AN OVERVIEW OF BANKING

INDUSTRY – UNIT I

Lecture Notes Series

By
Prof. Dr. Rajesh Mankani
(Strictly For Private Circulation)
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DEFINITION OF BANKS

 The term bank is either derived from old Italian word banca or from a French
word banque both mean a Bench or money exchange table
 In olden days, European money lenders or money changers used to display
(show) coins of different countries in big heaps (quantity) on benches or tables
for the purpose of lending or exchanging
 A bank is a financial institution which deals with deposits and advances and other
related services
 It receives money from those who want to save in the form of deposits and it
lends money to those who need it
 The definition of a bank varies from country to country
 Oxford Dictionary defines a bank as "an establishment for custody of money,
which it pays out on customer's order."

 Under English common law, a banker is defined as a person who carried on the
business of banking, which is specified as:
 Conducting current accounts for his customers
 Paying cheques drawn on him, and
 Collecting cheques for his customers

 Banking business means the business of receiving money on current or deposit

account, paying & collecting cheques drawn by or paid in by customers, making
of advances to customers & includes such other business as the authority may
prescribe for the purpose of the Act

 Banking business means the business of either or both of the following:

a) Receiving from the general public money on current, deposit, savings or other
similar account repayable on demand or within less than (3 months)…or with a
period of call or notice of less than that period
b) Paying or collecting cheques drawn by or paid in by customers

 Banking is defined in the Indian Banking Companies Act, 1949 as accepting for
the purposes of lending or investments, repayable on demand or otherwise as
withdrawal by cheques, draft order or otherwise
 And a bank is one, which does the business of banking
 A banker is one who, in the ordinary course of his business, honours cheques,
drawn upon himself by persons from & for whom he receives money in current
account

CHARACTERISTICS/FEATURES OF BANKS:

1. Dealing in Money: Bank is a financial institution which deals with other people's
money i.e. money given by depositors
 2. Individual / Firm / Company: A bank may be a person, firm or a company. A
banking company means a company which is in the business of banking

3. Acceptance of Deposit: A bank accepts money from the people in the form of
deposits which are usually repayable on demand or after the expiry of a fixed
period. It gives safety to the deposits of its customers. It also acts as a custodian
of funds of its customers

4. Giving Advances: A bank lends out money in the form of loans to those who
require it for different purposes

5. Payment & Withdrawal: A bank provides easy payment and withdrawal facility
to its customers in the form of cheques and drafts, It also brings bank money in
circulation. This money is in the form of cheques, drafts, etc

6. Agency & Utility Services: A bank provides various banking facilities to its
customers. They include general utility services and agency services

7. Profit & Service Orientation: A bank is a profit seeking institution having

service oriented approach

8. Ever Increasing Functions: Banking is an evolutionary concept. There is

continuous expansion and diversification as regards the functions, services and
activities of a bank

9. Connecting Link: A bank acts as a connecting link between borrowers and

lenders of money. Banks collect money from those who have surplus money and
give the same to those who are in need of money

10. Banking Business: A bank's main activity should be to do business of banking

which should not be subsidiary to any other business

11. Name Identity: A bank should always add the word "bank" to its name to enable
people to know that it is a bank and that it is dealing in money

DIFFERENT TYPES OF BANKS

1. Savings Bank:
• Saving banks are established to create saving habit among the people
• These banks are helpful for salaried people and low income groups
• The deposits collected from customers are invested in bonds, securities, etc
• At present most of the commercial banks carry the functions of savings banks
• Postal department also performs the functions of saving bank

2. Commercial Banks:
• Commercial banks are established with an objective to help businessmen
• These banks collect money from general public and give short-term loans to
businessmen by way of cash credits, overdrafts, etc.
• Commercial banks provide various services like collecting cheques, bill of
exchange, remittance money from one place to another place
• In India, commercial banks are established under Companies Act, 1956. In 1969,
14 commercial banks were nationalised by Government of India.
• The policies regarding deposits, loans, rate of interest, etc. of these banks are
controlled by the Central Bank

3. Industrial Banks / Development Banks:

• Industrial / Development banks collect cash by issuing shares & debentures and
providing long-term loans to industries. The main objective of these banks is to
provide long-term loans for expansion and modernisation of industries
• In India such banks are established on a large scale after independence. They
are Industrial Finance Corporation of India (IFCI), Industrial Credit and
Investment Corporation of India (ICICI) and Industrial Development Bank of India
(IDBI)

4. Land Mortgage / Land Development Banks:

• Land Mortgage or Land Development banks are also known as Agricultural
Banks because these are formed to finance agricultural sector. They also help in
land development
• In India, Government has come forward to assist these banks. The Government
has guaranteed the debentures issued by such banks. There is a great risk
involved in the financing of agriculture and generally commercial banks do not
take much interest in financing agricultural sector

5. Indigenous Banks:
• Indigenous banks means Money Lenders and Sahukars
• They collect deposits from general public and grant loans to the needy persons
out of their own funds as well as from deposits
• These indigenous banks are popular in villages and small towns
• They perform combined functions of trading and banking activities
• Certain well-known Indian communities like Marwaris and Multani even today run
specialised indigenous banks

6. Central / Federal / National Banks:

• Every country of the world has a central bank
• In India, Reserve Bank of India, in U.S.A, Federal Reserve and in U.K, Bank of
England
• These central banks are the bankers of the other banks
• They provide specialised functions i.e. issue of paper currency, working as
bankers of government, supervising and controlling foreign exchange
• A central bank is a non-profit making institution
• It does not deal with the public but it deals with other banks
• The principal responsibility of Central Bank is thorough control on currency of a
country
 7. Co-operative Banks:
• In India, Co-operative banks are registered under the Co-operative Societies Act,
1912
• They generally give credit facilities to small farmers, salaried employees, small-
scale industries, etc
• Co-operative Banks are available in rural as well as in urban areas
• The functions of these banks are just similar to commercial banks

8. Exchange Banks:
• Hong Kong Bank, Bank of Tokyo, Bank of America are the examples of Foreign
Banks working in India. These banks are mainly concerned with financing foreign
trade
• Following are the various functions of Exchange Banks:-
1. Remitting money from one country to another country
2. Discount, accept, collection of foreign bills of exchange
3. Buying and Selling Gold and Silver, currencies, and
4. Helping Import and Export Trade

9. Consumers Banks:
• Consumers bank is a new addition to the existing type of banks
• Such banks are usually found only in advanced countries like U.S.A. and
Germany
• The main objective of this bank is to give loans to consumers for purchase of the
durables like Motor car, television set, washing machine, furniture, etc
• The consumers have to repay the loans in easy instalments

10. Miscellaneous Banks:

• There are certain kinds of banks which have arisen in due course to meet the
specialized needs of the people
• In USA & UK, there are investment banks whose object is to control the
distribution of capital into several uses
• American Trade Unions have got labor banks, where the savings of the laborers
are pooled together
• In London, there is the London Discount House whose business is “to go about
the city seeking for bills to discount”
• There are numerous types of different banks in the world, carrying on one or the
other banking business

PRINCIPLES OF BANKING

1. Liquidity:
• Liquidity is an important principle of bank lending. Banks lend for short periods
only because they lend public money which can be withdrawn at any time by
depositors
• They therefore advance loans on the security of such assets which are easily
marketable & convertible into cash at a short notice
 2. Safety:
• The safety of funds lent is another principle of lending. Safety means that the
borrower should be able to repay the loan & interest in time at regular intervals
without default
• The repayment of the loan depends upon the nature of security, the character of
the borrower, his capacity to repay & his financial standing

3. Diversity:
• In choosing its investment portfolio, a commercial bank should follow the
principle of diversity
• It should not invest its surplus funds in a particular type of security but in different
types of securities
• It should choose the shares & debentures of different types of industries situated
in different regions of the country
• The same principle should be followed in the case of state governments & local
bodies
• Diversification aims to minimizing risk of the investment portfolio of a bank

4. Stability:
• Another important principle of a bank’s investment policy should be to invest in
those stocks & securities which possess a high degree of stability in their prices
• The bank cannot afford any loss on the value of its securities
• It should therefore invest its funds in the shares of reputed companies where the
possibility of decline in their prices is remote

5. Profitability:
• This is the cardinal principle for making investment by a bank
• It must earn sufficient profits
• It should therefore invest in such securities which offer an assured, fair & stable
return on the funds invested
• The earning capacity of securities & shares depends upon the interest rate & the
dividend rate & the tax benefits they carry

ORGANIZATION STRUCTURE OF BANKS

 Commercial banks in India may be broadly classified on the basis of two

criteria:
1. Statutory, and
2. Ownership

 On statutory basis, the banks are of two types:

1. Scheduled Banks
2. Non-Scheduled Banks

 On the basis of ownership, they may be classified into:

1. Public sector commercial banks
2. Private sector commercial banks

 In the category of scheduled banks, there are private sector banks & public
sector banks
 In fact all the public sector banks are scheduled banks
 In the private sector it is not so
 The Reserve Bank of India (RBI) is the supreme monetary & banking authority in
the country & has the responsibility to control the banking system in the country

 Reserve Bank of India (RBI):

 The country had no central bank prior to the establishment of the RBI. The RBI is
the supreme monetary and banking authority in the country and controls the
banking system in India. It is called the Reserve Bank’ as it keeps the reserves of
all commercial banks

 Schedule & Non-Scheduled Banks:

 A scheduled bank is a bank that is listed under the second schedule of the RBI
Act, 1934
 In order to be included under this schedule of the RBI Act, banks have to fulfil
certain conditions such as having a paid up capital and reserves of at least 0.5
million and satisfying the Reserve Bank that its affairs are not being conducted in
a manner prejudicial to the interests of its depositors
 Scheduled banks are further classified into commercial and cooperative banks
 Non- scheduled banks are those which are not included in the second schedule
of the RBI Act, 1934
 At present these are only three such banks in the country

 Commercial Banks:
 Commercial banks may be defined as, any banking organization that deals with
the deposits and loans of business organizations
 Commercial banks issue bank cheques and drafts, as well as accept money on
term deposits
 Commercial banks also act as moneylenders, by way of installment loans and
overdrafts
 Commercial banks also allow for a variety of deposit accounts, such as checking,
savings, and time deposit
 These institutions are run to make a profit and owned by a group of individuals

 Scheduled Commercial Banks (SCBs):

 Scheduled commercial banks (SCBs) account for a major proportion of the
business of the scheduled banks
 SCBs in India are categorized into the five groups based on their ownership
and/or their nature of operations
 State Bank of India and its six associates (excluding State Bank of Saurashtra,
which has been merged with the SBI with effect from August 13, 2008) are
recognised as a separate category of SCBs, because of the distinct statutes (SBI
Act, 1955 and SBI Subsidiary Banks Act, 1959) that govern them
 Nationalised banks and SBI and associates together form the public sector
banks group. IDBI ltd. has been included in the nationalised banks group since
December 2004
 Private sector banks include the old private sector banks and the new generation
private sector banks- which were incorporated according to the revised
guidelines issued by the RBI regarding the entry of private sector banks in 1993
 Foreign banks are present in the country either through complete
branch/subsidiary route presence or through their representative offices

 Types of Scheduled Commercial Banks (SCBs):

 Public Sector Banks: These are banks where majority stake is held by the
Government of India.
Examples of public sector banks are: SBI, Bank of India, Canara Bank, etc

 Private Sector Banks: These are banks in which majority of share capital of the
bank is held by private individuals. These banks are registered as companies
with limited liability. Examples of private sector banks are: ICICI Bank, Axis bank,
HDFC, etc
 Foreign Banks: These banks are registered and have their headquarters in a
foreign country but operate their branches in our country. Examples of foreign
banks in India are: HSBC, Citibank, Standard Chartered Bank, etc

 Regional Rural Banks: Regional Rural Banks were established under the
provisions of an Ordinance promulgated on the 26th September 1975 and the
RRB Act, 1976 with an objective to ensure sufficient institutional credit for
agriculture and other rural sectors
 The area of operation of RRBs is limited to the area as notified by GOI covering
one or more districts in the State
 RRBs are jointly owned by GOI, the concerned State Government and Sponsor
Banks (27 scheduled commercial banks and one State Cooperative Bank); the
issued capital of a RRB is shared by the owners in the proportion of 50%, 15%
and 35% respectively
 Prathama bank is the first Regional Rural Bank in India located in the city
Moradabad in Uttar Pradesh

Type of Commercial
Major Shareholders Major Players
Banks

SBI, PNB, Canara

Bank, Bank of
Public Sector Banks Government of India
Baroda, Bank of India,
etc

ICICI Bank, HDFC

Bank, Axis Bank,
Private Sector Banks Private Individuals
Kotak Mahindra Bank,
Yes Bank etc.

Standard Chartered
Bank, Citi Bank,
Foreign Banks Foreign Entity HSBC, Deutsche
Bank, BNP Paribas,
etc.
 Central Govt, Andhra Pradesh
Concerned State Govt Grameena Vikas
Regional Rural Banks and Sponsor Bank in Bank, Uttranchal
the ratio of 50 : 15 : Gramin Bank,
35 Prathama Bank, etc.

1. The Reserve Bank of India (RBI):

• The RBI is the supreme monetary & banking authority in the country & has the
responsibility to control the banking system in the country
• It keeps the reserves of all scheduled banks & hence is known as the “Reserve
Bank”

2. Public Sector Banks:

• State Bank of India & its Associates
• Nationalized Banks
• Regional Rural Banks Sponsored by Public Sector Banks

3. Private Sector Banks:

• Old generation Private Banks
• Foreign New Generation Private Banks
• Private Banks in India

4. Co-operative Sector Banks:

• State Co-operative Banks
• Central Co-operative Banks
 • Primary Agricultural Credit Societies
• Land Development Banks
• State Land Development Banks

5. Development Banks:
• Development Banks mostly provide long term finance for setting up industries.
They also provide short-term finance (for export & import activities):
a) Industrial Finance Corporation of India (IFCI)
b) Industrial Development Bank of India (IDBI)
c) Industrial Investment Bank of India (IIBI)
d) Small Industries Development Bank of India (SIDBI)
e) National Bank for Agriculture & Rural Development (NABARD)
f) Export – Import Bank of India (EXIM)

PAID-UP CAPITAL & RESERVES FOR BANKS IN INDIA

SN Particulars Amount
Rs.

1. If the place of business is more than one state 5 Lakhs

2. If the place of business is in Kolkata or Mumbai 10 Lakhs

or both
3. If the place of business is in one state none of 1 Lakh
which is situated in Kolkata or Mumbai plus
4. If the place of business is situated in the same 10,000
district plus
5. If the place of business is situated else where in 25,000
the state or in the same district
6. If it has only one business 50,000

7. Aggregate value of its paid up capital value & 15,00,000

reserve for foreign company shall not be less
than
8. If the place of Foreign Bank is situated in 20,00,000
Mumbai or Kolkata or both
9. Foreign Bank company required to pay deposit 20% of
with RBI at the end of financial year profit

 Cooperative Banks:
 • A co-operative bank is a financial entity which belongs to its members, who are
at the same time the owners and the customers of their bank
• Co-operative banks are often created by persons belonging to the same local or
professional community or sharing a common interest
• Co-operative banks generally provide their members with a wide range of
banking and financial services (loans, deposits, banking accounts, etc)
• They provide limited banking products and are specialists in agriculture-related
products
• Cooperative banks are the primary financiers of agricultural activities, some
small-scale industries and self-employed workers.
• Co-operative banks function on the basis of “no-profit no-loss”
• Anyonya Co-operative Bank Limited (ACBL) is the first co-operative bank in India
located in the city of Vadodara in Gujarat

• The co-operative banking structure in India is divided into following main 5

categories:
• Primary Urban Co-op Banks
• Primary Agricultural Credit Societies
• District Central Co-op Banks
• State Co-operative Banks
• Land Development Banks

 Difference between Scheduled Commercial and Schedule Co-operative

Banks:
• The basic difference between scheduled commercial banks and scheduled
cooperative banks is in their holding pattern
• Scheduled cooperative banks are cooperative credit institutions that are
registered under the Cooperative Societies Act
• These banks work according to the cooperative principles of mutual assistance
• Also, unlike commercial banks ,these banks work on the basis of “no-profit no-
loss”

BANKING SECTOR REFORMS 1991-2000

1 & 3 Jul External Payments Crisis, Rupee Devalued in two stages,

1991 Cumulative Devaluation about 18% in USD terms

Nov 1991 The Narsimahmam Committee Report suggested far reaching

reforms in the Indian Banking Sector. These included a phased
reduction in the SLR & CRR as well as accounting standards,
income recognition norms & capital adequacy norms
Mar 1992 A dual exchange rate system called Liberalized Exchange Rate
Management System (LERMS) introduced. This was the initial
 step to enable a transition to a market determined exchange rate
system
April 1992 Income recognition & asset classification norms introduced.
Provisioning & Capital adequacy standards specified. Indian
Banks required to fulfill these norms by 1994 & 1996
1992 SEBI formulated Insider Trading Regulations

1993 Guidelines for the establishments of private sector banks issued.

This heralds a new policy approach aimed at fostering greater
competition
1994 Committee on Reform of the Insurance Sector, R N Malhotra

Feb 3, 1995 Bharatiya Reserve Bank Note Mudran Ltd established as a fully
owned subsidiary of the Reserve Bank. Commenced printing of
Notes at Mysore on June 1 & at Salboni on Dec 11
Oct 1995 Banks are allowed to fix their own interest rates on domestic
term deposits with maturity of two years
1996 RBI Website made operational

June 6, 1997 RBI Conducts first auction of 14 day Treasury Bills. In Oct,
auction of 28 day Treasury Bills was introduced
Jul 10, 1997 Foreign Institutional Investors (debt funds) permitted to invest in
dated Government Securities
Nov 28, 1997 A series of measures introduced in response to the Asian
Currency Crisis
Apr 1998 Recommendations on the harmonization of the Role &
Operations of Development Financial Institutions & Banks paved
the way for universal banking in India
Nov 1999 RBI issued guidelines to banks for the issuance of debit cards &
smart cards to ease pressure on physical cash
1999 Foreign Exchange Management Act, 1999 replace FERA, 1973
with the objective of ‘facilitating external trade & payments’ &
‘promoting the orderly development & maintenance of foreign
exchange market in India’. The new act became operative from
Jun 2000 along with a sunset clause

CURRENT DEVELOPMENTS IN BANKING SECTOR

 GLOBALIZATION IN BANKING:
• Globalization implies the free movement of goods, services & capital throughout
the world
• Globalization refers to widening & deepening of international flow of trade,
capital, labor, technology, information & services
• Globalization is both a challenge & an opportunity for Indian banks to gain
strength in the domestic market & increase presence in the global market

• There are three distinct spells of development of Banking industry in post

independent India:
a) The pre-nationalization era from 1947 to 1969,
b) The post—nationalization cum pre-liberalization era from 1969 to 1991, and
c) The neo-liberalization era from 1991 onwards

 On 14th Aug 1991, the Govt. of India appointed a Committee headed by Mr. M
Narsimahmam (called Narasimahmam Committee-I) to suggest the modus
operandi for reforms of the Banking Sector
 On 16th Nov 1991, the said Committee submitted its Report suggesting
downsizing of PSBs through closure of branches, merger of PSBs, reduction of
priority sector lending from the then prevailing 40% to 10% of total advance
portfolio, abolition of Banking service Recruitment Board, granting of more
autonomy to PSBs in respect of both financial & administrative matters, to reduce
the supervisory & regulatory control of RBI & dilution of govt. holdings in PSBs
 The second phase of banking reforms were based on the recommendations of
Narsimahmam Committee 1998
 At that time Indian banking system was suffering from mounting NPA, over
staffing, lack of legal infrastructure for recovery of bank dues, absence of
autonomy & completely outdated systems needing technological support

 The major recommendations were:

1. Greater specialization for the banks in different niches like retail, export, SSI,
Corporate sector & Agriculture
2. Reduction of CRR to 5.5%
3. Reduction of average level of net NPAs for all banks below 5% by the year 2000
& 3% by 2002
4. Greater attention to be paid to ALM to avoid mismatch & to cover liquidity &
interest rate risks
5. Introduction of Voluntary Retirement Scheme

 Technology Infusion & Up Gradation Challenges:

• Keeping pace with technology upgradations is the most important challenge
banks are facing today
• Information networks now relay more & more content & knowledge
• Information is flowing through networks with greater intensity & changing
everything
• Power has shifted to customers who behave as active elements of a network &
not passive targets of a market
• There has been a secular shift in technology mobility, analytics & profusion of
media

• With the advancement of technology there is more focus on comfort of

customer providing services such as:
1. Automated Teller Machine Cards (ATM)
2. Credit Cards
3. Debit Cards
4. Internet Banking
5. Tele Banking
6. Corporate Cash Management
7. SWIFT Banking
8. Mobile Banking
9. Home Banking

• Many Indian banks are positioning themselves to seize the new opportunities
nationally & internationally
• Several PSBs are opening up new branches in foreign countries, eg. SBI

 Launch of Payments Bank by Paytm, Airtel & India Post Payments Bank
Ltd: Paytm has rolled out its first physical branch in Noida
• As a payment Bank, Paytm will be able to accept deposits upto Rs.1 lakh per
customer in wallet & saving/current accounts
• Further it can also offer other services like Debit cards, Online Banking & Mobile
Banking
• It will not be allowed to lend to customers, however it can offer products like
loans, insurance, mutual funds, pension funds, etc

 RBI to reconstitute oversight committee to tackle bad loans:

• The RBI is set to reconstitute Oversight Committee to operationalize the banking
ordinance, which was recently cleared by the Union Cabinet to amend the
Banking Regulation Act for the sake of giving more powers to RBI for effectively
dealing with non-performing assets (NPAs) in the banking sector
• The move is aimed at containing the bad loans which have reached to over Rs. 8
Lakh crores
• RBI has been authorized to issue directions to any banking company to initiate
insolvency resolution process under the provisions of the Insolvency &
Bankruptcy Code, 2016

 Heads of 7 PSU banks appointed:

• In a major restructuring in the banking sector, Appointments Committee of the
Cabinet (ACC), headed by PM Narendra Modi appointed heads of seven PSU
banks besides shifting managing directors of PNB & Bank of India
• Non-performance of the public sector banks in tackling the menace of non-
performing assets (NPAs) is said to be the reason behind the major restructuring
of the public sector banks
• Bad loans of PSUs surges by over Rs.1 Lakh crores to reach Rs.6.06 lakh crores
during April-Dec 2016-17
• Bulk of NPAs have come from power, steel, road infrastructure & textile sectors

 RBI tightens rules for JLFs:

• The RBI has tightened the rules around making the Joint Lenders’ Forum (JLF)
more effective, directing banks not to break any rules & to meet all deadlines
• As per the new norms, RBI has lowered the threshold needed for implementing
the corrective action plan (CAP)
• The decisions agreed to by a minimum of 60% of creditors by value & 50% of
creditors would now be valid to implement the CAP
• Once a decision is reached by the JLF, it would be binding on all other lenders &
they must implement it without any additional conditions
• The CAP can include resolution through the flexible structuring of project loans,
change in ownership under strategic debt restructuring or scheme of the
sustainable structuring of stressed assets

 RBI issues revised Prompt Corrective Action (PCA) framework for NPAs:
• RBI has come up with a notification titled “Revised Prompt Corrective Action
(PCA) framework for banks”
• The revised framework would apply to all banks operating in India including small
& foreign banks
• The new set of provisions will be effective from April 1 based on the financials of
banks as of March 2017
• Banks would be placed under PCA framework depending upon the audited
annual financial results & RBI’s supervisory assessment
• RBI may also impose PCA on any bank including migration from one threshold to
another if circumstances so warrant
• RBI has defined 3 kinds of risk thresholds & the PCA will depend upon the type
of risk threshold that was breached
• If a bank breaches the risk threshold, then mandatory actions include the
restrictions on dividend payment/remittance of profits, restriction on branch
expansion, higher provisions, restriction on management compensation &
directors fees
• Specifically, the breach of ‘Risk Threshold 3’ of CETI (Common equity tier 1) by a
bank would call for resolution through tools like amalgamation, reconstruction,
winding up among others

 Pradhan Mantri Yojna crosses loan targets:

• Loans disbursed under the Pradhan Mantri Mudra Yojna (PMMY) have crossed
its target of Rs.1.8 lakh crore in the F.Y. 2016-17
• Loans extended currently stand at Rs.1,80,087 crore of which a majority of the
loans were awarded by banks (Rs. 1.23 crore)
 • Non-banking financial institutions have lent about Rs.57,000 crores
• Current year’s budget target for 2017-18 is set for Rs.2.44 lakh crores
• Significantly, out of the 4 crore borrowers, over 70% of the borrowers were
women & around 20% borrowers belonged to SC category, 5% to ST & 35% to
OBC
• The objective of this scheme to launch a Micro Units Development & Refinance
Agency (MUDRA) Bank to support the entrepreneurs of SC,ST,OBC class in the
MSME sectors
• The scheme provides loans for non-agricultural activities upto Rs.10 lakhs & for
activities allied to agriculture such as diary, poultry, bee keeping, etc
• The scheme provides loans to micro units in 3 categories ranging from Rs.50000
to Rs.10 lakhs

 RBI keeps REPO rate unchanged in its first monetary policy review 2017-
18:
• The RBI in its first bimonthly monetary policy review of F.Y.2017-18, kept the key
policy rate, the repo rate, unchanged, but raised the reverse repo rate by 25bps
to 6% from 5.75%
• Repo rate is the rate at which RBI lends to its clients generally against govt.
securities – unchanged at 6.25%
• The reverse repo rate is the rate at which banks lend funds to the RBI, which was
raised to 6%
• Another important rate is the MSF Rate (Marginal standing facility) rate, at which
the scheduled banks can borrow funds overnight from RBI against govt.
securities – it was cut to 5%
• Bank rate is the rate charged by the central bank for lending funds to commercial
banks – set to 5% - this rate influences the lending rate of commercial banks
• CRR is the amount of funds that banks have to keep with RBI – unchanged at
4%
• SLR unchanged at 20.50% - it is the amount that banks have to maintain – a
stipulated proportion of their net demand & time liabilities (NDTL) in the form of
liquid assets like cash, gold & unencumbered securities, treasury bills, dated
securities, etc

BANKING REGULATION ACT – 1949

 The following are the important provisions under Banking Regulation Act –
1949 regarding control & regulation of Banking sector in India

 The act covers the following stipulations:

 Requirements regarding the minimum paid-up capital & reserves for
commencement of banking business
 Prohibition of charge on unpaid capital
 Payment of dividends only after writing off all capitalized expenses
 Transfer to reserve fund out of profits (min.20%)
 Maintenance of cash reserves by the non-scheduled banks (min. 3%)
 Restrictions on holding shares in other companies
 Restrictions on loans & advances to directors & others
 Licensing of banking companies & for new branches
 Maintenance of a % of liquid assets (min.25%-max.40)

 The following are the important provisions under Banking Regulation Act –
1949 regarding control & regulation of Banking sector in India

 The act also covers the following powers to RBI:

1. Power to call for & publish information, preparation of accounts, publication of
audited accounts, inspection of books & accounts of banking companies & giving
direction to the banking companies
2. Prior approval from RBI for appointment of a M.D. & for removal of managerial &
any other person
3. Power to appoint additional directors
4. Moratorium under the order of a High Court
5. Winding up of banking companies
6. Scheme of amalgamation to be sanctioned by RBI
7. Power to examine proceedings & tender advice in winding up proceedings
8. Power to inspect & make report to winding up
9. Power to call for returns & information from Liquidator of a Banking company
10. Issue f NOC for change of name
11. Issue of NOC for Alteration to Memorandum of a banking company

 AMENDMENT 2012:
 The act was amended with the Banking Laws (Amendment) Bill, 2012, which
seeks to further strengthen the regulatory power of the RBI & to further develop
the banking sector in India:

 Amendments:

1. Powers Granted to RBI under the bill:

• New Bank Licenses & Greater Regulatory Oversight:
• The Bill enables the RBI to issue new bank licenses to corporate houses which
will give RBI greater regulatory oversight over local banks & the ability to overrule
the board of directors of a banking company for not more than 12 months &
appoint an administrator for managing the company during that period
• Power to Inspect:
• The Bill shall give the powers to check the records, inspect books of
conglomerates & mutual fund bodies, insurance & other companies associated
with a bank to keep a check on lending practices
• Unclaimed Bank Accounts:
• RBI can transfer the balances of accounts lying dormant for more than 10 years
to the “Depositor Education & Awareness Fund” which shall be used to create
awareness among the bank customers
• Acquisition of Shares & Voting Rights:
 • Prior approval of RBI will be required for acquisition of 5% or more of shares or
voting rights in a banking company by any person – RBI empowered to impose
such conditions as it deems fit
• Regulating Cooperative Societies:
• A license from RBI is to be taken by primary cooperative societies to carry on the
business of banking & RBI shall have powers to conduct special audits of the
cooperative banks by extending applicability of Sec.30 of the Banking Regulation
Act
• Cash Reserve Ratio (CRR):
• RBI is empowered by this Bill to demand penalty interest from the bank if the
bank fails to maintain the prescribed minimum amount of Cash Reserve Ratio
(CRR) on any day

2. Amendments Related to Public/Private Sector Banks:

• Revised Voting Right: Private Sector Banks: The Bill increase shareholders
voting rights from 10% to 26% in private sector banks making investment
attractive for foreign players
• Revised Voting Right: Public Sector Banks: The Bill also enables the govt. to
raise voting rights in state banks such as the SBI to 10% from current 1%
acceding partially to foreign investors demands to have more say in Indian
banking
• Banking Merger: The Competition Commission of India will approve M&A in
banks except in the case of banks that are under trouble. In such cases, the RBI
will have the final authority
• Raising Investments: The Bill enables the nationalized banks to raise capital
through “bonus” & “rights” issues & also enables public sector banks to increase
or decrease the authorized capital with approval from the Govt. & RBI without
being limited by the ceiling of a maximum of Rs.3000 crores under the Banking
Companies (Acquisition & Transfer of Undertakings) Act, 1970/1980
• Stamp Duty: The Bill will allow foreign banks to convert their Indian operations
into local subsidiaries or transfer shareholding to a holding company of the bank
without paying stamp duty. This move will be helpful for the foreign banks to
expand their business operations into India
• Commodity Trading: The Govt. has dropped the controversial clause in the Bill
that would have allowed banks to trade in the commodity, futures market

PAYMENTS & SETTLEMENTS ACT – 2007

 The PSS Act, 2007 received the assent of the President on 20th Dec 2007 &
came into force w.e.f. 12th Aug 2008:

 The Objective of PSS Act, 2007:

• The PSS Act, 2007 provides for the regulation & supervision of payment systems
in India & designates the RBI as the authority for that purpose & all related
matters
 • The RBI is authorized under the Act to constitute a Committee of its Central
Board known as the Board for Regulation & Supervision of Payment &
Settlement Systems (BPSS), to exercise its powers & perform its functions &
discharge its duties under this statute
• The Act also provides the legal basis for “netting” & “settlement of finality”
• This is of great importance, as in India, other than the Real Time Gross
Settlement (RTGS) system, all other payment systems function on a net
settlement basis

 The Regulations made under the PSS Act, 2007:

• Under the Act, 2 regulations have been made by the RBI, namely the Board for
Regulation & Supervision of Payment & Settlement Systems Regulations, 2008 &
the Payment & Settlement Systems, Regulations, 2008
• Both these Regulations came into force along with the PSS Act, 2007 on 12 th
Aug, 2008
• The Board for Regulation & Supervision of Payment & Settlement Systems
Regulation, 2008 deals with the constitution of the BPSS, a committee of the
Central Board of Directors of the RBI. It also deals with its powers & functions,
meetings, quorum, sub-committees, advisory committees, etc
• The Payment & Settlement Systems Regulations, 2008 covers matters like form
of application for authorization for commencing/carrying on a payment system &
grant of authorization, payment instructions & determination of standards of
payment systems, furnishing of returns/documents/other information
• Sec 2(1) (i) of the PSS Act, 2007 defines a payment system to mean a system
that enables payment to be effected between a payer & a beneficiary, involving
clearing, payment or settlement service or all of them, but does not include a
stock exchange
• It is further stated by way of an explanation that a “payment system” includes the
systems enabling credit card operations, debit card operations, smart card
operations, money transfer operations or similar operations
• All systems (except stock exchanges & clearing corporations set up under stock
exchanges) carrying out either clearing or settlement or payment operations or all
of them are regarded as payment systems & all entities operating such systems
will be known as system providers
• Financial Market Infrastructure (FMI) is defined as a multilateral system among
participating institutions, including the operator of the system, used for the
purposes of clearing, settling, or recording payments, securities, derivatives or
other financial transactions
• The FMIs are subjected on an on-going basis, to the rules & regulations that are
consistent with the Principles for Financial Market Infrastructure (PFMIs) issued
by the Committee on Payment & Settlement Systems (CPSS) which is now
known as Committee on Payment & Market Infrastructure (CPMI)

NEGOTIABLE INSTRUMENTS ACT

 Negotiable Instruments are money/cash equivalents

 These can be converted into liquid cash subject to certain conditions & play an
important role in the economy in settlement of debts & claims
 The transactions involving the Negotiable Instruments in our country are
regulated by law & the framework of the Statute which governs the transactions
of these instruments is known as The Negotiable Instruments Act
 The act was framed in the year 1881 during British rule & has been amended 23
times to meet the requirements of times. The last amendment was in 2002

 What is a Negotiable Instrument?

 Sec 13 – “A Negotiable Instrument means a promissory note, bill of exchange or
cheque either to order or bearer”

 Transferability: A negotiable instrument as a document of title to money is

transferable either by the application of the law or by the custom of the trade
concerned

 Special Feature of N.I.: The special feature of such an instrument is the

privilege it confers to the person who receives it bonafide & for value, to possess
good title thereto, even if the transferor has no title or had defective title to the
instrument

 Distinctive features of Negotiable Instruments:

• Easily transferable from one person to another
• Confers absolute & good title on the transferee
• The holder of a Negotiable Instrument is called as the holder in due course &
possesses the right to sue upon the instrument in his own name

 Types of Negotiable Instruments:

• Negotiable instruments by Statute are of 3 types – cheques, bills of exchange &
promissory note
• Negotiable instruments by custom or usage: Some other instruments have
acquired the character of negotiability by the custom or usage of trade. Eg.
Promissory notes, Shah Jog Hundis, Delivery orders, Railway receipts, Bill of
Lading, etc are considered as quasi Negotiable Instruments

 Promissory Note: Sec 4: “A Promissory Note is an instrument in writing (not

being a bank note or a currency note), containing an unconditional undertaking,
signed by the maker to pay a certain sum of money only to, or to the order of a
certain person or to the bearer of the instrument”

 Bill of Exchange: Sec 5: “A Bill of Exchange is an instrument in writing

containing an unconditional order signed by the maker, directing a certain person
to pay a certain sum of money only to, or to the order of a certain person or to the
bearer of the instrument”

 According to Sec.7, the maker/creator of the instrument is known as “Drawer”

 The person to whom payment may be made is known as “Payee”
 The person who is directed to pay the amount is known as “Drawee” - He
accepts to pay the amount mentioned in the instrument
 In case of a promissory note, Drawer & Drawee are same
 In case of a cheque, the Drawee is always a Banker

 Cheque: According to Sec.6, “A cheque is a bill of exchange drawn on a

specified banker & not expressed to be payable otherwise than on demand”
 After 2002 amendment, cheque includes “the electronic image of a truncated
cheque & a cheque in the electronic form”

 M.I.C.R Cheques / Drafts: In MICR (Magnetic Ink Character Recognition)

cheques:
• First six numbers indicate the cheque number
• Next three numbers indicate city code
• Next three numbers indicate Bank code
• Next three numbers indicate Branch code

 Characteristics of Cheque, Bill of Exchange & Promissory Note:

1. Instrument in writing: Pencil writing is not forbidden by the law but to prevent
alteration, etc, the custom & usage do not allow this

2. Unconditional order/promise: Cheque & bill of exchange are orders of

creditors (drawers) to the debtors (drawee) to pay money. Instruments with
expressions such as “I.O.U Rs.500/-” is not a bill of exchange. On the other hand
a promise with following narration, duly signed & dated & accepted by a drawee
is a bill of exchange – “I promise to pay B or order Rs.5000”

3. Difference between cheque & bill of exchange: The main difference between
a cheque & a bill of exchange is that the former is always drawn on & is payable
by a banker specified therein

4. Certainty of the sum: The amount of the instrument must be certain

5. Payable to order or bearer: The instrument must be payable either to order or

to bearer as per the provision of Sec 13 of the Act.

6. Payee must be a certain person: The term ‘person’ includes besides

individuals, bodies corporate, local authorities, cooperative societies, etc, while a
payee may be more than one person

7. Term of Payment: A cheque is always payable on demand, while a bill may be

payable at sight or after a period of time specified therein. A Promissory note or
bill of exchange in which no time for payment is specified is payable on demand
(sec 19)
 8. Signature of the drawer/promisor: The negotiable instrument is valid only if it
bears the signature of the drawer/promisor

9. Delivery of the instrument: The making, acceptance or endorsement of an

instrument is completed by delivery in terms of Sec 46 of the Act. Stamping of
promissory notes & bill of exchange is necessary.

10. Currency note: The currency note is a promissory note payable to bearer on
demand. Sec 21 of RBI Act prohibits creation of this type of promissory notes by
others excepting the RBI

BIS (BANK FOR INTERNATIONAL SETTLEMENTS)

 Established on 17th May 1930, the Bank for International Settlements (BIS) is the
world’s oldest international financial organization
 The BIS has 60 member central banks, representing countries from around the
world that together make up about 95% of world GDP
 The head office is in Basel, Switzerland & there are two representative offices in
the Hong Kong Special Administrative Region of the People’s Republic of China
& in Mexico City
 The mission of the BIS is to serve central banks in their pursuit of monetary &
financial stability, to foster international cooperation in those areas & to act as a
bank for central banks

 In broad outline, the BIS pursues its mission by:

• Fostering discussion & facilitating collaboration among central banks
• Supporting dialogue with other authorities that are responsible for promoting
financial stability
• Carrying out research & policy analysis on issues of relevance for monetary &
financial stability
• Acting as a prime counterparty for central banks in their financial transactions,
and
• Serving as an agent or trustee in connection with international financial
operations

 BASEL PROCESS:
• The Basel Process refers to the role of the BIS in hosting & supporting the work
of the international secretariats engaged in standard setting & the pursuit of
financial stability
• Co-location at the BIS facilitates communication & collaboration among these
groups as well as their interaction with central bank Governors & other senior
officials in the context of the BIS’s regular meetings program
• The BIS also supports the work of these committees & associations with its
expertise in economic research & its practical experience in banking
• The outcomes of the Basel Process are visible to the public in the form of
committee reports that analyze specific topics & as regards the work of the
standard-setting committees, in the form of international agreed standards
• International agreement is the precondition for globally consistent standards, but
it does not substitute for national legislation
• In order to become binding, the agreements reached in Basel have to be
approved & implemented at the national level, following due regulatory &
legislative processes in each individual jurisdiction

 BASEL I: THE BASEL CAPITAL ACCORD:

• With the foundations for supervision of internationally active banks laid, capital
adequacy soon became the main focus of the Committee’s activities
• In early 1980s, the onset of the Latin American Debt crisis heightened the
Committee’s concerns that the capital ratios of the main international banks were
deteriorating at a time of growing international risks
• Backed by the G10 governors, Committee members resolved to halt the erosion
of capital standards in their banking systems & to work towards greater
convergence in the measurement of capital adequacy
• This resulted in a broad consensus on a weighted approach to the measurement
of risk, both on & off banks’ balance sheets
• There was strong recognition within the committee of the overriding need for a
multinational accord to strengthen the stability of the international banking
system & to remove a source of competitive inequality arising from differences in
national capital requirements
• Accordingly, a capital measurement system commonly referred to as the Basel
Capital Accord was approved by the G10 governors & released to banks in July
1988
• The 1988 accord called for a minimum ratio of capital to risk—weighted assets by
8% to be implemented by the end of 1992
• Ultimately this framework was introduced not only in member countries but also
in virtually all countries with active international banks
• In Sep 1993, the Committee issued a statement confirming that G10 countries’
banks with material international banking business were meeting the minimum
requirements set out in the Accord
• The Accord evolved over the next continuous periods of time
• It was amended in April 1995, to take effect at the end of that year, to recognize
the effects of bilateral netting of banks credit exposures in derivative products &
to expand the matrix of add-on factors
• In April 1996, another document was issued explaining how Committee members
intended to recognize the effects of multilateral netting
• The Committee also refined the framework to address risks other than credit risk,
which was the focus of the 1988 Accord
• In Jan 1996, the committee issued the amendment to incorporate market risks
(or Market Risk Amendment) to take effect at the end of 1997
• This was designed to incorporate within the Accord, a capital requirement for the
market risks, arising from banks’ exposures to foreign exchange, traded debt
securities, equities, commodities & options
• An important aspect of the Market Risk Amendment was that banks were, for the
first time, allowed to use internal models (value-at-risk model) as a basis for
measuring their market risk capital requirements, subject to strict quantitative &
qualitative standards

 BASEL II: THE NEW CAPITAL FRAMEWORK::

 In June 1999, the Committee issued a proposal for a new capital adequacy
framework to replace the 1988 accord which led to the release of a revised
capital framework in June 2004

 Generally known as “BASEL II”, the revised framework comprised of three

pillars:
1. Minimum capital requirements, which sought to develop & expand the
standardized rules set out in the 1988 accord
2. Supervisory review of an institution’s capital adequacy & internal assessment
process
3. Effective use of disclosure as a lever to strengthen market discipline &
encourage sound banking practices

 The new framework was designed to improve the way regulatory capital
requirements reflect underlying risks & to better address the financial innovation
that had occurred in recent years
 Following the June 2004 release, which focused primarily on the banking book,
the Committee turned its attention to the trading book
 In close cooperation with the International Organization of Securities
Commissions (IOSCO), the international body of securities regulators, the
Committee published in July 2005, a consensus document governing the
treatment of banks’ trading books under the new framework

 BASEL III:
 BASEL III is a comprehensive set of reform measures, developed by the Basel
Committee on Banking Supervision, to strengthen the regulation, supervision &
risk management of the banking sector. These measures aim to:
• Improve the banking sector’s ability to absorb shocks arising from financial &
economic stress, whatever the source
• Improve risk management & governance
• Strengthen banks’ transparency & disclosures

 The reforms target:

• Bank-level, or micro-prudential regulation, which will help raise the resilience of
individual banking institutions to periods of stress
 • Macro-prudential system wide risks that can build up across the banking sector
as well as the pro-cyclical amplification of these risks over time
 These two approaches to supervision are complementary as greater resilience at
the individual bank level reduces the risk of system wide shocks

BANKING CRISIS IN INDIA

 One of the most pressing problems affecting the Indian economy these days is
the poor health of its banking system
 The rising percentage of non-performing assets, where borrowers default on
repaying loans to banks, has reached alarming levels
 The total NPAs of 49 Indian Public & Private sector banks have risen to Rs.1.5
lakh crores
 In terms of NPAs as a percentage of the overall loans made by Indian banks, the
figure is as high as 20.20% for some banks like the Indian Overseas Bank
 Debt recovery tribunals were set up under the Recovery of Debts Due to Banks &
Financial Institutions Act, 1993 with the aim of streamlining the mechanism to
recover bad debts
 This process was earlier handled by civil courts before being shifted to 38 debt
recovery tribunals & five debt recovery appellate tribunals across the country

 Since their conception, these tribunals have been dogged by concerns

about their judicial independence because the Ministry of Finance, which
controls public-sector banks, has had significant influence on them:

1. Asset Quality: The biggest risk to India’s banks is the rise in bad loans
• The slowdown in the economy in the last few years led to a rise in bad loans or
non-performing assets (NPAs)
• These are loans which are not repaid back by the borrower & as such they are a
loss for the bank
• Net NPAs amount to only 2.36% of the total loans in the banking system, which
may not seem alarming
• However, it does not take into account restructured assets – when a borrower is
unable to pay back & the bank makes the loan more flexible to be paid back over
a longer period of time
• Restructured assets too put a pressure on a bank’s profitability
• Together, such stressed assets account for 10.90% of the total loans in the
system
• 36.90% of the total debt in India is at risk, according to an IMF report
• Yet banks have capacity to absorb only 7.9% loss – so if these debts turn bad
too, banks will face major losses

2. Capital Adequacy: One way a bank tries to ensure it is protected from bad loans
is by setting aide money as a ‘provision’
• This money cannot be used for any other purposes including lending as a result
of which, banks have lower capital available to use for its various operations
 • The Capital Adequacy Ratio measures how much capital a bank has
• When this falls, the bank has to borrow money or use depositors’ money to lend
• This money, however is riskier & costlier than the bank’s own capital
For eg. A depositor can withdraw his money anytime he wants, so a fall in CAR
(also called CRAR or Capital to Risk Assets Ratio) is worrisome
• In last few years, CRAR has declined steadily for Indian banks, especially for
public-sector banks
• Moreover, banks are not able to raise money easily, especially public-sector
banks which have higher number of bad loans
• If banks do not shore up their capital soon, some could fail to meet the minimum
capital requirement set by the RBI – in such a case, they could face severe
issues

3. Unhedged forex exposure : The fluctuations in the forex market have the
potential to inflict stress in the books of Indian companies who have borrowed
heavily abroad
• This stress can affect their ability to pay back debt to Indian banks
• As a result, the RBI wants banks to ensure companies they lend to do not
expose themselves to unnecessary debt in dollars

4. Employee & Technology : Public sector banks are seeing more employees
retire these days so younger employees are replacing the older, more-
experienced employees
• This, however, happens at junior levels as a result, there would be virtual
vacuum at the middle & senior levels
• This could lead to adverse impact on banks’ decision making process as this
segment of officers played a critical role in translating the top managements’
strategy into workable action plans
• Also banks need to embrace technology to offer better products which will help
make banks more efficient

5. Balance Sheet Management : In the past few years, many banks have tried to
delay setting aside money as provisions (for future bad loans)
• One reason for this is that a bank’s chief executives have a short tenure, during
which time they want to post higher net profits & cheer investors
• Deferring provisioning, is harmful in the long term
• It reduces the bank’s ability to withstand financial pressures
• This is even more problematic considering the poor capital adequacy in Indian
banks
• In fact, investors would be more happy if the management addresses & sorts out
problems rather than posting high net profits that cannot be sustained in the long
term

CRITICAL EVALUATION OF BANKING INDUSTRY IN INDIA

 The banking system analysis of the Indian Banking sector:

 1. The banking system in India is the most extensive. The total asset value of the
entire banking sector in India is nearly US$ 270 million
2. The total deposit is nearly US$ 220 billion
3. Presently the latest inclusions such as Internet banking & Core banking have
made banking operations more user friendly & easy
4. Almost 80% of the business are still controlled by PSBs & they are still
dominating the commercial banking system
5. The RBI has given licenses to new private sector banks as part of the
liberalization process. The RBI has also been granting licenses to industrial
houses. Many banks are successfully running in the retail & consumer segments
but are yet to delivery services to industrial finance, retail trade, small business &
agricultural finance
6. The PSBs will play an important role in the industry due to its number of
branches & foreign banks facing the constraint of limited number of branches.
Hence, in order to achieve an efficient banking system, the onus is on the
government to encourage the PSBs to be run on professional lines

DEREGULATION OF BANKING SYSTEM

 Prudential norms were introduced for income recognition, asset classification,

provisioning for delinquent loans C& for capital adequacy
 In order to reach the stipulated capital adequacy norms, substantial capital were
provided by the govt. to the PSBs
 Govt. pre-emption of banks’ resources through statutory liquidity ratio (SLR) &
cash reserve ratio (CRR) brought down in steps
 Interest rates on the deposits & lending sides almost entirely has been
deregulated
 New private sector banks allowed – to promote & encourage competition
 PSBs were encouraged to approach the public for raising resources
 Recovery of debts due to banks & the Financial Institutions Act, 1993, was
passed & special recovery tribunals set up to facilitate quicker recovery of loan
arrears
 Bank lending norms liberalized & a loan system to ensure better control over
credit introduced
 Banks asked to set up asset liability management (ALM) systems
 RBI guidelines issued for risk management systems in banks encompassing
credit, market & operational risks
 A credit information bureau being established to identify bad risks