5th sem comp in bankiing

Increasing competition in banking sector in india

CHAPTER-1

HISTORY AND DEVELOPMENT OF BANKING INDUSTRY

Finance is the life blood of trade, commerce and industry. Financial services

refer to services provided by the finance industry. The finance industry

encompasses a broad range of organizations that deal with the management of

money. Among these organizations are credit unions, banks, credit card

companies, insurance companies, consumer finance companies, stock

brokerages, investment funds and some government sponsored enterprises.

A bank is a financial institution that serves as a financial intermediary. In other

words, bank is a financial organization where people deposit their money to

keep it safe. That’s only part of how a bank works, though. A bank is a business

like a video store, a restaurant, or a skating rink. The business needs to make

enough money to pay the people who work there and the cost of things like

electricity, paper, and even paper clips. If you look at the diagram below, you

will see an example of how a bank earns enough money to stay in business.

In order for a bank to stay open, it needs to get a lot of people to put their

money in it. Each bank tries to make THEIR bank look better than all of the

others by offering services that some other banks might not have. Another way

to get more people to put their money in the bank is to pay them interest.

Interest is extra money the bank gives you to keep your money there. This

means that you earn money on every dollar you put into the bank. . Now-a-days,

bank money acts as the backbone of modern business. Development of any

country mainly depends upon the banking system.

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The term bank is derived from the French word Banco which means a Bench or

Money exchange table. In olden days, European money lenders or money

changers used to display (show) coins of different countries in big heaps

(quantity) on benches or tables for the purpose of lending or exchanging.

According to Oxford Dictionary a bank is defined as "an establishment for

custody of money, which it pays out on customer's order."

Assets of the largest 1,000 banks in the world grew by 6.8% in the 2008/2009

financial year to a record $96.4 trillion while profits declined by 85% to

$115bn. Growth in assets in adverse market conditions was largely a result of

recapitalisation. EU banks held the largest share of the total, 56% in 2008/2009,

down from 61% in the previous year. Asian banks' share increased from 12% to

14% during the year, while the share of US banks increased from 11% to 13%.

Fee revenue generated by global investment banking totaled $66.3bn in 2009,

up 12% on the previous year.

The United States has the most banks in the world in terms of institutions (7,085

at the end of 2008) and possibly branches (82,000). This is an indicator of the

geography and regulatory structure of the USA, resulting in a large number of

small to medium-sized institutions in its banking system. As of Nov 2009,

China's top 4 banks have in excess of 67,000 branches (ICBC:18000+,

BOC:12000+, CCB:13000+, ABC:24000+) with an additional 140 smaller

banks with an undetermined number of branches. Japan had 129 banks and

12,000 branches. In 2004, Germany, France, and Italy each had more than

30,000 branches—more than double the 15,000 branches in the UK

The economic functions of banks include:

1. Issue of money- in the form of banknotes and current accounts subject to cheque

or payment at the customer's order. These claims on banks can act as money

because they are negotiable or repayable on demand, and hence valued at par.

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They are effectively transferable by mere delivery, in the case of banknotes, or

by drawing a cheque that the payee may bank or cash.

2. Netting and settlement of payments – banks act as both collection and paying

agents for customers, participating in interbank clearing and settlement systems

to collect, present, be presented with, and pay payment instruments. This

enables banks to economise on reserves held for settlement of payments, since

inward and outward payments offset each other. It also enables the offsetting of

payment flows between geographical areas, reducing the cost of settlement

between them.

3. Credit intermediation – banks borrow and lend back-to-back on their own

account as middle men.

4. Credit quality improvement – banks lend money to ordinary commercial and

personal borrowers (ordinary credit quality), but are high quality borrowers. The

improvement comes from diversification of the bank's assets and capital which

provides a buffer to absorb losses without defaulting on its obligations.

However, banknotes and deposits are generally unsecured; if the bank gets into

difficulty and pledges assets as security, to raise the funding it needs to continue

to operate, this puts the note holders and depositors in an economically

subordinated position.

5. Maturity transformation – banks borrow more on demand debt and short term

debt, but provide more long term loans. In other words, they borrow short and

lend long. With a stronger credit quality than most other borrowers, banks can

do this by aggregating issues (e.g. accepting deposits and issuing banknotes)

and redemptions (e.g. withdrawals and redemptions of banknotes), maintaining

reserves of cash, investing in marketable securities that can be readily converted

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to cash if needed, and raising replacement funding as needed from various

sources (e.g. wholesale cash markets and securities markets).

Without a sound and effective banking system in India it cannot have a healthy

economy. The banking system of India should not only be hassle free but it

should be able to meet 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 most striking is its

extensive reach. It is no longer confined to only metropolitans or cosmopolitans

in India. In fact, Indian banking system has reached even to the remote corners

of the country. This is one of the main reason of India's growth process. The

government's regular policy for Indian bank since 1969 has paid rich dividends

with the nationalisation of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for

getting a draft or for withdrawing his own money. Today, he has a choice. Gone

are days when the most efficient bank transferred money from one branch to

other in two days. Now it is simple as instant messaging or dial a pizza. Money

have become the order of the day.

The first bank in India, though conservative, was established in 1786. From

1786 till today, the journey of Indian Banking System can be segregated into

three distinct phases. They are as mentioned below:

Early phase from 1786 to 1969 of Indian Banks

Nationalisation of Indian Banks and up to 1991 prior to Indian banking

sector Reforms.

New phase of Indian Banking System with the advent of Indian Financial

& Banking Sector Reforms after 1991.

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The following are the 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 : Nationalisation 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 crore.

After the nationalisation of banks, the branches of the public sector bank India

rose to approximately 800% in deposits and advances took a huge jump by

11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith

and immense confidence about the sustainability of these institutions.

Phase III

This phase has introduced many more products and facilities in the banking

sector in its reforms measure. In 1991, under the chairmanship of M

Narasimham, a committee was set up by his name which worked for the

liberalisation of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are

being put to give a satisfactory service to customers. Phone banking and net

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banking is introduced. The entire system became more convenient and swift.

Time is given more importance than money.

The financial system ofx India has shown a great deal of resilience. It is

sheltered from any crisis triggered by any external macroeconomics shock as

other East Asian Countries suffered. This is all due to a flexible exchange rate

regime, the foreign reserves are high, the capital account is not yet fully

convertible, and banks and their customers have limited foreign exchange

exposure.

The Banking Industry was once a simple and reliable business that took

deposits from investors at a lower interest rate and loaned it out to

borrowers at a higher rate.

However deregulation and technology led to a revolution in the Banking

Industry that saw it transformed. Banks have become global industrial

powerhouses that have created ever more complex products that use risk and

securitisation in models that only PhD students can understand. Through

technology development, banking services have become available 24 hours a

day, 365 days a week, through ATMs, at online bankings, and in electronically

enabled exchanges where everything from stocks to currency futures contracts

can be traded .

The Banking Industry at its core provides access to credit. In the lenders case,

this includes access to their own savings and investments, and interest payments

on those amounts. In the case of borrowers, it includes access to loans for the

creditworthy, at a competitive interest rate.

Banking services include transactional services, such as verification of account

details, account balance details and the transfer of funds, as well as advisory

services, that help individuals and institutions to properly plan and manage their

finances. Online banking channels have become key in the last 10 years.

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The collapse of the Banking Industry in the Financial Crisis, however, means

that some of the more extreme risk-taking and complex securitization activities

that banks increasingly engaged in since 2000 will be limited and carefully

watched, to ensure that there is not another banking system meltdown in the

future.

Mortgage banking has been encompassing for the publicity or promotion of the

various mortgage loans to investors as well as individuals in the mortgage

business.Online banking services has developed the banking practices easier

worldwide. Banking in the small business sector plays an important role. Find

various banking services available for small businesses.

BANKING REGULATION ACT, 1949

The legal framework of banking in India can be understood in the Banking

Regulation Act, 1949. The Banking Regulation Act, 1949 defines a banking

company as a company which transacts the business of banking in India

(Section 5-c).

Section 5 (b) of the act defines banking as accepting for the purpose of lending

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

otherwise and withdrawable by cheque, draft, order or otherwise

Section 49 A of the Act prohibits any institution other than a banking company

to accept deposit of money from public withdrawable by cheque. Thus, the

combination of the functions of acceptance of public deposits and withdrawable

of money by cheque by any institution cannot be performed without the

approval of Reserve Bank.

A banking company must perform both the essential functions of accepting

deposits and lending or investing. Any company which is engaged in the

manufacture of goods or carriers on any trade and which accepts deposits of

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money from the public is important. The banker accepts deposits of money and

not of anything else. The word ‘public’ implies that a banker accepts deposits

from any one who offers money for such purpose. The banker can refuse to

open an account in the name of a person who is considered as an undesirable

person such as a thief or a robber. Acceptance of deposits sjpi;d be the known

business of a banker. The essential feature of banking business is that the banker

does not refund the money on his own accord, even if the period for which it

was deposited expired. The depositor must make a demand for the same. The

Act also specifies that the withdrawal should be effected through order, cheque,

draft or otherwise. It implies that the demand should be made in a proper

manner and through an instrument in writing and not merely by verbal order or

a telephone message.

Section 7 of the Act, makes it essential for every company carrying on the

business of banking in India to use as part of its name at least one of the words-

bank, banker, banking or banking company. It also prohibits any other

company, or firm, individual, or group of individuals, from using any of these

words as part of its/ his name. Under Section 6 of the Act, the following

businesses may be undertaken by a banking company.

1. Borrowing, raising or taking money and lending or advancing money,

discounting of bills, granting letter of credit, traveller’s cheques, buying and

selling of bullion and species, buying and selling of foreign exchange, providing

safe deposit vaults, collection and transmitting money and securities,

underwriting and dealing in shares, debentures, bonds and investments of all

kinds.

2. Act as an agent of the government, local authority a person and can carry on

agency business

3. It may contract for public and private loans and negotiate and issue the same

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4. It may insure, guarantee, underwrite, participate in managing and carrying out of

any issue of state, municipal or other loans or of shares, debentures and may

lend money for the purpose of any such issue.

5. It may carry on and transact every kind of guarantee and indemnity business

6. It may manage, sell and realize any property which may come into its possession

in satisfaction of its claims.

7. It may acquire and hold and deal with any property, or any right, title or interest

in any such property which may form the security for any loan or advance

8. It may undertake and execute trusts and undertake the administration of estates

as executor, trustee or otherwise

9. It may acquire, construct and maintain any building for its own purpose

10. It may sell, improve, manage, develop, exchange, lease, mortgage, dispose of

or turn into account.

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CHAPTER-2

BUSINESS PROHIBITED FOR A BANKING COMPANY

Section 8, of the Banking Regulation Act, 1949, prohibits a banking company from engaging directly or indirectly in trading activities and undertaking trading risks. However, a banking company is permitted to deal in buying or selling or bartering of goods or engage in any trade or buy, sell or barter goods for others in order to:

a) Realize the securities given to it or held by it for a loan, if need arised for

realization of the amount lent.

b) In connection with the bills of exchange received for collection or negotiation

and undertaking the administrative of estates as executor, trustee etc.

For the purpose of this section, goods, means every kind of movable property,

other than actionable claims, stocks, shares, money bullion and species and all

other instruments

Section 9, prohibits a banking company from holding any immovable property,

howsoever acquired, except as is required for its own use for a period exceeding

seven years from the acquisition of the property. This period may be extended

upto 12 years by the Reserve bank. Property for its own use can be held by a

banking company on a permanent basis.

Section 19, of the Banking Act,(Amended in 1983) provides that a banking

company is permitted to form a subsidiary company for any or more of the

following purposes.

a) For undertaking of any business permitted for a banking company

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b) For carrying on the business of banking exclusively outside India (with previous

permission of the Reserve Bank)

MINIMUM PAID UP CAPITAL AND RESERVES

Section 11, contains provisions to ensure adequacy of minimum paid up capital

and reserves. Adequacy of capital is essential for the soundness of a banking

company. The banking companies (Amendment) Act, 1962, raised the

minimum amount of the value of paid up capital to Rs. 5 lakhs for any Indian

Bank commencing business after the commencement of the Act. The term

‘value’ means the real or exchangeable value and not the nominal value which

may be shown in the books of the banking company. The real or exchangeable

value of capital and reserves is computed by estimating the realizable value of

all the assets and deducting therefrom the amounts of outside liabilities. Section

12 also provides that the subscribed capital of a banking company should not be

less than one half of its authorized capital and the paid up capital should not be

less than one-half of the subscribed capital. Banking companies capital may

consist of equity shares or preference shares which were issued prior to 1944.

The minimum paid up capital and reserves of different banks are given below.

1. INDIAN BANKS

A Banking company incorporated in India, should have the minimum aggregate

value of its paid up capital and reserves as prescribed in the Act:

a) If it has places of business in more than one state Rs 5,00,000

b) If any such place of business is situated in Mumbai or Kolkata or both Rs. 10

lakhs

c) If it has all its places of business in one state, none of which is situated in the

city of Mumbai or Kolkata :

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i. In respect of its principal place of business is Rs. 1 lakh plus

ii. In respect of each of its other places of business situated in the district of

principal business is Rs. 10,000 plus

iii. In respect of each place of business situated elsewhere in the state outside

the same district, is Rs. 25,000 subject to the total of Rs. 5 lakhs

d) If it has only one place of business, is Rs. 50,000

e) If it has all its places of business in one state, one or more of which is, or are

situated in the city of Mumbai or Calcutta, Rs. 5 lakhs plus. Inrespect of each

place of business situated outside the city of Mumbai or Kolkatta is Rs. 25,000.

Subject to a total of Rs. 10 lakhs

The above requirements apply to those banks which were established before,

1962. The Banking Companies (Amendement) Act,1962, raised the minimum

amount of the value of the paid up capital to Rs. 5 lakhs for any Indian Bank

commencing businesses after that Act.

2. Foreign Banks

In case of a banking company incorporated outside India, the aggregate value of

its paid up capital and reserves shall not be less than Rs. 15 lakhs, and if it has a

place of business in the city of Mumbai or Kolkatta, or both Rs. 20 lakhs. The

banking company incorporated outside India is also required to deposit with the

Reserve Bank either in cash or in the form of unencumbered approved

securities, or both an amount equal to the minimum amount specified above.

The Act also requires a foreign banking company to deposit with the Reserve

Bank at the end of each calendar year an amount equal to 20% of the profit for

that year in respect of all businesses transacted through its branches in India.

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CHAPTER-3

BANKING IS NEED OF TIME

Although using a bank is the most common method of storing and accessing

your money, there are some alternatives you should consider. If you feel that

your bank isn't giving you what you want, then perhaps it is time for a change.

Here are some banking alternatives that might be able to offer you the features

and services that you require.

Of course, the main reason to use a bank is the fact that banks are widely

available, and they are the first option that comes to mind when dealing with

finances. In fact, some people aren't even aware that there are alternatives to

banking apart from keeping your money at home. Although banking has its

uses, it can cost you money for day-to-day financial matters that you can get for

less. Bank fees can be extremely expensive, but there are some alternatives.

Credit unions are one alternative to using conventional banks. Unlike banks,

credit unions are not for profit organisations that are run by their members.

Credit unions are used by people who share a workplace or occupation, or even

a religion. They offer many of the same services as banks, but because profit is

not their main function they can offer lower fees and higher interest rates on

savings than normal banks. Credit unions can be fairly large and organisations,

and some offer similar levels of convenience to a regular bank. If you are

looking for cheaper fees and better interest rates on savings then a credit union

might be right for you. However, credit unions are still small compared to

banks, and you cannot simply join the credit union of your choice. You have to

meet their specific requirements or be related to someone who is already a

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member in order to join. Also, you generally have to save money with a credit

union before you can have access to other financial products

Perhaps the best alternative to traditional banking is online banking. There are

many banks that operate solely online, and there are a lot of benefits to this sort

of bank. Although you might not be able to get money as easily as you could

with a normal bank, you can transfer funds and pay bills much more efficiently.

Also, online banks usually operate all day every day, meaning that you can

access your account and carry out transactions whenever you want. For paying

bills and transferring money, you can't really beat online banking

Although there are viable alternatives to traditional banking, perhaps the best

way to save yourself time and money is to have a combination of accounts. If

you are eligible for a credit union, then saving with them is probably the best

option as you can get great rates and you might be able to borrow money at a

much more reasonable rate if you need to do so in the future. You could

combine this with an online account to pay your bills, as this allows you to pay

bills quickly and manage your money more effectively so that you always pay

on time. Thirdly, having a traditional bank account is usually a good idea,

because if any problems arise you can go to your bank and speak to someone

face to face. If you look around at all the alternatives to regular banking then

you could save yourself money and make banking work more effectively for

you.

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CHAPTER-4

DIFFERENT TYPES OF BANKS

1. CENTRAL BANK

A central bank, reserve bank, or monetary authority is a public institution that

usually issues the currency, regulates the money supply, and controls the

interest rates in a country. Central banks often also oversee the commercial

banking system of their respective countries. In contrast to a commercial bank, a

central bank possesses a monopoly on printing the national currency, which

usually serves as the nation's legal tender.

The primary function of a central bank is to provide the nation's money supply,

but more active duties include controlling interest rates, and acting as a lender

of last resort to the banking sector during times of financial crisis. It may also

have supervisory powers, to ensure that banks and other financial institutions do

not behave recklessly or fraudulently.

Central banks in most developed nations are independent in that they operate

under rules designed to render them free from political interference. Examples

include the European Central Bank (ECB), the Bank of England, and the

Federal Reserve System of the United States

2. ADVISING BANK

An advising bank (also known as a notifying bank) advises a beneficiary

(exporter) that a letter of credit (L/C) opened by an issuing bank for anapplicant

(importer) is available. Advising Bank's responsibility is to authenticate the

letter of credit issued by the issuer to avoid fraud. The advising bank is not

necessarily responsible for the payment of the credit which it advises the

beneficiary of.

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The advising bank is usually located in the beneficiary's country. It can be (1) a

branch office of the issuing bank or a correspondent bank, or (2) a bank

appointed by the beneficiary. Important point is the beneficiary has to be

comfortable with the advising bank.

In case (1), the issuing bank most often sends the L/C through its branch office

or correspondent bank to avoid fraud. The branch office or the correspondent

bank maintains specimen signature(s) on file where it may counter-check the

signature(s) on the L/C, and it has a coding system (a secret test key) to

distinguish a genuine L/C from a fraudulent one (authentication) .

In case (2), the beneficiary can request the applicant to specify his/her bank (the

beneficiary's bank) as the advising bank in an L/C application. In many

countries, this is beneficial to the beneficiary, who may avail the reduced bank

charges and fees because of special relationships with the bank. Under normal

circumstances, advising charges is standard and minimal. In addition, it is more

convenient to deal with the beneficiary's own bank over a bank with which the

beneficiary does not maintain an account.

3. COMMERCIAL BANK

A commercial bank (or business bank) is a type of financial institution and

intermediary. It is a bank that provides transactional, savings, and money

market accounts and that accepts time deposits Commercial banks engage in

processing of payments by way of telegraphic transfer, EFTPOS, internet

banking, or other means, issuing bank drafts and bank cheques, accepting

money on term deposit, lending money by overdraft, installment loan, or other

means, providing documentary and standby letter of credit, guarantees,

performance bonds, securities underwriting commitments and other forms of off

balance sheet exposures, safekeeping of documents and other items in safe

deposit boxes, distribution or brokerage, with or without advice, of insurance,

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unit trusts and similar financial products as a “financial supermarket”, cash

management and treasury, merchant banking and private equity financing

Traditionally, large commercial banks also underwrite bonds, and make markets

in currency, interest rates, and credit-related securities, but today large

commercial banks usually have an investment bank arm that is involved in the

mentioned activities.

4. COMMUNITY DEVELOPMENT BANK

In the United States, community development banks (CDBs or CDFI Banks) are

commercial banks that operate with a mission to generate economic

development in low- to moderate-income (LMI) geographical areas and serve

residents of these communities. In the United States, community development

banks are certified as such by the Community Development Financial

Institutions Fund, a department within the U.S. Department of the Treasury.

In order to become a certified CDFI, CD Banks must apply to the United States

Community Development Financial Institutions Fund. Successful applicants

will have a primary mission of promoting community development and

principally serve under served markets and provide development services, in

addition to meeting other requirements[1]. CDFI Banks provide retail banking

services, they usually target customers from "financially underserved"

demographics.

While community development banks are one type of community development

financial institution, or CDFI,[2] some organizations use the terms

interchangeably. grants official certification of CDFI status to eligible CDBs.

Organizers wishing to start a new CDB can seek a state or national bank charter.

Federally chartered CDBs are regulated primarily by the Office of the

Comptroller of the Currency, like any national bank. According to the OCC

Charter Licensing Manual, CDBs are required "to lend, invest, and provide

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services primarily to LMI individuals or communities in which it is chartered to

conduct business." State-chartered community development banks are subject to

regulations, qualifications, and definitions that vary from state to state.

The Grameen Bank of Bangladesh is a microfinance organization and

community development bank founded by Muhammad Yunus. The bank has

grown into a family of over two dozen for-profit and nonprofit enterprises

including the Grameen Foundation, and the Grameen Bank and its founder were

awarded the Nobel Peace Prize in 2006.

5. CREDIT UNION

A credit union is a cooperative financial institution that is owned and controlled

by its members and operated for the purpose of promoting thrift, providing

credit at competitive rates, and providing other financial services to its

members. Many credit unions exist to further community development or

sustainable international development on a local level.

Worldwide, credit union systems vary significantly in terms of total system

assets and average institution asset size, ranging from volunteer operations with

a handful of members to institutions with several billion dollars in assets and

hundreds of thousands of members. Credit unions are typically smaller than

banks; for example, the average U.S. credit union has $93 million in assets,

while the average U.S. bank has $1.53 billion, as of 2007.

The World Council of Credit Unions (WOCCU) defines credit unions as "not-

for-profit cooperative institutions". In practice however, legal arrangements

vary by jurisdiction. For example in Canada credit unions are regulated as for-

profit institutions, and view their mandate as earning a reasonable profit to

enhance services to members and ensure stable growth.

This difference in viewpoints reflects credit unions' unusual organizational

structure, which attempts to solve the principal-agent problem by ensuring that

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the owners and the users of the institution are the same people. In any case,

credit unions generally cannot accept donations and must be able to prosper in a

competitive market economy.

6. CUSTODIAN BANK

A Custodian bank, or simply custodian, is a specialized financial institution

responsible for safeguarding a firm's or individual's financial assets and is not

likely to engage in "traditional" commercial or consumer/retail banking such as

mortgage or personal lending, branch banking, personal accounts, ATMs and so

forth.

The role of a custodian in such a case would be to hold in safekeeping

assets/securities such as stocks, bonds, commodities such as precious metals and

currency (cash), domestic and foreign, arrange settlement of any purchases and

sales and deliveries in/out of such securities and currency, collect information

on and income from such assets (dividends in the case of stocks/equities and

coupons (interest payments) in the case of bonds) and administer related tax

withholding documents and foreign tax reclamation, administer voluntary and

involuntary corporate actions on securities held such as stock dividends, splits,

business combinations (mergers), tender offers, bond calls, etc.

It provide information on the securities and their issuers such as annual general

meetings and related proxies, maintain currency/cash bank accounts, effect

deposits and withdrawals and manage other cash transactions, perform foreign

exchange transactions, often perform additional services for particular clients

such as mutual funds; examples include fund accounting, administration, legal,

compliance and tax support services, provide regular and special reporting on

any or all their activities to their clients or authorized third parties such as

MAIC Trust Account services for mergers & acquisitions payments.

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Custodian banks are often referred to as global custodians if they safekeep

assets for their clients in multiple jurisdictions around the world, using their

own local branches or other local custodian banks with which they contract to

be in their "global network" in each market to hold accounts for their respective

clients. Assets held in such a manner are typically owned by larger institutional

firms with a considerable amount of investments such as MAIC Trust services

& (QI) Qualified Intermediary services banks, insurance companies, mutual

funds, hedge funds and pension funds.

7. DEPOSITORY BANK

A depository bank (U.S. usage) is a bank organized in the United States which

provides all the stock transfer and agency services in connection with a

depository receipt program. This function includes arranging for a custodian to

accept deposits of ordinary shares, issuing the negotiable receipts which back up

the shares, maintaining the register of holders to reflect all transfers and

exchanges, and distributing dividends in U.S. dollars.

8. EXPORT CREDIT AGENCY

An export credit agency (known in trade finance as ECA) or Investment

Insurance Agency, is a private or quasi-governmental institution that act as an

intermediary between national governments and exporters to issue export

financing. The financing can take the form of credits (financial support) or

credit insurance and guarantees (pure cover) or both, depending on the mandate

the ECA has been given by its government. ECAs can also offer credit or cover

on their own account. This does not differ from normal banking activities. Some

agencies are government-sponsored, others private, and others a bit of both.

ECAs currently finance or underwrite about $430 billion of business activity

abroad - about $55 billion of which goes towards project finance in developing

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countries - and provide $14 billion of insurance for new foreign direct

investment, dwarfing all other official sources combined (such as the World

Bank and Regional Development Banks, bilateral and multilateral aid, etc.). As

a result of the claims against developing countries that have resulted from ECA

transactions, ECAs hold over 25% of these developing countries' US$2.2 trillion

debt. These data are unreliable in the absence of source, definition, or date.

Export credit agencies use three methods to provide funds to an importing entity

one is Direct lending which is the simplest structure whereby the loan is

conditioned upon the purchase of goods or services from businesses in the

organizing country, second is Financial intermediary loans where the export–

import bank lends funds to a financial intermediary, such as a commercial bank,

that in turn loans the funds to the importing entity and Interest rate equalization

is a commercial lender provides a loan to the importing entity at below market

interest rates, and in turn receives compensation from the export–import bank

for the difference between the below-market rate and the commercial rate.

9. INVESTMENT BANKING

An investment bank is a financial institution that assists individuals,

corporations and governments in raising capital by underwriting and/or acting

as the client's agent in the issuance of securities. An investment bank may also

assist companies involved in mergers and acquisitions, and provide ancillary

services such as market making, trading of derivatives, fixed income

instruments, foreign exchange, commodities, and equity securities.

Unlike commercial banks and retail banks, investment banks do not take

deposits. From 1933 (Glass–Steagall Act) until 1999 (Gramm–Leach–Bliley

Act), the United States maintained a separation between investment banking

and commercial banks. Other industrialized countries, including G8countries,

have historically not maintained such a separation.

21


There are two main lines of business in investment banking. Trading securities

for cash or for other securities (i.e., facilitating transactions, market-making), or

the promotion of securities (i.e., underwriting, research, etc.) is the "sell side",

while dealing with pension funds, mutual funds, hedge funds, and the investing

public (who consume the products and services of the sell-side in order to

maximize their return on investment) constitutes the "buy side". Many firms

have buy and sell side components.

An investment bank can also be split into private and public functions with a

Chinese wall which separates the two to prevent information from crossing. The

private areas of the bank deal with private insider information that may not be

publicly disclosed, while the public areas such as stock analysis deal with public

information.

An advisor who provides investment banking services in the United States must

be a licensed broker-dealer and subject to Securities & Exchange Commission

(SEC) and Financial Industry Regulatory Authority (FINRA) regulation.[1]

10. INDUSTRIAL BANK

An industrial loan company (ILC) or industrial bank is a financial institution

in the United States that lends money, and may be owned by non-financial

institutions. Though such banks offer FDIC-insured deposits and are subject to

FDIC and state regulator oversight, a debate exists to allow parent companies

such as Wal-Mart to remain unregulated by the financial regulators. "FDIC-

insured entities are subject to Sections 23A and 23B of the Federal Reserve Act,

which limits bank transactions with affiliates, including the parent company."

(FDIC.gov) The ILC is permitted to have branches in multiple states (which is

permitted by many states on a reciprocal basis). They are state-chartered, and

insured by the Federal Deposit Insurance Corporation. They are currently

22


chartered by seven states, with most chartered by Utah. Other states permitting

them

Companies that have set up industrial banks include UBS, General Electric Co.,

General Motors, Merrill Lynch & Co. Inc., Morgan Stanley, American Express

Co. Target Corp, Nordstrom, Harley-Davidson, First Data, UnitedHealth Group,

BMW, and Sallie Mae. In May 2005, Warren Buffett's Berkshire Hathaway,

Inc. announced plans to operate a Utah industrial bank to handle consumer

loans for its R. C. Willey Home Furnishings stores. The Blue Cross and Blue

Shield Association, Ford Motor Co., Ceridian Corp. and Home Depot await

approval.

However, the assets held by an ILC tend to paint an incomplete picture. The

actual loan book amount can be considered more important. In this view, for

example, UBS would replace Merrill Lynch as number 1.

11. MERCHANT BANK

A merchant bank is a financial institution which provides capital to companies

in the form of share ownership instead of loans. A merchant bank also provides

advisory on corporate matters to the firms they lend to.

Today, according to the US Federal Deposit Insurance Corporation (acronym

FDIC), "the term merchant banking is generally understood to mean negotiated

private equity investment by financial institutions in the unregistered securities

of either privately or publicly held companies."[1] Bothcommercial banks and

investment banks may engage in merchant banking activities. Historically,

merchant banks' original purpose was to facilitate and/or finance production and

trade of commodities, hence the name "merchant". Few banks today restrict

their activities to such a narrow scope.

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12. MUTUAL SAVINGS BANK

A mutual savings bank is a financial institution chartered through a state or

federal government to provide a safe place for individuals to save and toinvest

those savings in mortgages, loans, stocks, bonds and other securities.

Mutual savings banks were designed to stimulate savings by individuals; the

exclusive function of these banks is to protect deposits, make limited, secure

investments, and provide depositors with interest. Unlikecommercial banks,

savings banks have no stockholders; the entirety of profits beyond the upkeep of

the bank belongs to the depositors of the mutual savings bank. Mutual savings

banks prioritize security, and as a result, have historically been characteristically

conservative in their investments. This conservatism is what allowed mutual

savings banks to remain stable throughout the turbulent period of the Great

Depression, despite the failing of commercial banks and savings and loan

associations.

13. NATIONAL BANK

In banking, the term national bank carries several meanings:

especially in developing countries, a bank owned by the state

an ordinary private bank which operates nationally (as opposed to regionally or

locally or even internationally)

In the United States, an ordinary private bank operating within a specific

regulatory structure, which may or may not operate nationally, under the

supervision of the Office of the Comptroller of the Currency.

In the past, the term "national bank" has been used synonymously with "central

bank", but it is no longer used in this sense today. Some central banks may have

the words "National Bank" in their name; conversely if a bank is named in this

way, it is not automatically considered a central bank. For example, National-

Bank AG in Essen, Germany is a privately owned commercial bank, just like

24


National Bank of Canada of Montreal, Canada. On the other side, National

Bank of Ethiopia is the central bank of Ethiopia and National Bank of

Cambodia is the central bank of Cambodia.

14. OFFSHORE BANK

An offshore bank is a bank located outside the country of residence of the

depositor, typically in a low tax jurisdiction (or tax haven) that provides

financial and legal advantages. These advantages typically include greater

privacy (see also bank secrecy, a principle born with the 1934 Swiss Banking

Act), low or no taxation (i.e. tax havens), easy access to deposits (at least in

terms of regulation) and protection against local political or financial instability

While the term originates from the Channel Islands being "offshore" from the

United Kingdom, and most offshore banks are located in island nations to this

day, the term is used figuratively to refer to such banks regardless of location,

including Swiss banks and those of other landlocked nations such as

Luxembourg and Andorra.

Offshore banking has often been associated with the underground economy and

organized crime, via tax evasion and money laundering; however, legally,

offshore banking does not prevent assets from being subject to personal income

tax on interest. Except for certain persons who meet fairly complex

requirements, the personal income tax of many countries [2] makes no distinction

between interest earned in local banks and those earned abroad. Persons subject

to US income tax

For example, are required to declare on penalty of perjury, any offshore bank

accounts—which may or may not be numbered bank accounts—they may have.

Although offshore banks may decide not to report income to other tax

authorities, and have no legal obligation to do so as they are protected by bank

25


secrecy, this does not make the non-declaration of the income by the tax-payer

or the evasion of the tax on that income legal. Following September 11, 2001,

there have been many calls for more regulation on international finance, in

particular concerning offshore banks, tax havens, and clearing houses such as

Clearstream, based in Luxembourg, being possible crossroads for major illegal

money flows.

15. POSTAL SAVINGS SYSTEM

Many nations' post offices operated, or continue to operate postal savings

systems, to provide depositors who did not have access to banks a safe,

convenient method to save money and to promote saving among the poor.

16. PRIVATE BANK

Private banks are banks that are not incorporated. A private bank is owned by

either an individual or a general partner(s) with limited partner(s). In any such

case, the creditors can look to both the "entirety of the bank's assets" as well as

the entirety of the sole-proprietor's/general-partners' assets.

These banks have a long tradition in Switzerland, dating back to at least the

revocation of the Edict of Nantes (1685). However most have now become

incorporated companies, so the term is rarely true anymore. There are a few

private banks remaining in the U.S. One is Brown Brothers Harriman & Co., a

general partnership with about 30 members. Private banking also has a long

tradition in the UK where Coutts & Co has been in business since 1692.

"Private banks" and "private banking" can also refer to non-government owned

banks in general, in contrast to government-owned (or nationalized) banks,

which were prevalent in communist, socialist and some social democratic states

in the 20th century. Private banks as a form of organization should also not be

26


confused with "Private Banks" that offer financial services to high net worth

individuals and others.

17. RETAIL BANK

Retail banking refers to banking in which banking institutions execute

transactions directly with consumers, rather than corporations or other banks.

Services offered include: savings and transactional accounts, mortgages,

personal loans, debit cards, credit cards, and so forth.

18. SAVINGS AND LOAN ASSOCIATION

A savings and loan association (or S&L), also known as a thrift, is a financial

institution that specializes in accepting savings deposits and making mortgage

and other loans. The terms "S&L" or "thrift" are mainly used in the United

States; similar institutions in the United Kingdom, Ireland and some

Commonwealth countries include building societies and trustee savings banks.

They are often mutually held (often called mutual savings banks[citation needed]),

meaning that the depositors and borrowers are members with voting rights, and

have the ability to direct the financial and managerial goals of the organization,

similar to the policyholders of a mutual insurance company. It is possible for an

S&L to be a joint stock companyand even publicly traded. However, this means

that it is no longer truly an association, and depositors and borrowers no longer

have managerial control. By law, thrifts must have at least 65 percent of their

lending in mortgages and other consumer loans — making them particularly

vulnerable to housing downturns such as the deep one the U.S. has experienced

since 2007.

27


19. SAVINGS BANK

A savings bank is a financial institution whose primary purpose is accepting

savings deposits. It may also perform some other functions.

In Europe, savings banks originated in the 19th or sometimes even the 18th

century. Their original objective was to provide easily accessible savings

products to all strata of the population. In some countries, savings banks were

created on public initiative, while in others, socially committed individuals

created foundations to put in place the necessary infrastructure.

20. UNIVERSAL BANK

A savings bank is a financial institution whose primary purpose is accepting

savings deposits. It may also perform some other functions.

In Europe, savings banks originated in the 19th or sometimes even the 18th

century. Their original objective was to provide easily accessible savings

products to all strata of the population. In some countries, savings banks were

created on public initiative, while in others, socially committed individuals

created foundations to put in place the necessary infrastructure.

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CHAPTER-5

DIFFERENT TYPES OF PRODUCT

Bank deposits serve different purposes for different people. Some people cannot

save regularly; they deposit money in the bank only when they have extra

income. The purpose of deposit then is to keep money safe for future needs.

Some may want to deposit money in a bank for as long as possible to earn

interest or to accumulate savings with interest so as to buy a flat, or to meet

hospital expenses in old age, etc. Some, mostly businessmen, deposit all their

income from sales in a bank account and pay all business expenses out of the

deposits. Keeping in view these differences, banks offer the facility of opening

different types of deposit accounts by people to suit their purpose and

convenience.

On the basis of purpose they serve, bank deposit accounts may be classified as

follows:

1. Savings Bank Account

If a person has limited income and wants to save money for future needs, the

Saving Bank Account is most suited for his purpose. This type of account can

be opened with a minimum initial deposit that varies from bank to bank. Money

can be deposited any time in this account. Withdrawals can be made either by

signing a withdrawal form or by issuing a cheque or by using ATM card.

Normally banks put some restriction on the number of withdrawal from this

account. Interest is allowed on the balance of deposit in the account. The rate of

interest on savings bank account varies from bank to bank and also changes

29


from time to time. A minimum balance has to be maintained in the account as

prescribed by the bank.

2. Current Deposit Account

Big businessmen, companies and institutions such as schools, colleges, and

hospitals have to make payment through their bank accounts. Since there are

restriction on number of withdrawals from savings bank account, that type of

account is not suitable for them. They need to have an account from which

withdrawal can be made any number of times. Banks open current account for

them. Like savings bank account, this account also requires certain minimum

amount of deposit while opening the account. On this deposit bank does not pay

any interest on the balances. Rather the accountholder pays certain amount each

year as operational charge. For the convenience of the accountholders banks

also allow withdrawal of amounts in excess of the balance of deposit. This

facility is known as overdraft facility. It is allowed to some specific customers

and upto a certain limit subject to previous agreement with the bank concerned.

3. Fixed Deposit Account

Fixed Deposit Account is also known as Term Deposit Account. Many a time

people want to save money for long period. If money is deposited in savings

bank account, banks allow a lower rate of interest. Therefore, money is

deposited in a fixed deposit account to earn a interest at a higher rate. This type

of deposit account allows deposit to be made of an amount for a specified

period. This period of deposit may range from 15 days to three years or more

during which no withdrawal is allowed. However, on request, the depositor can

encash the amount before its maturity. In that case banks give lower interest

than what was agreed upon. The interest on fixed deposit account can be

withdrawn at certain intervals of time. At the end of the period, the deposit may

be withdrawn or renewed for a further period. Banks also grant loan on the

security of fixed deposit receipt.

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4. Recurring Deposit Account.

This type of account is suitable for those who can save regularly and expect to

earn a fair return on the deposits over a period of time. While opening the

account a person has to agree to deposit a fixed amount once in a month for a

certain period. The total deposit along with the interest therein is payable on

maturity. However, the depositor can also be allowed to close the account

before its maturity and get back the money along with the interest till that

period. The account can be opened by a person individually, or jointly with

another, or by the guardian in the name of a minor. The rate of interest allowed

on the deposits is higher than that on a savings bank deposit but lower than the

rate allowed on a fixed deposit for the same period.

Recurring Deposit Accounts may be of different types depending on the

purpose underlying the deposit. Some of these are as follows:

a) Home Safe Account (also known as Money Box Scheme):

Small savers find it convenient to deposit money under this scheme. For regular

savings, the bank provides a safe or box (Gullak) to the depositor. The safe or

box cannot be opened by the depositor, who can put money in it regularly,

which is collected by the bank’s representative at intervals and the amount is

credited to the depositor’s account. The deposits carry a nominal rate of interest.

b) Cumulative-cum-Sickness Deposit Account:

Regular deposits made in this type of account serve the purpose of having

money to meet large expenses in case there is sudden illness or other unforeseen

expenses. A certain fixed sum is deposited at regular intervals in this account.

The accumulated deposits over time along with interest can be used for payment

of medical expenses, hospital charges, etc.

31


c) Home Construction deposit Scheme/Saving Account:

This is also a type of recurring deposit account in which money can be

deposited regularly either for the purchase or construction of a flat or house in

future. The rate of interest offered on the deposit in this case is relatively higher

than in other recurring deposit accounts.

LOANS AND ADVANCES

The term ‘loan’ refers to the amount borrowed by one person from another. The

amount is in the nature of loan and refers to the sum paid to the borrower. Thus.

from the view point of borrower, it is ‘borrowing’ and from the view point of

bank, it is ‘lending’. Loan may be regarded as ‘credit’ granted where the money

is disbursed and its recovery is made on a later date. It is a debt for the

borrower. While granting loans, credit is given for a definite purpose and for a

predetermined period. Interest is charged on the loan at agreed rate and intervals

of payment. ‘Advance’ on the other hand, is a ‘credit facility’ granted by the

bank. Banks grant advances largely for short-term purposes, such as purchase of

goods traded in and meeting other short-term trading liabilities. There is a sense

of debt in loan, whereas an advance is a facility being availed of by the

borrower. However, like loans, advances are also to be repaid. Thus a credit

facility- repayable in instalments over a period is termed as loan while a credit

facility repayable within one year may be known as advances. However, in the

present lesson these two terms are used interchangeably.

Utility of Loans and Advances

Loans and advances granted by commercial banks are highly beneficial to

individuals, firms, companies and industrial concerns. The growth and

diversification of business activities are effected to a large extent through bank

financing. Loans and advances granted by banks help in meeting short-term and

long term financial needs of business enterprises.

32


Banks also borrow from other institutions as well as from the Reserve Bank of

India. When the Reserve Bank of India lends money to commercial banks, the

rate of interest it charges for lending is known as ‘Bank Rate’. The rate at which

commercial banks make funds available to people is known as ‘Lending-rate’.

The lending rates also vary depending upon the nature of loans and advances.

The rates also vary according to the purpose in view. For example if the loan is

sanctioned for the purpose of activities for the development of backward areas,

the rate of interest is relatively lower as against loans and advances for

commercial/business purposes. Similarly for smaller amounts of loan the rate of

interest is higher as compared to larger amounts. Again lending rates for

consumer durables, e.g. loans for purchase of two-wheelers, cars, refrigerators,

etc. are relatively higher than for commercial borrowings.

However, the Reserve Bank of India from time to time announces changes in

the interest-rate structure to regulate the lending of funds by banks. Different

rates of interest are prescribed for various categories of advances, such as

advances to agriculture, small scale industries, road transport, etc. Graded rates

of interest are prescribed for backward areas. Lower rate is normally charged

from agencies selling food-grains at fixed price through Govt. approved outlets.

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CHAPTER-6

TYPES OF LOANS

1. Loans

Loan is the amount borrowed from bank. The nature of borrowing is that the

money is disbursed and recovery is made in instalments. While lending money

by way of loan, credit is given for a definite purpose and for a pre-determined

period. Depending upon the purpose and period of loan, each bank has its own

procedure for granting loan. However the bank is at liberty to grant the loan

requested or refuse it depending upon its own cash position and lending policy.

There are two types of loan available from banks:

a) Demand loan

A Demand Loan is a loan which is repayable on demand by the bank. In other

words, it is repayable at short-notice. The entire amount of demand loan is

disbursed at one time and the borrower has to pay interest on it. The borrower

can repay the loan either in lumpsum (one time) or as agreed with the bank. For

example, if it is so agreed the amount of loan may be repaid in suitable

instalments. Such loans are normally granted by banks against security. The

security may include materials or goods in stock, shares of companies or any

other asset. Demand loans are raised normally for working capital purposes, like

purchase of raw materials, making payment of short-term liabilities.

b) Term loan

Medium and long term loans are called term loans. Term loans are granted for

more than a year and repayment of such loans is spread over a longer period.

The repayment is generally made in suitable instalments of a fixed amount.

Term loan is required for the purpose of starting a new business activity,

renovation, modernization, expansion/ extension of existing units, purchase of

34


plant and machinery, purchase of land for setting up of a factory, construction

of factory building or purchase of other immovable assets. These loans are

generally secured against the mortgage of land, plant and machinery, building

and the like.

2. Cash credit

Cash credit is a flexible system of lending under which the borrower has the

option to withdraw the funds as and when required and to the extent of his

needs. Under this arrangement the banker specifies a limit of loan for the

customer (known as cash credit limit) up to which the customer is allowed to

draw. The cash credit limit is based on the borrower’s need and as agreed with

the bank. Against the limit of cash credit, the borrower is permitted to withdraw

as and when he needs money subject to the limit sanctioned. It is normally

sanctioned for a period of one year and secured by the security of some tangible

assets or personal guarantee. If the account is running satisfactorily, the limit of

cash credit may be renewed by the bank at the end of year. The interest is

calculated and charged to the customer’s account.

Cash credit, is one of the types of bank lending against security by way of

pledge or /hypothetication of goods. ‘Pledge’ means bailment of goods as

security for payment of debt. Its primary purpose is to put the goods pledged in

the possession of the lender. It ensures recovery of loan in case of failure of the

borrower to repay the borrowed amount. In ‘Hypothetication’, goods remain in

the possession of the borrower, who binds himself under the agreement to give

possession of goods to the banker whenever the banker requires him to do so.

So hypothetication is a device to create a charge over the asset under

circumstances in which transfer of possession is either inconvenient or

impracticable.

35


3. Overdraft

Overdraft facility is more or less similar to ‘cash credit’ facility. Overdraft

facility is the result of an agreement with the bank by which a current account

holder is allowed to draw over and above the credit balance in his/her account.

It is a short-period facility. This facility is made available to current account

holders who operate their account through cheques. The customer is permitted

to withdraw the amount of overdraft allowed as and when he/she needs it and to

repay it through deposits in the account as and when it is convenient to him/her.

Overdraft facility is generally granted by a bank on the basis of a written request

by the customer. Sometimes the bank also insists on either a promissory note

from the borrower or personal security of the borrower to ensure safety of

amount withdrawn by the customer. The interest rate on overdraft is higher than

is charged on loan. The following are some of the benefits of cash credits and

overdraft:

i. Cash credit and overdraft allow flexibility of borrowing, which depends upon the

need of the borrower.

ii. There is no necessity of providing security and documentation again and again

for borrowing funds.

iii. This mode of borrowing is simple and elastic and meets the short term financial

needs of the business.

4. Discounting of Bills

Apart from sanctioning loans and advances, discounting of bills of exchange by

bank is another way of making funds available to the customers. Bills of

exchange are negotiable instruments which enable debtors to discharge their

obligations to the creditors. Such Bills of exchange arise out of commercial

transactions both in inland trade and foreign trade. When the seller of goods has

36


to realise his dues from the buyer at a distant place immediately or after the

lapse of the agreed period of time, the bill of exchange facilitates this task with

the help of the banking institution.

Banks invest a good percentage of their funds in discounting bills of exchange.

These bills may be payable on demand or after a stated period. In discounting a

bill, the bank pays the amount to the customer in advance, i.e. before the due

date. For this purpose, the bank charges discount on the bill at a specified rate.

The bill so discounted, is retained by the bank till its due date and is presented

to the drawee on the date of maturity. In case the bill is dishonoured on due date

the amount due on bill together with interest and other charges is debited by the

bank to the customers account.

Apart from these the banks also provides financial services to the corporate

sector and business and society

1) Merchant Banking

In banking, a merchant bank is a financial institution primarily engaged in

offering financial services and advice to corporations and to wealthy

individuals. The term can also be used to describe the private equity activities of

banking. The chief distinction between an investment bank and a merchant bank

is that a merchant bank invests its own capital in a client company whereas an

investment bank purely distributes (and trades) the securities of that company in

its capital raising role. Both merchant banks and investment banks provide fee

based corporate advisory services including in relation to mergers and

acquisitions.

2) Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets

for which it must pay a series of contractual, periodic, tax deductible payments.

37


The lessee is the receiver of the services or the assets under the lease contract

and the lessor is the owner of the assets. The relationship between the tenant

and the landlord is called a tenancy, and can be for a fixed or an indefinite

period of time (called the term of the lease). The consideration for the lease is

called rent. A gross lease is when the tenant pays a flat rental amount and the

landlord pays for all property charges regularly incurred by the ownership from

lawnmowers and washing machines to handbags and jewellry.[1]

Under normal circumstances, a freehold owner of property is at liberty to do

what they want with their property, including destroy it or hand over possession

of the property to a tenant. However, if the owner has surrendered possession to

another (the tenant) then any interference with the quiet enjoyment of the

property by the tenant in lawful possession is unlawful.

Similar principles apply to real property as well as to personal property, though

the terminology would be different. Similar principles apply to sub-leasing, that

is the leasing by a tenant in possession to a sub-tenant. The right to sub-lease

can be expressly prohibited by the main lease.

3) Mutual Funds

A Mutual Fund is a trust that pools the savings of a number of investors who

share a common financial goal. The money thus collected is then invested in

capital market instruments such as shares, debentures and other securities. The

income earned through these investments and the capital appreciation realised

are shared by its unit holders in proportion to the number of units owned by

them. Thus a Mutual Fund is the most suitable investment for the common man

as it offers an opportunity to invest in a diversified, professionally managed

basket of securities at a relatively low cost.

38


4) Money Transfer

Banks are helping business and society for transfer of money from place to

place or person to person. For this purpose, Demand Draft, Pay orders,

Telegraphic Transfer, Mail Transfer, Credit Cards etc type methods are used

5) Factoring

Factoring is a financial transaction whereby a business job sells its accounts

receivable (i.e., invoices) to a third party (called a factor) at a discount in

exchange for immediate money with which to finance continued business.

Factoring differs from a bank loan in three main ways. First, the emphasis is on

the value of the receivables (essentially a financial asset),[1][2] not the firm’s

credit worthiness. Secondly, factoring is not a loan – it is the purchase of a

financial asset (the receivable). Finally, a bank loan involves two parties

whereas factoring involves three.

The three parties directly involved are: the one who sells the receivable, the

debtor, and the factor. The receivable is essentially a financial asset associated

with the debtor's liability to pay money owed to the seller (usually for work

performed or goods sold). The seller then sells one or more of its invoices (the

receivables) at a discount to the third party, the specialized financial

organization (aka the factor), to obtain cash. The sale of the receivables

essentially transfers ownership of the receivables to the factor, indicating the

factor obtains all of the rights and risks associated with the receivables.

Accordingly, the factor obtains the right to receive the payments made by the

debtor for the invoice amount and must bear the loss if the debtor does not pay

the invoice amount. Usually, the account debtor is notified of the sale of the

receivable, and the factor bills the debtor and makes all collections. Critical to

the factoring transaction, the seller should never collect the payments made by

the account debtor, otherwise the seller could potentially risk further advances

from the factor. There are three principal parts to the factoring transaction; a.)

39


the advance, a percentage of the invoice face value that is paid to the seller upon

submission, b.) the reserve, the remainder of the total invoice amount held until

the payment by the account debtor is made and c.) the fee, the cost associated

with the transaction which is deducted from the reserve prior to it being paid

back the seller. Sometimes the factor charges the seller a service charge, as well

as interest based on how long the factor must wait to receive payments from the

debtor. The factor also estimates the amount that may not be collected due to

non-payment, and makes accommodation for this when determining the amount

that will be given to the seller. The factor's overall profit is the difference

between the price it paid for the invoice and the money received from the

debtor, less the amount lost due to non-payment

6) Finance Housing

There are a variety of housing finance schemes started by banks. Such as

purchase of new house, construction of new home, home improvement, repairs,

extension, land purchase, bridge loans, and balance transfer loans. Commercial

banks through their subsidiaries undertake housing finance as a specialized

business. Now a days, all the banks are permitted to provide housing finance to

the people. They provide housing finance and other related services to the needy

people at reasonable rate of interest.

7) Credit Cards

A Lot of people miscomprehend the usage of credit card thinking that it only

augments their expenditure & nothing else, however they are not aware of the

proper usage of the card. A Credit Card is plastic money which is used as a way

of payment, facilitating you to purchase products/services on credit. It eases

your life & your shopping experience is made simpler as you are not required to

carry cash at all the places; just swipe your credit card & you are given a free

credit period of 50-55 days by the bank. A lot of people think that the credit

40


period starts from the date of purchase which is not correct; you should note that

the credit period is calculated from the date of billing and not from the date of

purchase. - As soon as you get the credit card, you need to sign on the signature

panel - Spend within your credit limit: You should not cross the limit of the

credit allotted by the bank as they charge hefty fine from the card holders. -

Always check sales vouchers/charge slips and the purchase amount when you

sign them. - Change your PIN regularly & do not give out your card number or

CVV number (three-digit number) to anyone on the phone, unless you are

dealing with a reputable company. - When shopping online, submit credit card

details only through secure websites. - Always keep a track of your billing cycle

& pay bills on time to avoid interest charges & late fees. - Always scan your

credit card statements for unauthorized transactions. If you've been defrauded,

contact the issuing bank instantly. - Withdrawing cash from ATM through your

credit card is really expensive as there is a fee of Rs 350, plus 3.5 percent

interest per day. You must make sure that you withdraw the cash only in an

emergency.

8) Portfolio Management

Portfolio management is a process of investment in securities. It involves a

proper investment decision making. It involves proper money management. The

objective of this service is to help investors with the expertise of professionals.

It involves construction of a portfolio based upon the fact sheet of the investor

giving out his objectives, constraints, preferences and tax liability. The portfolio

should be reviewed and adjusted from time to time in tune with the market

conditions. The portfolio manager is an important person who holds the

financial institutions and banks. They handle the funds of the investors for a fee.

As per SEBI guidelines, the portfolio manager should get a certificate from the

SEBI for rendering the portfolio management services to the clients. The SEBI

has framed the code of conduct for the portfolio managers. The violation of the

41


regulations of SEBI is an offence and is punishable under the SEBI Act. Banks

usually extend services for managing surplus funds of their corporate customers

either directly or through merchant bankers. It involves helping their clients in

investing their funds in a manner that balances the liquidity, safety and

maximum yield

9) ATM

One of the channels of banking service delivery is vide the Automated Teller

Machine (ATM) whose traditional and primary use is to dispense cash upon

insertion of a plastic card and its unique Personal Identification Number (PIN).

ATM card is a plastic card with a magnetic strip with the account number of the

individual. The bank issues ATM cards to its current and saving accountholders.

A typical transaction would be that of cash withdrawal. The bank generally

restricts the maximum amount and the frequency with which one can withdraw

cash. The amount withdrawn is immediately debited to the concerned account

through accounting entries pre programmed on the ATM. Cash or cheques can

be deposited through the ATM for the credit to an account. ATMs can be

accessed may time. No employee interface is necessary. ATM offers a cost

effective solution alternative to labour costs. The scope of frauds, robberies and

misappropriation are reduced considerably if the PIN is maintained diligently.

10) Tele banking

Tele banking is a banking service offered by banks to enable customers to

access their accounts for information or transactions. A Telephone PIN (T-PIN)

is provided to each accountholder. The customer can call the exclusive tele-

banking numbers and provide the details to identify himself to the automated

voice. Upon the respective numbers matching the computerized systems, the

customer is given access to his account to query or transact on his account. Cash

42


withdrawal and deposit are not enabled through this service but many banks

offer a cash delivery or collection service to certain classes of cutomers.

11) Internet Banking

Internet is one of the channels of service delivery to a banking customer. The

access to account information as well as transaction is offered through the

worldwide network of computers on the internet. Every bank has special

firewalls and its own security measure to protect the accounts from non-

authentic use from unauthorized users. Each accountholder is provided a PIN

similar to that of the ATM. The access to the account is allowed upon a match

of the account details and PIN entered on the computer system. A higher level

of security may be reached by an electronic finger print. Account querying as

well as transaction are possible on the Internet Banking Platform. The

accounting is instantaneous and funds transfers can be effected immediately.

Financial services companies are using the Internet as the new distribution

channel.

INNOVATIVE STRATEGIES FOR NEW PRODUCT

These days banks are spending larger and larger percentages of their marketing

budgets to acquire customers. These efforts include outbound campaigns, both

online as well as through traditional methods. In this culture of instant response

and connectedness, customers expect to be able to make decisions when

presented with an offer in a very quick manner. However, in many cases the

inability to complete the acquisition process due to process that has does not

lend itself to support this type of behavior gets in the way of closing the loop.

As is demonstrated by the large number of online only banks that are popping

up every day, customers are getting more and more comfortable with these

types of transactions being handled online. Simply put, the ability to complete

43


the process of account opening online is a price to play in this business these

days.

Collabera's solution starts by streamlining the process by separating the require

steps from steps that can be completed at a later stage. This streamlined process

is then technology enables by leveraging existing platforms or in some cases

introducing new platforms that offer more flexible account opening processes.

Since the account opening process tends to vary by the product being offered, in

some cases providing a seamless and consistent customer experience is

achieved via integrating various services into a customer friendly front end.

Critical to this strategy is the integration of data flows for customer information

across the disparate data stores.

As is well understood, the initial process after the account is setup is a great

time to make a impression on the customer. This initial experience establishes

the foundation for the future. In our experience, there is an opportunity to do

more than just going through a checklist of items that make up the process of

on-boarding. The on-boarding process is a great time to gather information from

the customer that can then be sent off to the appropriate data stores for

consumption by various business functions. In many cases this on-boarding

process gets executed in silos.

The Collabera solution focuses on defining the process and then technology

enabling it in a way that can cover all bases. The process analysis includes all

aspects that are visible to the customer as well as background processes that are

triggered as part of this end to end process. The technical aspects focus on

integration and data enrichment prior to sharing the information with

appropriate resources.

44


The cost to acquire new customers is higher that it has ever been. Product

bundling is emerging as a key tactic in being able to offer products that will

increase the "stickiness factor" as well as increasing the revenue per customer

metric. Most banks are able to use the results of propensity analysis to

understand the most likely portfolio of products that would be of interest to a

customer. Using this data to identify the best primary product along with a

secondary set of products allows all customer communication to be much more

tailored. The result is a higher "redemption rate" on offers to the customer.

Executing on this type of a strategy requires a clear understanding of the overall

goals, the associated tactics, a clearly defined and completely integrated channel

strategy as well as a seamless integration amongst the technology platforms. In

many organizations the lack of an overall data strategy can be a challenge.

Collabera has assisted several banks in enabling these type of strategies. In our

opinion, traditional approaches to product bundling are limited to prepackaged

product bundling solutions. This one size fits all type of solution has yielded

some results in the past. However, given the competitive environment these

days, more sophisticated approaches are needed.

As banks struggle to increase the revenue per customer, cross sell strategies

have emerged as a way of achieving this target. In the past these type of

strategies have focused on offering multiple types of products from within a

segment of the banks business. Segments of Lines of Business, are typically

how the banks have internally organized themselves and no surprise that the

lack of customer centricity in this approach failed to deliver on the promise of

increasing wallet share by increase cross sell. Customers have looked for

solutions that cross multiple aspects of their profile – business and personal. As

banks rethink these strategies and align themselves behind better and more

robust cross sell strategies, it has become clear that knowing the customer at a

45


deeper level then before is key to success in the pursuit of higher cross sell

ratios.

Collabera's solutions associated with cross-sell strategies focus on two aspects.

1) Establishing a process that allows all customer facing function to truly act in

a way that will allow them to offer the entire portfolio of products and they are

incented to do so 2) Establishing metrics that allow the measurement of these

interactions in the form of measureable dashboards such as White Space

Analysis.

Banking customers are demanding tools that help manage their finances and

detect fraud. Alerts are a tool that can assist by proving timely, meaningful and

actionable notifications to customers on events related to their accounts. Alerts

can also be used to help customers conveniently transact business; for instance,

an alert may prompt a payment of a loan or transfer funds to prevent an

overdraft. Furthermore, functionality the functionality of a bank's online/mobile

alerts framework could be enhanced greatly by allowing clients to enroll/un-

enroll and tailor alerts that meet their needs.

In order to ensure customer adoption of these alerts, banks need to create a

positive experience for the user by allowing them to manage their alerts in one

location. This is best done by combining efforts with various business lines and

systems to guarantee that bank customers do not have to go to multiple

locations to manage their preferences. Typical lines of business that could

dramatically benefit from adopting the alerts functionality are Business

Banking, Collections, Credit Card, Debit Card, Deposits, Investments, Lending,

Line of Credit (overdraft), Marketing, Mobile Banking, Mortgage, Retail

Banking, Security, Web Banking. Email, SMS text messaging, and push

notifications are cost effective channels that reach customers quickly, which

46


increase the value of the products offered by many of these business units. The

Collabera solution focuses on defining the end-to-end alerts architecture,

including the process, technology, system integration, and business change

requirements. Collabera leverages its world-class toolkit of best-practice alerts,

and helps prioritize the adoption of the alerts functionality that meets the

business needs leveraging our proprietary Momentum methodology. Our alerts

architecture and design includes all aspects that are visible to the customer as

well as background processes that are triggered as part of this end to end

solution. A typical business case leveraging the Collabera Alerts framework to

monetize and setup a best practice alerts solution within their banking business

in mid-tier banks reflects between $5MM and $7MM of revenue over 3 years,

as a result of "monetized alerts" fee revenue and overall expense savings.

INNOVATIVE SERVICES TO CUSTOMERS

A conventional bank may treat its customers as coldly as the cash they deposit

or borrow. Many banks have conveniently used control and security as reasons

for their remarkably slow and impersonal services. In recent years, other service

industries, notably fast-food and airlines, have proven that customer service can

be a swift and enjoyable experience for both clients and employees without

sacrificing control, costs, and profits. Some banks have finally adopted these

new service paradigms and are now benchmarking with non-bank institutions to

learn about their best practices.

For instance, BayBanks of Massachusetts, is using the mail-order company L.L.

Bean, known for its superb order-taking and service delivery systems, as its

model for change. A major result of this functional benchmarking was the

establishment of a 24-hour customer service center that can not only respond to

queries and complaints but also promote and sell the bank's products and

47


services. The center even allows customers to open a checking account anytime

or negotiate an overdraft at 2 am. The ATM was also reconfigured from a mere

cash dispenser to a versatile and tireless account executive. The machine can

now buy and sell mutual funds. Inspired by L.L. Bean, Bay Banks published a

50-page catalogue to help customers appreciate and select from its more than

160 financial services.

Seafirst Bank in Seattle redefined itself from a "retail bank" to a "retailer" and

has benchmarked with retailers known for world class customer service such as

fast-food restaurant chains. Inspired by these models, Seafirst instituted a 5-

minute guarantee that says "Wait any longer than 5 minutes in line and the bank

guarantees $5 to your account." Moreover, if the customer complains of any

other inconvenience, he or she gets a $5 "I'm sorry coupon". Its branch offices

have official "greeters" to greet and guide customers to the right tellers or desks,

much like the guest relations officers (GRO) or receptionists of 5-star hotels.

The greeter mans a kiosk at the entrance of the bank. To reinforce this service

philosophy, branch managers are rated not only on sales but on service goals.

Achieving or even exceeding sales targets without achieving customer

satisfaction goals will not entitle a branch manager to receive the bank's

prestigious "Gold Club" award. Executives from the CEO down are encouraged

and expected to visit branches regularly to monitor service and get a first-hand

feel of the action. When Seafirst decided to redesign and re-layout its offices to

improve service, it acquired the services of an expert from the Godfather's Pizza

chain. One result was making the teller counter waist-high. It is now more open

and personal than the traditional counter that is intimidating and creates a

barrier between the client and the teller.

Like Seafirst, Citicorp looks as itself as less of a bank and more of a "factory".

This factory processes raw materials in the form of documents, application

48


forms, and customer requests and the final product is a satisfied customer.

Desks, departments, offices, and other work stations serve as the machines and

equipment of this document factory. In reorganizing the bank into a leaner and

better service center, the CEO John Reed, who has an engineering background,

applied the lessons and practices he learned from his visits to Ford Motor,

Cummins Engine, General Electric, Core Industries and Exxon. The first

process his reengineered was the back-room operations which consist of many

repetitive operations. Back-office of banks are known for snail-pace

bureaucracy that hampers front line operations and the ultimate customer

service. By applying the concept of "mass production", streamlining, and

standardization of tasks, Citicorp aims to remove this critical bottleneck. The

bank also benchmarked with Chrysler in getting its functional departments to

work effectively as teams.

Others banks, shedding their conservative "finance and control" images, have

likewise adopted innovative service strategies and practices. Banco Frances has

established an information center or "encyclopaedia" in the waiting lounge.

Here customers can browse through various bits and pieces of important service

information like the average time to finish a transaction and the company's

products and services. Information about the busiest day or days in the branch

are displayed so that customers may want to avoid these periods. In the new

branches of Garanti Bankasi, phone lines dedicated to customer service were

installed. Any customer can pick up this phone and relay his or her a complain,

question, or difficulty. The facility is designed to represent the company's

commitment to service and also serves as the customer's last resort in case

everything else fails.

Similarly, ASB Bank Limited has established a phone center to accept , process,

and resolve customer complaints. It also has a customer feedback programme

49


whereby whoever the customer complains to, say a staff employee or manager,

will be responsible for giving the client feedback on the status and progress his

or her complaint. The bank’s customer service center has created two customer

flows or lines to deliver services more effectively. One was for loans and

similar products that require customized and personalized services. The other

lines was for the standard and repetitive services like deposits and withdrawals.

By creating two service environments that cater to two different types of needs,

service is enhanced and speeded up.

Bank Pertanian Malaysia (BPM) has extended the concept of "mobile banking."

To the convenience and delight of customers living in longhouses along the

river banks of the Sarawak river, the bank has launched floating branches on

boats that provide full branch bank services. To further enhance service, BPM

has also reconfigured its automated teller machines to dispense not only cash,

but also commodity prices and information about its products and services. The

Korean Technology Banking Corporation (KTB) is setting up a Technology

Financing Information Center to serve the various needs of its clients, most of

which are setting up joint-ventures overseas. The Center will contain a huge

database of information analyzed from various data from internal and external

sources. By accessing this database, clients will get information about specific

technologies, local information, and other data relevant to the ventures they are

setting up. To facilitate processing, development financial institutions like the

Industrial Development Bank of India, requires borrowers to submit loan

application forms in electronic floppy disks.

Some banks and financial institutions have done such a remarkable job in

improving and reinventing customer service that they themselves have become

the benchmarks of other companies outside the banking sector. For instance,

American Express, the credit card company, is the recognized benchmark to

50


emulate when it comes to improving a company's billing process. Amex's

billing is reportedly the fastest and most accurate in the world in any industry.

Xerox, the benchmark for many quality practices, used the Amex model in

enhancing its billing systems. In China, the benchmark for customer service and

customer courtesy is surprisingly a bank: The Industrial and Commercial Bank.

Hundreds of retail shops and department stores, many of which are known for

rude service, visit the bank's branches to learn a few lessons on satisfying and

delighting customers. Before sweeping changes were made, the Industrial and

Commercial Bank was also known for bad service and discourteous front line

employees who even swear at clients. One radical and highly effective policy it

instituted was coming about with a list of words and phrases their employees

are forbidden to use when dealing with customers. For instance the popular

expression "When will you stop complaining?" is included in the banned list.

While other banks may refuse to change or accept soiled or old currency notes,

the bank will replace these without question.

Even clearing houses have adopted the new service paradigms to support the

banks' initiatives. For instance, the Singapore Clearing House Association has

cut the clearing of US$ checks deposited in Singapore from two weeks to 3

days. The new system requires participating banks to open US dollar accounts

with Citibank to service their respective clients.

Innovative banking in customer service is indeed a welcome and long-awaited

development. We hope that other banks and financial institutions will follow

suit soon. Satisfied customers are the best guarantee of stability and growth. As

in other service sectors, bank customers deserve the very best. In the past, banks

have rarely treated customers as people, preferring to treat them as account

numbers, passbooks, and loan applications. Customer service, in contrast to

51


customer processing, is a concept whose time has come for the banking industry

world wide.

52


CHAPTER-7

FUTURE OF BANKING IN RURAL AND

URBAN AREAS

The Reserve Bank of India has a mandate to be closely involved in matters

relating to rural credit and banking by virtue of the provisions of Section 54 of

the RBI Act. The major initiative in pursuance of this mandate was taken with

sponsoring of All-India Rural Credit Survey in 1951-52. This study made

agency-wise estimates of rural indebtedness and observed that cooperation has

failed but it must succeed. The Report of the Committee on Directions is still

considered a classic on the subject, and two of the four members were,

incidentally, from Andhra Pradesh. This is the origin of the policy of extending

formal credit through institutions while viewing local, traditional and informal

agencies as usurious. In the first stage, therefore, efforts were concentrated on

developing and strengthening cooperative credit structures. The Reserve Bank

of India has also been making financial contributions to the cooperative

institutions through evolving institutional arrangements, especially for

refinancing of credit to agriculture.

While enacting the State Bank of India Act in 1955, the objective was stated to

be the extension of banking facilities on a large scale, more particularly, in rural

and semi-urban areas. SBI, therefore, became an important instrument of

extending rural credit to supplement the efforts of cooperative institutions. In

1969, 14 major commercial banks were nationalised and the objective, inter

alia, was "to control the heights of economy". The nationalised banks thus

became important instruments for advancement of rural banking in addition to

cooperatives and State Bank of India. The next step to supplement the efforts of

53


cooperatives and commercial banks was the establishment of Regional Rural

Banks in 1975 in different states with equity participation from commercial

banks, Central and State Governments.

By 1982, to consolidate the various arrangements made by the RBI to promote/

supervise institutions and channel credit to rural areas, NABARD was

established. Though several efforts were made to increase the flow of

institutional credit for agricultural and rural lending, there were mismatches in

credit and production. Field studies conducted to determine the reason, revealed

that it was due to absence of effective local level planning. It was felt that with

the establishment of large network of branches, a system could be adopted to

assign specific areas to 45 each bank branch in which it can concentrate on

focussed lending and contribute to the development of the area. With a view to

implementing this approach, RBI introduced a scheme of "Service Area

Approach" for commercial banks. To further supplement the institutional

mechanism, the concept of Local Area Banks was taken up in 1996-97 and in-

principle approval has been given for 8 Local Area Banks.

As regards cost of credit, for most of the period, the administered interest rate

regime was applicable for bank lending and this included concessional terms for

priority sector. Currently, all interest rates on bank advances including in rural

areas are deregulated and there is no link between priority sector and interest

rate, though there are some regulations on interest rates by size of advance i.e.

below Rs. 2 lakh in respect of commercial banks.

As regards policy measures to enhance flow of credit to rural areas, apart from

availability of credit lines from the Reserve Bank of India, the concept of

priority sector was evolved to ensure directed credit. Currently, the stipulation is

that domestic commercial banks should extend credit to the extent of 40 per

54


cent of the total net bank credit to priority sector as a whole, of which 18 per

cent should be specifically for agriculture. Out of the target of 18 per cent for

agriculture, at least 13.5 per cent should be by way of direct loans to agriculture

and remaining could be in the form of indirect loans.

Where a bank fails to fulfil its commitment towards priority sector lending, it is

currently required to contribute to Rural Infrastructure Development Fund set

up by NABARD. NABARD in turn provides these funds to State Governments

and state owned corporations to enable them to complete various types of rural

infrastructure projects. It is pertinent to recognise that there are a large number

of credit linked programmes sponsored by the Government for direct assault on

poverty. In programmes relating to self-employment and women welfare, the

multiplicity of programmes has been reduced by having a comprehensive and

consolidated programme named Swaranjayanti Gram Swarojgar Yojna.

The financial sector reforms, which were introduced from 1991 onwards were

aimed at transforming the credit institutions into organisationally strong,

financially viable and operationally efficient units. The measures introduced

include reduction in budgetary support and concessionality of resources,

preparation of Development Action Plans and signing of Memoranda of

Understanding with the major controllers, and introduction of prudential norms

relating to income recognition and asset classification for RRBs and cooperative

banks. The lending rates for these institutions have also been deregulated. Other

measures of liberalization include allowing non-target group financing for

RRBs, direct financing for SCBs and CCBs, and liberalisation in investment

policies and non-fund business.

These measures have contributed to many RRBs turning around and becoming

more vibrant institutions. In the case of cooperative banks, there is greater

55


awareness of the problems of officialisation and politicisation and initiatives in

this regard include legislative actions on cooperative banks in Andhra Pradesh.

Recently, several policy initiatives have been taken to advance rural banking.

These include46 additional capital contribution to NABARD by the RBI and the

Government of India, recapitalisation and restructuring of RRBs, simplification

of lending procedures as per the Gupta Committee recommendations,

preparation of a special credit plans by public sector banks and launching of

Kisan Credit Cards. Finally, a scheme linking self help groups with banks has

been launched under the aegis of NABARD to augment the resources of micro

credit institutions. A Committee has gone into various measures for developing

micro credit, and has submitted its report, which is under the consideration of

the RBI. In respect of cooperatives, a Task Force under the chairmanship of my

esteemed and affectionate colleague Shri Jagdish Capoor, Deputy Governor has

been constituted to review the status and make recommendations for

improvement.

Undeniably, these initiatives have enabled a very wide network of rural

financial institutions, development of banking culture, penetration of formal

credit to rural areas and a counter to the dominance of moneylenders. These

initiatives have also financed modernisation of rural economies and

implementation of anti-poverty and self-employment programmes. However,

for the purpose of focussing on the future, generalisation on some concerns

regarding the current approach to rural credit and banking would be appropriate.

Firstly, the cooperative banks have different layers and many of them have

significantly large non-performing assets (NPAs). Many cooperatives are

undercapitalised. The public sector banking system also exhibits NPAs, and

some of them have so far been provided with recapitalised funds. The RRBs

56


also exhibit NPAs and these have been recapitalised from the Government of

India so far, which would imply a total recapitalisation of double the amount

provided by Government of India.

Secondly, according to the All-India Debt and Investment Survey, 1991-92, the

share of debt to institutional agencies in the case of rural households has

increased marginally from 61.2 per cent to 64 per cent between 1981 and 1991.

However, it must be noted that this figure relates to debt outstanding and the

overall share of the institutional credit in the total debt market is likely to be

smaller than what this figure indicates.

Thirdly, the cost of financial intermediation by the various rural financial

institutions is considered to be on the high side. The difference between the cost

of resources made available to NABARD by Reserve Bank of India and the

commercial rates of interest at which the cooperative banks lend for agriculture

in the deregulated interest rate regime is also considered to be on the high side.

Fourthly, empirical studies indicate that institutional credit is more likely to be

available for well to do among the rural community.

Fifthly, empirical studies also indicate that relatively backward regions have

less access to institutional credit than others do.

Sixthly, the non-availability of timely credit and the cumbersome procedures for

obtaining credit are also attributed to the functioning of the financial

institutions, though this is equally valid for rural and urban banking

Finally in regard to Government sponsored schemes, there has been overlap in

accountability in as much as the beneficiaries are identified on a joint basis.

57


Banks have been indicating that NPAs are proportionately more due to this

overlapping.

An important development in the formal segment of the rural financial markets

is the growing significance of non-banking financial companies, in particular, in

hire purchase and leasing operations. They also finance traders of agricultural

inputs and output. The NBFCs have only recently been brought under the

regulatory regime of RBI. While their importance is recognized in financing

diversified rural agriculture, its extent and scope of operations has not been

adequately researched.

Rural Credit Markets : New Realities

As mentioned earlier in the approach to rural banking, the basic thrust of our

policy has been to promote institutional credit and eliminate or ignore informal

finance. However, in reality, while formal credit has expanded its share,

informal finance continues to be significant. The idea of promotion of Self-Help

Groups and micro financing is an indirect admission of necessity of informal

finance. The future of rural banking cannot be appreciated without fully

understanding both formal and informal rural credit markets, especially their

linkages. Since in the earlier sections, organisation and functioning of the

formal credit system in the rural areas has been explained, in this section nature

of informal markets and the linkages will be explored.

The informal financial market which is legal but officially unrecorded

comprises unregulated financial activities i.e., outside the orbit of officially

regulated financial intermediaries. In the informal financial transactions, one

could treat borrowing and lending among friends and relatives as occasional and

not part of such an informal market. Consequently, there are three broad types

58


of informal financial transactions, viz., well-defined group,

tied-lending/borrowing; and untied lending/borrowing activities.

In the literature on well-defined groups, there are three broad types namely

Rotating Savings and Credit Associations (ROSCA); Accumulated Savings and

Credit Associations (ASCRA) and hybrid forms of both. There are some

variations under each category. Basic characteristics of these groups are that

they are voluntary in nature, usually among equals, with little or no outside

support or interference. Often, members have some special bonds based on

religion, caste, status, neighbourhood, etc. In brief, there is no patronclient

framework. In essence, therefore, these arrangements among well-defined

groups, though important, should not in my view be included in the concept of

informal financial markets. In the recent past, there have been efforts to provide

a bridge between formal financial markets and these well-defined groups in the

form of ‘micro-finance' initiatives. However, these initiatives do not constitute

marketisation of activities of well-defined groups. Thus, the informal financial

markets are those which are outside the orbit of officially regulated institutions.

These informal debt transactions may involve tied debt transactions and untied

debt transactions.

The general approach, at least at the policy level, to informal market whether

tied or untied, has not been positive since informal debt market has been

historically equated with either landlord or moneylender. The transactions are

considered to be expensive, especially in view of what is held to be of usurious

nature of interest rates. It is considered to be financing unproductive

expenditures since consumption needs are financed. Sometimes, it is said that

there are often unequal and exploitative arrangements, say, between the landlord

and the tenant or the agricultural labourer. Finally, it is held that, since these are

unregulated, they are prima facie not desirable.

59


Yet, the fact remains that informal debt markets do prevail, and studies have

shown that in some areas in our country, they account for 70 to 80 per cent of

debt transactions. Studies have also shown that many poor people have no

access to institutional credit. The arrangements in informal debt markets are

said to be flexible, and sometimes have in-built risk sharing arrangements.

These credit arrangements do provide for smoothening of consumption and

production requirements. Transaction costs in terms of certainty, timeliness,

procedural requirements, number of trips, etc. are somewhat negligible although

there may be hidden costs in tied lending. Moreover, while formal markets tend

to cater to less risky borrowings, informal markets provide for the more risky

borrowings and thus serve a purpose. Finally, it has been stated in the literature

that financial repression like directed credit, high reserve ratios, interest rate

ceilings, branch licensing, etc. make informal financial markets relatively

attractive and popular.

Perhaps, one way of reconciling the conflicting views on usefulness of informal

credit is to recognise some emerging realities of both formal and informal

markets. This would also help a rethink on approaches to rural credit and rural

banking.

First, it is no longer the case that the money lender and informal financing are

always synonymous, in view of the dynamics of rural economy already

described involving suppliers credit, buyers credit and credit for services sector.

Second, informal markets are less significant now than before, and have to face

competition or at least accept benchmarking of formal credit. The concept of

monopoly of moneylender in rural areas is not true in many areas now.

60


Third, when informal financial market is linked to socially undesirable

activities, there is certainly a cause for concern though the available evidence

shows that such a link is more a metropolitan or urban phenomenon rather than

a rural one.

Fourth, bank credit is really not severely restricted to what can be officially

determined as productive, since most of the credit-card financing by the banks

is, in fact, financing of consumption and at interest rates comparable to those

prevailing in the rural informal debt markets. In other words, it is no longer

unethical for banks to finance consumption credit through the credit card route.

Credit card business, so far, is an essentially urban phenomenon.

Hence, the financing of consumption by informal markets in rural areas cannot

be frowned upon when it is being done by banks through their credit card

business.

Fifth, the real extent of informal markets is grossly understated in any survey

that views data on outstanding debt since the turnover of debt is admittedly

much lower for public institutions than for private lending. The turnover-

differential is on account of several factors, including preference for short term

finance and better recovery-performance in informal markets.

Sixth, the social significance of informal credit is more than its proportion in

financial terms since the poorer sections draw far larger amounts from informal

than formal markets.

Seventh, a significant part of informal market is through leasing, hire purchase,

deferred payment, etc. with finance often provided by NBFCs. The informal

61


market is providing a range of financial products, which the formal banking

system is not able to.

Eighth, studies have demonstrated that expansion of literacy and education

tends to increase the access of rural folk to formal credit, reduce the informal

transaction costs in dealings with formal credit institutions and improves their

resistance to malpractices attributable to landlord or moneylender. The

exploitative nature of informal markets is more pronounced in tribal or less

developed areas while productive nature of informal markets is more

pronounced in prosperous villages. Indeed, one can argue that in many areas,

the formal credit structure has provided a positive institutional alternative to the

moneylenders and thus marginalising his role in providing credit to rural

masses.

Linkages in Rural Debt Markets

Having recognised that one cannot wish away informal markets, some tentative

generalizations on the relative roles of formal and informal markets and on the

linkages between them would also be necessary to capture the emerging but

complex realities. Such generalisations are possible on the basis of empirical

studies.

First, the formal credit has a tendency to flow more easily to agriculturally

developed regions and to relatively larger farmers leaving the backward regions

and small farmers to be largely served by the informal market. This

phenomenon is generally explained by four factors viz., poor-resource

endowment features of the borrower, poor personal factors (education, social

contact etc), underdevelopment of a region and higher transaction costs.

62


Second, as per empirical studies, transaction costs associated with formal credit

include fees for procuring necessary certificates (open), travel and related

expenses including loss of wages etc., and informal or unofficial commissions

(hidden). The transaction costs vary with type of credit agency involved, the

type of borrower and farm-size.

Third, uncertainties and delays usually associated with formal credit can also be

treated as additions to the transaction costs.

Fourth, the true cost of borrowing from the formal credit system is thus higher

than nominal cost if the above informal transaction costs are also included. To

the extent some transaction costs are fixed, the effective cost of borrowings for

smaller loans tends to be relatively higher than for a larger loan.

Fifth, there are usually hidden costs or concealed interest rates in respect of

informal credit also, which have to be added to the nominal costs to arrive at the

true cost. These hidden costs generally relate to tied lending, tied to land,

labour, input or output. The tied advance in respect of labour is particularly

relevant for migratory labour. The hidden costs are usually in the form of

undervaluation of labour and output of borrowers and overvaluation of inputs

supplied by lender.

Sixth, the choice between formal and informal credit depends on both the access

and relative true costs. Thus, recourse to informal credit, admittedly at far

higher nominal costs, is to be explained partly in terms of effective costs and the

extent of supply of formal credit.

Seventh, in assessing relative roles, both supply and demand side bottlenecks of

formal credit need to be appreciated. The former relate to asset-based lending

63


policies and complex formalities and procedures, while the latter relate to poor

endowment, lower education and social-contact, usually caste-based in

backward regions. Viewed differently, a larger role for informal credit may

arise due to low level of commercialisation and monopoly power of

moneylender; and it may also arise due to high level of commercialisation of

agriculture when supply from formal channel cannot match significant demand

for credit.

Eighth, it is also necessary to recognise that, to the extent informal markets tend

to lend to borrowers who are relatively less creditworthy, risk-premium is

bound to be higher. This would also get reflected in higher nominal interest

rates in informal markets and indeed higher true cost, though it may not be so

high if it is net of risk premium.

It is clear that the critical issue in respect of informal credit is the manner in

which the linkages among the participants in the market operate and result in

varying degrees of hidden costs. It is possible to make some exploratory

postulates here. First, trader-lenders are likely to provide most of production -

credit, while farmer-lender or moneylender is likely to provide most of

consumption - credit.

It is, of course, possible that some individuals combine the functions of farmer,

trader and moneylender. Second, informal markets are unlikely to finance credit

for investment purposes, given the time preference. Third, the levels of

education are likely to reduce the scope for gross overvaluation or

undervaluation in linked-transactions. Fourth, the inter-linked transactions

among parties with equal bargaining power are likely to minimise the hidden

costs. Fifth, from the supply side, farmer-lenders may tend to be associated with

64


land and labour market linkages while trader-lender is likely to be associated

with input-output markets.

On the demand side, agricultural labour may be associated with land and labour

markets while the farmer-cultivator with input-output linkages. In the process, it

is likely that a farmer would be a borrower from a trader and a lender to

agricultural labour, a common phenomenon in villages. It will, therefore, be

over simplification to divide the rural population into lenders and borrowers or

exploiters and exploited. Sixth, similarly it is necessary to appreciate the role of

linkages in credit-risk-mitigation. In fact, the risk reducing element of linkages

are not built into formal credit-channels. Incidentally to the extent the

transaction costs are front loaded in respect of formal credit, there is no

incentive to repay while the true costs of informal credit are spread out.

Seventh, in terms of bargaining power among the class of borrowers, the

agricultural labour and migratory labour appear to be weakest except in

agriculturally prosperous areas where labour-shortage is acute to cater to

agricultural and other operations. Similarly, the differential in bargaining power

between large and small borrowers is similar to that between large corporates

and small-industrialists in urban areas.

In brief, the linkages between formal and informal markets are complex,

contextual and dynamic.

CHAPTER-865


TECHNOLOGY AND RURAL BANKING

We should recognise that the role of banks, which is central to formal credit in rural areas, is fast changing. Many non-banks are providing avenues for savers and funds for investment purposes. Banks themselves are undertaking non-traditional activities. Banks are also becoming what are called universal banks and are already providing a range of financial services such as investments, merchant banking and even insurance products. Similarly, non banks are also undertaking bank like activities. At present in India, these are mostly confined to urban areas, but they will sooner than later spread to rural areas.

Another development relates to the gradual undermining of the importance of

branches of banks. The emergence of new technology allows access to banking

and banking services without physical direct recourse to the bank premise by

the customer. The concept of Automated Teller Machines (ATMs) is the best

example. At present, ATMs are city oriented in our country. It is inevitable that

ATMs will be widely used, in semi-urban and rural areas.

The technology-led process is leading us to what has been described as virtual

banking. The benefits of such virtual banking services are manifold. Firstly, it

confers the advantage of lower cost of handling a transaction. Secondly, the

increased speed of response to customer requirements under virtual banking vis-

à-vis branch banking can enhance customer satisfaction. Thirdly, the lower cost

of operating branch network along with reduced staff costs leads to cost

efficiency. Fourthly, it allows the possibility of improved quality and an

enlarged range of services being available to the customer more rapidly and

accurately at his convenience

66


Another development relates to the increasing popularity of credit cards, which

are bound to reach rural areas. Many Public Sector Banks are already in credit

card business. In fact, multipurpose cards could be a facility that IT could usher

in for rural population. The potential can be illustrated with SMART cards.

SMART cards – which are basically cards using computer circuits in them

thereby making them ‘intelligent' – would serve as multipurpose cards. SMART

cards are essentially a technologically improved version of credit and debit

cards and could be used also as ATM cards.

For the spread of virtual-banking and SMART cards to rural areas, it is essential

that electric power and telecom connectivity are continuous and supplies do not

drop especially during the hours when a bank's transactional activity is at

relatively high levels. The banks could, under such assured supply conditions

acquire the required banking software and also put in place the necessary

networking for providing anywhere banking facilities in rural and semi-urban

areas also.

Like banks in other parts of the world, Indian banks will have to get interested

in providing diversified range of financial products and services along with

those that they are already providing, by using technological advances. As the

level of education in rural areas rises and affluence spreads, customers will start

seeking efficient, quicker and low cost services.

As the financial system diversifies and other types of financial intermediaries

become active, in rural areas, savers would turn towards mutual funds or the

savers themselves decide to deploy part of their financial surpluses into equities

and debentures as also other fixed income securities. The bulk of bank deposits

in the rural areas are currently longer term deposits and as these come down;

67


there would be a distinct shortening of the average maturity structure of bank

deposits with an increase in asset liability mismatches.

The spreads that the banks now enjoy will progressively shrink making it more

difficult for them to survive. As more and more intermediaries enter rural areas

with greater level of technology, traditional banking business will come under

pressure. In order to face the competitive pressures being exerted by the

recently set up market savvy banks, banks which have extensive branch network

in most of the existing and potential rich rural and semi-urban areas may have to

provide such services.

68


CHAPTER-9

ROLE OF FOREIGN BANKS

A large number of foreign banks are now keen on opening shop in India to gain

a critical mass by April 2009, when private banking space is expected to open

up for foreign players. Foreign Banks in India always brought an explanation

about the prompt services to customers. After the set up foreign banks in India,

the banking sector in India also become competitive and accurative. The share

of foreign banks in the business done in the country (deposits and advances) has

been hovering between 5 and 7 per cent during the past decade.

A new rule announced by the Reserve Bank of India for the foreign banks in

India in this budget has put up great hopes among foreign banks which allow

them to grow unfettered. Now foreign banks in India are permitted to set up

local subsidiaries. The policy conveys that foreign banks in India may not

acquire Indian ones (except for weak banks identified by the RBI, on its terms)

and their Indian subsidiaries will not be able to open branches freely.

There are twenty-nine foreign banks are present in India through 273 branches

and 871 offsite ATMs. Besides, there are 34 foreign banks operating through

representative offices. Four have set up shop in the past one year. They are

Banco Bilbao Vizcaya Argentaria, Spain's second largest bank; Italy's Banca di

Roma; the Dublin-based Depfa Bank Plc.; and National Australia Bank Ltd.

Given a chance, all banks would like to convert their representative offices into

branches.

Standard Chartered Bank, the oldest foreign bank that came to India 150 years

ago, now operates the maximum number of branches, 83. It is followed by

69


HSBC, which entered India in 1867, with 47 branches. Citibank has 39

branches and ABN Amro, 28 branches. The only other bank that has a double

digit branch presence is Deutsche

India's GDP is seen growing at a robust pace of around 7% over the next few

years, throwing up opportunities for the banking sector to profit from.

The credit of banks has risen by over 25% in 2004-05 and the growth

momentum is expected to continue over the next four to five years.

Participation in the growth curve of the Indian economy in the next four years

will provide foreign banks a launch pad for greater business expansion when

they get more freedom after April 2009.

RBI is following a liberal branch licensing policy for those foreign banks who

want to go to the unbanked pockets. They have started sensing enormous

business opportunities in financing trade and small and medium sectors in small

towns in the world's second fastest growing economy.

India had committed to the World Trade Organzation (WTO) in 1997 to give 12

new branch licenses to foreign banks every year, including those given to new

entrants and the existing players. However, the Indian regulator has all along

been allowing foreign banks to open more branches, going beyond its

commitment to WTO. In fact, in the last four years till October 2007, it has

given its nod to 75 new foreign bank branches and many more ATMs (which do

not come under WTO norms).

Standard Chartered Bank, the oldest foreign bank that came to India 150 years

ago, now operates the maximum number of branches, 83. It is followed by

70


HSBC, which entered India in 1867, with 47 branches. Citibank has 39

branches and ABN Amro, 28 branches. The only other bank that has a double

digit branch presence is Deutsche, 11.

Despite their growing presence, foreign banks still have a very small market

share in the Indian banking industry—6.11% of total deposits and 6.83% of

total loan advances. But their returns from Indian operations are far higher than

those of their local counterparts. For instance, the average net profit per branch

for foreign banks in India was Rs11.99 crore last year against Rs33 lakh for the

public sector banks that account for close to 70% of the industry. The return on

assets for foreign banks last year was 1.65% and return on equity, 14.02%. The

comparable figures for public sector banks were 0.82% and 13.62%. Now you

know why foreign banks are ready to walk the extra mile to do business

anywhere in India

The Reserve Bank of India would like foreign banks to get a flavour of semi-

urban India and the rural hinterland. Going by the statistics provided in the

RBI's annual report, it appears that foreign banks are being gently nudged away

from metros, when they apply for permission to open a new branch.

The branches of foreign banks that have been approved between July 2006 and

June 2007 are mostly in smaller towns and tier-2 and tier-3 cities. Of the 13

branches for which permission was given, only one branch belonging to

Shinhan Bank has been allowed in New Delhi.

Hong Kong and Shanghai Banking Corporation (HSBC) received approvals for

three branches in Raipur, Jodhpur and Lucknow. ABN Amro got approvals for

branches in Kolhapur, Salem, Udaipur and Ahmedabad. Barclays Bank received

approval for branches in Kanchipuram and Bangalore

71


Most foreign banks follow a strategy of first setting up base in metros –

Mumbai, New Delhi, Kolkata and Chennai. Then, in the next stage, they move

to the mini-metros such as Bangalore, Hyderabad, Pune and Ahmedabad. Over

the last few years, some banks have talked about expanding their reach beyond

the conventional circuits of these eight places.

Foreign banks in India have got approval from the Reserve Bank of India to

open 10 branches and seven representative offices during the July 2006- June

2007 period. In the calendar year 2006, the RBI issued approvals for opening 13

branches of foreign banks in India. Under the WTO agreements, India is

required to allow the opening of 12 foreign branches every year.

A large number of foreign banks are now keen on opening shop in India to gain

a critical mass by April 2009, when private banking space is expected to open

up for foreign players.

The latest addition to the list of foreign banks wishing to set foot in India is the

Royal Bank of Scotland, which has total assets of over $806 billion.

The sudden interest in India follows the Reserve Bank of India's roadmap for

according foreign banks greater freedom in India.

Switzerland's UBS, ranked the world's best private bank by EuroMoney

magazine, has been preparing itself for India launch. Merrill Lynch and

Goldman Sachs too are believed to be showing interest.

72


It is not known whether they will go alone or partner with an Indian entity in the

new venture. Some of the new players are targeting the derivatives market to

grow in India. The huge retail space is also an enticing factor.

Merrill Lynch has a joint venture in Indian investment banking space -- DSP

Merrill Lynch. Goldman Sachs holds stakes in Kotak Mahindra arms.

US-based GE Capital last week announced its intention to set up a bank last

week soon after the banking sector roadmap was unveiled. It already has wide

presence in consumer finance through GE Capital India.

The RBI roadmap said the removal of limitations on the operations of wholly-

owned subsidiaries of foreign banks and treating them on a par with domestic

banks to the extent appropriate will be designed and implemented after

reviewing the experience till April 2009.

A total of 33 foreign banks are present in India and had total assets of Rs

1,36,315 crore (Rs 1363.15 billion) as at end-March 2004. Roughly they

account for about 7 per cent of the total banking space.

The list of foreign players includes banks like Citibank, Bank of America, Bank

of Nova Scotia, ABN-AMRO Bank, Deutsche Bank and JPMorgan Chase

Bank, which figure in the top 25 global banks ranked by The Banker magazine.

The other top banks like Credit Suisse Group, Industrial and Commercial Bank

of China, are still to start banking business in India.

73


India is expected to find a place in the strategy of these banks given the

country's growth prospects. There have been cases of foreign banks closing

shops in India too. Dresdner Bank and Commerzbank fall in this category.

India's GDP is seen growing at a robust pace of around 7 per cent over the next

few years, throwing up opportunities for the banking sector to profit from.

The credit of banks in India has risen by over 25 per cent in 2004-05 and the

growth momentum is expected to continue over the next few years.

Participation in the growth curve of the Indian economy in the next four years

will provide foreign banks a launch pad for greater business expansion when

they get more freedom after April 2009

74


TABLE 1

FINANCIAL PERFORMANCE OF FOREIGN BANKS IN INDIA

Item 2005-06 2006-07 variation

Absolute percentage

A.INCOME (i + ii) 17,662.07 24,959.06 7293.99 41.03

i)Interest Income

of which : Interest on Advance

Income on Investment

ii) Other Income

of which : Commission &Brokerage

12,290.82

7379.75

3,950.57

5,371.25

2,872.39

18,018.92

10,941.49

5,432.04

6,937.14

3,789.29

5728.09

3,561.74

1,481.46

1,565.90

916.89

46.60

48.26

37.50

29.15

31.92

B.EXPENDITURE (i+ii+iii) 14,593.47 20,370.90 5,777.43 39.59

i)Interest Expended

of which :Interest on Deposits

ii) Provisions and Contingencies

of which : Provision for NPAs

iii) Operating Expenses

of which : Wage Bill

5,149.50

3,161.17

3,589.84

96.43

5,854.13

2,005.17

7,615.02

4,758.24

5,014.65

332.48

7,741.22

3,081.11

2,465.53

1,597.07

1,424.81

236.06

1,887.09

1,075.94

47.88

50.52

39.69

244.81

32.24

53.66

C.PROFIT

i) Operating Profit

ii) Net Profit

6,658.44

3,068.60

9,599.81

4,585.16

2,941.37

1,516.56

44.18

49.42

D.NET INTEREST

INCOME/MARGIN

7,141.33 10,403.89 3,262.57 45.69

E.TOTAL ASSETS 1,99,358.03 2,78,016.49 78,658.46 39.46

SOURCE: RBI & BALANCE SHEETS OF RESPECTIVE BANKS

75


The table 1 which implies that income of foreign bank increased of 41.03 per

cent , while the expenditure of the foreign banks has increased nearly by 11 per

cent. The operating profit amounting Rs. 2941.37 i.e. 44.18 per cent and there is

an increase in net profit amounting to Rs 1516.56 i.e. 49.42 per cent. There also

increase in total asset. It may be concluded that there is a sufficient progress in

the foreign banks and the overall profitability of foreign banks is good

LIST OF FOREIGN BANKS HAVING REPRESENTATIVE OFFICES

IN INDIA AS ON NOVEMBER 3D, 2007

S. No Name and address of the

representative office

Country of

incorporation

Centre Date of

opening

1. Commonwealth Bank Australia Bangalore 7.11.2005

2. National Bank Australia Ltd Australia Mumbai 3.11.2006

3 Raiffeisen Zentral Bank

Osterreich AG

Austria Mumbai 1.11.1992

4 Fortis Bank Belgium Mumbai 6.10.1987

5 KB.C. Bank N.V. Belgium Mumbai 1.02.2003

6 Emirates Bank International Dubai Mumbai 16.06.2000

7 Credit Industriel et Commercial France New Delhi 1.04.1997

8 Natixis France Mumbai 4.01.1999

9 Bayerische Hypo - und

Vereinsbank

Germany Mumbai 12.07.1995

10 DZ Bank AG Deutsche Zentral Germany Mumbai 22.02.1996

11 Landesbank Baden -

Wurtlemberg

Germany Mumbai 1.11.1999

12 Presdner Bank AG Germany Mumbai 6.09.2002

13 Commerzbank Germany Mumbai 23.12.2002

14 DEPFABank Ireland Mumbai 9.2.2007

76


15 Intesa San paolo Spa Intesa

Sanpaolo Spa

Intesa San

paolo Spa

20.01.1991

16 Uni Credito Italiano Italy Mumbai 1.08.1998

17 Banca Populare Di Verona E

Novara

Italy Mumbai 18.06.2001

18 BPU Banca -Banche Popolari

Unite

Italy Mumbai 16.01.2006

19 Banca Popolare di Vicenza ItaIv Mumbai 29.04.2006

20 Monte Dei Paschi Di Sienna Italy Mumbai 07.04.2006

21 Banca di Roma Italv Mumbai 17.01.2007

22 Everest Bank Ltd Nepal New Delhi 24.03.2004

23 Caixa Geral de Depositos Portugal Mumbai

Goa (EC)

8.11.1999

24 Vnesheconombank (Bank for

Foreign Economic Affairs)

Russia New Delhi 1.3.1983

25 VTB India(Bank for Foreign

Trade)

Russia New Delhi May 2005

26 Promsvvazbank Russia New Delhi 25.04.2006

27 Banco de Sabadell SA Spain New Delhi 2.08.2004

28 Banca Bilbao Vizcava

Aroontaria, BBVA

Spain Mumbai 2.4.2007

29 Hatton National Bank Sri Lanka Chennai 1.01.1999

30 UBSAG Switzerland Mumbai 24.11.1994

31 Zurcher Kantonalbank Switzerland Mumbai 27.06.2006

32 The Bank of New York USA Mumbai 27.10.1983

33 Wachovia Bank NA USA Mumbai 1.11.1996

34 Svenksa Handelsbanken Sweden Mumbai 1.8.2006

35 Westpac Australia Mumbai 1.10.2007

77


CHAPTER-10

COMPETITION IN BANKING

78


Indian banking has come a long way since India embarked on the reforms path

about a decade-and-a-half ago in 1991-92. The reforms have unleashed

tremendous change in the banking sector. Today, Indian banks are as

technology-savvy as their counterparts in developed countries. On the

networking front, branch banking –the traditional forte, coupled with ATM

networks-the now imperative, have evolved to place the banking services on a

new trajectory.

The competitive forces have led to the emergence of Internet and mobile

banking too, to let banks attract and retain customers. The banking sector is also

gearing up to embrace the Basel II regime, to benchmark with the global

standards. Similarly, retail lending has emerged as another major opportunity

for banks. All these factors are driving up competition, which in turn forcing

banks to innovate. A slew of innovative products, which could not be imagined

even a couple of years ago, are a reality now.

Even mundane products like Saving Account, Personal Loans and Home Loans

have become subjects of innovation. The Narasimham Committee had proposed

wide-ranging reforms for Improving the financial viability of the banks,

Improving the macroeconomic policy framework for banks; Increasing their

autonomy from government directions; Allowing a greater entry to the private

sector in banking, Liberalizing the capital markets; Improvement in the

financial health and competitive position of the banks and Furthering

operational flexibility and competition among the financial institutions.

A number of reforms initiatives have been taken to remove or minimize the

distortions impinging upon the efficient and profitable functioning of banks.

79


These include Reduction in SLR & CRR, Transparent guidelines or norms for

entry and exit of private sector banks, Public sector banks have been allowed for

direct access to capital markets, The regulated interest rates have been

rationalized and simplified, Branch licensing policy has been liberalized and A

board for Financial Bank Supervision has been established to strengthen the

supervisory system of the RBI.

These and other measures that have been taken would help the highly regulated

and directed banking system to transform itself into one characterized by

openness, competition, prudential and supervisory discipline. They will also

make the new challenges particularly the growing demands from customers for

high quality services. The objective of this is to study, describe and analyze the

impact of banking sector reforms on the performance of commercial banks. On

the basis of the impact of these reforms, to suggest third new modified reforms

in the changing scenario.

By mid-1997, the RBI reported that the reform process had started yielding

results. But as observed by the NC in its second report, the improvement has

arrested the deterioration of the system earlier but there is still a considerable

distance to traverse. There has been improvement in several of the quantitative

indices but there are many areas in which weaknesses still persist. These include

customer service, technological up gradation, improvement in house keeping in

terms of reconciliation of entries and balancing of books.

The second report was submitted on 23rd April, 1998, which sets the pace for

the second generation of banking sector reforms. These include Merge strong

banks, close weak banks unviable ones; Two or three banks with international

orientation, 8 to 10 national banks and a large number of local banks; Increase

Capital Adequacy to match enhanced banking risk; Rationalize branches and

80


staff, review recruitment; De-politicize Bank Boards under RBI supervision;

Integrate NBFCs activities with banks.

But many cities saw no purpose in setting up the second NC on banking sector

reforms within six years and before the full implementation of the

recommendations of the first report of 1991. Strictly speaking, there were no

new recommendations made in the second report except two on Merger of

strong units of banks and Adaptation of the “narrow banking” concept to

rehabilitate the weak banks.

Various reform measures introduced in India have indeed strengthened the

Indian banking system in preparation for the global challenges ahead. Some of

the reforms introduced and their impact on banks and furnished in the table

(Indian banking on the reforms path) After the brief introduction of theme,

section II fixes the objectives, hypotheses and methodology along with the

database. Section III reviews the related studies and section IV highlights the

major issues faced by Indian banking sector. Section V analyses the results and

discussions whereas section VII exhibits the future agenda for the third reforms

and concludes the paper.

Banking in India is poised to enter yet another phase of reforms once the door

opens further to foreign players in 2009. This requires further improvement in

technology management, human resource management and the ability to foresee

rapid changes in the financial landscape and adopt quickly. At present, there is a

huge hiatus between the top management earnings of state owned banks and

private, as well as foreign banks. Banks have to lay down sound risk

management strategies and internal capital adequacy assessment committees to

ensure that they do not diverge from the prudential requirements.

81


Nair (2006) discusses the future challenges of technology in banking. The

author also point out how IT posses a bright future in rural banking, but is

neglected as it is traditionally considered unviable in the rural segment. A

successful bank has to be nimble and agile enough to respond to the new market

paradigm and ineffectively controlling risks. Innovation will be the key

extending the banking services to the untapped vast potential at the bottom of

the pyramid. Singh (2003) analyzed profitability management of banks under

the deregulated environment with some financial parameters of the major four

bank groups i.e. public sector banks, old private sector banks, new private sector

banks and foreign banks, profitability has declined in the deregulated

environment. He emphasized to make the banking sector competitive in the

deregulated environment.

They should prefer non-interest income sources. Singla (2008) examines that

how financial management plays a crucial role industrialists growth of banking.

It is concerned with examining the profitability position of the selected sixteen

banks of banker index for a period of six years (2001-06). The study reveals that

the profitability position was reasonable during the period of study when

compared with the previous years. Strong capital position and balance sheet

place. Banks in better position to deal with and absorb the economic constant

over a period of time. Shroff (2007) gives a summary of how Indian banking

system has evolved over the year.

The paper discusses some issues face by these systems. The author also gives

examples of comparable banking system for other countries and the lesson

learnt. Indian banking is at the threshold of the paradigm shift. The application

of technology and product innovations is bringing about structure change in the

Indian banking system. Subbaroo (2007) concludes the Indian banking system

has undergone transformation itself from domestic banking to international

82


banking. However, the system requires a combination of new technologies, well

regulated risk and credit appraisal, treasury management, product

diversification, internal control, external regulations and professional as well as

skilled human resource to achieve the heights of the international excellence to

play its role critically in meeting the global challenge.

This paper mainly concentrates on the major trends that change the banking

industry world over, viz. consolidation of players through mergers and

acquisitions globalization of players, development of new technology, universal

banking and human resource in banking, profitability, rural banking and risk

management. Banks will have to gear up to meet stringent prudential capital

adequacy norms under Basel I and II, the free trade agreements. Banks will also

have to cope with challenges posed by technological innovations in banking

Tiwari (2005) proposed a view that among the financial intermediaries banks

and financial institutions are vital players in running the funding activities of the

industries.

In the bank based system the financial institutions dominate in the aggregate

assets of the financial system while in market based system, equity market has

largest share of assets in the aggregate assets of the financial system. Uppal and

Kaur (2007) analysis the efficiency of all the bank groups in the post banking

sector reforms era. Time period of study is related to second post banking sector

reforms (1999-2000 to 2004-05). The paper concludes that the efficiency of all

the bank groups has increased in the second post banking sector reforms period

but these banking sector reforms are more beneficial for new private sector

banks and foreign banks. This paper also suggests some measures for the

improvement of efficiency of Indian nationalized banks. The sample of the

study in Indian banking industry which comprises five different ownership

83


groups and the ratio method is used to calculate the efficiency of different bank

groups. New private sector banks are compelling with foreign banks for

continuous improvement in their performance.

The analysis is based on ratio analysis. We used the following parameters to

assess the efficiency of Indian bank group’s vis-à-vis their counter parts.

Profitability per Employee: The profit per employee is in the range of Rs.0.41 to

2.32 Crores during the study period in G-I, similarly, it was between Rs.0.77 to

2.04 Crores in G-II, Rs.1.08 to 6.15 Crores in G-III and Rs.8.07 to 15.17 Crores

in G-V. The G-I, II (public sector banks), even old private sector banks (G-III)

have shown poor efficiency in terms of profit per employee as compared to new

private sector banks and foreign banks.

But our new private sector banks are competing with the foreign banks whose

average performance is higher (18.14) as compared to foreign banks where

average is only 11.68 in at the end of the study period. This overall trend of

increasing employee profitability may be attributed to the reduction in the

number of employees following the launch of VRS by some of the Indian banks

as well as higher profits by the banks. On an average, new private sector banks

enjoy a higher increase in their profitability per employee, as compared with

their counter part public sector banks.

This may be attributed largely to the better technology that the new private

sector banks employ, besides the advantage of carrying no historical baggage.

ICICI and HDFC Banks in G-IV are dominating in profit per employee whereas

Corporation Bank, OBC and PNB have the higher per employee profit in G-I

whereas Punjab & Sindh Bank, UCO Bank and Dena Bank are responsible for

lowering the profit per employee.

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On average, Indian banks pays less as compared to foreign banks. Among

Indian banks, new private sector banks pay on an average Rs.59.83 crores as

compared to G-I, II & III who pay Rs.14.00, 14.43 & 18.07 crores respectively.

The highest expenses per employee incurred by G-V (foreign banks) having

Rs.79.84 crores per employee. G-IV & G-V pays higher and attractive salary to

the efficient employees; they also provide better facilities and incentives to their

employees. Due to this reason, per employee expenses are higher even return

per employee is much higher as compared to their counterparts. Among the

Indian banks, average per branch expenses incurred by new private sector banks

(G-IV) is at the tune of Rs.1169.06 crores as compared to G-I, II % III with

branch expenses

Overall, we may conclude that among the Indian bank groups, new private

sector banks had shown excellent growth in their efficiency and this group is

competing with foreign banks in terms of many parameters of efficiency.

Number of factors are contributing in their excellent efficiency performance like

work culture, dedication, loyalty, technology, better facilities, new

products/services, management, transparency etc.

Business per Employee: Since different employees in a bank contribute in

different ways to the revenues and profits of a bank, it is difficult to come up

with one universal metric that captures the business per employee accurately.

The business per employee is quite low in G-I, II & III as compared to G-IV &

V. The average per employee business is the highest in G-IV i.e. Rs.905.83

crores and G-V has an average of Rs.901.50 crores in the study period. Thus,

deposits mobilization and advances per employee are higher in G-IV & V.

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These bank groups are providing a better interest on deposits and lower interest

on advances; their market policies are quite effective as compared to Indian

public sector banks. Hence, the new private sector banks in India have led the

way in this regard, because of the better use of technology and other

infrastructure.

The problem of NPAs is a matter of serious concern. It is a very serious

problem for our public sector banks. The report of the RBI on NPAs says that

reducing NPAs should be treated as a “national priority”. The average rate of

NPAs is very high i.e. 6.03 pc in old private sector banks where public sector

banks are in succession with 5.29 pc and 4.62 pc in G-I & II respectively, and

for this internal and external factors are responsible.

Internal factors such as business failure, inefficient management strained labor

relations, inappropriate technology and product obsolescence have also

contributed to the rise in NPAs whereas external factors like raw material

shortage, price escalation, power shortage, industrial recession, excess

capacities and the natural calamities like foods, accidents which leads waiving

heavy loans contributed to the rise in NPAs on the books of banks.

A national priority status will have to be accorded to the financial sector

reforms to strengthen the foundations of the Indian financial system and gear it

to meet the challenges of globalization. The on-going reforms process and the

agenda for the future reforms have to focus on making the financial system

viable and efficient so that it could contribute to enhancing the competitiveness

of the real economy and face the challenges of an increasingly integrated global

financial architecture. The future agenda would certainly have address to the

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following: Policies and strategies to reduce high level of NPAs: High level of

NPAs is the most crucial challenge faced by the Indian banking sector.

The banking sector reforms undertaken in India from 1992 onwards were

basically aimed at ensuring the safety and soundness of financial institutions

and at the same time at making the banking system strong, efficient,

functionally diverse and competitive. The reforms included measures for

arresting the decline in productivity, efficiency and profitability of the banking

sector. Furthermore, it was recognized that the Indian banking system should be

in tune with international standards of capital adequacy, prudential regulations,

and accounting and disclosure standards. Financial soundness and consistent

supervisory practices, as evident in our level of compliance with the Basel

Committeeís Core Principles for Effective Banking Supervision, have made our

banking system resilient to global shocks.

India has not faced any major economic/financial crises, though in 1990-91,

there was some pressure on the external sector with the current account deficit

and external debt servicing reaching large proportions. However, due to prudent

macroeconomic policies, it was possible to return the country to a sustainable

growth path. As well as the long history of regulation and supervision, Indian

banks have limited exposure to sensitive sectors such as real estate, equity, etc,

strict control over off-balance sheet activities, larger holdings of government

bonds (which helps limit credit risk), relatively well diversified credit portfolios,

statutory restrictions on connected lending, adequate control over currency and

maturity mismatches, etc, which has insulated them from the adverse impact of

financial crisis and contagion.

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Banks in India have played a significant role in the development of the Indian

economy. However, with the structural reforms initiated in the real economy

from the early 1990s, it was imperative that a vibrant and competitive financial

system should be put in place to sustain the ongoing process of reforms in the

real sector. The financial sector reforms have provided the necessary platform

for the banking sector to operate on the basis of operational flexibility and

functional autonomy, thereby enhancing efficiency, productivity and

profitability. The reforms also brought about structural changes in the financial

sector and succeeded in easing external constraints on its operation, introducing

transparency in reporting procedures, restructuring and recapitalising banks and

enhancing the competitive element in the market through the entry of new

banks.

The ongoing revolution in information and communication technology has,

however, largely bypassed the Indian banking system given the low initial level

of automation. The competitive environment created by financial sector reforms

has nonetheless compelled the banks to gradually adopt modern technology,

albeit to a limited extent, to maintain their market share. Banks continue to be

the major financial intermediaries with a share of 64% of total financial assets.

However, non-bank financial companies and development finance institutions

are also emerging as alternative sources of funding.

In India, foreign banks account for only around 8% of the total assets of the

banking system. Further, domestic households are not allowed to place deposits

abroad. Similarly, conditions for accessing overseas capital markets by

domestic corporates have been stringent, in terms of size, maturity, pricing, etc.

The impact of the entry of foreign banks on domestic banks is likely to depend

on various factors such as the structure, strength and competitiveness of

domestic banks, the share of foreign banks, and the regulatory/supervisory

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framework. While the entry of foreign banks could definitely improve the

competitive environment, they are not likely to weaken domestic banks. With

better technology and expertise in offering specialised banking products such as

derivatives, advisory services, trade finance, etc, the entry of foreign banks can

enhance healthy competition and has a positive spillover effect on the domestic

banks.

The domestic banks would be under peer pressure to improve operational

efficiency. It needs, however, to be recognised that the banking system in India

is quite competitive with the presence of public, private and foreign banks.

Thus, the major forces for change in the Indian context have been the following

consistent and strong regulatory and supervisory framework; structural reforms

in the real and financial sectors; commitment to adopt and refine regulatory and

supervisory standards on a par with international best practices; and competition

from foreign banks and new-generation private sector banks.

State banks in India have, over the years, played a very significant role in the

development of the economy and in achieving the objectives of the

nationalisation undertaken in 1969 and 1980, namely to reach the masses and

cater to the credit needs of all segments, including weaker sections, of the

economy. The period 1969-90 witnessed rapid branch expansion and an

adequate flow of credit to all sectors, including the neglected sectors of the

country. From 1990, however, it was recognised that steps were needed to

improve the financial health of banks to make them visible, efficient and

competitive to serve the emerging needs and enhance the efficiency of the real

sector.

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While the role of the large state banks has not undergone any structural changes

and they continue to serve the varying needs of the economy, what has changed

significantly, as a result of the reform process, is the focus on their

consolidation, efficiency, resilience, productivity, asset quality and profitability

through liberalisation, deregulation and adoption of prudential standards in line

with international best practices. As a part of financial sector reforms and with a

view to giving the state banks operational flexibility and functional autonomy,

partial privatisation has been authorised as a first step, enabling them to dilute

the stake of the Indian government to 51%. The government further proposed,

in the Union Budget for the financial year 2000-01, to reduce its holding in

nationalised banks to a minimum of 33% on a case by case basis.

The major problems for gradual privatisation are likely to be resistance from

staff to rationalisation of the branch network and emphasis on higher staff

productivity. The optimal size of a bank depends on several factors and differs

between countries depending on the level of economic development, the

number and diversity of financial institutions/instruments, the competitive

situation in the market, etc. Looking at the typical Indian situation, the big

banks operating in international markets have to coexist with banks operating

only at the national level, regional rural banks and cooperative banks, which

will induce the necessary competition in the market.

Most of the state banks have a strong national presence and are catering to the

needs of various segments of the economy. We do not expect to split the state

banks into smaller entities even after the gradual disinvestment of government

equity in them. Rather, there is a possibility of consolidation for synergising

business/regional strengths, and efforts in this area may be ìboard-drivenî with

the functional autonomy that will emerge as a result of such disinvestment.

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Under the Banking Regulation Act, banking companies cannot merge without

the approval of the Reserve Bank of India. The government and the Reserve

Bank do not play a proactive role in either encouraging or discouraging

mergers. It is our endeavour that the government and the RBI should only

provide the enabling environment through an appropriate fiscal, regulatory and

supervisory framework for the consolidation and convergence of financial

institutions, at the same time ensuring that a few large institutions do not create

an oligopolistic structure in the market.

Mergers should be based on the need to attain a meaningful balance sheet size

and market share in the face of heightened competition and driven by synergies

and locational and business-specific complementarities. While there is no

regulatory deterrence to bank mergers, their incidence has not been significant

and hence no problems have occurred in India. Mergers of banks help to reduce

the gestation period for launching/promoting new places of business, strengthen

product portfolios, minimise duplication, gain competitive advantage, etc.

They are also recognised as a good strategy for enhancing efficiency. Ideally,

mergers ought to be aimed at exploiting synergies, reducing overlap in

operations, ìright-sizingî and redeploying surplus staff either by retraining,

alternate employment or voluntary retirement, etc. As banks are leveraged and

the credibility of the top management has tremendous supervisory implications,

we prefer consensual mergers to hostile takeovers. The takeover codes should,

therefore, reflect the supervisory concerns.

It has been our endeavour to preserve the integrity and identity of banks. The

activities that the banks and their subsidiaries can undertake are restrictive, to

ensure that the interests of existing and future depositors are fully protected.

Banks are also not allowed to undertake trading in commodities. In pursuit of

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these objectives, the merger of a bank with a non-bank is generally not

favoured. However, the merger of a non-bank financial company with a bank is

allowed subject to the prior approval of the Reserve Bank of India and

compliance with all the regulatory and supervisory standards applicable to

banks. The issues that may arise in such mergers would be the bank ís ability to

comply with statutory and regulatory requirements in respect of liabilities and

assets taken over by it from the non-bank.

There is no separate agency/mechanism for preserving competition in the

banking sector. Promoting competition is, however, one of the key objectives of

financial sector reforms. The entry of new private sector and foreign banks and

introduction of new products and technology and operational freedom to banks

have ensured a competitive environment in the financial market. India being a

geographically vast country with its rural population constituting almost 70% of

the total, the role of regional rural banks remains important. The banking sector,

characterised by the presence of internationally active banks, national-level

banks and regional rural banks, is likely to be preserved to cater to the needs of

a varied customer base. Consequent to liberalisation and financial sector

reforms, there has been some blurring of distinction between the activities of

banks and DFIs.

In particular, the traditional distinction between commercial banking and

investment banking has tended to narrow somewhat. Banks have been moving

into certain areas which were the exclusive domain of the DFIs, eg project

finance and investment banking. DFIs have recently been given the option to

convert themselves into universal banks with the RBIís approval. To this end, a

DFI would need to prepare a transition path in order to comply fully with the

statutory and regulatory requirements applicable to banks. The RBI will

consider such requests on a case by case basis.

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Domestic banks account for 92% of total banking assets in India. Given the size

of the country and the policy to ensure that foreign banks market share does not

exceed 15%, domestic banks are likely to dominate the banking markets.

The financial sector reforms have brought about significant improvements in the

financial strength and the competitiveness of the Indian banking system. The

prudential norms, accounting and disclosure standards, risk management

practices, etc are keeping pace with global standards, making the banking

system resilient to global shocks. The consolidation and convergence of banks

in India has, however, not kept pace with global phenomena. The efforts on the

part of the Reserve Bank of India to adopt and refine regulatory and supervisory

standards on a par with international best practices, competition from new

players, gradual disinvestment of government equity in state banks coupled with

functional autonomy, adoption of modern technology, etc are expected to serve

as the major forces for change. In the emerging scenario, the supervisors and the

banks need to put in place sound risk management practices to ensure systemic

stability.

CONCLUSION

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Foreign Banks in India always brought an explanation about the prompt

services to customers. After the set up foreign banks in India, the banking sector

in India also become competitive and accurative. India is expected to find a

place in the strategy of these banks given the country's growth prospects. There

have been cases of foreign banks closing shops in India too. India's GDP is seen

growing at a robust pace of around 7 per cent over the next few years, throwing

up opportunities for the banking sector. Participation in the growth curve of the

Indian economy in the next four years will provide foreign banks a launch pad

for greater business expansion when they get more freedom after few years

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Education

5th sem comp in bankiing