Slide 1 - Definition and Functions of Banking

8/4/2019 Slide 1 - Definition and Functions of Banking

1/28

McGraw-Hill/Irwin

1-1

2006 The McGraw-Hill Companies, Inc., All Rights Reserved.

Slide - 01

DEFINITION OF BANKING

AND

FUNCTIONS OF BANKS


2/28

McGraw-Hill/Irwin

1-2


Outline/Learning Objectives

Definition of Banking and Banking Company.

Primary Activities/Core Functions of Banks

Ancillary/Subsidiary Activities of Banks

Prohibited Activities for Banks in India

Basic Principles of Banking

Types of Banking Groups in India

Traditional & Modern Functions of Banks

Emerging Trends and Challenges in Banking


3/28

McGraw-Hill/Irwin

1-3


Functions and Forms of Banking

What do banks do for their customers?

Why do banks perform those services?

How do banks compare to other financial serviceorganizations?

What factors have affected the operations of commercialbanks and other financial service organizations?

What are the principal sources and uses of funds for banks?

Mobilisation & Deployment of Resources by Banks

Key Words/Terminologies/Glossary.


4/28

McGraw-Hill/Irwin

1-4


DEFINITION OF BANK/BANKING u/r INDIAN LAW

Definition of Banking as per Indian Banking Regulation Act,1949 :

Accepting, for the purpose of lending or investment, of deposits ofmoney from the public, repayable on demand or otherwise, andwithdrawable by cheque, draft, order or otherwise. (Section 5b)

A Banking Company is a Company which transacts the business of

banking in India. (Section 5c) As per the above definition the following are the core or primary

functions/activities of a Bank/Commercial Bank.

Acceptance of Deposits of money from the public

And deploying such money either for the purpose of Lending i.e.giving loans

Or for making Investments (Mandated/Statutory Investments forSLR Purposes known as SLR Investments and Non-SLR/Non-Mandated Investments)


5/28

McGraw-Hill/Irwin

1-5



The other salient features of this banking definition are :

Subject to the obligation to repay the deposits to the customers ondemand or otherwise as per the terms of the deposits.

Thus the banker does not refund the money on its own accord,even if the period for which it was deposited expires. The depositorhas to make a demand for the same .

Deposits are withdrawable by means of any instrument in writingwhether a Cheque, Draft and Order or otherwise (withdrawal slip,letter, voucher.

Thus the demand should be made in a proper manner through aninstrument in writing and not merely by a verbal order or a

telephonic message. The phrase deposits of money from the public has great

significance. The banker accepts deposits from the public i.e., whoever offers his money as deposit. However, a banker can refuse toopen accounts for undesirable persons. Hence, moneylenders andindigenous bankers are Not considered as Banks.


6/28

McGraw-Hill/Irwin

1-6



The essential functions of a banking company are the acceptanceof deposits, and lending and/or investing such deposits. If the

purpose of acceptance of deposits is Not for lending or investing,the business cannot be called banking. Hence, a manufacturingcompany accepting deposits of money from public for financing itsown business is not considered as a banking company.

Its only a bank/banking company which can issue Cheques/Drafts,i.e., accepts chequable deposits. Hence, a Non-banking financecompany (NBFC) accepting deposits of money from public andengaged in lending and/or investing such deposits are Notconsidered as banks as they cannot issue Cheques/Drafts.

The Use of word Bank (Sec. 7 of BR Act, 1949) : Nocompany other than a banking company is permitted touse as part of its name words likeBank/Banker/Banking.


7/28McGraw-Hill/Irwin

1-7


Ancillary Permitted Banking Activities

As per section 6 of BR act, 1949, Banks are authorised to carry out thefollowing functions in addition to the above principal functions :

Discounting of Bills

Collection of Cheques and Bills

Payment Function/Remittance Services (DD, BC, MT, TT, ECS,

NEFT, RTGS, SWIFT, Credit/Debit Card/Smart Card etc.) Safe Custody of Articles

Hiring Safe Deposit Lockers

Conducting Foreign Exchange Transactions

Conducting Government Transactions

Issuing Letter of Credit and Guarantees

Merchant Banking Functions

Collection of Utility Bills/School fees

Distribution of Insurance and Mutual Fund Products



1-8


PROHIBITED BANKING ACTIVITIES

Section 8 of BR act prohibits a banking company from engaging in thefollowing activities :

Directly or indirectly in trading activities and undertaking tradingrisks

Buying or Selling or Bartering of Goods directly or indirectly

Section 9 prohibits a banking company from holding immovable

properties, howsoever acquired, except as is required for its ownuse, for a period exceeding 7 years from the acquisition of theproperty. RBI may extend this period by another 5 years.

Banking in India is governed by the following statutes :

Banking Regulation Act, 1949

RBI Act, 1934 SBI Act, 1955 & SBI (Subsidiary Banks) Act, 1959

Banking Companies (Acquisitions & Transfer of Undertakings) Act,1970 and 1980 (more popularly known as Bank Nationalisation Act)



1-9


BASIC PRINCIPLES OF BANKING

Principle of Intermediation

Principle of Prudence

Principle of Liquidity

Principle of Profitability

Principle of Solvency

Principle of Trust



1-10


TYPES OF BANKING GROUPS IN INDIA

Scheduled and Non-Scheduled Banks

(a) Scheduled Banks : included in the 2nd

schedule of the RBI Act, 1934.Paid up capital = or > Rs.5 lakh and they have convinced RBI that theiraffairs are Not conducted in a manner detrimental to the interest of theirdepositors. These Banks are required to maintain CRR and SLR.Scheduled Banks are classified as under :

1.1 Co-operative Banks (State and Urban Co-op Banks)

1.2 Commercial Banks

1.2.1 Foreign Scheduled Banks

1.2.2 Indian Scheduled Banks

(a) Private Sector Scheduled Banks : Both Old and New

(b) Public Sector Scheduled Banks (total 26 as of now)

(i) State Bank Group : SBI + its 5 subsidiaries

(ii) Nationalised Banks : 19 + IDBI Bank 1

(iii) Regional Rural Banks (RRBs) : about 84 as of now

(b) Non-Scheduled Banks : Not included in the 2nd schedule of theRBI act. Their No. has progressively reduced over the years.



1-11



Role and Functions of Commercial Banks :

(a) Traditional Functions : These are performed byalmost every bank, irrespective of its size, ownershippattern and operational area.

(b) Modern Functions : These are mostly performed by

large sized/modern banks, situated in commercial centresor metro cities.

Traditional Functions /(Core or Primary or Essential):

Financial Intermediation : (a) Deposit Function/Accepting

Deposits, (b) Loan Function/Making Loans and (c)Investment Function/Making Investments

Payment & Settlement System : Remittances of Fundsand settlement of financial/economic transactions within

the country and across countries.



1-12



Role and Functions of Commercial Banks :

Traditional Functions/(Ancillary activities orMiscellaneous Financial Services) : These are agencyservices aka non-fund based/Off-Balance Sheet Servicesor fee-based services, e.g., Issue of Credit/Debit Cards,Issue of Travellers Cheques, Drafts, Letter of Credits (LC),Bank Guarantees (BG or LG), Collection of Cheques, Bills,Safe Custody of Valuables, Safe Deposit Lockers,Conducting Govt. Business (Cllection of Taxes/Payment ofPensions), Collection of Utility Bills/School fees etc.



1-13



Modern Banking Functions :

(a) Cross-border fund raising services like : External Commercial Borrowings (ECB)

Global Depository Receipts (GDRs)/American Depository Receipts(ADRs)/International Depository Receipts (IDRs)

Non-Resident External (NRE) Rupee Accounts/Foreign Currency Non-

Resident (FCNR) Accounts

Syndication of Foreign Currency Loans

(b) Cross-border Banking Services/International Trade Finance

Import Financing/Leasing/

Export Financing/Forfaiting/Factoring/Leasing(c) Merchant Banking/Investment Banking Services : Non-fund basedor fee-based services. Financial Dis-intermediation. Project Appraisal,Financial Advisory Services including Fund Raising Services indomestic and international markets

1 14



1-14



(d) Portfolio Management Services (PMS)/Wealth Management andPrivate Banking Services like (i) Advisory Services : Flexible, unbiasedinvestment advices customised to meet clients needs (ii) TransactionSupport : Brokerage Services (3 in 1 account) (iii) Custodial Services :Demat Accounts for Shares/Bonds/Mutual Fund Units.

(e) Bancassurance and Bank Mutual Fund Business : Banks havemade entry into Insurance and Mutual Fund Business either with orwithout risk participation basis. Some Banks are floating Insurance(Life/Non-Life) Ventures and MF House and some banks are onlymarketing the Insurance and Mutual Fund Products by tying up withInsurance Companies and MF Houses.

1 15



1-15


Why do banks perform those services?

Banks are private firms with a public purpose. They seek

to maximize shareholder wealth (represented by themarket value of bank stock and dividends paid).

Banking is the management of risk. By taking risks, theyearn a profit.

-- Credit risk -- Foreign exchange risk

-- Interest rate risk -- Compliance risk

-- Liquidity risk -- Strategic risk

-- Price risk -- Reputation risk

Various factors that affect banks include market, social,

and legal and regulatory constraints.

1 16



1-16


What factors have affected the operations of commercial

banks and other financial service organizations?

Inflation and volatile interest rates:

Rising interest rates caused shorter-term deposit costs torise faster than longer-term loans. Also, as rates rose, themarket value of their assets declined and borrowersdefaulted on loans with greater frequency than normal.

Securitization: Banks are pooling loans for various kinds and selling

securities with claims on these loans.

Technological advances:

Telecommunications and computers are increasing

economies of scale and economies of scope for banks.

1 17



1-17




Fundamental Forces of Change in the

Banking & Financial Sector : Consumers/Customers have become better informed, more

sophisticated, more demanding, less forgiving and less loyal.

Capital and Money markets have increased their competition with

banks in attracting firms seeking debt funds. Deregulation/Reregulation and Liberalisation :

The elimination of laws that placed geographic limits on banks, theirproducts and services, and the interest rates they can pay ondeposits and charge on loans has increased banking risks for the

customers as well as for the banks themselves and this has alsostimulated bank mergers and consolidation.

De-specialization and Rising competition among financialinstitutions with one-stop shopping centers leading to Universal orUmbrella Banking. Intense Competition from Banks as well as Non-

Banks and Capital & Money Markets

1 18


18/28

McGraw-Hill/Irwin

1-18




Global integration of financial markets (Globalisation) andPrivatisation of Banking Sector is increasing competition from

foreign financial service firms.

Disintermediation & Securitisation

Technological Revolution/Convergence of Technology

Financial Innovation/Service or Product Proliferation

Rising Funding Costs and Shrinking Spreads Consolidation and Geographic Expansion

Convergence of Business/Universal Banking

Capital

Corporate Governance

Globalisation of Banking

Need for Multi-Skilled Banking & Finance Professionals

Increased risk of failure and weakness of Government DepositInsurance System

1 19Wh t th i i l d


19/28

McGraw-Hill/Irwin

1-19


What are the principal sources and uses

of funds for banks?

Assets

Loanscommercial and industrial (C&I) loans

real estate loans

consumer loans

Investments

short-term, liquid securities (e.g., Govt. Treasury securities)

long-term securities (Govt. as well as Corporate)

Cash

Other assets

buildings, equipment, etc.

1 20

Wh t th i i l d


20/28

McGraw-Hill/Irwin

1-20


What are the principal sources and uses

of funds for banks?

Liabilities

DepositsTransactions or demand deposits

Non-transactions or Term (Time) deposits

Non-deposit sources of funds (Borrowings/Refinancing)

Equity

Relatively small compared to debt sources of funds. Highlyleveraged compared to nonfinancial firms.

1 21


21/28

McGraw-Hill/Irwin

1-21


Mobilisation of Resources and Deployment of

Resources by Banks

Mobilisation of Resources (Cost and Stability of Deposits Core or StableDeposits and Non-Core or Unstable or Volatile Deposits)

Deposits/Funds Raising

Low Cost and No Cost Deposits like Current Deposit A/c and SavingsDeposit A/c (CASA)

Term (Time) or Fixed deposits

Non-deposit sources of funds (Borrowings/Refinancing)

Deployment of Resources

Lending (Risk, Return, Maturity Profile, Credit Concentration or ExposureNorms, Diversification, Govt. of India/RBI Regulation, Banks Credit orLoan Policy) Directed Credit Like Priority Sector Credit, Credit to ExportSector etc. and Non-Priority Credit.

Investments (Risk, Return, Maturity Profile, Concentration or ExposureNorms, Diversification, Govt. of India/RBI Regulation, Banks InvestmentPolicy) SLR or Mandated or Directed Investments and Non-SLR or Non-Mandated Investments.

1 22


22/28

McGraw-Hill/Irwin

1-22



Resources by Banks - 2

CD Ratio : What it is Credit (Loans) to Deposit Ratio. Duringperiods of high economic activity, credit demand/credit off takewill be high leading to high CD ratio (CDR). Higher CDR meanshigher revenue and profit. What is credit off take or loandemand? Low and high credit off take. Relation between Depositmobilisation and Credit Off take/Loan Demand. Relation between

Credit Off take/Loan Demand and Economic activity/BusinessConfidence. Relation between Deposit mobilisation and StockMarket Performance/Sentiment/Level of Interest Rate (BankDeposit Rates). When or under what circumstances CDR will goup and go down ? A higher CDR is better or a lower CDR is better

for the bank. Relation between a Banks CD ratio and BanksProfitability.

1-23


23/28

McGraw-Hill/Irwin

1-23



Resources by Banks - 2

ID Ratio : What it is Investment to Deposit Ratio.

During periods of low economic activity/recession,credit demand/off take will be low; banks will deploymore money in Investment leading to higher ID ratio(IDR) and consequently lower CDR. On an averageCredit/Loans earn higher return for the bank than the

average investments, so a higher CDR is better for thebank. Relation between CD ratio and ID ratio. When orunder what circumstances IDR will go up and go down? A higher IDR is better or a lower IDR is better for the

bank. Relation between a Banks ID ratio and BanksProfitability.

1-24


24/28

McGraw-Hill/Irwin

1 24


EMERGING TRENDS & CHALLENGES IN BANKING

UNIVERSAL BANKING

(BANCASSURANCE/PARA BANKINGACTIVITIES)

ELECTRONIC BANKING

GLOBALISATION OF BANKING

CRM IN BANKS

1-25


25/28

McGraw-Hill/Irwin

1 25


KEY WORDS/TERMINOLOGIES/GLOSSARY

Banking, Scheduled Banks, SLR, ECS,

EFT, NEFT, RTGS, SWIFTDeregulation, Globalisation, CD ratio, ID

ratio, Intermediation, Solvency

Universal Banking, Bancassurance,Electronic Banking

Primary or Core Banking Activities,

Ancillary or Subsidiary BankingActivities, CASA Deposit & CASA ratio

1-26


26/28

McGraw-Hill/Irwin

1 26


Home Task for Next Class For Self Check

HOME TASK/CONCEPT CHECK

QUESTIONS FOR SELF REVIEW :Question #1. Core or Primary activities of

a Bank.

Q. #2. Explain the Process of FinancialIntermediation.

Q. #3. Explain the concepts of SLR, CD

ratio, ID Ratio. How CDR & IDR arerelated to economic activity and eachother ?

1-27Topics for Next Class All of you Should get


27/28

McGraw-Hill/Irwin

1 27


Topics for Next Class All of you Should get

prepared before coming to the class

Process of Financial Intermediation

Different types of Intermediation andvarious risks of Financial Intermediation.

Why Banks and FIs are special ? Why

they are regulated ? Legal & Regulatory framework of Indian

Banking System.

Banking Regulation/Role and Functionsof RBI.

1-28


28/28

8

Web Resources

For information on regulation of depository

institutions and investment firms visit:SEBI www.sebi.gov.in

RBI www.rbi.org.in

IBA www.iba.org.in

BIS www.bis.org

IIBF www.iibf.org.in
http://www.rbi.org/http://www.iba.org.in/http://www.bis.org/http://www.bis.org/http://www.iba.org.in/http://www.rbi.org/

Slide 1 - Definition and Functions of Banking

Documents

Transcript of Slide 1 - Definition and Functions of Banking