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10

10

MONEY AND FINANCIAL INSTITUTIONS

In the previous chapter we learnt aboutmany sectors in the Indian economy andthe relative importance of each sector. Therise in the production of commodities invarious sectors led to the exchange ofgoods. In the previous class you alsolearnt about the 'barter system'. Find outthe main limitations of the barter systemand complete the following list.

• The difficulty to estimate the value ofcommodity

•

•

•

With the advent of money, we couldrectify almost all limitations of the bartersystem. Some of the examples givenbelow show how money performs itsfunctions.

• The seller gets money from the buyerwhen he sells the commodity . Hemakes use of that money to purchasegoods and services he requires.

• The value of goods and services canbe easily arrived at with the help ofmoney. Let us see an example. Whenwe say the price of rice is 26 per kg, itmeans that the value of rice is

expressed in terms of money.Accordingly, one can choose thecommodity.

• We keep a portion of our income forfuture needs. It can be stored in theform of money so that it can be used atany time.

In each of these contexts, money performsits functions in each situation. What arethose functions? Find out them throughdiscussions.

Functions of money•

•

•

When money is accepted as a medium ofexchange, economic activities becomesmooth. In the olden days those peoplewho could generate savings startedlending money to the needy. This led tothe emergence of local money lenders.When the number of borrowers increased,local money lenders started acceptingdeposits. Gradually, it became a financialinstitution. These institutions lend outmoney on the basis of certain criteria.What were the criteria they considered?

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10• Repayment capacity

• Reliability

Often, people found it difficult to get loandue to these criteria. Moreover, theseinstitutions were not functioning on thebasis of a common guidelines. Thishindered the easy availability of credit toall.

As the number of borrowers increasedmanifold, individuals themselves couldnot perform these operations. Thisnecessitated the setting up of morefinancial institutions. As a result, banksand other financial intermediaries came tostay.

See the flow chart showing the majorfinancial intermediaries.

Let us analyze each of them and its functions.

BanksBanks are those institutions which accept deposits from the public and lend out moneyto the borrower on certain conditions. They operate on the basis of common bye-lawand criteria. They act as an intermediary between borrowers and lenders. See thefollowing figure.

Depositors

Deposits are repaid alongwith interest

Acceptsdeposits

Repayment of loanwith interest

Loans aredisbursed

Institutions

People

Government

Institutions

People

Government

Borrowers

Insuranceorganizations

Mutual fundNon-banking

financial companies

Co-operativebanks

Commercialbanks

OtherDevelopment banks

Non-bankinginstitutions

Banks

Financial institutions

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10Based on the information given in thefigure, prepare a note on how banks act asa financial intermediary in the society.

With the transformation of local moneylenders into banks, the following changestook place in their economic functions:

• Economic functions becametransparent.

• People started getting more loans frombanks than from money lenders

• Fall in the interest rate and intensity ofexploitation

• Promoted saving habit of the people

• Loan availability led to the progress ofthe economy

Different types of banksIn each region, there are various banksperforming different functions. List thebanks in your region.

• •

• •

Though all types of banks performbasically the same functions, they aredifferentiated on the basis of certainactivities. On the basis of this, banks canbe categorized into different types. Eachof them is discussed below.

Commercial banks

This is the oldest form in the bankingsector. It follows branch banking systemin India. The banks which accept depositsand lend money for commercial purposesare called commercial banks. They lendout money for industrial and agricultural

purposes too. The lending of money issubject to certain conditions. These banksplay a decisive role in the economicactivities of a country.

Functions of commercial banks

Let us see the important functions of thesebanks:

1. Accepting deposits

The different types of deposits acceptedby commercial banks are given in the flowchart.

Saving deposits

It is a scheme for depositing surplusincome by individuals and institutions. Ithelps to promote saving habits of thepeople. Under this scheme, depositor canwithdraw money as and when he/shedesires. It offers low rates of interest.

Current deposits

Depositors can withdraw money from thisdeposit without any restriction at anytime.It does not offer any rate of interest.Normally, traders and industrialistsdeposit money in this scheme.

Fixed deposits

Fixed deposits are suitable for depositingmoney for a fixed period. It gives highrates of interest as compared to other

BankAcceptingdeposits

Savings deposits

Current deposits

fixed deposits

Recurring deposits

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10deposits. It can be normally withdrawnonly after the expiry of the period. Thehigher the period of deposit, the higherthe interest rate will be.

Recurring deposit

It is a variant of fixed deposit. Whenmoney is deposited at fixed intervals(daily, weekly, monthly) for a fixedperiod, it is called recurring deposit. Itcan be withdrawn only after the expiry ofthe period. It offers a rate of interest higherthan that of saving deposits.

2. Lending operations

Another function of commercial banks isto lend money for different purposes.They lend out money for trade, industry,agriculture, house construction, purchaseof vehicle, etc. on the basis of collateralsecurities. Which are the collaterals banksnormally accept?

• Physical assets

• Gold

• Title deed of the property

• Salary certificate

• Fixed deposit certificate

•

•

On the basis of these, commercial banksgive the following types of loans:

• Cash credit

• Loans

• Overdraft

Cash credit is given to individuals andinstitutions on the basis of collateralsecurities. Normally, it is given forcommercial and industrial purposes.Accepting trade related assets ascollaterals, banks provide cash credit totraders.

The liability created by individuals andinstitutions is called loans. Generally,loans which are given for a period of lessthan 18 months are called short term loans,and if it is for more than 18 months it isknown as long term loans.

Overdraft is the facility given topermanent and reliable customers towithdraw money over and above the creditbalance. This facility is provided to thosewho have current account deposit. Inorder to avail himself of this facility thecustomer has to make an agreement withthe banker.

See the following example:

A person, who has a credit balance of 10,000 in his account, is in need of 12,000. When he approaches the bank

he is permitted to withdraw 12,000. Theexcess money withdrawn over and abovethe credit balance is the overdraft. Thebank will charge interest for the excessamount withdrawn. For utilising thisfacility, prior agreement with the bank isrequired.

Other services

Apart from basic functions like acceptingdeposits and lending money, banksrender certain other services to theircustomers. The following is a boardcommonly seen in front of banks.

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10• Consumers can purchase goods with

the help of credit card. With the helpof ATM card, customers can purchasegoods without carrying money alongwith them.

• Banks act as an agent by helping thecustomers to remit their insurancepremium, telephone bills and topurchase travel tickets.

Growth of commercial banks in IndiaIndian banking system began with theestablishment of General Bank of India in1786. British East India company set up 3presidency banks in Bengal, Madras andBombay. In 1920, Imperial Bank of Indiawas started by merging three presidencybanks. After this, a number of banks wereestablished. As per the Reserve Bank ofIndia Act 1934, we set up the Reserve Bankof India in 1935. In 1949 India Governmentimplemented the Banking Regulation Actwith the intention of regulatingcommercial banks. Consequently RBIbecame the apex bank of all banks.

State Bank of India (SBI)

In 1955 ImperialBank was national-ized into StateBank of India.State Bank is theagent for all trans-actions betweenReserve Bank andboth central and state governments. SBIprovides financial help to agricultural sec-tor and small scale industry by openingbranches in different parts of the country.SBI is the largest commercial bank in In-dia.

These are the services rendered by banksto the public. The bank charges a fixedamount as commission or levies servicecharge for these activities. Let us see eachof these functions.

• Banks offer locker facilities to keepcostly articles (gold, diamond, etc.) oftheir customers.

• Money transfer is a system wherebymoney can be transferred from a placeto any other place in the world.Without any delay money can be sentto the needy with the help of moneytransfer.

• Automated Teller Machine [ATM]helps the customers to withdrawmoney without stepping into thebanks. You may remember thefacilities of ATM you studied in the

$ Locker

$ Money Transfer

$ ATM

$ e-payment

previous class. Find out theirpeculiarities from the ATM card.

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10After Independence the growth ofcommercial banks was rapid. The reasonsfor this are:

• Need of money due to plannedeconomic growth.

• Trust and interest of the public inbanking sectors.

• Formation of State Bank of India andits associate banks

• Nationalization of banks

• Expansion of banking network.

Nationalization of BanksBanking was earlier a private affair. Withthe domination of the objective of socialwelfare, nationalization was done by theGovernment.

Smt. Indira Gandhi, the then PrimeMinister, nationalized 14 banks withassets worth more than 50 crore on 19July 1969. What were the reasons behindthe bank nationalization?

• Centralization of financial helpprovided by banks, to big industrialistsand rich people in the society

• The economic crisis that led to theclosure of many small scale industriesand depression in the agriculturesector

• The awareness that banks shouldoperate with the objective of socialwelfare

• Neglect of agriculture and ruraleconomy

The growth of commercial banks afternationalization was praiseworthy. On 15April, 1980, six more banks werenationalized. The names of the banks

nationalized in two phases are givenbelow:

Nationalized banks• Central Bank of India

• Bank of India

• Punjab National Bank

• Bank of Baroda

• United Commercial Bank

• Canara Bank

• Dena Bank

• Syndicate Bank

• Union Bank of India

• Allahabad Bank of India

• Indian Overseas Bank

• Bank of Maharashtra

• Indian Bank

• Vijaya Bank

• Corporation Bank

• Andhra Bank

• Oriental Bank of Commerce

• Punjab and Sindh Bank

• United Bank of India

Now there are only 19 nationalised banksas New Bank of India has been mergedwith Punjab National Bank.

Apart from the nationalized banks, thereare banks in the private sector too. Someof the private banks which haveheadquarters in Kerala are:

• Federal Bank• South Indian Bank• Catholic Syrian Bank• Dhanalakshmi Bank

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10Which are the banks in your regioncoming under the category ofcommercial banks? Please list.

Cooperative bankWith the aim of extending financial helpto farmers, handicrafts men, small scaleindustrialists, etc. cooperative banks wereset up. Other objectives of cooperativebanks are:

• To promote saving habits among therural folk.

• To develop an attitude towards selfhelp and mutual help

• To promote rural investment

• To give emphasis to social progress

Co-operative banks have been functioningin India for more than a century.

The structure of cooperative banks is givenbelow.

Apart from serving the basic functions,cooperative banks operate on the basis of

principles like cooperation, self help,mutual help, etc. Co-operative banks,which have been set up for ruraldevelopment, provide loans to differentsectors. They are:

• Agricultural sector

• Cattle farming

• Dairy development

• Fishing

• Personal loans, etc

Nowadays cooperative banks concentratenot only on rural development but alsoon lending money for urban development.The latter category is known as 'UrbanCooperative Banks'. They lend money forthe following:

• Self employment units

• Industrial units

• Consumer loans

• Personal loans

National Bank for Agriculture andRural Development-NABARD

NABARD is the apex bank operating foragricultural and rural development.NABARD, under the control of theCentral Government, coordinates allbanks working for rural development.

Visit a cooperative bank in your region

and prepare a note on its functioning.

New Generation BanksThe banks which are given license after1991 are called New Generation Banks.The salient features of these banks are thefollowing:

State Co-operativeBank

District Co-operativeBanks

Primary Co-operativeBanks

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10• They operate with modern technology

• They are concentrated in towns andcities.

• Most of them are in the private sector.

• They operate with the newmanagement strategy.

List the important new generation banks.

Development banksIn addition to commercial banks andcooperative banks, certain other banks arealso functioning. Among these, the mostimportant one is Development Bank. Theylend long term credit for agricultural,industrial and commercial purposes.Land development banks, aiming atagricultural development, come underthis category. Likewise, IndustrialDevelopment Bank of India (IDBI) aimingat industrial development, also belongsto this category. Others are: IndustrialFinance Corporation of India (IFCI),National Agricultural and RuralDevelopment (NABARD), etc.

Non-Banking Financial Institutions(NDFI)The institutions which operate in thefinancial sector but not rendering bankingservices are called NBFI. They operate bymobilizing money from the public indifferent ways. Important ones amongthem are discussed below.

Non-Banking Financial Companies(NBFC)These institutions perform the basicfunctions of a bank like accepting deposits

and lending money. But they do notprovide the following services:

• Withdrawal of money using cheques.

• Issue of demand draft.

They are operating with the licence issuedby the RBI. They provide the followingservices to the public:

• Gold loan

• Housing loan

• Hire purchase

• Chitties

Kerala State Financial Enterprises (KSFE)is a non - banking financial company inthe public sector. They operate chitties,accept deposits, and lend money.

Prepare a note on KSFE in your regionafter visiting it.

Mutual FundCommon man and retail investors finddifficulty in investing the money in sharemarket. There are a number of constraintsfor them to invest in other assets. What arethese constraints?

• Ignorance about the share market andother assets (See share, and sharemarket given in chapter (11))

• Difficulty to undertake risk

•

Mutual fund helps these investors toovercome these constraints. It is a systemby which money is mobilized from suchinvestors for investing in shares and otherassets like debentures, real estate,

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10infrastructure, gold, etc. The profit or lossresulting from this is distributed amongthem. Mutual Fund Institutions operateboth in private and public sectors. Someexamples:

• Unit Trust of India

• LIC Mutual Fund

• SBI Mutual Fund

Insurance Institutions

These institutions provide security to lifeand property. Life Insurance Corporation(LIC) is a public sector organizationworking in this field. LIC offers differenttypes of insurance policies so as to protectthe life of individuals.

Certain Insurance Policies• Health Insurance policy

• Accident insurance policy

• Property and asset insurance policy

Collect more information from localpersons working in the LIC.

There are many private insurancecompanies operating in this sector. Thereare also public and private insurancecompanies giving insurance to motorvehicles.

Important public sectorinsurance companies

• United Insurance Company• National Insurance Company• Oriental Insurance Company• New India Assurance Company

Micro Finance

The objective of micro finance is to extendfinancial services to low income groups.It helps to promote saving habits and selfemployment activities among the poor.This mechanism helps members to availthemselves of loans without providingany collaterals.

See the success story given in the box.

Bangladesh Grameen BankBangladesh has a trackrecord of giving loans atvery low rate of interest tobackward categories.

The founder of thisinstitution is Prof. Mohammed Yunus, theNobel Laureate for peace in the year2006. It was established in 1970 as a smallorganization. It is now extended to 40,000villages and 60 lakh people. Poor womenearn income and improve the status bysetting up enterprises with the loanprovided by the Bank.

You have now understood the role ofGrameen Bank in Bangladesh inpromoting the standard of living of the

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10rural folk. There are similar instances inIndia. Kudumbasree in Kerala, self helpgroup for men, etc. are some examples.

Women or men in a region form smallgroups. Then they mobilize a fixed sumfrom each member and lend it out tomembers. Thus self help groups (SHGs)get loan at low rate of interest. With theassistance of local bodies, SHGs runproductive small enterprises. What aresuch activities?

SHG is a relief for the rural people whodepend on money lenders who chargeexorbitant rate of interest.

Private financial institutions

These institutions which are run by privateindividuals through mobilizing capital arecalled private financial institutions.Government has little control over theseinstitutions. Though they are undertakingbanking services, customers are exploitedheavily.

The list of banks you preparedearlier can be classified as shownin the following table.

New trends in banking sector

Today, banking sector is witnessingdrastic changes. The changes are inaccordance with the policy change in thebanking sector. Though they perform thebasic functions, they undertake differentinnovative activities in order to attract thecustomers. Some of them can bediscussed.

Commercial Banks Co-operative Private FinancialBanks InstitutionsPublic Sector Private Sector

• Pickles, food processing units

• Hotels

• DTP centres

•

•

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10Electronic bankingElectronic banking is a system of helpingthe customers without the support ofemployees and banking instruments. Itcarries out transactions with the help ofInternet. Following are its main features .

• Customers can send money anywherein the world and remit the billswithout stepping into the bank.

• Banking activities can be completedwithin a short time.

• Not expensive

Core bankingCentralized Online Real Time Electronic(CORE) banking system allows a branchto provide services to customers of anybranch of the same bank throughinterconnecting bank branches. It operateswith the help of Internet. A customer whoborrows money from a bank branch atThiruvananthapuram can repay the loaninstallment with the Ernakulam branchthrough this system. Customers can savemuch time through this system, avoidingcumbersome procedures at the counter.

Reserve Bank of India (RBI)Every country has a central bank. In a

country central bank isthe apex institution ofmonetary system.Issue of currencynotes, control of credit,liquidity control, etc.are the functions of

central bank. It is the duty of central bankto control the volume of money. The RBIis the central bank of India. Itsheadquarters is in Mumbai.

The figure showing the functions of theReserve Bank is given below:

1. Issue of currency notes

In India, Reserve Bank has the legal rightto issue all currency notes except onerupee note and subsidiary coins. TheFinance Ministry is authorised to issue onerupee note and subsidiary coins. TheReserve Bank issues notes subject tocertain conditions. Indian rupee acquiredan international symbol ( ) in 2010.

In 2010, a symbol for Indian rupee cameinto existence. Now India joins thecountries who have a symbol for theircurrency. As a result

• Indian rupee can be differentiated fromother rupee currency

• Using symbol is simple and convenient

• Indian rupee symbol has becomefamous along with the symbol of othercountries.

ReserveBank

Bankers’ bankAgent and adviserof Government

Issue of currencynotes

Controller ofcredit

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102. Agent and adviser of the government

The second important function of theReserve Bank is to act as the agent andadviser of the government. The ReserveBank gives advice to the government onmoney related matters.

3. Controller of Credit

The Reserve Bank of India controls themoney supply and credit to maintainstability in the economy.

InflationThe continuous rise in the price of goodsand services is called inflation. Increasein money supply, fall in production etc arethe reasons for inflation. The RBI triesto control inflation by regulating themoney supply.

4. Bankers’ Bank

Reserve Bank acts as bankers’ bank. Itregulates commercial banks and helpsthem in emergency. Hence the RBI iscalled bankers’ bank.

The role of banks is vital for the economicgrowth of a country. The timelyinterventions of the RBI strengthen theIndian banking sector and thereby therapid progress of the country.

Follow up activities

• Explain the factors that led to the formation of banks, saving the public fromlocal money lenders.

• Which are the banks we see around us? Distinguish their functions.

• What are the other services, of banks in addition to the basic functions?

• Micro finance is beneficial for rural development. Substantiate it.

• Explain e-banking and core banking as new trends in the banking sector.

• Indian rupee got international recognition in 2010. How?

• Mark the symbol of the currencies of various countries in a map.