BANKING FRAMEWORK

BANKING FRAMEWORK

WHAT IS A BANK?

Bank is a financial institution which acts as intermediary between entities who have surplus funds and those who need funds. People with surplus funds keep deposits with the banks out of which banks make loans to the people who need funds. Thus, they help in mobilizing the saving and putting these idle saving to productive use. They also act as levelers of distribution of wealth not only between persons but also between different areas by mobilizing funds from surplus area and investing them in deficit area, thereby achieving equitable distribution of wealth. However, modern banking covers a large number of other activities apart from accepting deposits and making loans.

DEFINITION OF BANKING

Banking is a legally defined activity, which means that it is governed by strict rules and regulations. Banking Regulation Act-1949 defines and governs banking activity in India. As per Section 5(b) of this act, banking has been defined as “the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, drafts, order or otherwise”. In simple words it means that banking relates to:

  1. accepting of deposits of money from public
  2. for the purpose of lending, i.e. making loans, and
  3. making investments (in approval govt. securities)

The above are three basic functions of the banks as defined in law. Besides, banking has three unique features that are not available to any other organization.

  1. The deposits are repayable on demand. This means that one has to make a demand for the repayment and whenever such demand is made; banker has to repay the amount. No company other than banks can accept deposits payable on demand.
  2. Banks are allowed to make use of cheques and no company other than banks can issue its own cheques.
  3. For Banks it is necessary to incorporate words like bank, banking, banker etc. in their name and no other organization is allowed to use such words in their name.

BANKING LICENCE

To do banking in India it is mandatory, i.e. compulsory by law, to obtain license from Reserve Bank of India (RBI). Even the foreign banks have to obtain a license from RBI before opening a branch in India. RBI also has powers to cancel the license if it is not satisfied with the functioning of the bank.

REGULATION OF BANKING

Banking Regulation Act 1949 authorizes Reserve Bank of India to regulate and control banks in India. As per section 35(a) of this law, RBI is fully authorized to issue any instructions / directions to the banks as it deems fit, as and when considered necessary. It is mandatory for all banks (including foreign) to comply with directions of the RBI.

  TYPES OF BANKS

Banks can be classified on a number of basis. One bank can be classified into more than one category.

CLASSIFICATION OF BANKS
RBI ACT OWNERSHIP CONSTITUTION
Scheduled Bank Public Sector Bank Statutory Bank
Non-Scheduled Bank Private Bank 1. Indian 2. Foreign Nationalized Bank
—— Cooperative Bank Regional Rural Bank

SCHEDULED BANK

A bank whose name appears in the second schedule of the RBI Act 1934 is called ‘Scheduled Bank’. Whenever RBI is not satisfied with the functioning of a bank, it may delete the name of that bank from the second schedule. Barring a few small banks, almost all banks (including foreign banks) in India are Scheduled Banks. The bank whose name does not appear in 2nd schedule is called ‘Non-Scheduled Bank’.

STATUTORY BANK

The banks which have been constituted under a separate Act of parliament are called Statutory Bank. E.g. of such banks are – Reserve Bank of India (Reserve Bank of India Act-1934), State Bank of India (State Bank of India Act-1955), IDBI BANK (Industrial Development Bank (Transfer of Undertaking and Repeal Act-2003).

PUBLIC SECTOR BANKS

All those banks where government share holding is 51% or more are called Public Sector Banks. Thus all nationalized banks, SBI, IDBI Bank and RRBs are Public Sector Banks. State Bank of India is the largest public sector bank in India.

PRIVATE BANKS

All banks other than public sector banks are called Private Banks. These banks are registered under Indian Companies Act, 1956. They are of two types – Indian Banks and Foreign Banks. Banks registered in India are called Indian Banks and those with their registered office outside India are called Foreign Banks. ICICI Bank Pvt. Ltd. is the largest private sector bank and Standard Chartered Bank is the largest foreign bank in India.

NATIONALISED BANKS

The banks which were nationalized in 1969 and 1980 vide Banking Companies (Acquisition and Transfer of Undertaking) Act are called nationalized banks. In all, 14 banks were nationalized in 1969 and 6 in 1980. Of the 6 banks nationalized in 1980, New Banks of India was merged with Punjab National Bank in 1993. (These banks fall in the category of public sector bank). Punjab National Bank is the largest nationalized bank.

REGIONAL RURAL BANKS (RRBs)

Narasimham Working Group (1975) proposed the establishment of RRBs as special purpose low cost banks which were started in 1976 to serve the banking needs of rural area. These banks were formed under Regional Rural Banks Act, 1976. A RRB cannot be formed of its own; it has to be sponsored by a public sector bank. The capital structure of RRB is jointly subscribed by Central Government – 50%, State Government- 15% and Sponsoring Bank – 35%.

COOPERATIVE BANKS

These banks are co-operative societies registered under respective State Cooperative Societies Act. They are not covered under Banking Regulation Act. For their organizational structure, they are governed by State Cooperative Societies Act and for their functions they are governed by RBI.

  • Both RRBs and Cooperative Banks are supervised by NABARD as well.
  • Inspection of RRBs and Cooperative Banks is conducted by NABARD under the provisions of Banking Regulation Act, 1949.

DIFFERENTIATED BANKING

According to Reserve Bank of India, India needs more variety of Banks to cater to different strata of society. Dr. Nachiket Mor Committee constituted by RBI has proposed establishment of “Payment Banks”. These banks will accept deposits and enable the customers to remit funds. They may not be allowed to make advances and will instead invest in Govt. securities only for interest income.

Another types of banks proposed are “Wholesale Banks” which will deal with corporate clients only. They may lend to financial institutions which will lend money to small businesses and low income customers.

DEVELOPMENT FINANCIAL INSTITUTIONS – DFIs

These financial institutions have been set up under different acts of the parliament, each for a specific purpose. They do not have bank license and hence cannot issue their own cheques. They have limited public dealings and generally they deal with banks and other financial institutions. In India, there are five major DFIs as under:

  • NABARD (National Bank for Agriculture and Rural Development): Set up in 1982 under NABARD Act 1981. It works for development of agriculture and rural economy. It is also the regulator of cooperative banks and RRBs. It is owned by government of India (99.50%) and RBI (0.50%).
  • EXIM Bank (Export Import Bank of India): Set up in 1982 under the Export-Import Bank of India Act 1981, wholly owned by Government of India, it works for promotion and financing of exports.
  • NHB (National Housing Bank): Set up on 9-July-1988 under the National Housing Bank Act 1987, it is owned by Reserve Bank of India and works for development of housing sector and also regulates housing finance companies.
  • SIDBI (Small Industries Development Bank of India): Set up on 2-April-1990 under SIDBI Act 1989 for the promotion, financing and development of the Micro, Small and Medium Enterprises (MSME) Promoted by IDBI, it is owned by a number of financial institutions.
  • IFCI (Industrial Finance Corporation of India): Established on 1-July-1948 under an Act of the Parliament, it is the first Development Financial Institution (DFI) in the country to cater to the long-term finance needs of the industrial sector. Govt. holds majority share in IFCI alongwith several other FIs.
 SOME OTHER FINANCIAL INSTITUTIONS

 Financial Systems have four components:

  • Central Banking Authority – RBI – for regulating money supply, currency, banks, NBFCs, MFIs, Govt. Debt.
  • Capital Market Regulator – SEBI – protecting investor’s interests, regulating stock exchanges, mutual funds.
  • Insurance Regulator – IRDA – for regulating insurance companies.
  • Pension Fund Regulator – PFRDA – for regulation and management of Pension Fund and pension schemes.
BANKING

 RESERVE BANK OF INDIA

The Reserve Bank of India was set up on the basis of the recommendations of the Royal Commission on Indian Currency and Finance also known as the Hilton-Young Commission. It is the central bank of the country, responsible for formulation and implementation of monitory and credit policy. It is fully owned by the government of India and acts as banker to the government and is sole issuer of currency.

  • It was established on 1-April-1935 under Reserve Bank of India Act 1934, with a capital of Rs. 5 crore. Sir Osborne Smith was the first Governor of RBI. First Indian Governor of RBI was C.D. Deshmukh.
  • It was nationalized on 1-January-1949. Its financial year is from July 1 to June 30
  • Governor– Dr. Raghuram G Rajan, HQ – Mumbai, Offices: 28 (19 regional offices, 9 sub-offices).
  • Deputy Governor (Four) :- H.R. Khan (RBI), Dr. R. Gandhi (RBI), Dr. Urjit Patel (Economist), S.S. Mundra (Banker). Both, Governor and Deputy Governors have tenure of Five year.

 FUNCTIONS

RBI gets all its powers to control and regulate the banks and to issue necessary directions to the banks from time to time, under the Banking Regulation Act 1949, Section 35-A. Major functions of RBI are as under:-

  • Formulation and administration of Monetary & Credit Policy.
  • Controller and regulator of banking business in India.
  • Issuing of notes and management of currency.
  • Banker to the Government.
  • Makes Ways and Means Advances (temporary overdrafts) to Central and State Governments.
  • Banker’s Bank (banker of the last resort).
  • Custodian of Foreign Exchange Reserves.
  • Acts as the agent of the Government policy with respect to India’s membership of the IMF and the World Bank.

 OTHER IMPORTANT FACTS ABOUT RBI:

  • The Central Office of Reserve Bank was initially established in Calcutta and then moved to Mumbai in 1937.
  • RBI emblem depicts a Panther under a Palm tree.
  • Dr. Manmohan Singh is the only Prime Minister who was also the Governnor of RBI (1982-1985).
  • First women Deputy Governor of RBI was K.J. Udeshi.
  • Note printing presses of RBI: Bharatiya Reserve Bank Note Mudran Pvt. Ltd. at Salboni (West Bengal) and Mysore (Karnataka).
  • Design of the currency note is approved by Govt. of India on the recommendation of RBI.

 BANKING OMBUDSMAN SCHEME 2006

The RBI introduced this scheme with the object of expediting resolution of complaints relating to certain services rendered by banks and to facilitate the settlement of such complaints to the satisfaction of customer. The Ombudsman is appointed are wise covering all banks of that area and has the jurisdiction to pass award upto Rs. 10 lacs in banking matters and upto Rs. 1 Lac in credit card cases. Appellant authority for ombudsman is the Deputy Governor of the RBI.

 BANKING CODES AND STANDARDS BOARD OF INDIA

It is a industry watch dog set up by RBI to monitor and assess the compliance with codes and minimum standards of service to individual customers, as prescribed by the RBI.

  • NPCI (National Payments Corporation of India): NPCI was formed by in 2009 by ten major banks to consolidate and integrate all electronic retail payment systems in India. NPCI aims to ensure that all these systems are customer friendly and available round the clock and affordable to all. Its major services include National Financial Switch for ATMs, implementation of RTGS, NEFT and ECS, Cheque Truncation System and Immediate Payment System-IMPS for mobile phone banking.
  • IBA (Indian Banks Association): It is the official association of all the banks operating in India. It acts as a bridge between banks on one hand and government and staff unions on the other. Presently, Mr. K.R. Kamath, CMD of Punjab National Bank is Chairman of IBA.
  • DICGC (Deposit Insurance & Credit Guarantee Corp.): It is a wholly owned subsidiary of RBI which provides an insurance cover of Rs. 1 Lac per depositor per bank, in case of bank failure. It also provides guarantee in case of default in repayment of small loans given by the banks.
  • ECGC (Export Credit Guarantee Corporation of India): ECGC is a Govt. body which provides export credit insurance facilities to exporters and banks in India. It encourages Indian exporters by giving them credit insurance covers.

STATE BANK OF INDIA

Arundhati Bhattacharya is the Chairman of SBI and Head Quarter is situated in Mumbai.

  • In January, 1921 the Imperial Bank of India was formed by amalgamation of three presidency banks – Bank of Bengal, Bank of Madras and Bank of Bombay.
  • Imperial Bank was nationalized by the Govt. of India under State Bank of India Act, 1955 and renamed as State Bank of India on 1-July-1955.
  • It is the biggest public sector commercial bank of India, handling around one fifth of total banking business with over 15,000 branches and around three lacs staff.
  • SBI has 5 subsidiary banks also under its control – State Bank of Patiala, State Bank of Bikaner & Jaipur, State Bank of Hyderabad, State Bank of Mysore and State Bank of Travancore. The two subsidiaries viz. State Bank of Saurashtra and State Bank of Indore have been merged with State Bank of India. There are plans to merge other subsidiaries also in near future.
  • NBFC (Non Banking Financial Company): These are companies which have functions similar to banking like accepting deposits and making loans. However, they do not have license for banking, although they are regulated by RBI.
CAPITAL MARKET

 SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

U.K. Sinha is the Chairman of SEBI and Head Quarter is situated in Mumbai.

Formed on 12-April-1992 under the Securities and Exchange Board of India Act,1992 to protect the interests of investors in capital market and to act as promoter and regulator of the capital market.

  • It is the regulatory authority of stock exchanges, mutual funds and for public issues for new shares, debentures and other securities.
  • Stock exchanges are private corporate bodies offering an organized market for buying and selling of corporate shares and other securities through authorized brokers.

THE BOMBAY STOCK EXCHANGE (BSE)

The Bombay Stock Exchange is the oldest stock exchange in Asia with a rich heritage of 134 years. Bombay Stock Exchange has two of world’s best exchanges, Deutsche Borse (Germany) and Singapore Exchange, as its strategic partners. The BSE Index, SENSEX, comprising of 30 top traded scrips, is India’s first stock market index that enjoys an iconic stature, and is tracked worldwide.

THE NATIONAL STOCK EXCHANGE (NSE)

The largest stock exchange of India in terms of volume was incorporated in Novermber 1992. Its sensitive index is called NIFTY comprising of 50 top traded scrips.

OVER THE COUNTER EXCHANGE OF INDIA (OTCEI)

A special stock exchange started in 1990 for listing of small companies, with paid up capital of less than Rs. 3 crores.

FORWARD MARKET COMMISSION

Ramesh Abhishek is the Chairman and Head Quarter is situated in Mumbai.

It is a regulatory authority for commodity futures market in India, under Ministry of Finance, set up under Forward Contracts (Regulation) Act, 1952.

MCX-SX: – Multi Commodity Exchange Stock Exchange.    

INSURANCE

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)

Chairman : T.S. VIJAYAN  HQ: MUMBAI

Formed under section-4 of IRDA Act 1999, it is the apex body to protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry in India. Insurance is of two types ;- Life and Non Life (general) and one insurance company can do only one type of insurance, either life or general.

LIFE INSURANCE CORPORATION (LIC)

Established: September 1, 1956 under LIC Act 1956.

Chairman : S.K. ROY  HQ: MUMBAI

It is the largest insurance company of India, controlling around 2/3rd of life insurance business.

GENERAL INSURANCE CORPORATION (GIC Re)

Chairman : ASHOK K ROY  HQ: MUMBAI

As a sole reinsurer in the domestic reinsurance market since November 2000, GIC Re provides reinsurance to the direct general insurance companies in the Indian market. It is fully owned by the Govt.

GENERAL INSURANCE 

In India 4 companies in public sector and several other in private sector are authorized for general insurance that covers areas like vehicle insurance, house insurance, insurance against fire & theft and marine insurance. The 4 public sector companies are The Oriental Ins. Co., National Ins. Co., United India Ins. Co. and New India Assurance Co.

PENSION

PENSION FUND REGULATORY AND DEVELOPMENT AUTHORITY (PFRDA)

Chairman : SH. HEMANT G. CONTRACTOR  HQ: NEW DELHI

Formed in August, 2003, it is the latest financial regulator in the country devoted to development and regulation of pension schemes in India. It has been converted into a statutory body w.e.f. 09-10-2013 with a passage of The Pension Funds Regulatory and Development Authority Act – 2013. It administers National Pension System (NPS) and pension lite scheme. To popularize the scheme, Government has introduced an incentive scheme called Swavalamban, under which Government will contribute a sum of Rs. 1000 per annum upto 2016-17 to all the accounts opened with minimum Rs. 1000 per annum and upto Rs. 12000 per annum. PRAN : Permanent Retirement Account Number.

SOME OTHER FINANCIAL INSTITUTIONS

FINANCIAL STABILITY AND DEVELOPMENT COUNCIL

A new super regulatory body formed in 2010 to co-ordinate, oversee and synergize the functions of the four chief financial regulators of Indian economy i.e. RBI, SEBI, IRDA and PFRDA. It is headed by Finance Minister. All four regulators are its members and government is represented by Finance Secretary.

CREDIT INFORMATION BUREAU OF INDIA LTD. (CIBIL)

Promoted by a group of banks in India, it is a kind of common database company which contains detail of credit obtained by commercial and consumer borrowers. By accessing this database, a bank can immediately know about the credit history of a prospective borrower and then decide whether to give a particular loan or not. CIBIL also generates ‘credit score’ for prospective borrowers.

WHAT IS A CREDIT INFORMATION REPORT?

A Credit Information Report (CIR) is a factual record of a borrower’s credit payment history compiled from information received from different credit grantors. Its purpose is to help credit grantors make informed lending decisions – quickly and objectively.

CREDIT RATING AND INFORMATION SERVICES OF INDIA LTD. (CRISIL)

In contrast to CIBIL, CRISIL is a credit rating agency. It has been prompted by number of banks. Their job is to evaluate the strength of various corporate loan products like debentures, bonds, fix deposits etc. and assign them a rating like A, AA, AAA, B, B+, BB etc. considering the company’s ability to repay the debt and timely payment of interest. Some other big credit rating agencies in India are ICRA, CARE.

WHAT IS CREDIT RATING?

Credit rating is an assessment of the probability of default on payment of interest and principal on a debt instrument. In simple words, it ranks the company or country’s ability to meet their debt obligations.

IMPORTANT COMMITTEES
SR. NO. COMMITTEE HEAD AREA OF REVIEW
1 Suresh Tendulkar Methodology for fixing poverty line
2 Dr. C Rangarajan Financial Inclusion Committee
3 Kirit Parikh Deregulation of Petrol/Diesel/Gas Prices
4 YH Malegham Functioning of Micro Finance Institutions
5 M Damodaran Improvement in customer services in banks
6 Raghuram Rajan Financial Sector Reforms
7 A K Khandelwal HR issues of Public Sector Banks
8 Saumitra Chaudhuri Whole Sale Price Index
9 M V Nair Review of priority sector lending norms
10 Parthasarthi Shome Review of implementation of GAAR
11 Vijay Kelkar Roadmap for fiscal consolidation
12 Bimal Jalan Scrutiny of applications for new banks
13 Vijaya Bhaskar Review of major financial benchmarks
14 Urjit Patel Formulation of monetary policy
15 P J Nayak Governance of Boards of Banks
16 Dr. Nachiket Mor Comprehensive Financial Services for Small Businesses and Low-Income Households
MONETARY AND CREDIT POLICY
(Annual Policy Statement)

Monetary policy aims at regulating the level of money supply in the country to ensure best possible economic growth and keeping inflation under control. Credit here means loan creation y the banks which forms a major portion of money supply.

RBI is responsible for maintaining optimum level of money supply in the country. Any excess in money supply may lead to inflationary conditions while its shortage may dry up the availability of funds to the business and industry, leading to a slowdown in the economy. Either of the situations is not good for the economy and that throws a big challenge before RBI as to how to maintain the optimum level of money supply which neither leads to inflation nor it adversely affects the industry.

RBI meets this challenge with the help of six policy rates which are also known as quantitative measures to regulate money supply. From the year 2014-15, RBI announces monetary policy every 2 months.

QUANTITATIVE MEASURES

These measures aim to control quantity of money supply directly as they affect the banking system as whole. Two of these, CRR and SLR are also called Statutory Measures as they are provided in two separate laws. Both of these are kept as proportion of total deposits of the banks. In banking parlance, total deposits are called ‘Demand and Time Liabilities’ (DTL) or Net Demand and Time Liabilities (NDTL).

STATUTORY LIQUIDITY RATIO (SLR)

It is a provision under section 24(2A) of Banking Regulation Act, 1949. As per this all banks are required to maintain a certain portion of their total deposits, as decided by RBI from time to time, in the form of approved securities, gold or cash. However, in practice, most of the banks block their SLR funds by investing in govt. securities approved by the RBI.

CASH RESERVE RATIO (CRR)

It is a provision under RBI Act 1934, section 42(1). As per this all banks are required to maintain a certain portion of their total deposits as decided by RBI from time to time, in the form of only cash with RBI.

LIQUIDITY ADJUSTMENT FACILITY (LAF)

Liquidity here refers to availability of funds with the banks. Whenver banks need funds, they can borrow from RBI under repo facility and in case they have surplus funds, they can deposit the same with RBI under reverse repo facility. Repo, Reverse Repo and MSF put together form LAF.

LAF Corridor: It is the gap between Repo rate and Reverse Repo rate. At present it is one per cent.

REPO RATE (RR)

The full form of Repo is Repurchase Agreement. It is the rate of interest that RBI charges to banks for short term lending against SLR securities. It is also known as Repo Rate Facility. Banks can borrow minimum Rs. 5 Crore and further in multiples of Rs. 5 Crore.

REVERSE REPO RATE (RRR)

It is the rate of interest that RBI pays to Banks for accepting short term deposits. IT is also known as Reverse Repo Rate Facility. At present, Reverse Repo Rate is calibrated at 100 basis points (BPS), representing 1 per cent, below repo rate.

MARGINAL STANDING FACILITY (MSF)

It is another type of facility for banks to borrow money from Reserve Bank of India, after closure of repo window. MSF is calibrated at one per cent (100 basis points) above repo rate.

BANK RATE (BR)

The rate of interest at which RBI is ready to give loan to the banks is called Bank Rate. Here loan is given against re-discounting of bills and can be given for a longer period, say for a few months. Bank rate is aligned to MSF rate i.e. it is same as MSF rate.

NOTE: Please note that whenever there is a change in the Repo rate, Reverse Repo Rate, SLR, CRR, MSF and Bank Rate shall stand changed automatically.

SUMMARY OF KEY RATES

KEY RATE RATE (11.02.2015) New Rate
SLR 22%
CRR 4%
REPO 7.75%
REVERSE REPO 6.75%
MSF 8.75%
BANK RATE 8.75%

LINKAGE OF RATES WITH MONEY SUPPLY

All the policy rates are inversely linked to the level of money supply. This means that as and when any one or more of these rates are increased, it will lead to a decrease in money supply and vice versa.

OPEN MARKET OPERATIONS (OMO)

Under this system, RBI buys or sells securities in the open market to increase or decrease the money supply respectively, in the market. To suck or absorb the liquidity, RBI will sell the securities and to inject or augment the liquidity, it will start buying securities there by releasing money in the market.

MARKET STABLISATION SCHEME (MSS)

To protect the domestic money supply levels from the impact of heavy inflow of money under FDI and FII, RBI resorts to MSS by off loading govt. securities held by it, sucking the liquidity from the market.

QUALITATIVE MEASURES

These are selective measures meant to regulate credit for specific purposes. Such measures may include changing marginal requirements for various types of loans, enforcing selective credit control, issuing directives to either curb or encourage some particular loan or simply moral persuasion to banks.

MEASURES OF MONEY SUPPLY

  • M0 – Reserve Money: Currency in circulation + deposits with RBI
  • M1 – Narrow Money: M0 + demand deposits with banking system
  • M2 – M1 + Post Office Saving Banks Deposits
  • M3 – Broad Money: M1 + Time Deposits with Banks
  • M4 – M3 + Total Post Office Deposits

Size of M3 in India is around Rs. 90 to 97 trillion.

Leave a comment