Principles & Practices of Banking module 1
- 1. WELCOME MODULE – 1 Introduction to Banking System 1
- 2. Introduction to Banking System Financial markets and its segmentation Financial system overview Recent developments in Indian financial system Role and functions of RBI Introduction to equity and debt markets Historical aspects of banking in India Evolution of banking system Types of banks (Public sector, Regional banks) Performance of public sector banks Performance of private sector banks Commercial banking Commercial bank’s structure Commercial bank’s functions (Primary & secondary function) Role of commercial banks in socio economic development Services rendered by commercial banks Credit creation and deployment of funds in commercial banks Role of RBI & GOI as regulator of banking system 2 Synopsis – Module 1
- 3. • The word “Bank” is derived from the word “Bancus or Banque” that is bench. Jews, who were considered to be the early bankers, transacted their business on benches in the market. Some people trace the origin of the word “Bank” from the German word “Back” meaning a joint stock fund. This seems to be better. • A banking company in India has been defined in the Banking Companies Act, 1949 as one “Which transacts the business of banking which means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or other wise and withdraw able by cheque, draft, order or otherwise”. • An establishment authorized by a government to accept deposits, pay interest, clear cheque, make loans, act as an intermediary in financial transactions, and provide other financial services to its customers. 3 Introduction to Banking
- 4. 4 FINANCIAL MARKET FINANCIAL MARKET MONEY MARKET CAPITAL MARKET ORGANIZED MARKET UNORGANIZED MARKET PRIMARY MARKET SECONDARY MARKET BANK’S FIN INSTIUTION NBFC CO-OP SOCIETY CORPORATES M-LENDER INDEGENIOUS - BANK CHIT FUND NIDHI’S CALL MONEY T-BILLS C P C B C O D IPO PROSECTUS OFFER OF SALE PVT PLACEMENT RIGHTS ISSUE E-IPO EQUITY SHARES GOVT SEC DEBENTURE BOND
- 5. Financial system overview The financial system of a country is an important tool for economic development of the country as it helps in the creation of wealth by linking savings with investments. It facilitates the flow of funds from the households (savers) to business firms (investors) to aid in wealth creation and development of both the parties. There are four main constituents of the financial system as follows • Financial Services • Financial Assets/Instruments • Financial Markets • Financial Intermediaries 5 Financial markets and its segmentation
- 6. Financial Services are concerned with the design and delivery of financial instruments, advisory services to individuals and businesses within the area of banking and related institutions, personal financial planning, leasing, investment, assets, insurance etc. These services includes. → Banking Services → Foreign Exchange services → Investment Services → Insurance Services → Some of the other services include the advisory services, venture capital, angel investment etc. Financial Instruments can be defined as a market for short-term money and financial assets that is a substitute for money. The term short-term means generally a period of one year substitutes for money is used to denote any financial asset which can be quickly converted into money. Some of the important instruments are as follows: → Call /Notice-Money → T-bills → Commercial paper → Commercial bill → COD 6
- 7. Financial Markets is a broad term describing any market place where buyers and sellers trade in financial assets such as stock, bonds etc. The financial markets are classified into two groups: Capital market - A capital market is an organized market which provides long-term finance for business. Capital Market also refers to the facilities and institutional arrangements for borrowing and lending long- term funds. Capital Market is divided into three groups: Corporate Securities Market Government Securities Market Long-Term Loans Market Money market - it is a market for short term loan or financial asset, it is a market for lending an borrowing of short term funds. It deals with near substitute of money whose maturity period is up to one year. Unorganized Market: It consists of Money lenders, Indigenous Bankers, Chit Funds, etc. Organized Money Market: It consists of Treasury Bills, Commercial Paper, Certificate Of Deposit, Call Money Market and Commercial Bill Market. Organised Markets work as per the rules and regulations of RBI. RBI controls the Organized Financial Market in India. Financial intermediaries is an institution which connects the deficit and surplus money. The best example of an intermediary is a bank which transforms the bank deposits to bank loans. The role of the financial intermediary is to distribute funds from people who have extra inflow of money to those who don’t have enough money to fulfill the needs. Financial Intermediaries are divided into two types Depository institutions Non-Depository institutions 7
- 8. Indian Government appointed a committee under the chairmanship of Sukhamoy Chakravarty in 1984 to review the Indian monetary system. Later, Narayanan Vaghul working group and Narasimham Committee was also set up. As per the recommendations of these study groups and with the financial sector reforms initiated in the early 1990s, the government has adopted following major reforms in the Indian money market. Deregulation of the Interest Rate Money Market Mutual Fund (MMMFs) Liquidity Adjustment Facility (LAF) Electronic Transactions Establishment of the Clearing Corporation of India Limited (CCIL) Development of New Market Instruments RBI has introduced safe & efficient modes of payment system MICR Introduction of smart cards, magnetic stripe cards, internet accounts, internet wallets, mobile accounts, mobile wallets etc 8 Recent developments in Indian financial system
- 9. ATMs / Point of Sale (POS) Terminals / Online Transactions Free 5 transactions at any ATM, re-crediting in 7 days & if exceeded mandated compensation CNP (Card not present) Cash withdrawal using debit card at PoS terminals Electronic Payments - The continued increase in the volume of cheques added pressure on the existing set-up, thus necessitating following cost- effective alternative systems 1. Electronic Clearing Service (ECS) Credit (in bulk like dividend, interest, salary, pension, etc) 2. Regional ECS (RECS) – (FEMA act 2000) 3. Electronic Clearing Service (ECS) Debit 4. National Electronic Funds Transfer (NEFT) System 5. Real Time Gross Settlement (RTGS)System 6. Clearing Corporation of India Limited (CCIL 7. IVR, RPS, FEMA 9
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- 11. The RBI was established on April 1 1935, in accordance with the provisions of the Reserve Bank of India Act 1934. It was initially privately owned and managed but since nationalization in 1943 it became fully owned by the GOI. The preamble of the RBI describes the basic Functions of Reserve Bank of India as: “To regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy frame work to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth” The RBI has 4 zonal offices at: 1. Chennai 2. Delhi 3. Kolkata 4. Mumbai It has 19 regional offices and 11 sub offices 11 Role & functions of RBI
- 12. ORGANIZATIONAL STRUCTURE OF RBI • The RBI affairs are governed by a central board of directors. The board is appointed by the GOI for a period of 4 years. • Full time officials: governor (Mr.Shaktikanta Das) and not more than 4 deputy governors (MrB.P.Kanungo, N.S.Vishwanathan, M.K.Jain) • Nominated by government: Ten directors from various fields and two government officials. 12
- 13. FUNCTIONS OF RBI IN INDIAN BANKING SYSTEM 1. Monetary authority 2. The issue of currency 3. The issuer of banking license (Sec 22 Banking Reg Act) 4. Banker’s to the government 5. Banker’s bank 6. Lender of last resort 7. Banker and debt manager of government 8. Money supply and controller of credit 9. Manager of foreign exchange 10. Regulator of economy 11. Managing government securities 12. Regulator and supervisor of payment and settlement systems 13. Developmental role 14. Publisher of monetary data and other data 15. Exchange manager and controller (IMF & Commercial bank) 16. Banking ombudsman service (Ombudsman scheme 1995) 17. Banking Codes and Standards Board of India(BCSBI) 18. Fair practices code for lenders 19. Miscellaneous functions 20. Provision for industrial finance 21. Provisions of training 13
- 14. RBI’s role in the economy is pivotal as it makes or breaks the economy. Below mentioned are the areas where RBI plays an important role. 1. Development of banking system 2. Development of financial institution 3. Development of backward areas 4. Bringing economic stability 5. Facilitating economic growth 6. Preparing proper interest rate culture. Supervisory functions of RBI 1. Providing license to banks & keeping control on the number of new branches 2. Doing periodical inspection of banks 3. Controlling NBFC – The NBFC institutions are not influenced by the working of a monetary policy. RBI has a right to issue directives to the NBFIs regarding their functioning. 4. Implementation of the deposit insurance scheme: in order to protect the deposit of small depositors, RBI work to implement the Deposit Insurance Scheme in case of bank failure. (For bank deposits below 1 lakh) example – PMC bank 14 RBI’s Role in Economic Development
- 15. RBI FUNCTIONS- GENERAL TERMS 1. Monetary policy 2. Cash Reserve Ratio (CRR) 3. Statutory Liquidity Ratio (SLR) 4. Repo Rate 5. Reverse Repo Rate 6. Fiscal Policy 15 Policy Repo Rate (ST) Reverse Repo Rate Marginal Standing Facility Rate(ST) Bank Rate (LT) CRR SLR Base Rate MCLR Savings Deposit Rate Term Deposit Rate> 1 year 5.45% 4.90% 5.40% 5.40% 4% 19.5% 8.95- 9.45% 7.70- 8.05% 3.50- 4.00% 6.00- 6.75%
- 16. DEBT MARKET • Debt market is where investors buy and sell debt securities, mostly in the form of bonds. Debt market in India is one of the largest in Asia. Like all countries, Indian debt market is also considered a useful substitute to banking channels for finance. • The debt market in India categories- the government securities or the G-Sec that are sovereign securities issued by the RBI on behalf of the government in India. The corporate bond market ( also known as the non-Gsec market) consists of financial institutions(FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures. • Bonds are considered to be risky investments for at least two reasons. First, bond market returns are less volatile than stock market returns. Second, should the company run into trouble, bond holders are paid first, before other expenses are paid 16 Debt market & Equity market
- 17. EQUITY MARKET • Equity market - An equity market is a market in which shares are issued and traded, either through exchanges or over-the-counter markets. Also known as the stock market, it is one of the most vital areas of a market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance. • Trading in an equity market - In the equity market, investors bid for stocks by offering a certain price, and sellers ask for a specific price. When these two prices match, a sale occurs. Often, there are many investors bidding on the same stock. When this occurs, the first investor to place the bid is the first to get the stock. When a buyer will pay any price for the stock, he or she is buying at market value; similarly, when a seller will take any price for the stock, he or she is selling at market value. 17
- 18. 1. Dividend 2. Not repayable 3. Dividend paid only if profit 4. Major risk 5. Dividend – sharing of profit 6. Profit after tax 7. Dividend paid or used as R&S 18 1. Interest 2. Repay as per T&C 3. Non cares profit, but pay Interest & principal 4. Less risky 5. Interest = Expenses 6. Expenses will reduce profit, reduce tax 7. Bond holders are paid first Difference B/w Equity & Debt Market
- 19. Banking in India has a very long history starting from the late 18 th century. The origin of modern banking started from 1770 in the name of “Bank of Hindustan” by English agency ‘House of Alexander & Co’ in Kolkatta however it was closed in 1832. Further in 1786 “General Bank of India” was started and it failed in 1791. The 3 presidency banks were • Bank of Bengal- Established in 1806 • Bank of Bombay - Established in 1840 • Bank of Madras - Established in 1843 These three presidency banks were re- organized and amalgamated to form a single entity named “Imperial Bank Of India” on 27th January ,1927. It was later transformed into “State Bank Of India” in 1955. 19 Historical aspects of banking in india
- 20. Some Of The Old Banks • Allahabad Bank was established in 1865 at Allahabad(Uttar Pradesh). It is the oldest joint stock bank of our country functioning till today. • Oudh Commercial Bank was established in 1881 at Faizabad(Uttar Pradesh).It is the First limited liability Bank in India and also first joint stock bank by Indians. However it failed in 1958. • Punjab National Bank was established in 1895 at Lahore(pakistan) and it was also the first bank to be managed solely by Indians. Impact of “Swadeshi” Movement • Due to the “Swadeshi” movement many banks were established between 1906 to 1911. Many local businessmen and strong political figures of India funded the banks for Indian community. Some of the banks that were established are as follows: 20 Name of the Bank Establishment Year Canara Bank 1906 Bank of India 1906 Corporation Bank 1906 Indian Bank 1907 Bank of Baroda 1908
- 21. 21 Types of banks (public sector, regional banks) RBI Scheduled Bank’s Non-Scheduled Bank’s Commercial Bank’s Co-Operative Bank’s Public Sector Bank’s Private Sector Bank’s Foreign Bank’s Regional Rural Bank’s SBI & Associate Bank’s Nationalized Bank’s Other Public Sector Bank’s State Co-Operative Bank’s District Co-Operative Bank’s Other Co-Operative Bank’s RBI Act 1934 Apex Bank (Cent Bank) 1 Apr 1935 1 Jan 1949 Nationalized BASEL ACCORD 1. SBI Act 1955 – Imperial Bank Renamed 2. Banking Regulation Act - 1949 3.IDBI Act 1964 1. The KA state Co-Op Apex Bank Ltd 2. BDCCB Bellary RRB- 50, 15, 35% 3. The Citizenship Co-Op Society, Bly >5 L <5 L, No Borrow Co-Op Societies Act 1912 Akhand Anand Co-Op Bank ltd Alavi Co-Op Bank Ltd Amarnath Co-Op Bank Ltd Amod Nagarik Sahakari Bank Ltd
- 22. Commercial Bank can be described as a financial institution that offers basic investment products like a savings account, current account, etc to the individuals and corporate. Along with that, it provides a range of financial services to the general public such as accepting deposits, granting loans and advances to the customers. They generally finance trade and commerce with short-term loans. They charge high rate of interest from the borrowers but pay much less rate of Interest to their depositors with the result that the difference between the two rates of interest becomes the main source of profit of the banks. Most of the Indian joint stock Banks are Commercial Banks such as Punjab National Bank, Allahabad Bank, Canara Bank, Andhra Bank, Bank of Baroda, etc. 22 COMMERCIAL BANKING
- 23. 23 FUNCTIONS OF COMMERCIAL BANK’S Primary functions Receiving of Deposits TIME LIABLITIES 1.Fixed Deposit 2.Recurring Deposit 3.Miscellaneous types of deposit DEMAND LIABLITIES 1.Savings A/c 2.Current A/c LENDING OF FUNDS 1.Overdraft 2.Cash credit 3.Loans & Adv 4.Discounting bills of exchange Secondary functions AGENCY SERVICES 1.Payment of rent, Insurance premium etc 2.Collecting of cheques 3.Dealing in foreign in exchange GENERAL UTILITY SERVICES 1.Safe custody deposits 2.Safe deposit locker facilities 3.Transfer of money 4.Issue to travelers, cheque, mail transfer etc. 5.Acting as referees 6.Merchant banking 7.Teller system 8.ATM 9.Credit cards 10.Gift cheques 11.E-Banking 12.Miscellaneous services Source : Book ‘Banking & Financial system’ by Dr.Nirmala Prasad, K.Chandradass j. PgNo-101 Debit card EFT Anywhere banking E-Pass book Tele banking Internet banking Corporate banking
- 24. PROCESS OF MONEY (CREDIT) CREATION • Suppose a man, say X, deposits Rs 10,000 with a bank and the LRR is 20% which means the bank keeps only the minimum required Rs 2,000 as cash reserve (LRR). The bank can use the remaining amount Rs 8,000 (10,000-2,000) for giving loan to someone (Mind, loan is never given in cash but it is redeposit in the favor of borrower) • The bank lends 8,000 to say, Y who is actually not given loan but only demand deposit account is opened in his name and the amount is credited to his account. This is the first round of credit creation in the form of secondary deposit (Rs 8000), which equals 80% of primary (Initial) deposit. • Again 20% of Y’s deposit (i,e 1,600) is kept by the bank as cash reserve and the balance Rs 6,400 (= 8,000-1600) is advanced to, say, Z. The bank gets new demand deposit of Rs 6,400. This is second round of credit creation which is 80% of first round of increase of Rs 8,000. • Banks creates credit through initial deposits and this process is known as credit creation or monetary creation. 24 CREDIT CREATION AND DEPLOYMENT OF FUNDS IN COMMERCIAL BANKS
- 25. IT IS BASED ON 2 ASSUMPTIONS: • All commercial banking system is one unit and known as banks. • All payments and receipts are made through banks only (in cash). LRR (Legal Reserve Ratio) = CRR + SLR Money multiplier = 1/LRR = 100/20 = 5 Times 25 SCENARIO DEPOSITED AMT LRR LOAN AMOUNT 1 10,000 2,000 8,000 2 8,000 1,600 6,400 3 6,400 1,280 5,120 ………! ………! ………! ………! 41 1.35 0.27 1.08 42 1.08 0.21 0.87 TOTAL 50,000 10,000 40,000
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