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NOTE ON BANKING

Bank – Definition Loans are of two types A is a financial institution which accepts money from the 1. Demand Loans: people in the form of ‘Deposits’ and gives advances to them in Eg: Gold Loans, Crop loans. the form of “Loans”. Loans Deposits are of two types 2. Term Loans: Eg: Housing loan / Personal Loan.

1. Demand Deposits Y Demand Loans are usually repayable in 12 to 18 Eg: Current Account / Savings Account. months. Deposits Y Term Loans are repayable in instalments. The 2. Term/Time Deposits repayment may extend to over twenty years, in Eg: Fixed Deposits / Recurring Deposits. some cases. Current Account: History of Banking Development in India Y Generally maintained by businesspersons / large The Banking Regulation Act, 1949 defines the term Banking institutions / companies. as “accepting, deposits for the purpose of lending or investment, Y No interest is paid for balances in the account. and withdrawable by cheque, draft, order or otherwise”. Y There are no restrictions on the number 1. The first bank in India was called the Bank of Hindustan transactions. and was established in 1770 by Alexander and Co, at Y Overdraft (OD) can be extended in this account, Calcutta, under European Management. at the discretion of the bank. 2. Presidency were established by the British: Bank Savings Account: of Bengal in 1806, followed by in 1840, Y Generally maintained by individuals. and in 1843. Y Nominal rate of interest will be paid on the 3. The first bank with limited liability, managed by Indians, balances in this account. was Oudh Commercial Bank founded in 1881. Y There are restrictions on the number of withdrawals. Subsequently, was established in Fixed Deposits: 1894. was established in 1865. Y A lumpsum amount will be deposited in this account. 4. In 1921, all Presidency Banks were merged and renamed Y The depositor cannot withdraw the amount before as the Imperial . the due date. [However, premature closure is 5. The Banking Companies Act was passed in February allowed with certain conditions] 1949, which was subsequently amended as the Banking Y A higher rate of interest is paid in this account, as Regulation Act, 1949. compared to savings account. 6. The largest bank – The – was Recurring or Cumulative Deposits: nationalized in 1955 and rechristened as State Bank of Y A particular fixed amount or instalment is India (SBI) followed by formation of its 8 Associate Banks deposited in this account every month. in 1959. [now five associate banks]. Y This account is useful to build a capital sum 7. The period from 1913 to 1918 witnessed a crisis in the through regular small savings. banking sector with as many as 94 banks collapsing.

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8. The Government issued an ordinance on July 19, 1969 functioning of the bank, which commenced operations on April acquiring ownership and control of 14 major banks in 1, 1935, with a share capital of 5 crore, and was nationalised the country. Six more commercial banks were nationalised in January 1949. It got its membership of Bank of International on 15 April, 1980. The fourteen banks nationalised on Settlements (BIS) in September 1996. 19th July 1969 were the of India, Bank of The general administration and direction of the RBI is managed India, Punjab National Bank, , UCO Bank, by a Central Board of Directors consisting of 20 members , , , which includes the Governor, 4 Deputy Governors, 1 , , Allahabad Bank, Indian Government official appointed by the Union Government of Bank, and . India to give representation to important strata in the economic [The fourteen banks nationalized had reserves or deposits life of the country. The head office of is of more than Rs.50 crores] at Mumbai. At Present Duvvuri Subbarao is the Governor of RBI. Six banks were nationalized on April 15, 1980. They had reserves or deposits of more than Rs.200 crore. The banks Functions of RBI: were 1. Issue of Notes: The Reserve Bank of India is the sole (1) authority for the issue currency notes of various (2) Punjab & Sind Bank denominations except one-rupee notes. The Reserve Bank (3) of India acts as the only source of legal tender (money) (4) because the one rupee notes issued by the Ministry of (5) Finance are also circulated through it. The RBI has (6) Oriental Bank of Commerce adopted the Minimum Reserve System for the issue of 9. Regional Rural Banks [RRBs] (also known as Grameena notes. Since 1957, it has been maintaining gold and Banks) were formed in 1975, initially in Uttar Pradesh, foreign exchange reserves of Rs.200 crore, of which at Haryana, Rajasthan and West Bengal. least Rs.115 crore should be in gold.

10. The Narsimhan Committee (1991) recommended granting 2. Banker to the Government: The RBI acts as the Banker, permission for the opening of new private banks. Ten Agent and Adviser to the Government. It performs all the private banks were granted permission during 1994 and banking functions of the state and central Governments 1995. These banks were known as “New Generation and it also tenders useful advice to the Government on Banks”, because of their stress on customer friendly and matters related to economic and monetary policy. It also automation friendly policies prominent among the ten manages the public debt for the Government. banks were ICICI Bank. HDFC Bank and UTI Bank [now 3. Bankers’ Bank: The RBI performs the same function ]. for the other banks as the other banks ordinarily perform Reserve Bank of India: for their customers. It is not only a banker to the commercial banks, but it is also the lender of the last resort. The Reserve Bank of India is the apex bank or central bank of the country. Central banks have different names in different 4. Controller of Credit: The RBI is the controller of credit countries. It is Reserve Bank of India in India, the Bank of i.e., it has the regulatory power to influence the volume England in England, the Federal Reserve System in America, of credit created by banks in India. It can do so by the Bank of France in France etc, The central bank is defined changing the Bank rate or through open market operations. as the bankers’ bank and lender of last resort. Its duty is to Since, 1956, selective controls on credit are increasingly control the monetary base and, through this, to control the being used by the Reserve Bank. In recent times ‘repo’ community’s supply of money. and ‘reverse repo’ rates are being increasingly used, rather than the conventional tool of Bank Rate. The Reserve Bank of India was set up on the basis of the Hilton Young Commission (1926). The Reserve Bank of India Act, 5. Custodian of Foreign Reserves: For the purpose of 1934 (II of 1934) provided the statutory basis for the keeping the foreign exchange rates stable the Reserve

2 NOTE ON BANKING

Bank buys and sells foreign currencies, and also maintains banks in the country. The share of the banking business and protects the country’s foreign exchange funds. of the State Bank Group is roughly 29 percent. In 1933, Structure of Commercial Banks in India the Act was amended to enable it to have access to the capital markets. The SBI thus raised The commercial banking system in India now consists of public over Rs.2,400 crore through public issue. The RBI stake sector scheduled banks and private sector scheduled banks as in SBI is now 55 per cent against 99 per cent earlier. (In well as non-scheduled banks. In terms of business, the public March 2010, Pranab Mukherjee moved the SBI Bill in sector banks now have a dominant position. They account for the Lok Sabha, which seeks to reduce the Union more than 70 per cent of the entire banking business in the Government’s shareholding in the State Bank of India country. from 55 per cent to 51 per cent, to allow the SBI to raise Under the Reserve Bank of India Act, 1934, banks were more capital from the market) classified as scheduled and non-scheduled banks. The ii. Other Nationalised Banks: A second category of public scheduled banks are those which are entered in the second sector banks is of nineteen commercial banks, of which schedule of RBI Act, 1934. All commercial banks, Indian and fourteen were nationalised on July 19, 1969. Each one of foreign, regional rural banks, and state co-operative banks are these fourteen banks had deposits of Rs.50 crore or more scheduled banks. Non – scheduled banks are those, which have at that time. After nationalisation of 14 banks there was a not been included in the second schedule of RBI Act, 1934. At rapid expansion of branch network. On April 15, 1980 present, there are only four non- scheduled banks in the country. six privately owned commercial banks were nationalised. To be included in the second schedule, a bank (a) must have With the nationalization of these six banks, the share of paid up capital and reserves of not less than Rs.5 lakhs. (b) It the private sector in the entire banking sector declined to must also satisfy the RBI that its affairs are not conducted in a just 9 percent. In 1993, New Bank of India merged with manner detrimental to the interests of depositors. Punjab National Bank. As a result, the number of public Scheduled banks are required to maintain a certain amount of sector banks other than the State Bank of India and its reserves with the RBI. Associates declined to nineteen. The total number of i. SBI and its Associate Banks: On the recommendations branches of the nineteen nationalized banks was 52,000 of the Rural Credit Survey Committee, the Imperial Bank as of December 2012. of India was converted into the State Bank of India on iii. Other Scheduled Commercial Banks: At present July 1, 1955. 92 per cent of its shares were acquired by relatively small scheduled commercial banks and ten the RBI, and thus it had the distinction of becoming the newly established banks with a network of 5,445 branches first state owned commercial bank in the country. In 1959, are the ones operating in the private sector. In terms of the State Bank of India (Associate Banks) Act was passed branches and also the business done by them, most of the and this paved the way for creating the State Bank Group. private sector banks are much smaller than both Now , State Bank of Bikaner nationalized banks and foreign banks. Their role in the and Jaipur, , , financial system of the country is just marginal. So far , and State ten new private sector banks have been set up and three Bank of Travancore consists of the State Bank Group. more proposals for setting up banks in the private sector These were the banks of the erstwhile princely states. have been approved in principle. These private sector The State Bank Group comprising the State Bank of India, banks (both old and new) account for less than 15 per and its associates has increased the number of branches cent of both deposits and aggregate advances. from 2,462 on June 30, 1969 to 15,000 in August, 2013. iv. Regional Rural Banks: Under the chairmanship of U. (Now State Bank of Saurashtra and State Bank of Indore Narsimham, the Working Group on Rural Banks have merged with State Bank of India). The State Bank recommended the setting up of these banks as part of a of India and its Associate Banks together account for multi – agency approach to rural credit. The first bank around 20 per cent of the total branches of all commercial was set up on October 2, 1975. The regional rural banks

3 NOTE ON BANKING

meet the credit requirement of weaker sections, small and from ANZ Bank. Thus Bank, which is marginal farmers landless labours, artisans and small based in the United Kingdom, has become the largest foreign entrepreneurs. As of June 2008, there were 196 regional bank operating in India, with 101 branches. rural banks with a network of 14,832 branches in the Some of the important foreign banks country. Ninety per cent of these have been opened in operating in India are listed below. rural areas and unbanked centres. As part of consolidation Bank Country and restructure policy of Government RRBs have been merged and brought the number down to 67 by January 1. Standard Chartered Bank UK 2013 and the branch network increased to 16000 2. HSBC UK 3. UK v. Foreign Banks: As of March 31, 2013 the country had 4. Bank UK 43 foreign banks with 331 branches located mainly in 5. Citibank USA big cities. Apart from financing of foreign trade, these 6. JP Morgan Chase Bank USA banks had made significant contribution to the 7. USA development of banking habits in the country as they have 8. ABN AMRO Bank The Netherlands performed all the functions of a commercial bank, 9. Abu Dhabi Commercial Bank UAE including acceptance of deposits and lending of funds 10. Sri Lanka for trade and commerce. 11. BNP Paribas Bank France vi. Lead Bank Scheme: The idea of the Lead Bank Scheme 12. Societe Generale France was mooted by the Gadgil Study Group in 1969. It had 13. China Trust Commercial Bank Taiwan the backing of Nariman Committee also. The Lead Bank 14. Germany had to formulate a plan for the banking structure in the 15. Scotia Bank Canada districts where such facilities were lacking at the time of 16. DBS Bank Singapore nationalization. Latest developments: The scheme now function as a way of monitoring credit Some more foreign banks are going to start their operations in flow for social and economic development in a district. India in 2010. Credit Suisse has received an in-principle Foreign Commercial Banks approval from RBI permitting it to open bank branches in India Foreign banks operating in India are banks of other countries and offer retail and wholesale banking services. Credit Suisse having their branches in India. As on 31/3/2013, there are about is a Zurich (Switzerland) based bank. Goldman Sachs has also 43 foreign banks having a total of more than 331 branches in approached the RBI for a banking licence. The Australia and most of the big cities of the country. New Zealand Banking Group (ANZ) has received an in- principle banking licence on March 3, 2010. Foreign banks have been operating in India for more than last 100 years but new economic policies implemented in 1990s The Industrial and Commercial Bank of China (ICBC), the encouraged many international banks to open their branches largest bank in China, is also planning to open branches in in India. India by the year end.

Foreign banks in India have brought in the latest technology Commonwealth Bank of Australia (Australia) and FirstRand and new banking practices. This has helped the domestic banks Bank Limited (South Africa) have started their operations in to improve their performance and provide better customer India. service. NEW BANKS IN PRIVATE SECTOR Foreign banks also perform the day-to-day banking functions In 1993, in recognition of the need to introduce greater which include acceptance of deposits and giving loans. They competition new private sector banks were allowed to be set also issue bank drafts, cheques, etc., to the customers. up in the Indian banking system. These banks are called ‘New In 2000, Standard Chartered Bank acquired Generation Private Banks’.

4 NOTE ON BANKING

Based on a review of experience gained on the functioning of announcing in February 2010 that RBI is considering new bank new private sector banks, revised guidelines were issued in licences to promoters in the private sector and also Non January 2001 for entry of new banks in the private sector. Banking Financial Companies (NBFCs) if they meet RBI eligibility criteria. The main requirements are: Corporates such as the Tatas and Birlas have shown interest in 1. Initial paid-up capital shall be Rs.200 crore; this will be banking licences. Among finance companies Reliance Capital raised to Rs.300 crore within three years of and Indiabulls have announced their interest in getting into commencement of business. banking. Lenders such as Exim Bank and SIDBI are also 2. Promoters’ contribution shall be a minimum of interested in a banking licence. 40 per cent of the paid-up capital of the bank at any point Foreign Direct Investment (FDI) limit in private sector banks of time. Their contribution of 40 per cent shall be locked is 74 per cent. in for 5 years from the date of licensing of the bank and excess stake above 40 per cent shall be diluted after one Co-operative Banks year of the bank’s operations. Co-operation means voluntary association on the basis of 3. Initial capital other than promoters’ contribution could equality and for some common purpose. The basic principle be raised through public issue or private placement. of co-operation is ‘each for all and all for each’.

4. Non-Banking Finance Companies (NBFCs) with good A co-operative bank is an institution established on track record can become banks. co-operative basis and deals in ordinary banking business. They are different from commercial banks. Commercial banks have 5. A minimum capital adequacy ratio of 10 per cent shall be been constituted by an Act passed by parliament while maintained on a continuous basis from commencement cooperative banks have been constituted by different states of operations. under various Acts related to cooperative societies of various 6. Priority sector lending target is 40 per cent of net bank states. Cooperative banks are generally concerned with the credit, as in the case of other domestic banks. These new rural and development credit and provide financial assistance private banks should open 25 per cent of the branches in for agricultural and rural activities. rural/semi-urban areas. A commercial bank can establish its branches in any district / Some of the New Generation Private Banks: state of the country, while cooperative bank can operate its 1. ICICI Bank activities only within limited area. Cooperative banks cannot 2. HDFC Bank open their branches in foreign countries while commercial 3. Axis Bank (previously called UTI Bank) banks can operate in foreign countries. 4. IndusInd Bank In India, the cooperative bank organization has a three tier set 5. up. State Co-operative Bank is the apex co-operative bank at 6. Development Credit Bank the state level. Central or District Cooperative Bank functions 7. at district level. Primary Agricultural Co-operative Credit Yes Bank was granted licence in 2004. Rabo Bank, a Dutch Society is at the village level. bank, has stake in Yes Bank. 1. Primary Agricultural Cooperative Credit Society Global Trust Bank, a new generation private bank, was (PACCS): It is a village level institution which directly amalgamated with Oriental Bank of Commerce on August 14, deals with rural people. It provides short term credit 2004. Oriental Bank of Commerce is a nationalized bank. facilities to the agriculture sector. Minimum 10 persons of a village can form a primary credit society. The Latest developments: management of the society is under the control of an The country is likely to get several more New Generation elected body. Private Banks with the Finance Minister Pranab Mukherjee The working capital of the primary credit societies, comes from

5 NOTE ON BANKING their own funds, deposits, borrowings and other sources. Borrowings of SCBs are mainly from the Reserve Bank of Borrowings are mainly from central cooperative banks. India and the rest from state governments. Borrowings form the chief source of working capital of the Advantages of co-operative credit institutions: societies. 1. It provides an effective alternative to the traditional Only the members of the societies are entitled to get loans defective credit system of the village money-lender. from them. Low interest rates are charged on the loans. 2. Co-operative societies charge comparatively low interest The various reconstruction and revival programmes for rates vis-a-vis the money-lenders. PACCSs adopted by Indian government and RBI have 3. Earlier, the cultivators used to borrow for consumption considerably reduced the number of primary credit societies and other unproductive purposes. But now, they mostly over the past three decades. There were 1,61,000 societies in borrow for productive purposes. Co-operative societies 1970-71. But as on March 31, 2001 there are about 1 lakh discourage unproductive borrowing. primary agricultural credit societies in India with approximately 10 crore members. A large number of societies face severe 4. Co-operatives help develop the habits of thrift among the financial problems due to low recovery rates. agriculturists by encouraging savings and investments.

2. District Central Cooperative Banks (DCCBs): The 5. Co-operative credit is available for purchasing improved working area of these banks is limited to one district only. seeds, chemical fertilizers, modern implements, etc. This CCBs are of two types: has helped in the introduction of better agricultural methods. (a) Unions whose membership is open only to cooperative societies. This exists in Regional Rural Banks (RRBs) Punjab, Haryana, Rajasthan, Orissa and Kerala. The Regional Rural Banks (RRBs) came into existence on (b) Mixed Central Cooperative Banks whose membership October 2, 1975. The first RRB in India was set up in is open to both individuals and cooperative societies. Moradabad in Uttar Pradesh.

CCBs get loans from the state cooperative banks and give loans The specific objective of RRBs is to provide credit and deposit to primary credit societies. The duration of such loans vary facilities to the small and marginal farmers, agricultural labourers and artisans. The RRBs have the responsibility to develop from one year to three years. In this way CCB plays a bridge agriculture, trade, commerce and industry in the rural areas. role between the state cooperative banks and primary credit societies. The RRBs, though basically scheduled commercial banks, differ from the latter in certain respects such as: the area of At the end of March 2013 there are 372 DCCBs in India. RRBs is limited to a specified region comprising one or more The most distressing feature of the functions of the central districts of a state. cooperative banks is the heavy and increasing burden of The sponsoring banks and the Reserve Bank of India provide overdue loans. The main causes of these overdues are (i) natural many subsidies and concessions to RRBs to enable them to calamities such as floods, droughts, etc. affecting the repaying function effectively. capacity of the borrowers and (ii) inadequate and inefficient The sponsor banks continue to provide managerial and supervision exercised by the banks. financial assistance to RRBs. They charge very low rates of 3. State Cooperative Banks (SCBs): SCBs are the apex interest on the borrowings of the RRBs. The cost of staff institutions in the three-tier cooperative credit structure, deputed to RRBs and training expenses of RRB staff are borne operating at the state level. Every state has a state by the sponsor banks. cooperative bank. National Bank for Agriculture and Rural Development SCB grants loans to central cooperative banks and regulates (NABARD) has the responsibility to lay down policies for their activities. SCB gets loans from RBI. SCB acts as a link RRBs, to oversee their operations, provide refinance facilities between RBI and Central Cooperative Banks. and attend to problems faced by them.

6 NOTE ON BANKING

RRBs have to act as alternative agencies to provide institutional exchange rate and domestic inflation. In the recent past Prime credit in rural areas. They are intended to eliminate money- Lending Rate (PLR) was decided by commercial banks with lenders. RRBs were not set up to replace co-operative credit reference to the bank rate and the deposit position of each societies but to supplement them. bank. [In recent times apart from bank rate, RBI is using ‘repo’ and ‘reverse repo’ rates to mop up excess liquidity and inject The Agricultural Credit Review Committee under the liquidity into the system.] chairmanship of Dr.A.M. Khusro observed that the weaknesses of RRBs were endemic and non-viability was built into their Cash Reserve Ratio (CRR): Every Commercial bank is structure. The RRBs had accumulated huge losses. The Khusro required to keep a certain percentage of its demand and time Committee recommended that RRBs should be merged with liabilities (Deposits) with the RBI (either as cash or book balance). The RBI varies this ratio as and when it perceives sponsor banks. the need to increase or decrease money supply. RBI is The Reserve Bank of India appointed the M.C. Bhandari empowered to fix the CRR at a rate ranging between 3% and Committee to suggest measures for restructuring RRBs. 15% (i.e., minimum 3%, maximum 15%). Like the Bank Rate, Most of the recommendations of the Bhandari Committee are CRR is also subject to frequent changes as RBI intervenes being implemented. The issued share capital of RRBs has been from time to time to correct monetary or exchange rate imbalances. enhanced from Rs.75 lakh to Rs.1 crore. Statutory Liquidity Ratio (SLR): All the commercial As on January 2013, the total number of RRBs is 67, with banks in the country are also required to keep about 16000 branches. (in addition to CRR) a certain percentage of their net demand RBI has allowed Regional Rural Banks to market mutual funds and time liabilities (NDTL) as liquid assets in the shape of through their branches. cash, gold or approved securities. As most of SLR money in Indian Monetary Policy (Credit Control) kept in treasury bills, government had, in the past been using SLR as a means to mobilise low cost resources. This abuse of The objective of planned economic development, adopted by SLR leads to distortion in the interest rate and credit supply. India, required an active monetary policy. The two standard In order to overcome this aims of the policy were: recommended that SLR should be brought down to 25%

Y Boost economic development. Repo and Reverse Repo Rates: Repo (Repurchase option) Y Control inflationary pressures. and reverse repo are instruments used by RBI in day-to-day liquidity management under the Liquidity Adjustment Facility Monetary Policy, was known as Credit Policy till 1992, the (LAF). Repo rate is the rate at which RBI lends to commercial year which marked the initiation of financial sector reforms. banks and reverse repo is the rate at which RBI borrows from The Reserve Bank of India is the main agency for implementing commercial banks. In case of inflationary tendencies. RBI can the monetary policy. There are some important instruments, to hike reverse repo rate and absorbs the excess liquidity in the achieve a stable monetary policy: market. Similarly, in case there is a perceived need to inject Bank Rate: It is the rate at which RBI discounts the bills of liquidity into the system, RBI can reduce the repo rate, which exchange. In practice it is the rate at which RBI lends to other will lead to release of money into the market. RBI occasionally commercial banks. It thus acts as signal to the economy on the resorts to the repo route to fine- tune the liquidity position, direction of the monetary policy. Bank rate had a limited impact without resorting to major policy instruments such as changes on the period before economic reforms (1991) when RBI would in CRR and Bank Rate. determine the interest rates structure. However with the Open market operations: This refers to the RBI buying delegation of this power to the commercial banks (except and selling of eligible securities to regulate money supply. interest rates in priority sectors) the importance of bank rate Traditionally RBI was not resorting to this method. However, has been revived. The bank rate is subject to frequent variation, after the large inflow of foreign funds since 1991, RBI has had as RBI uses changes in Bank Rate to regulate fluctuations in to step in to stabilise the flow to avoid excess liquidity.

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Objectives of Monetary Policy: development of total banking credit. As a result RBI directed domestic banks to provide 40% of their net bank credit to the Y Stability of external value: Fluctuation in priority sector. The concept of priority sector lending covered exchange rate of a currency affects foreign trade neglected sectors like Agriculture, Small Scale Industry (SSI), and investment. It is, therefore, important that the Road and Water Transport (RTO) Retail Trade, Professional rate of exchange is maintained without violent and Self Employed Persons, Housing and Education loans and fluctuations. also loans given to Scheduled Castes/Tribes, Small and Y Maintenance of domestic price level: Fluctuations Marginal Farmers, Tenant Farmers, Share Croppers, Artisans, in prices affect investment decisions. However, beneficiaries of the IRDP and Differential Rate of Interest monetary policy alone cannot ensure the Schemes. maintenance of domestic prices, several other factors such as erratic monsoons, changes in For foreign banks the overall target for PS lending as a ratio of tastes, fluctuation in world prices etc, affects total credit was fixed at 32% by RBI. domestic prices. Apart from the targets for priority sector lending, sub targets Y Reducing the impact of business cycles (Slumps were fixed for sub sectors. For example under the Differential and booms) by manipulation of credit and interest Rate of Interest scheme introduced in 1972, public sector banks policy. However economists are not of the same were required to fulfil the target of lending at least 1% of the opinion on whether business cycles are primarily total advances under this scheme. [The DRI scheme is aimed caused by monetary factors. at the “weakest of the weak”.]

Priority Sector Lending Priority sector lending can be described as an example of One of the main reasons for the nationalisation of banks in “Administered Credit” or “Directed Credit”. It is the RBI which July 1969 was to ensure that resources available with banks determines the direction and volume of credit to ensure social were made available to sectors which were starved of funds. objectives. (Administered Credit in banking can be compared In the pre-nationalisation era about 78% of the total bank credit to Administered Price Mechanism in pricing of petroleum was allocated to large and medium industries, and wholesale products like Petrol Diesel LPG and Kerosene. In both the trade; while the Agriculture sector accounted for a shocking cases the system of administered/directed credit/ prices is to 2.2% of the total bank credit (Significantly the figure of 78% ensure social objectives). declined to about 33% in 2000, in the post – nationalisation era) To sum up, the concept of priority sector lending acted as a Another important reason for introducing the concept of much needed corrective mechanism. Nationalised banks priority sector lending after the July 1969 nationalisation was diverted credit to areas and sectors where it was badly needed the fact that funds of the banks were being misutilised. For to meet the objectives of social banking. One criticism of the example in the pre nationalisation era about 70% of the total concept of priority sector lending was that it locked up the industrial advances went to only 1% of the total number of resources of the banks in low yielding assets borrowal accounts (Many banks in the pre- nationalisation era (A major chunk, about 40% of total credit, was directed to the were owned by big industrial houses). Public funds of the banks priority sector which may affect the profitability of banks). were made available to directors of the banks at concessional But the Government and RBI have persisted with the concept rates. These directors were also serving on the board of of priority sector lending despite this criticism, to meet social directors of other companies. obligations. To sum up, public money was being diverted and misutilised The concept of priority sector lending is here to stay in Indian for private profit. banking. The only possible changes could be perhaps reducing The concept of priority sector lending was therefore introduced the percentage of priority sector lending from the current 40%, to correct this imbalance and the distortion in sectoral or adding or deleting certain sectors to the list of priority sector.

8 NOTE ON BANKING

And finally the best argument for continuing the system of Security Interest Act, 2002 (SARFAESI Act) to enable banks priority sector lending is the fact that banks have been financing to realize their dues without intervention of courts and tribunals. big industrial houses, at concessional rates under the Below The Act enables the setting up of Asset Management Prime Lending Rate (BPLR) mechanism. If big industrial Companies to acquire NPAs of any bank or financial agency houses can be financed under BPLR, what prevents banks from by issuing debentures, bonds or any other security. This financing the neglected sectors at concessional rates or company (which is the second creditor) is entitled to serve a diverting a substantial portion of total bank credit to notice to the borrower to discharge his / her liabilities within traditionally neglected social groups/sectors. 60 days. Failing to discharge the liabilities in the stipulated NPAs of Scheduled Commercial Banks time will entitle the second creditor to take possession of the secured assets, take over the management of the assets and to Non Performing Assets (NPAs) are bad debts of banks/financial appoint any person to manage the secured assets. institutions. An asset becomes non-performing when it ceases to generate income for the bank. The SARFAESI Act 2002 puts in place a long overdue legal framework, without attendant delays, for the recovery of NPAs. NPA means an asset or borrowal account, which has been classified by a bank or financial institution as sub-standard, The recovery of NPAs got a boost after the enactment of doubtful or loss asset, in accordance with the directions or SARFAESI Act. guidelines issued by the Reserve Bank of India. NARASIMHAM COMMITTEE A major cause for poor performance and low profitability of RECOMMENDATIONS ON FINANCIAL banks was the accumulation of non-performing assets REFORMS: consisting of loans and advances given to corporates which, The Government of India constituted a 9-member committee for some reason, do not repay the amounts borrowed, or pay under the chairmanship of M. Narasimham, a former Governor the interest accumulated thereon. of the Reserve Bank of India to examine all aspects relating to NPA norms for Scheduled Commercial Banks: the structure, organization, functions and procedures of the financial system. The committee submitted its report in With effect from March 31, 2001 a non performing asset is an November 1991. advance where (a) Interest and / or instalment of principal remain overdue Basic approach of the committee: for a period of more than 180 days in respect of a term The Narasimham Committee (1991) was primarily interested loan; in improving the financial health of public sector banks and (b) The account remains ‘ out of order’ for a period of more development financial institutions (DFIs), so as to make them than 180 days in respect of an overdraft / cash credit (OD/ viable and efficient and meet fully the emerging needs of the CC); real economy. The Narasimham Committee (1991) acknowledged the spectacular success of the public sector (c) The bill remains overdue for a period of more than 180 days in case of the bills purchased and discounted; banks since their nationalization in July 1969, especially in: (a) Massive branch expansion, particularly in rural areas; (d) Interest and / or instalment of principal remains overdue (b) Expansion in the volume of deposits – bank deposits now for two harvest seasons but for a period of not exceeding constituted two-fifths of financial assets of the household two half years in the case of an advance granted for sector in 1991; agricultural purposes, and ; (c) Rural penetration of the banking system – rural deposits (e) Any amount to be received remains overdue for a period as a proportion of total deposits had increased from 3 per of more than 180days in respect of other accounts. cent to 15 per cent; SARFAESI Act: (d) Diversion of an increasing portion of the bank credit The Government of India enacted Securitization and to priority sectors, viz, agriculture, small industry, Reconstruction of Financial Assets and Enforcement of transport, etc.

9 NOTE ON BANKING Recommendation of the Narasimham Committee on Banking Sector Reforms (1998): Committee: The Finance Ministry of the Government of India appointed 1. It proposed a substantial reduction in the number of public Narasimham as chairman of one more committee. The sector banks (PSBs) through mergers and acquisitions. A Narasimham Committee on the Banking Sector Reforms 4 tier banking system was proposed. submitted its report to the Government in April 1998. I tier 3 or 4 large banks (including SBI) which could Some of the important recommendations of this Narasimham become international in character. Committee (1998): II tier 8 to 10 national banks 1. It recommended the merger of strong banks, which would III tier Local banks have a ‘multiplier effect’ on industry. IV tier Rural banks including RRBs 2. The committee suggested the setting up of small, local 2. RBI should permit the setting up of new banks in the banks which would be confined to states or a cluster of private sector. There should be no difference in the districts in order to serve local trade, small industry and treatment between public sector banks and private sector agriculture. At the same time, these banks should have banks. strong correspondent relationships with the larger national 3. The Government should allow foreign banks to open and international banks. offices in India either as branches or as subsidiaries. 3. The committee suggested higher capital adequacy 4. Assets Reconstruction Fund (ARF) should be set up, to requirements for banks to improve their inherent strength take over from the nationalized banks and financial and their risk absorption capacity. institutions, a portion of their bad and doubtful debts, at 4. It suggested the urgent need to review and amend the a discount. provisions of RBI Act, Banking Regulation Act, SBI Act, 5. The appointment of the Chief Executive of a bank Bank Nationalisation Act, etc., so as to bring them in line (Chairman and Managing Director) should not with the current needs of the banking industry. be based on political consideration but on professionalism Other recommendations related to the need for and integrity and should be made by an independent panel of experts. computerization process in PSBs, review of recruitment procedures, training and remuneration policies, etc. 6. The government should reduce the Statutory Liquidity Ratio (SLR) from the present 38.5 per cent to 25 per cent Capital Adequacy Standards over the next five years. A reduction in the SLR levels Healthy functioning of banks is essential for the proper would leave more funds with banks for allocation to functioning of an economy. As credit creation (i.e. loan agriculture, industry, trade, etc. disbursals) of banks is a highly risky business the safety of the depositors’ money depends on the quality of lending by banks. 7. The Cash Reserve Ratio (CRR) should be reduced from A bank’s failure has the potential to create chaos in an economy. the present high level of 15 per cent to 3 to 5 per cent. This is why governments of the world pay special attention to 8. Banks should be given more autonomy. the regulatory aspects of the banks. Banks should maximize 9. The system of directed credit programmes should be their credit creation while minimizing the risk and continue gradually phased out. their functioning permanently.

10. The RBI should, on priority, simplify the structure of The central banks of the world devised tools to minimise the interest rates. The Bank rate should be the anchor rate risks of banking. The Capital Adequacy Ratio (CAR) norm and all other interest rates should be closely linked to it. regulates the banks in such a way that they can sustain the probable risks and uncertainties of lending. It was in 1988 that Despite stiff opposition from bank unions and political parties in the country, the Government of India accepted the central banking bodies of the developed economies agreed all the major recommendations of Narasimham upon provision of the CAR. The agreement was known as the Committee (1991) and started implementing them. Basel Accord. The accord was agreed upon at Basel,

10 NOTE ON BANKING

Switzerland at a meeting of the Bank for International Z The total number of nationalised banks excluding the State Settlements (BIS). It was at this time that the Basel– norms of Bank group is now 19. the CAR were agreed upon – a requirement was imposed upon Z SBI and its Associate banks now number six. the banks to maintain a certain amount of free capital (i.e., Z New generation Government owned bank, IDBI Bank Ltd ratio) to their assets (i.e. loans and investments by the banks) has been categorised under a new Sub-group ‘Other Public as a cushion against probable losses in investments and loans. Sector Banks” Z A loan is an asset for the bank because it receives interest The CAR is the percentage of total capital to the total risk – as income on an advance. weighted assets. Z A deposit is a liability for the bank is because it has to be The RBI introduced the Capital-to-risk weighted assets ratio repaid on demand to the customer, and it carries the burden (CRAR) system for banks in India in 1992 in accordance with the of interest to be paid. standards of the BIS – as part of the financial sector reforms. In Z Asset Liability Management [ALM] is balancing the the coming years, the Basel norms were extended to NBFCs also. deposit and loan portfolios of the bank. The CAR norm was raised to 9 per cent with effect from March Z The first public sector bank to enter the credit card market 31, 2000. was in 1980. Z One of the founders of the Punjab National Bank was Meanwhile the BIS came up with another set of the CAR norms, Lala Lajpat Rai. popularly known as Basel-I. The Basel-II norm for the CAR is Z The first bank to provide internet banking service in India 12 per cent. was ICICI Bank. The Basel Accords (i.e. Basel I and II) are of paramount Z The Devkaran Nanjee family established Dena Bank. importance to the banking world and are presently implemented Z The Nobel Price in Economics was instituted by Bank of by over 100 countries across the world. The main objective of Sweden in 1968. the accords is to strengthen the international banking system. Z Thomas Sutherland established HSBC Bank in 1965 to Some Miscellaneous Points to Remember meet the demand for local banking facilities in Hong Kong Z The first bank to open a branch in Dharavi, one of Asia’s and China. biggest slums, is . Z The global sub-prime crisis had its origins in the USA. Z The bank with the maximum number of foreign branches Z The Banking Codes and Standards Institute is not meant is Bank of India. to substitute the Ombudsman, but has a wider role than Z The bank which has the humped bull of Mohenjadaro as the Ombudsman. its logo and has a name associated with the Indus ralley Z The concept of Ombudsman is borrowed from Sweden. civilisation is Indusind Bank. Z RBI estimates that despite the substantial progress since Z The first Indian bank to open a branch outside India was the July 1969 nationalisation, about 40% of the Indian Bank of India. population has no access to banking services. Z The bank which was honoured when Mahatma Gandhi Z The pioneer of micro-finance is Bangladeshi banker inaugurated its branch was Union Bank of India. Mohamed Yunus. Z The first Indian Bank to be listed on the New York Stock Z The micro-finance capital of India is Andhra Pradesh. Exchange is ICICI Bank. Z The new Base Rate concept to replace the Benchmark Z Standard Chartered Bank has the maximum network of Prime Lending Rate [BPLR] concept will be introduced branches in India, among foreign banks. from July 1, 2010. Z The oldest public sector bank in India, with a history of Z RBI was established in April 1935 on the basis of more than 130 years, is Allahabad Bank. recommendations of the Hilton Young Commission. Z India’s largest and second largest private sector banks across Z RBI was nationalised in 1949. all categories are ICICI Bank and HDFC Bank respectively. Z India became a member of the IMF in 1946. Z The European Country which was one of the worst Z RBI makes Ways and Means advances to the Government affected in the global financial crisis was Iceland. for 90 days.

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Z A high level Committee on Financial System [CFS] was recommendations of the CFS. set up in 1991 under the Chairmanship of M. Narsimham. Z NABARD was set up in 1982 and the National Housing A second committee under M. Narsimham was set up in Bank was set up as subsidiary of RBI in 1988 and IRDA 1997 to review the implementation of the was constituted in 2000.

Annexure – 1: Various Committees & Commissions on related to financial sector S.No. Committee Agenda 1. Chakravarty Committee (1985) Review the working of the monetary system. 2. Abid Hussain Committee (1987) Profit making public units should offer a part of their share capital to the public as part of long term strategy to establish the stock exchange. 3. Ghosh Committee (1991) Bank frauds & malpractices. 4. Vagul committee (1987) Money Market. 5. Dave Study Group Mutual Funds 6. J.V. Shetty Committee (1993) Review the system of lending under consortium arrangements & to suggest improvements therein. 7. Sundaram Committee (1993) Structure of export credit. 8. Goswami Committee (1993) Industrial sickness & corporate restructuring. 9. Narasimham Committee – I (1991) Examine all aspects relating to the structure, organization & functioning of the financial system. 10. Janakiraman Committee (1993) Securities transactions of banks & financial institutions. 11. Goiporia Committee (1990) Customer Service in banks. 12. Khanna Committee (1994) Monitoring the work of NBFCS. (Non-Banking Financial Corporations) 13. Narasimham Committee II (1998) Banking Sector Reforms: The reforms consisted of a) A shift of banking sector supervision from intrusive micro-level intervention over credit decisions toward prudential regulations and supervision.b) A reduction of the CRR and SLR.c) Interest rate and entry deregulation; and d) application of prudential norms. 14. Verma Committee (1999) Revival of weak public sector banks. 15. Kelkar Committee (2002) Indirect tax reforms 16. Khusro Committee (1986) Agricultural Credit 17. A.V. Gupta Committee (1997) Agricultural loans 18. Mahalanobis Committee National Income 19. Jilani Committee Loan Systems 20. J.J. Irani Committee Company Law reforms. 21. W.S. Saarraf Committee Technology issues in the banking sector. 22. Malhotra Committee Insurance Sector reforms. 23. S.S Tarapore Committee This committee was set up by the Reserve Bank of India under the Chairmanship of former RBI deputy governor S.S Tarapore to “lay the roadmap” to capital account convertibility. The five member committee recommended convertibility by 1999-2000

12 NOTE ON BANKING Annexure – 2: New Technology/ Trends in Annexure – 4: Economy Indicators (As 30.07.13) Banking Sector Y Bank Rate 10.25% Internet Banking: Banks have started offering services of Y Repo Rate 7.25% Internet Banking. Customers can view their accounts, print statement of accounts, request for chequebook, transfer funds Y Reverse Repo Rate 6.25% etc. sitting in the easy comfort of their home/ office or cyber Y Cash Reserve Ratio 4.0% café. Y Statutory Liquidity Ratio (SLR) 23.0% Core Banking: Core Banking Solution provides centralized system which provide centralized accounting, customer SOME PROMINENT PERSONALITIES information management and transaction processing functions. HEADING IMPORTANT ORGANISATIONS Once full migration to CBS is achieved ‘Branch Banking’ will become irrelevant. Person Institution

MICR Technology: with the phenomenal growth in volumes Y Pratip Chaudhuri State Bank of India of cheques to be handled by clearing houses in major business Y Chanda Kochchar ICICI Bank centres, at the instance of RBI, banks in selected centres introduced Magnetic Ink Character Recognition (MICR) Y Deepak Parekh HDFC technology with specially printed cheques with MICR band Y Prakash Bakshi NABARD printed at the bottom of cheques. The data contained in the MICR band is captured with the help of encoders, which Y Sushil Muhnot SIDBI

facilitates faster sorting, and settlement of payment of cheques. Y M. S. Raghavan IDBI Bank

Real time Gross Settlement (RTGS): This technological Y TCA Ranganathan Exim Bank initiative was launched by RBI in 2004 for faster settlement of payments. As transfers through RTGS can be effected Y U. K Sinha SEBI instantaneously, this is one of the fastest mode of transfer. Y T. S. Vijayan IRDA

Annexure – 3: Differential Rate of Interest Y Yogesh Agarwal PFRDA Scheme Y S. Krishnan PNGRB Y In April, 1972, the Government implemented this scheme in 162 districts of the country. Y Y. S. Bhave AERA

Y Under this scheme, public sector banks were directed to Y Rahul Khullar TRAI grant at least 1% of their total advances of the previous Y Y. V. Reddy 14th Finance Commission year to weaker sections of society at a concessional interest rate of 4%. Y Christine Lagarde IMF, MD Y New strategy for rural lending: Service area approach: Jim Yong Kim World Bank

Y This new approach was implemented under the purview Y Takehiko Nakao ADB

of Lead Bank Scheme since April 1, 1989. Y Roberto Azevedo WTO Y Under this new scheme, branches of commercial banks Y Amrita Patel NDDB were allotted certain specific semi-urban and rural areas. These banks were made responsible for over-all Y M.S. Swaminathan National Commission on development in these allotted areas. Farmers

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