COMMERCIAL BANKING

BANKING

Under Banking Regulation Act,1949 ,

“ banking includes accepting deposits

from public, for the purpose of lending

or investment; and repayable on demand

or otherwise and withdrawable by check ,

draft, order or otherwise .”

THE INDIAN BANKING SYSTEM

PublicSectorBanks

Private SectorBanks

Cooperative Banks

DevelopmentBanks

• SBI and its 5 associates

*19 nationalized banks

*Regional Rural banks sponsored by Public sector banks

*New Generation private Sector banks

* Old Generation Private Banks

*Foreign banks

*Scheduled Cooperative Banks

*Non- scheduled Banks

*Central CB

*State CB

*Urban CB

*Primary Agricultural Societies

* Industrial Finance Corporation of India (IFCI)1948*ICICI 1956 )* IDBI (1964)*Industrial Investment Bank of India (IIBI)1971

*SIDBI 1990*NABARD 1982 *Exim Bank 1982*National Housing Bank (NHB) 1988

Structure of Commercial Banks:

• Public Sector Banks: SBI and its five associated banks with 16260 branches.

• 19 nationalized banks with 39095 branches and 86 regional rural banks with15144 branches are the public sector banks.

• Private Sector Banks: There are(15+7) 22 banks in the private sector with 8965 branches. Private sector banks have made rapid progress after the new economic policy of 1991.

• Foreign Banks: There are 32 such Banks with 295 branches.

Private Sector commercial Banks in India

• ICICI

• HDFC

• AXIS

• KOTAK MAHINDRA

• YES BANK

• INDUS IND

• ING VYSYA

Foreign Banks in India

• Standard Chartered

• HSBC

• Citi Bank

• Royal Bank of Scotland

• Bank of Tokyo Mitsubishi

• Bank of America

Nationalised Banks/ Public Sector

• SBI and its subsidiaries• PNB• CANARA Bank• BOI• UNION BANK• Central Bank• BOB• Indian Bank• Dena Bank• Syndicate Bank• Oriental Bank of Commerce• Corporation Bank• Punjab & Sind Bank• UCO Bank• United Bank of India• IDBI Bank ….

Balance Sheet of a Bank

Liabilities

• SB• CA• TD• Call Money• Inter Bank Deposit• RBI Borrowing

Assets

• Cash in hand• Bank Credit• Investment in government

or other securities• Deposit with other bank

Primary Functions

• Receiving Deposits

• Lending to Public

• Investment

• Creation of credit

Receiving Deposits

• Demand Deposits:

-Current Account

-Savings Bank Account

-Auto- Sweep Facility

• Time Deposits:

-Fixed Deposit

-Cash Certificate

-Recurring deposit

Lending to Public

• Cash Credit

• Overdraft

• Demand Loan

• Term Loan

• Bills purchasing/ Discounting

• Packing credit

Investment

• Treasury Bills

• Government Bonds

• Bonds of Public Sector Units

• Money Market Instruments

• Corporate Securities

• Equity of RRBs and Co-operatives

• SLR & Other Requirements

Creation of Credit

• Add to money supply, Money Multiplier ,

Deposit multiplier

• Process of crediting the account of the customer for the loan sanctioned

• Act of drawing cheques on the accounts

• Recipient or payee depositing the cheque into his account

Secondary Functions- Agency Services

• Collection of Income & Instruments

• Payments• Purchase & Sale of

Securities• Investment

Counselling• Remittance of Funds

• Depository Participation

• Safe-Custody Facilities

• Tax Collection• Merchant Banking

General Utility Services

• Trustee, Attorney & Administrator

• Safe Deposit Lockers

• Travellers’ Cheques• Acting As Referees• Letters of Credit

• Underwriting• Lease financing• Publication• Performance

Guarantee• Dealing in Foreign

Exchange

Agency Services

• A customer may leave standing instructions with the banker for payment of different sums to different institutions. Bank arranges payment insurance premium, subscriptions to clubs and societies as per the instruction of the customer. Banks charge a nominal amount of charges for these services rendered.

• Bank collect dividend and interest on securities as per standing instructions of the customers.

• Banks undertake purchase and sale of securities on behalf of customers.

• It facilitates in transfer of fund from one bank to another.• It helps in collection and payment of cheques, bills and promissory

notes.• It acts as an executor or trustee because it facilitates in the

administration of a will.

Changing Role of Commercial Banks

• Housing Finance• Sale of Mutual

Fund Units• Bancassurance• Issue of Credit

Cards/Smart Cards• Issue of ATM/Debit

Cards

• Electronic Transfer of Funds: National level numbering of accounts, MICR cheques, At Par Cheques, mobile banking & Internet Banking

Electronic Banking

• ATMs• Tele-banking• Any-time Banking• Any-where banking• Shared Payment

Network System

• NEFT• RTGS• Online Payment• Mobile Banking• Internet Banking

FINANCIALSERVICES

• Advice in portfolio management /investment counseling

• Facilitate merger and acquisition

• Management and distribution of mutual funds

• Sell insurance products

FIDUCIARY SERVICES

• Manage employee pension

• Act as trustees and manage the asset for others

Role of Commercial Banks in Economic Development

• A well developed banking system is essential for the economic development of any country. In a modern economy, banks are not merely leaders in money and credit but leaders in the process of economic growth.

• Capital Formation: Capital formation involves three stages: generation of savings; mobilization of savings; channelisation of savings into productive use. Commercial banks play a crucial role. They offer incentives to savers mobilize savings through a wide network and make the savings available to business houses for investment.

• Entrepreneurship Development: Commercial banks provide funds to entrepreneurs and thereby promote entrepreneurship in the country.

• Utilization of latent resources: Banks make the funds available to the needy.

Role of Commercial Banks in Economic Development

• Assist Priority Sector: They pay special attention to the priority sector like agriculture, small scale industry, export sector and self employed.

• Employment Generation: They provide jobs to a large number of

people. In addition they help in employment generation by boosting

industry and trade. • Social Welfare: Banks provide loans for education and marriage of

children, house building etc. • Implementation of Monetary Policy: A well developed banking

system helps the RBI to execute its monetary policy. The RBI cannot regulate and control credit without the active cooperation of banks

Reforms in Banking Sector

• The GOI constituted a high level committee on financial reforms under the chairmanship of Mr. M. Narasimhan, the then Governor of the RBI which submitted its report on April 23, 1998. The recommendations of the Committeewere aimed at:

• To improve the financial health of banks.

• To correct and improve the macroeconomic policy setting within which banks operate

• To ensure a degree of operational flexibility and internal autonomy.

• To introduce greater degree of professionalism in banking

Reforms cont..

• Interest rate deregulation. • Adoption of prudential norms in terms of capital adequacy

income recognition, asset classification, provisioning etc. • Reduction in lowering of reserve requirements (SLR and CRR),

thus releasing more lendable resources which banks can deploy profitably

• Government equity in banks has been reduced and strong banks have been allowed to access the capital market for raising additional capital.

• Banks now enjoy greater operational freedom in terms of opening of branches, and banks with a good track record of profitability have greater flexibility in recruitment

Reforms cont..

• New private sector banks have been set up and foreign banks permitted to expand their operations in India including through subsidiaries.

• New areas have been opened up for bank financing: insurance, credit cards, infrastructure financing, leasing, gold banking, etc

• New instruments have been introduced for greater flexibility and better risk management like interest rate swaps, forward rate agreements etc.

• Limits for investment in overseas markets by banks, mutual funds and corporates have been liberalised.

Reforms cont..• Several new institutions have been set up including the

Clearing Corporation of India Ltd., Credit Information Bureau India Ltd.

• Technology infrastructure for the payments and settlement system in the country has been strengthened with electronic funds transfer, Centralised Funds Management System etc

• Credit delivery mechanism has been reinforced to increase the flow of credit to priority sectors through focus on micro credit and Self Help Groups.

Reforms cont..

• RBI guidelines have been issued for putting in place risk management systems in banks. Risk Management Committees in banks address credit risk, market risk and operational risk. Banks have specialised committees tomeasure and monitor various risks and have been upgrading their risk management skills and systems.

• The limit for foreign direct investment in private banks has been increased from 49% to 74%. In addition, the limit for foreign institutional investment in private banks is 49%.

• Wide ranging reforms have been carried out in the area of capital market. CDs are allowed in Dematerialised form only.

BRANCH BANKING In branch banking system a typical commercial bank

is a large institution having a large number of branches scattered all over the country .

The branches may be located in the same city ,state or across other states within the nation or overseas.

The branches are controlled from one location referred to as head office.

Merits:• Facilitates allocation or transfer of savings to the most

efficient use• Division of labour• Provision of remittance facilities• Spread of risks

• Leads to uniform structure of interest rates • Banks need not specialize in any particular

area or industry• Fosters trader-customer contacts across the

nation as well as cross borders Demerits:• Delays• Loss of initiative• Lack of familiarity with local conditions and

special problems of the region• Local savings get transferred elsewhere

RETAIL BANKING • It refers to the mobilization of deposits from individuals

and lending to small business and in retail loan markets .

• It consists of large volumes of low value transactions. • It includes a comprehensive range of financial

products viz., deposit products ,residential mortgage , credit cards , auto finance , personal loans ,consumer durable loans ,loans against equity shares , loans for subscribing to Initial Public Offers , debit cards , bill payment services , mutual funds , investment advisory services.

• These products provide an opportunity for banks to diversify the asset portfolio with high profitability and relatively lower NPA s.

• Net banking ,phone banking, mobile banking, ATMs and bill payments are the new facilities that the banks are using to lure the customers and also to reduce their total operating cost.

WHOLESALE BANKING

• It refers to dealing with large customers often multinational companies , government or government enterprises .

• The wholesale banks deal in large valued transactions , usually in small volumes .

• They draw funds from and lend funds to business .• It also includes transactions which the banks conduct

with each other via inter bank markets separate from customers .

• It is domestic as well as international .

The practices basic to wholesale banking are :

• Interbank markets in domestic and foreign currencies

• Issue of certificates of deposit in domestic and foreign currencies

• Lending by means of term loans ( roll over credits)

• Wholesale banking practices such as loan syndication; rollover credits and floating rate of loans have filtered through retail end .

UNIVERSAL BANKING

• Universal banks are considered as one-stop financial supermarket offering broad range of services .in a narrow sense, universal banking denotes combination of banking and insurance and investment activities .universal banks are those banks that offer a wide range of financial services , beyond commercial banking, insurance and investment banking etc.

• ICICI was the first bank to turn itself into universal bank.

Merits :

• Greater economic efficiency in the form of :-

• lower cost ,

• higher out put

• better product

Demerits :

• Chances of gaining monopoly , which would have undesirable consequences on economic efficiency

• Conflict of interest

BANKING REGULATION ACT ,1949

• License from RBI – establish; expand; close; shift .

• Closer look over the over all management of banks – appoint / terminate the chairman

• Exercise control over advances given by banks

• Can put restriction on any transaction

• Can inspect books of accounts

RESERVE BANK OF INDIA ACT ,1934

Cash Reserve Ratio :- Sec 42 Every bank has to maintain an average daily balance with RBI 3% to15 % of Net Demand and Time Liabilities.

The regulator fixes this rate taking into consideration:• Macro economic condition• Money supply in the market CRR is maintained in the form of :• Deposit with RBI• Cash balance in currency chest kept in bank- deemed to be

deposited in RBI• Approved assets

Yield :

• Apex bank provides a yield of 6% on CRR maintained i.e.

• No yield for first 3% CRR

• 6 % yield if CRR is greater than 3 %.

• This is payable quarterly

Penalty:

• Incase of default a penalty is charged on CRR generally greater than bank rate.

Statutory Liquidity Ratio Section 24 (2A)

• In addition to CRR bank has to maintain statutory reserve in the form of :

– Cash– Gold– Approved securities– Balance in the form of current account

This is to control money supply for credit purpose ; increase bank investment in government in government securities ; ensure solvency of banks.

• SLR now a days is 25 % of Net Demand and Time Liabilities.

Yield :

• Investment in selected portfolio earns large yields for the bank.

Penalty:

• Penalty is charged at the rate of 3% p.a. in case of default .

• 5 % in case of continuous default.

DEMAND LIABILITIES

Current depositSavings DepositMargin against LC/GuaranteeBalance of cash credit account

TIME LIABILITIES

Fixed DepositsCash CertificateIndian Development BondsRecurring Deposit

Net Demand and Time Liabilities

Excludes :

• Liabilities of overseas branches

• Interbank liabilities

• Non resident deposits

• Vostro account balance

PRUDENTIAL NORMS

• Income recognition not on accrual basis but on realization basis

• Asset classification : standard ; sub standard – till 12 months ; doubtful – after 12 months ; • Capital adequacy :desirable 9% or more of the

risk (credit risk) weighted assets as base capital

• Provision of bad debts / assets Standard Assets: 1% Sub Standard Assets: Secured -10% Unsecured - 20% Doubtful Assets: Secured - up to 12 months - 20% 12-36 months - 30% more than 36 months - 100% Unsecured -100%• Loss Assets: value of security goes below

10% of outstanding liabilities. Provision required is 100%

USE OF FUNDS

• 6% CRR

• 25% SLR

• 40% Priority Sector Lending :

agriculture ,SSE, artisans ;self

employed etc

• 29% Others

THE INDIAN BANKING SYSTEM

The banking system in India has three tiers : • scheduled commercial banks; • the regional rural banks and • the cooperative and special purpose banks .

There are approximately : • more than 350 central cooperative banks • 167 scheduled commercial banks and 4 non SCB • 20 land development banks and • a number of primary agricultural credit societies .• 80369 bank branches in India

• In terms of business, the public sector banks namely the State Bank of India and the nationalized banks dominate the banking sector.

• Scheduled commercial banks constitute those banks which have been included in the 2nd Schedule of the RBI Act 1934.

These banks enjoy certain privileges such as:• free concessional remittances facilities • financial accommodation from RBI • minimum cash reserve ratio to be kept with RBI

Select Financial Parameters of Scheduled Commercial Banks

http://www.rbi.org.in/scripts/PublicationsView.aspx?id=11900

• CRAR • Net NPAs/Net Advances • Interest Income/Working Funds • Non-Interest Income/ Working Funds • Operating Profit/Working Funds • Return on Assets • Business per employee • Profit per employee

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