges on it. When businesses need money to
cover their daily expenses such as salary, wages, or purchasing raw materials, they can think
over this kind of credit facility from the banks.

Loans vs Advances Comparative Table

Basis of
Loans Advances
Comparison

It is a financing facility provided by

It is a credit facility provided by
banks to business organizations or
banks to business organizations
Meaning individuals for a particular period that
where businesses need money for a
carries the interesting part and other
short period.
charges.

In nature, it is debt. Unlike other

In nature, it is a Credit Facility. It has
debts, it has to be repaid on an equal
Nature to be repaid in a single transaction
installment basis which carries
within a particular period.
repayment interest.

Repayment Bridge to Short-term needs.

Long Term
Duration Maximum for one year only.

Yes, it is secured against collateral

Security as a Yes, primary security and directors’
Security. Sometimes it can be
Collateral guarantee.
unsecured also.

Legal There are various legal formalities as As compared, less legal formalities
Formality the amount is huge under this facility. and documentation.

It provides less money. Usually, the

Monetary
It can raise a huge amount of debt. 2-3 months of working capital could
Value
be raised.

Interest Banks charge an interest portion on it. Most of the time, the interesting
part is not available, but we need to
 Basis of
Loans Advances
Comparison

pay bank charges on it, which would

be minimal in comparison.

CASH CREDIT AND OVERDRAFT

Cash credit and overdraft are two types of short-term loan facilities offered by the lenders to the
businesses. Overdraft facility is also offered to individuals based on their relationship with the bank.
Cash credit is referred to as a short-term business loan that is offered to businesses for maintaining the
working capital, while overdraft facilities are offered to businesses and individuals who wish to withdraw
more than their available balance in the bank account.

Cash Credit Overdraft

Definition

Cash credit is a type of short term loan
facility that is provided by banks or
financial institutions to businesses for
maintaining their working capital
Overdraft facility is also a loan facility, which is provided to an
individual or a business, based on the relationship with the bank.
In this system, an individual can withdraw an amount greater
than his available balance till a specified limit as per regulations
of the bank

Purpose

For maintaining the working capital of Overdraft facility is offered for meeting short term obligations
the business, cash credit is offered of individuals or businesses

Rate of Interest

Rate of Interest is comparatively lower Rate of interest is higher than the cash credit
than overdraft

Need of account

New account needs to be opened Overdraft can be availed from an existing account

Calculation of Interest

Calculated based on the entire amount Calculated based on only the amount that is availed
that is withdrawn
Duration of loan

The loan duration is generally 1 year The loan duration can vary and it can be monthly, quarterly, half
yearly or yearly

What Is A Term Loan?

A term loan is a short term or long term loan that is given for a stipulated period. Financial
institutions provide these loans on a condition of repayment in fixed instalments (EMI) along
with interest. They are offered at both floating and fixed rates of interest. The repayment
tenure of term loans ranges between 12 months to 60 months. Personal loans, business loans,
auto loans, education loans, gold loans, and home loans are some examples of term loans.

Understanding Term Loan

Term loans are the amount that are commonly granted to the small businesses. Along with the
amount, the repayment schedule of the term loan is also pre-determined. However, these loan
interest rate might be fixed or floating. Generally, the tenure of these loans goes up to 5 years,
but occasionally, the mandate for these loans can extend up to 10 years.

These loans are not for personal use and hence, are offered only to businesses for capital
expenditure and business expansion amongst others. They are often tailor-made to suit the
financial needs of MSME businesses. There are also various benefits of using this loan to
raise capital. The benefits include a requirement of minimal documentation, quick and easy
disbursal of the required funds, as well as flexibility in repayment of the loan.

Types of Term Loan:

There are various types of term loan that businesses can choose from. They are often suited to
the requirements of borrowers based on factors like- the amount of funding required by the
business, the repayment capacity of the borrower and the financial health of the company in
terms of cash flow and in-hand availability of cash. Most terms of the loan, including the rate
of interest to be charged on the loan depends on factors like these. The most common
classification of term loan is done in terms of the loan tenure. Hence, the types of term loan
are as follows:

 Short Term Loan:

These are term loan which have a maximum tenure of 2 years. Mostly, these loans have
tenures of 1 to 2 years. These kinds of loan are primarily used for the day-to-day
requirements of the business or for the fulfilment of the working capital needs of the
business. There are various sources from which a business can get a short term loan. They
are- commercial banks, trade credit, discounting bills of exchange etc.

Usually, short term business loans have a rate of interest which is higher than the other type
of term loan, principally due to the shorter time frame. These loans may even involve weekly
repayment schedules if the loan tenure is very short. Any business willing to procure such a
loan should be mindful of the fact that not only these loans have rates of interest, but the
charges are also higher, in case the business defaults on any instalment.
  Medium Term Loan:

These are loan which have a tenure of 2 to 5 years. These types of loans could be said to be a
hybrid of the short termand long term loans. In most cases, these types of loans are procured
by businesses to carry out renovation or repairing of a fixed asset. An example could be the
renovation of a showroom. The characteristics of these loans are somewhat a mixture of short
and long term loans. The rates of interest charged are higher than the long-term loans;
however, the documentation during the loan application process is relatively more
comfortable when compared to longer-term loans.

 Long term Loan:

They are term loan which, in a majority of the cases, have a tenure of over five years. The
tenures can even extend up to 25 or 30 years depending on the nature of requirement. Due to
the higher ticket size of loans and higher associated risks, most of the long term loans are
secured, i.e. they require collateral. Examples for these kinds of loans are home loan, car loan
or loan against property etc. In the case where the loans are secured, the rates charged are
also lower. However, there are cases where even long term loans are unsecured. In such
cases, the interest rates charged are higher due to the higher risk involved.

Advantages of Term Loan

Acquiring working capital to buy any equipment and supplies for essential business activities
is the main motive of a these loan. The bank's money guarantees you have the funds to
purchase things for the organization as needed, which offers you a feeling of serenity.

 Cheap

Term credits are the least expensive source of short term finance. They are also considered
for medium term finance.

 Tax reduction

The amount of interest of these loans falls under tax-deductible expenditure. Therefore, the
tax advantage is accessible to such interest.

 Flexibility

These loans are negotiable. Therefore, they can be easily negotiated between the borrower
and the bank. Even the T&C (terms and conditions) of these loans are flexible and not rigid.

 Control

The term loan represents debt financing. So the equity shareholders do not lose their interest,
and it isn't weakened.

 Least eligibility requirements and hassle-free documentation

You can easily avail of these loans. The least eligibility criteria include the submissions of a
few essential documents, making the whole process of loan hassle-free.

Disadvantages of term loans

Though these loans are considered one of the best sources for outside credit; still, one should
be cautious enough not to land in detrimental financial circumstances. A few disadvantages
of these loans are:

 Commitment

Yearly interest installments, and reimbursement of the principal amount is mandatory for the
borrower. The inability of not meeting these installments brings up an issue on the borrower's
liquidity position, and its reality will be in question.

 Risk

Term credits, like any other kind of debt financing, also increase the company's financial risk.
Debt financing benefits only if the concerned inward return rate is more noteworthy than its
capital cost; else, it unfavorably affects shareholders' advantage.

How does a term loan work?

Due to various reasons like pre-determined loan value and repayment schedule, interest rates
etc., these loan are one of the most convenient loans for businesses to avail. There are various
aspects which are required to be understood for the business to comprehend how a term loan
works. There are five aspects of a term loan: the loan value, interest rate, loan tenure, the
repayment schedule, and whether the loan is secured or unsecured.

The loan value of a this loan is fixed. This amount depends on the type of loan chosen as well
as the eligibility of the borrower. The business loan interest rate charged on this loan can be
fixed or floating. It depends on the borrower what kind of rate it opts for. The loan tenure is
also pre-determined. The business must pay the amount availed in EMIs according to the
predetermined repayment schedule throughout the loan tenure. Finally, the loans availed can
be secured or unsecured. However, unsecured loan would have a higher rate of interest when
compared to secured loans.

Loan Syndication

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Loan Syndication is the process where a bunch of banks and lenders fund various
fragments of a loan of an individual borrower. Loan Syndication happens when a
borrower requires a loan amount which is too big for a single bank to provide. Thus,
a bunch of banks come together to form a syndicate and provide the necessary loan
amount to the borrower.

The advantages of Loan Syndication

 Best prices are available for business
  You have the option of reducing your term loans
 The syndicate banks will also share feedback on issues related to your business
 Loan syndication allows the lenders to have a greater visibility of the borrowers in the
open market
 Borrowers have the option of choosing among multi currency options, prepayment
rights, and risk management techniques.

What are the stages of loan syndication process

There are 3 stages of loan syndication process. We will list down each of them
below:
Stage 1
The first stage of the loan syndication process is the pre-mandate stage which is
initiated by the borrower. The stage involves the borrower either liaison with a single
lender or inviting competitor bids from multiple lenders. The borrower has to
mandate to the lead bank. After the lead lender has been chosen, they will start the
appraisal process. The lead bank will see to the needs of the borrower and will
design a loan structure for the borrower and develop a credit proposal.
Stage 2
The next stage involves the lender placing the loan and disbursement. The lead
lender initiates selling the loan at the marketplace for which it will prepare an
information memorandum, term sheet, and a legal documentation. The lead bank will
then approach other banks for participation. Once the loan contract is finalized, the
loan amount is disbursed.
Stage 3
The final stage is the post-closure stage which involves monitoring through an
escrow account. Escrow account is nothing but the account in which the borrower
will deposit the revenue. It’s the agent’s responsibility to ensure that the repayment
of loan is the top priority and the payment is done before making payments to any
other parties. In the post-closure stage, it’s the job of the agent to manage the
operating and running of the loan facility on a regular basis.

What is Security?
One of the major functions of a bank is to provide credit to the customers for various
purposes such as home, vehicle etc and a bank’s strength and solvency depends on the quality
of its loans and advances. Security resembles an insurance against emergency. It provides a
protection to the lender in case of loan default as the lender could acquire the security if the
repayment is not done by the borrower.

What are Secured and Unsecured loans?

An arrangement in which a lender gives money or property to a borrower and the borrower
agrees to return the property or repay the money, usually along with interest, at some future
point in time is called a loan.

A loan can be broadly classified as a secured and unsecured loan.

Secured loans
Secured Loans are those which are protected by some sort of asset or collateral, for example
– mortgage, auto loan, construction loan etc. If the lender is unable to repay the loan, the
borrower has the right to sell off the asset to recover the loan.

Unsecured loan
Unsecured loans include things like credit card purchases, education loan where borrower
don’t have to provide any physical item or valuable assets as security for the loan. If a person
is not able to repay this type of loan it leads to a bad credit history which creates problems in
future when he tries to get a loan from other lenders or the lender may appoint a collection
agency which will use all its possible tools to recover the amount.

Basis for comparison Secured loan Unsecured loan

Asset Compulsory Not compulsory

Basis Collateral Creditworthiness

Risk of loss Very less High

Tenure Long period Short period

Borrowing limit High Less
Rate of interest Low High

What is the importance of Asset/collateral?

For lender: It reduces the risk associated with the loan default as in the case of insolvency of
the borrower the lender could sell off his asset to compensate the loss occurred. Moreover,
the borrower will make payments if he doesn’t want to lose his pledged security.
For borrower: Secured loan has a low rate of interest and give more time to repay the loan so
a borrower with low income can easily afford it. Secondly, if a borrower has bad credit or
limited income, most of the financial institutions are reluctant in providing a loan but if he
pledges collateral, the lender may be more willing to approve his application.

Types of security
There are two types of security

Primary Security
When an asset acquired by the borrower under a loan is offered to the lender as security for
the financed amount then that asset is called Primary Security. In simple terms, it is the thing
that is being financed.
Example: A person takes a housing loan of Rs 50 lakh from the bank and purchases a
residential loan. That flat will be mortgaged to the bank as primary security.

Collateral Security
If the bank or financial institution feels that the primary security is not enough to cover the
risk associated with the loan it asks for an additional security along with primary security
which is called Collateral Security. It guarantees a borrower’s performance on a debt
obligation. It can also be issued by a third party or an intermediary.
Example: A person takes a loan of Rs 2 crore for the types of machinery. So to secure itself in
the case of default by the borrower it asks for mortgaging residential flat or hypothecating
jewellery, which will be termed as collateral security.
RBI has advised the banks not to obtain any collateral security in case of all priority sector
advances up to Rs. 25000. In other cases, it is left to the mutual agreement of the borrower
with the bank.

When collateral security is required?

Collateral security is not required in housing loan, car loan, personal loan etc. It is required
by lenders in corporate loans like cash credit because in cash credit primary security such as
stock and book debts can be sold any time by the borrower so an additional security in shape
of immovable property or some other assets are taken to secure loan.

What are collateral free loans?

Loans that are disbursed without collateral or security, which limit the lender’s exposure to
risk, are called collateral free loans. This facility is provided under Credit Guarantee Fund
Trust for Micro and Small Enterprises (CGTMSE), where micro and small enterprises can be
extended loan upto Rs. 1 crore without security. This scheme was launched to solve the
problem of lack of funding that these enterprises face as well as to boost their development.
Banks tend to safeguard their advances by taking different kinds of securities. The
main purpose of taking security is to fall back on it in case the loan is defaulted. Banks
take movable properties, immovable properties or a debt as security for loan. The
method of creating charge over properties depend upon the nature of property and
nature of charge. For example, when a bank gives loan against the security of gold
ornaments, it takes the possession of the ornaments whereas when it advances
against the security of a vehicle or a house property, the bank does not take physical
possession.

Types of Charges

Bank charge over properties confines itself to one or more of the following five types of
charges.

1. Assignment
2. Lien
3. Hypothecation
4. Pledge
5. Mortgage
They are further explained below:

1. Assignment

It is a mode of providing security to a bank for an advance. It is transfer of a right of

property or a debt. The transferor is called assignor and the transferee is called
assignee.

Borrowers generally assign the actionable claims to the banker as security for an
advance. In banking practice, a borrower m ay assign the book debt, money due from
government department and life insurance policies as security for an advance.

As regard to the mode of assignment, no particular form or words is necessary for

effecting an assignment, if the intention is clear from the language used. An
assignment can be absolute or by the way of security.
An assignment may be legal or equitable assignment. A legal assignment is the
absolute transfer of an actionable claim, must be in writing and signed by the assignor.
The assignor informs his debtor, also in writing, intimating the assignee’s name and
address. The assignee also serves a notice on the debtor and seeks his confirmation
of balance assigned. If the formality is not fulfilled, the assignment is called an
equitable assignment. Banks generally go in for legal assignment and insist for
obtaining an acknowledgement of assignment from the debtor.
2. Lien

Lien is the right of the banker to retain possession of the goods and securities owned
by the debtor until the debt due from the latter is paid. For example, while giving loan
against shares banks obtain letter of consent from borrower to the concerned company
for the lien over shares in favor of lender and accretion (dividend, bonus shares, right
shares). The bank’s lien is an implied pledge. A banker acquires the right to sell the
goods which came into its possession in the ordinary course of banking business, in
case the debt is not paid.

However, when a customer inadvertently leaves a packet containing certain share

certificates, life insurance policies, fixed deposit receipts of other banks, etc. while
leaving the bank premises, the bank will have no right of lien over those securities
because those were not given to the bank in the normal course of banking business.

3.Hypothecation

Hypothecation differs form mortgage in two respects. Firstly mortgage relates to

immovable property whereas hypothecation relates to movable property. Secondly, in a
mortgage, there is transfer of interest in the property to the creditor but i n
hypothecation there is only an obligation to repay money and no transfer of interest. In
a mortgage registered with land revenue office (LRO), charge over both fixed and
current assets are created.

Hypothecation charge extends to all the goods and moveab le properties with the
borrower as per the agreement of hypothecation and operations in these accounts are
permitted on the basis of stock statement, submitted by the borrower periodically
usually every month. Hypothecation can, however, be created as a fi xed charge over a
particular machinery/vehicle etc.

The term ‘Hypothecation’ means a charge in or upon any moveable property, existing
or future, created by a borrower in favor of a secured creditor, without delivery of
possession of the movable property t o such creditor, as a security for financial
assistance and includes floating charges and crystallization of such charge in to fixed
charge on movable property. Hypothecation agreements obtained by BFIs generally
have a clause under which hypothecation can be converted into a pledge at a later
date.
This form of charge is ideal from the point of view of the borrower as he is always in
control of goods offered as security to the bank. In case of default by the borrower, the
bank can take possession of goods and convert it to pledge.

4. Pledge

In the pledge, the ownership of goods remain with the borrower whereas physical
control over these goods will be exercised by the bank. Goods may be delivered by the
debtor (the pledger also known as pawnor ) to the cr editor (pledgee also known as
pawnee ). Pledge can be created only in case of existing goods which are in the
possession of the pawnor himself. There can be no pledge of future goods or goods
which the pawnor is likely to get into his possession subsequent ly. Since delivery is
involved, goods must be specific and identified.

The borrower has a right to get the goods returned to him after payment of debt
created here against. The delivery of goods must be with an intention of the parties to
create security for the debt or performance of a promise.

In case of default by the borrower, the BFIs can sell the goods after giving a
reasonable notice of sale as required. Notice must clearly indicate the intention of the
pledgee to sell the security and is compulsory before the sale can be affected. If the
bank realises more than its due by such sale, the excess realised will have to be
returned to the borrower. However, if there is any shortfall, the BFI can proceed
against the borrower in a court of law for the recov ery of the balance.

This mode of charge can be considered an ideal one for the bank as it has full control
over the security and can even realise it without any legal process merely by serving a
notice on the borrower. The borrower, however, is put to grea t disadvantage as he
loses control over the goods and may involve operational difficulties. Generally, the
raw material or finished goods or stock in trade etc not immediately required by the
borrower can be offered to the bank for pledge.

5.Mortgage

Mortgage is a transfer of an interest in a specific immovable property for the purpose

of securing an existing or future debt. The person transferring the interest is known as
mortgagor and the person to whom the interest is transferred is known as mortgagee.
Immovable property will include land, things attached to the earth or permanently
fastened to anything attached to the earth. Immovable property does not include
standing timber, growing crops or grass. Attached to the earth means:

Difference between Letter of Guarantee and Bank Guarantee

a. “Letter of Guarantee”:

 Letter of Guarantee (also known as “Letter of Credit”) referred

to as a documentary credit acts as a promissory note from a
bank. Letter of Guarantee represents an obligation taken on by a
bank to make a payment once certain criteria are met. Once these
terms are completed and confirmed, the bank will transfer the
funds. The letter of credit ensures the payment will be made as
long as the services are performed.

 Letters of credit are especially important in international trade

due to the distance involved and potentially differing laws in the
countries of the businesses involved. In these transactions, it is
not always possible for the parties to meet in person. The bank
issuing the letter of credit holds payment on behalf of the buyer
until it receives confirmation that the goods in the transaction
have been shipped.

b. “Bank Guarantee”:

 Bank Guarantees insure both parties in a contractual agreement

from credit risk. For instance, a construction company and its
cement supplier may enter into a new contract to build a mall.
Both parties may have to issue bank guarantees to prove their
financial stance and capability. In a case where the supplier fails
to deliver cement within a specified time, the construction
company would notify the bank, which then pays the company
the amount specified in the bank guarantee.

 Bank guarantees represent a more significant contractual

obligation for banks than letters of credit do. A bank guarantee,
like a letter of credit, guarantees a sum of money to a beneficiary
unlike a letter of credit the sum is only paid if the opposing party
does not fulfil the stipulated obligations under the contract. This
 can be used to essentially insure a buyer or seller from loss or
damage due to non-performance by the other party in a contract.

While letters of credit are used mostly in international trade agreements, bank
guarantees are often used in real estate contracts and infrastructure projects. Both
bank guarantees and letters of credit work to reduce financial risk.