COMMERCIAL BANKING &

CUSTOMER – BANKER
RELATIONSHIP – UNIT II
Lecture Notes Series
By
Prof. Dr. Rajesh Mankani
(Strictly For Private Circulation)
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INTRODUCTION TO COMMERCIAL BANKING

 According to Investopedia, “a commercial bank is a financial institution that

provides various financial services, such as accepting deposits & issuing loans”
 Commercial bank customers can take advantage of a range of investment
products that commercial banks offer like savings account & certificates of
deposit
 The loans a commercial bank issues can vary from business loans & auto loans
to mortgages
 According to Sec.42(6) of the RBI, 1934, Commercial banks are classified into
two categories:
 Scheduled banks; and
 Non-scheduled banks

 A Scheduled Bank means a bank included in the ‘Second Schedule’ of the RBI
Act, 1934
 The RBI is empowered to include in the Second Schedule, a bank which carries
on the business of banking which satisfies the following conditions:
1. It must have a paid-up capital & reserve of an aggregate value of not less than 5
lakhs
2. It must satisfy the RBI that its affairs are not being conducted in a manner
detrimental to the interests of its depositors, and
3. It must be:
 A state co-operative bank, or
 A company as defined in the Companies Act, 1956, or
 Indian scheduled commercial banks, and
 Foreign scheduled commercial banks

NON SCHEDULED BANKS

 The commercial banks which are not included in the second schedule of the RBI
Act are called as Non Scheduled banks
 They are not entitled for refinancing facilities of RBI & are mainly engaged in
money lending, discounting, collection of bills & various other services
 The public sector banks i.e. the State Bank, its seven subsidiaries & 20
nationalized banks have been notified as scheduled banks
 The RBI is authorized to exclude the name of a Bank from the second schedule if
any of the above mentioned conditions are not fulfilled & it becomes a non-
scheduled bank

STRUCTURAL CHANGES IN THE INDIAN BANKING SYSTEM

 A variety of structural & institution developments have taken place in the

landscape of Indian Banking
 There has been no contraction of banking facilities though there has been a
decline in the number of banks from 566 in 1951 to 89 in June 1969
  In the place of old imbalance, a healthy & balanced growth of branch banking is
to be witnessed in the present times
 The RBI seems to have made a good & judicious use of the powers vested in it
for bringing about mergers & for sanctioning the opening of branches
 Post nationalization of 14 major Indian scheduled banks in 1960, there have
been far reaching changes in the Indian banking system

EVOLUTION OF COMMERCIAL BANKING

 The commercial banking industry in India started in 1786 with the establishment
of the Bank of Bengal in Calcutta
 The Indian government at the time established three Presidency Banks, viz., the
Bank of Bengal (1809), Bank of Bombay (1840) & the Bank of Madras (1843)
 In 1921, the three Presidency banks were amalgamated to form the Imperial
Bank of India, which took up the role of a commercial bank, a bankers’ bank & a
banker to the government
 The Imperial Bank of India was established with mainly European shareholders
 It was only with the established of RBI as the central bank of the country in 1935,
that the quasi-central banking role of the Imperial Bank of India came to an end
 In 1860, the concept of limited liability was introduced in Indian banking, resulting
in the establishment of joint-stock banks
 In 1865, the Allahabad Bank was established with purely Indian shareholders, &
PNB started in 1895
 Between 1906 to 1913, other banks like Bank of India, Central Bank of India,
Bank of Baroda, Canara Bank, Indian Bank & Bank of Mysore were set up
 After independence, the GOI started taking steps to encourage the spread of
banking in India
 In order to serve the economy in general & the rural sector in particular, the All
India Rural Credit Survey Committee recommended the creation of a state-
partnered & state-sponsored bank taking over the Imperial Bank of India &
integrating with it, the former state-owned & state-associate banks
 Accordingly, State Bank of India (SBI) was constituted in 1955 & subsequently in
1959, the State Bank of India (subsidiary bank) Act was passed, enabling the SBI
to take over eight former state-associate banks as its subsidiaries
 One important feature of the reforms of the 1990s was that the entry of new
private sector banks was permitted
 Following, this decision, new banks such as ICICI Bank, HDFC Bank, IDBI Bank
& UTI Bank were set up
 Commercial banks in India have traditionally focused on meeting the short-term
financials needs of industry, trade & agriculture
 However, given the increasing sophistication & diversification of the Indian
economy, the range of services extended by commercial banks has increased
significantly, leading to an overlap with the functions performed by other financial
institutions

FUNCTIONS OF COMMERCIAL BANKING

 Commercial bank being the financial institution performs diverse types of
functions
 It satisfies the financial needs of the sectors such as agriculture, industry, trade,
communication, etc that means they play very significant role in a process of
economic social needs
 The functions performed by banks are changing according to change in time and
recently they are becoming customer centric and widening their functions
 Generally the functions of commercial banks are divided into two categories viz.
primary functions and the secondary functions

 Primary Functions of Commercial Banks:

 Commercial Banks performs various primary functions some of them are given
below:

1. Accepting Deposits: Commercial bank accepts various types of deposits from

public especially from its clients. It includes saving account deposits, recurring
account deposits, fixed deposits, etc. These deposits are payable after a certain
time period
2. Making Advances: The commercial banks provide loans and advances of
various forms. It includes an overdraft facility, cash credit, bill discounting, etc.
They also give demand and term loans to all types of clients against proper
security
 3. Credit creation: It is most significant function of the commercial banks. While
sanctioning a loan to a customer, a bank does not provide cash to the borrower
Instead it opens a deposit account from where the borrower can withdraw. In
other words while sanctioning a loan a bank automatically creates deposits. This
is known as a credit creation from commercial bank

 Secondary Functions of Commercial Banks:

 Along with the primary functions each commercial bank has to perform several
secondary functions too. It includes many agency functions or general utility
functions. The secondary functions of commercial banks can be divided into
agency functions and utility functions:

1. Agency Functions : Various agency functions of commercial banks are:

a. To collect and clear cheques, dividends and interest warrant
b. To make payment of rent, insurance premium, etc
c. To deal in foreign exchange transactions
d. To purchase and sell securities.
e. To act as trusty, attorney, correspondent and executor
f. To accept tax proceeds and tax returns

2. General Utility Functions : The general utility functions of the commercial banks
include:
a. To provide safety locker facility to customers
b. To provide money transfer facility
c. To issue travelers’ cheques
d. To act as referees
e. To accept various bills for payment e.g phone bills, gas bills, water bills, etc
f. To provide merchant banking facility
g. To provide various cards such as credit cards, debit cards, Smart cards, etc

RETAIL BANKING

 Retail banking is a banking in which all necessities of general public are

coordinated to satisfy the customers
 Retail banking serves the needs of individuals
 Retail banking encompasses deposit & asset linked products as well as other
financial services offered to numerous personal banking customers & small
businessmen
 It tends to be domestic rather than international
 Products offered by retail banks are credit cards, housing & educational loans,
deposits, loans for subscription of IPOs, etc
 India has experienced a surge in retail banking & retail loans are estimated to
have accounted for nearly 1/5th of all bank credit

FEATURES OF RETAIL BANKING

 (1) Multiple products: Retail banks provide various products like flexi deposits,
credit cards, insurance investment, demat account, ATM cards, portfolio
management, etc, payment of water, electricity, telephone, rent, etc
(2) Multiple delivery channels: In retail banking, bank services reach the
customers not only through branch banking, but also through call centers,
internet kiosks, etc
(3) Multi customer groups: Retail bank provides services to individual customers,
small businessmen & sometimes to corporates also
(4) Large number of small customers: Retail banking is characterized by the
existence of a large number of small customers who consume personal banking
& small business services. The relationship size of each account is small but the
number of relationships is huge
(5) The retail banking industry is diverse & competitive

IMPORTANCE OF RETAIL BANKING

(1) Reduction of risk: If any big loan becomes unrecoverable then it creates a
heavy loss to bank, whereas if the same amount of loan is given as loan to a
large number of customers, then the risk is reduced
(2) Reduction in NPA: It provides various financial & non-financial products &
services to customers. Their products provide an opportunity for banks to
diversify the asset portfolio & leads to low NPAs
(3) Different Products: It offers various products to customers like car loans,
education loans, deposit consultancy service, credit card, mutual funds, etc
(4) Consumers Oriented: Retail banks offer various products according to the
requirements of individual customers. Hence the customers get more benefit
from retail banking & individual customer banking needs are satisfied here
(5) Better Yield: Retail banking results in better yield & improved bottom line for a
bank. It leads to the increase of financial inclusion in India

PRODUCTS OFFERED BY RETAIL BANKING

 Apart from the basic products, the retail banking provides various products &
services according to the requirement of customers

 Following are the general products & services offered by retail banks:

(1) Deposit products like saving account, current account, fixed deposit, recurring
deposit, etc
(2) Loans like residential housing loans, personal loans, auto finance, education
loan, consumption loans for consumer durables like refrigerators, television,
washing machines, home theatres, music systems, smart phones, etc
(3) Non-financial services like investment advisory services, consultancy, etc
(4) Standing instruction: payment of utility bills like water, rent, insurance premium,
as per instructions of customers
 (5) Retail banks provide e-banking, internet banking, mobile banking, etc, to save
the time of customers & avoid branch visits
(6) Value added services: such as demat account, issue of free ATM cards, portfolio
management, etc

CORPORATE BANKING

 Corporate banking typically serves the financial needs of large corporate houses
both domestic & multinational entitles of public sectors & government
 Sometimes, it is also referred to as wholesale banking
 Corporate or wholesale banks normally supply capital for business ventures &
construction activities on a long term basis
 The corporate clients a few in number but they keep high balances & make high
value transactions
 Traditionally, banks had primarily been focusing on production based activities &
financed working capital requirement as well as term loans to corporate

FEATURES OF CORPORATE BANKING

(1) Corporate bank serves the need of corporate, those having a separate & distinct
legal entity
(2) Corporate bank provides business current account, commercial loans,
syndicated lending facilities, etc
(3) Many corporate banks provide structured products, capital market services &
corporate solutions
(4) Corporate banking involves comparatively fewer borrowers & the account size is
usually large
(5) It provides financial services for the needs of setting up new projects, expansion,
diversification, financial restructuring, etc

SIGNIFICANCE OF CORPORATE BANKING

 Corporate bank is also called as business bank because it provides loans to

corporate entities
 This bank operation involves large-scale companies & government
 Corporate banks provide funds to start business units, modernization of factories,
purchase of capital equipment, etc & hence it leads to more production & growth
of the country’s economy
 Now-a-days they also provide non-fund services such as investment & risk
management, cash management, etc. Some such banks are ICICI, HDFC, etc
PRODUCTS & SERVICES OF CORPORATE BANKING

CORPORATE BANKING PRODUCTS &

SERVICES

Traditional Finance Product & Services (current

services)

• Term Loan
• Working Capital
• Letter of Credit
• Bank Guarantee Funding Non-Funding

• Syndication Loan • Letter of Credit

• Structured Project • Bank Guarantee
Finance • Cash Management
• Consortium Finance Service
• Commercial Bank • Channel Financing
• Working Capital • Investment, etc
• Short term finances,
etc

(1) Traditional Services: Corporate banks provide both funded & non-funded
products & services
 Traditionally it provided more term loans for productive based corporate entities
 Corporate bank was famous for working capital finance
 Before 1993, single corporate bank could give maximum Rs.5 crores as working
capital finance to single corporate entity
 From Oct 1993, this floor limit was raised to Rs.50 crores
 The banks issued letters of credit, bank guarantees also for export & import
business

(2) Funding Services: Nowadays, they provide various funding services to big
corporate houses & governments. Some of them are:

(a) Loan Syndication: Loan syndication is done when a borrower wants to raise a
relatively large amount of money quickly & conveniently & if the amount exceeds
the exposure limits of any one bank & the borrower does not want to deal with a
large number of lenders. The major benefits reaped by corporates in syndication
are account, tenure & price
 (b) Project Finance: In project financing, lenders rely on the assets like revenue
producing contracts & other cash flows generated by the project, as collateral for
the debt
• Project financing, sometimes operates through a Special Purpose Vehicle (SPV),
a business entity that has no asset of its own beyond those of the project, &
which is jointly owned by project participants
• Project finance has been employed in almost all capital intensive industries,
particularly in construction & infrastructure development, transportation, export
finance, etc

(c) Consortium Finance: Consortium advances have now come to stay for large
advances from banks particularly to corporate sector
• Consortium takes place when two or more banks jointly participate in financing a
corporate borrower
• It helps the banks to pool their resources & share the credit risk & at the same
time fund large-scale financial needs of the borrower
• In 1994, Shetty committee recommended that exposure of individual banks to a
single borrower should not exceed 25% of the networth of the bank & size of the
consortium should not exceed 5 members

(d) Others: Other types of products are working capital loan, term loans, overdrafts,
bill discounting, etc

(3) Non-Funding Services: Corporate banks provide various non-funded services

such as cash management including both short-term holdings of cash & funds held
for longer periods, transmission & receipt of money handling foreign currency &
holding against changes in value, investment, risk-management, letter of credit,
bank guarantee & so on

RURAL BANKING

 Rural Banking system occupies a significant position in the structure of Indian

banking system
 Being an agrarian economy with more than 50% of the population depending on
agriculture for their livelihood, rural banking has acquired increasing relevance in
the recent decades
 Till, 1970, the financial need of rural areas were fulfilled by money lenders – they
charged high rates of interest on the loan amounts
 The SBI took some effort to improve their share in contributing to rural finance &
in 1972, the banking commission report recommended creation of “Rural Banks”
 After the announcement of Indira Gandhi government’s 20 point Economic
program in 1975, the government appointed a working group on rural banks
headed by Narasimham
 Based on the recommendation of the committee, Regional Rural Bank Act was
established in 1976
 Now, new guidelines have been issued by RBI in 2011 according to which, every
village with a population of 5000 or more should have bank branch by the end of
Sep 2012

 The following banks provide rural finance:

(1) Cooperative Banks: Rural cooperative banks play a pivotal role in the rural
credit delivery system with credit cooperatives forming almost 70% of rural credit
outlets
 These banks mainly provide short-term credit to agriculturalists, small farmers &
small scale industries
 The cooperative banks play a very useful role in financing agriculture & allied
activities

(2) Local Development Banks: Agriculturists require short-term & long-term loans
 Land development banks provides term loans to agriculturists for purchasing
tools & equipment & cattle & making permanent improvement on land
 The long-term loans are granted against the security of immovable property such
as land
 Land development banks are organized on cooperative basis in India
 These banks are presently called as Agriculture & Rural Development Banks.
The other purposes for which loans are given are:
(a) Purchase of tractors, pump sets, electronic motors, etc
(b) Digging/construction of wells, fencing of land, etc
(c) Redemption of old debts
(d) Construction of tanks, etc

(3) Regional Rural Banks (RRBs): The Regional Rural Bank was established to
promote, regulate with a view to developing the rural economy for the purpose of
development of agriculture, trade, commerce, industry & other productive
activities in the rural areas, credit & other facilities, particularly to the small &
marginal farmers, agricultural labourers, small entrepreneurs & other matters
connected therewith & incidental thereto

(4) Local Area Banks (LABs): The Union Budget 1996-97 announced a very
important policy measure regarding the development of commercial banking in
India, namely the setting up of local area as commercial banks in the private
sector
 It has hoped that the large number of problems faced by RRBs & other
commercial & cooperative banks would be addressed by the local area banks
especially in the rural areas
 The main objectives of these banks are:
(a) Providing an institutional mechanism for promoting rural & semi-urban savings;
and
(b) For providing credit for viable economic activities in the local areas
 (5) NABARD: This was established in July 1982. It is an apex institution concerned
with the policy, planning & operations in the field of agriculture & other rural
economic activities
 One of the main functions of NABARD is coordination of the activities of different
agencies in the field of agriculture & rural credit & implementation of measures to
improve the absorptive capacity of credit delivery system
 NABARD has set up the Rural Infrastructure Development Fund since 1996-97
 Commercial banks also provide various products & services to the rural people
through their branches but commercial bank branches cover only 7% of rural
sector & large market is still untapped

FEATURES OF RURAL BANKING

(a) Rural banking involves increasing the accessibility of banking services to the
poor in a commercially sustainable manner
(b) Rural banking providing financial assistance to rural area people for the purpose
of agricultural activities, small business activities & for personal purposes
(c) The rate of interest on the loan & advance is less compared with other bank’s
interest
(d) It provides various products like deposit, loans, insurance, etc
(e) Rural banking faces some challenges like customers scattered over wide areas,
operational challenges, cultural diversity, rural infrastructure, profitability, etc

SIGNIFICANCE OF RURAL BANKING

(a) Nearly about 70% Indians reside in village. Out of them, most of the people are
doing agricultural activities. Their financial needs are met through rural banking
(b) Rural economy inclusive of agriculture & non-agriculture constitutes about 50%
of GDP. Hence operating rural banking is a must
(c) Current demand for credit in Rural India is more than 2 lakh crores. Hence, there
is a lot of scope to have more rural banks
(d) Still in rural areas, high proportion of rural lending is from informal source. Hence
there is a need of rural banks. It eliminates moey lenders who charge high rate of
interest from the poor farmers
(e) It reaches many people through self-help groups, it increases the Micro-finance &
financial inclusion operations. Micro finance is a novel approach to ‘banking with
poor’ as they attempt lower transaction cost with high degree of payments

PRODUCTS & SERVICES OF RURAL BANKING

 Rural banking provides the following services in rural areas through various
banks such as regional rural banks, land development banks, cooperative banks,
commercial banks, etc:
• Deposits
• Loans & advances to agriculture & allied activities
• Loans & advances to MSMEs (Micro, Small & Medium Enterprises)
 • Kisaan Credit Cards (KCC)
• Working capital loans (short term)
• No-frills accounts, Jan Dhan Yojna accounts for the purpose of financial inclusion
• Insurance (ICICI Lombard Medical Insurance scheme ‘Sanjeevani’ for farmers in
Punjab)
• Mutual funds, etc

BANKING OMBUDSMAN

 The concept of Ombudsman has gained importance in many countries like the
UK, Australia, New Zealand as an effective means of customer grievance
redressal
 In India too, the RBI has introduced a similar scheme of Ombudsman from June
14, 1995 to protect the interests of the customers as well as to redress their
grievances
 Indeed, it is a landmark event in the history of Indian banking

 The main objects of the scheme are:

(1) To resolve & settle complaints relating to the provision of banking services
(2) To resolve disputes between a bank & its constituents as well as between one
bank & another bank through the process of conciliation, mediation & arbitration
(3) To make available an expeditious & cost-effective grievance redressal
mechanism to bank customers as well as to bankers themselves

 Appointment of Ombudsman:
 The RBI may appoint one or more persons as Banking Ombudsman to carry out
the functions entrusted to him under the scheme
 The Banking Ombudsman must be a person of high standing in the legal,
banking, financially services & public administration
 Generally, he will be appointed for a period of three years & he will be eligible for
extension for a further period of two years subject to an overall age limit of 65
years

 Powers & Duties of Banking Ombudsman:

 The powers & duties of the Banking ombudsman may be classified as
follows:
(1) General Powers & Duties
(2) Specific Powers & Duties

(1) General Powers & Duties:

(a) To receive complaints relating to the provision of banking services
(b) To consider such complaints & facilitate their satisfaction, or (i) Settlement by
agreement or (ii) Settlement by recommendation or (iii) Settlement by an Award
as the case may be in accordance with the provisions under this scheme
(c) The ombudsman has all powers of a court
(2) Specific Powers & Duties: It can receive all the complaints regarding deficiency in
banking services such as:
(a) Non-payment or delayed payment of cheques, drafts, bills, etc
(b) Non-issue of drafts to customers as well as to outsiders
(c) Non-adherence to prescribed working hours by branches
(d) Failure to honour guarantee of letter of credit commitments by bankers
(e) Claims in respect of unauthorized/fraudulent withdrawals from deposit accounts
(f) Complaints relating to deposits, eg. Delay in collection
(g) Complaints from Indian exporters regarding delay in receipt of export proceeds,
handling of export bills, collection of bills, etc

 Amendment & Revised Scheme:

 This scheme was amended in 2002 & the amended scheme came into effect
from June 14, 2002
 As per the Amendment, this scheme now covers commercial banks, regional
rural banks & scheduled primary co-operative banks
 The RBI has announced a revised scheme called Banking Ombudsman Scheme
2006, on Dec 28, 2005 which came into effect from Jan 2006
 On the basis of the experience, the RBI once again revised the scheme in 2009
 One of the main features of the recent amendment is the scope of the Banking
Ombudsman scheme has been expanded to include deficiencies arising out of
interest banking

 Nature of Complaints:
 There are 15 offices of the Banking Ombudsman spread throughout the country
 In 2012-13, it received 70,541 complaints & disposed of 69,705 complaints
achieving a disposal rate of 93%
 These complaints mainly relate to the following:
• Unsolicited credit cards
• Charging of annual fee in spite of being offered the card free
• Authorization of loans over phone
• Non-settlement of insurance claims
• Disputes over wrong billing
• Abusive calls
• Non-adherence to prescribed working hours
• Delay in payment of pension/wrong pension calculation
• Refusal/delay in sanctioning educational loans, micro, small & medium enterprise
loans
• During 2015-16, 95,377 complaints were received against scheduled commercial
banks by 15 regional offices of the ombudsman as against 85,131 during 2014-
15
• Public sector banks witnessed a marginal decline in the share of complaints
received at Banking Ombudsman office to 68.2% from 70.5% in the previous
year
• Majority (73%) of the complaints were received from urban & metropolitan
centres under this scheme