BANKING AND FINANCIAL SERVICES (BFS).

Unit-1
Structure of Banking in India: Functions of RBI, structure and
functions of commercial banks. Monetary system, Sources of funds,
Quantitative and qualitative measures of credit control. Banking sector
reforms, Bank performance analysis and Future of Banking.(Theory)

Financial System
Financial system acts as a nerve system of the country's economy. A
nation's economic development principally rely on the effective and
efficient financial system. The financial system consists of many
subsystems like financial services, financial markets, financial
institutions, etc. Generally, developing economies’ financial system is
also in the process of development.
In any economy, individuals and organizations earn and spend money.
Financial system is the system, which induces savings, transfer of those
savings into an industrial effort and stimulates an entrepreneur to
undertake various business ventures. It is a key weapon in monitoring
the economic progress of any country, because eventually all efforts and
resources are measured in financial terms.
Contribution of Financial System to Economic growth &
Development.
 Mobilizing savings and converting it into investment.
 Providing required capital to the busines organizations to carry out
their activities.
 Generating income or profit.
  Raising productivity of capital through efficient allocation.

Components of Financial System

1. Financial Markets
2. Financial Institutions
3. Financial Instruments
4. Financial Services
1. Financial Markets: This is a place or mechanism where funds or
savings are transferred from one section to another section of financial
system. These markets can be broadly classified into,
(i).Money market and capital market
(ii).Primary and secondary market.

2. Financial Institutions: These are institutions which are dealing in the

financial market. They mobilize and transfer the savings or funds from
surplus units to deficit units and provide various financial services.
These financial institutions include, Commercial banks, Merchant banks,
Insurance companies, Mutual funds etc. They are the backbone of the
financial system.
3. Financial Instruments: The instruments that are traded or dealt in a
financial market are financial assets or securities or financial
instruments. Financial instruments may be classified into capital market
instruments and money market instruments. Some of the examples of
these financial instruments are equity shares, preference shares,
debentures, bonds, certificate of deposits, commercial papers etc.
4. Financial Services: Financial services are the services offered by
financial institutions in financial markets. The financial services help not
only to raise the required funds but also ensure their efficient use. The
various financial services provided includes, leasing, merchant banking,
credit cards, factoring, banking, insurance, etc.
Banking Financial Institutions in India.
(1) Reserve Bank of India
(2) Commerical Banks
(3) Co-operative Banks
Non-banking Financial Institutions in India.
1. Indigenous Bankers and Financial Agencies
2. Development Banks
3. Insurance Companies
4. Mutual Funds
5. Finance Companies
6. Merchant Banking Institutions
7. Pension Funds
8. Discount Houses
9. Acceptance House
10. Housing finance companies
11. Leasing and hire purchase companies
12. Venture capital firms
13. Debt securitization companies.

Origin of the Word ‘Bank’

Finance is the life blood of trade, commerce and industry. Now-a-days,
banking sector acts as the backbone of modern business. Development
of any country mainly depends upon the banking system. The term bank
is either derived from old Italian word banca or from a French word
banque both mean a Bench or money exchange table. In olden days,
European money lenders or money changers used to display (show)
coins of different countries in big heaps (quantity) on benches or tables
for the purpose of lending or exchanging.
However modern Banking is of recent origin. The development of
banking from the traditional lines to the modern structure passes through
Merchant bankers, Goldsmiths, Money lenders and Private banks.
Merchant Bankers were originally traders in goods. Gradually they
started to finance trade and then become bankers. Goldsmiths are
considered as the men of honesty, integrity and reliability. They
provided strong iron safe for keeping valuables and money. They issued
deposit receipts (Promissory notes) to people when they deposit money
and valuables with them. The goldsmith paid interest on these deposits.
Apart from accepting deposits, Goldsmiths began to lend a part of
money deposited with them.
Bank of Hindustan(1770) was the first Indian bank established in India.
Later on, the East India Company started three presidency banks, Bank
of Bengal(1806), Bank of Bombay(1840) and Bank of Madras(1843)
These bank were given the right to issue notes in their respective
regions. Allahabad bank was established in 1865 and Alliance Bank in
1875. Another landmark in the history of Indian banking was the
formation of Imperial bank of India in 1921 by amalgamating 3
presidency banks It is the Imperial Bank which performed some central
banking functions in India. A number of banks failed during the first half
of the 20 th Century. It affected the people’s belief and faith in Banks.
The Reserve Bank of India (RBI) was originally established in 1935 by
an Act promulgated by the Government of India, but as a shareholder
institution like the Bank of England. After India's independence, in the
context of the need for close integration between its policies and those of
the Government, the Reserve Bank became a state - owned institution
from January 1, 1949. It was during this year that the Banking
Regulation Act was enacted to provide a framework for regulation and
supervision of commercial banking activity.
By independence, India had a fairly well developed commercial banking
system in existence. Reserve bank of India was nationalized in the year
1949. The enactment of the Banking Companies Act 1949 (Later it was
renamed as Banking Regulation Act) was a bold step in the history of
banking in India. In 1955, Imperial Bank of India was nationalized and
renamed as State bank of India (SBI). The SBI started number of
branches in urban and rural areas of the country.
In 1967, Govt introduced the concept of social control on banking
sector. Nationalization of 14 commercial banks in 1969 was a revolution
in the history of banking in India. Six more commercial banks were
nationalized in 1980. Other landmarks in the history of Indian banking
were the establishment of National Bank for Agricultural and Rural
Development (1988), merger of New Bank of India with Punjab
National Bank (1993), merger of State Bank of Sourashtra with SBI
(2008), merger of State Bank of Indore with SBI (2010) and the recent
merger of SBI with it’s associate banks along with Bharatiya Mahila
Bank.
At present we have 18 Public sector Banks. They are,
1.Nationalised Banks-17
2.SBI

Meaning of Bank
In simple terms, a bank is an institution that accepts various types of
deposits and then advances money in form of loans to people requiring
it.
A bank is a financial institution which deals with deposits and advances
and other related services. It receives money from those who want to
save in the form of deposits and it lends money to those who need it.

Definition of Bank.
Banking Regulation Act of 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 withdrawable by cheque, draft,
order or otherwise”.

Features of Bank
 Dealing in Money
 Acceptance of Deposit
 Giving Advice
 Providing Loans
 Performing Agency and Utility functions.
 Profit and Service orientation

Reserve Bank of India(RBI)

The Reserve Bank of India (RBI) was established on 1st April 1935
under the Reserve Bank of India Act, 1934. After its establishment, it
took over the function of issuing paper currency from the Government of
India and of controlling credit from the Imperial Bank of India. It
originally started as a shareholders bank with a paid-up capital of 5
crores. It was nationalized on 1st January 1949 and since then it has been
functioning as a State owned and State-controlled Central Bank.
Key Points
• RBI was set up on the recommendations of Hilton Young
Commission.
• It was started with a paid-up capital of 5 cr as private shareholders
bank.
• It was set up on 1st April, 1935 in kolkata and later in the year 1937
headquarters was moved to Mumbai.
• The Government of India nationalised the Reserve Bank under the
Reserve Bank (Transfer of Public Ownership) Act, 1948..

Objectives of RBI
The primary goals of the RBI according to the preamble of the same are
as follows.
• To regulate the issue of Banknotes.
• To secure monetary stability in the country.
• To meet the economic challenges by modernising the monetary
policy framework.
Management vested with RBI
The Reserve Bank had a paid up capital of 5 crore divided into 5 lakh
shares of 100 each. The Government of India owns all shares. The
management is vested in the Central Board of Directors, which has
twenty members as given below:
1. One Governor and four Deputy Governors appointed by the
Government of India for a Notes period of five years. Their salary, etc.,
are decided by the Central Board of Directors in consultation with the
Government of India.
2.Four directors nominated from the local boards, located at Bombay
(Mumbai), Calcutta(Kolkata), Madras (Chennai) and New Delhi by the
Government of India. Their tenure is also five years.
3.Ten other directors nominated by the Government of India whose term
is four years.
4.An official of the Government of India to attend the meetings of the
Central Board. His tenure is not fixed and he does not enjoy the right to
vote in the meetings.
5.The Central Board is required, under the Act, to meet at least six times
a year. The Governor of the Reserve Bank can call the meeting of the
Central Board, whenever he thinks necessary. Each local board has at
least four members, appointed by the Government of India for a period
of four years and representing all interests. The local boards render
advice to the Central Board and also perform the various jobs assigned
to them by the Central Board.

Functions of RBI
RBI performs various traditional banking function as well as
promotional and developmental measures to meet the dynamic
requirements of the country. Main functions of RBI can be broadly
classified into three. These are
I. Monetary functions or Central banking functions
II. Supervisory functions
III.Promotional and Developmental functions.
1) Monetary Functions
A. Issue of currency notes
B. Acting as banker to the Government
C. Serving as banker of other banks
D. Controlling credit
E. Controlling foreign exchange operations

A. Issue of Currency Notes

Under Section22 of the Reserve Bank of India Act of 1934, the
Reserve Bank of India is given the monopoly of note issue. Now
RBI is the sole authority for the issue of currency notes in the
country. The RBI has a separate department called the Issue
Department for the issue of currency notes. Since 1956 system of
Note Issue changed from Proportional Reserve System to
minimum reserve system. Under Proportional reserve system of
note issue, not less than 40% of the total volume of notes issue by
the RBI was to be covered by gold coins, bullion and foreign
securities. But under the Minimum reserve system of note issue,
RBI is required to maintain a minimum reserve of gold or foreign
securities or both against the notes issued.
No maximum limit is fixed on the volume of notes. RBI maintains
gold and foreign exchange reserves of Rs.200 crores of which 115
crores is in gold & balance in foreign securities, Govt. of India
securities, eligible commercial bills, etc.
This change from Proportional Reserve system to Minimum
Reserve system is made because of two major reasons. Firstly, the
planned economic development of the country called for an
increased supply of money, which could not be had under the
proportional reserve system. Secondly, the foreign exchange held
as reserve by the Reserve bank had to be released for financing the
five year plans. In short, this was to enable the expanding currency
requirements of the economy.

B.Banker to Government
The Reserve bank act as a banker to the Central and State
Governments. As a banker to the Government RBI acts in three
capacities, viz.,
a) as a banker,
b) as a financial agent, and
c) as a financial advisor
a) As a Banker
1. Accepts deposits from the Central and State Government.
2. Collects money on behalf of Government and makes
payments on behalf of the Government, in accordance with their
instructions.
3. Arranges for the transfer of funds from one place to another
on behalf of the Governments
4. Makes arrangements for the supply of foreign exchange to the
Central and State Governments.
5. Short term advances are granted to Central and State
Governments for a period not exceeding three months. These
advances are granted up to a certain limit without any collateral
securities.
6. In times of emergencies like war, extraordinary loans are also
granted to the Governments by the RBI.

b) As a Financial Agent
1. Acts as an agent of the Central and State Governments in the
matter of floatation of loans. On account of Reserve Bank’s
intimate knowledge of the financial markets, it is able to obtain
the best possible terms for the Government in this matter.
Further by coordinating the borrowing programmers of the
various Governments, it is able to minimize the adverse effects
of Government borrowings on the money and securities market.
2. On behalf of Central Government RBI sells treasury bills of
90 days maturity at weekly auctions and secures short-term
finance for the Central Government.
3. RBI manages and keeps the accounts of the public debts of
the Central and State Governments. It arranges for the payment
of interest and principal amount on the public debt on the due
dates.
4. As an agent RBI also represents Government of India in the
International institutions like the IMF, the IBRD etc.
c) As a Financial Advisor
1.It advices the Central and State Government on all financial
and economic matters such as the floating of loans, agricultural
and industrial finance etc.
2.Advice on matters of International finance is also given to
Central Government.
3.It collects the recent information on current economic and
financial developments in India and abroad, with the help of its
Research and Statistics Department and keeps Government
informed periodically.
C. Banker’s Bank
1.It holds a part of the cash balances of the commercial banks in
the form of CRR and SLR.
2.It acts as the clearing house and by acting as clearing house
the Reserve bank helps the member banks in the settlement of
the mutual indebtedness without physical transfer of cash.
3.It provides cheap remittance facilities to the commercial banks
4.It provides financial accommodation to the commercial banks,
at times of financial crisis the RBI is the lender of last resort for
the commercial banks. Financial assistance is given by the
Reserve bank either by rediscounting eligible bills or by
granting loans against approved securities.
D. Control of Credit
RBI undertakes the responsibility of controlling credit in order
to ensure internal price stability and promote sufficient credit
for the economic growth of the country. Price stability is
essential for economic development. To control credit, RBI
 makes use of both quantitative and qualitative weapons by
virtue of the powers given to it by Reserve Bank of India Act of
1934 and the Indian Banking Regulation Act of 1949. These
weapons are listed below.
a) Quantitative Measures
1. Bank rate policy(5.65% at present):
Bank rate is the lending rate of central bank. It is the official
minimum rate at which central bank of a country rediscounts the
eligible bills of exchange of the commercial banks and other
financial institutions or grants short term loans to them. By
increasing bank rate, RBI can make bank credit costlier.
2. Open Market Operations:
RBI Act authorizes the RBI to engage in the purchase of
securities of central and State Government and such other
securities as specified by Central Govt. RBI uses this weapon to
offset the seasonal fluctuations in money market. When there is an
excessive supply of money, RBI sells the securities in the open
market. In that way RBI is able to withdraw the excess money
from circulation. But when there is shortage of money supply in
the market, it purchases securities from the open market and as a
result, more money is arrived at for circulation.
3. Variable Cash reserve ratio:
Under the RBI Act of 1934, every scheduled and non-
scheduled bank is required to maintain a fixed percentage of total
time and demand liabilities as cash reserve with RBI. It is called
statutory Cash Reserve Ratio (CRR). An increase in CRR reduces
lending capacity of the bank and a decrease in CRR increases the
lending capacity. RBI can prescribe a CRR ranging up to 15%
which is at present 4%.
4. Variable Statutory Liquidity Ratio
According to sec 24 of Banking Regulations Act 1949, every
commercial bank is required to maintain a certain percentage of its
total deposits in liquid assets such as cash in hand, excess reserve
with RBI, balances with other banks, gold and approved
Government and other securities. This proportion of liquid assets
to total deposits is called SLR. It empowers RBI to fix the SLR up
to 40%. The variation of the SLR is intended to reduce the
lendable funds in the hands of the commercial banks and to check
the expansion of bank credit. An increase in SLR will decrease the
lendable funds in the hands of commercial banks and vice versa.
Present rate of SLR is 19.5%.
5. Repo Rate and Reverse Repo Rate
Repo rate is the rate at which RBI lends to commercial banks
generally against government securities. Reduction in Repo rate
helps the commercial banks to get money at a cheaper rate and
increase in Repo rate discourages the commercial banks to get
money as the rate increases and becomes expensive. Reverse Repo
rate is the rate at which RBI borrows money from the commercial
banks. The increase in the Repo rate will increase the cost of
borrowing and lending of the banks which will discourage the
public to borrow money and will encourage them to deposit.
As the rates are high the availability of credit and demand
decreases resulting to decrease in inflation. This increase in Repo
Rate and Reverse Repo Rate is a symbol of tightening of the
policy. As of now, the repo rate is 5.40% and reverse repo rate is
5.15%.
b) Qualitative Measures

1. Credit Ceiling/Credit Rationing

In this operation RBI issues prior information or direction that
loans to the commercial banks will be given up to a certain limit.
In this case commercial bank will be tight in advancing loans to the
public. They will allocate loans to limited sectors. Few example of
ceiling are agriculture sector advances, priority sector lending.
2. Credit Authorization Scheme
Credit Authorization Scheme was introduced in November,
1965 when P C Bhattacharya was the chairman of RBI. Under this
instrument of credit the commercial banks are required to obtain
the RBI’s prior authorization for sanctioning any fresh credit
beyond the authorized limits.
3. Moral Suasion
Moral Suasion is just as a request by the RBI to the commercial
banks to follow a particular line of action. RBI may request
commercial banks not to give loans for unproductive purpose
which does not add to economic growth but increases inflation.
4. Regulation of margin requirements:
Margin refers to the difference between loan amount and the
market value of collateral place to raise the loan. RBI fixes a lower
margin to borrowers whose need is urgent. For e.g. if RBI believes
that farmers should be financed urgently, RBI would direct to
lower the margin requirement on agricultural commodities. RBI
has used this weapon for a number of times.
Example: Actual value of security is 100 and the amount of
loan is 85, therefore margin requirement is 15%.
5. Issuing of directives:
 Banking Regulations Act, 1949 empowers RBI to issue
directives to banks and banks are bound to comply with such
directives. RBI directives may relate to:
 Purpose for which advance may or may not be made
 Margins requirement
 Maximum amount of loan that can be sanctioned to any
company, firm or individual
 Rate of interest and other terms and conditions on which loans
may be given.
6. Direct Action:
Direct action is the last option through which central bank takes a
direct action against the bank which does not act in conformity
with the policy of Reserve Bank of India. In case of direct action
the central bank can impose fine and penalty and can deny giving
out loans to the commercial bank. Such type of force keeps
commercial banks away from unsought credit activities.
E. Control of foreign Exchange operations
One of the central banking functions of the RBI is the control of
foreign exchange operations. For the control of foreign exchange
business, the RBI has set up a separate department called the
Exchange Control Department in September, 1939. This
Department has been granted wide powers to regulate the foreign
exchange business of the country. As the central bank of India, it is
the responsibility of the RBI to maintain the external value of the
Indian rupee stable. India being member of the IMF, the RBI is
required to maintain stable exchange rates between the Indian
rupee and the currencies of all other member countries of the
I.M.F. Besides maintaining stable exchange rates, RBI also acts as
the custodian of the foreign exchange reserves of the country. The
foreign exchange reserves of the country held by RBI includes
Euro, U.S. dollars, Japanese yen etc.
II. Supervisory Functions
RBI has been given several supervisory powers over the different
banking institutions in the country. The supervisory functions
relate to licensing and establishment, branch expansion, liquidity
of assets, amalgamation, reconstruction and liquidation of
commercial banks and cooperative banks.
III. Development and Promotional Functions
a) Provision of Agricultural Credit: - For the promotion of
agricultural credit RBI has set up a separate department called the
Agricultural Credit Department. It. has also set up two funds
namely,
1.The National Agricultural Credit (Long term operations) and
2.The National Agricultural credit (stabilization) fund for
facilitating Long term, Medium term and Short term finance for
agricultural purposes.
b) Provision for Industrial finance: - RBI has played a very
significant role in the field of industrial finance by helping the
setting up of a number of public sector industrial finance
corporations that provide short term, medium term, and long term
finance for industrial purpose. These industrial finance
corporations include
• Industrial finance Corporation of India (IFCI),
• State Finance Corporations (SFC), Industrial Development
Bank of India (IDBI),
• Industrial Reconstruction Corporation of India (IRCI),
• Refinance Corporation of India, and
• Unit Trust of India (UTI).
Besides the above RBI also renders the Credit Guarantee
Scheme which intends to give protection to banks against possible
losses in respect of their advances to small scale industrial units.
c) Development of Bill Market: - A bill market is a place where
short term bill of 3 month duration are generally discounted or
rediscounted. RBI plays a very important role in the promotion of
Bill Market as a well-developed bill market is essential for the
smooth functioning of the credit system.
d) Collection and publication of statistics on financial and
economic matters: - These functions of RBI are extremely useful
to the Government in knowing and solving the various economic
problems. They are also of immense help to financial institutions,
business and industry and for general public.
e) Miscellaneous functions:- RBI has established training centers
for staff for its own staff and other banks. Bankers’ training college
Mumbai, National Institute of Bank Management Mumbai, Staff
Training College Madras, and College of Agricultural Banking at
Pune are the institutions run by RBI.
Commercial Banking
Meaning:
Commercial Bank can be described as a financial institution,
that offers basic investment products like a savings account,
current account, etc to the individuals and corporates. Along with
that, it provides a range of financial services to the general public
such as accepting deposits, granting loans and advances to the
customers.
It is more of a profit making company, which pays interest at a
low rate to the depositors and charges higher rate of interest to
the borrowers and in this way, the bank earns the profit.
Structure of Commercial banks
Commercial banks are the foundations that receive deposits from
individuals and enterprises and lend loans to them. They generate
credit. Commercial banks in India are regulate under the Banking
Regulation Act of 1949. These banks are further categorized as −

A.Scheduled Commercial banks

B.Non-scheduled Commercial banks
A.Scheduled Commercial banks:
Scheduled banks are banks which are listed in the 2nd schedule of
the Reserve Bank of India Act, 1934.
In India, for a bank to qualify as a scheduled bank, it needs to
meet the criteria as underplayed by the Reserve Bank of India. The
following is a list of the criterions
 1. The paid up capital and collected fund of the bank
should not be less than Rs. 5 lac.
2. Any activity of the bank should not adversely affect the
interests of the depositors.
Thus, any commercial, cooperative, nationalized, foreign
bank and any other banking foundation that accepts and satisfies
these set conditions are termed as scheduled banks but not all
scheduled banks are commercial banks.
Scheduled Banks are categorised into:
a) Private Banks
b) Public Banks
c) Foreign Banks

a) Private Banks:
These banks acquire larger parts of stake or congruity is
maintained by the private shareholders and not by government.
Thus, banks where maximum amount of capital is in private hands
are considered as private-sector banks. In India, we have two types
of private-sector banks −
• Old Private-Sector Banks
• New Private-Sector Banks
Old private sector banks are those which existed in India at the
time of nationalization of major banks but were not nationalized
due to their small size or some other reason. After the banking
reforms, these banks got license to continue and have existed in
India along with new private banks and government banks.
i.e., Karnataka Bank, Karur Vyasya Bank etc.
Banks which started their operations after liberalization in the
1990s are the new private-sector banks. These banks were
permitted entry into the Indian banking sector after the amendment
of the Banking Regulation Act in 1993.
i.e., Axis Bank, Kotak Mahindra Bank etc.
b) Public Sector Banks:
A public sector bank in India refers to a banking institution
which is owned or controlled by the central government to the
extent of 51 or more shareholding in a bank; the rest of the
holdings could be held by the management/founders or the general
public.
At present there are 18 Public sector banks in India. They are
categorised as,
• SBI and
• Nationalised Banks(17 in number).
State Bank of India(SBI) is one of the public sector banks in India.
Government of India holds 61% of the stake in this bank. The
name of Imperial Bank was renamed as SBI in the year 1955 and it
was nationlised as per the SBI Act, 1955.
Nationalization is a process whereby a national government or
State takes over the private industry, organisation or assets into
public ownership. 14 were nationalised in 1969 and 6 banks were
nationalised in 1980. At present there are 17 Nationalised banks in
India.
c) Foreign Banks:
Banks set up in foreign countries, and operate their branches in the
home country are called as foreign banks. They should follow the
regulations of both home country and foreign country/countries.
i.e., Barclays Bank, Bank of America etc,.
B) Non-Scheduled Banks:
Non-scheduled commercial banks refer to the banks which are not
covered in the Reserve Bank of India’s second schedule. The paid-
up capital of such banks is not more than Rs. 5 lakhs.

Functions of Commercial Banks

(a) Primary functions
(b) Secondary functions
(c) Modern functions
1).Primary Functions.
Following are the primary functions of a commercial bank:
(i) Accepting deposits:
Accepting deposits is the main function of a commercial bank.
Banks accept deposits of money from people who have surplus
money. Banks offer the following types of deposit schemes to
attract money from all quarters of public.
Deposits may be of following types,
(I) Fixed deposits:
Under fixed deposits schemes, people deposit their money for
a period from seven days to ten years; and fixed deposit is
repayable by bank only after the expiry of the specified period. In
fact, the longer is the period of deposit; the higher is the rate of
interest. These are also called as Time Liabilities.
(II) Savings deposits:
The aim of savings deposits scheme is to mobilize the small
savings of the public. A person can open a savings bank account,
by depositing a small amount of money. He/she can withdraw
money from his/her account and also make additional deposits.
However, there may be restrictions on the number of
withdrawals and the amount to be withdrawn, in a given period.
The rate of interest on saving deposits is lower than payable on
fixed deposits. These are also called as Demand Liabilities.
(III) Recurring deposits:
The aim of recurring deposit scheme is to encourage regular
savings by people. A person can deposit a fixed amount say Rs.
100, every month for a fixed period. The amount deposited,
together with interest, is repayable on maturity.
(IV) Current deposit accounts:
Current deposit accounts are opened by businessmen. The
account holder can deposit and withdraw money, whenever
required. No interest is paid on current deposit accounts. Rather, a
certain charge is made by the bank from the account holder, for the
services provided by the bank. This is also one of the Demand
Liabilities.
ii).Lending Loans:
Loans are lent by way of following means,
(I) Loans:
Banks advance a certain sum of money to a customer;
which is called a loan. A loan, by a bank, is granted against
some security or mortgage. Normally banks do not advance
loans for long periods. However, of late, there is a change in
this policy.
(II) Overdraft:
Under the overdraft facility, a customer having a
current account is allowed to withdraw more than what has
been deposited. The excess amount withdrawn by the
customer is known as overdraft. The overdraft is allowed up
to a certain limit and for an agreed period. Interest is charged
by the bank on the overdrawn amount.
(III) Cash credit:
Under cash credit scheme, a loan limit is sanctioned and a
cash credit account is opened in the name of the borrower.
The borrower can withdraw money from the account from
time to time – subject to the sanctioned limit. Interest is
charged by the bank on the amount actually withdrawn by the
borrower, and not on the sanctioned amount.
(IV) Discounting of bills:
Under this form of lending money, banks en-cash customers’
bills of exchange, before they become actually due for payment.
For this, banks charge what is known as a nominal discount.
iii). Credit Creation:
A unique function of the bank is to create credit. In fact,
credit creation is the natural outcome of the process of advancing
loan as adopted by the banks. When a bank advances a loan to its
customer, it does not lend cash but opens an account in the
borrower’s name and credits the amount of loan to this account.
Thus, whenever a bank grants a loan, it creates an equal amount of
bank deposit. Creation of such deposits is called credit creation
which results in a net increase in the money stock of the economy.
Banks have the ability to create credit many times more than their
deposits and this ability of multiple credit creation depends upon
the cash-reserve ratio of the banks.
b)Secondary Functions
(i) Collection of cheques and bills:
Banks collect cheques of their customers drawn on other
banks; and credit their proceeds to the accounts of their customers.
Banks also collect bills of exchange on behalf of their customers
from the acceptors of bills on due dates; and credit the proceeds to
the accounts of their customers.
(ii) Agency functions:
Banks, under instructions of the customers:
• Undertake to pay insurance premium
• Collect dividend, interest etc. on their investments
• Undertake to buy or sell shares, debentures etc. on behalf of
their customers.
(iii)Provision of remittance facilities:
Banks provide remittance facilities for transfer of funds from
one place to another, usually through bank drafts. The banks
charge commission for issuing bank drafts.
(iv) Issuing letters of credit:
Letters of credit are most useful in import trade. They give a
proof of the credit worthiness of the importer. A letter of credit
issued by the importer’s bank contains an undertaking by the
bank to honour the bills of exchange drawn by the exporter on
the importer up to the amount specified, in the letter of credit.
(v) Letter of reference:
Through a letter of reference, a bank provides information
about the financial condition of the customer to traders of the
same country or other countries.
(vi) Traveller’s cheques:
Banks provide the facility of traveller’s cheques to their
customers who are travelling. With this facility, the customer
need not carry cash (which is risky) with him and can travel
safety.
(vii) Lockers facility:
Banks provide lockers facility to their customers, where
customers can keep their gold, silver ornaments and important
documents safely.
c).Modern Functions
I. ATM services
Automated Teller Machine (ATM) is an electronic
telecommunications device that enables the clients of banks
to perform financial transactions by using a plastic card.
Automated Teller Machines are established by banks to
enable its customers to have anytime money. It is used to
withdraw money, check balance, transfer funds, get mini
statement, make payments etc. It is available at 24 hours a
day and 7 days a week.
II. Debit card and credit card facility
Debit card is an electronic card issued by a bank which
allows bank clients access to their account to withdraw cash
or pay for goods and services. Debit card removes the need
for cheques as it immediately transfers money from the
client's account to the business account. Credit card is a card
issued by a financial institution giving the holder an option to
borrow funds, usually at point of sale. Credit cards charge
interest and are primarily used for short- term financing.
III.Telebanking
Telephone banking is a service provided by a bank or other
financial institution, that enables customers to perform
financial transactions over the telephone, without the need to
visit a bank branch or automated teller machine.
IV. Internet Banking:
Online banking (or Internet banking or E-banking) is a
facility that allows customers of a financial institution to
conduct financial transactions on a secured website operated
by the institution. To access a financial institution's online
banking facility, a customer must register with the institution
for the service, and set up some password for customer
verification. Online banking can be used to check balances,
transfer money, shop online, pay bills etc.
V. Mobile Banking:
Mobile banking is a system that allows customers of a
financial institution to conduct a number of financial
transactions through a mobile device such as a mobile phone
or personal digital assistant. It allows the customers to bank
anytime anywhere through their mobile phone. Customers
can access their banking information and make transactions
on Savings Accounts, Demat Accounts, Loan Accounts and
Credit Cards at absolutely no cost.
VI. Electronic Clearing Services :
It is a mode of electronic funds transfer from one bank
account to another bank account using the services of a
Clearing House. This is normally for bulk transfers from one
account to many accounts or vice-versa. This can be used
both for making payments like distribution of dividend,
interest, salary, pension, etc. by institutions or for collection
of amounts for purposes such as payments to utility
companies like telephone, electricity, or charges such as
house tax, water tax etc
VII. Electronic Fund Transfer/National Electronic Fund
Transfer(NEFT):
National Electronic Funds Transfer (NEFT) is a nation-
wide payment system facilitating one-to-one funds transfer.
Under this Scheme, individuals, firms and corporate can
electronically transfer funds from any bank branch to any
individual, firm or corporate having an account with any
other bank branch in the country participating in the Scheme.
In NEFT, the funds are transferred based on a deferred net
settlement in which there are 11 settlements in week days and
5 settlements in Saturdays.
VIII. Real Time Gross Settlement System(RTGS):
It can be defined as the continuous (real-time) settlement of
funds transfers individually on an order by order basis . 'Real
Time' means the processing of instructions at the time they
are received rather than at some later time. It is the fastest
possible money transfer system in the country.
Sources of Funds
Commercial bank uses various categories of sources to raise
the funds. The major source of commercial bank funds are
summarized as follows:
1. Capital:
a). Paid-Up Capital
b). Reserve Fund
2.Deposits:
a). Current deposit
b). Savings deposit
c). Fixed deposit
3.Borrowings:
a).Central Bank
b).Inter-Bank market
c).International Financial Institutions
d).Issuing Certificate of Deposits and
e).Issuing Bonds
1.Capital:
Capital refers to the money or money’s worth invested
by the investor at the time of starting up of a particular
business. The capital invested could be regarded as one of the
sources of funds for banks. This has two types,
 a). Paid-up Capital:
Paid-up capital indicates the contribution made by the
shareholders of the bank. By definition, it is the part of
subscribed capital which has been called-up and paid.
b). Reserve fund:
Reserve fund is the amount accumulated over the years
out of undistributed profit. It actually belongs to the
shareholders. The accumulation of such retained
reserves is an essential condition for financial
soundness, stability and growth of the bank to fulfill
special roles assigned to them from time to time.
2.Deposits:
a).Current Deposits:
The depositors of such deposits can withdraw and deposit
money when-ever they desire. Since banks have to keep the
deposited amount of such accounts in cash always, they carry
either no interest or very low rate of interest. These deposits
are called as Demand Deposits because these can be
demanded or withdrawn by the depositors at any time they
want. Such deposit accounts are highly useful for traders and
big business firms because they have to make payments and
accept payments many times in a day.
b).Fixed Deposits:
These are the deposits which are deposited for a definite
period of time. This period is generally not less than one year
and, therefore, these are called as long term deposits. These
deposits cannot be withdrawn before the expiry of the
stipulated time and, therefore, these are also called as time
deposits.
c). Saving Deposits:
In such deposits, money up to a certain limit can be
deposited and with-drawn once or twice in a week. On such
deposits, the rate of interest is very less. As is evident from
the name of such deposits their main objective is to mobilize
small savings in the form of deposits. These deposits are
generally done by salaried people and the people who have
fixed and less income.
3). Borrowings:
Borrowings from Central Bank and other banks or
institutions are also sources of raising funds of commercial
bank. But, by nature, those are emergency sources and are
restored to only when the bank is unable to meet the
commitments of its own. Therefore the sources of borrowings
are-
a). Central Bank :
The Central Bank will provide liquidity to the banks and
other institutions when sour aces dry up. They may grant
accommodation to scheduled banks by way of-
i). Rediscounting or purchase of eligible bills; and
ii). Loans and advances against certain securities
 b).Borrowing from Inter Bank:
The interbank lending market is a market in which banks
extend loans to one another for a specified. Such loans are
made at the interbank rate(also called the overnight rate if the
term of the loan is overnight).These are-
1. Interbank call money(period of lending is 1 day),
Notice Money( 2 days- 14 days) and Term Money(More
than 15 days).
2. Repurchase agreement(Repo).
c).Borrowing from international financial institutions:
These are provide by the international institution like,
International Monetary Fund (IMF), World Bank and its
affiliated bodies, ADB, IDB and other foreign
agencies/development partners.
d).Borrowings from issuing money market instrument
such as Certificate of Deposits( It has the same
characteristics as Fixed Deposit but it is negotiable unlike
FD). Only Banks can issue CD.
e). Borrowings from issuing Bonds.
 Banking Sector Reforms
Narasimham Committee Report I - 1991
The Narsimham Committee was set up in order to study the
problems of the Indian financial system and to suggest some
recommendations for improvement in the efficiency and
productivity of the financial institution.
The committee has given the following major
recommendations:-
1. Reduction in the SLR and CRR : The committee
recommended the reduction of the higher proportion of the
Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio
'CRR'. Both of these ratios were very high at that time. The
SLR then was 38.5% and CRR was 15%. This high amount
of SLR and CRR meant locking the bank resources for
government uses. It was hindrance in the productivity of the
bank thus the committee recommended their gradual
reduction. SLR was recommended to reduce from 38.5% to
25% and CRR from 15% to 3 to 5%.
2. Phasing out Directed Credit Programme(Priority Sector
Lending) : In India, since nationalization, directed credit
programmes were adopted by the government. The
committee recommended phasing out of this programme.
This programme compelled banks to earmark then financial
resources for the needy and poor sectors at confessional rates
of interest. It was reducing the profitability of banks and thus
the committee recommended the stopping of this
programme.
3. Interest Rate Determination : The committee felt that the
interest rates in India are regulated and controlled by the
authorities. The determination of the interest rate should be
on the grounds of market forces such as the demand for and
the supply of fund. Hence the committee recommended
eliminating government controls on interest rate and phasing
out the concessional interest rates for the priority sector.
4. Structural Reorganizations of the Banking sector : The
committee recommended that the actual numbers of public
sector banks need to be reduced. Three to four big banks
including SBI should be developed as international banks.
Eight to Ten Banks having nationwide presence should
concentrate on the national and universal banking services.
Local banks should concentrate on region specific banking.
Regarding the RRBs (Regional Rural Banks), it
recommended that they should focus on agriculture and rural
financing. They recommended that the government should
assure that henceforth there won't be any nationalization and
private and foreign banks should be allowed liberal entry in
India.
5. Establishment of the ARF Tribunal : The proportion of
bad debts and Non-performing asset (NPA) of the public
sector Banks and Development Financial Institute was very
alarming in those days. The committee recommended the
establishment of an Asset Reconstruction Fund (ARF). This
fund will take over the proportion of the bad and doubtful
debts from the banks and financial institutes. It would help
banks to get rid of bad debts.
6. Removal of Dual control : Those days banks were under the
dual control of the Reserve Bank of India (RBI) and the
Banking Division of the Ministry of Finance (Government of
India). The committee recommended the stepping of this
system. It considered and recommended that the RBI should
be the only main agency to regulate banking in India.
7. Banking Autonomy : The committee recommended that the
public sector banks should be free and autonomous. In order
to pursue competitiveness and efficiency, banks must enjoy
autonomy so that they can reform the work culture and
banking technology upgradation will thus be easy.
8. Capital Adequecy Ratio:Capital Adequacy Ratio (CAR) is
defined as the ratio of bank's capital to its risk assets. Capital
Adequacy Ratio (CAR) is also known as Capital to Risk
(Weighted) Assets Ratio (CRAR).Narasimham Committee in
1991 to suggest reforms in the financial sector. In the year
1992-93 the Narasimham Committee submitted its first
report and recommended that all the banks are required to
have a minimum capital of 8% to the risk weighted assets of
the banks. The ratio is known as Capital to Risk Assets
Ratio (CRAR). All the 27 Public Sector Banks in India
(except UCO and Indian Bank) had achieved the Capital
Adequacy Norm of 8% by March 1997.
Important aspects to be considered while calculating the
capital adequacy ratio
A. Tier-I Capital Capital which is first readily available to
protect the unexpected losses is called as Tier-I Capital. It is
also termed as Core Capital.
Tier-I Capital consists of :-
a. Paid-Up Capital.
b. Statutory Reserves.
c. Other Disclosed Free Reserves : Reserves which are not
kept side for meeting any specific liability.
d. Capital Reserves : Surplus generated from sale of Capital
Assets.

B. Tier-II Capital Capital which is second readily available

to protect the unexpected losses is called as Tier-II Capital.
Tier-II Capital consists of :-
a. Undisclosed Reserves and Paid-Up Capital Perpetual
Preference Shares.
b. Revaluation Reserves (at discount of 55%).
c. Hybrid (Debt / Equity) Capital.
d. Subordinated Debt.
e. General Provisions and Loss Reserves.
There is an important condition that Tier II Capital cannot
exceed 50% of Tier-I Capital for arriving at the prescribed
Capital Adequacy Ratio.
C. Risk Weighted Assets Capital Adequacy Ratio is
calculated based on the assets of the bank. The values of
bank's assets are not taken according to the book value but
 according to the risk factor involved. The value of each asset
is assigned with a risk factor in percentage terms.

Suppose CRAR at 10% on Rs. 150 crores is to be maintained.

This means the bank is expected to have a minimum capital of
Rs. 15 crores which consists of Tier I and Tier II Capital items
subject to a condition that Tier II value does not exceed 50% of
Tier I Capital. Suppose the total value of items under Tier I
Capital is Rs. 5 crores and total value of items under Tier II
capital is Rs. 10 crores, the bank will not have requisite CRAR
of Rs. 15 Crores. This is because a maximum of only Rs. 2.5
Crores under Tier II will be eligible for computation.
9. Classification of Assets NPA have been divided or
classified into following four types:-
a. Standard Assets : A standard asset is a performing asset.
Standard assets generate continuous income and repayments
as and when they fall due. Such assets carry a normal risk
and are not NPA in the real sense. So, no special provisions
are required for Standard Assets.
b. Sub-Standard Assets : All those assets (loans and advances)
which are considered as non-performing for a period of 12
months are called as Sub-Standard assets.
c. Doubtful Assets : All those assets which are considered as
non-performing for period of more than 12 months are called
as Doubtful Assets.
d. Loss Assets : All those assets which cannot be recovered are
called as Loss Assets.
Provision for types of assets

These assets can be identified by the Central Bank or by the

Auditors.Some of these recommendations were later accepted
by the Government of India and became banking reforms.

Narasimham Committee Report II - 1998

In 1998 the government appointed yet another committee
under the chairmanship of Mr. Narsimham. It is better known
as the Banking Sector Committee. It was told to review the
banking reform progress and design a programme for further
strengthening the financial system of India. The committee
focused on various areas such as capital adequacy, bank
mergers, bank legislation, etc.
It submitted its report to the Government in April 1998 with
the following recommendations.
1. Strengthening Banks in India : The committee
considered the stronger banking system in the context of
the Current Account Convertibility 'CAC'. It thought that
Indian banks must be capable of handling problems
regarding domestic liquidity and exchange rate
management in the light of CAC. Thus, it recommended
the merger of strong banks which will have 'multiplier
effect' on the industry.
2. Narrow Banking : Those days many public sector banks
were facing a problem of the Non-performing assets
(NPAs). Some of them had NPAs were as high as 20
percent of their assets. Thus for successful rehabilitation
of these banks it recommended 'Narrow Banking Concept'
where weak banks will be allowed to place their funds
only in short term and risk free assets.
3. Capital Adequacy Ratio : In order to improve the
inherent strength of the Indian banking system the
committee recommended that the Government should
raise the prescribed capital adequacy norms. This will
further improve their absorption capacity also. Currently
the capital adequacy ration for Indian banks is at 9
percent.
4. Bank ownership : As it had earlier mentioned the
freedom for banks in its working and bank autonomy, it
 felt that the government control over the banks in the form
of management and ownership and bank autonomy does
not go hand in hand and thus it recommended a review of
functions of boards and enabled them to adopt
professional corporate strategy.
5. Review of banking laws : The committee considered that
there was an urgent need for reviewing and amending
main laws governing Indian Banking Industry like RBI
Act, Banking Regulation Act, State Bank of India Act,
Bank Nationalisation Act, etc. This upgradation will bring
them in line with the present needs of the banking sector
in India.
Apart from these major recommendations, the committee has
also recommended faster computerization, technology
upgradation, training of staff, depoliticizing of banks,
professionalism in banking, reviewing bank recruitment, etc.

Bank performance Analysis

The performance of banks could be analyzed by using
following methods,
a. CAMEL Approach
b. Financial Ratio Analysis
c. Asset Quality Analysis
d. Financial Statements Analysis
a.CAMEL Approach
C-Capital Adequacy: This indicates the bank’s
capacity to maintain capital commensurate with
the nature and extent of all types of risks, as also
the ability of the bank’s managers to Financial
Performance Analysis of Selected Banks using
CAMEL Approach to identify, measure, monitor
and control these risks. In accordance with this
following ratios are considered:
i. Capital Adequacy Ratio
ii. Equity Capital to Total Assets
iii. Advances to Total Assets Ratio
iv. Government Securities to Total Investments
A-Asset Quality: This measure reflects the
magnitude of credit risk prevailing in the bank
due to its composition and quality of loans,
advances, investments and off-balance sheet
activities. Following ratios are considered for the
purpose of analysis
(i) Net NPAs to Net Advances
(ii) Net NPAs to Total Assets
(iii) Total Investments to Total Assets.
M-Management Quality: Signaling the ability of
the board of directors and senior managers to
identify, measure, monitor and control risks
associated with banking. This qualitative measure
uses risk management policies and processes as
indicators of sound management. Following ratios
are identified to indicate the quality perspective:
(i) Business per employee
(ii) Profit per employee
(iii) Total advances to total deposits
(iv) Return on Net Worth
E-Earnings: This indicator not only shows the
amount of and the trend in earnings but also
analyses the robustness of expected earnings
growth in future. For better understanding of
above dynamics, following ratios are considered:
(i) Return on Assets (ROA),
(ii) Net Interest Margin (NIM),
(iii) Interest income to Total income,
(iv) Cost to Income ratio
L-Liquidity: This measure takes into account the
adequacy of the bank’s current and potential
sources of liquidity, including the strength of its
fund management practices. To measure this
impact, following ratios are used.
(i) Liquid Assets to Demand Deposits
(ii) Liquid Assets to Total Deposits
(iii) Liquid Assets to Total Assets S-Sensitivity
to Market Risk: This is a recent addition to
the ratings parameters and reflects the
degree to which changes in interest rates,
commodity prices and equity prices can
affect earnings and hence, the bank’s capital.
 Because of lack of availability of data for
this parameter, this group component is not
considered in this paper.

b.Financial Ratio Analysis

A ratio shows an arithmetical relationship between two
figures. It is an assessment o f the significance o f one figure
in relation to the other. It takes the form o f a quotient by
dividing one figure by the other. In financial analysis, these
ratios are customarily expressed in the form of ‘times’,
‘Proportion’, ‘percentage’, or ‘per one’. They describe the
significant relationship which exists between figures shown
on a Balance Sheet, in a Profit & Loss a/c or any other part o
f the accounting organization. It helps to give solutions to the
following problem,
I. whether the profitability o f the enterprises is
satisfactory,
II. whether the enterprise’s financial condition is
basically sound?
III. whether the company is credit worthy;
IV. whether the capital structure of the business is in
proper alignment; &
V. whether the companies operations are doing well so
far as turnover is concerned.
c.Asset Quality Analysis
Asset quality is another important aspect o f the evaluation o
f a bank’s performance under the Reserve Bank o f India
guidelines, the advances o f a bank are to be disclosed in a
classified manner as:
(i)Standard (ii) Sub-Standard (iii) Doubtful and loss
asset
d. Financial Statements Analysis of Banks
While the general structure of financial statements for banks
isn’t that much different from a regular company, the nature
of banking operations means that there are significant
differences in the subclassification of accounts. Banks use
much more leverage than other businesses and earn a spread
between the interest income they generate on their assets
(loans) and their cost of funds (customer deposits). The
various forms of financial statements to be analysed are,
i. Income statement
ii. Balance Sheet
iii. Cash flow Statement
iv. Statement of changes in Equity

Future of Banking in India.

The future of the banking ecosystem will look much different
than today and will extend well beyond financial services.
There is a unique opportunity to capitalize on the insights
banks hold and the innovation that they can build, buy or
collaborate with to become the center of a consumer’s
everyday life.
 Simple, fast and secure engagement: The most used apps
on most people’s phones are those that are easiest to use,
well-designed and can accomplish a task in the fastest and
most secure manner. Biometrics and strong UX design are
table stakes in this battle for the consumer.
 Personalized view of finances: Rather than requiring the
consumer to search for the information they want, it will be
either easy to find or proactively delivered without asking.
The ability to see a current real-time financial profile after
each transaction and to be able to build personalized budget
scenarios is a foundational need.
 Access to financial and non-financial data: If a banking
organization wants to be at the center of a consumer’s life, it
must be able to share all of the insights it has surrounding a
consumer’s life. This goes far beyond financial insights, to
include eCommerce history, travel history, medical
information, insurance and investment data, warranties and
legal documents, etc. Instead of being in multiple places, the
financial institution will provide a digital repository for
everything in the consumer’s life (a lockbox of life).
 Advisor recommendations: Being the central repository of
customer data comes with the requirement that value is
provided in return for this position in the consumer’s life.
Beyond simply providing basic financial services advisory
capabilities, a banking organization of the future will need to
also provide purchase recommendations, health and dietary
recommendations, travel and hospitality advice, etc.
Obviously not provided under one roof, the importance of
 APIs and a strong ecosystem collaboration will be key to the
relationship.
 Digital concierge: An outgrowth of being an advisor is being
a life concierge. With extensive insight into the way a
customer conducts their life, it will be important for the bank
of the future to provide reminders that are based on historical
trends. This can range from arranging transportation to
building a shopping list. It will include the morning ‘your
upcoming day at a glance’ delivered most likely by voice
having the ability to answer questions in real time.
 Digital beyond mobile(Augmented Reality and Virtual
Reality): The marketplace is changing at hyper speed, with
technology and innovations coming faster than ever in the
past. Developers need to move beyond mobile, developing
solutions that can be delivered across channels that may not
exist today (AR, VR, etc.).
The future of the banking industry will depend on its ability
to leverage the power of customer insight, advanced analytics
and digital technology to provide services that help today’s
tech-savvy customers manage their finances and better
manage their daily lives.