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OPERATIONS RESEARCH

Commercial Banking: An Introduction-Part-1

Introduction

The banking sector is a vital cog in the machinery of any modern economy. It is one of the major financial pillars of the financial system. are one of the oldest of financial intermediaries in the financial system. They play a crucial role in the mobilisation of deposits and disbursal of credit in of credit to various sectors of the economy. A well-functioning banking system efficiently deploys mobilised savings in productive sectors and a solvent banking system ensures that the is capable of meeting its obligations to the depositors. In India, the banking sector is the dominant form of financial institution and accounts for more than half the assets of the financial sector.

Evolution of Commercial Banking

Enhancement of the RBI Act 1935 gave birth to scheduled banks in India, and some of these banks had already been established around 1881. The prominent among the scheduled banks is the , which was set up in 1865 with European management. The first bank which was established with Indian ownership and management was the Oudh Commercial Bank, formed in 1881, followed by the Ayodhya Bank in 1884, the in 1894 and in 1899. Thus, there were five Banks in existence in the 19th century. During the period 1901-1914, twelve more banks were established, prominent among which were the (1906), the (1906), the (1907), the (1908) and the of India (1911).

Thus, the five big banks of today had come into being prior to the commencement of the First World War. In 1913, and also in 1929, the Indian Banks faced serious crises. Several banks succumbed to these crises. Public confidence in banks received a jolt. There was a heavy rush on banks. An important point to be noted here is that no commercial bank was established during the First World War, while as many as twenty scheduled banks came into existence after independence - two in the public sector and one in the private sector. The was formed in 1950 by the merger of four existing commercial banks. Certain non-scheduled banks were included in the second schedule of the Reserve Bank. In view of these facts, the number of scheduled banks rose to 81. Out of 81 Indian scheduled banks, as many as 23 were either liquidated or merged into or amalgamated with other scheduled banks in 1968, leaving 58 Indian schedule banks.

It may be emphasized at this stage that banking system in India came to be recognized in the beginning of 20th century as powerful instrument to influence the pace and pattern of economic development of the country. In 1921 need was felt to have a State Bank endowed with all support and resources of the Government with a view to helping industries and banking facilities to grow in all parts of the country. It is towards the accomplishment of this objective that the three Presidency Banks were amalgamated to form the . The role of the Imperial Bank was envisaged as "to extend banking facilities, and to render the money resources of India more accessible to the trade and industry of this country, thereby promoting financial system which is an indisputable condition of the social and economic advancement of India."

Until 1935 when RBI came into existence to play the role of Central Bank of the county and regulatory authority for the banks, Imperial Bank of India played the role of a quasi-central bank. It functioned as a commercial bank but at times the Government used it for regulating the money supply by influencing its policies.

Thus, the role of commercial banks in India remained confined to providing vehicle for the community's savings and attending to the credit needs of only certain selected and limited segments of the economy.

Financial services

Commercial banks are the heart of our financial system. They hold the deposits of millions of persons, governments and business units. They make funds available through their lending and investing activities to borrowers - individuals, business firms, and governments. In doing so, they facilitate both the flow of goods and services from producers to consumers and the financial activities of governments. They provide a large portion of our medium of exchange and they are the media through which monetary policy is effected. These facts obviou51y add up to the conclusion that the commercial banking system of the nation is important to the functioning of its economy.

Commercial banks playa very important role in our economy; in fact, it is difficult to imagine how our economic system could function efficiently without many of their services. They are the heart of our financial structure, since they have the ability, in cooperation with the , to add to the money supply of the nation and create additional purchasing power. Banks' lending, investments and related activities facilitate the economic processes of production, distribution and consumption.

The major task of banks and other financial institutions is to act as intermediaries, channelling savings into investment and consumption: through them, the investment requirements of savers are reconciled with the credit needs of investors and consumers.

If this process of transference is to be carried out efficiently, it is absolutely essential that the banks are involved. Indeed, in performing their tasks, they realise important economies of scale: the savings placed at their disposal are employed in numerous and large transactions adapted to the specific needs of borrowers. In this way, they are able to make substantial cost savings for both savers and borrowers, who would otherwise have to make individual transactions with each other. However, there is more to these economies of scale than just the cost aspect.

Commercial banks have been referred to as 'department stores of finance' as they provide a wide variety of financial services. In addition to the acceptance of deposits, lending and investing, they provide a multitude of services, including transfer of funds, collection, foreign exchange, safe custody, safe deposit locker, traveller'5 cheque, merchant banking services, credit cards, gift cheques, etc.

Commercial Banks provide various securities related services. Commercial banks in India have set up subsidiaries to provide capital market related services, recruitment banking merchant banking etc.

Merchant banking services are activities i.e. counseling corporate clients who are in need of capital on capital structure, from of capital to be raised, the terms and conditions of issue underwriting of the issue, timing of the issue & preparation of prospectus and publicity for grooming the issue for the market. While providing these services they act as sponsor of issue, render expert advice on matters pertaining to investment decision, render the services as corporate counseling and advice on mergers acquisition and reorganization.