Banking Theory & Practice

Dr. S.G. Rama Rao

Introduction to Indian Banking System

Basic Banking Terms

• Finance: The proper management of money.

• Money: The current medium of exchange or means of payment.

• Credit or Loan: A sum of money to be returned normally with interest.

Bank• It is a financial firm.• The firm which deals banking activities.• It is an institution whose debts are

widely accepted in settlement of other people’s debts to each other.

Banking System

• The Merchant• The Gold Smith (safe lockers)• The Money lender (receiving deposits and

advancing loans)

Functions of a Bank

• Primary Functions–Receipts of Deposits (Savings, Fixed, RD, etc.)

–Granting of Loans (with surety) and Advances–Dealing with money (creating money)

Contd..

• Subsidiary Functions– Agency Services (on behalf of customer)• Act as agent• Collect the cheques• Payment of Insurance Premium, etc.

– General Services• Money transfer• Providing lockers• Help in foreign currency dealings, etc.

Functions of a Bank

Role of Banks• Receiving Deposits• Lending (loan)• Portfolio Management (investment)• Foreign exchange dealings• Encourage the use of technology (ATMs,

Internet banking, etc.)

• Help to economic growth

Challenges

• Changing needs of customers• Managing with regulatory reforms• Maintaining high quality assets• Management of impaired (harm) assets• Keeping pace with technology up-gradations• Sustaining healthy bottom lines and increasing

shareholder value

Banking History

• Bank of Venice was the first bank to start commercial banking operations in 1157.

• Modern banking system began with the opening of Bank of England in 1694.

• Bank of Hindustan was the first bank to be established in India in 1770.

Important Milestones of the Banking Industry

Contd..

Important Milestones of the Banking Industry

Contd..

Important Milestones of the Banking Industry

Contd..

Important Milestones of the Banking Industry

Indian Banking History• Name must include the word ‘Bank’, ‘Banker’ or

‘Banking’ for banking operations in India.• In the first half of the nineteenth century, three

Presidency Banks were started in Bengal (1809), Bombay (1840) and Madras (1843) with the financial participation of the Government for conducting banking business and issue currency notes.

• Towards the end of the 19th Century the cash balances of the government were kept in the government treasuries and the government drop its connections with the Presidency Banks.

Contd..

• The Imperial Bank came into existence on the 27th January, 1921 by the Imperial Bank of India Act of 1920.

• It was established by the amalgamation of the three Presidency Banks.

• The Imperial Bank was the biggest bank until 1935.• Until the establishment of the Reserve Bank of India in

1935, the Imperial Bank performed certain central banking functions, although it was purely a commercial bank.

• It acted as the sole-banker to the Government up to establishment of RBI.

Indian Banking History

Public sector banks in India and Private sector banks in India

Public Sector Banks• These are those in which the majority stake is

held by the Government of India (GoI).

• Public sector banks together make up the largest category in the Indian banking system.

• Public Sector Banks (SBI and associates + Nationalized banks) control more than 75% of the total deposits businesses in India whereas Private Sector Banks around 17-18%.

Public Sector Banks

State Bank of India & Its Seven Associate Banks

1. State Bank of Bikaner and Jaipur2. State Bank of Hyderabad3. State Bank of Indore4. State Bank of Mysore5. State Bank of Patiala6. State Bank of Saurashtra7. State Bank of Travancore

Nationalised Banks

List of Public Sector Banks

Indian Private Sector Banks

Private Sector Banks• Nationalisation of 14 banks in the year 1969 and

another set of 6 banks in the year 1989 reduced the importance of Private sector banks in India.

• As a part of liberalization programme Government took the initiatives on Private Sector banks for creating competition among the banks.

• The Indian economy’s liberalisation in the early 1990s has resulted in the conception of various private sector banks.

• These are working under the guidelines of RBI.• HDFC was amongst the first to received an

approval from RBI to set up a bank in the Private sector.

• Banks needs to maintain a net worth of Rs.300 crore at all times.

• Aggregate foreign investment in private banks from all sources (FDI, NRI, etc.), the guidelines stipulate that it can’t exceed 74% of the paid up capital of the bank.

Private Sector Banks

Types of Private Banks• Old Private sector banks are those banks

which were not nationalized at the time of bank nationalization that took place during 1969 and 1980.

• New private sector banks include those that were established (after 1991) in the past twenty years such as Yes Bank, Axis bank, etc.

• Foreign Banks

List of Old Private Sector Banks (13)

List of New Private Sector Banks (7)

List of Foreign Banks (41) in India

Differences between Commercial Banks

Type of Commercial Banks

Major Shareholders

Major Players

Public Sector BanksGovernment of India

SBI, PNB, Canara Bank, Bank of Baroda, etc.

Private Sector BanksPrivate Individuals

ICICI Bank, HDFC Bank, Axis Bank, Yes Bank, etc.

Foreign BanksForeign Entity

HSBC, Standard Chartered Bank, City Bank, etc.

Indian banks operations abroad and

Local Area Banks

Indian Banks’ Operations Abroad• The survey report, which was released today, covered

171 overseas branches, 24 overseas subsidiaries on Indian banks and 309 branches of foreign banks operating in India.

• The overseas subsidiaries of Indian banks registered 11 per cent growth in headcount in 2011-12.

• The report said Indian banks operating abroad employed 66.3 per cent of staff from local sources, 30.8 per cent from India and remaining 2.9 per cent from other countries.

• "The profitability ratio, i.e. profit to total assets, of branches of Indian banks operating abroad decreased to 0.7 per cent (from 1.1 per cent) in 2011-12.

• The profitability ratio of foreign banks operating in India increased to 2.4 per cent (from 2.3 per cent) in 2011-12," the survey report said.

• Bahrain, Belgium, Hong Kong, Japan, Singapore, Sri Lanka, UAE, UK and USA were the major countries that accounted together for nearly 91 per cent of the total trade in banking services of the Indian banks' branches.

Indian Banks’ Operations Abroad

Overseas offices of Indian Banks abroad as on March 31, 2013

Overseas offices of Indian Banks abroad as on March 31, 2013

Local Area Banks

Objective

• Setting up of local area banks in private sector to cater to the credit needs of the local people and to provide efficient and competitive financial intermediation services in their area of operation.

Scope of Activities• These banks are being set up in district towns,

their activities will be focussed on the local customers.

• It is expected that their lending will be to – agriculture and allied activities, – SSI, – trading activities and – the non-farm sector

Registration and Licensing• The bank shall be registered as a public

limited company under the Companies Act, 1956.

• It will be licensed under the Banking Regulation Act, 1949 and will be eligible for including in the Second Schedule of the Reserve Bank of India Act, 1934.

Capital

• The minimum paid up capital for such a bank shall be Rs.5 crore.

• The promoters‘ contribution for such a bank shall at least be Rs.2 crore.

Promoters

• The promoters of the bank may comprise individuals, corporate entities, trusts and societies.

• In the application for a banking licence the details of the initial contribution of promoters, and the manner and method through which the minimum share capital of Rs.5 crore will be raised will need to be indicated.

Area of Operation & Head Office

• The area of operation of the proposed bank shall be a maximum of three geographically neighboring districts.

• The Head/Registered Office of the bank will be located at a centre within the area of operation of the bank.

Branch Licensing

• The bank shall be allowed to open branches only in its area of operation and in regard to branch licensing, it shall be governed by the existing policy.

Pre-Reforms Development

Lead Bank Scheme• The National Credit Council was set up in Dec.’67 to

determine the priorities of bank credit among various sectors of the economy.

• The NCC appointed a study group on the organizational framework for the implementation of social objectives in Oct.’68 under the Chairmanship of Prof. D R Gadgil.

• Prof. DR Gadgil recommended in Oct.’69 the adoption of an “Area approach” for the development of credit and banking in the country on the basis of local conditions.

• The Committee of Bankers appointed by RBI under the Chairmanship of Sr. F.K.F. Nariman also endorsed this area approach.

• Under the scheme, the country was divided into 338 districts and mostly public sector banks to play he ‘Lead’ role in coordinating the efforts of all credit institutions in the district.

• The performance of the branches within the lead area are monitored by Block Level Bankers Committee at the block level, District consultative committee at the district level and State Level Bankers Committee at the state level.

Lead Bank Scheme

Returns submitted by the Lead Bank

• Lead Bank Return 1 (Service area credit plan): Details about annual credit plan of the branch.

• Lead Bank Return 2 (Service area operation scroll): Details about priority sector credit disbursement made each day during the month to Lead District Manager.

• Lead Bank Return U2 : Modified version of LBR2, submitted by semi urban/urban branches once in a quarter.

Returns submitted by the Lead Bank

• Lead Bank Return 3 (Service area recovery and outstanding statement): It is in 3 parts.– Part A: Deposit and Advance Position – to be

submitted on quarterly basis.– Part B: Outstanding under various Priority Sector

Advances – to be submitted on a half yearly basis.– Part C: State of Recovery of Priority Sector

Advances giving details of demand, collection and balances to be submitted on an annual basis.

Cooperative Banks• A co-operative bank is a financial entity which

belongs to its members, who are at the same time the owners and the customers of their bank.

• Co-operative banks are often created by persons belonging to the same local or professional community or sharing a common interest.

Differences Between Cooperative and Commercial BanksCommercial Banks Cooperative Banks

Registration Banking Regulation Act, 1949

The Co-operative Societies Act, 1904 of the concerned state.

Main ObjectiveTo accept deposits from public for the purpose of lending to industry and commerce.

To accept deposits from the members and the public for the purpose of providing loans to farmers and small businessmen with a motto of service.

Availability of Funds Massive funds Limited funds

Area of Operation Operate over a larger area Limited and mostly confined to

State.

Nationalisation Nationalised banks These are not nationalised banks.

Differences Between Cooperative and Commercial Banks

Commercial Banks Cooperative Banks

Merchant Banking Services

Provide merchant banking services such as advising the companies regarding the public issue of shares.

Do not provide merchant banking services.

Mutual Funds Do operate mutual funds Do not operate mutual funds.

Basis of operation

Operates on the commercial principles. They operate to earn a profit.

The basis of operations is on co-operative lines, i.e. service to its members and the society.

Rate of Interest

Provide a lesser rate of interest as compared to co-operative banks.

A little higher rate of interest on deposits as compared to commercial banks.

Some facts about Cooperative banks in India

• Some cooperative banks in India are more forward than many of the state and private sector banks.

• According to NAFCUB (National Federation of Urban Co-operative Banks & Credit Societies Ltd.) the total deposits & lending of Cooperative Banks in India is much more than Old Private Sector Banks & also the New Private Sector Banks.

• This exponential growth of Co operative Banks in India is attributed mainly to their much better local reach, personal interaction with customers, and their ability to catch the nerve of the local clientele.

Regional Rural Banks (RRBs)• RRB was introduced in India based on the

recommendations of Narasimham Committee.• Initially 5 RRBs were started in UP, Rajasthan,

Haryana, Bihar and West Bengal on 2nd October, 1975.

• Each RRB has a maximum authorized capital of Rs.5 cr.

• The shareholder-wise GoI/sponsor banks/State Governments proportion and amount is 50:35:15 and Rs.11 billion: Rs.8 billion: Rs.3 billion respectively in the financial year 2012.

• As on March 31, 2012, RRBs had a network of 16,914 branches.

• Under the agenda of financial inclusion, 73,000 villages that are not covered by any bank and have a population of 2,000 and above were to be covered by RRBs through ICT-enabled Business Correspondents by March 31, 2012.

Regional Rural Banks (RRBs)

National Bank for Agriculture and Rural Development

• NABARD is an apex development bank with an authorization for facilitating credit flow for promotion and development of agriculture, small-scale industries, cottage and village industries, handicrafts and other rural crafts.

• It also has the mandate to support all other allied economic activities in rural areas, promote integrated and sustainable rural development and secure prosperity of rural areas.

NABARD is entrusted with• Providing refinance to lending institutions in rural

areas

• Bringing about or promoting institutions development and Evaluating, monitoring and inspecting the client banks

• Act as a coordinator in the operations of rural credit institutions

• To help sectors of the economy that they have special credit needs for eg. Housing, small business and agricultural loans etc.

EXPORT-IMPORT (EXIM) BANK OF INDIA

• Export-Import Bank of India is the premier export finance institution of the country, set up in 1982 under the Export-Import Bank of India Act 1981.

• Government of India launched the institution with a mandate, not just to enhance exports from India, but to integrate the country’s foreign trade and investment with the overall economic growth.

• Since its inception, Exim Bank of India has been both a catalyst and a key player in the promotion of cross border trade and investment.

Role of the EXIM Bank• It is encouraging project exports from India.

• The Bank provides financial assistance by way of term loans in Indian rupees / foreign currencies for setting up new production facility, expansion / modernization / upgradation of existing facilities and for acquisition of production equipment/technology.

• Under its Export Marketing Finance programme, Exim Bank supports Small and Medium Enterprises in their export marketing efforts.

• The Bank has launched the Rural Initiative Programme with the objective of linking Indian rural industry to the global market.

• Programme for Research and development• It also offers consultancy services like

agreements between Indian companies and foreign companies for trading.

Role of the EXIM Bank

National Housing Bank (NHB)• The Sub-Group on Housing Finance for the Seventh Five Year Plan (1985-90)

identified the non-availability of long-term finance to individual households on any significant scale as a major gap obstructing progress of the housing sector and recommended the setting up of a national level institution.

• The Committee of Secretaries considered' the recommendation and set up the High Level Group under the Chairmanship of Dr. C. Rangarajan, the then Deputy Governor, RBI to examine the proposal and recommended the setting up of National Housing Bank as an autonomous housing finance institution. The recommendations of the High Level Group were accepted by the Government of India.

• NHB was set up on July 9, 1988 under the National Housing Bank Act, 1987.

• NHB is wholly owned by Reserve Bank of India, which contributed the entire paid-up capital.

• The Head Office of NHB is at New Delhi.

Objectives• To promote a sound, healthy, viable and cost effective housing

finance system to cater to all segments of the population and to integrate the housing finance system with the overall financial system.

• To promote a network of dedicated housing finance institutions to adequately serve various regions and different income groups.

• To augment resources for the sector and channelise them for housing.

• To make housing credit more affordable.

Objectives• To regulate the activities of housing finance companies based

on regulatory and supervisory authority derived under the Act.

• To encourage augmentation of supply of buildable land and also building materials for housing and to upgrade the housing stock in the country.

• To encourage public agencies to emerge as facilitators and suppliers of serviced land, for housing.

Housing and Urban Development Corporation Ltd. (HUDCO)

• It was incorporated on April 25, 1970 under the Companies Act 1956, as a fully owned enterprise of the Government of India.

• The establishment of HUDCO in 1970 as a sectoral institution for comprehensively dealing with the problems of growing housing shortages, rising number of slums and for fulfilling the pressing needs of the economically weaker section of the society was one of the significant steps in the series of initiatives taken by Government.

• Thus the setting up of HUDCO was aimed at accelerating the pace of construction and elimination of housing shortages and for orderly development of urban centres.

Housing Development Finance Corporation (HDFC)

• The Housing Development Finance Corporation Limited (HDFC) was amongst the first to receive an ‘in principle’ approval from the Reserve Bank of India (RBI) to set up a bank in the private sector, as part of RBI’s liberalisation of the Indian Banking Industry in 1994.

• The bank was incorporated in August 1994 in the name of ‘HDFC Bank Limited’, with its registered office in Mumbai, India.

• HDFC Bank commenced operations as a Scheduled Commercial Bank in January 1995.

• HDFC Bank is headquartered in Mumbai.

• As on March 31, 2013, the Bank has a network of 3062 branches in 1845 cities across India.

• The Bank also has a network of 10743 ATMs across India.

Industrial Development Bank of India (IDBI)

• It was established on 1-7-1964 as a wholly owned subsidiary of RBI.

• The Bank offers personalized banking and financial solutions to its clients in the retail and corporate banking arena through its large network of Branches and ATMs, spread across length and breadth of India.

• Headquarters: Mumbai

Industrial Development Bank of India (IDBI)

• Change of name of IDBI Ltd. to IDBI Bank Ltd.– The Bank truly reflects the functions it is carrying on, the

name of the Bank was changed to IDBI Bank Limited and the new name became effective from May 07, 2008.

• Merger of IDBI Bank Ltd. with IDBI Ltd. (The merger became effective from April 02, 2005.)

• Merger of United Western bank with IDBI Ltd. (The merger came into effect on October 03, 2006.)

Developmental Activities of IDBI• Promotional Activities– Support to science and technology– Energy conservation– Common quality testing Centers for small

industries, etc.• Technical Consultancy Organizations– Advisory and consultancy services

• Entrepreneurship Development Institute– Conducting studies or surveys of relevance to

industrial development.

Industrial Finance Corporation of India (IFCI) Ltd.

• At the time of independence in 1947, India's capital market was relatively under-developed.

• Although there was significant demand for new capital, there was a dearth of providers.

• Merchant bankers and underwriting firms were almost non-existent and commercial banks were not equipped to provide long-term industrial finance in any significant manner.

• It was established on July 1, 1948, as the first Development Financial Institution in the country to cater to the long-term finance needs of the industrial sector.

• IFCI should directly access the capital markets for its funds needs.

• It is with this objective that the constitution of IFCI was changed in 1993 from a statutory corporation to a company under the Indian Companies Act, 1956.

• Subsequently, the name of the company was also changed to "IFCI Limited" with effect from October 1999.

Industrial Finance Corporation of India (IFCI) Ltd.

Industrial Investment Bank of India• The Industrial Investment Bank of India is a 100% government

of India-owned financial investment institution.

• It was established in 1971 by resolution of the Parliament of India u/s 617 of the Companies Act.

• The bank was headquartered at Kolkata and has presence in New Delhi, Mumbai, Chennai, Bengaluru, Ahmedabad and Guwahati.

• The Industrial Reconstruction Corporation of India Ltd., set up in 1971 for rehabilitation of sick industrial companies, was reconstituted as Industrial Reconstruction Bank of India in 1985 under the IRBI Act, 1984.

Industrial Investment Bank of India• With a view to converting the institution into a full-fledged

development financial institution, IRBI was incorporated under the Companies Act 1956, as Industrial Investment Bank of India Ltd. (IIBI) in March 1997.

• IIBI offered a wide range of products and services, including term loan assistance for project finance, short duration non-project asset-backed financing, working capital/other short-term loans to companies, equity subscription, asset credit, equipment finance and investments in capital market and money market instruments.

Industrial Credit and Investment Corporation of India Bank

• ICICI was founded on 5th January 1955 as a public limited company with government supported and under the sponsorship of the world bank.

• ICICI established at the head quarters of the Bombay with a specific purpose of assisting the industries in private sector.

• It started its operations as a wholly privately owned institutions but with nationalisation of life insurance business.

• The LIC of India became its major share holder.

Objectives and functions of ICICI• Encouraging and promoting ownership: The corporation aim is to

encourage to come forward to establish industries and promote the private ownership.

• Underwriting issues of shares and Debentures: There is dynamo of getting shares to such fail companies it giving the underwriting commission to issue of shares and Debentures.

• Granting required loans in rupees repayable over a period of 15 years: Granting term loans to capital assets by purchase of land, machinery. If grants the money or cash to the companies.

• Making foreign currency for payments: Making similar forms of foreign currency for payments of imported capital equipment and technical service.– Furnishing technical and administrative assistance to industries– Expansion and modernisation of such enterprises.

Small Industries Development Bank of India

• Small Industries Development Bank of India (SIDBI), set up on April 2, 1990 under an Act of Indian Parliament, is the Principal Financial Institution for the Promotion, Financing and Development of the Micro, Small and Medium Enterprise (MSME) sector and for Co-ordination of the functions of the institutions engaged in similar activities.

Four basic objectives are set out in the SIDBI Charter

• Financing• Promotion• Development• Co-ordination

Infrastructure Development Finance Co. (IDFC)

• It was born out of the need for a specialized financial intermediary for infrastructure.

• Incorporated on January 30, 1997 in Chennai, and it was set up on the recommendations of the 'Expert Group on Commercialisation of Infrastructure Projects' under the Chairmanship of Dr. Rakesh Mohan.

Questions