21 Banking-Theory-Law and Practice

5/28/2018 21 Banking-Theory-Law and Practice

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BANKING THEORY LAW AND PRACTICE

BBA 2.1


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BANKING THEORY LAW AND PRACTICE

Evolution of Banks Functions of Commercial Banks Balance Sheet of Commercial Banks Credit Creation,

Organization and structure of Banks Unit Banking and Mixed Banking u!lic Sector and rivate Sector Banks "ationalization of Commercial Banks O!#ects rogress$

Central Bank Evolution Functions Credit Control Measures

Mone% market &ndian mone% market Com'onents Characteristics of develo'ed and under develo'ed monemarket$

Banker and Customer (eneral and S'ecial relationshi's "egotia!le instruments Features )%'es of account )%'es of customers ass Book Che*ue Features Crossing Endorsements

a%ing !anker +uties older in due course a%ment in the due course rotection Collecting !anker +utie rotection

Text and Reference B!"#

-$ Basu . )heor% and ractice of +evelo'ment Banking

/$ Muran#an S$0$ . Modern Banking in &ndia1$ 2edd% 3 4''anniah . Banking )heor% and ractice5$ "atara#an 3 (ordon . Banking )heor% and ractice


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Le""n 1E$OL%TION O& BANKING

E'()t*n f Ban!*n+ In"t*t)t*n"

Origin of the 6ord 7Bank8$ O'inion is divided in regard to this$ 4ccording to some authorities, the 6ork 7Bank8 itseis derived from the 6ords 7!ancus8 or 7!an*ee,8 that is, a !ench$ )he earl% !ankers, the 9e6s in :om!ard%transacted their !usiness on !enches in the market 'lace$ ;hen a !anker failed his 7!anco8 6as !roken u' !% th'eo'le, hence the 6ord 7!ankru't$8 )his et%molog% is ho6ever, ridiculed !% Macleod on the ground 4ges8$ )here arothers, 6ho are of the o'inion that the 6ord 7!ank8 is originall% derived from the (erman 6ord 7!ack8 meaning a #oin

stock fund, 6hich 6as &talianised into 7!anco8 6hen the (ermans 6ere masters of a great 'art of &tal%$ )his a''earto !e more 'ossi!le$ But 76hatever8 !e the origin of the 6ord resen+a% Banking in &ndia, -st edition,'@@A 7&t 6ould trace the histor% of !anking in Euro'e from the Middle 4ges$8 E42: &S)O2 OF B4"0&"( 4s earl% as / B$C$, the Ba!%lonians had develo'ed a !anking s%stem)here is evidence to sho6 that the tem'les of Ba!%lon 6ere used as !anks, and such great tem'les as those oE'hesus and of +el!hi 6ere the most 'o6erful of the (reek !anking institutions$ But the s'read of irreligion soodestro%ed the 'u!lic sense of securit% in de'ositing mone% and valua!les in tem'les, and the 'riests 6ere no longeacting as financial agents$ )he 2omans did not organize State Banks as did the (reeks, !ut their minute regulationsas to the conduct of 'rivate !anking, 6ere calculated to create the utmost confidence in it$ ;ith the end of thcovilisaiton of anti*uit%, and as a result of administrative decentralization and demoralization of the (overnmenauthorit%, 6ith its inevita!le counter'art of commercial insecurit%, !anking degenerated for a 'eriod of some centurieinto a s%stem of financial makeshifts$ But that 6as not the onl% cause$ Old 're#udices die hard, and 4ristotle=s dictumthat the charging of inerest 6as unnatural and conse*uentl% immoral 6as adhered to fanaticall%$ Even no6 som

Mohammedans, in o!edience to the commands contained in that !ehalf in their religious !ooks, refuse to acce'interest on mone% loans$ )he follo6ers of 4ristotle=s dictum forgot that the ancient 6orld, the e!res includedalthough it had to s%stem of !anks that 6ould !e considered ade*uate from the modern 'oint of vie6, and maintainemone%lenders and made no sin of interest, !ut onl% of usur%$ o6ever, u'on the revival of civilization, gro6innecessit% forced the issue in the middle of the -/th centur%, and !anks 6ere esta!lished at Denice and (enoathough in fact the% did not !ecome !anks as 6e understood them toda%, till long after$ 4gain the origin of moder!anking ma% !e traced to the mone% dealers in Florence, 6ho received mone% on de'osit, and 6ere lenders omone% in the -5th centur%, and the names of the Bardi, 4ccia#uoli, eruzzi, itti and Medici soon !ecame famounthroughout Euro'e, as !ankers$ 4t one time, Florence is said to have had eight% !ankers, though it could !oast of n'u!lic !ank$

T,e De'e(-ent f Br*t*", Ban!*n+2O4: EC4"(E2 in England, 6e find during the reign of Ed6ard &&&, mone% changing?an im'ortant function o

the !ankers of those da%s?6as taken u' !% a 2o%al Exchanger for the !enefit of the Cro6n$ e exchanged thvarious foreign coins, tendered to his m% travelers and merchants entering the kingdom, into British mone%, and, othe other hand, su''lied 'ersons going out of the countr% 6ith the foreign mone% the% re*uired$)E (O:+SM&)S &t is 'ro!a!l% true to sa% that the ground 6as 're'ared for modern !anking in England, !% thinflux of gold from 4merica in the Eliza!ethan 4ge and the simultaneous gro6th of foreign trade$ :and ceased to !the onl% form of 6ealth, and the countr% gentlemen and the to6n merchants, !egan to hold 'art of their 7ca'ital8 cash$ &m'etus 6as given to 'u!lic !anking !% the seizure, !% Charles & in -5 of -1, !ullion left for safe custod!% the cit% merchants at the 2o%al Mint$ 4s a result of this 2o%al re'udiation, the merchants !egan to entrust thecashiers 6ith large sums, !ut the later mis?a''ro'riated their masters= mone% for their o6n !enefit$ Finding that theem'lo%ees had not treated them !etter than their king, the cit% merchants decided to kee' their cash 6itgoldsmiths,6ho in those da%s had strong rooms and em'lo%ed 6atchmen$

E42: 2E(&""&"( OF 7&SSUE8 4"+ 7+EOS&)8 B4"0&"( ? )hus, large sums of mone% 6ere left 6ith thgoldsmiths for safe custod% against their signed recei'ts, kno6n as 7goldsmiths= notes,8 em!od%ing an undertaking treturn the mone% to he de'ositor or to !earer on demand$ )6o develo'ments *uickl% follo6ed, 6hich 6ere thfoundation of 7issue8 and 7de'osit8 !anking, res'ectivel%$ )he first 6as that the goldsmiths= note !ocmome 'a%a!le t!earer, and so 6as transformed from a recei't to a !ank note$ &t 6as 'a%a!le on demand, and en#o%ed considera!lcirculation$ Secondl%, the goldsmiths graduall% discovered that large sums of mone% 6ere left in their kee'ing for lon'eriods and, follo6ing the exam'le of +utch !ankers, the% thought it safe and 'rofita!le to lend out a 'art of thecustomers= mone% 'rovided such loans 6ere ra'id 6ithin a fixed time$ Further, realizing that the !usiness of loaning oother 'eo'le=s mone% at interest 6as 'rofita!le, and in order to attract larger amounts, the more enter'rising of thgoldsmiths !egan to offer interest on mone% de'osited 6ith them, instead of charging a fee for their services iguarding their clients= gold$ )his marks an im'ortant ste' in the develo'ment of !anking in England$ Business gre6 tsuch an extent that it soon !ecame clear that a goldsmith could al6a%s s'are a certain 'ro'ortion of his cash foloans, regardless of the date at 6hich his notes fell due$ &t e*uall% !ecame safe for him to make his notes 'a%a!le a


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an% time, for so long as his credit remained good, he could calculate, on the la6 of average, the amount of gold hneeded to meet the dail% claims of his note holders and de'ositors$

7CU22E") 4CCOU")8$ &t 6as in -G/, that this develo'ment of English !anking received a rude set!ack$ Charle&& !orro6ed heavil% from the goldsmiths and 'rom'tl% like his father re'udiated his de!ts$ 4 crisis ensued, and 6afollo6ed !% a general sus'ension of 'a%ments$ Confidence, ho6ever, 6as restored in s'ite of the shock and thgeneral !elief, 6hich it 'roduced among 'eo'le that the goldsmiths 6ere guilt% of im'rudence and exor!itan'ractices$ &t 6as soon after this date that the goldsmiths found that the% could receive mone% on 6hat is no6 terme7current account,8 i$e$, mone% 6ithdra6al 6ithout notice$

EARLY GROWTH O& /OINT0TOCK BANK IN INDIA)he origin of modern !anking in &ndia dates !ack to -GG 6hen the first #oint?stock !ank, named the industan Bank6as started !% the English 4genc% house of 4lexander 3 Co, in Calcutta$ )he !ank 6as, ho6ever, 6ould u' in -@1/$

Pre"*denc Ban!")he real gro6th of modern commercial !anking !egan in the countr% 6hen the government 6as a6akened to thneed for !anks in -@ 6ith the esta!lishment of the first residenc% Bank, called the Bank of Bengal, in Calcutta that %ear$ )hen follo6ed the esta!lishment of t6o other residenc% Banks, namel%, the Bank of Bom!a% in -@5 anthe Bank of Madras in -@51$ )o each of these !anks, the government had su!scri!ed 2s$ 1 lakhs to their sharca'ital$ o6ever, a ma#or 'art of their share ca'ital 6as contri!uted !% the Euro'ean shareholders$ )hese residencBanks, ho6ever, en#o%ed the mono'ol% of government !anking$ )he% 6ere also given the right of note?issue in -@/16hich 6as ho6ever, 6ithdra6n in -@/$

)hese three residenc% Banks continued till -H/$ &n -H/- the% 6ere amalgamated into the &m'erial Bank of &ndia$

Ind*an /*nt0tc! Ban!"

)he %ear -@ is a landmark in the histor% of 'u!lic !anks in &ndia, since in that %ear the 'rinci'le of limited lia!ilit6as first a''lied to #oin?stock !anks$ Since -@ till the end of the nineteenth centur%, a num!er of &ndian #oint stoc!anks come into existence$ For instance, the 4llaha!ad Bank 6as started at 4llaha!ad in -@I$ &n -@GI, the 4lliancBank of Simla 6as started$ &n -@@H, another &ndian !ank called Oudh Commercial Bank 6as esta!lished$ &n -@HI, thfamous un#a! "ational Bank came into existence$&ns'ired !% the S6adeshi Movement, several &ndian entre'reneurs ventured into the modern !anking !usines+uring the !oom 'eriod of -H?-1, thus, there 6as s mushroom gro6th of !anks$ Man% 'rominent !anks also caminto existence during this 'eriod$ )hese 6ere the Bank of &ndia >-HA, the Canara Bank >-HA, the Bank of Barod>-H@A, and the Central Bank of &ndia >-H--A$

&re*+n Ban!"&n addition to the &ndian #oint?stock !anks, a num!er of multi?national foreign !anks called 7exchange !anks8, 6ittheir head offices in their home countries, entered the !anking s%stem of &ndia$ Exchange !anks 6ere essentialmeant for financing the foreign trade of the countr%, !ut the% also conducted !anking activit% in com'etition 6ith &ndia!anks$ )he exchange !anks are termed 7foreign !anks8, !ecause the% 6ere financed and managed !% non?&ndians$

Ban! Cr*"*")ill a!out the middle of the t6entieth centur%, &ndian #oint?stock !anks had a checkered career in the countr%$ )h!anking sector ex'erience severe set?!acks during the 'riod?-H-1?-G, as -@ !anks failed and another 1G1 !ankfailed on -H//?1 6hich 6as again follo6ed !% the failure of / more !anks in -H1G?1@$)he Central Banking En*uir% Committee >-H/HA traced the follo6ing ma#or causes of !ank failure in &ndia.>-A &nsufficient 'aid?u' ca'ital and reservesJ>/A oor li*uidit% of assetsJ>1A Com!ination of non?!anking activities 6ith !anking$>5A &rrational credit 'olic% causing reckless and in#udicious advancesJ>IA Favouritism !% the directors the their vested interestsJ>A &ncom'etent and inex'erienced directorsJ>GA MismanagementJ>@A +ishonest managementJ>HA Creation of long?term loans on the !asis of short?term de'ositsJ>-A &ndulgence in s'eculative investmentJ>--A &gnorgance of the 'eo'le a!out !anking !usinessJ>-/A :ack of co?ordinate among #oint?stock !anksJ>-1A 4!sence of a central !ank for overall su'ervision and controlJ>-5A :ack of suita!le !anking legislation for regulation of !anks$


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4nd a!ove all, the shattered 'u!lic confidence in !anks ma% !e accounted for the failure of man% &ndian commercia!anks over time$4nother event of !ank failure took 'lace in -H5?5G, 6ith the crash of the 4$B$C$ Bank, the ExchangBank of &ndia and 4frica and the "ath Banks$

Eventuall%, at the time of &nde'endence >in -H5GA, &ndia inherited an extremel% 6eak !anking structure, 6itthe ur!an?orientation, com'rising I55 small non?scheduled !anks and H scheduled !anks, giving !ulk finance to thtrading sector$ Moreover, onl% a fe6 of them 'ossessed on all?&ndia character, 6hile most of them had limitegeogra'hical coverage in their !usiness$

3A/OR BANKING DE$ELOP3ENT4RE&OR3 D%RING THE PLANNING ERA4fter inde'endence, the (overnment of &ndia launched economic 'lanning in the countr% since -HI-$ +uring the las1G %ears of the 'lanning era, commercial !anking has undergone drastic transformation through several im'ortandevelo'mentsK reforms and 'olic% measures introduced !% the government$Some of the ma#or changes introduced in the &ndian !anking s%stem ma% !e enlisted as follo6s.>-A :i*uidation and amalgamation of !anksJ>/A "ationalization of the 2eserve Bank of &ndiaJ>1A Banking legislationJ>5A Evolution of 'u!lic sector !anking through !ank nationalization$>IA +eclining significance of foreign !anksJ>A Structural changes of commercial !ankingJ>GA "e6 strategies in !anking !usiness$

Ban!*n+ # Def*n*t*n4 !anking com'an% is defined a com'an% 6hich transacts the !usiness of !anking in &ndia$ )he Banking 2egulatio4ct defines the !usiness of !anking !% stating the essential functions of a !anker$ &t also states the various othe!usinesses a !anking com'an% ma% !e engaged in and 'rohi!its certain !usinesses to !e 'reformed !% it$)he term Section I>!A

)he sailent features of this definition are as follo6s.>iA 4 !anking com'an% must 'erform !oth of the essential functions, viz$, >aA acce'ting of de'osits, and >!A lending oinvesting the same$ &f the 'ur'ose of acce'ting of de'osits is not to lend or invest, the !usiness 6ill not !e calle!anking !usiness$ )he ex'lanation to Section I>cA makes it clear that an% com'an% 6hich is engaged in thmanufacture of goods or carries on an% trade and 6hich acce'ts de'osits of mone% from the 'u!lic merel% for th'ur'ose of financing its !usiness, as such manufacturer or trader shall not !e deemed to transact the !usiness o

!anking$>iiA )he 'hrase


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*r /,n Pa+et5" Def*n*t*n#4ccording to Sir 9ohn aget, 7"o 'erson or !od% cor'orate or other6ise, can !e !anker 6ho does not >iA take de'osit, accounts, >iiA take current accounts, >iiiA issue and 'a% che*ues, and >ivA collecche*ues, crossed and uncrossed, for his customers$8 )his definitions 'oints out the four essential functions of th!anking !usiness$ Sir 9ohn aget also la%s em'hasis on the 'erformance of the a!ove functions in a regular anrecognized manner$ 4ccording to his, 7one claiming to !e a !anker must 'rofess himself to !e one and the 'u!limust acce't his as such, his main !usiness must !e that of !anking from 6hich, generall%, he should !e a!le to earhis living$8 )he a!ove?mentioned function are considered as the essential functions of a !anker !ut this definition doenot include the other functions 6hich are no6 !eing 'erformed !% modern !ankers$

"ame must include the 6ord


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LEON 2

&%NCTION O& CO33ERCIAL BANK

4 commercial !ank is a financial institution 6hose main !usiness is to acce't de'osits from the 'u!lic and to giveloans to those 6ho re*uire it for short 'eriods$ )he general functions of a commercial !ank ma% !e summarized as

follo6s.?

1. Rece*'*n+ f De-"*t")he most im'ortant functions of the commercial !anks is to receive de'osits form the 'u!lic$ )he commercial !anknot onl% 'rotect them !ut also hel' transfer of funds through che*ues and even undertake to re'a% the mone% in legatender mone%$+e'osits received !% the commercial !anks are of various t%'es, ? fixed de'osits, savings de'osits, current de'ositand recurring de'osits$ Fixed de'osits or )ime de'osits are 6ith the !ank for a s'ecified 'eriod of time and the% ca!e 6ithdra6n onl% after the ex'ir% of the said 'eriod$ )he interest rate de'ends on the time agreed u'on$ )he longethe maturit% 'eriod, the higher the interest rate and vice versa$ Form the 'oint of vie6 of safet% and interest, fixede'osits are 'refera!le$Savings de'osits are those de'osits received su!#ect to certain restrictions$ For instance, the interest is normallo6er on savings de'ositsJ 6ithdra6als ma% !e made once or t6ice a 6eek$

Current de'osit or demand de'osits as the% the often called, are those de'osits 6ithdra6a!le !% thde'ositor at an% time 6ithout an% 'rior notice !% means of che*ues$ )he !anks do not 'a% an% interest on deman

de'osits, !ut in fact make a small charge on customers 6ith current account$2ecurring de'osits are those de'osits received !% the !anks in e*ual monthl% 'remium for a certain num!e

of %ears the total of 6hich 6ill !e 'aid to the de'ositor 6ith interest due thereon after the ex'ir% of the date of maturit%+e'osits at cal according to 6hich de'osits ma% !e 6ithdra6n 6hen asked for !% the de'ositor, de'osits a

short notice !% 6hich de'ositors are re*uired to give notice !efore certain num!er of da%s >G,/-,1,5I or HA fo6ithdra6al of de'osits, short?time de'osits for short 'eriod of a %ear or less for lo6er interest and retirement !enefitde'osits, are some of the im'ortant forms of de'osits received !% the commercial !anks$

2. 3a!*n+ (an" and Ad'ance")he second 'rinci'al functions of the commercial !ank is to make loans and advances out of the 'u!lic de'osits+irect loans and advances are given to all 'ersons against 'ersonal securit%, gold and silver and other mova!le animmova!le assets$ )his the !anks do !% overdraft facilities, that is, !% allo6ing the !orro6er or overdra6 his currenaccount and also !% discounting !ills of exchange$ )he merchants and manufacturers ena!led to o!tain ade*uat

funds for 'roduction of goods and services$ )he% hel' in the develo'ment of those industries 6hich 'erform the mosuseful service to the communit%$)he loans and advances made !% the commercial !anks are of various forms, like cash credit, overdraft, demanloan, hire 'urchase loan, etc$ Cash credit is that loan given !% a commercial !ank in installments against the securitof ra6 materials, 'roduced goods, etc$ Overdraft is made on securit% against stock and shares, insurance 'oliciesetc$, under current account$ +emand loan is 'aid in full to the de!tor at a time$ ire 'urchase loans are made to a'ersons for the 'urchase of customer dura!le goods like radio, !ic%cle, tailoring machine, sites for !uildings etc anthese loans are re'a%a!le to the !ank in eas% installments 6ith interest due thereon$

6. A+enc er'*ce"4 commercial !ank 'rovides a range of investment services$ Customers can arrange for dividends to !e sent to the!ank and directl% remitted into their !ank accounts, or for the !ank to detach cou'ons from !earer !onds and 'resenthem for 'a%ments and to act u'on announcements in the ress of dra6n !onds, cou'ons 'a%a!le, etc$ Orders fothe 'urchase or sale of stock exchange securities are executed through the !anks= !rokers 6ho 6ill also theo'inions on securities or lists of securities$Similarl%, !anks 6ill make a''lications of !ehalf of their customers for allotments arising from ne6 ca'ital issues, 'acalls as the% fall due >that is, su!scri'tions to ca'ital issues made over a 'eriodA, and ultimatel% o!tain the sharcertificate or other documents of title$ On certain agreed terms the !anks 6ill allo6 their names to a''ear on a''rove'ros'ectuses or other documents as !ankers for the issue of ne6 ca'ital, the% 6ill receive a''lications and carr% ouother instructions$

4 commercial !ank undertakes the 'a%ment of su!scri'tions, 'remia, rents and collection of che*ues, !ill'romissor% notes etc$, on !ehalf of its customers$ &t also acts as a corres'ondent or re'resentative of its customersother !anks and financial cor'orations$Most of the commercial !anks have an executor and trustee de'artmentsJ some ma% have affiliated com'anies tdeal 6ith this !ranch of their !usiness$ )he% aim to 'rovide, !efore, a com'lete range of trustee, executor, or advisor


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services for a small charge$ )he !usiness of !anks acting as trustees, executors, administrators, etc$, hacontinuousl% ex'anded 6ith considera!le usefulness to their customers$ B% a''ointing a !ank as an executor otrustee of his 6ill the customer secures the advantage of continuit%, and avoids having to make changesJ im'artialitin dealing 6ith !eneficiaries and in the exercise of discretionsJ and the legal and s'ecialized kno6ledge 'ertaining texecutor and trustee services$ ;hen a 'erson dies 6ithout making a 6ill the next?of?kin can em'lo% the !ank to act aadministrator and to deal 6ith the estate in accordance 6ith the rules relating to intestacies$ 4lternativel%, if a testatomakes a 6ill !ut fails to a''oint an executor, or if an executor is una!le of un6illing to act, the !ank can usuallundertake the administration 6ith the consent of the 'ersons 6ho are immediatel% concerned$ Banks 6ill act solel% o

#ointl% 6ith others in these maters, as also in the case of trustee for stocks, shares funds, 'ro'erties or othe

investments$ Under a declaration of trust, a !ank undertakes the su'ervision of investments and distri!ution oincomeJ a customer=s investments can !e transferred into the !ank=s name of control, this ena!ling it to acimmediatel% u'on a notice or rights issue, allotment letters, etc$ 4lternativel%, 6here it is not desired to a''oint th!ank as nominee, these services ma% still !e carried out !% a''ointing the !ank as attorne%$ ;here !usiness iincluded in an estate or trust, a !ank 6ill 'rovide for its management for a limited 'eriod, 'ending its sale to the !esadvantage as a going concern or transfer to a !eneficiar%$rivate com'anies 6ishing to set u' 'ension funds ma% a''oint a !ank as a custodian, trustee and investmenadviser, 6hile retaining the administration of the scheme in the hands of the management of the fund$Most !anks 6ill undertake on !ehalf of their customers the 're'aration of income tax returns and claims for threcover% of over'aid taxJ the% also assist the customers in checking of assessments$ &n addition to the usual claiminvolving 'ersonal allo6ances and reliefs, claims are 're'ared on !ehalf of residents a!road, minors, charities, etc$

7. Genera( %t*(*t er'*ce"

)hese services are those in 6hich the !ankers 'osition in not that of an agent for his customer$ )he% include the issuof credit instruments like letters of credit and travellers= che*ues, the acce'tance of !ills of exchange, the safcustod% of valua!les and documents, the transaction of foreign exchange !usiness, acting as a referee as to thres'ecta!ilit% and financial standing of customers and 'roviding s'ecialized advisor% service to customers$

B% selling drafts or orders and !% issuing letters of credit, circular notes, travellers= che*ues, etc$, a commercia!anker is discharging a ver% im'ortant function$ 4 !anker=s draft is an order, addressed !% one office of a !ank to another of its !ranches or !% an% one !ank to another, to 'a% a s'ecified sum to the 'erson concerned$ 4 letter of credis a document issued !% a !anker, authorizing some other !anker to 6hom it si addressed, to honour the che*ues oa 'erson named in the document, to the extent of a stated amount in the letter and to charge the same to the accounofhte grantor of the letter of credit 4 letter of credit includes a 'romise !% the issuing !anker to acce't all !ills to thlimits of credit$ ;hen the 'romise to acce't is conditional on the recei't of the documents of title to goods, it is callea documentar% letter of credit$ But the !anker 6ill still !e lia!le for !ills negotiated !efore the ex'ir% of the 'eriod of it

currenc%$


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service are 'rovided 6ith a leather 6allet, 6hich the% lock !efore 'lacing in the chute$ )he 6allet is o'ened !% thcustomer 6hen he calls at the !ank the next da% to 'a% the contents into his account$

4nother function of great value, !oth to !ankers and to !usinessman, is that of a referee as to the res'ecta!ilit% afinancial status of the customer$

4mong the services introduced !% modern commercial !anks during the last *uarter of a centur% or so, the !ank girand credit cards deserve s'ecial mention$ )he !ank giro is a s%stem !% 6hich a !ank customer 6ith man% 'a%mentto make, instead of dra6ing a che*ue for each item, ma% sim'l% instruct his !ank to transfer to the !ank accounts ohis creditor the sum due from him, and he 6rites one che*ue de!iting his account 6ith the total amount$ Cred

advices containing the name of each creditor 6ith the name of his !ank and the !ranch 6ill !e cleared through thfor exam'le, fuel !ills, rates, etc$A 'rom'tl% as the% !ecome due, 6hilsre'a%ments are s'read over a -/?monthl% 'eriod from the customer=s current account$

4ll these ne6 mone% transmission services have 'articular regard to the develo'ments in com'uterized !ook?kee'in6hich the !anks in some countries have alread% introduced$ Some !anks are re'orted to !e ex'erimenting 6ith thuse of electronic machines 6hich 6ill scan che*ues and dis'ense notes or coins, thus saving time at the counter$

O'er"ea" Tread*n+ er'*ce"2ecognition of overseas trade has led modern commercial !anks to set u' !ranches s'ecializing in the finance oforeign trade and some !anks in some countries have taken interest in ex'ort houses and factoring organizations

4ssisted !% !anks affiliated to them in overseas territories, the% are a!le to 'rovide a com'rehensive net6ork o

services for foreign !anking !usiness, and ma% transactions can !e carried through from start to finish !% a hom!ank or its su!sidiar%$ &n 'laces 6here !anks are not directl% re'resented !% such affiliated undertakings, the% hav6orking arrangements 6ith corres'ondents so that !anks are in a 'osition to undertake foreign !anking !usiness ian% 'art of the 6orld$

)he !anks 'rovide more than #ust a means for the settlements of de!ts !et6een trades !oth at home ana!road for the goods the% !u% and sellJ the% are also 'roviders of credit and ena!le the com'an% to release thca'ital 6hich 6ould other6ise !e tied u' in the goods ex'orted$

8. Infrat*n and t,er er'*ce"4s 'art of their com'rehensive !anking services, man% !anks act as a ma#or sources of information o

overseas trade in all as'ects$ Some !anks 'roduce regular !ulletins on trade and economic conditions at home ana!road, and s'ecial re'orts on commodities and markets$ &n some cases the% invite en*uiries for those 6ishing textend their foreign trade, and are a!le through their corres'ondents to furnish the names of re'uta!le and interestedealers of goods and commodities and to advise on the a''ointment of suita!le agents$ For !usinessmen travelina!road letters of introduction, indicating the 'ur'ose of #ourne% taken, can !e issued addressed to !ankincorres'ondents in the various centers it is 'ro'osed to visit$ &n this 6a% it is often 'ossi!le to esta!lish ne6 avenues o!usiness$ On re*uest, !anks o!tain for customers, for !usiness houses, confidential o'inions on the financial standinof com'anies, firms or individuals at home or overseas$Commercial !anks furnish advice and information outside the sco'e merel% of trade$ &f it is desired to set u' su!sidiar% or !ranch overseas >or for an overseas com'an% to set u' in the home countr%A the% hel' to esta!liscontracts 6ith local !anking organizations$

)o sum u', the service rendered !% a modern commercial !ank is of inestima!le value$ &t mo!ilizes thscattered saving of the communit% and redistri!utes them into more useful channels$ &t ena!les large 'a%ments to !made over long distances 6ith maximum ex'enses$ &t constitutes the ver% life !lood of an advanced economisociet%$ &n the 6ords of ;alter :eaf. 7)he !anker is the universal ar!iter of the 6orld=s econom%$8


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Cerc*a( Ban!" and Ecn*c De'e(-entCommercial !anks have come to 'la% a significant role in the develo'ment of countries$ &n fact, 6ithout th

evolution of commercial !anking in the -@th and the -Hth centuries, &ndustrial 2evolution 6ould not have taken 'lacin England$ &t 6ill !e e*uall% true to state that 6ithout the develo'ment of sound commercial !anking, underdevelo'ecountries cannot ho'e to #oin the ranks of advanced countries$ For, industrial develo'ment re*uires the use of ca'ita6hich 6ill not !e 'ossi!le 6ithout the existence of !anks to 'rovide the necessar% finance to ac*uire ca'ital$ Besidesindustrial develo'ment 6ill !e im'ossi!le 6ithout the existence of markets to dis'ose of the goods 'roduced$ But ho6can markets !e extended 6ithout the services of commercial !anksL

&n this section, 6e shall deal 6ith the im'ortant services 'rovided !% commercial !anks and sho6 ho6 !ank

'la% a significant role in the economic develo'ment of nations$>iA Banks are necessar% for trade and industr%. 4ll economic 'rogress in the last / %ears or so has !een !ased oextensive trade and industrialization, 6hich could not have taken 'lace 6ithout the use of mone%$ But mone% does nomean coins and currenc% notes, onl% since these form onl% a small 'ro'ortion of the total volume of mone% su''l%$ is the !ank de'osits on 6hich che*ues can !e issued that constitute the im'ortant sources of mone%$ &n all largtransactions, 'a%ments are not made in terms of mone% !ut in terms of che*ues and drafts$ Bet6een countries, tradis financed through !ill so exchange 6hich are discounted >i$e$, !oughtA !% !anks$ ;ithout the use of the !anche*ue, the !ank draft and the !ill of exchange, internal trade and international trade could not have develo'ed, an6ithout such trade, s'ecialization and industrial develo'ment could not have taken 'lace$>iiA Banks hel' in distri!ution of funds !et6een regions. 4nother 6a% !% 6hich commercial !anks encourag'roduction and enhance national income is !% the transference of sur'lus ca'ital from regions 6here it is not 6anteso much, to those regions 6here it can !e more usefull% and efficientl% em'lo%ed$ )his distri!ution of funds !et6eeregions has the effect of o'ening u' !ack6ard regions and 'a%ing the 6a% for their economic develo'ment$

>iiiA Banks create credit and hel' in !usiness ex'ansion. Fluctuations in !ank credit have an im'ortant !earing on thlevel of economic activit%$ Ex'ansion of !ank credit 6ill 'rovide more funds to entre'reneurs and, hence, 6ill lead tmore investment$ Under conditions of full em'lo%ment, ex'ansion of !ank credit 6ill have the effect of inflationar'ressure$ But under conditions of unem'lo%ment, it 6ill 'ush u' 'roduction in the countr%$ On the other hand, decline in !ank credit 6ill result in decline in 'roduction, em'lo%ment, sales and 'rices$ From the vie6 of an underdevelo'ed econom%, the ex'ansion of !ank credit offering more financial resources to industries in one of thcontri!utor% causes for greater economic develo'ment$

>ivA Banks monetize de!t. 4 ver% im'ortant service the !anks render to he communit% is the creation of demande'osits in exchange of de!ts of other >viz$, short and long?term securitiesA$ Commercial !anks !u% de!ts of other6hich are not generall% acce'ta!le as mone%, either !ecause the de!tors are not sufficientl% kno6n or !ecause thede!t is 'a%a!le onl% after a 'eriod of time$ &n return for them, the% issue demand de'osits 6hich are general

acce'ted as mone%$ B% these exchange o'erations, !anks monetize de!t$ )he significance of !anks toda% flo6s fromthe fact that the% are 7not merel% traders in mone% !ut also, in an im'ortant sense, manufacturers of mone%$8 Banmone% is used for the 'romotion of industr% and trade$ &t is rightl% said that the% have not onl% the 'o6er to determinthe aggregate volume of !ank mone% in existence !ut to influence the uses to 6hich that mone% should !e 'ut$

>vA Banks 'romote ca'ital formation. Commercial !anks afford facilities for saving and thus encourage ha!its of thriand industr% among 'eo'le$ )he mo!ilize the idle and dormant ca'ital of the communit% and make it availa!le fo'roductive 'ur'oses$ Economic develo'ment de'ends u'on the diversion of economic resources from consum'tioto ca'ital formation$ 4 higher rate of saving and investment is, therefore, 6hat constitutes real ca'ital formation$ &this, the role of !anks is invalua!le$ But then there can !e other institutions also in a countr% such as insuranccom'anies 6hich ma% hel' in mo!ilizing the savings of the communit% for 'roductive 'ur'oses$

>viA Banks influence interest rates . Banks can influence economic activit% in another 6a% also$ )he% can influence thrate of interest in the mone% market through its su''l% of funds$ B% offering more or less funds, it can exert a 'o6erfinfluence u'on interest rates$ Besides, it can also influence the 'eo'le to hold more less !ank mone% or less or morother assets$ &n this 6a%, too, it can influence the interest rates$ 4 chea' mone% 'olic% 6ith lo6 rate of interest 6tend to stimulate economic activit%, if other conditions are favoura!le$&n a develo'ing countr% like &ndia, !anking facilities are highl% inade*uate$ )he vast num!er of 'eo'le living in villageand to6s do not have an% !anking facilities and conse*uentl% all their savings are 6asted$ )he o'ening of !anks these areas or extension of !ank facilities 6ill hel' mo!ilize savings in these areas and, 6hen 'ut in the hands oentre'reneurs, 6ill !ecome 'roductive Besides in &ndia commercial !anks have started undertaking ne6 functions thel' the 'rivate sector industries$ )he% hel' in concluding deferred 'a%ments agreements !et6een &ndian industriaunits and foreign firms to ena!le the former to im'ort machiner% and other essential items$

)hus, !ans have come to occu'% an im'ortant 'lace in the industrial and commercial life of a nation$ develo'ed !anking organization is a necessar% condition for the industrial develo'ment of a countr%$K

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LEON 6 BALANCE HEET O& CO33ERCIAL BANK

T,e L*a9*(*t*e" and A""et" f a Ban! # A Ba(ance ,eetBanking is !usiness much like na% other !usiness$ 4n indication of the financial 'osition of a !usines

concern ma% !e o!tained !% examining its statement of lia!ilities and assets, called the -A Ca'ital. )he !ank ca'ital from its shareholders !% issuing various t%'es of shares, such as ordinar%, 'referencedeferred shares, etc$ )he !alance sheet ma% sho6 the amounts of authorized ca'ital, issued ca'ital, and su!scri!eca'ital$ But the actual lia!ilit% of a !ank to its shareholders consists of the ca'ital originall% 'aid in and anaccumulation of undistri!uted 'rofits$

>/A 2eserve Fund . &t is the amount accumulated over the %ears out of undistri!uted 'rofits$ )he !ank ma% use thifund to offset its unex'ected losses in certain %ears$ Sometimes a !ank is re*uired !% lo6 to transfer a 'art of itannual 'rofits to the reserve fund so long as amount in the fund does not !ecome e*ual to its 'aid?u' ca'ital$

>1A +e'osits. +e'osits from the 'u!lic constitute the !iggest 'ro'ortion of !ank=s 6orking funds$ )he de'osits arcategorized as the demand de'osits and the time de'osits$ &t is the former that re'resents the !ulk of the mone

su''l% 6ith 'u!lic$ &t is on the !asis of their de'osit lia!ilities that the !anks make loan and investments after kee'inascertain cash reserve ratio$+emand de'osits are distinguished from time de'osits$ )ime de'osits are those against 6hich che*ues cannot !6ritten$ +emand de'osits ma% arise out of the credits created !% a !ank as a claim against itself$ But in sim'le termsa customer is said to have 7made a de'osit8 6hen he gives the !ank cash or its e*uivalent and the !ank gives him de'osit credit$ 4 de'osit, therefore, is the 'romise that the !ank gives the de'ositor in exchange for the cash h7de'osits8$ )he cash in an asset, the de'osit is a lia!ilit%$ )he de'ositor is a creditor of the !ank having lent its cashand he can claim re'a%ment at an% time$

>5A &nter?!ank !orro6ings . :ia!ilities are created 6hen a !ank !orro6s from another !ank on a tem'orar% !asis$ large !ank, in 'articular, ma% have de'osit lia!ilities not onl% for the account of the general 'u!lic !ut also for othe!anks in the countr%$)he !ank ma% also !orro6 form the central !ank of the countr% on the !asis of the eligi!le securities or get financiaaccommodation in times of need or stringenc% !% rediscounting their !ills of exchange$

>IA :ia!ilities relating to !ills . )he !ank ma% have some !ills 6hich are 'a%a!le !% it out of its resources$ &t ma% alsacce't some !ills from its customers for collection$ )he amount 6hen collected is credited to the accounts of thcustomers$ ence the amount under this head is sho6n on !oth the sides of the !alance sheet$ )he% !ecome thlia!ilities of the !ank after collection, !ut the% are to !e treated as assets !efore collection$ )he !anks also acce't oendorse the !ills of exchange on !ehalf of their customers, 6hich sim'l% means that the !ank guarantees th'a%ment of !ills at maturit%$ )hus, 6hen the !ank has acce'ted !ills for its customers it is technicall% lia!le to meethem on maturit%, !ut since the customers are ex'ected to meet them and have 'resuma!l% given due securit%, thilia!ilit% of the customers to the !ank is an offsetting asset against the acce'tance$ &n addition to the a!ove, the !anks make some 'rovision for the contingent or unforeseea!le lia!ilities$ )h'rofit earner !% the !ank is also sho6n as the lia!ilit% !ecause it is 'a%a!le to the shareholders$

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&t ma% !e em'hasized, ho6ever, that the assets of a !ank are !ased on its lia!ilities$ Banks, unlike othe!usiness organization, ac*uire onl% a ver% small 'art of their total assets !% issuing ca'ital?account claims$ 4n evemore im'ortant 'oint is that the volume of ca'ital?account claims or share ca'ital changes onl% slo6l% and 6ithinarro6 limits relative to !ank assets$ Bank reserves, !orro6ings from other !anks and the central !ank are also versmall relative to total assets$ Most of the assets of !anks are ac*uired !% creating and issuing !ank credits in the formof de'osit claims$ )he volume of de'osits that the !anking s%stem can issue de'ends on its reserve re*uirementenforced !% the central !ank and the currenc% volume of reserves availa!le to !anks$

A""et"

;e shall no6 !riefl% descri!e the main items of a !ank=s assets in descending order or li*uidit% anascending order of 'rofita!ilit%, and sho6 ho6 the% reflect these t6o considerations$

1. Ca", Ba(ance")he first asset in the 'ortfolio of a commercial !ank=s assets is cash?6ith itself and 6ith the central !ank of th

countr%$ &n certain countries, as in &ndia, ever% commercial !ank is re*uired !% la6 to kee' some cash reserveagainst its de'osits$ Cash is called the 'rimar% reserve of a !ank$ B% ex'erience a !ank kno6s ho6 much casreserves 6ill have to !e ke't to meet the demands of de'ositors$ art of this cash is ke't in the !ank=s 'remises, certain 'ortion 6ith other commercial !anks for 'ur'oses of inter?!ank ad#ustments and a certain 'ortion is ke't ade'osit 6ith the central !ank of the countr%$ 4 de'osit 6ith other commercial !anks or 6ith the central !ank regarded as cash !% a commercial !ank$ &n &ndia, commercial !ank are o!liged, !% la6, to kee' a certain 'ro'ortion ototal de'osits in the form of cash reserves 6ith the 2eserve Bank of &ndia$)he success of a !ank de'ends u'on the maintenance of sufficient cash reserves to honor the che*ues 'resented !

the clients$ But onl% a small 'ercentage of de'ositors ma% !e 6ithdra6ing their de'osits through che*ues and othemethods at an% 'articular time$ 4t the same time, if some are 6ithdra6ing, others ma% !e de'ositing$ 4 commerci!ank has therefore, to ad#ust its !usiness in such a 6a% that the amount of cash flo6ing in and the amount of casflo6ing out should !e e*ual, kee'ing of course a margin of extra cash for the sake of safet%$ )oo much of cash 6reduce the 'rofit?earning ca'acit% of a !ank, at the same time, it should not kee' too lo6 cash reserves !elo6 thminimum considered necessar% or 'rudent$

2. 3ne at ca(( and ,rt Nt*ceCash, !eing a !arren asset, should not !e ke't !e%ond the minimum necessar% for safet%$ But a !ank ma

feel that there ma% !e a heav% 'ressure on its cash reserves due to seasonal changes in de'ositors= and !orro6erre*uirements$ )o meet this 'ressure, it ma% !e !orced to carr% large cash reserves even in times 6hen the% are nore*uired at all$ )he other and !etter alternative for the !ank is to kee' some highl% li*uid !ut earning assets 6hich ca!e converted into cash *uickl% and 6ithout loss$ )here are t6o t%u'es of such assets, viz$, >aA call and short notic

loans to the !rokers in the stock market$, dealers in the discount market and to other !anks, >!A short?term treasur!ills >!orro6ings of the government for short 'eriodsA$ )hese assets can !e *uickl% converted into cash and 6ithouloss, as a and 6hen the !ank 6ants$ ence !anks regard such assets as secondar% reserves as different from cas6hich is their 'rimar% reserve$ 4t the same time, these assets !ring in some revenue income to the !ank$

6. ,rt0ter B*(("4 commercial !ank like to ac*uire assets 6hich are for short 'eriod >generall% for H da%sA and 6hich are easimarketa!le and hence sufficientl% li*uid and at the same time !ring in some interest income to the !ank$ Such assetare sometimes called 7self?li*uidating8 !ecause there is evidence of genuine commercial transactions, at the end o6hich the necessar% finance 6ill !e realized to re'a% the original loan$ )hese self?li*uidating !ills consist mainl% o!ills of exchange$ 4 !ill of exchange is 6ritten 'romises !% a merchant, 6ho has ordered certain goods, to 'a% s'ecified sum of mone% on a s'ecified sum of mone% on a s'ecified date$ )his !ill ma% !e guaranteed !% a !ank or 6ell?kno6n merchant house?kno6n in :ondon as the 4cce'tance ouses$ Besides commercial !ills, there are shordated treasur% !ill through 6hich the government !orro6s funds for short 'eriods$

Commercial !anks like short?dated 'a'er or !ill for a num!er of reasons . First of all, these assets are highlnegotia!le and can !e easil% !ought and sold$ &n countries like England, there is a s'ecial !ill market in 6hich thes!ills are !ought and sold >or discountedA$ )herefore, if a commercial !ank re*uires additional funds, it can easirediscount the !ills in the !ill market or the discount market$ Secondl%, these !ills are eligi!le for rediscounting 6itthe central !ank of the countr%$ )hat is, if a commercial !ank 6ants cash, it can rediscount >or sellA the short?term !il6ith the central !ank$ )hirdl%, these !ill !ring in handsome interest for the commercial !anks$ )hus, commercial !ank'refers these short?dated !ills !ecause of their high marketa!ilit% as 6ell as their interest incomeJ the% are regardeas ideal !ank assets !ecause the% satisf% the t6in considerations of li*uidit% and 'rofit$

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7. Lan" and Ad'ance"

)he most 'rofita!le of all assets is !ank loans and advances$ )his asset is universall% sought after !% !anksBank loans and advances ma% !e made to !usinessmen either !% the s%stem of overdrafts of an agreed amount or !discounting !ills of exchange$ :oans and advances carr% a high rate of interest !ecause of the risk involved, loli*uidit% and the difficult% of shifting them$ )he% involve great risk to the !ank !ecause of the 'ossi!le failure of th!orro6ers and in extreme cases !ecause of their insolvenc% and li*uidation$ 4gain, these loans and advances have lo6 li*uidit% and lo6 shifta!ilit% in the sense that the% cannot !e converted into cash easil% as and 6hen the !anre*uires additional cash to meet 6ithdra6als, nor is there an% 'ossi!ilit% of shifting them to other !anks or institution

4s a matter of fact, all !ank failure ma% !e ascri!ed to fault% 'olicies regarding loans and advances$ From the 'oint ovie6 of safet% of the !ank and its li*uidit%, loans and advances are 'oor assets$ But the high %ield of these assetcom'ensates for the difficulties associated 6ith them$ )hese assets, thus, have lo6 li*uidit% !ut high %ield$

8. In'e"tent"

Banks make investments in the 'rofit?%ielding securities$ &nvestments in government securities re'resent th!ook value of central and state government securities, including treasur% !ills and treasur% de'osit recei'ts etc$ Bankma% make investments in other a''roved securities as 6ell$ )he different t%'es of investments are sho6n se'aratein the !alance sheet$ Banks regard their short?term investments as their secondar% reserves as different from cas6hich is their 'rimar% reserve$

:. Pr-ert*e"

Building, furniture and fixtures etc$ are the other assets of the !anks$ )hese fixed assets are often referred tas 7+ead Stock8$ )he% are generall% sho6n at their de'reciated value$ )hese are, in a 6a%, the secret reserves of th!anks 6hich can !e availed of in case of crises or colla'se$

)he amount of assets that a !ank can command de'ends u'on the amount of its lia!ilities$ Man% t%'es oassets are availa!le to a !ank, 'rofitless and 'rofita!le, li*uid and non?li*uid$ 4 !ank must therefore formulate 'ortfolio 'olic% determining 6hat t%'es and 'ro'ortions of assets it 6ill ac*uire and hold$

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LEON 7

CO33ERCIAL BANK # CREDIT CREATION

Cntr( f Ban!" 'er De-"*t"

Bank de'osits are of t6o t%'es$ )here are current de'osits 6hich are used !% !usinessmen, industrialists and otheto settle de!ts$ )hese current de'osits, in 6hich che*ues are issued, are also kno6n as cash de'osits or deman

de'osits$ )he second t%'e of !ank de'osits, 6hich are not meant for current transactions, are kno6n as savingde'osits$ )he% are ke't in !ans as a form of savings or investments so as to earn interest from the !anks$ )hsavings de'osits are not held to meet the needs of the 'resents or the near future, !ut are ke't !% individuals as 'aof their total stock of 6ealth, Savings de'osits ma% also !e kno6n as time de'osits$ On t%'e of savings de'osits ikno6n as fixed de'osits, i$e$, de'osits of mone% 6hich can !e 6ithdra6n onl% after a given 'eriod of time$

)he distinction !et6een current de'osits and savings de'osits a matter of degree onl%$ Mone% is ke't in a !ank fothe sake of convenience$ &t is used to meet excess of 'a%ments over recei'ts$ Current de'osits are useful to mee'a%ments immediatel% !ut savings de'osits are ke't to settle de!ts in future$ &n the case of current de'osits thde'ositor ex'ects onl% convenience of 'a%ment of de!ts$ &n the case of savings de'osits, ho6ever, the de'ositoex'ects an interest income also$

;ho decides the distri!ution of de'osits into current de'osits and savings de'ositsL &t is the customer 6h

decides 6hether he 6ould 'refer current de'osits or savings de'osits$ Besides, if a de'ositor feels that he has tolarge a volume of current de'osits from 6hich he is getting nothing, he ma% convert 'art of it into savings de'osi:ike6ise, a customer 6ith savings de'osit ma% turn 'art of it into current de'osit$ )he !ank has nothing to do 6itthis$

Pr*ar and Der*'at*'e De-"*t"

+e'osits ma% !e created in t6o 6a%s.

>aA eo'le ma% de'osit their cash 6ith the !anking s%stem$ i$e$, the% convert their cash into demand de'ositsOne form of mone% >cash 6ith the 'u!licA has !een changed into another form of mone% >!ank mone%A$ )he initiativfor creating de'osits is taken !% he customers themselves$ Such de'osits are kno6n as 'rimar% de'osits$ 4''arentthe total volume of mone% remains the same through, in fact, it is not so$

>!A rimar% de'osits !ring cash to the !anking s%stem$ Using this cash, the !anking s%stem !u%s assets fromthe market >!ills, !onds, de!entures, etc$A or it lends to !usinessmen and industrialists$ "o6, 6henever a !ank !u%assets from the market or ends to certain 'arties, it does not give to them !ut creates demand de'osits to their name)hese de'osits are secondar% or derived from the 'rimar% de'osit?hence the% are kno6n as derivative de'osits$ )hinitiative for creating de'osits comes from the !anking s%stem$ &n a modern mone% econom%, the second from thde'osits has !ecome *uite significant$ ;hen 6e sa% !anks have control over de'osits has !ecome *uite significan;hen 6e sa% !anks have control over de'osits, 6e mean that the% have control over the total volume of de'osits$ :eus see ho6 the !anking s%stem is a!le to create the derivative de'osits through ac*uiring assets$

Lan" Create De-"*t"

Mone% at call and short notice are extremel% short?'eriod loans made !% a !ank to s'eculators and !rokers ithe mone% market and the ca'ital market >i$e$, stock exchangeA$ )he !ank credits the de'osit accounts of thess'eculators and dealers for their 'romises to re'a% at call or short notice$ )he s'eculators and dealers 6ould usthese de'osits to 'a% off their creditors$ )he creditors 6ho receive che*ues or drafts credit them to their accounts)hus as a result of loan made !% !ank, de'osits e*ual to the value of the loans have !een created$

Bills discounted refer to the commercial !ills and financial !ills 6hich are short?dated 'a'er >generall% for H da%s6hich a !ank ac*uires from the !ill market$ ;hen a !ank !u%s >or discountA a !ill of exchange from a 'art%, it 6icredit the account of the latter >if the 'art% kee's an account 6ith !ankA or it 6ill 'a% the 'art% through a che*ue oitself$ )he 'art% selling the !ills 6ill de'osit the che*ue in its !ank account$ &n !oth cases, !ank de'osits 6ill increase

Bank advances, commonl% kno6n as loans, are made !% the !ank to industrialists, !usinessmen, traders and others;hen a loan is sanctioned, the !ank creates a de'osit in the name of the !orro6er$ &t allo6s the !orro6er to dra6 o

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this de'osit to 'a% off his creditors$ &n this case also, ever% loan a !ank makes is creating a de'osit$ "aturall%, th!anks create more de'osits sim'l% !% making more and more advances$

Finall%, investments are made !% a !ank 6hen it 'urchases and holds (overnments !onds and other securities 6hichave a longer life than three months$ ;hen a !ank !u%s a !ond from the (overnment, it 'laces at he dis'osal of th(overnment a !ank de'osit 6hich the (overnment can use in an% 6a% it likes$ &f a !ank !u%s an old (overnmen!ond from the stock exchange, it 6ill create a de'osit in the name of the seller 6ho is free to use the mone% in an6a% he likes$

From 6hat 6e have descri!ed a!ove, it should !e clear that ever% time a !ank ac*uires an earning asset, it creates de'osit in the name of the 'erson or institution from 6hom the asset is 'urchased$ )he asset ma% !e 'romise to 'a6ithin a da% or t6o or it ma% !e a 'romise to 'a% 6ithin three months or it ma% !e a (overnment=s &$O$U$ to !redeemed over a long 'eriod of time$ 4gainst the 'romises of individuals, institutions and the (overnment, 6hich dnot constitute mone% the !ank gives it o6n 'romise >viz, the !ank de'ositA 6hich is mone%, i$e$, it is creating mone%)6o 'oints should !e mentioned here$First, ever% asset ac*uired !% !ank an e*uivalent !ank de'osit$ &t is 'erfectl% correct to state that !ank loans creatde'osits$ Bank take the initiative to give loans and advances and ac*uire other earning assets. !% doing go, thecontrol the total volume of de'osits in the !anking s%stem$

Secondl%, commercial !anks monetize the de!t of others$ 4gainst the 'romises of other to 'a%, the !anks give theo6n 'romises to 'a%$ )he former is not mone% !ut the latter is mone%$ &n this sense, !anks create mone%$

L**tat*n" t Creat*n f De-"*t"

4n im'ortant *uestion arises here$ &f a !ank can !u% assets #ust !% giving its o6n 'romise to 'a% >i$e$, !ank de'ositsis there an% limit to its !u%ing of assetsL &s there an% limit to its creation of de'ositsL ;e are an6ering this *uestiorather ela!oratel% in the next section$ One 'oint, ho6ever, ma% !e em'hasized here$ 4gainst its de'osits, commercial !ank has to kee' cash reserves$ )he 'ro'ortion of cash to de'osits ma% !e fixed !% la6 or its ma% !determined according to convention and general usage$ 4s the volume of earning assets increases, the volume o!ank de'osits also increases !ut the ratio of cash de'osits rises, !usiness transactions 6ill increase, giving rise to aincrease in 'rice levels$ eo'le, therefore, 6ill demand more currenc% notes for 'ur'oses of trade and exchange;hen the 'u!lic dra6 out cash from !anks, the ratio of cash to !ank de'osits 6ill decline still further$ )he cash ratio thus, su!#ect to decline on t6o rounds . >aA increase in de'osits, and >!A drain of cash into circulation$

&f the a!solute size of the cash reserves 6ith commercial !anks in the countr% is given, the maximum amount o

de'osits 6hich !anks can create 6ill de'end u'on the cash reserve ratio to de'osits$ Su''ose that commercial !ankhave cash reserves of 2s$ - crores and further the legal cash reserves ratio to de'osits is - 'er cent$ )hen thcommercial !anks can create and maintain de'osits 6orth 2s$ -, crores$ &f the volume of !ank de'osits is less!anks can ac*uire some more earning assets and increase the !ank de'osits also$ Of course, it is assumed thathere are 'eo'le 6illing to !orro6 from commercial !anks$ Su''ose that the volume of de'osits 2s$ -,/ crore6hile the size of cash reserves in 2s$ - crores$ ;ith legal cash reserve ratio at - 'er cent, commercial !anks 6have to reduce their de'osits !% dis'osing of some of their earning assets$ )here 6ill, thus, !e a simultaneous declinof !ank assets and !ank de'osits, till the ratio of cash reserves to !ank de'osits !ecomes - 'er cent$

)hus the commercial !anks have a!solute control over the volume of !ank de'osits, su!#ect or course to . >aA thsu''l% of cash, >!A the 'u!lic demand for cash, and >cA the cash reserve ratio to !e maintained$ )he central !anenters the 'icture through its control of cash$ B% su''l%ing more cash, the central !ank can ex'ect commercial !anto increase their earning assets and increase their !ank de'osits$ B% reducing cash, the central !ank can attem't tachieve the o''osite result$

T,e tec,n*;)e f Cred*t Creat*n

+emand de'osits or cash de'osits are mone% are used as such, for ever% de'ositor having a current accounin a commercial !ank can meet his o!ligations through che*ues dra6n on his account$ Ex'ansion or contraction ode'osits, therefore, means ex'ansion and contraction of mone% in the countr%$ "o6, as indicated alread%, !anks havthe 'o6er to ex'and or contract demand de'osits and the% exercise this 'o6er through granting more or less loanand advances$ "o6, this 'o6er of commercial !anks to ex'and de'osits through ex'anding loans and advances ikno6n as credit creation$

1


16/151

Bank credit reall% refers to !ank loans and advances and creation refers to the multi'lication of loans anadvances$ 4s ever% !ank loan creates an e*uivalent de'osit, credit creation !% the !anks im'lies also multi'lication o!ank de'osits$ )he 6ord creation= is used to im'l% that !ank are uni*ue institutions and that the% can create asset>or give loans and 'urchase !ills and !ondsA out of nothing$ Or 6ith a small amount of cash, the% are in a 'osition tac*uire a large amount of assets$

4t one time, there 6as needless controvers% regarding the a!ilit% of commercial !anks to create credit$ Som6riters meant !% !ank credit !ank loans and investments and, therefore, maintained that !ank could never and morthan the amount 6hich it had !een entrusted 6ith !% the de'ositors$ Su''ose that a 'erson de'osited 2s$ -,

6hich a !ank, the latter could lend u' to 2s$ -, and not more$ &n fact, it should lend for less, since it had tmaintain a small margin of cash reserve against the 6ithdra6al of mone% !% the de'ositors$ &n an% case the !ancould not lend more than 2s$ -, and, therefore, it 6as concluded that !ank could not create credit$

&t is true that a !ank cannot lend more than 6hat it has got$ But it is e*uall% true that 6hat is lent out !% a !ancomes !ack to the !ank !% 6a% of ne6 de'osits, 6hich ma% again !e lent out, and so on?de'osit !ecoming the !asifor a loan or investment, 6hich again returning to the !ank as fresh de'osit !ecomes the !asis for a loan oinvestment, 6hich again returning to the !ank as fresh de'osit !ecomes the !asis for a ne6 loan, and so onCommercial !anks, therefore, are a!le to multi'l% loans and investments and thus multi'l% de'osits$ 4 small volumof cash is the !asis for multi'lication of de'osits through multi'lication of loans and advances >7loan create de'osits8&t is in this sense that !anks create credit$ Credit creation can !e defined as the ex'ansion of !ank de'osits througthe 'rocess of more loans and advances and investments$

Tec,n*;)e f Cred*t Creat*n

:et us ex'lain, in highl% sim'lified manner, the techni*ue or the 'rocess of credit creation !% assuming.

>aA the existence of a num!er of !anks, 4,B,C,+, etc$, each 6ith different sets of de'ositors.

>!A Ever% !ank has to kee' / 'er cent of cash reserves, according to la6J and

>cA 4 ne6 de'osit of 2s$ -, has !een made 6ith !ank 4 to start 6ith

4fter the ne6 de'osit of 2s$ -, has !een made in Bank 4, the !alance sheet of the !ank >taking onl% thne6 transactionA is as follo6s.

Ba(ance ,eet f Ban! A

:ia!ilities 4mount>2s$A

4ssets 4mount>2s$A

"e6 +e'osit -, "e6 Cash -,

)otal -, -,

Under the dou!le?entr% s%stem the amount of 2s$ -, is sho6n on !oth sides$ )he de'osit of 2s$ -, a lia!ilit% for the !ank since it is o!liged to return the amount to the de'ositor 6henever he demands$ 4t the samtime, the amount is an asset to the !ank 6hich it ma% use to earn an interest income$ Bank 4 has to kee' onl% / 'ecent reserve, i$e$, 2s$ / against its ne6 de'ositJ it has a sur'lus of 2s$ @ 6hich it can 'rofita!l% em'lo%$ Su''os

that Bank 4 gives a loan to Mr$ 6ho uses the amount to 'a% off his creditors$ 4fter the loan has !een made and thamount so 6ithdra6n !% Mr$ to 'a% ff his creditors, the !alance sheet of Bank$ 4 6ill !e as follo6s .

Ba(ance ,eet f Ban! A


4ssets 4mount>2s$A

+e'osit -, Cash /

:oan to Mr$ @

)otal -, -,

1


17/151

"o6, the creditors of Mr$ , 6ho got 2s$ @ from the latter, ma% !e assumed to de'osit the amount 6ith the!ank, viz$, Bank B$ >)his assum'tion is unnecessar%, for the creditors of Mr$ ma% !e !anking 6ith Bank 4 de'ositin2s$ @ 6ith Bank 4 itselfA$ )he !alance sheet of Bank B 6ill !e as follo6s.

Ba(ance ,eet f Ban! B

:ia!ilities 4mount

>2s$A

4ssets 4mount

>2s$A"e6 +e'osit @ "e6 Cash @

)otal @ @

4fter kee'ing a cash reserve of 2s$ -, >viz$, / 'ercent of 2s$ @A, Bank B is free to lend the !alance o2s$ 5 to an% one$ Su''ose that the !ank !u%s !ills 6orth 2s$ 5$

)he !alance sheet of Bank 6ill !e. Ba(ance ,eet f Ban! B

:ia!ilities 4mount>2s$A 4ssets 4mount>2s$A

+e'osit @ "e6 Cash -

Bills 5

)otal @ -,

;e can assume that the sellers of !ills 6ho received 2s$ 5 from Bank B 6ould !e de'ositing thamount in their !ank, viz, Bank C$ Bank C=s !alance sheet 6ill as follo6s.

Ba(ance ,eet f Ban! C

:ia!ilities 4mount

>2s$A

4ssets 4mount

>2s$A+e'osit 5 "e6 Cash 5

)otal 5 5

Bank C finds that it has excess cash reserves to the extent or 2s$ I-/ >since under / 'er cent casreserve, it 6ill have to kee' a cash reserve of 2s$ -/@ onl% against a de'osit of 2s$ 5A$ Su''ose that Bank invests 2s$ I-/$ &ts Balance Sheet 6ill !e as follo6s

Ba(ance ,eet f Ban! C

:ia!ilities 4mount

>2s$A

4ssets 4mount

>2s$A+e'osit 5 "e6 Cash -/@

&nvestment I-/

)otal 5 5

"o6, Mr$ 6ho sold the long?term securities to Bank C for 2s$ I-/ ma% !e ex'ected to de'osit the amoun6ith his !ank, viz$, Bank +, 6hich in turn ma% kee' / 'er cent as cash reserve and lend the rest$ 4nd this 'rocess oa de'osit !ecoming a loan or an investment 6hich, in turn, !ecoming a ne6 de'osit goes on and on till the originade'osit of 2s$ -, is com'letel% exhausted$ )he original de'osit of 2s$ -, !ecomes additional de'osits of 2s

1


18/151

@, 5, I-/, 5-, 1/@, etc$ &f 6e add u' all these de'osits, the total 6ill !e 2s$ 5,HHH$HH or 2s$ I$ )his is th'rocess of de'osit multi'lication through the 'rocess of credit creation$

T,e fr)(a f Cred*t Creat*n

4s credit creation de'ends u'on the ratio of cash reserves to de'osits, the de'osit multi'lier is

50.2

1

20%

1K

ismultiplierdepositthe0.2,orcentrper20isratioreservescash!

deositstoreservescasho!ratior

multiplier"epositK

in #hichr

1K

===

=

=

=

&f cash reserve ratio is - 'er cent or $- the de'osit multi'lier is -, and so on$ )he higher the cash reservration, the lo6er 6ill !e the de'osit multi'lier$ )he total de'osit creation 6ill !e additional cash >MA multi'lied !% thde'osit multi'lier$ )hat is

4dditional 4ggregate +e'osit >+A M 0

&f the commercial !anks get fresh cash of 2s$ - crores, as a result of (overnemnt s'ending, the% 6ould !a!le to multi'l% de'osits through loans and investments to the extent or 2s$ I crores >assuming a cash reserve o2s$ / 'er centA$ )hat is

+ M 0 2s$ - crores I 2s$ I crores

So far, 6e have assumed that credit creation 6ill take 'lace 6hen there are man% !anks$ o6ever, it is noreall% necessar% that there should !e man% !anks, it is #ust sufficient that there is onl% one !ank$ Even then, th'rocess of credit creation 6ill !e the same$ )hat is, 6henever the !ank ahs excess cash reserves, it 6ill lend or investhe sameJ this amount 6ill come !ack to the !ank in the form of a ne6 de'osit 6hich 6ill !ecome the !asis for %eanother loan, and so on$ )he mone% 6hich goes out from the !ank !% 6a% of loans etc$, and the mone% concerned ato ho6 a de'ositor gets the cash 6hich 6as 6ith the !ank a 6hole ago$ )hus credit creation 6ill take 'lace, 6hethe6e consider onl% one !ank in an isolated to6n or 6e consider the !anking s%stem as a 6hole$

Cred*t Cntract*n"

9ust as there is multi'le ex'ansion of de'osits there is multi'le contraction of !ank de'osits too6hen cash is removed from the !anking s%stem$ Su''ose there are a num!er of !anks in the !anking s%stem$ 4neach !ank has to kee' a cash reserve ratio of / 'er cent against de'osits$ :et us further assume for the sake osim'licit% that ever% !ank ahs a cash reserve of 2s$ -,, total de'osits of 2s$ I, and loans and investment6orth 2s$ 5,$ Su''ose that a de'ositor 6ithdra6s 2s$ -, from Bank 4$ )he !alance sheet of Bank 4 6ill !e afollo6s.

Ban! A


4ssets 4mount>2s$A

+e'osit 5H, Cash H,

:oans 3 &nvestments 5,

)otal 5H, 5H,

1


19/151

4gainst de'osit lia!ilities of 2s$ 5H, Bank 4 re*uires 2s$ H,@ as cash reserve, >)his is / 'er cent of de'ositsBut the Bank has onl% 2s$ H,, leaving it 6ith a deficienc% of 2s$ @$ )he !ank 6ill make u' the deficienc% !dis'osing of 2s$ @ 6orth of investments to someone 6ho ma% !e assumed to the !anking 6ith Bank B and 6hotherefore, dra6s a che*ue against Bank B in 'a%ment$ 4fter Bank 4 has collected the amount from Bank B, th!alance sheet of Banks 4 and B 6ill !e as follo6s.

Ban! A

:ia!ilities 4mount

>2s$A

4ssets 4mount

>2s$A+e'osit 5H, Cash H,@

:oans 3 &nvestments 1H,/

)otal 5H, 5H,

Ban! B


4ssets 4mount>2s$A

+e'osit 5H,/ Cash H,/

:oans 3 &nvestments 5,

)otal 5H,/ 5H,/

From the !alance sheet of Bank 4, it 6ill !e clear that !% dis'osing of some investments it has !een a!le to restoritself to a satisfactor% 'osition$ o6ever, the !alance shee' of Bank B sho6s a reduction of 2s$ @ from its de'osiand of the same amount from it cash$ )his account has !een 'aid to Bank 4 against the sale of investments of 2s@$ Bank B is no6 deficient of cash to the extent of 2s$ 5$ >&t re*uires 2s$ H$@5 against total de'osits of 2s5H,/J !ut it actuall% has 2s$ H,/ onl%A )o make u' the deficienc%, Bank B 6ill sell some of the investments tsome one 6ho ma% !e !anking 6ith Bank C, and 6ho issue che*ue against Bank C in 'a%ment$ 4fter Bank B hareceived the 'a%ment from Bank C, the !alances sheets of the t6o !anks 6ill !e.

Ban! B

:ia!ilities 4mount>2s$A 4ssets 4mount>2s$A

+e'osit 5H,/ Cash H,@5

:oans 3 &nvestments 1H,1

)otal 5H,/ 5H,/

Ban! C


4ssets 4mount>2s$A

+e'osit 5H,1 Cash H,1

:oans 3 &nvestments 5,)otal 5H,1 5H,1

Bank B has ad#usted itself, !ut !ank C has deficienc% of cash 6hich it 6ill make u' !% de'osing of its investments o!% contracting loans$ )his 'rocess goes on till al the effects are full% exhausted$ )hus the original reduction de'osit!% 2s$ -, from Bank 4 is follo6ed !% reduction of de'osits !% 2s$ @ from Bank B, of 2s$ 5 form Bank C, anso on$ )he 'rocess of contraction of Bank de'osits in the same as that of ex'ansion?onl% in the reserve direction$

L**tat*n" n Cred*t Creat*n

1


20/151

)heoreticall%, the !anking s%stem can create an unlimited amount of mone% !% 6a% of ex'ansion of de'ositso6ever, there are creation factors on 6hich the volume of credit creation de'ends$ &t is not 'ossi!le, rather it dangerous, to attem't credit ex'ansion !e%ond a creation limit$

>iA 4mount of cash held . )he firs im'ortant factor on 6hich the extent of credit creation de'ends is thamount of cash 6hich commercial !anks 'osses$ ;e have sho6n that !anks have to redeem their demand de'ositin coins and currenc% notes at the re*uest of their de'ositors$ Fialure to do so 6ill mean instantaneous failure of th!ank$ )he larger the amount of cash 6ith the !anking s%stem, the larger 6ill !e the credit creation$ 4s Cro6ther 'utit, 7)he !ank=s cash in the lever 6ith 6hich the 6hole gigantic s%stem is mani'ulated$8

>iiA 2atio of cash reserves . )he re*uired ratio of cash reserves to de'osits is another im'ortant factor o6hich the volume of credit creation 6ill de'end$ ;e have sho6n that credit creation 6ill !e the reserve of the casreserve ratio$ &f a !ank considers or the la6 re*uires that cash reserve e*uivalent to - 'er cent of de'osits should !ke't as cash, the !ank ma% ex'and the amount of its de'osits to - times the volume of its cash resources, if a !anis re*uired to kee' / 'er cent cash reserve against its de'osits, credit creation 6ill !e to the extent of I times onl%)hus, he higher the 'ercentage of cash reserve ratio to !e ke't, the smaller 6ill !e the volume of credit creation$

>iiiA u!lic=s desire to hold cash . Credit creation de'ends u'on the amount of cash 6ith the !anking s%stem6hich 6ill in turn de'ends u'on the desire of the general 'u!lic to hold cash$ &f for an% reason the% decide to havmore cash >assuming the total amount of currenc% notes and coins to !e constantA, the !anks 6ill !e left 6ith smaller amount of cash and thus credit creation 6ill !e smaller$ &n fact, large ex'ansion of de'osits 6ill add to the totamount of mone% su''l% in the countr% and this 6ill !e accom'anied !% an increased volume of !usiness, risin

'rices, 6ages, retain trade, and so on$ )he de'ositors 6ill like to kee' more cash in the form of coins and currencnotes$ )his 6ill mean reduction in the volume of cash reserves 6ith the !anks$

>ivA "ature of !usiness conditions in the countr% . Credit creation 6ill de'end u'on ht nature of !usinesconditions$ Credit creation 6ill !e large during a 'erious of !usiness 'ros'erit% 6hile it 6ill !e smaller during de'ression$ &n 'eriods of !usiness 'ros'erit%, there 6ill !e more demand for loans and advances for investmen'ur'oses$ 4nd as 6e have seen, ex'ansion of de'osit de'ends u'on the volume of !ank loans and advances)herefore, during 'eriods of !usiness 'ros'erit%, man% 'eo'le a''roach !anks for loans and advances and hence thvolume of !ank credit 6ill !e high$ Besides, the !anks are 6illing to lend freel% during such 'eriods !ecause of thgeneral o'timism and the high 'ercentage of returns$

+uring 'eriods of !usiness de'ression, ho6ever, the amount of loans and advances 6ill !e sma!usinessmen and industrialists ma% not come for6ard to !orro6 in this 'eriod$ Besides, !anks ma% 'refer to kee

excess reserves and sacrifice earnings$ )here can !e man% reasons for this$

>aA Banks ma% antici'ate a 'ossi!le loss of de'ositor=s confidence in them and therefore, of 'ossi!le run othem$

>!A )he% ma% not !e sure a!out the a!ilit% of !orro6ers to re'a%, &n de'ression, the credit is contracted, 'art!ecause of deficienc% of sound investments of !orro6ers and 'artl% !ecause 'ro'er securities are not availa!le$

>cA )he% ma% !e afraid of falling 'rices of securities$ ence the% ma% not like to invest in them$ )hus, thema% elect to hold more cash reserves 6ith themselves and ma% not ex'and credit to the maximum extent, !ut normal times 6e can ex'ect them to lend and invest u' to the maximum extent 'ermitted !% their cash reserves$

>vA :eakages in credit creation . )here ma% !e a difference !et6een the maximum 'otential credit ex'ansioand the actual ex'ansion !ecause of certain leakages in credit creation$ )hese leakage have !een actuall% omitted iour sim'le exam'le of credit creation given a!ove$ )he im'ortant leakages are.

>aA )he !anks ma% not !e a!le to make loans and investments exactl% according to the sur'lus funds thema% have$ For exam'le, if a !ank has a sur'lus fund of 2s$@, it is not necessar% that the exact amount of 2s$ @ma% !e lent out$ )o the extent that the actual loan is short of 2s$ @, credit creation 6ill !e smaller$

>!A )he amounts of advances made !% the !anks have !een assumed to return to them !% 6a% of ne6 de'osits$ Buthe% ma% not, as the 'u!lic ma% 6ish to hold some cash 6ith themselves$ 4gain, therefore, the ne6 de'osits ever%

ma% not !e !% full amount of the loans made earlier$ Credit creation, therefore, 6ill !e limited again$

2


21/151

>ivA Monetar% 'olic% of the central !ank$ )he extent of credit creation 6ill largel% de'end u'on the monetar%'olic% of the central !ank of the countr%$ For one thing, the central !ank has the influence the volume of mone% in the

countr% and for another, it can directl% or indirectl% influence the !anks 'o6er to ex'and or contract credit$

*+n*f*cance f Cred*t Creat*n and Cntract*n

Bank de'osits in modern communities form the 'redominant t%'e of mone% and hence ex'ansion of !ankde'osits means ex'ansion of mone% su''l%, and contraction means contraction of mone% su''l%$ But fluctuations in

the volume of mone% su''l% have a direct effect on the level of !usiness activit%, 'rices and 6ages$ 4n increase in th

volume of credit, !% leading to an increase in the mone% su''l%, 6ill lead to a rise in 'rices and 'rofit margins andconse*uentl% increase in !usiness and economic activit%$ On the other hand, contractions, of !ank credit 6ill result icontraction of !usiness activit%$ 4t one time, the ex'ansion and contraction of credit 6ere given the 'ride of 'lace inthe ex'lanation of !usiness c%cles and also in an% 'olic% designed to control them$ But, these da%s, the% are given a

secondar% im'ortance onl%$ )hat is, ver% ma% not !e res'onsi!le for 'ros'erit% or de'ression !ut 6hen once'ros'erit% or de'ression starts, credit ex'ansion contraction accelerates the tem'o of c%clical fluctuations$ )he

ex'ansion of !ank credit to the maximum extent ma% 7!oom the !oom8, 6hile the failure to create as much credit astheir reserves 'ermit ma% 7de'ress the de'ression8$

;hether credit ex'ansion >and contractionA 'la%s are 'rimar% role or onl% a secondar% role in the causation oc%clical fluctuations, it is !ut o!vious that an% 'olic% designed to !ring a!out !usiness sta!ilit% should include

measures to !ring a!out sta!ilit% in credit ex'ansion and contraction$

2


22/151

LEON 8

ORGANIATION AND TR%CT%RE O& BANK

Ban!*n+ Or+an*"at*n"

1. Pr*'ate Ind*'*d)a("

:a6 does not 'rohi!it a 'rivate individual from carr%ing on !anking !usiness$ is main difficult% 6ould !e tattract de'ositors in the 'resent da%s 6hen there are re'uted !ig !anking com'anies and cor'orations in the 'rivatand 'u!lic sectors$ )he maximum num!er of de'ositors have also !een restricted under the 2eserve Bank of &ndi

4ct$

rohi!ition of acce'tance of de'osits !% unincor'orated Bodies Cha'ter &&&C has !een &"SE2)E+ &" )2eserve Bank of &ndia 4ct, -H15 !% the Banking :a6s >4mendmentA 4ct, -H@1 6ith effect from -I$/$-H@5 containinsections 5I2, 5IS and 5I)$ Section 5IS 'rovides that no 'erson, !eing an individual or a firm or an unincor'orateassociations of individuals shall have de'osits from more than follo6ing num!er of de'ositors.

>iA &ndividual "ot more than /I de'ositors excludingrelatives$

>iiA Firm "ot more than /I de'ositors 'er 'artner andnot more than /I in all, excluding relatives ofan% of the 'artner$

>iiiA Unincor'orated association ofindividuals

"ot more than /I de'ositors 'er individual andnot more than /I in all, excluding relatives ofan% of the individuals$

Su!?sections / 'rovides that 6here at the commencement of the 4ct num!er of de'ositors, exceed the a!ove limthe 'erson shall re'a% 6ithin / %ears such num!er of de'ositors to !ring them 6ithin the limits s'ecified$

>aA a 'erson shall !e deemed to !e a relative of another if, and if, ? >iA the% are mem!ers of a indu undivide

famil%, or >iiA the% are hus!and and 6ife, of >iiiA the one is related to the other in the manner indicated in the list orelatives.

>!A a 'erson in 6hose favor a credit !alance is outstanding for a 'eriod not exceeding months in anaccount relating to mutual dealings in the ordinar% course of trade or !usiness shall not, on account of such !alancalone, !e deemed to !e a de'ositor$

&n 0anta Mehta D$ Union of &ndia and others, >-H@GA, the +elhi igh Court has held that section 5I?S >rea6ith section 5@B>I4A of Cha'ter &&&?C of the 2eserve Bank of &ndia 4ct, -H15, as introduced !% section - of thBanking :a6s >amendmentA 4ct, -H@1, 6hich im'oses a ceiling on de'ositors in the case of &ndividuals, Firm an

4ssociation is not discriminator% and does not affect he fundamental right to carr% on !usiness or to form associatioor unions$ &t is not violative of 4rticles -5 and -H of the Constitution, )here is nothing demonstra!l% irrelevant o'erverse in limiting the num!er of de'ositors that an individual, form or association could acce't$ "or is there anelement of com'ulsion on individuals and firms or associations 6hich are not incor'orated to incor'orate themselveas a com'an%$ Cha'ter &&&?C im'oses reasona!le restrictions on the right of individuals firms and unincor'orateassociation to carr% on the !usiness of acce'tance of de'osits and advancing or giving loans to the 'u!lic$ )here is further safeguard that Cha'ter &&&?C is !eing o'erated under the su'ervision and control of the 2eserve Bank of &ndia

Section 5I) further 'rovides that an officer of the 2eserve Bank or the State (overnment, authorized in th!ehalf, ma% o!tain a search 6arrant from courts so as to ena!le them to enter into and search an% 'remisesus'ected to !e used for the 'ur'ose connected 6ith the recei't of the de'osits in contravention of sections 5ISSuch 6arrant shall !e executed in the same 6a% and shall have the same effect as a search 6arrant issued undethe Code of Criminal rocedure, -HG1$

II. Partner",*- &*r"

2


23/151

4 firm 6ith more than ten 'artners cannot carr% on !anking !usiness . it has to !e registered as a com'an>Section -->-A of the Com'anies 4ct, -HIA$ 4 !anking firm of ten 'artners or less faces the same difficulties as aindividual 6ould face$

)he la6 relating to artnershi' Firms is laid do6n in the &ndian artnershi' 4ct, -H1/$

III. H*nd) /*nt &a*( "te

4 man% 'laces in &ndia other than cities !anking !usiness 6as carried on !% 'rivate !anks o6ned !% #oinindu Families$ )he most 'rominent among these are the D4ish%a, the 9ain and the Marathi families scattered a

over &ndia, the "attukottai Chett%s in the State of MadrasJ the 0hatries and the 4uroras in un#a!, and the Multaniein (u#arat and the Uttar radesh$ )his s%stem !ears striking resem!lance to our modern #oint stock !anks in morthan one res'ect$ &ts lie is institutional, and not 'ersonal, and as such, it en#o%s un!roken continuit%, it has a distincexistence in la6 and the going out or the coming in of 'ersons makes not the slightest difference to the continuit% othat !od%$ )he conce't of 9oint indu famil% is recognized !% la6$ 4 !usiness, according to that la6, is a distincherita!le asset$ ;here a indu dies leaving a !usiness it asses like other herita!le 'ro'erties to his heirs$ &f he dieleaving male issues it descends to them$ &n the hands of the male issues it !ecomes 9oint Famil% !usiness and thfirm 6hich consists of the male issued !ecomes a #oint famil% firm >Mulla=s indu :a6A$ )he #oint o6nershi' is not aordinar% 'artnershi' arising out of contract !ut a famil% artnershi' created !% the o'eration of :a6$ )he rights anlia!ilities of the co?'artners constituting the famil% firm as also of the 'ersons dealing 6ith the firm are not to !determined !% exlusive reference to the &ndian artnershi' 4ct !ut are to !e considered 6ith regard to certain rules othe indu :a6$

I$ Ban!*n+ C-an*e" and Cr-rat*n"

)he !ulk of !anking !usiness no6 in &ndia is carried on !% scheduled !anks 6hich are the Banking Com'anies anthe nationalized Banks$ Bulk of the !anking !usiness in the countr% is in the 'u!lic sector$ )here are altogether /!anks in the 'u!lic sector, com'rising the State Bank of &ndia and its G associate !anks, -H commercial !anknationalized in 9ul% -HH, and in 4'ril -H@$ )he 'u!lic sector !anks account for a!out HN of the total !ankin!usiness in &ndia$

)he 'rovisions regulating the formation, management and administration of the !anking com'anies in thrivate sector are laid do6n in the Banking 2egulation 4ct >'reviousl% kno6n as the Banking Com'anies 4ct, -H5HA$

)he Board of +irectors of !anking com'an% in the 'rivate sector is to !e constituted under section -4 of thBanking 4c$

)he Chief Executive of such a !anking com'an% is the 'rivate sector is to !e constituted under section -4 othe Banking 2egulation 4ct$

)he -H !anks in the 'u!lic sector have their o6n directors a''ointed !% the Central (overnment under th'rovisions of the Banking Com'anies >4c*uisition and )ransfer of UndertakingsA 4ct, -HG and -H@$

%n*t $er")" Branc, Ban!*n+

)he structure of !anking differs from countr% to countr% de'ending u'on the socio, economic and 'oliticaconditions$ Broadl% s'eaking, there are t6o t%'es of !anking s%stems?!ranch !anking and unit !anking$ )here 6as gro6ing controvers% among economist and !ankers as to the relative su'eriorit% of the t6o !anking s%stems$ Eveno6 the echo of the controvers% has not altogether 'assed a6a%$ )he controvers% has, ho6ever, no 'racticasignificance$

Branc, Ban!*n+

)he !ranch !anking s%stem is a s%stem in 6hich ever% commercial !ank has a net6ork of !ranches o'eratinthroughout the countr%$ Ever% !ank is a se'arate legal entit% and ahs one !oard of directors and one grou' oshareholders$

3er*t f Branc, Ban!*n+

Branch !anking has certain definite advantage over unit !anking$ )he follo6ing are some of them$

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1. Ad'anta+e f t,e (ar+e "ca(e 0 -erat*n"

Firstl%, the !ranch !anking s%stem has the advantages of large scale o'erations$ 2$S$ Sa%ers is also of thsame vie6$ Efficienc% in administration, econom% in 6orking, effective central !anking control, etc$, are some of thim'ortant advantages of having !ranch !anking s%stem$ )he !anking functions can !e divided into a num!er ode'artments and 'laced under different individuals or grou's of individuals$ Bank officers can !e given managemenand su'ervisor% training at the training centres esta!lished for that s'ecific 'ur'ose$ Ex'ert advice from the heaoffice is al6a%s availa!le to all the !ranches$

2. Ecn f re"er'e"

Ever% !ank is su''osed to kee' a certain of its total de'osits as cash reserves in order to gain and retain th'u!lic confidence at large$ But 'rofita!ilit% is an o''osing consideration$ )he greater the amount of cash 6ith th!anks, the lesser the 'rofita!ilit% and the lesser the amount of cash 6ith the !anks, the greater the 'rofita!ilit%$ &!ranch !anking, ho6ever, the existence of a large num!er of !ranches ena!les a !ank to kee' the reserves at as lo6a level as 'ossi!le so that the 'rofit?earning ca'acit% of the !ank 6ould not reduced$

6. Pr-er d*"tr*9)t*n f ca-*ta(

Branch !anking makes 'ossi!le the movement of ca'ital from one 'lace to another through the !ranches of !ank$ Because of such transfers of ca'ital, there are certain advantages$ Firstl%, funds can !e transferred from thos'laces 6here the% are a!undant to those 'laces 6here the% are scarce$ Secondl%, the dis'arities in the different rate

of interest ruling at different 'laces can !e largel% mitigated$ )hirdl% idle ca'ital in one lace can !e transferred tanother 'lace 6here it can !e 'rofita!ilit% invested$ Fourthl%, ca'ital is 'ut to the most 'roductive use$ :astl%, th'rofit?earning ca'acit% of the !ank is greatl% increased$

7. Lan" and ad'anta+e" +*'en n er*t"

Under the s%stem of !ranch !anking, local influential, !ut not credit?6orth% 'ersons cannot secure an% loanor advance from the !ank !ecause the !ranch manager can al6a%s shift the res'onsi!ilit% of refusal on to the heaoffice at a far off cit%$ )his is !ecause loans and advances are made on the !asis of merits f the 'ur'oses for 6hicthe% are sought !% the customers$

8. Re*ttance 9)"*ne"" ade ea"

;hen the !ank has several !ranches in different 'laces, remittance !usiness can !e 'erformed 6ith great ease o6ith little difficult%$

:. Benef*t t "a(( c)n*t*e"

Even small communities en#o% the advantage of the services of the more 'o6erful and sunder !anks$


25/151

)he !ranch managers do not have ade*uate 'o6ers in granting large loans and the% have to get the a''rovaof the head office !efore transacting such large !usiness$ )his means dela%$ But this arguments is not valid in thesda%s !ecause the !ranch managers are in close touch 6ith the head office through tele'hone and telegram$

2. Lac! f "-at, fr (ca( need"

)he !ranch managers do not have an% kno6ledge a!out the local condions or local 'ro!lems and difficulties or loca!orro6ers$ )his is 'erha's, due to the fre*uent transfer of !ranch managers$ )herefore the !anch !anking s%stem

does not s%m'athise 6ith the local needs$

6. &)nd" f a re+*n )"e e("e>,ere

Funds of one region or localit% ma% !e used in other regions or localities$

7. Creat*n f n-( ->er

)he !ranch !anking s%stem creaters some sort of mono'ol% 'o6er$ Under !ranch !anking, there concentration of financial resources in the hands of a fe6 !anks 6hich results in the creation of mono'ol%$

8. C-et*t*'e >a"te

+ue to keen com'etition !et6een the !ranches of different !anks in one region or localit%, there is found to !a large 6astage of time, energ% and financial resources of the region or localit%$

:. Preferent*a( treatent ",>n t near9 f*r"

)he !ranches of the !anks sho6 a good deal of 'referential treatment to those firms 6hich are situatenear!% the !ranches detrimental to the gro6th of firms at far off 'laces$

!A )he unit !anker has s'ecialized kno6ledge of the local industries and occu'ations, customs and 're#udicese can serve the local needs of the small communities in an effective manner$ &n fact, he 'a%s great attentioto the financial 'ro!lems and needs of the individual enter'rises in his area$

>cA Since the affairs of the !ank are less scattered, there are ver% fe6 'ossi!ilities for fraud and irregularitiesmanagement and su'ervision do not offer an% serious 'ro!lems$

>dA Unit !anking is free from the diseconomies of large?scale o'erations 6hich are generall% associated 6it!ranch !anking$

D*"ad'anta+e" f %n*t Ban!*n+

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4mong the disadvantages of unit !anking, the most im'ortant is that a unit !ank has limited financiresources and, therefore, cannot 6ithstand a !usiness de'ression or a run on it$ 4 ver% im'ortant factor 6hiccontri!utes to the lo6 survival rate of a unit !ank is its lack of diversification of de'osits and assets and s'ecializatioin those industries 6hich are located in the area$ 4n% difficult% in these industries 6ill automaticall% land the !ank alsin difficulties$ &n fact, during the (reat +e'ression of -H1=s so man% unit !anks failed in the U$S$4$ nearl% I,-!anks that it !ecame clear that such !anks 6ere ill?e*ui''ed to 6ithstand adversit%$

4nother demerit of unit !anking is that it is not a!le to 'rovide full and ade*uate !anking facilities to smacommunities !ecause the area of its o'erations is restricted and the unit !ank ma% not command ade*uat

resources$ &nade*uac% of financial resources is res'onsi!le for the ina!ilit% of unit !anking s%stem to su''ort aefficient management$

:astl%, the unit !anker, !eing a local man, ma% have to follo6 considerations other than strict economic 'rinci'les igranting loans and advances$ For instance, it ma% !e ver% difficult and even dangerous for the !anker to refuse ainfluential local !usinessman 6ho ma% not !e so credit6orth%$ &f he lends, the !usinessman ma% default and land th!ank in difficulties, and if the loan is refused, the unscru'ulous !usinessman ma% circulate remours a!out thsolvenc% of the !ank and thus !ring a!out the !ank=s failure$ )o sum u', it is agreed that the !ranch !anking s%stemhas far more su!stantial merits and has greater 'o6er of survival than the unit !anking s%stem$ Even in 4mericatraditionall% considered as the home of unit !anking, the trend since -H1=s has !een to6ards !ranch !anking, or tget the advantages of !ranch !anking !% 6hat are kno6n as grou' !anking and chain !anking s%stem$

Ot,er Ban!*n+ "te"

)here are three other t%'es of !anking s%stem also, viz$, the grou', the chain and the corres'ondent !anks$

(rou' !anking is one 6here t6o or more se'aratel% incor'orated !anks are !rought under the control of holding com'an% 6hich ma% or ma% not !e a !anking com'an%$ )he !anks so !rought together ma% !e unit !anks o!ranch !anks or !oth$

Chain !anks refer to se'aratel% incor'orated !anks !rought under common control !% a device other than thholding com'an%$ )his ma% !e through some 'ersons !eing directors of t6o or more !anking com'anies or samgrou's of 'ersons o6ning them$

Under the corres'ondent !anking s%stem, !anks are linked together through de'osits !% smaller !anks osome of their cash reserves 6ith !igger !anks$ ere the !igger !anks 6ith 6hich de'osits are so made are callecorres'ondent !anks$ )hese !anks in turn ma% de'osit some of their cash !alances 6ith still !igger !anks

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Documents

21 Banking-Theory-Law and Practice