Merchant Banking &Financial Services

Module - 1 Bank & Banking

BY: VIKAS JAIN(MBA)

Definition of Bank & Banker

As per Sec.5 (b) of the Banking Regulation Act Banking' means accepting, for the purpose of lending or investment, of deposits of money from the public repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise."

According to Sec. 2 of the Bill of Exchange Act, 1882, banker includes a body of persons, whether incorporated or not who carry on the business of banking.

Role of Banking
Banks provide funds for business as well as personal needs of individuals. They play a significant role in the economy of a nation. Let us know about the role of banking. It encourages savings habit amongst people and thereby makes funds available for productive use. It acts as an intermediary between people having surplus money and those requiring money for various business activities. It facilitates business transactions through receipts and payments by cheques instead of currency. It provides loans and advances to businessmen for short term and long-term purposes.

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It also facilitates import export transactions. It helps in national development by providing credit to farmers, small-scale industries and self-employed people as well as to large business houses which lead to balanced economic development in the country. It helps in raising the standard of living of people in general by providing loans for purchase of consumer durable goods, houses, automobiles, etc. There are various types of banks which operate in our country to meet the financial requirements

Central Bank
The Reserve Bank of India is the central Bank that is fully owned by the Government. It is governed by a central board (headed by a Governor) appointed by the Central Government. It issues guidelines for the functioning of all banks operating within the country. The Bank was constituted for the need of following: To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its advantage

Commercial Banks
Commercial Banks are banking institutions that accept deposits and grant short-term loans and advances to their customers. In addition to giving short-term loans, commercial banks also give medium-term and long-term loan to business enterprises. Now-a-days some of the commercial banks are also providing housing loan on a long-term basis to individuals. There are also many other functions of commercial banks, which are discussed later in this lesson.

SCHEDULE COMMERCIAL BANK

All banks which are included in the Second Schedule to the Reserve Bank of India Act, 1934 are scheduled banks. These banks comprise
a) b) Scheduled Commercial Banks Scheduled Cooperative Banks.

SCHEDULE COMMERCIAL BANK

Scheduled Commercial Banks in India are categorized into five different groups according to their ownership and / or nature of operation. These bank groups are (i) State Bank of India and its associates, (ii) Nationalized Banks (iii) Regional Rural Banks (iv) Foreign Banks (v) Other Indian Scheduled Commercial Banks (in the private sector).

Types of Commercial banks

Commercial banks are of three types i.e., Public sector banks, Private sector banks and Foreign banks.

Public Sector Banks

State Bank of India and its associate banks called the State Bank Group 20 nationalized banks Regional rural banks mainly sponsored by public sector banks

Private Sector Banks

In case of private sector banks majority of share capital of the bank is held by private individuals. These banks are registered as companies with limited liability. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd., Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank Ltd., Global Trust Bank, Vysya Bank, etc. Old generation private banks New generation private banks Foreign banks operating in India Scheduled co-operative banks Non-scheduled banks

Foreign Banks
These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Some of the foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, Grindlays Bank, etc. The number of foreign banks operating in our country has increased since the financial sector reforms of 1991.s

Development Banks
Business often requires medium and long-term capital for purchase of machinery and equipment, for using latest technology, or for expansion and modernization. Such financial assistance is provided by Development Banks. They also undertake other development measures like subscribing to the shares and debentures issued by companies, in case of under subscription of the issue by the public. Industrial Finance Corporation of India (IFCI) and State Financial Corporations (SFCs) are examples of development banks in India.

Development Banks/Financial Institutions

IFCI IDBI ICICI IIBI SCICI Ltd. NABARD Export-Import Bank of India National Housing Bank Small Industries Development Bank of India North Eastern Development Finance Corporation

Co-operative Sector - Definition

People who come together to jointly serve their common interest often form a co-operative society under the Co-operative Societies Act. When a cooperative society engages itself in banking business it is called a Co-operative Bank. The society has to obtain a license from the Reserve Bank of India before starting banking business. Any co-operative bank as a society is to function under the overall supervision of the Registrar, Co-operative Societies of the State. As regards banking business, the society must follow the guidelines set and issued by the Reserve Bank of India.

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The co-operative sector is very much useful for rural people. The cooperative banking sector is divided into the following categories. State co-operative Banks: These are the apex (highest level) cooperative banks in all the states of the country. They mobilize funds and help in its proper channelization among various sectors. The money reaches the individual borrowers from the state co-operative banks through the central co-operative banks and the primary credit societies. Central co-operative banks :These banks operate at the district level having some of the primary credit societies belonging to the same district as their members. These banks provide loans to their members (i.e., primary credit societies) and function as a link between the primary credit societies and state co-operative

banks.

 Primary Agriculture Credit Societies: These are formed at the village or town level with borrower and non-borrower members residing in one locality. The operations of each society are restricted to a small area so that the members know each other and are able to watch over the activities of all members to prevent frauds.

Specialized Banks
There are some banks, which cater to the requirements and provide overall support for setting up business in specific areas of activity. EXIM Bank, SIDBI and NABARD are examples of such banks. They engage themselves in some specific area or activity and thus, are called specialized banks. Let us know about them

i. Export Import Bank of India (EXIM Bank): If you want to set

up a business for exporting products abroad or importing products from foreign countries for sale in our country, EXIM bank can provide you the required support and assistance. The bank grants loans to exporters and importers and also provides information about the international market. It gives guidance about the opportunities for export or import, the risks involved in it and the competition to be faced, etc.

(ii). Small Industries Development Bank of India (SIDBI): If you want to establish a smallscale business unit or industry, loan on easy terms can be available through SIDBI. It also finances modernization of small-scale industrial units, use of new technology and market activities. The aim and focus of SIDBI is to promote, finance and develop small-scale industries s

 iii. National Bank for Agricultural and Rural Development (NABARD): It is a central or apex institution for financing agricultural and rural sectors. If a person is engaged in agriculture or other activities like handloom weaving, fishing, etc. NABARD can provide credit, both short-term and long-term, through regional rural banks. It provides financial assistance, especially, to co-operative credit, in the field of agriculture, small-scale industries, cottage and village industries handicrafts and allied economic activities in rural areas.

Functions of Commercial Banks

The functions of commercial banks are of two types. (A) Primary functions; and (B) Secondary functions. Let us discuss details about these functions.

Primary functions
The primary functions of a commercial bank include: a) Accepting Deposits: The most important activity of a commercial bank is to mobilize deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank Generally the following three types of deposits are accepted: Current deposit or demand deposits Savings deposits Fixed or time deposits

Current Deposits or Demand Deposits

These deposits are repayable on demand. They are known as demand deposits in USA and current deposits in England. These deposits are usually opened with a minimum balance prescribed by the bank and any amount can be deposited in the account. These deposits can be withdrawn by the issue of cheque. Generally no interest is allowed on current account. These accounts are normally opened by bussiness houses

Savings Deposits
Savings deposit accounts are maintained by the commercial banks to pool the small savings of low and middle income groups. This is a device to encourage thrift among the persons who earn only fixed income every month. Certain restrictions may vary from bank to bank. Usually, all banks restrict the maximum amount that can be deposited in or withdrawn from savings accounts. The number of cheques that can be drawn against the account within a specified period is also restricted.

Fixed Deposits or Time Deposits

These are deposits for a fixed period. These deposits are known as fixed deposits in England and time deposits in the United States. Fixed deposits are advantageous to both the banker and the depositor. The depositors prefer this type of deposits as they earn a higher rate of interest. The banker is interested in such deposits because they get the money for a fixed period. As the repayment is certain, the depositors are able to invest the money for long periods and thus, earn a higher return on the investment. Cheque system is not allowed against fixed deposits.

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b) Grant of loans and advances: The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies according to the purpose and period of loan and also the mode of repayment i) Loans: A loan is granted for a specific time period. Generally commercial banks provide short-term loans. But term loans, i.e., loans for more than a year may also be granted. The borrower may be given the entire amount in lump sum or in installments. Loans are generally granted against the security of certain assets. A loan is normally repaid in installments. However, it may also be repaid in lump sum.

 ii) Advances An advance is a credit facility provided by the bank to its customers. It differs from loan in the sense that loans may be granted for longer period, but advances are normally granted for a short period of time. Further the purpose of granting advances is to meet the day-to-day requirements of business. The rate of interest charged on advances varies from bank to bank. Interest is charged only on the amount withdrawn and not on the sanctioned amount.

Types of Advances
Banks grant short-term financial assistance by way of cash credit, overdraft and bill discounting. a) Cash Credit: Cash credit is an arrangement whereby the bank allows the borrower to draw amount up to a specified limit. The amount is credited to the account of the customer. The customer can withdraw this amount as and when he requires. Interest is charged on the amount actually withdrawn. Cash Credit is granted as per terms and conditions agreed with the customers. b) Overdraft: Overdraft is also a credit facility granted by bank. A customer who has a current account with the bank is allowed to withdraw more than the amount of credit balance in his account. It is a temporary arrangement. Overdraft facility with a specified limit may be allowed either on the security of assets, or on personal security, or both.

 c) Discounting of Bills: Banks provide short-term finance by discounting bills, that is, making payment of the amount before the due date of the bills after deducting a certain rate of discount. The party gets the funds without waiting for the date of maturity of the bills. In case any bill is dishonoured on the due date, the bank can recover the amount from the customer.

Secondary functions
In addition to the primary functions of accepting deposits and lending money, banks perform a number of other functions, which are called secondary functions. These are as follows Issuing letters of credit, travellers cheque, etc Undertaking safe custody of valuables, important document and securities by providing safe deposit vaults or lockers. Providing customers with facilities of foreign exchange dealings. Transferring money from one account to another; and from one branch to another branch of the bank through cheque, pay order, demand draft.

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Standing guarantee on behalf of its customers, for making payment for purchase of goods, machinery, vehicles etc. Collecting and supplying business information. Providing reports on the credit worthiness of customers. Providing consumer finance for individuals by way of loans on easy terms for purchase of consumer durables like televisions, refrigerators, etc. Educational loans to students at reasonable rate of interest for higher studies, especially for professional courses.

Banker & Customer Relationship

Banking is a trust-based relationship. There are numerous kinds of relationship between the bank and the customer. The relationship between a banker and a customer depends on the type of transaction. Thus the relationship is based on contract, and on certain terms and conditions. The banker customer relationship is fiducial relationship. The terms and conditions governing the relationship is not be leaked by the banker to a third party

Classification of Relationship
The relationship between a bank and its customers can be broadly categorized in to General Relationship and Special Relationship

General Relationship
If we look at Sec 5(b) of Banking Regulation Act, we would notice that banks business hovers around accepting of deposits for the purposes of lending. Thus the relationship arising out of these two main activities are known as General Relationship.

Debtor-Creditor:
When a 'customer' opens an account with a bank, he fills in and signs the account opening form. By signing the form he enters into an agreement/contract with the bank. When customer deposits money in his account the bank becomes a debtor of the customer and customer a creditor. The money so deposited by customer becomes banks property and bank has a right to use the money as it likes. The bank is not bound to inform the depositor the manner of utilization of funds deposited by him.

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Bank does not give any security to the depositor i.e. debtor. The bank has borrowed money and it is only when the depositor demands, banker pays. Banks position is quite different from normal debtors. Banker does not pay money on its own, as banker is not required to repay the debt voluntarily. The demand is to be made at the branch where the account exists and in a proper manner and during working days and working hours.

CreditorDebtor:
Lending money is the most important activities of a bank. The resources mobilized by banks are utilized for lending operations. Customer who borrows money from bank owns money to the bank. In the case of any loan/advances account, the banker is the creditor and the customer is the debtor. when he borrows money from the bank. Borrower executes documents and offer security to the bank before utilizing the credit facility. In addition to opening of a deposit/loan account banks provide variety of services, which makes the relationship more wide and complex. Depending upon the type of services rendered and the nature of transaction, the banker acts as a bailee, trustee, principal, agent, lessor, custodian etc.

Special Relationship
In addition to these two activities banks also undertake other activities mentioned in Sec.6 of Banking Regulation Act. Relationship arising out of the activities mentioned in Sec.6 of the act is termed as special relationship.

1. Bank as a Trustee
In case of trust banker customer relationship is a special contract. When a person entrusts valuable items with another person with an intention that such items would be returned on demand to the keeper the relationship becomes of a trustee and trustier. Customers keep certain valuables or securities with the bank for safekeeping or deposits certain money for a specific purpose (Escrow accounts) the banker in such cases acts as a trustee. Banks charge fee for safekeeping valuables .

2. Bailee Bailor:
Sec.148 of Indian Contract Act, 1872, defines "Bailment" "bailor" and "bailee". A "bailment" is the delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the "bailor". The person to whom they are delivered is called, the "bailee". Banks secure their advances by obtaining tangible securities. In some cases physical possession of securities goods (Pledge), valuables, bonds etc., are taken. While taking physical possession of securities the bank becomes bailee and the customer becomes bailor. Banks also keeps articles, valuables, securities etc., of its customers in Safe Custody and acts as a Bailee. As a bailee the bank is required to take care of the goods bailed.

3 Lessor and Lessee:

Providing safe deposit lockers is as an ancillary service provided by banks to customers. While providing Safe Deposit Vault/locker facility to their customers bank enters into an agreement with the customer. The agreement is known as Memorandum of letting and attracts stamp duty. The relationship between the bank and the customer is that of lessor and lessee. Banks lease (hire lockers to their customers) their immovable property to the customer and give them the right to enjoy such property during the specified period i.e. during the office/ banking hours and charge rentals.

4 Agent and Principal:

Sec.182 of The Indian Contract Act, 1872 defines an agent as a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done or who is so represented is called the Principal. Thus an agent is a person, who acts for and on behalf of the principal and under the latters express or implied authority and the acts done within such authority are binding on his principal and, the principal is liable to the party for the acts of the agent.

Continued
Banks collect cheques, bills, and makes payment to various authorities viz., rent, telephone bills, insurance premium etc., on behalf of customers. . Banks also abides by the standing instructions given by its customers. In all such cases bank acts as an agent of its customer, and charges for theses services. As per Indian contract Act agent is entitled to charges. No charges are levied in collection of local cheques through clearing house. Charges are levied in only when the cheque is returned in the clearinghouse.

5 As a Custodian
A custodian is a person who acts as a caretaker of some thing. Banks take legal responsibility for a customers securities. While opening a de-mat account bank becomes a custodian. Bank has the right to break-open the locker in case the locker holder defaults in payment of rent. Banks do not assume any liability or responsibility in case of any damage to the contents kept in the locker. Banks do not insure the contents kept in the lockers by customers

6 As a Guarantor
Banks give guarantee on behalf of their customers and enter in to their shoes. Guarantee is a contingent contract. As per sec 31,of Indian contract Act guarantee is a " contingent contract ". Contingent contract is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen. It would thus be observed that banker customer relationship is transactional relationship.

IT Products & Services

E-banking (Electronic Banking) With advancement in information and communication technology, banking services are also made available through computer. Now, in most of the branches you see computers being used to record banking transactions. Information about the balance in your deposit account can be known through computers. In most banks now a days human or manual teller counter is being replaced by the Automated Teller Machine (ATM). Banking activity carried on through computers and other electronic means of communication is called electronic banking or e-banking.

Debit Card
Banks are now providing Debit Cards to their customers having saving or current account in the banks. The customers can use this card for purchasing goods and services at different places in lieu of cash. The amount paid through debit card is automatically debited (deducted) from the customers account.

Credit Card
Credit cards are issued by the bank to persons who may or may not have an account in the bank. Just like debit cards, credit cards are used to make payments for purchase, so that the individual does not have to carry cash. Banks allow certain credit period to the credit cardholder to make payment of the credit amount. Interest is charged if a cardholder is not able to pay back the credit extended to him within a stipulated period. This interest rate is generally quite high.

Net Banking
With the extensive use of computer and Internet, banks have now started transactions over Internet. The customer having an account in the bank can log into the banks website and access his bank account. He can make payments for bills, give instructions for money transfers, fixed deposits and collection of bill, etc under internet banking, one can do any transaction simply at in front of a computer the following type of transaction can be done online Pay utility bills, view and print your statements Transfer funds online between accounts Stop cheques, request cheque books

Phone Banking
In case of phone banking, a customer of the bank having an account can get information of his account, make banking transactions like, fixed deposits, money transfers, demand draft, collection and payment of bills, etc. by using telephone . As more and more people are now using mobile phones, phone banking is possible through mobile phones. In mobile phone a customer can receive and send messages (SMS) from and to the bank in addition to all the functions possible through phone banking.

Types of Accounts
Saving account: a saving account is a type of account that can be opened in any commercial bank, the deposits made

Savings Account
A Savings bank account is the most common operating

account for individuals and others for non-commercial transactions. A Savings account helps people to put through day-today banking transactions besides earning some return on the savings made. Banks generally put some ceilings on the total number of withdrawals permitted during specific time periods. Banks also stipulate certain minimum balance to be maintained in savings accounts. Normally a higher minimum balance is stipulated in cheque operated accounts as compared to non-cheque operated accounts. Banks as a rule do not give overdraft facility in a saving account,

Current Account
Current accounts are cheque operated accounts maintained for mainly business purposes. Unlike savings bank account no limits are fixed by banks on the number of transactions permitted in the Account. Banks generally insist on a higher minimum balance to be maintained in current account. Considering the large number of transactions in the account and volatile nature of balances maintained overnight banks generally levy certain service charges for operating a Current account.

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In terms of RBI directive banks are not allowed to pay any interest on the balances maintained in Current accounts. However, legal heirs of a deceased person are paid interest at the rates applicable to Savings bank deposit from the date of death of the account holder till the date of settlement.

Fixed deposits
Fixed deposits are saving instruments, in which a specified

amount is deposited in an account for a specified tenure and the bank pays the interest accordingly. Generally fixed deposits carry a high rate of interest as the money is locked for a longer time period, such as one year, three year or five to ten year also. A fixed deposit is a very useful instrument for long-term planning. Some of the important features of this deposits are as followsInterest may be paid monthly, quarterly or yearly. Interest earned can also be reinvested Minimum deposit has to be maintained

Recurring Deposit
Recurring deposit is another important form of savings instrument. A recurring deposit can be opened by an individual, wherein a specified amount is deposited every month in the account. A recurring deposit provides the following advantages: Encourages savings Has a high rate of interest Loans are available against the deposits Non applicability of tax deducted at source.

De-mat Account
Demat refers to a dematerialised t account maintained by the Stock broking agencies, for the purpose of buying and selling of stocks in stock market by the account holder like maintaining a savings/current account by an individual in a bank. Demat account is a safe and convenient means of holding securities just like a bank account is for funds. Today, practically 99.9% settlement (of shares) takes place on demat mode only. The dematerialised account is used to avoid holding physical shares: the shares are converted in to electronic form.