Вы находитесь на странице: 1из 57

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 1 INTRODUCTION TO FINANCIAL SYSTEM

1.1 INTRODUCTION TO FINANCIAL SYSTEM


The economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations. There are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation. These are briefly discussed below;

Traditional financial systems in India


The National Bank for Agriculture and Rural Development has planned to conduct a study on the traditional micro-finance system in the northeast for exploring ways to link them with formal banking institutions. In many remote areas of the northeast, where formal banking institutions have not yet reached, traditional micro-finance systems are the only means for savings and credit. These systems have become so popular in some parts of the northeast that people prefer to invest

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

more money in these financial bodies than banks. Marup in Manipur and Sonchoi in Assam were some of the most popular traditional micro-finance systems in the northeast. Nabard executive director A K Bandyopadhyay said it was absolutely necessary to study the traditional micro-finance systems so that they could be formally linked to banks and financial institutions. "We need to know how the traditional microfinance systems are working and how exchange of ideas can take place. That is why we want to carry out a comprehensive study on this," added Bandyopadhyay. The study of traditional micro-finance system has become necessary to find out what has made them more popular than banks. Experts, however, said access barriers to banks have made the traditional system so popular among people. Over the years, these systems have evolved into efficient financial institutions. "For instance, there are places in Manipur where there are no bank branches. In such a situation it is the Marup which serves as the most dependable financial institution.

1.2 FINANCIAL MARKETS


A Financial Market can be defined as the market in which financial assets are created or transferred. As against a real transaction that involves exchange of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of interest or dividend.

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Money Market- The money market is a wholesale debt market for low-risk,
highly-liquid, short-term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions.

Capital Market - The capital market is designed to finance the long-term


investments. The transactions taking place in this market will be for periods over a year.

Forex Market - The Forex market deals with the multicurrency requirements,
which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe.

Credit Market- Credit market is a place where banks, FIs and NBFCs purvey
short, medium and long-term loans to corporate and individuals.

1.3 FINANCIAL INTERMEDIATION


Having designed the instrument, the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the security should be passed on to take place. There should be a proper channel within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries came into existence. Financial intermediation in the organized sector is conducted by a widerange of institutions functioning under the overall surveillance of the Reserve Bank of India. In the initial stages, the role of the

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

intermediary was mostly related to ensure transfer of funds from the lender to the borrower. This service was offered by banks, FIs, brokers, and dealers. However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the markets are different, there may be a few intermediaries offering their services in more than one market e.g. underwriter. However, the services offered by them vary from one market to another.

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

1.4 FINANCIAL INSTRUMENTS


Are those assets that are near substitutes for money. The term short-term means generally a period upto one year and near substitutes to money is used to denote any financial asset which can be quickly converted into money with minimum transaction cost.

Some of the important money market instruments are briefly discussed below;

1. Call/Notice Money 2. Treasury Bills 3. Term Money 4. Certificate of Deposit 5. Commercial Papers

1. Call /Notice-Money Market


Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions.

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

2. Inter-Bank Term Money


Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days

3. Treasury Bills.
Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

4. Certificate of Deposits
Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term deposits, commercial papers and

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

intercorporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

5. Commercial Paper
CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. The minimum maturity period of CP is 7 days.

Capital Market Instruments


The capital market generally consists of the following long term period i.e., more than one year period, financial instruments; In the equity segment Equity shares, preference shares, convertible preference shares, non-convertible preference shares etc and in the debt segment debentures, zero coupon bonds, deep discount bonds etc.

Hybrid Instruments
Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible debentures, warrants etc.

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 2

HISTORY OF BANKING 2.1 HISTORY OF BANKING FINANCIAL SYSTEM


Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock Bank: A company that issues stock and requires shareholders to be held liable for the company's debt) It was not the first though. That honor belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla. When the American Civil War stopped the supply of cotton to Lancashire from the Confederate States, promoters opened banks to finance trading in Indian cotton. With large exposure to speculative ventures, most of the banks opened in India during that period failed. The depositors lost money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century. Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862; branches in Madras and Puducherry, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

trading port in India, mainly due to the trade of the British Empire, and so became a banking center. The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India. Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities. The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally under capitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments." The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi movement. The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. The fervour of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Canara ( South Kanara ) district. Four nationalised

10

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

banks started in this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking". During the First World War (1914-1918) through the end of the Second World War (1939-1945), and two years thereafter until the independence of India were challenging for Indian banking. The years of the First World War were turbulent, and it took its toll with banks simply collapsing despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following table: Authorised capital (Rs. Lakhs) 274 710 56 231 76 209 35 109 5 4 25 1 Paid-up Capital (Rs. Lakhs)

Number of Years banks that failed 1913 1914 1915 1916 1917 1918 12 42 11 13 9 7

a) Post-Independence
The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal, paralyzing banking activities for months. India's independence marked the end of a regime of the Laissez-faire for the Indian banking. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in

11

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

1948 envisaged a mixed economy. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The major steps to regulate banking included:

The Reserve Bank of India, India's central banking authority, was nationalized on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).[Reference www.rbi.org.in]

In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India."

The Banking Regulation Act also provided that no new bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could have common directors.

b) Traditional Banking Services


Banks provide a number of services to consumers around the world. Traditional bank locations as well as electronic banking systems allow us to access bank accounts, deposit and withdraw funds, pay bills and more.

Traditional Banking Services


Bank locations and branch locations offer a full range of services to the customer. Physical bank locations are fully staffed with knowledgeable employees ranging from tellers to loan officers.
o

12

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Functions
o

At a traditional bank, the customer can conduct a number of banking transactions. These include cashing a check, withdrawing funds, opening a new account and applying for a loan.

Considerations
Many consumers utilize both traditional banking services and electronic banking systems for different reasons. Some people prefer to cash checks at the bank, however they may pay bills online. Convenience of electronic banking makes it a very popular option for many peopleBanks In India In India the banks are being segregated in different groups. Each group has their own benefits and limitations in operating in India. Each has their own dedicated target market. Few of them only work in rural sector while others in both rural as well as urban. Many even are only catering in cities. Some are of Indian origin and some are foreign players. All these details and many more is discussed over here. The banks and its relation with the customers, their mode of operation, the names of banks under different groups and other such useful informations are talked about. One more section has been taken note of is the upcoming foreign banks in India. The RBI has shown certain interest to involve more of foreign banks than the existing one recently. This step has paved a way for few more foreign banks to start business in India

13

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 3

TYPES OF BANKING IN THE FINANCIAL SYSTEM

a) Modern Banking
"Modern Banking" is a sequel to the highly successful "Modern Banking in Theory and Practice," first published in 1996. Over the last decade many aspects of banking have changed considerably, though the key features that distinguish banks from other financial institutions remain. Some might question the need for a book on banking rather than one on financial institutions - while banks remain special and unique to the financial sector, books need to be devoted to them. "Modern Banking" focuses on the theory and practice of banking, and its prospects in the new millennium. The book is written for courses in banking and finance at Masters/MBA level, or undergraduate degrees specialising in this area. Bank practitioners wishing to deepen and broaden their understanding of banking issues may also be attracted to this book. While they often have exceptional and detailed knowledge of the areas they have worked in, busy bankers may be all too unaware of the key broader issues. Consider the fundamental questions: "What is unique about a bank?" and "What differentiates it from other financial institutions?" Answering these questions begins to show how banks should evolve and adapt - or fail. If bankers know the underlying reasons for "why" profitable banks exist, it will help them to devise strategies for sustained growth.

14

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

"Modern Banking" concludes with a set of case studies that give practical insight into the key issues covered in the book: The core banking functionsDifferent types of banks and diversification of bank activitiesRisk management: issues and techniquesGlobal regulation: Basel 1 and Basel 2.Bank regulation in the UK, US, EU, and JapanBanking in emerging marketsBank failure and financial crisesCompetitive issues, from cost efficiency to mergers and acquisitionsCase Studies including: Goldman Sachs, Bankers Trust/Deutsche Bank, Sumitomo Mitsui, Bancomer

b)Public sector Banks


Among the Public Sector Banks in India, United Bank of India is one of the 14 major banks which were nationalised on July 19, 1969. Its predecessor, in the Public Sector Banks, the United Bank of India Ltd., was formed in 1950 with the amalgamation of four banks viz. Comilla Banking Corporation Ltd. (1914), Bengal Central Bank Ltd. (1918), Comilla Union Bank Ltd. (1922) and Hooghly Bank Ltd. (1932).

Oriental Bank of Commerce (OBC), a Governmet of India Undertaking offers Domestic, NRI and Commercial banking services. OBC is implementing a GRAMEEN PROJECT in Dehradun District (UP) and Hanumangarh District (Raiasthan) disbursing small loans. This Public Secotor Bank India has implemented 14 point action plan for strengthening of credit delivery to women and has designated 5 branches as specialized branches for women entrepreneurs.

15

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

This means that all the resources should be used efficiently to improve the productivity and ensure a win-win situation. To survive in the long run, it is essential to focus on cost saving. Previously, banks focused on the 'revenue' model which is equal to cost plus profit. Post the banking reforms, banks shifted their approach to the 'profit' model, which meant that banks aimed at higher profit maximization. Banks such as State Bank of India, Bank of Baroda, Syndicate Bank and Canara Bank are known as Public sector banks. Public sector banks are controlled and managed by the Government of India. Public sector banks have been serving the nation for over centuries and are well known for their affordable and quality services.

The banking sector in India is mostly dominated by the Public sector banks. The Public sector banks in India alone account for about 75 percent of the total advances in the Indian banking industry. Public sector banks have shown remarkable growth over the last five four decades.

c)Private sector banks


Private Banks are banks like HDFC bank, ICICI Bank, UTI bank and IDBI bank. The concept of private banking was introduced about 15 years ago. These are the banks that do not have any government stakes.

Private Banks have gained quite a strong foothold in the Indian banking industry over the last few years especially because of optimum use of technology. The Private Banks are accountable for a share of 18.2 percent of the Indian banking industry.

16

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

IndusInd Bank was the first private bank in India. Currently the bank is among the fastest growing Bank Private Banks in the country. IDBI which is ranked as the tenth largest global development bank is counted as one of the finest financial institutions in the subcontinent.

Private banks
Private banking in India was practiced since the begining of banking system in India. The first private bank in India to be set up in Private Sector Banks in India was IndusInd Bank. It is one of the fastest growing Bank Private Sector Banks in India. IDBI ranks the tength largest development bank in the world as Private Banks in India and has promoted a world class institutions in India.

The first Private Bank in India to receive an in principle approval from the Reserve Bank of India was Housing Development Finance Corporation Limited, to set up a bank in the private sector banks in India as part of the RBI's liberalisation of the Indian Banking Industry. It was incorporated in August 1994 as HDFC Bank Limited with registered office in Mumbai and commenced operations as Scheduled Commercial Bank in January 1995.

ING Vysya, yet another Private Bank of India was incorporated in the year 1930. Bangalore has a pride of place for having the first branch inception in the year 1934. With successive years of patronage and constantly setting new standards in banking, ING Vysya Bank has many credits to its account

17

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

c) Co--operative banks
The Co operative banks in India started functioning almost 100 years ago. The Cooperative bank is an important constituent of the Indian Financial System, judging by the role assigned to co operative, the expectations the co operative is supposed to fulfil, their number, and the number of offices the cooperative bank operate. Though the co operative movement originated in the West, but the importance of such banks have assumed in India is rarely paralleled anywhere else in the world. The cooperative banks in India plays an important role even today in rural financing. The businessess of cooperative bank in the urban areas also has increased phenomenally in recent years due to the sharp increase in the number of primary Co operative Banks in India are registered under the Co-operative Societies Act. The cooperative bank is also regulated by the RBI. They are governed by the Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1965.

18

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 4 4.1 ROLE OF BANKS IN THE FINANCIAL SYSTEM


Money lending in one form or the other has evolved along with the history of the mankind. Even in the ancient times there are references to the moneylenders. Shakespeare also referred to shylocks who made unreasonable demands in case the loans were not repaid in time along with interest. Indian history is also replete with the instances referring to indigenous money lenders, sahukars and zamindars involved in the business of money lending by mortgaging the landed property of the borrowers. Towards the beginning of the twentieth century, with the onset of modern industry in the country, the need for government regulated banking system was felt. The british government began to pay attention towards the need for an organised banking sector in the country and reserve bank of india was set up to regulate the formal banking sector in the country. But the growth of modern banking remained slow mainly due to lack of surplus capital in the indian economic system at that point of time. Modern banking institutions came up only in big cities and industrial centres. The rural areas, representing vast majority of indian society, remained dependent on the indigenous money lenders for their credit needs. Independence of the country heralded a new era in the growth of modern banking. Many new commercial banks came up in various parts of the country. As the modern banking network grew, the government began to realise that the banking sector was catering only to the needs of the well-to-do and the capitalists. The interests of the poorer sections as well as those of the common man were being ignored. In 1969, indian government took a historic decision to nationalise 14 biggest private commercial

19

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

banks. A few more were nationalised after a couple of years. This resulted in transferring the ownership of these banks to the state and the reserve bank of india could then issue directions to these banks to fund the national programmes, the rural sector, the plan priorities and the priority sector at differential rate of interest. This resulted in providing fillip the banking facilities to the rural areas, to the underprivileged and the downtrodden. It also resulted in financial inclusion of all categories of people in almost all the regions of the country. However, after almost two decades of bank nationalisation some new issues became contextual. The service standards of the public sector banks began to decline. Their profitability came down and the efficiency of the staff became suspect. Nonperforming assets of these banks began to rise. The wheel of time had turned a full circle by early nineties and the government after the introduction of structural and economic reforms in the financial sector, allowed the setting up of new banks in the private sector. The new generation private banks have now established themselves in the system and have set new standards of service and efficiency. these banks have also given tough but healthy competition to the public sector banks.

a) MODERN
Banking system and the financial institutions play very significant role in the economy. first and foremost is in the form of catering to the need of credit for all the sections of society. the modern economies in the world have developed primarily by making best use of the credit availability in their systems. an efficient banking system must cater to the needs of high end investors by making available

20

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

high amounts of capital for big projects in the industrial, infrastructure and service sectors. at the same time, the medium and small ventures must also have credit available to them for new investment and expansion of the existing units. rural sector in a country like india can grow only if cheaper credit is available to the farmers for their short and medium term needs.credit availability for infrastructure sector is also extremely important. the success of any financial system can be fathomed by finding out the availability of reliable and adequate credit for infrastructure projects. fortunately, during the past about one decade there has been increased participation of the private sector in infrastructure projects. The banks and the financial institutions also cater to another important need of the society i.e. mopping up small savings at reasonable rates with several options. the common man has the option to park his savings under a few alternatives, including the small savings schemes introduced by the government from time to time and in bank deposits in the form of savings accounts, recurring deposits and time deposits. another option is to invest in the stocks or mutual funds. In addition to the above traditional role, the banks and the financial institutions also perform certain new-age functions which could not be thought of a couple of decades ago. the facility of internet banking enables a consumer to access and operate his bank account without actually visiting the bank premises. the facility of atms and the credit/debit cards has revolutionised the choices available with the customers. the banks also serve as alternative gateways for making payments on account of income tax and online payment of various bills like the telephone, electricity and tax. the bank customers can also invest their funds in various stocks or mutual funds straight from their bank accounts. in the modern day economy, where people have no time to make these payments by standing in queue, the service provided by the banks is commendable. while the commercial banks cater to

21

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

the banking needs of the people in the cities and towns, there is another category of banks that looks after the credit and banking needs of the people living in the rural areas, particularly the farmers. regional rural banks (rrbs) have been sponsored by many commercial banks in several states. these banks, along with the cooperative banks, take care of the farmer-specific needs of credit and other banking facilities.

b) FUTURE
Till a few years ago, the government largely patro-nized the small savings schemes in which not only the interest rates were higher, but the income tax rebates and incentives were also in plenty. the bank deposits, on the other hand, did not entail such benefits. as a result, the small savings were the first choice of the investors. but for the last few years the trend has been reversed. the small savings, the bank deposits and the mutual funds have been brought at par for the purpose of incentives under the income tax. moreover, the interest rates in the small savings schemes are no longer higher than those offered by the banks.

22

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 5 BANK AN INTERMEDIARY IN THE ECONOMY 5.1 ROLE OF COMMERCIAL BANKS IN THE ECONOMIC DEVELOPMENT OF A COUNTRY
Commercial banks play an important and active role in the economic development of a country. If the banking system in a country is effective, efficient and disciplined it brings about a rapid growth in the various sectors of the economy. The following is the significance of commercial banks in the economic development of a country. Role of Commercial Banks in the Economic Development of a Country

BANKS PROMOTE CAPITAL FORMATION:


Commercial banks accept deposits from individuals and businesses, these deposits are then made available to the businesses which make use of them for productive purposes in the country. The banks are, therefore, not only the store houses of the countrys wealth, but also provide financial resources necessary for economic development. In any Merchant Account, capital occupies a position of crucial and strategicimportance. The bank plays an important role in removing the deficiency of capital by stimulating savings and investments. A sound banking system helps

23

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

in mobilisation of the savings of the merchants and makes them available for investment in productive merchandise industries. No economic development of sizeable extent in merchant account is possible unless there is sufficient degree of capital formation. Capital is must in all businesses. Capital is also considered as life-blood of any busines Banks help a lot in pushing up small business to a certain height by giving financial help and also by promoting capital formation. There are other non-banking financial institutions that also provide monetary help. But these financial institutions charge a higher rate of interest than the banks. Merchant account is maintained with lots of withdrawals and deposits and also various other transactions. Credit card processing is an example of a merchant account. In modern days, going to the bank for making transactions like withdrawal is eliminated. These services are replaced by e-commerce and electronic banking systems. Internet is used as a main medium for such kind of transactions. But it is also important to visit banks sometimes to make deposits into the respective account. Merchant account is accessed at any time of the day. A high level of technological support is needed in the background. Merchants usually accept credit cards to receive payments from the customers. Banks perform two important functions in the capital formation of merchant account holders. They are: (a) Banks attract deposits by offering attractive rates of interests and thus converting savings which would have remained as immobile capital into active capital; and (b) The banks distribute these savings through loans amongst the merchant account holders which are directly or indirectly connected to economic development. Bank plays an important role in encouraging savings and making merchandise business stand firmly in the poorest market situations. The merchants also find satisfaction in the offers provided by the banks. This improves the bank and merchant relationship.

24

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

INVESTMENT IN NEW ENTERPRISES


Businessmen normally hesitate to invest their money in risky enterprises. The commercial banks generally provide short and medium term loans to entrepreneurs to invest in new enterprises and adopt new methods of production. The provision of timely credit increases the productive capacity of the economy. Economic Development of a Country With the Standard & Poor's 500 Stock Index up 4.89 percent and the Lehman Aggregate Bond Index up 2.41 percent last year, you could be thinking of adjusting your portfolio to improve its performance by taking bigger risks--perhaps more than would be appropriate for you. Given the potential losses inherent in such a plan, the following resolutions may be helpful as you review your investment strategies this year:

Allocate your assets among bonds, stocks, money-market instruments and funds in proportions that reflect the amount of risk necessary to achieve your goals. In many cases, that may mean your portfolio shouldn't be more conservative "just because" you're older or because that's what a rule of thumb tells you. It should really be about allocating for your particular goals, tax situation, risk tolerance and unique circumstances, and not just because you're at a certain age or point in your life.

Be wary of recommendations of all-purpose model portfolio asset allocations. While they may indicate how various investment strategists feel about the near-term relative attractiveness of stocks and bonds, they're not taking your particular investment goals and risk tolerance into account. On the other hand, if you don't have the time or inclination to do the necessary initial portfolio construction, disciplined re-balancing and continuous re-

25

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

alignment over time, you may want to consider "lifestyle" or "life cycle" funds, which perform these functions for you.

Have realistic expectations about the performance of your portfolio. On average, the years of exceptional returns for stocks are just a memory now. Annual returns below the long-term average of about 10 percent per annum seem more likely in the foreseeable future. With that in mind, understand that the average returns for balanced portfolios are likely to be in the singledigit range.

Resolve to maximize your net returns by minimizing commissions when buying or selling individual securities and purchasing mutual funds with reasonable expense ratios. When investing in taxable accounts, be mindful of the tax consequences of owning mutual funds that make large taxable distributions of capital gains. Consider placing funds with low turnover ratios that distribute long-term capital gains in taxable accounts and funds that have large amounts of short-term gains distributions in retirement accounts, such as IRAs, 401(k)s, or other tax-deferred accounts.

When investing for income, resist the temptation to chase high yields. Higher yields are generally associated with higher risk. Plus, with some investments, what appears to be a yield may actually be a return of capital.

Don't forget about tax-exempt bonds and bond funds. Tax-exempt state or local government bonds or bond funds, whose yields are usually lower than those of taxable issues of comparable credit quality and maturity, may pay more than the after-tax return you'd receive when investing in comparable taxable securities. So do the math and make sure you compare apples with apples--meaning, compare your prospective after-tax income from taxable securities with the return from tax-exempts.

26

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Accept that there's no shortcut to mutual fund selection. Whether you do it or an adviser does it for you, funds need to be researched to determine if they're suitable for your portfolio. One of the best and most robust sources of research is the prospectus. Data indicating superior past performance--which funds must report in accordance with the Securities and Exchange Commission (SEC)--don't assure you of superior future performance. Neither do ratings, such as the star rating calculated by Morningstar. They may provide the additional dimension of past performance, but, as Morningstar points out, the stars don't have predictive value. Such data constitute the beginning, not the end, of the selection process and provide a first-round screen as to which funds you might want to study further.

Don't be too impressed by high absolute returns. It's important to compare performance data for a mutual fund with performance data for the relevant benchmark index for the same time period. You can find the appropriate index in the fund's prospectus. For domestic stock funds, the index will generally either be the S&P, Russell or another broad market index. For domestic bond funds, you'll generally see a Lehman Brothers bond index. You should also consider comparing fund returns with the returns of its peer group, as computed by Lipper or Morningstar. By focusing on relative returns, you should get a sense as to whether the fund has performed as well as could be expected.

27

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

PROMOTION OF TRADE AND INDUSTRY


With the growth of commercial banking, there is vast expansion in trade and industry. The use of bank draft, check, bill of exchange, credit cards and letters of credit etc has revolutionized both national and international trade. Economic Development of a Country Department ofCommerce The department is entrusted with formulating and implementing the foreign trade policy and responsibilities relating to multilateral and bilateral commercial relations, state trading, export promotion measures, and development and regulation of certain export oriented industries and commodities. In order for the smooth functioning, the Department is divided into eight divisions:[5]

Administrative and General Division Finance Division Economic Division Trade Policy Division Foreign Trade Territorial Division State Trading & Infrastructure Division Supply Division Plantation Division

28

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

The subjects under the administrative control of the Department include:[6]


International trade Foreign Trade State trading Management of Indian Trade Services Special Economic Zones

This department was established in the year 1995, and in the year 2000 Department of Industrial Development was merged with it. This department is responsible for formulation and implementation of promotional and developmental measures for growth of the industrial sector, keeping in view the national priorities and socioeconomic objectives. While individual administrative ministries look after the production, distribution, development and planning aspects of specific industries allocated to them, Department of Industrial Policy & Promotion is responsible for the overall Industrial Policy. It is also responsible for facilitating and increasing the FDI flows to the country. Department of Industrial Policy and Promotion is also responsible for intellectual property rights relating to patents, designs, trademarks, and geographical indication of goods and oversees the initiative relating to their promotion and protection.

29

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

DEVELOPMENT OF AGRICULTURE
The commercial banks particularly in developing countries are now providing credit for development of agriculture and small scale industries in rural areas. The provision of credit to agriculture sector has greatly helped in raising agriculture productivity and income of the farmers. Role of Commercial Banks in the Economic Development of a Country.From a nation dependent on food imports to feed its population, India today is not only self-sufficient in grain production but also has a substantial reserve. The progress made by agriculture in the last four decades has been one of the biggest success stories of free India. Agriculture and allied activities constitute the single largest contributor to the Gross Domestic Product, almost 33 percent of it. Agriculture is the means of livelihood of about two-thirds of the workforce in the country. This increase in agricultural production has been brought about by bringing additional area under cultivation, extension of irrigation facilities, the use of improved high-yielding variety of seeds, better techniques evolved through agricultural research, water management, and plant protection through judicious use of fertilizers, pesticides and cropping practices.

BALANCED DEVELOPMENT OF DIFFERENT REGIONS Balanced development of different regions: The commercial banks play an important role in achieving balanced development in different regions of the country.

30

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

They help in transferring surplus capital from developed regions to the less developed regions. The traders, industrialist etc of less developed regions are able to get adequate capital for meeting their business needs. This in turn increases investment, trade and production in the economy. India has lower spatial income disparities than countries such as Brazil, China and Indonesia, but these disparities have grown dramaticallythe standard deviation of state level per capita GDP rose from just below 0.3 in the 1980s to over 0.4 in the 1990s, an increase of more than one third (World Bank, 2006). The gap between rural and urban areas also widened despite average growth in both (Sen and Himanshu, 2005). The contribution of rural-urban disparities to overall inequality has grown correspondingly (Gajwani et al., 2007). A remarkable feature of Indian spatial disparities is the presence of backward areas even within states that have grown faster and are at relatively high income levels on average. Eastern and Northern Karnataka, and Inland Eastern Maharashtra, are examples of lagging regions within prosperous states. Moreover, they form a contiguous corridor with deprived areas of Andhra Pradesh, Orissa, Chhattisgarh, Jharkhand and Bihar. Income disparities are matched, even exceeded, by disparities in non-income indicators. Disparities in access to toilets range from 70 per cent in some districts of India to 10 per cent in others. Although Maharashtras Infant Mortality Rate (IMR) is near the best in the country, its worst districts have IMRs that are higher than those of states with lower ranks. Thus while income and non-income poverty in some parts of India is at the relatively low levels of Latin America averages, in other parts of India it approaches or is worse than African averages (World Bank, 2006).

31

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

India is not unique. High and rising spatial disparities are a feature of many developing countries. In Peru, for example, the incidence of income poverty in districts at sea level is three quarters of that in mountain districts. In China rural per capita income in Shanghai province is more than five times that in Guizhou province. Moreover, Chinese regional inequality increased throughout the 1990s and early 2000s, reaching an all time historical high. In Indonesia, the poverty reducing impact of growth has been higher in Java and Bali than in the remote areas of Kalimantan and Irian Jaya, with a resulting widening poverty gap between regions (Kanbur and Venables, 2007). Globally, opening up of an economy appears to be correlated with rising spatial inequality. This is not surprising, since global integration leads to a sharper expression of comparative advantage, and regions well placed in terms of location, education, governance and other initial conditions tend to surge ahead as global opportunities are better accessed while others lag behind. This is the case for China and for India, where sharply rising regional disparities have coincided with the period of external liberalization. The same argument applies to liberalization in general (Gajwani et al., 2007 and Kanbur and Venables, 2007). India should strive for regionally balanced development, between states and within states. In doing so, it would be in good global company.

INFLUENCING ECONOMY ACTIVITY


The banks can also influence the economic activity of the country through its influence on Availability of credit The rate of interest

32

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

If the commercial banks are able to increase the amount of money in circulation through credit creation or by lowering the rate of interest, it directly affects economic development. A low rate of interest can encourage investment. The credit creation activity can raise aggregate demand which leads to more production in the economy. While consumers and producers make most decisions that mold the economy, government activities have a powerful effect on the U.S. economy in at least four areas. Stabilization and Growth. Perhaps most importantly, the federal government guides the overall pace of economic activity, attempting to maintain steady growth, high levels of employment, and price stability. By adjusting spending and tax rates (fiscal policy) or managing the money supply and controlling the use of credit (monetary policy), it can slow down or speed up the economy's rate of growth -- in the process, affecting the level of prices and employment. For many years following the Great Depression of the 1930s, recessions -- periods of slow economic growth and high unemployment -- were viewed as the greatest of economic threats. When the danger of recession appeared most serious, government sought to strengthen the economy by spending heavily itself or cutting taxes so that consumers would spend more, and by fostering rapid growth in the money supply, which also encouraged more spending. In the 1970s, major price increases, particularly for energy, created a strong fear of inflation -- increases in the overall level of prices. As a result, government leaders came to concentrate

33

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

more on controlling inflation than on combating recession by limiting spending, resisting tax cuts, and reining in growth in the money supply. Ideas about the best tools for stabilizing the economy changed substantially between the 1960s and the 1990s. In the 1960s, government had great faith in fiscal policy -- manipulation of government revenues to influence the economy. Since spending and taxes are controlled by the president and the Congress, these elected officials played a leading role in directing the economy. A period of high inflation, high unemployment, and huge government deficits weakened confidence in fiscal policy as a tool for regulating the overall pace of economic activity. Instead, monetary policy -- controlling the nation's money supply through such devices as interest rates -- assumed growing prominence. Monetary policy is directed by the nation's central bank, known as the Federal Reserve Board, with considerable independence from the president and the Congress.

MONETIZATION OF THE ECONOMY:


The commercial banks by opening branches in the rural and backward areas are reducing the exchange of goods through barter. The use of money has greatly increased the volume of production of goods. The non monetized sector (barter economy) is now being converted into monetized sector with the help of commercial banks.Role of Commercial Banks in the Economic Development of a Country

34

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

EXPORT PROMOTION CELLS: In order to increase the exports of the country, the commercial banks have established export promotion cells. They provide information about general trade and economic conditions both inside and outside the country to its customers. The banks are therefore, making positive contribution in the process of economic development.

Role of Banks in 21 st century


The commercial banks are now not confined to local banking. They are fast changing into global banking i.e, understanding the global customer, using latest information technology, competing in the open market with high technology system, changing from domestic banking to investment banking etc. The commercial bank are now considered the nerve system of all economic development in the country.

What is virtual banking?


Providing the banking services through extensive use of information technology without direct recourse to the bank by the customer is called virtual banking.The origin of virtual banking can be traced to the 1970,s with the installation of ATMs. The principal types of virtual banking services include automated teller machines (ATMs), phone banking and most recently internet banking.

35

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

With the increasing use of internet banking there is greater reliance now on information technology and the decrease of physical bank branches to deliver the banking services to the customer.

CREDIT CREATION BY COMMERCIAL BANK?


Central bank is the first source of money supply in the form of currency in circulation. The Reserve Bank of Indian is the note issuing authority of the country. The RBI ensures availability of currency to meet the transaction needs of the economy. The Total Volume of money in the economy should be adequate to facilitate the various types of economic activities such as production, distribution and consumption.

The commercial banks are the second most important sources of money supply. The money that commercial banks supply is called credit money. The process of 'Credit Creation' begins with banks lending money out of primary deposits. Primary deposits are those deposits which are deposited in banks. In fact banks cannot lend the entire primary deposits as they are required to maintain a certain proportion of primary deposits in the form of reserves with the RBI under RBI & Banking Regulation Act. After maintaining the required reserves, the bank can lend the remaining portion of primary deposits. Here bank's lend the money and the process of credit creation starts. Suppose there are a number of Commercial Banks in the Banking System Bank 1, Bank 2, Bank 3, & So on. To begin with let us suppose that an individual "A" makes a deposit of Rs. 100 in bank 1. Bank "1" is required to maintain a Cash Reserve Requirement of 5%

36

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

(Prevailing Rate) which is decided by the RBI's Monetary Policy from the deposits made by 'A'. Bank "1" is required to maintain a cash reserve of Rs. 5 (5% of 100). The bank has now lendable funds of Rs. 95(100 5). Let the Bank "1" lend Rs. 95 to a borrower; say B. the method of lending is the same that is bank 1 opens an account in the name of the borrower cheque for the loan amount. At the end of the process of deposits & lending, the balance sheet of bank reads as given below:-

Balance Sheet of Bank "1" Liabilities A's deposits Amount 100 Assets Amount

Cash Reserve 5 Loan to "B" 95 100

Total

100

Total

Now suppose that money that borrowed from bank "1" is paid to individual "C" in settlement of his past debts. The individual "C" deposits the money in his bank say, bank 2. Now bank 2 carries out its banking transaction. It keeps a cash reserve to the extent of 5%, that is Rs. 4.75 (5% of 95) and lend Rs. 90.5 to a borrower D. at the end of the process the balance sheet of Bank 2 will be look like:Balance Sheet of Bank "2" Liabilities B's deposits Amount 95 Assets Amount

Cash Reserve 4.75 Loan to "C" 90.5 95

Total

95

Total

37

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

The amount advanced to D will return ultimately to the banking system, as described in case of B and the process of deposits and credit creation will continue until the reserve with the banks is reduced to zero. The final picture that would emerge at the end of the process of deposit & credit creation by the banking system is presented in the consolidated balance sheet of all banks are as under:-

The combined Balance sheet of Banks Bank Liabilities Deposits Bank 1 Bank 2 Bank 3 Bank n Total 100 95 90.5 00 2,000 95 90.5 85.98 00 1,900 5 4.75 4.52 00 100 100 95 90.5 00 2,000 Assets Credits Reserve Total Assets

It can be seen from the combined balance sheet that a primary deposits of Rs. 100 in a bank 1 leads to the creation of the total deposit of Rs. 2,000. The combined balance sheet also shows that the banks have created a total credit of Rs. 2,000. And maintained a total cash reserve of Rs.100.Which equals the primary deposits. The total deposit created by the commercial banks constitutes the money supply by the banks.

38

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 6 6.1 DEVELOPMENT BANKS IN INDIA


A Development Bank is a polygonal development finance institution devoted to improving the social and monetary development of its associate nations. Its main emphasis is the welfare of the people. For example the Asian Development Bank's overarching goal is to decrease poverty in Asia and the Pacific. It helps improve the value of people's lives by providing loans and scientific support for a broad variety of development activities.

A development bank's policies or programs center on the following priorities:


a) Economic Growth b) Human Development c) Gender and Development d) Good Governance e) Environmental Protection f) Private Sector Development g) Regional cooperation

39

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

a) The main functions of a Development Bank:


a) Increase loans and equity investments to its developing associate countries (DMCs) for their monetary and social development. b) Provides technical help for the planning and implementation of development projects and programs and for advisory services. c) Promotes and facilitates speculation of public and private capital for growth and development. d) Responds to requests for assistance in coordinating growth policies and plans of its increasing member countries.

b) Formation of Development Banks In India:


Development banks were set up in India at various points of time starting from the late 1940s to cater to the medium to long term financing requirements of industry as the capital market in India had not developed sufficiently. The endorsement of planned industrialization at the national level provided the critical enticement for organization of Development banks at both all-India and state levels. In order to perform their role, Development Banks were extended funds in the shape of Long Term Operations (LTO) Fund of the Reserve bank of India and government guaranteed bonds, which constituted main sources of their funds. Funds from these sources were not only available at concessional rates, but also on a long term basis with their maturity period ranging from 10-15 years. On the asset side, their operations were marked by near absence of competition. A large variety of economic institutions have come into existence over the years to

40

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

perform a type of financial actions While some of them operate at all-India level, others are state level institutions. Besides providing direct loans, financial institutions also extend economic assistance by way of underwriting and direct contribution and by issuing guarantees. Recently, some Development Banks have started extending short term/working capital finance, although long term lending continues to be their major activity. 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 presenceof internationally active banks, national-level banks and regional rural banks, is likely to be preservedto cater to the needs of a varied customer base. Consequent to liberalisation and financial sectorreforms, there has been some blurring of distinction between the activities of banks and DFIs. Inparticular, the traditional distinction between commercial banking and investment banking has tendedto narrow somewhat. Banks have been moving into certain areas which were the exclusive domain ofthe DFIs, eg project finance and investment banking. DFIs have recently been given the option toconvert themselves into universal banks with the RBI.s approval. To this end, a DFI would need toprepare a transition path in order to comply fully with the statutory and regulatory requirementsapplicable to banks. The RBI will consider such requests on a case by case basis.Banks play a large role in the economy of every country in the world. They offer a large and ever expanding number of services to the public and private sector such as long and short-term loans, annuities, savings accounts, mortgages, financial advice, and other financial services. Today people want more and more innovative services and with more competition in the banking industry, advertising has become much more common and it is vital for banks looking to survive in a tough market. One of the main jobs

41

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

for a banking executive today is

to identify who

their target

market

is and

to market services that will appeal to that segment. Part of identifying your target market is determining the age, race, and ethnic make-up of the main customers and designing a campaign that will appeal to that group of people. If the target market for example is young married couples a good marketing campaign may involve long-term savings programs, If the target market is older couples who are in general better off financially the focus should be accounts that pay a fair market rate in interest. Since people in this category tend to have larger bank balances offering them more for their money makes it much Banks are getting more serious about marketing and it shows. All you have to do is watch television for a short period of time and you'll see a number of ads for banks that have branches all over the country. Expect this trend to continue as banks add more services in attempt to get more return on their money. In a competitive marketplace, effective marketing can be the difference between success and failure.

42

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 7 7.1 SERVICES FEE BASED AND FUND BASED

What are the different types of services offered by banks?


(The Economic Times (India) Via Thomson Dialog NewsEdge)Banks offer the following services to account holders at their specified branches - multi-city / Payable at Par (PAP) cheque facility, anywhere banking facility, trade services, phone banking facility, internet banking facility, credit card, debit/ATM card, mobile banking and Real Time Gross Settlement (RTGS). Foreign banks are expanding the number of products on offer, their complexity such as derivatives, leverage financing. Doorstep banking facilities are being offered by some of these banks to cater to convenience lifestyle of its customers. Private banks are extending services including wealth management and equity trading apart from credit cards.

How do banks price their services?


The pricing mechanism is dependent on client relationship and the nature of the transaction. The pricing can be arrived at by profiling customers into different segments. The large corporate segment comprises of the bulk and large value transactions. This segment is characterised by multiple service relationships. The pricing in this segment is transaction based and depends on the size of transactions and on the banks' relationship with the corporate. Hence, the pricing is decided on a one to one basis and public. The other segments comprise the brokers, small and medium enterprises (SME), other banks and the retail segment. In each of these cases, the pricing is not made public and is determined on the basis of the nature of the transaction and the banks' relationship with the

43

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

client, on a one to one basis. Typically, high volumes and low value characterise the SME segment. Therefore the pricing for this segment differs from that of the large corporates. Similarly the pricing for the banks is very different. In the retail segment, the bank publishes its tariff.

How do services contribute to the bank's income?


Increasingly banks are witnessing a growth in their non-interest or fee-based incomes. With interest spreads decreasing, banks have little option but to ramp up their revenues from feebased income. Fee-based income constitutes a major portion of a bank's other income. The ratio of other income to total income is an indicator of the size of fee-based income. Treasury incomes of public sector banks are no longer the major revenue driver and have been coming down as a result of rising interest rates. Volatility of interest rates are compelling banks to increase their fee based income.

What is non-fund based income?


The non-fund based income comprises of revenues from both financial commitment and services rendered. Financial commitment includes guarantees, letters of credit and bankers acceptances etc. The fees charged may vary from bank to bank and is dependant on the relationship of the bank with the client and the size of the transaction. On the other hand, the revenues from services rendered include fees from funds transfer and enabling services like ATM, internet banking etc. The revenues from funds transfer come from corporate services such as cash management, foreign exchange remittances and from retail services including drafts, pay orders etc.

44

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Which is the most important component for the fee-based income of banks?
The cash management business contributes to banks' fee based revenue stream in a major way. The cash management business comprises four types of services including collection of outstation cheques, disbursement of outstation cheques, payment of dividends, interest, and The tariff differs depending on the volumes, the banks' profitability and the banks' relationship with the client. As a proportion of the total fee based income, cash management is the most important component. The other streams of income like auto loans, personal loans, loans against shares among others are residual. State Bank of India

When did RBI grant freedom to banks to prescribe service charges?


Indian Banks' Association (IBA) has dispensed with the practice of prescribing service charges to be levied by banks for various services rendered by them. With effect from September 1999, the Reserve Bank has granted freedom to Why is RBI taking note of different service charges levied by banks?

RBI has been receiving representations from the public about unreasonable and nontransparent service charges being levied by the banks. The RBI has directed the banks to display and update on their web sites, offices and branches, the details of the charges prescribed by them for various services. It has advised the banks to display the charges in specified formats. The display may also be in local language.

Hitherto, it was left to the banks to fix charges consistent with the cost of providing these services and also to ensure that customers with low value/volume of transactions were not penalised.

45

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 8
CASE STUDY ON SBI State Bank of India (BSE:SBI), a public sector bank, is the largest bank in India.[1] SBI accounts for almost one-fifth of the nations loans.[1] Besides personal and corporate banking, SBI is also involved in NRI (Non Resident Indian) services through its network in India and overseas. The bank has 21 subsidiaries and 10,186 branches. SBI was recognized as the best bank in India in 2008 by The Banker magazine of The Financial Times.[2] Banks across Asia are looking to shore up their balance sheets as they prepare for a tougher business environment amid a global economic downturn. SBI, which had no direct exposure to sub-prime mortgages, has said that it would still need to raise USD $2-4 billion capital to boost its Tier-1 capital adequacy ratio, but whether it would be done through a rights issue or other means has not been finalized.[3] Tier 1 capital is a core measure of a bank's financial strength. It is composed of core capital, which consists primarily of equity capital and cash reserves.

Company overview
SBI offers banking services as well as an array of financial services which include Mutual Funds, Credit cards, Life Insurance, Merchant Banking, Security Trading & Primary dealership in the Money market. The Bank is actively involved in non-profit activity called community services banking apart from its normal banking activity.

46

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Associate banks
There are six associate banks that fall under SBI, and together these seven banks constitute the State Bank Group. They are: State Bank of Indore State Bank of Bikaner & Jaipur State Bank of Hyderabad State Bank of Mysore State Bank of Patiala State Bank of Travancore SBI is the only Indian bank that figures in Fortunes top 100 banks. Its 11,000 branches and 5,600 automatic teller machines give it a reach throughout the length and breadth of the country; its work force of 200,000 dwarfs all other banks in India (its nearest competitor is Punjab National Bank, which has around 56,000 employees [4]).[5] It is also the second largest bank in the world, measured by the number of branches and employees.[6]

Joint Ventures
SBI has entered into strategic agreements with banks, insurers and other companies. Insurance Australia Group (IAG) has signed a $170 million joint venture agreement with the State Bank of India (SBI) to establish a general insurance company in India.

47

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

SBI will become the first public sector bank in India to enter the custody services sector. State Bank of India (SBI) and Societe Generale Securities Services (SGSS), part of Societe Generale Group, have announced a joint venture which will offer custody and related services in India. The new company, SBI SG Custodial Services, will be based in Mumbai and offer a range of services to both foreign and domestic investors and clients, covering custody, depository, fund administration, registration and transfer agent services. The joint venture will leverage SBIs strength in the Indian financial sector.[7] India is a preferred destination for private equity funds in real estate. SBI has planned to capitalize on this opportunity by teaming up with Australias Macquarie Group for a $2 billion infrastructure fund, and with an affiliate of Unitech Ltd, the countrys second largest publicly traded real estate company, to float a private equity (PE) real estate fund.[8] Punjab National bank - Punjab National Bank (PNB) is the second largest governmentowned commercial bank in India with about 4,500 branches across 764 cities.[15] This financial institution offers services in personal and corporate banking, including industrial, agricultural, and export finance, as well as international banking. It competes with SBI mostly in retail lending and wholesale businesses[16] ICICI Bank (formerly Industrial Credit and Investment Corporation of India) is India's largest private sector bank and second largest overall in terms of assets. Together with its subsidiaries, ICICI Bank offers a complete spectrum of financial services and products ranging from commercial banking to investment banking, mutual fund to insurance. It is also the largest issuer of credit cards in India. HDFC - Housing Development Finance Corporation Limited Bank Limited or HDFC Bank is the second largest private bank in India, catering to the whole universe of

48

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

financial services from commercial to investment banking, mutual fund to insurance.[17] On February 25, 2008 HDFC agreed to buy Centurion Bank of Punjab. The combined entity has the largest branch network among private banks in India, a strong deposit base of around Rs 1220 billion and net advances of around Rs 890 billion. Bank of Baroda - Bank of Baroda is another private player. It has a rich countrywide network of over 2800 branches. It also has significant international presence with a network of 74 offices in 25 countries. ICICI Bank Limited (NSE: ICICIBANK, BSE: 532174, NYSE: IBN) is the second largest financial services company in India. Headquartered in Mumbai, it offers a wide range of banking products and financial services to corporate and retail customers through a variety of delivery channels and through its specialised subsidiaries in the areas of investment banking, life and non-life insurance, venture capital and asset management. The Bank has a network of 2,533 branches and 6,800 ATMs in India, and has a presence in 19 countries, including India.[2]The bank has subsidiaries in the United Kingdom, Russia, and Canada; branches in United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre; and representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia. The company's UK subsidiary has established branches in Belgium and Germany.[3]ICICI Bank's equity shares are listed in India on Bombay Stock Exchange and the National Stock Exchange of India Limited and its American Depositary Receipts (ADRs) are listed on the New York Stock Exchange (NYSE).

49

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 9

LITERATURE REVIEW

Title: Indian Financial System Textbook Publisher: I K International pvt Ltd Author: D.K

Indian Financial System explains the changing dimensions of the country's financial setup owing to the financial sector reforms. The book assesses the Indian financial system in the light of contemporary changes that have taken place in financial markets, mutual funds industry, insurance and banking sectors etc. The book provides a sound theoretical foundation, giving a clear conceptual understanding of the subject. It gives a complete picture of the structure, operations and functions of various components of the Indian financial system. Every chapter in the book begins with the objectives of learning and is followed by objective, analytical and essay-type questions. The book would be useful for graduate and postgraduate level students of commerce, management and economics

50

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Title: Indian Financial System Publisher: Pearson Author: Bharati V Pathak The Financial System is the mirror reflection of an economy. The performance of any economy to a large extent, is dependent on the performance of the financial institution. In such an environment the agility to adopt to emerging dynamics is the deciding the growth of sound financial system. The rules of the game is on Mergers and Acquisitions. The financial services industry is seeing a consolidation, with all segments In the post liberalisation era, the finance sector is witnessing a complete metamorphosis. Deregulation measures have included the freeing up of direct controls over ownership, liberalising interest rates and credit allocation, deregulating foreign exchange transaction controls, freeing up the entry of new firms, and expanding and broadening the base of the banking system both for nationals and international business ventures. At the same time, non-banking financial institutions, securities markets and money markets have developed to mobilize and allocate savings. Experience suggests liberalisation. In this context, "Fundamentals of the Indian Financial System" is a subject that is assuming greater importance and is bound to be one of the key topics of discussion during the next two/three decades. This is, as it should be, to consider what sorts of financial institutions will be best suited to be economic environment in the 21st century.

51

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Title:

Indian Financial System

Publisher: Anmol Publications Author: ISBN: V K Bhalla 8174889205

About the Book: Indian financial system is one of the largest in the world with a broad variety of banking, financial and capital market institutions and instruments. What kind of structural changes in the Indian financial system are required to cope with an increasing complex and faster moving international economic and financial environment? Some of the important issues in the context of financial sector are: (1) Is there any need of heavy reforms in financial sector along with the adjustment process?; (2) Is it necessary that the reforms should be supplemented by significant inflow of foreign direct investments?; (3) Is the internal adjustment progress (for the promotion of exports) more important than the package of DFL, imported technology and enhanced productivity?; (4) Is there any relationship between inefficiency and adjustment process'; and, finally, (5) Is technical process pre-requisite for the success of adjustment process? Adequate attention to these may effectively take care of the distortions on the financial side and the process of reforms may be smooth, politically and administratively sustainable and bring the desired, effective and quick results by making the Indian financial system vibrant and competitive, a necessary concomitant of trade and industrial policy liberalization. Indian Financial System analyses the initiatives aimed at developing a healthy, efficient and

52

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

market-oriented system by deregulating interest rates, development of market

instruments for pricing public debt and bank loans, upgrading of India's regulatory and accounting standards to international norms, adjustments in monetary and financial policies, and exchange rate management for an increasingly liberalised and open economic and financial environment.

53

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 10 CONCLUSION
The financial sector reforms have brought about significant improvements in the financial strength andthe competitiveness of the Indian banking system. The prudential norms, accounting and disclosurestandards, risk management practices, etc are keeping pace with global standards, making thebanking system resilient to global shocks.The consolidation and convergence of banks in India has, however, not kept pace with globalphenomena. The efforts on the part of the Reserve Bank of India to adopt and refine regulatory andsupervisory standards on a par with international best practices, competition from new players,gradual disinvestment of government equity in state banks coupled with functional autonomy, adoptionof modern technology, etc are expected to serve as the major forces for change. In the emergingscenario, the supervisors and the banks need to put in place sound risk management practices toensure systemic stability.The face of banking is changing rapidly. Competition is goingto be tough and with financial liberalisation under the WTO,banks in India will haveto benchmark themselves against thebest in the world. For a strong and resilient banking and financialsystem, therefore, banks need to go beyond peripheral issuesand tackle significant issues like improvements in profitability,efficiency and technology, while achieving economies of scalethrough consolidation and exploring available costeffectivesolutions. In India money market is regulated by Reserve bank of India and Securities Exchange Board of India (SEBI) regulates capital market. Capital market consists of primary market and secondary market. All Initial Public Offerings comes under the primary market and all secondary market transactions deals in secondary market. Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange.

54

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

Secondary market comprises of equity markets and the debt markets. In the secondary market transactions BSE and NSE plays a great role in exchange of capital market instruments.

55

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

CHAPTER 11 BIBLOGRAPHY

Title: Indian financial system, Publisher: Himalaya, Author Dr.G Ramesh Babu Title: Indian Financial System, publisher: I.KInternational pvt ltd, Author: DK Murthy Gopal Title: Indian Financial System, Publisher: Pearson, Author: Bharati V Pathak Title: Indian financial System, Publisher: Anmol publication, Author: V.K Bhalla Title: Indian financial System, publisher: TataMcGrawHill, Author: Gurusamy Title: Dynamics of the Indian Financial System ,Publisher:Global Publishing Author:Preeti Singh

56

ROLE OF BANKS IN INDIAN FINACIAL SYSTEM

57