1.7 TOP TEN INDIAN BANKING COMPANIES DURING

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1 1.1 INTRODUCTION 1.2 ORIGIN OF BANKS 1.3 MEANING AND DEFINITIONS OF BANK 1.4 FUNCTIONS OF BANKS 1.5 IMPORTANCE OF BANKS 1.6 STRUCTURE OF INDIAN BANKING SYSTEM Reserve Bank of India (RBI) Scheduled Banks Non-Scheduled Banks Commercial Banks Co-operative Banks Regional Rural Banks Foreign Banks in India Public Sector Banks Private Sector Banks 1.7 TOP TEN INDIAN BANKING COMPANIES DURING REFERENCES

2 1.1 INTRODUCTION Trade is the calm health of nations. Credit is its lifeblood. Money is its nerve system. Trade originated in barter between primitive peoples. The first property was communal owned by a group or a tribe. Personal property developed out of individual possession of ornaments, usually stones or shells that gave them a quality of decoration. The possessor of such property could exchange it for articles of utility, and this gave rise to individual barter and individual wealth. This principle of barter next extended itself to exchange between groups or tribes each of which had a surplus of useful things desired by the other. Primitive Barter necessitated physical exchange of the things. This exchange became burdensome and impossible if not been relieved by a transfer of evidence of value a medium of exchange which in itself was not wealth, but a token of wealth. That was the beginning of money. Wealth consists in things that have inherent utility. Land is useful, therefore it is wealth. A deed to land is only an evidence of ownership of land; therefore in itself it is not wealth. A gold coin is wealth only in so far as the metal it contains has a value of utility. A man may be called a billionaire, and yet have very little money. His rating rests upon ownership or control of useful property, whether land, tools or goods. The wealth of the world could not possibly be represented by actual money. Exchanges of it could not be carried on through accompanying transfers of actual money. Money is the active principle the nerve center of credit. Banking grew out of the necessities of credit in exchange. The growth was forced, and slow. The first banking system in known history was perfected about twelve thousand years ago, in the empire that preceded the Assyrian. 1

3 Banking has enabled a ten-fold increase in general production, and set up that machinery of exchange without which industry and commerce would stagnate in a week. It has enabled those groupings of industry by which production costs and selling prices have in so many familiar cases put basic necessaries into the hands of all the people. To quote a valuable book by Earl Dean Howard and Dr. Joseph French Johnson: "Money is an instrument and banking an institution to assist production of wealth and thereby increase the material welfare of the people by facilitating the indispensable operations of exchange without which all other productive effort would have but a fraction of its efficacy, without which we would still be in a state of industrial barbarism." Banking, in its crude form, is an age-old phenomenon. It was in existence even in ancient times. In India, the references to money-lending business are found in the Manu Smriti. Chaldean, Egyptian and Phoenician history also records the existence of rudimentary banking in early days. Prof. Marshall in his book, Money, Credit and Commerce, (1923) writes about the activities of money-changers in the temples of Olympia and other sacred places in Greece, around 2,000 B.C. To quote him, Private moneychangers began with the task of reducing many metallic currencies, to a common unit of value, and even to accept money on deposit at interest, and to lend it out at higher interest permitting meanwhile drafts to be drawn on them. As a matter of fact, the origin of banking lies in the business of money changing in ancient days. Crowther, speaks about three ancestors of a modern commercial bank, viz., the merchant, the money-lender and the goldsmith. The merchants or traders issued documents like hundi to remit the funds. Modern banks introduced cheques or demand drafts for remittance purposes. Moneylenders gave loans. Bankers too gave loans. Goldsmiths received deposits and created credit. Banks also received deposits and adopted the process of credit in a similar fashion, by issuing cheques. In short, the evolution of 2

4 commercial banking is related to the practice of safe-keeping of gold and other valuables with merchants/goldsmiths/ money-lenders. Etymologically, however, the word bank is derived from the Greek word banque, or the Italian word banco both meaning a bench referring to a bench at which money-lenders and money-changers used to display their coins and transact business in the market place. In India, however, modern banking started when the English agency houses in Kolkata and Mumbai began to serve as bankers to the East India Company and the Hindustan Bank was the first banking institution of its kind to be established in ORIGIN OF BANKS There is no unanimity among the economists about the origin of the word Bank. The word bank is itself derived from the Greek word banque i.e., a bench. The ancient meaning of bank related with the money changers by the persons seating on benches. Peoples can change their money from these persons. They had funds of different currencies and can change any currency in another currency as required by the businessman. Afterwards the word bank was used in the sense of credit. As the second opinion the word bank was developed from the German word banck. The word banck means a joint stock firm. Banking is as old as is the authentic history and origins of modern commercial banking are traceable in ancient time. The new testament mentions about the activities of the money changers in the temples of Jerusalem. In ancient Greece around 2000 B.C. the famous temples of Ephesus, Delphi and Olympia were used as depositories fir people s surplus funds and these temples were the centres of money-lending transactions. The priests of these great temples acted as the financial agents until public confidence was destroyed by the spread of disbelief in the religion. Traces of credit by 3

5 compensation and by transfer orders are found in Assyria, Phoenicia and Egypt before the system attained full development in Greece and Rome. In India, the ancient Hindu scriptures refer to the money-lending activities in Vedic period. During the Ramayana and Mahabharata period, banking had become a full fledged business. The Vaishyas community earns interest by lending money. They performed most of those functions which banks perform in modern times. As a public enterprise, banking made its first beginning around the middle of the twelfth century in Italy. The Bank of Venice, founded in 1157, was the first public banking institution. After its establishment, were established the Bank of Barcelona and the Bank of Genoa in 1401 and 1407 respectively. Apart from these banks, the famous Bank of Amsterdam was established in 1609 in Holland and it enjoyed a prestigious position for a long time in the sphere of international commerce. In the year 1694 the Bank of England was established. Modern banking was started with the establishment of the Bank of Amsterdam. The Bank of England is the oldest unit of modern banking. Joint stock companies had entered in the banking sector in eighteenth century. The Banking Act of 1833 had opened the way of establishment of joint stock banks. While banking arose far early and more rapidly in some countries, it was only in the nineteenth century that the modern joint stock commercial banking system developed in the leading countries of the world. 1.3 MEANING AND DEFINITIONS OF BANK You know people earn money to meet their day-to-day expenses on food, clothing, education of children, housing, etc. and to meet future expenses on marriage, higher education of children, house building and other social functions. These are heavy expenses, which can be met if some money is saved out of the present income. Saving of money is also necessary for old 4

6 age and ill health when it may not be possible for people to work and earn their living. The necessity of saving money was felt by people even in olden days. They used to hoard money in their homes. With this practice, savings were available for use whenever needed, but it also involved the risk of loss by theft, robbery and other accidents. Thus, people were in need of a place where money could be saved safely and would be available when required. Banks are places where people can deposit their savings with the assurance that they will be able to withdraw money whenever required. People who wish to borrow money for business or other purposes can also get loans from the banks. A bank is a person who carries on the business of banking, which is: conducting current accounts for customers paying cheques drawn on him, and collecting cheques for his customers. Bank is a lawful organisation, which accepts deposits that can be withdrawn on demand. It also lends money to individuals and business houses that need it. A Bank is an institution which accepts deposits from the general public and extends loans to the households, the firms and the government. Banks are those institutions which operate in money. Thus, they are moneytraders. With the process of development, functions of banks are also increasing and diversifying. Now, the banks are not nearly the traders of money, they also create credit. Their activities are increasing and diversifying. Hence, it is very difficult to give a universally acceptable definition of bank. The important definitions of bank are as follows given on different bases: 5

7 (A) Definitions given in Dictionaries: In different dictionaries bank has been defined in different ways:- (1) Webster s Dictionary: Bank is an institution which trades in money, establishment for the deposit, custody and issue of money, as also for making loans and discounts and facilitating the transmission of remittances from one place to another. (2) Oxford Dictionary: Bank is an establishment for custody of money received from or on behalf of its customers. Its essential duty is to pay their drafts on it. Its profits arise from the use of the money left employed by them. (B) Definitions under Laws of Different Countries or Legal Meaning of Bank: Legal definitions of Bank under different laws are as follows:- (1) Indian Banking Regulation Act, 1949: Banking Company is one who does banking business. Banking business means to accepting for the purpose of lending or investment of deposits of money from the public repayable on demand or otherwise and withdrawable by cheque, draft order or otherwise. (2) American Federal Act has defined State Bank as, any bank, banking federation, trust company, saving bank (excluding mutual banks) or other institutions who engaged in the business of accepting deposits and incorporated under any state law. (C) Definitions on the basis of views of scholars: The economist defined the term bank are discussed below:- (1) According to Prof. Kinley: A bank is an establishment which makes to individuals such advances of money or other means of payment as may be required and safely made; and to which individuals entrust money or means of payment when not required by them for use. 6

8 (2) According to Prof. R.S. Sayers: Banks are institutions, whose debts usually referred to as bank deposits are commonly accepted in final settlement of other people s debts. In other words, Bankers are not merely traders in money but also in important sense manufacturers of money. (3) According to Prof. Findaly Shirras: A banker is a person, firm or company, having place of business where credits are opened by the deposits or collection of money or currency, subject to be paid or remitted upon draft, cheque or order when money is advanced or loaned on stock, bonds, bullion, bill of exchange and promissory note are received for discount or sale. The most suitable definition of the bank is A bank is an institution which deals in money and credit. When we say that the bank deals in money and credit, what we mean is that the bank buys and sells money and credit. By sale of money, what is meant is the giving of loans. Likewise, by purchase of money, we mean borrowing money from others. In both the situations, the price of money is paid in the form of interest. 1.4 FUNCTIONS OF BANKS Banks not only deals in money and credit, but also they perform large ### variety of functions such as agency functions, credit creation and general service. Here we use the meaning of modern banks in a narrow sense as commercial banks. Following are the main functions of Commercial Banks or Modern Banks:- (a) Primary or Traditional Functions. (b) Agency or Representative Functions. (c) General Utility Functions. (d) Financial and Managerial Arrangement for Foreign Trade. (e) Function of Credit Creation. 7

9 Functions of Banks Functions of Banks (A) (B) (C) (D) (E) Primary or Traditional Functions Agency or Representative Functions General Utility Functions Financial & Managerial Arrangement for Foreign Trade Credit Creation 1. Accepting Deposits: (i) Fixed Deposit A/c (ii) Current Account (iii) Savings Bank A/c (iv) Other Accounts 2. Advancing of Loans (i) Cash Credit (ii) Loans & Advances (iii) Overdraft (iv) Discounting of Bills of Exchange 1. Collection of cheques and bills 2. Payment of cheques and bills 3. Collecting payment on behalf of customers 4. Remittance facilities 5. Purchase and Sales of securities 6. Trustee and Executor 7. Underwriting Function 8. Other Agency Functions 1. Safe custody of valuables 2. Issuing of Travellers cheques 3. Information about customers 4. Financial Advisor 5. Publication of Statistics 6. Accepting Bills of Exchange 7. Guaranteer of Loans 8. Providing Consumer Loans 9. Arrangement of Public Debts 10. Foreign Exchange Transactions Figure 1.1 8

10 (A) Primary or Traditional Functions: The primary functions of modern banks are as follows: 1. Accepting Deposits: The main function of a commercial bank is to accept deposits from the public and providing loans. Banks required money for providing loans. Their share capital does not create sufficient funds for providing loans. Therefore, banks accept deposits from the persons or institutions and pay interest to the depositors. Persons or institutions deposit their surplus funds with banks for the purpose of earning of interest and safety of funds. Banks play the reasonable interests on the deposits. The bank not only undertakes to take care of the deposit but also agree to honour the demands of the depositors from withdrawal of money from the deposit. The bank generally accept deposit by the way of opening following accounts: (i) Fixed Deposit Account: This is also known as term deposit or time deposit account. Money in this account is accepted for a fixed period, say one, two or ten years. The money so deposited cannot be withdrawn before the maturity period or the expiry of the fixed time. The rate of interest on this account is higher than that on other accounts and varies according to the period of deposit. It matures at a definite date. If a depositor withdraws this amount before the maturity period, he entails an interest penalty. Thus, bank can fully use this amount for a certain period. (ii) Current Account: This is also known as demand deposit or current deposit. The depositor can withdraw the money from this account whenever he requires it. Generally, the bank grants no interest on this account because it has to keep the cash ready all the time to meet the requirement of the depositors. This account is generally opened by businessman, companies, institutions and Government, who may have to withdraw money several times in a day. In the case of current account bank has to pay off the debt on demand either to the 9

11 depositor himself or to anyone else whom he authorizes by writing a cheque. Bank cannot use this money freely, so he does not pay any interest on current account deposits. The amount deposited in current account is the debt of the bank. Overdraft facilities are also available on current account. (iii) Savings Bank Account: This type of account is generally opened by small and middle income group persons. They deposit their small savings in this account and earn interest. By depositing their small savings they also help in capital formation. Deposits in this account earn interest at nominal rates, as the banks can always be called upon by a depositor to release his amount. In practice, the bank imposes a limit on the number and amount of withdrawals during a particular period. The depositors are also given cheque facility to withdraw money from this account. (iv) Other Accounts: Banks are also providing deposit facilities to different type of customers by opening different accounts. They also open Home Safe Account for housewife or very small savers. The other accounts are: Indefinite Period Deposit Account, Recurring Deposit Account, Daily Saving Deposit Account, Retirement Scheme, Monthly Income Scheme, Minor Saving Account, Former s Deposit Account, Home Deposit Account, Accounts related to Insurance benefits etc. 2. Advancing of Loans: The important function of commercial bank is advancing loans to their customers. The bank received deposit by different ways and pay interest on the deposits. Bank grant loan from this amount and charge interests at a higher rate. These loans are generally granted to traders, industrialists, farmers and self-employed persons. Generally, bank sanctions following type of loans and advanced: (i) Cash Credit: In this system bank advances loans on the basis of security of shares, debentures, other securities and tangible assets. It 10

12 may also be based on the promissory notes of the borrowers. In cash credit banks grant loans and deposit it in the borrowers account. The borrower can withdraw this amount at any time and interest is charged on the used amount. Under this type of loan, borrower withdraw sum of money according to his requirements but he cannot exceed the credit limit sanctioned to him. When the borrower mortgage goods (stock) kept in the godown, the godown remains in the possession of the bank. (ii) Loans and Advances: Here the bank gives a specified sum of money to a person or a firm against some collateral security. The loan money is credited to the account of the borrower and the borrower can withdraw loan amount according to his requirements. The borrower has to pay interest on the entire amount of loan from the date of sanctioning of loan to the date of repayment. If borrower fails to repay the loan, its collateral security can be sold by the bank in the market and recover his loan amount. (iii) Overdraft: Commercial banks also allow a customer to draw cheques for a sum which is greater than the balance lying in his account. This is known as overdraft facility which can be allowed upto an agreed limit. In the case of overdraft, a customer pays interest on the amount by which his current account is actually overdrawn. He does not have to pay interest on the entire amount of overdraft sanctioned to him by the bank. This facility is granted against some collateral security for short period. (iv) Discounting of Bills of Exchange: Banks also lend money by discounting bills of exchange. In case the holder of a bill needs money immediately, he can get his bills discounted by a bank. The bank charges a commission for discounting of bills. When the bill matures, the bank can get payment directly from the banker of the debtor who originally accepted the bill. 11

13 (B) Agency or Representative Functions: The bank performs various agency functions or services for its customers. For these services, the bank charges commission from its customers. A few services are rendered by the bank to its customer free of charge. The various agency services rendered by the bank are as follows: 1. Collection of Cheques, Bills of Exchange and other Credit Instruments: Bank collects the payment of cheques, bills of exchange or other credit instruments on behalf of its customers from other banks and credit it in their accounts. Generally, this service is rendered free of charge but on outstation credit instruments, bank charges nominal fees. 2. Making Payment of Cheque, Bill of Exchange etc.: Commercial banks perform the function of making payments of cheque, bills of exchange etc. Bank pay insurance premium, rent, subscriptions etc. on behalf of their customers and debit their account. Banks also accept bills of exchange on behalf of their customers and make payment on due date. 3. Collecting dividends, interest etc. on shares and debentures of the customers: The bank collects dividends and interests paid by the companies on shares and debentures on behalf of their customers and credit it in their account. 4. Remittance Facilities: On request of the customer, bank helps in transferring funds from one place to another through bank drafts, cheques, and mail transfers. Bank charges fee for its services. 5. Purchase and Sale of Security: Bank purchases and sells securities in the share market on order and on behalf of its customers. They charge appropriate commission for their services. 6. Trustee and Executor: Banks also acts as a trustee, executor, administrator and attorney. As a trustee, bank takes care of the assets of the customers. It also helps in the administration of the trust. As an executor the bank preserves the wills of the customers and execute it 12

14 as per the desire of the customer. As an attorney, the bank signs transfer forms and documents on behalf of the customer. 7. Underwriting Function: Bank also execute the function of underwriting shares, debentures, bonds and other securities issued by the public limited company or Government. Bank provide guarantee of minimum funds to the company. The underwriting function of bank creates public confidence in the working of companies. Bank charges commission for underwriting services. 8. Other agency functions: The bank also acts as an agent, representative or correspondent of customers. The bank may obtain passports, traveller s tickets and even secure air tickets for its customers. (C) General Utility Functions: Bank also provides following general utility services to its customers: 1. Safe custody of valuable goods: The bank provides locker facilities to its customers for safekeeping of their valuables like shares and debentures certificates, gold ornaments, documents etc. Bank charges annual rent for providing lockers. 2. Issuing of Traveller s Cheques etc.: The bank also issues traveller s cheques or circular letters of credit for the benefit of its customers. Customer can obtain certain amount at a certain place by presenting traveller s cheque. Thus, customers may free from the problems of keeping cash with them. 3. Giving Information about its Customers: Since the bank is closely acquainted with its customers, it can pass on reliable information about their credit-worthiness to other concerned parties at other places. The bank s information is considered as reliable. It reduces risk and helps in explanation of trade and business. 4. Financial Advisor: Since the bank is fully acquainted with the economic situation in the country, it is in a position to render useful 13

15 advice to its customers on financial matters. This helps the customer in taking appropriate decisions. 5. Publication of Statistics: Large commercial bank collects statistics about money, banking, trade and commerce and publishes them. They present the analysis of these economic statistics which helps in economic and business decisions. 6. Accepting Bills of Exchange: The banks accept exchange bills on behalf of their customers. This benefits the customers because when the bank signifies its acceptance on the exchange bill, it becomes readily discountable in the money market. 7. Guaranteer of Loans: Commercial banks act as guarantor of the loans of industrial and business houses granted by National and International Financial Institutions, and thus help to get loans easily. 8. Providing Consumer Loan: Commercial banks grant consumer loan to their customers on their personal credit, for purchasing of consumer article such as Television, Refrigerator, Scooter etc. and can be repaid in easily installments. 9. Arrangement of Public Debts: Commercial banks help in selling of securities issued by the Government as an agent of RBI. 10. Foreign Exchange Transactions: Some commercial banks also take the responsibility of foreign exchange transactions and have a separate for this purpose. (D) Financial and Managerial Arrangement for Foreign Trade: Commercial banks have played an important role in the expansion of foreign trade. They make available short term credit to the traders engaged in foreign trade and undertake the functioning of acceptance and discounting of bills, hundies and letter of credit. These banks also take the task of establishing mutual relationship between exporters and importers. 14

16 (E) Credit Creation: Commercial banks undertake the function of credit creation according to the credit policy of Reserve Bank of India. Granting of loans and advances is an important function of the bank. As we know, when the bank grants loans to its customers, it generally does not lend out cash, equal to the amount of the loan, to the customer as an individual money-lender does, but on the contrary, opens an account in his (borrower s) name and credits the amount of the loan to his account. Thus, whenever a bank grants a loan, it creates a deposit or a liability against itself, which leads to a net increase in the money stock of the economy. This is known as creation of credit or money by the bank. 1.5 IMPORTANCE OF BANKS Banks play very important role in the economic life of the nation. The health of the economy is closely related to the soundness of its banking system. Banks are essential for all type of economic systems whether they are developed or developing. No developing country can progress without setting a sound system of banking in the country. Although banks create no new wealth but their borrowing, lending and related activities facilitates the process of production, distribution, exchange and consumption of wealth. In this way they become very effective partners in the process of economic development. Today, modern banks are very useful for the utilization of the resources of the country. The banks are mobilizing the savings of the people for the investment purposes. The savings are encouraged and saving rate increases. If there would be no banks then a great portion of a capital of the country would remain idle. A bank as a matter of fact is just like a heart in the economic structure and the capital provided by it is like blood in it. As long as blood is in circulation the organs will remain sound and healthy. If the blood is not supplied to any organ then that part would become useless. The 15

17 importance of a sound system of banking for a developing country may be depicted as follows: 1. Promotion of Saving: The basic function of commercial banks is to mobilize the savings of the community and to utilize it in productive investment. By accepting deposits banks promote the habit of thrift and saving in the society. People collect their small savings and deposit it in the bank to earn interest. These small savings later result in capital formation in the country. 2. Capital formation: By encouraging savings among the people, banks promote capital formation which is the basis of economic development of the country. These savings are used to provide loans to industries and business. Commercial banks also create credit. This credit and finance works as capital to the industries. Thus, by collecting small savings banks help in capital formation and ultimately in the economic development of the country. 3. Financing for Trade and Industries: The banks also encourage industrial development and business expansion by providing funds to entrepreneurs. Modern industries require a huge amount of capital. They cannot run without sufficient capital. Commercial banks have to finance small and large industries by giving term loans. Banks collect scattered small saving in the society and utilize this amount by giving loans to industries, business and Government. They also help in increasing productivity of capital by providing funds to the entrepreneurs. 4. Mobility of Capital: Capital is the main factor for developing modern lines of production. Commercial banks mobilize the dormant capital of the country for production purposes. Commercial banks can contribute to capital mobilization by investing capital in more useful places than less productive places. Thus, by mobilizing capital they contribute in increasing production, employment, national income and economic development of the country. 16

18 5. Flexibility of Monetary System and Price Stability: Banks regulate the supply of money in an economy through credit creation. Price stability can be maintained by balancing between the demand and supply of money. Thus, banks help in price stabilizing and in maintaining flexibility in monetary system. 6. Remittance facility: Banks help in remitting money from one place to another. Remittance facilities provided by the banks help in promoting national and international trade. It also reduces business risk and transfer of money cost. 7. Helps in Public Finance: Banks play an important role in collecting funds through public debts. They also act as a financial advisor and financier to the Government, when needed. Profits of public sector banks are used as a source of public finance. They collect fund through selling Government security to the public. 8. Employment Generation: Banks help in development and expansion of industrial and business activities. They have opened the vista of development in the country. With the growth of industrial, business and banking activities employment opportunities in the country has increased to a considerable extent. 9. Finance for priority sectors: In an underdeveloped economy, commercial banks hesitate in extending financial accommodation to the priority sectors such as agriculture, small scale industries on account of the risks involved therein. They mostly extend credits to trade and commerce where the risk involved is far less. But for the development of these countries it is essential that banks take risks in extending credit facilities to the priority sectors. Nationalised commercial banks are doing this job successfully. 10. Innovations: Innovations are an essential prerequisite for economic development. These innovations required financial facilities. In developed countries, banks extend credit facilities for innovations. But the entrepreneurs in developing countries cannot bring about these innovations due to lack of adequate bank credit. The banks should, 17

19 therefore, pay special attention to the financing of business innovations in developing countries by extending cheap credit to the entrepreneurs. 11. Promotion of Sound Banking System: A sound banking system is essential for the economic development of a developing country. Bank helps in promotion of banking trends in public. With the development of banking activities, cheques and drafts are being used in transactions. It reduced the requirement of coins and currency in circulation. 12. Balanced Regional Development: Banks help in proper allocation of funds among different regions of the country and thus help in balanced regional development. Now, banks have stared acting as powerful agents of growth. In this role, they do not follow economic development rather banks create the infrastructure essential for economic development. Thus, banks can act as engines of balanced regional development in the country. 13. Expansion of Markets: Banks help in the expansion of markets through extending funds for large scale production. Commercial banks encouraged business activities in a number of ways, e.g., act as an intermediary, accepting bills of exchange, issuing of letter of credit etc. The presence of banks makes it possible for commerce and industry to extend their area of operation. 14. Developing Entrepreneurs: Banks have assumed the role of developing entrepreneurs especially in developing countries. This role is being effectively played by underwriting new scrips, by granting assistance either as mentor for promoting new ventures or financing promotional activities under the joint guarantee system. Thus, commercial banks can play a useful role in promoting the economic development of an economy. Bank s lending and investment activities lead to changes in the quantity of money in circulation which in turn influence the nature and quality of production. Therefore, commercial banks have been rightly crowned as the nerve centre of all economic activity. In fact, the economic development of a country is not possible without a sound system of commercial banking. 18

20 1.6 STRUCTURE OF INDIAN BANKING SYSTEM The banks play a stellar role in the development of the nation with its high social content and commitment. The banks act as a development agency and are the source of hope and aspirations of the masses. Banking and finance is like oxygen to any democracy. The structure of the banking system is determined by two basic factors economic and legal. The development of the economy and the spread of banking habit calls for increasing banking services. The demand for these banking services affects the banks structure and organisation. National objectives and aspirations result in government regulations, which have a profound influence on the banking structure. These regulations are basically of two types (i) (ii) First, regulations which result in the formation of new banks to meet the specific needs of a group of economic activities and Secondly, legislation that affects the structure by means of nationalisation, mergers or liquidation. It is no exception in case of India as banking is one of the most heavily regulated businesses in the world. The Indian banking system has come from a long way from being a sleepy business institution to a highly proactive and dynamic entity. Indian economy is having a vibrant banking sector, powered by both improved-efficiency public sector banks and growth-hungry private ones. Banking Segment in India functions under the umbrella of Reserve Bank of India - the regulatory, central bank. India follows a bank-based financial system with a multilayered network consisting of scheduled and nonscheduled banks. These scheduled and non-scheduled banks functions under different categories consisting of: large state-owned banks, old private banks, new private banks, foreign banks, regional rural banks, cooperative banks, non-banking finance companies (NBFCs) and development financial institutions. 19

21 Structure of Indian Banking System (As on 31 st October, 2006) RESERVE BANK OF INDIA [Central Bank and Supreme Monetary Authority] SCHEDULED BANK NON-SCHEDULED BANKS COMMERCIAL BANKS [186] CO-OPERATIVE BANKS [86] REGIONAL RURAL BANKS [102] FOREIGN BANKS IN INDIA [29] PUBLIC SECTOR BANKS [28] PRIVATE SECTOR BANKS [27] SCHEDULED URBAN COOPERATIVE BANKS [55] SCHEDULED STATE COOPERATIVE BANKS [31] STATE BANK OF INDIA AND ITS ASSOCIATES [08] NATIONALISED BANKS [19] OTHER PUBLIC SECTOR BANK [ IDBI ] OLD PRIVATE BANKS [19] NEW PRIVATE BANKS [08] Figure 1.2 Note: Figures in parentheses indicate number of banks in each group. Source: Reserve Bank of India, Report on Trend and Progress of Banking in India, various issues. 20

22 The viable banking structure, extremely useful and indispensable, playing a substantial role in the growth of Indian economy is shown in Figure Reserve Bank of India (RBI) A bank which is entrusted with the functions of guiding and regulating the banking system of a country is known as its Central bank. Such a bank does not deal with the general public. India s central bank is the Reserve Bank of India. Reserve Bank of India (RBI), was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, Though initially RBI was privately owned, it was nationalized on January 1, The RBI is the apex monetary institution in the money market which acts as the monetary authority of the country. The RBI is an organ of the government which, by reason of its operations, influences the working of financial institutions of the country. In India, the R performs the functions as depicted in Figure Functions of Reserve Bank of India Controller of Credit Custodian of Foreign Reserves Publication of Data Control Banking System Issue Currency Notes Bankers Bank Execute Monetary Policy Banker to the Government Figure

23 The Reserve Bank of India also has three fully owned subsidiaries: National Housing Bank (NHB), Deposit Insurance and Credit Guarantee Corporation of India (DICGC), Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL). The general administration and direction of RBI is governed by Central Board of Directors consisting of 20 members which includes 1 Governor, 4 Deputy Governors, 1 Government Official appointed by the Government of India to give representation to important stratas in economic life of the country. Besides, 4 Directors are nominated by the Government of India to represent 4 local boards situated in Mumbai, Kolkata, Chennai and New Delhi Scheduled Banks Scheduled banks constitute those banks which have been included in the Second Schedule of the Reserve Bank of India Act, 1934 and these banks are entitled to borrowing facilities from the RBI. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42(6)(a) of the Act. On their part, they are required to maintain a certain minimum balance in their accounts with the RBI. They come within the direct influence of the various credit control measures of the RBI; and the effects of these measures diffuse through the length and breadth of the economy Non-Scheduled Banks The banks, which are not covered by the Second Schedule of Reserve Bank of India, are called as non-scheduled banks. "Non-scheduled banks in India" means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank" Commercial Banks Commercial banks are joint stock companies dealing in money and credit; the heart of financial system, since they have the ability, in cooperation with the RBI, to add to the money supply of the nation and create 22

24 additional purchasing power. Commercial banks lending, investments and related activities facilitate the economic processes of production, distribution and consumption. Commercial banks have been referred to as department stores of finance as they provide wide variety of financial services like transfer of funds, collection, foreign exchange, safe custody, safe deposit locker, traveller s cheque, merchant banking services, credit cards, gift cheques, etc. in addition to the acceptance of deposits, lending and investing. The commercial banking structure in India comprises of (i) (ii) (iii) (iv) Regional Rural Banks Foreign Banks in India Public Sector Banks Private Sector Banks Development Process of Commercial Banking in India after Independence 1949 Regulation BANKING COMPANIES ACT, Nationalisation Phase-I Nationalisation Phase-II Insurance Cover to Deposits STATE BANK OF INDIA (SBI) SBI SUBSIDIARIES DEPOSIT INSURANCE CORPORATION 1968 Social Control NATIONAL CREDIT COUNCIL 1969 Nationalisation Phase-III 14 MAJOR COMMERCIAL BANKS 1971 Credit Guarantee CREDIT GUARANTEE CORPORATION 1975 New Rural Banks REGIONAL RURAL BANKS Nationalisation Phase-IV Reorganisation of Banking SIX COMMERCIAL BANKS WITH OVER DEPOSITS OF Rs. 200 CRORES 1996 New Banks NEW PRIVATE BANKS 1998 Review RE-EXAMINATION Figure

25 1.6.5 Co-operative Banks Farmers in India are scattered all over the country and need short-term and/or long-term borrowings for agricultural purposes. This need is not fulfilled by commercial banks which are unsuited for financing agriculture; land which these farmers can offer to cover bank advances is not generally accepted as security by commercial banks. Therefore, cooperative banks best suited for this purpose. Thus, the co-operative banking sector has been developed in the country to supplant the village moneylender, the predominant source of rural finance, as the terms on which he made finance available have generally been usurious and detrimental to the development of Indian agriculture. Although the cooperative banking sector receives concessional finance from the RBI, it is governed by the State legislation. The co-operative banking structure in India comprises of (1) Primary Urban Co-operative Banks (2) Short-Term Lending Oriented Co-operative Banks (i) Primary Agricultural Credit Societies (PACS) (ii) Central Co-operative Banks (CCBs) (iii) State Co-operative Banks (SCBs) (3) Long-Term Lending Oriented Co-operative Banks (i) Land Development Banks (LDBs) / State Co-operative Agriculture and Rural Development Banks (SCARDBs) Regional Rural Banks A new category of scheduled banks came into existence in 1975 when 6 Regional Rural Banks (RRBs) came into existence under the Regional Rural Banks Ordinance, This ordinance was promulgated by the Government of India on September 26, The ordinance was subsequently replaced by the Regional Rural Banks Act, Although co-operative and commercial banks achieved a high reach and disbursement of credit, there existed a vast gap in the area of rural credit. 24

26 In order to fill up this gap, a new set up of banks, namely, RRBs was established. RRBs were set up as institutions which combine the local feel and familiarity with rural problems, which the co-operatives posses and the degree of business organisation, ability to mobilise deposits, access to central money markets, and modernized outlook which commercial banks have. The major objective of setting up RRBs was to develop the rural economy by providing for the purpose of development of agriculture, trade, commerce, industry and other productive activities in the rural areas, credit and other facilities, particularly to the small and marginal farmers, agricultural labourers, artisans, and small entrepreneurs. The authorized capital of each RRB is Rs. one crore and the issued capital is Rs. 25 lakh. Of the issued capital, 50 per cent is authorized by the Government of India, 15 per cent by the concerned state government and the balance, namely, 35 percent by the sponsor bank. RRBs are required to maintain a cash reserve ratio of three percent/ they are not liable to pay income tax as they are deemed to be cooperative societies Foreign Banks in India These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Foreign banks have been operating in India since decades or over a century. ANZ Grindlays has been in India for more than hundred years, while Standard Chartered Bank has been since Many other foreign banks set up their branches in India during the 1990s the liberalisation period. Some of the foreign banks have set up different entities as subsidiaries in the form of either non-banking financing companies in the non-financial sector in India that undertake diverse businesses such as dealing in securities, leasing and finance, and information and technology. Also, foreign banks have wholly-owned subsidiaries to run their global business process outsourcing jobs. A foreign bank can set up a wholly-owned nonbanking subsidiary if it brings in USD 50 million. Unlike the banks there is no regulation on these NBFCs for setting up branch networks. As per the 25

27 existing norms, a bank s exposure to a single corporate entity is restricted at 15 percent of its capital while for a group it is at 40 percent. The strong presence of foreign banks in India has benefited the financial system by enhancing competition, transfer of technology and specialised skills resulting in higher efficiency and greater customer satisfaction. In terms of the Press Note No.2 (2004 series) issued by the Ministry of Commerce and Industry on March 5, 2004, foreign banks will be permitted to have either branches or subsidiaries not both. They may operate in India through any one of the three channels viz., (i) branch; (ii) a wholly owned subsidiary; or (iii) a subsidiary with aggregate foreign investment upto a maximum of 74 percent in a private bank. The RBI has prepared a road map for the presence of foreign banks in India. Under the road map, during the first phase, between March 2005 and March 2009, foreign banks satisfying the eligibility criteria prescribed by the RBI will be permitted to establish presence by way of selling up a wholly-owned banking subsidiary or converting the existing branches into a subsidiary. The wholly-owned banking subsidiary should have a minimum capital of Rs. 300 crore and sound corporate governance. The second phase will commence in April after the RBI undertakes a review of the experience gained and after due consultation with all the stakeholders. New foreign banks are allowed to conduct business in India after consideration of the financial soundness of the bank, international and home country ranking, rating, international presence, and economic and political relations between the two countries. Foreign banks need to park 20 percent of their profits from India operations with the RBI; and kept as cash, as unencumbered approved securities or a combination of the two Public Sector Banks These are the banks where majority stake, ownership and control are held by the Government of India or Reserve Bank of India. Public sector banks are divided into following categories 26

28 (i) (ii) (iii) State Bank of India and its Associates Nationalised Banks Other public sector banks IDBI Bank Ltd. State Bank of India and its Associates The evolution of State Bank of India can be traced back to the first decade of the 19th century. It began with the establishment of the Bank of Calcutta in Calcutta, on June 2, The bank was redesigned as the Bank of Bengal, three years later, on January 2, It was the first ever jointstock bank of the British India, established under the sponsorship of the Government of Bengal. Subsequently, the Bank of Bombay (established on April 15, 1840) and the Bank of Madras (established on July 1, 1843) followed the Bank of Bengal. These three banks dominated the banking scenario in India, until they were amalgamated to form the Imperial Bank of India, on January 27, An important turning point in the history of State Bank of India is the launch of the first Five Year Plan of independent India, in Until the Plan, the commercial banks of the country, including the Imperial Bank of India, confined their services to the urban sector and were not equipped to respond to the growing needs of the economic revival taking shape in the rural areas. In order to serve the economy as a whole and rural sector in particular, the All India Rural Credit Survey Committee recommended the formation of a state-partnered and state-sponsored bank and proposed the take over of the Imperial Bank of India, integrating with it, the former state-owned or state-associate banks. Subsequently, an Act was passed in the Parliament of India in May As a result, the State Bank of India (SBI) was established on July 1, This resulted in making the SBI more powerful, because as much as a quarter of the resources of the Indian banking system were controlled directly by the State. Later on, the State Bank of India (Subsidiary Banks) Act was passed in The Act enabled 27

29 the State Bank of India to make the State-associated banks as its subsidiaries. These subsidiaries of SBI were (i) State Bank of Bikaner and Jaipur (SBBJ) (ii) State Bank of Hyderabad (SBH) (iii) State Bank of Indore (SBIR) (iv) State Bank of Mysore (SBM) (v) State Bank of Patiala (SBP) (vi) State Bank of Saurashtra (SBS) (vii) State Bank of Travancore (SBT) The State Bank of India holds the dominant market position among all Indian banks. It is the largest commercial bank of India and is ranked as one of the top banks worldwide. SBI is now planning to position itself as universal bank catering to the diverse needs of the society. The Table 1.1 hereunder shows the list of the State Bank Group as on March 31, Table 1.1 State Bank of India and its Associates as on March 31, 2009 Name of the Bank Year of Incorporation State Bank of India (SBI) 1955 State Bank of Bikaner and Jaipur (SBBJ) 1966 State Bank of Hyderabad (SBH) 1941 State Bank of Indore (SBIR) 1960 State Bank of Mysore (SBM) 1913 State Bank of Patiala (SBP) 1917 State Bank of Saurashtra (SBS) * 1902 State Bank of Travancore (SBT) 1945 Note : * State Bank of Saurashtra was merged with State Bank of India on August 13, Sources: (i) Annual Reports of various banks for the year (ii) Report on Trend and Progress of banking in India, RBI,

30 Nationalised Banks Nationalised banks dominate the banking system in India. The history of nationalised banks in India dates back to mid-20th century, when Imperial Bank of India was nationalised (under the SBI Act of 1955) and re-christened as State Bank of India (SBI) in July Before 1969, State Bank of India (SBI) was the only public sector bank in India. SBI was nationalised in 1955 under the SBI Act of Then on July 19, 1960, its seven subsidiaries were also nationalised with deposits over 200 crores. However, the major nationalisation of banks happened in 1969 by the then-prime Minister Indira Gandhi. In 1969, fourteen (14) big Indian joint stock banks in the private sector were nationalised. In the year 1980, the second phase of nationalisation of Indian banks took place, in which 7 more banks were nationalised with deposits over 200 crores. With this, the Government of India held a control over 91% of the banking industry in India. In all, 28 banks were nationalised from 1955 to At present, there are 27 nationalised banks: the State Bank of India and its seven associates and 19 nationalised banks (New India Bank was merged with Punjab National Bank). The major objectives behind nationalisation were to widen the branch network of banks particularly in the rural and semi-urban areas which, in turn, would help in greater mobilisation of savings and flow of credit to neglected sectors such as agriculture and small-scale industries. After the nationalisation of banks there was a huge jump in the deposits and advances with the banks. The Table 1.2 shows the list of the nationalised banks of India as on March 31,