Role of Banking Sector in India

Role of banking sector in India
ROLE OF BANKING SECTOR IN INDIA

BACHELOR OF COMMERCE
BANKING & INSURANCE
SEMESTER V
(2015-16)
SUBMITTED BY:
SIDHANTA BADATIYA
ROLL NO: 02
PROJECT GUIDE:
PROF.DHANYA PANICKER
N.G.ACHARYA & D.K.MARATHE COLLEGE OF ARTS, SCIENCE &

COMMERCE,
N.G.ACHARYA MARG, CHEMBUR, MUMBAI 400071
ROLE OF BANKING SECTOR IN INDIA

1
BACHELOR OF COMMERCE
BANKING AND INSURANCE
SEMESTER V
Submitted
In Partial Fulfillment of the requirements
For the Award of the Degree of
Bachelor of Commerce Banking & Insurance
By
SIDHANTA BADATYA
ROLL NO: 02

COMMERCE,
N.G.ACHARYA MARG, CHEMBUR, MUMBAI 400071

COMMERCE, CHEMBUR, MUMBAI 400071
CERTIFICATE
This is to certify that Shri/Miss Sidhanta R. Badatya of B.Com.
Banking & Insurance Semester V (Academic Year) has
successfully completed the project on ROLE OF BANKING
SECTOR IN INDIA_ under the guidance of Mrs. Dhanya

Panicker
Course coordinator
Project Guide/ Internal Examiner
Principal
External
Examiner
ACKNOWLEDGEMENT
I am grateful to the UNIVERSITY OF MUMBAI to have introduced this final
project of our curriculum. With a deep sense of gratitude, I wish to express my
sincere thanks to my project guide PROF.DHANYA PANICKER who in spite
of his busy schedule was always ready with his invaluable guidance and kind
attention throughout the semester with the project work and without whose
intelligent direction and patience this project would have been impossible. I take
the opportunity to thank PROF.DHANYA PANICKER, Banking &Insurance
coordinator for giving me the opportunity to work on this project I would also
like to express my gratitude towards the library staff of N.G.ACHARYA &
D.K.MARATHE college of Arts, Science and Commerce.
I would like to thank the librarian of our college for providing us with
books needed to complete my project , my family & friends without whose
support my project would not have been impossible.
CHAPTER 1
INTRDUCTION TO INDIAN BANKING SECTOR

Meaning
A bank is a financial institution that provides banking and other financial
services to theircustomers. A bank is generally understood as an institution
which provides fundamentalbanking services such as accepting deposits
and providing loans. There are also nonbanking institutions that provide
certain banking services without meeting the legal definition of a bank.
Banks are a subset of the financial services industry. As per Section 5(b) of
the Banking Regulation Act, 1949, "banking"means the 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.
Definitions :
1. Indian Banking Regulation Act 1949 - Banking Company is one
which transacts the business of banking which means the accepting for
the purpose of lending or investment of deposits money from the public
repayable on demand or otherwise and withdrawable by cheque, draft,
order or otherwise.
2. Oxford Dictionary defines a bank as an establishment for custody of
money, which it pays out on customers order.
3. The Websters Dictionary Defines a bank as an institution which

trades in money, establishment for the deposit, custody and issue of
money, as also for making loans and discounts and facilitating the
transmission of remittances from one place to another.
Characteristics / Features of a Bank
1. Dealing in Money
Bank is a financial institution which deals with other people's money i.e.
money given by depositors.
2. Individual / Firm / Company

A bank may be a person, firm or a company. A banking company means a
company which is in the business of banking.
3. Acceptance of Deposit
A bank accepts money from the people in the form of deposits which are
usually repayable on demand or after the expiry of a fixed period. It gives
safety to the deposits of its customers. It also acts as a custodian of funds of
its customers.
4. Giving Advances
A bank lends out money in the form of loans to those who require it for
different purposes.
5. Payment and Withdrawal

A bank provides easy payment and withdrawal facility to its customers in
the form of cheques and drafts, It also brings bank money in circulation.
This money is in the form of cheques, drafts, etc.
6. Agency and Utility Services

A bank provides various banking facilities to its customers. They include
general utility services and agency services.
6
7. Profit and Service Orientation

A bank is a profit seeking institution having service oriented approach.
8. Ever increasing Functions

A bank's main activity should be to do business of banking which should
not be subsidiary to any other business.
9. Connecting Link
A bank acts as a connecting link between borrowers and lenders of money.
Banks collect money from those who have surplus money and give the same
to those who are in need of money.
10. Banking Business

Banking is an evolutionary concept. There is continuous expansion and
diversification as regards the functions, services and activities of a bank.
11. Name Identity

A bank should always add the word "bank" to its name to enable people to
know that it is a bank and that it is dealing in money.
Introduction to the Indian Banking system
A banking system also referred as a system provided by the bank which

offers cash management services for customers, reporting the transactions
of their accounts and portfolios, throughout the day.
The banking system in India should not only be hassle free but it should be
able to meet the new challenges posed by the technology and any other
external and internal factors.
For the past three decades, Indias banking system has several outstanding
achievements to its credit. The Banks are the main participants of the
financial system in India. The Banking sector offers several facilities and
opportunities to their customers.
All the banks safeguard the money and valuables and provide loans, credit,
and payment services, such as checking accounts, money orders, and
cashiers cheques. The banks also offer investment and insurance products.
As a variety of models for cooperation and integration among finance
industries have emerged, some of the traditional distinctions between banks,
insurance companies, and securities firms have diminished.
In spite of these changes, banks continue to maintain and perform their
primary role i.e. accepting deposits and lending funds from these deposits.
History of Indian Banking System

The first bank in India, called The General Bank of India was established in
the year 1786. The East India Company established The Bank of
Bengal/Calcutta (1809), Bank of Bombay (1840) and Bank of Madras (1843).
The next bank was Bank of Hindustan which was established in 1870.
These three individual units (Bank of Calcutta, Bank of Bombay, and Bank
of Madras) were called as Presidency Banks. Allahabad Bank which was
established in 1865, was for the first time completely run by Indians. Punjab
National Bank Ltd. was set up in 1894 with head quarters at Lahore.
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. In
1921, all presidency banks were amalgamated to form the Imperial Bank of
India which was run by European Shareholders. After that the Reserve
Bank of India was established in April 1935.
At the time of first phase the growth of banking sector was very slow.
Between 1913 and 1948 there were approximately 1100 small banks in
India. 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).
Reserve Bank of India was vested with extensive powers for the supervision
of banking in India as a Central Banking Authority. After independence,
Government has taken most important steps in regard of Indian Banking

Sector reforms.
In 1955, the Imperial Bank of India was nationalized and was given the
name "State Bank of India", to act as the principal agent of RBI and to
handle banking transactions all over the country. It was established under
State Bank of India Act, 1955. Seven banks forming subsidiary of State
Bank of India was nationalized in 1960. On 19th July, 1969, major process
of nationalization was carried out. At the same time 14 major Indian
commercial banks of the country were nationalized.
In 1980, another six banks were nationalized, and thus raising the number
of nationalized banks to 20. Seven more banks were nationalized with
deposits over 200 Crores. Till the year 1980 approximately 80% of the
banking segment in India was under governments ownership.
On the suggestions of Narsimham Committee, the Banking Regulation Act
was amended in 1993 and thus the gates for the new private sector banks
were opened.
The following are the major steps taken by the Government of India to
Regulate Banking institutions in the country:1949 : Enactment of Banking Regulation Act.
1955 : Nationalisation of State Bank of India.
1959 : Nationalization of SBI subsidiaries.
1961 : Insurance cover extended to deposits.
1969 : Nationalisation of 14 major Banks.
1971 : Creation of credit guarantee corporation.
1975 : Creation of regional rural banks.
1980 : Nationalisation of seven banks with deposits over 200 Crores.
Nationalisation
By the 1960s, the Indian banking industry has become an important tool to
facilitate the development of the Indian economy. At the same time, it has
emerged as a large employer, and a debate has ensured about the possibility
to nationalise the banking industry.
Indira Gandhi, the-then Prime Minister of India expressed the intention of
the Government of India (GOI) in the annual conference of the All India
Congress
Meeting
in
paper
entitled
"Stray
thoughts
on
Bank
Nationalisation". The paper was received with positive enthusiasm.

Thereafter, her move was swift and sudden, and the GOI issued an
ordinance and nationalised the 14 largest commercial banks with effect from
the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of
India, described the step as a "Masterstroke of political sagacity" Within two
weeks of the issue of the ordinance, the Parliament passed the Banking
Companies (Acquisition and Transfer of Undertaking) Bill, and it received the
presidential approval on 9 August, 1969.
A second step of nationalisation of 6 more commercial banks followed in
1980. The stated reason for the nationalisation was to give the government
more control of credit delivery. With the second step of nationalisation, the
GOI controlled around 91% of the banking business in India. Later on, in
the year 1993, the government merged New Bank of India with Punjab
National Bank. It was the only merger between nationalised banks and
resulted in the reduction of the number of nationalised banks from 20 to 19.
After this, until the 1990s, the nationalised banks grew at a pace of around
4%, closer to the average growth rate of the Indian economy.
The nationalised banks were credited by some; including Home minister P.
Chidambaram, to have helped the Indian economy withstand the global
financial crisis of 2007-2009.
Liberalisation :
In the early 1990s, the then Narsimha Rao government embarked on a
policy of liberalisation, licensing a small number of private banks. These
came to be known as New Generation tech-savvy banks, and included
Global Trust Bank (the first of such new generation banks to be set up),
10
which
later
amalgamated
with
Oriental
Bank
of
Commerce,
Axis
Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move along
with the rapid growth in the economy of India revolutionized the banking
sector in India which has seen rapid growth with strong contribution from
all the three sectors of banks, namely, government banks, private banks and
foreign banks.
The next stage for the Indian banking has been setup with the proposed
relaxation in the norms for Foreign Direct Investment, where all Foreign
Investors in banks may be given voting rights which could exceed the
present cap of 10%, at present it has gone up to 49% with some restrictions.
The new policy shook the banking sector in India completely. Bankers, till
this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go
home at 4) of functioning. The new wave ushered in a modern outlook and
tech-savvy methods of working for the traditional banks. All this led to the
retail boom in India. People not just demanded more from their banks but
also received more. Currently (2007), banking in India is generally fairly
mature in terms of supply, product range and reach-even though reach in
rural India still remains a challenge for the private sector and foreign banks.
In terms of quality of assets and capital adequacy, Indian banks are
considered to have clean, strong and transparent balance sheets as
compared to other banks in comparable economies in its region.
The Reserve Bank of India is an autonomous body, with minimal pressure
from the government. The stated policy of the Bank on the Indian Rupee is
to manage volatility but without any fixed exchange rate-and this has mostly
been true. With the growth in the Indian economy expected to be strong for
quite some time-especially in its services sector-the demand for banking
services, especially retail banking, mortgages and investment services are
expected to be strong.
In March 2006, the Reserve Bank of India allowed Warburg Pincus to
increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%.
This is the first time an investor has been allowed to hold more than 5% in a
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private sector bank since the RBI announced norms in 2005 that any stake
exceeding 5% in the private sector banks would need to be voted by them.
In recent years critics have charged that the non-government owned banks
are too aggressive in their loan recovery efforts in connection with housing,
vehicle and personal loans. There are press reports that the banks' loan
recovery efforts have driven defaulting borrowers to suicide.
12
CHAPTER-2
STRUCTURE AND ROLE OF AN INDIAN BANKING
SECTOR
Introduction
The structure of banking varies widely from country to country. Often a
countrys banking structure is aconsequences of the regulatory regime to
which it is subjected.
The banking system in India works under the constraints that go with social
control and public ownership. Nationalization, for instance, was a structural
change in the functioning of commercial banks which was considered
essential to better serve the needs of development of the economy in
conformity with national policy and objectives. Similarly to meet the major
objectives of banking sector reforms, government stake was reduced to 51
per cent in public sector banks. New private sector banks were allowed and
foreign banks were permitted additional branches.
Importance of Banks
Banks play an important role in the economic growth of a country. In the
modern set up, banks are not to be considered dealers in money but as the
13
leaders of development. The importance of bank for a countrys economy can

be explained in following ways Banks by playing attractive interest rate on deposits try to promote
thrift and savings in an economy. The investment of these savings in
productive channel results in capital formation.
The scattered small savings in the country can be put to optimum
use by commercial banks. Banks utilize this amount by giving loans
to industrial houses and the government. By providing funds to the
entrepreneurs, bank help in increasing productivity of capital.
Banks help in remitting money from one place to another. The
cheque, bank draft, letter of credit, bills, hundies enable traders to
transfer large sums of money from one place to another.
By their ability to create credit, the banks have placed at the disposal
of the nation a large amount of money. The bank can increase the
supply of money through credit creation.
With the growth of banking activity, employment opportunity in the
country has increased to a considerable extent.
The banks help in capital formation in the country. A high rate of
saving and investment promote capital formation.
Money deposited in the bank and other precious items are now
absolutely safe. For keeping valuables, banks are providing locker
facilities. Now people are free from any type of risks.
14
Structure of Indian Banking System

1 .Reserve Bank of India (RBI)
The Indian Banking structure has a wide and comprehensive form.
Apex Institutions in the form of banking institutions are playing
important role in the country. The chief regulator of banking system in
our country is the Reserve Bank of India.
The Reserve Bank of India (RBI) was established in April 1935 with a
share capital of Rs. 5 Crores on the basis of the recommendations of
the Hilton Young Commission. The share capital was divided into
shares of Rs. 100 each fully paid which was entirely owned by private
shareholders in the beginning. The Government held shares of
nominal value of Rs. 2,20,000.
The Reserve Bank of India was set up as a private shareholder bank
under the Reserve Bank of India Act,1934 and it started functioning
as the central bank since 1st April 1935.
15
Objectives of RBI:
The following were the objectives of RBI when it was set up:
To manage adequate money and credit in the country.

To maintain the stability of rupee internally and externally,
Balanced and well managed banking development in the country.
To develop well organized money market.
To provide adequate agriculture credit.
To manage public debt.
To seek international monetary co-operation.
Centralization of cash reserves of commercial banks
To set up Government banks.
Publication of data.
Functions of RBI:
RBI is an apex banking institution of the country. It carries on several
functions as a central bank. According to RBI Act, 1934, the principal
function of RBI is to issue notes and maintain reserves, currency and credit
to maintain monetary stability in the general interest of the nation.
As a central banking authority RBI carries on the following functions:
1. RBI regulates issue of bank notes above one rupee denomination.
2. Undertakes distribution of all currency notes and coins on behalf of
the government.
3. Acts as the banker to the Government of India and the State
governments, Commercial andCooperative banks.
4. Formulates and administers the monetary policy.
5. Maintain exchange value of rupee.
6. Represent India at the International Monetary Fund (IMF)
16
7. RBI acts as a banker for all the commercial banks. All scheduled
banks come under the direct.control of RBI. All commercial as well as
schedule bank has to keep a minimum reserve with theRBI. They have
to submit weekly reports to RBI about their transactions. By
performing 3 functions,the RBI helps the member banks significantly.
They are given below such as:
-It acts as the lender of the last resort.
-It is the custodian of cash reserves of commercial banks.It clears, transfers the transaction. It acts as the central clearing house.
8. Regulation of Banking system
9. Credit Control
2. Commercial Banks
Commercial Banks is financial Institution that accepts deposits for the
purpose of lending. In other words, commercial Banks provide services such
as accepting deposits, giving business loans and also allow for variety of
deposit accounts. They collect money from those who have it to spare and
lend to those whorequire it. Commercial Bank is a banker to the general
public. Commercial Banks registered under Indian companies Act, 1936 and
are also governed by the Indian Banking Regulation Act, 1949.
A. Scheduled Banks
Scheduled banks are those which have been in II schedule of Reserve Banks
of India act, 1934 and following criteria should satisfied.
1. Minimum paid up capital Rs. 5 lakh.
2. It must be a corporation as co-operative society.
3. Any activity of bank will not adversely affect the interest of depositors
Scheduled banks consist public sector banks, private sector banks, foreign
banks, and regional rural banks.
1) Public Sector Banks: Public banks are those in which 50% of their
capital is provided by central government, 15% by concerned state
government and 35% by sponsored commercial banks. In India, there
17
are 27 public sector banks. They includes the state bank of India and
its 6 associated banks such as state bank of Hyderabad, state bank of
Mysore etc. and 19 nationalized banks and IDBI banks Ltd. Public
sector banks mostly situated in rural area than urban area.
2) Private Sector Banks: Private Banks are those in which majority of
share capital kept by businesshouse and individual. After the
nationalization, entry of private sector banks is restricted. But some
ofprivate banks continued to operate such as Jammu & Kashmir
bank Ltd. To increase the competition spiritand improve the working
of public sector banks, RBI permitted the entry of private sector
banks in July,1993.
3) Foreign Banks: Foreign banks are those which incorporated outside
India and open their branches inIndia. Foreign banks performed all
the function like other commercial banks in India. Foreign banks
aresuperior in technology and management than India banks.They
offer different types of products and services such as offshore
banking, online banking, personalbanks etc. They provide loans for
automobiles, small and large businesses. Foreign banks also
providespecial types of credit card which are nationally and
internationally accepted. These banks earn lots of profitand create
new ways of investments in the country.
4) Regional Rural BanksRegional rural banks established 1975 with
mandate to ensure sufficient credit for agriculture and ruralsector.
RRBs are jointly owned by government of India, concerned state
government and sponsor bank.The capital share being 50 %, 15% and
35% respectively. Now these Days, there are 14,475 regional
ruralbanks in India. NABARD control and prepare the policies for
Regional Rural Banks. The basic objectiveof establishing RRBs in
India was to provide the credit to rural sector especially the small and
mediumfarmers, artisans, agricultural labour and even small
entrepreneurs.
B. Non Scheduled Banks:

Non-scheduled banks in India define in clause (C) of section 5 of
Banksregulation Act 1949. Non-scheduledbanks are those which are not
schedule bank and their paid upcapital and reserves less than Rs.5 lakh
and are not included in the 2nd schedule of the Reserve Bank of India Act,
1934
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3. Development Banks
It is considered as a hybrid institution which combines in itself the
functions of a finance corporation and a development corporation. They also
act as a catalytic agent in promoting balanced and viable development by
assuming promotional role of discovering project ideas, undertaking
feasibility studies and also provide technical, financial and managerial
assistance for the implementation of project.
In India Industrial Development Bank on India (IDBI) is the unique example
of development bank. It has been designated as the principal institution of
the country for co-ordinating the working of the institutions engaged in
financing, promoting or development of industry.
In India such banks are established on a large scale after independence.
They are Industrial Finance Corporation of India (IFCI), Industrial Credit
and Investment Corporation of India (ICICI) and Industrial Development
Bank of India (IDBI).
4. Co-operative Banks
In India, Co-operative banks are registered under the Co-operative Societies
Act, 1912. They generally give credit facilities to small farmers, salaried
employees, small-scale industries, etc. Co-operative Banks are available in
rural as well as in urban areas. The functions of these banks are just
similar to commercial banks.
The main business of co-operative banks is to provide finance to agriculture.
They aim at developing a system of credit. Agriculture finance is a special
field. The co-operative banks play a useful role in providing cheap exit
facilities to the farmers.
In India there are three wings of co-operative credit system namely - (i) Short
term, (ii) Medium-term, (iii) Long term credit. The former has a three tier
structure consisting of state co-operative banks at the state level. At the
intermediate level (district level) these are central co-operativebanks, which
are generally established for each district.
19
5. Specialised Banks
These banks are established and controlled under the special act of
parliament. These banks have got the special status. One of the major bank
is National Bank for Agricultural and Rural development (NABARD)
established in 1982, as an apex institution in the field of agricultural and
other economic activities in rural areas. In 1990 a special bank named small
industries development Bank of India (SIDBI) was established. It was the
subsidiary of Industrial development Bank of India. This bank was
established for providing loan facilities, discounting and rediscounting of
bills, direct assistance and leasing facility.
6. Export - Import Bank

These banks have been established for the purpose of financing foreign
trade. They concentrate their working on medium and long-term financing.
The Export-Import Bank of India (EXIM Bank) was established on January
1, 1982 as a statutory corporation wholly owned by the central government.
7. Saving Banks
Saving banks are established to create saving habit among the people. These
banks are helpful for salaried people and low income groups. The deposits
collected from customers are invested in bonds, securities, etc. At present
most of the commercial banks carry the functions of savings banks. Postal
department also performs the functions of saving bank.
8. Land Mortgage / Land Development Banks
20
Land Mortgage or Land Development banks are also known as Agricultural

Banks because these are formed to finance agricultural sector. They also
help in land development.
In India, Government has come forward to assist these banks. The
Government has guaranteed the debentures issued by such banks. There is
a great risk involved in the financing of agriculture and generally
commercial banks do not take much interest in financing agricultural sector.
9. Indigenous Banks
Indigenous banks mean Money Lenders and Sahukars. They collect deposits
from general public and grant loans to the needy persons out of their own
funds as well as from deposits. These indigenous banks are popular in
villages and small towns.
They perform combined functions of trading and banking activities. Certain
well-known indian communities like Marwaries and Multani even today run
specialised indigenous banks.
10. Exchange Banks
Hong Kong Bank, Bank of Tokyo, Bank of America are the examples of
Foreign Banks working in India. These banks are mainly concerned with
financing foreign trade.
Following are the various functions of Exchange Banks :1. Remitting money from one country to another country,
2. Discounting of foreign bills,
3. Buying and Selling Gold and Silver, and
4. Helping Import and Export Trade.
Consumers
21
Consumers bank is a new addition to the existing type of banks. Such

banks are usually found only in advanced countries like U.S.A. and
Germany. The main objective of this bank is to give loans to consumers for
purchase of the durables like Motor car, television set, washing machine,
furniture, etc. The consumers have to repay the loans in easy installments.
Summary
This unit examines the structure of the banking industry in India. Banks in
India are organized as commercialbanking institutions and cooperative
banking societies. Commercial banks are owned by the public sector, private
sector and foreign banks. The public sector banks dominate the banking
industry both in terms of volumes and reach of branches. The cooperative
banking segment of Indian banking is small in comparison to the
commercial banking segment. It is also plagued by poor performance.
However, it has an important place as a provider of banking services to
smaller sections of the society.
This unit also provides an overview of the statutory framework for banking
in India. The Banking Regulation Act, 1949 is the most important legislation
for banks in India. This act lays down the definition of banking and
allowable banking activities. It also gives the RBI wide-ranging regulatory
power to control banks in India starting from their licensing.
Bank act as payment agents by conducting checking or current accounts for
customer, paying cheque drawn by customers on the bank, and collecting
cheque deposited to customers current accounts. Banksalso enable
customer payments via other payment methods such as automated teller
machine (ATM), Telegraphic Transfer etc.
Banks borrow money by accepting funds deposited on current accounts, by
accepting term deposits, and by issuing debt securities such as banknotes
and bonds. Banks lend money by making advances to customers on current
accounts, by making instalment loans and by investing in marketable debt
securities and other forms of money lending.
Banks also provide almost all payment services and a bank accounts
considered indispensable by most businesses, individuals and governments.
22
CHAPTER 3
ROLE OF RBI IN INDIA
As a central bank, the Reserve Bank has significant powers and duties to
perform. For smooth and speedy progress of the Indian Financial System, it
has to perform some important tasks. Among others it includes maintaining
monetary and financial stability, to develop and maintain stable payment
system, to promote and develop financial infrastructure and to regulate or
control the financial institutions.
23
Introduction
Central Bank is an apex financial institution of a country. It is needed to
regulate and control the monetary system of an economy. The need for a
central bank in India was felt during 18th century.
The earliest attempts to set up a central bank dates back to 1773 when
Warren Hastings recommended to establish the General Bank of Bengal
and Bihar as Central Bank of India. In 1913 Lord Keynes also
recommended to set up a Central Bank. Later on in 1921, by amalgamating
three presidency Banks (Presidency Bank of Bengal, Presidency Bank of
Madras and Presidency Bank of Bombay), Imperial Bank of India was set up.
Though Imperial Bank of India performed certain central banking function,
but the right of Note issue was not given to Imperial Bank of India and
Government of India performed the function of credit control.
The establishment of a Central Bank that would issue notes and at the
same time function as banker to the Government was recommended in 1926
by the Royal Commission in India Currency and Finance (known as the
Hilton Young Commission). In 1931, Central Banking inquiry committee also
recommended for setting up of a Central Bank in India.
In 1933, the Round Table Conference also suggested to set up a Central
Bank free from political influence. As a result of all these recommendations
and suggestions, a fresh bill was passed by the assembly on December 22,
1933 and got Governor General Ascent on March 6, 1934. Thus the Reserve
Bank of India started working since, 1st April, 1935 in accordance with the
provision of the Reserve Bank of India Act, 1934.
24
The pattern of central banking in India was based on the Bank of England.
England has a highly developed banking system in which the functioning of
the central bank as a bankers bank and their regulation of money supply
set the pattern. The central banks function as lender of last resort was on
the condition that the banks maintain stable cash ratios as prescribed from
time to time. The effective functioning of the British model depends on an
active securities market where open market operations can be conducted at
the discount rate. The effectiveness of open market operations however
depends on the member banks dependence on the central bank and the
influence it wields on interest rates. Later models, especially those in
developing countries showed that central banks play an advisory role and
render technical services in the field of foreign exchange, foster the growth of
a sound financial system and act as a banker to government.
Meaning
Reserve Bank of India is the central bank of the country which was
nationalized in the year 1949.
It is an apex institution which has been guiding, monitoring, regulating,
controlling and promoting the destiny of IFS since its inception. It is oldest
among the central banks in the developing countries
The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The
Act, 1934 (II of 1934) provides the statutory basis of the functioning of the
Bank.
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.
Functions
25
The Reserve Bank of India Act of 1934 entrust all the important functions of
a central bank the Reserve Bank of India.
1. Issuing Authority:
Under Section 22 of the Reserve Bank of India Act, the Bank has the sole
right or authority or monopoly of issuing currency notes other than one
rupee notes and coins and coins of smaller denominations. Although one
rupee coins and notes and coins of smaller denominations are issued by the
Government of India, but put into circulation only through RBI. The
currency notes issued by the Bank are legal tender everywhere in India.
The affairs of the bank relating to note issue and its general banking
business are conducted through two separate departments, the Issue and
Banking Department. The Issue Department is liable for the aggregate value
of currency notes of Government of India and the currency notes of the
Reserve Bank in circulation and it maintains eligible assets for equivalent
value.
The expansion and contraction of currency in circulation is affected through
the Banking Department. Cash deposits and withdrawals by scheduled
banks are handled by the Banking Department.
2. Banker of Government:
The second important function of the Reserve Bank of India is to act as
banker to the Government of India statutorily and to state governments by
virtue of agreements entered into with them. The Reserve Bank is agent of
Central Government and of all State Governments in India excepting that of
Jammu and Kashmir.
The Reserve Bank has the obligation to transact Government business, via.
To keep the cash balances as deposits free of interest, to receive and to make
payments on behalf of the Government and to carry out their exchange
remittances and other banking operations. It is not entitled to any
remuneration for these services.
In addition to these ordinary banking operations the Reserve Bank of India
helps the Government - both the Union and the States to float new loans
and to manage public debt. The RBI is entitled to charge a commission for
these activities. Under public debt management the RBI manages deficit/
26
surplus in the central and state government by providing money to fill the
gap between receipts and payments. It is done in the following ways:
1. For Central Government: The deficit/ surplus in the central
government account with the RBI are managed by the creation/
cancellation of ad-hoc treasury bills which are held in the Issue
Department and hence the budget deficit/ surplus is monetized.
2. For State Government: The gap between receipts and payments of
state governments is by ways and means advances. These advances
are of three types:
Normal/ clean advances which are without any collateral security.

Secured advances are against the pledge of the central government
securities.
Special advances are granted at the discretion of RBI.
3. Bankers Bank and Lender of the Last Resort or Father of Banks:

The Reserve Bank of India acts as the bankers bank. The RBI controls the
volume of reserves of the banks and determines their deposit credit creation
ability. The banks hold all/ a part of their reserves with the RBI and in
times of need, they borrow from the RBI.
According to the provisions of the Banking Companies Act of 1949, every
scheduled bank was required to maintain with the Reserve Bank a cash
balance equivalent to 5% of its demand liabilities and 2 per cent of its time
liabilities in India.
By an amendment of 1962, the distinction between demand and time
liabilities was abolished and banks have been asked to keep cash reserves
equal to 3 per cent of their aggregate deposit liabilities. The minimum cash
requirements can be changed by the Reserve Bank of India.
The scheduled banks can borrow from the Reserve Bank of India on the
basis of eligible securities or get financial accommodation in times of need or
stringency by rediscounting bills of exchange.
Since commercial banks can always expect the Reserve Bank of India to
come to their help in times of banking crisis the Reserve Bank becomes not
only the bankers bank but also the lender of the last resort.
27
4. Controller of Credit:
The Reserve Bank of India is the controller of credit i.e. it has the power to
influence the volume of credit created by banks in India. It can do so
through changing the Bank rate or through open market operations.
According to the Banking Regulation Act of 1949, the Reserve Bank of India
can ask any particular bank or the whole banking system not to lend to
particular groups or persons on the basis of certain types of securities.
Since 1956, selective controls of credit are increasingly being used by the
Reserve Bank.
Every bank will have to get the permission of the Reserve Bank before it can
open a new branch. Each scheduled bank must send a weekly return to the
Reserve Bank showing, in detail, its assets and liabilities. This power of the
Bank to call for information is also intended to give it effective control of the
credit system. The Reserve Bank has also the power to inspect the accounts
of any commercial bank.
As supreme banking authority in the country, the Reserve Bank of India,

therefore, has the following powers:
a) It holds the cash reserves of all the scheduled banks.
b) It controls the credit operations of banks through quantitative and
qualitative controls.
c) It controls the banking system through the system of licensing,
inspection and calling for information.
d) It acts as the lender of the last resort by providing rediscount
facilities to scheduled banks.
5. Custodian of Foreign Reserves:

The RBI maintains the external value of the rupee through the regulation of
foreign exchange market coupled with domestic policies. In the external
sector, the task of RBI has following dimensions:
To administer foreign exchange control.

To choose the exchange rate system and fix or manage the exchange
rates between the rupees an other currencies.
28
To manage exchange reserves.

To interact with monetary authorities of other countries and with the
international financial institutions such as IMF and World Bank.
The RBI administers the exchange control according to the Foreign

Exchange Maintenance Act (FEMA) to primarily regulate the demand for
foreign exchange within the limits of available supply. The controls are
administered through the authorized foreign exchange dealers.
But after the early nineties, as the rupee became fully convertible on current
account, the rate has been market related. The controls on foreign exchange
are being gradually relaxed. As the custodian of the foreign exchange
reserves, the RBI also sees to the investment and utilization of foreign
exchange reserves in the most advantageous manner.
After India became a member of the International Monetary Fund in 1946,
the Reserve Bank has the responsibility of maintaining fixed exchange rates
with all other member countries of the I.M.F.
Besides maintaining the rate of exchange of the rupee, the Reserve Bank
has to act as the custodian of Indias reserve of international currencies. The
vast sterling balances were acquired and managed by the Bank. Further, the
RBI has the responsibility of administering the exchange controls of the
country.
6. Supervisory Functions:
To promote a sound and effective banking system, the RBI is vested with
wide ranging powers to supervise and control banks. The main powers are:
To issue licences for the establishment of new banks.

To issue licences for setting up of bank branches.
To prescribe for banks, the minimum requirements regarding capital
and resources, the transfer ofreserve fund and maintenance of cash
reserve and other liquid assets.

To inspect the organisational set up: branch expansion, mobilisation
of deposits, investments, credit portfolio management, region wise
29
performance, profit planning, manpower planning, training and so on
regarding banks.
To investigate into complaints, irregularities and fraud in respect of
banks.
To check improper investments and injudicious advances by the
banks.
To control appointment, re-appointment, termination of chairman/
chief executive officer of private sector banks.

To approve/ force amalgamation.
7. Promotional/Developmental Functions
Along with the routine traditional functions, central banks especially in the
developing country like India have to perform numerous functions. These
functions are country specific functions and can change according to the
requirements of that country. The RBI has been performing as a promoter of
the financial system since its inception. Some of the major development
functions of the RBI are maintained below.
Development of the Financial System :

The financial system comprises the financial institutions, financial
markets and financial instruments. The sound and efficient financial
system is a precondition of the rapid economic development of the
nation.
The RBI has encouraged establishment of main banking and nonbanking institutions to cater to the credit requirements of diverse
sectors of the economy.
Development of Agriculture :
In an agrarian economy like ours, the RBI has to provide special
attention for the credit need of agriculture and allied activities. It has
successfully rendered service in this direction by increasing the flow of
credit to this sector.
30
It has earlier the Agriculture Refinance and Development Corporation

(ARDC) to look after the credit, National Bank for Agriculture and
Rural Development (NABARD) and Regional Rural Banks (RRBs).
Provision of Industrial Finance :

Rapid industrial growth is the key to faster economic development. In
this regard, the adequate and timely availability of credit to small,
medium and large industry is very significant.
In this regard the RBI has always been instrumental in setting up
special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM
BANK etc.
Provisions of Training :
The RBI has always tried to provide essential training to the staff of
the banking industry. The RBI has set up the bankers' training
colleges at several places. National Institute of Bank Management i.e
NIBM, Bankers Staff College i.e BSC and College of Agriculture
Banking i.e CAB are few to mention.
Collection of Data :
Being the apex monetary authority of the country, the RBI collects
process and disseminates statistical data on several topics. It includes
interest rate, inflation, savings and investments etc. This data proves
to be quite useful for researchers and policy makers.
Publication of the Reports :

The Reserve Bank has its separate publication division. This division
collects and publishes data on several sectors of the economy. The
reports and bulletins are regularly published by the RBI. It includes
RBI weekly reports, RBI Annual Report, Report on Trend and Progress
of Commercial Banks India., etc. This information is made available to
the public also at cheaper rates.
Promotion of Banking Habits :
31
As an apex organization, the RBI always tries to promote the banking

habits in the country. It institutionalizes savings and takes measures
for an expansion of the banking network.
It has set up many institutions such as the Deposit Insurance
Corporation-1962, UTI-1964, IDBI-1964, NABARD-1982, NHB-1988,
etc. These organizations develop and promote banking habits among
the people. During economic reforms it has taken many initiatives for
encouraging and promoting banking in India.
Promotion of Export through Refinance :

The RBI always tries to encourage the facilities for providing finance
for foreign trade especially exports from India. The Export-Import
Bank of India (EXIM Bank India) and the Export Credit Guarantee
Corporation of India (ECGC) are supported by refinancing their
lending for export purpose.
7. Monetary Planning and Control Functions:

The RBI regulates the availability, cost and terms and conditions of credit in
the market. It aims at regulating and controlling the money supply as per
the requirements of the economy and the monetary policy.
Reserve Bank of India's Credit Policy

The Reserve Bank of India has a credit policy which aims at pursuing higher
growth with price stability. Higher economic growth means to produce more
quantity of goods and services in different sectors of an economy; Price
stability however does not mean no change in the general price level but to
control the inflation. The credit policy aims at increasing finance for the
agriculture and industrial activities. When credit policy is implemented, the
role of other commercial banks is very important. Commercial banks flow of
credit to different sectors of the economy depends on the actual cost of
credit and arability of funds in the economy.
Objectives of RBI
The specific features of the Indian economy, including its socio-economic
characteristics, make it necessary for the Reserve Bank to operate with
32
multiple objectives. Regulation, supervision and development of the financial

system remain within the legitimate ambit of monetary policy broadly
interpreted in India.
The role of communication policy, therefore, lies in articulating the hierarchy
of objectives in a given context in a transparent manner, emphasizing a
consultative approach as well as autonomy in policy operations and
harmony with other elements of macroeconomic policies.
RBI functions within the framework of a mixed economic system. Main

objectives of RBI are:
To maintain monetary stability so that the business and economic life

can deliver welfare gains of a properly functioning mixed economy.
To maintain financial stability so that the monetary stability can be

safely pursued and economic units can conduct their business with
confidence.
To maintain stable payment system so that financial transactions can

be safely and efficiently executed.
To promote the development of financial infrastructure of markets and

systems and to enable it to operate efficiently.
To ensure that credit allocation by the financial system broadly

reflects the national economic priorities.
To regulate the overall volume of money and credit in the economy

with a view to ensure a reasonable degree of price stability.
To establish monetary relations with other countries of the world and

international financial institutions
Role of RBI in Economic Development

Reserve Bank of India or RBI happens to be the first and foremost monetary
authority in the dominion of India and with the exception of this attribute; it
does act in the role of bank of the national and state governments.
33
RBI is known to formulate, implement and keep tabs on the monetary policy
and it also has to make certain the sufficient flow of credit to productive
sectors.
The acceptance of economic liberalization and reform has allowed the
relaxation of restrictions on foreign direct investment and inward portfolio
capital flows. India retains tight controls on outward portfolio capital flows,
restricting the access of residents to foreign capital markets and domestic
markets in foreign currency-denominated securities. The relaxation of these
controls and further liberalization of the capital account remain
controversial policy issues for India. For convenience the role of RBI on the
economy of India has been dealt under the three areas :
a) RBI on Forex Reserves
b) RBI on Corporate Debt Restructuring
c) RBI on Banking
a) RBI on Forex Reserves
Foreign exchange reserves play an irreplaceable role in many emerging
economies. The central, or reserve, bank creates and then uses domestic
money to buy foreign exchange. If a central bank creates more domestic
money, it can buy more foreign exchange. It does not have to pump iron to
build reserves. It does not have to sweat it out. It has to merely pump
domestic money into the domestic economy and coolly build foreign
exchange reserves. The creation of foreign exchange reserves is wholly a
white-collar job.
The Reserve Bank of India (RBI) undertook a review of the main policy and
operational matters relating to management of the reserves, including
transparency and disclosure and decided to compile and make public halfyearly reports on management of foreign exchange reserves for bringing
about more transparency and also for enhancing the level of disclosure in
this regard.
These reports are being prepared with reference to positions as of 31st
March and 30th September each year, with a time lag of about 3 months.
The reports talk about the report is a compilation of quantitative
information with regard to external reserves, such as, level of foreign
exchange reserves, sources of accretion to foreign exchange reserves,
external
liabilities
vis-vis
foreign
exchange
reserves,
34
prepayment/repayment of external debt, Financial Transaction Plan (FTP) of

IMF, adequacy of reserves, etc.
b) RBI on Corporate Debt Restructuring

The objective of the Corporate Debt Restructuring (CDR) framework is to
ensure timely and transparent mechanism for restructuring of the corporate
debts of viable entities facing problems, outside the purview of BIFR, DRT
and other legal proceedings, for the benefit of all concerned.
In particular, the framework will aim at preserving viable corporate that are
affected by certain internal and external factors and minimize the losses to
the creditors and other stakeholders through an orderly and coordinated
restructuring programme.
The major modifications made in the existing CDR mechanism relate to

a) Extension of the scheme to entities with outstanding exposure
of Rs.10 crore or more.
b) Requirement of support of 60% of creditors by number in
addition to the support of 75% of creditors by value with a view
to make the decision making more equitable
c) Discretion to the core group in dealing with wilful defaulters in
certain cases other than cases involving frauds or diversion of
funds with malafide intentions.
d) Linking the restoration of asset classification prevailing on the
date of reference to the CDR Cell to implementation of the CDR
package within four months from the date of approval of the
package.
e) Restricting the regulatory concession in asset classification and
provisioning to the first restructuring where the package also
has to meet norms relating to turn-around period and minimum
sacrifice and funds infusion by promoters.
35
f) Convergence in the methodology for computation of economic

sacrifice among banks and FIs.
g)
Limiting RBIs role to providing broad guidelines for CDR

mechanism.
h) Enhancing disclosures in the balance sheet for providing greater

transparency.
i) Pro-rata sharing of additional finance requirement by both term
lenders and working capital lenders.
j) Allowing OTS as a part of the CDR mechanism to make the exit
option more flexible and
k) Regulatory treatment of non-SLR instruments acquired while
funding interest or in lieu of outstanding principal and
valuation of such instruments.
C) RBI on Banking
Though the RBI, as part of its monetary management mandate, had, from
the very beginning, been vested with the powers, under the RBI Act, 1934,
to regulate the volume and cost of bank credit in the economy through the
instruments of general credit control, it was not until 1949 that a
comprehensive enactment, applicable only to the banking sector, came into
existence. The Banking Regulation Act from March 1966. The Act vested in
the Reserve Bank the responsibility relating to licensing of banks, branch
expansion, and liquidity of their assets, management and methods of
working, amalgamation, reconstruction and liquidation.
Important changes in several provisions of the Act were made from time to
time, designed to enlarge or amplify the responsibilities of the RBI or to
impart flexibility to the relative provisions, commensurate with the
imperatives of the banking sector developments.
1.Branch Authorization Policy
The RBI announced a new Branch Authorization Policy in September 2005
under which certain changes were brought about in the authorization
process adopted by the RBI for the bank branches in the country.
36
The objective is to ensure that the banks take an integrated view of their
branch- network needs, including branch relocations, mergers, conversions
and closures as well as setting up of the ATMs, over a one-year time horizon,
in tune with their own business strategy, and then approach the RBI for
consolidated annual authorizations accordingly.
2. Operations of Foreign Banks in India
At present, there are 29 foreign banks operating in India with a network of
273 branches and 871 off-site ATMs. Among some circles, a doubt is
sometimes expressed as to whether the regulatory environment in India is
liberal in regard to the functioning of the foreign banks and whether the
regulatory approach towards foreign participation in the Indian banking
system is consistent with liberalized environment.
India issues a single class of banking licence to foreign banks and does not
require them to graduate from a lower to a higher category of banking
licence over a number of years, as is the practice followed in certain other
jurisdictions. This single class of licence places them virtually on the same
footing as an Indian bank and does not place any restrictions on the scope
of their operations
Thus, a foreign bank can undertake, from the very first day of its operations,
any or all of the activities permitted to an Indian bank and all foreign banks
can carry on both retail as well as wholesale banking business. This is in
contrast with practices in many other countries.
The independence of the Reserve Bank holds the key to effective monetary
control. An independent Reserve Bank can hold out threat of a high rate of
interest on Government borrowing if the Government indulges in fiscal
excesses. As the high rate interests retard the rate of economic growth and
adversely affect the chances of the politicians re-election they behave more
responsibly than they otherwise would.
37
CHAPTER- 4
ROLE OF COMMERCIAL BANK IN INDIA
Introduction
Commercial Banks are very important component of the money market.
They play a very important role in Indian Financial system. Indian banking
industry is regulated by Reserve Bank of India. Commercial Bank act as
Intermediaries because they accept deposits from savers and lend these
funds to borrowers.
Meaning of Commercial Banks

Commercial Banks is financial Institution that accepts deposits for the
purpose of lending. In other words, commercial Banks provide services such
as accepting deposits, giving business loans and also allow for variety of
deposit accounts. They collect money from those who have it to spare and
lend to those who require it.
38
Commercial Bank is a banker to the general public. Commercial Banks

registered under Indian companies Act, 1936 and are also governed by the
Indian Banking Regulation Act, 1949.
Definitions:
Various definitions of a bank have been given by various authors. Some
important definitions of a bank listed below.
According to the Indian Companies (Regulation) Act, 1949, the
accepting, for the purpose of lending or Investment, of deposits of money
from public, repayable on demand or otherwise and withdrawable by
cheque, draft, order or otherwise.
According to Prof. Kinley, A bank is an establishment which makes to
individuals such advances of money as may be required and safety made,
and to which individuals entrust money when not required by them for use.
According to John Paget, No body can be a banker who does not (i) take
deposit accounts (ii) take current accounts, (iii) issue and pay cheques, and
(iv) Collect cheques- crossed and uncrossed for its customers.
Functions of Commercial Banks

1. Accepting Deposits:
Accepting deposits is one of major function of commercial bank. It is the
business of bank to accept deposits so that he can lend it to other and earn
interest. Basically, the money is accepted as deposit for safekeeping. Banks
also pay interest on these deposits. To attract depositors banks maintain
different types of accounts. These are as following.
a) Fixed Deposit Accounts: The account which is opened for fixed
period by depositing amount is known as fixed deposit account. The
money deposited in this account cannot be withdrawn before expiry of
period. A high rate of interest is paid on fixed deposits.
39
b) Current Deposit Account: Current deposit accounts are mostly

opened by businessmen and traders who withdraw money number of
times a day. Banks does not pay interest on these types of account.
The bank collects certain charges from depositors for services
rendered by it.
c) Saving Account: Saving account is most suited for those people who
want to save money for future needs. These types of account can be
opened with a minimum initial deposit. A minimum balance has to be
maintained in account as prescribed by bank. Some restrictions are
imposed ondepositor regarding number of deposit withdrawal and
amount to be withdrawn in given period.
d) Recurring Deposit Account: The purpose of these accounts is to
encourage public for regular saving, particularly by fixed income
group. Fixed amount is deposit is deposited at regular intervals for a
fixed term and repaid on maturity.
2. Grant of Loans and Advances
Besides accepting deposit, the second most important function of
commercial bank is advancing of loan to the public. After keeping certain
part of deposits received by bank as reserve and the rest of balance given as
loan. The different types of loan and advances are given by bank as follow.
a) Call Money : There are generally short term credit that range from
one day to fort night. There are even one nigh call money advances
made available to bank with the help of this market. The rate of
interest depends upon the conditions prevailing in money market.
b) Overdraft :In over draft, a customer can withdraw money from his
current account and available balance below zero. When the amount
withdrawn is within the authorized limit then rate of interest charged
at agreed rate. Overdraft is allowed normally against the security of
negotiable Instrument and credit worthy customers without security.
c) Cash Credit: In cash credit, Bank advance loan against the customer
current asset or personal guarantee. The borrower has option to
withdraw the funds as and when required to extent of his needs but
he cannot exceed the credit limit allowed to him. The cash credit limit
depends on the debtors need and as agreed with the bank. The bank
charges interest only on money withdrawn from by them.
40
d) Discounting of Bills: Under this type of lending, Bank pay amount

before due date of bill after deducting certain rate of discount or
commission. The holder of bill gets money immediately without
waiting for the date of maturity. If bill of exchange dishonoured on due
date the bank can recover the amount from the customer.
e) Direct Loan: A loans granted for a fixed maturity period more than
one year. Loans are usually secured against some collateral security.
The borrower can withdraw entire money through cheques. The
interest is charged on entire amount of loan. Repayment of loan either
in installments or in lump
3. Credit Creation
Credit creation is also an important function of commercial Bank. The
process of credit creation automatically performed when bank accept
deposits and provide loans Prof Sayers says, Banks are not merely supply of
money but in an important sense, they are manufacturers of money. In this
process, customers deposit their money in bank. Bank keeps certain
amount of deposit as cash reserve and rest of balance given as loan and
advances.
Banks not required to keep the entire deposits in cash. The amount of loan
does not give directly to borrower. The borrowers open an account and then
bank deposit money in that account. Here, banks lends money and process
of credit creation starts. The current cash reserve ratio is 6% in 2011.
4. Secondary Functions:- These are as follow:1) Sale and Purchased of Securities: On the behalf of customer,
commercial bank sale and purchase of the securities of private
companies as well as government securities.
2) Transfer of Funds: Commercial Bank also provide facilities to
transfer funds from one place to another place in form Bank draft,
cheques, mail transfer etc.
3) Collection and Payment of Credit Instrument: Commercial Bank
collect and make payment on behalf of their customers Commercial
41
Bank collect and pay negotiable instruments and also pay rent,
income tax fees, insurance premium etc.
4) Locker Facility: Commercial Banks provides locker facility to their
customers. We can keep gold, silver and important documents in
locker.
5) Letter of Credit: Letter of credit certified the credit worthiness of
their customers which issued by commercial banks.
6) Collection of Information: Commercial Banks also collect the
information relating to Industry, trade, commerce which made
available to their customers.
7) Travellers Cheque ad Credit Card: Commercial Banks issue
travellers cheques and credit cards to their customers. They can
travel without fear of theft and loss of money. Credit card is used to
make payment for purchases so that individual does not have to
carry cash.
8) Foreign Exchange: Commercial banks provide facility to their
customers dealing in foreign exchange. Commercial Banks are
authorized dealers in India.
9) Issuing of Gift Cheques: Commercial Banks issues the gift cheques
like Rs 11,51, 101,501 etc.
10) Educational Loans: Commercial Banks also provide educational loan
to student for higher studies at reasonable rate of interest.
11) Consumer Finance: Commercial Banks provide consumer finance
facility for purchase consumer durables like televisions, refrigerators
etc.
12) Automated Teller Machine: Now a days with the help of ATM, we
can deposit or withdraw money from our account any time.
42
CHAPTER-5
ROLE OF MERCHANT BANK IN INDIA
Introduction
The Notification of the Ministry of Finance defines merchant banker as Any
person who is engaged in the business of issue management either by
making arrangements regarding selling, buying or subscribing to securities
as manager-consultant, advisor or rendering corporate advisory services in
relation to such issue management
The Amendment Regulation specifies that issue management consist of
Prospectus and other information relating to issue, determining financial
structure, tie-up of financiers and final allotment and refund of the
subscriptions, underwriting and portfolio management services.
In the words of Skully A Merchant Bank could be best defined as a financial
institution conducting money market activities and lending, underwriting
and financial advice, and investment services whose organization is
characterized by a high proportion of professional staff able to able to
approach problems in an innovative manner and to make and implement
decisions rapidly.
Nature and Characteristics of Merchant Banking
The services of merchant bank cover project counseling, pre investment

activities, feasibility studies, project reports, design of capital structure,
issue management, underwriting, loan syndication, mobilization of funds
from Non-Resident
Indians,
foreign
currency finance, mergers,
amalgamation, takeover, venture capital, buy back and public deposits.
Main Characteristics of Merchant Banking:
High proportion of decision makers as a percentage of total staff.

43
Quick decision process.

High density of information.
Intense contact with the environment.
Loose organizational structure.
Concentration of short and medium term engagements.
Emphasis on fee and commission income.
Innovative instead of repetitive operations.
Sophisticated services on a national and international level.
Low rate of profit distribution.
High liquidity ratio.
Functions/ Services Offered by Merchant Bankers

1. Project Appraisal:
This service helps corporates in analyze the soundness of a project, which
may be setting up a new unit/expansion/modernization etc. It is a process
of examining the technical, commercial, financial and economic viability of a
project to ensure that it generates sufficient returns on the resources
invested in it.
A service project report will be prepared for the company, including
finalization of capital structure. Project appraisal includes:
a) Financial appraisal (liquidity analysis, capital structure analysis,

profitability analysis etc
b) Technical appraisal (factors of production, technology, civil works, site
location etc)
c) Economic appraisal (also known as cost-benefit analysis, social cost,
impact on employment, impact of the economy)
2. Syndication of Loan:
Merchant Bankers arrange short, medium and long term loans for their
clients. They analyze the pattern of clients cash flows, based on which the
terms of borrowing can be defined. It then prepares a detailed loan
44
memorandum which is circulated to various banks and financial institutions

and they are invited to participate in the syndicate.
The merchant banks then negotiate the terms of lending based on which the
final allotment is done. It also arranges for raising foreign exchange loans
and external commercial borrowings for import of capital.
3. Issue Management:
This is the primary function of merchant bankers. It refers to the
management of securities offering of corporates to the general public and
existing shareholders on rights basis.
Merchant bankers act as lead managers and assists companies in arriving
at quantum and nature of issue and obtaining consent/clearance from
various statutory authorities, preparing draft prospectus, obtaining
approval from appropriate authorities etc. it also assists companies in tying
up with underwriters for the issue, appoint other intermediaries like
brokers, bankers, advertising agents, registrar to the issue and co-ordinates
the activities of these agencies and institutions from the successful flotation
of the issue.
It also helps in listing the securities in stock exchange, finalizing basis of
allotment, arranging for refund, handling investor complaints etc.
4. Underwriting of Issues:
In order to ensure full subscription or the stipulated minimum subscription
of 90% of the issue, companies enter into an agreement with financial
institutions, banks, brokers and bankers to underwrite the issue amount.
Merchant bankers can underwrite issues and assist companies in tying up
with other underwriters.
5. Corporate Counseling:
Endearing assistance to corporate clients on various aspects of business
operations in the areas of financial planning, performance budgeting,
restructuring capital, and other aspects of financial management and
monitoring systems and operations.
6. Bankers to the Issue:
45
Collection of subscription money/application money for an issue from the

investors, acknowledgement, proper accounting of the money received,
sending reports/certificates, informing collection details are the services
provided in the banker to the issue role.
7. Investment Counseling:
This activity involved assisting firms, companies, trusts, funds and
associations in the choice of shares and stocks for investment depending
upon the needs and the risk-return trade-off, as well as taxation and time
considerations.
8. Portfolio Management Services:
A portfolio is a collection of different kinds of investments. Merchant
bankers provide portfolio management services.
9. Registrar and Transfer Agent:
Transfer agency work involves carrying out transfer work in respect of
securities after complying with stipulated formalities/procedures.
Preparation and printing of dividend warrants and dispatching them to
share holders are also covered here. Other services include attending to
complaints of applicants/investors, coding and verification of applications,
allotment, processing and dispatching allotment letters, providing various
documents and certificates etc.
10. Mergers, Amalgamations and Acquisitions:
Some companies desire to restructure themselves in order to effectively
meet competition. Merchant bankers provide all requisite guidance and
services for restructuring, to prepare due diligence, necessary clearance
from statutory bodies like SEBI, ROC etc as per the statutory stipulations,
for the process of mergers, acquisitions and amalgamations.
11. Venture Capital:
Merchant Bankers help to obtaining venture capital for financing their new
and innovative strategies.
46
12. Non-resident Investment: Merchant bankers provide investment

advisory services to attract NRI investment in primary and secondary
markets, undertake buying and selling securities on their behalf, secure
clearances from RBI under FEMA for repatriation of interest and dividends
etc.
14. Joint Ventures:

Merchant Bankers help corporates with joint ventures in India and abroad.
Scope for Merchant Banking in India

Growth of New Issues Market:
The growth of new issue market is unprecedented since 1990-1991.
Merchant banking can help with the further sophistication and penetration
of the new issues market.
Entry of Foreign Investors:
Foreign institutional investors were allowed to invest in the primary and
secondary market in 1992 and also, Indian companies were allowed to
directly tap foreign capital through euro issues.
Further, foreign direct investment by NRIs has risen considerably due to
number of incentives offered to them. They need the services of merchant
bankers to advise them for their investment in India. The increasing number
of joint ventures abroad by Indian companies also requires expert services of
merchant bankers.
Changing Policy of Financial Institutions:
The policy of decentralization, increase in demand for technical and financial
services and encouragement of small and medium industries, requires the
services of merchant bankers.
Development of Debt Market:
47
The development of debt market will offer tremendous opportunity to

Merchant Bankers.
Innovations in Financial Instruments:
The Indian capital market has witnessed innovations in the introduction of
financial instruments. This has further extended the role of merchant
bankers as market makers for these instruments.
Corporate Restructuring:
Due to liberalization and globalization, competition in the corporate sector is
becoming intense. To survive and thrive, companies need new strategies,
structures and methods of functioning. This has led to corporate
restructuring including mergers, acquisitions, etc. These developments offer
a good opportunity to merchant bankers to extend their area of operations.
Disinvestment:
The government of India has raised Rs. 2000 crores through disinvestment
of equity shares of selected public sector undertakings in 93-94. Merchant
Bankers can help in the disinvestment process.
CHAPTER -6
ROLE OF DEVELOPMENTS BANKS IN INDIA
48
Meaning of Development Banks

Development banks are specialized financial institutions. They provide
medium and long-term finance to the industrial and agricultural sector.
They provide finance to both private and public sector.
Development banks are multipurpose financial institutions. They do term
lending, investment in securities and other activities. They even promote
saving and investment habit in the public.
Development Banks in India

Development banking was started after the World War II. It provided finance
to reconstruct the buildings and industries which were destroyed in the war.
In India, development banking was started immediately after independence.
The arrangement of development banks in India is depicted below.
Development banks in India are classified into following four groups:

49
1. Industrial Development Banks :

It includes, for example, Industrial Finance Corporation of India
(IFCI), Industrial Development Bank of India (IDBI), and Small
Industries Development Bank of India (SIDBI).
2. Agricultural Development Banks :
It includes, for example, National Bank for Agriculture & Rural
Development (NABARD)
3. Export-Import Development Banks :
It includes, for example, Export-Import Bank of India (EXIM Bank).
4. Housing Development Banks :
It includes, for example, National Housing Bank (NHB).
Industrial Finance Corporation of India (IFCI) is the first development bank
in India. It started in 1948 to provide finance to medium and large-scale
industries in India.
The nine important functions of development banks in India are as follows:

1. To promote and develop small-scale industries (SSI) in India.
2. To finance the development of the housing sector in India.
3. To facilitate the development of large-scale industries (LSI) in India.
4. To help the development of agricultural sector and rural India.
5. To enhance the foreign trade of India.
6. To help to review (cure) sick industrial units.
50
7. To encourage the development of Indian entrepreneurs.
8. To promote economic activities in backward regions of the country.
9. To contribute in the growth of capital markets.
Now let's discuss each important function of development banks one by one.
1. Small Scale Industries (SSI)

Development banks play an important role in the promotion and
development of the small-scale sector. Government of India (GOI) started
Small industries Development Bank of India (SIDBI) to provide medium and
long-term loans to Small Scale Industries (SSI) units. SIDBI provides direct
project finance, and equipment finance to SSI units. It also refinances banks
and financial institutions that provide seed capital, equipment finance, etc.,
to SSI units.
2. Development of Housing Sector

Development banks provide finance for the development of the housing
sector. GOI started the National Housing Bank (NHB) in 1988.
NHB promotes the housing sector in the following ways:
1. It promotes and develops housing and financial institutions.
2. It refinances banks and financial institutions that provide credit to the
housing sector.
3. Large Scale Industries (LSI)

Development banks promote and develop large-scale industries (LSI).
Development financial institutions like IDBI, IFCI, etc., provide medium and
long-term finance to the corporate sector. They provide merchant banking
services, such as preparing project reports, doing feasibility studies,
advising on location of a project, and so on.
4. Agriculture and Rural Development

51
Development banks like National Bank for Agriculture & Rural Development
(NABARD) helps in the development of agriculture. NABARD started in 1982
to provide refinance to banks, which provide credit to the agriculture sector
and also for rural development activities. It coordinates the working of all
financial institutions that provide credit to agriculture and rural
development. It also provides training to agricultural banks and helps to
conduct agricultural research.
5. Enhance Foreign Trade

Development banks help to promote foreign trade. Government of India
started Export-Import Bank of India (EXIM Bank) in 1982 to provide
medium and long-term loans to exporters and importers from India. It
provides Overseas Buyers Credit to buy Indian capital goods. It also
encourages abroad banks to provide finance to the buyers in their country
to buy capital goods from India.
6. Review of Sick Units

Development banks help to revive (cure) sick-units. Government of India
(GOI) started Industrial investment Bank of India (IIBI) to help sick units.
IIBI is the main credit and reconstruction institution for revival of sick units.
It facilitates modernization, restructuring and diversification of sick-units by
providing credit and other services.
7. Entrepreneurship Development
Many development banks facilitate entrepreneurship development. NABARD,
State Industrial Development Banks and State Finance Corporations provide
training to entrepreneurs in developing leadership and business
management skills. They conduct seminars and workshops for the benefit of
entrepreneurs.
8. Regional Development
Development banks facilitate rural and regional development. They provide
finance for starting companies in backward areas. They also help the
companies in project management in such less-developed areas.
9. Contribution to Capital Markets
52
Development banks contribute the growth of capital markets. They invest in

equity shares and debentures of various companies listed in India. They also
invest in mutual funds and facilitate the growth of capital markets in India.
CHAPTER- 7
CHANGING ROLE OF BANKS INDIA
Introduction
The role of banks in India has changed a lot since economic reforms of 1991.
These changes came due to LPG, i.e. liberalization, privatization and
globalization policy being followed by GOI. Since then most traditional and
outdated concepts, practices, procedures and methods of banking have
changed significantly.
Today, banks in India have become more customer focused and serviceoriented than they were before 1991. They now also give a lot of importance
to their rural customers. They are even willing ready to help them and serve
regularly the banking needs of country-side India.
53
The changing role of banks in India can be glanced in points depicted below.
The following points briefly highlight the changing role of banks in India.
1. Better customer service,
2. Mobile banking facility,
3. Bank on wheels scheme,
4. Portfolio management,
5. Issue of electro-magnetic cards,
6. Universal banking,
54
7. Automated teller machine (ATM),

8. Internet banking,
9. Encouragement to bank amalgamation
10.
Encouragement to personal loans,
11.
Marketing of mutual funds,
12.
Social banking, etc.
The above-mentioned points indicate the role of banks in India is changing.

Now let's discuss how banking in India is getting much better day after day.
1. Better Customer Service

Before 1991, the overall service of banks in India was very poor.
very long queues (lines) to receive payment for cheques and
money. In those days, some bank staffs were very rude to their
However, all this changed remarkably after Indian economic
1991.
There were
to deposit
customers.
reforms of
Banks in India have now become very customer and service focus. Their
service has become quick, efficient and customer-friendly. This positive
change is mostly due to rising competition from new private banks and
initiation of Ombudsman Scheme by RBI.
2. Mobile Banking
Under mobile banking service, customers can easily carry out major
banking transactions by simply using their cell phones or mobiles.
Here, first a customer needs to activate this service by contacting his bank.
Generally, bank officer asks the customer to fill a simple form to register
(authorize) his mobile number. After registration, this service is activated,
and the customer is provided with a username and password. Using secret
credentials and registered phone, customer can now comfortably and
55
securely, find his bank balance, transfer money from his account to another,
ask for a cheque book, stop payment of a cheque, etc.
Today, almost all banks in India provide a mobile-banking service.
3. Bank on Wheels
The 'Bank on Wheels' scheme was introduced in the North-East Region of
India. Under this scheme, banking services are made accessible to people
staying in the far-flung (remote) areas of India. This scheme is a generous
attempt to serve banking needs of rural India.
4. Portfolio Management
In portfolio management, banks do all the investments work of their clients.
Banks invest their clients' money in shares, debentures, fixed deposits, etc.
They first enter a contract with their clients and charge them a fee for this
service. Then they have the full power to invest or disinvest their clients'
money. However, they have to give safety and profit to their clients.
5. Issue of Electro-Magnetic Cards

Banks in India have already started issuing Electro-Magnetic Cards to their
customers. These cards help to carry out cash-less transactions, make an
online purchase, avail ATM facility, book a railway ticket, etc.
Banks issue many types of electro-magnetic cards, which are as follows:
1. Credit cards help customers to spend money (loaned up to a certain
limit as previously settled by the bank) which they don't have in hand.
They get a monthly statement of their purchases and withdrawals.
Along with the transacted amount, this statement also includes the
interest and service fee.
The entire amount (as reflected in the statement of credit card) must
be paid back to the bank either fully or in installments, but before due
date.
2. Debit cards help customers to spend that money which they have
saved (credited) in their individual bank accounts. They need not
carry cash but instead can use a debit card to make a purchase (for
shopping) and/or withdraw money (get cash) from an ATM. No interest
is charged on the usage of debit cards.
56
3. Charge cards are used to spend money up to a certain limit for a

month. At the end of the month, customer gets a statement. If he has
a sufficient balance, then he only had to pay a small fee.
However, if he doesn't have a necessary balance, he is given a grace
period (which is generally of 25 to 50 days) to repay the money.
4. Smart cards are currently being used as an alternative to avail public
transport services.
In India, this covers Railways, State Transport and City (Local) Buses.
Smart card has an integrated circuit (IC) embedded in its plastic body.
It is made as per norms specified by ISO.
5. Kisan credit cards are used for the benefit of the rural population of
India. The Indian farmers (kisans) can use this card to buy
agricultural inputs and goods for self-consumption. These cards are
issued by both Commercial and Co-operative banks.
6. Universal Banking
In India, the concept of universal banking has gained recognition after year
2000. The customers can get all banking and non-banking services under
one roof. Universal bank is like a super store. It offers a wide range of
services, including banking and other financial services like insurance,
merchant banking, etc.
7. Automated Teller Machine (ATM)

There are many advantages of ATM. As a result, many banks have opened
up ATM centres to offer convenience to their customers. Now banks are
operating ATM centres not only in their branches but also at public places
like airports, railway stations, hotels, etc.
Some banks have joined together and agreed upon to set up common ATM
centres all over India.
8. Internet Banking
57
Internet banking is also called as an E-banking or net banking. Here, the

customer can do banking transactions through the medium of the internet
or world wide web (WWW). The customer need not visit the bank's branch.
Through this facility, the customer can easily inquiry about bank balance,
transfer funds, request for a cheque book, etc. Most large banks offer this
service to their tech-savvy customers.
9. Encouragement to Bank Amalgamation

Failure of banks is well-protected with the facility of amalgamation. So
depositors need not worry about their deposits. When weaker banks are
absorbed by stronger banks, it is called amalgamation of banks.
10. Encouragement to Personal Loans

Today, the purchasing power of Indian consumers has increased
dramatically because banks give them easy personal loans. Generally,
interest charged by the banks on such loans is very high. Interest is
calculated on reducing balance.
Large banks offer loans up to a huge amount like one crore. Some banks
even organise Loan Mela (Fair) where a loan is sanctioned on the spot to
deserving candidates after they submit proper documents.
11. Marketing of Mutual Funds

A mutual fund collects money from many investors and invests the money in
shares, bonds, short-term money market instruments, gold assets; etc.
Mutual funds earn income by interest and dividend or both from its
investments. It pays a dividend to subscribers. The rate of dividend
fluctuates with the income on mutual fund investments.
Now banks have started selling these funds in their own names. These
funds are not insured like other bank deposits.
There are different types of funds such as open-ended funds, closed-ended
funds, growth funds, balanced funds, income funds, etc.
58
12. Social Banking

The government uses the banking system to alleviate poverty and
unemployment. Many social development programmes are initiated by the
banks from time to time.
The success of these programmes depends on financial support provided by
the banks. Banks supply a lot of finance to farmers, artisans, scheduled
castes (SC) and scheduled tribe (ST) families, unemployed youth and people
living below the poverty line (BPL)
CHAPTER-8
ECONOMICS REFORMS OF THE BANKING SECTOR IN
INDIA
Indian banking sector has undergone major changes and reforms during
economic reforms. Though it was a part of overall economic reforms, it has
changed the very functioning of Indian banks.
This reform has not only influenced the productivity and efficiency of many
of the Indian Banks, but has left everlasting footprints on the working of the
banking sector in India.
59
Let us get acquainted with some of the important reforms in the banking
sector in India.
1. Reduced CRR and SLR :
The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are
gradually reduced during the economic reforms period in India. By
Law in India the CRR remains between 3-15% of the Net Demand and
Time Liabilities.
It is reduced from the earlier high level of 15% plus incremental CRR
of 10% to current 4% level. Similarly, the SLR Is also reduced from
early 38.5% to current minimum of 25% level.
This has left more loanable funds with commercial banks, solving the
liquidity problem.
2. Deregulation of Interest Rate :
During the economics reforms period, interest rates of commercial
banks were deregulated. Banks now enjoy freedom of fixing the lower
and upper limit of interest on deposits.
60
Interest rate slabs are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs.
Interest rates on the bank loans above Rs.2 lakhs are full
decontrolled. These measures have resulted in more freedom to
commercial banks in interest rate regime.
3. Fixing prudential Norms :
In order to induce professionalism in its operations, the RBI fixed
prudential norms for commercial banks. It includes recognition of
income sources.
Classification of assets, provisions for bad debts, maintaining
international standards in accounting practices, etc. It helped banks
in reducing and restructuring Non-performing assets (NPAs).
4. Introduction of CRAR :
Capital to Risk Weighted Asset Ratio (CRAR) was introduced in 1992.
It resulted in an improvement in the capital position of commercial
banks, all most all the banks in India has reached the Capital
Adequacy Ratio (CAR) above the statutory level of 9%.
5. Operational Autonomy :
During the reforms period commercial banks enjoyed the operational
freedom. If a bank satisfies the CAR then it gets freedom in opening
new branches, upgrading the extension counters, closing down
existing branches and they get liberal lending norms.
6. Banking Diversification :
The Indian banking sector was well diversified, during the economic
reforms period. Many of the banks have stared new services and new
products. Some of them have established subsidiaries in merchant
banking, mutual funds, insurance, venture capital, etc which has led
to diversified sources of income of them.
7. New Generation Banks :
During the reforms period many new generation banks have
successfully emerged on the financial horizon. Banks such as ICICI
Bank, HDFC Bank, UTI Bank have given a big challenge to the public
sector banks leading to a greater degree of competition.
61
8. Improved Profitability and Efficiency :

During the reform period, the productivity and efficiency of many
commercial banks has improved. It has happened due to the reduced
Non-performing loans, increased use of technology, more
computerization and some other relevant measures adopted by the
government.
These are some of the import reforms regarding the banking sector in
India.With these reforms, Indian banks especially the public sector banks
have proved that they are no longer inefficient compared with their foreign
counterparts as far as productivity is concerned.
CHAPTER - 9
CHANGING ROLE OF UNIVERSAL BANKING
62
Introduction
The term Universal Banking is popular in India after period of
1991, when we have accepted new economic policy of Globalization,
Liberalization and Privatization (L.P.G). It becomes essential for Indian
banks to go for Indian banks to go for universal banking because foreign
banks were permitted to start a business in India, they have come along
with universal banking.
So in order to compete with foreign banks, Indian banks become universal.
Along with traditional functions of banks, under one roof, banks are
providing investment services as well as insurance services. Development of
information and technology educate consumers about universal banking.
In India, two reports in 1998 mentioned the concept of universal banking.
They are, the Narasimham Committee Report and the S.H. Khan Committee
Report.
Both these reports advised to consolidate (bring together) the banking
industry through mergers and integration of financial activities. That is,
they advised a combination of all banking and financial activities. That is,
they suggested a Universal banking.
In 2000, ICICI asked permission from RBI to become a universal bank. RBI
wants some big domestic financial institutions to become universal banks.
63
Meaning
Universal banking is a combination of Commercial banking, Investment
banking, Development banking, Insurance and many other financial
activities.
It is a place where all financial products are available under one roof. So, a
universal bank is a bank which offers commercial bank functions plus other
functions such as Merchant Banking, Mutual Funds, Factoring, Credit
cards, Housing Finance, Auto loans, Retail loans, Insurance, etc
Universal banking is done by very large banks. These banks provide a lot of
finance to many companies. So, they take part in the Corporate Governance
(management) of these companies. These banks have a large network of
branches all over the country and all over the world. They provide many
different financial services to their clients.
Needs of Universal Bank

The global retail financial services market is growing very fast which
leads to development of foreign banks which attract consumers by
providing variety of services.
Information and technology development or internet banking (Ebanking), attracted consumers which makes the available information
about banking activities.
Liberalization and banking sector reforms leads to universal banking
instead of traditional banking.
Foreign banks as well as private sector banks started providing variety
of services under universal banking like insurance and investment.
Customer demand for investment in different sources for which expert
advice is available by banks, development of I.T sector widened the
responsibility of bank for universal services.
Changing role of Universal bank
64
After globalization, Indian economy is integrated with global economy or

world economy because of which universal banking started facing various
challenges for example competition from foreign banks, foreign financial
institutions and non-banking financial institutions.
To make profit and to remain in competition it has become essential to all
the banks to go for fresh capital by attracting new consumers and expand
their modern services along with traditional activities.
The major 3 things which the bank has to keep in mind :
1. Maintaining capital adequacy ratio.
2. Regulation of interest rates policy and acceptance of free exchange
rate.
3. Development of information and technology sector will make the
bank to spread the risk in universal business as well as in foreign
market.
Following are the importance functions performed by universal banking in

open economy
1. Credit market:
All kinds of credit or finance are provided through commercial banking. An
important credit is long term finance for industrial sector, project finance
and issue of shares and bonds on behalf of industrial sector through
Developmental Financial Institutions for example IDBI, ICICI etc.
2. Consumer Finance:
To improve the standard of living of common people, different kind of
consumer credit is made available to consumers for consumption purpose,
for housing, education, gold purchase, for purchasing vehicles and
renovation of house
3. Saving in mutual funds:
65
These banks mobilizes savings from common people through mutual funds
and invest in capital market which is ultimately used by industries for
industrial development and infrastructural development.
4. Capital and money market:
Every bank has to maintain CRR and VRR with central bank as well as SLR
for which they are purchasing treasury bills as well as assets of banks and
financial institutions. They also purchase commercial papers and invest in
commercial deposit of RBI. They buy and sell financial assets in money
market.
It also operates in capital market to provide advisory services to industries
for business, undertaking issue of shares and providing finance for
industries. Through mutual funds it operates in capital market.
5. Merchant Banking:
For development of industries all the efforts are taken by merchant banks
that are operating in capital market.
For example
1. Advisory services regarding project planning
2. Technological advice
3. Advice on financial matters and undertaking of issue of shares and
bonds in capital market.
Advantages of Universal Banking
The benefits or advantages of universal banking are:1. Investors' Trust :

Universal banks hold stakes (equity shares) of many companies. These
companies can easily get other investors to invest in their business.
This is because other investors have full confidence and faith in the
66
Universal banks. They know that the Universal banks will closely
watch all the activities of the companies in which they hold a stake.
2. Economics of Scale :
Universal banking results in economic efficiency. That is, it results in
lower costs, higher output and better products and services. In India,
RBI is in favour of universal banking because it results in economies
of scale.
3. Resource Utilisation :
Universal banks use their client's resources as per the client's ability
to take a risk. If the client has a high risk taking capacity then the
universal bank will advise him to make risky investments and not safe
investments. Similarly, clients with a low risk taking capacity are
advised to make safe investments.
Today, universal banks invest their client's money in different types of
Mutual funds and also directly into the share market. They also do
equity research. So, they can also manage their client's portfolios
(different investments) profitably.
4. Profitable Diversification :
Universal banks diversify their activities. So, they can use the same
financial experts to provide different financial services. This saves cost
for the universal bank. Even the day-to-day expenses will be saved
because all financial services are provided under one roof, i.e. in the
same office.
5. Easy Marketing :
The universal banks can easily market (sell) all their financial
products and services through their many branches. They can ask
their existing clients to buy their other products and services. This
requires less marketing efforts because of their well-established brand
name.
For e.g. ICICI may ask their existing bank account holders in all their
branches, to take house loans, insurance, to buy their Mutual funds,
etc. This is done very easily because they use one brand name (ICICI)
for all their financial products and services.
67
6. One-stop Shopping :
Universal banking offers all financial products and services under one
roof. One-stop shopping saves a lot of time and transaction costs. It
also increases the speed or flow of work. So, one-stop shopping gives
benefits to both banks and their clients.
Disadvantages of Universal Banking
The limitations or disadvantages of universal banking are:1. Different Rules and Regulations :
Universal banking offers all financial products and services under
one roof. However, all these products and services have to follow
different rules and regulations. This creates many problems.
For e.g. Mutual Funds, Insurance, Home Loans, etc. have to follow
different sets of rules and regulations, but they are provided by the
same bank.
2. Effect of failure on Banking System :
Universal banking is done by very large banks. If these huge banks
fail, then it will have a very big and bad effect on the banking system
and the confidence of the public.
For e.g. Recently, Lehman Brothers a very large universal bank failed.
It had very bad effects in the USA, Europe and even in India.
3. Monopoly :
Universal banks are very large. So, they can easily get monopoly power
in the market. This will have many harmful effects on the other banks
and the public. This is also harmful to economic development of the
country.
4. Conflict of Interest :
Combining commercial and investment banking can result in conflict
of interest. That is, Commercial banking versus Investment banking.
Some banks may give more importance to one type of banking and
68
give less importance to the other type of banking. However, this does
not make commercial sense.
CHAPTER -10
RECOMMENDATION OF NARASIMHAM COMMITTEE
From the 1991 India economic crisis to its status of third largest economy in
the world by 2011, India has grown significantly in terms of economic
development. So has its banking sector. During this period, recognising the
evolving needs of the sector, the Finance Ministry of Government of India
(GOI) set up various committees with the task of analysing India's banking
sector and recommending legislation and regulations to make it more
effective, competitive and efficient.]
Two such expert Committees were set up under the chairmanship of M.
Narasimham. They submitted their recommendations in the 1990s in
reports widely known as the Narasimham Committee-I (1991) report and
the Narasimham Committee-II (1998) Report. These recommendations not
only helped unleash the potential of banking in India, they are also
69
recognised as a factor towards minimising the impact of global financial

crisis starting in 2007.
Unlike the socialist-democratic era of the 1960s to 1980s, India is no longer
insulated from the global economy and yet its banks survived the 2008
financial crisis relatively unscathed, a feat due in part to these Narasimham
Committees
Narasimham Committee Report I - 1991
The Narsimham Committee was set up in order to study the problems of the
Indian financial system and to suggest some recommendations for
improvement in the efficiency and productivity of the financial institution.
The committee has given the following major recommendations:1. Reduction in the SLR and CRR :
The committee recommended the reduction of the higher proportion of
the Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio 'CRR'.
70
Both of these ratios were very high at that time. The SLR then was
38.5% and CRR was 15%. This high amount of SLR and CRR meant
locking the bank resources for government uses.
It was hindrance in the productivity of the bank thus the committee
recommended their gradual reduction. SLR was recommended to
reduce from 38.5% to 25% and CRR from 15% to 3 to 5%.
2. Phasing out Directed Credit Programme :

In India, since nationalization, directed credit programmes were
adopted by the government. The committee recommended phasing out
of this programme. This programme compelled banks to earmark then
financial resources for the needy and poor sectors at confessional
rates of interest.
It was reducing the profitability of banks and thus the committee
recommended the stopping of this programme.
3. Interest Rate Determination :
The committee felt that the interest rates in India are regulated and
controlled by the authorities. The determination of the interest rate
should be on the grounds of market forces such as the demand for
and the supply of fund.
Hence the committee recommended eliminating government controls
on interest rate and phasing out the concessional interest rates for the
priority sector.
4. Structural Reorganizations of the Banking sector :
The committee recommended that the actual numbers of public sector
banks need to be reduced. Three to four big banks including SBI
should be developed as international banks. Eight to Ten Banks
having nationwide presence should concentrate on the national and
universal banking services.
Local banks should concentrate on region specific banking. Regarding
the RRBs (Regional Rural Banks), it recommended that they should
focus on agriculture and rural financing.
71
They recommended that the government should assure that

henceforth there won't be any nationalization and private and foreign
banks should be allowed liberal entry in India.
5. Establishment of the ARF Tribunal :
The proportion of bad debts and Non-performing asset (NPA) of the
public sector Banks and Development Financial Institute was very
alarming in those days.
The committee recommended the establishment of an Asset
Reconstruction Fund (ARF). This fund will take over the proportion of
the bad and doubtful debts from the banks and financial institutes. It
would help banks to get rid of bad debts.
6. Removal of Dual control :
Those days banks were under the dual control of the Reserve Bank of
India (RBI) and the Banking Division of the Ministry of Finance
(Government of India).
The committee recommended the stepping of this system. It
considered and recommended that the RBI should be the only main
agency to regulate banking in India.
7. Banking Autonomy :
The committee recommended that the public sector banks should be
free and autonomous. In order to pursue competitiveness and
efficiency, banks must enjoy autonomy so that they can reform the
work culture and banking technology upgradation will thus be easy.
Some of these recommendations were later accepted by the Government of
India and became banking reforms.
Narasimham Committee Report II - 1998

In 1998 the government appointed yet another committee under the
chairmanship of Mr. Narsimham. It is better known as the Banking Sector
Committee. It was told to review the banking reform progress and design a
programme for further strengthening the financial system of India.
The committee focused on various areas such as capital adequacy, bank
mergers, bank legislation, etc.
72
Problems Identified By The Narasimham Committee

1. Directed Investment Programme :
The committee objected to the system of maintaining high liquid
assets by commercial banks in the form of cash, gold and
unencumbered government securities. It is also known as the
statutory liquidity Ratio (SLR). In those days, in India, the SLR was as
high as 38.5 percent.
According to the M. Narasimham's Committee it was one of the
reasons for the poor profitability of banks. Similarly, the Cash Reserve
Ratio- (CRR) was as high as 15 percent. Taken together, banks needed
to maintain 53.5 percent of their resources idle with the RBI.
2. Directed Credit Programme :
Since nationalization the government has encouraged the lending to
agriculture and small-scale industries at a confessional rate of
interest. It is known as the directed credit programme. The committee
opined that these sectors have matured and thus do not need such
financial support.This directed credit programme was successful from
the government's point of view but it affected commercial banks in a
bad manner. Basically it deteriorated the quality of loan, resulted in a
shift from the security oriented loan to purpose oriented. Banks were
given a huge target of priority sector lending, etc. ultimately leading to
profit erosion of banks.
3. Interest Rate Structure :
The committee found that the interest rate structure and rate of
interest in India are highly regulated and controlled by the
government. They also found that government used bank funds at a
cheap rate under the SLR.
At the same time the government advocated the philosophy of
subsidized lending to certain sectors. The committee felt that there
was no need for interest subsidy. It made banks handicapped in terms
of building main strength and expanding credit supply.
4. Additional Suggestions :
73
Committee also suggested that the determination of interest rate

should be on grounds of market forces. It further suggested
minimizing the slabs of interest.
Along with these major problem areas M. Narasimham's Committee
also found various inconsistencies regarding the banking system in
India. In order to remove them and make it more vibrant and efficient,
it has given the following recommendations.
It submitted its report to the Government in April 1998 with the following
recommendations.
1. Strengthening Banks in India :
The committee considered the stronger banking system in the context
of the Current Account Convertibility 'CAC'. It thought that Indian
banks must be capable of handling problems regarding domestic
liquidity and exchange rate management in the light of CAC.
Thus, it recommended the merger of strong banks which will have
'multiplier effect' on the industry.
2. Narrow Banking :
Those days many public sector banks were facing a problem of the
Non-performing assets (NPAs). Some of them had NPAs were as high
as 20 percent of their assets.
Thus for successful rehabilitation of these banks it recommended
'Narrow Banking Concept' where weak banks will be allowed to place
their funds only in short term and risk free assets.
3. Capital Adequacy Ratio :
In order to improve the inherent strength of the Indian banking
system the committee recommended that the Government should
raise the prescribed capital adequacy norms.
This will further improve their absorption capacity also. Currently the
capital adequacy ration for Indian banks is at 9 percent.
4. Bank ownership :
74
As it had earlier mentioned the freedom for banks in its working and
bank autonomy, it felt that the government control over the banks in
the form of management and ownership and bank autonomy does not
go hand in hand and thus it recommended a review of functions of
boards and enabled them to adopt professional corporate strategy.
5. Review of banking laws :
The committee considered that there was an urgent need for
reviewing and amending main laws governing Indian Banking
Industry like RBI Act, Banking Regulation Act, State Bank of India
Act, Bank Nationalisation Act, etc. This upgradation will bring them in
line with the present needs of the banking sector in India.
Apart from these major recommendations, the committee has also
recommended faster computerization, technology upgradation, training of
staff, depoliticizing of banks, professionalism in banking, reviewing bank
recruitment, etc.
Evaluation of Narsimham Committee Reports

The Committee was first set up in 1991 under the chairmanship of Mr. M.
Narasimham who was 13th governor of RBI. Only a few of its
recommendations became banking reforms of India and others were not at
all considered. Because of this a second committee was again set up in
1998.
As far as recommendations regarding bank restructuring, management
freedom, strengthening the regulation are concerned, the RBI has to play a
major role. If the major recommendations of this committee are accepted, it
will prove to be fruitful in making Indian banks more profitable and
efficient.
75

Role of Banking Sector in India

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