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MANAGEMENT OF FINANCIAL SERVICES (S3 MBA)
Study Materials - UNIT II
Prepared by Prof. P. Madhusoodanan Pillai
The Syllabus
Regulatory and supervisory frame work Role of RBI, SEBI, and Ministry of
Finance, Govt. of India finance bill and financial services supervision and
regulation of banking companies in India Regulatory/ Institutional/ and
Environmental constraints.
I. BAKING IN INDIA
Introduction
In the earlier societies functions of a bank were done by the correspondinginstitutions dealing with loans and advances. Britishers brought into India the modernconcept of banking by the start of Bank of England in 1694. In 1708, the bank ofEngland was given the monopoly for the issue of currency notes by an Act. Innineteenth century various banks started operations, which primarily were receiving
money on deposits, lending money, transferring money from one place to anotherand bill discounting.
Without a sound and effective banking system in India it cannot have a healthyeconomy. The banking system of India should not only be hassle free but it shouldbe able to meet new challenges posed by the technology and any other external andinternal factors.
For the past three decades India's banking system has several outstandingachievements to its credit. The most striking is its extensive reach. It is no longerconfined to only metropolitans or cosmopolitans in India. In fact, Indian banking
system has reached even to the remote corners of the country. This is one of themain reason of India's growth process.
The government's regular policy for Indian bank since 1969 has paid rich dividendswith the nationalisation of 14 major private banks of India. Not long ago, an accountholder had to wait for hours at the bank counters for getting a draft or for withdrawinghis own money. Today, he has a choice. Gone are days when the most efficientbank transferred money from one branch to other in two days. Now it is simple asinstant messaging or dial a pizza. Money have become the order of the day.
The first bank in India, though conservative, was established in 1786. From 1786 till
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today, the journey of Indian Banking System can be segregated into three distinctphases. They are as mentioned below:
Early phase from 1786 to 1969 of Indian Banks Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector
Reforms. New phase of Indian Banking System with the advent of Indian Financial &
Banking Sector Reforms after 1991.
To make this write-up more explanatory, I prefix the scenario as Phase I, Phase IIand Phase III.
Phase I The General Bank of India was set up in the year 1786. Next came Bank ofHindustan and Bengal Bank. The East India Company established Bank of Bengal(1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units
and called it Presidency Banks. These three banks were amalgamated in 1920 andImperial Bank of India was established which started as private shareholders banks,mostly Europeans shareholders.
In 1865 Allahabad Bank was established and first time exclusively by Indians,Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank,Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.
During the first phase the growth was very slow and banks also experienced periodicfailures between 1913 and 1948. There were approximately 1100 banks, mostlysmall. To streamline the functioning and activities of commercial banks, theGovernment of India came up with The Banking Companies Act, 1949 which waslater changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No.23 of 1965). Reserve Bank of India was vested with extensive powers for thesupervision of banking in India as the Central Banking Authority.
During those days public has lesser confidence in the banks. As an aftermathdeposit mobilisation was slow. Abreast of it the savings bank facility provided by thePostal department was comparatively safer. Moreover, funds were largely given totraders.
Phase II
Government took major steps in this Indian Banking Sector Reform afterindependence. In 1955, it nationalised Imperial Bank of India with extensive bankingfacilities on a large scale specially in rural and semi-urban areas. It formed StateBank of india to act as the principal agent of RBI and to handle banking transactionsof the Union and State Governments all over the country.
Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on19th July, 1969, major process of nationalisation was carried out. It was the effort of
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the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks inthe country was nationalised.
Second phase of nationalisation Indian Banking Sector Reform was carried out in1980 with seven more banks. This step brought 80% of the banking segment in India
under Government ownership.
The following are the steps taken by the Government of India to Regulate BankingInstitutions in the Country:
1949 : Enactment of Banking Regulation Act. 1955 : Nationalisation of State Bank of India. 1959 : Nationalisation of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalisation of 14 major banks.
1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalisation of seven banks with deposits over 200 crore.
After the nationalisation of banks, the branches of the public sector bank India rose
to approximately 800% in deposits and advances took a huge jump by 11,000%.
Banking in the sunshine of Government ownership gave the public implicit faith and
immense confidence about the sustainability of these institutions.
Phase III
This phase has introduced many more products and facilities in the banking sector in
its reforms measure. In 1991, under the chairmanship of M Narasimham, a
committee was set up by his name which worked for the liberalisation of banking
practices.
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 is
introduced. The entire system became more convenient and swift. Time is given
more importance than money.
The financial system of India has shown a great deal of resilience. It is sheltered
from any crisis triggered by any external macroeconomics shock as other East Asian
Countries suffered. This is all due to a flexible exchange rate regime, the foreign
reserves are high, the capital account is not yet fully convertible, and banks and their
customers have limited foreign exchange exposure.
Why Banking Sector Reforms needed in India?
1. High Regulated Sector
2. Prevalence of High Reserve Requirements
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3. Interest Rate Controls
4. Large Allocations to Priority Sector
5. Poor Lending Strategies
6. Lack of Internal Risk Management
7. Low Yields on Government Securities
8. Waiver of Loans on Political Grounds
9. Lack of Competition
10.High Cost of Operations
11.Poor Customer Service
12.Poor Loan Recovery
13.Weak Capital Position
14.Political Interference
15.Lack of Institutional Autonomy
16.Lack of Accountability in Banks
17.Vague Reporting Formats
18.Technology Deficiency
Recent History of Indian Banking
Indian banking system, over the years has gone through various phases after
establishment of Reserve Bank of India in 1935 during the British rule, to function as
Central Bank of the country. Earlier to creation of RBI, the central bank functions
were being looked after by the Imperial Bank of India. With the 5-year plan having
acquired an important place after the independence, the Govt. felt that the private
banks may not extend the kind of cooperation in providing credit support, theeconomy may need. In 1954 the All India Rural Credit Survey Committee submitted
its report recommending creation of a strong, integrated, State-sponsored, State-
partnered commercial banking institution with an effective machinery of branches
spread all over the country. The recommendations of this committee led to
establishment of first Public Sector Bank in the name of State Bank of India on July
01, 1955 by acquiring the substantial part of share capital by RBI, of the then
Imperial Bank of India. Similarly during 1956-59, as a result of re-organisation of
princely States, the associate banks came into fold of public sector banking.
Another evaluation of the banking in India was undertaken during 1966 as the privatebanks were still not extending the required support in the form of credit disbursal,
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into State Bank of India in 1955 and nationalisation of 14 major private banks during
1969.
Expansion phase had begun in mid-60s but gained momentum after nationalisation
of banks and continued till 1984. A determined effort was made to make banking
facilities available to the masses. Branch network of the banks was widened at avery fast pace covering the rural and semi-urban population, which had no access to
banking hitherto. Most importantly, credit flows were guided towards the priority
sectors. However this weakened the lines of supervision and affected the quality of
assets of banks and pressurized their profitability and brought competitive efficiency
of the system at a low ebb.
Consolidation phase: The phase started in 1985 when a series of policy initiatives
were taken by RBI which saw marked slowdown in the branch expansion. Attention
was paid to improving house-keeping, customer service, credit management, staff
productivity and profitability of banks. Measures were also taken to reduce thestructural constraints that obstructed the growth of money market.
Reforms phase The macro-economic crisis faced by the country in 1991 paved the
way for extensive financial sector reforms which brought deregulation of interest
rates, more competition, technological changes, prudential guidelines on asset
classification and income recognition, capital adequacy, autonomy packages etc.
Bank Nationalisation & Public Sector Banking
Organised banking in India is more than two centuries old. Till 1935 all the banks
were in private sector and were set up by individuals and/or industrial houses which
collected deposits from individuals and used them for their own purposes. In the
absence of any regulatory framework, these private owners of banks were at liberty
to use the funds in any manner, they deemed appropriate and resultantly, the bank
failures were frequent.
Move towards State ownership of banks started with the nationalisation of RBI and
passing of Banking Companies Act 1949. On the recommendations of All India Rural
Credit Survey Committee, SBI Act was enacted in 1955 and Imperial Bank of India
was transferred to SBI. Similarly, the conversion of 8 State-owned banks (State Bank
of Bikaner and State Bank of Jaipur were two separate banks earlier and merged)
into subsidiaries (now associates) of SBI during 1959 took place. During 1968 the
scheme of social control was introduced, which was closely followed by
nationalisation of 14 major banks in 1969 and another six in 1980.
Keeping in view the objectives of nationalisation, PSBs undertook expansion of
reach and services. Resultantly the number of branches increased 7 fold (from 8321
to more than 60000 out of which 58% in rural areas) and no. of people served per
branch office came down from 65000 in 1969 to 10000. Much of this expansion has
taken place in rural and semi-urban areas. The expansion is significant in terms of
geographical distribution. States neglected by private banks before 1969 have a vast
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network of public sector banks. The PSBs including RRBs, account for 93% of bank
offices and 87% of banking system deposits.
II. REFORMS IN BANKING SUPERVISION IN INDIA
The Basel Committee on Banking Supervision, which is a committee of bankingsupervisory authorities of G-10 countries, has been in the forefront of theinternational attempt in the development of standards and the establishment of aframework for bank supervision towards strengthening international financial stability.In 1997, in consultation with the supervisory authorities of a few non G-10 countriesincluding India, it drew up the 25 Core Principles for Effective Banking Supervisionwhich were in the nature of minimum requirements intended to guide supervisoryauthorities which were seeking to strengthen their current supervisory regime.Being one of the central banks which was involved in the exercise of drawing up the
Core Principles, the Reserve Bank of India had assessed its own position withrespect to these Principles in 1998. The assessment had shown that most of theCore Principles were already enshrined in our existing legislation or currentregulations. Gaps had been identified between existing practice and principle mainlyin the areas of risk management in banks, inter-agency cooperation with otherdomestic/international regulators and consolidated supervision. Internal workinggroups were set up to suggest measures to bridge these gaps and theirrecommendations have been accepted by the Board for Financial Supervision andare now in the process of being implemented.Given the spread and reach of the Indian banking system, with over 60,000branches of more than 100 banks, implementation is a challenge for the supervisors.
However, the Reserve Bank of India is committed to the full implementation of theCore Principles. The Bank also serves on the Core Principles Liaison Group of theBCBS, which has been formed to promote the timely and complete implementationof these principles worldwide. It gives me great pleasure to release this documentwhich is intended to provide the reader with a framework within which one can viewthe developments in the Indian Banking System in a proper perspective. Thedocument reflects the position as existing on date and will be updated to reflectfuture changes. As supervision is a dynamic process, readers may refer to theReserve Bank of India for the latest position or for any clarifications.
Core Principles for Banking Supervision- Status in India
Section I: Preconditions for Effective Banking Supervision
Principle I: Framework and Coordination
An effective system of banking supervision will have clear responsibilities andobjectives for each agency involved in the supervision of banks. Each such agencyshould possess operational independence and adequate resources. A suitable legalframework for banking supervision is also necessary including provisions relating toauthorisation of banking establishments and their ongoing supervision; powers toaddress compliance with laws as well as safety and soundness concerns; and legal
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protection for supervisors. Arrangements for sharing information betweensupervisors and protection for confidentiality of such information should be in place.
1.1 The Reserve Bank of India (RBI), an autonomous body created under an act ofthe Indian parliament i.e. The Reserve Bank of India Act, 1934, is entrusted,
interalia, with the sole responsibility of regulation and supervision of banks under theBanking Regulation Act, 1949. Section 35 of the Banking Regulation Act vestspowers in RBI for inspection of books of any banking company at any time.
1.2 Both the regulatory and supervisory functions of RBI were earlier carried outthrough its Department of Banking Operations and Development (DBOD) tillDecember 1993, when a separate department entitled Department of Supervision(DOS) was formed to take over the supervisory function, leaving regulatory functionsto DBOD. In November 1994, RBI constituted the Board for Financial Supervision(BFS) under RBI (BFS) Regulations 1994 to give undivided attention to theprudential supervision and regulation of banks, financial institutions and non-bank
financial institutions in an integrated manner. DBOD continues to perform theregulatory function pertaining to banks.
However, DOS has since been bifurcated into Department of Banking Supervision(DBS) and Department of Non-Banking Supervision (DNBS). DBS is responsible forthe supervision of commercial banks and their merchant banking subsidiaries. Bothregulation and supervision of the development financial institutions (DFIs) arehandled by the Financial Institutions Division (FID) of the DBS.
1.3 DNBS is responsible for supervision and regulation of Non-banking FinancialCompanies (NBFCs). No NBFC can commence or carry on the business of anonbanking financial institution without obtaining a certificate of registration fromRBI. The NBFC with net owned funds of Rs.2.5 million and above (since enhancedto Rs.20 million effective from 20 April 1999) are mandatorily required to beregistered with RBI. Maintenance of liquid assets at a specified percentage of publicdeposits is compulsory. RBI is empowered to give directions to NBFCs and can evenprohibit NBFCs which do not adhere to a set of prudential norms from acceptingdeposits and impose penalties under the provisions of the RBI Act. A system of on-site examination based on CAMELS rating model and off-site surveillance of variousstatutory returns of NBFCs is in place. Besides, special formats for off-sitesurveillance of NBFCs with asset size of Rs.1 billion and above have been devised.
1.4 The BFS has been constituted under the aegis of RBI. It is an autonomous bodyand directs the policies and operations relating to supervision of banks, DFIs andNBFCs. The Governor of the Reserve Bank is the Chairman of the BFS while theDeputy Governor in charge of supervision is the Vice-chairman. The other twoDeputy Governors of the Bank, together with four non-official directors from theCentral Board of the Bank, are the members of the BFS. Since its formation inNovember 1994, the BFS, which meets every month, has positioned a new strategyfor on-site supervision of banks and a system of off-site monitoring, based onquarterly reporting system.
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1.5 RBI has been given broad powers under Section 35A of the Banking RegulationAct to issue directions to banking companies in general or to any banking companyin particular, if it is satisfied that these are required
a) in the public interest; or
b) in the interest of banking policy; orc) to prevent the affairs of any banking company being conducted in a mannerdetrimental to the interests of the depositors or in a manner prejudicial to theinterests of the banking company; ord) to secure the proper management of any banking company generally.
1.6 The Central Government, after consultation with RBI, may acquire oramalgamate or reconstitute a banking company, which is being managed in amanner detrimental to the interest of its depositors or which has failed to comply withdirections issued by RBI under the Banking Regulation Act. The RBI has powers toapply for winding up of a banking company that is unable to meet its commitments
and / or its continuation is prejudicial to the interest of its depositors. The RBI canintervene in the banks management if directors / management are not found to befit and proper in the course of operation. The RBI can cancel the licence of abanking company provided the conditions stated in Section 22(3) of the BankingRegulation Act are not fulfilled.
1.7 Section 7 of the RBI Act provides for operational independence to RBI while atthe same time reserving the Central Governments right to issue directions to RBIfrom time to time in public interest. The management of RBI rests with the CentralBoard of Directors. The RBI is headed by the Governor who is appointed by theCentral Government for a term not exceeding five years and is eligible forreappointment.
1.8 An annual report on the working of RBI with detailed analysis of its annualaccounts and an assessment of the Indian economy is submitted to the CentralGovernment under Section 53(2) of the RBI Act. The RBI compiles two financialstatements viz. Weekly statement of its affairs and annual balance sheet as at 30June of each year in terms of Section 53 of the RBI Act, 1934 and transmits these tothe Central Government. The Central Government publishes these statements in theGazette of India. The RBI publishes fortnightly a consolidated statement containingaggregate liabilities and assets of all the scheduled commercial banks as per Section
43 of the RBI Act. The RBI brings out certain publications at regular intervals on thefinancial strength and performance of banking industry and state of economy. Thepublications include Banking Statistics, Report on Currency and Finance, Report onTrends and Progress of Banking in India (Section 36(2) of the Banking RegulationAct), Credit Information Review, and monthly RBI bulletin containing statistics onselective economic and banking indicators and weekly statistical supplements.
1.9 The RBI equips its officers with latest techniques of supervision through ongoingtraining programmes organised at its own staff colleges viz. Reserve Bank StaffCollege, Chennai; College of Agricultural Banking, Pune; Bankers Training College,Mumbai; and Institute for Development and Research of Banking Technology,
Hyderabad. Besides, the RBI regularly deputes its officers to training programmes,seminars and conferences conducted by international bodies, Central Banks of other
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countries and international organisations like Bank for International Settlements andthe International Financial Institutions.
1.10 On-going analysis of off-site returns is carried out in a computerisedenvironment. The RBI has initiated steps to move from Local Area Networking (LAN)
to Wide Area Networking (WAN) with a view to connect its Regional Offices andcommercial banks through VSAT based connectivity by December 2000.
1.11 The banking laws are reviewed and updated from time to time considering thechanging needs of the banking industry and economy. The Banking Regulation Actwas last amended in 1994. An expert committee set up in February 1999 on therecommendations of the Committee on Banking Sector Reforms is engaged in thetask of examining various banking laws and all relevant banking related legislations.The committee is expected to submit its recommendations by December, 1999.
1.12 The RBI has the necessary powers to issue licence to a company for carrying
on the business of banking. The RBI is vested with powers to issue guidelines onany issue relating to functioning of banks. This helps the Bank in laying downprudential guidelines for sound management of banks. It has issued severalmandatory guidelines on liquidity maintenance, capital adequacy, incomerecognition, asset classification and provisioning, connected lending and prudentialnorms on large exposures. The Banking Regulation Act vests powers in RBI toensure compliance with its provisions. Noncompliance with mandatory guidelinescan invite monetary and / or non-monetary penalties.
1.13 The Banking Regulation Act provides for explicit protection to the supervisorsunder Section 54. No suit or other legal proceeding shall lie against RBI or any of itsofficers for anything or any damage caused or likely to be caused by anything donein good faith or intended to be done in pursuance of the Banking Regulation Act.
1.14 RBI shares relevant information with overseas supervisors on request.Information from overseas supervisors is received with the understanding that thiswould remain confidential. Information needs of domestic regulatory bodies likeSecurities and Exchange Board of India (SEBI), National Bank for Agricultural andRural Development (NABARD), National Housing Bank (NHB), etc, are attended toon mutual understanding. A High level Committee on Capital Markets consisting ofGovernor of RBI, Chairman of SEBI and Economic Affairs Secretary of the Central
Government, serves as a forum for discussing common regulatory issues.
III. THE BANKING REGULATION ACT IN 1949
Banking Legislation Act Aims At
1. Protecting Interest Of Depositors
2. Ensuring Control Over Credit
3. Streamlining Procedures
4. Evolving Uniform Banking Practices
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5. Developing Banking On Sound Lines
Main Provisions Of Act
1. Built In Safeguards
2. Powers And Consequential Functions And Responsibilities Of Rbi.
3. Section 5 B Defines Business Of Banking As Accepting, For The
Purpose Of Lending Or Investment, Deposits Of Money From The
Public, Repayable On Demand Or Otherwise And Withdraw able By
Cheques, Drafts Or Otherwise.
IV.METHODS OF ONGOING BANKING SUPERVISION OFBANKING COMPANIES IN INDIA
Principle XVI: Instruments of Supervision
An effective banking supervisory system should consist of some form of both on-siteand off-site supervision.
The main instrument of supervision in India is the periodical on-site inspection ofbanks that is supplemented by off-site monitoring and surveillance. Since 1995, on-site inspections are based on CAMELS (Capital Adequacy, Asset Quality,Management, Earning, Liquidity and Systems & Controls) model and aim atachieving the following objectives:
i) Evaluation of banks safety and soundness,ii) Appraisal of the quality of Board and top management,iii) Ensuring compliance with prudential regulations,iv) Identifying the areas where corrective action is required to strengthen the bankv) Appraisal of soundness of banks assets,vi) Analysis of key financial factors such as capital, earnings, and liquidity anddetermine banks solvency,vii) Assessment of the quality of its management team and evaluation of the bankspolicies, systems of management, internal operations and control, andviii) Review of compliance with banking laws and regulations as well as supervisoryguidance conveyed on specific policies.
To ensure continuity in supervision, RBI also undertakes targeted appraisals ofspecific portfolios at control site, commissioned audits of specific areas by externalauditors and monitoring visits for follow-up or review of selected areas of concern.
RBI is gradually moving towards a risk-based supervisory framework that is basedon both off-site and on-site inputs. Pursuant to the new supervision strategyapproved by the BFS, the RBI has introduced a formal Supervisory ReportingSystem. The reporting is essentially prudential in content and tri-monthly in
periodicity. The total package of Supervisory Returns for commercial banks(designated DSB Returns) comprises 12 Reports (9 to be filed at Quarterly intervals,
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2 at half-yearly intervals and 1 at yearly interval). Analysis of the returns is done forindividual bank, peer group and industry as a whole. These analysis help in detectingearly warning signals.
Principle XVII: Supervisory Contact
Banking supervisors must have regular contact with bank management and thoroughunderstanding of the institutions operations.
17.1 The contact between supervisors and banks is almost continuous. Seniorexecutives at Regional office of RBI meet the bank management if serioussupervisory issues crop up. Senior Executives at Central Office of RBI meet annuallytop management of banks to discuss matters of supervisory concerns identifiedduring on-site inspection. The overall CAMELS rating is communicated to the bankmanagement. Supervisory concerns emanating out of off-site supervision are alsocommunicated to banks on an ongoing basis.
17.2 Meetings are also held with banks for various purposes like discussions onResource
Management. Banks are often consulted before introduction of major reportingchanges and senior bank officers are often associated with the working groups andcommittees setup by the RBI to examine / deliberate on regulatory / supervisoryissues. RBI Nominee Directors on the Boards of banks are also required to reportbimonthly on the important policy decisions taken by the bank in particularhighlighting supervisory issues, if any.
Principle XX: Consolidated Supervision
An essential element of bank supervision is the capability of the supervisors tosupervisethe banking group on a consolidated basis.
The on-site inspection reports of the banks include comments on earningperformance of the banks subsidiaries and joint ventures. In addition, the RBIconducts inspection of merchant banking subsidiaries of banks. The banks are
required to conduct internal audit / inspection of their subsidiaries as a measure ofcontrol over them. Periodical review notes on these subsidiaries put up to the banksBoard are sent to RBI.
Private sector banks are required to annex the balance sheet and profit and lossaccounts of their subsidiaries to the annual report of the bank. Public sector banksgenerally give a brief description of the performance of their subsidiaries in theDirectors report that forms part of the annual accounts of the bank. The question ofpublishing balance sheet and profit and loss account of subsidiaries as an annexureto the annual report of the public sector banks is also being examined in connectionwith the introduction of a system of consolidated supervision.
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Principle XXI: Adequate Records & Financial Statements
Bank supervisors must be satisfied that each bank maintains adequate recordsdrawn up in accordance with consistent accounting policies and practices thatenable the supervisor to obtain a true and fair view of the financial condition of the
bank and the profitability of its business and that the bank publishes on a regularbasis financial statements that fairly reflect its condition.
21.1 RBI is committed to enhance and improve increasing the levels of transparencyand disclosure in the annual accounts of banks. The formats for preparation offinancial statements are prescribed under Section 29 of the Banking Regulation Act.The financial statements are prepared based on accounting standards prescribed byInstitute of Chartered Accountants of India (ICAI) except those that have beenspecifically modified by RBI in consultation with ICAI keeping in view the nature ofbanking industry. The banks are mandated to disclose additional information as partof annual financial statements:
1. Capital Adequacy Ratio;2. Tier I ratio;3. Tier II ratio;4. Percentage of shareholding of the Government of India in
nationalised banks;5. Net NPL ratio;6. Amount of provision made towards NPLs and provisions
for income-tax for the year;7. Amount of subordinated debt raised as Tier II capital;8. Gross value of investments, provision for depreciation on
investments and net value of investments separately forwithin India and outside India;
9. Interest income as percentage to working funds;10.Non-interest income as a percentage to working funds;11.Operating profit as a percentage to working funds;12.Return on assets; business (deposits and advances) per
employee13.Profit per employee;14.Maturity pattern of certain assets and liabilities;15.Movement in NPLs;
16.Foreign currency assets and liabilities;17.Lending to sensitive sectors as defined from time to time.
Principle XXII: Supervisory Intervention
Banking supervisors must have at their disposal adequate supervisory measures tobring about timely corrective action when banks fail to meet prudential requirementssuch as minimum capital adequacy ratios when there are regulatory violations orwhere depositors are threatened in any other way. In extreme circumstances thisshould include the ability to revoke the banking licence or recommend its revocation.
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V. CENTRAL BAKING
Introduction to central banking
It is often said that central bankers have more power than the President, King,
Parliament or whatever nominal ruling body governs the state in question. They gainthis distinction for the simply reason that they control the money supply.
Origins of central banking can trace back to at least the 11th century, when theKnights Templar used their enormous treasury to form the first truly internationalbanking system. The Templars' credibility, and ability to protect depositors' funds,were such that they won the trust of monarchs across Europe. Crusade-boundnobles could deposit savings and withdraw funds at any branch in Europe through achecking system.
Central banking has evolved quite a bit in the thousand years since the Templers'
heyday, but the overall design remains the same. Chief among the central banker'sresponsibilities is securing investor confidence. The US Federal Reserve, forinstance, was created to rationalize the money supply after extreme deflationaryrecessions in the late 1800s, due to wild fluctuations in the price of gold. Ripples ofpanic would wipe out entire regions' banking industries as depositors withdrewfunds, forcing banks to close, defaulting on their obligations to other banks and inturn forcing those banks to close. A lender of last resort, the "Fed," was created. TheFed's weathering of all the crises, recessions and panics of the 20th century hasgiven it enormous credibility as a safe haven of capital from all over the world.
Central banks vary in the degree to which they are insulated from short-term politicalwinds. In the US, the Fed is mandated by Congress to have as its goals "fullemployment," low inflation, and steady growth of GDP, although in practice the Fedis largely autonomous. The Federal Reserve has three instruments with which toinfluence the money supply: open market operations, discount lending, and reserverequirements. The most frequently used of the three are open market operations.The FOMC meets 8 times a year to discuss the direction of their future operationsand their funds target rate. That number has historically been very important foreveryone from billionaire bankers calculating costs of leverage to blue-collar workersworried about their mortgages.
The Bank of England
The Bank of England (formally the Governor and Company of the Bank of England)
is the central bank of the United Kingdom and is the model on which most modern
central banks have been based. Established in 1694, it is the second oldest central
bank in the world (the oldest being the Bank of Sweden established in 1668). It was
established to act as the English Government's banker, and to this day it still acts as
the banker forHM Government. The Bank was privately owned and operated from
http://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/Sveriges_Riksbankhttp://en.wikipedia.org/wiki/Kingdom_of_Englandhttp://en.wikipedia.org/wiki/Her_Majesty's_Governmenthttp://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/Sveriges_Riksbankhttp://en.wikipedia.org/wiki/Kingdom_of_Englandhttp://en.wikipedia.org/wiki/Her_Majesty's_Government -
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its foundation in 1694. It was subordinated to the Treasury after 1931 in making
policy and was nationalised in 1946.
In 1997 it became an independent public organisation, wholly owned by the Treasury
Solicitor on behalf of the Government, with independence in setting monetary policy.[3][4][5]
The Bank has a monopoly on the issue of banknotes in England and Wales,
although not in Scotland, Northern Ireland, the Isle of Man, or the Channel Islands.[citation needed] The Bank's Monetary Policy Committee has devolved responsibility for
managing the monetary policy of the country. The Treasury has reserve powers to
give orders to the committee "if they are required in the public interest and by
extreme economic circumstances" but such orders must be endorsed by Parliament
within 28 days.[6]
The Bank's Financial Policy Committee held its first meeting in June2011 as a macro prudential regulator to oversee regulation of the UK's financial
sector.
The Bank's headquarters has been located in London's main financial district, the
City, on Thread needle Street, since 1734. It is sometimes known by the
metonym The Old Lady of Thread needle Streetor simply The Old Lady. The current
Governor is Sir Mervin King, who took over on 30 June 2003 from Sir Edward
George. As well as its London offices, the Bank of England also has secondary
offices in Leeds.
The Peels Act of 18844
Sir Robert Peel, 2nd Baronet (5 February 1788 2 July 1850) was a
British Conservative statesman who served as Prime Minister of the United
Kingdom from 10 December 1834 to 8 April 1835, and again from 30 August 1841 to
29 June 1846. Peel, whilst Home Secretary, helped create the modern concept of
the police force, leading to officers being known as "bobbies" (in England) and
"Peelers" (in Ireland) to this day. Whilst Prime Minister, Peel repealed the CornLaws and issued the Tamworth Manifesto, leading to the formation of the
Conservative Party out of the shattered Tory Party.
THE RESERVE BANK OF INDIA
The Reserve Bank of India was set up on the basis of the recommendations of the
Royal Commission on Indian Currency and Finance also known as the Hilton-Young
Commission.
http://en.wikipedia.org/wiki/Bank_of_England#cite_note-2http://en.wikipedia.org/wiki/Bank_of_England#cite_note-2http://en.wikipedia.org/wiki/Bank_of_England#cite_note-3http://en.wikipedia.org/wiki/Bank_of_England#cite_note-3http://en.wikipedia.org/wiki/Bank_of_England#cite_note-4http://en.wikipedia.org/wiki/England_and_Waleshttp://en.wikipedia.org/wiki/Bank_of_Scotlandhttp://en.wikipedia.org/wiki/Northern_Irelandhttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/wiki/Monetary_Policy_Committeehttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Bank_of_England#cite_note-5http://en.wikipedia.org/wiki/Financial_Policy_Committeehttp://en.wikipedia.org/wiki/Threadneedle_Streethttp://en.wikipedia.org/wiki/Mervyn_King_(economist)http://en.wikipedia.org/wiki/Edward_Georgehttp://en.wikipedia.org/wiki/Edward_Georgehttp://en.wikipedia.org/wiki/Leedshttp://en.wikipedia.org/wiki/Prime_Minister_of_the_United_Kingdomhttp://en.wikipedia.org/wiki/Prime_Minister_of_the_United_Kingdomhttp://en.wikipedia.org/wiki/Home_Secretaryhttp://en.wikipedia.org/wiki/Policehttp://en.wikipedia.org/wiki/Corn_Lawshttp://en.wikipedia.org/wiki/Corn_Lawshttp://en.wikipedia.org/wiki/Tamworth_Manifestohttp://en.wikipedia.org/wiki/Tory_(British_political_party)http://en.wikipedia.org/wiki/Bank_of_England#cite_note-2http://en.wikipedia.org/wiki/Bank_of_England#cite_note-3http://en.wikipedia.org/wiki/Bank_of_England#cite_note-4http://en.wikipedia.org/wiki/England_and_Waleshttp://en.wikipedia.org/wiki/Bank_of_Scotlandhttp://en.wikipedia.org/wiki/Northern_Irelandhttp://en.wikipedia.org/wiki/Wikipedia:Citation_neededhttp://en.wikipedia.org/wiki/Monetary_Policy_Committeehttp://en.wikipedia.org/wiki/Monetary_policyhttp://en.wikipedia.org/wiki/Bank_of_England#cite_note-5http://en.wikipedia.org/wiki/Financial_Policy_Committeehttp://en.wikipedia.org/wiki/Threadneedle_Streethttp://en.wikipedia.org/wiki/Mervyn_King_(economist)http://en.wikipedia.org/wiki/Edward_Georgehttp://en.wikipedia.org/wiki/Edward_Georgehttp://en.wikipedia.org/wiki/Leedshttp://en.wikipedia.org/wiki/Prime_Minister_of_the_United_Kingdomhttp://en.wikipedia.org/wiki/Prime_Minister_of_the_United_Kingdomhttp://en.wikipedia.org/wiki/Home_Secretaryhttp://en.wikipedia.org/wiki/Policehttp://en.wikipedia.org/wiki/Corn_Lawshttp://en.wikipedia.org/wiki/Corn_Lawshttp://en.wikipedia.org/wiki/Tamworth_Manifestohttp://en.wikipedia.org/wiki/Tory_(British_political_party) -
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The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of the Reserve Bank of India Act, 1934. Though initially RBI was privately
owned, it was nationalized in 1949. Its central office is in Mumbai where the
Governor of RBI sits. RBI has 22 regional offices and most of them are located in
state capitals. The Reserve Bank of India also has three fully owned subsidiaries:National Housing Bank (NHB), Deposit Insurance and Credit Guarantee Corporation
of India (DICGC), Bharatiya Reserve Bank Note Mudran Private Limited
(BRBNMPL).
The functions of Reserve Bank are governed by central board of directors. The
board is appointed by the Government of India. The directors are nominated /
appointed for a period of four years. As per the Reserve Bank of India Act there are
Official Directors and Non-Official Directors. The Official Directors are appointed by
the government and include Governor and Deputy Governors of RBI. There cannot
be more than four Deputy Governors. Non-Official Directors are nominated by thegovernment. These include ten Directors from various fields and one government
official. Apart from these, there are four other Non-Official Directors, one each from
four local boards in Mumbai, Kolkata, Chennai and New Delhi.
RBI Act, 1934 preamble
Whereas it is expedient to constitute a RBI to regulate the issue of Bank notes and
the 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;
And whereas in the present disorganization of the monetary systems of the world it isnot possible to determine what will be suitable as permanent basis for the Indian
monetary system; But whereas it is expedient to make temporary provision on the
basis of the existing monetary system, and to leave the question of the monetary
standard best suited to India to be considered when the international monetary
position has become sufficiently clear and stable to make it possible to frame
permanent measures
RBI was Established in 1935 Overtook Currency issue from central government of
India; and Credit control from the then Imperial Bank of India
RBI A Regulator to the Indian Banking System:
1. Formulate, Implement and Monitor the monetary Policy
2. Manage the foreign exchange reserves
3. Prescribe Exchange Control Norms to facilitate external trade and
payment
Banks in India are governed under extant guidelines viz., Banking RegulationAct, 1949
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Current Thrust
1. Continuing financial reforms for induction of best practices and
technological changes
2. Transparency, diversification of ownership and strong corporategovernance practices to mitigate prospects of systemic risks
3. To improve efficiency parameters of SCBs
Policy Trends
1. Roadmap for entry of foreign Banks
2. Implementation of Basel II framework:
3. Promoting Banking consolidation
Other Operational Policies
Main Functions of RBI
Reserve Bank of India is the main monetary authority of the country. It formulates,
implements and monitors the monetary policy and thereby plays a key role in
maintaining price stability and ensuring adequate flow of credit to productive sectors.
RBI is the regulator and supervisor of the financial system in the country. It
prescribes broad parameters of banking operations within which the country's
banking and financial system functions. It manages the foreign exchange of the
country. Performs merchant banking function for the central and the state
governments; also acts as their banker. Maintains banking accounts of all scheduled
banks. Issues and exchanges or destroys currency and coins not fit for circulation.
1. Bank of Issue
2. Banker of Government
3. Bankers Bank and Lender of the Last Resort
4. Controller of Credit
5. Custodian of Foreign Reserves
6. Supervisory Functions
7. Promotional Functions
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Network of Currency Chests
Management of Currency
Currency Management essentially relates to planning, designing, issue and
withdrawal of currency, ensuring its integrity, availability and the maintenance ofquality. The Department of Currency Management (DCM) of the Reserve Banklocated at Central Office, Mumbai, takes policy decisions on the designs of banknotes, forecasts the demand for notes and coins, ensures the smooth distribution ofbank notes and coins throughout the country, arranges to withdraw unfit notes,administers the RBI Note Refund Rules and reviews/rationalizes the worksystem/procedures at the Issue Office on ongoing basis. The operational work isconducted by the Issue Departments of the Bank with responsibility for managing theinventory, distribution and servicing of currency in its respective issue circles.
(ii) The Reserve Bank is responsible for issuing coins and notes to the public ondemand and for maintaining the quality of the notes issued. Reserve Bank'sresponsibility thus is not only to put currency into such other denominations of notesand/or coins as may be required by the public. With a view to mitigating the hardshipto the public in genuine cases, the Bank arranges to make refund of the value ofmutilated notes as per the Note Refund Rules.
2. Currency Chests
In order that the Bank's obligations may be satisfactorily discharged without recourseto extensive and frequent physical remittance of notes and coins between various
centres, the Bank maintains currency chests of its own at treasuries and branches ofthe banks at all important centres. In the State of Orissa, there are 130 Currencychests, the list of which is provided in the end. These currency chests are intendedto facilitate the distribution, exchange and remittance of notes, including one rupeenotes and rupee coins and small coins.
(ii) RBI has launched a special drive under its clean note policy to withdraw allsoiled and mutilated notes from the members of public and put in its place fresh andclean notes. In order to facilitate the members of public, to exchange such notes,RBI has delegated powers to all the 130 currency chest branches in Orissa toexchange soiled, torn, damaged/ mutilated/ defective notes. Soiled and cut notes
should also be accepted over bank counters in payment of Government dues and forcredit of accounts of the public maintained with banks. Reserve Bank of India,Bhubaneswar has opened three special counters, two for exchange of soiled notesof all denominations and one solely for exchange of mutilated notes. Notes whichhave turned extremely brittle or badly burnt, charred or inseparably stuck up togetherand therefore can not withstand normal handling, are also accepted at RBIBhubaneswar for adjudication under a Special Procedure.
3. Facilities/ Services at the Currency Chest Branches
Salient features of genuine notes are required to be displayed at bank branches for
information of public. The bank branches should have adequate number of dualdisplay note counting machines provided at the payment counters for the benefit of
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customers. Stapling of currency note packets has been done away with andinformation on non stapling of note packets should be displayed on the noticeboards. Citizens' Charter for exchange of notes and coins should be displayed atnotice board for information and benefit of common persons. All the notice boardsare trilingual.
(ii) Exchange value of soiled notes will be paid in coins and/or notes ofdenomination Rs.10/- and above, across the counter as per extant rules. While theintention of the RBI is to mop up all such soiled/mutilated Re.1/-, Rs.2/- and Rs.5/-notes and above in exchange, all Re.1/-, Rs.2/- and Rs.5/- notes would continue tobe legal tender. Any note with slogans and message of a political nature writtenacross it ceases to be a legal tender and a claim on such a note will be rejected.Similarly, notes which are disfigured may also be rejected. The notes which arefound to be deliberately cut or tampered with, if presented for payment of exchangevalue, will be rejected.
(iii) The banks have been advised to direct all their branches to accept coins of alldenominations tendered at their counters either for exchange or for deposit inaccounts. However, as accepting coins packed in polythene sachets of 100 eachwould be more convenient, the banks have been advised to keep such sachets atthe counters and make them available to the customers. A notice to this effectshould be displayed suitably inside as also outside the branch premises forinformation of the public. RBI, Bhubaneswar is operating two counters for issue ofcoins, one for bulk issue and the other for issue in small pouches. This apart, a coinvending machine is installed in its premises which can be used by the public to getcoins in exchange for notes.
(iv) All the currency chest branches are required to display at their branch premises,at a prominent place, a board indicating the availability of note exchange facility withthe legend, "MUTILATED NOTES ARE ACCEPTED AND EXCHANGED HERE".Banks should ensure that all their designated branches provide facilities forexchange of notes and coins and place details of designated branches in publicdomain.
(v) RBI has devised a scheme of penalties for those banks which refuse toexchange soiled/mutilated notes tendered by any member of public. All members ofpublic are advised to avail of the aforesaid facilities to the fullest extent. Any
suggestion / complaint / grievance as regards exchange of soiled notes and non-availability of coins/notes (denomination of Rs.10/- and above) may be addressed toRBI, Bhubaneswar.
RBI is located only in 18 places for currency operations
Distribution of notes and coins throughout the country is done through designated
bank branches, called chests
Chest is a receptacle in a commercial bank to store notes and coins on behalf of the
Reserve Bank
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Deposit into chest leads to credit of the commercial banks account and withdrawal,
debit
Regulatory and supervisory frame work of RBI over the Fis
A paradigm shift in banking - Any where banking; Any time banking
Governance and ownership of banks- Govt. ownership to Mixed ownership
RBIs Approach - Diversified ownership in private sector; Important shareholders
are fit and proper; Directors and CEOs are fit and proper; Private Sector Banks
maintain minimum capital as 200 crores initially and 300 crores with in 3 years;
Policy and processes are transparent and fair
VI. MONETARY POLICY
Monitory policy is the policy employs by the Central Bank to control credit for fulfillingthe goal of monetary authority to maintain full employment and price stability.
Monetary policy to encourage saving largely take the form of the development of
financial intermediaries. It can encourage those with a productive surplus to save by
taking the risk out of lending directly to investors, and of the development of branch
banking which can tap small savings. Because of the law of large numbers, financial
intermediaries are also able to borrow short and lend long, which is advantageous to
lenders and borrowers alike. Monetary policy to encourage saving may also attempt
to encroach on the unorganised money market, which lends mainly for consumption
purposes. Paradoxically the development of the organised money market can bothlower average interest rates in the economy at large and raise the level of saving
because the unorganised money market charges very high interest rates and lends
mainly for consumption purposes, whereas in the organised money market interest
rates are lower and lending is more for investment purposes
A well-developed financial system has four main requisites, each of which can
contribute to the process of financial deepeningand to raising the level of saving.
These four requisites comprise: the monetisation of the economy and the
replacement of barter as a is a by replacing barter objects, or commodity money
which may be costly to produce. It also saves time, which is a resource if themarginal product of labour time is positive, by avoiding the double coincidence of
wants, necessitated by barter. Money generates resources by facilitating exchange
and thereby permitting the greater division of labour and specialisation.
Monetary expansion to meet the increased demand for money per unit of output and to
facilitate the needs of trade in a growing economy does not imply inflation. This is easily seen
taking the where M is the nominal money supply, V is the income velocity of
circulation of money, Kd (=1/V) is the demand to hold money per unit of money
income, P is the average price of final goods and services, and Y is real income.
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Historically, the growth of the money economy has also been a powerful
stimulus to the development of banking and credit mechanism which themselves can
act as a stimulus to saving and investment. When the range of financial assets is
narrow, saving tends to take the form of the acquisition of physical assets. While in
principle this should not mean that the level of saving is reduced below what it mightotherwise be, in practice and it depends on how sellers of physical assets dispose of
the sale proceeds. If a portion of the proceeds is consumed, the saving of one
person is offset by the dissaving of another, and fewer resources are released for
investment than if financial assets had been acquired, issued by financial institution
with an investment function. This is a major reason why the statistical on saving and
investment in developing countries understate the saving and investment capacity of
these countries.
The development of a national banking system, comprising a central bank, a
commercial banking system and special development banks, is one of the firstpriorities of development planning. The function of a central bank include the
following: The issue of currency and lending to government which can transfer real
resources to government, the development of a fractional reserve banking system
through which it can provide liquidity and control credit of other financial
institutions, especially institution to provide long-term loan finance for development
and to provide a market for government securities; the maintenance of a high level
of demand to achieve capacity growth; and the application of selective credit control
if necessary in the interest of developing particular sector of the economy. The
stabilisation role of the central bank is essentially secondary to its development role.
Stabilisation is particularly difficult in a developing country where credit control, the
main instrument of stabilisation policy, is ill-developed.
Monetary Policy Objectives
Twin Objectives
maintaining price stability
ensuring availability of adequate credit to productive sectors of the economy to
support growth
Basic Thrust
1. Ensure a monetary and interest rate environment enabling continuation
of the growth momentum consistent with price stability and inflation
expectations
2. Focus on credit quality and financial market conditions to support
export and investment demand in the economy
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3. To respond swiftly to evolving global developments.
As a monetary authority, a central banks primary objective is to ensure
macroeconomic financial stability in general and external stability in particular. As a
custodian, the central banks main objectives are to ensure liquidity, safety and yield
on deployment of reserves
Direct Instruments
Administered interest rates
Reserve requirements
Selective credit control
Indirect Instruments
Open Market Operations Reserve Bank controls money supply by buying
and selling government securities, or other instruments
Market Stabilization Scheme (MSS) Government of India dated
securities/Treasury Bills are being issued to absorb enduring surplus
liquidity.
Liquidity Adjustment Facility (LAF)
Repo Auctions and
Reverse Repo Auctions,
Cash Reserve Ratio (CRR)
Minimum amount that commercial banks must keep as cash reserves
LAF has emerged as the tool for both liquidity management and also as a signalling
devise for interest rate in the overnight market.
Monetary Policy Key Highlights
MID TERM REVIEW
Repo Rate increased to 7.25% from 7% / Bank Rate at 6% / Reverse repo
rate under the LAF at 6%/ CRR at 5% unchanged (to increase by 0.5% in 2
stages)
GDP growth forecast: 8.0 % (2006-07) / Inflation: 5.0-5.5 % (2006-07)
AN ASSESSMENT
Real GDP 9.2% during Jul-Sept 06 & 9.1% in the H1 06-07.
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Y-o-Y increase in non-food bank credit up 30.1 % (Nov24,06)
YoY M3 growth at 19.4 % (Nov24,06)
YoY expansion in reserve money 17.5 % (Nov24,06)
YoY WPI inflation - 5.3 % (Nov25,06)
Liberal Policy
Borrowers eligible for additional ECBs of US $ 250 million (Avg
maturity > 10 years)
Foreign exchange earners to retain upto 100 % of forex earnings
Allow prepayment of ECB up to US $ 300 million (without prior
approval)
Existing limit of US $ 2 billion on investments in Government securities
by FIIs enhanced to US $ 3.2 billion by March 31, 2007.
Extant ceiling of overseas investment by MFs of US $ 2 billion
enhanced to US $ 3 billion
VII. SUPERVISION AND SUPERVISORY POLICY OF RBI
The Board for Financial Supervision (BFS)was constituted in 1994
1. Foreign exchange Banks Road Map Operate on three channels :
branches; a wholly owned subsidiary; subsidiary with an aggregate foreign
investment up to a maximum of 74% in a private bank
2. Payment of dividends- RBI has permitted banks to declare dividend
from 2005 as: capital to risk weighted of at least 9% for proceeding 2
completed years; net non performing assets of less than 7%- over all dividend
shall not exceed 40% subject to SEBI
3. Marginal Autonomy for PSBs- In 2005: Boards of PSBs could enjoy more
freedom; revise their guidelines; Additional autonomy on their HR policies;
prescription of standards for Banking business; fix accountability
4. Mergers and Amalgamation of Banks norms for buying and selling of
shares; proposal for merger; determination of SWAP ratios; disclosures;
schemes for BFIs & NBFIs; RRBs State sponsorship- Ministry of Finance
5. Insurance Business- subject to IRDA- CBs to have Insurance business as a
joint venture on a risk participation basis; to undertake insurance business as
agents of Insurance Companies on a fee basis; without any risk participation
by banks and their subsidiaries.
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The supervisory strategy of RBI involves three approaches:
1. Off-shore monitoring and surveillance 1995 FIs not accepting public
deposits but have assets of Rs.500crores and above would be subject to off-
shore site supervision of RBI; Online connectivity has to be given to Regional
Offices and HO of Banks
2. Monitoring of Frauds- 2002 to look in to the existing mechanism for vigilance
management in their institutions and remove the loopholes; Technical paper
on frauds in 2004; separate Fraud Monitoring Cell; Fraud Monitoring and
Reporting System
3. Modification In Format of Declaration Of Indebtedness from Statutory
Auditors-
4. RBI and the financial Systems- the role of Central bank regulatory,promotional and financial roles- NABARD & IDBI control over money market
and capital market- interest rate structure RBI as the leader- RBI and Banks
Functions of RBI-
1. Traditional functions: as lender of last resort, as banker to banks,
banker to Govt., note issue authority- Ministry of Finance - Govt. of India -
currency chests-
2. Developmental functions: to increase the volume of investment
and change the pattern of financial flows to promote investment; to havebalanced viable financial system- Credit control and RBI RBI as a leader of
financial system RBI and Indigenous banks
The Bill Market schemes: old (1952) made advance to scheduled
banks against promissory notes and new (1970)- 90 days RBI on money
market and capital market RBI and interest rate structure to organized &
unorganized sectors : by changing Bank Rates, fixation of minimum and
maximum lending rate, changes in treasury bills rate, credit policy, OMOs
Monetary policy of RBI RBI and Commercial banks scheduled banks
which includes cooperative banks & RRBs, Non-scheduled banks DepositInsurance corporation in 1962, regulation regarding paid up capital as 5-10
lakh, opening new branches, control over management and inspection,
deposits to RBI, voluntary and compulsory amalgamation, liquidation.
VIII. FOREIGN TRADE POLICY OF RBI - PREAMBLE
For India to become a major player in world trade, an all encompassing,
comprehensive view needs to be taken for the overall development of the
countrys foreign trade. While increase in exports is of vital importance, we
have also to facilitate those imports which are required to stimulate oureconomy. Coherence and consistency among trade and other economic
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policies is important for maximizing the contribution of such policies to
development. Thus, while incorporating the existing practice of enunciating an
annual Exim Policy, it is necessary to go much beyond and take an integrated
approach to the developmental requirements of Indias foreign trade. This is
the context of the new Foreign Trade Policy.
Objectives:
Trade is not an end in itself, but a means to economic growth and national
development. The primary purpose is not the mere earning of foreign
exchange, but the stimulation of greater economic activity. The Foreign Trade
Policy is rooted in this belief and built around two major objectives. These are:
(i) To double our percentage share of global merchandise trade within the
next five years; and
(ii) To act as an effective instrument of economic growth by giving a thrust to
employment generation.
Governed by Directorate General of Foreign Trade under Ministry of Commerce
& Industry
1. Mandate for Comprehensive overall development of the Indias foreign trade.
2. GoI announced a bold Foreign Trade Policy for five years (2004-2009)
a. double India's share in world trade within five years, and
b. to focus on the generation of additional employment in the process
3. In spirit of WTO requirements - Annual Budget announcements by the
Ministry of Finance have consistently and progressively reduced peak excise
and customs duty
Exports and Imports shall be free, except in cases where they are regulated by the
provisions of this Policy or any other law for the time being in force.
Market Access Initiative (MAI) scheme is intended to provide financial assistance formedium term export promotion efforts with a sharp focus on a country and product.
Duty Exemption & Remission Schemes
Special Focus Initiatives Thrust on agriculture, handlooms, handicraft, gems &
jewellery, leather and Marine sectors.
Funds to be earmarked under Agri Process Zone
Exports Promotion Capital Goods Scheme (EPCG)
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Export oriented units (EoUs), Electronics Hardware Technology Parks (EHTP),
Software Technology Parks (STP) and Bio-technology parks (BTP)
Special Economic Zones
Free Trade & Warehousing Zones
Deemed Exports
IX. COMMERCIAL BANKING SYSTEM IN INDIA
History of Banking in India
Banking in India has a very old origin. It started in the Vedic period where literature
shows the giving of loans to others on interest. The interest rates ranged from two to
five percent per month. The payment of debt was made pious obligation on the heir
of the dead person.
Modern banking in India began with the rise of power of the British. To raise the
resources for the attaining the power the East India Company on 2nd June 1806
promoted the Bank of Calcutta. In the mean while two other banks Bank of Bombay
and Bank of Madras were started on 15 th April 1840 and 1st July, 1843 respectively.
In 1862 the right to issue the notes was taken away from the presidency banks. The
government also withdrew the nominee directors from these banks. The bank of
Bombay collapsed in 1867 and was put under the voluntary liquidation in 1868 and
was finally wound up in 1872. The bank was however able to meet the liability of
public in full. A new bank called new Bank of Bombay was started in 1867.
On 27th January 1921 all the three presidency banks were merged together to form
the Imperial Bank by passing the Imperial Bank of India Act, 1920. The bank did not
have the right to issue the notes but had the permission to manage the clearing
house and hold Government balances. In 1934, Reserve Bank of India came into
being which was made the Central Bank and had power to issue the notes and wasalso the banker to the Government. The Imperial Bank was given right to act as the
agent of the Reserve Bank of India and represent the bank where it had no braches.
In 1955 by passing the State Bank of India 1955, the Imperial Bank was taken over
and assets were vested in a new bank, the State Bank of India.
Bank Nationalization:
After the independence the major historical event in banking sector was the
nationalization of 14 major banks on 19 th July 1969. The nationalization was deemed
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as a major step in achieving the socialistic pattern of society. In 1980 six more banks
were nationalized taking the total nationalized banks to twenty.
Structure of schedule commercial banks:
The composition of the board of directors of a scheduled commercial bank shallconsist of whole time chairman. Section 10A of the Banking Regulation Act, 1949
provides that not less than fifty-one per cent, of the total number of members of the
Board of directors of a banking company shall consist of persons, who shall have
special knowledge or practical experience in respect of one or more of the matters
including accountancy, agriculture and rural economy, banking, co-operation,
economics, finance, law, small-scale industry, or any other matter the special
knowledge of, and practical experience in, which would, in the opinion of the
Reserve Bank, be useful to the banking company. Out of the aforesaid number of
directors, not less than two shall be persons having special knowledge or practical
experience in respect of agriculture and rural economy, co-operation or small-scale
industry.
Besides the above the board of the scheduled bank shall consist of the directors
representing workmen and officer employees. The Reserve Bank of India and the
Central Government also has right to appoint their nominees into the board of the
banks.
Present scenario of the banks in India:
Banks are extremely useful and indispensable in the modern community. The bankscreate the purchasing power in the form of bank notes, cheques bills, drafts etc,
transfers funds bring borrows and lenders together, encourage the habit of saving
among people.
The banks have played substantial role in the growth of Indian economy. From the
meager start in 1860 the banks have come to long way. At present in India there are
20 nationalized banks, State bank of India and its seven Associate banks, 21 old
private sector banks and 8 new private sector banks. Besides them there are more
than 30 foreign banks either operating themselves or having their branches in India.
The statistical table hereunder shows the financial position of the banks as on31.03.2005.
Structure of schedule commercial banks:
The composition of the board of directors of a scheduled commercial bank shall
consist of whole time chairman. Section 10A of the Banking Regulation Act, 1949
provides that not less than fifty-one per cent, of the total number of members of the
Board of directors of a banking company shall consist of persons, who shall have
special knowledge or practical experience in respect of one or more of the matters
including accountancy, agriculture and rural economy, banking, co-operation,
economics, finance, law, small-scale industry, or any other matter the specialknowledge of, and practical experience in, which would, in the opinion of the
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Reserve Bank, be useful to the banking company. Out of the aforesaid number of
directors, not less than two shall be persons having special knowledge or practical
experience in respect of agriculture and rural economy, co-operation or small-scale
industry.
Besides the above the board of the scheduled bank shall consist of the directorsrepresenting workmen and officer employees. The Reserve Bank of India and the
Central Government also has right to appoint their nominees into the board of the
banks.
Present scenario of the banks in India:
Banks are extremely useful and indispensable in the modern community. The banks
create the purchasing power in the form of bank notes, cheques bills, drafts etc,
transfers funds bring borrows and lenders together, encourage the habit of saving
among people.The banks have played substantial role in the growth of Indian economy. From the
meager start in 1860 the banks have come to long way. At present in India there are
20 nationalized banks, State bank of India and its seven Associate banks, 21 old
private sector banks and 8 new private sector banks. Besides them there are more
than 30 foreign banks either operating themselves or having their branches in India.
The statistical table hereunder shows the financial position of the banks as on
31.03.2005.
The banks in India are operating through 55530 branches. All the banks together
had the net worth of Rs. 149385 crores as on 31 st March, 2005. The banks also hadthe deposit base of Rs. 1836985 crores and the advances of Rs. 1151113 crores
taking the total business to Rs. 2988098 crores. During the year 2004-05 the banks
had earned the interest income of Rs. 154761 crores. The average net NPA ratio of
the banks was also less 3.84% in year 2005.
Classification of Banks can be Done in Many Ways
Based on Functioning
1. Commercial Banks
2. Co-operative Banks
3. Development Banks
Built In Safeguards Relate to :
1) Organisation
2) Management
3) Operations Of A Banking Company
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1) Permitted Business
2) Holding Immovable Property
3) Formation Of Subsidiary Companies
4) Use Of Word Bank, Banking Company, Banker And Banking
5) Paid Up Capital And Reserves
6) Change Of Name
Section 5 B of Act Covers Primary Functions:
Section 6 Spells Out Other Types Of Banking Business, A Banking Company
Can Undertake.
1) Primary Functions
2) Agency Functions
3) General Utility Functions
2. Acceptance Of Deposits
3. Lending Money
4. Borrowing Money
5. Making Investments
6. Collection And Payment Of Cheques
7. Collection And Payment Of Bills
8. Remittance Of Funds
9. Collection Of Government Taxes
10.Undertaking Administration Of Estates As Executors And Trustees.
Current Number of Nationalized Banks:
There are 26 Nationalized Banks in the country at present. They are as follows:
1. Allahabad Bank2. Andhra Bank3. Bank of Baroda4. Bank of India5. Bank of Maharashtra
6. Canara Bank7. Central Bank of India
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8. Corporation Bank9. Dena Bank10. IDBI Bank Ltd.11. Indian Bank12. Indian Overseas Bank
13. Oriental Bank of Commerce14. Punjab & Sind Bank15. Punjab National Bank16. Syndicate Bank17. UCO Bank18. Union Bank of India19. United Bank of India20. Vijaya Bank
State Bank Group
1. State Bank of Bikaner & Jaipur2. State Bank of Hyderabad3. State Bank of India4. State Bank of Mysore5. State Bank of Patiala6. State Bank of Travancore
State Bank of Indore has merged with SBI from August 26, 2010.
Current Number of Old Private Banks
There are 14 Old Private sector Banks in the country as follows:
1. Catholic Syrian Bank Ltd.2. City Union Bank Ltd.3. Dhanalakshmi Bank Ltd.4. Federal Bank Ltd.5. ING Vysya Bank Ltd.6. Jammu & Kashmir Bank Ltd.7. Karnataka Bank Ltd.8. Karur Vysya Bank Ltd.
9. Lakshmi Vilas Bank Ltd.10. Nainital Bank Ltd.11. Ratnakar Bank Ltd.12. SBI Commercial & International Bank Ltd13. South Indian Bank Ltd.14. Tamilnad Mercantile Bank Ltd.
The number of the old Private Banks in India was 15 until recently and the latestreports from RBI (2009-10) show this 15. The Bank of Rajasthan Ltd has recentlymerged with ICICI Bank Ltd.
Current Number of New Private Banks
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There are 7 New Private sector Banks in India as follows:1. Axis Bank Ltd.2. Development Credit Bank Ltd3. HDFC Bank Ltd.4. ICICI Bank Ltd.
5. IndusInd Bank Ltd.6. Kotak Mahindra Bank Ltd.7. Yes Bank Ltd
Current Number of Foreign Banks
As of end of 2009, there were 32 Foreign Banks in India with 293 branches. 43foreign banks were operating in India through representatives ofoffices.
Under the WTO agreements, the Reserve bank of India has to allow a minimum of
12 Branches of all the foreign banks to be opened in a year
Various Types of banking services:
The flow chart below shows the various types of banking services:
Land Mortgage IFCIRural Credit IRBI Mutual Funds
Indutrial Dev. SFCs Pvt. NBFC Housing Finance HDFC
EXIM Bank SIDBI& NABARD
Commercial
Banks
Specialized
banks
Institutional
banks
Non Banking
Financial
Institutions
Nationalis
ed banks
(20)
SBI and
Associate
Banks
Private
Sectors
Banks
Foreign
Banks
Oldprivate
sector
banks
Newprivate
sector
banks
CENTRAL BANK
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Future is bright:
The Information Technology (IT) is becoming an important component of the bankingsector. The customers have become more demanding and they need value addedservices from the banks. The foreign banks have raised the expectations of thecustomers causing the bank to invest strongly on IT. The Indian banks have startedto meet the expectations of the people by opening both onsite and offsite ATMs.Banks have also started tele-banking, anytime/anywhere banking, mobile bankingand Internet banking to give the facilities to the customers. Banks have alsofollowing the RBI sponsored technology programmes like mail messaging, Electronicfund transfers (EFT), Structured Financial Messaging System (SFMS), (Real TimeGross Settlement (RTGS), Centralized Fund Management System (CFMS) andNegotiated Dealing System / Public Debt Office (NDS/PDO).
Banks have been given more teeth to tackle the Non performing assets by passingthe Securitization and Reconstruction of Financial Assets and Enforcement ofSecurity Interest Act, 2002. Under this Act, the banks can take over the assets of thedefaulters either by themselves or with the help of Court. The power is in addition tothe power to recover through the Debt Recovery Tribunal. The Asset ReconstructionCompanies have been formed which also take over the distress assets from thebanks.
Conclusive Remarks
Banking Sector in India is likely to undergo a major change. This change will be inthe form of mergers and acquisitions and takeovers. The State Bank of India may
merge all its associate banks with itself to make a one bank. The banks based in
South India may look for a bank in North India to have presence in North. Similarly
banks in North may look for banks in South to increase its area of operations.
Consolidation will be the key to the banking sector in future.
X. THE STRUCTURE OF FINANCIAL MARKET
In a closed economy there exists commodity markets and financial markets.A
financial system comprise creation of money and credit through financial
intermediaries and financial market. Financial market envisages all of the
transactions of financial claims whether long term or short term securities. Securities
represent a financial claim on the issued, which are paper assets in the hands of
investors. They include commercial paper, treasury bills, certificate of deposits
which are short term in character. The long- term securities are Govt promissory
notes, public
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sector undertakings bonds, equities of business corporations and debentures of
corporate sector. Besides securities there are other financial claims such as
guarantees, mortgages, and foreign currencies. Thus, the financial market include
Securities Market and market for Financial Claims.
The securities markets are broadly divided into Money Market and CapitalMarket.Following figure shows the structure of financial markets.
Financial Markets
Securities Market Market for other Financial Claims
Money Market Capital Market Financial Mortgages
Guarantees Market
Market
Call Money Market. Bill Market Foreign Exchange
Treasurey Commercial Market
bill Market Bills Market
Primary Markets Secondary MarketsGoverment Industrial Goverment Industrial
Securities Securities Securities Securities
Market market Market market
Securities Market
A financial market deals with securities and other financial claims. Securities are of
two types, viz, short term securities and long term securities. Money Marketfacilitates short term securities and Capital Market deals long term securities.
Money Market
Money market is an association of brokers, commercial banks, discount houses,
business men ,investors through which short term funds are transacted to meet the
temporary needs of small investors .It never deals money but exchange funds such
as commercial papers, treasury bills, bank calls or call loans etc.Major constituents
of money market are call money markets and bills markets.
Call money market
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They are markets for call loans which should be repaid at call or on demand .
A call represents the demand made by the lenders of the money and they are
repayable form one to fourteen days. Call loans are referred as money at short
notices. Usually call loans are provided by the commercial banks form their cash in
hand .They are very sensitive to Central Bank policies . In many countries call loansare used for inter bank transactions, plays in bill market , stock exchanges, bullion
markets and individual merchants deal with foreign trade
Bill market
Bill market refers to trading on short term bills of Govt and private companies.
The market of such bills range from three to six months. Bill market is classified into
treasury bill market and commercial bill market. Treasury bills market deals in
treasury bills or promissory notes issued by the Govt. They are finance bills arising
goods and represent claims in Govt with out any endorsement. The Govt guarantees
on such bills make them highly liquid. In India the maturity of treasury bills has raisedfrom 90 days to 182 days, and most probably they are called as gilt- edged
securities. At the same time, commercial bills market deals with commercial papers,
or bills of exchange issued by companies. A bill of exchange denotes a
negotiable self liquidating paper originated from short term accommodation. The bills
of exchange are worth discounting before maturity and invites trading on them based
on market rates prevailing over regions and bank rates. These bills are brought to
the money market by professional bill brokers who gain commission with their deal ofbills. Commercial banks are a major buyer of commercial papers.
The Activities of Brokers and Dealers in Money Market
Brokers and dealers of securities represent a substantial source of demand
for short term funds. Dealers need funds for financing their investors of securities
and brokers need funds to relent to their customers who wish to borrow money to
finance stock purchases. Suppose an investor is in need of a fund will approach to a
broker. The broker immediately arrange it or inform the source of a fund. After some
negotiations the borrower gets a fund or bill from the possession and it is then
presented to the commercial bank for discount. Since the bill is self liquidating in
nature, all the parties are trusted in its use or transaction .But the activities in money
market depends upon the level of business activities. It is only in advanced nations
that the facilities of money market are commonly available. In the case of less
developed countries the actions in money market are limited with the absence of an
organised bill market. So the essential conditions of developed money market are:
organised commercial banking system, presence of a central bank , availability credit
instruments, the existence of sub markets, availability of funds and organised
trading activities.
Capital Market
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Capital market is the market for long term funds. Many firms, households and
Govt. save more than they invest and such surpluses are transferred to those who
have deficits. The transfer of long term funds is done through a set of institutions,
securities markets together with a set of financial intermediaries and specialised
agencies. Collectively these markets, institutions and firms are called the capitalmarkets . House holds, firms and Govt. operate in the capital market both as
borrowers and lenders. Capital market can be classified as primary and secondary
market on the basis of source of origin of the securities.
Primary Market
Primary market is termed as the new issue of shares and securities to the
public. Securities issued for the first time are offered through the primary market.
Issuers of securities such as Govt public sector undertakings or corporate sector
may approach the public through primary market. A large number of intermediary
institutions such as merchant bankers, under writers, brokers and commercial banksundertake intermediary between the issuer of securities and the public. The issue in
primary market is called as public issue where people can buy original shares of
companies.
Secondary market
The secondary markets are meant for trading old securities. It is usually
called as stock exchanges. Once the investor purchases new issue of bonds or
shares from primary market they may wish to sell it at a profit. Since trading of
shares accompany with speculation in stock exchanges, investors buy and sell old
shares and securities. On the basis of issues in the secondary market, industrial
securities, Govt securities and financial institution's securities are exchanged. The
securities in stock exchange include equity shares, preference shares and
debentures or bonds . The principal objectives of stock exchanges are to provide
liquidity to the existing securities and to facilitates capital requirements to joint stock
enterprises. Most of the deals in secondary markets are with brokers. They include
commission brokers, floor brokers, taravaniwalas and Arbitragerers. Conditions in
stock exchanges are commonly classified as bullish orbearish, depending upon the
general level of prices. A bull is a person on the stock exchange market who holds
large number of shares and when price increases he opens the sale of shares. Abear is a person on the stock market who wish to buy shares when share prices are
lower. However the most common type of stock exchange is Over the Counter
Exchanges (OTC), where buying and selling of shares are held at
the counter. The securities in the capital markets are Government securities and
industrial securities.
Government Securities Market
In the Government Securities Market trading on securities issued by Central,
State and local Governments are held. The short term Government securities aretermed as guilt-edged securities. Apart form Government agencies issuing in
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securities, other institutions such as Central Bank, leading commercial banks, co-
operative banks, the LIC and the like financial intermediaries do business in
Government securities market. Trusts, individual joint stock companies, local
authorities etc, buy and sell Government securities. But such securities are dealing
in the OTC market where the activities of brokers are limited on account of theabsence of speculation and forward deals.
Industrial Securities Market
The industrial securities market refers to other new issue market and stock
exchanges where shares and debentures issued by companies in the private sector
are traded. The term industrial security denotes securities issued by companies
which include equity shares, preference shares and debentures. Such securities are
r