INDIAN BANKING SYSTEM

BACHELOR OF COMMERCE
BANKING & INSURANCE
SEMESTER V
2015-2016
SUBMITTED BY
NITESH SHIVGAN
ROLL NO. 09

LORDS UNIVERSAL COLLEGE

TOPIWALA MARG, OFF STATION ROAD,
NEAR HOTEL RATNA,
GOREGAON (WEST), MUMBAI-400 104

INDIAN BANKING SYSTEM

BACHELOR OF COMMERCE
BANKING & INSURANCE
SEMESTER V
2015-2016
SUBMITTED
IN PARTIAL FULFILLMENT OF THE
REQUIREMENTS
FOR THE AWARD OF DEGREE OF BACHELOR OF
COMMERCE- BANKING & INSURANCE
BY
NITESH SHIVGAN
ROLL NO. 09
LORDS UNIVERSAL COLLEGE
TOPIWALA MARG, OFF STATION ROAD,
NEAR HOTEL RATNA,
GOREGAON (WEST), MUMBAI-400 104

DECLARATION
I Nitesh Shivgan the Student of B.Com. Banking & Insurance Semester V
(2015-2016) hereby declare that I have completed the Project on
INDIAN BANKING SYSTEM
The Information submitted is true and original to the best of my knowledge.

_________________
(Signature of the Student)
Nitesh shivgan
Roll No. 09

ACKNOWLEDGEMENT

To list who all have helped me is difficult because they are so numerous and the
depth is so enormous.
I would like to acknowledge the following as being idealistic channels and fresh
dimensions in the completion of this project.
I take this opportunity to thank the University of Mumbai for giving me
chance to do this project.
I would like to thank my Principal, Dr. Vinayak Paralikar for providing the
necessary facilities required for completion of this project.
I take this opportunity to thank our Coordinator Prof. Mrs.Erali Shah, for her
moral support and guidance.
I would also like to express my sincere gratitude towards my project guide
Prof.Mrs Erali Shah. Whose guidance and care made the project successful.
I would like to thank my College Library, for having provided various
reference books and magazines related to my project.
Lately, I would like to thank each and every person who directly or indirectly
helped me in the completion of the project especially my Parents and Peers
who supported me throughout my project.

INDEX
Sr. No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

Particulars
Introduction
Objective of study
Significance of Study
Limitation of Study
Scope of Banking Sector
Banking in India
Indian Banking Industry
Types of Banking
Structure of Indian Banking System
3 Phase of Indian Banking System
Services Provided by Banks
Reserve Bank of India
Guideline on Fair Practice Code
Micro Factors Affecting Banking
System
Organization Profile
Conclusion
Bibliography

Page no.
1-2
3
4
5
6
7-8
9-10
11
12-15
16-20
21-32
33-41
42-44
45-52
53-56
57

EXECUTIVE SUMMARY
The pace of development for the Indian banking industry has been tremendous
over the
past decade. As the world reels from the global financial meltdown, Indias
banking sector
has been one of the very few to actually maintain resilience while continuing to
provide

growth opportunities, a feat unlikely to be matched by other developed markets

around the
world. FICCI conducted a survey on the Indian Banking Industry to assess the
competitive
advantage offered by the banking sector, as well as the policies and structures
required to
further stimulate the pace of growth.

INTRODUCTION
Recent time has witnessed the world economy develop serious difficulties in
terms of lapse
of banking & financial institutions and plunging demand. Prospects became
very uncertain
causing recession in major economies. However, amidst all this chaos Indias
banking sector
has been amongst the few to maintain resilience.

A progressively growing balance sheet, higher pace of credit expansion,

expanding
profitability and productivity akin to banks in developed markets, lower
incidence of nonperforming assets and focus on financial inclusion have
contributed to making Indian
banking vibrant and strong. Indian banks have begun to revise their growth
approach and
re-evaluate the prospects on hand to keep the economy rolling. The way
forward for the
Indian banks are to innovate to take advantage of the new business opportunities
and at the
same time ensure continuous assessment of risks.
A rigorous evaluation of the health of commercial banks, recently undertaken by
the
Committee on Financial Sector Assessment (CFSA) also shows that the
commercial banks are
robust and versatile. The single-factor stress tests undertaken by the CFSA
divulge that the
banking system can endure considerable shocks arising from large possible
changes in credit
1
quality, interest rate and liquidity conditions. These stress tests for credit,
market and
liquidity risk show that Indian banks are by and large resilient.
Thus, it has become far more imperative to contemplate the role of the Banking
Industry in
fostering the long term growth of the economy. With the purview of economic
stability and

growth, greater attention is required on both political and regulatory

commitment to long
term development programme. FICCI conducted a survey on the Indian
Banking Industry to
assess the competitive advantage offered by the banking sector, as well as the
policies and
structures that are required to further the pace of growth.

OBJECTIVES OF STUDY

To study broad outline of management of credit, market and operational

risks associated with banking sector.
To understand the importance of banking sector.

 To study the Indian banking scenario and its problem.

Long term and short term finances.
To study the role of Bank in Indian market.
Different types of services provided by the Banks.
To study various bank, corporate and commercial.
To study aims at learning the techniques involved to manage the various
types of Banks, various methodologies undertaken.
To offer suggestions based upon various technologies used in Banking
sector.

SIGNIFICANCE OF THE STUDY

To make a detailed study of various financial services provide by the
different banks.
To analyse customers view point regarding their banks.
To study effective and most popular bank among the customers regarding
its services.
To find out the rate of interest of banks and reaction of customers on it.
To make analysis on the economic benefits provided by various banks.

 Suggest the investors whether to invest in shares of Banking Companies.

SCOPE OF STUDY
A healthy banking system is essential for any economy striving to achieve good
growth and yet remain stable in an increasingly global business environment.
The Indian banking system with one of the largest banking network in the
world, has witnessed a series of reform over the past few years like the
deregulation of interest rates, dilution of the Government state in public sector
banks (PSBs) and the increased participation of private sector banks. The
growth of the retail financial services sector has been a key development on the
market front. Indian banks (both public and private) have not only been keen on
top the domestic market but also to compete in the global market place.

Studying the increasing business scope of the bank.

Market segmentation to find the potential customers for the banks.
Customers perception on the various product of the Bank.
The corporate sector has stepped up its demand for credit to fund its
expansion plans there has also been a growth in retail banking.
The report seeks to present a comprehensive picture of the various types
of banks the banks can be broadly classified into two categories. 1.
Nationalise Bank 2. Private Bank.
Within each of these broad groups, an attempt has been made to cover as
comprehensively as possible, under the various sub-groups.
4

Limitation of study
Every work has its own limitation. Limitations one extent to which the process
should not exceed. Limitations of this projects are: The project was constrained by the time limit of two months.
The major limitations of this study is data availability as the data is
propriety and not readily for dissemination.
Due to ongoing process of globalization and increasing competition, no
one model or method will suffice over a long period of time and constant
up graduation will be required. As such the project can be considered as

an overview of the various banks prevailing in Punjab National Bank and

in the Banking Industry.
The project study is restricted to banking sector used in India only.
The conclusion made is based on sample study and does not apply to all
the individuals.
In India the banks are being segregated in different groups has their own
benefits and limitations in operating in India.
All banks are not included.
PROBLEMS: - The corporate sector has stopped up its demand for credit
to fund its expansion plans, there has also been a growth in retail banking.
However, even as the opportunities increase, there are some issues and
challenges that Indian banks will have to control with if they are to
emerge successful in the medium to long term.

SCOPE OF BANKING SECTOR

Banking business has history of over 200 years. From the times of the
Bank of Bengal (1806) the sector has been witnessing qualitative and
quantitative changes. Main players during the pre-independence period were
credit Lyonnais, Allahabad Bank, Punjab National Bank and Bank of India was
proclaimed the central Bank of India and was vested with controlling powers
over the commercial banks.

The drastic development taken places during the first 25 years since
independence was Nationalization of many private banks. With this, central
government become major policy maker for these nationalized banks
With economic liberalization measures many private and foreign banking
companies were allowed to operate in the country. Favourable economic climate
and a variety of other factors such as demand for wide range of financial
products from various sections of the society led to mutually beneficial growth
to the banking sector and economic growth process. This was coincided by
technology development in the banking operations. Today most of the Indian
cities have networked banking facility as well as Internet banking facility. A
customer is empowering to operate his account from any part of the country.
UTI bank, ICICI Bank and Bank of Punjab are the main winners of the race.

BANKING IN INDIA
Banking in India originated in the first decade of 18th century withThe
General Bank of India coming into existence in 1786. This was followed by
Bank of Hindustan. Both these banks are now defunct. The oldest bank in the
existence in India is the State Bank of India being established as The Bank
Bengal in Calcutta in June 1806. A couple of decades later, foreign banks like
Credit Lyonnais started their Calcutta operations in the 1850s. At that point of
time, Calcutta was the most active trading port, mainly due to the trade of the
British Empire, and due to which banking activity took roots there and

prospered. The first fully Indian owned bank was the Allahabad Bank, which
was established in 1865.
By the 1900s, the market expanded with the establishment of banks such
as Punjab National Bank, in 1895 in Lahore and Bank of India, in 1906, in
Mumbai both of which were founded under private ownership. The Reserve
Bank of India formally took on the responsibility of regulating the Indian
banking sector from 1935. After Indias independence in 1947, The Reserve
Bank was nationalizing and given broader powers.
Definition of the Bank: - Financial institution whose primary activity is
to act as a payment agent for customers and to borrow and lend money. Banks
are important players of the market and offer services as loans and funds.
Banking was originated in 18th century.
First bank were General Bank of India and Bank of Hindustan, now
defunct.
Punjab National Bank and Bank of India was the only private bank in
1906.
Allahabad bank first fully India owned bank in 1865.

Bank of
Bengal

Bank of
Bombay

Imperial
Bank of
India

State bank
of India

Bank of
Madras

INDIAN BANKING INDUSTRY

In India, given the relatively underdeveloped capital market and with
little internal resources, f i r m s a n d e c o n o m i c e n t i t i e s d e p e n d ,
l a r ge l y, o n f i n a n c i a l i n t e r me d i a r i e s t o m e e t t h e i r f u n d
requirements. In terms of supply of credit, financial intermediaries can broadly
be categorized as institutional and non-institutional. The major institutional
suppliers of credit in India are banks and non-bank financial institutions
(that is, development financial institutions or DFIs), other financial
institutions (FIs), and non-banking finance companies (NBFCs). The noninstitutional or unorganized sources of credit include indigenous
bankers and money-lenders. Information about the unorganized sector is
limited and not readily available.

An important feature of the credit market is its term structure:

(a) Short-term credit
(b) Medium-term credit
(c) Long-term credit.
While banks and NBFCs predominantly cater for short-term needs, FIs provide
mostly medium and long-term funds.

Indian Banking Sector Experience

India inherited a weak financial system after Independence in 1947. At end1947, there were 625commercial banks in India, with an asset base of Rs. 11.51
billion. Commercial banks mobilized household savings through demand
and term deposits, and disbursed credit primarily to large corporations.
Following Independence, the development of rural India was given the
highest priority. The commercial banks of the country including the
IBI had till then confined their o p e r a t i o n s t o t h e u r b a n s e c t o r a n d
w e r e n o t e q u i p p e d t o r e s p o n d t o t h e e me rge n t n e e d s o f economic
regeneration of the rural areas. In order to serve the economy in general and the
rural sector in particular, the All India Rural Credit Survey Committee
recommended the creation of a state-partnered and state-sponsored bank
by taking over the IBI, and integrating with it, the former state-owned
or state-associate banks.
9
Accordingly, an act was passed in Parliament in M a y 1 9 5 5 , a n d t h e
State Bank of India (SBI) was constituted on July 1, 1955.
M o r e t h a n q uarter of the resources of the Indian banking system thus passed
under the direct control of the State. Subsequently in 1959, the State Bank
of India (Subsidiary Bank) Act was passed (SBIAct), enabling the SBI to
take over 8 former State-associate banks as its subsidiaries (later named
Associates).
The GOI also felt the need to bring about wider diffusion of banking facilities
and to change the u n e v e n d i s t r i b u t i o n o f b a n k l e n d i n g . Th e
p r o p or t i o n o f c r e d i t g o i n g t o i n d u s t r y a n d t r a d e increased from a
high 83% in 1951 to 90% in 1968. This increase was at the expense of some
crucial segment of the economy like agriculture and the small-scale
industrial sector. Bank failures and mergers resulted in a decline in number
of banks from 648 (including 97 scheduled commercial banks or SCBs and 551

non-SCBs) in 1947 to 89 in 1969 (comprising 73 SCBs and16 non-SCBs).

The lop-sided pattern of credit disbursal, and perhaps the spate of bank
failures during the sixties, forced the government to resort to nationalization of
banks. In July 1969, the GOI nationalized 14 scheduled commercial banks
(SCBs), each having minimum aggregate deposits of Rs. 500 million.
State-control was considered as a necessary catalyst for economic
growth and ensuring an even distribution of banking facilities.
Subsequently, in 1980, the GOI nationalized another 6 banks2, each having
deposits of Rs. 2,000 million and above.
The nationalization of banks was the culmination of pressures
t o u s e t h e b a n k s a s p u b l i c instruments of development. The GOI imposed
`social control on banks. However, by the 1980s, it was generally perceived
that the operational efficiency of banks was declining. Banks were
characterized by low profitability, high and growing non-performing
assets (NPAs), and low capital base. Average returns on assets were only
around 0.15% in the second half of the 1980s, and capital aggregated an
estimated 1.5% of assets. Poor internal controls and the lack of
proper disclosure norms led to many problems being kept under cover. The
quality of customer service did not keep pace with the increasing expectations.
In 1991, a fresh era in Indian banking began, with the introduction of banking
sector reforms as part of the overall economic liberalization in India.

10

Types of Banking
Commercial bank has two meanings:
o Commercial bank is the term used for a normal bank to distinguish it
from an investment bank. (After the great depression, the U.S.
Congress required that banks only engage in banking activities,
whereas investment banks were limited to capital markets activities.
This separation is no longer mandatory.)
o Commercial bank can also refer to bank or a division of a bank that
mostly deals with deposits and loans from corporations or large
businesses, as opposed to normal individual members of the public
(retail banking). It is the most successful department of banking.

 Community development bank are regulated banks that provide

financial services and credit to underserved market or populations.
Private banks manage the assets of high net worth individuals.
Offshore banks are banks located in jurisdiction with low taxation and
regulation. Many offshore banks are essentially private banks.
Saving banks accept saving deposits.
Postal saving banks are saving banks associated with national postal
system.
There is some example of banks in India: Private sector bank
HDFC, ICICI, Axis bank, Yes bank, Kotak Mahindra bank,
Bank of Rajasthan
Rural Bank
United bank of India, Syndicate bank, National bank for
agriculture and rural development (NABARD)
Commercial bank
State Bank, Central Bank, Punjab National Bank, HSBC,
ICICI, HDFC etc.
Retail bank
BOB, PNB
Universal Bank
Deutsche bank
11

Structure of Organized Indian Banking System:

The organized banking system in India can be classified as given below:

Reserve Bank of India (RBI):

The country had no central bank prior to the establishment of the RBI. The RBI
is the supreme monetary and banking authority in the country and controls the
banking system in India. It is called the Reserve Bank as it keeps the reserves
of all commercial banks.

12
Commercial Banks:

Commercial banks mobilize savings of general public and make them available
to large and small industrial and trading units mainly for working capital
requirements.
Commercial banks in India are largely Indian-public sector and private sector
with a few foreign banks. The public sector banks account for more than 92
percent of the entire banking business in Indiaoccupying a dominant position
in the commercial banking. The State Bank of India and its 7 associate banks
along with another 19 banks are the public sector banks.
Scheduled and Non-Scheduled Banks:
The scheduled banks are those which are enshrined in the second schedule of
the RBI Act, 1934. These banks have a paid-up capital and reserves of an
aggregate value of not less than Rs. 5 lakhs, hey have to satisfy the RBI that
their affairs are carried out in the interest of their depositors.
All commercial banks (Indian and foreign), regional rural banks, and state
cooperative banks are scheduled banks. Non- scheduled banks are those which
are not included in the second schedule of the RBI Act, 1934. At present these
are only three such banks in the country.

13
Regional Rural Banks:

The Regional Rural Banks (RRBs) the newest form of banks, came into
existence in the middle of 1970s (sponsored by individual nationalized
commercial banks) with the objective of developing rural economy by
providing credit and deposit facilities for agriculture and other productive
activities of all kinds in rural areas.
The emphasis is on providing such facilities to small and marginal farmers,
agricultural laborers, rural artisans and other small entrepreneurs in rural areas.
Other special features of these banks are:
(i) their area of operation is limited to a specified region, comprising one or
more districts in any state; (ii) their lending rates cannot be higher than the
prevailing lending rates of cooperative credit societies in any particular state;
(iii) the paid-up capital of each rural bank is Rs. 25 lakhs, 50 percent of which
has been contributed by the Central Government, 15 percent by State
Government and 35 percent by sponsoring public sector commercial banks
which are also responsible for actual setting up of the RRBs.
These banks are helped by higher-level agencies: the sponsoring banks lend
them funds and advise and train their senior staff, the NABARD (National Bank
for Agriculture and Rural Development) gives them short-term and medium,
term loans: the RBI has kept CRR (Cash Reserve Requirements) of them at 3%
and SLR (Statutory Liquidity Requirement) at 25% of their total net liabilities,
whereas for other commercial banks the required minimum ratios have been
varied over time.

14
Cooperative Banks:

Cooperative banks are so-called because they are organized under the
provisions of the Cooperative Credit Societies Act of the states. The major
beneficiary of the Cooperative Banking is the agricultural sector in particular
and the rural sector in general.
The cooperative credit institutions operating in the country are mainly of two
kinds: agricultural (dominant) and non-agricultural. There are two separate
cooperative agencies for the provision of agricultural credit: one for short and
medium-term credit, and the other for long-term credit. The former has three
tier and federal structure.
At the apex is the State Co-operative Bank (SCB) (cooperation being a state
subject in India), at the intermediate (district) level are the Central Cooperative
Banks (CCBs) and at the village level are Primary Agricultural Credit Societies
(PACs).
Long-term agriculture credit is provided by the Land Development Banks. The
funds of the RBI meant for the agriculture sector actually pass through SCBs
and CCBs. Originally based in rural sector, the cooperative credit movement has
now spread to urban areas also and there are many urban cooperative banks
coming under SCBs

15

3 Phases of Indian Banking System

Phases of Indian Banking System are summarized below:

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 Indias 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 the remote comers of the country. This is one
of the main reasons of Indias growth process.
The governments regular policy for Indian bank since 1969 has paid rich
dividends with the nationalization 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.
16
They are as mentioned below:

i. Early phase from 1786 to 1969 of Indian banks.

ii. Nationalization of Indian Banks and up to 1991 prior to Indian banking sector
Reforms.
iii. New phase of Indian Banking System with the advent of Indian Financial
and Banking Sector Reforms after 1991.
To make this write-up more explanatory, I prefix the scenario as Phase I, Phase
II and Phase III.
Phase I:
The Genera; Bank of India was set up in the year 1786. Next came Bank of
Hindustan and Bengal Bank. The East India Company established Bank of
Bengal (1806), Bank of Bombay (1840) and Bank of Madras (1843) as
independent units and called them Presidency Banks. These three banks were
amalgamated m 1921 and imperial Bank of India was established which started
as private shareholders banks, mostly Europeans shareholders.
In 1865 Allahabad Bank was established and first time exclusively by Indians,
Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore.
Between 1885 and 1913, Bank of India Central Bank of India, Bank of Baroda,
Canara Bank, Indian Bank, and Bank of Mysore were set up Reserve Bank of
India came in 1935.

17

During the first phase the growth was very slow and banks also experienced
periodic failures between 1913 and 1948. There were approximately 1100
banks, mostly small. To streamline the functioning and activities of commercial
banks, the Government of India came up with the Banking Companies Act,
1949 which was later changed to Banking Regulation Act, 1949 as per
amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested
with extensive power for the supervision of banking in India as the Central
Banking Authority.
During those days public has lesser confidence in the banks. As an aftermath
deposit mobilization was slow. Abreast of it the savings bank facility provided
by the Postal department was comparatively safer. Moreover, funds were largely
given to traders.
Phase II:
Government took major steps in the Indian Banking Sector Reform after
independence. In 1955, it nationalized Imperial Bank of India with extensive
banking facilities on a large scale especially in rural and semi urban areas. It
formed State Bank of India to act as the principal agent of RBI and to handle
banking transactions of the Union and State Governments all over the country.
Seven banks forming subsidiary of State Bank of India were nationalized on
19th July 1959. In 1969, major process of nationalization was carried out. It was
the effort of the then Prime Minister of India, Mrs. Indira Gandhi 14 major
commercial banks in the country was nationalized.
Second phase of nationalization in Indian Banking Sector Reform was carried
out in 1980 with six more banks. This step brought 80% of the banking segment
in India under Government ownership.
18

The following are the steps taken by the Government of India to Regulate
Banking Institutions in the country.
i. 1949: Enactment of Banking Regulation Act.
ii. 1955: Nationalization of State Bank of India.
iii. 1959: Nationalization of SBI subsidiaries.
iv. 1961: Insurance cover extended to deposits.
v. 1969: Nationalization of 14 major banks.
vi. 1971: Creation of credit guarantee corporation.
vii. 1975: Creation of regional rural banks.
viii. 1980: Nationalization of 6 banks with deposits over 200 crores.
After the nationalization the branches of the public sector banks in India rose to
approximately 800% and 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.

19

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 setup by his name which worked for the
liberalization of banking practices.
The country is flooded with foreign banks and their ATM stations. Efforts are
being made to give a satisfactory service to customers. Phone banking and net
banking is introduced. The entire system became more convenient and swift.
Time is given more importance than money.
The financial system of India has shown a great deal of resilience. It is sheltered
from any crisis triggered by any external macro-economic 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.

20

Services Provided by the Bank

Banks provide two types of services: 1. Fund based
2. Non-fund Based

Banking services

Fund Based

Non-Fund Based

Services

Services

21

FUND BASED AND NON-FUND BASED FUNCTIONS

The difference between fund-based and non-fund based credit assistance lies
mainly in the cash outflow. While the former involves all immediate cash
outflow, the latter may or not involve cash outflow a banker. In other words, a
fund based credit facility to a borrower would result in depletion of actual
liquidity of a banker immediately whereas grant of non-fund based credit
facilities to a borrower may or may not affect the bankers liquidity.

Fund Based Services

Fund Based services

Loans & Advances

Commercial
Loans

Leasing & Hire

Purchase

Capital Market
Investments

Personal
Loans

22

Investment

Debt Market
Investments

FUND BASED FACILITY

Fund based functions of bank are those in which banks make
development of their funds either by granting advances or by making
investments for meeting gaps in funds requirements of their customers /
borrowers. Fund-based functions of a bank may be classified into two parts: Granting of Loans and Advances
Making Investments in shares / debentures / bonds.

I.
LOANS AND ADVANCES
1. Commercial Loans segment
a. Working capital: -Working capital is current assets minus current
liabilities. Working capital measures how much in liquid assets a
company has available to build its business. The number can be
positive or negative, depending on how much debt the company is
carrying. In general, companies that have a lot of working capital will
be more successful since they can expand and improve their
operations. Companies with negative capital may lack the funds
necessary for growth, also called net current or current capital.
A loan whose purpose is to finance everyday operation of a
company. A working capital loan is not used to buy long term assets or
investments. Instead it used to clear accounts payable, wages, etc.
b. Cash Credit: -this facility is given by the banker to the customer by
way of a certain amount of credit facility. Its limit is fixed on the basis
of security of the companys current assets.
c. Overdraft: -Banks allow selected customers to write cheque in excess
of the balances in their current account, ie, to overdrafts are arranged
up to limits which depend on the customers credit standing and the
bank managers humour. The arrangements allow flexibility in the
amount spent and, equally, allow flexibility in repayments (although
technically a bank can demand repayment of an overdraft within 24
hours). In that respect overdrafts are unlike personal loans, which are
structured with regular repayments. Interest on overdraft is changed on
the fluctuating daily balance
23

d. Bills Discounting: -This is the most important form in which a bank

lends without any collateral security. The seller draws bills of exchange
on the buyer of goods on credit. Such a bill may either be a clean bill
or documentary bill which is accompanied by documents of title to
goods, viz railway receipts. The bank purchase bills payable on
demand and credit the customers account with the amount of bills less
the discount. On maturity of the bills, the bank present them to its
acceptor for payment. In case the discounted bill is dishonoured by the
non-payment, the bank can recover the full amount from the customer
along with the expense in that connection.
II.

Term Loan: -A bank loan to a company, with a fixed maturity and

often featuring amortization of principal. If this loan is in the form of a
line of credit, the funds are drawn down shortly after the agreement is
signed. Otherwise, the borrower usually uses the funds from the loan
soon after they become available. Bank term loans are very a common
kind of lending.

a. Capital Expenditure: -Money spent to acquire or upgrade physical assets

such as building and machinery also called capital spending or capital
expenses.
b. Project finance: - Financing arrangements where the funds are made
available for a specific purpose (the project), with the loan repayment
geared to the projects cash flow. Project finance is used in connection
with raising large amount of money for big - ticket, energy-related
facilities. The term has come to be loosely applied to various forms of
financing. A financing of a particular economic unit in which a lender is
satisfied to look initially to the cash flows and earnings of that economic
unit as the source of funds from which a loan will be required and to the
assets of the economic unit as collateral for the loan.

24

c. Education Loan: -Education in India (popularly known as Education

loans) have become a popular method of funding higher education in
India with the cost of educational degrees going higher. The spread of selffinancing institutions (which has less to no funding from the government)
for higher education in fields of engineering, medical and management
which has higher fees than their government aided counterparts have
encouraged the trend in India. Most large public sector and private sector
banks offer educational loans.

III.

Personal Loan Segment: Loan granted for personal, family, or household use, a
distinguished from a loan financing a business. Though in some
situations the lender may require a co-signer or guarantor. If
unsecured, the loan is made on the basis of the borrowers integrity
and ability to pay. Generally, these loans are used for debt
consolidation, or to pay for vacations, education expenses, or
medical bills, and are amortized over a fixed term with regular
payments of principal and interest.

25

NON FUND BASED FACILITY

It is generally perceived that the non-fund based business is very

remunerative to bank and the borrowers. The banks, besides getting
handsome commission or fee and some other service charges, also get
the low cost deposits in the shape of margin and ancillary business.
The funds of the borrower are not blocked in the advances to be given
to the suppliers or beneficiaries and this keeps his liquidity position
comfortable, production smooth and costs low.

Non Fund Based Services

Funds
remittance/Transf
er facilities

Letter of
Credit/Bank
Guarantee

Agency
Functions

Merchant
Banking
Functions

26

Purpose for Non-Fund Based Facility

The borrowers need such facilities not only for purchases of current assets or
financing there of or take benefit of certain services with the help of non-fund

based facilities. They also need the facilities for acquisition of fixed assets
including their financing.
Prudential exposure norms as per extent guidelines of Reserve Bank of India
provides that the maximum exposure of a bank for all its fund based and nonfund based credit facilities, investments, underwritings, investments in bonds
and commercial paper and other commitment should not exceed 25% of its net
worth to an individual borrower and 50% of its, net worth to group. It may
however, be rioted that while calculating exposure, the non-fund based facilities
are to be taken at 50% of the sanctioned limit. To illustrate the point let us
consider the following example: Example 1
Particulars

Rs.

Net worth of the bank

Rs. In
Crores
700

Maximum Exposure permitted for an individual

borrower (25% of net worth of the bank) Working
Capital Control and Banking Policy

175

Maximum Exposure permitted for all borrowers

Under the same group (50% of the net worth of the
bank)

27

657
350

Example 2
Particulars

Rs. In
Crore

Limit Sanctioned to Borrowers

Fund based

100

Non Fund Based

100

Total

200

Total Exposure
For Fund based limits @50% of limits

100

For Non Fund based limits @50% of limits

50

Total

150

Total credit limits to the above borrower are Rs.200 crores which are in
excess of the maximum exposure norm of Rs.175 crores. But for the purpose of
determining exposure we have taken non fund based limits at 50% of its value
and total exposure is taken at Rs. 150 crores which is well within the norm.
Fund Remittance / Transfer Facilities: Issue of demand draft
Collection of Bills and Cheque
28

Letter of Credit / Bank Guarantee

Letter of Credit
Bank should normally open letters of credit for their own customers who
enjoy credit facilities with them Customers maintaining current account
only and not enjoying any credit limits should not be granted L/C
facilities except in cases where no other credit facility is needed by the
customer.
The request of such customer for sanctioning and opening of letter of
credit should be properly scrutinised to establish the genuine need of the
customer. The customer may be, required to submit a complete loan
proposal Including financial statements to satisfy the bank about his,
needs and also his financial resources, to mire the bills drawn under
Where a customer enjoys credit facilities with some other bank, the
reasons for his approaching the bank for sanctioning L/C limits have to be
clearly stated. The bank opening L/C on behalf of such customer should
invariably make a reference to the, existing banker of the customer.
In all cases of opening of letters of credit, the bank has to ensure that the
customer is able to retire the bills drawn under L/C as per the financial
arrangement already finalised.
Bank Guarantee
The conditions relating to obliging being a customer of the bank enjoying
credit facilities as discussed in case of letters of credit are equally
applicable for guarantees also. In fact, guarantee facilities also cannot be
sanctioned in isolation.
Financial guarantees will be issued by the banks only if they are satisfied
that the customer will be in a position to reimburse the bank in case the
guarantee is invoked and the bank is required to make the payment in
terms of guarantee.
Performance guarantee will be issued by the banks only on behalf of
those customers with whom the bank has sufficient experience and is
satisfied that the customer has the necessary experience and means to
perform the obligations under the contract and is not likely to commit any
default.
29

 As a rule, banks will guarantee shorter maturities and leave longer

maturities to be guaranteed by other institutions. Accordingly, no bank
guarantee will normally have a maturity of more than 10 years.
Banks should not normally issue guarantees on behalf of those customers
who enjoy credit facilities with other banks.
Agency Function
The banks render important services as agent on behalf of their
customers in return for a small commission. When banks act as agent, law
of agency applies. The agency functions or services of bank are as
follows:
1. Collection of Cheques: Commercial banks collect the cheques, bills of exchange, etc, on
behalf of their customers. Banks collect local and outstation cheques and
bills of exchange through clearing house facilities provided by the central
bank.
2. Collection of Income: The commercial banks collect dividends, interest on investment,
pension and rent of property due to the customers. When any income is
collected by the bank, a credit voucher is sent to the customer for
information.
3. Payment of expenses: The banks make payment of insurance premiums, rent, trade
subscription, school fee and other obligation of the customers. When any
expense is paid by the bank, a debit voucher is sent to the customer for
information.
4. Dealer in Securities: The banks carry out purchase and sale of securities on behalf of their
customers. Banks do it well because they are aware of the market
conditions.
30
5. Act as Trustee: -

The banks act as trustee to manage trust property as per instructions

of property owners. Banks are required to follow the terms and conditions
of trust deed.
6. Act as an Agent: Commercial bank sometimes acts as an agent on behalf of its
customers at home or abroad in dealing with other banks or
financial institutions.
7. Obeys Standing Instructions: Sometimes, customer may order his bank to do something on his
behalf regarding the conduct of his account. This written order is called
standing instruction. The bank being the agent of its customer obeys the
standing instructions.
8. Acts as Tax Consultant: Commercial bank acts as tax consultant to its client. The commercial
bank prepares general sales tax return, income tax return, etc. Tiles the
same with tax authorities.

Merchant Banking
In India merchant banking services were started only in 1967 by National
Grind lays Bank followed by City Bank in 1970. The State Bank of India was
the first Indian Commercial Bank having set up separate Merchant Banking
Division in 1972. In India merchant banks have been primarily operating as
issue houses than full- fledged merchant banks as in other countries.
A merchant bank may be defined as an institution or an organization which
provides a number of services including management of securities issues,
portfolio services, underwriting of capital issues, insurance, credit syndication,
financial advices, project counseling etc. There is a distinction between a
commercial bank and a merchant bank. The merchant banks mainly offer
financial services for a fee. while commercial banks accept deposits and grant
loans. The merchant banks do not act as repositories for savings of the
individuals.
31
Functions of Merchant Banks:

The basic function of a merchant banker is marketing corporate and other

securities. Now they are required to take up some allied functions also.
1.Issue management: In the past, the function of a merchant banker had been mainly
confined to the management of new public issues of corporate securities
by the newly formed companies, existing companies (further issues) and
the foreign companies in dilution of equity as required under FERA in
this capacity the merchant banks usually act as sponsor of issues.
They obtain consent of the Controller of Capital Issues (now, the
Securities and Exchange Board of India) and provide a number of other
services to ensure success in the marketing of securities. The services
provided by them include, the preparation of the prospectus, underwriting
arrangements, appointment of registrars, brokers and bankers to the issue,
advertising and arranging publicity and compliance of listing
requirements of the stock-exchanges, etc.
They act as experts of the type, timing and terms of issues of corporate
securities and make them acceptable for the investors on the one hand and
also provide flexibility and freedom to the issuing companies.
2.Loan syndication: Merchant banks provide specialized services in preparation of
project, loan applications for raising short-term as well as long- term
credit from various bank and financial institutions, etc. They also manage
Euro-issues and help in raising funds abroad.
3.Leasing and Finance: Many merchant bankers provide leasing and finance facilities to
their customers. Some of them even maintain venture capital funds to
assist the entrepreneurs. They also help companies in raising finance by
way of public deposits.

32

Reserve Bank of India

Establishment
The Reserve Bank of India was established on April 1, 1935 in
accordance with the provision of the Reserve bank of India Act, 1934.
The Central Office of the Reserve Bank was initially established in
Calcutta but was permanently moved to Mumbai in 1937. The Central
Office is where the Governor sits and where policies are formulated.
Though originally privately owned, since nationalization in 1949,
the Reserve Bank is fully owned by the Government of India.

RBI Guidelines for Licensing of New Banks in the Private Sector

The Guidelines for Licensing of New Banks in Private Sector

Key features of the guidelines are:
(i)Eligible Promoters: Entities / groups in the private sector, entities in
public sector and Non-Banking Financial Companies (NBFCs) shall be
eligible to set up a bank through a wholly-owned Non-Operative
Financial Holding Company (NOFHC).
(ii) Fit and Proper criteria: Entities / groups should have a past record
of sound credentials and integrity, be financially sound with a successful
track record of 10 years. For this purpose, RBI may seek feedback from
other regulators and enforcement and investigative agencies.
(iii) Corporate structure of the NOFHC: The NOFHC shall be wholly
owned by the Promoter / Promoter Group. The NOFHC shall hold the
bank as well as all the other financial services entities of the group.

33

(iv) Minimum voting equity capital requirements for banks and

shareholding by NOFHC: The initial minimum paid-up voting equity
capital for a bank shall be `5 billion. The NOFHC shall initially hold a
minimum of 40 per cent of the paid-up voting equity capital of the bank
which shall be locked in for a period of five years and which shall be
brought down to 15 per cent within 12 years. The bank shall get its shares
listed on the stock exchanges within three years of the commencement of
business by the bank.
(v) Regulatory framework: The bank will be governed by the provisions
of the relevant Acts, relevant Statutes and the Directives, Prudential
regulations and other Guidelines/Instructions issued by RBI and other
regulators. The NOFHC shall be registered as a non-banking finance
company (NBFC) with the RBI and will be governed by a separate set of
directions issued by RBI.
(vi) Foreign shareholding in the bank: The aggregate non-resident
shareholding in the new bank shall not exceed 49% for the first 5 years
after which it will be as per the extant policy.
(vii) Corporate governance of NOFHC: At least 50% of the Directors
of the NOFHC should be independent directors. The corporate structure
should not impede effective supervision of the bank and the NOFHC on a
consolidated basis by RBI.
(viii) Prudential norms for the NOFHC: The prudential norms will be
applied to NOFHC both on stand-alone as well as on a consolidated basis
and the norms would be on similar lines as that of the bank.
(ix) Exposure norms: The NOFHC and the bank shall not have any
exposure to the Promoter Group. The bank shall not invest in the equity /
debt capital instruments of any financial entities held by the NOFHC.
(x) Business Plan for the bank: The business plan should be realistic and
viable and should address how the bank proposes to achieve financial
inclusion.

34

(xi) Other conditions for the bank:

The Board of the bank should have a majority of independent
Directors.
The bank shall open at least 25 per cent of its branches in unbanked
rural centers (population up to 9,999 as per the latest census).
The bank shall comply with the priority sector lending targets and
sub-targets as applicable to the existing domestic banks.
Banks promoted by groups having 40 per cent or more
assets/income from non-financial business will require RBIs prior
approval for raising paid-up voting equity capital beyond `10 billion
for every block of `5 billion.
Any non-compliance of terms and conditions will attract penal
measures including cancellation of license of the bank.
(xii) Additional conditions for NBFCs promoting / converting into a
bank: Existing NBFCs, if considered eligible, may be permitted to
promote a new bank or convert themselves into banks.
Procedure for application:
In terms of Rule 11 of the Banking Regulation (Companies) Rules, 1949,
applications shall be submitted in the prescribed form (Form III). The
eligible promoters can send their applications for setting up of new banks
along with other details mentioned in Annex II to the Guidelines to the
Chief General Manger-in-Charge, Department of Banking Operations and
Development, Reserve Bank of India, Central Office, 12th Floor, Central
Office Building, Mumbai 400 001

35
Procedure for RBI decisions:
At the first stage, the applications will be screened by the Reserve
Bank. Thereafter, the applications will be referred to a High Level
Advisory Committee, the constitution of which will be announced
shortly.
The Committee will submit its recommendations to the Reserve
Bank. The decision to issue an in-principle approval for setting up
of a bank will be taken by the Reserve Bank.
The validity of the in-principle approval issued by the Reserve
Bank will be one year.
In order to ensure transparency, the names of the applicants will be
placed on the Reserve Bank website after the last date of receipt of
applications.

Guidelines on Ownership and Governance in Private Sector Banks

Banks are special as they not only accept and deploy large amount of
uncollateralized public funds in fiduciary capacity, but they also leverage such
funds through credit creation. The Banks are also important for smooth
functioning of the payment system. In view of the above, legal prescriptions for
ownership and governance of banks laid down in Banking Regulation Act, 1949
have been supplement by regulatory prescription issued by RBI from time to
time. The existing legal framework and significant current practice in particular
cover the following aspects:

i.

The composition of Board of Directors comprising members with

demonstrable professional and other experience in specific sector like
agriculture, rural economy, co-operation, SSI, law, etc., approval of
Reserve Bank of India for appointment of CEO as well as terms and
conditions thereof, and powers for removal of managerial personnel,
CEO and directors, etc. in the interest of depositors are governed by
various sections of the Banking Regulation Act, 1949.

36
ii.

Guidelines on corporate governance covering criteria for appointment of

directors, role and responsibilities of directors and the Board, signing of
declaration and undertaking by directors, etc., were issued by RBI on
June 20, 2002 and June 25, 2004, based on the recommendations of
Ganguly Committee and review by the BFS.

iii.

Guidelines for acknowledgement of transfer/allotment of shares in private

sector banks were issued in the interest of transparency by RBI on
February 3, 2004.

iv.

Foreign investment in the banking sector is governed by Press Note dated

March 5, 2004 issued by the Government of India, Ministry of Commerce
and Industries.

v.

The earlier practice of RBI nominating directors on the board of all

private sector banks has yielded place to such nomination in select private
sector banks.

vi.

Against this background, it is considered necessary to lay down a

comprehensive framework of policy in transparent manner relating to
ownership and governance in the Indian private sector banks as described
below.
The broad principles underlying the framework of policy relating
to ownership and governance of private sector banks would have to
ensure that
The ultimate ownership and control of private sector banks is well
diversifying. While diversified ownership minimizes the risk of
misuse or imprudent use of leveraged funds, it is no substitute for
effective regulation. Further, the fit and proper criterion, on a
continuing basis, has to be the over-riding consideration in the path
of ensuring adequate investments, appropriate restructuring and
consolidation in the banking sector. The pursuit of the goal of
diversified ownership will take account of these basis objectives, in
a systematic manner and the process will be spread over time as
appropriate.

 Important shareholders (i.e., shareholding of 5per cent and above)

are fit and proper. As laid down in the guidelines dated February
3, 2004 on acknowledgment for allotment and transfer of shares.

37
The directors and the CEO who manage the affairs of the bank are
fit and proper as indicated in circular dated June 25, 2004 and
observe sound corporate governance principles.
Private sector banks have minimum capital/net worth for optimal
operations and systemic stability.
The policy and the processes are transparent and fair.
Minimum Capital:
The capital requirement of existing private sector should be on par
with the entry capital requirement for new private sector banks prescribed
in RBI guidelines of January 3, 2001, which is initially Rs.200crore, with
a commitment to increase to Rs.30 crores within three years. In order to
meet this requirement, all banks in private sector should have a net worth
will have to submit a time-bound programmed for capital augmentation to
RBI. Where the net worth declines to a level below Rs.300 crores, it
should be restored to Rs.300 crores within a reasonable time.

Foreign investment in private sector banks

In terms of the Government of India press note the aggregate foreign
investment in private banks from all sources (FDI, FII, NRI) cannot exceed 74
per cent. At all times, at least 26 per cent of the private sector banks will have to
be held by resident Indians.
Foreign Direct Investment (FDI) (other than by foreign banks or foreign
bank group)
i.

The policy already articulated in guidelines for determining fit and

proper status of shareholding of 5 per cent and above will be equally

applicable for FDI. Hence any FDI in private banks where

shareholding reaches and exceeds 5 per cent either individually or as a
group will have to comply with the criteria indicated in the aforesaid
guidelines and get RBI acknowledgment for transfer of shares.
ii.

To enable assessment of fit and proper the information on

ownership/beneficial ownership as well as other relevant aspects will
be extensive.
38

Foreign Institutional Investors (FIIs)

i.

Currently there is a limit of 10 per cent for individual FII investment

with the aggregate limit for all FIIs restricted to 24 per cent which can
be raised to 49 per cent with the approval of Board/General Body.
This dispensation will continue.

ii.

The present policy requires RBIs acknowledgment for

acquisition/transfer of shares of 5 per cent and more of a private sector
bank by FIIs based upon the policy guidelines on acknowledgment of
acquisition/transfer of shares issued. For this purpose, RBI may seek
certification from the concerned FII of all beneficial interest.

Non-Resident Indian (NRIs)

Currently there is limit of 5 per cent for individual NRI portfolio
investment with the aggregate limit for all NRIs restricted to 10 per cent
which can be raised to 24 per cent with the approval of Board/General Body.
Further, the policy guidelines on acknowledgment for acquisition/transfer
will be applied.

Due diligence process

The process of due diligence in all cases of shareholders and directors as

above, will involve reference to the relevant regulator, revenue authorities,
investigation agencies and independent credit reference agencies as
considered appropriate.

39

Transition Arrangements
i.

The current minimum capital requirement for entry of new bank is

Rs.200 crores to be increased to Rs.300 crores within three years of
commencement of business. A few private sector banks which have
been in existence before these capital requirements were prescribed
have less than Rs.200 crore net worth. In the interest of having
sufficient minimum size for financial stability, all the existing private
banks should also be able to fulfil the minimum net worth requirement
of Rs.300 crore required for a new entry. Hence any bank with the net
worth below this level will be required to submit a time bound
program for capital augmentation to RBI for approval.

ii.

Where any existing shareholding of any individual entity/group of

entities is 5 per cent and above, due diligence outlined in the
guidelines will be undertaken to ensure fulfilment of fit and proper
criteria.

iii.

Where any existing shareholding by any individual entity/group of

related entities is in excess of 10 per cent, the bank will be required to
indicate a time table for reduction of holding to the permissible level.
While considering such cases, RBI will also take into account the
terms and conditions of the banking licenses.

iv.

Any bank having shareholding in excess of 5 per cent in any

otherbank in India will be required to indicate a time bound plan for
reduction in such investments to the permissible limit. The parent of

any foreign bank having presence in India, having shareholding

directly or indirectly through any other entity in the banking group in
excess of 5 per cent in any other bank in India will be similarly
required to indicate a time bound plan for reduction of such holding to
5 per cent.
40
v.

Banks will be required to undertake due diligence before appointment

of directors and Chairman/CEO on the basis of criteria that will be
separately indicated and provide all the necessary
certification/information to RBI`

vi.

Banks having more than one member of a family, or close relatives or

associates on the Board will be required to ensure compliance with
these requirements at the time of considering any induction of renewal
of terms of such directors.

vii.

Action plans submitted by private banks outlines the milestones for

compliance with the various requirements for ownership and
governance will be examined by RBI for consideration and approval.

Continuous monitoring arrangements

i.

Where RBI acknowledgment has already been obtaining for transfer of

shares of 5 per cent and above, it will be the banks responsibility to
ensure continuing compliance of the fit and proper criteria and provide
an annual certificate to the RBI of having undertaken such continuing due
diligence.

ii.

Similar continuing due diligence on compliance with the fit and proper
criteria for directors/CEO of thee bank and certified to RBI annually.

iii.

RBI may, when considered necessary, undertake independent verification

of fit and proper test conducted by banks through a process of due
diligence.

41

Guidelines on Fair practices code

Loan application forms shall be comprehensive to include information
about rate of interest (fixed/floating) and manner of charging
(monthly/quarterly/half yearly/rest), process fees and other charges, penal
interest rates, pre-payment option and any other matter which affects the
interest of the borrower, so that a meaningful comparison with that of
other banks can be made and informed decision can be taken by the
borrower.
Banks and Financial Institution should devise a system of giving
acknowledgment for receipt of all loans application. Banks/Financial
Institutions should verify the loan application within a reasonable period
of time. If additional details /documents are required, they should
intimate the borrowers immediately. If all the requirements are complied
with the borrowers, banks/financial institution should acknowledge for
the same and state the specific time period from the date of
acknowledgement within which a decision on the specific loan request
will be conveyed to the borrowers.
Acknowledgment should also state the amount of process fees paid or to
be paid and the extent to which such fees shall be refunded in the event of
rejection of any application for loan.
In the case of rejection of any loan application, lenders, should convey in
writing the specific reason thereof.

 Lenders should ensure that there is proper assessment of credit

requirement of borrowers. The credit limit, which may be sanctioned,
should be mutually settled.

42
Terms and conditions and other caveats governing credit facilities given
by banks/Financial Institution arrived at after negotiation by the lending
institution and the borrower should be reduced in writing duly witnessed
and certified by the authorized sanctioning authority; in respect of
advances sanctioned by the Board of Directors or its committee the
documents of understanding should be certified by the authorized
signatory preferably at company secretary level. A copy of such
agreement should be made available to the borrowers for their record.
Lenders should ensure timely disbursement of loans sanctioned.
Stipulation of margin and security should be based on due diligence and
credit worthiness of borrowers.
Lenders should keep the borrowers apprised of the state of their accounts
from time to time and shall give notice of any changes in the terms and
conditions including interest rates and charges are effected only
prospectively. To ensure the above, Banks/Financial institution should
create appropriate information dissemination mechanism.
The loan agreement should clearly specify the liability of lenders to
borrowers in regard to allowing drawings beyond the sanctioned limits,
honoring the cheques issued for the purpose other than agreed,
disallowing large cash withdrawals and obligation to meet further
requirements of the borrowers on account of growth in business etc.
without proper vision and sanction in credit limit, and disallowing
drawings on a borrower account on its classification as a non-performing
assets or on account of non-compliance with the terms of sanction.

43
Lenders should give reasonable notice to borrowers before taking
decision to recall / accelerate payment or performance under the
agreement or seeking additional securities.
Lenders should release all securities on receiving payment of loan or
realization of loan subject to any other claim lenders may have against
borrowers. If such right of set off is to be exercised, borrowers shall be
given notice about the same with full particulars about the remaining
claims and the documents under which lenders are entitled to retain the
securities till the relevant claims are settled/paid.

44

MICRO FACTORS AFFECTING INDIAN BANKING

INDUSTRY
Loan Demand:
Over the past three years, Indian Banking Industry has seen sustained strength
in credit growth, which is not just a function of economic buoyancy but also the
broad-basing of loan demand. This has recently been articulated by the central
bank too:
A contextual analysis of the co-movement between macroeconomic
performance and bank credit in the current phase of the business cycle suggests
that factors other than demand may also be at work: financial deepening from a
low base; structural shifts in supply elasticitys; rising efficiency of credit
markets; and competitive pressures augmenting the overall supply of credit.
(Reserve Bank of India, Monetary Policy Review, October 2006).
Loan growth sustained for very long

Source: RBI
45
The slowdown of the mid-1990s hit the banks very hard because corporate,
which accounted for a lions share of bank credit, went into a less profitable and
hence a financial restructuring mode. There was no retail credit then, banks did
not focus on Small and Medium Enterprises and farm lending was done
grudgingly, under compulsion. Along with the diversification of the pie that
keeps the tempo of demand intact, after a long time industry has also started
demanding higher levels of credit. In the five years prior to FY05, growth in
industrial credit was almost wholly driven by infrastructure. There is a
perceptibly wider participation from other segments during FY05 and FY06.
If a substantial portion of loan growth gets driven by the banking system taking
away market shares from informal sectors this is clearly happening to farm
credit, SMEs and to a limited extent non-mortgage retail interest rate
considerations influencing demand will be relatively low. SMEs and the rural
folk have accessed credit from other sources at exorbitant interest rates, and
hence banks rates going by 200-300bps is not so meaningful. That explains the

apparent lack of correlation between rates that have been rising and loan
demand.
Rising funding costs with soft lending rates irrational:
Plenty of historical evidence of return of pricing power to banks:
Concerns are often expressed about banks ability to increase lending rates in
the face of competition and government pressure. The reality is that banks,
which led the mortgage price war, have increased mortgage rate by 200-300bps
from the bottom, and is yet to see significant resistance. That PSU banks raised
prime lending rates twice in. Competition from overseas borrowings is a serious
factor only with AAA companies, and banks have reduced exposure to them
considerably during the last 3-4 years.
46
Government stand is understandably against higher interest rates. However, it is
unlikely that the government will be able to influence the course of interest rates
single-handedly.

Inflexibility of deposit growth a myth:

With 100-200bps increase in the card rates of deposits, banks have managed to
move the deposit growth rate from 15-16% to 19- 20%, on a larger base. In the
last five years, household financial savings have moved out of equities and
long-term products to bank deposits in percentage terms. The point to note here
is that component of cash (currency) has marginally risen thats the real,
incremental opportunity as more cash from chests moves into bank deposits first
before potentially going to other avenues.

The Q4FY07 is expected to be a period of margin pressure. This is because as

the last interest-rate cycle showed, deposit costs increase first, and followed by
lending rates. Q4 is also usually a period of tight liquidity, and the RBI could be
increasing CRR or SLR requirements to further tighten the liquidity. Also,
banks will be cautious about the actual implementation of the lending rate
increases and may do it in a graduated fashion so as not to invite outright
resistance or overt attention from the government. HDFC Bank, PNB, SBI and a
few others have nevertheless already made a beginning by increasing their
prime lending rates after the cash reserve ratio hike by the RBI. However, the
fight for deposits has intensified and it is possible that in Q4FY07 banks could
be increasing their exposure to high-cost wholesale deposits, taken at higher
than card rates.
47
Banks increased risk appetite good for loan yields:
The banks lending risk appetite has increased significantly over the last five
years banks veering more towards lending at increasing spreads rather than
investing in risk-free bonds. Accordingly, banks are willing to take higher risks,
which is good for overall asset yields.
Investment spreads may increase in future:
As long-duration bonds at high interest rates have been coming up for maturity
and getting re-priced at lower interest rates, yields on investments have been
continuously falling over the last few years.

48
Non Performing Loans (NPLs): concerns overstated:
Loan growth-NPL
The asset price deflation (read real estate prices) may hurting banks asset
quality has been blown out of proportion.
Residential mortgages:
It is very unlikely in near term that there can be a large-scale increase in
delinquencies on loans taken for the first house (typically self-occupied); unless
there is a household income problem, it does not matter to the borrower whether
the price of the house he is staying in is rising or falling. Even then, with an
average loan-to-value of 75%, a 25% fall is theoretically not possible. LTV
ratios had gone up to more risky levels at the peak of the mortgage boom.

Problems can arise more frequently for loans taken for the second house,
typically for investment/speculation. Banks have been reluctant to disclose the
exact volume of second houses financed. Most banks claim that it is in the range
of 2-5% of incremental mortgage lending. There is a possibility that some
individuals have been hiding from banks the fact that they
already have one more loan, but this is becoming increasingly difficult with a
credit bureau now in full swing. Even if the assumption that 10% of the
outstanding mortgages are for the second house and all of that goes bad, it will
mean 1% of the banking systems loans go bad. Commercial real estate:
According to figures disclosed by the RBI itself, real estate loans constituted
2.0% of gross non-food credit of banks as of end-June 2006. Even if it has been
growing at high percentage rates is not material as the base was very low.
49
In any case, by increasing standard assets provisioning on these loans to 100bps
from 25bps, risk weights from 100% to 150% and instructing banks not to lend
unless the developer has all the permissions.
One stark example of this is the largest bank SBI itself. In the mid 1990s, SBIs
portfolio was distributed between large corporate, farm credit and trade, with
little coming from others. The Sep06 portfolio looks dramatically different.

SBIs loan portfolio now quite diversified

Source: Company data,

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Cost of borrowing has risen, but so have incomes:
The apparent disconnect between interest rates rising now for two years and
lending not losing steam can be explained by i) rising incomes in case of
individuals, thereby imparting increased thrust to retail lending, and ii)
improved corporate profitability through better pricing power.
While there are several studies illustrating the household income growth in
India, according to National Council for Applied Economic Research, an
explosive growth is underway in the percentage of households earning Rs91,
000-1,000,000 pa, the most prominent individual borrowers for banks.

The corporate pricing power story is less known because of the media harping
on high competition and margin compression. While these issues cannot be
summarily dismissed, it is a fact that manufactured product inflation has been
rising. Even the RBI has recently commented on the increased ability of
manufacturers to pass on cost increases. And with a considerably de-leveraged
corporate India compared with the early/mid 1990s, these levels of increases in
interest costs have been easily absorbed by companies.

Technology:
The trend in banking is changing from computerization of branches to laying a
common platform by having a core banking solution in all the branches. At the
same time, Indian banks are looking at internet banking which promises to grow
into an alternate self-service channel. As the mindset of the Indian customer
undergoes a change, Indian banks need to encompass the extension of all the
services that are required and dictated by customers.

51
In future, banks will need to focus on value-differentiating services by keeping
in-Houser their competitive advantages while partnering with others who
complement its services. The emergence of peer-to-peer money transmission
mechanisms (such as Western Union Money Transfer) poses a challenge to
current role of bankers and emphasizes the role of robust payment systems like
RTGS in maintaining and promoting financial stability.
Areas of Improvement:

Few challenges associated with technology adoption by banks are:

Indian banks still dont have the robust systems required for
efficient functioning of online banking. RBI has provided
guidelines relating to security and other issues and hopefully,
online banking will see a surge in the usage from current 1% to at
least 10% in the next couple of years.
Banks need to explore newer channels such as SMS, WAP and 3G
mobile telephony applications to facilitate online access to
customers.
Banks, in a drive to carry on with tremendous expansion in terms
of customer base, needs to have employees who are well informed
about products and services and are comfortable with technology
which requires extensive training.
Potential Pitfalls:
Banks should not get overwhelmed by the concept of automation and online
banking. The banks need to realize that they need to maintain different delivery
for different generations. Banks still need to maintain brick-and-mortar
locations that people feel comfortable with.
52

ORGANIZATION PROFILE
FORMATION OF THE COMPANY
The Housing Development Finance Corporation Limited (HDFC) was
amongst the first to receive an in principle approval from the Reserve
Bank of India (RBI) to set up a bank in the private sector, as part of the
RBIs liberalization of the Indian Banking Industry in 1994. The bank
was incorporated in August 1994 in the name of HDFC Bank Limited,

with its registered office in Mumbai, India. HDFC Bank commenced

operations as a Scheduled Bank in January 1995.
PROMOTER
HDFC is Indias premier housing finance company and enjoys an
impeccable track record in India as well as in international markets. Since
its inception in 1977, the Corporation has maintained a consistent and
healthy growth in its operations to remain the market leader in mortgages.
Its outstanding loan portfolio covers well over a million dwelling units.
HDFC has developed significant expertise in retail mortgage loans to
different market segments and also has a large corporate client base for its
housing related credit facilities. With its experience in the financial
markets, a strong market reputation, large shareholder base and unique
consumer franchise, HDFC was ideally positioned to promote a bank in
the Indian environment.
BUSINESS FOCUS
HDFC Banks mission is to be a world-class Indian Bank. The objective
is to build sound customer franchises across distinct business so as to be
the preferred provider of banking services for target retail and wholesale
customer segment, and to achieve healthy growth in profitability,
consistent with the banks risk appetite. The bank is committed to
maintain the highest level of ethical standards, professional integrity,
corporate governance and regulatory compliance. HDFC Banks business
philosophy is based on four core values Operational Excellence,
Customer Focus, Product Leadership and People.
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CAPITAL STRUCTURE
The authorized capital of HDFC Bank is Rs.550 crores (RS.5.5 billion).
The paid-up capital is Rs.424.6crore (Rs.4.2 billion). The HDFC group
holds 19.4% of the banks equity and about 17.6% of the equity is held by
the ADS Depository (in respect of the banks American Depository
Shares (ADS) Issue). Roughly 28% of the equity is held by the Foreign

Institutional Investors (FIIs) and the bank has about 570,000

shareholders. The shares are listed on the Stock Exchange, Mumbai and
the National Stock Exchange. The banks American Depository Shares
are listed on the New York Stock Exchange (NYSE) under the symbol
HDB.
TIMES BANK AMALGAMATION
In a milestone transaction in the Indian banking industry, Times Bank
Limited (another new private sector bank promoted by Bennett, Coleman
& Co) was merged with HDFC Bank Ltd., effective February 26, 2000.
As per the scheme of amalgamation approved by the shareholders of both
banks and the Reserve Bank of India, shareholders of Times Bank
received 1 share of HDFC Bank for every 5.75 shares of Times Bank.
The acquisition added significant value to HDFC Bank in terms of
increased branch network, expanded geographic reach, enhanced
customer base, skilled manpower and the opportunity to cross-sell and
leverage alternative delivery channels.

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DISRTUBUTION NETWORK
HDFC Bank is headquartered in Mumbai. The Bank at present has an
enviable network of over 1229 branches spread over 444 cities across
India. All branches are linked on an online real-time basis. Customers in
over 120 locations are also serviced through Telephone Banking. The
Banks expansion plans take into account the need to have a presence in
all major industrial and commercial centers where its corporate customers
are located as well as the need to build a strong retail customer base for
both deposits and loan products. Being a clearing/settlement bank to

various leading stock exchange, the bank has branches in the centers
where the NSC/BSC has a strong and active member base. The bank also
has a network of about over 2526 networked ATMs across these cities.
Moreover, HDFC Banks ATM network can be accessed by al domestic
and international Visa/MasterCard, Visa Electron/Maestro, Plus/Circus
and American Express Credit/Charge cardholders.

TECHNOLOGY
HDFC Bank operates in a highly automated environment in terms of
information technology and communication systems. All the banks
branches have online connectivity, which enables the bank to offer speedy
funds transfer facilities to its customers. Multi-branches access is also
provided to retail customers through the branch network and Automated
Teller Machines (ATMs). The bank has made substantial efforts and
investments in acquiring the best technology available internationally, to
build the infrastructure for a world class bank. The banks business is
supported by scalable and robust systems which ensure that our clients
always get the finest services we offer. The bank has prioritized its
engagement in technology and the internet as one of its key goals and has
already made significant progress in web-enabling in core business in
each of its businesses, the bank has succeeded in leveraging its market
position, expertise and technology to create a competitive advantage and
build market share.

55
BUSINESSFOCUS
HDFC Banks mission is to be a World Class Indian Bank. The objective
is to build sound customer franchises across distinct businesses so as to
be the preferred provider of banking services to target retail and
wholesale customer segments, and to achieve healthy growth in
profitability, consistent with the banks risk appetite. The bank I
committed to maintain highest level of ethical standards, professional
integrity, corporate governance and regulatory compliance. HDFC Banks

business philosophy is based on four core values Operational

Excellence, Customer Focus, Product Leadership and People.

PRODUCT SCOPE
HDFC Bank offer a bunch of products and services to meet every need of
the people. The company cares for both, individuals as well as corporate
and a small and medium enterprises. For individuals, the company has a
range accounts, investment, and pension scheme, different types of loans
and cards that assist the customers. The customers can choose the suitable
one for range of products which will suit their life stage and needs. For
organizations the company has the host of customized solutions that
range from Funded services, Non funded services, Value addition
services, Mutual Fund etc. These affordable plans apart from providing
long term value to the employees help in enhancing goodwill of the
company. The product of the company is categorized into various sections
which are as follow:
o Accounts and Deposits
o Loans
o Investments and Insurance
o Forex and Payment Services
o Cards
o Customer center

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CONCLUSION
The project involves valuation of major Indian Banks including ICICI Bank,
SBI and HDFC Bank. The methodology followed is Target Pricing, which
including estimating growth rate by regression on historical sales to forecast
next year sales, earning and Profit and Loss account. Then EPS is calculated

which is multiplied to Historical P/E to forecast intrinsic value of share. All

shares are undervalued and expected to give positive risk adjusted returns to
investors. Since the intrinsic value is more than current market price for all the
companies, the share can be recommended to conservative investors.

57

BIBLIOGRAPHY
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www.bankreport.rbi.org.in
www.giichinese.com.tw/chinese/rnc41934-bankingsector.html

v)
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www.thokalath.com/banks
www.qualisteam.com/Banks/Asia/India/
http://economics.about.com/b/2005/11/24/banking-inindia.htm
viii) http://business.mapsofindia.com/banks-in-india
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www.bestindiansites.com/banks
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xiii) http://en.wikipedia.org/wiki/Banking_in_India

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