BANKING FUNCTIONS

INDEX

1

Sr. No. Page No.

01 INTRODUCTION 03

02 HISTORY OF BANKING IN INDIA 03

03 THE BANKING STRUCTURE IN INDIA 06

04 THE BANKING STRUCTURE IN INDIA 08

05 TYPES OF BANKS 10

06 BANKING FUNCTIONS 13

07 FUNCTION OF COMMERCIAL BANKS 14

08 BIBLIOGRAPHY 18

INTRODUCTION

2

India cannot have a healthy economy without a sound and effective banking system. The

banking system should be hassle free and able to meet the new challenges posed by

technology and other factors, both internal and external.

In the past three decades, India's banking system has earned several outstanding

achievements to its credit. The most striking is its extensive reach. It is no longer confined to

metropolises or cities in India. In fact, Indian banking system has reached even to the

remote corners of the country. This is one of the main aspects of India's growth story.

The government's regulation policy for banks has paid rich dividends with the

nationalization of 14 major private banks in 1969. Banking today has become convenient

and instant, with the account holder not having to wait for hours at the bank counter for

getting a draft or for withdrawing money from his account.

HISTORY OF BANKING IN INDIA

The first bank in India, though conservative, was established in 1786. From 1786 till today,

the journey of Indian Banking System can be segregated into three distinct phases:

Early phase of Indian banks, from 1786 to 1969

Nationalization of banks and the banking sector reforms, from 1969 to 1991

New phase of Indian banking system, with the reforms after 1991

Phase 1

The first bank in India, the General Bank of India, was set up in 1786. Bank of Hindustan and

Bengal Bank followed. The East India Company established Bank of Bengal (1809), Bank of

Bombay (1840), and Bank of Madras (1843) as independent units and called them

Presidency banks. These three banks were amalgamated in 1920 and the Imperial Bank of

India, a bank of private shareholders, mostly Europeans, was established. Allahabad Bank

was established, exclusively by Indians, in 1865. Punjab National Bank was set up in 1894

with headquarters in Lahore. Between 1906 and 1913, Bank of India, Central Bank of India,

Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. The Reserve

Bank of India came in 1935.

3

During the first phase, the growth was very slow and banks also experienced periodic

failures between 1913 and 1948. There were approximately 1,100 banks, mostly small. To

streamline the functioning and activities of commercial banks, the Government of India

came up with the Banking Companies Act, 1949, which was later changed to the Banking

Regulation Act, 1949 as per amending Act of 1965 (Act No. 23 of 1965). The Reserve Bank of

India (RBI) was vested with extensive powers for the supervision of banking in India as the

Central banking authority. During those days, the general public had lesser confidence in

banks. As an aftermath, deposit mobilization was slow. Moreover, the savings bank facility

provided by the Postal department was comparatively safer, and funds were largely given to

traders.

Phase 2

The government took major initiatives in banking sector reforms after Independence. In

1955, it nationalized the Imperial Bank of India and started offering extensive banking

facilities, especially in rural and semi-urban areas. The government constituted the State

Bank of India to act as the principal agent of the RBI and to handle banking transactions of

the Union government and state governments all over the country. Seven banks owned by

the Princely states were nationalized in 1959 and they became subsidiaries of the State

Bank of India. In 1969, 14 commercial banks in the country were nationalized. In the second

phase of banking sector reforms, seven more banks were nationalized in 1980. With this, 80

percent of the banking sector in India came under the government ownership.

Phase 3

This phase has introduced many more products and facilities in the banking sector as part of

the reforms process. In 1991, under the chairmanship of M Narasimham, a committee was

set up, which worked for the liberalization of banking practices. Now, the country is flooded

with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service

to customers. Phone banking and net banking are introduced. The entire system became

more convenient and swift. Time is given importance in all money transactions.

4

The financial system of India has shown a great deal of resilience. It is sheltered from crises

triggered by external macroeconomic shocks, which other East Asian countries often

suffered. This is all due to a flexible exchange rate regime, the high foreign exchange

reserve, the not-yet fully convertible capital account, and the limited foreign exchange

exposure of banks and their customers.

Nationalization Process

1955: Nationalization of State Bank of India

1959: Nationalization of SBI subsidiaries

1969: Nationalization of 14 major banks

1980: Nationalization of seven banks with deposits over Rs 200 crore

The nationalisation of banks in India took place in 1969 by Mrs. Indira Gandhi the then

prime minister. It nationalised 14 banks then. These banks were mostly owned by

businessmen and even managed by them.

Central Bank of India

Bank of Maharashtra

Dena Bank

Punjab National Bank

Syndicate Bank

Canara Bank

Indian Bank

Indian Overseas Bank

Bank of Baroda

Union Bank

Allahabad Bank

United Bank of India

UCO Bank

Bank of India

5

THE BANKING STRUCTURE IN INDIA

The banking sector in India functions under the umbrella of the RBI—the regulatory, central

bank. The Reserve Bank of India Act was passed in 1934 and the RBI was constituted in 1935

as the apex bank. The Banking Regulations Act was passed in 1949. This Act brought the RBI

under government control. Under the Act, the RBI received wide-ranging powers in regards

to establishment of new banks, mergers and amalgamations of banks, opening and closing

of branches of banks, maintaining certain standards of banking business, inspection of

banks, etc. The Act also vested licensing powers and the authority to conduct inspections

with the RBI. Banks in India can broadly be classified as regional rural banks or RRBs,

scheduled commercial banks or SCBs, and co-operative banks.

The commercial banking structure in India consists of scheduled commercial banks and

unscheduled banks. Scheduled banks constitute those banks that are included in the Second

Schedule of Reserve Bank of India (RBI) Act, 1934.

As on June 30, 1999, there were 300 scheduled banks in India having a total network of

64,918 branches. The scheduled commercial banks in India comprise State Bank of India and

its associates (8), nationalised banks (19), foreign banks (45), private sector banks (32), co-

operative banks, and regional rural banks. Before the nationalization of Indian banks, the

State Bank of India (SBI) was the only nationalized bank, which was nationalized on July 1,

1955, under the SBI Act of 1955. The nationalization of seven State Bank subsidiaries took

place in 1959.

After the nationalization of banks in India, the branches of the public sector banks rose to

approximately 800 percent in deposits and advances took a huge jump by 11,000 percent.

6

7

BANKING STRUCTURE IN INDIA

SCHEDULED BANKS IN INDIA

Scheduled Commercial Banks

Nationalised Banks

Private Banks

Regional Rural bank

Scheduled Co-Operative Bank

NAFSCOB

Urban Co-Operative

Banks

Rural Co-operative

Credit Institutin

Long Term Structure

State

Co-operativ

e Agriculture &

Rural

Developmen

t Banks

Primar

y Co-operativ

e Agriculture &

Rural

Developmen

t Banks

Short Term structureStatee

Co-operativ

e Banks

District centarl Co-operativ

e bBanksPrimar Agricultut=r

e Credit

Socities

All India Financial Institution

NABARD

SIDBI

EXIM

IDBI

THE PRESENT BANKING SCENARIO

Indian banking had come a long way since India adopted reforms path. Today Indian Banks

are as technology savvy as their counter parts in developed countries. The

competitive and reform force have led to the emergence of internet, ebanking, ATM, credit

card and mobile banking too, to let banks attract and retain customers. This apart retail

lending has emerged as another major opportunity for banks. Due to globalization,

liberalization and privatization mode, Indian banks going global and many global banks

setting up shops in India, the Indian banking system is set to involve into a totally new level

it will help the banking system grow in strength going into the future.

In recent times economy is been pushing to increase the role of multi-national banks in the

banking sector.

But it is opposed on the front that it will lead to state run insurers loosing business and

workers their job. There are several reasons why giving foreign investor’s greater voting

rights are fraught with dangers. When domestic or foreign investors acquire a large share

holding in any bank and exercise proportionate voting rights, it creates potential problems

not only of excursive concentration in the banking sector but also can expose the economy

to more intensive financial crises at the slightest hint of panic.

Opposition is not considering the need of present situation. FDI in banking sector can solve

various problems of the overall banking sector. Such as –

Innovative Financial Products

Technical Developments in the Foreign Markets

Problem of Inefficient Management

Non-performing Assets

Financial Instability

Poor Capitalization

Changing Financial Market Conditions

8

If we consider the root cause of these problems, the reason is low-capital base and all the

problems is the outcome of the transactions carried over in a bank without a substantial

capital base. In a nutshell, we can say that, as the FDI is a non-debt inflow, which will

directly solve the problem of capital base. Along with that it entails the following benefits

such as

Technology Transfer

As due to the globalization local banks are competing in the global market, where innovative

financial products of multinational banks is the key limiting factor in the development of

local bank. They are trying to keep pace with the technological development in the banks.

Now a days banks have been prominent and prudent in the rapid expansion of consumer

lending in domestic as well as in foreign markets. It needs appropriate tools to assess (how

such credit is managed) credit management of the banks and authorities in charge of

financial stability. It may need additional information and techniques to monitor for

financial vulnerabilities. FDI's tech transfers, information sharing, training programs and

other forms of technical assistance may help meet this need.

Better Risk Management

As the banks are expanding their area of operation, there is a need to change their

strategies exert competitive pressures and demonstration effect on local institutions, often

including them to reassess business practices, including local lending practices as the whole

banking sector is crying for a strategic policy for risk management.

Through FDI, the host countries will know efficient management technique. The best

example is Basel II. Most of the banks are opting Basel II for making their financial system

more safer.

Financial Stability and Better Capitalization

Host countries may benefit immediately. From foreign entry, if the foreign bank re-capitalize

a struggling local institution. In the process also provides needed balance of payment

finance. In general; more efficient allocation of credit in the financial sector, better

9

capitalization and wider diversification of foreign banks along with the access of local

operations to parent funding, may reduce the sensitivity of the host country banking system

and lead towards financial stability.

So due to the aforesaid benefits economy has consistent flow of FDI over the past few years.

In addition to that, the govt. has also taken step to enhance the FDI (eg. Telecom, civil

aviation) FDI up to 100% through the Reserve Bank's automatic route was permitted for a

no. of new sectors in 2005-06 such as Greenfield airport projects, export trading. All these

measures have been contributing towards increasing direct investment.

TYPES OF BANKS

10

TYPES OF BANKS

Retail Banks

Commercial banks

Central banksSpecialized banks

Cooperative banks

Investment Banks

The banking industry can be divided into following sectors, based on the clientele served

and products and services offered:

Retail Banks

Commercial banks

Cooperative banks

Investment Banks

Specialized banks

Central banks

Retail Banks:

Retail banks provide basic banking services to individual consumers. Examples include

savings banks, savings and loan associations, and recurring and fixed deposits. Products and

services include safe deposit boxes, checking and savings accounting, certificates of deposit

(CDs), mortgages, personal, consumer and car loans.

Commercial Banks:

Banking means accepting deposits of money from the public for the purpose of lending or

investment. Commercial Banks provide financial services to businesses, including credit and

debit cards, bank accounts, deposits and loans, and secured and unsecured loans. Due to

deregulation, commercial banks are also competing more with investment banks in money

market operations, bond underwriting, and financial advisory work. Commercial banks in

modern capitalist societies act as financial intermediaries, raising funds from depositors and

lending the same funds to borrowers. The depositors’ claims against the bank, their

deposits, are liquid, meaning banks are expected to redeem deposits on demand, instantly.

Banks’ claims against their borrowers are much less liquid, giving borrowers a much longer

span of time to repay money owed banks. Because a bank cannot immediately reclaim

money lent to borrowers, it may face bankruptcy if all its depositors show up on a given day

to withdraw all their money.

There are two types of commercial banks, public sector and private sector banks.

11

Public Sector Banks:

Public sectors banks are those in which the government has a major stake and they usually

need to emphasize on social objectives than on profitability.

Private sector banks:

Private sector banks are owned, managed and controlled by private promoters and they are

free to operate as per market forces.

Investment Banks:

An investment bank is a financial institution that assists individuals, corporations and

governments in raising capital by underwriting and/or acting as the client's agent in the

issuance of securities. An investment bank may also assist companies involved in mergers

and acquisitions, and provide ancillary services such as market making, trading of

derivatives, fixed income instruments, foreign exchange, commodities, and equity securities.

Investment banks aid companies in acquiring funds and they provide advice for a wide range

of transactions. These banks also offer financial consulting services to companies and give

advice on mergers and acquisitions and management of public assets.

Cooperative Banks:

Cooperative Banks are governed by the provisions of State Cooperative Societies Act and

meant essentially for providing cheap credit to their members. It is an important source of

rural credit i.e., agricultural financing in India.

Specialized Banks:

Specialized banks are foreign exchange banks, industrial banks, development banks, export-

import banks catering to specific needs of these unique activities. These banks provide

financial aid to industries, heavy turnkey projects and foreign trade.

Central Banks:

12

Central banks are bankers’ banks, and these banks trace their history from the Bank of

England. They guarantee stable monetary and financial policy from country to country and

play an important role in the economy of the country. Typical functions include

implementing monetary policy, managing foreign exchange and gold reserves, making

decisions regarding official interest rates, acting as banker to the government and other

banks, and regulating and supervising the banking industry.

These banks buy government debt, have a monopoly on the issuance of paper money, and

often act as a lender of last resort to commercial banks. The term bank nowadays refers to

these commercial banks. The Central bank of any country supervises controls and regulates

the activities of all the commercial banks of that country. It also acts as a government

banker. It controls and coordinates currency and credit policies of any country. The Reserve

Bank of India is the central bank of India.- Learn more at www.technofunc.com. Your online

source for free professional tutorials.

BANKING FUNCTIONS

The banking industry is growing rapidly. It's estimated that the assets of the 1,000 largest banks are worth almost $100 trillion USD. With the growth in the industry banks manages a diverse portfolio of functions. Apart from the segments discussed above banks also need to manage following functions and can also be classified based on functions:

Banking TechnologyInternal and External ReconciliationsInternal and External ClearingSurveillanceHuman ResourcesFinanceLegal and ComplianceSales and TradingTransaction Banking- Learn more at www.technofunc.com. Your online source for free professional tutorials.

FUNCTION OF COMMERCIAL BANKS

13

These functions of banks are explained below.

Primary Functions of Banks

The primary functions of a bank are also known as banking functions. They are the main functions of a bank.

These primary functions of banks are explained below.

1. Accepting Deposits

The bank collects deposits from the public. These deposits can be of different types, such as

Saving Deposits Fixed Deposits Current Deposits Recurring Deposits

a. Saving Deposits

This type of deposits encourages saving habit among the public. The rate of interest is low. At present it is about 4% p.a. Withdrawals of deposits are allowed subject to certain restrictions. This account is suitable to salary and wage earners. This account can be opened in single name or in joint names.

b. Fixed Deposits

14

Functions of Banks

Primary Functions

Accepting Deposits

Saving DepositsFixed Deposits

Current DepositsRecurring Deposits

Granting Advances

OverdraftCash Credit

LoansDiscounting of

Bills

Secoundry Functions

Agency FunctionsTransfer of

Funds'Periodic Payment

Collection of ChequesPortfolio

ManagementPeriopdic Collection

Other Agency Functions

Utility Functions

DraftsLockers

UnderwritingProject ReportsSocial Welfare ProgrammesOther Utility

Functions

Lump sum amount is deposited at one time for a specific period. Higher rate of interest is paid, which varies with the period of deposit. Withdrawals are not allowed before the expiry of the period. Those who have surplus funds go for fixed deposit.

c. Current Deposits

This type of account is operated by businessmen. Withdrawals are freely allowed. No interest is paid. In fact, there are service charges. The account holders can get the benefit of overdraft facility.

d. Recurring Deposits

This type of account is operated by salaried persons and petty traders. A certain sum of money is periodically deposited into the bank. Withdrawals are permitted only after the expiry of certain period. A higher rate of interest is paid.

2. Granting of Loans and Advances

The bank advances loans to the business community and other members of the public. The rate charged is higher than what it pays on deposits. The difference in the interest rates (lending rate and the deposit rate) is its profit.

The types of bank loans and advances are :-

Overdraft Cash Credits Loans Discounting of Bill of Exchange

a. Overdraft

This type of advances are given to current account holders. No separate account is maintained. All entries are made in the current account. A certain amount is sanctioned as overdraft which can be withdrawn within a certain period of time say three months or so. Interest is charged on actual amount withdrawn. An overdraft facility is granted against a collateral security. It is sanctioned to businessman and firms.

b. Cash Credits

The client is allowed cash credit upto a specific limit fixed in advance. It can be given to current account holders as well as to others who do not have an account with bank. Separate cash credit account is maintained. Interest is charged on the amount withdrawn in excess of limit. The cash credit is given against the security of tangible assets and / or guarantees. The advance is given for a longer period and a larger amount of loan is sanctioned than that of overdraft.

15

c. Loans

It is normally for short term say a period of one year or medium term say a period of five years. Now-a-days, banks do lend money for long term. Repayment of money can be in the form of installments spread over a period of time or in a lumpsum amount. Interest is charged on the actual amount sanctioned, whether withdrawn or not. The rate of interest may be slightly lower than what is charged on overdrafts and cash credits. Loans are normally secured against tangible assets of the company.

d. Discounting of Bill of Exchange

The bank can advance money by discounting or by purchasing bills of exchange both domestic and foreign bills. The bank pays the bill amount to the drawer or the beneficiary of the bill by deducting usual discount charges. On maturity, the bill is presented to the drawee or acceptor of the bill and the amount is collected.

Secondary Functions of Banks

The bank performs a number of secondary functions, also called as non-banking functions.

These important secondary functions of banks are explained below.

1. Agency Functions

The bank acts as an agent of its customers. The bank performs a number of agency functions which includes:-

Transfer of Funds Collection of Cheques Periodic Payments Portfolio Management Periodic Collections Other Agency Functions

a. Transfer of Funds

The bank transfer funds from one branch to another or from one place to another.

b. Collection of Cheques

The bank collects the money of the cheques through clearing section of its customers. The bank also collects money of the bills of exchange.

c. Periodic Payments

On standing instructions of the client, the bank makes periodic payments in respect of electricity bills, rent, etc.

16

d. Portfolio Management

The banks also undertakes to purchase and sell the shares and debentures on behalf of the clients and accordingly debits or credits the account. This facility is called portfolio management.

e. Periodic Collections

The bank collects salary, pension, dividend and such other periodic collections on behalf of the client.

f. Other Agency Functions

They act as trustees, executors, advisers and administrators on behalf of its clients. They act as representatives of clients to deal with other banks and institutions.

2. General Utility Functions

The bank also performs general utility functions, such as:-

Issue of Drafts, Letter of Credits, etc. Locker Facility Underwriting of Shares Dealing in Foreign Exchange Project Reports Social Welfare Programmes Other Utility Functions

a. Issue of Drafts and Letter of Credits

Banks issue drafts for transferring money from one place to another. It also issues letter of credit, especially in case of, import trade. It also issues travellers' cheques.

b. Locker Facility

The bank provides a locker facility for the safe custody of valuable documents, gold ornaments and other valuables.

c. Underwriting of Shares

The bank underwrites shares and debentures through its merchant banking division.

d. Dealing in Foreign Exchange

The commercial banks are allowed by RBI to deal in foreign exchange.

17

e. Project Reports

The bank may also undertake to prepare project reports on behalf of its clients.

f. Social Welfare Programmes

It undertakes social welfare programmes, such as adult literacy programmes, public welfare campaigns, etc.

g. Other Utility Functions

It acts as a referee to financial standing of customers. It collects creditworthiness information about clients of its customers. It provides market information to its customers, etc. It provides travellers' cheque facility.

18

BIBLIOGRAPHY

www.wikipedia.org

www.investopedia.com

www.moneycontrol.com

money.livemint.com

http://www.technofunc.com/

www.finance-glossary.com

(For definition of certain financial terms)

Financial Management -by I. M. Pandey

Financial Management- by Ravi Kishor

19