Banking in India 2 Chotu

8/6/2019 Banking in India 2 Chotu

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BANKING IN INDIA

Name: Debashis Mondal

Program of Study: Master of Business Administration

Session of study: 2009 - 2011

Name of Internal guide: Prof. Sushmit Mitra

Name of the Topic: Banking in India

Date of Project Report Submission:


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CONTENTS

PARTICULARS Page No.

Declaration by student

Declaration by Internal Guide

4

5

Executive Summary

Objective of Study

Introduction

6

7

8

Types of Banks 12

Banking Sector in India 13

Role of Banks 14

Role of Banks in Indian Economy 16

Evolution of Banking 17

Methodology

Limitations of The Study

Recommendation

Conclusion

Bibliography


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DECLARATION BY INTERNAL GUIDE

This is to certify that the work embodied in the project report titled Banking in India

done by Debashis Mondal was conducted under my supervision.

Signature:

Prof. Sushmit Mitra

Date:


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EXECUTIVE SUMMARY

The banking system remains, as always, the most dominant segment of the financial

sector. Indian banks continue to build on their strengths under the regulator's watchful

eye and hence, have emerged stronger.

The project is primarily focused on the banking sector in India and how they are working

in the Indian scenario. Indian banking industry is becoming one of the most dominant

banking system in the world. It has starched greatly after the globalization. So here I have

tried to analyze the industry and how it work. In this project I have shown the different

types of banks that we have in our country and their different functions.


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OBJECTIVE OF STUDY

Banks play very important role in the economic life of the nation. The health of the

economy is closely related to the soundness of its banking system. Although banks create

no new wealth but their borrowing, lending and related activities facilitate the process of

production, distribution, exchange and consumption of wealth. In this way they become

very effective partners in the process of economic development. A bank as a matter of

fact is just like a heart in the economic structure and the Capital provided by it is like

blood in it. As long as blood is in circulation the organs will remain sound and healthy. If

the blood is not supplied to any organ then that part would become useless. So the main

objectives of this project are stated bellow.

Broad Objectives:

To have a clear idea about the banking sector.

To find out the working process of a bank.

To know the current scenario of the banking system in India.

To know the growth and the future prospects.

Specific Objectives:

To understand the different function of a bank.

To find out the difference between the private sector and the public

sector banks.

To find out the role of the RBI and the Government of India.

To understand the modern banking system and its advantages.


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INTRODUCTION

Banks over the years have become a significant aspect of an economy. With the ongoing

financial depression, the position of banks have become all the more important in the

course of

working of the money market and hence the economy of a nation. The banking sector

forming a

portion of the financial sector primarily works as a financial intermediary generating

money

supply. From the different macroeconomic models, banks have been found to be a part of

the

supply side of the economy. However, over time banks have transformed from merely

money

generating organizations to a multi tasking entity. In this paper, we shall deal with the

role of

banks in the context of the world economy as well as the Indian economy . The first

section will

illustrate the functions of a bank along with its classification. In the second section, we

shall

discuss the role of a banks as a major component of the service sector rendering to the

economy


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as a whole. In the third section, we would like to empirically validate our hypothesis with

a

comprehensive data analysis.

What is a Bank? While the question may seem elementary, the answer can be quite

complex. Understanding what banking is all about will help the paper to illustrate the role

of banks better.

A bank is a financial institution where an individual can deposit money. Banks provide a

system for easily transferring money from one person or business to another. Using banks

and the many services they offer saves an incredible amount of time, and ensures that the

funds of micro as well as macroeconomic agents "pass hands" in a legal and structured

manner. There are also other types of financial institutions that operate just like banks.

Functions of a bank : Functioning of a Bank is among the more complicated of

corporate operations. Since

Banking involves dealing directly with money, governments in most countries regulate

this sector rather stringently. In India, the regulation traditionally has been very strict and

in the opinion of certain quarters, responsible for the present condition of banks, where

NPAs are of a very high order. The process of financial reforms, which started in 1991

has

cleared the cobwebs somewhat but a lot remains to be done. The multiplicity of policy

and

regulations that a Bank has to work with, makes its operations even more complicated,

sometimes bordering on illogical. This section attempts to give an overview of the

functions in as simple manner as possible.

Banking Regulation Act of India, 1949 defines Banking as "accepting, for the purpose of

lending or investment of deposits of money from the public, repayable on demand or

otherwise and withdraw able by cheques, draft, order or otherwise". Deriving from this


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definition and viewed solely from the point of view of the customers, Banks essentially

perform the following functions:

1. Accepting Deposits from public/others (Deposits)

2. Lending money to public (Loans)

3. Transferring money from one place to another (Remittances)

4. Credit Creation

5. Acting as trustees6. Keeping valuables in safe custody

7. Investment Decisions and analysi

8. Government business

9. Other types of lending and transactions.

In addition to providing a safe custodian of money, banks also loan money to businesses

and consumers. A large portion of a bank's business is lending. How do banks get the

money they loan? The money comes from depositors who intend to save a portion of

their wealth. Banks acting as intermediaries, use these deposits as loans to prospective

borrowers.

The objective of commercial banks like any other organization is profit maximisation.

This profit

generally originates from the interest differential between borrowers and lenders. In the

present

day, however, the banking operation has extended much beyond simple lending exercise.

So

there are other different channels of profit ensuing from other investment programmes as

well.


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However, it should be mentioned in this context that the entire deposit held by a bank

cannot be

given as loans as the Central Bank retains a portion of this money in the form of cash-

reserve for

unforeseen circumstances.

Banks create money in the economy by making loans. The amount of money that banks

can

lend is directly affected by the reserve requirement set by the Federal Reserve. The

reserve

requirement is currently 3 percent to 10 percent of a bank's total deposits. This amount

can be

held either in cash on hand or in the bank's reserve account with the Fed. To see how this

affects

the economy, think about it like this. When a bank gets a deposit of $100, assuming a

reserve

requirement of 10 percent, the bank can then lend out $90. That $90 goes back into the

economy,

purchasing goods or services, and usually ends up deposited in another bank. That bank

can then

lend out $81 of that $90 deposit, and that $81 goes into the economy to purchase goods or

services and ultimately is deposited into another bank that proceeds to lend out a

percentage of it.


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In this way, money grows and flows throughout the community in a much greater amount

than

Physically exists. That $100 makes a much larger ripple in the economy than you may

realize.

Other services offered by banks:

Credit Cards

Personal Loans

Home and Car Loans

Mutual Funds


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Business Loans

Safe Deposit Boxes

Debit Cards

Trust Services

Signature Guarantees

.and many other investment services.


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TYPES OF BANKS:

Central Bank: A central bank, reserve bank, or monetary authority is the entity

responsible for the monetary policy of a country or of a group of member states. Its

primary responsibility is to

maintain the stability of the national currency and money supply, but more active duties

include

controlling subsidized-loan interest rates, and acting as a lender of last resort to the

banking

sector during times of financial crisis (private banks often being integral to the national

financial

system). It may also have supervisory powers, to ensure that banks and other financial

institutions do not behave recklessly or fraudulently.

Commercial Banks: A commercial Bank performs all kinds of banking functions such as

accepting deposits, advancing loans, credit creation & agency functions. They generally

advance short term loans to their customers; in some cases they may give medium term

loans also.

Industrial Banks: Ordinarily, the industrial banks perform three main functions: Firstly,

Acceptance of Long term deposits: Since the industrial bank give long term loans, they

cannot

accept short term deposits from the public. Secondly, Meeting the credit requirements of

companies: Firstly the industries require to purchase land to erect buildings and purchase

heavy

machinery. Secondly the industries require short term loans to buy raw materials & to

make


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payment of wages to workers. Thirdly it does some Other Functions - The industrial

banks

tender advice to big industrial firms regarding the sale & purchase of shares &

debentures.

Agricultural Banks: As the commercial & the industrial Banks are not in a position to

meet the credit requirements of agriculture, there arises the need for setting up special

types of banks to

finance agriculture. Firstly, the farmers require short term loans to buy seeds, fertilizers,

ploughs

and other inputs. Secondly, the farmers require long term loans to purchase land, to effect

permanent improvements on the land to buy equipment & to provide for irrigation works.

Foreign Exchange Banks: Their main functions are to make international payments

through the purchase and sale of exchange bills. As is well known, the exporters of a

country prefer to receive the payment for their exports in their own currency. Hence their

arises the problem of converting the currency of one country into the currency of another.

The foreign exchange banks try to solve this problem. These banks specialize in

financing foreign trade.

Indigenous Banks: According to the Indian Enquiry Committee, Indigenous banker is a

person or a firm which accepts deposits, transacts business in hundies and advances loans

etc.

BANKING SECTOR IN INDIA

Central Bank:


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The Reserve Bank of India is the central Bank that is fully owned by the

Government. It is governed by a central board (headed by a Governor) appointed by the

Central Government. It issues guidelines for the functioning of all banks operating within

the country.

Public Sector Banks:

a. State Bank of India and its associate banks called the State Bank Group

b. 20 nationalized banks

c. Regional rural banks mainly sponsored by public sector banks

Private Sector Banks:

a. Old generation private banks

b. New generation private banks

c. Foreign banks operating in India

d. Scheduled co-operative banks

e. Non-scheduled banks

Co-operative Sector:

The co-operative sector is very much useful for rural people. The co-operative banking

sector is divided into the following categories.

a. State co-operative Banks

b. Central co-operative banks

c. Primary Agriculture Credit Societies

Development Banks/Financial Institutions:


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IFCI, IDBI , ICICI Bank , IIBI

SCICI Ltd.

NABARD

Export-Import Bank of India

National Housing Bank

Small Industries Development Bank of India

North Eastern Development Finance Corporation

ROLE OF BANKS

A proper financial sector is of special importance for the economic growth of developing

and

underdeveloped countries. The commercial banking sector which forms one of the

backbones of

the financial sector should be well organized and efficient for the growth dynamics of a

growingeconomy. No underdeveloped country can progress without first setting up a sound

system of

commercial banking. The importance of a sound system of commercial banking for a

developing

country may be depicted as follows:

Capital Formation: The rate of saving is generally low in an underdeveloped economy

due to the existence of deep-rooted poverty among the people. Even the potential savings

of the country cannot be realized due to lack of adequate banking facilities in the country.

To mobilize dormant savings and to make them available to the entrepreneurs for

productive purposes, the development of a sound system of commercial banking is

essential for a developing economy.


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Monetization: An underdeveloped economy is characterized by the existence of a large

non monetized sector, particularly, in the backward and inaccessible areas of the country.

The existence of this non monetized sector is a hindrance in the economic development

of the country. The banks, by opening branches in rural and backward areas, can promote

the process of monetization in the economy.

Innovations: Innovations are an essential prerequisite for economic progress. These

innovations are mostly financed by bank credit in the developed countries. But the

entrepreneurs in underdeveloped countries cannot bring about these innovations for lack

of bank credit in an adequate measure. The banks should, therefore, pay special attention

to the financing of business innovations by providing adequate and cheap credit to

entrepreneurs.

Finance for Priority Sectors: The commercial banks in underdeveloped countries

generally hesitate in extending financial accommodation to such sectors as agriculture

and small scale industries, on account of the risks involved there in. They mostly extend

credit to trade and commerce where the risk involved is far less .But for the development

of these countries it is essential that the banks take risk in extending credit facilities to thepriority sectors, such as agriculture and small scale industries.

Provision for Medium and Long term Finance: The commercial banks in

underdeveloped countries invariably give loans and advances for a short period of time.

They generally hesitate to extend medium and long term loans to businessmen as it is

well known, the new business need medium and long term loans for their proper

establishment. The commercial banks should, therefore, change their policies in favor of

granting medium and long term accommodation to business and industry.

Cheap Money Policy: The commercial banks in an underdeveloped economy should

follow cheap money policy to stimulate economic activity or to meet the threat of


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business recession. In fact , cheap money policy is the only policy which can help

promote the economic growth of an underdeveloped country . It is heartening to note that

recently the commercial banks have reduced their lending interest rates considerably.

Need for a Sound Banking System: A sound system of commercial banking is an

essential prerequisite for the economic development of a backward country.

ROLE OF BANKS IN INDIAN ECONOMY

In India, as in many developing countries, the commercial banking sector has been the

dominant element in the counters financial system. The sector has performed the key

functions of providing liquidity and payment services to the real sector and has accounted

for the Bulk of the financial intermediation process. Besides institutionalizing savings,

the banking sector has contributed to the process of economic development by serving as

a major source of credit to households, government, and business and to weaker sectors

of the economy like village and small-scale industries and agriculture. Over the years,

over 30-40% of gross household savings, have been in the form of bank deposits andaround 60% of the assets of all financial institutions accounted for by commercial banks.


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An important landmark in the development of banking sector in recent years has been

the initiation if reforms following the recommendations of the first Narasimham

Committee on Financial System. In reviewing the strengths and weaknesses of these

banks, the Committee suggested several measures to transform the Indian banking sector

from a highly regulated to a more market oriented system and to enable it to compete

effectively in an increasingly globalised environment. Many of the recommendations of

the Committee especially those pertaining to interest rate, an institution of prudential

regulation and transparent accounting norms were in line with banking policy reforms

implemented by a host of developing countries since 1970s.

EVOLUTION OF BANKING IN INDIA

Introduction: Banking in India originated in the last decades of the 18th century. The

first banks were The General Bank of India, which started in 1786, and Bank of

Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in

India is the State Bank of India, which originated in the Bank of Calcutta in June 1806,

which almost immediately became the Bank of Bengal. This was one of the three


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presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all

three of which were established under charters from the British East India Company. For

many years the Presidency banks acted as quasi-central banks, as did their successors.

The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's

independence, became the State Bank of India.

Growth: Indian merchants in Calcutta established the Union Bank in 1839, but it failed

in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank,

established in 1865 and still functioning today, is the oldest Joint Stock bank in India.

(Joint Stock Bank: A company that issues stock and requires shareholders to be held

liable for the company's debt) It was not the first though. That honor belongs to the Bank

of Upper India, which was established in 1863, and which survived until 1913, when it

failed, with some of its assets and liabilities being transferred to the Bank of Shimla.

When the American civil war stopped the supply of cotton to Lancashire from the

Confederate States, promoters opened banks to finance trading in Indian cotton. With

large exposure to speculative ventures, most of the banks opened in India during that

period failed. The depositors lost money and lost interest in keeping deposits with banks.

Subsequently, banking in India remained the exclusive domain of Europeans for next

several decades until the beginning of the 20th century.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The

Comptoire dEscompte de Prais opened a branch in Calcutta in 1860, and another

in Bombay in 1862; branches in Madras and Puducherry, then a French colony,

followed. HSBC established itself in Bengal in 1869. Calcutta was the most active

trading port in India, mainly due to the trade of the British Empire, and so became

a banking center.

The first entirely Indian joint stock bank was the Oudh Commercial Bank,

established in 1881 in Faizabad . It failed in 1958. The next was the Punjab


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National Bank, established in Lahore in 1895, which has survived to the present

and is now one of the largest banks in India.

Around the turn of the 20th Century, the Indian economy was passing through a

relative period of stability. Around five decades had elapsed since the Indian

mutiny, and the social, industrial and other infrastructure had improved. Indians

had established small banks, most of which served particular ethnic and religious

communities.

The presidency banks dominated banking in India but there were also some

exchange banks and a number of Indian joint stock. All these banks operated in

different segments of the economy. The exchange banks, mostly owned by

Europeans, concentrated on financing foreign trade. Indian joint stock banks were

generally undercapitalized and lacked the experience and maturity to compete

with the presidency and exchange banks. This segmentation let Lord Curzon to

observe, "In respect of banking it seems we are behind the times. We are like

some old fashioned sailing ship, divided by solid wooden bulkheads into separate

and cumbersome compartments."

The period between 1906 and 1911, saw the establishment of banks inspired by

the Swadeshi movement. The Swadeshi movement inspired local businessmen

and political figures to found banks of and for the Indian community. A number

of banks established then have survived to the present such as Bank of India,

Corporation Bank, Indian Bank, Bank of Boroda, Canara Bank, and Central Bank

of India.

During the First World War (1914-1918) through the end of the Second World

War (1939-1945), and two years thereafter until the independence of India were

challenging for Indian banking. The years of the First World War were turbulent,


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and it took its toll with banks simply collapsing despite the Indian economy

gaining indirect boost due to war-related economic activities. At least 94 banks in

India failed between 1913 and 1918 as indicated in the following table:

Years Number of

banks

that failed

Authorized capital

(Rs. Lakhs)

Paid-up Capital

(Rs. Lakhs)

1913 12 274 35

1914 42 710 109

1915 11 56 5

1916 13 231 4

1917 9 76 25

1918 7 209 1

Nationalization:

Despite the provisions, control and regulations Reserve Bank of India, banks in

India except the State Bank of India or SBI, continued to be owned and operated

by private persons. By the 1960s, the Indian banking industry had become an

important tool to facilitate the development of the Indian Economy. At the same

time, it had emerged as a large employer, and a debate had ensued about the

nationalization of the banking industry. Indira Gandhi and the Prime Minister of

India expressed the intention of the Government of India in the annual conference

of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank

Nationalization." The meeting received the paper with enthusiasm.

Thereafter, her move was swift and sudden. The Government of India issued an

ordinance and nationalized the 14 largest commercial banks with effect from the

midnight of July 19, 1969. Jayprakash Narayan, a national leader of India,


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described the step as a "masterstroke of political sagacity."Within two weeks of

the issue of the ordinance, the parliament passed the Banking Companies

(Acquisition and Transfer of Undertaking) Bill, and it received the presidential

approval on 9 August 1969.

A second dose of nationalization of 6 more commercial banks followed in 1980.

The stated reason for the nationalization was to give the government more control

of credit delivery. With the second dose of nationalization, the Government of

India controlled around 91% of the banking business of India. Later on, in the

year 1993, the government merged New Bank of India with Punjab National

Bank. It was the only merger between nationalized banks and resulted in the

reduction of the number of nationalized banks from 20 to 19. After this, until the

1990s, the nationalized banks grew at a pace of around 4%, closer to the average

growth rate of the Indian economy.

Liberalizations:

In the early 1990s, the then Narshima Rao government embarked on a policy of

liberalization , licensing a small number of private banks. These came to be

known asNew Generation tech-savvy banks, and included Global Trust Bank (the

first of such new generation banks to be set up), which later amalgamated with

Oriental Bank of Commerce, Axis Bank, ICICI Bank and HDFC Bank . This

move, along with the rapid growth in the economy of India, revitalized the

banking sector in India, which has seen rapid growth with strong contribution

from all the three sectors of banks, namely, government banks, private banks and

foreign banks.

The next stage for the Indian banking has been set up with the proposed relaxation

in the norms for Foreign Direct Investment, where all Foreign Investors in banks


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may be given voting rights which could exceed the present cap of 10%,at present

it has gone up to 74% with some restrictions.

The new policy shook the Banking sector in India completely. Bankers, till this

time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%;Go home at 4) of

functioning. The new wave ushered in a modern outlook and tech-savvy methods

of working for traditional banks.All this led to the retail boom in India. People not

just demanded more from their banks but also received more.

Currently (2007), banking in India is generally fairly mature in terms of supply,

product range and reach-even though reach in rural India still remains a challenge

for the private sector and foreign banks. In terms of quality of assets and capital

adequacy, Indian banks are considered to have clean, strong and transparent

balance sheets relative to other banks in comparable economies in its region. The

Reserve Bank of India is an autonomous body, with minimal pressure from the

government. The stated policy of the Bank on the Indian Rupee is to manage

volatility but without any fixed exchange rate-and this has mostly been true.

With the growth in the Indian economy expected to be strong for quite some time-

especially in its services sector-the demand for banking services, especially retail

banking, mortgages and investment services are expected to be strong. One may

also expect M&As, takeovers, and asset sales.

In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its

stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first

time an investor has been allowed to hold more than 5% in a private sector banksince the RBI announced norms in 2005 that any stake exceeding 5% in the

private sector banks would need to be vetted by them.


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In recent years critics have charged that the non-government owned banks are too

aggressive in their loan recovery efforts in connection with housing, vehicle and

personal loans. There are press reports that the banks' loan recovery efforts have

driven defaulting borrowers to suicide.

Documents

Banking in India 2 Chotu