Role of Banking Sector in India

8/19/2019 Role of Banking Sector in India

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Role of banking sector in India

“ROLE OF BANKING SECTOR IN INDIA”

BACHELOR OF COMMERCE

BANKING & INSURANCE

SEMESTER V

(2015-16)

SUBMITTED B!

SIDHANTA BADATIA

ROLL NO! 02

"RO#ECT GUIDE!

"ROF$DHANA "ANICKER

N$G$ACHARA & D$K$MARATHE COLLEGE OF ARTS% SCIENCE &

COMMERCE%

N$G$ACHARA MARG% CHEMBUR% MUMBAI '0001

“ROLE OF BANKING SECTOR IN INDIA”

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BACHELOR OF COMMERCE

BANKING AND INSURANCE

SEMESTER V

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N$G$ACHARA & D$K$MARATHE COLLEGE OF ARTS% SCIENCE &

COMMERCE% CHEMBUR% MUMBAI '0001

CERTIFICATE

This is to certify that Shri/Miss Sidhanta R. Badatya of B.Com.

Banking & Insrance ! Semester " #$cademic %ear has

sccessflly com'leted the 'ro(ect on “ROLE OF BANKINGSECTOR IN INDIA” _ nder the gidance of Mrs. Dhanya

Panickr

Course coordinator Principal

Project Guide/ Internal Examiner External

Examiner

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ACKNOWLEDGEMENT

I am grateful to the UNIVERSITY OF MUMBAI to have introduced thi final

!ro"ect of our curriculum# $ith a dee! ene of gratitude% I &ih to e'!re m(

incere than) to m( !ro"ect guide "ROF$DHANA "ANICKER &ho in !ite

of hi *u( chedule &a al&a( read( &ith hi invalua*le guidance and )indattention throughout the emeter &ith the !ro"ect &or) and &ithout &hoe

intelligent direction and !atience thi !ro"ect &ould have *een im!oi*le# I ta)e

the o!!ortunit( to than) "ROF$DHANA "ANICKER % Ban)ing +Inurance

coordinator for giving me the o!!ortunit( to &or) on thi !ro"ect I &ould alo

li)e to e'!re m( gratitude to&ard the li*rar( taff of N$G$ACHARA &

D$K$MARATHE college of Art% Science and ,ommerce#

I &ould li)e to than) the li*rarian of our college for !roviding u &ith

*oo) needed to com!lete m( !ro"ect % m( famil( + friend &ithout &hoe

u!!ort m( !ro"ect &ould not have *een im!oi*le#

CHAPTER – 1

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INTRDUCTION TO INDIAN BANKING SECTOR

Meaning

A bank is a financial institution that provides banking and other financial

services to theircustomers. A bank is generally understood as an institution

which provides fundamentalbanking services such as accepting deposits

and providing loans. There are also nonbanking institutions that provide

certain banking services without meeting the legal definition of a bank.

Banks are a subset of the financial services industry. As per Section 5(b) of

the Banking Regulation Act, 1949, "banking"means the accepting, for thepurpose of lending or investment, of deposits of money from the public,

repayable on demand or otherwise, and withdrawable by cheque, draft,

order or otherwise.

Definitions :

1.Indian Banking Regulation Act 1949 -“Banking Company is one

which transacts the business of banking which means the accepting for

the purpose of lending or investment of deposits money from the public

repayable on demand or otherwise and withdrawable by cheque, draft,

order or otherwise”.

2.Oxford Dictionary defines a bank as “an establishment for custody of

money, which it pays out on customer’s order.”

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3. The Webster’s Dictionary Defines a bank as “an institution which

trades in money, establishment for the deposit, custody and issue of

money, as also for making loans and discounts and facilitating the

transmission of remittances from one place to another”.

Characteristics / Features of a Bank

1. Dealing in Money

Bank is a financial institution which deals with other people's money i.e.

money given by depositors.

2. Individual / Firm / Company

A bank may be a person, firm or a company. A banking company means a

company which is in the business of banking.

3. Acceptance of Deposit

A bank accepts money from the people in the form of deposits which areusually repayable on demand or after the expiry of a fixed period. It gives

safety to the deposits of its customers. It also acts as a custodian of funds of

its customers.

4. Giving Advances

A bank lends out money in the form of loans to those who require it for

different purposes.

5. Payment and Withdrawal

A bank provides easy payment and withdrawal facility to its customers in

the form of cheques and drafts, It also brings bank money in circulation.

This money is in the form of cheques, drafts, etc.

6. Agency and Utility Services

A bank provides various banking facilities to its customers. They include

general utility services and agency services.

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7. Profit and Service Orientation A bank is a profit seeking institution having service oriented approach.

8. Ever increasing Functions

A bank's main activity should be to do business of banking which should

not be subsidiary toany other business#

9. Connecting Link

A bank acts as a connecting link between borrowers and lenders of money.

Banks collect money from those who have surplus money and give the same

to those who are in need of money.

10. Banking Business

Banking is an evolutionary concept. There is continuous expansion and

diversification as regards the functions, services and activities of a bank.

11. Name Identity

A bank should always add the word "bank" to its name to enable people to

know that it is a bank and that it is dealing in money.

Introduction to the Indian Banking system

A banking system also referred as a system provided by the bank which

offers cash management services for customers, reporting the transactions

of their accounts and portfolios, throughout the day.

The banking system in India should not only be hassle free but it should be

able to meet the new challenges posed by the technology and any other

external and internal factors.

For the past three decades, India’s banking system has several outstanding

achievements to its credit. The Banks are the main participants of the

financial system in India. The Banking sector offers several facilities and

opportunities to their customers.

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All the banks safeguard the money and valuables and provide loans, credit,

and payment services, such as checking accounts, money orders, and

cashier’s cheques. The banks also offer investment and insurance products.

As a variety of models for cooperation and integration among finance

industries have emerged, some of the traditional distinctions between banks,

insurance companies, and securities firms have diminished.

In spite of these changes, banks continue to maintain and perform their

primary role i.e. accepting deposits and lending funds from these deposits.

History of Indian Banking System The first bank in India, called The General Bank of India was established in

the year 1786. The East India Company established The Bank of

Bengal/Calcutta (1809), Bank of Bombay (1840) and Bank of Madras (1843).

The next bank was Bank of Hindustan which was established in 1870.

These three individual units (Bank of Calcutta, Bank of Bombay, and Bank

of Madras) were called as Presidency Banks. Allahabad Bank which was

established in 1865, was for the first time completely run by Indians. Punjab

National Bank Ltd. was set up in 1894 with head quarters at Lahore.

Between 1906 and 1913, Bank of India, Central Bank of India, Bank of

Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. In

1921, all presidency banks were amalgamated to form the Imperial Bank of

India which was run by European Shareholders. After that the Reserve

Bank of India was established in April 1935.

At the time of first phase the growth of banking sector was very slow.

Between 1913 and 1948 there were approximately 1100 small banks in

India. To streamline the functioning and activities of commercial banks, the

Government of India came up with the Banking Companies Act, 1949 which

was later changed to Banking Regulation Act 1949 as per amending Act of

1965 (Act No.23 of 1965).

Reserve Bank of India was vested with extensive powers for the supervision

of banking in India as a Central Banking Authority. After independence,


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Government has taken most important steps in regard of Indian Banking

Sector reforms.

In 1955, the Imperial Bank of India was nationalized and was given the

name "State Bank of India", to act as the principal agent of RBI and to

handle banking transactions all over the country. It was established under

State Bank of India Act, 1955. Seven banks forming subsidiary of State

Bank of India was nationalized in 1960. On 19th July, 1969, major process

of nationalization was carried out. At the same time 14 major Indian

commercial banks of the country were nationalized.

In 1980, another six banks were nationalized, and thus raising the number

of nationalized banks to 20. Seven more banks were nationalized with

deposits over 200 Crores. Till the year 1980 approximately 80% of the

banking segment in India was under government’s ownership.

On the suggestions of Narsimham Committee, the Banking Regulation Act

was amended in 1993 and thus the gates for the new private sector banks

were opened.

The following are the major steps taken by the Government of India to

Regulate Banking institutions in the country:-

1949 : Enactment of Banking Regulation Act.

1955 : Nationalisation of State Bank of India.

1959 : Nationalization of SBI subsidiaries.

1961 : Insurance cover extended to deposits.1969 : Nationalisation of 14 major Banks.

1971 : Creation of credit guarantee corporation.

1975 : Creation of regional rural banks.

1980 : Nationalisation of seven banks with deposits over 200 Crores.

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By the 1960s, the Indian banking industry has become an important tool to

facilitate the development of the Indian economy. At the same time, it has

emerged as a large employer, and a debate has ensured about the possibility

to nationalise the banking industry.

Indira Gandhi, the-then Prime Minister of India expressed the intention of

the Government of India (GOI) in the annual conference of the All India

Congress Meeting in a paper entitled "Stray thoughts on Bank

Nationalisation". The paper was received with positive enthusiasm.

Thereafter, her move was swift and sudden, and the GOI issued an

ordinance and nationalised the 14 largest commercial banks with effect from

the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of

India, 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 step of nationalisation of 6 more commercial banks followed in

1980. The stated reason for the nationalisation was to give the government

more control of credit delivery. With the second step of nationalisation, the

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

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

National Bank. It was the only merger between nationalised banks and

resulted in the reduction of the number of nationalised banks from 20 to 19.

After this, until the 1990s, the nationalised banks grew at a pace of around

4%, closer to the average growth rate of the Indian economy.

The nationalised banks were credited by some; including Home minister P.

Chidambaram, to have helped the Indian economy withstand the global

financial crisis of 2007-2009.

Liberalisation :

In the early 1990s, the then Narsimha Rao government embarked on a

policy of liberalisation, licensing a small number of private banks. These

came to be known as New Generation tech-savvy banks, and included

Global Trust Bank (the first of such new generation banks to be set up),

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which later amalgamated with Oriental Bank of Commerce, Axis

Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move along

with the rapid growth in the economy of India revolutionized 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 setup with the proposed

relaxation in the norms for Foreign Direct Investment, where all Foreign

Investors in banks may be given voting rights which could exceed the

present cap of 10%, at present it has gone up to 49% 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 the 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 as

compared 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.

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

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private sector bank since the RBI announced norms in 2005 that any stake

exceeding 5% in the private sector banks would need to be voted by them.

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.

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CHAPTER-2

STRUCTURE AND ROLE OF AN INDIAN BANKING

SECTOR

Introduction

The structure of banking varies widely from country to country. Often a

country’s banking structure is aconsequences of the regulatory regime to

which it is subjected.

The banking system in India works under the constraints that go with social

control and public ownership. Nationalization, for instance, was a structural

change in the functioning of commercial banks which was considered

essential to better serve the needs of development of the economy in

conformity with national policy and objectives. Similarly to meet the major

objectives of banking sector reforms, government stake was reduced to 51

per cent in public sector banks. New private sector banks were allowed and

foreign banks were permitted additional branches.

Importance of Banks

Banks play an important role in the economic growth of a country. In themodern set up, banks are not to be considered dealers in money but as the

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leaders of development. The importance of bank for a country’s economy can

be explained in following ways-

Banks by playing attractive interest rate on deposits try to promote

thrift and savings in an economy. The investment of these savings inproductive channel results in capital formation.

The scattered small savings in the country can be put to optimum

use by commercial banks. Banks utilize this amount by giving loans

to industrial houses and the government. By providing funds to the

entrepreneurs, bank help in increasing productivity of capital.

Banks help in remitting money from one place to another. The

cheque, bank draft, letter of credit, bills, hundies enable traders totransfer large sums of money from one place to another.

By their ability to create credit, the banks have placed at the disposal

of the nation a large amount of money. The bank can increase the

supply of money through credit creation.

With the growth of banking activity, employment opportunity in the

country has increased to a considerable extent.

The banks help in capital formation in the country. A high rate of

saving and investment promote capital formation.

Money deposited in the bank and other precious items are now

absolutely safe. For keeping valuables, banks are providing locker

facilities. Now people are free from any type of risks.

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Structure of Indian Banking System

1 .Reserve Bank of India (RBI)

The Indian Banking structure has a wide and comprehensive form.

Apex Institutions in the form of banking institutions are playing

important role in the country. The chief regulator of banking system in

our country is the Reserve Bank of India.

The Reserve Bank of India (RBI) was established in April 1935 with a

share capital of Rs. 5 Crores on the basis of the recommendations of

the Hilton Young Commission. The share capital was divided into

shares of Rs. 100 each fully paid which was entirely owned by private

shareholders in the beginning. The Government held shares of

nominal value of Rs. 2,20,000.

The Reserve Bank of India was set up as a private shareholder bank

under the Reserve Bank of India Act,1934 and it started functioningas the central bank since 1st April 1935.

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Objectives of RBI:

The following were the objectives of RBI when it was set up:

To manage adequate money and credit in the country.

To maintain the stability of rupee internally and externally,

Balanced and well managed banking development in the country.

To develop well organized money market.

To provide adequate agriculture credit.

To manage public debt.

To seek international monetary co-operation.

Centralization of cash reserves of commercial banks

To set up Government banks. Publication of data.

Functions of RBI:

RBI is an apex banking institution of the country. It carries on several

functions as a central bank. According to RBI Act, 1934, “the principal

function of RBI is to issue notes and maintain reserves, currency and creditto maintain monetary stability in the general interest of the nation.”

As a central banking authority RBI carries on the following functions:

1.RBI regulates issue of bank notes above one rupee denomination.

2.Undertakes distribution of all currency notes and coins on behalf of

the government.

3.Acts as the banker to the Government of India and the State

governments, Commercial andCooperative banks.

4.Formulates and administers the monetary policy.

5.Maintain exchange value of rupee.

6.Represent India at the International Monetary Fund (IMF)

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7.RBI acts as a banker for all the commercial banks. All scheduled

banks come under the direct.control of RBI. All commercial as well as

schedule bank has to keep a minimum reserve with theRBI. They have

to submit weekly reports to RBI about their transactions. By

performing 3 functions,the RBI helps the member banks significantly. They are given below such as:

-It acts as the lender of the last resort.

-It is the custodian of cash reserves of commercial banks.It clears, -

transfers the transaction. It acts as the central clearing house.

8.Regulation of Banking system

9.Credit Control

2. Commercial Banks

Commercial Banks is financial Institution that accepts deposits for the

purpose of lending. In other words, commercial Banks provide services such

as accepting deposits, giving business loans and also allow for variety ofdeposit accounts. They collect money from those who have it to spare and

lend to those whorequire it. Commercial Bank is a banker to the general

public. Commercial Banks registered under Indian companies Act, 1936 and

are also governed by the Indian Banking Regulation Act, 1949.

A.Scheduled Banks

Scheduled banks are those which have been in II schedule of Reserve Banks

of India act, 1934 and following criteria should satisfied.

1. Minimum paid up capital Rs. 5 lakh.

2. It must be a corporation as co-operative society.

3. Any activity of bank will not adversely affect the interest of depositors

Scheduled banks consist public sector banks, private sector banks, foreign

banks, and regional rural banks.

1)Public Sector Banks:Public banks are those in which 50% of their

capital is provided by central government, 15% by concerned state

government and 35% by sponsored commercial banks. In India, there

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are 27 public sector banks. They includes the state bank of India and

its 6 associated banks such as state bank of Hyderabad, state bank of

Mysore etc. and 19 nationalized banks and IDBI banks Ltd. Public

sector banks mostly situated in rural area than urban area.

2)Private Sector Banks:Private Banks are those in which majority of

share capital kept by businesshouse and individual. After the

nationalization, entry of private sector banks is restricted. But some

ofprivate banks continued to operate such as Jammu & Kashmir

bank Ltd. To increase the competition spiritand improve the working

of public sector banks, RBI permitted the entry of private sector

banks in July,1993.

3)Foreign Banks:Foreign banks are those which incorporated outsideIndia and open their branches inIndia. Foreign banks performed all

the function like other commercial banks in India. Foreign banks

aresuperior in technology and management than India banks.They

offer different types of products and services such as offshore

banking, online banking, personalbanks etc. They provide loans for

automobiles, small and large businesses. Foreign banks also

providespecial types of credit card which are nationally and

internationally accepted. These banks earn lots of profitand create

new ways of investments in the country.

4)Regional Rural BanksRegional rural banks established 1975 with

mandate to ensure sufficient credit for agriculture and ruralsector.

RRB’s are jointly owned by government of India, concerned state

government and sponsor bank.The capital share being 50 %, 15% and

35% respectively. Now these Days, there are 14,475 regional

ruralbanks in India. NABARD control and prepare the policies for

Regional Rural Banks. The basic objectiveof establishing RRB’s in

India was to provide the credit to rural sector especially the small and

mediumfarmers, artisans, agricultural labour and even small

entrepreneurs.

B. Non Scheduled Banks:

Non-scheduled banks in India define in clause (C) of section 5 of

Banksregulation Act 1949. Non-scheduledbanks are those which are not

schedule bank and their paid upcapital and reserves less than Rs.5 lakh

and are not included in the 2nd schedule of the Reserve Bank of India Act,1934

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3. Development Banks

It is considered as a hybrid institution which combines in itself the

functions of a finance corporation and a development corporation. They also

act as a catalytic agent in promoting balanced and viable development by

assuming promotional role of discovering project ideas, undertaking

feasibility studies and also provide technical, financial and managerial

assistance for the implementation of project.

In India ‘Industrial Development Bank on India’ (IDBI) is the unique example

of development bank. It has been designated as the principal institution ofthe country for co-ordinating the working of the institutions engaged in

financing, promoting or development of industry.

In India such banks are established on a large scale after independence.

They are Industrial Finance Corporation of India (IFCI), Industrial Credit

and Investment Corporation of India (ICICI) and Industrial Development

Bank of India (IDBI).

4. Co-operative Banks

In India, Co-operative banks are registered under the Co-operative Societies

Act, 1912. They generally give credit facilities to small farmers, salaried

employees, small-scale industries, etc. Co-operative Banks are available in

rural as well as in urban areas. The functions of these banks are just

similar to commercial banks.

The main business of co-operative banks is to provide finance to agriculture. They aim at developing a system of credit. Agriculture finance is a special

field. The co-operative banks play a useful role in providing cheap exit

facilities to the farmers.

In India there are three wings of co-operative credit system namely - (i) Short

term, (ii) Medium-term, (iii) Long term credit. The former has a three tier

structure consisting of state co-operative banks at the state level. At the

intermediate level (district level) these are central co-operativebanks, which

are generally established for each district.

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5. Specialised Banks

These banks are established and controlled under the special act of

parliament. These banks have got the special status. One of the major bank

is ‘National Bank for Agricultural and Rural development’ (NABARD)established in 1982, as an apex institution in the field of agricultural and

other economic activities in rural areas. In 1990 a special bank named small

industries development Bank of India (SIDBI) was established. It was the

subsidiary of Industrial development Bank of India. This bank was

established for providing loan facilities, discounting and rediscounting of

bills, direct assistance and leasing facility.

6. Export - Import Bank

These banks have been established for the purpose of financing foreign

trade. They concentrate their working on medium and long-term financing.

The Export-Import Bank of India (EXIM Bank) was established on January

1, 1982 as a statutory corporation wholly owned by the central government.

$Saving Banks

Saving banks are established to create saving habit among the people. These

banks are helpful for salaried people and low income groups. The deposits

collected from customers are invested in bonds,securities, etc. At present

most of thecommercial banks carry the functions of savings banks. Postal

department also performs the functions of saving bank#

8. Land Mortgage / Land Development Banks

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LandMortgage or Land Development banks are also known as Agricultural

Banks because these are formed to finance agricultural sector. They also

help in land development.

In India, Government has come forward to assist these banks. TheGovernment has guaranteed the debentures issued by such banks. There is

a great risk involved in the financing of agriculture and generally

commercial banks do not take much interest in financing agricultural sector.

9. Indigenous Banks

Indigenous banks meanMoney Lenders andSahukars. They collect deposits

from general public and grant loans to the needy persons out of their ownfunds as well as from deposits. These indigenous banks are popular in

villages and small towns.

They perform combined functions of trading and banking activities. Certain

well-known indian communities likeMarwaries andMultani even today run

specialised indigenous banks.

10. Exchange Banks

Hong Kong Bank, Bank of Tokyo, Bank of America are the examples of

Foreign Banks working in India. These banks are mainly concerned with

financing foreign trade.

Following are the various functions of Exchange Banks :-

1.Remitting money from one country to another country,

2.Discounting of foreign bills,

3.Buying and Selling Gold and Silver, and

4.Helping Import and Export Trade.

Consumers

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Consumers bank is a new addition to the existing type of banks. Such

banks are usually found only in advanced countries like U.S.A. and

Germany. The main objective of this bank is to give loans to consumers for

purchase of the durables like Motor car, television set, washing machine,

furniture, etc. The consumers have to repay the loans in easy installments.

Summary

This unit examines the structure of the banking industry in India. Banks in

India are organized as commercialbanking institutions and cooperative

banking societies. Commercial banks are owned by the public sector, private

sector and foreign banks. The public sector banks dominate the bankingindustry both in terms of volumes and reach of branches. The cooperative

banking segment of Indian banking is small in comparison to the

commercial banking segment. It is also plagued by poor performance.

However, it has an important place as a provider of banking services to

smaller sections of the society.

This unit also provides an overview of the statutory framework for banking

in India. The Banking Regulation Act, 1949 is the most important legislation

for banks in India. This act lays down the definition of banking andallowable banking activities. It also gives the RBI wide-ranging regulatory

power to control banks in India starting from their licensing.

Bank act as payment agents by conducting checking or current accounts for

customer, paying cheque drawn by customers on the bank, and collecting

cheque deposited to customers current accounts. Banksalso enable

customer payments via other payment methods such as automated teller

machine (ATM), Telegraphic Transfer etc.

Banks borrow money by accepting funds deposited on current accounts, by

accepting term deposits, and by issuing debt securities such as banknotes

and bonds. Banks lend money by making advances to customers on current

accounts, by making instalment loans and by investing in marketable debt

securities and other forms of money lending.

Banks also provide almost all payment services and a bank accounts

considered indispensable by most businesses, individuals and governments.

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CHA"TER =

ROLE OF RBI IN INDIA

As a central bank, the Reserve Bank has significant powers and duties to

perform. For smooth and speedy progress of the Indian Financial System, it

has to perform some important tasks. Among others it includes maintaining

monetary and financial stability, to develop and maintain stable payment

system, to promote and develop financial infrastructure and to regulate or

control the financial institutions.

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Introduction

Central Bank is an apex financial institution of a country. It is needed to

regulate and control the monetary system of an economy. The need for a

central bank in India was felt during 18th century.

The earliest attempts to set up a central bank dates back to 1773 when

Warren Hastings recommended to establish the “General Bank of Bengal

and Bihar” as Central Bank of India. In 1913 Lord Keynes alsorecommended to set up a Central Bank. Later on in 1921, by amalgamating

three presidency Banks (Presidency Bank of Bengal, Presidency Bank of

Madras and Presidency Bank of Bombay), Imperial Bank of India was set up.

Though Imperial Bank of India performed certain central banking function,

but the right of Note issue was not given to Imperial Bank of India and

Government of India performed the function of credit control.

The establishment of a Central Bank that would issue notes and at the

same time function as banker to the Government was recommended in 1926 by the Royal Commission in India Currency and Finance (known as the

Hilton Young Commission). In 1931, Central Banking inquiry committee also

recommended for setting up of a Central Bank in India.

In 1933, the “Round Table Conference” also suggested to set up a Central

Bank free from political influence. As a result of all these recommendations

and suggestions, a fresh bill was passed by the assembly on December 22,

1933 and got Governor General Ascent on March 6, 1934. Thus the Reserve

Bank of India started working since, 1st April, 1935 in accordance with the

provision of the Reserve Bank of India Act, 1934.

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The pattern of central banking in India was based on the Bank of England.

England has a highly developed banking system in which the functioning of

the central bank as a banker’s bank and their regulation of money supply

set the pattern. The central bank’s function as ‘lender of last resort’ was onthe condition that the banks maintain stable cash ratios as prescribed from

time to time. The effective functioning of the British model depends on an

active securities market where open market operations can be conducted at

the discount rate. The effectiveness of open market operations however

depends on the member bank’s dependence on the central bank and the

influence it wields on interest rates. Later models, especially those in

developing countries showed that central banks play an advisory role and

render technical services in the field of foreign exchange, foster the growth of

a sound financial system and act as a banker to government.

Meaning

Reserve Bank of India is the central bank of the country which was

nationalized in the year 1949.

It is an apex institution which has been guiding, monitoring, regulating,

controlling and promoting the destiny of IFS since its inception. It is oldest

among the central banks in the developing countries

The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The

Act, 1934 (II of 1934) provides the statutory basis of the functioning of the

Bank.

The Bank was constituted for the need of following:

• To regulate the issue of banknotes

• To maintain reserves with a view to securing monetary stability and

• To operate the credit and currency system of the country to its

advantage.

Functions

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The Reserve Bank of India Act of 1934 entrust all the important functions of

a central bank the Reserve Bank of India.

1. Issuing Authority:

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole

right or authority or monopoly of issuing currency notes other than one

rupee notes and coins and coins of smaller denominations. Although one

rupee coins and notes and coins of smaller denominations are issued by the

Government of India, but put into circulation only through RBI. The

currency notes issued by the Bank are legal tender everywhere in India.

The affairs of the bank relating to note issue and its general banking business are conducted through two separate departments, the Issue and

Banking Department. The Issue Department is liable for the aggregate value

of currency notes of Government of India and the currency notes of the

Reserve Bank in circulation and it maintains eligible assets for equivalent

value.

The expansion and contraction of currency in circulation is affected through

the Banking Department. Cash deposits and withdrawals by scheduled

banks are handled by the Banking Department.

2. Banker of Government:

The second important function of the Reserve Bank of India is to act as

banker to the Government of India statutorily and to state governments by

virtue of agreements entered into with them. The Reserve Bank is agent of

Central Government and of all State Governments in India excepting that of

Jammu and Kashmir.

The Reserve Bank has the obligation to transact Government business, via.

To keep the cash balances as deposits free of interest, to receive and to make

payments on behalf of the Government and to carry out their exchange

remittances and other banking operations. It is not entitled to any

remuneration for these services.

In addition to these ordinary banking operations the Reserve Bank of India

helps the Government - both the Union and the States to float new loans

and to manage public debt. The RBI is entitled to charge a commission forthese activities. Under public debt management the RBI manages deficit/

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surplus in the central and state government by providing money to fill the

gap between receipts and payments. It is done in the following ways:

1.For Central Government: The deficit/ surplus in the central

government account with the RBI are managed by the creation/cancellation of ad-hoc treasury bills which are held in the Issue

Department and hence the budget deficit/ surplus is monetized.

2.For State Government: The gap between receipts and payments of

state governments is by ‘ways and means advances’. These advances

are of three types:

• Normal/ clean advances which are without any collateral security.

• -Secured advances are against the pledge of the central governmentsecurities.

• -Special advances are granted at the discretion of RBI.

3. Bankers’ Bank and Lender of the Last Resort or Father of Banks:

The Reserve Bank of India acts as the bankers’ bank. The RBI controls the

volume of reserves of the banks and determines their deposit credit creation

ability. The banks hold all/ a part of their reserves with the RBI and in

times of need, they borrow from the RBI.

According to the provisions of the Banking Companies Act of 1949, every

scheduled bank was required to maintain with the Reserve Bank a cash

balance equivalent to 5% of its demand liabilities and 2 per cent of its time

liabilities in India.

By an amendment of 1962, the distinction between demand and time

liabilities was abolished and banks have been asked to keep cash reserves

equal to 3 per cent of their aggregate deposit liabilities. The minimum cash

requirements can be changed by the Reserve Bank of India.

The scheduled banks can borrow from the Reserve Bank of India on the

basis of eligible securities or get financial accommodation in times of need or

stringency by rediscounting bills of exchange.

Since commercial banks can always expect the Reserve Bank of India to

come to their help in times of banking crisis the Reserve Bank becomes notonly the banker’s bank but also the lender of the last resort.

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4. Controller of Credit:

The Reserve Bank of India is the controller of credit i.e. it has the power to

influence the volume of credit created by banks in India. It can do sothrough changing the Bank rate or through open market operations.

According to the Banking Regulation Act of 1949, the Reserve Bank of India

can ask any particular bank or the whole banking system not to lend to

particular groups or persons on the basis of certain types of securities.

Since 1956, selective controls of credit are increasingly being used by the

Reserve Bank.

Every bank will have to get the permission of the Reserve Bank before it canopen a new branch. Each scheduled bank must send a weekly return to the

Reserve Bank showing, in detail, its assets and liabilities. This power of the

Bank to call for information is also intended to give it effective control of the

credit system. The Reserve Bank has also the power to inspect the accounts

of any commercial bank.

As supreme banking authority in the country, the Reserve Bank of India,

therefore, has the following powers:

a)It holds the cash reserves of all the scheduled banks.

b)It controls the credit operations of banks through quantitative and

qualitative controls.

c)It controls the banking system through the system of licensing,

inspection and calling for information.

d)It acts as the lender of the last resort by providing rediscount

facilities to scheduled banks.

5. Custodian of Foreign Reserves: The RBI maintains the external value of the rupee through the regulation of

foreign exchange market coupled with domestic policies. In the external

sector, the task of RBI has following dimensions:

• To administer ‘foreign exchange control’.

• To choose the exchange rate system and fix or manage the exchange

rates between the rupees an other currencies.

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• To manage exchange reserves.

• To interact with monetary authorities of other countries and with the

international financial institutions such as IMF and World Bank.

The RBI administers the exchange control according to the Foreign

Exchange Maintenance Act (FEMA) to primarily regulate the demand for

foreign exchange within the limits of available supply. The controls are

administered through the authorized foreign exchange dealers.

But after the early nineties, as the rupee became fully convertible on current

account, the rate has been market related. The controls on foreign exchange

are being gradually relaxed. As the custodian of the foreign exchange

reserves, the RBI also sees to the investment and utilization of foreign

exchange reserves in the most advantageous manner.

After India became a member of the International Monetary Fund in 1946,

the Reserve Bank has the responsibility of maintaining fixed exchange rates

with all other member countries of the I.M.F.

Besides maintaining the rate of exchange of the rupee, the Reserve Bank

has to act as the custodian of India’s reserve of international currencies. The

vast sterling balances were acquired and managed by the Bank. Further, theRBI has the responsibility of administering the exchange controls of the

country.

6. Supervisory Functions:

To promote a sound and effective banking system, the RBI is vested with

wide ranging powers to supervise and control banks. The main powers are:

• To issue licences for the establishment of new banks.

• To issue licences for setting up of bank branches.

• To prescribe for banks, the minimum requirements regarding capital

and resources, the transfer ofreserve fund and maintenance of cash

reserve and other liquid assets.

• To inspect the organisational set up: branch expansion, mobilisation

of deposits, investments, credit portfolio management, region wise

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performance, profit planning, manpower planning, training and so on

regarding banks.

• To investigate into complaints, irregularities and fraud in respect of

banks.• To check improper investments and injudicious advances by the

banks.

• To control appointment, re-appointment, termination of chairman/

chief executive officer of private sector banks.

• To approve/ force amalgamation.

7. Promotional/Developmental Functions

Along with the routine traditional functions, central banks especially in the

developing country like India have to perform numerous functions. These

functions are country specific functions and can change according to the

requirements of that country. The RBI has been performing as a promoter of

the financial system since its inception. Some of the major development

functions of the RBI are maintained below.

Development of the Financial System :

The financial system comprises the financial institutions, financial

markets and financial instruments. The sound and efficient financial

system is a precondition of the rapid economic development of the

nation.

The RBI has encouraged establishment of main banking and non-

banking institutions to cater to the credit requirements of diverse

sectors of the economy.

Development of Agriculture :

In an agrarian economy like ours, the RBI has to provide special

attention for the credit need of agriculture and allied activities. It has

successfully rendered service in this direction by increasing the flow of

credit to this sector.

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It has earlier the Agriculture Refinance and Development Corporation

(ARDC) to look after the credit, National Bank for Agriculture and

Rural Development (NABARD) and Regional Rural Banks (RRBs).

Provision of Industrial Finance :

Rapid industrial growth is the key to faster economic development. In

this regard, the adequate and timely availability of credit to small,

medium and large industry is very significant.

In this regard the RBI has always been instrumental in setting up

special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM

BANK etc.

Provisions of Training :

The RBI has always tried to provide essential training to the staff of

the banking industry. The RBI has set up the bankers' training

colleges at several places. National Institute of Bank Management i.e

NIBM, Bankers Staff College i.e BSC and College of Agriculture

Banking i.e CAB are few to mention.

Collection of Data :

Being the apex monetary authority of the country, the RBI collects

process and disseminates statistical data on several topics. It includes

interest rate, inflation, savings and investments etc. This data proves

to be quite useful for researchers and policy makers.

Publication of the Reports :

The Reserve Bank has its separate publication division. This division

collects and publishes data on several sectors of the economy. The

reports and bulletins are regularly published by the RBI. It includes

RBI weekly reports, RBI Annual Report, Report on Trend and Progress

of Commercial Banks India., etc. This information is made available to

the public also at cheaper rates.

Promotion of Banking Habits :

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As an apex organization, the RBI always tries to promote the banking

habits in the country. It institutionalizes savings and takes measures

for an expansion of the banking network.

It has set up many institutions such as the Deposit InsuranceCorporation-1962, UTI-1964, IDBI-1964, NABARD-1982, NHB-1988,

etc. These organizations develop and promote banking habits among

the people. During economic reforms it has taken many initiatives for

encouraging and promoting banking in India.

Promotion of Export through Refinance :

The RBI always tries to encourage the facilities for providing finance

for foreign trade especially exports from India. The Export-Import

Bank of India (EXIM Bank India) and the Export Credit Guarantee

Corporation of India (ECGC) are supported by refinancing their

lending for export purpose.

7. Monetary Planning and Control Functions:

The RBI regulates the availability, cost and terms and conditions of credit in

the market. It aims at regulating and controlling the money supply as per

the requirements of the economy and the monetary policy.

R.8.>. B< 4 I/,?8 C./, "3,;@

The Reserve Bank of India has a credit policy which aims at pursuing higher

growth with price stability. Higher economic growth means to produce more

quantity of goods and services in different sectors of an economy; Price

stability however does not mean no change in the general price level but to

control the inflation. The credit policy aims at increasingfinance for the

agriculture and industrial activities. When credit policy is implemented, therole of other commercial banks is very important. Commercial banks flow of

credit to different sectors of the economy depends on the actual cost of

credit and arability of funds in the economy.

Objectives of RBI

The specific features of the Indian economy, including its socio-economic

characteristics, make it necessary for the Reserve Bank to operate with

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multiple objectives. Regulation, supervision and development of the financial

system remain within the legitimate ambit of monetary policy broadly

interpreted in India.

The role of communication policy, therefore, lies in articulating the hierarchyof objectives in a given context in a transparent manner, emphasizing a

consultative approach as well as autonomy in policy operations and

harmony with other elements of macroeconomic policies.

RBI functions within the framework of a mixed economic system. Main

objectives of RBI are:

• To maintain monetary stability so that the business and economic life

can deliver welfare gains of a properly functioning mixed economy.

• To maintain financial stability so that the monetary stability can be

safely pursued and economic units can conduct their business with

confidence.

• To maintain stable payment system so that financial transactions can

be safely and efficiently executed.

• To promote the development of financial infrastructure of markets and

systems and to enable it to operate efficiently.

• To ensure that credit allocation by the financial system broadly

reflects the national economic priorities.

• To regulate the overall volume of money and credit in the economy

with a view to ensure a reasonable degree of price stability.

• To establish monetary relations with other countries of the world andinternational financial institutions

Role of RBI in Economic Development

Reserve Bank of India or RBI happens to be the first and foremost monetary

authority in the dominion of India and with the exception of this attribute; it

does act in the role of bank of the national and state governments.

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RBI is known to formulate, implement and keep tabs on the monetary policy

and it also has to make certain the sufficient flow of credit to productive

sectors.

The acceptance of economic liberalization and reform has allowed therelaxation of restrictions on foreign direct investment and inward portfolio

capital flows. India retains tight controls on outward portfolio capital flows,

restricting the access of residents to foreign capital markets and domestic

markets in foreign currency-denominated securities. The relaxation of these

controls and further liberalization of the capital account remain

controversial policy issues for India. For convenience the role of RBI on the

economy of India has been dealt under the three areas

a) RBI on Forex Reserves

b) RBI on Corporate Debt Restructuring

c) RBI on Banking

a) RBI on Forex Reserves

Foreign exchange reserves play an irreplaceable role in many emerging

economies. The central, or reserve, bank creates and then uses domestic

money to buy foreign exchange. If a central bank creates more domesticmoney, it can buy more foreign exchange. It does not have to pump iron to

build reserves. It does not have to sweat it out. It has to merely pump

domestic money into the domestic economy and coolly build foreign

exchange reserves. The creation of foreign exchange reserves is wholly a

white-collar job.

The Reserve Bank of India (RBI) undertook a review of the main policy and

operational matters relating to management of the reserves, including

transparency and disclosure and decided to compile and make public half-

yearly reports on management of foreign exchange reserves for bringing

about more transparency and also for enhancing the level of disclosure in

this regard.

These reports are being prepared with reference to positions as of 31st

March and 30th September each year, with a time lag of about 3 months.

The reports talk about the report is a compilation of quantitative

information with regard to external reserves, such as, level of foreign

exchange reserves, sources of accretion to foreign exchange reserves,external liabilities visà-vis foreign exchange reserves,

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prepayment/repayment of external debt, Financial Transaction Plan (FTP) of

IMF, adequacy of reserves, etc.

b) RBI on Corporate Debt Restructurn!

The objective of the Corporate Debt Restructuring (CDR) framework is to

ensure timely and transparent mechanism for restructuring of the corporate

debts of viable entities facing problems, outside the purview of BIFR, DRT

and other legal proceedings, for the benefit of all concerned.

In particular, the framework will aim at preserving viable corporate that are

affected by certain internal and external factors and minimize the losses to

the creditors and other stakeholders through an orderly and coordinated

restructuring programme.

The major modifications made in the existing CDR mechanism relate to

a)Extension of the scheme to entities with outstanding exposure

of Rs.10 crore or more.

b)Requirement of support of 60% of creditors by number in

addition to the support of 75% of creditors by value with a view

to make the decision making more equitable

c)Discretion to the core group in dealing with wilful defaulters in

certain cases other than cases involving frauds or diversion of

funds with malafide intentions.

d)Linking the restoration of asset classification prevailing on thedate of reference to the CDR Cell to implementation of the CDR

package within four months from the date of approval of the

package.

e)Restricting the regulatory concession in asset classification and

provisioning to the first restructuring where the package also

has to meet norms relating to turn-around period and minimum

sacrifice and funds infusion by promoters.

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f)Convergence in the methodology for computation of economic

sacrifice among banks and FIs.

g) Limiting RBI’s role to providing broad guidelines for CDR

mechanism.

h)Enhancing disclosures in the balance sheet for providing greater

transparency.

i)Pro-rata sharing of additional finance requirement by both term

lenders and working capital lenders.

j)Allowing OTS as a part of the CDR mechanism to make the exit

option more flexible and

k)Regulatory treatment of non-SLR instruments acquired while

funding interest or in lieu of outstanding principal and

valuation of such instruments.

C) RBI on Banking

Though the RBI, as part of its monetary management mandate, had, from

the very beginning, been vested with the powers, under the RBI Act, 1934,

to regulate the volume and cost of bank credit in the economy through the

instruments of general credit control, it was not until 1949 that a

comprehensive enactment, applicable only to the banking sector, came into

existence. The Banking Regulation Act from March 1966. The Act vested in

the Reserve Bank the responsibility relating to licensing of banks, branch

expansion, and liquidity of their assets, management and methods of

working, amalgamation, reconstruction and liquidation.

Important changes in several provisions of the Act were made from time totime, designed to enlarge or amplify the responsibilities of the RBI or to

impart flexibility to the relative provisions, commensurate with the

imperatives of the banking sector developments.

1.Branch Authorization Policy

The RBI announced a new Branch Authorization Policy in September 2005

under which certain changes were brought about in the authorization

process adopted by the RBI for the bank branches in the country.

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The objective is to ensure that the banks take an integrated view of their

branch- network needs, including branch relocations, mergers, conversions

and closures as well as setting up of the ATMs, over a one-year time horizon,

in tune with their own business strategy, and then approach the RBI for

consolidated annual authorizations accordingly.

2. Operations of Foreign Banks in India

At present, there are 29 foreign banks operating in India with a network of

273 branches and 871 off-site ATMs. Among some circles, a doubt is

sometimes expressed as to whether the regulatory environment in India is

liberal in regard to the functioning of the foreign banks and whether the

regulatory approach towards foreign participation in the Indian banking

system is consistent with liberalized environment.

India issues a single class of banking licence to foreign banks and does not

require them to graduate from a lower to a higher category of banking

licence over a number of years, as is the practice followed in certain other

jurisdictions. This single class of licence places them virtually on the same

footing as an Indian bank and does not place any restrictions on the scope

of their operations

Thus, a foreign bank can undertake, from the very first day of its operations,

any or all of the activities permitted to an Indian bank and all foreign banks

can carry on both retail as well as wholesale banking business. This is in

contrast with practices in many other countries.

The independence of the Reserve Bank holds the key to effective monetary

control. An independent Reserve Bank can hold out threat of a high rate of

interest on Government borrowing if the Government indulges in fiscal

excesses. As the high rate interests retard the rate of economic growth and

adversely affect the chances of the politicians’ re-election they behave more

responsibly than they otherwise would.

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CHAPTER- 4

ROLE OF COMMERCIAL BANK IN INDIA

Introduction

Commercial Banks are very important component of the money market.

They play a very important role in Indian Financial system. Indian banking

industry is regulated by Reserve Bank of India. Commercial Bank act as

Intermediaries because they accept deposits from savers and lend these

funds to borrowers.

Meaning of Commercial Banks

Commercial Banks is financial Institution that accepts deposits for the

purpose of lending. In other words, commercial Banks provide services such

as accepting deposits, giving business loans and also allow for variety of

deposit accounts. They collect money from those who have it to spare and

lend to those who require it.

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Commercial Bank is a banker to the general public. Commercial Banks

registered under Indian companies Act, 1936 and are also governed by the

Indian Banking Regulation Act, 1949.

Definitions:

Various definitions of a bank have been given by various authors. Some

important definitions of a bank listed below.

According to the Indian Companies (Regulation) Act, 1949, “the

accepting, for the purpose of lending or Investment, of deposits of money

from public, repayable on demand or otherwise and withdrawable by

cheque, draft, order or otherwise.”

According to Prof. Kinley, “A bank is an establishment which makes to

individuals such advances of money as may be required and safety made,

and to which individuals entrust money when not required by them for use.”

According to John Paget,“No body can be a banker who does not (i) take

deposit accounts (ii) take current accounts, (iii) issue and pay cheques, and

(iv) Collect cheques- crossed and uncrossed for its customers.”

Functions of Commercial Banks

1. Accepting Deposits:

Accepting deposits is one of major function of commercial bank. It is the business of bank to accept deposits so that he can lend it to other and earn

interest. Basically, the money is accepted as deposit for safekeeping. Banks

also pay interest on these deposits. To attract depositors banks maintain

different types of accounts. These are as following.

a)Fixed Deposit Accounts: The account which is opened for fixed

period by depositing amount is known as fixed deposit account. The

money deposited in this account cannot be withdrawn before expiry of

period. A high rate of interest is paid on fixed deposits.

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b)Current Deposit Account:Current deposit accounts are mostly

opened by businessmen and traders who withdraw money number of

times a day. Banks does not pay interest on these types of account.

The bank collects certain charges from depositors for services

rendered by it.

c)Saving Account:Saving account is most suited for those people who

want to save money for future needs. These types of account can be

opened with a minimum initial deposit. A minimum balance has to be

maintained in account as prescribed by bank. Some restrictions are

imposed ondepositor regarding number of deposit withdrawal and

amount to be withdrawn in given period.

d)Recurring Deposit Account: The purpose of these accounts is toencourage public for regular saving, particularly by fixed income

group. Fixed amount is deposit is deposited at regular intervals for a

fixed term and repaid on maturity.

2. Grant of Loans and Advances

Besides accepting deposit, the second most important function of

commercial bank is advancing of loan to the public. After keeping certain

part of deposits received by bank as reserve and the rest of balance given asloan. The different types of loan and advances are given by bank as follow.

a)Call Money : There are generally short term credit that range from

one day to fort night. There are even one nigh call money advances

made available to bank with the help of this market. The rate of

interest depends upon the conditions prevailing in money market.

b)Overdraft :In over draft, a customer can withdraw money from his

current account and available balance below zero. When the amount withdrawn is within the authorized limit then rate of interest charged

at agreed rate. Overdraft is allowed normally against the security of

negotiable Instrument and credit worthy customers without security.

c)Cash Credit:In cash credit, Bank advance loan against the customer

current asset or personal guarantee. The borrower has option to

withdraw the funds as and when required to extent of his needs but

he cannot exceed the credit limit allowed to him. The cash credit limit

depends on the debtor’s need and as agreed with the bank. The bankcharges interest only on money withdrawn from by them.

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d)Discounting of Bills:Under this type of lending, Bank pay amount

before due date of bill after deducting certain rate of discount or

commission. The holder of bill gets money immediately without

waiting for the date of maturity. If bill of exchange dishonoured on duedate the bank can recover the amount from the customer.

e)Direct Loan: A loans granted for a fixed maturity period more than

one year. Loans are usually secured against some collateral security.

The borrower can withdraw entire money through cheques. The

interest is charged on entire amount of loan. Repayment of loan either

in installments or in lump

3. Credit Creation

Credit creation is also an important function of commercial Bank. The

process of credit creation automatically performed when bank accept

deposits and provide loans Prof Sayers says, “Banks are not merely supply of

money but in an important sense, they are manufacturers of money”. In this

process, customers deposit their money in bank. Bank keeps certain

amount of deposit as cash reserve and rest of balance given as loan and

advances.

Banks not required to keep the entire deposits in cash. The amount of loan

does not give directly to borrower. The borrowers open an account and then

bank deposit money in that account. Here, bank’s lends money and process

of credit creation starts. The current cash reserve ratio is 6% in 2011.

4. Secondary Functions:- These are as follow:-

1) Sale and Purchased of Securities: On the behalf of customer,

commercial bank sale and purchase of the securities of private

companies as well as government securities.

2)Transfer of Funds:Commercial Bank also provide facilities to

transfer funds from one place to another place in form Bank draft,

cheques, mail transfer etc.

3) Collection and Payment of Credit Instrument:Commercial Bankcollect and make payment on behalf of their customers Commercial

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Bank collect and pay negotiable instruments and also pay rent,

income tax fees, insurance premium etc.

4)Locker Facility:Commercial Banks provides locker facility to their

customers. We can keep gold, silver and important documents inlocker.

5) Letter of Credit: Letter of credit certified the credit worthiness of

their customers which issued by commercial banks.

6) Collection of Information:Commercial Banks also collect the

information relating to Industry, trade, commerce which made

available to their customers.

7) Traveller’s Cheque ad Credit Card:Commercial Banks issue

traveller’s cheques and credit cards to their customers. They can

travel without fear of theft and loss of money. Credit card is used to

make payment for purchases so that individual does not have to

carry cash.

8)Foreign Exchange:Commercial banks provide facility to their

customers dealing in foreign exchange. Commercial Banks are

authorized dealers in India.

9)Issuing of Gift Cheques:Commercial Banks issues the gift cheques

like Rs 11,51, 101,501 etc.

10)Educational Loans: Commercial Banks also provide educational loan

to student for higher studies at reasonable rate of interest.

11)Consumer Finance:Commercial Banks provide consumer finance

facility for purchase consumer durables like televisions, refrigerators

etc.

12)Automated Teller Machine:Now a days with the help of ATM, we

can deposit or withdraw money from our account any time.

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CHAPTER-5

ROLE OF MERCHANT BANK IN INDIA

Introduction

The Notification of the Ministry of Finance defines merchant banker as “Anyperson who is engaged in the business of issue management either by

making arrangements regarding selling, buying or subscribing to securities

as manager-consultant, advisor or rendering corporate advisory services in

relation to such issue management”

The Amendment Regulation specifies that issue management consist of

Prospectus and other information relating to issue, determining financial

structure, tie-up of financiers and final allotment and refund of the

subscriptions, underwriting and portfolio management services.

In the words of Skully “A Merchant Bank could be best defined as a financial

institution conducting money market activities and lending, underwriting

and financial advice, and investment services whose organization is

characterized by a high proportion of professional staff able to able to

approach problems in an innovative manner and to make and implement

decisionsrapidly.”

Nature and Characteristics of Merchant Banking

The services of merchant bank cover project counseling, pre investment

activities, feasibility studies, project reports, design of capital structure,

issue management, underwriting, loan syndication, mobilization of funds

from Non-Resident Indians, foreign currency finance, mergers,

amalgamation, takeover, venture capital, buy back and public deposits.

Main Characteristics of Merchant Banking:

• High proportion of decision makers as a percentage of total staff.

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• Quick decision process.

• High density of information.

• Intense contact with the environment.

• Loose organizational structure.

• Concentration of short and medium term engagements.• Emphasis on fee and commission income.

• Innovative instead of repetitive operations.

• Sophisticated services on a national and international level.

• Low rate of profit distribution.

• High liquidity ratio.

Functions/ Services Offered by Merchant Bankers

1. Project Appraisal:

This service helps corporates in analyze the soundness of a project, which

may be setting up a new unit/expansion/modernization etc. It is a process

of examining the technical, commercial, financial and economic viability of a

project to ensure that it generates sufficient returns on the resources

invested in it.

A service project report will be prepared for the company, including

finalization of capital structure. Project appraisal includes:

a)Financial appraisal (liquidity analysis, capital structure analysis,

profitability analysis etc

b) Technical appraisal (factors of production, technology, civil works, site

location etc)

c)Economic appraisal (also known as cost-benefit analysis, social cost,

impact on employment, impact of the economy)

2. Syndication of Loan:

Merchant Bankers arrange short, medium and long term loans for their

clients. They analyze the pattern of clients cash flows, based on which the

terms of borrowing can be defined. It then prepares a detailed loan

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memorandum which is circulated to various banks and financial institutions

and they are invited to participate in the syndicate.

The merchant banks then negotiate the terms of lending based on which the

final allotment is done. It also arranges for raising foreign exchange loansand external commercial borrowings for import of capital.

3. Issue Management:

This is the primary function of merchant bankers. It refers to the

management of securities offering of corporates to the general public and

existing shareholders on rights basis.

Merchant bankers act as lead managers and assists companies in arrivingat quantum and nature of issue and obtaining consent/clearance from

various statutory authorities, preparing draft prospectus, obtaining

approval from appropriate authorities etc. it also assists companies in tying

up with underwriters for the issue, appoint other intermediaries like

brokers, bankers, advertising agents, registrar to the issue and co-ordinates

the activities of these agencies and institutions from the successful flotation

of the issue.

It also helps in listing the securities in stock exchange, finalizing basis ofallotment, arranging for refund, handling investor complaints etc.

4. Underwriting of Issues:

In order to ensure full subscription or the stipulated minimum subscription

of 90% of the issue, companies enter into an agreement with financial

institutions, banks, brokers and bankers to underwrite the issue amount.

Merchant bankers can underwrite issues and assist companies in tying up

with other underwriters.

5. Corporate Counseling:

Endearing assistance to corporate clients on various aspects of business

operations in the areas of financial planning, performance budgeting,

restructuring capital, and other aspects of financial management and

monitoring systems and operations.

6. Bankers to the Issue:

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Collection of subscription money/application money for an issue from the

investors, acknowledgement, proper accounting of the money received,

sending reports/certificates, informing collection details are the services

provided in the banker to the issue role.

7. Investment Counseling:

This activity involved assisting firms, companies, trusts, funds and

associations in the choice of shares and stocks for investment depending

upon the needs and the risk-return trade-off, as well as taxation and time

considerations.

8. Portfolio Management Services:

A portfolio is a collection of different kinds of investments. Merchant

bankers provide portfolio management services.

9. Registrar and Transfer Agent:

Transfer agency work involves carrying out transfer work in respect of

securities after complying with stipulated formalities/procedures.

Preparation and printing of dividend warrants and dispatching them toshare holders are also covered here. Other services include attending to

complaints of applicants/investors, coding and verification of applications,

allotment, processing and dispatching allotment letters, providing various

documents and certificates etc.

10. Mergers, Amalgamations and Acquisitions:

Some companies desire to restructure themselves in order to effectively

meet competition. Merchant bankers provide all requisite guidance andservices for restructuring, to prepare due diligence, necessary clearance

from statutory bodies like SEBI, ROC etc as per the statutory stipulations,

for the process of mergers, acquisitions and amalgamations.

11. Venture Capital:

Merchant Bankers help to obtaining venture capital for financing their new

and innovative strategies.

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12. Non-resident Investment:Merchant bankers provide investment

advisory services to attract NRI investment in primary and secondary

markets, undertake buying and selling securities on their behalf, secure

clearances from RBI under FEMA for repatriation of interest and dividends

etc.

14. Joint Ventures:

Merchant Bankers help corporates with joint ventures in India and abroad.

Scope for Merchant Banking in IndiaGrowth of New Issues Market:

The growth of new issue market is unprecedented since 1990-1991.

Merchant banking can help with the further sophistication and penetration

of the new issues market.

Entry of Foreign Investors:

Foreign institutional investors were allowed to invest in the primary and

secondary market in 1992 and also, Indian companies were allowed to

directly tap foreign capital through euro issues.

Further, foreign direct investment by NRIs has risen considerably due to

number of incentives offered to them. They need the services of merchant

bankers to advise them for their investment in India. The increasing number

of joint ventures abroad by Indian companies also requires expert services of

merchant bankers.

Changing Policy of Financial Institutions:

The policy of decentralization, increase in demand for technical and financial

services and encouragement of small and medium industries, requires the

services of merchant bankers.

Development of Debt Market:

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The development of debt market will offer tremendous opportunity to

Merchant Bankers.

Innovations in Financial Instruments:

The Indian capital market has witnessed innovations in the introduction of

financial instruments. This has further extended the role of merchant

bankers as market makers for these instruments.

Corporate Restructuring:

Due to liberalization and globalization, competition in the corporate sector is

becoming intense. To survive and thrive, companies need new strategies,

structures and methods of functioning. This has led to corporaterestructuring including mergers, acquisitions, etc. These developments offer

a good opportunity to merchant bankers to extend their area of operations.

Disinvestment:

The government of India has raised Rs. 2000 crores through disinvestment

of equity shares of selected public sector undertakings in 93-94. Merchant

Bankers can help in the disinvestment process.

CHAPTER -6

ROLE OF DEVELOPMENTS BANKS IN INDIA

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1.Industrial Development Banks :

It includes, for example, Industrial Finance Corporation of India

(IFCI), Industrial Development Bank of India (IDBI), and Small

Industries Development Bank of India (SIDBI).

2. Agricultural Development Banks :

It includes, for example, National Bank for Agriculture & Rural

Development (NABARD)

3.Export-Import Development Banks :

It includes, for example, Export-Import Bank of India (EXIM Bank).

4.Housing Development Banks :

It includes, for example, National Housing Bank (NHB).

Industrial Finance Corporation of India (IFCI) is the first development bank

in India. It started in 1948 to provide finance to medium and large-scale

industries in India.

The nine important functions of development banks in India are as follows:

1.To promote and develop small-scale industries (SSI) in India.

2.To finance the development of the housing sector in India.

3.To facilitate the development of large-scale industries (LSI) in India.

4.To help the development of agricultural sector and rural India.

5.To enhance the foreign trade of India.

6.To help to review (cure) sick industrial units.

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7.To encourage the development of Indian entrepreneurs.

8.To promote economic activities in backward regions of the country.

9.To contribute in the growth of capital markets.

Now let's discuss each important function of development banks one by one.

1. Small Scale Industries (SSI)

Development banks play an important role in the promotion and

development of the small-scale sector. Government of India (GOI) started

Smallindustries Development Bank of India (SIDBI) to provide medium and

long-term loans to Small Scale Industries (SSI) units. SIDBI provides direct

project finance, and equipment finance to SSI units. It also refinances banks

and financial institutions that provide seedcapital, equipment finance, etc.,

to SSI units.

2. Development of Housing Sector

Development banks providefinance for the development of the housing

sector. GOI started the National Housing Bank (NHB) in 1988.

NHB promotes the housing sector in the following ways:

1.It promotes and develops housing and financial institutions.

2.It refinances banks and financial institutions that provide credit to the

housing sector.

3. Large Scale Industries (LSI)

Development banks promote and develop large-scale industries (LSI).

Development financial institutions like IDBI, IFCI, etc., provide medium and

long-term finance to the corporate sector. They providemerchant banking

services, such as preparing project reports, doing feasibility studies,

advising on location of a project, and so on.

4. Agriculture and Rural Development

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Development banks like National Bank for Agriculture & Rural Development

(NABARD) helps in the development of agriculture. NABARD started in 1982

to provide refinance to banks, which provide credi

Documents

Role of Banking Sector in India