Banking and Insurance

Introduction to Banking

MONEY AND BANKING

“Every branch of knowledge has its fundamental discovery. In mechanics, its wheel, in science fire, in politics the vote. Similarly, in economics, in the whole commercial side of Man’s social existence, money is the essential invention on which all the rest is based”

(Crowther 1963)

2

PHASES IN EVOLUTION OF MONEY• Robinson Crusoe Economy

(Man provided for himself)

• Barter Economy(Exchange of goods for goods)

• Money Economy(Common medium of exchange –MONEY)

3

DIFFICULTIES IN BARTER ECONOMY

• Lack of double co-incidence of wants and possessions

• Lack of common measure of value (Chromer’s quote “How many bushels of corn be exchanged for one tiger”)

• Lack of divisibility of certain goods• Difficulty of settling contracts involving future

payments• Difficulty to store wealth

4

Banking-History

• Origin of the word “Bank”• Meaning of Bank• Global Banking History• History of Banking in Indian Context

5

Need for Banks

• Security to savings• Control supply of money and credit.• Encourage public confidence in the working of

financial system• Avoid focus of power in few hands• To set equal norms and conditions to all types

of customers

6

Evolution of Banking in India• Banking in India originated in the last decades of the 18th Century.• Presidency Banks: Bank of Bengal in 1809, Bank of Bombay in 1840 and

Bank of Madras in 1843• Joint Stock Bank – Allahabad Bank in 1865 & PNB in 1895 (Indian

shareholders)• Swadeshi Movement b/w 1906 – 1911: BOI, Corporation Bank, Indian

Bank, Bank of Baroda, Canara Bank, Central Bank of India• Imperial Bank of India in 1921 (mainly European Shareholders)• Reserve Bank of India in 1935• State Bank of India – 1955• SBI Subsidiary Bank Act in 1959 (8 state Banks)• Nationalisation of 14 banks – 1969• Second Dose of Nationalisation of 6 more banks – 1980

7

Number Of Banks, Capital & deposits

8

Failure of Banks

9

Phases in Evolution of Banking

• Ist Phase (Pre-Independence – 1947)• Early years of Independence (1947-

1967)• 1967-1991• 1991-Present

10

Nationalization of Banks

• An attempt to use scarce resources for the purpose of planned development.

• A large number of small accounts not profitable as a result of which limited lending in the rural sector.

• Need to cater to credit needs of priority sector and reduce lopsided distribution of banks was high on priority

11

Nationalisation of Banks• To better align the banking system to the needs of planning and economic

policy, it was considered necessary to have social control over banks• With the nationalisation of the 20 banks, the major segment of the

banking sector came under the control of the Government.• The nationalisation of banks imparted major impetus to branch expansion

in un-banked rural and semi-urban areas, which in turn resulted in huge deposit mobilization, thereby giving boost to the overall savings rate of the economy

• It also resulted in scaling up of lending to agriculture and its allied sectors • However, this arrangement also saw some weaknesses like reduced bank

profitability, weak capital bases, and banks getting burdened with large non-performing assets

12

Objectives behind the Nationalisation of Banks

• Social Welfare : to direct the funds for the needy and required sectors of the Indian economy

• Controlling Private Monopolies : It was necessary to check these monopolies in order to ensure a smooth supply of credit to socially desirable sections

• Expansion of Banking : to spread banking across the country. Reducing Regional Imbalance : necessary for banks to go in the rural areas where the banking facilities were not available

• Priority Sector Lending : catering funds to the priority sector like agriculture sector

• Developing Banking Habits : necessary to develop savings habit for the larger part of the population living in rural areas.

13

Demerits of Nationalisation• Inadequate banking facilities : in the backward states and

North-Eastern states of India• Limited resources mobilized and allocated : Issues in

resources allocation even though sufficient deposits were mobilised

• Lowered efficiency and profits : Banks were controlled and faced political pressures resulting in lower efficiency and poor profitability of banks and leading to NPAs

• Increased expenditure : Due to huge expansion in a branch network, large staff administrative expenditure, trade union struggle, etc. banks expenditure increased to dangerous levels.

14

Reforms in the Banking Sector• To create a strong and competitive banking system, a number of

reform measures were initiated in early 1990s• Narsimham Committee 1991 & 1998• The thrust of the reforms was on increasing operational efficiency, strengthening supervision over banks, creating competitive conditions and developing technological and institutional infrastructure. • These measures led to the improvement in the financial health,

soundness and efficiency of the banking system• One important feature of the reforms of the 1990s was that the entry

of new private sector banks was permitted. Following this decision, new banks such as ICICI Bank, HDFC Bank, IDBI Bank and UTI Bank were set up

15

Definition of Banks•In India, the definition of the business of banking has been given in the Banking Regulation Act, (BR Act), 1949. •According to Section 5(c) of the BR Act, 'a banking company is a company which transacts the business of banking in India.' •Section 5(b) of the BR Act defines banking as, 'accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable, by cheque, draft, order or otherwise.' •This definition points to the three primary activities of a commercial bank which distinguish it from the other financial institutions. (i) maintaining deposit accounts including current accounts, (ii) issue and pay cheques, and (iii) collect cheques for the bank's customers.

16

Role of Banks in an Economy

17

Role of Banks in an EconomyBanks play a critical role in the economic development of countries. If the Banking System is effective, efficient and disciplined, it brings about a rapid growth in the various sectors of the economy.

In emerging economies, banks are special for three important reasons:1. Development & Supervision of other intermediaries : They take a leading

role in developing other financial intermediaries and markets. 2. Corporate Funding : Along with the presence of well-developed equity

and bond markets, the corporate sector depends heavily on banks to meet its financing needs.

3. Increased number of savers : In emerging markets such as India, banks cater to the needs of a vast number of savers from the household sector, who prefer assured income and liquidity and safety of funds, because of their inadequate capacity to manage financial risks.

18

Role in credit movement

19

Role of Banks in an Economy

• Banks promote Capital Formation• Investment in new enterprises• Promotion of Trade and Industry• Development of Agriculture• Balanced development of different regions• Influencing economic activity• Implementation of Monetary Policy• Monetisation of the economy• Export Promotion Cells

20

Banking Transformation• Forms of banking have changed over the years and evolved with the needs

of the economy, that is , they are now no more confined to local banking.• The transformation of the banking system has been brought about by

deregulation, technological innovation and globalisation.• While banks have been expanding into areas which were traditionally out

of bounds for them, non-bank intermediaries have begun to perform many of the functions of banks. Banks thus compete not only among themselves, but also with nonbank financial intermediaries, and over the years, this competition has only grown in intensity. Globally, this has forced the banks to introduce innovative products, seek newer sources of income and diversify into non-traditional activities.

• The commercial banks are now considered the nerve system of all economic development in a country

21