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MANAGEMENT OF FINANCIAL SERVICES (S3 MBA)

Study Materials - UNIT II

Prepared by Prof. P. Madhusoodanan Pillai

The Syllabus

Regulatory and supervisory frame work Role of RBI, SEBI, and Ministry of

Finance, Govt. of India finance bill and financial services supervision and

regulation of banking companies in India Regulatory/ Institutional/ and

Environmental constraints.

I. BAKING IN INDIA

Introduction

In the earlier societies functions of a bank were done by the correspondinginstitutions dealing with loans and advances. Britishers brought into India the modernconcept of banking by the start of Bank of England in 1694. In 1708, the bank ofEngland was given the monopoly for the issue of currency notes by an Act. Innineteenth century various banks started operations, which primarily were receiving

money on deposits, lending money, transferring money from one place to anotherand bill discounting.

Without a sound and effective banking system in India it cannot have a healthyeconomy. The banking system of India should not only be hassle free but it shouldbe able to meet new challenges posed by the technology and any other external andinternal factors.

For the past three decades India's banking system has several outstandingachievements to its credit. The most striking is its extensive reach. It is no longerconfined to only metropolitans or cosmopolitans in India. In fact, Indian banking

system has reached even to the remote corners of the country. This is one of themain reason of India's growth process.

The government's regular policy for Indian bank since 1969 has paid rich dividendswith the nationalisation of 14 major private banks of India. Not long ago, an accountholder had to wait for hours at the bank counters for getting a draft or for withdrawinghis own money. Today, he has a choice. Gone are days when the most efficientbank transferred money from one branch to other in two days. Now it is simple asinstant messaging or dial a pizza. Money have become the order of the day.

The first bank in India, though conservative, was established in 1786. From 1786 till

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today, the journey of Indian Banking System can be segregated into three distinctphases. They are as mentioned below:

Early phase from 1786 to 1969 of Indian Banks Nationalisation of Indian Banks and up to 1991 prior to Indian banking sector

Reforms. New phase of Indian Banking System with the advent of Indian Financial &

Banking Sector Reforms after 1991.

To make this write-up more explanatory, I prefix the scenario as Phase I, Phase IIand Phase III.

Phase I The General Bank of India was set up in the year 1786. Next came Bank ofHindustan and Bengal Bank. The East India Company established Bank of Bengal(1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units

and called it Presidency Banks. These three banks were amalgamated in 1920 andImperial Bank of India was established which started as private shareholders banks,mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians,Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank,Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodicfailures between 1913 and 1948. There were approximately 1100 banks, mostlysmall. To streamline the functioning and activities of commercial banks, theGovernment of India came up with The Banking Companies Act, 1949 which waslater changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No.23 of 1965). Reserve Bank of India was vested with extensive powers for thesupervision of banking in India as the Central Banking Authority.

During those days public has lesser confidence in the banks. As an aftermathdeposit mobilisation was slow. Abreast of it the savings bank facility provided by thePostal department was comparatively safer. Moreover, funds were largely given totraders.

Phase II

Government took major steps in this Indian Banking Sector Reform afterindependence. In 1955, it nationalised Imperial Bank of India with extensive bankingfacilities on a large scale specially in rural and semi-urban areas. It formed StateBank of india to act as the principal agent of RBI and to handle banking transactionsof the Union and State Governments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on19th July, 1969, major process of nationalisation was carried out. It was the effort of

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the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks inthe country was nationalised.

Second phase of nationalisation Indian Banking Sector Reform was carried out in1980 with seven more banks. This step brought 80% of the banking segment in India

under Government ownership.

The following are the steps taken by the Government of India to Regulate BankingInstitutions in the Country:

1949 : Enactment of Banking Regulation Act. 1955 : Nationalisation of State Bank of India. 1959 : Nationalisation of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalisation of 14 major banks.

1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalisation of seven banks with deposits over 200 crore.

After the nationalisation of banks, the branches of the public sector bank India rose

to approximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and

immense confidence about the sustainability of these institutions.

Phase III

This phase has introduced many more products and facilities in the banking sector in

its reforms measure. In 1991, under the chairmanship of M Narasimham, a

committee was set up by his name which worked for the liberalisation of banking

practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being

put to give a satisfactory service to customers. Phone banking and net banking is

introduced. The entire system became more convenient and swift. Time is given

more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered

from any crisis triggered by any external macroeconomics shock as other East Asian

Countries suffered. This is all due to a flexible exchange rate regime, the foreign

reserves are high, the capital account is not yet fully convertible, and banks and their

customers have limited foreign exchange exposure.

Why Banking Sector Reforms needed in India?

1. High Regulated Sector

2. Prevalence of High Reserve Requirements

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3. Interest Rate Controls

4. Large Allocations to Priority Sector

5. Poor Lending Strategies

6. Lack of Internal Risk Management

7. Low Yields on Government Securities

8. Waiver of Loans on Political Grounds

9. Lack of Competition

10.High Cost of Operations

11.Poor Customer Service

12.Poor Loan Recovery

13.Weak Capital Position

14.Political Interference

15.Lack of Institutional Autonomy

16.Lack of Accountability in Banks

17.Vague Reporting Formats

18.Technology Deficiency

Recent History of Indian Banking

Indian banking system, over the years has gone through various phases after

establishment of Reserve Bank of India in 1935 during the British rule, to function as

Central Bank of the country. Earlier to creation of RBI, the central bank functions

were being looked after by the Imperial Bank of India. With the 5-year plan having

acquired an important place after the independence, the Govt. felt that the private

banks may not extend the kind of cooperation in providing credit support, theeconomy may need. In 1954 the All India Rural Credit Survey Committee submitted

its report recommending creation of a strong, integrated, State-sponsored, State-

partnered commercial banking institution with an effective machinery of branches

spread all over the country. The recommendations of this committee led to

establishment of first Public Sector Bank in the name of State Bank of India on July

01, 1955 by acquiring the substantial part of share capital by RBI, of the then

Imperial Bank of India. Similarly during 1956-59, as a result of re-organisation of

princely States, the associate banks came into fold of public sector banking.

Another evaluation of the banking in India was undertaken during 1966 as the privatebanks were still not extending the required support in the form of credit disbursal,

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into State Bank of India in 1955 and nationalisation of 14 major private banks during

1969.

Expansion phase had begun in mid-60s but gained momentum after nationalisation

of banks and continued till 1984. A determined effort was made to make banking

facilities available to the masses. Branch network of the banks was widened at avery fast pace covering the rural and semi-urban population, which had no access to

banking hitherto. Most importantly, credit flows were guided towards the priority

sectors. However this weakened the lines of supervision and affected the quality of

assets of banks and pressurized their profitability and brought competitive efficiency

of the system at a low ebb.

Consolidation phase: The phase started in 1985 when a series of policy initiatives

were taken by RBI which saw marked slowdown in the branch expansion. Attention

was paid to improving house-keeping, customer service, credit management, staff

productivity and profitability of banks. Measures were also taken to reduce thestructural constraints that obstructed the growth of money market.

Reforms phase The macro-economic crisis faced by the country in 1991 paved the

way for extensive financial sector reforms which brought deregulation of interest

rates, more competition, technological changes, prudential guidelines on asset

classification and income recognition, capital adequacy, autonomy packages etc.

Bank Nationalisation & Public Sector Banking

Organised banking in India is more than two centuries old. Till 1935 all the banks

were in private sector and were set up by individuals and/or industrial houses which

collected deposits from individuals and used them for their own purposes. In the

absence of any regulatory framework, these private owners of banks were at liberty

to use the funds in any manner, they deemed appropriate and resultantly, the bank

failures were frequent.

Move towards State ownership of banks started with the nationalisation of RBI and

passing of Banking Companies Act 1949. On the recommendations of All India Rural

Credit Survey Committee, SBI Act was enacted in 1955 and Imperial Bank of India

was transferred to SBI. Similarly, the conversion of 8 State-owned banks (State Bank

of Bikaner and State Bank of Jaipur were two separate banks earlier and merged)

into subsidiaries (now associates) of SBI during 1959 took place. During 1968 the

scheme of social control was introduced, which was closely followed by

nationalisation of 14 major banks in 1969 and another six in 1980.

Keeping in view the objectives of nationalisation, PSBs undertook expansion of

reach and services. Resultantly the number of branches increased 7 fold (from 8321

to more than 60000 out of which 58% in rural areas) and no. of people served per

branch office came down from 65000 in 1969 to 10000. Much of this expansion has

taken place in rural and semi-urban areas. The expansion is significant in terms of

geographical distribution. States neglected by private banks before 1969 have a vast

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network of public sector banks. The PSBs including RRBs, account for 93% of bank

offices and 87% of banking system deposits.

II. REFORMS IN BANKING SUPERVISION IN INDIA

The Basel Committee on Banking Supervision, which is a committee of bankingsupervisory authorities of G-10 countries, has been in the forefront of theinternational attempt in the development of standards and the establishment of aframework for bank supervision towards strengthening international financial stability.In 1997, in consultation with the supervisory authorities of a few non G-10 countriesincluding India, it drew up the 25 Core Principles for Effective Banking Supervisionwhich were in the nature of minimum requirements intended to guide supervisoryauthorities which were seeking to strengthen their current supervisory regime.Being one of the central banks which was involved in the exercise of drawing up the

Core Principles, the Reserve Bank of India had assessed its own position withrespect to these Principles in 1998. The assessment had shown that most of theCore Principles were already enshrined in our existing legislation or currentregulations. Gaps had been identified between existing practice and principle mainlyin the areas of risk management in banks, inter-agency cooperation with otherdomestic/international regulators and consolidated supervision. Internal workinggroups were set up to suggest measures to bridge these gaps and theirrecommendations have been accepted by the Board for Financial Supervision andare now in the process of being implemented.Given the spread and reach of the Indian banking system, with over 60,000branches of more than 100 banks, implementation is a challenge for the supervisors.

However, the Reserve Bank of India is committed to the full implementation of theCore Principles. The Bank also serves on the Core Principles Liaison Group of theBCBS, which has been formed to promote the timely and complete implementationof these principles worldwide. It gives me great pleasure to release this documentwhich is intended to provide the reader with a framework within which one can viewthe developments in the Indian Banking System in a proper perspective. Thedocument reflects the position as existing on date and will be updated to reflectfuture changes. As supervision is a dynamic process, readers may refer to theReserve Bank of India for the latest position or for any clarifications.

Core Principles for Banking Supervision- Status in India

Section I: Preconditions for Effective Banking Supervision

Principle I: Framework and Coordination

An effective system of banking supervision will have clear responsibilities andobjectives for each agency involved in the supervision of banks. Each such agencyshould possess operational independence and adequate resources. A suitable legalframework for banking supervision is also necessary including provisions relating toauthorisation of banking establishments and their ongoing supervision; powers toaddress compliance with laws as well as safety and soundness concerns; and legal

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protection for supervisors. Arrangements for sharing information betweensupervisors and protection for confidentiality of such information should be in place.

1.1 The Reserve Bank of India (RBI), an autonomous body created under an act ofthe Indian parliament i.e. The Reserve Bank of India Act, 1934, is entrusted,

interalia, with the sole responsibility of regulation and supervision of banks under theBanking Regulation Act, 1949. Section 35 of the Banking Regulation Act vestspowers in RBI for inspection of books of any banking company at any time.

1.2 Both the regulatory and supervisory functions of RBI were earlier carried outthrough its Department of Banking Operations and Development (DBOD) tillDecember 1993, when a separate department entitled Department of Supervision(DOS) was formed to take over the supervisory function, leaving regulatory functionsto DBOD. In November 1994, RBI constituted the Board for Financial Supervision(BFS) under RBI (BFS) Regulations 1994 to give undivided attention to theprudential supervision and regulation of banks, financial institutions and non-bank

financial institutions in an integrated manner. DBOD continues to perform theregulatory function pertaining to banks.

However, DOS has since been bifurcated into Department of Banking Supervision(DBS) and Department of Non-Banking Supervision (DNBS). DBS is responsible forthe supervision of commercial banks and their merchant banking subsidiaries. Bothregulation and supervision of the development financial institutions (DFIs) arehandled by the Financial Institutions Division (FID) of the DBS.

1.3 DNBS is responsible for supervision and regulation of Non-banking FinancialCompanies (NBFCs). No NBFC can commence or carry on the business of anonbanking financial institution without obtaining a certificate of registration fromRBI. The NBFC with net owned funds of Rs.2.5 million and above (since enhancedto Rs.20 million effective from 20 April 1999) are mandatorily required to beregistered with RBI. Maintenance of liquid assets at a specified percentage of publicdeposits is compulsory. RBI is empowered to give directions to NBFCs and can evenprohibit NBFCs which do not adhere to a set of prudential norms from acceptingdeposits and impose penalties under the provisions of the RBI Act. A system of on-site examination based on CAMELS rating model and off-site surveillance of variousstatutory returns of NBFCs is in place. Besides, special formats for off-sitesurveillance of NBFCs with asset size of Rs.1 billion and above have been devised.

1.4 The BFS has been constituted under the aegis of RBI. It is an autonomous bodyand directs the policies and operations relating to supervision of banks, DFIs andNBFCs. The Governor of the Reserve Bank is the Chairman of the BFS while theDeputy Governor in charge of supervision is the Vice-chairman. The other twoDeputy Governors of the Bank, together with four non-official directors from theCentral Board of the Bank, are the members of the BFS. Since its formation inNovember 1994, the BFS, which meets every month, has positioned a new strategyfor on-site supervision of banks and a system of off-site monitoring, based onquarterly reporting system.

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1.5 RBI has been given broad powers under Section 35A of the Banking RegulationAct to issue directions to banking companies in general or to any banking companyin particular, if it is satisfied that these are required

a) in the public interest; or

b) in the interest of banking policy; orc) to prevent the affairs of any banking company being conducted in a mannerdetrimental to the interests of the depositors or in a manner prejudicial to theinterests of the banking company; ord) to secure the proper management of any banking company generally.

1.6 The Central Government, after consultation with RBI, may acquire oramalgamate or reconstitute a banking company, which is being managed in amanner detrimental to the interest of its depositors or which has failed to comply withdirections issued by RBI under the Banking Regulation Act. The RBI has powers toapply for winding up of a banking company that is unable to meet its commitments

and / or its continuation is prejudicial to the interest of its depositors. The RBI canintervene in the banks management if directors / management are not found to befit and proper in the course of operation. The RBI can cancel the licence of abanking company provided the conditions stated in Section 22(3) of the BankingRegulation Act are not fulfilled.

1.7 Section 7 of the RBI Act provides for operational independence to RBI while atthe same time reserving the Central Governments right to issue directions to RBIfrom time to time in public interest. The management of RBI rests with the CentralBoard of Directors. The RBI is headed by the Governor who is appointed by theCentral Government for a term not exceeding five years and is eligible forreappointment.

1.8 An annual report on the working of RBI with detailed analysis of its annualaccounts and an assessment of the Indian economy is submitted to the CentralGovernment under Section 53(2) of the RBI Act. The RBI compiles two financialstatements viz. Weekly statement of its affairs and annual balance sheet as at 30June of each year in terms of Section 53 of the RBI Act, 1934 and transmits these tothe Central Government. The Central Government publishes these statements in theGazette of India. The RBI publishes fortnightly a consolidated statement containingaggregate liabilities and assets of all the scheduled commercial banks as per Section

43 of the RBI Act. The RBI brings out certain publications at regular intervals on thefinancial strength and performance of banking industry and state of economy. Thepublications include Banking Statistics, Report on Currency and Finance, Report onTrends and Progress of Banking in India (Section 36(2) of the Banking RegulationAct), Credit Information Review, and monthly RBI bulletin containing statistics onselective economic and banking indicators and weekly statistical supplements.

1.9 The RBI equips its officers with latest techniques of supervision through ongoingtraining programmes organised at its own staff colleges viz. Reserve Bank StaffCollege, Chennai; College of Agricultural Banking, Pune; Bankers Training College,Mumbai; and Institute for Development and Research of Banking Technology,

Hyderabad. Besides, the RBI regularly deputes its officers to training programmes,seminars and conferences conducted by international bodies, Central Banks of other

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countries and international organisations like Bank for International Settlements andthe International Financial Institutions.

1.10 On-going analysis of off-site returns is carried out in a computerisedenvironment. The RBI has initiated steps to move from Local Area Networking (LAN)

to Wide Area Networking (WAN) with a view to connect its Regional Offices andcommercial banks through VSAT based connectivity by December 2000.

1.11 The banking laws are reviewed and updated from time to time considering thechanging needs of the banking industry and economy. The Banking Regulation Actwas last amended in 1994. An expert committee set up in February 1999 on therecommendations of the Committee on Banking Sector Reforms is engaged in thetask of examining various banking laws and all relevant banking related legislations.The committee is expected to submit its recommendations by December, 1999.

1.12 The RBI has the necessary powers to issue licence to a company for carrying

on the business of banking. The RBI is vested with powers to issue guidelines onany issue relating to functioning of banks. This helps the Bank in laying downprudential guidelines for sound management of banks. It has issued severalmandatory guidelines on liquidity maintenance, capital adequacy, incomerecognition, asset classification and provisioning, connected lending and prudentialnorms on large exposures. The Banking Regulation Act vests powers in RBI toensure compliance with its provisions. Noncompliance with mandatory guidelinescan invite monetary and / or non-monetary penalties.

1.13 The Banking Regulation Act provides for explicit protection to the supervisorsunder Section 54. No suit or other legal proceeding shall lie against RBI or any of itsofficers for anything or any damage caused or likely to be caused by anything donein good faith or intended to be done in pursuance of the Banking Regulation Act.

1.14 RBI shares relevant information with overseas supervisors on request.Information from overseas supervisors is received with the understanding that thiswould remain confidential. Information needs of domestic regulatory bodies likeSecurities and Exchange Board of India (SEBI), National Bank for Agricultural andRural Development (NABARD), National Housing Bank (NHB), etc, are attended toon mutual understanding. A High level Committee on Capital Markets consisting ofGovernor of RBI, Chairman of SEBI and Economic Affairs Secretary of the Central

Government, serves as a forum for discussing common regulatory issues.

III. THE BANKING REGULATION ACT IN 1949

Banking Legislation Act Aims At

1. Protecting Interest Of Depositors

2. Ensuring Control Over Credit

3. Streamlining Procedures

4. Evolving Uniform Banking Practices

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5. Developing Banking On Sound Lines

Main Provisions Of Act

1. Built In Safeguards

2. Powers And Consequential Functions And Responsibilities Of Rbi.

3. Section 5 B Defines Business Of Banking As Accepting, For The

Purpose Of Lending Or Investment, Deposits Of Money From The

Public, Repayable On Demand Or Otherwise And Withdraw able By

Cheques, Drafts Or Otherwise.

IV.METHODS OF ONGOING BANKING SUPERVISION OFBANKING COMPANIES IN INDIA

Principle XVI: Instruments of Supervision

An effective banking supervisory system should consist of some form of both on-siteand off-site supervision.

The main instrument of supervision in India is the periodical on-site inspection ofbanks that is supplemented by off-site monitoring and surveillance. Since 1995, on-site inspections are based on CAMELS (Capital Adequacy, Asset Quality,Management, Earning, Liquidity and Systems & Controls) model and aim atachieving the following objectives:

i) Evaluation of banks safety and soundness,ii) Appraisal of the quality of Board and top management,iii) Ensuring compliance with prudential regulations,iv) Identifying the areas where corrective action is required to strengthen the bankv) Appraisal of soundness of banks assets,vi) Analysis of key financial factors such as capital, earnings, and liquidity anddetermine banks solvency,vii) Assessment of the quality of its management team and evaluation of the bankspolicies, systems of management, internal operations and control, andviii) Review of compliance with banking laws and regulations as well as supervisoryguidance conveyed on specific policies.

To ensure continuity in supervision, RBI also undertakes targeted appraisals ofspecific portfolios at control site, commissioned audits of specific areas by externalauditors and monitoring visits for follow-up or review of selected areas of concern.

RBI is gradually moving towards a risk-based supervisory framework that is basedon both off-site and on-site inputs. Pursuant to the new supervision strategyapproved by the BFS, the RBI has introduced a formal Supervisory ReportingSystem. The reporting is essentially prudential in content and tri-monthly in

periodicity. The total package of Supervisory Returns for commercial banks(designated DSB Returns) comprises 12 Reports (9 to be filed at Quarterly intervals,

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2 at half-yearly intervals and 1 at yearly interval). Analysis of the returns is done forindividual bank, peer group and industry as a whole. These analysis help in detectingearly warning signals.

Principle XVII: Supervisory Contact

Banking supervisors must have regular contact with bank management and thoroughunderstanding of the institutions operations.

17.1 The contact between supervisors and banks is almost continuous. Seniorexecutives at Regional office of RBI meet the bank management if serioussupervisory issues crop up. Senior Executives at Central Office of RBI meet annuallytop management of banks to discuss matters of supervisory concerns identifiedduring on-site inspection. The overall CAMELS rating is communicated to the bankmanagement. Supervisory concerns emanating out of off-site supervision are alsocommunicated to banks on an ongoing basis.

17.2 Meetings are also held with banks for various purposes like discussions onResource

Management. Banks are often consulted before introduction of major reportingchanges and senior bank officers are often associated with the working groups andcommittees setup by the RBI to examine / deliberate on regulatory / supervisoryissues. RBI Nominee Directors on the Boards of banks are also required to reportbimonthly on the important policy decisions taken by the bank in particularhighlighting supervisory issues, if any.

Principle XX: Consolidated Supervision

An essential element of bank supervision is the capability of the supervisors tosupervisethe banking group on a consolidated basis.

The on-site inspection reports of the banks include comments on earningperformance of the banks subsidiaries and joint ventures. In addition, the RBIconducts inspection of merchant banking subsidiaries of banks. The banks are

required to conduct internal audit / inspection of their subsidiaries as a measure ofcontrol over them. Periodical review notes on these subsidiaries put up to the banksBoard are sent to RBI.

Private sector banks are required to annex the balance sheet and profit and lossaccounts of their subsidiaries to the annual report of the bank. Public sector banksgenerally give a brief description of the performance of their subsidiaries in theDirectors report that forms part of the annual accounts of the bank. The question ofpublishing balance sheet and profit and loss account of subsidiaries as an annexureto the annual report of the public sector banks is also being examined in connectionwith the introduction of a system of consolidated supervision.

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Principle XXI: Adequate Records & Financial Statements

Bank supervisors must be satisfied that each bank maintains adequate recordsdrawn up in accordance with consistent accounting policies and practices thatenable the supervisor to obtain a true and fair view of the financial condition of the

bank and the profitability of its business and that the bank publishes on a regularbasis financial statements that fairly reflect its condition.

21.1 RBI is committed to enhance and improve increasing the levels of transparencyand disclosure in the annual accounts of banks. The formats for preparation offinancial statements are prescribed under Section 29 of the Banking Regulation Act.The financial statements are prepared based on accounting standards prescribed byInstitute of Chartered Accountants of India (ICAI) except those that have beenspecifically modified by RBI in consultation with ICAI keeping in view the nature ofbanking industry. The banks are mandated to disclose additional information as partof annual financial statements:

1. Capital Adequacy Ratio;2. Tier I ratio;3. Tier II ratio;4. Percentage of shareholding of the Government of India in

nationalised banks;5. Net NPL ratio;6. Amount of provision made towards NPLs and provisions

for income-tax for the year;7. Amount of subordinated debt raised as Tier II capital;8. Gross value of investments, provision for depreciation on

investments and net value of investments separately forwithin India and outside India;

9. Interest income as percentage to working funds;10.Non-interest income as a percentage to working funds;11.Operating profit as a percentage to working funds;12.Return on assets; business (deposits and advances) per

employee13.Profit per employee;14.Maturity pattern of certain assets and liabilities;15.Movement in NPLs;

16.Foreign currency assets and liabilities;17.Lending to sensitive sectors as defined from time to time.

Principle XXII: Supervisory Intervention

Banking supervisors must have at their disposal adequate supervisory measures tobring about timely corrective action when banks fail to meet prudential requirementssuch as minimum capital adequacy ratios when there are regulatory violations orwhere depositors are threatened in any other way. In extreme circumstances thisshould include the ability to revoke the banking licence or recommend its revocation.

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V. CENTRAL BAKING

Introduction to central banking

It is often said that central bankers have more power than the President, King,

Parliament or whatever nominal ruling body governs the state in question. They gainthis distinction for the simply reason that they control the money supply.

Origins of central banking can trace back to at least the 11th century, when theKnights Templar used their enormous treasury to form the first truly internationalbanking system. The Templars' credibility, and ability to protect depositors' funds,were such that they won the trust of monarchs across Europe. Crusade-boundnobles could deposit savings and withdraw funds at any branch in Europe through achecking system.

Central banking has evolved quite a bit in the thousand years since the Templers'

heyday, but the overall design remains the same. Chief among the central banker'sresponsibilities is securing investor confidence. The US Federal Reserve, forinstance, was created to rationalize the money supply after extreme deflationaryrecessions in the late 1800s, due to wild fluctuations in the price of gold. Ripples ofpanic would wipe out entire regions' banking industries as depositors withdrewfunds, forcing banks to close, defaulting on their obligations to other banks and inturn forcing those banks to close. A lender of last resort, the "Fed," was created. TheFed's weathering of all the crises, recessions and panics of the 20th century hasgiven it enormous credibility as a safe haven of capital from all over the world.

Central banks vary in the degree to which they are insulated from short-term politicalwinds. In the US, the Fed is mandated by Congress to have as its goals "fullemployment," low inflation, and steady growth of GDP, although in practice the Fedis largely autonomous. The Federal Reserve has three instruments with which toinfluence the money supply: open market operations, discount lending, and reserverequirements. The most frequently used of the three are open market operations.The FOMC meets 8 times a year to discuss the direction of their future operationsand their funds target rate. That number has historically been very important foreveryone from billionaire bankers calculating costs of leverage to blue-collar workersworried about their mortgages.

The Bank of England

The Bank of England (formally the Governor and Company of the Bank of England)

is the central bank of the United Kingdom and is the model on which most modern

central banks have been based. Established in 1694, it is the second oldest central

bank in the world (the oldest being the Bank of Sweden established in 1668). It was

established to act as the English Government's banker, and to this day it still acts as

the banker forHM Government. The Bank was privately owned and operated from

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its foundation in 1694. It was subordinated to the Treasury after 1931 in making

policy and was nationalised in 1946.

In 1997 it became an independent public organisation, wholly owned by the Treasury

Solicitor on behalf of the Government, with independence in setting monetary policy.[3][4][5]

The Bank has a monopoly on the issue of banknotes in England and Wales,

although not in Scotland, Northern Ireland, the Isle of Man, or the Channel Islands.[citation needed] The Bank's Monetary Policy Committee has devolved responsibility for

managing the monetary policy of the country. The Treasury has reserve powers to

give orders to the committee "if they are required in the public interest and by

extreme economic circumstances" but such orders must be endorsed by Parliament

within 28 days.[6]

The Bank's Financial Policy Committee held its first meeting in June2011 as a macro prudential regulator to oversee regulation of the UK's financial

sector.

The Bank's headquarters has been located in London's main financial district, the

City, on Thread needle Street, since 1734. It is sometimes known by the

metonym The Old Lady of Thread needle Streetor simply The Old Lady. The current

Governor is Sir Mervin King, who took over on 30 June 2003 from Sir Edward

George. As well as its London offices, the Bank of England also has secondary

offices in Leeds.

The Peels Act of 18844

Sir Robert Peel, 2nd Baronet (5 February 1788 2 July 1850) was a

British Conservative statesman who served as Prime Minister of the United

Kingdom from 10 December 1834 to 8 April 1835, and again from 30 August 1841 to

29 June 1846. Peel, whilst Home Secretary, helped create the modern concept of

the police force, leading to officers being known as "bobbies" (in England) and

"Peelers" (in Ireland) to this day. Whilst Prime Minister, Peel repealed the CornLaws and issued the Tamworth Manifesto, leading to the formation of the

Conservative Party out of the shattered Tory Party.

THE RESERVE BANK OF INDIA

The Reserve Bank of India was set up on the basis of the recommendations of the

Royal Commission on Indian Currency and Finance also known as the Hilton-Young

Commission.

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The Reserve Bank of India was established on April 1, 1935 in accordance with the

provisions of the Reserve Bank of India Act, 1934. Though initially RBI was privately

owned, it was nationalized in 1949. Its central office is in Mumbai where the

Governor of RBI sits. RBI has 22 regional offices and most of them are located in

state capitals. The Reserve Bank of India also has three fully owned subsidiaries:National Housing Bank (NHB), Deposit Insurance and Credit Guarantee Corporation

of India (DICGC), Bharatiya Reserve Bank Note Mudran Private Limited

(BRBNMPL).

The functions of Reserve Bank are governed by central board of directors. The

board is appointed by the Government of India. The directors are nominated /

appointed for a period of four years. As per the Reserve Bank of India Act there are

Official Directors and Non-Official Directors. The Official Directors are appointed by

the government and include Governor and Deputy Governors of RBI. There cannot

be more than four Deputy Governors. Non-Official Directors are nominated by thegovernment. These include ten Directors from various fields and one government

official. Apart from these, there are four other Non-Official Directors, one each from

four local boards in Mumbai, Kolkata, Chennai and New Delhi.

RBI Act, 1934 preamble

Whereas it is expedient to constitute a RBI to regulate the issue of Bank notes and

the keeping of reserves with a view to securing monetary stability in India and

generally to operate the currency and credit system of the country to its advantage;

And whereas in the present disorganization of the monetary systems of the world it isnot possible to determine what will be suitable as permanent basis for the Indian

monetary system; But whereas it is expedient to make temporary provision on the

basis of the existing monetary system, and to leave the question of the monetary

standard best suited to India to be considered when the international monetary

position has become sufficiently clear and stable to make it possible to frame

permanent measures

RBI was Established in 1935 Overtook Currency issue from central government of

India; and Credit control from the then Imperial Bank of India

RBI A Regulator to the Indian Banking System:

1. Formulate, Implement and Monitor the monetary Policy

2. Manage the foreign exchange reserves

3. Prescribe Exchange Control Norms to facilitate external trade and

payment

Banks in India are governed under extant guidelines viz., Banking RegulationAct, 1949

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Current Thrust

1. Continuing financial reforms for induction of best practices and

technological changes

2. Transparency, diversification of ownership and strong corporategovernance practices to mitigate prospects of systemic risks

3. To improve efficiency parameters of SCBs

Policy Trends

1. Roadmap for entry of foreign Banks

2. Implementation of Basel II framework:

3. Promoting Banking consolidation

Other Operational Policies

Main Functions of RBI

Reserve Bank of India is the main monetary authority of the country. It formulates,

implements and monitors the monetary policy and thereby plays a key role in

maintaining price stability and ensuring adequate flow of credit to productive sectors.

RBI is the regulator and supervisor of the financial system in the country. It

prescribes broad parameters of banking operations within which the country's

banking and financial system functions. It manages the foreign exchange of the

country. Performs merchant banking function for the central and the state

governments; also acts as their banker. Maintains banking accounts of all scheduled

banks. Issues and exchanges or destroys currency and coins not fit for circulation.

1. Bank of Issue

2. Banker of Government

3. Bankers Bank and Lender of the Last Resort

4. Controller of Credit

5. Custodian of Foreign Reserves

6. Supervisory Functions

7. Promotional Functions

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Network of Currency Chests

Management of Currency

Currency Management essentially relates to planning, designing, issue and

withdrawal of currency, ensuring its integrity, availability and the maintenance ofquality. The Department of Currency Management (DCM) of the Reserve Banklocated at Central Office, Mumbai, takes policy decisions on the designs of banknotes, forecasts the demand for notes and coins, ensures the smooth distribution ofbank notes and coins throughout the country, arranges to withdraw unfit notes,administers the RBI Note Refund Rules and reviews/rationalizes the worksystem/procedures at the Issue Office on ongoing basis. The operational work isconducted by the Issue Departments of the Bank with responsibility for managing theinventory, distribution and servicing of currency in its respective issue circles.

(ii) The Reserve Bank is responsible for issuing coins and notes to the public ondemand and for maintaining the quality of the notes issued. Reserve Bank'sresponsibility thus is not only to put currency into such other denominations of notesand/or coins as may be required by the public. With a view to mitigating the hardshipto the public in genuine cases, the Bank arranges to make refund of the value ofmutilated notes as per the Note Refund Rules.

2. Currency Chests

In order that the Bank's obligations may be satisfactorily discharged without recourseto extensive and frequent physical remittance of notes and coins between various

centres, the Bank maintains currency chests of its own at treasuries and branches ofthe banks at all important centres. In the State of Orissa, there are 130 Currencychests, the list of which is provided in the end. These currency chests are intendedto facilitate the distribution, exchange and remittance of notes, including one rupeenotes and rupee coins and small coins.

(ii) RBI has launched a special drive under its clean note policy to withdraw allsoiled and mutilated notes from the members of public and put in its place fresh andclean notes. In order to facilitate the members of public, to exchange such notes,RBI has delegated powers to all the 130 currency chest branches in Orissa toexchange soiled, torn, damaged/ mutilated/ defective notes. Soiled and cut notes

should also be accepted over bank counters in payment of Government dues and forcredit of accounts of the public maintained with banks. Reserve Bank of India,Bhubaneswar has opened three special counters, two for exchange of soiled notesof all denominations and one solely for exchange of mutilated notes. Notes whichhave turned extremely brittle or badly burnt, charred or inseparably stuck up togetherand therefore can not withstand normal handling, are also accepted at RBIBhubaneswar for adjudication under a Special Procedure.

3. Facilities/ Services at the Currency Chest Branches

Salient features of genuine notes are required to be displayed at bank branches for

information of public. The bank branches should have adequate number of dualdisplay note counting machines provided at the payment counters for the benefit of

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customers. Stapling of currency note packets has been done away with andinformation on non stapling of note packets should be displayed on the noticeboards. Citizens' Charter for exchange of notes and coins should be displayed atnotice board for information and benefit of common persons. All the notice boardsare trilingual.

(ii) Exchange value of soiled notes will be paid in coins and/or notes ofdenomination Rs.10/- and above, across the counter as per extant rules. While theintention of the RBI is to mop up all such soiled/mutilated Re.1/-, Rs.2/- and Rs.5/-notes and above in exchange, all Re.1/-, Rs.2/- and Rs.5/- notes would continue tobe legal tender. Any note with slogans and message of a political nature writtenacross it ceases to be a legal tender and a claim on such a note will be rejected.Similarly, notes which are disfigured may also be rejected. The notes which arefound to be deliberately cut or tampered with, if presented for payment of exchangevalue, will be rejected.

(iii) The banks have been advised to direct all their branches to accept coins of alldenominations tendered at their counters either for exchange or for deposit inaccounts. However, as accepting coins packed in polythene sachets of 100 eachwould be more convenient, the banks have been advised to keep such sachets atthe counters and make them available to the customers. A notice to this effectshould be displayed suitably inside as also outside the branch premises forinformation of the public. RBI, Bhubaneswar is operating two counters for issue ofcoins, one for bulk issue and the other for issue in small pouches. This apart, a coinvending machine is installed in its premises which can be used by the public to getcoins in exchange for notes.

(iv) All the currency chest branches are required to display at their branch premises,at a prominent place, a board indicating the availability of note exchange facility withthe legend, "MUTILATED NOTES ARE ACCEPTED AND EXCHANGED HERE".Banks should ensure that all their designated branches provide facilities forexchange of notes and coins and place details of designated branches in publicdomain.

(v) RBI has devised a scheme of penalties for those banks which refuse toexchange soiled/mutilated notes tendered by any member of public. All members ofpublic are advised to avail of the aforesaid facilities to the fullest extent. Any

suggestion / complaint / grievance as regards exchange of soiled notes and non-availability of coins/notes (denomination of Rs.10/- and above) may be addressed toRBI, Bhubaneswar.

RBI is located only in 18 places for currency operations

Distribution of notes and coins throughout the country is done through designated

bank branches, called chests

Chest is a receptacle in a commercial bank to store notes and coins on behalf of the

Reserve Bank

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Deposit into chest leads to credit of the commercial banks account and withdrawal,

debit

Regulatory and supervisory frame work of RBI over the Fis

A paradigm shift in banking - Any where banking; Any time banking

Governance and ownership of banks- Govt. ownership to Mixed ownership

RBIs Approach - Diversified ownership in private sector; Important shareholders

are fit and proper; Directors and CEOs are fit and proper; Private Sector Banks

maintain minimum capital as 200 crores initially and 300 crores with in 3 years;

Policy and processes are transparent and fair

VI. MONETARY POLICY

Monitory policy is the policy employs by the Central Bank to control credit for fulfillingthe goal of monetary authority to maintain full employment and price stability.

Monetary policy to encourage saving largely take the form of the development of

financial intermediaries. It can encourage those with a productive surplus to save by

taking the risk out of lending directly to investors, and of the development of branch

banking which can tap small savings. Because of the law of large numbers, financial

intermediaries are also able to borrow short and lend long, which is advantageous to

lenders and borrowers alike. Monetary policy to encourage saving may also attempt

to encroach on the unorganised money market, which lends mainly for consumption

purposes. Paradoxically the development of the organised money market can bothlower average interest rates in the economy at large and raise the level of saving

because the unorganised money market charges very high interest rates and lends

mainly for consumption purposes, whereas in the organised money market interest

rates are lower and lending is more for investment purposes

A well-developed financial system has four main requisites, each of which can

contribute to the process of financial deepeningand to raising the level of saving.

These four requisites comprise: the monetisation of the economy and the

replacement of barter as a is a by replacing barter objects, or commodity money

which may be costly to produce. It also saves time, which is a resource if themarginal product of labour time is positive, by avoiding the double coincidence of

wants, necessitated by barter. Money generates resources by facilitating exchange

and thereby permitting the greater division of labour and specialisation.

Monetary expansion to meet the increased demand for money per unit of output and to

facilitate the needs of trade in a growing economy does not imply inflation. This is easily seen

taking the where M is the nominal money supply, V is the income velocity of

circulation of money, Kd (=1/V) is the demand to hold money per unit of money

income, P is the average price of final goods and services, and Y is real income.

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Historically, the growth of the money economy has also been a powerful

stimulus to the development of banking and credit mechanism which themselves can

act as a stimulus to saving and investment. When the range of financial assets is

narrow, saving tends to take the form of the acquisition of physical assets. While in

principle this should not mean that the level of saving is reduced below what it mightotherwise be, in practice and it depends on how sellers of physical assets dispose of

the sale proceeds. If a portion of the proceeds is consumed, the saving of one

person is offset by the dissaving of another, and fewer resources are released for

investment than if financial assets had been acquired, issued by financial institution

with an investment function. This is a major reason why the statistical on saving and

investment in developing countries understate the saving and investment capacity of

these countries.

The development of a national banking system, comprising a central bank, a

commercial banking system and special development banks, is one of the firstpriorities of development planning. The function of a central bank include the

following: The issue of currency and lending to government which can transfer real

resources to government, the development of a fractional reserve banking system

through which it can provide liquidity and control credit of other financial

institutions, especially institution to provide long-term loan finance for development

and to provide a market for government securities; the maintenance of a high level

of demand to achieve capacity growth; and the application of selective credit control

if necessary in the interest of developing particular sector of the economy. The

stabilisation role of the central bank is essentially secondary to its development role.

Stabilisation is particularly difficult in a developing country where credit control, the

main instrument of stabilisation policy, is ill-developed.

Monetary Policy Objectives

Twin Objectives

maintaining price stability

ensuring availability of adequate credit to productive sectors of the economy to

support growth

Basic Thrust

1. Ensure a monetary and interest rate environment enabling continuation

of the growth momentum consistent with price stability and inflation

expectations

2. Focus on credit quality and financial market conditions to support

export and investment demand in the economy

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3. To respond swiftly to evolving global developments.

As a monetary authority, a central banks primary objective is to ensure

macroeconomic financial stability in general and external stability in particular. As a

custodian, the central banks main objectives are to ensure liquidity, safety and yield

on deployment of reserves

Direct Instruments

Administered interest rates

Reserve requirements

Selective credit control

Indirect Instruments

Open Market Operations Reserve Bank controls money supply by buying

and selling government securities, or other instruments

Market Stabilization Scheme (MSS) Government of India dated

securities/Treasury Bills are being issued to absorb enduring surplus

liquidity.

Liquidity Adjustment Facility (LAF)

Repo Auctions and

Reverse Repo Auctions,

Cash Reserve Ratio (CRR)

Minimum amount that commercial banks must keep as cash reserves

LAF has emerged as the tool for both liquidity management and also as a signalling

devise for interest rate in the overnight market.

Monetary Policy Key Highlights

MID TERM REVIEW

Repo Rate increased to 7.25% from 7% / Bank Rate at 6% / Reverse repo

rate under the LAF at 6%/ CRR at 5% unchanged (to increase by 0.5% in 2

stages)

GDP growth forecast: 8.0 % (2006-07) / Inflation: 5.0-5.5 % (2006-07)

AN ASSESSMENT

Real GDP 9.2% during Jul-Sept 06 & 9.1% in the H1 06-07.

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Y-o-Y increase in non-food bank credit up 30.1 % (Nov24,06)

YoY M3 growth at 19.4 % (Nov24,06)

YoY expansion in reserve money 17.5 % (Nov24,06)

YoY WPI inflation - 5.3 % (Nov25,06)

Liberal Policy

Borrowers eligible for additional ECBs of US $ 250 million (Avg

maturity > 10 years)

Foreign exchange earners to retain upto 100 % of forex earnings

Allow prepayment of ECB up to US $ 300 million (without prior

approval)

Existing limit of US $ 2 billion on investments in Government securities

by FIIs enhanced to US $ 3.2 billion by March 31, 2007.

Extant ceiling of overseas investment by MFs of US $ 2 billion

enhanced to US $ 3 billion

VII. SUPERVISION AND SUPERVISORY POLICY OF RBI

The Board for Financial Supervision (BFS)was constituted in 1994

1. Foreign exchange Banks Road Map Operate on three channels :

branches; a wholly owned subsidiary; subsidiary with an aggregate foreign

investment up to a maximum of 74% in a private bank

2. Payment of dividends- RBI has permitted banks to declare dividend

from 2005 as: capital to risk weighted of at least 9% for proceeding 2

completed years; net non performing assets of less than 7%- over all dividend

shall not exceed 40% subject to SEBI

3. Marginal Autonomy for PSBs- In 2005: Boards of PSBs could enjoy more

freedom; revise their guidelines; Additional autonomy on their HR policies;

prescription of standards for Banking business; fix accountability

4. Mergers and Amalgamation of Banks norms for buying and selling of

shares; proposal for merger; determination of SWAP ratios; disclosures;

schemes for BFIs & NBFIs; RRBs State sponsorship- Ministry of Finance

5. Insurance Business- subject to IRDA- CBs to have Insurance business as a

joint venture on a risk participation basis; to undertake insurance business as

agents of Insurance Companies on a fee basis; without any risk participation

by banks and their subsidiaries.

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The supervisory strategy of RBI involves three approaches:

1. Off-shore monitoring and surveillance 1995 FIs not accepting public

deposits but have assets of Rs.500crores and above would be subject to off-

shore site supervision of RBI; Online connectivity has to be given to Regional

Offices and HO of Banks

2. Monitoring of Frauds- 2002 to look in to the existing mechanism for vigilance

management in their institutions and remove the loopholes; Technical paper

on frauds in 2004; separate Fraud Monitoring Cell; Fraud Monitoring and

Reporting System

3. Modification In Format of Declaration Of Indebtedness from Statutory

Auditors-

4. RBI and the financial Systems- the role of Central bank regulatory,promotional and financial roles- NABARD & IDBI control over money market

and capital market- interest rate structure RBI as the leader- RBI and Banks

Functions of RBI-

1. Traditional functions: as lender of last resort, as banker to banks,

banker to Govt., note issue authority- Ministry of Finance - Govt. of India -

currency chests-

2. Developmental functions: to increase the volume of investment

and change the pattern of financial flows to promote investment; to havebalanced viable financial system- Credit control and RBI RBI as a leader of

financial system RBI and Indigenous banks

The Bill Market schemes: old (1952) made advance to scheduled

banks against promissory notes and new (1970)- 90 days RBI on money

market and capital market RBI and interest rate structure to organized &

unorganized sectors : by changing Bank Rates, fixation of minimum and

maximum lending rate, changes in treasury bills rate, credit policy, OMOs

Monetary policy of RBI RBI and Commercial banks scheduled banks

which includes cooperative banks & RRBs, Non-scheduled banks DepositInsurance corporation in 1962, regulation regarding paid up capital as 5-10

lakh, opening new branches, control over management and inspection,

deposits to RBI, voluntary and compulsory amalgamation, liquidation.

VIII. FOREIGN TRADE POLICY OF RBI - PREAMBLE

For India to become a major player in world trade, an all encompassing,

comprehensive view needs to be taken for the overall development of the

countrys foreign trade. While increase in exports is of vital importance, we

have also to facilitate those imports which are required to stimulate oureconomy. Coherence and consistency among trade and other economic

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policies is important for maximizing the contribution of such policies to

development. Thus, while incorporating the existing practice of enunciating an

annual Exim Policy, it is necessary to go much beyond and take an integrated

approach to the developmental requirements of Indias foreign trade. This is

the context of the new Foreign Trade Policy.

Objectives:

Trade is not an end in itself, but a means to economic growth and national

development. The primary purpose is not the mere earning of foreign

exchange, but the stimulation of greater economic activity. The Foreign Trade

Policy is rooted in this belief and built around two major objectives. These are:

(i) To double our percentage share of global merchandise trade within the

next five years; and

(ii) To act as an effective instrument of economic growth by giving a thrust to

employment generation.

Governed by Directorate General of Foreign Trade under Ministry of Commerce

& Industry

1. Mandate for Comprehensive overall development of the Indias foreign trade.

2. GoI announced a bold Foreign Trade Policy for five years (2004-2009)

a. double India's share in world trade within five years, and

b. to focus on the generation of additional employment in the process

3. In spirit of WTO requirements - Annual Budget announcements by the

Ministry of Finance have consistently and progressively reduced peak excise

and customs duty

Exports and Imports shall be free, except in cases where they are regulated by the

provisions of this Policy or any other law for the time being in force.

Market Access Initiative (MAI) scheme is intended to provide financial assistance formedium term export promotion efforts with a sharp focus on a country and product.

Duty Exemption & Remission Schemes

Special Focus Initiatives Thrust on agriculture, handlooms, handicraft, gems &

jewellery, leather and Marine sectors.

Funds to be earmarked under Agri Process Zone

Exports Promotion Capital Goods Scheme (EPCG)

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Export oriented units (EoUs), Electronics Hardware Technology Parks (EHTP),

Software Technology Parks (STP) and Bio-technology parks (BTP)

Special Economic Zones

Free Trade & Warehousing Zones

Deemed Exports

IX. COMMERCIAL BANKING SYSTEM IN INDIA

History of Banking in India

Banking in India has a very old origin. It started in the Vedic period where literature

shows the giving of loans to others on interest. The interest rates ranged from two to

five percent per month. The payment of debt was made pious obligation on the heir

of the dead person.

Modern banking in India began with the rise of power of the British. To raise the

resources for the attaining the power the East India Company on 2nd June 1806

promoted the Bank of Calcutta. In the mean while two other banks Bank of Bombay

and Bank of Madras were started on 15 th April 1840 and 1st July, 1843 respectively.

In 1862 the right to issue the notes was taken away from the presidency banks. The

government also withdrew the nominee directors from these banks. The bank of

Bombay collapsed in 1867 and was put under the voluntary liquidation in 1868 and

was finally wound up in 1872. The bank was however able to meet the liability of

public in full. A new bank called new Bank of Bombay was started in 1867.

On 27th January 1921 all the three presidency banks were merged together to form

the Imperial Bank by passing the Imperial Bank of India Act, 1920. The bank did not

have the right to issue the notes but had the permission to manage the clearing

house and hold Government balances. In 1934, Reserve Bank of India came into

being which was made the Central Bank and had power to issue the notes and wasalso the banker to the Government. The Imperial Bank was given right to act as the

agent of the Reserve Bank of India and represent the bank where it had no braches.

In 1955 by passing the State Bank of India 1955, the Imperial Bank was taken over

and assets were vested in a new bank, the State Bank of India.

Bank Nationalization:

After the independence the major historical event in banking sector was the

nationalization of 14 major banks on 19 th July 1969. The nationalization was deemed

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as a major step in achieving the socialistic pattern of society. In 1980 six more banks

were nationalized taking the total nationalized banks to twenty.

Structure of schedule commercial banks:

The composition of the board of directors of a scheduled commercial bank shallconsist of whole time chairman. Section 10A of the Banking Regulation Act, 1949

provides that not less than fifty-one per cent, of the total number of members of the

Board of directors of a banking company shall consist of persons, who shall have

special knowledge or practical experience in respect of one or more of the matters

including accountancy, agriculture and rural economy, banking, co-operation,

economics, finance, law, small-scale industry, or any other matter the special

knowledge of, and practical experience in, which would, in the opinion of the

Reserve Bank, be useful to the banking company. Out of the aforesaid number of

directors, not less than two shall be persons having special knowledge or practical

experience in respect of agriculture and rural economy, co-operation or small-scale

industry.

Besides the above the board of the scheduled bank shall consist of the directors

representing workmen and officer employees. The Reserve Bank of India and the

Central Government also has right to appoint their nominees into the board of the

banks.

Present scenario of the banks in India:

Banks are extremely useful and indispensable in the modern community. The bankscreate the purchasing power in the form of bank notes, cheques bills, drafts etc,

transfers funds bring borrows and lenders together, encourage the habit of saving

among people.

The banks have played substantial role in the growth of Indian economy. From the

meager start in 1860 the banks have come to long way. At present in India there are

20 nationalized banks, State bank of India and its seven Associate banks, 21 old

private sector banks and 8 new private sector banks. Besides them there are more

than 30 foreign banks either operating themselves or having their branches in India.

The statistical table hereunder shows the financial position of the banks as on31.03.2005.

Structure of schedule commercial banks:

The composition of the board of directors of a scheduled commercial bank shall

consist of whole time chairman. Section 10A of the Banking Regulation Act, 1949

provides that not less than fifty-one per cent, of the total number of members of the

Board of directors of a banking company shall consist of persons, who shall have

special knowledge or practical experience in respect of one or more of the matters

including accountancy, agriculture and rural economy, banking, co-operation,

economics, finance, law, small-scale industry, or any other matter the specialknowledge of, and practical experience in, which would, in the opinion of the

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Reserve Bank, be useful to the banking company. Out of the aforesaid number of

directors, not less than two shall be persons having special knowledge or practical

experience in respect of agriculture and rural economy, co-operation or small-scale

industry.

Besides the above the board of the scheduled bank shall consist of the directorsrepresenting workmen and officer employees. The Reserve Bank of India and the

Central Government also has right to appoint their nominees into the board of the

banks.

Present scenario of the banks in India:

Banks are extremely useful and indispensable in the modern community. The banks

create the purchasing power in the form of bank notes, cheques bills, drafts etc,

transfers funds bring borrows and lenders together, encourage the habit of saving

among people.The banks have played substantial role in the growth of Indian economy. From the

meager start in 1860 the banks have come to long way. At present in India there are

20 nationalized banks, State bank of India and its seven Associate banks, 21 old

private sector banks and 8 new private sector banks. Besides them there are more

than 30 foreign banks either operating themselves or having their branches in India.

The statistical table hereunder shows the financial position of the banks as on

31.03.2005.

The banks in India are operating through 55530 branches. All the banks together

had the net worth of Rs. 149385 crores as on 31 st March, 2005. The banks also hadthe deposit base of Rs. 1836985 crores and the advances of Rs. 1151113 crores

taking the total business to Rs. 2988098 crores. During the year 2004-05 the banks

had earned the interest income of Rs. 154761 crores. The average net NPA ratio of

the banks was also less 3.84% in year 2005.

Classification of Banks can be Done in Many Ways

Based on Functioning

1. Commercial Banks

2. Co-operative Banks

3. Development Banks

Built In Safeguards Relate to :

1) Organisation

2) Management

3) Operations Of A Banking Company

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1) Permitted Business

2) Holding Immovable Property

3) Formation Of Subsidiary Companies

4) Use Of Word Bank, Banking Company, Banker And Banking

5) Paid Up Capital And Reserves

6) Change Of Name

Section 5 B of Act Covers Primary Functions:

Section 6 Spells Out Other Types Of Banking Business, A Banking Company

Can Undertake.

1) Primary Functions

2) Agency Functions

3) General Utility Functions

2. Acceptance Of Deposits

3. Lending Money

4. Borrowing Money

5. Making Investments

6. Collection And Payment Of Cheques

7. Collection And Payment Of Bills

8. Remittance Of Funds

9. Collection Of Government Taxes

10.Undertaking Administration Of Estates As Executors And Trustees.

Current Number of Nationalized Banks:

There are 26 Nationalized Banks in the country at present. They are as follows:

1. Allahabad Bank2. Andhra Bank3. Bank of Baroda4. Bank of India5. Bank of Maharashtra

6. Canara Bank7. Central Bank of India

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8. Corporation Bank9. Dena Bank10. IDBI Bank Ltd.11. Indian Bank12. Indian Overseas Bank

13. Oriental Bank of Commerce14. Punjab & Sind Bank15. Punjab National Bank16. Syndicate Bank17. UCO Bank18. Union Bank of India19. United Bank of India20. Vijaya Bank

State Bank Group

1. State Bank of Bikaner & Jaipur2. State Bank of Hyderabad3. State Bank of India4. State Bank of Mysore5. State Bank of Patiala6. State Bank of Travancore

State Bank of Indore has merged with SBI from August 26, 2010.

Current Number of Old Private Banks

There are 14 Old Private sector Banks in the country as follows:

1. Catholic Syrian Bank Ltd.2. City Union Bank Ltd.3. Dhanalakshmi Bank Ltd.4. Federal Bank Ltd.5. ING Vysya Bank Ltd.6. Jammu & Kashmir Bank Ltd.7. Karnataka Bank Ltd.8. Karur Vysya Bank Ltd.

9. Lakshmi Vilas Bank Ltd.10. Nainital Bank Ltd.11. Ratnakar Bank Ltd.12. SBI Commercial & International Bank Ltd13. South Indian Bank Ltd.14. Tamilnad Mercantile Bank Ltd.

The number of the old Private Banks in India was 15 until recently and the latestreports from RBI (2009-10) show this 15. The Bank of Rajasthan Ltd has recentlymerged with ICICI Bank Ltd.

Current Number of New Private Banks

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There are 7 New Private sector Banks in India as follows:1. Axis Bank Ltd.2. Development Credit Bank Ltd3. HDFC Bank Ltd.4. ICICI Bank Ltd.

5. IndusInd Bank Ltd.6. Kotak Mahindra Bank Ltd.7. Yes Bank Ltd

Current Number of Foreign Banks

As of end of 2009, there were 32 Foreign Banks in India with 293 branches. 43foreign banks were operating in India through representatives ofoffices.

Under the WTO agreements, the Reserve bank of India has to allow a minimum of

12 Branches of all the foreign banks to be opened in a year

Various Types of banking services:

The flow chart below shows the various types of banking services:

Land Mortgage IFCIRural Credit IRBI Mutual Funds

Indutrial Dev. SFCs Pvt. NBFC Housing Finance HDFC

EXIM Bank SIDBI& NABARD

Commercial

Banks

Specialized

banks

Institutional

banks

Non Banking

Financial

Institutions

Nationalis

ed banks

(20)

SBI and

Associate

Banks

Private

Sectors

Banks

Foreign

Banks

Oldprivate

sector

banks

Newprivate

sector

banks

CENTRAL BANK

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Future is bright:

The Information Technology (IT) is becoming an important component of the bankingsector. The customers have become more demanding and they need value addedservices from the banks. The foreign banks have raised the expectations of thecustomers causing the bank to invest strongly on IT. The Indian banks have startedto meet the expectations of the people by opening both onsite and offsite ATMs.Banks have also started tele-banking, anytime/anywhere banking, mobile bankingand Internet banking to give the facilities to the customers. Banks have alsofollowing the RBI sponsored technology programmes like mail messaging, Electronicfund transfers (EFT), Structured Financial Messaging System (SFMS), (Real TimeGross Settlement (RTGS), Centralized Fund Management System (CFMS) andNegotiated Dealing System / Public Debt Office (NDS/PDO).

Banks have been given more teeth to tackle the Non performing assets by passingthe Securitization and Reconstruction of Financial Assets and Enforcement ofSecurity Interest Act, 2002. Under this Act, the banks can take over the assets of thedefaulters either by themselves or with the help of Court. The power is in addition tothe power to recover through the Debt Recovery Tribunal. The Asset ReconstructionCompanies have been formed which also take over the distress assets from thebanks.

Conclusive Remarks

Banking Sector in India is likely to undergo a major change. This change will be inthe form of mergers and acquisitions and takeovers. The State Bank of India may

merge all its associate banks with itself to make a one bank. The banks based in

South India may look for a bank in North India to have presence in North. Similarly

banks in North may look for banks in South to increase its area of operations.

Consolidation will be the key to the banking sector in future.

X. THE STRUCTURE OF FINANCIAL MARKET

In a closed economy there exists commodity markets and financial markets.A

financial system comprise creation of money and credit through financial

intermediaries and financial market. Financial market envisages all of the

transactions of financial claims whether long term or short term securities. Securities

represent a financial claim on the issued, which are paper assets in the hands of

investors. They include commercial paper, treasury bills, certificate of deposits

which are short term in character. The long- term securities are Govt promissory

notes, public

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sector undertakings bonds, equities of business corporations and debentures of

corporate sector. Besides securities there are other financial claims such as

guarantees, mortgages, and foreign currencies. Thus, the financial market include

Securities Market and market for Financial Claims.

The securities markets are broadly divided into Money Market and CapitalMarket.Following figure shows the structure of financial markets.

Financial Markets

Securities Market Market for other Financial Claims

Money Market Capital Market Financial Mortgages

Guarantees Market

Market

Call Money Market. Bill Market Foreign Exchange

Treasurey Commercial Market

bill Market Bills Market

Primary Markets Secondary MarketsGoverment Industrial Goverment Industrial

Securities Securities Securities Securities

Market market Market market

Securities Market

A financial market deals with securities and other financial claims. Securities are of

two types, viz, short term securities and long term securities. Money Marketfacilitates short term securities and Capital Market deals long term securities.

Money Market

Money market is an association of brokers, commercial banks, discount houses,

business men ,investors through which short term funds are transacted to meet the

temporary needs of small investors .It never deals money but exchange funds such

as commercial papers, treasury bills, bank calls or call loans etc.Major constituents

of money market are call money markets and bills markets.

Call money market

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They are markets for call loans which should be repaid at call or on demand .

A call represents the demand made by the lenders of the money and they are

repayable form one to fourteen days. Call loans are referred as money at short

notices. Usually call loans are provided by the commercial banks form their cash in

hand .They are very sensitive to Central Bank policies . In many countries call loansare used for inter bank transactions, plays in bill market , stock exchanges, bullion

markets and individual merchants deal with foreign trade

Bill market

Bill market refers to trading on short term bills of Govt and private companies.

The market of such bills range from three to six months. Bill market is classified into

treasury bill market and commercial bill market. Treasury bills market deals in

treasury bills or promissory notes issued by the Govt. They are finance bills arising

goods and represent claims in Govt with out any endorsement. The Govt guarantees

on such bills make them highly liquid. In India the maturity of treasury bills has raisedfrom 90 days to 182 days, and most probably they are called as gilt- edged

securities. At the same time, commercial bills market deals with commercial papers,

or bills of exchange issued by companies. A bill of exchange denotes a

negotiable self liquidating paper originated from short term accommodation. The bills

of exchange are worth discounting before maturity and invites trading on them based

on market rates prevailing over regions and bank rates. These bills are brought to

the money market by professional bill brokers who gain commission with their deal ofbills. Commercial banks are a major buyer of commercial papers.

The Activities of Brokers and Dealers in Money Market

Brokers and dealers of securities represent a substantial source of demand

for short term funds. Dealers need funds for financing their investors of securities

and brokers need funds to relent to their customers who wish to borrow money to

finance stock purchases. Suppose an investor is in need of a fund will approach to a

broker. The broker immediately arrange it or inform the source of a fund. After some

negotiations the borrower gets a fund or bill from the possession and it is then

presented to the commercial bank for discount. Since the bill is self liquidating in

nature, all the parties are trusted in its use or transaction .But the activities in money

market depends upon the level of business activities. It is only in advanced nations

that the facilities of money market are commonly available. In the case of less

developed countries the actions in money market are limited with the absence of an

organised bill market. So the essential conditions of developed money market are:

organised commercial banking system, presence of a central bank , availability credit

instruments, the existence of sub markets, availability of funds and organised

trading activities.

Capital Market

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Capital market is the market for long term funds. Many firms, households and

Govt. save more than they invest and such surpluses are transferred to those who

have deficits. The transfer of long term funds is done through a set of institutions,

securities markets together with a set of financial intermediaries and specialised

agencies. Collectively these markets, institutions and firms are called the capitalmarkets . House holds, firms and Govt. operate in the capital market both as

borrowers and lenders. Capital market can be classified as primary and secondary

market on the basis of source of origin of the securities.

Primary Market

Primary market is termed as the new issue of shares and securities to the

public. Securities issued for the first time are offered through the primary market.

Issuers of securities such as Govt public sector undertakings or corporate sector

may approach the public through primary market. A large number of intermediary

institutions such as merchant bankers, under writers, brokers and commercial banksundertake intermediary between the issuer of securities and the public. The issue in

primary market is called as public issue where people can buy original shares of

companies.

Secondary market

The secondary markets are meant for trading old securities. It is usually

called as stock exchanges. Once the investor purchases new issue of bonds or

shares from primary market they may wish to sell it at a profit. Since trading of

shares accompany with speculation in stock exchanges, investors buy and sell old

shares and securities. On the basis of issues in the secondary market, industrial

securities, Govt securities and financial institution's securities are exchanged. The

securities in stock exchange include equity shares, preference shares and

debentures or bonds . The principal objectives of stock exchanges are to provide

liquidity to the existing securities and to facilitates capital requirements to joint stock

enterprises. Most of the deals in secondary markets are with brokers. They include

commission brokers, floor brokers, taravaniwalas and Arbitragerers. Conditions in

stock exchanges are commonly classified as bullish orbearish, depending upon the

general level of prices. A bull is a person on the stock exchange market who holds

large number of shares and when price increases he opens the sale of shares. Abear is a person on the stock market who wish to buy shares when share prices are

lower. However the most common type of stock exchange is Over the Counter

Exchanges (OTC), where buying and selling of shares are held at

the counter. The securities in the capital markets are Government securities and

industrial securities.

Government Securities Market

In the Government Securities Market trading on securities issued by Central,

State and local Governments are held. The short term Government securities aretermed as guilt-edged securities. Apart form Government agencies issuing in

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securities, other institutions such as Central Bank, leading commercial banks, co-

operative banks, the LIC and the like financial intermediaries do business in

Government securities market. Trusts, individual joint stock companies, local

authorities etc, buy and sell Government securities. But such securities are dealing

in the OTC market where the activities of brokers are limited on account of theabsence of speculation and forward deals.

Industrial Securities Market

The industrial securities market refers to other new issue market and stock

exchanges where shares and debentures issued by companies in the private sector

are traded. The term industrial security denotes securities issued by companies

which include equity shares, preference shares and debentures. Such securities are

r