PRINCIPLES AND

PRACTICES OF
BANKING
(As Per the New Syllabus of S.Y. BAF, 2017-18,
Semester III, University of Mumbai)

O. P. AGARWAL
M.Com., LL.B. (Hons.,) C.A.I.B. (London), C.A.I.I.B.,
Diplomas in Co-operation/Industrial Finance
Chief Manager (Retired) Bank of Maharashtra,
General Manager’s Office, Mumbai and Former In-charge,
Bank of Maharashtra, Staff Training Centre, New Delhi.

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 PREFACE TO FIRST EDITION
The students and professors of the Bachelor of Com., in Accounts and Finance, needed a
book on the Principles and Practices of Banking subject as per the revised syllabus applicable from
the academic year 2017-18 of the Mumbai University.
I, as a retired banker, have endeavoured my best to incorporate and describe the various
topics viz. Banking Regulation Act, 1949, retail banking for individuals along with money market,
capital market and debt markets.
There are certain other regulations viz., Consumer Protection Act, Banking Qmbudsman
Scheme, Negotiable Instrument Act, 1881, as to payment and collection of cheques.
I have tried to explain the topics in plain language which is understandable and explainable
in the examinations, by the students. Information technology is playing a very laudable role in
providing banking services to the customers. Marketing of Banking Service is essential as in the
commodity markets’ product, which cannot be skipped in the banking development.
I need to acknowledge my gratitude to my wife Mrs. Veena Agarwal, M.A. (Eco.) for her
support in the completion of this book.
Suggestions, as always, are most welcomed from the readers.

O.P. Agarwal
704/11-D, Springleaf Bldg.,
Lokhandawala Complex,
Kandivali (East),
Mumbai – 400 0101.
 SYLLABUS
Sr. No. Modules/Units
1. Indian Financial System
Indian Financial System – An Overview
Banking Regulation
Retail Banking, Wholesale Banking and International Banking
Role of Money Market, Debt Market, Capital Market, Forex Market and SEBI
50 Mutual Funds and Insurance Companies and IRDA
Factoring, Forfaiting Services and Off-balance Sheet Items
Risk Management, Basel Accords
CIBIL, Fair Practices Code for Debt Collection
2. Functions of Banks
Banker Customer Relationship
KYC/AML/CFT Norms
Bankers Special Relationship
Consumer Protection – COPRA, Banking Ombudsman Scheme
Payment and Collection of Cheque and Other Negotiable Instrument
Opening Accounts of Various Types of Customers
80 Ancillary Services
Cash Operations
Principles of Lending, Working Capital Assessment and Credit Monitoring
Priority Sector Advances
Agricultural Finance
Micro, Small and Medium Enterprises – MSMED Act, Policy package
Government Sponsored Schemes – SGSY; SJSRY; PMRY; SLRS
Self-help Groups
Credit Cards, Home Loans, Personal Loans and Consumer Loans
Documentation
Different Types of Charging Securities
Types of Collaterals and their Characteristics
Non-performing Assets
Financial Inclusion
3 Banking Technology
Payments System and Electronic Banking
20 Data Communication and EFT Systems
Role of Technology and Its Impact on Banks
4 Marketing and Services of Banking
Marketing, Social Marketing
20 Consumer Behaviour and Product
Pricing, Distribution and Channel Management
Note : Relevant Law/Statute/Rule in force and relevant Standards in force on 1st April immediately preceding
commencement of Academic Year is applicable for ensuring examination after relevant year.
 PAPER PATTERN
Maximum Marks: 75
Questions to be Set: 05
Duration: 2½ Hours
All questions are compulsory carrying 15 Marks each.
Q. No. Particulars Marks
Q.1 Objective Questions* 15
(A) Sub-questions to be asked (10) and to be answered (any 08)
(B) Sub-questions to be asked (10) and to be answered (any 07)
(*Multiple Choice/True or False/Match the Columns/
Fill in the Blanks)
Q.2 Full Length Question 15
OR
Q.2 Full Length Question 15
Q.3 Full Length Question 15
OR
Q.3 Full Length Question 15
Q.4 Full Length Question 15
OR
Q.4 Full Length Question 15
Q.5 (A) Theory Questions 08
(B) Theory Questions 07
OR
Q.5 Short Notes 15
To be asked (05)
To be answered (03)

Note: Theory question of 15 Marks may be divided into two sub-questions of 7/8 and 10/5
Marks
 CONTENTS
Chapter 1 : Indian Financial System 1-18
1.1 An Overview of IFS
1.2 Evolution of Indian Financial System
1.3 Classification of IFS
1.4 Evolution of Commercial Banking
1.5 Era of Nationalisation to 1991
1.6 Era of Economic Reforms (1992-2003)
1.7 From 2004 to Date
1.7.1 Regulating Cooperative Banks
1.7.2 Agricultural and Rural Development Banks
1.7.3 Regional Rural Banks (RRBs)
1.7.4 Local Area Banks (LABs)
1.8 Development Banks
1.9 Financial Markets
1.10 Financial Companies
1.11 Questions
Chapter 2 : Banking Regulation Act, 1949 19-28
2.1 Banking and Banks’ Business
2.2 Business Permitted
2.3 Prohibited Businesses
2.4 Supervisory and Controlling Authorities and Control of Credit
2.5 Application of B.R. Act to Cooperative Banks
2.6 Bankers’ Liabilities and Penalties
2.7 Questions
Chapter 3 : Retail Banking and Wholesale Banking 29-47
3.1 Definition – Retail Banking
3.2 Retail Banking Products
3.3 Wholesale Banking or Corporate Banking
3.4 International Banking or Multinational Banking
3.5 Role of Money Market
3.6 Debt Market
3.7 Capital Market
3.8 Foreign Exchange Market (Forex)
3.9 Securities and Exchanges Board of India (SEBI)
3.10 Questions
Chapter 4 : Mutual Funds and Insurance Companies 48-64
4.1 Definition of Mutual Funds
4.2 Types of Funds/Classification of Funds
4.3 Insurance Companies
4.4 Insurance Regulatory and Development Authority (IRDA) Act, 1999
4.5 Factoring
4.6 Forfaiting Services
4.7 Off-balance Sheet Exposure
4.8 Questions
Chapter 5 : Risk Management 65-90
5.1 Changing Scenario of Risk Management
5.2 Risks in Banks
5.3 Types of Risk in Banks’
5.4 Basel Committee Recommendations
5.5 Credit Information Bureaus of India Ltd. (CIBIL)
5.6 Debt Recovery Policy
5.7 Questions
Chapter 6 : Functions of Banks 91-104
6.1 Banker Customer Relationship
6.2 Know Your Customer (K.Y.C.)/AML/CFT Norms
6.3 Consumer Protection Act, 1986 (COPRA)
6.4 Payment and Collection of Cheques and Other Negotiable Instruments (Sec. 131)
6.5 Opening Accounts of Various Types of Customers
6.6 Ancillary Services
6.7 Cash Operations
6.8 Questions
Chapter 7 : Principles of Lending and Priority Sector Advances 105-150
7.1 Principles of Lending
7.2 Working Capital Assessment
7.3 Credit Monitoring
7.4 Priority Sector Advances – An Overview
7.5 Micro-Small and Medium Enterprises (MSMEs) Sector
7.6 Self-help Groups
7.7 Credit Cards – Introduction and Criteria
7.8 Home Loans
7.9 Personal Loans
7.10 Consumer Loans
 7.11 Documentation
7.12 Different Types of Changing Securities
7.13 Classification of Securities and their Characterises
7.14 Non-performing Assets (NPAs)
7.15 Financial Inclusion
7.16 Questions
Chapter 8 : Banking Technology 151-168
8.1 e-banking (Electronic Banking)
8.2 Electronic Funds Transfer
8.3 Technology: The Indian Context
8.4 Impact on Banks
8.5 Questions
Chapter 9 : Marketing and Services of Banking 169-185
9.1 Marketing of Services
9.2 Social Marketing
9.3 Customer Behavior and Product
9.4 Pricing Financial Services
9.5 Distribution and Delivery Channels Management
9.6 Questions
 F undamentals of
INDIAN FINANCIAL
Database CHAPTER
SYSTEM
Management System 1
1.1 A N O VERVIEW OF IFS
The liberalisation of the financial sector in India which formed a key part of the overall liberalisation
process, blurred the distinction between various financial intermediaries and promoted greater efficiency
and competiveness in the financial markets. With the growth of the debt capital markets and entry of
mutual funds, disintermediation have gradually set in.
The ‘system’ stands for a set of bodily organs like composition or concurring in function, a
scheme of Classification and a Method of Organisation.
‘Finance’ holds the key to all human activities. Finance is the study of money — its nature, creation,
behaviour, regulation and administration. So all these activities dealing in finance are organised in a
system, known as the “financial system.”
The term financial system is a set of interrelated activities/services, working together to achieve
some predeterminad purpose or goal. It includes different markets, institutions, instruments, services
and mechanisms, which influence the generation of savings, investment, capital formation and growth.
According to Robinson, the primary function of the system is “to provide a link between savings
and investment for the creation of new wealth and to permit portfolio adjustment in the composition
of the existing wealth.

1.2 E VOLUTION OF I NDIAN F INANCIAL S YSTEM

The evolution of the financial system has been interlinked with the growth of macroeconomics.
In India, the evolution of the financial systems reflected its political, social and economic needs and
aspirations. The government has exerted its influence, over the flow of credit, interest rates, credit
control and direction. If is also a big borrower as well as regulator of the financial system. A bulk
contributor of the Indian Financial System is the public sector, even though cooperatives and private
sectors are there to compete with other institutions.

1.3 C LASSIFICATION OF I NDIAN F INANCIAL S YSTEM

The Indian financial system is broadly classified into two groups:
(i) Organised Sector, and
(ii) Unorganised Sector

1
 2  Principles and Practices of Banking
There are users of the financial services and also providers of financial services. The provides are
Reserve Bank of India, commercial banks, financial institutions, money and capital markets and informal
financial enterprises.
Organised Sector – The organised sector consists of a network of banks, other financial and
investment institutions and a range of financial instruments, which together function in fairly developed
capital and money markets. Short-term funds are provided by the commercial and cooperative banks.
About 83% of such banking business are managed by 21 leading public sector banks. In addition to
commercial banks, there is a network of cooperative and development, regional rural banks at district,
city and block levels. During the last two decades Indian banks have diversified into areas such as
merchant banking, mutual funds, learning, factoring, foreign exchange and corporate treasury services.
The financial institutions in India mainly consist of public sector banks (21), private sector banks (22),
regional rural banks (56), small finance banks (8), payment banks (11), urban cooperative banks (53),
state cooperative banks (31), district central cooperative banks (373), NBFCs (11,769 registered with
RBI and 34,754 unregd.) and institutions of mutual funds (42).
Hence the organised financial system comprises the following subsystems:
 Commercial banks (public and private sector)
 Cooperative banks/Cooperative societies
 Development banking (Long-term financial institutions provider)
 Money markets; and
 Financial institutions
Unorganised Financial System
It comprises relatively less controlled in regulated moneylenders, indigenous bankers, lending
pawnbrokers, landlords, traders etc. There are other financial companies like Chit Funds and Nidhi
Cos. etc., which are also not regulated by RBI or the government.

1.4 E VOLUTION OF C OMMERCIAL B ANKING

In India, the ancient Hindu scriptures refer to the rnoneylending activities in the Vedic period.
During the Ramayana and Mahabharat eras, banking had become a full fledged business activity and
during the Manu Smriti period which followed the Vedic period and Epic age, the business of banking
was carried on by the members of the Vaishya community.
Banking is different from moneylending but the two terms have in practice been taken to convey
the same meaning. Banking has two important functions to perform, one of accepting deposits and
other of lending monies and/or investment of funds.
During the Moghul period, metallic money was issued and the indigenous bankers added one
more line of money changing to their already profitable business. They started exchanging money
circulating in one part of the country with the money currently in another part of the country making
good margin for themselves. The indigenous bankers could not however, develop to any considerable
extent the systems of obtaining deposits from the public, which today is an important function of a
banker.
The English traders, who came to India in the 17th century, established some contacts with the
indigenous bankers by borrowing funds from them. In 1786, the English Agency Houses had established
the Bank of Bengal at Calcutta. With the advent of modern banking conducted on Western lines, the
 Indian Financial System  3

indigenous bankers lost further importance. The English Agency Houses in Calcutta and Bombay
were the bankers to the East India Company and the European merchants in India. They had no
capital of their own and depended mainly on deposits from the public for finance. These agency
houses failed as they combined banking with trading.
Among the earliest banks established in India were the Banks of Bengal (1806), Bombay (1840)
and Madras (1843). These banks were also known as “Presidency banks”. In 1860, the concept of
limited liability was introduced in banking. These banks (Presidency banks) were allowed to issue notes
to a limited extent, but this right was taken over by the government in 1862. In view of limited liability,
several joint stock banks were floated. Some of the important banks that were established during 1860
to 1900, were:
Evolution of Commercial Banking in India

Bank of Bengal Bank of Bombay Bank of Madras

(1806) (1840) (1843)

Presidency Banks
Features

Limited Liability — Issue of Notes to Limited Extent

Joint Stock Banks — Started during 1860-1990

Allahabad Bank Alliance Bank Oudh Bank Punjab National

Ltd. of Simla Ltd. Ltd. Bank Ltd.
Started during 1900-1910

People Bank Bank of India Bank of Baroda Central Bank

of India Ltd. Ltd. Ltd. of India Ltd.
Presidency Banks merged in 1921 and renamed Imperial Bank of India,
further renamed in 1955 as State Bank of India*
Subsidiary to S.B. of India Act, passed in 1959

S.B. Bikaner S.B. of S.B. of S.B. of S.B. of S.B. of S.B. of

and Jaipur Hyderabad Indore Mysore Patiala Saurashtra Travancore
14 Banks Nationalised in 1969
6 Banks Nationalised in 1980
196 Regional Rural Banks opened in 1976 onwards
9 New Private Sector Banks during 1994 to 1996
22 Old Private Sector Banks
43 Foreign Banks
8 Small Finance Banks
11 Payment Banks
*Merged with S.B. India on 31.3.2017
 4  Principles and Practices of Banking
 Allahabad Bank Ltd.
 The Alliance Bank of Simla Ltd,
 The Oudh Bank Ltd.
 The Punjab National Bank Ltd.
Thus, by the end of the year 1900, there were three classes of bank.,, in India, viz.,
(i) Presidency banks, numbering 3
(ii) Joint stock banks, numbering 9
(iii) Exchange banks or foreign banks, numbering 8
The Swadeshi movement, which started in the early 1900s, gave stimulus to the growth of
indigenous joint stock banks. Some of the banks established during the 1900 to 1910 period were:
(i) The Peoples Bank of India Ltd.
(ii) The Bank of India Ltd.
(iii) The Bank of Baroda Ltd.
(iv) The Central Bank of India Ltd.
In 1921, the three presidency banks were merged to form the Imperial Bank of India. On the
eve of independence in August 1947, there were 648 commercial banks, comprising 97 scheduled and
551 non scheduled banks. The number of offices of banks stood at 2,987, with total eposits at ` 1,000
crore and advances at ` 475 crore.
During the 50 years or the period 1900 to 1950, the Indian joint stock banks specialised in
providing short term credit, for trade in the form of cash credit and overdraft facilities, foreign
exchange business, remained the monopoly of foreign banks. Between 1900 and 1925, many banks
failed. The Central Banking Enquiry Committee was constituted in 1929, it gave reasons for the failure
of banks as:
(a) Insufficient capital
(b) Poor liquidity of assets
(c) Combination of non banking activities with banking activities
(d) Irrational credit policy, and
(e) Incompetent and inexperienced directors
On the basis of major recommendations of the Central Banking Enquiry Committee, the RBI
Act was passed in 1934. While in 1949, the Banking Regulation Act, was passed for regulation and
supervision of banks. It gave wide powers to RBI to regulate, supervise and develop the banking
systems.
During 1950 to 1969, two important developments took place, first, the All India Rural Credit
Survey Committee, which examined the issue of credit availability in the rural areas, recommended the
creation of a State partnered/ sponsored bank entrusted with the task of opening branches in the
rural areas. Accepting. This recommendation, the State Bank of India Act, 1955, was passed and the
Imperial Bank of India was renamed State Bank of India. Later in 1959, the State Bank of India
(Subsidiary Bank) Act, was passed enabling SBI, to takeover eight princely state associated banks, as
their subsidiaries.
Banks were:
State Bank of Bikaner*
State Bank of Hyderabad
 Indian Financial System  5

State Bank of Indore**

State Bank of Jaipur*
State Bank of Mysore
State Bank of Patiala
State Bank of Saurashtra**
State Bank of Travancore
These two banks merged into one bank)
(** Merged with State Bank of India in 30.6.2010 and rest 5 on 31.3.2017)
Secondly, the need for wider diffusion of banking facilities and to change the uneven distributive
pattern of bank lending was realised. The scheme of social control, over banks, was announced in
Parliament in December 1967. The National Credit Control Council was set Lip in 1968, to assesses
the demand for bank credit, from various sectors of the economy and to determine their respective
priorities in allocation.
At the launch of the First Five Year Plan in 1951, there were 566 commercial banks consisting of
92 scheduled and 474 non­scheduled banks. In 1969, the total number of banks declined to 89 out of
which 73 were scheduled and 16 were non scheduled.

1.5 E RA OF N ATIONALISATION TO 1991

The Indian banking scene underwent significant changes during the period 1969 to 1990. The
social control measures, of not less than 51% of the directors of the board of a banking company had
to consist of persons with special knowledge or practical experiences in respect of accountancy,
agriculture, rural economy, banking, cooperation, economics, finance, law and SSIs, were not considered
adequate to achieve the desired social and economic objectives. The Government of India, therefore,
on 19th July, 1969, nationalised by an ordinance, 14 major Indian commercial banks having deposits of
` 50 crores and above. The objectives of nationalisation were:
An institution such as the banking system, which touches and should touch lives of millions, has
to be inspired by a larger social purpose and has to subserve national priorities and objectives, such as
rapid growth in agriculture, small industry and exports, raising employment levels, encouragement of
new entrepreneurs, and the development of backward areas. The acquisition of ownership of banks
was, thus, to enable the banks to play more efficiently the role of a catalytic agent for the economic
growth by extending banking facilities to the most deserving classes.
Again in 1980, the Government of India had nationalised another six banks, each having deposits
of ` 200 crores or above. The banks nationalised in 1969 and 1980 were as below:
Banks Nationalised in 1969
1. Central Bank of India
2. Bank of India
3. Punjab National Bank
4. Bank of Baroda
5. United Commercial Bank
6. Canara Bank
 6  Principles and Practices of Banking

7. United Bank of India

8. Dena Bank
9. Syndicate Bank
10. Union Bank of India
11. Allahabad Bank
12. Indian Overseas Bank
13. Indian Bank
14. Bank of Maharashtra
Banks Nationalised in 1980
15. Andhra Bank
16. Corporation Bank
17. Oriental Bank of Commerce
18. Punjab and Sindh Bank
19. Vijaya Bank
20. New Bank of India*
*This bank was merged with PNB in 1990 and a new bank IDBI Ltd., was added in the year 2003.
Another important structural development was the formation of ’ the Regional Rural Banks
(RRBs), which were started in 1976. Their ownership vests with the sponsoring commercial bank, the
Central Government and the State Government of the area. Under this approach, 196 RRBs were set
Lip.
Major developments in banking during 1970 to 1991 were:
1973-74 – Setting targets for priority sector lending.
1974-75 – Prescription of norms for lending and working capital limits by Tandon
Committee.
1982-83 – Prof. Chakrabarty’s report on monitoring system in India.
Establishment of National Bank for Agriculture and Rural Development
(NABARD)
1985-86 – Introduction of MICR Technology
Introduction of Health Code system for bank loans
1985-86 – Permission to banks to float mutual funds.
1988-89 – Vaghul Working Group on Money market.
– Establishment of Discount and Finance House of India (DFHI) and the National
Housing Bank (NHB)
– Adoption of Service Area Approach.
1989-90 – Enhancement of access to call money market, in terms of number of participants.
– Establishment of the Small Industries Development Bank of India (SIDBI)
During nationalisation and thereafter, there was wide branch expansion in rural and semi urban
areas, backward regions and under banked states so that interregional disparities could be reduced.
The details of the programme of ’ branch network were as follows:
 Indian Financial System  7

Year branches Total branches Rural branches Semi urban

1969 8262 1833 3342
1980 32419 15105 8122
1991 60220 35206 11344
Source: Bank Quest, Oct-Dec., 2002 of IIBF
The total number of bank branches increased eight fold between 1961) and 1991 and the bulk
of the increase was on account of rural branches, which increased from less than 1,900 in 1961) to
over 35 thousand in 1991.
One of the objectives of branch expansion was to mop up national savings, both actual and
potential and to channel them into investments according to Five Year Plan priorities.
` in Crores
Year Deposits Total Term Deposits Saving Deposits
1969 5173 3280 1524
1980 37988 19253 10937
1991 230758 128768 56902
The RBI’s credit policy over the years, laid increasing emphasis on channeling of bank credit
to preferred sectors and borrowers of small means. The credit operations of banks were:
` in Crores
1969 1980 1991
Bank Credit 3729 25371 125592
Priority Sector 659 8501 45425
%age of which 18 33 36
Agriculture 258 3584 18157
% 39 42 42
SSI Sector 347 3229 18150
% 52 37 42
Note. Figures are in percentages to vertical totals.

1.6 E RA OF E CONOMIC R EFORMS (1992-2003)

The period, 1992-2003, may be regarded as the present or the current phase in the evolution of
Indian Banking. Like the phase of 1969-1991 began with a bang, i.e., nationalisation of banks, the
current phase also began towards market oriented banking, as a result of the introduction of financial
reforms, especially banking reforms. India’s economic reforms programme began as a response to
the macroeconomic crises that developed in early 1991. The crises manifested itself in rising inflation,
high level fiscal deficit, low growth and unsustainable current account deficit, and the Gulf War of
1990 precipitated, the “balance of payment” crisis.
 8  Principles and Practices of Banking
The main plank of economic reforms comprised:
(a) Stabilisation of the economy so as to keep under control inflationary and balance of
payment pressures.
(b) Deregulation of the real and financial sectors and removal of licence and permit system
from all spheres.
(c) Liberalisation of international trade in various sectors to promote competition and
efficiency by removing the high degree of protection enjoyed by the domestic industry,
and
(d) Integration with world economy to attract capital and modern technology.
The banking reforms have the specific task of achieving:
(i) A suitable modification in the policy framework within which banks operate,
(ii) Improvement in the financial health and competitive capabilities of banks,
(iii) Building financial infrastructure relating to supervision, audit and technology, and
(iv) Upgradation of the level of managerial competence and the quality of human resources.
The basis for banking reforms approved by the Committee on Financial System (Narasimham
Committee), which were made recommendations in November, 1991 for transforming highly regulated
policy to a more market oriented system.
The various measures were:
(a) Reduction in the pre emption of funds through lowering of the CRR and SLR from
63.5% to 31.5% (CRR 6.5% and SLR 25%) in October 2001.
(b) Redefining and redesigning directed credit programmes.
(c) Dismantling administered interests.
(d) Establishment of Discount and Finance House of India, Securities Trading Corporation
of India and Negotiated Payment Settlement System.
(e) Improving financial health of banks through prescription of risk weighted capital adequacy
ratios, re-capitalisation and restructuring of weak banks.
(f) Amendment to the bank branch licensing policy to deal effectively with the loss making
branches.
(g) Withdrawing the concept of MPBF and increasing the share of loan segment in banks
credit.
(h) Setting up of special Debt Recovery Tribunals (DRTs) for improving recovery of bank
loans.
(i) Norms for floating new private sector banks.
(j) Deregulation of interest rates all loans over ` 2 lakh.
Various measures were taken by RBI and Government for economic reforms, such as:
(i) Introduction of Banking Ombudsman Scheme in 1995.
(ii) Freedom to banks to decide their Prime Lending Rate (PLR).
(iii) Introduction of the concept of Local Area Banks.
(iv) Granting of conditional autonomy to the public sector banks.
(v) Revision of capital adequacy norms in 1998-99.
 Indian Financial System  9

(vi) Deregulation of interest rates of all term deposits.

(vii) Introduction of Voluntary Retiremen0t Scheme (VRS) in public sector banks resulting in
about 11% reduction of employees in 2001.
There has been a growing presence of private sector banks, more so, after the introduction of
financial sector reforms from 1992. Six new private sector banks, listed as under, were issued licenses
in 1994-95 and four more licences in 1995-96, commenced operations during the same year. Minimum
net owned funds of private sector banks was ` 300 crores w.e.f. July 2006 to 2011.
1. UTI Bank Ltd.
2. Indus Ind. Bank Ltd.
3. ICICI Banking Corporation Ltd.
4. Global Trust Bank Ltd.
5. Centurion Bank Ltd.
6. HDFC Bank Ltd,
7. Times Bank Ltd.
8. Bank Of Punjab Ltd.
9. IDBI Bank Ltd.
10. Kotak Mahindra Bank Ltd.
Out of these above listed banks, following banks merged with and/or acquired by other banks:
(i) Merger of Times Bank with HDFC Bank Ltd., in 1999-2000.
(ii) Bank of Madhura merged with the ICICI Bank in 2000-01.
(iii) Centurion Bank acquired Bank of Punjab Ltd., in October 2005.
(iv) Global Trust Bank Ltd., merged with Oriental Bank of Commerce in 2004.
(v) Bharat Overseas Bank Ltd., merged with Indian Overseas Bank in 2007.
(vi) Sangli Bank Ltd., merged with ICICI Bank Ltd.
(vii) United Western Bank Ltd., merged with Kotak Mahindra Bank Ltd.
(viii) UTI Bank Ltd., converted to AXIS Bank Ltd.
(ix) Centurion Bank of Punjab Ltd., merged with HDFC Bank Ltd., in May 2008.
(x) Bank of Rajasthan Ltd., merged with ICICI Bank Ltd., in July 2010.
Private sector banks have been rapidly increasing their presence in the recent times and offering a
variety of newer services to the customers and posing a stiff competition to the group of public
sector banks.
The response of the banks to the reforms has been impressive. The following position was of
public sector banks at the end of March 2001:
(a) Capital adequacy 9% required, actual was in excess of 10% in March 2001.
(b) Ratio of gross NPAs to gross advances in 1992-93 was 23% reduced to 12.4%.
(c) PSB in 1993-94 had loss of ` 4,705 crore which turned into profit of ` 2,095 crore in
March 2001.
(d) Total branches at the end of March 2001, 65,901.
 10  Principles and Practices of Banking

1.7 F ROM 2004 TO D ATE

India has become $ 2.0767 trillion economy in 2014 end. As per World Bank report, India’s
GDP stands at $ 2.067 trillion in just 7 years. But still it is in the lower middle income category. India’s
gross national income per person has risen to $1,610 which converts to ` 1,01,430 by present exchange
rate (June 2015) (E.T. Newspaper 04 07 2015)
The Indian banking system faces several difficult challenges, viz., high cost of doing business,
yearly increases in NPA, low levels of Customer satisfaction, phenomenal growth in the volume of
capital inflows, etc. There are several areas of concern, which needs to be addressed.
Indian banks will have to operate in a deregulated competitive financial sector. Competitive pressure
is building up on Indian banks, both from within and from outside. Competition is likely to intensify
in the coming years within the industry, from NBFCs and from foreign entities. Competition is not
just in terms of number of competitors but in terms of proliferation of innovations, specialised
markets, cross border trade in financial services and capital flows.
We cannot lag behind other countries and we have to transform the Indian banking system from
being a largely domestic to a truly international one, and this should enable India to emerge as all
international banking centre. Information and communication technology has reduced costs, increased
volumes and has facilitated customised products. It has played all important role in the payments and
settlement system. Technology has opened new avenues in banking, for discharging the same functions
in a cost effective manner, 24 hour 7 days banking, telebanking, Internet banking, e-banking, home-
banking and mobile banking.
Asset liability mismatches expose the banks to various types of risk, i.e., risks of illiquidity and
insolvency, risks arising from globalisation and deregulation. Risk management is a continuous process
of controlling assets and liabilities in terms of size, maturities and yields.
In any banking system, no bank, howsoever owned, can survive unless it continuously strives to
transform its organisation as a self­governing, self-correcting and self-adjusting equity. In this millennium,
mankind is destined to serve not one but two masters. The first is no longer the owner, but the
customer, who is supreme, regardless of whether he is rich or poor, young or old, domestic or
foreign. The second is profits and there is no third thing. And just as “income recognition” and capital
adequacy are two sides of the same coin, so also it is with customer satisfaction and profits.
There are two models, emerging in the banking scenario today. One or them is universal banking
in which banks are attempting to provide products and services developed by them to the customers.
The second one is Customer Relationship Management (CRM). Many retail banks are focusing all new
strategies to maximise customer acquisition, cross sell, retain customers, and increase profitability,
while increasing customer service and satisfaction levels, reducing product costs and improving
distribution. Banks have started selling their customers, online banking and consultation services to
add, both value to their services and to satisfy their customers. But, even after selling a series of
financial transactions to the customer on the internet, the customer needs a good reason to remain
loyal to the bank. As use of the Internet continues to expand, more banks are using the web to offer
products and services or otherwise enhance communication with customers. But once a customer is
online, it is hard to keep him or her loyal to the bank. For financial inclusion NO FRILL accounts were
opened by all banks. The position of all such banks at the end of 31.03.2009 was as under:
 Indian Financial System  11

Number of accounts
(cumulative figure)
Public Sector banks 2,98,59,178
Private Sector banks 31,24,101
Foreign Banks 41,482
Total 3,30,24,761
The commercial banking sector plays an important role in the mobilisation of deposits and
disbursement of credit to various sectors of the economy. Traditional banking has come a long way
through from goldsmiths who were tile literal bankers to the virtual banks. Banking is going through a
metamorphosis. Technology, deregulation, disintermediation and securitisation are the major forces
that are producing ripples in the industry.
Savings banks accounts were opened under Prime Minister Jan Dhan Yojna 2014 in order to
have social security to poors with zero balance with accidnt benefit and life cover. Total 28.23 crore
accounts were opened till 31.03.2017 with balance of ` 63,971.38 crores.
District Central Cooperative Banks: It is a federation of PACs (primary agricultural credit
societies) located in a specific area, i.e., district. These organisations are linking points between primary
cooperative agricultural credit societies and State Cooperative Banks. District Central Cooperative
Banks undertake banking related activities. They also grant credit to customers on the basis of first
class gilt securities, gold, etc.
State Cooperative Banks: SCBs occupies a key position in the cooperative credit structure. The
RBI reaches to the cultivators through the States Cooperative Banks. Resource of such state level coop.
Banks comprises share capital, reserve funds, various type of deposits, loans and overdrafts/borrowings
and surplus funds of district Central Cooperative Banks affiliated to the respective banks. These banks
lend to affiliated District Central Cooperative Banks. The main functions of State Cooperative Banks
are as follows:
(i) Acts as bankers’ bank for District Central Cooperative Banks.
(ii) Connects Cooperative Credit Societies or banks with money market in the country.
(iii) Supervises, controls and renders guidance to the District Central Cooperative Banks.
(iv) Performs functions like issuing drafts, cheques and letters of credit, etc.
(v) Assists the state governments in drawing up cooperative development related plans for
the State.
There were 31 (in 2017) state cooperative banks in India, with total aggregate deposits of ` 71,315
crore and ` 21,582 crore advances at the end of 2008-09. NABARD gives loans to RRBs at 4.5%,
while the interest rate for cooperative banks is around 4%. In the year 2010-11, government had used
` 5,000 crore fund for meeting short-term financial needs of cooperatives and RRBs for farm sector.
Among non agricultural credit, which is provided by the urban cooperative banks and employees
cooperative credit societies are the main institutions under the cooperative sector. Urban cooperative
banks are also known as “Common man’s banks” play an important role in the life of urban people.
Urban cooperative banks having deposits of ` 100 crore and above are given the status of scheduled
bank under RBI Act, 1934, subject to minimum demand and time liabilities of ` 250 crores.
 12  Principles and Practices of Banking
The position of UCB as on 31st March 2017 were as below:
No. of Scheduled UCBs — 53 (March 2016)
No. of banks — 1,561 (March 2016)
— (including 119 fully ladies branches)
Owned funds — ` 12,843 crores, 9% CRAR in 95.4% banks
Deposits — ` 3,92,179 crores
Borrowings — ` 2,45,013 crores
Gross NPAs — 6.55% on 31.3.2016
Most of the urban cooperatives banks are situated in the States of Maharashtra/Gujarat/
Karnataka/Andhra Pradesh/Tamil Nadu/Goa and Uttar Pradesh.
As per RBI statistics, there are only nine urban cooperative banks which are having deposits of
` 1,000 crores or above, while 60% UCBs are having deposit totals of less than ` 25 crores.
Implementation of Vaidyanathan Committee’s recommendations had been asked by the RBI to
the State Governments. The finance package of ` 14,839 crores was to be shared at 53% by the State
Government, while cooperative societies had been asked to contribute 16%. [As all cooperative societies
had C.A.R. of 7% and after 5 years in 2012, it was raised to 12%.] RBI directed all UCBs to implement
CBS system in Dec. 2014.

1.7.1 Regulating Cooperative Banks

In discussions on banking licences, one rather ignored area is that of urban cooperative banks
(UCBs). This has remained somewhat below the radar. However, it appears that there might be some
action in this space if the Reserve Bank of India (RBI) considers issuing licences for new urban
cooperative banks in the near future. A the report submitted by an expert committee of RBI, led by
Y.H. Malegam, lays down some of the principles for issuing new licences.
It is, however, important for RBI to recognise the difference in the form of organisation before
e banking on opening up the gates for new cooperative banks. Cooperatives are distinct from other
forms of organisation, as they are organised on the Principle of Mutuality. RBI needs to recognise the
complexity of the cooperative form. This complexity emanates from the principles of cooperation,
which treats capital as incidental and not central to business.
In this context we should consider one critical principle of open membership that defines
cooperatives. Most UCBs operate in violation of this principle in spirit. The principle is anybody who
is willing to use the services of the cooperative, as per the terms of engagement should not be denied
membership, unless there are genuine capacity constraints. Open membership permits a member to
walk out, when he or she does not want the services. Therefore, the share capital of a cooperative is
incidental and is in the nature of a fixed deposit where a member can subscribe to or withdraw from
it at any time.
RBI needs to recognise this oxymoron — that there could be no cooperative “banking”. Banks
seek deposits from public and uses them for lending. If we follow the cooperative principles, there
could be no “public” as deposits come from owner members. Thus, from a puritanical view one could
argue for a neighbourhood level cooperative society. Federated structures could provide the sophisticated
 Indian Financial System  13

services to the members by having multiple neighbourhood societies promote the upper tier organization.
The European and the North American models are basically neighbourhood credit unions and federated
structures. Neighbourhood cooperatives might need to be a bank to be a part of the payments system.
The UCBs (with the notable exceptions like the Sewa Bank), work as neighbourhood banks
rather than as cooperatives, It is impossible to break into a DCB’s membership club. So, as the expert
report rightly recognises, these are borrowerrun organisations with depositors having optional
membership. The conflict of interest of a borrower run bank is stark. If RBI were to issue new
licences, it should move the control entirely to the depositors (except for institutional deposits) rather
than accepting the recommendation that at least 50% of the deposits should be represented by members.
Till now, we had no instances of cooperatives going below the capitalisation requirements because
of withdrawal of membership under the open membership route. Most DCB collapses were because
of a ‘run’, an indication that DCBs are a close club where members are too entrenched to withdraw
membership; and deposits were held by customers, not members.
A new formula was proposed by the report that the new members should pay a premium to
obtain membership to represent the accumulated and indivisible reserves of the DCB appears fair,
but has a dangerous flip side. The members withdrawing from membership also get a premium
representing indivisible reserves. The implication is significant when considered with the other
recommendation that the membership should represent more than 50% of the depositor base. These
two together would make a perfect case for a run led by members in case of trouble. While the
principle of withdrawing members getting a premium representing their unencashed loyalty and
patronage is desirable, it is dangerous in a bank. The cooperative should at least fence the minimum
amounts required for capital adequacy as non distributable amounts.
The issue of professionalism in running a UCB was a serious issue and RBI considered the
recommendations of the committee to have sliced governance, a board of directors (elected) for
strategy formulation and a board of management (appointed/co-opted) who satisfy the fit and
proper criteria for governing the operations.
The committee recommended lower capitalisation for UCBs operating in unbanked areas. Granting
a licence for starting/running an UCB is a technical issue, and this cannot be treated as a nation building
exercise. Cooperatives operate as neighbourhood institutions and it might not be a good idea to grant
licences at lower capitalisation. If a cooperative society could morph into a bank at scale, then the
unbanked areas Could start with societies than undercapitalised banks. However, the eventual question
that RBI should stand upto is, whether the regulator considers these institutions as banks incorporated
as cooperatives or as cooperatives wanting to do banking. This makes a world of difference. This
might be the one opportunity for RBI to restore cooperation in cooperative banks.
1.7.2 Agricultural and Rural Development Banks
The avenues for borrowing on long-term basis provide only short-term credit requirements and
the funds of the commercial banks and cooperative societies could not be blocked for longer periods
of time. Against this backdrop only the institution of Land Development Banks or Agricultural and
Rural Development Banks, came into existence in the form of term finance, for buying equipment like
pump sets, tractors, electric motors and other equipment, which are being used by the farming
community. These banks provide long term credit against the mortgage of land as security generally
for a period of 5 to 20 years.
 14  Principles and Practices of Banking
The first cooperative land development or land mortgage bank was established at Jhind in Punjab
in 1920. Subsequently, similar banks were established in other parts of the country, viz., in Madras
province in 1929 and in Bombay State. Loans are given to members on the mortgages of their lands
usually upto 30 times the land revenue payable in other states of course, after assessing the value of the
lands and scrutinising the legal title of the members, duly taking into account their need and their
repaying capacity. The other purposes for which the loans are given are for
(i) fencing of land,
(ii) digging wells,
(iii) construction of wells,
(iv) tubewells,
(v) tanks, etc.,
(vi) redemption of old debts, and
(vii) effective permanent improvement in the productivity of land.
Land Development Banks do not have a uniform pattern. However, the structure can be easily
described as Under:
(i) Central Land Development Banks at the top, and
(ii) Primary Land Development Banks at the base.
Central Land Development Banks tend to centralise the working of mortgage banking by issuing
bonds and debentures for and on behalf of Primary Land Development Banks and making funds
available to them. Primary Land Development Banks constitute the base of long term agricultural
credit. However, having regard to the vast demands of development credit, one could only say that
LDBs had not made a great dent in this area. Also, the follow up and monitoring aspects of their
operation are not that intense, so as to avoid the pitfalls of misapplied loans, wrong end usage and
improper credit assessment. Percentage share of different banks in total deposit amount as on 1.3.2000
was 3.7% (UCBs) 4. 1% (Land Dev.), 2.7% (RRBs), and 89.5% (Commercial banks).

1.7.3 Regional Rural Banks (RRBs)

The Regional Rural Bank Act, 1976 was passed by Parliament to promote, regulate with a view
to developing the rural economy. It was for the purpose of development of agriculture, trade, commerce,
industry and other productive activities in the rural areas, credit and other facilities, particularly to the
small and marginal Farmers, agricultural labourers, artisans and small entrepreneurs and for matters
connected therewith and incidental thereto.
The authorised capital of each RRB was ` 5 crores, divided into five lakh fully paid Lip shares of
` 100 each, provided that the Central Government may, after consultation with the NABARD and
sponsoring bank, increase or decrease the authorised capital, but it shall not be reduced to below ` 25
lakh. file share of RBB capital is divided as 50% by Central Government, 15% by the concerned State
Governments and 35% by the sponsoring bank.
In Jan. 2013 there were 56 RRBs in 23 states with 15,475 branches in the country. The total loan
outstanding was ` 83,562 crores, and deposits were ` 1,42,814 crores at the end of March, 2010. As
of now, 30 RRBs had accumulated losses to the extent of ` 1,808 crores. There was a need of around
` 2,200 crores to bring the CAR of RRBs to 9% by tile year 2011-12.
 Indian Financial System  15

Business of RRBs
(i) The granting of loans and advances, particularly to small and marginal farmers and
agricultural labourers, whether individually or in groups, and to cooperative societies,
Including agricultural marketing societies and processing societies, cooperative farming
societies, primary agriculture credit societies or farmers’ service societies for agricultural
purposes or agricultural operations or for other purposes connected therewith.
(ii) The granting of loans and advances, particularly to artisans, small entrepreneurs and
persons of small means engaged in trade, commerce or industry or other productive
activities, within the notified area in relation to tile RRBs.
Regulation
Besides the RBI, which is the regulatory authority for the RRBs in accordance with the provisions
of Banking Regulation Act, 1949, the Banking Regulation Act empowers NABARD, to undertake the
inspection of RRBs. A RRB seeking permission of the RBI for opening branches, etc., has to obtain
the recommendation of NABARD.
1.7.4 Local Area Banks (LABs)
In August 1996, the RBI issued guidelines for setting up LABs. The starting of such banks was
allowed for promoting rural savings as well as for the provision of credit for viable economic activities
in the local areas. To cater to the needs of the local people and to provide efficient and competitive
financial intermediation services in areas of operation. It was extending over two or three Contiguous
districts as also to tapping retail savings where tile branches of commercial banks are insignificant. The
RBI gave approval of setting up Local Area Banks, a total of 4, in Maharashtra, Karnataka, Punjab and
Andhra Pradesh States. The guidelines of opening of LABs were as below:
(i) LABs should focus on local Customers and lending to agriculture and allied activities,
SSI, agro industrial activities, trading and non farm sector.
(ii) LABs will have overall priority sector lending target of 40% of net bank credit and
weaker sector lending norm of 10%.
(iii) The bank is to be registered as public limited company under the Companies Act, 1956
or 2013.
(iv) The minimum paid-up capital is ` 5 crore (Raised to ` 50 crore by March, 2011) and
promoters’ contribution of at least ` 2 crore.
(v) Promoters may be individuals, corporate trusts or societies.
(vi) The area of operation is in a maximum of three Contiguous districts and the registered
office should be situated within the area of operation.
(vii) The voting rights of an individual shareholder is governed by the ceiling of 10% of the
total voting rights as per aection 12(2) of B.R. Act, 1949.
(viii) Prudential norms and capital adequacy of 10% of risk weighted assets (8% since beginning
in 1996) is to be compiled with.
(ix) Out of local area banks numbering four, bank from Punjab is allowed to become
Capital Small Finance Bank Ltd. and started working from April 2016 hence present
number is three only.
In view of liberalisation of Indian economy, if the fruits are to percolate down to the teeming
millions, inhabiting rural India, it would be necessary to provide them easy and timely access to institutional
 16  Principles and Practices of Banking
finance. The freedom to determine their lending rates is given to LABs, like RRBs by RBI. ]’his may
promote healthy competition in the nonurban areas, resulting in the resources being Put to more
efficient and productive areas. The agricultural sector, in view of its recent turnaround and the
forthcoming Favourable impact of the formation of the World Trade Organisation (WTO), is heading
towards a major boom. LABs are considered complementary to the efforts of the nationalised banks
and RRBs, but at the same time take some pressure off the PSBs in their priority sector credit
commitments and promote capital formation and higher investment in rural and semi urban areas.

1.8 D EVELOPMENT B ANKS

Another important feature of the structure and organization of the Indian banking systems is the
establishment of many financial corporations, which provide finance to the sectors of the economy,
to which commercial and cooperative banks do not provide finance.
Medium and long-term finance is provided by these development banks all India status and by
State level institutions in their respective states (such states are 29 in number now). Such India financial
institutions are –
IDBI, NABARD, Exim Bank, National Housing Bank.
Other investment institutions are Life Insurance Corpn. of India, GIC, Mutual funds, para-
banking institutions such as for hire purchase financing and leasing and factoring are undertakens by
private sector’s non-banking financial companies (NBFCs). State financial corps., also provide finances
in their states. Such SFCs are 18 in number.

1.9 F INANCIAL M ARKETS

Indian financial markets are broadly categorised into the Money Market, Foreign Exchange Market,
Securities Market (Stock exchanges) including equity/bonds and credit markets.
The capital market has evidenced tremendous growth in the last two and half decades in terms
of resource mobilisation, listing of shares, and market capitalization. The market capitalization for
listed companies at the end of 26.5.2017 was ` 1,25,63,952 crores and the BSE-30 index was 31074
points. Activities in the network of 21 stock exchanges listing over seven thousand companies (only in
BSE and NSE stock exchanges in Mumbai) are being regulated by Securities and Exchange Board of
India (SEBI). The short-term money market comprises
 Call money market
 Interbank money market
 Bills rediscounting market
 Treasury bills (91 days to 364 days)
 Inter corporate funds market
Discount and Finance House of India Ltd. (DFHIL) is the leader of the money market of
money overnight for few days to few months.

1.10 F INANCIAL C OMPANIES

There investment and finance companies are housing finance, chit funds, Nidhi companies etc.
which also mobilize and channel savings into investment. They are only partly controlled by RBI under
the Companies Act, 2013. Similarly, moneylenders and indigenous bankers are licensed under the state
laws and regulated by State agencies.
 Indian Financial System  17

1.11 Q UESTIONS
(A) (i) Describe the classification of Indian financial systems and overview of IFS.
(ii) Discuss the evolution of commercial banking.
(iii) Write about the era of nationalisation of bank and after (1969 to 1991) till economic
liberalisation.
(iv) Explain the present banking from the year 2004 to date.

(B) Write short notes in not exceeding 15 lines

(i) State cooperative banks
(ii) Land development banks
(iii) Regional Rural Banks
(iv) Financial Markets
(v) Development Banks

(C) State which of the following statements are true or false ?

(i) The important goal of the financial services is to mobilize and allocate savings.
(ii) Term lending institutions are non-fund based market intermediarier.
(iii) Banking companies earn a major part of their income through fee-based activities.
(iv) A forward contract is a derivative of a spot contract ?
[Answer : (i) True, (ii) False, (iii) False, (iv) True]

(D) Fill in the banks

(i) Finance is the study of …………… its nature, creation behaviour administration.
(ii) The organized sector consist of a network of ……….. other financial and investment
institutions.
(iii) Banking is ………………… from moneylending but the two terms have in past been
taken to convey the same meaning.
(iv) The total number of bank braches increased …………. fold between 1969 and 1991.
(v) District Central Cooperative bank is a ……….. of PACs located in specified area, i.e.,
district.
[Answer : (i) money, (ii) banks, (iii) different, (iv) eight, (v) Federation]
 18  Principles and Practices of Banking

(E) Match the following

(i) RBI reaches to the cultivators (a) in the life of urban people
(ii) Urban Cooperative banks play (b) for development of agriculture,
an important role trade, commerce, industry activities
in rural area
(iii) The RRBs were prmoted (c) rural savings as well as for
provision of credit for viable
economic activities in the local areas
(iv) Local Area Banks were started (d) development banks
for promoting
(v) Medium and long-term finance (e) money market, foreign exchange
is provided by market, securities market
(vi) Indian financial markets are broadly (f) through state cooperative banks
categorized into the

[Answer : (i) (d), (ii) (a), (iii) (b), (iv) (c), (v) (e), (vi) (f)]
