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Banking and Financial Service Unit 1

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UNIT – I: BANKING SYSTEM
Functions of Bank:
What are the Functions of Banks? Diagram
The functions of banks are briefly hi...
d. Recurring Deposits
This type of account is operated by salaried persons and petty traders. A certain sum of money is
pe...
a. Transfer of Funds
b. Collection of Cheques
c. Periodic Payments
d. Portfolio Management
e. Periodic Collections
f. Othe...
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Banking and Financial Service Unit 1

  1. 1. UNIT – I: BANKING SYSTEM Functions of Bank: What are the Functions of Banks? Diagram The functions of banks are briefly highlighted in following Diagram or Chart. These functions of banks are explained in following paragraphs of this article. A. Primary Functions of Banks The primary functions of a bank are also known as banking functions. They are the main functions of a bank. These primary functions of banks are explained below. 1. Accepting Deposits The bank collects deposits from the public. These deposits can be of different types, such as :- a. Saving Deposits b. Fixed Deposits c. Current Deposits d. Recurring Deposits a. Saving Deposits This type of deposits encourages saving habit among the public. The rate of interest is low. At present it is about 4% p.a. Withdrawals of deposits are allowed subject to certain restrictions. This account is suitable to salary and wage earners. This account can be opened in single name or in joint names. b. Fixed Deposits Lumpsum amount is deposited at onetime foraspecific period. Higherrate ofinterest is paid, which varies with the period of deposit. Withdrawals are not allowed before the expiry of the period. Those who have surplus funds go for fixed deposit. c. Current Deposits This type of account is operated by businessmen. Withdrawals are freely allowed. No interest is paid. In fact, there are service charges. The account holders can get the benefit of overdraft facility.
  2. 2. d. Recurring Deposits This type of account is operated by salaried persons and petty traders. A certain sum of money is periodically deposited into the bank. Withdrawals are permitted only after the expiry of certain period. A higher rate of interest is paid. 2. Granting of Loans and Advances The bank advances loans to the business community and other members of the public. The rate charged is higher than what it pays on deposits. The difference in the interest rates (lending rate and the deposit rate) is its profit. The types of bank loans and advances are :- a. Overdraft b. Cash Credits c. Loans d. Discounting of Bill of Exchange a. Overdraft This type of advances is given to current account holders. No separate account is maintained. All entries are made in the current account. A certain amount is sanctioned as overdraft which can be withdrawn within a certain period of time say three months or so. Interest is charged on actual amount withdrawn. An overdraft facility is granted against a collateral security. It is sanctioned to businessman and firms. b. Cash Credits The client is allowed cash credit upto a specific limit fixed in advance. It can be given to current account holders as well as to others who do not have an account with bank. Separate cash credit account is maintained. Interest is chargedon the amountwithdrawn in excessof limit. The cash credit is given against the security of tangible assets and / or guarantees. The advance is given for a longer period and a larger amount of loan is sanctioned than that of overdraft. c. Loans It is normally for short term say a period of one year or medium term say a period of five years. Now-a- days, banks do lend money for long term. Repayment of money can be in the form of installments spread over a period of time or in a lumpsum amount. Interest is charged on the actual amount sanctioned, whether withdrawn or not. The rate of interest may be slightly lower than what is charged on overdrafts and cash credits. Loans are normally secured against tangible assets of the company. d. Discounting of bill of exchange The bank can advance money by discounting or by purchasing bills of exchange both domestic and foreign bills. The bank pays the bill amount to the drawer or the beneficiary of the bill by deducting usual discount charges. On maturity, the bill is presented to the drawee or acceptor of the bill and the amount is collected. B. Secondary Functions of Banks ↓ The bank performs a number of secondary functions, also called as non-banking functions. These important secondary functions of banks are explained below. 1. Agency Functions The bank acts asan agentofits customers.The bank performsanumberofagency functions which includes :-
  3. 3. a. Transfer of Funds b. Collection of Cheques c. Periodic Payments d. Portfolio Management e. Periodic Collections f. Other Agency Functions a. Transfer of Funds The bank transfer funds from one branch to another or from one place to another. b. Collection of Cheques The bankcollects themoney ofthe chequesthroughclearingsectionofits customers.The bank also collects money of the bills of exchange. c. Periodic Payments On standing instructions of the client, the bank makes periodic payments in respect of electricity bills, rent, etc. d. Portfolio Management The banks also undertakes to purchase and sell the shares and debentures on behalf of the clients and accordingly debits or credits the account. This facility is called portfolio management. e. Periodic Collections The bank collects salary, pension, dividend and such other periodic collections on behalf of the client. f. Other Agency Functions They act as trustees, executors, advisers and administrators on behalf of its clients. They act as representatives of clients to deal with other banks and institutions. 2. General Utility Functions The bank also performs general utility functions, such as :- a. Issue of Drafts, Letter of Credits, etc. b. Locker Facility c. Underwriting of Shares d. Dealing in Foreign Exchange e. Project Reports f. Social Welfare Programmes g. Other Utility Functions a. Issue of Drafts and Letter of Credits Banks issuedraftsfortransferringmoneyfromoneplace to another.It also issuesletter ofcredit, especially in case of, import trade. It also issues travelers’ cheques. b. Locker Facility The bank provides a locker facility for the safe custody of valuable documents, gold ornaments and other valuables.
  4. 4. c. Underwriting of Shares The bank underwrites shares and debentures through its merchant banking division. d. Dealing in Foreign Exchange The commercial banks are allowed by RBI to deal in foreign exchange. e. Project Reports The bank may also undertake to prepare project reports on behalf of its clients. f. Social Welfare Programmes It undertakes social welfare programmes, such as adult literacy programmes, public welfare campaigns, etc. g. Other Utility Functions It acts as a referee to financial standing of customers. It collects creditworthiness information about clients of its customers. It provides market information to its customers, etc. It provides travellers' cheque facility Commercial Banks and their service areas: Defining Commercial Bank A commercial bank is a financial institution that is authorized by law to receive money from businesses and individuals and lend money to them. Commercial banks are open to the public and serve individuals, institutions, and businesses. A commercial bank is almost certainly the type of bank you think of when you think about a bank because it is the type of bank that most people regularly use. Banks are regulated by federal and state laws depending on how they are organized and the services they provide. Commercial banks are also monitored through the Federal Reserve System. Functions A commercial bank is authorized to serve the following functions:  Receive deposits - take money in from individuals and businesses (called depositors)  Disburse payments - make payments upon the direction of its depositors, such as honoring a check  Collections - a bank will act as your agent to collect funds from another bank payable to you, such as when someone pays you by check drawn on an account from a different bank  Invest funds in securities for a return  Safeguard money - banks are considered a safe place to store your wealth  Maintain and service savings and checking accounts of its depositors  Maintain custodial accounts - accounts controlled by one person but for the benefit of another person, such as a trust account Setting up of off-shore Banking units: Offshore Banking Unit An offshore banking unit (OBU) is a financial service unit (normally a branch or subsidiary of a non- resident bank), which plays an intermediary role between non-resident borrowers and lenders. Generally an offshore banking unit is located in an international financial center or in the case of India. found in Special Economic Zones. Offshore banking units are allowed to accept deposits from foreign banks, from some onshore banks that permit deposits and other offshore banking units, and the OBU may make loans to non-resident companies as well.
  5. 5. The advantage of an offshore banking unit versus that of an onshore bank is that the offshore banking unit is free of regulations and restrictions normally imposed on domestic financial establishments as it pertains to foreignexchangeandsometimetax concessionsandreliefpackages. The activities ofan offshorebanking unit are not subject to the local restrictions as there might be on foreign exchange or other banking activities or regulations. Under law, offshore banking units (OBUs) are not authorized to take domestic deposits or conduct activity with local establishments or clients. All trade activity of the offshore banking unit must be offshore. For purpose of this document the offshore banking unit herein will sometime be referred to as the OBU. In most jurisdictions where offshore banking units are established, the OBU has a specific function, has a defined range of financial functions and banking activities that can be undertaken by the OBUS. In cased such as India and Australia foreign exchange activities conducted by the OBUs are free of regulations that normally apply to onshore financial entities, and receive tax concessions. These are simply economic strategies usedto attract foreigncompanyinvestment, andengagein a lucrative foreignexchangebusiness. Some offshore banking units may be branches of either resident or nonresident banks. In such cases, the ownership of the establishments is directly under control of the parent company and the accounts of the OBU are transposed onto accounts books of the parent company. On the other hand, the OBU can be and independent establishment or a franchise, where the name of the parent company is used, but the management and accounts of the offshore banking unit are independent from that of the parent company. However, in most cases offshore banking units are branches of locally owned and established banks which set up the offshore banking unit to capitalize on international business and foreign exchange benefits afforded the offshore banking unit. These companies cannot take local deposits and assets of the offshore banking unit are held separately from parent company. The advantages of offshore banking units for some is that the existence of the offshore banking unit establishment enables the company to conduct financial transactions with no currency restrictions; enables the company to make loans and payments in multi currencies; and enables the company to offer flexible international financial trade options that would not otherwise be possible with the domestic bank. The first application of an offshore banking unit was established in the euro market and soon Singapore, Hong Kong India and other countries followed. In Australia, their tax policies are not very favorable for offshore banking business, but the country in 1990, established legislation for the provision of offshore banking unit, offering relaxed tax provisions. This move ensured the country was able to compete as an international financial center. The additional benefits of offshore banking units may include tax exemptions on withholding tax and other tax relief packages on specific activities, such as offshore borrowing. Legislation for offshore banking units are specific and defines the types of activities that can be conducted by the offshore banking units, generally: and permanent establishment in the jurisdiction Some of the offshore banking unit activities and offshore banking services are: borrowing, lending, trading activities, investment activity, hedging activity. Most entities who are eligible to be offshore banking unit are banks, subsidiaries of such banks, other financial intuitions that are permitted to foreign exchange activity, life insurance companies, and fund managers. In the United States, the International Banking Facility (IBF) is an in-house shell branch that makes loans to foreign customers. Its function is to that of on offshore banking unit. IBF deposits are limited to non-U.S. Residents, other IBFs, and banks owning an IBF, are free from reserve requirements, federal deposit insurance assessments, and exempt from some state income taxes. Offshore banking units have a similar function to offshore banks, but the legal form or structure of th e entity is different and has a few more legislative restrictions. Offshore banking units are found in specific zones, such are tax havens, trade-free or free trade zones. Central Banking -Role of RBI:
  6. 6. Reserve Bank of India RBI Governor at headquarters in Mumbai Establishment: The Reserve Bank of India was established in 1935 under the provisions of the Reserve Bank of India Act, 1934 in Calcutta, eventually moved permanently to Mumbai. Though originally privately owned, was nationalized in 1949. Organisation and Management: The Reserve Bank”s affairs are governed by a central board of directors. The board is appointed by the Government of India for a period of four years.  Full-time officials : Governor and not more than four Deputy Governors. The Governor of RBI is RaghuramRajan. There are 4 Deputy Governors, H R Khan, DrUrjit Patel, R Gandhiand SS Mundra.  Nominated by Government: ten Directors from various fields and two government Officials  Others: four Directors – one each from four local boards Main Role and Functions of RBI  Monetary Authority: Formulates, implements and monitors the monetary policy for A) maintaining price stability, keeping inflation in check ; B) ensuring adequate flow of credit to productive sectors.  Regulator and supervisor of the financial system: lays out parameters of banking operations within which the country”s banking and financial system functions for- A) maintaining public confidence in the system, B) protecting depositors’ interest ; C) providing cost-effective banking services to the general public.  Regulator and supervisor of the payment systems: A) Authorisessetting upof payment systems; B) Lays down standards for working of the payment system; C)lays down policies for encouraging the movement from paper-based payment systems to electronic modes of payments. D) Setting up ofthe regulatoryframework ofnewer payment methods. E) Enhancement of customerconvenience in payment systems. F) Improving security and efficiency in modes of payment.  Manager of Foreign Exchange: RBI manages forex under the FEMA- Foreign Exchange Management Act, 1999. in order to A) facilitate external trade and payment B) promote development of foreign exchange market in India.  Issuer of currency: RBI issues and exchanges currency as well as destroys currency & coins not fit for circulation to ensure that the public has adequate quantity of supplies of currency notes and in good quality.  Developmental role : RBI performs a wide range of promotional functions to support national objectives. Under this it setup institutions like NABARD, IDBI, SIDBI, NHB, etc.  Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker.  Banker to banks: An important role and function of RBI is to maintain the banking accounts of all scheduled banks and acts as banker of last resort.  Agent of Government of India in the IMF. Monetary Policy of RBI: Monetary Policy of India: Main Elements and Objectives! Monetary Policy of India is formulated and executed by Reserve Bank of India to achieve specific objectives. It refers to that policy by which central bank of the country controls(i) the supply of money, and (ii) cost of money or the rate of interest, with a view to achieve particular objectives. In the words of D.C. Rowan, “The monetary policy is defined as discretionary act undertaken by the authorities designed to influence (a) the supply of money, (b) cost of money or rate of interest, and (c) the availability of money for achieving specific objective.” Thus, monetary policy of India refers to that policy which is concerned with the measures taken to regulate the volume of credit created by the banks. The main objectives of monetary policy are to achieve price stability, financial stability and adequate availability of credit for growth.
  7. 7. Following are the main elements of the monetary policy of India: i. It regulates the stocks and the growth rate of money supply. ii. It regulates the entire banking system of the economy. iii. It determines the allocation of loans among different sectors. iv. It provides incentives to promote savings and to raise the savings-income ratio. v. It ensures adequate availability of credit for growth and tries to achieve price stability. Objectives of Monetary Policy: According to RBI Governor Dr. D. Subba Rao, “The objectives of monetary policy in India are price stability and growth. These are pursued through ensuring credit availability with stability in the external value of rupee and overall financial stability.” Following are the main objectives of monetary policy: i. To Regulate Money Supply in the Economy: Money supply includes both money in circulation and credit creation by banks. Monetary policy is farmed to regulate the money supply in the economy by credit expansion or credit contraction. By credit expansion (giving more loans), the money supply can be expanded. By credit contraction (giving less loans) money supply can be decreased. The main aim of the monetary policy of the Reserve Bank was to control the money supply in such a manner as to expand it to meet the needs of economic growth and at the same time contract it to curb inflation. In other words monetary policy aimed at expanding and contracting money supply according to the needs of the economy. ii. To Attain Price Stability: Another major objective of monetary policy in India is to maintain price stability in the country. It implies Control over inflation. Price level, is affected by money supply. Monetary policy regulates money supply to maintain price stability. iii. To promote Economic Growth: An important objective of monetary policy is to make available necessary supply of money and credit for the economic growth of the country. Those sectors which are quite significant for the economic growth are provided with adequate availability of credit. iv. To Promote saving and Investment: By regulating the rate of interest and checking inflation, monetary policy promotes saving and investment. Higher rates of interest promote saving and investment. v. To Control Business Cycles: Boom and depression are the main phases of business cycle. Monetary policy puts a check on boom and depression. In period of boom, credit is contracted, so as to reduce money supply and thus check inflation. In period of depression, credit is expanded, so as to increase money supply and thus promote aggregate demand in the economy. vi. To Promote Exports and Substitute Imports: By providing concessional loans to export oriented and import substitution units, monetary policy encourages such industries and thus help to improve the position of balance of payments. vii. To Manage Aggregate Demand: Monetary authority tries to keep the aggregate demand in balance with aggregate supply of goods and services. If aggregate demand is to be increased than credit is expanded and the interest rate is lowered down. Because of
  8. 8. low interest rate, more people take loan to buy goods and services and hence aggregate demand increases and vice-verse. viii. To Ensure more Credit for Priority Sector: Monetary policy aims at providing more funds to priority sector by lowering interest rates for these sectors. Priority sector includes agriculture, small- scale industry, weaker sections of society, etc. ix. To Promote Employment: By providing concessional loans to productive sectors, small and medium entrepreneurs, special loan schemes for unemployed youth, monetary policy promotes employment. x. To Develop Infrastructure: Monetary policy aims at developing infrastructure. It provides concessional funds for developing infrastructure. xi. To Regulate and Expand Banking: RBI regulates the banking system of the economy. RBI has expanded banking to all parts of the country. Through monetary policy, RBI issues directives to different banks for setting up rural branches for promoting agricultural credit. Besides it, government has also set up cooperative banks and regional rural banks. All this has expanded banking in all parts of the country. Monetary Policy Techniques Broadly, instruments or techniques of monetary policy can be divided into two categories: (A) Quantitative or General Methods. (B) Qualitative or Selective Methods. A. Quantitative or General Methods: 1. Bank Rate or Discount Rate: Bank rate refers to that rate at which a central bank is ready tolend money to commercial banks or to discount bills of specified types. Thus by changing the bank rate, the credit and further money supply can be affected. In other words, rise in bank rate increases rate of interest and fall in bank rate lowers rate of interest. During the course of inflation, monetary authority raises the bank rate to curb inflation. Higher bank rate will check the expansion of credit of commercial banks. They will be left with less resources which would restrict the credit creating capacity of the bank. On the contrary, during depression, bank rate is lowered, business community will prefer to have more and more loans to pull the economy out of depression. Therefore, bank rate or discount rate can be used in both types of situation i.e. inflation and depression. 2. Open Market Operations By open market operations, we mean the sale or purchase of securities. As is known that the credit creating capacity of the commercial banks depend on the cash reserves of the banks. In this way, the
  9. 9. monetary authority (Central Bank) controls the credit by affecting the base of the credit-creation by the commercial banks. If the credit is to be decreased in the country, the central bank begins to sell securities in the open market. This will result to reduce money supply with the public as they will withdraw their money with the commercial banks to purchase the securities. The cash reserves will tend to diminish. This happens in the period of inflation. During depression when prices are falling, the central bank purchases securities resulting in expansion of credit and aggregate demand, 3. Variable Reserve Ratio: The commercial banks have tokeep given percentage as cash-reserve with the central bank. In lieu of that cash ratio, it allows commercial banks to contract or expand its credit facility. If the central bank wants to contract credit (during inflation period) it raises the cash reserve ratio. As a result, commercial banks are left with less amount of deposits. Their favour to credit is curtailed. If there is depression in the economy, the reserve ratiois reduced to raise the credit creating capacity of commercial banks. Therefore, variable reserve ratiocan be used to affect commercial banks to raise or reduce their credit creation capacity 4. Change of Liquidity: According to this method, every bank is required to keep a certain proportion of its deposits as cash with it. When the central bank wants to contract credit, it raises its liquidity ratio and vice versa. B. Qualitative or Selective Methods: 1. Change in Marginal Requirements: Under this method, the central bank effects a change in the marginal requirement to control and release funds. When the central bank feels that prices are rising on account of stock-piling of some commodities by the traders, then the central bank controls credit by raising the marginal requirements. (Marginal requirement is the difference between the market value of the assets and its maximum loan value). Let us suppose, a borrower pledged goods worth Rs. 1000 as security with a bank and gets a loan amounting to Rs. 800. Thus marginal requirement is Rs. 200 or 20 percent. If this margin is raised, the borrower will have to pledge goods of greater value to secure loan of a given amount. This would reduce money supply and inflation would be curtailed. Similarly, in case of depression, central bank reduces margin requirement. This will in turn raise the credit creating capacity of the commercial banks. Therefore, margin requirement is a significant tool in the hands of central authority during inflation and depression. 2. Regulation of consumer credit: During inflation, this method is followed to control excess spending of the consumers. Generally the hire purchase facilities or installment methods are used to reduce to the minimum to curb the
  10. 10. expenditure on consumption. On the contrary, during depression period, more credit facilities are allowed so that consumer may spend more and more to pull the economy out of depression. 3. Direct Action: This method is adopted when some commercial banks do not co-operate with the central bank in controlling the credit. Thus, central bank takes direct action against the defaulter. The central bank may take direct action in a number of ways as under. (i) It may refuse rediscount facilities to those banks who are not following its directions. (ii) It may follow similar policy with the bank seeking accommodation in excess of its capital and reserves. (iii) It may change rates over and above the bank rate. (iv) Any other strict restrictions on the defaulter institution. 4. Rationing of the credit: Under this method, the central bank fixes a limit for the credit facilities to commercial banks. Being the lender of the last resort, central bank rations the available credit among the applicants. Generally, rationing of credit is done by the following four ways. (i) Central bank can refuse loan to any bank. (ii) Central bank can reduce the amount of loans given to the banks. (iii) Central bank can fix quota of the credit. (iv) Central bank can determine the limit of the credit granted to a particular industry or trade. 5. Moral Persuasion or Advice: In the recent years, the central bank has used moral suasion also as a tool of credit control. Moral suasion is a general term describing a variety of informal methods used by the central bank to persuade commercial banks to behave in a particular manner. Moral suasion takes the form of Directive and Publicity. In-fact, moral persuasion is a sort of advice. There is no element of compulsion in it. The central bank focuses on the dangerous consequences of the credit expansion and seeks their co-operation. The effectiveness of this method depends on the prestige enjoyed by the central bank on the degree of co- operation extended by the commercial banks. 6. Publicity: Publicity is also another qualitative technique. It means to force them to follow only that credit policy which is in the interest of the economy. The publicity generally takes the form of periodicals and journals. The banks are not kept informed about the type of monetary policy, the central bank regards goods for the economy. Therefore, the main aim of this method is to bring the banking community under the pressure of public opinion. Liquidity management- Liquidity concepts:
  11. 11. Retail Banking: Retail banking is a major form of commercial banking but mainly targeted to consumers rather than corporate clients. It is the method of banks' approach to the customers for sale of their products. The products are consumer-oriented like offering a car loan, home loan facility, financial assistance for purchase of consumer durables, etc. Retail banking therefore has large customer-base and hence, large number of transactions with small values. It may therefore be cost ineffective in a highly competitive environment. Most of the Rural and semi-urban branches of banks, in fact, do retail banking. In the present day situation when lending to corporate clients lead to credit risk and market risk, retail banking may eliminate market risk. It is one of the reasons why many a wholesale bankers like foreign banks also prefer to go for consumer financing albeit for marginally higher net worth individual. The main three important functions of retail banking is 1. Give Credit 2. Accept deposit 3. Money management 1) Give Credit Banks offer credit to their clients for purchasing it also includes mortgages and loans. By doing this banks will increaseliquidity in theeconomy.this will leadto increaseemployment andcreate more opportunities. 2) Accept Deposit Banks are a secure place for those who want to deposit their savings. Banks will give a higher rate of interest to savings accounts, certificates of deposits, and other financial products. 3) Money Management The retail bankwill helpto managemoneythroughaccountsandcards.It will helpto do transactionsonline at any place. Types of Retail Banks 1) Community development bank A community bank is a commercial bank which provides financial services to low to moderate-income people. 2) Private Banks Private Banks are who provides financial services to the high net worth clients with high levels of income or assets. Private Banks will provide personal basis services. 3) Postal Saving Banks Postal saving banks provide services to those who don't have access to banks. Postal saving banks are safe and convenient to save money. Postal saving banks are specially designed for the poor section of society. Types of Products
  12. 12. 1) Current Account A current account is also known as transaction account, checking account or a demand deposit account. A current account held at a bank or any other financial institution. A current account is available to the account holder at any time on demand and number of times directly. A current account can be accessed many times for money withdrawals, electronic transactions etc. 2) Saving Account A saving accountis a deposit accountwhich held at a retail bank which pays ahigh rate ofinterest. In saving account an account holder cannot do transactions frequently. 3) Debit Card A debit card is also known as the bank card or check card. It is a plastic card which is used instead of cash while making a purchase. One can only make payment if there is any surplus amount in the account. 4) Credit Card A credit cardis a payment cardwhich is issued to the account holderswho payfortheir goodsand services. In credit, if there is no balance in the account then also an account holder can transact and pay money to the merchant. In credit card, an account holder will get a line of credit from the bank. 5) ATM Card An ATM card is a card issued by the bank which enables a customer to access ATM to transact deposits, cash withdrawals, and obtaining account information. 6) Loans A loanis thelending ofmoneyfromone organization,entity oran individual to anotherorganization, entity or an individual. There are many types of loans like a secured loan, unsecured loan, demand loan, subsidized loan and concessional loan. 7) Certificate of Deposits A certificate of deposits is a term deposit issued by the banks. CDs have a fixed term and a fixed rate of interest. At the end of maturity period, money will get along with interest earned. Advantages of Retail Banking: Advantages of Retail Banking are given below 1. Retail deposits are stable and constitute core deposits. 2. They are interest insensitive and less bargaining for additional interest. 3. They constitute low cost funds for the banks. 4. Effective customer relationship management with the retail customers built a strong base. 5. Retail banking increases the subsidiary business of the banks. 6. Retail banking results in better yield and improved bottom line for a bank. 7. Retail segment is a good avenue for funds development. 8. Consumer loans are presumed to be of lower risk and NPA perception. 9.Retail banking helps economic revival of the nation through increased production activity. 10. Retail banking improves lifestyle and fulfils aspirations of the people through affordable credit. 11. Innovative product development credit. 12. Retail banking involves minimum marketing efforts in a demand-driven economy. Disadvantages of Retail Banking: Disadvantages of Retail Banking are given below:
  13. 13. 1. Designing own and new financial products is very costly and time consuming for the bank. 2. Customers now-a-days prefer net banking to branch banking. The banks that are slow in introducing technology-based products, are finding it difficult to retain the customers who wish to opt for net banking. 3. Customers are attracted towards other financial products like mutual funds etc. 4. Though banks are investing heavily in technology, they are not able to exploit the same to the full extent. 5. A major disadvantage is monitoring and follow up of huge volume of loan accounts inducing banks to spend heavily in human resource department 6. Long term loans like housing loan due to its long repayment term in the absence of proper follow-up, can become NPAs. Co-operative banking: Types & Function of Co-operative Banks in India The co-operative banks are small-sized units which operate both in urban and non-urban centers. They finance small borrowers in industrial and trade sectors besides professional and salary classes. Regulated by the Reserve Bank of India, they are governed by the Banking Regulations Act 1949 and banking laws (co-operative societies) act, 1965. The co-operative banking structure in India is divided into following 5 categories: Primary Co-operative Credit Society The primary co-operative credit society is an association of borrowers and non-borrowers residing in a particular locality. The funds of the society are derived from the share capital and deposits of members and loans from central co-operative banks. The borrowing powers of the members as well as of the society are fixed. The loans are given to members for the purchase of cattle, fodder, fertilizers, pesticides, etc. Central Co-operative Banks These are the federations of primary credit societies in a district and are of two types-those having a membership of primary societies only and those having a membership of societies as well as individuals. The funds of the bank consist of share capital, deposits, loans and overdrafts from state co-operative banks and joint stocks. These banks provide finance to member societies within the limits of the borrowing capacity of societies. They also conduct all the business of a joint stock bank. State Co-operative Banks The state co-operative bank is a federation of central co-operative bank and acts as a watchdog of the co-operative banking structure in the state. Its funds are obtained from share capital, deposits, loans and overdrafts from the Reserve Bank of India. The state co-operative banks lend money to central co-operative banks and primary societies and not directly to the farmers. Land Development Banks The Land development banks are organized in 3 tiers namely; state, central, and primary level and they meet the long term credit requirements of the farmers for developmental purposes. The state land development banks oversee, the primary land development banks situated in the districts and tehsil areas in the state. They are governed both by the state government and Reserve Bank of India. Recently, the supervision of land development banks has been assumed by National Bank for Agriculture and Rural development (NABARD). The sources of funds for these banks are the debentures subscribed by both central and state government. These banks do not accept deposits from the general public.
  14. 14. Urban Co-operative Banks The term Urban Co-operative Banks (UCBs), though not formally defined, refers to primary co-operative banks located in urban and semi-urban areas. These banks, till 1996, were allowed to lend money only for non- agricultural purposes. This distinction does not hold today. These banks were traditionally centered on communities, localities, work place groups. They essentially lend to small borrowers and businesses. Today, their scope of operations has widened considerably. The origins of the urban co-operative banking movement in India can be traced to the close of nineteenth century. Inspired by the success of the experiments related to the co-operative movement in Britain and the co-operative credit movement in Germany, such societies were set up in India. Co-operative societies are based on the principles of cooperation, mutual help, democratic decision making, and open membership. Co-operatives represented a new and alternative approach to organization as against proprietary firms, partnership firms, and joint stock companies which represent the dominant form of commercial organization. They mainly rely upon deposits from members and non-members and in case of need, they get finance from either the district central co- operative bank to which they are affiliated or from the apex co-operative bank if they work in big cities where the apex bank has its Head Office. They provide credit to small scale industrialists, salaried employees, and other urban and semi-urban residents. Functions of Co-operative Banks Co-operative banks also perform the basic banking functions of banking but they differ from commercial banks in the following respects 1. Commercial banks are joint-stock companies under the companies’ act of 1956, or public sector bank under a separate act of a parliament whereas co-operative banks were established under the co-operative society’s acts of different states. 2. Commercial bank structure is branch banking structure whereas co-operative banks have a three tier setup, with state co-operative bank at apex level, central / district co-operative bank at district level, and primary co-operative societies at rural level. 3. Only some of the sections of banking regulation act of 1949 (fully applicable to commercial banks), are applicable to co-operative banks, resulting only in partial control by RBI of co-operative banks and 4. Co-operative banks function on the principle of cooperation and not entirely on commercial parameters. Problems of Co-operative Banks Duality of control system of co-operative banks However, concerns regarding the professionalism of urban co-operative banks gave rise to the view that they should be better regulated. Large co-operative banks with paid-up share capital and reserves of Rs.1 lakh were brought under the purview of the Banking Regulation Act 1949 with effect from 1st March, 1966 and within the ambit of the Reserve Bank’s supervision. This marked the beginning of an era of duality of control over these banks. Banking related functions (viz. licensing, area of operations, interest rates etc.) were to be governed by RBI and registration, management, audit and liquidation, etc. governed by State Governments as per the provisions of respective State Acts. In 1968, UCB’s were extended the benefits of deposit insurance. Towards the late 1960s there was debate regarding the promotion of the small scale industries. UCB’s came to be seen as important players in this context. The working group on industrial financing through Co-operative Banks, (1968 known as Damry Group) attempted to broaden the scope of activities of urban co-operative banks by recommending these banks should finance the small and cottage industries. This was reiterated by the Banking Commission in 1969.
  15. 15. The Madhavdas Committee (1979) evaluated the role played by urban co-operative banks in greater details and drew a roadmap for their future role recommending support from RBI and Government in the establishment of such banks in backward areas and prescribing viability standards. The Hate Working Group (1981) desired better utilization of bank’s surplus funds and that the percentage of the Cash Reserve Ratio (CRR) & the Statutory Liquidity Ratio (SLR) of these banks should be brought at par with commercial banks, in a phased manner. While the Marathe Committee (1992) redefined the viability norms and ushered in the era of liberalization, the Madhava Rao Committee (1999) focused on consolidation, control of sickness, better professional standards in urban co-operative banks and sought to align the urban banking movement with commercial banks. A feature of the urban banking movement has been its heterogeneous character and its uneven geographical spread with most banks concentrated in the states of Gujarat, Karnataka, Maharashtra, and Tamil Nadu. While most banks are unit banks without any branch network, some of the large banks have established their presence in many states when at their behest multi-state banking was allowed in 1985. Some of these banks are also Authorized Dealers in Foreign Exchange. Advantages of cooperative societies 1. Voluntary organization The membership of a cooperative society is open to all. Any person with common interest can become a member. The membership fee is kept low so that everyone would be able to join and benefit from cooperative societies. At the same time, any member who wants to leave the society is free to do so. There are no entry or exit barriers. 2. Ease of formation Cooperatives can be formed much easily when compared to a company. Any 10 members who have attained majority can join together for forming a cooperative society by observing simple legal formalities. 3. Democracy A co-operative society is run on the principle of ‘one man one vote‘. It implies that all members have equal rights in managing the affairs of the enterprise. Members with money power cannot dominate the management by buying majority shares. 4. Equitable distribution of surplus The surplus generated by the cooperative societies is distributed in an equitable manner among members. Therefore all the members of the cooperative society are benefited. Further the society is also benefited because a sum not exceeding 10 per cent of the surplus can be utilized for promoting the welfare of the locality in which the cooperative is located. 5. Limited liability The liability of the members in a cooperative society is limited to the extent of their capital contribution. They cannot be personally held liable for the debts of the society. 6. Stable existence A cooperative society enjoys separate legal entity which is distinct from its members. Therefore its continuance is in no way affected by the death, insanity or insolvency of its members. It enjoys perpetual existence. 7. Each for all and all for each Co-operative societies are formed on the basis of self help and mutual help. Therefore memberscontribute their efforts to promote their common welfare.
  16. 16. 8. Greater identity of interests It operates in a limited geographical area and there is greater identity of interest among members. Memberswould beinteracting with eachother. They cancooperateandmanage the activities ofthe society in a more effective manner. 9. Government support The government with a view to promote the growth of cooperative societies extends all support to them. It provides loans at cheap interest rates, provides subsidies etc. 10. Elimination of middlemen Cooperatives societies can deal directly with the producers and with the ultimate consumers. Therefore they are not dependent on middlemen and can save the profits enjoyed by the middlemen. 11. Low taxes To promote the co-operative movement and also because of the fact that it is a non-profit enterprise, government provides various exemptions and tax concessions. 12. Rural credit Co-operative societies have contributed significantly in freeing villagers from money lenders. Earlier, moneylendersusedto chargehighratesofinterest and theearningsofthe villagers werespent onpayment on interest alone. Co-operatives provide loans at cheaper interest rates and have benefited the rural community. After the establishment of co-operatives, the rural people were able to come out of the grip of money lenders. 13. Role in agricultural progress Co-operative societies have aided the government’s efforts to increase agricultural production. They have improved the life of the people in rural areas. They serve as a link between the government and agriculturists. High yielding seeds, fertilizers, etc. are distributed by the government through the cooperatives. 14. Own sources of finance A cooperative society has to transfer at-least one-fourth of its profits to general reserve. Therefore it need not depend on outsider’s funds to meet its future financial requirements. It can utilize the funds available in the general reserve. 15. Encourages thrift Cooperative societies encourage the habit of savings and thrift among their members. They provide loans only for productive purposes and not for wasteful expenditure. 16. Fair price and good quality Co-operative societies buy and sell in bulk quantities directly from the producers or to the consumers. Products are processed and graded before they are sold. Bulk purchases and sales ensure fair prices and good quality. 17. Social benefit Co-operative societies have played an important role in changing social customs and curbing unnecessary expenditure. The profits earned by the co-operatives have been used for providing basic amenities to the society. Disadvantages of cooperative societies
  17. 17. 1. Limited funds Co-operative societies have limited membership and are promoted by the weaker sections. The membership fees collected is low. Therefore the funds available with the co-operatives are limited. The principle of one-man one-vote and limited dividends also reduce the enthusiasm of members. They cannot expand their activities beyond a particular level because of the limited financial resources. 2. Over reliance on government funds Co-operative societies are not able to raise their own resources. Their sources of financing are limited and they depend on government funds. The funding and the amount of funds that would be released by the government are uncertain. Therefore co-operatives are not able to plan their activities in the right manner. 3. Imposed by government In the Western countries, co-operative societies were voluntarily started by the weaker sections. The objective is to improve their economic status and protect themselves from exploitation by businessmen. But in India, the co-operative movement was initiated and established by the government. Wide participation of people is lacking. Therefore the benefit of the co-operatives has still not reached many poorer sections. 4. Benefit to rural rich Co-operatives have benefited the rural rich and not the rural poor. The rich people elect themselves to the managing committee and manage the affairs of the co-operatives for their own benefit. The agricultural produce of the small farmers is just sufficient to fulfill the needs of their family. They do not have any surplus to market. The rich farmers with vast tracts of land, produce in surplus quantities and the servicesofco-operativessuchas processing,grading,correctweighment andfairprices actually benefit them. 5. Inadequate rural credit Co-operative societies give loans only for productive purposes and not for personal or family expenses. Therefore the rural poor continue to depend on the money lenders for meeting expenses of marriage, medical care, social commitments etc. Co-operatives have not been successful in freeing the rural poor from the clutches of the money lenders. 6. Lack of managerial skills Co-operative societies are managed by the managing committee elected by its members. The members of the managing committee may not have the required qualification, skill or experience. Since it has limited financial resources, its ability to compensate its employees is also limited. Therefore it cannot employ the best talent. Lack of managerial skills results in inefficient management, poor functioning and difficulty in achieving objectives. 7. Government regulation Co-operative societies are subject to excessive government regulation which affects their autonomy and flexibility. Adhering to various regulations takes up much of the management’s time and effort. 8. Misuse of funds If the members of the managing committee are corrupt they can swindle the funds of the co -operative society. Many cooperative societies have faced financial troubles and closed down because of corruption and misuse of funds.
  18. 18. 9. Inefficiencies leading to losses Co-operative societies operate with limited financial resources. Therefore they cannot recruit the best talent, acquire latest technology or adopt modern management practices. They operate in the traditional mold which may not be suitable in the modern business environment and therefore suffer losses. 10. Lack of secrecy Maintenance of business secrets is the key for the competitiveness of any business organization. But business secrets cannot be maintained in cooperatives because all members are aware of the activities of the enterprise. Further, reports and accounts have to be submitted to the Registrar of Co -operative Societies. Therefore information relating to activities, revenues, members etc becomes public knowledge. 11. Conflicts among members Cooperative societies are based on the principles of co-operation and therefore harmony amongmembers is important. But in practice, there might be internal politics, differences of opinions, quarrels etc. among members which may lead to disputes. Such disputes affect the functioning of the co-operative societies. 12. Limited scope Co-operative societies cannot be introduced in all industries. Their scope is limited to only certain areas of enterprise. Since the funds available are limited they cannot undertake large scale operations and is not suitable in industries requiring large investments. 13. Lack of accountability Since the management is taken care of by the managing committee, no individual can be made accountable forin efficient performance.Thereisa tendency to shift responsibility among themembersof themanaging committee. 14. Lack of motivation Memberslack motivation to put in their wholeheartedeffortsforthe successofthe enterprise.It is because there is very little link between effort and reward. Co-operative societies distribute their surplus equitably to all members and not based on the efforts of members. Further there are legal restrictions regarding dividend and bonus that can be distributed to members. 15. Low public confidence Public confidence in the co-operative societies is low. The reason is, in many of the co-operatives there is political interference and domination. The members of the ruling party dictate terms and therefore the purpose for which cooperatives are formed is lost. Reforms in the Banking sector: BANKING SECTOR REFORMS :- Since nationalization of banks in 1969, the banking sector had been dominated by the public sector. There was financial repression, role of technology was limited, no risk management etc. This resulted in low profitability and poor asset quality. The country was caught in deep economic crises. The Government decided to introduce comprehensive economic reforms. Banking sector reforms were part of this package. In august 1991, the Government appointed a committee on financial system under the chairmanship of M. Narasimhan. FIRST PHASE OF BANKING SECTOR REFORMS / NARASIMHAN COMMITTEE REPORT – 1991:- To promote healthy development of financial sector, the Narasimhan committee made recommendations. I) RECOMMENDATIONS OF NARASIMHAN COMMITTEE :- 1. Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks (including SBI) at top and at bottom rural banks engaged in agricultural activities.
  19. 19. 2. The supervisory functions over banks and financial institutions can be assigned to a quasi-autonomous body sponsored by RBI. 3. Phased reduction in statutory liquidity ratio. 4. Phased achievement of 8% capital adequacy ratio. 5. Abolition of branch licensing policy. 6. Proper classification of assets and full disclosure of accounts of banks and financial institutions. 7. Deregulation of Interest rates. 8. Delegation of direct lending activity of IDBI to a separate corporate body. 9. Competition among financial institutions on participating approach. 10. Setting up asset Reconstruction fund to take over a portion of loan portfolio of banks whose recovery has become difficult. II) Banking Reform Measures Of Government :- On the recommendations of Narasimhan Committee, following measures were undertaken by government since 1991 :- 1. Lowering SLR And CRR The high SLR and CRR reduced the profits of the banks. The SLR has been reduced from 38.5% in 1991 to 25% in 1997. This has left more funds with banks for allocation to agriculture, industry, trade etc. The Cash Reserve Ratio (CRR) is the cash ratio of a banks total deposits to be maintained with RBI. The CRR has been brought down from 15% in 1991 to 4.1% in June 2003. The purpose is to release the funds locked up with RBI. 2. Prudential Norms :- Prudential norms have been started by RBI in order to impart professionalism in commercial banks. The purpose of prudential norms include proper disclosure of income, classification of assets and provision for Bad debts so as to ensure hat the books of commercial banks reflect the accurate and correct picture of financial position. Prudential norms required banks to make 100% provision for all Non-performing Assets (NPAs). Funding for this purpose was placed at Rs. 10,000 crores phased over 2 years. 3. Capital Adequacy Norms (CAN) :- Capital Adequacy ratio is the ratio of minimum capital to risk asset ratio. In April 1992 RBI fixed CAN at 8%. By March 1996, all public sector banks had attained the ratio of 8%. It was also attained by foreign banks. 4. Deregulation Of Interest Rates :- The Narasimhan Committee advocated that interest rates should be allowed to be determined by market forces. Since 1992, interest rates has become much simpler and freer. a) Scheduled Commercial banks have now the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates. b) Interest rate on domestic term deposits has been decontrolled. c) The prime lending rate of SBI and other banks on general advances of over Rs. 2 lakhs has been reduced. d) Rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled. e) The interest rates on deposits and advances of all Co-operative banks have been deregulated subject to a minimum lending rate of 13%. 5. RecoveryOf Debts :- The Government of India passed the “Recovery of debts due to Banks and Financial Institutions Act 1993” in order to facilitate and speed up the recovery of debts due to banks and financial institutions. Six Special Recovery Tribunals have been set up. An Appellate Tribunal has also been set up in Mumbai. 6. Competition From New Private Sector Banks :- Now banking is open to private sector. New private sector banks have already started functioning. These new private sector banks are allowed to raise capital contribution from foreign institutional investors up to 20% and from NRIs up to 40%. This has led to increased competition. 7. Phasing Out Of Directed Credit :- The committee suggested phasing out of the directed credit programme. It suggested that credit target for priority sector should be reduced to 10% from 40%. It would not be easy for government as farmers, small industrialists and transporters have powerful lobbies. 8. Access To Capital Market :- The Banking Companies (Acquisation and Transfer of Undertakings) Act was amended to enable the banks to raise capital through public issues. This is subject to provision that the holding of Central Government would not fall below 51% of paid-up-capital. SBI has already raised substantial amount of funds through equity and bonds. 9. FreedomOf Operation :-
  20. 20. Scheduled Commercial Banks are given freedom to open new branches and upgrade extension counters, after attaining capital adequacy ratio and prudental accounting norms. The banks are also permitted to close non-viable branches other than in rural areas. 10. Local Area banks (LABs) :- In 1996, RBI issued guidelines for setting up of Local Area Banks and it gave Its approval for setting up of 7 LABs in private sector. LABs will help in mobilizing rural savings and in channeling them in to investment in local areas. 11. Supervision Of Commercial Banks :- The RBI has set up a Board of financial Supervision with an advisory Council to strengthen the supervision of banks and financial institutions. In 1993, RBI established a new department known as Department of Supervision as an independent unit for supervision of commercial banks. SECOND PHASE OF REFORMS OF BANKING SECTOR (1998) / NARASIMHAN COMMITTEE REPORT 1988 :- To make banking sector stronger the government appointed Committee on banking sector Reforms under the Chairmanship of M. Narasimhan. It submitted its report in April 1998. The Committee placed greater importance on structural measures and improvement in standards of disclosure and levels of transparency. Following are the recommendations of Narasimhan Committee :- 1) Committee suggested a strong banking system especially in the context of capital Account Convertibility (CAC). The committee cautioned the merger of strong banks with weak ones as this may have negative effect on stronger banks. 2) It suggested that 2 or 3 large banks should be given international orientation and global character. 3) There should be 8 to10 national banks and large number of local banks. 4) It suggested new and higher norms for capital adequacy. 5) To take over the bad debts of banks committee suggested setting up of Asset Reconstruction Fund. 6) A board for Financial Regulation and supervision (BFRS) can be set up to supervise the activities of banks and financial institutions. 7) There is urgent need to review and amend the provisions of RBI Act, Banking Regulation Act, etc. to bring them in line with current needs of industry. 8) Net Non-performing Assets for all banks was to be brought down to 3% by 2002. 9) Rationalization of bank branches and staff was emphasized. Licensing policy for new private banks can be continued. 10) Foreign banks may be allowed to set up subsidiaries and joint ventures. On the recommendations of committee following reforms have been taken:- 1) New Areas :- New areas for bank financing have been opened up, such as :- Insurance, credit cards, asset management, leasing, gold banking, investment banking etc. 2) New Instruments:- For greater flexibility and better risk management new instruments have been introduced such as :- Interest rate swaps, cross currency forward contracts, forward rate agreements, liquidity adjustment facility for meeting day-to-day liquidity mismatch. 3) Risk Management:- Banks have started specialized committees to measureand monitor various risks. They are regularly upgrading their skills and systems. 4) Strengthening Technology:- For payment and settlement system technology infrastructure has been strengthened with electronic funds transfer, centralized fund management system, etc. 5) Increase Inflow Of Credit :- Measures are taken to increase the flow of credit to priority sector through focus on Micro Credit and Self Help Groups. 6) Increase in FDI Limit :- In private banks the limit for FDI has been increased from 49% to 74%. 7) Universal banking :- Universal banking refers to combination of commercial banking and investment banking. For evolution of universal banking guidelines have been given. 8) Adoption Of Global Standards :- RBI has introduced Risk Based Supervision of banks. Best international practices in accounting systems, corporate governance, payment and settlement systems etc. are being adopted. 9) Information Technology :-
  21. 21. Banks have introduced online banking, E-banking, internet banking, telephone banking etc. Measures have been taken facilitate delivery of banking services through electronic channels. 10) Management Of NPAs:- RBI and central government have taken measures for management of non-performing assets (NPAs), such as corporate Debt Restructuring (CDR), Debt Recovery Tribunals (DRTs) and Lok Adalts. 11) Mergers And Amalgamation :- In May 2005, RBI has issued guidelines for merger and Amalgamation of private sector banks. 12) Guidelines For Anti-Money Laundering :- In recent times, prevention of money laundering has been given importance in international financial relationships. In 2004, RBI revised the guidelines on know your customer (KYC) principles. 13) Managerial Autonomy :- In February. 2005, the Government of India has issued a managerial autonomy package for public sector banks to provide them a level playing field with private sector banks in India. 14) Customer Service:- In recent years, to improve customer service, RBI has taken many steps such as :- Credit Card Facilities, banking ombudsman, settlement off claims of deceased depositors etc. 15) Base Rate System Of Interest Rates:- In 2003 the system of Benchmark Prime Lending Rate (BPLR) was introduced to serve as a benchmark rate for banks pricing of their loan products so as to ensure that it truly reflected the actual cost. However the BPLR system tell short of its objective. RBi introduced the system of Base Rate since 1st July, 2010. The base rate is the minimum rate for all loans. For banking system as a whole, the base rates were in the range of 5.50% - 9.00% as on 13th October, 2010. CONCLUSION:- To satisfy the growing demands from customers for high quality service, commercial banks will have to find out new ways and method to face new challenges. Stress testing: Stress testing is the process of determining the ability of a computer, network, program or device to maintain a certain level of effectiveness under unfavorable conditions. The process can involve quantitative tests donein a lab, such asmeasuring the frequencyoferrorsorsystemcrashes. The termalso refers to qualitative evaluation of factors such as availability or resistance to denial-of-service (DOS) attacks. Stress testing is often done in conjunction with the more general process of performance testing. When conducting a stress test, an adverse environment is deliberately created and maintained. Actions involved may include:  Running several resource-intensive applications in a single computer at the same time  Attempting to hack into a computer and use it as a zombie to spread spam  Flooding a server with useless e-mail messages  Making numerous, concurrent attempts to access a single Web site  Attempting to infect a system with viruses, Trojans, spyware or other malware. The adverse condition is progressively and methodically worsened, until the performance level falls below a certain minimum orthe system fails altogether. In orderto obtain the most meaningful results, individual stressors are varied one by one, leaving the others constant. This makes it possible to pinpoint specific weaknesses and vulnerabilities. For example, a computer may have adequate memory but inadequate security. Such a system, while able to run numerous applications simultaneously without trouble, may crash easily when attacked by a hacker intent on shutting it down. Stress testing can be time-consuming and tedious. Nevertheless, some test personnel enjoy watching a system break down under increasingly intense attacks or stress factors. Stress testing can provide a means to measure gracefuldegradation,the ability ofa system to maintain limited functionality evenwhen a large part of it has been compromised. Once the testing process has caused a failure, the final component of stress testing is determining how well or how fast a system can recover after an adverse event.

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