BANKING PRACTICE

UNIT 1
INDIAN BANKING SYSTEM

Structure and other Details (with Diagrams)

Bank is an institution that accepts deposits of money from the public.
Anybody who has account in the bank can withdraw money. Bank also lends money.

Indigenous Banking:

The exact date of existence of indigenous bank is not known. But, it is certain that the old
banking system has been functioning for centuries. Some people trace the presence of indigenous
banks to the Vedic times of 2000-1400 BC. It has admirably fulfilled the needs of the country in
the past.

However, with the coming of the British, its decline started. Despite the fast growth of modern
commercial banks, however, the indigenous banks continue to hold a prominent position in the
Indian money market even in the present times. It includes shroffs, seths, mahajans, chettis, etc.
The indigenous bankers lend money; act as money changers and finance internal trade of India
by means of hundis or internal bills of exchange.

Defects:

The main defects of indigenous banking are:

(i) They are unorganized and do not have any contact with other sections of the banking world.

(ii) They combine banking with trading and commission business and thus have introduced trade
risks into their banking business.

(iii) They do not distinguish between short term and long term finance and also between the
purpose of finance.

(iv) They follow vernacular methods of keeping accounts. They do not give receipts in most
cases and interest which they charge is out of proportion to the rate of interest charged by other
banking institutions in the country.
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.

Scheduled & Non –scheduled Banks

A scheduled bank is a bank that is listed under the second schedule of the RBI Act, 1934. In
order to be included under this schedule of the RBI Act, banks have to fulfill certain conditions
such as having a paid up capital and reserves of at least 0.5 million and satisfying the Reserve
Bank that its affairs are not being conducted in a manner prejudicial to the interests of its
depositors. Scheduled banks are further classified into commercial and cooperative 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.

Commercial Banks

Commercial banks may be defined as, any banking organization that deals with the deposits and
loans of business organizations. Commercial banks issue bank checks and drafts, as well as
accept money on term deposits.  Commercial banks also act as moneylenders, by way of
installment loans and overdrafts. Commercial banks also allow for a variety of deposit accounts,
such as checking, savings, and time deposit. These institutions are run to make a profit and
owned by a group of individuals.

Scheduled Commercial Banks (SCBs):

Scheduled commercial banks (SCBs) account for a major proportion of the business of the
scheduled banks. SCBs in India are categorized into the five groups based on their ownership
and/or their nature of operations. State Bank of India and its six associates (excluding State Bank
of Saurashtra, which has been merged with the SBI with effect from August 13, 2008) are
recognised as a separate category of SCBs, because of the distinct statutes (SBI Act, 1955 and
SBI Subsidiary Banks Act, 1959) that govern them. Nationalized banks  and SBI and associates
together form the public sector banks group IDBI ltd. has been included in the nationalized banks
group since December 2004. Private sector banks include the old private sector banks and the
new generation private sector banks- which were incorporated according to the revised
guidelines issued by the RBI regarding the entry of private sector banks in 1993.

Foreign banks are present in the country either through complete branch/subsidiary route
presence or through their representative offices.
TYPES OF SCHEDULED COMMERCIAL BANKS

Public Sector Banks

These are banks where majority stake is held by the Government of India.
Examples of public sector banks are: SBI, Bank of India, Canara Bank, etc.

Private Sector Banks

These are banks majority of share capital of the bank is held by private individuals. These banks
are registered as companies with limited liability. Examples of private sector banks are: ICICI
Bank, Axis bank, HDFC, etc.

Foreign Banks

These banks are registered and have their headquarters in a foreign country but operate their
branches in our country. Examples of foreign banks in India are: HSBC, Citibank, Standard
Chartered Bank, etc

Regional Rural Banks

Regional Rural Banks were established under the provisions of an Ordinance promulgated on the
26th September 1975 and the RRB Act, 1976 with an objective to ensure sufficient institutional
credit for agriculture and other rural sectors. The area of operation of RRBs is limited to the area
as notified by GoI covering one or more districts in the State.

RRBs are jointly owned by GoI, the concerned State Government and Sponsor Banks (27
scheduled commercial banks and one State Cooperative Bank); the issued capital of a RRB is
shared by the owners in the proportion of 50%, 15% and 35% respectively.

Prathama bank is the first Regional Rural Bank in India located in the city Moradabad in Uttar
Pradesh.

Type of Major Shareholders Major Players

Commercial
Banks

Public Sector Government of India SBI, PNB, Canara Bank, Bank of

Banks Baroda, Bank of India, etc

Private Sector Private Individuals ICICI Bank, HDFC Bank, Axis Bank,
 Banks Kotak Mahindra Bank, Yes Bank etc.

Foreign Banks Foreign Entity Standard Chartered Bank, Citi Bank,

HSBC, Deutsche Bank, BNP Paribas,
etc.

Regional Rural Central Govt, Andhra Pradesh Grameena Vikas

Banks Concerned State Govt and Bank, Uttranchal Gramin Bank,
Sponsor Bank in the ratio of 50 : Prathama Bank, etc.
15 : 35
Cooperative Banks

A co-operative bank is a financial entity which belongs to its members, who are at the same time
the owners and the customers of their bank. Co-operative banks are often created by persons
belonging to the same local or professional community or sharing a common interest. Co-
operative banks generally provide their members with a wide range of banking and financial
services (loans, deposits, banking accounts, etc).

They provide limited banking products and are specialists in agriculture-related products.

Cooperative banks are the primary financiers of agricultural activities, some small-scale
industries and self-employed workers.

Co-operative banks function on the basis of “no-profit no-loss”.

Anyonya Co-operative Bank Limited (ACBL) is the first co-operative bank in India located in
the city of Vadodara in Gujarat.

The co-operative banking structure in India is divided into following main 5 categories:

• Primary Urban Co-op Banks

• Primary Agricultural Credit Societies

• District Central Co-op Banks

• State Co-operative Banks

• Land Development Banks

 The basic difference between scheduled commercial banks and scheduled cooperative banks is
in their holding pattern. Scheduled cooperative banks are cooperative credit institutions that are
registered under the Cooperative Societies Act. These banks work according to the cooperative
principles of mutual assistance.Also,unlike commercial banks ,these banks work on the basis of
“no-profit no-loss”.

How Banks Function

Banks make money by lending your money out at interest and by charging you for services
provided. Banks keep on lending money.

The other big revenue items generated by banks are the fees they charge. Bank charge for every
service, whether it is for an electronic transaction, or permitting a transfer through the Internet
banking system.

RESERVE BANK OF INDIA: FUNCTIONS AND PROMOTIONAL ROLES

Let us make in-depth study of the functions and promotional roles of Reserve Bank of India
(RBI).
Functions:

The Reserve Bank of India is performing various functions related to monetary management,
banking operations, foreign exchange, developmental works and research on problems of
economy.

The following are some of the major functions normally performed by the Reserve Bank of
India:
1. Note Issue:
Being the Central Bank of the country, the RBI is entrusted with the sole authority to issue
currency notes after keeping certain minimum reserve consisting of gold reserve worth Rs. 115
crore and foreign exchange worth Rs. 85 crore. This provision was later amended and simplified.
2. Banker to the Government:
The RBI is working as banker of the government and therefore all funds of both Central and
State Governments are kept with it. It acts as an agent of the government and manages its public
debt. RBI also offering “ways and means advance” to the government for short periods.
3. Banker’s Bank:
The RBI is also working as the banker of other banks working in the country. It regulates the
whole banking system of the country, keep certain percentage of their deposits as minimum
reserve, works as the lender of the last resort to its scheduled banks and operates clearing houses
for all other banks.
4. Credit Control:
The RBI is entrusted with the sole authority to control credit created by the commercial banks by
applying both quantitative and qualitative credit control measures like variation in bank rate,
open market operation, selective credit controls etc.
5. Custodian of Foreign Exchange Reserves:
The RBI is entrusted with sole authority to determine the exchange rate between rupee and other
foreign currencies and also to maintain the reserve of foreign exchange earned by the
Government. The RBI also maintains its relation with International Monetary Fund (IMF).
6. Developmental Functions:
The RBI is also working as a development agency by developing various sister organisations like
Agricultural Refinance Development Corporation. Industrial Development Bank of India etc. for
rendering agricultural credit and industrial credit in the country.
On July 12, 1986, NABARD was established and has taken over the entire responsibility of
ARDC. Half of the share capital of NABARD (Rs. 100 crore) has been provided by the Reserve
Bank of India. Thus, the Reserve Bank is performing a useful function for controlling and
managing the entire banking, monetary and financial system of the country.

Regulatory and Promotional Roles of Reserve Bank of India:

The Reserve Bank of India (RBI) has been playing an important role in the economy of the
country both in its regulatory and promotional aspects. Since the inception of planning in 1951,
the developmental activities are gaining momentum in the country. Accordingly, more and more
responsibilities have been entrusted with the RBI both in the regulatory and promotional area.
Now-a-days, the RBI has been performing a wide range of regulatory and promotional functions
in the country.
The following are some of the regulatory and promotional functions performed by the RBI:
1. Regulating the Volume of Currency:
The RBI is performing the regulatory role in issuing and controlling the entire volume of
currency in the country through its Issue Department. While regulating the volume of currency
the RBI is giving priority on the demand for currency and the stability of the economy equally.
2. Regulating Credit:
The RBI is also performing the role to control the credit money created by the commercial banks
through its qualitative and quantitative methods of credit control and thereby maintains a balance
in the money supply of the country.
3. Control over Commercial Banks:
Another regulatory role performed by the RBI is to have control over the functioning of the
commercial banks. It also enforces certain prudential norms and rational banking principles to be
followed by the commercial banks.
4. Determining the Monetary and Credit Policy:
The RBI has been formulating the monetary and credit policy of the country every year and
thereby it controls the Statutory Liquidity Ratio (SLR), Cash Reserve Ratio (CRR), bank rate,
interest rate, credit to priority sectors etc.
5. Mobilizing Savings:
The RBI is playing a vital promotional role to mobilize savings through its member commercial
banks and other financial institutions. RBI is also guiding the commercial banks to extend their
banking network in the unbanked rural and semi-urban areas and also to develop banking habits
among the people. All these have led to the attainment of greater degree of monetization of the
economy and has been able to reduce the activities of indigenous bankers and private money-
lenders.
6. Institutional Credit to Agriculture:
The RBI has been trying to increase the flow of institutional credit to agriculture from the very
beginning. Keeping this objective in mind, the RBI set up ARDC in 1963 for meeting the long
term credit requirement of rural areas. Later on in July 1982, the RBI set up NABARD and
merged ARDC with it to look after its agricultural credit functions.
7. Specialized Financial Institutions:
The RBI has also been playing an important promotional role for setting specialized financial
institutions for meeting the long term credit needs of large and small scale industries and other
sectors. Accordingly, the RBI has promoted the development of various financial institutions
like, WCI, 1DBI, ICICI, SIDBI, SFCs, Exim Bank etc. which are making a significant
contribution to industry and trade of the country.
8. Security to Depositors:
In order to remove the major hindrance to the deposit mobilization arising out of frequent bank
failures, the RBI took major initiative to set up the Deposit Insurance Corporation of India in
1962. The most important objective of this corporation is to provide security to the depositors
against such failures.
9. Advisory Functions:
The RBI is also providing advisory functions to both the Central and State Governments on both
financial matters and also on general economic problems.
10. Policy Support:
The RBI is also providing active policy support to the government through its investigation
research on serious economic problems and issues of the country and thereby helps the
Government to formulate its economic policies in a most rational manner. Thus, it is observed
that the RBI has been playing a dynamic role in the economic development process of the
country through its regulatory and promotional framework.

NATIONALIZED & SCHEDULED BANKS IN INDIA

The scheduled commercial banks are those banks which are included in the second schedule of
RBI Act 1934 and which carry out the normal business of banking such as accepting deposits,
giving out loans and other banking services. The major difference between Scheduled
Commercial Banks and Scheduled Cooperative Banks is their holding pattern, since cooperatives
are registered under the Cooperative Societies Act as cooperative credit institutions.

Scheduled Commercial Banks can be further divided into four groups:

 Public Sector Banks: This includes:

 SBI & Associates
 Nationalized Banks
 Other Public Sector Banks
 Private Banks
 Foreign Banks
 Regional Rural Banks

Scheduled Commercial Banks (Public Sector)

At present, there are 27 Public Sector Banks in India including SBI (plus its 5 associates) and 19
nationalized banks. Further, there are two banks which have been categorized by RBI as “Other
Public Sector Banks”. IDBI and Bhartiya Mahila Bank come under this category.

SBI & Associates

State Bank of India with its around 17,000 branches and around 200 foreign offices, is India’s
largest banking and financial services company by assets. With over 2 lakh employees, SBI is
banker to millions of Indians. This bank got birth in the British Era. Its first parents were three
presidency banks viz. Bank of Calcutta (later Bank of Bengal), Bank of Bombay and the Bank of
Madras. In 1921, these three presidency banks were merged in one entity called “Imperial Bank
of India”. The Imperial Bank of India was nationalized in 1955 and was renamed a State Bank of
India. Thus, State bank of India is the oldest Bank of India.

In 1959, there were eight associates of SBI. The current five associate banks of SBI are:
 State Bank of Bikaner & Jaipur
 State Bank of Hyderabad
 State Bank of Mysore
 State Bank of Patiala
 State Bank of Travancore
Apart from the above, the SBI also has seven non-banking subsidiaries viz. SBI Capital Markets
Ltd, SBI Funds Management Pvt Ltd, SBI Factors & Commercial Services Pvt Ltd, SBI Cards &
Payments Services Pvt. Ltd. (SBICPSL), SBI DFHI Ltd, SBI Life Insurance Company Limited
and SBI General Insurance.

Nationalized Banks
There are 19 nationalized banks in India as follows
1. Andhra Bank
2. Bank of Baroda
3. Bank of India
4. Bank of Maharashtra
5. Canara Bank
6. Central Bank of India
7. Corporation Bank
8. Dena Bank
9. Indian Bank
11. Indian Overseas Bank
12. Oriental Bank of Commerce
13. Punjab & Sind Bank
14. Punjab National Bank
15. Syndicate Bank
16. UCO Bank
17. Union Bank of India
18. United Bank of India
19. Vijaya Bank

Other Public Sector Banks

Further, there are two scheduled commercial banks in India, which have been classified as “other
Public Sector Banks”. These are
1. IDBI
2. Bhartiya Mahila Bank.

Scheduled Commercial Banks (Private Banks)

In private sector banks, most of the capital is in private hands. There are two types of private
sector banks in India viz. Old Private Sector Banks and New Private Sector Banks.

Old Private Banks

There are 13 old private sector banks as follows:

1. Catholic Syrian Bank
2. City Union Bank
3. Dhanlaxmi Bank
4. Federal Bank
5. ING Vysya Bank
6. Jammu and Kashmir Bank
7. Karnataka Bank
8. Karur Vysya Bank
9. Lakshmi Vilas Bank
10. Nainital Bank
11. Ratnakar Bank
12. South Indian Bank
13. Tamilnad Mercantile Bank

Out of the above banks, the Nainital Bank is a subsidiary of the Bank of Baroda, which has
98.57% stake in it. Some other old generation private sector banks in India have merged with
other banks. For example, Lord Krishna Bank merged with Centurion Bank of Punjab in 2007;
Sangli Bank merged with ICICI Bank in 2006; Centurion Bank of Punjab merged with HDFC in
2008.

New Private Sector Banks

The new private sector banks were incorporated as per the revised guidelines issued by the RBI
regarding the entry of private sector banks in 1993. At present, there are seven new private sector
banks as follows:
1. Axis Bank
2. Development Credit Bank (DCB Bank Ltd)
3. HDFC Bank
4. ICICI Bank
5. IndusInd Bank
6. Kotak Mahindra Bank
7. Yes Bank

Apart from the above, there are two banks which are yet to commence operation. These have
obtained ‘in-principle’ licenses from RBI. They are

1. IDFC
2. Bandhan Bank of Bandhan Financial Services.

Foreign Banks
As of December 2014, there are 43 foreign banks from 26 countries operating as branches in
India and 46 banks from 22 countries operating as representative offices in India. Most of the
foreign banks in India are niche players. RBI policy towards presence of foreign banks in India is
based upon two cardinal principles viz. reciprocity and single mode of presence. more details
about regulation of Foreign Banks by RBI, click here

Regional Rural Banks

Regional Rural Banks were started in 1970s due to the fact that even after nationalization, there
were cultural issues which made it difficult for commercial banks, even under government
ownership, to lend to farmers. Each RRB is owned by three entities with their respective shares
as follows:
 Central Government → 50%
 State government → 15%
 Sponsor bank → 35%
What are Development Banks?
Development banks are those which have been set up mainly to provide infrastructure facilities
for the industrial growth of the country. They provide financial assistance for both public and
private sector industries.

Objectives of Development Banks

The main objectives of the development banks are
1. to promote industrial growth,
2. to develop backward areas,
3. to create more employment opportunities,
4. to generate more exports and encourage import substitution,
5. to encourage modernisation and improvement in technology,
6. to promote more self employment projects,
7. to revive sick units,
8. to improve the management of large industries by providing training,
9. to remove regional disparities or regional imbalance,
10. to promote science and technology in new areas by providing risk capital,
11. to improve capital market in the country.

Development Banks in India

Working capital requirements are provided by commercial banks, indigenous bankers, co-
operative banks, money lenders, etc. The money market provides short-term funds which mean
working capital requirements.

The long term requirements of business concerns are provided by industrial banks, and the
various long term lending institutions which are created by government. In India these long term
lending institutions are collectively referred as development banks. They are:

1. Industrial Finance Corporation of India (IFCI), 1948

2. Industrial Credit and Investment Corporation of India (ICICI), 1955
3. Industrial Development of Bank of India (IDBI), 1964
 4. State Finance Corporation (SFC), 1951
5. Small Industries Development Bank of India (SIDBI), 1990
6. Export Import Bank (EXIM)
7. Small Industries Development Corporation (SIDCO)
8. National Bank for Agriculture and Rural Development (NABARD).

In addition to these institutions, there are also institutions such as Life Insurance Corporation of
India, General Insurance Corporation of India, National Housing Bank, Unit Trust of India, etc.,
which are providing investment funds.

Differences between Commercial banks and Development banks

The following are some of the differences between commercial banks and development banks.
COMMERCIAL BANKS DEVELOPMENT BANKS
Provide short term loans. Provide long term loans.
Accept deposits from commercial
Accept deposits from the public.
banks, Central and State governments.
Provide refinancing tacilities to
Direct finance to customers.
commercial banks.
Play an important role in hire
Plays an important role in the money market.
purchase, lease finance, housing loan.
Public sector banks have their share capital contributed by the
Central and Statement governments
government while private sector banks have share capital
contribute capital.
contributed by the public.
Promote savings among the public and help commercial They promote economic growth of the
activities. country.