Note on Banking

Bank Definition

before the due date. [However, premature

A bank is a financial institution which accepts

money from the people in the form of Deposits
and gives advances to them in the form of
Loans.

closure is allowed with certain conditions]

Deposits ar
o types
aree of tw
two
1. Demand Deposits. Eg: Current
Account / Savings Account.
Deposits
2. Term/Time Deposits.Eg: Fixed
Deposits / Recurring Deposits.

A higher rate of interest is paid in this account,

as compared to savings account.

Recurring or Cum
ulativ
Cumulativ
ulativee Deposits

A particular fixed amount or instalment is

deposited in this account every month.

This account is useful to build a capital sum

through regular small savings.

Loans ar
o types
aree of tw
two
1. Demand Loans. Eg: Gold Loans,

Curr
ent Account
Current

Crop loans.

Generally maintained by businesspersons /

large institutions / companies.

No interest is paid for balances in the account.

There are no restrictions on the number

transactions.

Overdraft (OD) can be extended in this

account, at the discretion of the bank.

Savings Account

Generally maintained by individuals.

Nominal rate of interest will be paid on the

balances in this account.

There are restrictions on the number of

withdrawals.

Fix
ed Deposits
ixed

Loans
2. Term Loans. Eg: Housing loan /
Personal Loan.
Demand Loans are usually repayable in 12 to
18 months.
Term Loans are repayable in instalments. The
repayment may extend to over twenty years,
in some cases.

History of Banking Dev

elopment in India
Development
The Banking Regulation Act, 1949 defines the term
Banking as accepting, deposits for the purpose
of lending or investment, and withdrawable by
cheque, draft, order or otherwise.
1. The first bank in India was called the Bank

A lumpsum amount will be deposited in this

account.

of Hindustan and was established in 1770 by

The depositor cannot withdraw the amount

European Management.

Alexander and Co, at Calcutta, under

NOTE ON BANKING
2. Presidency Banks were established by the
British: Bank of Bengal in 1806, followed
by Bank of Bombay in 1840, and Bank of
Madras in 1843.

[The fourteen banks nationalized had reserves

3. The first bank with limited liability, managed

by Indians, was Oudh Commercial Bank
founded in 1881. Subsequently, Punjab
National Bank was established in 1894.
Allahabad Bank was established in 1865.

than Rs.200 crore. The banks were

4. In 1921, all Presidency Banks were merged

and renamed as the Imperial Bank of India.

(5) Corporation Bank

or deposits of more than Rs.50 crores]

Six banks were nationalized on April 15,
1980. They had reserves or deposits of more
(1) Andhra Bank
(2) Punjab & Sind Bank
(3) New Bank of India
(4) Vijaya Bank
(6) Oriental Bank of Commerce

5. The Banking Companies Act was passed in

February 1949, which was subsequently
amended as the Banking Regulation Act,
1949.

9. Regional Rural Banks [RRBs] (also known

6. The largest bank The Imperial Bank of India

was nationalized in 1955 and rechristened
as State Bank of India (SBI) followed by
formation of its 8 Associate Banks in 1959.
[now seven associate banks].

10. The

7. The period from 1913 to 1918 witnessed a

crisis in the banking sector with as many as
94 banks collapsing.
8. The Government issued an ordinance on July
19, 1969 acquiring ownership and control of
14 major banks in the country. Six more
Commercial banks were nationalised from 15
April, 1980. The fourteen banks nationalised
on 19th July 1969 were the Central Bank of
India, Bank of India, Punjab National Bank,
Canara Bank, UCO Bank, Syndicate Bank,
Bank of Baroda, United Bank of India, Union
Bank of India, Dena Bank, Allahabad Bank,
Indian Bank, Indian Overseas Bank and Bank
of Maharashtra.
2

as Grameena Banks) were formed in 1975,

initially in Uttar Pradesh, Haryana, Rajasthan
and West Bengal.
Narsimhan

Committee

(year)

recommended granting permission for the

opening of new private banks. Ten private
banks were granted permission during 1994
and 1995. These banks were known as New
Generation Banks, because of their stress
on customer friendly and automation friendly
policies Prominent among the ten banks were
ICICI Bank. HDFC Bank and UTI Bank
[now Axis Bank].

Reserv
Reservee Bank of India
The Reserve Bank of India is the apex bank or
central bank of the country. Central banks have
different names in different countries. It is Reserve
Bank of India in India, the Bank of England in
England, the Federal Reserve System in America,
the Bank of France in France etc, The central bank
is defined as the bankers bank and lender of last
resort. Its duty is to control the monetary base

NOTE ON BANKING
and, through this, to control the communitys
supply of money.
The Reserve Bank of India was setup on the basis
of the Hilton Young commission (1926). The
Reserve Bank of India Act, 1934 (II of 1934)
provided the statutory basis for the functioning
of the bank, which commenced operations on
April 1, 1935, with a share capital of 5 crore, and
was nationalised in January 1949. It got its
membership of Bank of International Settlements
(BIS) in September 1996.
The general administration and direction of the
RBI is managed by a Central Board of Directors
consisting of 20 members which includes the
Governor, 4 Deputy Governors, 1 Government
official appointed by the Union Government of
India to give representation to important strata in
the economic life of the country. The head office
of Reserve Bank of India is at Mumbai. At Present
Duvvuri Subbarao is the Governor of RBI.

Functions of RBI
1. Issue of Notes: The Reserve Bank of India is
the sole authority for the issue currency notes
of various denominations except one-rupee
notes. The Reserve Bank of India acts as the
only source of legal tender (money) because
the one rupee notes issued by the Ministry of
Finance are also circulated through it. The RBI
has adopted the Minimum Reserve System for
the issue of notes. Since 1957, it has been
maintaining gold and foreign exchange
reserves of Rs.200 crore, of which at least
Rs.115 crore should be in gold.
2. Banker to the Government: The RBI acts
as the Banker, Agent and Adviser to the

Government. It performs all the banking

functions of the state and central Governments
and it also tenders useful advice to the
Government on matters related to economic
and monetary policy. It also manages the
public debt for the Government.
3. Bankers Bank: The RBI performs the same
function for the other banks as the other banks
ordinarily perform for their customers. It is
not only a banker to the commercial banks,
but it is also the lender of the last resort.
4. Controller of Credit: The RBI is the
controller of credit i.e., it has the regulatory
power to influence the volume of credit created
by banks in India. It can do so by changing the
Bank rate or through open market operations.
Since, 1956, selective controls on credit are
increasingly being used by the Reserve Bank.
In recent times repo and reverse repo rates
are being increasingly used, rather than the
conventional tool of Bank Rate.
5. Custodian of Foreign Reserves: For the
purpose of keeping the foreign exchange rates
stable the Reserve Bank buys and sells foreign
currencies, and also maintains and protects the
countrys foreign exchange funds.

Structur
cial Banks in India
Structuree of Commer
Commercial
The commercial banking system in India now
consists of public sector scheduled banks and
private sector scheduled as well as non-scheduled
bank. In terms of business, the public sector banks
now have a dominant position. They account for
more than 80 per cent of the entire banking
business in the country.
3

NOTE ON BANKING
Under the Reserve Bank of India Act, 1934, banks
were classified as scheduled and non-scheduled
banks. The scheduled banks are those which are
entered in the second schedule of RBI Act, 1934.
All commercial banks, Indian and foreign,
regional rural banks, and state co-operative banks
are scheduled banks. Non scheduled banks are
those, which have not been included in the second
schedule of RBI Act, 1934. At present, there are
only five non- scheduled banks in the country. To
be included in the second schedule, a bank (a)
must have paid up capital and reserves of not less
than Rs.5 lakhs. (b) It must also satisfy the RBI
that its affairs are not conducted in a manner
detrimental to the interests of depositors.
Scheduled banks are required to maintain a certain
amount of reserves with the RBI.
i.

SBI and its Associate Banks: On the

recommendations of the Rural Credit Survey
Committee, the Imperial Bank of India was
converted into the State Bank of India on July
1, 1955. 92 per cent of its shares were
acquired by the RBI, and thus it had the
distinction of becoming the first state owned
commercial bank in the country. In 1959, the
State Bank of India (Associate Banks) Act
was passed and this paved the way for
creating the State Bank Group. Now State
Bank of Hyderabad, State Bank of Bikaner
and Jaipur, State Bank of Indore, State Bank
of Mysore, State Bank of Patiala, State Bank
of Saurashtra and State Bank of Travancore
consists of the State Bank Group. These were
the banks of the erstwhile prince by states.

The State Bank Group comprising the State

Bank of India, and its associates has increased
the number of branches from 2,462 on June
30, 1969 to 13, 684 in June, 2009. (Now State
Bank of Saurashtra has merged with State
Bank of India). The State Bank of India and
its Associate Banks together account for
around 20 per cent of the total branches of
all commercial banks in the country. The
share of the banking business of the State
Bank Group is roughly 29 percent. In 1933,
the State Bank of India Act was amended to
enable it to have access to the capital markets.
The SBI thus raised over Rs.2,400 crore
through public issue. The RBI stake in SBI
is now 55 per cent against 99 per cent earlier.
(In March 2010, Pranab Mukherjee moved
the SBI Bill in the Lok Sabha, which seeks
to reduce the Union Governments
shareholding in the State Bank of India from
55 per cent to 51 per cent, to allow the SBI
to raise more capital from the market)
ii. Other Nationalised Banks: A second
category of public sector banks is of nineteen
commercial banks, of which fourteen were
nationalised on July 19, 1969. Each one of
these fourteen banks had deposits of Rs.50
crore or more at that time. After
nationalisation of 14 banks there was a rapid
expansion of branch network. On April 15,
1980 six privately owned commercial banks
were nationalised. With the nationalization
of these six banks, the share of the private
sector in the entire banking sector declined
to just 9 percent. In 1993, New Bank of India

NOTE ON BANKING
merged with Punjab National Bank. As a

network of 14,832 branches in the country.

result, the number of public sector banks

Ninety per cent of these have been opened in

other than the State Bank of India and its

rural areas and unbanked centres.

Associates declined to nineteen. The total

v.

Foreign Banks: As of June 30, 2009 the

number of branches of the nineteen

country had 29 foreign banks with 273

nationalized banks was 38,046 as of 2008.

branches located mainly in big cities. Apart

iii. Other Scheduled Commercial Banks: At

present

relatively

small

from financing of foreign trade, these banks

scheduled

had made significant contribution to the

commercial banks and ten newly established

development of banking habits in the country

banks with a network of 5,445 branches are

as they have performed all the functions of a

the ones operating in the private sector. In

commercial bank, including acceptance of

terms of branches and also the business done

deposits and lending of funds for trade and

by them, most of the private sector banks are

commerce.

much smaller than both nationalized banks

and foreign banks. Their role in the financial
system of the country is just marginal. So far
ten new private sector banks have been set
up and three more proposals for setting up
banks in the private sector have been
approved in principle. These private sector
banks (both old and new) account for less
than 15 per cent of both deposits and
aggregate advances.
iv. Regional Rural Banks: Under the
chairmanship of U. Narsimham, the Working
Group on Rural Banks recommended the
setting up of these banks as part of a multi
agency approach to rural credit. The first

vi. Lead Bank Scheme: The idea of the Lead

Bank Scheme was mooted by the Gadgil
Study Group in 1969. It had the backing of
Nariman Committee also. The Lead Bank had
to formulate a plan for the banking structure
in the districts where such facilities were
lacking at the time of nationalization. The
scheme now function as a way of monitoring
credit flow for social and economic
development in a district.

For
eign Commer
cial Banks
oreign
Commercial
Foreign banks operating in India are banks of
other countries having their branches in India. At
present, there are about 30 foreign banks having

bank was set up on October 2, 1975. The

a total of more than 250 branches in most of the

regional rural banks meet the credit

big cities of the country.

requirement of weaker sections, small and

Foreign banks have been operating in India for

marginal farmers landless labours, artisans

more than last 100 years but new economic

and small entrepreneurs. As of June 2008,

policies implemented in 1990s encouraged many

there were 196 regional rural banks with a

international banks to open their branches in India.

5

NOTE ON BANKING
Foreign banks in India have brought in the latest

Latest dev
elopments
developments

technology and new banking practices. This has

Some more foreign banks are going to start their

operations in India in 2010. Credit Suisse has
received an in-principle approval from RBI
permitting it to open bank branches in India and
offer retail and wholesale banking services. Credit
Suisse is a Zurich (Switzerland) based bank.
Goldman Sachs has also approached the RBI for
a banking licence. The Australia and New Zealand
Banking Group (ANZ) has received an inprinciple banking licence on March 3, 2010.

helped the domestic banks to improve their

performance and provide better customer service.
Foreign banks also perform the day-to-day
banking functions which include acceptance of
deposits and giving loans. They also issue bank
drafts, cheques, etc., to the customers.
In 2000, Standard Chartered Bank acquired
Grindlays Bank from ANZ Bank. Thus Standard
Chartered Bank, which is based in the United
Kingdom, has become the largest foreign bank
operating in India.

Some of the important foreign banks

operating in India are listed below.
Bank

Country

1. Standard Chartered Bank UK

2. HSBC

UK

3. Royal Bank of Scotland

UK

4. Barclays Bank

UK

5. Citibank

USA

6. JP Morgan Chase Bank

USA

7. Bank of America

USA

8. ABN AMRO Bank

The Netherlands

9.

Abu Dhabi Commercial Bank UAE

10. Bank of Ceylon

Sri Lanka

11. BNP Paribas Bank

France

12. Societe Generale

France

13. China Trust Commercial

Taiwan

14. Deutsche Bank

Germany

15. Scotia Bank

Canada

16. DBS Bank

Singapore

The Industrial and Commercial Bank of China

(ICBC), the largest bank in China, is also planning
to open branches in India by the year end.
CIMB Bank Berhad (Malaysia), Commonwealth
Bank of Australia (Australia) and FirstRand Bank
Limited (South Africa) are also going to start their
operations in India.

NEW B
ANKS IN PRIV
ATE SECT
OR
BANKS
PRIVA
SECTOR
In 1993, in recognition of the need to introduce
greater competition new private sector banks were
allowed to be set up in the Indian banking system.
These banks are called New Generation Private
Banks.
Based on a review of experience gained on the
functioning of new private sector banks, revised
guidelines were issued in January 2001 for entry
of new banks in the private sector.

The main requirements are:

1. Initial paid-up capital shall be Rs.200 crore;
this will be raised to Rs.300 crore within three
years of commencement of business.
2. Promoters contribution shall be a minimum
of 40 per cent of the paid-up capital of the

NOTE ON BANKING
bank at any point of time. Their contribution

Latest dev
elopments
developments

of 40 per cent shall be locked in for 5 years

The country is likely to get several more New

from the date of licensing of the bank and

Generation Private Banks with the Finance

excess stake above 40 per cent shall be diluted

Minister Pranab Mukherjee announcing in

after one year of the banks operations.

February 2010 that RBI is considering new bank

3. Initial capital other than promoters

licences to promoters in the private sector and

contribution could be raised through public

also Non Banking Financial Companies (NBFCs)

issue or private placement.

if they meet RBI eligibility criteria.

4. Non-Banking Finance Companies (NBFCs)

Corporates such as the Tatas and Birlas have

with good track record can become banks.

shown interest in banking licences. Among

5. A minimum capital adequacy ratio of 10 per

finance companies Reliance Capital and

cent shall be maintained on a continuous basis

Indiabulls have announced their interest in getting

from commencement of operations.

into banking. Lenders such as Exim Bank and

6. Priority sector lending target is 40 per cent of

SIDBI are also interested in a banking licence.

net bank credit, as in the case of other

Foreign Direct Investment (FDI) limit in private

domestic banks. These new private banks

sector banks is 74 per cent.

should open 25 per cent of the branches in

Co-operativ
Co-operativee Banks

rural/semi-urban areas.

Co-operation means voluntary association on the

Some of the New Generation Private Banks:

basis of equality and for some common purpose.

1. ICICI Bank

The basic principle of co-operation is each for

2. HDFC Bank

all and all for each.

3. Axis Bank (previously called UTI Bank)

A co-operative bank is an institution established

4. IndusInd Bank

on co-operative basis and deals in ordinary

5. Kotak Mahindra Bank

banking business. They are different from

6. Development Credit Bank

7. Yes Bank

commercial banks. Commercial banks have been

constituted by an Act passed by parliament while
cooperative banks have been constituted by

Yes Bank was granted licence in 2004. Rabo

different states under various Acts related to

Bank, a Dutch bank, has stake in Yes Bank.

cooperative societies of various states.

Global Trust Bank, a new generation private bank,

Cooperative banks are generally concerned with

was amalgamated with Oriental Bank of

the rural and development credit and provide

Commerce on August 14, 2004. Oriental Bank of

financial assistance for agricultural and rural

Commerce is a nationalized bank.

activities.
7

NOTE ON BANKING
A commercial bank can establish its branches in

over the past three decades. There were

any district / state of the country, while

1,61,000 societies in 1970-71. But as on

cooperative bank can operate its activities only

March 31, 2001 there are about 1 lakh primary

within limited area. Cooperative banks cannot

agricultural credit societies in India with

open their branches in foreign countries while

approximately 10 crore members. A large

commercial banks can operate in foreign

number of societies face severe financial

countries.

problems due to low recovery rates.

In India, the cooperative bank organization has a

2. Central Cooperative Banks (CCBs): The

three tier set up. State Co-operative Bank is the

working area of these banks is limited to one

apex co-operative bank at the state level. Central

district only. CCBs are of two types:

or District Cooperative Bank functions at district

level. Primary Agricultural Co-operative Credit
Society is at the village level.
1. Primary Agricultural Cooperative Credit
Society (PACCS): It is a village level
institution which directly deals with rural
people. It provides short term credit facilities
to the agriculture sector. Minimum 10 persons
of a village can form a primary credit society.
The management of the society is under the
control of an elected body.
The working capital of the primary credit
societies, comes from their own funds,

(a) Cooperative Banking Unions whose

membership is open only to cooperative
societies. This exists in Punjab, Haryana,
Rajasthan, Orissa and Kerala.
(b) Mixed Central Cooperative Banks whose
membership is open to both individuals
and cooperative societies.
CCBs get loans from the state cooperative
banks and give loans to primary credit
societies. The duration of such loans vary from
one year to three years. In this way CCB plays
a bridge role between the state cooperative

deposits, borrowings and other sources.

banks and primary credit societies.

Borrowings are mainly from central

At the end of March 2004 there were 366

cooperative banks. Borrowings form the chief

CCBs in India.

source of working capital of the societies.

The most distressing feature of the functions

Only the members of the societies are entitled

of the central cooperative banks is the heavy

to get loans from them. Low interest rates are

and increasing burden of overdue loans. The

charged on the loans.

main causes of these overdues are (i) natural

The various reconstruction and revival

calamities such as floods, droughts, etc.

programmes for PACCSs adopted by Indian

affecting the repaying capacity of the

government and RBI have considerably

borrowers and (ii) inadequate and inefficient

reduced the number of primary credit societies

supervision exercised by the banks.

NOTE ON BANKING
3. State Cooperative Banks (SCBs): SCBs are the
apex institutions in the three-tier cooperative
credit structure, operating at the state level.
Every state has a state cooperative bank.
SCB grants loans to central cooperative banks
and regulates their activities. SCB gets loans
from RBI. SCB acts as a link between RBI
and Central Cooperative Banks.
Borrowings of SCBs are mainly from the
Reserve Bank of India and the rest from state
governments.
Advantages of co-operative credit institutions:
1. It provides an effective alternative to the
traditional defective credit system of the
village money-lender.
2. Co-operative societies charge comparatively
low interest rates vis-a-vis the money-lenders.
3. Earlier, the cultivators used to borrow for
consumption and other unproductive
purposes. But now, they mostly borrow for
productive purposes. Co-operative societies
discourage unproductive borrowing.
4. Co-operatives help develop the habits of thrift
among the agriculturists by encouraging
savings and investments.
5. Co-operative credit is available for purchasing
improved seeds, chemical fertilizers, modern
implements, etc. This has helped in the
introduction of better agricultural methods.

Regional Rural Banks (RRBs)

The Regional Rural Banks (RRBs) came into
existence on October 2, 1975. The first RRB in
India was set up in Moradabad in Uttar Pradesh.

The specific objective of RRBs is to provide

credit and deposit facilities to the small and
marginal farmers, agricultural labourers and
artisans. The RRBs have the responsibility to
develop agriculture, trade, commerce and industry
in the rural areas.
The RRBs, though basically scheduled
commercial banks, differ from the latter in certain
respects such as: the area of RRBs is limited to a
specified region comprising one or more districts
of a state.
The sponsoring banks and the Reserve Bank of
India provide many subsidies and concessions to
RRBs to enable them to function effectively.
The sponsor banks continue to provide managerial
and financial assistance to RRBs. They charge
very low rates of interest on the borrowings of
the RRBs. The cost of staff deputed to RRBs and
training expenses of RRB staff are borne by the
sponsor banks.
National Bank for Agriculture and Rural
Development (NABARD) has the responsibility
to lay down policies for RRBs, to oversee their
operations, provide refinance facilities and attend
to problems faced by them.
RRBs have to act as alternative agencies to
provide institutional credit in rural areas. They
are intended to eliminate money-lenders. RRBs
were not set up to replace co-operative credit
societies but to supplement them.
The Agricultural Credit Review Committee under
the chairmanship of Dr.A.M. Khusro observed
that the weaknesses of RRBs were endemic and
non-viability was built into their structure. The
9

NOTE ON BANKING
RRBs had accumulated huge losses. The Khusro
Committee recommended that RRBs should be
merged with sponsor banks.
The Reserve Bank of India appointed the M.C.
Bhandari Committee to suggest measures for
restructuring RRBs.
Most of the recommendations of the Bhandari
Committee are being implemented. The issued
share capital of RRBs has been enhanced from
Rs.75 lakh to Rs.1 crore.
As on September 2007, the total number of RRBs
is 95.
RBI has allowed Regional Rural Banks to market
mutual funds through their branches.

Indian Monetary PPolicy

olicy (Cr
edit Contr
ol)
(Credit
Control)
The objective of planned economic development,
adopted by India, required an active monetary
policy. The two standard aims of the policy were:
Boost economic development.
Control inflationary pressures.
Monetary Policy, was known as Credit Policy till
1992, the year which marked the initiation of
financial sector reforms. The Reserve Bank of
India is the main agency for implementing the
monetary policy. There are some important
instruments, to achieve a stable monetary policy:
Bank Rate: It is the rate at which RBI discounts
the bills of exchange. In practice it is the rate at
which RBI lends to other commercial banks. It
thus acts as signal to the economy on the direction
of the monetary policy. Bank rate had a limited
impact on the period before economic reforms
(1991) when RBI would determine the interest
10

rates structure. However with the delegation of

this power to the commercial banks (except
interest rates in priority sectors) the importance
of bank rate has been revived. The bank rate is at
present (as on March 4, 2010) six per cent but is
subject to frequent variation, as RBI uses changes
in Bank Rate to regulate fluctuations in exchange
rate and domestic inflation. In the recent past
Prime Lending Rate (PLR) was decided by
commercial banks with reference to the bank rate
and the deposit position of each bank. [In recent
times apart from bank rate, RBI is using repo
and reverse repo rates to mop up excess liquidity
and inject liquidity into the system.]
Cash Reserve Ratio (CRR): Every Commercial
bank is required to keep a certain percentage of its
demand and time liabilities (Deposits) with the RBI
(either as cash or book balance). The RBI varies
this ratio as and when it perceives the need to
increase or decrease money supply. RBI is
empowered to fix the CRR at a rate ranging between
3% and 15% (i.e., minimum 3%, maximum 15%).
At present CRR is 5.75% (As of March 4, 2010).
Like the Bank Rate, CRR is also subject to frequent
changes as RBI intervenes from time to time to
correct monetary or exchange rate imbalances.
Statutory Liquidity Ratio (SLR): All the
commercial banks in the country are also required
to keep (in addition to CRR) a certain percentage
of their net demand and time liabilities (NDTL)
as liquid assets in the shape of cash, gold or
approved securities. As most of SLR money in
kept in treasury bills, government had, in the past
been using SLR as a means to mobilise low cost
resources. This abuse of SLR leads to distortion

NOTE ON BANKING
in the interest rate and credit supply. In order to
overcome this Narasimham Committee
recommended that SLR should be brought down
to 25% (As of March 4, 2010, the minimum
percentage of SLR is 25% and maximum 40%).
Repo & Reverse Repo Rates: Repo (Repurchase
option) and reverse repo are instruments used by
RBI in day-to-day liquidity management under
the Liquidity Adjustment Facility (LAF). Repo
rate is the rate at which RBI lends to commercial
banks and reverse repo is the rate at which RBI
borrows from commercial banks. In case of
inflationary tendencies. RBI can hike reverse repo
rate and absorbs the excess liquidity in the market.
Similarly, in case there is a perceived need to
inject liquidity into the system, RBI can reduce
the repo rate, which will lead to release of money
into the market. RBI occasionally resorts to the
repo route to fine- tune the liquidity position,
without resorting to major policy instruments such
as changes in CRR and Bank Rate. As of March
4, 2010 the repo rate is 4.75% and reverse repo
rate is 3.25%

Maintenance of domestic price level:

Fluctuations in prices affect investment
decisions. However, monetary policy alone
cannot ensure the maintenance of domestic
prices, several other factors such as erratic
monsoons, changes in tastes, fluctuation in
world prices etc, affects domestic prices.

Reducing the impact of business cycles (Slumps

and booms) by manipulation of credit and
interest policy. However economists are not of
the same opinion on whether business cycles
are primarily caused by monetary factors.

Priority Sector Lending

One of the main reasons for the nationalisation
of banks in July 1969 was to ensure that resources
available with banks were made available to
sectors which were starved of funds. In the
prenationalisation era about 78% of the total bank
credit was allocated to large and medium
industries, and wholesale trade; while the
Agriculture sector accounted for a shocking 2.2%
of the total bank credit (Significantly the figure

Open market operations: This refers to the RBI

buying and selling of eligible securities to regulate
money supply. Traditionally RBI was not resorting
to this method. However, after the large inflow
of foreign funds since 1991, RBI has had to step
in to stabilise the flow to avoid excess liquidity.

of 78% declined to about 33% in 2000, in the

Objectiv
es of Monetary PPolicy
olicy
Objectives

the pre nationalisation era about 70% of the total

industrial advances went to only 1% of the total

Stability of external value: Fluctuation in

exchange rate of a currency affects foreign
trade and investment. It is, therefore,
important that the rate of exchange is
maintained without violent fluctuations.

post nationalisation era)

Another important reason for introducing the
concept of priority sector lending after the July
1969 nationalisation was the fact that funds of
the banks were being misutilised. For example in

number of borrowal accounts (Many banks in the

prenationalisation era were owned by big
industrial houses). Public funds of the banks were
made available to directors of the banks at
11

NOTE ON BANKING
concessional rates. These directors were also
serving on the board of directors of other
companies.

be compared to Administered Price Mechanism

To sum up, public money was being diverted and

misutilised for private profit.

of administered/directed credit/ prices is to ensure

The concept of priority sector lending was

therefore introduced to correct this imbalance and
the distortion in sectoral development of total
banking credit. As a result RBI directed domestic
banks to provide 40% of their net bank credit to
the priority sector. The concept of priority sector
lending covered neglected sectors like
Agriculture, Small Scale Industry (SSI), Road and
Water Transport (RTO) Retail Trade, Professional
and Self Employed Persons, Housing and
Education loans and also loans given to Scheduled
Castes/Tribes, Small and Marginal Farmers,
Tenant Farmers, Share Croppers, Artisans,
beneficiaries of the IRDP and Differential Rate
of Interest Schemes.

To sum up, the concept of priority sector lending

For foreign banks the overall target for PS lending

could be perhaps reducing the percentage of

as a ratio of total credit was fixed at 32% by RBI.

priority sector lending from the current 40%, or

Apart from the targets for priority sector lending,

sub targets were fixed for sub sectors. For example
under the Differential Rate of Interest scheme
introduced in 1972, public sector banks were
required to fulfil the target of lending at least 1%
of the total advances under this scheme. [The DRI
scheme is aimed at the weakest of the weak.]

adding or deleting certain sectors to the list of

Priority sector lending can be described as an

example of Administered Credit or Directed
Credit. It is the RBI which determines the
direction and volume of credit to ensure social
objectives. (Administered Credit in banking can

industrial houses can be financed under BPLR,

12

in pricing of petroleum products like Petrol Diesel

LPG and Kerosene. In both the cases the system
social objectives).
acted as a much needed corrective mechanism.
Nationalised banks diverted credit to areas and
sectors where it was badly needed to meet the
objectives of social banking. One criticism of the
concept of priority sector lending was that it
locked up the resources of the banks in low
yielding assets (A major chunk, about 40% of total
credit, was directed to the priority sector which
may affect the profitability of banks). But the
Government and RBI have persisted with the
concept of priority sector lending despite this
criticism, to meet social obligations.
The concept of priority sector lending is here to
stay in Indian banking. The only possible changes

priority sector.
And finally the best argument for continuing the
system of priority sector lending is the fact that
banks have been financing big industrial houses,
at concessional rates under the Below Prime
Lending Rate (BPLR) mechanism. If big
what prevents banks from financing the neglected
sectors at concessional rates or diverting a
substantial portion of total bank credit to
traditionally neglected social groups/sectors.

NOTE ON BANKING
NP
As of Scheduled Commer
cial Banks
NPAs
Commercial
Non Performing Assets (NPAs) are bad debts of
banks/financial institutions. An asset becomes
nonperforming when it ceases to generate income
for the bank.
NPA means an asset or borrowal account, which
has been classified by a bank or financial
institution as sub-standard, doubtful or loss asset,
in accordance with the directions or guidelines
issued by the Reserve Bank of India.
A major cause for poor performance and low
profitability of banks was the accumulation of
nonperforming assets consisting of loans and
advances given to corporates which, for some
reason, do not repay the amounts borrowed, or
pay the interest accumulated thereon.

NPA norms for Scheduled Commercial

Banks
With effect from March 31, 2001 a non
performing asset is an advance where
(a) Interest and / or instalment of principal
remain overdue for a period of more than 180
days in respect of a term loan;
(b) The account remains out of order for a
period of more than 180 days in respect of
an overdraft / cash credit (OD/CC);
(c) The bill remains overdue for a period of more
than 180 days in case of the bills purchased
and discounted;
(d) Interest and / or instalment of principal
remains overdue for two harvest seasons but
for a period of not exceeding two half years
in the case of an advance granted for
agricultural purposes, and ;

(e) Any amount to be received remains overdue

for a period of more than 180days in respect
of other accounts.

SARF
AESI Act
SARFAESI
The Government of India enacted Securitization
and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002
(SARFAESI Act) to enable banks to realize their
dues without intervention of courts and tribunals.
The Act enables the setting up of Asset
Management Companies to acquire NPAs of any
bank or financial agency by issuing debentures,
bonds or any other security. This company (which
is the second creditor) is entitled to serve a notice
to the borrower to discharge his / her liabilities
within 60 days. Failing to discharge the liabilities
in the stipulated time will entitle the second
creditor to take possession of the secured assets,
take over the management of the assets and to
appoint any person to manage the secured assets.
The SARFAESI Act 2002 puts in place a long
overdue legal framework, without attendant
delays, for the recovery of NPAs.
The recovery of NPAs got a boost after the
enactment of SARFAESI Act. There was a decline
in gross NPAs from Rs.70,860 crores in 2001-02
to Rs.51,820 crores in 2005-06.
The NPAs of Scheduled Commercial Banks
(SCBs) were at 1.9 per cent of total assets at end
March 2005.

Narasimham Committee
Recommendations On FFinancial
inancial Reforms:
The Government of India constituted a 9-member
committee under the chairmanship of
13

NOTE ON BANKING
M. Narasimham, a former Governor of the
Reserve Bank of India to examine all aspects
relating to the structure, organization, functions
and procedures of the financial system. The
committee submitted its report in November 1991.

Basic appr
oach of the committee
approach
The Narasimham Committee (1991) was
primarily interested in improving the financial
health of public sector banks and development
financial institutions (DFIs), so as to make them
viable and efficient and meet fully the emerging
needs of the real economy. The Narasimham
Committee (1991) acknowledged the spectacular
success of the public sector banks since their
nationalization in July 1969, especially in:
(a) Massive branch expansion, particularly in
rural areas;
(b) Expansion in the volume of deposits bank
deposits now constituted two-fifths of financial
assets of the household sector in 1991;
(c) Rural penetration of the banking system
rural deposits as a proportion of total deposits
had increased from 3 per cent to 15 per cent;
(d) Diversion of an increasing portion of the bank
credit to priority sectors, viz, agriculture,
small industry, transport, etc.

Recommendation of the Narasimham

Committee
1. It proposed a substantial reduction in the
number of public sector banks (PSBs)
through mergers and acquisitions. A 4 tier
banking system was proposed.
I tier

14

3 or 4 large banks (including SBI)

which could become international in
character.

II tier 8 to 10 national banks

III tier Local banks
IV tier Rural banks including RRBs
2. RBI should permit the setting up of new banks
in the private sector. There should be no
difference in the treatment between public
sector banks and private sector banks.
3. The Government should allow foreign banks
to open offices in India either as branches or
as subsidiaries.
4. Assets Reconstruction Fund (ARF) should be
set up, to take over from the nationalized
banks and financial institutions, a portion of
their bad and doubtful debts, at a discount.
5. The appointment of the Chief Executive of a
bank (Chairman and Managing Director)
should not be based on political consideration
but on professionalism and integrity and
should be made by an independent panel of
experts.
6. The government should reduce the Statutory
Liquidity Ratio (SLR) from the present 38.5
per cent to 25 per cent over the next five
years. A reduction in the SLR levels would
leave more funds with banks for allocation
to agriculture, industry, trade, etc.
7. The Cash Reserve Ratio (CRR) should be
reduced from the present high level of 15 per
cent to 3 to 5 per cent.
8. Banks should be given more autonomy.
9. The system of directed credit programmes
should be gradually phased out.
10. The RBI should, on priority, simplify the
structure of interest rates. The Bank rate

NOTE ON BANKING
should be the anchor rate and all other interest
rates should be closely linked to it.

current needs of the banking industry. Other

Despite stiff opposition from bank unions and

political parties in the country, the Government

computerization process in PSBs, review of

of India accepted all the major recommendations

of Narasimham Committee (1991) and started
implementing them.

remuneration policies, etc.

recommendations related to the need for

recruitment procedures, training and

Capital Adequacy Standards

Healthy functioning of banks is essential for the

Committee on Banking Sector Reforms

(1998)

proper functioning of an economy. As credit

The Finance Ministry of the Government of India

appointed Narasimham as chairman of one more
committee. The Narasimham Committee on the
Banking Sector Reforms submitted its report to
the Government in April 1998.

risky business the safety of the depositors money

Some of the important recommendations of this

Narasimham Committee (1998):

aspects of the banks. Banks should maximize their

1. It recommended the merger of strong banks,

which would have a multiplier effect on
industry.

continue their functioning permanently.

2. The committee suggested the setting up of

small, local banks which would be confined
to states or a cluster of districts in order to serve
local trade, small industry and agriculture. At
the same time, these banks should have strong
correspondent relationships with the larger
national and international banks.

Adequacy Ratio (CAR) norm regulates the banks

3. The committee suggested higher capital

adequacy requirements for banks to improve
their inherent strength and their risk absorption
capacity.

at a meeting of the Bank for International

4. It suggested the urgent need to review and

amend the provisions of RBI Act, Banking
Regulation Act, SBI Act, Bank Nationalisation
Act, etc., so as to bring them in line with the

maintain a certain amount of free capital (i.e.,

creation (i.e. loan disbursals) of banks is a highly

depends on the quality of lending by banks. A
banks failure has the potential to create chaos in
an economy. This is why governments of the
world pay special attention to the regulatory
credit creation while minimizing the risk and
The central banks of the world devised tools to
minimise the risks of banking. The Capital
in such a way that they can sustain the probable
risks and uncertainties of lending. It was in 1988
that the central banking bodies of the developed
economies agreed upon provision of the CAR.
The agreement was known as the Basel Accord.
The accord was agreed upon at Basel, Switzerland
Settlements (BIS). It was at this time that the
BaselI norms of the CAR were agreed upon a
requirement was imposed upon the banks to
ratio) to their assets (i.e. loans and investments
by the banks) as a cushion against probable losses
in investments and loans.
15

NOTE ON BANKING
The CAR is the percentage of total capital to the
total risk weighted assets.
The RBI introduced the Capital-to-risk weighted
assets ratio (CRAR) system for banks in India in
1992 in accordance with the standards of the BIS
as part of the financial sector reforms. In the
coming years, the Basel norms were extended to
NBFCs also.
The CAR norm was raised to 9 per cent with effect
from March 31, 2000.
Meanwhile the BIS came up with another set of
the CAR norms, popularly known as Basel-II. The
Basel-II norm for the CAR is 12 per cent.
The Basel Accords (i.e. Basel I and II) are of
paramount importance to the banking world and
are presently implemented by over 100 countries
across the world. The main objective of the accords
is to strengthen the international banking system.

Some Miscellaneous Points to Remember

The first bank to open a branch in Dharavi,
one of Asias biggest slums, is Indian Bank.
The bank with the maximum number of
foreign branches is Bank of India.
The bank which has the humped bull of
Mohenjadaro as its logo and has a name
associated with the Indus ralley civilisation is
Indusind Bank.
The first Indian bank to open a branch outside
India was Bank of India.
The bank which was honoured when Mahatma
Gandhi inaugurated its branch was Union
Bank of India.
The first Indian Bank to be listed on the New
York Stock Exchange is ICICI Bank.
16

Standard Chartered Bank has the maximum

network of branches in India, among foreign
banks.
The oldest public sector bank in India, with a
history of more than 130 years, is Allahabad
Bank.
Indias largest and second largest private
sector banks across all categories are ICICI
Bank and HDFC Bank respectively.
The European Country which was one of the
worst affected in the global financial crisis was
Iceland.
The total number of nationalised banks
excluding the State Bank group is now 19.
SBI and its Associate banks now number seven.
A loan is an asset for the bank because it
receives interest as income on an advance.
A deposit is a liability for the bank is because
it has to be repaid on demand to the customer,
and it carries the burden of interest to be paid.
Asset Liability Management [ALM] is
balancing the deposit and loan portfolios of
the bank.
The first public sector bank to enter the credit
card market was Central Bank of India in
1980.
One of the founders of the Punjab National
Bank was Lala Lajpat Rai.
The first bank to provide internet banking
service in India was ICICI Bank.
The Devkaran Nanjee family established
Dena Bank.
The Nobel Price in Economics was instituted
by Bank of Sweden in 1968.

NOTE ON BANKING
Thomas Sutherland established HSBC Bank
in 1965 to meet the demand for local banking
facilities in Hong Kong and China.

The new Base Rate concept to replace the

Benchmark Prime Lending Rate [BPLR]
concept will be introduced from July 1, 2010.

The global sub-prime crisis had its origins in

RBI was established in April 1935 on the basis

of recommendations of the Hilton Young
Commission.

the USA.
The Banking Codes and Standards Institute
is not meant to substitute the Ombudsman, but
has a wider role than the Ombudsman.
The concept of Ombudsman is borrowed from
Sweden.
RBI estimates that despite the substantial
progress since the July 1969 nationalisation,
about 40% of the Indian population has no
access to banking services.
The pioneer of micro-finance is Bangladeshi
banker Mohamed Yunus.
The micro-finance capital of India is Andhra
Pradesh.

RBI was nationalised in 1949.

India became a member of the IMF in 1946.
RBI makes Ways and Means advances to the
Government for 90 days.
A high level Committee on Financial System
[CFS] was set up in 1991 under the
Chairmanship of M. Narsimham. A second
committee under M. Narsimham was set up
in 1997 to review the implementation of the
recommendations of the CFS.
NABARD was set up in 1982 and the National
Housing Bank was set up as subsidiary of RBI
in 1988 and IRDA was constituted in 2000.

Annexur
e-1: V
arious Committees & Commissions on rrelated
elated to financial sector
Annexure-1:
Various
S.No

Committee

Agenda

1.

Chakravarty Committee

(1985) Review the working of the monetary system.

2.

Abid Hussain Committee (1987)

Profit making public units should offer a part of their share

capital to the public as part of long term strategy to
establish the stock exchange.

3.

Ghosh Committee (1991)

Bank frauds & malpractices.

4.

Vagul committee (1987)

Money Market.

5.

Dave Study Group

Mutual Funds

6.

J.V. Shetty Committee (1993)

Review the system of lending under consortium

arrangements & to suggest improvements therein.

7.

Sundaram Committee (1993)

Structure of export credit.

8.

Goswami Committee (1993)

Industrial sickness & corporate restructuring.

9.

Narasimham Committee-I (1991) Examine all aspects relating to the structure, organization
& functioning of the financial system.
17

NOTE ON BANKING
10. Janakiraman Committee (1993)

Securities transactions of banks & financial institutions.

11. Goiporia Committee (1990)

Customer Service in banks.

12. Khanna Committee (1994)

Monitoring the work of NBFCS. (Non-Banking Financial

Corporations)

13. Narasimham Committee-II (1998) Banking Sector Reforms: The reforms consisted of
a) A shift of banking sector supervision from intrusive
micro-level intervention over credit decisions toward
prudential regulations and supervision.
b) A reduction of the CRR and SLR.
c) Interest rate and entry deregulation; and
d) application of prudential norms.
14. Verma Committee (1999)

Revival of weak public sector banks.

15. Kelkar Committee (2002)

Indirect tax reforms

16. Khusro Committee (1986)

Agricultural Credit

17. A.V. Gupta Committee (1997)

Agricultural loans

18. Mahalanobis Committee

National Income

19. Jilani Committee

Loan Systems

20. J.J. Irani Committee Company

Law reforms.

21. W.S. Saarraf Committee

Technology issues in the banking sector.

22. Malhotra Committee

Insurance Sector reforms.

23. S.S Tarapore Committee

This committee was set up by the Reserve Bank of India

under the Chairmanship of former RBI deputy governor
S.S Tarapore to lay the roadmap to capital account
convertibility. The five member committee recommended
convertibility by 1999-2000

Annexur
e-2: New T
echnolo
gy/ T
Annexure-2:
Technolo
echnology/
Trrends in
Banking Sector
Internet Banking: Banks have started offering
services of Internet Banking. Customers can
view their accounts, print statement of accounts,
request for chequebook, transfer funds etc.
sitting in the easy comfort of their home/ office
or cyber caf.
18

Core Banking: Core Banking Solution provides

centralized system which provide centralized
accounting, customer information management
and transaction processing functions. Once full
migration to CBS is achieved Branch Banking
will become irrelevant.
MICR Technology: with the phenomenal
growth in volumes of cheques to be handled by

NOTE ON BANKING
clearing houses in major business centres, at the
instance of RBI, banks in selected centres
introduced Magnetic Ink Character Recognition
(MICR) technology with specially printed
cheques with MICR band printed at the bottom
of cheques. The data contained in the MICR
band is captured with the help of encoders,
which facilitates faster sorting, and settlement
of payment of cheques.
Real time Gross Settlement (RTGS): This
technological initiative was launched by RBI in
2004 for faster settlement of payments. As
transfers through RTGS can be effected
instantaneously, this is one of the fastest mode
of transfer.

Annexur
e-3: Differ
ential Rate of Inter
est
Annexure-3:
Differential
Interest
Scheme
In April, 1972, the Government implemented
this scheme in 162 districts of the country.
Under this scheme, public sector banks were
directed to grant at least 1% of their total
advances of the previous year to weaker
sections of society at a concessional interest
rate of 4%.
New strategy for rural lending: Service area
approach:
This new approach was implemented under
the purview of Lead Bank Scheme since April
1, 1989.
Under this new scheme, branches of
commercial banks were allotted certain
specific semi-urban and rural areas. These
banks were made responsible for over-all
development in these allotted areas.

Annexur
e-4: Economy Indicators
Annexure-4:
(As a March 4, 2010)
Bank Rate

6.0%

Repo Rate

4.75%

Reverse Repo Rate

3.25%

Cash Reserve Ratio

5.75%

Statutory Liquidity Ratio (SLR) 25%

Prime Lending Rate (PLR)

12.25%-12.5%

Savings Bank Rate

3.5%

Deposit Rate

6 -7.50%s

Some Pr
ominent PPersonalities
ersonalities Heading
Prominent
Important Or
Orgganisations
Person
O.P. Bhatt
Chanda Kochchar

Institution
State Bank of India
ICICI Bank

Deepak Parekh
HDFC Bank
Umesh Chandra Sarangi NABARD
Rajendra Mohan Malla
Yogesh Agarwal

SIDBI
IDBI

T.C. Venkat Subramanium Exim Bank

T.S. Narayana Sami
United Stock Exchange
of India
C.B. Bhave
SEBI
J Harinarayana
D Swaroop

IRDA
PFRDA

L Man Singh
Y.S. Bhave

PNGRB
AERA

J S Sarma
Vijay Kelkar

TRAI
13th Finance Commission

Dominique Strauss Khan IMF

Robert Zoellick
World Bank
Haruhiko Kuroda
Pascal Lamy

ADB
WTO

Amrita Patel
M.S. Swaminathan

NDDB
National Commission
on Farmers
19

NOTE ON BANKING
BANKING PR
ODUCTS
PRODUCTS

BANKING CHANNELS

20