Module 1: Banking system and structure in India:

Banking can be defined as the business activity of accepting and safeguarding money owned by other individuals and
entities, and then lending out this money in order to earn a profit.
Introduction to banking system:
Banks are the important segment in Indian financial system. An efficient banking system helps the nation’s
economic development. Various categories of stakeholders of the society use the banks for their different requirements.
Apart from accepting deposits & lending money, banks in today’s changed global business environment offer many more
value added services to their clients. The RBI & central bank of the country plays different roles like the regulator,
supervisor & facilitator of the Indian banking system.
Bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be
performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a
country, banks are highly regulated in most countries
Evolution of Indian banking system:
The evolution of Indian Banking System can be categorized into 4 different phases. They are:

I pre independence phase (up to 1947)

II 1947 to 1967
III 1967 to 1991
IV After 1991

I pre independence phase (up to 1947):

The origin & growth of banking in India dates back to vedic times, which may be taken to range from 2000 BC to
1400 BC. Money lending was being practiced even in early Aryans days is evidenced by the reference to money –
lending as one of the four honest businesses, the other three being cultivation, trade & harvesting. Debts is often
reflected a normal condition prevalent in the vedic society.
The British came to India in the 17th century; they found a reasonably well established indigenous banker system. The
English traders, however, could not easily avail themselves of the credit facilities extended by the indigenous system,
as the business was conducted in the vernacular languages with which British were not aware. On the other hand,
indigenous bankers were ignorant of the ways & the method of banking practiced in the west. English merchant houses
were set up themselves the business of banking addition to commercial & trading activities. When the British acquired
political control of the country, the system of revenue collection by these indigenous bankers was abolished in the year
1778.
The established of the bank of Hindustan in the year 1770 in Calcutta by lending agency house marks the beginning
of modern banking in India on the pattern of European banks. It collapsed in the year 1832.
The half of the 18th century was the Bengal bank which had been in existence as early as the year 1784. This bank,
unlike the earlier one, was not connected with any agency house.
The general bank in India which came into existence in the year 1786, was the first joint stock bank in India that issue
shares & having limited liability of its shareholders. Subsequently in the year 1787, this bank appointed bankers to the
government. It did not survive much & was ultimately dissolved in the year 1791.
The 1st presidency bank known as the bank of Bengal was established in the year 1806 in Calcutta. The uniform
currency was established throughout the British India in the year 1835. 2 more presidency banks viz, the Bank of
Bombay in the year 1840 & subsequently the Bank of Madras in the year 1843 were setup. And all the three Banks
like central banks in their respective operations for they performed central banking functions & also acted as Banker to
the govt. it continued until the year 1920 & ultimately conclude in the formation of the imperial bank of India on 27 th
January 1921 as an amalgamated central bank of the country barring the power to issue Bank notes.
The 1st Indian joint stock bank was the oudh commercial bank which was established in the year 1881 followed by the
Punjab national bank 1894 & the people’s bank 1901.
In 1906 3 more banks were founded, the bank of India, Bank of Rangoon & The Indian Specie bank all of which had
paid up capital exceeding rupees 15 Lakh each. Many of these banks witnessed failures due to economic depression &
 Indian bank faced serious crisis
The establishment of RBI in the year 1935 marked the beginning of a new era in the history of Indian banking. The
central banking enquiry committee addressed himself to the problem of series of banks failures & recommended that
special act to be passed for regulating the banking system.

II 1947 to 1967:
The post-Independence era marked the enactment of banking companies act, 1949 which was later renamed as the
banking regulation act in the year 1966 gave wider powers to RBI to regulate, supervise & develop the Banking
system. In subsequent year efforts of RBI were mainly directed towards institutionalization of saving consolidated of
banking structure & re-orienting the credit system to emerging needs of economy. Setting up of SBI act , and its
subsidiaries & efforts were made for branch expansion of SBI to include more rural areas into banking ambit.

III 1967 to 1991

This phased marked the following improvements
1) Tightening of social controls over banking sectors
2) Expansion in bank branches & increase lending to priority sectors was been more prominent.
3) At the end of this phase banks suffered a lot with the NPA & were low on profitability efficiency & productivity
4) Until the beginning of 1990’s the financial sector in India could be described as an example of financial repression.
The capital & forex markets lacked depth & there was a serious balance of payment in India.

IV After 1991
This year saw the dawn of one of the most productive Phase in Indian history. The GOI constituted a high powered
committee on financial system under the chairmanship of Sri M Narasimham which gave its recommendations that
formed the base of financial sector reforms .this improved the profitability, competitiveness capital positions & asset
quality in most of the banks.

Adoption of banking technology

The IT revolution had a great impact in the Indian banking system:
 Introduction of online banking inIndia.
 Formation of committee on Mechanization in the banking Industry in 1984, providing use of standardized cheque
forms andencoders.
 Formation of committee on Computerization in Banks (1988) which emphasized that settlement operation must be
computerized in the clearing houses ofRBI.
 Focused on computerization of branches and increasing connectivity among branches throughcomputers.
 Formation of Committee on Technology Issues relating to Payments System, Cheque Clearing and Securities
Settlement in the Banking Industry (1994) emphasized on Electronic Funds Transfer (EFT) system, with the BANKNET
communications network as its carrier.
 ATMs installed in India by various banks as on end March 2005 is17,642.
Types of Banks:
The financial system in India comprises of commercial banks including public sector, private sector & foreign banks,
co-operative banks, development finance institutions & various other institutions in the area of insurance, mutual funds &
govt. securities. Commercial banks occupy a predominant place in the financial system & payment systems. The banking
system is headed by the RBI which is the monetary authority of the country & performs the role of central Banking.
1. The public sector banks:
It are owned and operated by the government, who has a major/ full share in them. At least 51% of
ownership is vested with the GOI & the management control of these nationalized banks is only with central
govt. they are classified as public sector banks. The share of these banks are listed in stock exchanges. These are
regulated by the statutes of govt. & some provisions of banking regulation act, 1949 as per sec 51. Apart from
the nationalized banks, SBI, IDBI Bank & regional rural banks are included in t he category of public sector
banks. The major focus of these banks is to serve the people rather earn profits. Some examples of these banks
include State Bank of India, Punjab National Bank, Bank of Maharashtra,etc.
Regulations:
 SBI regulated by SBI Act 1955
 Nationalized banks regulated by banking companies act 1970 & 1980. During 1993-94 1st phase of financial
reforms was initiated & recovery of weak banks was put in to path. During 2006-07 the public sector banks were
allowed to raise capital as stipulated by the Basel Accords but not exceeding 49% of their equity base.

2. The regional rural banks

It were brought into operation with the objective of providing credit to the rural and agricultural regions
and were brought into effect in1975 by RRB Act. The recommendation of working group headed by shri
Narasimham, to serve the rural population in addition to the banking services offered by the co -operative banks &
commercial banks in rural areas. RRBs were expected to play a vital role in mobilizing the savings of the small &
marginal farmers, rural artisans, agricultural labourers & small entrepreneurs & inculcate banking habit among the
rural people. These are working in all states except goa & Sikkim. These are governed by RRB comprises of 50%
of capital by central govt. 15% by state govt. & 35% by sponsoring public sector bank. There are recent policy of
recapitalization & amalgamation of RRBs. The performance of RRBs dropped down due to multiplicity of control
such as RBI is the banking regulator, while NABARD is the supervisor with limited powers. These banks are
restricted to operate only in the areas specified by government of India. These banks are owned by Government
and a sponsor bank. This sponsorship was to be done by a nationalized bank and a State Cooperative bank.
Prathama Bank is one such example, which is located in Moradabad in U.P.

3. The private sector banks

Banks whose majority stake holding was with private individuals & corporate are called pvt. Sector
banks. It are owned and operated by private institutes. They should meet priority sector lending targets of RBI.
The purpose of the banks is that the ownership & control is well diversified with sound corporate governance.
There are more than 35 private sector banks of which 13 were old. Those non-nationalized banks which
continue operations even today are classified as old generation pvt. Sector banks like Jammu & Kashmir Bank
ltd, federal bank etc. They are free to operate and are controlled by market forces. A greater share is held by
private players and not the government. For example, Axis Bank, Kotak Mahindra Bank etc. in July 1993 on
account of banking sector reforms the RBI allowed many new banks to start banking operations. New pvt. Sector
banks-
 Came into operation after 1991 with introduction of economic and financial sector reforms.
 They are strategic in their thinking & operations.
 They have capital of Rs. 200-300 cr
 The foreign investment in Pvt Sector banks should be < 74% & at least 26% of paid up capital should be of
resident Indians.

4. State bank of India

GOI entered commercial banking taking over imperial bank of India & converted to SBI on 1 st July, 1955. SBI is
st
the 1 one to make public issue in 1993-94. The shareholding of RBI increased up to 68.93% at present. The State bank of
Saurashtra, State bank of Indore is merged with SBI during 2008 & 2010 respectively. The SBI merged other 5
associate’s banks such as state bank of Hydrebad, State bank of Patiala, State bank of Travancore, State bank of Bikaner
& Jaipur, State bank of Mysore, for the 100th year anniversary in the year 2016 & become a big bank.

5. Foreign banks:
It are registered or incorporated in their home country not in India. These banks support the financing of exports &
imports. They are required to invest an assigned capital of USD 25 million at the time of opening 1 st branch in India.
They can operate in India through the following modes:
 Through branches
  Through wholly-owned subsidiaries
 Through subsidiaries with the maximum aggregate of foreign bank of 74% in private sector bank.
RBI has given a 2 phase road map for the presence of foreign banks in India:
 To establish wholly-owned subsidiaries with Rs. 300 crs capital & 10% capital adequacy.
 Extension of national treatment for dilution of stake & permitting mergers & acquisitions

6. Co-operative banks:
It plays an important role in the Indian financial system, especially at the village level. The growth of cooperative
movement commenced with the passing of the Act of 1904. A cooperative society registered or deemed to have
been registered under any state or central Act. Apart from various other laws like the banking laws Act, 1965 &
banking regulation & miscellaneous provisions Act, 2004 would also be applicable for governing the banking
activities. These cooperative banks cater to the needs of agriculture, retail trade, small & medium industry & self-
employed businessmen usually in urban, rural & semi urban areas. This is a small scale banking carried on a no
profit no loss basis for mutual cooperation & help. They help in financing rural & agricultural development. Most
of them are non-scheduled banks only. They borrow from RBI, NABARD, and Banks etc. these may be
categorized into-
 Urban & rural co-operative banks.
 Central & state co-operative banks.

7. Development banks:
A part from these banks we have also development banks in India. History of development banking in India
can be traced to the establishment of the Industrial Finance Corporation of India in 1948. Subsequently, with the
passing of State Financial Corporation Act 1951, several SFCs came into being. With the introduction of financial
sector reforms, many changes have been witnessed in the domain of development banking. The major 4
development banks which assist in extending long term lending & refinance facilities to different areas of
economy for the economic development pertaining to small scale & medium industries, agricultural sector &
Housing sector & NABARD, small industries development bank of India, national housing bank & exim bank.
This financial institution plays crucial role in assisting different segments including the rural economic
development.

Performance of public sector bank

The financial system of any country consists of financial institutions, financial markets, financial instruments,
financial services and financial assets. An efficient and a smooth financial system plays an important role in the
nation's economic development. A well developed country will have well-organized financial Institutions.
Financial Institutions are an important part of the Indian Financial System. The institutions are divided into two
categories, banking and non-banking. Banks play a pivotal role in India's economy. The year 1969 was a
landmark in the history of commercial banking in India. In July 1969, the government nationalized 14 major
commercial banks of the country. In 1980, 6 more banks were nationalized.
The first Five Year Plan held in the 1951 accorded the development of the rural areas as the highest priority. The
plan was for the time period between 1951‒1956. The All India Rural Credit Survey Committee advised the
government to create state partnered and state ownedbanks.AnactwaspassedintheparliamentinMay1955and the
State Bank of India was constituted. Later the State Bank of India Act was passed in 1959 to take over the
associate banks of SBI and its subsidiaries.
The pre-nationalization period saw a lion's share in the industrial sector to the bank's credit. Large scale
industries cornered a large portion of the credit and the share of small scale industries was marginal. There
were many reasons for the dominance of the large scale industries in the banking sector. Many commercial
banks were under the ownership and control of big industrial houses. A disturbing feature of the pre -
nationalization banking policy was the negligence of agriculture sector to the bank's credit. This Were neither
interested nor geared up to meet the risky and small credit requirements of the farmers. Similarly, the share of
other non-industrial sectors was also very low. Since the commercial banks were under the control of big
industrialists, the loan able funds of the banks were sometimes used to finance socially undesirable activities
like hoarding of essential commodities.
share hovered around 2% of the total commercial bank credit. The privately owned commercial banks
The post-nationalization period witnessed certain drastic changes in the economy. All the leading commercial
banks of the country were nationalized in the year 1969with
someobjectivesinmind.Theobjectivesofnationalizationwereasfollows:

 To break the ownership and control of banks by a few business families.

 To prevent concentration of wealth and economic power.
 To mobilize savings of the masses from every nook and corner of the country.
To pay more attention to the priority sectors of the economy like agriculture and small scale industries, the post-
nationalization period saw a remarkable expansion in the banking and financial system. The biggest achievement
of nationalization was the reallocation of sectoral credit in favor of agriculture, small scale industries and
exports. Within agriculture, credit for the procurement of food grains, i.e., food credit was a
majorthing.Otheragricultureactivitiesincludedpoultryfarming,dairyandpiggery.
Certain other sectors of the economy which also received attention for credit allocation were professionals, self-
employed individuals, artisans and other weaker sections of the society. Conversely, there was a sharp fall in
bank credit to large scale industries. However, the share of small-scale industry registered an upward trend.
Nationalization of commercial banks had many pros and cons for the economy. The government paid more
attention to agriculture than industry. The country witnessed increasing numbers of bank branches in the rural
areas. Branch expansion program resulted in mobilization of savings from all parts of the country.

Commercial Banking:
Meaning:
A commercial bank is a profit-seeking business firm, dealing in money & credit. It is a financial institution dealing in
money in the sense that it accepts deposits of money from the public to keep them in its custody for safety. So also, it
deals in credit, i.e., it crates credit by making advances out of the funds received as deposits to needy people. It thus,
functions as a mobilize of saving in the economy.
A commercial bank is a type of financial institution that accepts deposits, offers checking account services, makes
business, personal & mortgage loans, & offers basic financial products like certificate of deposit & savings account to
individuals & small businesses.
A commercial bank is a financial institution which performs the functions of accepting deposits from the general
public & giving loans for investment with the aim of earnings profit.

Structure of commercial bank:

The commercial banks can be broadly classified under two heads:
1. Scheduled commercial Banks:
Scheduled Banks refer to those banks which have been included in the Second Schedule of Reserve Bank of India
Act, 1934. It are entitled to avail of certain facilities from the RB such as, obtaining accommodation in the form of
refinance & loans & advances, remittance facility at concession rates as also a grant of authorized dealers license to
handle forex business. The certain obligation of RB, like maintainenance of CRR as per prescribed levels & submission
of fortnightly returns prescribed from time to time u/s 42 of the RBI Act, the following conditions to be fulfilled before
banks included in 2nd scheduled:
 It must have paid up capital & reserve of an aggregate value of not less than Rs. 5lakh. However, presently to
start a commercial bank, the RBI prescribed a minimum capital of Rs. 100 crores
 It must satisfy the RBI that its affairs are not being conducted in a manner detrimental to the interest of the
depositors &
 It must be a state co-operative bank or a company as defined in the companies Act, 1956 or an institution
notified by the central govt. in the behalf or a corporation or a company incorporated by or under law in force
in any place outside India.

In India, scheduled commercial banks are of three types:

(i) Public Sector Banks:
These banks are owned and controlled by the government. The main objective of these banks is to provide service to the
society, not to make profits. State Bank of India, Bank of India, Punjab National Bank, Canada Bank and Corporation
Bank are some examples of public sector banks.
Public sector banks are of two types:
(a) SBI and its subsidiaries;
(b) Other nationalized banks.

Nationalized banks:
Indian banking system witnessed a major revolution in the year 1969 when under a dynamic premiership of late Smt
Indira Gandhi 14 major commercial banks in the private sector were nationalized on 19 th July, 1969. Most of these banks
having deposits of above Rs. 500 crores were promoted in the past by the industrialists. The purpose of nationalization
was:
 To increase the presence of banks across the nation
 To provide banking services to different segment of the society.
 To change the concept of class banking into mass banking, &
 To support priority sector lending & growth
In 1980, another 6 banks more commercial banks with deposits of above Rs. 200 crores were nationalized. Later on
the new bank of India merged with punjab national bank. The nationalization results rapid branch expansion & the
number of commercial bank branches have increased many folds in metro, urban, semi-urban & rural areas.
(ii) Private Sector Banks:
These banks are owned and controlled by private businessmen. Their main objective is to earn
Profit.

(iii) Foreign Banks:

These banks are owned and controlled by foreign promoters. Their number has grown rapidly since 1991, when the
process of economic liberalization had started in India. Bank of America, American Express Bank, Standard Chartered
Bank are examples of foreign banks.

2. Non-Scheduled Banks:
Non-Scheduled banks refer to those banks which are not included in the Second Schedule of Reserve Bank of India
Act, 1934 on account of their failure to comply with the minimum requirements for being scheduled prior to the
independence of the country, the banking structure consisted of large numbers of joint stock banks which were small &
weak & quite. A few of them were managed by bad or dishonest management. Consequently, depositors were the victims
of a number of banks failures as a result of their ignorance of the banking business as also due to reality of the banking
laws. The govt. pursued the policy of consolidating banking system in the country through a process of voluntary
amalgamations, transfer of liabilities & assets & participation & arrangement of weak & inefficient banks. The banking
Act were enacted which led to gradual elimination of the numbers of such banks as they were not in a position to fulfill
various requirements of the Act, especially as regards paid up capital & reserves. The process of elimination was further
accelerated after the liquidation of 2 scheduled bank.

Functions of commercial banks

1. Primary or Principle functions
2. Secondary or Subsidiary function
1. Primary or Principle functions:
 Receiving deposits/ accepting of deposits
Accepting various types of deposits is an important function of the commercial banks. The primary function of
these banks is mobilizes saving of the household sector. Deposits constitute the main sources of the funds for
commercial banks. Deposits are of various types like demand deposits, savings deposits and fixed deposits.
 Demand deposits
Demand deposits also known as current deposits are those which can be withdrawn by the depositor at any
time by means of cheques. The bank does not pay any interest on demand deposits & in case, the customer is
required to leave minimum balance undrawn with the bank. In fact, a bank makes a small charge on the customers
with a current account. It is convenient for businessmen & industrialists to pay creditors by drawing cheques and
also get the cheques received by them collected.
 Savings deposits
Savings deposits are meant mainly for professional men & middle class people to help them deposit their
small savings. It can be opened with an introduction. Money can be deposited at any time but the maximum
cannot go beyond a certain limit. There is a restriction on the amount that can be withdrawn at a particular time or
during a week. It is those deposits on which a bank pays a certain percentage of interest to the depositors but the
bank places certain restrictions on their withdrawals.
For instance, today in India only 150 withdrawals in a year are allowed by the banks. Further the total amount
withdrawals that can be made are restricted to Rs.20, 000. Or 10% of the credit balance in the customer’s
accounts whichever is greater. A proper and satisfactory introduction is necessary to open savings bank account.
These accounts are meant for encouraging thrift and a habit of savings among the people.
 Fixed deposits
There are deposits which can be withdrawn after the expiry of a specified fixed period these are also called time
deposits. The rate of interest is higher than that allowed on savings deposit. The fixed deposits are withdrawn by
surrendering the fixed deposit receipts, obtained from the bank at the time of depositing the money. They are
attracted by the payment of interest which is usually higher for longer period. FD are liked by depositors both for
their safety and as well as for their interest. In India, they are accepted between 3 months & 10 years
 Lending of funds
The 2nd primary function of this bank is to make loans & advances to all types of persons, particularly to
businessmen & entrepreneurs. Loans are made against personal security, gold & silver, stocks of goods & other
assets. The bank lends fund by means of loans, overdrafts, cash credits and discounting of bills.
 Term Loans
Banks give term loans to traders, industrialists & now to agriculturists also against some colletral securities.
The maturity period varies between 1 to 10 years. Loan is financial accommodation under which bank grants an
advance on a separate account called loan account. Interest is charged on the entire amount of loan sanctioned.
Loans are given to all types of persons against the personal security of the borrower or against the personal
 movable or immovable properties.
 Overdraft
The depositor of a current account holder is allowed to drawn over & above of his account upto previously
agreed limit. An overdraft is a financial accommodation under which a current account holder is permitted to
overdraw his account up to an agreed limit. Interest is charged on the exact amount overdrawn by the customer. It
is granted against the security of the borrower. It is advantageous to the borrower because interest is charged only
on the amount actually overdrawn by him.
 Cash credit
A cash credit is a financial accommodation under which an advance is granted on a separate account called
cash credit account up to a specified limit. The bank gives loans to the barrowers against certain security. Interest
is charged on the amount made use of by the borrower. The entire loan is not given at one particular time, instead
the amount is credited into his account in the bank, but under the emergency cash will be given. The barrower is
required to pay interest only on the amount of credit availed to him. It is granted against the security of goods or
personal security of one or more persons other than the borrower. Traders prefer cash credit to direct loans as they
need not pay interest on the entire amount.
 Discounting bills of bills of exchange:
It is another one type of lending which is very popular with the modern banks. The holder of a bill can get it
discounted by the bank, when he is in need of money. After deducting his commission, the bank pays the present
price of the bill to the holder. Discounting of bills is a financial arrangement under which a customer holding a
bill of exchange can get a loan equivalent to the value of the bill, less discount. The discount represents interest
on the money lent for the unexpired period of the bill. On maturity, the banker collects the proceeds of the bill
from its acceptor.
 Money at call:
Bank also grant loans for a very short period, generally not exceeding 7 days to the barrowers, usually dealers
or brokers in stock exchange markets against collateral securities like stock or equity shares, debentures, etc.,
offered by them. Such advances are repayable immediately at short notice.
 Consumer credit:
Bank also grant credit to households in a limited amount to buy some durable consumer goods such as
television sets, fridge to meet some personal needs like payment of hospitals bills etc. such consumer credit is
made in lump-sum & is repayable in installments in a short time. Under the 20-point programme, the scope of
consumer credit has been extended to cover expenses.
 Investment of funds on securities
Investment of funds in securities is one of the important functions of commercial banks; they invest a
considerable amount of their funds in Government and industrial securities.
 Creation of credit:
A unique function of the bank is to create credit. Banks supply money to traders & manufacturers.
They also create or manufacture of cash. Bank deposits are regarded as money. They are as cash. The reason is they can
be used for the purchase of goods & services & also in the payment debts. When a bank grants a loan to its customer, it
does not pay cash. It simply credits the account of the barrower. He can withdraw the amount whenever he wants by a
cheque.
 Promote the use of cheques:
The commercial bank renders an important service by providing to their customers a cheap medium
of exchange like cheques. It is found much more convenient to settle debts through cheques rather than through the use of
cash. The cheque is the most developed type of credit instrument in money market.
 Financing internal & foreign trade:
The bank finances internal & foreign trade through discounting of exchange bills. Sometimes, the
bank gives short-term loans to traders on the security of commercial papers. This discounting business greatly facilitates
the movement of internal & external trade.
 Remittance of funds:
Commercial banks, on account of their network of branches throughout the country, also provide
facilities to remit funds from one place to another for their customers by issuing bank drafts, mail transfers or telegraphic
transfers on nominal commission charges. As compared to the postal money orders or instruments, bank drafts have
proved to be a much cheaper mode of transferring money & have helped the business community considerably.

2. Secondary or subsidiary Functions

The secondary or subsidiary functions of a bank can be divided into two classes, viz
a) Agency service
Agency services are those services which are rendered by the bank as an agent of their customer. The agency services are
of immense value to the people at large. The various agency services rendered by banks are as follows:
 Collection & payment of credit instruments: bank collects & pays various instruments like cheques, bills of
exchange, promissory notes drafts, etc. on behalf of the customer.
 Purchase & sale of securities: banks made many buying & selling of various securities like share, stocks, bonds,
debentures on behalf of their customers.
 Collection of dividends on shares: Banks collect dividends & interests on shares & debentures of their customer
& credit them to their accounts.
 Act as correspondent: Bank act as representative & correspondents of their customers they get passports,
travellers tickets & even secure air & sea passengers for their customers.
 Income tax consultancy: Bank may also employ income tax experts to prepare IT returns for their customers &
to help them to get refund of IT.
 Execution of standing orders: Bank executes the standing instruction of their customers for making various
periodic payments they pay subscriptions, rent, insurance premium etc. On behalf of their customer.
 Acts as trustee & executor: Banks preserves the Wills of their customer & executes them after their death.

b) General utility services

These are the services rendered not only to the customers but also to the general public as well.
 Locker Facility
Bank provides locker facility to their customers. The customers can keep their valuables, such as gold and silver
ornaments, important documents; shares and debentures in these lockers for safe custody.
 Traveller’s Cheques and Credit Cards
Banks issue traveller’s cheques to help their customers to travel without the fear of theft or loss of money. With
this facility, the customers need not take the risk of carrying cash with them during their travels.
 Letter of Credit
Letters of credit are issued by the banks to their customers certifying their credit worthiness. Letters of credit are
very useful in foreign trade.
 Collection of Statistics
Banks collect statistics giving important information relating to trade, commerce, industries, money and banking.
They also publish valuable journals and bulletins containing articles on economic and financial matters.
 Acting Referee
Banks may act as referees with respect to the financial standing, business reputation and respectability of
customers.
 Underwriting Securities
Banks underwrite the shares and debentures issued by the Government, public or private companies.
 Gift Cheques
Some banks issue cheques of various denominations to be used on auspicious occasions.
 Accepting Bills of Exchange on Behalf of Customers
Sometimes, banks accept bills of exchange, internal as well as foreign, on behalf of their customers. It enables
customers to import goods.
  Merchant Banking
Some commercial banks have opened merchant banking divisions to provide merchant banking services.

Role of commercial banks in socio economic development

Banks help in accelerating the economic growth of a country in the following ways:
Accelerating the Rate of Capital Formation: Accelerating the rate of capital formation: it is the most important
determinant of economic development. The basic problem of a developing economy is slow rate of capital formation.
Banks promote & encourage the habit of saving among people. They mobilise idle resources for production purposes.
Economic development depends upon the diversion of economic resources from consumption to capital formation.
Banks help in this direction by encouraging saving & mobilizing them for productive uses.
Provision of finance & credit:It is one of important source of finance & credit for industry & trade. Credit is pillar of
development. Banks become the nerve center of all commerce & trade. Banks are instruments for developing internals
as well as external trade.
Monetization of economy: an underdeveloped economy is characterized by the existence of a large non-monetized
sector. The banks by opening branches in rural & backward areas can promote the process of monetization in the
economy.
Innovation: it is an essential perquisite for economic development. These innovations are mostly financed by bank
credit in the developed countries. But in developed countries, entrepreneurs hesitate to invest in new ventures
undertake innovations largely due to lack of funds . facilities of bank loans enable the entrepreneurs to step up their
investment on innovational activities .
Implementation of monitory policy
Economic development needs an appropriate monitory policy. But a well-developed banking is a necessary
pre condition for the effective implementation of monitory policy . Control & regulation of credit by the monitory
authority is not possible without the active cooperation of the banking system in India.
Development of Agriculture
Underdeveloped economies are primarily agricultural economies majority of the population in these
economies lives in rural area. These economies require the development of agriculture & small scale industries &
paying more attention to trade & commerce & have neglected agriculture & industry in rural area. The bank provide
loans to agriculture & modernization of agriculture.
Regional Development
Bank can also play an important role in achieving balanced development in different regions of the country.
they transfer surplus capital from the developed regions to the underdeveloped regions . This reallocation of funds
between regions will promote economic & regional development.
Promote Industrial Development
Bank encourages industrial development by granting long term loan. Credit is pillar to development. in
underdeveloped country like India the bank are granting short term & medium term loan to industries , this helps
industrial concerns to secure adequate capital for their establishment expansion & modernization. The bank helping
manufacturers to secure machinery & equipment’s from foreign countries under installment system by guarantying
deferred payments.

Developing Entrepreneurship:
Banks promote entrepreneurship by underwriting the shares of new and existing companies and granting
assistance in promoting new ventures or financing promotional activities. Banks finance sick (loss-making) industries
for making them viable units.
Promoting Balanced Regional Development:
Commercial banks provide credit facilities to rural people by opening branches in the backward areas. The funds
collected in developed regions may be channelized for investments in the under developed regions of the country. In
this way, they bring about more balanced regional development.
Help to Consumers:
Commercial banks advance credit for purchase of durable consumer items like Vehicles, T.V., refrigerator etc.,
 which are out of reach for some consumers due to their limited paying capacity. In this way, banks help in creating
demand for such consumer goods.
Fulfillment of socio-economic objectives:
In recent years, the commercial banks, particularly in developing countries, have been called upon to help achieve
certain socio-economic objectives laid down by the state. Banking is used to achieve the national policy objectives of
reducing inequalities of income & wealth, removal of poverty & elimination of unemployment in the country.

Services rendered by commercial banks

1. Accepting Deposit
Accepting deposit from savers or account holders is the primary function of bank. Banks accept deposit from
those who can save money, but cannot utilize in profitable sectors.People prefer to deposit their savings in a
bank because by doing so, they earn interest.
2. Advancing Of Loans
Banks are profit oriented business organizations. So they have to advance loan to public and generate
interest from them as profit. After keeping certain cash reserves, banks provide short-term, medium-term and
long-term loans to needy borrowers.
3. Discounting of bill of exchange
Bill of exchange is a negotiable instrument, which is accepted by the debtor, drawn upon him/her by the
creditor and agrees to pay the amount mentioned on maturity. Discounting bill of exchange is another function
of modern commercial bank. Under this, banks purchase bill of exchange from holder in discount after making
some marginal deduction in the form of commission. The banks pay the deducted value to the holders when
traders discount it into bank.
4. Cheque Payment
Banks provide cheque pads to the account holders. Account holders can draw cheque upon bank to pay
money. Banks pay for cheques of customers after formal verification and official procedures..
5. Remittance
Remittance is a system, through which cash fund is transferred from one place to another. Banks provide the
facilities of remittance to the customers and earn some service charge.
6. Collection and Payment of Credit Instruments
In modern business, different types of credit instruments such as bill of exchange, promissory notes, cheques
etc. are used. Banks deal with such instruments. Modern banks collect and pay different types of credit
instruments as the representative of the customers.
7. Foreign Currency Exchange
Banks deal with foreign currencies. As the requirement of customers, banks exchange foreign currencies with
local currencies, which is essential to settle down the dues in the international trade.
8. Consultancy
Modern commercial banks are large organizations. They can expand their function to consultancy business. In
this function, banks hire financial, legal and market experts, who provide advices to customers in regarding
investment, industry, trade, income, tax etc.
9. Bank Guarantee
Customers are provided the facility of bank guarantee by modern commercial banks. When customers have to
deposit certain fund in governmental offices or courts for specific purpose, bank can present itself as the
guarantee for the customer, instead of depositing fund by customers.

Credit creation and deployment of funds:

An important function performed by the commercial banks is the creation of credit. The process of
banking must be considered in terms of monetary flows, that is, continuous depositing and withdrawal of cash
from the bank. It is only this activity which has enabled the bank to manufacture money. Therefore the banks
are not only the purveyors of money but manufacturers of money
Basic of Credit Creation
The basis of credit money is the bank deposits. The bank deposits are of two kinds viz.,
(1) Primary deposits, and
(2) Derivative deposits.
Primary Deposits:
Primary deposits arise or formed when cash or cheque is deposited by customers.
When a person deposits money or cheque, the bank will credit his account. The customer is free to withdraw
the amount whenever he wants by cheques. These deposits are called “primary deposits” or “cash deposits.” It
is out of these primary deposits that the bank makes loans and advances to its customers. The initiative is taken
by the customers themselves. In this case, the role of the bank is passive. So these deposits are also called
“passive deposits.” These deposits merely convert currency money into deposit money. They do not create
money. They do not make any net addition to the stock of money. In other words, there is no increase in the
supply of money.

Derivative Deposits:
• Bank deposits also arise when a loan is granted or when a bank discounts a bill or purchase government
securities.
Deposits which arise on account of granting loan or purchase of assets by a bank are called “derivative
deposits.” Since the bank play an active role in the creation of such deposits, they are also known as “active
deposits.”Thus, credit creation implies multiplication of bank deposits. Credit creation may be defined as “the
expansion of bank deposits through the process of more loans and advances and investments.”

 Process of Credit Creation

• An important aspect of the credit creating function of the commercial banks is the process of multiple-
expansion of credit.
The banking system as a whole can create credit which is several times more than the original increase in the
deposits of a bank. This process is called the multiple-expansion or multiple-creation of credit. Similarly, if
there is withdrawal from any one bank, it leads to the process of multiple- contraction of credit. The process of
multiple credit-expansions can be illustrated by assuming:
Limitation on Credit Creation
The commercial banks do not have unlimited power of credit creation. Their power to create credit is limited by
the following factors:
1) Amount of Cash: the power to create credit depends on the cash received by banks. If receive more cash,
they can create more credit. If they receive less cash they can create less credit. Cash supply is controlled by the
central bank of the country.
2) Reserve Ratio: all deposits cannot be used for credit creation. Bank must keep certain % of deposits in cash
as reserve. The volume of bank credit depends also on the cash reserve ratio the banks have to keep.
3) Banking Habits of the People: the loan advanced to a customer should again come back into banks as
primary deposit. Then only there can be multiple expansions. This will happen only when the banking habit
among the people is well developed.
4) Nature of Business Conditions in the Economy: it depends upon the nature of business conditions. It will
be large during a period of prosperity, while it will be smaller during a depression.
5) Leakages in Credit-Creation: there may be some leakages in the process of credit creation. The funds may
not flow smoothly from one bank to another. Some people may keep a portion of their amount as idle cash.
6) Sound Securities: a bank creates credit in the process of acquiring sound & profitable assets like bills &
govt securities. People cannot offer sound securities, a bank cannot create credit.
7) Liquidity Preference: if people desire to hold more cash the power of the banks to create credit is reduced.
8) Monetary Policy of the Central Bank: the central bank has the power to influence the volume of money
in circulation & through this it can influence the volume of credit created by the banks. It has certain powerful
weapons, like the bank rate, open market operations with the help of which it can exercise control on the
expansion & contraction of credit by the commercial bank.

Role of RBI as a regulator

The central bank of the country is the Reserve bank of India( RBI). It 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 Govt held shares of nominal value of Rs.2, 20,000.
RBI was nationalized in the year 1949. The general superintendence and direction of the bank is entrusted
to central Board of Directors of 20 members, the Governor and four deputy Governors, one Govt official from
the Ministry of finance, ten nominated Directors by the central Govt to represent the four local Boards with the
headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consists of five members each central
Govt appointed for a team of four years to represent territorial and economic interests and the interests of co-
operative and indigenous banks.
The Reserve Bank of India Act 1934 was commenced on April1, 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 bank notes.
 To maintain reserves with a view to securing monetary stability
 To operate the credit and currency system of the country to its advantage.
The Reserve Bank of India Act 1934 was commenced on April1, 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
 To operate the credit and currency system of the country to its advantage.
The RBI act covers : (i) the constitution (ii) powers (iii) functions of the RBI. The act does not directly deal with the
regulation of the banking system except for few sec like 42 which relates to the maintenances of CRR by banks & sec 18
which deals with direct discount of bills of exchange & promissory notes as part of rediscounting facilities to regulate the
credit to the banking system.

The RBI act deals with:

1. Incorporation, capital, management & business of the RBI.
2. The functions of the RBI such as issue of bank notes, monetary control, banker to the central & state govt. & banks,
lender of last resort & other functions.
3. General provisions in respect of reserve fund, credit funds, audit & accounts.
4. Issuing directives & imposing penalties for violation of the provisions of the Act.
Functions of RBI:
The functions of the RBI can be categorized as follows:
 Monetary policy
 Regulation & supervision of the banking & non-banking financial institution including credit information
companies.
 Regulation of money, forex & govt. securities markets as also certain financial derivatives.
 Debt & cash management current & capital account management.
 Bankers to bank
 Banker to the central & state govt.
 Oversight of the payment & settlement systems.
 Currency management
 Developmental role
 Research & statistics

RBI ACT 1934 – Important Provisions

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve
Bank of India Act, 1934. Some of the important provisions of the act are given below.

Important Provisions of the RBI ACT 1935

SEC 2.E – SCHEDULED BANK: As per this section, a Scheduled bank means a bank whose name is included in the
2nd schedule of the RBI ACT 1934. The essential condition of capital is that such banks have paid-up capital and
reserves of not less than ₹ 25.00 lac. Banks which are not included in the 2nd Schedule of RBI ACT 1934 are called
Non-scheduled Bank.

SEC. 17 – TYPES OF BUSINESS: Defines various types of business which RBI may transact, which include
acceptance of deposit without interest from Central/State Govt. purchase/sale of forex, securities, rediscounting the bills,
P/N, grant loans etc.

SEC 21 – RIGHT TO TRANSACT GOVT BUSINESS: RBI to transact government business in India i.e. remittance,
exchange, keeping deposit free of interest etc.

SECT 22 – BANK NOTES: Sole right to issue bank notes.

SEC 23-ISSUE DEPARTMENT: Bank notes shall be issued by issue department against the security of gold coins
bullion, rupee coins, foreign securities & other approved securities up to ₹ 200 crores.

SEC 24-DENOMINATION OF NOTES: RBI issues all currency notes for denomination 2, 5 ,10, 20, 50, 100, 200, 500,
1000, 2000, 5000, 10000.

SEC 28-RULES FOR REFUNDING VALUE: RBI can frame rules for the refunding value of mutilated, soiled or
imperfect notes as the matter of grace.

SEC 31 PROHIBITS ISSUE OF BEARER B/E, P/N PAYABLE TO BEARER: No person or entity in India other than
RBI or the Central Government is authorized to draw, accept make or issue any bill of exchange, hundi, promissory note,
drafts payable or bearer.

SEC 33 – ASSETS OF THE ISSUE DEPARTMENT: The assets of issue department consist of gold coin, gold bullion,
foreign securities etc. The aggregate value of gold coin, gold bullion, foreign securities held as assets shall not be less
than ₹ 200.00 crore and ₹ 115.00 crores respectively.

SEC 42- CASH RESERVE RATIO (CRR): Consequent to GOI’S notification of Sec. of RBI (Amendment) Act 2006
minimum statutory floor and ceiling limit no longer exists. Further, no interest will be payable on CRR balances w.e.f
fortnight beginning 31st March 2007. CRR is maintained on fortnightly basis: Saturday to following Friday – 14 days.

SEC 45 A-F COLLECTING & FURNISHING OF CREDIT INFORMATION:

 Borrower enjoying secured credit limit of ₹ 10.00 lac and above unsecured limits ₹ 5.00 lac & above: Return as on
last Friday of April and October every year. (Half Yearly)
 Doubtful, loss and suit filed accounts with the aggregate of outstanding ₹ 100 lac and above: Half Yearly March and
September
 Basic Statistical Return(BSR): BSR-I regarding borrowal a/cs of above ₹ 2 lac. BSR-II containing information about
deposits with break-up into current, savings & term deposits.

SEC 45 H-T: NBFC: No NBFC shall commence business or carry on the business of a non-banking company without
 obtaining a certificate of registration and having the net owned fund of ₹ 25.00 lac or such other amount not exceeding ₹
200.00 lac, as the RBI may notify.

SEC 49 – PUBLICATION (DECLARATION) OF BANK RATE: RBI shall make public from time to time the standard
rate at which it is prepared to buy re-discount B/E or the other commercial paper eligible for purchase under the Act.
Role of GOI as a regulator of Banking System
Bank regulations are a form of government regulation which subject banks to certain requirements,
restrictions and guidelines. This regulatory structure creates transparency between banking institutions and the
individuals and corporations with whom they conduct business, among other things.
Given the interconnectedness of the banking industry and the reliance that the national (and global)
economy hold on banks, it is important for regulatory agencies to maintain control over the standardized
practices of these institutions. Supporters of such regulation often hinge their arguments on the "too big to fail"
notion. This holds that many financial institutions (particularly investment banks with a commercial arm) hold
too much control over the economy to fail without enormous consequences. This is the premise for government
bailouts, in which government financial assistance is provided to banks or other financial institutions who
appear to be on the brink of collapse. The belief is that without this aid, the crippled banks would not only
become bankrupt, but would create rippling effects throughout the economy leading to systemic failure.

Objectives of bank regulation

Objectives of bank regulation, and the emphasis, vary between jurisdictions. The most common objectives are:
1. Prudential—to reduce the level of risk to which bank creditors are exposed (i.e. to protect depositors)
2. Systemic risk reduction—to reduce the risk of disruption resulting from adverse trading conditions for
banks causing multiple or major bank failures
3. Avoid misuse of banks—to reduce the risk of banks being used for criminal purposes,
e.g. Laundering the proceeds of crime
4. To protect banking confidentiality
5. Credit allocation—to direct credit to favored sectors
6. It may also include rules about treating customers fairly and having corporate social responsibility(CSR)

General principles of Bank regulation

• Minimum requirements:
Requirements are imposed on banks in order to promote the objectives of the regulator. Often, these
requirements are closely tied to the level of risk exposure for a certain sector of the bank. The most important
minimum requirement in banking regulation is maintaining minimum capital ratios. To some extent, U.S. banks
have some leeway in determining who will supervise and regulate them.
• Supervisory review:
Banks are required to be issued with a bank license by the regulator in order to carry on business as a bank, and
the regulator supervises licensed banks for compliance with the requirements and responds to breaches of the
requirements through obtaining undertakings, giving directions, imposing penalties or revoking the bank's
license.
• Market discipline
The regulator requires banks to publicly disclose financial and other information, and depositors and other
creditors are able to use this information to assess the level of risk and to make investment decisions. As a
result of this, the bank is subject to market discipline and the regulator can also use market pricing information
as an indicator of the bank's financial health.
Licensing of banking companies
• Save as hereinafter provided, no company shall carry on banking business in India unless it holds a
license issued in that behalf by the Reserve Bank and any such license may be issued subject of such conditions
as the Reserve Bank may think fit to impose.]
Every banking company in existence on the commencement of this Act, before the expiry of six months from
such commencement, and every other company before commencing banking business [in India], shall apply in
writing to the Reserve Bank for a license under this section.
Power to publish information
The Reserve Bank or the National Bank, or both, if they consider it in the public interest so to do, may publish
any information obtained by them under this Act in such consolidated form as they think fit.