comparative study of commercial banks

8/8/2019 Comparative Study of Commercial Banks

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COMPARATIVE STUDY OF COMMERCIAL BANKS

AND CO-OPERATIVE BANKS

Introduction

The robust macroeconomic environment continued to underpin the financial performance of Indian banks during 2004-05,

with major bank groups successfully weathering the impact of an upturn in interest cycle. The demand for credit was

broad-based during 2004-05 with agriculture and industry joining the housing and retail sectors to drive up the demand forcredit. A sharp increase in net interest income mitigated to a large extent the impact of a sharp decline in non-interest

income mainly on account of decline in trading profits. Banks continued to earn sizeable profits albeit somewhat lower than

last year. Asset quality of scheduled commercial banks improved further during 2004-05. Capital base of banks kept pace

with the sharp increase in risk-weighted assets.

ORIGIN AND EVOLUTION OF INDIAN BANKING

Opinions differ as to the origin of the work "Banking". The word "Bank" is said to be of Germanic origin, cognate with the

French word "Banque" and the Italian word "Banca", both meaning "bench". It is surmised that the word would have drawn

its meaning from the practice of the Jewish money-changers of Lombardy, a district in North Italy, who in the middle ages

used to do their business sitting on a bench in the market place. Again, the etymological origin of the word gains further

relevance from the derivation of the word "Bankrupt" from the French word "Banque route" and the Italian word "Banca-

rotta" meaning "Broken bench" due probably to the then prevalent practice of breaking the bench of the money-changer,

when he failed.

Banking is different from money-lending but 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.

It follows from the above that the rates of interest allowed on deposits and charged on advances must be known andreasonable. The money-lender advances money out of his own private wealth, hardly accepts deposits and usually charges

high rates of interest. More often, the rates of interest relate to the needs of the borrower. Money-lending was practised in

all countries including India, much earlier than the recent type of Banking came on scene.

DEFINATION AS PER BANKING REGULATION ACT 1949

A Bank borrow by accepting deposits of money from the public, the deposits are to be repaid on demand or after fixed

period. They can be withdrawn by the depositors by means of cheque, draft, order or any other way. A Bank accepts

deposits (i.e. borrows) for the purposes of lending mainly to traders, industrialists and manufacturers and the like as also,

for the purposes of investing in government securities to fulfill statutory obligations. Thus, Banking Regulations Act, 1949

defines Banking as accepting for the purposes of lending or investment of deposits of money from the public repayable on

demand or otherwise and withdrawable by cheque, draft , order or otherwise.

By and large, this definition can be satisfactory. As per the provision of the Banking Regulation Act, every company willing

to do banking business must obtain license from the Reserve Bank for carrying on banking business in India. Besides, all

companies carrying on banking business must use the word bank, banker or banking as per of their names. It may be

noted that money-lenders are not bankers.

Basic Concepts of Banking

Banking is different from money lending, but the two terms, usually carry the same significance to the general public. The

money lender, advances money out of his own private wealth, hardly accepts deposits from general public and usually

charges high rate of interest. More often, the rates of interest relate to the needs of the borrower and at times the rates

may be exorbitant. On the other hand the banking is defined in section 5(b) of the Banking Regulation Act, 1949, as the

acceptance of deposits of money from the public for the purpose of lending or investment. Such deposits of money from

the public are used for the purpose of lending or investment. Such deposits may be repayable on demand or otherwise and

with drawable by cheque, draft order or otherwise. Thus a bank must perform two basic and essential functions:

(i) acceptance of deposits and

(ii) lending or investment of such deposits.

The deposits may be repayable on demand or a for a period of time as agreed by the banker and the Customer. In terms

of the definition, the banker can accept deposits of money and Not Anything Further accepting deposits form frolic

unapplied that a banker accepts deposits form anyone who offers money for such purpose Accepting of deposits for lending

and investments have been the original functions of banking but gradually there functions were extended and others were

added from time to time and presently banks perform a number of economic activities which may affect all walks ofeconomic life.

Significance of Banks

The importance of a bank to modern economy, so as to enable them to develop, can be stated as follow:

(i) The banks collect the savings of those people who can save and allocate them to those who need it. These savings

would have remained idle due to ignorance of the people and due to the fact that they were in scattered and oddly small

quantities. But banks collect them and divide them in the portions as required by the different investors.


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(ii) Banks preserve the financial resources of the country and it is expected of them that they allocate them appropriately

in the suitable and desirable manner.

(iii) They make available the means for sending funds from one place to another and do this in cheap, safe and convenient

manner.

(iv) Banks arrange for payments by changes, order or bearer, crossed and uncrossed, which is the easiest and most

convenient, Besides they also care for making such payments as safe as possible.

(v) Banks also help their customers, in the task of preserving their precious possessions intact and safe.

(vi) To advance money, the basis of modern industry and economy and essential for financing the developmental process,

is governed by banks.

(vii) It makes the monetary system elastic. Such elasticity is greatly desired in the present economy, where the phase of

economy goes on changing and with such changes, demand for money is required. It is quite proper and convenient for

the government and R.B.I. to change its currency and credit policy frequently, This is done by RBI, by changing the supply

of money with the changing the supply of money with the changing needs of the public.

Although traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their

wings far and wide into many allied and even unrelated activities.

Banking as an Ancestral Service

For the history of modern banking in India, a reference to the English Agency Houses in the days of East India Company is

necessary. Those agency houses, with no capital of their own and depending entirely on deposits, were in fact trading

firms carrying on banking as a part of their business and vanished form the scene in the crises of 1829-32. In the first half

of the 19th century, the East India company established 3 banks The Bank of Bengal in 1809, the Bank of Bombay in 1840

and the Bank of Madras in 1843.

The Bank of Bengal was given Charter with a capital of Rs.50 Lakhs. This bank was given powers in different years as to:

(i) Rate of interest was limited to 12%.

(iii) Power to issue currency notes was given in 1824.

(iii) Power to open new branches given in 1839.

(iv) Power to deal in inland exchange was given in 1839.

These 3 banks were also known as Presidency Banks. The currency notes issued by presidency banks were not popular,

those were replaced by Government Paper Money in 1862. In 1860, the principle of limited liability was introduced in India

in Joint Stock banks, to avoid mushroom growth of banks, which failed mostly due to speculation, mismanagement and

fraud. During the .crises in between 1862-75, numerous banks failed, including

Bank of Bombay. The Bank of Bombay was later restarted in the same year; with the same name. Due to failure of banks,

during 1862-75 only only one bank was established in 1865 i.e. the Allahabad Bank Ltd. Indian banks were restarted

functioning in the year 1894, when the Indian mints were closed to the free coinage of silver. The only important bank

registered after the closure of the mints was the Punjab National Bank Ltd. with its head office at Lahore in 1895.

In the Swadeshi movement, number of banks were opened by Indians during 1906-13. Those new banks were:

Peoples Bank of India Ltd. Bank of India Ltd.

Central Bank of India Ltd.

Indian Bank Ltd.

Bank of Baroda Ltd.

This boom of opening new banks was overturned by the most severe crises of 1913-17. Therefore the period of

amalgamation started. All the three presidency banks were amalgamated on 27th. Jan. 1921 and the Imperial Bank of

India was established This bank was allowed to hold Government balances and to manage the public debt and clearing

houses till the establishment of the RBI in 1935. With the passing of the State Bank of India Act, 1955, the undertaking of

Imperial bank of India, was taken over by the newly constituted SBI. It had the largest number branches, which gave it


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the privilege of conversion into Government business institution of the country

Pursuant to the provisions of the State Bank of India (Subsidiary Bank) Act, 1959,

The following banks were constituted as subsidiary of SBI :

State Bank of Bikaner & Jaipur

State Bank of Indore State Bank of Travancore

State Bank of Hydrabad

State Bank of Patiala

State Bank of Saurashtra

State Bank of Mysore

In 1960, the Palai Central Bank in Kerala failed and that gave suspicion to the depositors. As such Deposit Insurance of

Credit Guarantee Corporation (DIGGC) was established to guarantee repayment of deposits up to Rs. 10,000 to each

depositor in case of failure of banks. On 19th July, 1969, 14 Joint Stock banks were nationalized which were having

minimum depositors of Rs.50 crores and above. This brought into its fold 50% of banks' operations Again in April, 1980, 6

more banks were brought under area of nationalised banks, to total business of 95% in its fold. These 6 banks were giving

tough competition to nationalized bankers and were indulged into irregularities causing concern to depositors.

Business Position of scheduled banks as on 29/4/05

Deposits Rs. 17,81,580 Crore

Credits Rs. 11,27,433 Crore

Bank Rate 6% (even in Oct 2005)

Prime Lending Rate (PLR) in between 10.5% -11.50%

CRR 4.50%

SLR 25%

Presently, as a part of deregulation many new generation private sector banks have been permitted viz. ICICI 1 (IDBI)

HDFC and the nationalized banks are being privatized to the extent of 49%.

INTRODUCTION OF COMMERCIAL BANK

Commercial banks are the oldest, biggest, and fastest growing intermediaries in India. they are also the most important

depositories of public saving and the most important disburses of finance. commercial banking in India is a unique

systems, the like of which exist nowhere in the world. the truth of this statement becomes clear as one studies the

philosophy and approaches that have contributed to the evolution of the banking policy, programmes and operation in

India.

The banking systems in India works under the constraints that go with social control and public ownership. the public

ownership of banks has been achieved in three stages:1955,July1969, and April 1980. Not only the private sector and

foreign banks are required to meet targets in respect of sectoral development of credit, regional distribution of branches,

and regional credit- deposits ratios. the operations of banks have been determined by Lead Bank Scheme, Differential Rate

of Interest Scheme, Credit Authorisation Scheme, inventory norms and lending systems prescribed by the authorities, the

formulation of the credit plans, and Service Area Approach.

Balancing Profitability with Liquidity Management

Commercial banks ordinarily are simple business or commercial concerns which provide various types of financial services

to 'customers in return for payments in one form or another, such as interest, discounts, fees, commission, and so on.

Their objective is to make profits. However; what distinguishes them from other business concerns (financial as well as

manufacturing) is the degree to which they have to balance the principle of profit maximization with certain other

principles.

In India especially, banks are required to mod their performance in profit-making if that clashes with their obligations in

such areas as 'social welfare, social justice, and promotion of regional balance in development. In any case, compared to


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other business concerns, banks in general have to pay much more attention to balancing profitability with liquidity/It is

true that all business concerns face liquidity constraint in various areas of their decision-making and, therefore, they have

to devote considerable attention to liquidity management. But with banks, the need for maintenance of liquidity is much

greater because of the nature of their liabilities. Banks deal in other people's money, a substantial part of which is

repayable on demand.- That is why for banks, unlike other business concerns, liquidity management is as important as

profitability management

This is reflected in the management and control of reserves of commercial banks.

MANAGEMENT OF RESERVES

The banks are expected to hold voluntarily a part of their deposits in the form of ready cash which is known as cash

reserves; and the ratio of cash reserves to deposits is known as the (cash) reserve ratio. As banks are likely to be tempted

not to hold adequate amounts of reserves if they are left to guide themselves on this point, and since the temptation may

have extremely destabilising effect on the economy in general, the Central Bank in every country is empowered to

prescribe the reserve ratio that all banks must maintain. The Central Bank also undertakes, as the lender of last resort, to

supply reserves to banks in times of genuine difficulties. It should be clear that the function of the legal reserve

requirements is two-fold:

(a) to make deposits safe and liquid, and

(b) to enable the Central Bank to control the amount of checking deposits or

bank money which the banks can create.

Since the banks are required to maintain a fraction of their deposit liabilities as reserves, the modern banking system isalso known as the fractional reserve banking.

CREATION OF CREDIT

Another distinguishing feature of banks is that while they can create as well as transfer money (funds), other financial

institutions can only transfer funds. In other words, unlike other financial institutions, banks are not merely financial

intermediaries. This aspect of bank operations has been variously expressed. Banks are said to create deposits or credit or

money, or it can be said that every loan given by banks creates a deposit. This has given rise to the important concept of

deposit multiplier or credit multiplier or money multiplier.

The import of this is that banks add to the money supply in the economy, and since money supply is an important

determinant of prices, nominal national income, and other macro-economic variables, banks become responsible in a

major way for changes in economic activity. Further, as indicated in Chapter One, since banks can create credit, they can

encourage investment for some time without prior increase in saving.

BASIS AND PROCESS OF CREDIT CREATION

Creation of money by banks. In modern economies, almost all exchanges are effected by money. Money is said to be a

medium of exchange, a store of value, a unit of account. There is much controversy as to what, in practice in a given year,

is the measure of supply of money in any economy. We do not need to go into that controversy here. Suffice it to say that

everyone agrees that currency and demand deposits with banks are definitely to be included in any measure of money

supply. Thus, apart from the currency issued by the government and the Central Bank, the demand or current or

checkable deposits with banks are accepted by the public as money. Therefore, since the loan operations of banks lead to

the creation of checkable deposits, they add to the supply of money in the economy. To recapitulate, the money-creating

power of banks stems from the fact that modern banking is a fractional reserve banking, and that certain liabilities of

banks are accepted (used) by the public as money.

Credit Ratio

Non-food credit grew at a high rate during 2004-05.Normally, the rate of credit is higher than the rate of growth of

deposits due to the base effect- the outstanding deposits is much higher than the outstanding credit. For instance, while

the outstanding deposits at end-March 2005 were Rs,18,19,900 crore, the outstanding credit was Rs, 11,04,913 crore.

Also, in any given year, the accretion to credit has generally remained lower than the accretion to deposits. During 2004-

05, however, incremental credit and deposits were more or less of the same magnitude, while incremental investments in

relation to deposits during the year were much lower than in the previous year. This resulted in some unusual behaviour of

the credit-deposit (C-D) ratio and investment-deposit (I-D) ratio Among bank-groups, the new private sector banks had

the highest C-D ratio, followed by foreign banks, old private sector and public sector banks

Bank Credit


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Volume of Credit Commercial banks are a major source of finance to industry and commerce. Outstanding bank credit has

gone on increasing from Rs 727 crore in 1951 to Rs 19,124 crore in 1978, to Rs 69,713 crore in 1986, Rs 1,01,453 crore in

1989-90, Rs 2,82,702 crore in 1997, and to Rs 6,09,053 crore in 2002. Banks have introduced many innovative schemes

for the disbursement of credit. Among such schemes are village adoption, agricultural development branches and equity

fund for small units. Recently, most of the banks have introduced attractive educational loan schemes for pursuing studies

at home or abroad. They have moved in the direction of bridging certain defects or gaps in their policies, such as giving too

much credit to large scale industrial units and commerce, and giving too little credit to agriculture, small industries, and soon.

Types of Credit Banks in India provide mainly short-term credit for financing working capital needs although, as will be

seen subsequently, their term loans have increased over the years. The various types of advances provided by them are:

(a) loans, (b) cash credit, (c) overdrafts (0D), (d) demand loans, (e) purchase and discounting of commercial bills, and (h)

installment or hire-purchase credit.

Cash Credit and Overdraft

Cash credits and overdrafts are said to be running accounts, from which the borrower can withdraw funds as and when

needed up to the credit limit sanctioned by his banker. Usually, while cash credit is given against the security of

commodity stocks, overdrafts are allowed on personal or joint current accounts. Interest is charged on the outstanding

amount borrowed and not on the credit limit sanctioned. In order to curb the misuse of this facility, banks used to levy a

commitment charge on unutilised portion of the credit limit sanctioned. However, this practice has now been discontinued.Although these advances are mostly secured and of a self-liquidating character, banks are known to provide them on

'clean basis' in certain cases. Technically, these advances are repayable on demand, and are of a short-term nature.

Actually, the widespread prevalent practice is to roll over these advances from time to time.

As a result, cash credits actually become long-term advances in many cases. Although, technically these advances are

highly liquid, it has been pointed out that it is a myth to regard them so because even the most profitable borrower would

hardly be in a position to repay them on demand.

Purchasing and Discounting of Bills

Purchasing and discounting of bills-internal and foreign-is another method of advancing credit by banks. It is adopted

mainly to finance trade transactions and movement of goods. Bill finance is either repayable on demand or after a period

not exceeding 90 days. It has been observed that bills traded in India are often fake bills created out of book debts of

industrial and business units. Bill financing has certain favourable features. Banks can raise funds in the secondary markets

by rediscounting bills with the RBI and financial institutions like IDBI and Discount and Finance House of India (DFHI).

They can also earn some money if the rediscount rate is lower than the discount rate. Further, the buying and selling of

bills expand the banks' business more quickly by the faster recycling of funds.

Among these different systems of bank credit, cash credit/overdraft system remains the most important one. The shift

away from it has been slow. Of the total bank credits, the outstanding cash credit and overdrafts accounted for about 66

per cent in 1935, 69 per cent in 1949, 57 per cent in 1973, 52 per cent in 1976, 45 per cent in 1986 and 48 per cent in

1994, and 36 per cent in 2002.

MONETARY AND CREDIT POLICY

The policy Statements of the Reserve Bank provide a frame work for the monetary, structural and prudential measures

that are initiated from time to time consistent with the overall objectives of growth, price stability and financial stability.


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SPECIAL ROLE OF BANKS

As said earlier, commercial banks have a special role in India. In fact, many financial experts even abroad have, of late,

been emphasising the special place that banks hold in their countries also. The "privileged role" of the banks is the result

of their unique features. For example, the liabilities of banks are money, and, therefore, they are an important part of the

payments mechanism of any country; they also have access to the discount window of the RBI, call money market (asboth borrowers and lenders), and the deposit insurance. It would be difficult to eliminate such distinctive features of banks

in the near future. There is also an important question as to whether they should be wiped out, and, if it is done, whether

it would not have adverse consequences on the financial system.

For a financial system to mobilise and allocate savings of the country successfully and productively, and to facilitate day-

to-day transactions, there must be a class of financial institutions that the public views as safe and convenient outlets for

its savings. In virtually all countries, the single dominant class of institutions that has emerged to play this crucial role as

both the repository of a large fraction of the society's liquid savings and the entity through which payments are made is

the commercial banks. The structure and working of the banking system are integral to a country's financial stability and

economic growth.


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Bank lending is specially important for companies. The theory of financial contracting under asymmetric information holds

that information-intensive and information-problematic firms submit to the tight and detailed loan covenants so as to

reduce agency costs. They delegate the tasks of monitoring and renegotiating debt contracts to financial intermediaries

because these tasks are costly and the intermediaries are in a better position to reduce the costs. Intermediaries are more

efficient in monitoring debt contracts because they are unlikely to free-ride on information-production by others as they

have a larger stake, and they can renegotiate contracts more cheaply than the dispersed debenture holders. The public

bond covenants tend to set their conditions on events that are relatively easy to verify, viz., a major change in capitalstructure or a downgrading of credit rating. In contrast, the intermediary loan contracts are conditioned by performance

measures such as working capital and net worth which are less easily controlled by the managers.

Further, the violation of a financial covenant often triggers financial distress. When this happens, banks can restructure the

terms of contracts, viz., wave covenants, extend maturity, extend more loans, and require more collateral. Such a

flexibility reduces the cost of financial distress. Information asymmetries and free-riding by bond-holders, on the other

hand, may force the financially distressed firms into inefficient spending cutbacks, and even bankruptcy. It has been found

in the US that the firms' stock prices rise after an announcement that they have received bank loans, while they fall in

response to announcement of a public bond offering.

Similarly, there are reasons why loans from even other financial institutions may not be a perfect substitute for bank loans.

The economies of scope between deposit taking and lending give banks an information advantage over finance companies

and other financial institutions. The deposit history of firms may inform banks about the credit risk involved in lending to

these firms. Information on deposits activity may also make it easier for banks to monitor working capital covenants. The

phenomenon of "compensating balances" can mostly exist only in the case of banks, and not other institutions. The lending

and deposit-taking activities of banks are complementary, and, go to build up banking relationship which increases theavailability of funds to the firms, which, in turn, enables them to partially avoid taking more expensive trade credit.

Personal relationships are far less important in borrowing from other financial institutions than from banks. Moreover,

significant differences in collateral requirements exist between banks and other financial institutions. All such differences

effectively segment the market for business lending, and make bank loans highly unsubstitutable.

The Indian banking system has a very wide reach and deep presence in metropolises, cities, semi-urban areas, and the

remotest corners of the rural areas with its vast number of branches. It is one of the largest banking systems in the world.

It has been rightly claimed in certain circles that the diversification and development of the Indian economy are in no small

measure due to the active role banks have played in financing economic activities of different sectors They have been

playing an important role in developing mutual funds, merchant banks, Primary Dealers, asset management companies,

and debt markets. They operate as issuers, investors, underwriters, guarantors in financial-markets. By their participation,

banks influence the growth and liquidity of debt markets.

They would help in securitisation of debt market. They hold about 60 per cent of debt stock of government securities, and

they account for more than 50 per cent of the issuance of bonds through public issues and private placements.

Because of such considerations, the important position which banks have historically come to occupy in India should not be

unwittingly destroyed or undermine in the name of promoting equity culture. Otherwise, monetary authorities would find it

more and more difficult to achieve the goal of stability of the financial system and of the prices. The banking reforms,

therefore, must aim not only at profitable banking but also at a viable, sound, safe, and social banking.


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GROWTH OF COMMERCIAL BANKS IN INDIA

INDIAN BANKING SYSTEM

RESERVE BANK OF INDIA

AGGREGATE DEPOSITS OF SCHEDULED COMMERCIAL BANKS


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Aggregate deposits of SCBs increased at a lower rate during 2004-05 as compared with the previous year during 2004-05

on account of slowdown in demand deposits and savings deposits. Decline in demand deposits was due mainly to the base

effect as demand deposits had witnessed an unusually high growth last year. Reversing the trend of the previous year,

bank credit registered a robust growth during the year. Although banks investment in government securities during the

year 2004-05 slowed down significantly, the banking sector at end March 2005 held about 38.4% of its net demand and

time liabilities in SLR securities, much in excess of the statutory minimum requirement of 25%. The non SLR investments

of SCBs continued to decline during 2004-05, reflecting the portfolio adjustments by banks subsequent to guidelines onnon-SLR securities issued by the Reserve Bank in November and December 2003

PRUDENTIAL REGULATION

A key element of the ongoing financial sector reforms has been the strengthening of the prudential framework by

developing sound risk management systems and encouraging transparency and accountability. With a paradigm shift from

micro-regulations to macro-management, prudential norms have assumed an added significance. The focus of prudential

regulation in recent years has been on ownership and governance of Banks Basel II.

OWNERSHIP AND GOVERNANCE OF BANKS

Banks are special for several reasons. They accept and deploy large amount of collateralized public funds and leverage

such funds through credit creation. Banks also administer the payment mechanism. Accordingly, ownership and

governance of banks assume special significance. Legal prescription relating to ownership and governance laid down in the

Banking Regulation Act, 1949 have, therefore, been supplemented by regulatory prescriptions issued by the Reserve Bankfrom time to time.

The existing legal framework and significant current practices cover the following aspects:

i) composition of Boards of Directors:

ii) guidelines for acknowledgement of transfer/allotment of shares in private sector banks issued as on February 3, 2004:

iii) guidelines and corporate governance

iv) foreign Investment in the banking sector, which is governed by he Press Note of March 5, 2004 issued by the Ministry

of Commerce and Industry, Government of India.

The Reserve Bank in consultation with government of India, laid down a comprehensive policy frame work on February 28,

2005.

The broad principles underlying the framework ensure that

i) ultimate ownership and control is well diversified

ii) important shareholders are fit and proper

iii) directors and CEO are fit and proper and observe sound corporate governance principles.

iv) Private sector banks maintain minimum capital (initially Rs 200 crore, with a commitment to increase to Rs 300 crore

within three years )/net worth (Rs. 300 crore at all times) for optimal operations and for systematic stability:

v) Policy and process are transparent and fair.

IMPLEMENTATION OF THE NEW CAPITAL ADEQUACY FRAMEWORK (BASEL II NORMS)

Given the financial innovations and growing complexity of financial transactions, the Basel Committee on Banking

Supervision released the New Capital Adequacy Framework on June 26, 2004 which is based on three pillars of minimum

capital requirements, supervisory review and market discipline. The revised framework has been designed to provide

options to banks and banking systems, for determining the capital requirements for credit risk, market risk and operational

risk and enables banks/supervisors to select approaches that are most appropriate for their operations and financial

markets. The revised framework is expected to promote adoption of stronger risk management practices in banks. Under

Basel II, banks capital requirements will be more closely aligned with the underlying risks in banksbalance sheets. One of

the important features of the revised framework is the emphasis on operational risk.


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Appellate Tribunals (DRATs); and

(d) Legal and institutional provisions.

Progress in Implementation of Risk Based Supervision

Several initiatives have been taken for a gradual roll out of the risk based supervision (RBS) process since the

announcement made in the Monetary and Credit Policy of April 2000. There were two rounds of pilot run of RBS covering

23 banks in public sector, private sector (old and new) and foreign banks categories during 2003-2005. Evaluation of thefindings of first pilot run revealed that the bank level preparedness for RBS/Risk Based Internal Audit (RBIA) process was

very slow. There were certain overlaps under both the business and control risks. Several steps were, therefore, taken to

streamline the RBS process.

First, pending amendment to risk profile templates, changes were made in the structure of inspection report to capture

and report business risk and control risk in one place.

Second, a work book together with a sample of on-site inspection report was designed to help the inspecting officers to

undertake the RBS.

Third, natural resource group with officers from different departments of the Reserve Bank and the Executive Director

Chairperson is in existence to analyse risk models employed by banks in India.

Fourth internal group was formed to revisit the Profile Templates (RPTs).The revised RPTs, methodology for risk

assessment and also guidelines for arriving at the supervisory rating of the bank were discussed in Conference of Regional

Offices of the Reserve Bank held on July 22 and 23, 2005.

Monitoring of Frauds

With a view to reducing the incidence of frauds, the Reserve Bank advised banks in October 2002 to look into the existing

mechanism for vigilance management in their institutions and remove the loopholes, if any, with regard to fixing of staff

accountability and completion of staff side action in all fraud cases within the prescribed time limit, which would act as a

deterrent. Banks were also urged to bring to the notice of the Special Committee of the Board constituted to monitor large

value frauds and the actions initiated in this regard.

A Technical Paper on Bank Frauds covering various aspects such as nature of frauds, present arrangement for follow-up of

frauds, international legal framework relating to frauds, possible further measures with regard to legal and organisational

perspectives was prepared and placed in the BFS meeting held on April 8, 2004.

The Technical Paper recommended the constitution of a separate Cell to monitor frauds not only in commercial banks but

also in financial institutions, Local Area Banks, urban co-operative banks and non-banking finance companies. As the

proposal was accepted by the BFS, a separate Fraud Monitoring Cell (FrMC) was constituted on June I, 2004 under the

overall administrative control of the Department of Banking Supervision. The FrMC is expected to adopt an integrated

approach and pay focused attention on the frauds reported by financial entities mentioned above.

A Master Circular dated October 18, 2002 on "Frauds - Classification and Reporting" was revised on August 7, 2004 and

was placed on Reserve Bank's website. The formats in the Master Circular have been revised according to requirements of

Fraud Reporting and Monitoring System (FRMS) package.

With a view to having integrated approach and ensure uniformity in reporting requirements for all the institutions under

the ambit of Fraud Monitoring Cell, the Master Circular was made applicable to FIs local area banks (LABs) as well.

Modification in Format of Declaration Indebtedness from Statutory Auditors

Statutory auditors of banks were required to provide a declaration to banks in which are undertaking audit to the effect

that no Credit facility (including guaranteeing any facilities availed of by third party) was availed of by the proprietor/any

of the partners of the audit firm/ members of his/their families or by the firm/ company in which he/they are partners/ orDirector/s from any other bank/financial institution.

Banks were also advised that while appointing their statutory central/branch auditors, they should obtain a declaration

from concerned audit firms duly signed by their main partner/proprietor to the effect that credit facilities, if any, availed of

from other banks/FIs by them/their partners/members of family/company in which they are partners/ Directors or the

credit facilities from such institutions guaranteed by them on behalf of third parties had not turned non-performing in

terms of the prudential norms of the Reserve Bank.

The format of declaration of indebtedness to be obtained from the partners/proprietors of audit firms to be appointed as

statutory auditors of banks was modified in January 2005 to include that neither the proprietor/main partner nor of the


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partners/members of their families or the firm/company in which they are partners/directors has been declared as a willful

defaulter by any bank/financial institution.

Payment and Settlement Systems

The payment and settlement systems are at the core of financial system infrastructure in a country. A well-functioning

payment and settlement system is crucial for the successful implementation of monetary policy and maintaining the

financial stability. Central banks have therefore, always maintained a keen interest in the development of a payment andsettlement system as part of their responsibilities for monetary and financial stability .In India, the development of a safe,

secure and sound payment and settlement system has been the key policy objective. In this direction, the Reserve Bank,

apart from performing the regulatory and supervisory functions, has also been making efforts to promote functionality and

modernization of the payment and settlement systems on an on-going basis, In order to provide focused attention to the

payment and settlement systems, the Reserve Bank constituted the Board for regulation and supervision of Payment and

Settlement Systems (BPSS) as a Committee of its Central Board.

The Reserve Bank of India (Board for regulation and supervision of Payment and Settlement Systems) Regulations, 2005

were notified in the Gazette of India on February 18, 2005. The BPSS is headed by the Governor of the Reserve Bank with

the Deputy Governor in-charge of Payment and Settlement Systems as the Vice-Chairman and the other Deputy Governors

and two members of the Central Board of the Reserve Bank as members. The Executive Directors in-Charge of the

Department of Payments and Settlement Systems (DPSS) and Financial Market Committee and Legal Adviser-in-Charge

are permanent invitees. The Board also has an external expert as a permanent invitee.

Functions and powers of the BPSS include formulating policies relating to the regulation and supervision of all types ofpayment and settlement systems, setting standards for existing and future systems, authorising the payment and

settlement systems and determining criteria for membership. The National Payments Council, which was set up in 1999,

has been designated as a Technical Advisory Committee of the BPSS. To assist the BPSS in performing its functions, a new

department, the Department of Payments and Settlement Systems (DPSS), was set up in Reserve Bank in March 2005.

The BPSS has met three times since constitution in March 2005.

The Board at its meetings, inter alia, has emphasised that

(i) Payment system services in India should taken to a level comparable with the best in world;

(ii) Appropriate legal infrastructure may be created as early as possible;

(iii) A plan drawn up to "leapfrog" from cash to electronic modes of payment, Wherever possible; cheque clearing system

would have to be made more efficient through cheque truncation system; and

(iv) Usage of the Real Time Gross Settlements (RTGS) System be increased both in terms of opening additional branch

outlets and more number of transactions being put through.

For modernising the payment and settlement systems in India, a three-pronged approach has been adopted with due

emphasis on consolidation, development and integration. The consolidation of the existing payment systems involves the

strengthening of computerized cheque clearing and expanding the reach of Electro Clearing Services (ECS) and Electronic

Fund Transfer (EFT).

.

Legal Reforms in the Banking Sector

An efficient financial system requires a regulatory framework with well-defined objectives, adequate and clear legal

framework and transparent supervisory procedure. This, in turn, requires comprehensive legislations to enable the

regulatory authorities to discharge their responsibilities effectively. The Reserve Bank has, therefore, been making

constant efforts to upgrade and strengthen the legal framework in tune with the changing environment.The Enforcement of Security Interest, Recovery Debts Laws (Amendment) Act, 2004 (Act NO.30 of 2004) has amended

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest 2002 (SARFAESI), the Recovery

of Debts to Banks and Financial Institutions Act, 1993 and the Companies Act, 1956. By this amendment Act, the

SARFAESI Act has been amended, inter alia, to:

(i) Enable the borrower to make application before the Debt Recovery Tritbunal against the measures taken by the creditor

without depositing any portion of money due;

(ii) Provide that the Debt Recovery Tribunal shall dispose of the application as expeditiously as possible within a period

60days from the date of application; and


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(iii) Enable any person aggrieved by any order made by Debt Recovery Tribunal to file an appeal before the Debt Recovery

Appellate Tribunal after depositing with the Appellate Tribunal fifty percent of the amount of debt due from him as claimed

by the secured creditor or as determined by the Debt Recovery Tribunal, whichever is less.

The Credit Information Companies (Regulation) Act, 2005 is aimed at providing for regulation of credit information

companies and to facilitate efficient distribution of credit. The Act will come into force after it is notified by Government in

the official Gazette. After the Act comes into force, no company can commence or carry on the business of creditinformation without obtaining a certificate of registration from the Reserve Bank.

The Act sets out procedures for obtaining certificate of registration, the requirements of minimum capital and management

of credit information companies. The Act also empowers the Reserve Bank to determine policy in relation to functioning of

credit information companies and to give directions to such companies, credit institutions and specified users.

The Act also lays down the functions of credit information companies, powers and duties of auditors, obtaining of

membership by credit institutions in credit information companies, information privacy principles, alterations of credit

information files and credit reports, regulation of unauthorized access to credit information, offences and penalties,

obligations as to fidelity and secrecy. Other salient features of the Act include settlement of disputes between credit

institutions and credit information companies or between credit institutions and their borrowers. The Act also provides for

amendment of certain enactments so as to permit disclosure of credit information

LIABILITIES OF BANKS

Deposits

Commercial banks deal in other people's money which they receive as deposits of various types. These deposits serve as a

means of payment and as a medium of saving, and are a very important variable in the national economy. Deposits

constitute the major source of funds for banks, and in 1996 they were about 92 per cent of total liabilities of all scheduled

commercial banks.

Types of Deposit Indian banks accept two main types of deposits-demand deposits and term deposits.

Demand Deposits: Demand deposits can be sub-divided into two categories-current and savings.

Current Deposits

Current deposits are chequable accounts and there are no restrictions on the amount or the number of withdrawals from

these accounts. It is possible to obtain a clean or secured overdraft on current account. Banks also extend to the account-

holders certain useful services such as free collection of out-station cheques and issue of demand drafts. At present banks

generally do not pay interest on current deposits. All current deposits are included in order to estimate the volume of

money supply in a given period of time.

Savings deposits earn interest; the rate of this interest was 5 per cent in 1990 and is 4.5 per cent at present. Certain

categories of banks are however allowed to pay interest (both on saving and fixed deposits) at rates higher than the

general level fixed for them. For example, with effect from July 1, 1977, banks with demand and time liabilities of less than

Rs 25 crore were allowed to pay interest rate higher by 0.25 to 0.50 per cent per annum on savings deposits and term

deposits up to and inclusive of five years. Although cheques can be drawn on savings accounts, the number of withdrawals

and the maximum amount that might, at any time, be withdrawn from an account without previous notice are restricted.

The practice with regard to the division of savings deposits into demand and time liabilities has undergone a change.

Earlier, in respect of each account, the maximum amount withdrawable without prior notice (or where the balance in the

account was not more than this maximum, the whole of the balance) was regarded as a demand liability; and the excess

over the maximum amount was treated as a time liability.

With effect from August 16, the average of the monthly minimum balances in a savings account on which interest is being

credited is to be regarded as a time liability and the excess over the said amount, as a demand liability. In other words,

before August 1978, demand deposits included that portion of savings deposits which was freely withdrawable, whereas

after the new regulation, what is included is the portion of savings deposits that is freely drawn upon by the depositors,

while the portion which remains with the banks earning interest is taken as time deposits. The new rule has resulted in an

increase in time deposits, and a decrease in demand deposits and money supply.

Call Deposit


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Call deposits is the third sub-category of demand deposits. They are accepted from fellow bankers and are repayable on

demand. These deposits carry an interest charge. They form a negligible part of total bank liabilities.

Term Deposits Time deposits are also known as fixed deposits or term deposits and they are a genuine saving medium.

They have different maturity periods on which depends the rate of interest.

BANKING ASSETS

Investments

Banks have four categories of assets:

Cash in hand and balances with the RBI,

Assets with the banking system,

Investments in government and other approved securities, and

Bank credit.

Among these assets, investment in cash and government securities serves the liquidity requirements of banks and is

influenced by the RBI policy. Quantitatively, bank credit and investment in government securities are banks' most

important assets. Commercial banks in India invest a negligible part of their resources in shares and debentures of joint

stock companies. In fact, for a long time they were discouraged from undertaking such investments. However, since 2/3

years, the policy in this regard has been liberalised and at present banks are allowed to invest five per cent of their

incremental deposits in corporate shares and convertible debentures.

Commercial banks' investments are of three types:

(a) Government of India securities;

(b) other approved securities, and

(c) non- approved securities.

While the first two types are known as SLR securities, the third one is known as non-SLR securities.

Investment in SLR Securities

At present, the banks are statutorily required to invest 25 per cent of their demand and time liabilities in the first two

types of securities. The investments in the first type of securities is the major part of banks' investments. The government

securities accounted for 95.59 per cent of their total investment portfolio in 2002-03. Their investments in the second type

are marginal, while those in the third type are emerging as substantial investments.

The commercial banks' investments in Central government securities were 28.1 per cent and 31. 6 per cent of their total

assets in 2001-02 and 2002-03, respectively. The other approved securities accounted for hardly one-or two per cent of

the assets of commercial banks in the years just mentioned.

The phenomenon of investments in government securities far in excess of statutory requirements has been due to

(a) high fiscal deficit effect,

(b) capital adequacy norms effect,

(c) foreign exchange sterilisation effect, and

(d) slack credit demand effect.

All these effects are easy to understand. The fiscal deficit has been largely financed through public borrowings, and the

banks have been the major subscribers to the government borrowing programme. Similarly, due to unprecedented and

heavy increase in foreign exchange accruals, the RBI has been carrying out an intensive sterilisation Programme which has

resulted in a significant increase in the supply of government securities, which the banks have been purchasing. Further,

all scheduled banks are required to maintain minimum capital to total risk weighted assets ratio which was nine per cent in2002-03. Given the very-low-risk (risk less) nature of the government securities, banks have preferred to buy and hold

substantial amount of government securities for this purpose also. Finally, due to industrial recession in the recent past,

the industrial sector's credit off take has been slack, and banks, therefore, have invested their surplus liquidity in

government securities.

Thus, the banks' investments in government securities cannot really be decided in terms of the ideology of public vs.

private sector. The large size of the State and the attendant enormous volume of government expenditure, the portfolio

management considerations of banks, the accrual of resources to the banks, foreign capital flows, and demand for credit,

have always determined and will continue to determine the level of investment-deposit ratio of banks. Hence, it is

erroneous to argue, as the RBI has done, that a large recourse of banks to gilts to invest their resources is a dissipation of


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"banking knowledge capital" regarding credit appraisal, or a possibility of severing of the link between liquidity, credit,

money, and economic activity.

Investment in Non-SLR Securities

After 1985, there has been a liberalisation of investment norms for banks which has enabled them to be active players in

financial markets. The ambit of eligible investments has been enlarged to cover Commercial Paper (CP)" units of mutual

funds, shares and debentures of PSUs, and shares and debentures of private corporate sector, which are all known as non-SLR investments. Similarly, the limit on investments in the capital market has been gradually increased. Now, banks can

invest in equities to the extent of five per cent of their outstanding (and not incremental as earlier) advances. Effective

May 2001, the total exposure of a bank to stock markets with sub-ceilings for total advances to all stock brokers and

merchant bankers has been limited to five per cent of the total advances (including CPs) as on March 31 of the previous

year.

The aggregate balance sheet of SCBs expanded at a higher rate of 19.3% excluding the impact of conversion of a non-

banking entity into a banking entity since October 1, 2004) during 2004-2005 as compared with 16.2 percent in 2003-04.

The ratio of assets of SCBs to GDP at factor cost at current prices increased significantly to 80% from 78.3% in 2003-04

reflecting further deepening of leverage enjoyed by the banking sector. The degree of leverage enjoyed by the banking

system as reflected in the equity multiplier declined to 15.8-16.9 in the previous year.

The behavior of major balance sheet indicators show that a divergent during 2004-05. on the back of robust economic

growth and industrial recovery, loans and advances witnessed strong growth, while investment in rising interest rate

scenario, slowed down significantly. Deposits showed a lackluster performance in the wake of increased competition fromother saving instruments. Borrowings and net-owned funds however, increased sharply underscoring the growing

importance of non-deposits resources of SCBs.

Bank group-wise, assets of new private sector banks grew at the highest rate.(19.4%),followed by public sector

banks(15.1%eacluding the conversion impact),foreign banks (13.6%) and old private sector banks (10.6%).PSBs

continued to accounts for the major share in he total assets, deposits, advances and investments of SCBs at end-March

2005, followed distantly by new private sector banks. The share of foreign banks in total assets and advances was higher

than that of old private sector banks.

Deposits

Deposits of SCBs grew at a lower rate 15.4 per cent (excluding the conversion impact) during 2004-05 as compared with

16.4 per cent in the previous year on account of slowdown in demand deposits and savings deposits. Deceleration in

demand deposits was due mainly to the base effect as demand deposits had witnessed an usually high growth last year.

The growth in demand deposits, however was in line with the long-term average. Savings deposits, which reflect the

strength of the retail liability franchise and are at the core of the banks customer acquisition efforts grew at a healthy rate,

though the growth was somewhat lower than the high growth of last year. The higher growth of term deposits was mainly

o ac count of NRI deposits and certificate of deposits (CDs).Excluding these deposits, the growth rate of term deposits

showed a declaration, which was on account of a possible substitution in favour of postal deposits and other investments

products, which continued to grow at a high rate benefiting from tax incentives and their attractive rate of return in

comparison with time deposits.

Factors Affecting Composition of Bank Deposits

The following factors appear to be relevant:

(a) Increase in national income.

(b) Expansion of banking facilities in new areas and for new classes of

people.

(c) Increase of banking habit.

(d) Increase in the relative rates of return on deposits.

(e) Increase in deficit financing.(f) Increase in bank credit.

(g) Inflow of deposits from Non-Resident Indians (NRIs).

(h) Growth of substitutes.

DEPOSIT INSURANCE

Bank deposits are insured up to a specified amount by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Deposit Insurance Corporation (DIC) was set up in January 1962, and it became a part of DICGC subsequently: The

insured amount has been increased in successive stages from Rs 1,500 in 1962, to Rs 5,000 in January 1968, Rs 10,000 in

April 1970, Rs 20,000 in July 1976, Rs 30,000 in June 1980, and Rs 1,00,000 in May 1993. It is necessary to raise this


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amount further now. The fully protected accounts as a proportion of the total number of accounts have increased from 78

per cent in 1962 to 99 per cent in 1995-96. The proportion of insured deposits to total assessable deposits (i.e., the entire

amount of deposits including those which are not provided insurance cover) has also gone up from 24 per cent in 1962 to

75 per cent in 1995-96.

Deposit Insurance Scheme covers commercial banks, co-operative banks, and the RRBs. As at the end of March 1996, it

covered 2,122 banks comprising 102 commercial banks, 196 RRBs and 1,824 cooperative banks.

Maturity profile of Assets and Liabilities of Banks

The maturity structure of commercial banks assets and liabilities reflects various concerns of banks pertaining to businessexpansion, liquidity management, cost of funds, return on assets, assets quality and also risk appetite during an industrial

upturn. In general, major components of balance sheet, including deposits, borrowings, loans and advances and

investments , for all bank groups encompassed a non-linear portfolio structure across the spectrum of maturity during

2004-05. Furthermore, for all banks groups, the maturity structure of loans and advances depicted a synchronous

behaviour with that of deposits. The maturity structure of deposits and that of investments differed across bank groups.

PSBs and old private banks held a larger share of their investment in higher maturity bucket, particularly more than five

year maturity bucket, while private sector and foreign banks held more than 50% of their investments in up to one year

maturity bucket. The residual maturity classification of consolidated international claims reveals that banks continued to

prefer to invest in/lender for short-term purposes, particularly upto 6 months period whose share in total claims incrased

by3.4% points to 73.6% during 2004-05.

MONETARY CONDITION

Monetary condition remained comfortable during 2005-06, despite a sustained pick-up in credit demand from the

commercial sector. Banks were able to finance the higher demand for commercial credit by curtailing their incremental

investments in Government securities. Strong growth in deposits on the current fiscal year and higher investment by non-bank sources in government securities also enabled banks to meet credit demand. The year on year growth in M at 16.6%

up to September 30, 2005 was higher than the indicative trajectory of 14.5% indicated in the Annual Policy Statement for

2005-06.

Banks Operations in the Capital Market

In an increasing market oriented environment, banks need to continuously raise capital to sustain the growth in their

operations. Several banks therefore, accessed the capital market during 2004-05 to strengthen their capital base.

BANK GROUP WISE DISTRIBUTION OF BRANCHES OF SCHEDULED COMMERCIAL BANKS (As at end-June 2005)

CAPITAL BASED

The capital base of commercial banks has become a subject of great attention in the whole world in the recent past. In

India, it had become progressively very weak; the ratio of paid-up capital and reserves to deposits of Indian banks had

declined from 6.7 per cent in 1956 to 4.1 per cent in 1961, 2.4 per cent in 1969, 1.2 per cent in 1984, and 2.1 per cent in

1986. It increased to 7.53 per cent in 1995. which was the result of the prescription of capital adequacy norms by the

authorities since 1992-93.

The Bas1e Committee on Banking Supervision appointed by the Bank for International Settlement (BIS) established in

1988 a system in which minimum capital requirements were set for banking firms based on the risk of bank assets. It

specified Capital to Risk (weighted) Assets Ratio (CRAR) of eight per cent as the capital adequacy norm. This risk-based

capital standard has been adopted by many countries including India where it came into force in 1992-93. In the following

years, a multi-pronged policy has been implemented to reach the said eight per cent level. First, the government has been

providing budgetary support to banks for this purpose.

In fact, it has contributed Rs 20,446 crore by way of capital to the banks during 1985 to 2002. Since 1992, it has

contributed over Rs 17,746 crore to the capital base of the nationalised banks. Second, a number of banks have raisedequity capital on the stock market. In addition, banks have been allowed since 1993-94 to issue, with the prior approval of

the RBI, subordinated debts in the form of unsecured redeemable bonds qualifying for Tier II capital. Seven public sector

banks raised a sum of Rs 1145.74 crore during 1995-96 through such an instrument. The twelve PSBs have raised capital

through fresh capital issues to the tune of Rs 6501 crore during 1993-2002. Three PSBs raised another Rs 773 crore of

equity capital during 2002-03. Further, the nationalised banks have returned the capital of Rs 1253 crore to the

government till the end of 2002-03. As a result, the government shareholding in PSBs has declined. The share of the

government in the equity capital of various banks ranged from 57 per cent to 75 per cent in 2003.

By the end of March 2003, all the PSBs have achieved CRAR above the stipulated minimum. In fact, 26 out of 27 PSBs had

a CRAR above 10 per cent. For PSBS as a whole, the CRAR stood at 12.64 percent at the end of March 2003. Similarly,


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now all the old private sector banks and foreign banks also have the CRAR above the stipulated level now. The number of

PSBs paying dividend to the government has increased from seven in 1995-96 to 14 (out of 19) in 2000-01, and the total

amount of dividend paid has been about Rs 2294 crore during 1995-96 to 2001-01.

RISK EXPOSURES OF BANKS

The overall risk exposure of banks is determined by their lending to sensitive sectors such as capital market, real estate,

and commodities' and off-balance sheet activities. comprising forward exchange contracts, guarantees, acceptances and

endorsements. The exposure of scheduled commercial banks in India on both of these counts has gone up significantly at

present.

BANKS FOREIGN BUSINESS

Indian banks do business in foreign countries also and this business has grown slowly over time. Banks' foreign business

actually began during early 1940s on a very modest sca

le; it expanded to a certain extent during the 1950s and 1960s; and the fastest growth of this business occurred really

during 1975-1982. This business is mainly concentrated in areas inhabited largely by Indian expatriate population, and incountries which are important trading partners of India.

In 1985, 13 Indian banks had 139 offices in 26 countries. Bank of Baroda, Bank of India, State Bank of India, and Indian

Overseas Bank accounted, respectively, for 41, 17, 17, and 8 per cent of total branches. Indian banks also have three

deposit-taking companies, three wholly-owned subsidiaries, two majority-owned subsidiaries and four joint venture banks

abroad. There was a reduction in this business after 1985. As a result of the closure of branches by some banks, the

number of foreign offices of nine banks was 114 as on 30 April, 1990, and the four banks had 11 representative offices in

that year. The banks have never done well in their overseas business. About $1 billion had to be provided in 1992-93 Jo

meet provisioning requirements of overseas branches, some of which are being closed even now.

The total number of overseas branches of Indian banks was reduced from 101 to 97 as at the end of June 1996, of which

96 branches belonged to eight public sector banks, and the remaining one belonged to a private sector bank. The number

of wholly-owned subsidiaries, joint venture banks, and representative offices were 11,7, and 14, respectively in 1996.

BANKS AS AUTHORISED DEALERS

The RBI has designated 92 banks, including 35 foreign banks, as Authorized Dealers (ADs) in foreign exchange, an they

are functioning in this capacity through their 27,762 branches. ADs can buy and sell foreign exchange on behalf of their

clients, subject to limits deemed sufficient. Increase in capital flows and the relaxation of balance sheet restrictions in

respect of foreign exchange operations has transformed banks into active participants in the foreign exchange market. The

changes in capital flows directly affect bank liquidity, profitability. The turnover in the foreign exchange business of banks

has increased over the years.

RETAIL BANKING

Banks today operate under their spreads, declining margins, and rising costs. Consumer finance was not a favouredavenue for banks in India till the other day. They were primarily financing production-based activities. but the industrial

recession, economic downturn, industrial sickness, mounting NPAs with corporates, failure of many big companies have

made banks prefer to be selective in their lending to corporates which has become more risky. As a result, banks are

diverting their resources to retail lending In addition to financing working capital of corporates and giving term loans,

banks are diversifying into retail banking or personal banking which appears to be a viable alternative to cope up with the

poor credit offtake and far augmenting business in the current situation. The reduction in SLR/CRR, poor credit demand

due to recession, greater risk due to high NPAs in traditional lending, and similar changes have made banks to diversify

their business in the form of retail, personal loans such as education loans, home loans, auto loans, white goods loans,

credit card loans, travel loans (along with entering into treasury operations). The Indian commercial banks' retail lending

has almost doubled during 2000-03. Their housing loans disbursals increased from Rs 14746 crore in 2001-02 to Rs 33841


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crore in 2002-03. Information technology, net banking, mobile banking, telebanking, A TMs, and demat accounts have

facilitated the growth of retail banking.

The retail banking has created challenges before the banks to set up and invest heavily in new credit delivery or

distribution channels which can economise on transactions costs, increase sales productivity, and offer greater convenience

in service provision. Banks are increasing off-site delivery channels which are helping ill new product development,

increasing speed of transactions processing and reducing transactions costs. It has been suggested that banks should

follow the following steps for making new distribution channels successful (RBI, Bulletin, January 2004, pp. 103-105):

Understand customers' current transaction behaviour and their underlying attitude.

Use sophisticated experimental customer research to assess the economic impact of tactics designed to change that

behaviour.

Develop an integrated channel migration plan which blends economic and non-economic incentives to ensure !hat right

initiatives are targeted at the right customers Protect sales effectiveness by utilising the non-branch channels .Design non-

branch channels to emphasise personalised interaction to counteract decreased / loyalty among remote customers.

Resources Raised by Banks From the Primary Capital Market

Scheduled Commercial banks, both in public and private sectors, raised large resources from the domestic and

international capital markets. Total resource mobilization by banks through public issues (excluding offer for sale) in the

domestic capital market increased sharply by 263.3 per cent during 2004-05. Encouraged by a firm trend in the prices of

the banking sector scrips in the secondary market and satisfactory financial results, seven banks raised Rs. 7,444 crore

from the equity market during 2004-05. This included two equity issues aggregating Rs.3,336 crore (including premium)

by public sector banks and five equity issues aggregating Rs.4,108 crore by private sector banks.

Regional Rural Banks

Regional Rural Banks (RRBs) form an integral part of the Indian banking system with focus on serving the rural sector.

There are 196 RRBs operating in 26 States across 518 districts with a network of 14,446 branches as on March 31, 2004.

Majority of the branches of RRBs are located in rural areas. RRBs combine the local feel and familiarity with rural problems,

which the co-operatives possess, and the degree of business organisation as well as the ability to mobilise deposits, which

the commercial banks possess. RRBs are specialised rural financial institutions for catering to the credit requirements of

the rural sector. In the context of recent focus of the Government of India on doubling the flow of credit to the agricultural

sector, it is felt that the RRBs could be used as an effective vehicle for credit delivery in view of their rural orientation

Development of co-operative bank

Co-operative banks in India have come a long way since the enactment of the Agricultural Credit Co-operative Societies

Act in 1904. The century old co-operative banking structure is viewed as an important instrument of banking access to the

rural masses and thus a vehicle for democratisation of the Indian financial system. Co-operative banks mobilise deposits

and purvey agricultural and rural credit with a wider outreach. They have also been an important instrument for various

development schemes, particularly subsidy based programmes for the poor.

The co-operative banking structure in India comprises urban co-operative banks and rural co-operative credit institutions.

Urban co-operative banks consist of a single tier, viz., primary co-operative banks, commonly referred to as urban co-

operative banks (UCBs). The rural co-operative credit structure has traditionally been bifurcated into two parallel wings,

viz., short-term and long-term. Short-term co-operative credit institutions have a federal three-tier structure consisting of

a large number of primary agricultural credit societies (PACS) at the grass-root level, central co-operative banks (CCBs) at

the district level and State co-operative banks (StCBs) at the State/apex level. The smaller States and Union Territories

(UTs) have a two tier structure with StCBs directly meeting the credit requirements of PACS.

The long-term rural co-operative structure has two tiers, viz., State co-operative agriculture and rural development banks

(SCARDBs) at the State level and primary co-operative agriculture and rural development banks (PCARDBs) at the

taluka/tehsil level. However, some States have a unitary structure with the State level banks operating through their own

branches; three States have a mixed structure incorporating both unitary and federal systems

The Co-operative Movement was launched in India by the acts of 1904 and 1912 passed by the Central Government .There

are a number of State Co-operative banks, Central co-operative Banks, Land Development Banks and a host of Credit

Societies. The resources of Co-operative Credit institution mainly consist of deposit and borrowings. Owing to the limited

resources of the members, these institution do not have much of share capital. Unfortunately, sufficient reserves have also

not been built up owing to meagre profits.

PUBLIC SECTOR BANKS

The term public sector banks by itself connotes a situation where the major/ful l stake in the banks are held by the

government.


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Excepting the Reserve Bank of India which was nationalized in 1949 there was no other bank which had the tag of public

sector bank till 1969. with the nationalization of banks brought in by Banking Companies Act,1970, 14 Banks each of which

had a level of more than Rs 50 crores in time and demand liabilities acquired the character of nationalized banks effective

from 19 July 1969. This was subsequently followed by nationalization of 6 more private Sector Commercial banks, each of

which had crossed the deposit limit of Rs 200 crore in the year 1980, effective from 15/4/1980. Thus, as on date there are

totally 19 nationalised banks existing as on date, consequent to the merger of New Bank of India with Punjab National

Bank in September 1993. Consequent to an Amendment made to the Banking Companies Acts, 1970/1980 in 1994,

Nationalised banks have been permitted to offer their equity shares to the public to the extent of 49% of their capital.

Public sector banks are as follows

Nationalised Banks

Allahabad Bank

Andhra Bank

Bank of India

Bank of Baroda

Bank of Maharashtra

Canara Bank

Central Bank of India

Corporation Bank

Dena Bank

Indian Bank

Indian Overseas Bank Oriental Bank of Commerce

Punjab and Sind Bank

Punjab National Bank

Syndicate Bank

UCO Bank

Union Bank of India

United Bank of India

Vijaya Bank

State Bank Group

State Bank of India

State Bank of Bikaner and Jaipur

State Bank of Hyderabad

State Bank of Indore

State Bank of Mysore

State Bank of Patiala

State Bank of Saurashtra

State Bank of Travancore

IDBI LTD.

Private Sector Banks

By private sector banks we mean those banks where equity is held by private share holders, that is to say there is no

government holding of the equity shares.

This category of banks also occupies a significant position in the Banking Scenario. There are already 25 private Sector

operating in our country for quite some time. These banks are also listed as under

v The ING Vysya Bank Ltd.

v The Federal Bank Ltd.

v The Jammu Kashmir Bank Ltd.

v Bank of Rajasthan Ltd.v Karnataka Bank Ltd.

v The South Indian Bank Ltd.

v The United Western Bank Ltd.

v The Catholic Syrian Bank Ltd.

v The Karur Vysya Bank Ltd.

v Tamilnadu Mercantile Bank Ltd.

v The Laxmi Vilas Bank Ltd.

v The Sangli Bank Ltd.

v The Dhanlaxmi Bank Ltd.

v Bharat Overseas Bank Ltd.


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v City Union Bank Ltd.

v Lord Krishna Bank Ltd.

v Bareilly Corporation Bank Ltd.

v Nanital Bank Ltd.

v The Ratnakar Bank Ltd.

v The Ganesh Bank of Kurundwad Ltd.

v SBI Comm. & Int. Bank Ltd

v Development credit Bank Ltdv Madura Bank Ltd.

There has been a growing presence of private sector banks more so, after the introduction of financial sector reforms from

1991. Six new private banks listed as under were issued licences in 1994-95.

New Private sector Banks

Centurion Bank of Punjab Ltd.

HDFC Bank

ICICI Bank Ltd.

Indusland Bank Ltd.

Kotak Mahindra Bank Ltd.

UTI Bank Ltd.

Again, during 1995-96, the following three banks were issued the licence and commenced their operations:

v Times Bank Ltd.

v Bank of Punjab Ltd.

v IDBI Bank Ltd.

Thus apart from the twenty-five old private sector banks, we have got nine private sector banks which became operational

subsequent to 1992.

The size of the private sector banks in our country as on date is furnished hereunder (as at June97)

v Number of private sector banks in operation : 35

v Number of bank branches of private sector banks : 4,473

v Amount of advances(as at March96) : 31,692 crores

v Amount of advances(as at March96) : 21,5888 crores( Sources RBI)

Private Sector Banks have been rapidly increasing their presence in the recent times and offering a variety of newer

services to the customer and possing a stiff competition to the group of public sector banks

New Technology in Banking

The importance of sophisticated or high technology for improving customer service, productivity, and operational efficiency

of banks is well-recognised. As a part of their action plans, banks in India have introd, :ed many new techniques and a

considerable degree of mechanisation and computerisation in their operations. By the end of June 1996, they had installed

13,522 Advance Ledger Posting Machines (ALPM) at 4,238 branches, and 895 mini-computers at their regional and zonal

offices at 441 branches. Three banks had installed mainframe computers and others were at various stages of doing so.

They are developing and standardising suitable computer softwares in a big way. They have introduced mechanised

cheque clearance, using magnetic ink character recognition (MICR) technology. The computerisation of clearing house

settlement has been completed at a number of centres. They are in the process of setting up exclusive data

communication network for banks known as BANKNET. For this, the RBI and 36 banks have become members of the

Society for Worldwide Inter-bank Financial Telecommunications (SWIFT) and have installed two SWIFT Regional Processors

at Mumbai. Through this network, any bank will be able to establish connection with its own offices and with any other

banks' offices/computers in the national and international network.

Banks are now switching to Personal Computers (PCs) and LAN/W AN systems. At the end of June 1996, the banks had

installed 2,120 PCs, LAN at 916 branches, WAN at 175 branches, 937 signature storage and retrieval systems, and 315 on-

line terminals. The RBI has put in place Electronic Funds Transfer (EFT) system, Delivery vs. Payments (DVP) system,

Electronic Clearing Services, and RBINET. It has also taken steps to set up a Very Small Aperture Terminal (VSAT) Network

which will cover all banks and financial institutions to serve a number of tasks like MIS, data warehousing, transactionprocessing, currency chest accounting, ATMs, EFT, EDT, Smart/Credit cards, etc. It will cover 2,800 centres soon. So far all

the PSBs have crossed the 70 per cent level of computerisation of their business. As a part of Indian Financial Network

(INFINET), the number of VSATs has increased from 924 in March 2002 to more than 2000 in June 2003. Banks are

sharing A TMs by forming alliances as it was done by UTI Bank, Citi bank, IDBI Bank, and Standard Chartered Bank, which

formed "Cashnet" alliance in 2003. Now, there are 27 cities where cheque clearing is performed using mechanised

technology of reader sorter which process cheques at more than 2000 per minute. The 'currency verification and

processing systems' have been made operational at various offices of the RBI which has resulted ill the "clean note policy".

In not a very far off future, the banking system in India and the payments mechanism (system) which it operates would


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witness the following technological innovations, which are already a reality in a country like USA. The place of physical

transfer in the form of cash or cheques is being taken there by "On-line electronics payments method" comprising fedwire,

CHIPs, and ACHs. The Fedwire is a communication system that allows banks to transfer deposits and government

securities. It is an electronic equivalent of payment by cash. The electronic equivalent of payment by cheque is the

Clearing House Interbank Payment System or CHIPs. Then there is ACHs which involves exchange of magnetic tapes rather

than pieces of paper (Automated Clearing Houses).

While Fedwire and CHIPs execute payments immediately, ACHs is a slower method of electronic payments. The mostubiquitous medium of electronic payment spreading in developed countries is the electronic debit card or cash card which

is inserted in a machine and after punching in a personal identification number (PIN) which gives access to the electronic

payment systelH. There are two principle types of machine into which card can be inserted: the automated teller machines

(ATMs) and the electronic funds transfer at point of sale (EFTPOs).

Other Diversifications in Banking

Since the mid-1980s, many far-reaching changes have taken place in the Indian banking sector. Many banks have set up

specialised subsidiary companies and assets-liabilities management companies, and either through them or on their own,

they have entered into related activities, such as merchant banking, mutual funds, hire-purchase finance, housing finance,

venture capital, equipment leasing, factoring, securities booking and trading, and a host of other financial services. By the

end of June 1996, 11 banks had set up 11 equipment leasing and merchant banking subsidiaries, while five public sector

banks had set up their mutual funds, which floated many investment (unit) schemes. Some banks have also launched

venture capital funds. The total number of housing finance subsidiaries of banks was eight at the end of June 1996. They

are entering into the areas of factoring, computer-related services and equity participation also. Two subsidiaries of bankshave invested in the equity capital of OTCEI. Banks have begun to have portfolio investment in hire purchase companies

and venture capital funds. Through these changes, the interface and links of the banking sector with the capital market

and other financial institutions have been growing..

Asset-Liability Management

In the recent past, banks in India have started using the Asset-Liability Management (ALM) as the technique or strategy

for financial management. ALM aims at planning, directing, and regulating the levels, changes, mixes of assets and

liabilities of banks in the short-run, usually three to twelve months, with a view to enable them to achieve their long-term

objectives. The net interest margin and its variability are the focus of its attention so as to maximise Return On Equity

(ROE), and to minimise fluctuations in ROE. It also links capital, non-interest income and expenses, and strategic choices

regarding products, markets, and bank structure. ALM involves giving balanced emphasis necessary in a competitive

environment characterised by deregulatiom. and greater viability (volatility) of interest rates, variable rates pricing, and

the use of interest rates derivatives.

Co-operative Banks

INTRODUCTION

Co-operative banks are an important constituent of the Indian financial system, judging by the role assigned to them, the

expectations they are supposed to fulfills, their number, and the number of offices they operate. The co-operative

movement originated in the West, but the importance that such banks have assumed in India is rarely paralleled anywhere

else in the world. Their role in rural financing continues to be important even today, and their business in the urban areas

also has increased in recent years mainly due to the sharp increase in the number of primary co-operative banks.

ORIGIN AND GROWTH OF CO-OPERATIVE BANKS

Co-operative banks are a part of the vast and powerful superstructure of co-operative institutions which are engaged in thetasks of production, processing, marketing, distribution, servicing, and banking in India. The beginning of co-operative

banking in this country dates back to about 1904 when official efforts were initiated to create a new type of institution

based on the principles of co-operative organisation and management, which were considered to be suitable for solving the

problems peculiar to Indian conditions. In rural areas, as far as agricultural and related activities were concerned, the

supply of credit, particularly institutional credit, was woefully inadequate, and unorganised money market agencies, such

as money lenders, were providing credit often at exploitatively high rates of interest. The co-operative banks were

conceived in order to substitute such agencies, provide adequate short-term and long-term institutional credit at

reasonable rates of interest, and to bring about integration of the unorganised and organised segments of the Indian

money market.


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When the national economic planning began in India, co-operative banks were made an integral part of the institutional

framework of community development and extension services, which was assigned the important role of delivering the

fruits of economic planning at the grassroot levels. In other words, they became a part of the arrangements for

decentralised plan formulation and implentation for the purpose of rural development in general, and agricultural

development in particular. Today co-operative banks continue to be a part of a set of institutions which are engaged in

financing rural and agricultural development. This set-up comprises the RBI, NABARD, commercial banks, regional rural

banks, and co-operative banks. The relative importance of co-operative banks in financing agricultural and rural

development has undergone some changes over the years. Till 1969, they increasingly substituted the informal sectorlenders. After the nationalisation of banks and the creation of RRBs and NABARD, however, their relative share has

somewhat declined. All the institutional sources contributed about 4 per cent of the total rural credit till 1954. The

contribution increased to 62 per cent by 1990. The share of

co-operative banks in this institutional lending has declined from 80 per cent in 1969 to about 42 per cent at present. The

percentage of rural population covered by the agricultural credit co-operatives was 7.8 in 1951, 36 in

comparative study of commercial banks

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