#01 Banking-An Introduction

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MBFI Lecture Note # 01

Financial Institutions can be defined as entities whose assets are almost entirely

financial assets. And, Financial Assetscan be defined as claims on others such

as individuals, firms, companies, institutions and the government (claims such as

receivables sundry debtors are generally not considered as financial assets).

However, in India, the legal definition [Section 45-I of the RBI Act 1934] is as

follows.

"Financial Institution" means any non-banking institution which carries on as its

business or part of its business any of the following activities, namely:-

a) the financing, whether by way of making loans or advances or otherwise,

of any activity other than its own;

b) the acquisition of shares, stock, bonds, debentures or securities issued by

a government or local authority or other marketable securities of a like

nature;

c) letting or delivering of any goods to a hirer under a hire-purchase

agreement as defined in clause (c ) of section 2 of the Hire-Purchase Act,

1972;

d) the carrying on of any class of insurance business;e) managing, conducting or supervising, as foreman, agent or in any other

capacity, of chits or kuries as defined in any law which is for the time

being in force in any State, or any business, which is similar thereto;

f) collecting, for any purpose or under any scheme or arrangement by

whatever name called monies in lump sum or otherwise, by way of

subscriptions or by sale of units, or other instruments or in any other

manner and awarding prizes or gifts, whether in cash or kind, or

disbursing monies in any other way, to persons from whom monies are

collected or to any other person. Butdoes not include any institution,

which carries on as its principal business,-

a) agricultural operations; or

b) industrial activity; or;

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MBFI Lecture Note # 01can draw checks and banks have to honour these cheques provided they

have funds or balance in their accounts.

o Movement of funds DD, TT, MT & EFT

Banks facilitate the movement of funds from one place to another by

issuing what are known as demand drafts (DD), telegraphic transfers (TT),

mail transfers (MT) and electronic fund transfers (EFT). A customer in

Chennai who wants to send money to someone in Mumbai, for instance,

can simply tell his banker to issue a DD/TT favouring that person payable

in Mumbai.

Financial Intermediation

o Banks enable financial intermediation ie they intermediate between

those who have money/savings (Savers) and those who need

money/investors/entrepreneurs (Borrowers)

o Efficient allocation of capital is crucial for an economy to ensure that

resources put to best and efficient use

o Economic growth depends on savings and efficient use of saving

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Indian Financial System

Historical Perspective

Financial systems evolve over a period of time and are influenced by the politico

economic environment. And, economic development is accompanied by growth of

financial organizations.

Upto 1951

Post independence and before the Five Year Plans started

Closed character of industrial entrepreneurship

Not well organized securities and capital market

Lack of intermediaries

Lack of institutional infrastructure

Bank lending security and collateral based

The Plans period (up to the late eighties)

Pursuance of goals of accelerated economic growth with social justice

Adoption of the mixed economy model and use of Five Year Plans

Need felt for alignment of financial system with the priorities of

governments economic policy

Government control over distribution of credit & finance

Emphasis shifted from Business to Development

Directed bank lending loans only for desired sectors

Fortification of the institutional structure

New institutions :

development banks

UTI

Insurance companies

Public / government ownership to direct savings into desired sectors

Nationalization of major banks in 1969

Control over corporate management of banks

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Cap on voting rights of shareholders

Approval of RBI required over appointment of the Chairman managing

Director and other Directors of the Board of Directors

Micro regulation by RBI

Problems in this period PSU banks

Concentration on deposit mobilization, branch expansion and following

ministry/RBI directives

Lack of competition

Bureaucratization

Not profit oriented, NPAs, overstaffing

Non-uniform accounting

Low capitalization

Development Financial Institutions (DFIs)

DFIs acted as mere canalizing agencies- channeling money from the

government to borrowers

Accumulated mountains of debt

NPAs and no prudential norms

Became dens of corruption

BOP Crisis of the early 1990s led to structural changes and reforms

leading to a the present liberalized and deregulated environment

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Indian Financial System An Overview

Institution

s

8

BanksFinancial

D F Is

NBFCs

Services Merchant / Investment Bankers

Mutual Funds

Credit Rating Agencies

InsuranceLife Insurance Companies

General Insurance Companies

Regulators

R B I

SEBI

IRDA

Markets

Primary

Secondary

Capital Market

Money Market

Instruments

Debt

Equity

Hybrid

Shares

Convertible Debentures

Foreign Exchange Market

G-Secs, Bonds, Debentures, CDs, CPs, Call Money, ICDsDebt


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Banking Scenario in India

Types of Banks in India

Commercial Banks

Cooperative Banks

Regional Rural Banks

Local Area Banks

Scheduled Banks

o RBI , after being satisfied that a bank conforms to certain standards,

gives recognition to it by including it in the Second Schedule to the

Reserve Bank of India Act 1934

o Importance

Status

Certain privileges such are refinance etc

Support from RBI in case of trouble

Stricter regulation and supervision by RBI

o As of now, all commercial banks, RRBs, State cooperative Banks and

most Urban Cooperative banks are scheduled

Commercial Banks

Companies which have been granted banking license by RBI

Doing commercial banking

Public Sector Banks

Old Private Sector Banks

New Private Sector Banks

Foreign Banks ( branches of banks incorporated outside India)

RBI treats all commercial banks on the same footing

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Cooperative Banks

Financial Institutions set up in the cooperative mode

State Cooperative Banks

District / Central Cooperative Banks

Urban Cooperative Banks / Primary Credit Societies

Primarily under the Registrar of Cooperative Societies

Banks regulated by RBI - brought under RBI regulation in 1966

Though the ownership pattern id different, thye are an important segment of

the financial (& payment) system

Recently difficulties in some of the banks in this sector created problems in the

entire banking system currently the dual control is an area of concern

Regional Rural Banks

196 in number

set up in 1976

to provide credit and other facilities in the rural area

o local area of operationso manned by local people (hence low cost and local knowledge)

o sponsored by a public sector bank

o ownership GOI 50%, State 15% and bank 35%

o all RRBs have been granted the scheduled bank status

o supervision is by NABARD

Local Area Banks

guidelines issued in 1996

Minimum Capital Rs 5 crs (promoter not less than 2 crs)

Commercial banking but limited to three contiguous districts

7 approved 5 issued licenses

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#01 Banking-An Introduction