BANKING INSTITUTIONS

Unit – II:
Commercial Banks
Public and Private Sector Banks
Structure and Comparative Performance
Competition
Interest Rates
Spread and NPAs
Adequacy Norms and Capital Market Support
1 Banking Innovations
BPLR to Base Rate
Core Banking System
Financial Inclusion
 BANKING INSTITUTIONS
Unit – II:
Current Rates
Policy Rates
Reserve Rates
Lending Rates
Deposit Rates
Co-operative Banks – Role
2
Government Initiatives to Strengthen
Cooperative Banks
 Organization of Indian Financial
3
System
 Structure of Indian Banking System
4
 History of Indian Banking System
5
• The first bank in India was established in 1786.
• From 1786 till today, the journey of Indian
Banking System can be segregated into three
distinct phases.
 Early phase from 1786 to 1969 of Indian
Banks
 Nationalization of Indian Banks and up to
1991 prior to Indian banking sector
Reforms.
 New phase of Indian Banking System with
the advent of Indian Financial & Banking
Sector Reforms after 1991.
 PHASE I
 General Bank of India was set up in the year 1786
 East India Company established Bank of Bengal (1809),
Bank of Bombay (1840) and Bank of Madras (1843)
 These banks were amalgamated in 1920 and Imperial
Bank of India was established
 In 1865 Allahabad Bank was established
 Between 1906 and 1913, Bank of India, Central Bank of
India, Bank of Baroda, Canara Bank, Indian Bank, and
Bank of Mysore were set up.
 PHASE I

 Reserve Bank of India came in 1935.

 Growth was very slow and banks also experienced
periodic failures between 1913 and 1948.
 To streamline the functioning and activities of
commercial banks, the Government of India came
up with The Banking Companies Act, 1949 which
was later changed to Banking Regulation Act 1949
as per amending Act of 1965 (Act No. 23 of 1965).
 PHASE I

 Reserve Bank of India was vested with extensive

powers for the supervision of banking in India as
the Central Banking Authority.
 Public has lesser confidence in the banks.
 Deposit mobilization was slow.
 Savings bank facility provided by the Postal
department was comparatively safer.
 PHASE I

 Reserve Bank of India was vested with extensive

powers for the supervision of banking in India as
the Central Banking Authority.
 Public has lesser confidence in the banks.
 Deposit mobilization was slow.
 Savings bank facility provided by the Postal
department was comparatively safer.
 PHASE II
 In 1955, Imperial Bank of India was nationalized.
 State Bank of India was formed to act as the
principal agent of RBI and to handle banking
transactions of the Union and State Governments
all over the country.
 Seven banks forming subsidiary of State Bank of
India was nationalized in 1960
 On 19th July, 1969, 14 major commercial banks
in the country were nationalized.
 PHASE II

 Second phase of nationalization Indian Banking

Sector Reform was carried out in 1980 with seven
more banks.
 80% of the banking segment in India was under
Government ownership.
 Banking in the sunshine of Government ownership
gave the public implicit faith and immense
confidence about the sustainability of these
institutions.
 PHASE III
 In 1991, under the chairmanship of M
Narasimham, a committee was set up by his name
which worked for the liberalization of banking
practices.
 Efforts were made to give a satisfactory service
to customers.
 The entire system became more convenient and
swift.
 Time is given more importance than money.
 History of RBI
13
 History of RBI
14
Types of BANKS
Types of BANKS
 BROAD CLASSIFICATION OF BANKS IN INDIA
17 1) The RBI: The RBI is the supreme monetary and banking
authority in the country and has the responsibility to
control the banking system in the country. It keeps the
reserves of all scheduled banks and hence is known as the
“Reserve Bank”.
2) Public Sector Banks:
State Bank of India and its
Associates
Nationalized Banks (19)
Regional Rural Banks Sponsored by
Public Sector Banks (196)
 BROAD CLASSIFICATION OF BANKS IN INDIA
183) Private Sector Banks:

 Old Generation Private Banks (22)

 Foreign New Generation Private Banks (8)
 Banks in India (40)
4) Co-operative Sector Banks:
State Co-operative Banks (At the state level)
Central Co-operative Banks (At the district level)
Primary Agricultural Credit Societies (Village Level)
Land Development Banks Example: Orissa
Provincial Co-operative Land Mortgage Bank
Limited
State Land Development Banks
 BROAD CLASSIFICATION OF BANKS IN INDIA
19  5) Development Banks: Development Banks mostly
provide long term finance for setting up industries. They
also provide short-term finance (for export and import
activities)
 Industrial Finance Co-operation of India
 Industrial Development of India (IDBI)
 Industrial Investment Bank of India (IIBI)
 Small Industries Development Bank of India
 National Bank for Agriculture and Rural
Development (NABARD)
 Export-Import Bank of India
 COMMERCIAL BANKS
Commercial banks comprising of public sector banks, foreign
banks, and private sector banks represent the most important
financial intermediary in the Indian financial system.
Main Functions:
A)Acceptance of deposits:
 Fixed deposit account
 Saving bank account
 Current account
 Recurring deposit
B) Advancing of loans
 Loans (Demand loan, Term loan)
 Cash credit
 Overdraft
 Discounting of bills
 COMMERCIAL BANKS
C) Agency function
 Collecting receipts
 Making payments
 Buy and sell securities
 Trustee and executor
D ) General utility function
 Issuing letter of credit
 Underwriting shares and debentures
 Safe custody of valuables
 Providing ATM and credit card facilities
 Providing credit information
 Cooperative Banks
 These banks play a vital role in mobilizing savings and
stimulating agricultural investment.
 Co-operative credit institutions account for the second largest
proportion of 44.6% of total institutional credit.
 The co-operative sector is very much useful for rural people.
 The co-operative banking sector is divided into the following
categories.
 State Co-operativeBanks
 Central Co-operative Banks
 Primary Agricultural Credit Societies
Development Banks
 A Development Bank may be defined as a financial institution
concerned with providing all types of financial assistance to
business units in the form of loans, underwriting, investment
and guarantee operations and promotional activities-economic
development in general and industrial development in
particular.

 A development bank is basically a term lending institution. It is

a multipurpose financial institution with a broad development
outlook.

 The industrial finance corporation of India, the first

development bank was established in 1948. Subsequently many
other institutions were set-up. Ex. IDBI, IFCI, SIDBI etc.
 Functions of Development
Banks
 Fostering Industrial growth
 Providing Long term assistance
 Balanced development
 Providing Promotional services
 Infrastructure Development
 Entrepreneurial Development
 Fulfilling Socio Economic objectives
 Investment Banks

An investment bank is a financial institution that assists

individuals, corporations and governments in raising capital by
underwriting or acting as the client's agent in the issuance of
securities.
Functions of Investment Banks
 Serve as trading intermediaries for clients
 Lend and invest banks’ assets
 Provide advice on mergers, acquisitions, and other financial
transactions
 Research and develop opinions on securities, markets, and
economies
 Issue, buy, sell, and trade stocks and bonds
 Manage investment portfolios
Functions of Investment Banks

 Serve as trading intermediaries for clients

 Lend and invest banks’ assets
 Provide advice on mergers, acquisitions, and
other financial transactions
 Research and develop opinions on securities,
markets, and economies
 Issue, buy, sell, and trade stocks and bonds
 Manage investment portfolios
 Merchant Banks
A merchant bank is a financial institution that provides capital to
companies in the form of share ownership instead of loans. A merchant
bank also provides advise on corporate matters to the firms in which
they invest.
 The Major Merchant Banking activities which the Bank offers to its
clients are:
Issue Management - Management of Public Issues i.e.
IPOs, FPOs, Right Issues, etc. as Book Running Lead
Manager
Bankers to the Issue
Payment of Dividend Warrants / Interest Warrants /
Refund Orders
Debenture Trustee
Underwriting
Monitoring Agency
What is KYC?
KYC (Know Your Customer) is a framework for banks
which enables them to know / understand the customers
and their financial dealings to be able to serve them better.

Banking operations are susceptible to the risks of money

laundering and terrorist financing.
 Reserve Bank of India has advised banks to make the
Know Your Customer (KYC) procedures mandatory while
opening and operating the accounts and has issued the
KYC guidelines under Section 35 (A) of the Banking
Regulation Act, 1949.

 .
 When does KYC apply?

 Opening a new account.

 In respect of accounts where documents as per current KYC
standards have not been submitted while opening the initial
account.
 Opening a Locker Facility where these documents are not
available with the Bank for all the Locker facility holders.
 When the Bank feels it necessary to obtain additional
information from existing customers based on conduct of
account.
 When there are changes to signatories, mandate holders,
beneficial owners etc.
 For non-account holders approaching the Bank for high
value one-off transactions like Drafts, Remittances etc.
 Nationalized Banks

•Nationalised banks dominate the banking system in India.

• The history of nationalised banks in India dates back to mid-
20th century, when Imperial Bank of India was nationalised
(under the SBI Act of 1955) and re-christened as State Bank of
India (SBI) in July 1955.
•Then on 19th July 1960, its seven subsidiaries were also
nationalised with deposits over 200 crores.
• However, the major nationalisation of banks happened in 1969
by the then-Prime Minister Indira Gandhi.
• In the year 1980, the second phase of nationalisation of Indian
banks took place, in which 7 more banks were nationalised with
deposits over 200 crores.
 COMMERCIAL BANKS
The commercial banking structure in India consists of:

• Scheduled Commercial Banks

• Nonscheduled Banks

Scheduled Banks in India constitute those banks which have been included in
the Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI in turn
includes only those banks in this schedule which satisfy the criteria laid down
vide section 42 (6) (a) of the Act.
Non-Scheduled Banks
 Akhand Anand Co-operative Bank Limited.
 Alavi Co-Operative Bank Limited.
 Amarnath Co-Operative Bank Limited.
 Amod Nagrik Sahakari Bank Limited.
 SCHEDULED COMMERCIAL BANKS
Scheduled Banks: “Banks which have been included in the second scheduled of
the RBI Act, 1934”.
The banks included in this category should fulfil two conditions:

 Any activity of the bank will not adversely affect the interests of the
depositors.
 The paid up capital and collected fund of the bank should not be less than
Rs. 5 lac.

 Examples of Scheduled Banks are: Scheduled Commercial Banks in India

are categorised in 5 different groups according to their ownership / nature
of operation.
 These bank groups are: (i) State Bank of India (ii) Nationalised Banks, (iii)
Regional Rural Banks, (iv) Foreign Banks (v) Other Indian Scheduled
Commercial Banks (in the private sector).
 Interest Rates of Banks
33
 An interest rate is the rate at which interest is paid by a
borrower for the use of money borrowed from a lender.
 Fixed Rate of Interest: Here the interest rate doesn't
fluctuate during the given period of the loan. This
allows the borrower to accurately predict their future
payments.
 Floating Rate of Interest: Also known as variable
rate or adjustable rate. It refers to any type of debt
instrument, such as a loan, bond, mortgage, or credit,
that does not have a fixed rate of interest over the life
of the instrument.
 Such debt typically uses an index or other base rate for
establishing the interest rate for each relevant period.
 Interest Rates - Factors
34
Interest Rates depend upon the following factors:
 Monetary policies of the Central Bank of India
 Rate of Inflation
 Default
 Opportunity Cost
 Loan Tenure
 International Foreign Exchange rates
 Interest Rates Spread
35
 The net interest rate spread is the difference between
the average yield that a financial institution receives
from loans, along with other interest-accruing
activities, and the average rate it pays on deposits and
borrowings.
 The net interest rate spread is a key determinant of a
financial institution's profitability.
 Example: Credit depositors may receive 1.25% on their
money deposited. On the other hand while issuing a
mortgage to a home buyer the interest charged is
4.75%. In this case, the net interest rate spread would
be 3.5%, minus any fees or costs incurred by the bank
in effecting both transactions.
 Non-Performing Assets
36
 An asset, including a leased asset, becomes non-
performing when it ceases to generate income for the
bank.
 A ‘non-performing asset’ (NPA) was defined as a credit
facility in respect of which the interest and/ or
instalment of principal has remained ‘past due’ for a
specified period of time.
 The nonperforming asset is, therefore, not yielding any
income to the lender in the form of interest payments.
 Non-Performing Assets
37
 With effect from March 31, 2004, a non-performing
asset (NPA) shall be a loan or an advance where;
 interest and/ or installment of principal remain overdue
for a period of more than 90 days in respect of a term
loan,
 the account remains ‘out of order’ for a period of more
than 90 days, in respect of an Overdraft/Cash Credit
(OD/CC),
 the bill remains overdue for a period of more than 90 days
in the case of bills purchased and discounted,
 interest and/or instalment of principal remains overdue
for two harvest seasons but for a period not exceeding
two half years in the case of an advance granted for
agricultural purposes, and
 any amount to be received remains overdue for a period
of more than 90 days in respect of other accounts.
 Non-Performing Assets
38
 'Out of Order' status: An account should be treated
as 'out of order' if the outstanding balance remains
continuously in excess of the sanctioned limit/drawing
power.
 ‘Overdue’: Any amount due to the bank under any
credit facility is ‘overdue’ if it is not paid on the due
date fixed by the bank.
 Non-Performing Assets - Types
39
 Banks are required to classify NPAs into the following three
categories based on the period and the realisability of the dues:
 Sub-standard Assets
 Doubtful Assets
 Loss Assets
 Sub-standard Assets: With effect from 31 March 2001, a sub-
standard asset is one, which has remained NPA for a period
less than or equal to 18 months.
 Doubtful Assets: With effect from 31 March 2001, an asset is
to be classified as doubtful, if it has remained NPA for a period
exceeding 18 months.
 Loss Assets: Loss asset is considered uncollectible and of such
little value that its continuance as a bankable asset is not
warranted although there may be some salvage or recovery
value.
 Capital Adequacy Norms
40
 Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital
in relation to its risk weighted assets and current liabilities.
 It is decided by central banks and bank regulators to prevent
commercial banks from taking excess leverage and becoming
insolvent in the process.
 Capital Adequacy Ratio = (Tier I + Tier II + Tier III (Capital
funds)) /Risk weighted assets .
 The risk weighted assets take into account credit risk, market
risk and operational risk.
 The Basel III norms stipulated a capital to risk weighted assets
of 8%.
 However, as per RBI norms, Indian scheduled commercial
banks are required to maintain a CAR of 9% while Indian
public sector banks are emphasized to maintain a CAR of
12%.
 Capital Adequacy Norms
41
 Tier 1 capital is used to describe the capital adequacy of a bank
and refers to core capital that includes equity capital and
disclosed reserves. Equity capital is inclusive of instruments
that cannot be redeemed at the option of the holder.
 Tier 2 capital is the secondary component of bank capital, in
addition to Tier 1 capital, that makes up a bank's required
reserves.
 Tier 2 capital is the secondary layer of a bank's capital held as
required reserves.
 Tier 2 capital is subordinate to Tier 1 capital and is considered
riskier as it is more difficult to calculate if liquidation is
required.
 Tier 2 capital is comprised of revaluation reserves, general
provisions, subordinated term debt, and hybrid capital
instruments.
 Capital Adequacy Norms
42
 Tier 3 capital is tertiary capital, which many banks hold to
support their market risk, commodities risk, and
foreign currency risk. Tier 3 capital includes a greater variety
of debt than tier 1 and tier 2 capitals.

 Tier 3 capital debts may include a greater number of

subordinated issues, undisclosed reserves and general loss
reserves as compared with tier 2 capital. To qualify as tier 3
capital, assets must be limited to 250% of a banks tier 1
capital, be unsecured, subordinated, and have a minimum
maturity of two years.
 Capital Adequacy Norms
43
 A bank shall comply with the capital adequacy ratio
requirements at two levels:
 (a) the consolidated (“Group”) level capital adequacy ratio
requirements, which measure the capital adequacy of a bank
based on its capital strength and risk profile after consolidating
the assets and liabilities of its subsidiaries / joint ventures /
associates etc. except those engaged in insurance and any non-
financial activities; and
 (b) the standalone (“Solo”) level capital adequacy ratio
requirements, which measure the capital adequacy of a bank
based on its standalone capital strength and risk profile.
 Benchmark Prime Lending Rate
44
 A bank shall comply with the capital adequacy ratio
requirements at two levels:
 Benchmark Prime Lending Rate (BPLR) means internal
benchmark rate used to determine the interest rates on
advances/loans sanctioned upto June 30, 2010.
 Benchmark Prime Lending Rate (BPLR) is the rate at which
commercial banks charge their customers who are most credit
worthy.
 According to the Reserve Bank of India (RBI), banks can fix
the BPLR with the approval of their Boards. However, the RBI
stipulates the interest rates as BPLR is influenced by the Repo
rate and Cash Reserve Ratio (CRR) apart from individual
bank's policy.
 BPLR calculations are not transparent. Hence it has been
discontinued.
 Base Rate Rate
45
 Base rate is the minimum interest rate of a bank, below which
it cannot lend, except for DRI allowances, loans to bank's own
employees and loans to bank's depositors against their own
deposits.
 The base rate system has replaced the BPLR from July 1,
2010. RBI has allowed to continue with BPLR at which the
loans were approved, previously.
 Individual banks fix their own base rates and so each bank has
its own base rate.
 The calculations of base rate involve elements which can be
clearly identified and are common across buyers.
 Banks have to declare their respective base rates in the website
in order to make lending more transparent.
 The base rate gives a clear indication that the bank may not be
able to lend below this.
 Core Banking System
46  Core banking can be defined as a back-end system that
processes banking transactions across the various branches of a
bank.
 A core banking system is the software used to support a bank’s
most common transactions.
 The system essentially includes deposit, loan and credit
processing.
 Among the integral core banking services are floating new
accounts, servicing loans, calculating interests, processing
deposits and withdrawals, and customer relationship
management activities.
 Examples of core banking products include Infosys’ Finacle,
Nucleus FinnOne and Oracle's Flexcube application (from
their acquisition of Indian IT vendor i-flex).
 Core banking systems have made it possible to execute
transactions remotely, from any part of the world.
 Cooperative Credit Institutions - Structure
47
 Cooperative Banks
48  Cooperative bank is an institution established on the
cooperative basis and dealing in ordinary banking business.
 Like other banks, the cooperative banks are founded by
collecting funds through shares, accept deposits and grant
loans.
 The structure of cooperative network in India can be divided
into 2 broad segments-
 Urban Cooperative Banks
 Rural Cooperatives
 Urban Cooperatives can be further divided into scheduled and
non-scheduled. Both the categories are further divided into
multi-state and single-state.
 The rural cooperatives are further divided into short-term and
long-term structures. The short-term cooperative banks are
three tiered operating in different states.
 Cooperative Banks and Joint Stock Banks - Differences
S.No.49 Cooperative Banks
1.  Issue shares of unlimited liability,
2.  One shareholder has one vote
whatever the number of shares he
may hold.
3.  Concerned with the rural credit and
provide financial assistance for
agricultural and rural activities.
4.  Cooperative banking in India is
federal in structure.
5.  Cooperative credit societies are
located in the villages spread over
entire country.
Joint Stock Banks
 Issue shares of limited
liability.
 The voting right of a
shareholder is determined
by the number of shares he
possesses.
 Concerned with the credit
requirements of trade and
industry.
 No federal structure
 Banks and branches mostly
in urban and metro areas