Documentos de Académico
Documentos de Profesional
Documentos de Cultura
R.G. Saha
2015
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Published by: Himalaya Publishing House Pvt. Ltd., for Amity Directorate of Distance & Online Education, Noida
Syllabus
Management of Financial Institutions
Course Objective:
The aim of the course is to orient the finance students to the change in the financial industry. The financial
industry much like the computer industry is changing rapidly. A course that merely describes the existing
institutions will not prepare the students adequately for the change. Thus, familiarization with institutions of today
and developing an understanding why they are the way they are, and why they are changing is the core aim of the
course. An Indian perspective will be added but conceptually the global frameworks will be used. At the end of this
course, the students will understand:
Course Contents:
Module l:
Introduction
Financial Institutions and Economic Development, Types of Money, Process of Capital
Formation, Technology of Financial System Pooling, Netting, Credit Substitution and
Delegation.
Module II:
Financial Intermediaries
Understanding Financial Intermediaries Commercial Banks, Central Bank, Cooperative Banks,
Banking System in USA and India, International Banking, Banking Operations, Retail and
Wholesale Banking, Near Banks, Universal Banking, NBFCs.
Examination Scheme:
Component Codes
H1
H2
H3
EE1
Weightage (%)
10
10
10
70
Contents
Unit 1: Introduction
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
1.10
1.11
1.12
1.13
1.14
1.15
1.16
1.17
1.18
1.19
1.20
1.21
1.22
1.23
1.24
1.25
1.26
1.27
1.28
1.29
1.30
1.31
1.32
1.33
1.34
1.35
1.36
1.37
Introduction
Financial Institutions
Meaning of Financial Institutions
Benefits of Financial Institutions
Classification of Financial Institutions
Role of Financial Institutions
Functions of Financial Institutions
Types of Non-Banking Financial Institutions
Financial Institutions and Economic Development
Introduction to Money
History of Money
History of Money in India
Meaning of Money
Features of Money
Functions of Money
Types of Money
Role and Significance of Money in a Modern Economy
Monetary System
Capital Formation
Process of Capital Formation
Financial System
Definitions of Financial System
Meaning of Financial System
Meaning of Financial Dualism
Objectives of Financial System
Purpose of Financial System
Functions of Financial System
Structure of Indian Financial System or Components of Financial System
Technology of Financial System
Summary
Check Your Progress
Questions and Exercises
Key Terms
Check Your Progress: Answers
Case Study
Further Readings
Bibliography
1 44
Introduction
Meaning of Financial Intermediary
Classification of Financial Intermediaries
Functions of Financial Intermediaries
Commercial Banks
45 113
2.6
2.7
2.8
2.9
2.10
2.11
2.12
2.13
2.14
2.15
2.16
2.17
2.18
2.19
2.20
2.21
2.22
2.23
2.24
2.25
2.26
2.27
2.28
2.29
2.30
2.31
2.32
2.33
2.34
2.35
2.36
2.37
2.38
2.39
2.40
2.41
2.42
2.43
2.44
2.45
2.46
2.47
2.48
2.49
2.50
2.51
2.52
Introduction
Meaning of Bank Lending
Principles of Lending
Five Cs of Lending Principles
Forms of Lending
Types of Lending
Lending Facilities Granted by Banks
Who are the Borrowers?
Study of Borrowers
Balance Sheet Analysis
Goal of Balance Sheet Analysis
How to Perform a Balance Sheet Analysis?
Project Appraisal
Checklist for Project Appraisal
Project Appraisal Criteria
Marketing of Bank Services
Importance of Bank Marketing
Marketing Approach in Banks
Features of Bank Marketing
Prudential Norms
Prudential Guidelines on Restructuring of Advances
Narasimham Committee Recommendations
Recommendations of the Committee
Highlights of Narasimham Committee Recommendations on Banking Reforms in India
Performance Analysis of Banks
Regulatory Institutions in India
Reserve Bank of India
Credit Control
Meaning of Credit Control
Objectives of Credit Control
Need for Credit Control
Methods of Credit Control
RBI Publications
Securities and Exchange Board of India
Organization of SEBI
Management of the Board
Objectives of SEBI
Functions of SEBI
Powers of Securities and Exchange Board of India
Lenders Liability Act
Banking Innovations
Basel Committee Recommendations
Capital Adequacy Ratio (CAR)
Risk Weighted Assets
Risk-based Supervision
Asset Liability Management (ALM) in Commercial Banks
Benefits of ALM
114 178
3.48
3.49
3.50
3.51
3.52
3.53
3.54
3.55
3.56
3.57
3.58
3.59
3.60
3.61
3.62
3.63
3.64
3.65
3.66
3.67
3.68
3.69
3.70
3.71
3.72
3.73
3.74
3.75
Introduction
Developmental Banks
Features of a Developmental Bank
Role of Developmental Banks in Industrial Financing
Types of Developmental Banks in India
Origin of Industrial Developmental Bank of India (IDBI)
Origin of State Financial Corporations (SFCs)
Origin of State Industrial Development Corporations (SIDCs)
Origin of Life Insurance Corporation of India (LICI)
Origin of Export-Import Bank of India (EXIM Bank)
National Bank for Agriculture and Rural Development (NABARD)
Resource Mobilization of Developmental Banks
Project Examination by Developmental Banks
Summary
Check Your Progress
Questions and Exercises
Key Terms
Check Your Progress: Answers
Case Study
179 205
Introduction
Meaning of Insurance
Definition of Insurance
Historical Background of Insurance
Historical Background of Insurance in India
Types of Insurance
Role of Insurance Companies
Role of Insurance Companies in Industrial Financing
Principles of Insurance
Life Insurance
Meaning of Life Insurance
Purposes of Life Insurance
The Importance of Life Insurance
Life Insurance Products and Policies
General Insurance
Meaning of General Insurance
Objectives for Practicing of General Insurance
Principles of General Insurance
Features of General Insurance
Functions of General Insurance
General Insurance Corporation of India (GICI)
The General Insurance Business (Nationalization) Amendment Act, 2002 Act No. 40 of 2002
Insurance Sector Reforms in India
Major Policy Changes under IRDA Act
Insurance Companies in India
Protection of the Interest of Policyholders
New Developments in Insurance as a Sector in the Indian Financial System
Bancassurance
Various Models for Bancassurance
Status of Bancassurance in India
Bancassurance Models in Europe
Bancassurance in India
The Major Need for Bancassurance in India
Obstacles in the Success of Bancassurance
Regulating Guidelines of IRDA
Recommendations of Committee Constituted by IRDA on Bancassurance
Bancassurance Models in India
Summary
Check Your Progress
Questions and Exercises
Key Terms
Check Your Progress: Answers
Case Study
Further Readings
Bibliography
206 250
Introduction
Notes
Unit 1:
Introduction
Structure:
1.1 Introduction
1.2 Financial Institutions
1.3 Meaning of Financial Institutions
1.4 Benefits of Financial Institutions
1.5 Classification of Financial Institutions
1.6 Role of Financial Institutions
1.7 Functions of Financial Institutions
1.8 Types of Non-Banking Financial Institutions
1.9 Financial Institutions and Economic Development
1.10 Introduction to Money
1.11 History of Money
1.12 History of Money in India
1.13 Meaning of Money
1.14 Features of Money
1.15 Functions of Money
1.16 Types of Money
1.17 Role and Significance of Money in a Modern Economy
1.18 Monetary System
1.19 Capital Formation
1.20 Process of Capital Formation
1.21 Financial System
1.22 Definition of Financial System
1.23 Meaning of Financial System
1.24 Meaning of Financial Dualism
1.25 Objectives of Financial System
1.26 Purpose of Financial System
1.27 Functions of Financial System
1.28 Structure of Indian Financial System or Components of Financial System
1.29 Technology of Financial System
1.30 Summary
1.31 Check Your Progress
1.32 Questions and Exercises
1.33 Key Terms
1.34 Check Your Progress: Answers
1.35 Case Study
Amity Directorate of Distance and Online Education
Notes
1.1 Introduction
Financial institution is an institution that provides financial services for its clients or
members. Probably, the most important financial service provided by financial institutions
is acting as financial intermediaries. Most financial institutions are regulated by the
government. Broadly speaking, there are three major types of financial institutions:
(i) Depositary Institutions: Deposit-taking institutions that accept and manage deposits
and make loans, including banks, building societies, credit unions, trust companies, and
mortgage loan companies, (ii) Contractual Institutions: Insurance companies and pension
funds; and (iii) Investment Institutes: Investment Banks, underwriters and brokerage firms.
The Financial Institutions in India, comprising of 15 institutions at the national-level
and 47 institutions at the State-level, have played a significant role in their designated
domain in promoting development in the country. Although primarily engaged in providing
medium- and long-term assistance to industry in the form of project finance, financial
institutions have, over the years, rendered an array of varied industry-related services,
including providing risk capital, underwriting new issues, identifying investment projects,
preparing and evaluating project reports, galvanizing spatially balanced industrial
development (including backward area development), disseminating technical advice and
market-related information and management services. Financial Institutions were also
called upon, particularly in the pre-reform era, to undertake a range of developmental and
promotional activities in tune with contemporaneous national objectives and priorities.
These inter alia included evolution of an enabling institutional infrastructure for
entrepreneurship and broad-based capital market development.
Introduction
Notes
There are a number of institutions that collect and provide funds for the necessary
sector or individuals. On the other hand, there are several institutions that act as
middlemen to join the deficit and surplus units. Investing money on behalf of the client
is another variety of functions of financial institutions.
In post-Independence India, people were encouraged to increase savings; a tactic
intended to provide funds for investment by the Indian government. However, there was
a huge gap between the supply of savings and demand for the investment opportunities
in the country.
Notes
Introduction
Notes
2. Non-Banking Institutions
A Non-Bank Financial Institution (NBFI) is a financial institution that does not have
a full banking license or is not supervised by a national or international banking regulatory
agency. NBFIs facilitate bank-related financial services, such as investment, risk pooling,
contractual savings, and market brokering. Examples of these include insurance firms,
pawn shops, cashiers check issuers, check cashing locations, payday lending, currency
exchanges, and micro loan organizations. Alan Greenspan has identified the role of NBFIs
in strengthening an economy, as they provide multiple alternatives to transform an
economys savings into capital investment which act as backup facilities.
(i) Non-Banking Finance Companies
Non-Banking Financial Companies (NBFCs) are financial institutions that provide
banking services without meeting the legal definition of a bank, i.e., one that does not
hold a banking license. These institutions are not allowed to take deposits from the public.
Nonetheless, all operations of these institutions are still exercised under bank regulation.
(ii) Development Financial Institutions
Development Finance Institution (DFI) is generic term used to refer to a range of
alternative financial institutions including microfinance institutions, community development
financial institution and revolving loan funds. These institutions provide a crucial role in
providing credit in the form of higher risk loans, equity positions and risk guarantee
instruments to private sector investments in developing countries. DFIs are backed by
states with developed economies.
DFIs have a general mandate to provide finance to the private sector for investments
that promote development. The purpose of DFIs is to ensure investment in areas where
otherwise, the market fails to invest sufficiently. DFIs aim to be catalysts, helping
companies implement investment plans and especially seek to engage in countries where
there is restricted access to domestic and foreign capital markets and provide risk
mitigation that enables investors to proceed with plans which they might otherwise
abandon. DFIs specialize in loans with longer maturities and other financial products. DFIs
have a unique advantage in providing finance that is related to the design and
implementation of reforms and capacity-building programmes adopted by governments.
All India Financial Institutions (AIFIs) is a group composed of Development Finance
Institutions (DFIs) and Investment Institutions that play a pivotal role in the financial
markets. Also known as financial instruments, the financial institutions assist in the
proper allocation of resources, sourcing from businesses that have a surplus and
distributing to others who have deficitsthis also assists by ensuring the continued
circulation of money in the economy. Possibly of greatest significance, the financial
institutions act as an intermediary between borrowers and final lenders, providing safety
and liquidity. All India Financial Institutions includes, IFCI, IDBI, IIBI, SIDBI, IDFC,
NABARD, EXIM Bank and NHB. The State-level Institutions includes SFCs and SIDCs.
Other Financial Institutions are ECGC and DICGC.
3. Mutual Funds
A mutual fund is a type of professionally-managed collective investment vehicle that
pools money from many investors to purchase securities. While there is no legal definition
Amity Directorate of Distance and Online Education
Notes
of mutual fund, the term is most commonly applied only to those collective investment
vehicles that are regulated, available to the general public and open-ended in nature. Hedge
funds are not considered a type of mutual fund.
(i) Mutual funds in public sector
Unit Trust of India was the first mutual fund set up in India in the year 1963. In early
1990s, Government allowed public sector banks and institutions to set up mutual funds.
In the year 1992, Securities and Exchange Board of India (SEBI) Act was passed. The
objectives of SEBI are to protect the interest of investors in securities and to promote
the development of and to regulate the securities market.
(ii) Mutual funds in private sector
In spite of being a relatively new entrant, HDFC MF has become the second largest
fund house in India in a span of 10 years. It has grown manifold because of their steady
performance of its schemes like HDFC Top 200, HDFC Equity, etc. One more reason
for the declining market share is that the number of public sector players is shrinking.
Today, there are only 6 players in a market with 40 players. On the other hand, public
sector accounted for 10 out of a total of 31 players in March, 2000.
4. Insurance and Housing Finance Companies
The banks providing the housing finance and related facilities such as Bank of Baroda,
Canara Bank, Corporation Bank, IDBI Bank, Punjab National Bank and State Bank of India.
Companies Act 1956 which primarily transacts or has one of its principal objects and the
main feature of the business is providing finance for housing, whether directly or indirectly.
Introduction
Notes
Notes
Introduction
Notes
Financial Institutions give advice for expansion and modernization of the business
units. They give expert advice on mergers and amalgamations, acquisition and takeovers,
diversification of business, foreign collaborations and joint ventures, technology
upgradation, etc.
(v) Managing Public Issue of Companies
Financial Institutions advice and manage the public issue of companies.
They provide following services:
z
10
Notes
Introduction
11
Notes
12
Notes
Both financial markets and institutions can thus improve resource allocation and
productivity growth. By reducing control problems of investors vis--vis owners and
managers of enterprises, improved corporate governance can also increase savings and
capital accumulation.
6. Finally, financial institutions and markets allow cross-sectional diversification
across projects, allowing risky innovative activity while guaranteeing an ex ante contracted
interest rate to savers. Furthermore, aggregate risk that cannot be diversified away at a
specific point in time can be diversified by long-living financial intermediaries over time.
Introduction
13
Commodity Money
Notes
Bartering has several problems; most notably that it requires a coincidence of wants.
For example, if a wheat farmer needs what a fruit farmer produces, a direct swap is
impossible as seasonal fruit would spoil before the grain harvest. A solution is to trade
fruit for wheat indirectly through a third, intermediatee, and commodity: the fruit is
exchanged for the intermediate commodity when the fruit ripens. If this intermediate
commodity doesnt perish and is reliably in demand throughout the year (e.g., copper,
gold, or wine) then it can be exchanged for wheat after the harvest. The function of the
intermediate commodity as a store-of-value can be standardized into a widespread
commodity money, reducing the coincidence of wants problem. By overcoming the
limitations of simple barter, commodity money makes the market in all other commodities
more liquid.
Many cultures around the world eventually developed the use of commodity money.
Ancient China, Africa, and India used cowry shells. Trade in Japans feudal system was
based on the koku a unit of rice. The shekel was an ancient unit of weight and currency.
The first usage of the term came from Mesopotamia circa 3000 BC and referred to a specific
weight of barley, which related other values in a metric such as silver, bronze, copper,
etc. A barley/shekel was originally both a unit of currency and a unit of weight.
Wherever trade is common, barter systems usually lead quite rapidly to several key
goods being imbued with monetary properties. In the early British colony of New South
Wales, rum emerged quite soon after settlement as the most monetary of goods. When
a nation is without a currency it commonly adopts a foreign currency. In prisons where
conventional money is prohibited, it is quite common for cigarettes to take on a monetary
quality, and throughout history, gold has taken on this unofficial monetary function.
Standardized Coinage
From early times, metals, where available, have usually been favored for use as protomoney over such commodities as cattle, cowry shells, or salt, because they are at once
durable, portable, and easily divisible. The use of gold as proto-money has been traced
back to the fourth millennium BC when the Egyptians used gold bars of a set weight as
a medium of exchange, as had been done earlier in Mesopotamia with silver bars. The
first known ruler who officially set standards of weight and money was Pheidon. The first
stamped money (having the mark of some authority in the form of a picture or words)
can be seen in the Bibliothque Nationale of Paris. It is an electrum stater of a turtle
coin, coined at Aegina Island. This remarkable coin dates about 700 BC. Electrum coins
were also introduced about 650 BC in Lydia.
Coinage was widely adopted across Ionia and mainland Greece during the 6th century
BC, eventually leading to the Athenian Empires 5th century BC, dominance of the region
through their export of silver coinage, mined in southern Attica at Laurium and Thorikos.
A major silver vein discovery at Laurium in 483 BC led to the huge expansion of the
Athenian military fleet. Competing coinage standards at the time were maintained by
Mytilene and Phokaia using coins of Electrum; Aegina used silver.
It was the discovery of the touchstone which led the way for metal-based commodity
money and coinage. Any soft metal can be tested for purity on a touchstone, allowing
one to quickly calculate the total content of a particular metal in a lump. Gold is a soft
metal, which is also hard to come by, dense, and storable. As a result, monetary gold
spread very quickly from Asia Minor, where it first gained wide usage, to the entire world.
14
Notes
Using such a system still required several steps and mathematical calculation. The
touchstone allows one to estimate the amount of gold in an alloy, which is then multiplied
by the weight to find the amount of gold alone in a lump. To make this process easier,
the concept of standard coinage was introduced. Coins were pre-weighed and pre-alloyed,
so as long as the manufacturer was aware of the origin of the coin, no use of the touchstone
was required. Coins were typically minted by governments in a carefully protected process,
and then stamped with an emblem that guaranteed the weight and value of the metal.
It was, however, extremely common for governments to assert that the value of such money
lay in its emblem and thus to subsequently reduce the value of the currency by lowering
the content of valuable metal.
Although gold and silver were commonly used to mint coins, other metals could be
used. For instance, Ancient Sparta minted coins from iron to discourage its citizens from
engaging in foreign trade. In the early seventeenth century, Sweden lacked more precious
metal and so produced plate money, which were large slabs of copper approximately
50 cm or more in length and width, appropriately stamped with indications of their value.
Metal based coins had the advantage of carrying their value within the coins
themselves on the other hand, they induced manipulations: the clipping of coins in the
attempt to get and recycle the precious metal. A greater problem was the simultaneous
co-existence of gold, silver and copper coins in Europe. English and Spanish traders valued
gold coins more than silver coins, as many of their neighbors did, with the effect that
the English gold-based guinea coin began to rise against the English silver based crown
in the 1670s and 1680s. Consequently, silver was ultimately pulled out of England for
dubious amounts of gold coming into the country at a rate no other European nation would
share. The effect was worsened with Asian traders not sharing the European appreciation
of gold altogether gold left Asia and silver left Europe in quantities European observers
like Isaac Newton, Master of the Royal Mint observed with unease.
Stability came into the system with national Banks guaranteeing to change money
into gold at a promised rate; it did, however, not come easily. The Bank of England risked
a national monetary catastrophe in the 1730s when customers demanded their money
be changed into gold in a moment of crisis. Eventually Londons merchants saved the
bank and the nation with monetary guarantees.
Another step in the evolution of money was the change from a coin being a unit
of weight to being a unit of value. a distinction could be made between its commodity
value and its specie value. The difference is these values are seigniorage.
Trade Bills of Exchange
Bills of exchange became prevalent with the expansion of European trade toward
the end of the middle Ages. A flourishing Italian wholesale trade in cloth, woolen clothing,
and wine, tin and other commodities was heavily dependent on credit for its rapid
expansion. Goods were supplied to a buyer against a bill of exchange, which constituted
the buyers promise to make payment at some specified future date. Provided that the
buyer was reputable or the bill was endorsed by a credible guarantor, the seller could
then present the bill to a merchant banker and redeem it in money at a discounted value
before it actually became due.
These bills could also be used as a form of payment by the seller to make additional
purchases from his own suppliers. Thus, the bills an early form of credit became both
a medium of exchange and a medium for storage of value. Like the loans made by the
Egyptian grain banks, this trade credit became a significant source for the creation of
Introduction
15
new money. In England, bills of exchange became an important form of credit and money
during last quarter of the 18th century and the first quarter of the 19th century before bank
notes, checks and cash credit lines were widely available.
Notes
Tallies
The acceptance of symbolic forms of money opened up vast new realms for human
creativity. A symbol could be used to represent something of value that was available in
physical storage somewhere else in space, such as grain in the warehouse. It could also
be used to represent something of value that would be available later in time, such as
a promissory note or bill of exchange, a document ordering someone to pay a certain
sum of money to another on a specific date or when certain conditions have been fulfilled.
In the 12th Century, the English monarchy introduced an early version of the bill of
exchange in the form of a notched piece of wood known as a tally stick. Tallies originally
came into use at a time when paper was rare and costly, but their use persisted until
the early 19th Century, even after paper forms of money had become prevalent. The
notches were used to denote various amounts of taxes payable to the crown. Initially,
tallies were simply used as a form of receipt to the tax payer at the time of rendering
his dues. As the revenue department became more efficient, they began issuing tallies
to denote a promise of the tax assessee to make future tax payments at specified times
during the year. Each tally consisted of a matching pair one stick was given to the
assessee at the time of assessment representing the amount of taxes to be paid later
and the other held by the Treasury representing the amount of taxes be collected at a
future date.
The Treasury discovered that these tallies could also be used to create money. When
the crown had exhausted its current resources, it could use the tally receipts representing
future tax payments due to the crown as a form of payment to its own creditors, who
in turn could either collect the tax revenue directly from those assessed or use the same
tally to pay their own taxes to the government. The tallies could also be sold to other
parties in exchange for gold or silver coin at a discount reflecting the length of time
remaining until the taxes was due for payment. Thus, the tallies became an accepted
medium of exchange for some types of transactions and an accepted medium for store
of value. The Treasury soon realized that it could also issue tallies that were not backed
by any specific assessment of taxes. By doing so, the Treasury created new money that
was backed by public trust and confidence in the monarchy rather than by specific revenue
receipts.
Goldsmith Bankers
Goldsmiths in England had been craftsmen, bullion merchants, money changers and
moneylenders since the 16th century. But they were not the first to act as financial
intermediates; in the early 17th century, the scrivener were the first to keep deposits for
the express purpose of relending them. Merchants and traders had amassed huge hoards
of gold and entrusted their wealth to the Royal Mint for storage. In 1640, King Charles
I seized the private gold stored in the mint as a forced loan (which was to be paid back
over time). Thereafter merchants preferred to store their gold with the goldsmiths of London,
who possessed private vaults, and charged a fee for that service. In exchange for each
deposit of precious metal, the goldsmiths issued receipts certifying the quantity and purity
of the metal they held as a bailee (i.e., in trust). These receipts could not be assigned
(only the original depositor could collect the stored goods). Gradually, the goldsmiths took
over the function of the scrivener of relending on behalf of a depositor and also developed
Amity Directorate of Distance and Online Education
16
Notes
modern banking practices; promissory notes were issued for money deposited which by
custom and/or law was a loan to the goldsmith, i.e., the depositor expressly allowed the
goldsmith to use the money for any purpose including advances to his customers. The
goldsmith charged no fee, or even paid interest on these deposits. Since the promissory
notes were payable on demand, and the advances (loans) to the goldsmiths customers
were repayable over a longer time period, this was an early from of fractional reserve
banking. The promissory notes developed into an assignable instrument, which could
circulate as a safe and convenient form of money backed by the goldsmiths promise to
pay. Hence, goldsmiths could advance loans in the form of gold money, or in the form
of promissory notes, or in the form of checking accounts. Gold deposits were relatively
stable, often remaining with the goldsmith for years on end, so there was little risk of
default so long as public trust in the goldsmiths integrity and financial soundness was
maintained. Thus, the goldsmiths of London became the forerunners of British banking
and prominent creators of new money based on credit.
Demand Deposits
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section by adding citations to reliable sources. Unsourced material may be challenged
and removed.
The primary business of the early merchant banks was promotion of trade. The new
class of commercial banks made accepting deposits and issuing loans their principal
activity. They lend the money they received on deposit. They created additional money
in the form of new bank notes. The money they created was partially backed by gold,
silver or other assets and partially backed only by public trust in the institutions that
created it.
Demand deposits are funds that are deposited in bank accounts and are available
for withdrawal at the discretion of the depositor. The withdrawal of funds from the account
does not require contacting or making any type of prior arrangements with the bank or
credit union. As long as the account balance is sufficient to cover the amount of the
withdrawal, and the withdrawal takes place in accordance with procedures set in place
by the financial institution, the funds may be withdrawn on demand
Bank Notes
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section by adding citations to reliable sources. Unsourced material may be challenged
and removed.
The history of money and banking are inseparably interlinked. The issuance of paper
money was initiated by commercial banks. Inspired by the success of the London
goldsmiths, some of which became the forerunners of great English banks, banks began
issuing paper notes quite properly termed bank notes which circulated in the same way
that government issued currency circulates today. In England, this practice continued up
to 1694. Scottish banks continued issuing notes until 1850. In USA, this practice continued
through the 19th century, where at one time there were more than 5000 different types
of bank notes issued by various commercial banks in America. Only the notes issued
by the largest, most creditworthy banks were widely accepted. The script of smaller, lesser
known institutions circulated locally. Farther from home, it was only accepted at a
discounted rate, if it was accepted at all. The proliferation of types of money went hand
in hand with a multiplication in the number of financial institutions.
Introduction
17
These bank notes were a form of representative money which could be converted
into gold or silver by application at the bank. Since banks issued notes far in excess
of the gold and silver they kept on deposit, sudden loss of public confidence in a bank
could precipitate mass redemption of bank notes and result in bankruptcy. The use of
bank notes issued by private commercial banks as legal tender has gradually been
replaced by the issuance of bank notes authorized and controlled by national governments.
The Bank of England was granted sole rights to issue bank notes in England after 1694.
In the USA, the Federal Reserve Bank was granted similar rights after its establishment
in 1913. Until recently, these government-authorized currencies were forms of
representative money, since they were partially backed by gold or silver and were
theoretically convertible into gold or silver.
Notes
18
Notes
The term representative money has been used in the past to signify that a certain
amount of bullion was stored in a Treasury while the equivalent paper in circulation
represented the bullion. Representative money differs from commodity money which is
actually made of some physical commodity. In his Treatise on Money (1930:7), Keynes
distinguished between commodity money and representative money, dividing the latter into
fiat money and managed money.
Fiat Money
Fiat money refers to money that is not backed by reserves of another commodity.
The money itself is given value by government fiat or decree, enforcing legal tender laws,
previously known as forced tender, whereby debtors are legally relieved of the debt if
they pay it in the governments money. By law, the refusal of a legal tender (offering)
extinguishes the debt in the same way acceptance does. At times in history (e.g., Rome
under Diocletian, and post-revolutionary France during the collapse of the assignats), the
refusal of legal tender money in favor of some other form of payment was punished with
the death penalty.
Governments through history have often switched to forms of fiat money in times
of need such as war, sometimes by suspending the service they provided of exchanging
their money for gold, and other times by simply printing the money that they needed.
When governments produce money more rapidly than economic growth, the money supply
overtakes economic value. Therefore, the excess money eventually dilutes the market
value of all money issued. This is called inflation. See open market operations.
In 1971, the United States finally switched to fiat money indefinitely. At this point
in time, many of the economically developed countries currencies were fixed to the US
dollar and so this single step meant that much of the western worlds currencies became
fiat money based. Following the Gulf War, the president of Iraq, Saddam Hussein, repealed
the existing Iraqi fiat currency and replaced it with a new currency. Despite having no
backing by a commodity and with no central authority mandating its use or defending
its value, the old currency continued to circulate within the politically isolated Kurdish
regions of Iraq. It became known as the Swiss dinar. This currency remained relatively
strong and stable for over a decade. It was formally replaced following the Iraq War.
Introduction
19
in Ceylon (Sri Lanka) in 1872, India in 1957 and in Pakistan in 1961. Among the earliest
issues of paper rupees were those by the Bank of Hindustan (1770-1832), the General
Bank of Bengal and Bihar (1773-75, established by Warren Hastings), the Bengal Bank
(1784-91), amongst others.
Notes
Historically, the rupee was a silver based currency. This had severe consequences
in the 19th century, when the strongest economies in the world were on the gold standard.
The discovery of vast quantities of silver in the US and various European colonies resulted
in a decline in the relative value of silver to gold. Suddenly, the standard currency of India
could not buy as much from the outside world. This event was known as the fall of the
Rupee. During British rule, and the first decade of independence, the rupee was subdivided
into 16 annas. Each anna was subdivided into either 4 pieces, or 12 pies. In 1957,
decimalisation occurred and the rupee was now divided into 100 Naye Paise (Hindi for
new praises). After a few years, the initial Naye was dropped. However, many still refer
to 25, 50 and 75 paise as 4, 8 and 12 annas respectively, not unlike the now largely
defunct usage of bit in American English for 1/8 dollar. However, the usage is in decline.
Reserve Bank Issues During British India
Office at Calcutta. Section 22 of the RBI Act, 1934, empowered it to continue issuing
Government of India notes until its own notes were ready for issue. The bank issued the
first five rupee note bearing the portrait of George VI in 1938. This was followed by ` 10
in February, ` 100 in March and ` 1,000 and ` 10,000 in June 1938. The first Reserve
Bank issues were signed by the second Governor, Sir James Taylor. In August 1940,
the one-rupee note was reintroduced as a wartime measure, as a Government note with
the status of a rupee coin. During the war, the Japanese produced high-quality forgeries
of the Indian currency. This necessitated a change in the watermark. The profile portrait
of George VI was changed to his full frontal portrait. The security thread was introduced
for the first time in India. The George VI series continued till 1947 and thereafter as a
frozen series till 1950 when post-independence notes were issued.
Republic of India Issues
After Independence of India, the government brought out the new design Re. 1 note
in 1949. Initially, it was felt that the Kings portrait be replaced by a portrait of Mahatma
Gandhi. Finally, however, the Lion Capital of Asoka was chosen. The new design of notes
was largely along earlier lines. In 1953, Hindi was displayed prominently on the new notes.
The economic crisis in late 1960s led to a reduction in the size of notes in 1967. High
denomination notes, like ` 10,000 notes were demonetized in 1978. The Mahatma Gandhi
Series was introduced in 1996. Prominent new features included a changed watermark,
windowed security thread, latent image and intaglio features for the visually handicapped.
20
Notes
Introduction
21
Once again, transportability has played a key role in the use of metals like gold,
silver, copper, and nickel as money. Carrying around a satchel of metal coins was never
much of a burden. However, these metals were largely replaced by paper currencies in
the 20th century because paper was lighter and easier to carry. Items such as granite
blocks, radioactive plutonium, and maple syrup come up short on the transportability scale.
Items that are physically heavy relative to their value in exchange, or need special handling,
are not easily transportable. Heading off to the market with a vat of syrup or a lead canister
of plutonium just does not work.
Notes
4. Non-counterfeitability
This fourth characteristic means that money cannot be easily duplicated. A given
item cannot function as a medium of exchange if everyone is able to print up, whip up,
or make up a batch of money any time that they want. Why would anyone accept money
in exchange for a good, if they can make their own? Money that is easily duplicated ceases
to be the medium of exchange.
Preventing the unrestricted duplication of money is a task that has long been
relegated to government. In fact, this task is one of the prime reasons why governments
exist. An economy needs government, absolutely needs government, to regulate the total
quantity of money in circulation. By controlling money duplication, governments are also
able to control the total quantity in circulation, and this control is what gives money value
in exchange.
While governments try to keep pace with counterfeiters, they are usually a step or
two behind. Through the years, governments have tried to thwart counterfeiters by stamping
images on coins, using special ink and paper for currency, and generally maintaining high
levels of security surrounding money production.
22
Notes
Introduction
23
6. Fiduciary Money
Notes
Todays monetary system is highly fiduciary. Whenever any bank assures the
customers to pay in different types of money and when the customer can sell the promise
or transfer it to somebody else, it is called the fiduciary money. Fiduciary money is
generally paid in gold, silver or paper money. There are cheques and bank notes, which
are the examples of fiduciary money because both are some kind of token which are used
as money and carry the same value.
7. Commercial Bank Money
Commercial Bank money or demand deposits are claims against financial institutions
that can be used for the purchase of goods and services. A demand deposit account is
an account from which funds can be withdrawn at any time by cheque or cash withdrawal
without giving the bank or financial institution any prior notice. Banks have the legal
obligation to return funds held in demand deposits immediately upon demand (or at call).
Demand deposit withdrawals can be performed in person, via cheques or bank drafts, using
automatic teller machines (ATMs), or through online banking.
24
Notes
Introduction
25
Thus, the problem of capital formation becomes two-fold: one, how to save more;
and two, how to utilize the current savings of the community for capital formation. We
discuss the factors on which capital accumulation depends.
Notes
1. Increasing Savings
(a) Power and Will to Save
Savings depend upon two factors: the power to save and the will to save.
The power to save of the community depends upon the size of the average income,
the size of the average family and the standard of living of the people. Other things being
equal, if the income of the people increases or the size of the family is small or people
get accustomed to a particular standard of living which does not lean towards conspicuous
consumption, the power to save increases.
The power to save also depends upon the level of employment in the country. If
employment opportunities increase and existing techniques and resources are employed
fully and efficiently, incomes increase and so do the propensity of the people to save.
Savings also depend upon the will to save. People may themselves forego
consumption in the present and save. They may do so to meet emergencies, for family
purposes or for social status. But they will save only if certain facilities or inducements
are available.
People save if the government is stable and there is peace and security in the country.
People do not save when there is lawlessness and disorder, and there is no security of
life, property and business. The existence of banking and financial institutions paying high
rates of interest on different term deposits also induces people to save more.
The taxation policy of the government also affects the savings habits of the people.
Highly progressive income and property taxes reduce the incentive to save. But low rates
of taxation with due concessions for savings in provident fund, life insurance, health
insurance, etc. encourage savings.
(b) Perpetuation of Income Inequalities
Perpetuation of income inequalities had been one of the major sources of capital
formation in 18th century England and early 20th century Japan. In most communities,
it is the higher income groups with a high marginal propensity to save that do the majority
of savings. If there is unequal distribution of income, the societys upper level incomes
accrue to the businessmen, the traders and the landlords who save more and hence invest
more on capital formation. But this policy of deliberately creating inequalities is not favoured
now either in developed or developing economics when all countries aim at reducing income
inequalities.
(c) Increasing Profits
Professor Lewis is of the view that the ratio of profits to national income should be
increased by expanding the capitalist sector of the economy, by providing various
incentives and protecting enterprises from foreign competition. The essential point is that
profits of business enterprises should increase because they know how to use them in
productive investment.
(d) Government Measures
Like private households and enterprises, the government also saves by adopting a
number of fiscal and monetary measures. These measures may be in the form of a
budgetary surplus through increase in taxation (mostly indirect), reduction in government
Amity Directorate of Distance and Online Education
26
Notes
expenditure, expansion of the export sector, raising money by public loans, etc. If people
are not saving voluntarily, inflation is the most effective weapon. It is regarded as hidden
or invisible tax. When prices rise, they reduce consumption and thus divert resources from
current consumption to investment. Besides, the government can increase savings by
establishing and running public undertakings more efficiently so that they earn larger profits
which are utilized for capital formation.
(2) Mobilization of Savings
The next step for capital formation is the mobilization of savings through banks,
investment trusts, deposit societies, insurance companies, and capital markets. The
kernal of Keyness theory is that decisions to save and decisions to invest are made largely
by different people and for different reasons. To bring the savers and investors together,
there must be well-developed capital and money markets in the country. In order to
mobilize savings, attention should be paid to the starting of investment trusts, life
insurance, provident fund, banks, and cooperative societies. Such agencies will not only
permit small amounts of savings to be handled and invested conveniently but will allow
the owners of savings to retain liquidity individually but finance long-term investment
collectively.
(3) Investment of Savings
The third step in the process of capital formation is the investment of savings in
creating real assets. The profit-making classes are an important source of capital formation
in the agricultural and industrial sectors of a country. They have an ambition for power
and save in the form of distributed and undistributed profits and thus invest in productive
enterprises.
Besides, there must be a regular supply of entrepreneurs who are capable, honest
and dependable. To perform his economic function, the entrepreneur requires two things,
according to Professor Schumpeter, first, the existence of technical knowledge to produce
new products; second, the power of disposal over the factors of production in the form
of bank credit.
To these may he added, the existence of such infrastructure as well-developed means
of transport, communications, power, water, educated and trained personnel, etc. Further,
the social, political and economic climatic conditions in the country must be conducive
for the emergence of a growing supply of entrepreneurs.
Domestic sources for capital formation are required to be supplemented by external
sources. There are two reasons for external borrowing, according to Professor A.J. Brown.
One is that it may be the easiest way of getting hold of capital funds at all, and the other
that it may be the easiest way of getting foreign currency with which to buy imports which
are needed for development.
The countries which have borrowed most from abroad for development purposes are
those which have at some stage had a colonial status, have been developed by European
immigrants, or have traded heavily with the highly developed countries, or have satisfied
all these conditions.
Introduction
27
lenders and borrowers to exchange funds. The global financial system is basically a
broader regional system that encompasses all financial institutions, borrowers and lenders
within the global economy.
Notes
28
Notes
Introduction
29
Notes
30
Notes
goods and services and transfers economic resources through time and across geographic
regions and industries.
4. Risk Function
The term risk and uncertainty relates to future which remains unknown for the
investors who expect future incomes through their savings.
Whenever the mobilized savings are invested into different productive activities, the
investors are exposed to lower risk. This is mainly because of the benefits of diversification
that is available to even small investors. Every investors preference will be influenced by
considerations such as convenience, lower risk, liquidity, etc.
Financial intermediaries enable the investors to diversify investments widely which
helps in reducing the risk of capital depreciation and poor dividends. Hence, a combination
of financial assets will help in minimizing risk.
5. Policy Function
The government intervenes in the financial system to influence macroeconomic
variables like interest rates or inflation so if country needs more money government would
cut rate of interest through various financial instruments and if inflation is high and too
much money is available in the system, then government would increase the rate of
interest. It makes available price-related information which is a valuable assistance to those
who need to take economic and financial decisions.
6. Provides Financial Services
A financial system minimizes situations where the information is an asymmetric and
likely to affect motivations among operators or when one party has the information and
the other party does not. It provides financial services such as insurance, pension, etc.
and offers portfolio adjustment facilities.
Example: It provides fee based or advisory based financial services such as issue
management, portfolio management, corporate counselling, credit rating, stock broking,
etc. and fund based or asset based financial services such as hire purchase, equipment
leasing, bill discounting, housing finance, insurance service, venture capital, etc.
7. Lowers the Cost of Transactions
A financial system helps in the creation of a financial structure that lowers the cost
of transactions. This has a beneficial influence on the rate of return to savers. It also
reduces the cost of borrowing. Thus, the system generates an impulse among the people
to save more.
8. Financial Deepening and Broadening
A well-functioning financial system helps in promoting the process of financial
deepening and broadening. Financial deepening refers to an increase of financial assets
as a percentage of the Gross Domestic Product (GDP). Financial broadening refers to
building an increasing number and a variety of participants and instruments.
Financial broadening begins when corporations seek to employ labor and capital
according to their relative contribution to production. It can also influence demand for capital
goods (and the labor to create and employ it) which depends on expected consumer
Introduction
31
demand in a future period. It also includes profit maximization which aims to produce more
with more productive capital and less labor so that production generally becomes
increasingly more capital intensive.
Notes
32
Notes
(c) Diversification
As financial institutions are dealing in huge amounts of pooled funds, they diversify
their investments in such a way that the risk involved would reduce considerably.
2. Financial Markets
A financial market is a market in which people and entities can trade financial
securities, commodities and other fungible items of value at low transaction costs and
at prices that reflect supply and demand. Securities include stocks and bonds, and
commodities include precious metals or agricultural goods.
There are both general markets (where many commodities are traded) and
specialized markets (where only one commodity is traded). Markets work by placing many
interested buyers and sellers, including households, firms, and government agencies, in
one place, thus making it easier for them to find each other. An economy which relies
primarily on interactions between buyers and sellers to allocate resources is known as
a market economy in contrast either to a command economy or to a non-market economy
such as a gift economy.
Financial market transactions can be distinguished by whether they involve new or
existing securities, whether the transaction of new securities reflects a public offering or
a private placement, and whether the securities have short-term or long-term maturities.
New securities are issued by firms in the primary market and purchased by investors.
If investors desire to sell the securities that they have previously purchased, they use
the secondary market. The sale of new securities to the general public is referred to as
a public offering; the sale of new securities to one investor or a group of investors is referred
to as a private placement. Securities with short-term maturities are called money market
securities, and securities with long-term maturities are called capital market securities
Finance is a prerequisite for modern business and financial institutions play a vital
role in an economic system. It is through financial markets the financial system of an
economy works. The main objectives of financial markets are:
1. To facilitate creation and allocation of credit and liquidity;
2. To serve as intermediaries for mobilization of savings;
3. To assist process of balanced economic growth;
4. To provide financial convenience.
3. Financial Intermediaries
Financial intermediation consists of channelling funds between surplus and deficit
agents.
4. Financial Services
Financial services are the economic services provided by the finance industry, which
encompasses a broad range of organizations that manage money, including credit unions,
banks, credit card companies, insurance companies, consumer finance companies, stock
brokerages, investment funds and some government sponsored enterprises.
Efficiency of emerging financial system largely depends upon the quality and variety
of financial services provided by financial intermediaries. The term financial services can
be defined as activities, benefits and satisfaction connected with the sale of money that
offers to users and customers, financial related value.
Introduction
33
Notes
1. Fee-based Services
Bank Management sets fees and charges for banking services to ensure that the
bank is adequately compensated for the services it provides. When setting fees and
charges, bankers take into consideration the possible exposure to loss, which may be
incurred for providing the service, the effort required of the Bank and the amount of time
required the performing the service properly. Some of the more common fee-based services
being offered by Banks to retail customers today are described in this section.
2. Fund-based Services
Fund-based services include cash credit, overdraft, bill discounting, short-term loans,
and export financing (pre-shipment as well as post-shipment). Fee-based facilities include
letters of credit and bank guarantees.
34
Notes
Introduction
35
Notes
Structured finance is a sector of finance that was created to help transfer risk using
complex legal and corporate entities. This transfer of risk, as applied to the securitization
of various financial assets (mortgages, credit card receivables, auto loans, etc.) has helped
provide increased liquidity or funding sources to markets like housing and to transfer risk
to buyers of structured products; it also permits financial institutions to remove certain
assets from their balance sheets as well as provides a means for investors to gain access
to diversified asset classes. However, it arguably contributed to the degradation in
underwriting standards for these financial assets, which helped give rise to both the
inflationary credit bubble of the mid-2000s and the credit crash and financial crisis of 20072009.
(vi) Securitization
Securitization is the financial practice of pooling various types of contractual debt
such as residential mortgages, commercial mortgages, auto loans or credit card debt
obligations (or other non-debt assets which generate receivables) and selling their related
cash flows to third party investors as securities, which may be described as bonds, passthrough securities, or collateralized debt obligations (CDOs). Investors are repaid from the
principal and interest cash flows collected from the underlying debt and redistributed
through the capital structure of the new financing. Securities backed by mortgage
receivables are called mortgage-backed securities (MBS), while those backed by other
types of receivables are asset-backed securities (ABS).
Off-balance sheet treatment for securitizations coupled with guarantees from the
issuer can hide the extent of leverage of the securitizing firm, thereby facilitating risky
capital structures and leading to an underpricing of credit risk. Off-balance sheet
securitizations are believed to have played a large role in the high leverage level of US
financial institutions before the financial crisis, and the need for bailouts.
The granularity of pools of securitized assets can mitigate the credit risk of individual
borrowers. Unlike general corporate debt, the credit quality of securitized debt is nonstationary due to changes in volatility that are time- and structure-dependent. If the
transaction is properly structured and the pool performs as expected, the credit risk of
all tranches of structured debt improves; if improperly structured, the affected tranches
may experience dramatic credit deterioration and loss.
(vii) Intergovernmental risk pool
A risk pool is one of the forms of risk management mostly practiced by insurance
companies. Under this system, insurance companies come together to form a pool, which
can provide protection to insurance companies against catastrophic risks such as floods,
earthquakes, etc. The term is also used to describe the pooling of similar risks that
underlies the concept of insurance. While risk pooling is necessary for insurance to work,
not all risks can be effectively pooled. In particular, it is difficult to pool dissimilar risks
in a voluntary insurance bracket, unless there is a subsidy available to encourage
participation.
Risk pooling is an important concept in supply chain management. Risk pooling
suggests that demand variability is reduced if one aggregates demand across locations
because as demand is aggregated across different locations, it becomes more likely that
high demand from one customer will be offset by low demand from another. This reduction
in variability allows a decrease in safety stock and therefore reduces average inventory.
36
Notes
2. Netting
Netting is a process the National Securities Clearing Corporation (NSCC) uses to
streamline securities transactions. To net, the NSCC compares the entire buy and sell
orders for each individual security and matches purchases by clients of one brokerage
firm with corresponding sales by other clients of the firm.
In the context of credit risk, there are at least three specific types of netting:
(a) Close-out netting
In the counterparty bankruptcy or any other relevant event of default specified in the
relevant agreement if accelerated (i.e., effected), all transactions or all of a given type are
netted (i.e. set off against each other) at market value or, if otherwise specified in the
contract or if it is not possible to obtain a market value, at an amount equal to the loss
suffered by the non-defaulting party in replacing the relevant contract. The alternative would
allow the liquidator to choose which contracts to enforce and which not to (and thus
potentially cherry pick). There are international jurisdictions where the enforceability of
netting in bankruptcy has not been legally tested.
(b) Netting by novation
The legal obligations of the parties to make required payments under one or more
series of related transactions are canceled and a new obligation to make only the net
payments is created.
(c) Settlement or payment netting
For cash settled trades, this can be applied either bilaterally or multilaterally and
on related or unrelated transactions.
(i) Bilateral Net Settlement System
A settlement system in which every individual bilateral combination of participants
settles its net settlement position on a bilateral basis.
(ii) Multilateral Net Settlement System
A settlement system in which each settling participant settles its own multilateral
net settlement position (typically by means of a single payment or receipt).
3. Credit Substitution
Credit substitution refers to liability transfer between one party to another party. For
example, a bank substitutes its own credit for the credit of the borrower.
Replacement of credit of one party to a transaction with the (superior) credit of a
financial institution.
4. Delegation
Delegation is the process of appointment of someone to act for other. Delegation
helps to reduces transaction cost for following reasons:
1. Delegation allows specialization.
2. The delegate is in a stronger position.
3. Revealing information.
Introduction
37
1.30 Summary
Notes
Financial institution is an institution that provides financial services for its clients or
members. Probably, the most important financial service provided by financial institutions
is acting as financial intermediaries. Most financial institutions are regulated by the
government.
Financial institutions provide services as intermediaries of financial markets. They
are responsible for transferring funds from investors to companies in need of those funds.
Financial institutions facilitate the flow of money through the economy. To do so, savings
are brought to provide funds for loans.
Non-Bank Financial Institution (NBFI) is a financial institution that does not have a
full banking license or is not supervised by a national or international banking regulatory
agency. NBFIs facilitate bank-related financial services, such as investment, risk pooling,
contractual savings, and market brokering. Examples of these include insurance firms,
pawn shops, cashiers check issuers, check cashing locations, payday lending, currency
exchanges, and micro loan organizations.
Non-Banking Financial Companies (NBFCs) are financial institutions that provide
banking services without meeting the legal definition of a bank, i.e. one that does not
hold a banking license. These institutions are not allowed to take deposits from the public.
Nonetheless, all operations of these institutions are still exercised under bank regulation.
Capital formation implies the diversion of the productive capacity of the economy to
the making of capital goods which increases future productive capacity. The process of
Capital Formation involves three distinct but interdependent activities, viz., savings financial
intermediation and investment. However, poor country/economy may be, there will be a
need for institutions which allow such savings, as are currently forthcoming, to be invested
conveniently and safely and which ensure that they are channeled into the most useful
purposes. A well-developed financial structure will therefore aid in the collections and
disbursements of investible funds and thereby contribute to the capital formation of the
economy. Indian capital market although still considered to be underdeveloped has been
recording impressive progress during the post-interdependence period.
Insurance companies underwrite economic risks associated with illness, death,
damage and other risks of loss. In return to collecting an insurance premium, insurance
companies provide a contingent promise of economic protection in the case of loss. There
are two main types of insurance companies: general insurance and life insurance. General
insurance tends to be short-term, while life insurance is a longer-term contract, which
terminates at the death of the insured. Both types of insurance, life and general, are
available to all sectors of the community.
Contractual savings institutions give individuals the opportunity to invest in collective
investment vehicles (CIV) as a fiduciary rather than a principal role. Collective investment
vehicles pool resources from individuals and firms into various financial instruments
including equity, debt, and derivatives. Note that the individual holds equity in the CIV
itself rather what the CIV invests in specifically. The two most popular examples of
contractual savings institutions are pension funds and mutual funds.
Pension funds are mutual funds that limit the investors ability to access their
investments until a certain date. In return, pension funds are granted large tax breaks
in order to incentives the working population to set aside a portion of their current income
for a later date after they exit the labor force (retirement income).
38
Notes
Market makers are broker-dealer institutions that quote a buy and sell price and
facilitate transactions for financial assets. Such assets include equities, government and
corporate debt, derivatives, and foreign currencies. After receiving an order, the market
maker immediately sells from its inventory or makes a purchase to offset the loss in
inventory. The differential between the buying and selling quotes, or the bid-offer spread,
is how the market-maker makes profit. A major contribution of the market makers is
improving the liquidity of financial assets in the market.
Financial institution is an establishment that conducts financial transactions such
as investments, loans and deposits. Economic development is the sustained, concerted
actions of policy makers and communities that promote the standard of living and
economic health of a specific area. Economic development can also be referred to as
the quantitative and qualitative changes in the economy. Financial institutions play a vital
role for economic development of a country.
Money is a token or item which acts as a medium of exchange that has both legal
and social acceptance with regards to making payment for buying commodities or receiving
services, as well as repayment of loans.
Durability means that an item retains the same shape, form, and substance over
an extended period of time; that it does not easily decompose, deteriorate, degrade, or
otherwise change form. However, durability also extends beyond the physical realm to
include social and institutional durability.
Durability is critical for money to perform the related functions of medium of exchange
and store of value. People are willing to accept an item in payment for one good because
they are confident that the item can be traded at a later time for some other good. An
item works as a medium of exchange precisely because it stores value from one
transaction to the next. And this requires durability.
Fiat money is that type of money the value of which is ascertained with the help
of legal methods instead of the associated availableness of commodities and services.
Fiat money can symbolize government promises or a commodity. The word fiat means
the command of the sovereign. It is the type of money that is issued by the command
of the sovereign. The paper money is generally called as the fiat money. This type of money
forms a monetary standard. It has been made mandatory by law to accept the fiat money,
as an exchange medium, whenever it is offered to anyone.
Credit money refers to the claim placed to a legal individual, which can be implemented
to buy goods and services. Soft money refers to the paper currency rather than gold, silver,
or any other types of coined metal. Hard money refers to the value of different gold, silver,
or platinum coins (bullion) in circulation in the field of international trade.
Commercial Bank money or demand deposits are claims against financial institutions
that can be used for the purchase of goods and services. A demand deposit account is
an account from which funds can be withdrawn at any time by cheque or cash withdrawal
without giving the bank or financial institution any prior notice. Banks have the legal
obligation to return funds held in demand deposits immediately upon demand (or at call).
Demand deposit withdrawals can be performed in person, via cheques or bank drafts, using
automatic teller machines (ATMs), or through online banking.
Monetary system is a set of mechanisms by which a government provides money
in a countrys economy. It usually consists of a mint, central bank, and commercial banks.
The Monetary system of India plays a very important role in the economic
development. The monetary system performs a number of functions.
Introduction
39
Capital formation refers to net additions of capital stock such as equipment, buildings
and other intermediate goods. A nation uses capital stock in combination with labor to
provide services and produce goods; an increase in this capital stock is known as capital
formation.
Notes
Saving and investment are essential for capital formation. According to Marshall,
saving is the result of waiting or abstinence. When a person postpones his consumption
to the future, he saves his wealth which he utilizes for further production. If all people
save like this, the aggregate savings increase which are utilized for investment purposes
in real capital assets like machines, tools, plants, roads, canals, fertilizers, seeds, etc.
Financial intermediation consists of channeling funds between surplus and deficit
agents. A financial intermediary is a financial institution that connects surplus and deficit
agents. The classic example of a financial intermediary is a bank that consolidates bank
deposits and uses the funds to transform them into bank loans.
Financial services are the economic services provided by the finance industry, which
encompasses a broad range of organizations that manage money, including credit unions,
banks, credit card companies, insurance companies, consumer finance companies, stock
brokerages, investment funds and some government sponsored enterprises.
Bank Management sets fees and charges for banking services to ensure that the
bank is adequately compensated for the services it provides. When setting fees and
charges, bankers take into consideration the possible exposure to loss, which may be
incurred for providing the service, the effort required of the Bank and the amount of time
required the performing the service properly. Some of the more common fee based services
being offered by Banks to retail customers today are described in this section.
Fund-based services include cash credit, overdraft, bill discounting, short-term loans,
and export financing (pre-shipment as well as post-shipment). Fee based facilities include
letters of credit and bank guarantees.
40
Notes
Introduction
41
Notes
42
Notes
Fiat money: Fiat money is that type of money the value of which is ascertained
with the help of legal methods instead of the associated availableness of
commodities and services.
Credit money: Credit money refers to the claim placed to a legal individual,
which can be implemented to buy goods and services.
Introduction
43
taking out the consolidation loan in June. It also covered an additional 500. The bank
agreed to lend them this because they had said they were worried about how they would
pay for all the extras they would need over the Christmas period.
Notes
By early 2005, realizing that they were unable to meet their repayment commitments,
Mr. and Mrs. A complained to the bank. They said they had asked for help in managing
their debts but instead it had made their situation worse.
Question:
1. Discuss how to solve Mr. and Mrs. As complaints?
1.37 Bibliography
1. Siklos, Pierre (2001), Money, Banking, and Financial Institutions: Canada in
the Global Environment, Toronto: McGraw-Hill Ryerson, p. 40, ISBN 0-07087158-2.
2. Hoggson, N.F. (1926), Banking through the Ages, New York, Dodd, Mead &
Company.
3. Goldthwaite, R.A. (1995), Banks, Places and Entrepreneurs in Renaissance
Florence, Aldershot.
4. Mishler, Lon and Cole, Robert E. (1995), Consumer and Business Credit
Management, Homewood: Irwin, pp. 128-129, ISBN 0-256-13948-2.
5. Statistics Department (2001), Source Data for Monetary and Financial
Statistics, Monetary and Financial Statistics: Compilation Guide, Washington
D.C.: International Monetary Fund, p. 24, ISBN 978-1-58906-584-0. Retrieved
2009-03-14.
6. For Banks, Wads of Cash and Loads of Trouble Article by Eric Lipton and
Andrew Martin in The New York Times July 3, 2009 Hampshire, Great Britain,
Variorum.
7. Baum W.C. and Tolbert S.M. (1985), Investing in Development: Lessons of the
World Bank Experience, Oxford: Oxford University Press, p. 8.
8. Choudhary, S. (1988), Project Management, New Delhi: Tata McGraw Hill,
p. 3.
9. Harrison, F.L. (1992), Advance Project Management, Metropolitan, New Delhi,
p. 13.
10. James, M. Kouzes and Barry Z. Posner (1987), The Leadership Challenge,
Jossey Bass, Sans Francisco.
11. Prasanna Chandra (1988), Projects, Preparation, Appraisal, Budgeting and
Implementation: Tata McGraw Hill, New Delhi.
Amity Directorate of Distance and Online Education
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Notes
Financial Intermediaries
45
Notes
Unit 2:
Financial Intermediaries
Structure:
2.1 Introduction
2.2 Meaning of Financial Intermediary
2.3 Classification of Financial Intermediaries
2.4 Functions of Financial Intermediaries
2.5 Commercial Banks
2.6 Definitions of Commercial Bank
2.7 Meaning of Commercial Bank
2.8 Significance of Commercial Banks
2.9 Structure of Commercial Bank in India
2.10 Role of Commercial Bank in the Economic Development of India
2.11 Functions of Commercial Banks
2.12 Classification of Commercial Banks
2.13 Central Bank or RBI
2.14 History of the Reserve Bank of India
2.15 Establishment of RBI
2.16 Organizational Structure of RBI
2.17 Functional Departments of RBI
2.18 Objectives of Reserve Bank of India
2.19 Role of Reserve Bank of India
2.20 Main Functions of RBI
2.21 Monetary Policy of Reserve Bank of India
2.22 Objectives of Monetary Policy
2.23 Cooperative Banks
2.24 History of Cooperative Banking in India
2.25 Structure of Cooperative Banking in India
2.26 Cooperative Banks Irritants and Future Trends
2.27 Major Irritants in the Functioning of the Cooperative Banks
2.28 Banking System in USA and India
2.29 International Banking
2.30 Benefits of Having an International Banking
2.31 Banking Operations
2.32 Retail Banking
2.33 Meaning of Retail Banking
2.34 Retail Banking in India
2.35 Features of Retail Banking
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Notes
2.1 Introduction
A financial intermediary is a financial institution that connects surplus and deficit
agents. The classic example of a financial intermediary is a bank that consolidates bank
deposits and uses the funds to transform them into bank loans.
Financial Intermediaries are the firms that provide services and products which
customers may not be able to get more efficiently by themselves in final markets. In other
words, they act as middlemen between investors and borrowers in financial system.
Financial intermediaries may be classified into two:
(i) Capital market intermediaries
Those institutions who provide only long-term funds to individual and companies are
called capital market intermediaries, e.g., financial corporations, investing institutions, etc.
Financial Intermediaries
47
Notes
Those institutions who provide only short-term funds to individuals and corporate
customers are called money market intermediaries, e.g., commercial banks, cooperative
banks, etc.
48
Notes
Financial Intermediaries
49
productive uses. Commercial bank being the financial institution performs diverse types
of functions. It satisfies the financial needs of the sectors such as agriculture, industry,
trade, communication, etc. That means they play a very significant role in a process of
economic and social needs. The functions performed by banks are changing according
to changes in time and recently they are becoming customer centric and widening their
functions. Generally, the functions of commercial banks are divided into two categories,
viz., primary functions and secondary functions.
Notes
50
Notes
As on 30th June, 1999, there were 300 scheduled banks in India having a total network
of 64,918 branches. Scheduled commercial banks in India include State Bank of India
and its associates (7), nationalized banks (19), foreign banks (45), private sector banks
(32), cooperative banks and regional rural banks.
Scheduled banks in India means the State Bank of India constituted under the State
Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank
of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding new bank constituted
under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act,
1970 (5 of 1970), or under section 3 of the Banking Companies (Acquisition and Transfer
of Undertakings) Act, 1980 (40 of 1980), or any other bank being a bank included in the
Second Schedule to the Reserve Bank of India Act, 1934 (2 of 1934), but does not include
a cooperative bank.
(A) Scheduled Banks in India (Public Sector)
Public Sector Banks (PSBs) are banks where a majority stake (i.e., more than 50%)
is held by a government. The shares of these banks are listed on stock exchanges. The
Central Government entered the banking business with the nationalization of the Imperial
Bank of India in 1955. A 60% stake was taken by the Reserve Bank of India and the
new bank was named as the State Bank of India. The seven other state banks became
the subsidiaries of the new bank when nationalized on 19 July 1960. The next major
nationalization of banks took place in 1969 when the government of India, under Prime
Minister Indira Gandhi, nationalized an additional 14 major banks. The total deposits in
the banks nationalized in 1969 amounted to 50 crores. This move increased the presence
of nationalized banks in India, with 84% of the total branches coming under government
control.
The following are the Scheduled Banks in India (Public Sector):
(i) Nationalized Banks
z
Allahabad Bank
Andhra Bank
Bank of Baroda
Bank of India
Bank of Maharashtra
Canara Bank
Corporation Bank
Dena Bank
Indian Bank
Syndicate Bank
UCO Bank
Vijaya Bank
Financial Intermediaries
z
IDBI Bank
51
Notes
52
Notes
One of the positive points of these banks is that, they lean heavily on service and
technology and as such, they are likely to attract more business in days to come with
the restructuring of the industry round the corner.
List of the Old Private Sector Banks in India
Year of Establishment
1.
Bank of Punjab
1943
2.
1920
3.
1904
4.
Dhanlaxmi Bank
1927
5.
Federal Bank
1931
6.
1930
7.
1938
8.
Karnataka Bank
1924
9.
1916
10.
1926
11.
Nainital Bank
1912
12.
Ratnakar Bank
1943
13.
1955
14.
1905
15.
1921
16.
1936
Year of Establishment
1.
1994
2.
1989
1994
1995
3.
4.
Financial Intermediaries
53
5. HDFC Bank
1994
6. ICICI Bank
1996
7. IndusInd Bank
1994
1985
9. Yes Bank
2005
Notes
54
Notes
Financial Intermediaries
55
4. Development of agriculture
Notes
The commercial banks particularly in developing countries are now providing credit
for development of agriculture and small scale industries in rural areas. The provision of
credit to agriculture sector has greatly helped in raising agriculture productivity and income
of the farmers.
5. Balanced development of different regions
The commercial banks play an important role in achieving balanced development in
different regions of the country. They help in transferring surplus capital from developed
regions to the less developed regions. The traders, industrialist, etc. of less developed
regions is able to get adequate capital for meeting their business needs. This in turn
increases investment, trade and production in the economy.
6. Influencing economic activity
The banks can also influence the economic activity of the country through its
influence on (a) availability of credit and (b) the rate of interest. If the commercial banks
are able to increase the amount of money in circulation through credit creation or by
lowering the rate of interest, it directly affects economic development. A low rate of interest
can encourage investment. The credit creation activity can raise aggregate demand which
leads to more production in the economy.
7. Implementation of monetary policy
The central bank of the country controls and regulates volume of credit through the
active cooperation of the banking system in the country. It helps in bringing price stability
and promotes economic growth within the shortest possible period of time.
8. Monetization of the economy
The commercial banks by opening branches in the rural and backward areas are
reducing the exchange of goods through barter. The use of money has greatly increased
the volume of production of goods. The non-monetized sector (barter economy) is now
being converted into monetized sector with the help of commercial banks.
9. Export promotion cells
In order to increase the exports of the country, the commercial banks have
established export promotion cells. They provide information about general trade and
economic conditions both inside and outside the country to its customers. The banks
are therefore, making positive contribution in the process of economic development.
1. Primary Functions
Primary functions of the commercial banks include:
(i) Acceptance of Deposits
Commercial bank accepts various types of deposits from public especially from its
clients. These deposits are payable after a certain time period. Banks generally accept
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Notes
three types of deposits, viz., (a) Current Deposits, (b) Savings Deposits, (c) Fixed Deposits
and (d) Recurring Deposit.
(a) Current Deposits
These deposits are also known as demand deposits. These deposits can be
withdrawn at any time. Generally, no interest is allowed on current deposits, and in case,
the customer is required to leave a minimum balance undrawn with the bank. Cheques
are used to withdraw the amount. These deposits are kept by businessmen and
industrialists who receive and make large payments through banks. The bank levies certain
incidental charges on the customer for the services rendered by it.
The Reserve bank of India prohibits payment of interest on current accounts or on
deposits up to 14 days or less except where prior sanction has been obtained. Banks
usually charge a small amount known as incidental charges on current deposit accounts
depending on the number of transaction.
(b) Savings Deposits
If the customer wishes to withdraw more than the specified amount at any one time,
he has to give prior notice. Interest is allowed on the credit balance of this account. The
rate of interest is greater than the rate of interest on the current deposits and less than
that on fixed deposit. This system greatly encourages the habit of thrift or savings.
Savings deposit account is meant for individuals who wish to deposit small amounts
out of their current income. It helps in safe guarding their future and also earning interest
on the savings. A saving account can be opened with or without cheque book facility.
There are restrictions on the withdrawals from this account. Savings account holders are
also allowed to deposit cheques, drafts, dividend warrants, etc. drawn in their favour for
collection by the bank. To open a savings account, it is necessary for the depositor to
be introduced by a person having a current or savings account with the same bank.
(c) Fixed Deposits
These deposits are also known as time deposits. These deposits cannot be
withdrawn before the expiry of the period for which they are deposited or without giving
a prior notice for withdrawal. If the depositor is in need of money, he has to borrow on
the security of this account and pay a slightly higher rate of interest to the bank. They
are attracted by the payment of interest which is usually higher for longer period. Fixed
deposits are liked by depositors both for their safety and as well as for their interest. In
India, they are accepted between three months and ten years.
Fixed deposits are most useful for a commercial bank. Since they are repayable
only after a fixed period, the bank may invest these funds more profitably by lending at
higher rates of interest and for relatively longer periods. The rate of interest on fixed deposits
depends upon the period of deposits. The longer the period, the higher is the rate of interest
offered. The rate of interest to be allowed on fixed deposits is governed by rules laid down
by the Reserve Bank of India.
(d) Recurring Deposits
Recurring deposits are a special kind of term deposits offered by banks in India which
help people with regular incomes to deposit a fixed amount every month into their recurring
deposit account and earn interest at the rate applicable to fixed deposits. It is similar
to making FDs of a certain amount in monthly installments, for example ` 1,000 every
month. This deposit matures on a specific date in the future along with all the deposits
made every month. Thus, recurring deposit schemes allow customers with an opportunity
to build up their savings through regular monthly deposits of fixed sum over a fixed period
of time.
Financial Intermediaries
57
The recurring deposit can be funded by standing instructions which are the
instructions by the customer to the bank to withdraw a certain sum of money from his
savings/current account and credit to the recurring deposit every month.
Notes
58
Notes
Financial Intermediaries
59
Notes
Among other forms of bank advances there are packing credits given to exporters
for a short duration, export bills purchased/discounted, import finance, advances against
import bills, finance to the self-employed, credit to the public sector, credit to the
cooperative sector and above all, credit to the weaker sections of the community at
concessional rates.
(iii) Creation of Credit
One of the important functions of commercial bank is the creation of credit. Credit
creation is the multiple expansions of banks demand deposits. It is an open secret now
that banks advance a major portion of their deposits to the borrowers and keep smaller
parts of deposits to the customers on demand. Even then the customers of the banks
have full confidence that the depositors lying in the banks is quite safe and can be
withdrawn on demand. The banks exploit this trust of their clients and expand loans by
much more time than the amount of demand deposits possessed by them. This tendency
on the part of the commercial banks to expand their demand deposits as a multiple of
their excess cash reserve is called creation of credit. Banks supply money to traders and
manufacturers. They also create or manufacture money. Bank deposits are regarded as
money. They are as good as cash. The reason is they can be used for the purchase
of goods and services and also in payment of debts. When a bank grants a loan to its
customer, it does not pay cash. It simply credits the account of the borrower. He can
withdraw the amount whenever he wants by a cheque. In this case, bank has created
a deposit without receiving cash. That is, banks are said to have created credit. Sayers
says banks are not merely purveyors of money, but also in an important sense,
manufacturers of money.
The commercial banks create multiple expansions of their bank deposits and due
to this, these are called the factories of credit. The banks advance a major portion of their,
deposits to the borrowers and keep a smaller part with them. The customers have full
confidence on the bank. The banks expand loans by much more than the amount of cash
possessed by them. This tendency on the part of the banks to lend more than the amount
of cash possessed by them is called Creation of Credit in Economics. The process of
Credit Creation begins with banks lending money out of primary deposits. Primary
deposits are those deposits which are deposited in banks. In fact banks cannot lend the
entire primary deposits as they are required to maintain a certain proportion of primary
deposits in the form of reserves with the RBI under RBI and Banking Regulation Act. After
maintaining the required reserves, the bank can lend the remaining portion of primary
deposits. Here, banks lend the money and the process of credit creation starts.
Meaning of Credit Creation
Credit creation is the multiple expansions of banks demand deposits. It is an open
secret now that banks advance a major portion of their deposits to the borrowers and keep
smaller parts of deposits to the customers on demand. Even then the customers of the
banks have full confidence that the depositors lying in the banks is quite safe and can
be withdrawn on demand.
Assumptions of Credit Creation
The concept of credit creation is based on the following assumptions:
1. The banks, while granting loans, do not give the amount in cash, instead it
credits the accounts of the customers with the amount of loan.
Amity Directorate of Distance and Online Education
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Notes
Financial Intermediaries
61
Notes
62
Notes
Financial Intermediaries
63
Notes
(g) Act as Trustee and Executor: Banks preserve the Wills of their customers
and execute them after their death.
(ii) General Utility Services
General utility services are those services which are rendered by commercial banks
not only to the customers but also to the general public.
In addition to agency services, the modern banks provide many general utility services
for the community as given below:
(a) Safe Deposit Vaults
A bank undertakes the safe custody of the customers valuables and documents
by providing a safe deposit vault. These are kept in specially constructed strong rooms.
There are lockers available to the customer on a nominal charge. There are two keys for
each locker, one is given to the customer and the other remains with the Bank Manager.
The locker is opened as well as closed by both the keys one after another. Customers
can keep custody. A register is maintained by the bank in which all the particulars about
the valuables and documents are recorded in it. Banks provide the services of safe deposit
vault on hire basis to the customers.
(b) Collection of Cheques, Bills and Promissory Notes
The customers deposit cheques, bills of exchange and promissory note into their
accounts with the banks. These instruments are collected by the bank on behalf of their
customers and credited to their accounts. These services are provided by the cheques,
bills and promissory notes issued on branches out of the city are collected with some
nominal charges for postage, etc. This is a very popular and essential service provided
by the banks to their customers.
(c) Issuing Letter of Credit
A letter of credit is a commercial instrument of assured payment. It is widely used
by the businessman for various purposes. The bank undertakes to make payment to a
seller on production of documents stipulated in the letter of credit. It specifies as to when
payment is to be made which may be either on presentation of documents by the paying
bank or at some future date depending upon the terms stipulated in the letter. There are
many parties involved in the letter of credit. One is the applicant who is the buyer of goods
or importer of goods. He makes an application to a bank who issues the letter of credit.
The bank is known as issuing bank. The beneficiary is named in the letter of credit who
is the seller of goods or exporter. Other banks are also involved in the transaction such
as negotiating bank, confirming bank and advising bank. There are different types of letter
of credit. This is a very important service provided by the banks especially for the importers
and exporters.
(d) Bank Drafts
A bank draft is an order from one branch to another branch of the same bank to
pay a specified sum of money to a person named therein or to his order. A draft is always
payable on demand. Banks issue drafts at the request of the customers on their branches
at the place of destination for remitting money from one place to another place. Any person
who wants to remit money has to purchase a draft from the bank by paying the amount
in advance to the bank. The purchaser of the draft then sends the draft to the payees
place of residence by post or courier for the purpose of encashment at the drawee branch
Amity Directorate of Distance and Online Education
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Notes
of the bank. The bank issuing the draft charges some commission depends upon the
amount of the draft. The purchaser need not be a customer of the bank.
The bank draft is like a bill of exchange payable on demand. In case the draft is
lost by a purchaser, he has to report to the issuing banker for loss of the draft without
any endorsement, the banker may safely refuse to pay the amount of the draft. The bank
should take all the precautions and payment of the draft should be made only when the
banker is fully satisfied about the valid title of the holder. The banker should take an
indemnity bond and then issue a duplicate draft to the purchaser. The draft may be
cancelled by the bank if it is not delivered to the payee. When a bank draft is delivered
to the payee, he acquires a right in the instrument, which cannot be set aside by the
stop-payment order issued by the purchaser. The bank issuing the draft sends an advice
to the drawee branch, intimating about the issue of the draft. The drawee branch after
verifying the signature of the authorized officials makes the payment. However, the
payment of the draft should not be refused because of non-receipt of drawing advice.
(e) Automated Teller Machine (ATM)
ATM is a channel of banking service to its customers. Its traditional and primary
use is to dispense cash upon insertion of a plastic card and its unique PIN, i.e., Personal
Identification Number. The banks issue ATM card to their customers having current or
savings account holding a certain minimum balance in their accounts. ATM card is a
plastic card with a magnetic strip with the account number of the individuals. When the
card is inserted into the machine, the sensing equipment of the machine identifies the
account holder and asks his PIN. It is a secret number which is known only to the account
holder.
Advantages of ATM
Following are the advantages of ATM:
1. ATM provides 24 hour service; the customer can withdraw cash up to a certain
limit during 24 hours. It is now called all time money facility.
2. It provides a great deal of convenience to customers. Most of the ATMs are
located at the convenient place and as such this facility is a boon to customers.
ATM machines are installed at suitable locations such as airport, railway station,
residential colony, near big malls, etc.
3. ATM facility also reduces pressure on bank staff. The bank staff is free from
the botheration of keeping large ready cash for withdrawal by people.
4. Here, the work of deposition and withdrawal is handled by the machine. The
machines are perfect and provide accurate service. The human errors are absent
when operations are performed by machines.
5. Operations through machines provide a kind of privacy and secrecy to banking
business.
Disadvantages of ATM
The various disadvantages of ATM are as follows:
(i) Security: Unlike bank tellers, ATMs do not require the person performing the
transaction to present picture identification. Rather, the person must only insert
a bank card and enter a personal identification number. If the bank card is stolen
and the number ascertained, an unauthorized person can easily access the
account.
(ii) Inability to perform complex transactions: ATMs can only perform relatively
basic transactions. This means that people who need to complete these longer
Financial Intermediaries
65
transactions will be forced to use the teller, restricting use of the ATM for people
who need to complete simple business. In this sense, the ATM is rather like
the express line in a supermarket faster for some, but unavailable to others.
Notes
(iii) Fees: With the advent of ATMs came ATM fees. Not only do banks of which
you are not a member charge fees for the use of their ATMs, but users are
often charged surreptitious fees by their own banks for using other banks ATMs
meaning the customer is docked twice for the same transaction.
(iv) Privacy: Unlike banks, in which security guards and tellers are present to
ensure the person performing a transaction receives privacy, there is no such
guarantee when using an ATM. People may try to spy on users as delicate
information appears on the screen, without the user being aware.
(v) Difficulty of use through illiterate people: The performance of business at
an ATM is generally quicker than that at a human teller. However, the ATM
is incapable of providing personalized instruction to the user in a way that a
human teller can. This can result in longer wait times if the user currently using
the machine is struggling to complete a transaction.
f) Debit Card
A debit card is a plastic card that provides an alternative payment method to cash
when making purchases. Functionally, it can be called an electronic check, as the funds
are withdrawn directly from either the bank account or from the remaining balance on the
card. In some cases, the cards are designed exclusively for use on the Internet, and so
there is no physical card.
In many countries, the use of debit cards has become so widespread that their volume
of use has overtaken or entirely replaced the check and, in some instances, cash
transactions. Like credit cards, debit cards are used widely for telephone and Internet
purchases and, unlike credit cards, the funds are transferred immediately from the bearers
bank account instead of having the bearer pay back the money at a later date.
Debit cards may also allow for instant withdrawal of cash, acting as the ATM card
for withdrawing cash and as a check guarantee card. Merchants may also offer cash back
facilities to customers, where a customer can withdraw cash along with their purchase.
(g) Credit Card
A credit card is an instrument of payment. It is a source of revolving credit. The cards
are plastic cards issued by the banks to their customers. The name of the customer,
card number and expiry date are printed on the plastic cards. Some banks also use the
photograph of the customers on the credit card. The card holder can buy goods or services
from various merchant establishments where such arrangements exist. The card issuing
bank makes the payment to the supplier or seller. The outstanding amount on account
of use of the credit card is payable by the card holder to the bank over a specific period
which carries a fixed amount of interest. A debit card is a payment card used to obtain
cash, goods and services automatically debiting the payments to the card holders bank
account instantly, in which credit balance exists.
A credit card is more than a simple piece of plastic, it is first and foremost a flexible
payment tool accepted at 30 million locations worldwide, and if the card balance is paid
off every month, then no interest is charged on purchases made so, essentially, shortterm credit is granted without the consumer paying any interest.
Some of the features of Credit Card are:
1. Access to unsecured credit (no collateral required against amounts charged).
2. Interest-free payment from time of purchase to the end of the billing period.
Amity Directorate of Distance and Online Education
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Notes
3. Instant payment of purchases, allowing for instant receipt of goods and services.
4. 24/7 access.
5. Fraud protection.
Advantages and Disadvantages of Credit Card
Advantages of Credit Card:
1. Offer free use of funds, provided you always pay your balance in full, on time.
2. Be more convenient to carry than cash.
3. It helps to establish a good credit history.
4. To provide a convenient payment method for purchases made on the Internet
and over the telephone.
5. Give you incentives, such as reward points, that you can redeem.
Disadvantages of Credit Card:
1. Cost much more than other forms of credit, such as a line of credit or a personal
loan, if you dont pay on time.
2. Damage your credit rating if your payments are late.
3. Allow you to build up more debt than you can handle.
4. Have complicated terms and conditions.
(h) Tele Banking
Telephone banking is a service provided by a Commercial Banks, which allows its
customers to perform transactions over the telephone.
Most telephone banking services use an automated phone answering system with
phone keypad response or voice recognition capability. To guarantee security, the
customer must first authenticate through a numeric or verbal password or through security
questions asked by a live representative. With the obvious exception of cash withdrawals
and deposits, it offers virtually all the features of an automated teller machine: account
balance information and list of latest transactions, electronic bill payments, funds transfers
between a customers accounts, etc.
Usually, customers can also speak to a live representative located in a call centre
or a branch, although this feature is not always guaranteed to be offered 24/7. In addition
to the self-service transactions listed earlier, telephone banking representatives are usually
trained to do what was traditionally available only at the branch: loan applications,
investment purchases and redemptions, cheque book orders, debit card replacements,
change of address, etc.
(i) Internet Banking
Internet is a channel of service to banking customers. The access to account
information as well as transaction is offered through the world wide web network of
computers on the internet. Each account holder is provided with a PIN similar to that of
ATM or phone banking. The access to the account is allowed to the customer upon a
match of the account details and PIN entered on the computer system. A higher level
of security may be reached by an electronic fingerprint. Transaction such as e-business,
Railway-Air Reservation, payment of bills, transfer of money, etc. can be carried out while
sitting in the house with the help of an internet.
The following is a list of the advantages of internet banking:
1. Easy to Set-up: It is easy and fast to set up an internet bank account. All that
users have to do to create an online bank account is complete a short form and then
Financial Intermediaries
67
set the security features such as a password and username. Finally, they just print and
sign a form and send it in to the bank.
Notes
2. Fewer Costs: There are fewer costs associated with internet banking because
online banks do not have the overhead like traditional banks. Because there are fewer
costs, internet banks pass the savings on to consumers such as reduced service charges
and increased interest rates for savings accounts. They can even offer reduced lending
rates for their loans.
3. Easy and Convenient Online Bank Comparison: It is easy to research many
internet banks online allowing to compare such features as interest rates, available credit
cards and their interest rates, FDIC Bank rating, and terms and interest rates of their
loans.
4. Easy Bank Account Monitoring: Internet banking and money 24 hours a day,
7 days a week. It can track such things as deposits, clearing of checks, account balance.
It allows to keep the account from going into the negative.
5. Maintain Accurate Financial Records: It can keep track of the financial records
by using software programs such as Microsoft Money or Quicken. This will allow to budget
more efficiently and track the spending.
6. Convenient Banking: Traditional banking has always been slow. With online
banking, It will no longer have to stand in long lines to obtain financial information about
your account. As well, there is less paperwork and applying for loans is faster, easier,
and more convenient.
Disadvantages of Internet Banking
1. Security: While banks typically offer secure web pages to conduct customers
business transactions, this doesnt guarantee complete safety. All websites, even secure
ones, may be susceptible to Internet criminals who try to hack into customers account
and gain access to businesss private financial information. This can lead to fraudulent
use of businesss identity and potentially cost the customers thousands of rupees.
2. Site Disruption: A technical malfunction could cause the banks website to go
offline for a period of time, possibly resulting in problems for customers business. For
example, you may need immediate funds after normal banking hours to make a payment
or emergency business purchase. Routine site maintenance also occurs, although this
normally takes place during off-peak hours.
3. Site Navigation: If the customers are new to online banking, it may take some
time to get used to it, taking valuable time out of work day. Online banking offers a large
number of transactions, so frustration may occur while customers are learning to navigate
the site. Banks also update web pages to add new features, requiring additional learning
and possibly the need to change account numbers or passwords.
4. User Apprehension: Some business owners may not feel comfortable with the
idea of placing vital financial information into an online account, or may be apprehensive
about using the Internet. If you are a longtime small business owner who is used to doing
banking in person or even by telephone, this hurdle might be difficult to surmount.
5. Accessibility: If customers business is located in a rural or remote area, the
Internet options could be limited. Depending on the business, this can make conducting
transactions difficult.
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Furthermore, the loans offered by industrial banks are often secured by a third party who
acts as guarantor for the loan.
Notes
Industries require a huge capital for a long period to buy machinery and equipment.
Industrial banks help such industrialists. They provide long-term loans to industries.
Besides, they buy shares and debentures of companies, and enable them to have fixed
capital. Sometimes, they even underwrite the debentures and shares of big industrial
concerns. The industrial banks play a vital role in accelerating industrial development. In
India, after attainment of independence, several industrial banks were started with large
paid up capital. They are, The Industrial Finance Corporation (IFC), The State Financial
Corporations (SFC), Industrial Credit and Investment Corporation of India (ICICI) and
Industrial Developmental Bank of India (IDBI), etc.
Investment banking, otherwise known as industrial banks, provides long-term finance
to industries. Germany is considered to be the hometown of investment banking. These
banks help the companies, corporations and the Government in issuing and marketing
their securities. These banks serve as intermediaries in the marketing of securities. They
help in promoting industries. Investment banks act in three different capacities, viz.,
(a) As originators, (b) As underwriters and (c) Retailers. As originators, they help in the
promotion of new ventures, as underwriters, they underwrite the new issues and as
retailers, they sell securities to the investors.
B. On the Basis of the System of Commercial Bank
1. Branch Bank
This is a system of banking where the business is carried on by a single office with
a network of branches spread throughout the country. The Head Office is generally located
in a big city and the branches operate in different parts of the country. England offers
the best example of Branch banking, wherein the entire Commercial Banking business
is carried out by four major banks, popularly known as the Big four. The other countries
following this system are Scotland, Australia, and India.
A comparison between unit banking and branch banking is essentially a comparison
between large-scale and small-scale operations. Obviously, a bank having branches has
some advantages over the unit bank. However the latter too are efficient in their own way.
The advantages of one system of banking incidentally happen to be the disadvantages
of the other.
Merits of Branch Banking
Following are the chief merits of branch banking system:
(i) Large-scale Operations
Branch banking enjoys all the advantages of large-scale operations and reaps the
benefit of division of labor. In comparison of this, the scope for the application of
specialization in unit banking is comparatively limited.
(ii) Economy in Reserves
Branch Banking offers the advantage of keeping lower cash reserves in each branch.
The reserves can be moved from one branch to another in times of necessity. Economy
of reserves is of vital consideration to the banker. Unit banks do not possess this advantage
and they have to totally depend upon their own reserves.
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Since there is no arrangement for the cheap remittance of funds under unit banking
system, there often arises inequality in the rates of interest in different parts of the county.
For example, the interest rates are generally lower in big commercial and industrial centers
they are rather high in the backward and under developed areas of the country.
(v) Less Development of Banking in Smaller Towns and Cities
Unit banks are not in a position to open uneconomic branches in small localities
because their financial resources are already limited and they cannot afford to open
branches in small localities.
System Suitable in India
There was predominance of unit banking in India prior to independence because of
the following reasons:
(a) There were many provinces having different laws.
(b) Economic interests favored small banks serving a limited area.
(c) There was lack of initiative by the banks to open branches outside their local
areas of operation.
(d) Due to large number of illiterate people, personal contact and informal
procedures played an important role in dealing with the customers, which was
possible only in case of small regional banks.
Now, the situation has changed totally and the unit banks cannot meet the
requirements of our developing economy.
Branch banking is preferred in India because of the following reasons:
1. There is a probability of failure of small banks, which causes a serious setback
to the peoples faith in banking. This is evident from the fact they many banks
failed or merged with bigger banks during the early years of independence.
2. India has launched upon an ambitious and extensive programmes of economic
development, which requires adequate capital, which can be provided only by
large banks having branches.
3. Small banks are not suited to mobilize the savings of rural areas, as they cannot
function economically. In such areas, only the big banks can afford to open
their branches in rural areas and can provide financial and other help to the poor
people to get employment under the self-employment schemes.
4. In order to make the control measures of Central Government and Reserve Bank
effective, branch banking is suitable in India.
3. Group Bank
Group banking is that system of banking under which two or more banks are directly
or indirectly controlled by an association, trust, or corporation. This type of banking is
also known as holding company banking. The holding company holds the majority shares
in the companies under its control and the companies whose shares are held by the holding
company are known as subsidiary companies. In our country, the State Bank of India
is an example of the holding company and its seven subsidiaries, viz., (a) State Bank
of Bikaner and Jaipur, (b) State Bank of Indore, (c) State Bank of Hyderbad, (d) State
Bank of Patiala, (e) State Bank of Mysore, (f) State Bank of Saurashtra and (g) State
Bank of Trivandrum are the subsidiary banks.
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6. Savings Bank
Notes
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Notes
The Reserve Bank of India is the central banking institution of India and controls the
monetary policy of the rupee as well as US$ 300.21 billion (2010) of currency reserves.
The institution was established on 1 April 1935 during the British Raj in accordance with
the provisions of the Reserve Bank of India Act, 1934 and plays an important part in the
development strategy of the government. It is a member bank of the Asian Clearing Union.
1935-1950:
The Central Bank was founded in 1935 to respond to economic troubles after the
First World War. The Reserve Bank of India was set up on the recommendations of the
Hilton-Young Commission. The commission submitted its report in the year 1926, though
the bank was not set up for another nine years. The Preamble of the Reserve Bank of
India describes the basic functions of the Reserve Bank as to regulate the issue of bank
notes, to keep reserves with a view to securing monetary stability in India and generally
to operate the currency and credit system in the best interests of the country. The Central
Office of the Reserve Bank was initially established in Kolkata, Bengal, but was
permanently moved to Mumbai in 1937. The Reserve Bank continued to act as the central
bank for Myanmar till Japanese occupation of Burma and later up to April 1947, though
Burma seceded from the Indian Union in 1937. After partition, the Reserve Bank served
as the central bank for Pakistan until June 1948 when the State Bank of Pakistan
commenced operations. Though originally set up as a shareholders bank, the RBI has
been fully owned by the Government of India since its nationalization in 1949.
1950-1960:
Between 1950 and 1960, the Indian government developed a centrally planned
economic policy and focused on the agricultural sector. The administration nationalized
and established commercial banks based on the Banking Companies Act, 1949 (later
called Banking Regulation Act), a central bank regulation as part of the RBI. Furthermore,
the central bank was ordered to support the economic plan with loans.
1960-1969:
As a result of bank crashes, the Reserve Bank was requested to establish and
monitor a deposit insurance system. It restored the trust in the national bank system and
was initialized on 7 December 1961. The Indian government founded funds to promote
the economy and used the slogan-developing Banking. The Government of India
restructured the national bank market and nationalized a lot of institutes. As a result,
the RBI had to play the central part of control and support of this public banking sector.
1969-1985:
Between 1969 and 1980, the Indian government nationalized 6 more commercial
banks, following 14 major commercial banks being nationalized in 1969 (as mentioned
in RBI website). The regulation of the economy and especially the financial sector was
reinforced by the Government of India in the 1970s and 1980s. The central bank became
the central player and increased its policies for a lot of tasks like interests, reserve ratio
and visible deposits. The measures aimed at better economic development and had a huge
effect on the company policy of the institutes. The banks lent money in selected sectors,
like agri-business and small trade companies. The branch was forced to establish two
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new offices in the country for every newly established office in the town. The oil crises
in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce
the effects.
1985-1991:
A lot of committees analyzed the Indian economy between 1985 and 1991. Their
results had an effect on the RBI. The Board for Industrial and Financial Reconstruction,
the Indira Gandhi Institute of Development Research and the Security and Exchange Board
of India investigated the national economy as a whole, and the security and exchange
board proposed better methods for more effective markets and the protection of investor
interests. The Indian financial market was a leading example for so-called financial
repression. The Discount and Finance House of India began its operations on the
monetary market in April 1988; the National Housing Bank, founded in July 1988, was
forced to invest in the property market and a new financial law improved the versatility
of direct deposit by more security measures and liberalization.
1991-2000:
The national economy came down in July 1991 and the Indian rupee was devalued.
The currency lost 1% relative to the US dollar, and the Narasimham Committee advised
restructuring the financial sector by a temporal reduced reserve ratio as well as the
statutory liquidity ratio. New guidelines were published in 1993 to establish a private
banking sector. This turning point reinforced the market and was often called neo-liberal.
The central bank deregulated bank interests and some sectors of the financial market
like the trust and property markets. This first phase was a success and the central
government forced a diversity liberalization to diversify owner structures in 1998.
The National Stock Exchange of India took the trade on in June 1994 and the RBI
allowed nationalized banks in July to interact with the capital market to reinforce their
capital base. The central bank founded a subsidiary company the Bharatiya Reserve Bank
Note Mudran Limited in February 1995 to produce Bank Notes.
Since 2000:
The Foreign Exchange Management Act from 1999 came into force in June 2000.
It helped in improving the foreign exchange market, international investments in India and
foreign transactions. The RBI promoted the development of the financial market in the last
years, allowed online banking in 2001 and established a new payment system in 20042005. The Security Printing and Minting Corporation of India Ltd., a merger of nine
institutions, was founded in 2006 which produced bank notes and coins.
The national economys growth rate came down to 5.8% in the last quarter of 20082009 and the central bank promoted the economic development.
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Notes
The Preamble of the Reserve Bank of India describes the basic functions of the
Reserve Bank as: To regulate the issue of Bank Notes and 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.
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(iv) To help for the development of organized money market in the country.
(v) To assist for proper arrangement of agriculture finance.
(vi) To assist for proper arrangement of industrial finance.
(vii) To assist for proper management of public debts.
(viii) To establish monetary relations with other countries of the world and
international financial institutions.
(ix) To helps for centralization of cash reserves of commercial banks.
(x) To maintain balance between the demand and supply of currency.
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Notes
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Where the RBI has no offices of its own, the function of clearing house is carried
out in the premises of the State Bank of India. The entire clearing house operations carried
on by RBI are computerized. The inter-bank cheque clearing settlement is done twice a
day.
Notes
The RBI acts as a lender of last resort or emergency fund provider to the other member
banks. As such, if the commercial banks are not able to get financial assistance from
any other sources, then as a last resort, they can approach the RBI for the necessary
financial assistance.
In such situations, the RBI provides credit facilities to the commercial banks on
eligible securities including genuine trade bills which are usually made available at Bank
Rate.
RBI rediscounts bills under Section 17(2) and 17(3) and grants advances against
securities under Section 17(4) of RBI Act. However, many of these transactions are
practically carried out through separate agencies like DHFI, Securities Trading Corporation
of India, primary dealers.
The RBI now mainly provides refinance facilities as direct assistance. Rediscounting
of bills fall under the following categories:
(i) Commercial Bill
A bill arising out of bonfire commercial or trade transaction drawn and payable in
India and mature within 90 days from the date of purchase or discount is eligible for
rediscount.
(ii) Bills for Financing Agricultural Operations
A bill issued for purpose of financing seasonal agricultural operations or the marketing
of crops and maturing within 15 months from the date of purchase or rediscount.
(iii) Bills for Financing Cottage and Small-scale Industries
Bills drawn or issued for the purpose of financing the production and marketing of
products of cottage and small industries approved by RBI and mature within 12 months
from the date of discount.
(iv) Refinance
Under agricultural and small-scale industries, activities are now provided by NABARD
by obtaining financial assistance from RBI.
(v) Bill for Holding or Trading in Government Securities
Such a bill should mature within 90 days from the date of purchase or rediscounting
and be drawn and payable in India.
(vi) Foreign Bills
Bonfire bill arising out of export of goods from India and which mature within 180
days from the date of shipment of goods are eligible.
As lender of last resort, the RBI facilitates the following:
(a) Provides financial assistance to commercial banks at the time of financial needs.
(b) It helps the commercial banks in maintaining liquidity of their financial resources.
(c) Enables the commercial banks to carry out their activities with minimum cash
reserves.
(d) As a lender of last resort, the RBI can exercise full control over the commercial
banks.
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The RBI aims at economic stability in the country whenever, there is a danger to
the economic stability, it takes immediate measures to put the economy on proper course
by effective policy changes and implementation thereof.
The Reserve Bank of India is the main source of monetary information and data related
to banking. These information are very much essential for framing the economic policies
and banking policies. It is the duty of the reserve bank to collect and publish the information
regularly in the form of weekly statements, monthly bulletins, annual reports, reports on
trends and progress of banking sector in India, etc.
14. Promotion of Banking Habits
The RBI institutionalizes saving through the promotion of banking habit and expansion
of the banking system territorially and functionally.
Accordingly, RBI has set up deposit insurance corporation in 1962, Unit Trust of India
in 1964, the IDBI in 1964, the Agricultural Refinance Corporation in 1963, Industrial
Reconstruction Corporation of India in 1972, NABARD in 1982 and the National Housing
Bank in 1988, etc.
It has helped to bring into existence several industrial finance corporations such as
Industrial Finance Corporation of India, Industrial Credit and Investment Corporation of India
for industrialization of the country. Similarly, sector specific corporations took care of
development in their respective spheres of activity.
15. Provides Refinance for Export Promotion
The RBI takes the initiative for widening facilities for the provision of finance for foreign
trade particularly of exports.
The Export Credit and Guarantee Corporation (ECGC) and Exam Banks render useful
functions on this line. To encourage exports, the RBI is providing refinance facilities for
export credit given by commercial banks. Further, the rate of interest on export credits
continues to be prescribed by RBI at a lower rate.
The ECGC provides an insurance cover on export receivables. EXIM Bank extends
long-term finance to project exporters and foreign currency credit for promotion of Indian
exports. Students should know that many of these institutions were part of Reserve Bank
earlier although they are currently functioning as separate financial institutions.
16. Facilities for Agriculture
The RBI extends indirect financial facilities to agriculture regularly. Through NABARD,
it provides short-term and long-term financial facilities to agriculture and allied activities.
It established NABARD for the overall administration of agricultural and rural credit. Indian
agriculture would have starved of a cheap credit but for the institutionalization of rural credit
by RBI.
The Reserve Bank was extending financial assistance to the rural sector mainly
through contributions to the National Rural Credit Funds being operated by NABARD. RBI
presently makes only a symbolic contribution of ` 1.00 crore.
It, however, extends cheap indirect financial assistance to the agricultural sector by
providing large sums of money through General Line of Credit to NABARD. The loans and
advances extended to NABARD by RBI and outstanding as on June 1999 amounted to
` 5073 crore.
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This type of inspection is carried on periodically once a year or two covering all
branches of banks. Banks are obliged to take remedial measures on the lapses/
deficiencies pointed out during inspection. In addition RBI also calls for periodical
information concerning certain assets and liabilities of the banks to verify that the banks
continue to remain in good health.
Notes
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Main Duties
Monetary Policy Department is entrusted with the responsibility of designing,
formulating and implementing monetary policy of the Reserve Bank. Accordingly, the
Department prepares Governors Statements on Monetary Policy. The Policy Statements
are currently brought out four times in a year. The Annual Policy (April) and its Second
Quarter Review (October) consist of two parts: Part A: Monetary Policy and Part B:
Developmental and Regulatory Policies. The First Quarter Review (July) and the Third
Quarter Review (January) of Monetary Policy comprise only Part A.
Monetary policy formulation is carried out by the Reserve Bank in consultation with
various stakeholders such as banks, market participants and industry and trade
associations. In pursuance of the objective of further strengthening the consultative process
of monetary policy formulation, a Technical Advisory Committee (TAC) on Monetary Policy
has been set up, which meets ahead of the Annual Policy and the quarterly reviews, to
review macroeconomic and monetary developments and advise the Reserve Bank on the
stance of monetary policy.
Main Activities
Preparation of Reserve Banks Annual Policy Statement and its Reviews in each
quarter. Conduct of Technical Advisory Committee meetings on Monetary Policy in each
quarter before the announcement of Policy Statement/Reviews or at any other time as
and when needed. Conduct of pre-policy consultation meetings with the bankers, market
participants, trade bodies, self-regulatory organizations and economists and journalists
to facilitate the policy formulation process.
Definitions of Monetary Policy
According to Prof. Harry Johnson, Monetary policy is a policy employing the central
banks control of the supply of money as an instrument for achieving the objectives of
general economic policy is a monetary policy.
According to A.G. Hart, Monetary policy is a policy which influences the public
stock of money substitute of public demand for such assets of both that is policy which
influences public liquidity position is known as a monetary policy.
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policy having an objective of price stability tries to keep the value of money stable. It helps
in reducing the income and wealth inequalities. When the economy suffers from recession,
the monetary policy should be an easy money policy but when there is inflationary
situation there should be a dear money policy.
Notes
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of the total rural credit. It also stands for 36% of the total distribution of rural fertilizers
and 28% of rural fair price shops.
Notes
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2. Commercial Banks
Notes
Commercial bank is an institution that accepts deposit, makes business loans and
offer related services to various like accepting deposits and lending loans and advances
to general customers and business man.
These institutions run to make profit. They cater to the financial requirements of
industries and various sectors like agriculture, rural development, etc. it is a profit making
institution owned by government or private of both.
Commercial bank includes public sector, private sector, foreign banks and regional
rural banks:
(a) Public sector Banks
It includes SBI, seven (7) associate banks and nineteen (19) nationalized banks.
Altogether there are 27 public sector banks. The public sector accounts for 90% of total
banking business in India and State Bank of India is the largest commercial bank in terms
of volume of all commercial banks.
(b) Private Sector Banks
Private sector banks are those whose equity is held by private shareholders. For
example, ICICI, HDFC, etc. Private sector bank plays a major role in the development
of Indian banking industry.
(c) Foreign Banks
Foreign banks are those banks, which have their head offices abroad. CITI Bank,
HSBC, Standard Chartered, etc. are the examples of foreign bank in India.
(d) Regional Rural Banks (RRB)
These are state sponsored regional rural oriented banks. They provide credit for
agricultural and rural development. The main objective of RRB is to develop rural economy.
Their borrowers include small and marginal farmers, agricultural laborers, artisans, etc.
NABARD holds the apex position in the agricultural and rural development.
3. Cooperative Bank
Cooperative bank was set up by passing a cooperative act in 1904. They are
organized and managed on the principal of cooperation and mutual help. The main objective
of cooperative bank is to provide rural credit.
The cooperative banks in India play an important role even today in rural cooperative
financing. The enactment of Cooperative Credit Societies Act, 1904, however, gave the
real impetus to the movement. The Cooperative Credit Societies Act, 1904 was amended
in 1912, with a view to broad basing it to enable organization of non-credit societies.
Three tier structures exist in the cooperative banking:
(i) State cooperative bank at the apex level.
(ii) Central cooperative banks at the district level.
(iii) Primary cooperative banks and the base or local level.
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(a) There are many advantages to opening an international bank account with
Standard Bank Isle of Man.
(b) Safe and secure global access to your money 24/7.
(c) Quick and easy transfers in multiple currencies gives you greater flexibility over
your finances.
(d) Simple and convenient to operate and offers one central location for all your
banking requirements.
(e) Unlimited access to foreign exchange.
(f) Provides security against exchange rate fluctuations.
(g) Grow and protect your money in a stable offshore jurisdiction on the Isle of Man.
(h) Confidential service wherever you are in the world.
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The Indian Banks are competing with one another to grab a pie of the retail banking
sector, which has tremendous potential as retail loans constitute only 8% of GDP in India,
whereas their percentage is about 35 in other Asian economies. Retail banking
environment today is changing fast. The changing customer demographics demands that
create a differentiated application based on scalable technology, improved service and
banking convenience. Higher penetration of technology and increase in global literacy
levels has set up the expectations of the customer higher than never before. Increasing
use of modern technology has further enhanced reach and accessibility. The market today
gives us a challenge to provide multiple and innovative contemporary services to the
customer through a consolidated window so as to ensure that the banks customer gets
Uniformity and Consistency of service delivery across time and at every touch point
across all channels. The pace of innovation is accelerating and security threat has become
prime of all electronic transactions. High cost structure rendering mass-market servicing
is prohibitively expensive. Present-day tech-savvy bankers are now more looking at
reduction in their operating costs by adopting scalable and secure technology thereby
reducing the response time to their customers so as to improve their client base and
economies of scale. The solution lies to market demands and challenges lies in innovation
of new offering with minimum dependence on branches a multi-channel bank, and to
eliminate the disadvantage of an inadequate branch network. Generation of leads to cross
sell and creating additional revenues with utmost customer satisfaction has become focal
point worldwide for the success of a Bank. Traditional lending to the corporate are slow
moving along with high NPA risk, treasure profits are now losing importance; hence, Retail
Banking is now an alternative available for the banks for increasing their earnings. Retail
Banking is an attractive market segment having a large number of varied classes of
customers. Retail Banking focuses on individual and small units. Customized and wide
ranging products are available. The risk is spread and the recovery is good. Surplus
deployable funds can be put into use by the banks. Products can be designed, developed
and marketed as per individual needs.
Currently retail banking is helping the banks in boosting their profit. As reported in
Financial Express, the banking sector witnesses during the period ended June 2010, with
their growth rising at 54.8%. A rise in commercial and retail lending rates, growth in feebased income and lower provisioning helped banks boost their profits.
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The system provides customer- specific information in the form of account balances,
transaction details and statement of accounts. This system allows bi-directional
capabilities. Transactions can be submitted by the customer for online update. This
system requires high degree of security and control.
4. Automated Teller Machine (ATM)
ATM is designed to perform the most important function of bank. It is operated by
plastic card with its special features. The plastic card is replacing cheques, personal
attendance of the customer, banking hours restrictions and paper based verification.
5. Credit Cards/Debit Cards
The Credit Card holder is empowered to spend wherever and whenever he wants with
his Credit Card within the limits fixed by his bank. Credit Card is a post-paid card. Debit
Card, on the other hand, is a prepaid card with some stored value.
6. Smart Card
Banks are adding chips to their current magnetic stripe cards to enhance security
and offer new service, called Smart Cards. Smart Cards allow thousands of times of
information storable on magnetic stripe cards.
7. Core Banking Solutions
Core Banking Solutions is new jargon frequently used in banking circles. The
advancement in technology especially internet and information technology has led to new
way of doing business in banking.
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to more than double, from roughly $16 billion in fiscal 2010 to between $35 billion and
$40 billion by 2015. McKinseys analysis shows that returns on equity are typically in
the range of 15% to 30%.
India presents a strong case for the growth of wholesale banking due to continued
globalization of Indian companies, India being seen as a favorable investment destination,
increase in infrastructure spending, stable government, robust markets, stable currency,
low deficits, etc. Wholesale banking thus comprises a major share of the banking revenues
due to the above factors and also due to an increased inclination of government towards
mid-segment companies which have increasing banking requirements. In wholesale
banking too, it is the corporate banking which comprises a lions share, i.e., about 85%.
Likewise, with the rebound of economy and a positive outlook, the possibility of a growth
in investment banking, M&A, etc. is highly likely. Wholesale clientele for banks are highly
significant for banks to drive business. Banks provide various forms of banking solutions
like project finance, leasing finance, working capital finance, merchant banking,
syndication services, etc. are also provided to clients The major advantage in wholesale
banking is that a client can have easy and one-place access to all its finances and their
details. This makes internal stock transfers, fund transfers, allocations and distributions
simpler. It however, it increases the risk it poses to the clients as all their funds are parked
in one institution and the businesses depend on the financial health of the bank for smooth
run. In cases of economic downturns, if the banks crash, all the dependent businesses
come to a standstill instantly. Thus, businesses usually diversify into several financial
institutions to remain afloat during any crisis. The major Indian Banks which are involved
in wholesale banking are SBI, ICICI, IDBI Bank, Canara Bank, Bank of India, Punjab
National Bank, Bank of Baroda, Central Bank of India, etc.
Wholesale banking includes high ticket exposures primarily to corporates. Internal
processes of most banks classify wholesale banking into mid corporates and large
corporates according to the size of exposure to the clients. A large portion of wholesale
banking clients also account for off balance sheet businesses. Hedging solutions form
a significant portion of exposures coming from corporates. Hence, wholesale banking
clients are strategic for the banks with the view to gain other business from them. Various
forms of financing, like project finance, leasing finance, finance for working capital, term
finance, etc. form part of wholesale banking transactions. Syndication services and
merchant banking services are also provided to wholesale clients in addition to the variety
of products and services offered.
Wholesale banking is also a well diversified banking vertical. Most banks have a
presence in wholesale banking. But this vertical is largely dominated by large Indian banks.
While a large portion of the business of foreign banks comes from wholesale banking,
their market share is still smaller than that of the larger Indian banks. A number of large
private players among Indian banks are also very active in this segment.
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6. One-stop Shopping
Universal banking offers all financial products and services under one roof. One-stop
shopping saves a lot of time and transaction costs. It also increases the speed or flow
of work. So, one-stop shopping gives benefits to both banks and their clients.
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The working and operations of NBFCs are regulated by the Reserve Bank of India
(RBI) within the framework of the Reserve Bank of India Act, 1934 (Chapter IIIB) and the
directions issued by it under the Act. As per the RBI Act, a non-banking financial company
is defined as: (i) a financial institution which is a company; (ii) a non-banking institution
which is a company and which has as its principal business the receiving of deposits,
under any scheme or arrangement or in any other manner, or lending in any manner;
(iii) such other non-banking institution or class of such institutions, as the bank may, with
the previous approval of the Central Government and by notification in the Official Gazette,
specify.
Under the Act, it is mandatory for a NBFC to get itself registered with the RBI as
a deposit taking company. This registration authorizes it to conduct its business as an
NBFC. For the registration with the RBI, a company incorporated under the Companies
Act, 1956 and desirous of commencing business of non-banking financial institution,
should have a minimum net owned fund (NOF) of ` 25 lakh (raised to ` 200 lakh w.e.f.
April 21, 1999). The term NOF means, owned funds (paid-up capital and free reserves,
minus accumulated losses, deferred revenue expenditure and other intangible assets) less,
(i) investments in shares of subsidiaries/companies in the same group/all other NBFCs;
and (ii) the book value of debentures/bonds/outstanding loans and advances, including hirepurchase and lease finance made to, and deposits with, subsidiaries/companies in the
same group, in excess of 10% of the owned funds.
The registration process involves submission of an application by the company in
the prescribed format along with the necessary documents for RBIs consideration. If the
bank is satisfied that the conditions enumerated in the RBI Act, 1934 are fulfilled, it issues
a Certificate of Registration to the company. Only those NBFCs holding a valid Certificate
of Registration can accept/hold public deposits. The NBFCs accepting public deposits
should comply with the Non-Banking Financial Companies Acceptance of Public Deposits
(Reserve Bank) Directions, 1998, as issued by the bank. Some of the important regulations
relating to acceptance of deposits by the NBFCs are:
(a) They are allowed to accept/renew public deposits for a minimum period of
12 months and maximum period of 60 months.
(b) They cannot accept deposits repayable on demand.
(c) They cannot offer interest rates higher than the ceiling rate prescribed by RBI
from time to time.
(d) They cannot offer gifts/incentives or any other additional benefit to the
depositors.
(e) They should have minimum investment grade credit rating.
(f) Their deposits are not insured.
(g) The repayment of deposits by NBFCs is not guaranteed by RBI.
The types of NBFCs registered with the RBI are:
(i) Equipment leasing company is any financial institution whose principal
business is that of leasing equipments or financing of such an activity.
(ii) Hire-purchase company is any financial intermediary whose principal
business relates to hire purchase transactions or financing of such transactions.
(iii) Loan company means any financial institution whose principal business is that
of providing finance, whether by making loans or advances or otherwise for any
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Notes
activity other than its own (excluding any equipment leasing or hire-purchase
finance activity).
(iv) Investment company is any financial intermediary whose principal business
is that of buying and selling of securities.
2.45 Summary
A financial intermediary is a financial institution that connects surplus and deficit
agents. The classic example of a financial intermediary is a bank that consolidates bank
deposits and uses the funds to transform them into bank loans.
Financial Intermediaries are the firms that provide services and products which
customers may not be able to get more efficiently by themselves in final markets. In other
words, they act as middlemen between investors and borrowers in financial system.
Financial intermediary is a financial institution such as bank, building society,
insurance company, and investment bank or pension fund. A financial intermediary offers
a service to help an individual/firm to save or borrow money. A financial intermediary helps
to facilitate the different needs of lenders and borrowers.
Commercial bank is a profit-seeking business firm, dealing in money and credit. It
is a financial institution dealing in money in the sense that it accepts deposits of money
from the public to keep them in its custody for safety. So, it deals in credit, i.e., it creates
credit by making advances out of the funds received as deposits to needy people. It thus,
functions as mobilizer of savings in the economy. A bank is, therefore like a reservoir
into which how the savings, the idle surplus money of households and from which loans
are given on interest to businessmen and others who need them for investment or
productive uses. Commercial bank being the financial institution performs diverse types
of functions. It satisfies the financial needs of the sectors such as agriculture, industry,
trade, communication, etc. That means they play a very significant role in a process of
economic and social needs. The functions performed by banks are changing according
to changes in time and recently they are becoming customer centric and widening their
functions. Generally the functions of commercial banks are divided into two categories,
viz., primary functions and the secondary functions.
Commercial bank refers to a bank that lends money and provides transactional,
savings, and money market accounts and that accepts time deposit. A commercial bank
is a type of financial institution and intermediary. Commercial banks engage for providing
documentary and standby letter of credit, guarantees, performance bonds, securities
underwriting commitments and other forms of off balance sheet exposures.
Public Sector Banks (PSBs) are banks where a majority stake (i.e., more than
50%) is held by a government. The shares of these banks are listed on stock exchanges.
The Central Government entered the banking business with the nationalization of the
Imperial Bank of India in 1955. A 60% stake was taken by the Reserve Bank of India
and the new bank was named as the State Bank of India. The seven other state banks
became the subsidiaries of the new bank when nationalized on 19 July 1960. The next
major nationalization of banks took place in 1969 when the government of India, under
Prime Minister Indira Gandhi, nationalized an additional 14 major banks. The total deposits
in the banks nationalized in 1969 amounted to 50 crores. This move increased the
presence of nationalized banks in India, with 84% of the total branches coming under
government control.
Financial Intermediaries
107
Private sector banks in India are all those banks where greater parts of stake or equity
are held by the private shareholders and not by government. These are the major players
in the banking sector as well as in expansion of the business activities India. The present
private sector banks equipped with all kinds of contemporary innovations, monetary tools
and techniques to handle the complexities are a result of the evolutionary process over two
centuries. They have a highly developed organizational structure and are professionally
managed. Thus, they have grown faster and stronger since past few years.
Notes
Private sector banks have been functioning in India since the very beginning of the
banking system. Initially, during 1921, the private banks like bank of Bengal, bank of
Bombay and bank of Madras were in service, which all together formed Imperial Bank
of India.
Reserve Bank of India (RBI) came in picture in 1935 and became the centre of every
other bank taking away all the responsibilities and functions of Imperial bank. Between
1969 and 1980, there was rapid increase in the number of branches of the private banks.
In April 1980, they accounted for nearly 17.5% of bank branches in India. In 1980, after
6 more banks were nationalized, about 10% of the bank branches were those of private
sector banks. The share of the private bank branches stayed nearly same between 1980
and 2000. Then from the early 1990s, RBIs liberalization policy came in picture and with
this the government gave licences to a few private banks, which came to be known as
new private sector banks.
Loans are made against personal security, gold and silver, stocks of goods and other
assets. The second primary function of a commercial bank is to make loans and advances
to all types of persons, particularly to businessmen and entrepreneurs.
Credit creation is the multiple expansions of banks demand deposits. It is an open
secret now that banks advance a major portion of their deposits to the borrowers and keep
smaller parts of deposits to the customers on demand. Even then the customers of the
banks have full confidence that the depositors lying in the banks is quite safe and can
be withdrawn on demand.
ATM is a channel of banking service to its customers. Its traditional and primary use
is to dispense cash upon insertion of a plastic card and its unique PIN, i.e., Personal
Identification Number. The banks issue ATM card to their customers having current or savings
account holding a certain minimum balance in their accounts. ATM card is a plastic card
with a magnetic strip with the account number of the individuals. When the card is inserted
into the machine the sensing equipment of the machine identifies the account holder and
asks his PIN. It is a secret number which is known only to the account holder.
Industrial Bank is a financial institution with a limited scope of services. Industrial
banks sell certificates that are labeled as investment shares and also accept customer
deposits. They then invest the proceeds in installment loans for consumers and small
businesses. These banks are also known as Morris Banks or industrial loan companies.
A unit bank is one, which conducts its banking operations through a single office
within a strictly limited area or with a limited number of offices in that area. It is essentially
a localized system. Group banking is that system of banking under which two or more
banks are directly or indirectly controlled by an association, trust, or corporation. This
type of banking is also known as holding company banking. The holding company holds
the majority shares in the companies under its control and the companies whose shares
are held by the holding company are known as subsidiary companies.
Exchange banks are those banks maintain the facilities to finance mostly for the
foreign trade of a country. Their main function is to discount, accept and collect foreign
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Notes
bills of exchange. They buy and sell foreign currency and thus help businessmen in their
transactions. They also carry on the ordinary banking business.
The Reserve Bank of India is the central banking institution of India and controls the
monetary policy of the rupee as well as US$ 300.21 billion (2010) of currency reserves.
The institution was established on 1 April 1935 during the British Raj in accordance with
the provisions of the Reserve Bank of India Act, 1934 and plays an important part in the
development strategy of the government. It is a member bank of the Asian Clearing Union.
A cooperative bank is a financial entity which belongs to its members, who are at
the same time the owners and the customers of their bank. Cooperative banks are often
created by persons belonging to the same local or professional community or sharing a
common interest. Cooperative banks generally provide their members with a wide range
of banking and financial services (loans, deposits, banking accounts, etc.).
Urban Cooperatives can be further divided into scheduled and non-scheduled. Both
the categories are further divided into multi-state and single-state. Majority of the banks
are fall in the non-scheduled and single-state category. Banking activities of Urban
Cooperative Banks are monitored by RBI. Registration and Management activities are
managed by Registrar of Cooperative Societies (RCS). These RCS operate in single-state
and Central RCS (CRCS) operate in multiple state.
The rural cooperatives are further divided into short-term and long-term structures.
The short-term cooperative banks are three tiered operating in different states. These are:
State Cooperative Banks They operate at the apex level in states. District Central
Cooperative Banks They operate at the district levels. Primary Agricultural Credit
Societies They operate at the village or grass-root level.
International banking enables people who live or work abroad to manage their finances
in one central location. By keeping your money in one place, it allows you to make
transfers and payments in several currencies from a stable and secure offshore jurisdiction.
Providing you with a link between all of your banking arrangements, you can be in complete
control of your money, wherever you are in the world.
Retail banking is the provision of services by a bank to individual consumers, rather
than to companies, corporations or other banks. Services offered include savings and
transactional accounts, mortgages, personal loans, debit cards, and credit cards.
Retail banking is typically mass market banking where individual customers use local
branches of larger commercial banks. Services offered include savings and checking
accounts, mortgages, personal loans, debit cards, credit cards and so.
Wholesale banking is the provision of services by banks to organizations such as
Mortgage Brokers, large corporate clients, mid-sized companies, real estate developers
and investors, international trade finance businesses, institutional customers (such as
pension funds and government entities/agencies), and services offered to other banks or
other financial institutions.
Financial intermediaries are all institutions that accept deposits from individuals,
businesses and governments and lend funds to borrowers. They include savings banks,
trust and mortgage loan companies, credit unions and caisses populaires. Their functions
are similar to those of the chartered banks; they are often referred to as near banks.
Universal Banking is a banking system in which banks provide a wide variety of
financial services, including both commercial and investment services. Universal banking
is common in some European countries, including Switzerland. In the United States,
however, banks are required to separate their commercial and investment banking services.
Financial Intermediaries
109
Proponents of universal banking argue that it helps banks better diversify risk. Detractors
think dividing up banks operations is a less risky strategy.
Notes
110
Notes
Financial Intermediaries
111
Public Sector Banks: Public Sector Banks (PSBs) are banks where a majority
stake (i.e., more than 50%) is held by a government.
Private-sector Banks: Private-sector banks are all those banks where greater
parts of stake or equity are held by the private shareholders and not by
government.
Group Banking: Group banking is that system of banking under which two
or more banks are directly or indirectly controlled by an association, trust or
corporation.
Notes
112
Notes
complained to the bank. She said its decision to lend her son the money had been "illjudged and irresponsible" and that it had taken advantage of her sons inexperience.
Mrs. D told the bank that her son had planned to go travelling for a year after he
graduated. She was concerned that the loan repayments would not only prevent him from
saving money for his travels, but also leave him short of cash. She also believed that,
by lending him the money, the bank had actively encouraged her son to buy a powerful
motorbike.
Mrs. D thought the bank should write-off the loan and take the motorbike in exchange.
The bank disagreed, so - with her sons knowledge and agreement Mrs. D brought the
dispute to us on his behalf.
Question:
1. As a bank manager, how to rectify the ill-judged and irresponsible?
2.52 Bibliography
1. Kem, H.J. (2005), Global Retail Banking: Changing Paradigms, Chartered
Financial Analyst, ICFAI Press, Hyderabad, Vol. XI, No. 10, pp. 56-58.
2. Neetu Prakash, (2006), Retail Banking in India, ICFAI University Press,
Hyderabad pp. 2-10.
3. Dhanda Pani Alagiri (2006), Retail Banking Challenges, ICFAI University
Press, Hyderabad, pp. 25-34.
4. Manoj Kumar Joshi (2007). Growth Retail Banking in India, ICFAI University
Press, Hyderabad, pp. 13-24.
5. Manoj Kumar Joshi (2007), Customer Services in Retail Banking in India, ICFAI
University Press, Hyderabad, pp. 59-68.
6. S. Santhana Krishnan (2007), Role of Credit Information in Retail Banking: A
Business Catalyst, ICFAI University Press, Hyderabad, pp. 68-74.
7. Sunil Kumar (2008), Retail Banking in India, Hindustan Institute of
Management and Computer Studies, Mathura.
8. Divanna, J.A. (2009), The Future Retail Banking", Palgrave Macmillan, New
York.
9. Birendra Kumar (2009), Performance of Retail Banking in India, Asochem
Financial Pulse (AFP), India.
10. Sapru R.K. (1994), Development Administration, Sterling, New Delhi.
11. United Nations Industrial Development Organization (1998), Manual for
Evaluation of Industrial Projects, Oxford and IBH, New York.
Financial Intermediaries
113
12. T.E. Copeland and J.F. Weston (1988), Financial Theory and Corporate Policy,
Addison-Wesley, West Sussex (ISBN 978-0321223531).
13. E.J. Elton, M.J. Gruber, S.J. Brown and W.N. Goetzmann (2003), Modern
Portfolio Theory and Investment Analysis, John Wiley & Sons, New York (ISBN
978-0470050828).
14. E.F. Fama (1976), Foundations of Finance, Basic Books Inc., New York (ISBN
978-0465024995).
15. Marc M. Groz (2009), Forbes Guide to the Markets, John Wiley & Sons Inc.,
New York (ISBN 978-0470463383).
16. R.C. Merton (1992), Continuous Time Finance, Blackwell Publishers Inc. (ISBN
978-0631185086).
17. Keith Pilbeam (2010), Finance and Financial Markets, Palgrave (ISBN 9780230233218).
18. Steven Valdez, An Introduction to Global Financial Markets, Macmillan Press
Ltd. (ISBN 0-333-76447-1).
19. The Business Finance Market: A Survey, Industrial Systems Research
Publications, Manchester (UK), New Edition 2002 (ISBN 978-0-906321-19-5).
Notes
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Notes
Unit 3:
Structure:
3.1 Introduction
3.2 Meaning of Bank Lending
3.3 Principles of Lending
3.4 Five Cs of Lending Principles
3.5 Forms of Lending
3.6 Types of Lending
3.7 Lending Facilities Granted by Banks
3.8 Who are the Borrowers?
3.9 Study of Borrowers
3.10 Balance Sheet Analysis
3.11 Goal of Balance Sheet Analysis
3.12 How to Perform a Balance Sheet Analysis?
3.13 Project Appraisal
3.14 Checklist for Project Appraisal
3.15 Project Appraisal Criteria
3.16 Marketing of Bank Services
3.17 Importance of Bank Marketing
3.18 Marketing Approach in Banks
3.19 Features of Bank Marketing
3.20 Prudential Norms
3.21 Prudential Guidelines on Restructuring of Advances
3.22 Narasimham Committee Recommendations
3.23 Recommendations of the Committee
3.24 Highlights of Narasimham Committee Recommendations on Banking Reforms
in India
3.25 Performance Analysis of Banks
3.26 Regulatory Institutions in India
3.27 Reserve Bank of India
3.28 Credit Control
3.29 Meaning of Credit Control
3.30 Objectives of Credit Control
3.31 Need for Credit Control
3.32 Methods of Credit Control
3.33 RBI Publications
3.34 Securities and Exchange Board of India
3.35 Organization of SEBI
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Notes
Objectives
After studying this unit, you should be able to understand:
z
Understand the Internet Banking, Mobile Banking, E-Banking Risk and E-Finance
3.1 INTRODUCTION
The successful banks operating within the financial system are those that consider
and coordinate basic principles of lending and monitor the activities of borrowers regularly.
The major business of banking company is to grant loans and advances to traders as
well as commercial and industrial establishment.
The most important use of banks money is lending. Yet, there are risks in lending.
While lending loans or advances, the banks usually keep such securities and assets as
support so that lending may be safe and secured. Suppose, any particular state is hit
by disaster, the bank gets advantage from lending to another states' units. Thus, the effect
on the entire business of banking is reduced.
The recent distress in the financial system witnessed more importantly in the banking
sector. Lending limit regulations restrict the total amount of loans and credits that a bank
may extend to a single borrower. This restriction is usually stated as a percentage of
the banks capital or assets.
It is widely held that a bank is an institution that accepts deposits from customers
and looks after their money, offers cheque books to customers to enable them to make
payments to others and provides other financial services which include lending. In a
nutshell, a banks major operation is the acceptance of deposits and granting of loans
to different kinds of customers.
The commercial banks engage in retail banking services through branch networks
and operate with a broad deposit base consisting of demand and time deposit. They provide
short-term lending. On the other hand, merchant banks are licensed to provide wholesale
banking, take deposit and arrange syndicated loan facilities for long term by pooling,
sometimes, a consortium of banks, including other financial institutions, to finance capital
intensive projects. From the foregoing, it is realized that banks are generally debtors; they
borrow money in order to lend them out to make profit. No bank can ever survive by just
being a custodian of deposit, but they exist by lending from the deposit on fixed interest
charged. Money lent on interest is always supposed to be secured on some guarantees
or security.
Since banks depend largely on lending, the need to adhere to the basic principles
of lending is quite inevitable. The principles, if strictly followed, will guarantee depositors
and shareholders funds, increase profitability and make a healthy turnover. Such advances
in turn assist in the transformation of rural environment, promote rapid expansion of banking
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habit and improve and boost the nations economy. The basic considerations in bank
lending are the character of the client seeking loan from the bank. The client must be
an honest, upright customer whose record of transaction with the financial institution or
in the society is remarkable. The information on the character of the borrower could be
obtained through a completed form of his guarantor or his statement of account.
Notes
118
Notes
6. Principle of Spread
The principle of good lending is the diversification of advances. An element of risk
is always present in every advance. However, secure it might appear to be. In fact, the
entire banking business is one of taking calculated risks and a successful banker is an
expert in assessing such risks.
7. Principle of National Interest, Suitability, etc.
Even when an advance satisfies all good principles, it may still not be suitable. The
advance may run counter to national interest. The Central Bank may have issued a directive
prohibiting banks to allow a particular type of advance.
8. Principle of Ideal Advance
L.C. Mather describes an ideal advance as one which is granted to a reliable
customer for an approved purpose in which the customer has adequate experience, safe
in the knowledge that the money will be used to advantage and repayment will be made
within a reasonable period from trading receipts or known maturities due on or about given
dates.
119
liquidity requirements, capital constraints and rate of return objectives. The credit process
relies on each banks system and controls that allow management and credit officers to
evaluate risk and return trade-offs. The credit process includes three functions:
(a) Business development and credit analysis, (b) Underwriting or credit execution and
administration and (c) Credit review.
Notes
A credit policy formalizes lending guidelines that employees follow to conduct bank
business. As already pointed out in our previous discussion that it identifies preferred loan
qualities and establishes procedures for granting, documenting and reviewing loans.
The managements credit philosophy determines how much risk the bank will take
and in what form. Here, we need to know a very important concept that is called a banks
credit culture. This refers to the fundamental principles that drive lending activities and
how management analysis risk. This lending philosophy would differ from bank to bank.
Values Driven
(a) Focus is on credit quality with strong risk management systems and controls.
(b) Primary emphasis is on bank soundness and stability and a consistent market
presence.
(c) Underwriting is conservative and significant loan concentrations are not allowed.
(d) Typical outcome is lower current profit from loans with fewer loan losses.
Current Profit Driven
(a) Focus is on short-term earnings.
(b) Primary emphasis is banks annual profit plan.
(c) Management is often attracted to high-risk and high-return borrowers.
(d) Outcome is typically higher profit in good times, followed by lower profit in bad
times when loan losses increase.
Market Share Driven
(a) Focus is on having the highest market share of loans among competitors.
(b) Primary emphasis is on loan volume and growth with the intent of having the
largest market share.
(c) Underwriting is very aggressive and management accepts loan concentrations
and above-average credit risk.
(d) Outcome is that loan quality suffers over time, while profit is modest because
loan growth comes from below-market pricing and greater risk taking.
120
Notes
121
the rate of commission is 80 + 0.75% per quarter or part thereof with a minimum of 3%.
In respect of DPGs secured by 100% cash margin or by 100% term deposits, only 25%
of the applicable rate on issue of such guarantee with a minimum of 28 only, are leviable.
Notes
Security: Security provided for the guarantee may be in the form of our own deposits
or other acceptable tangible security, such as GP Notes, Insurance Policies having
adequate surrender value and easily marketable shares.
Issuance of Bank Guarantee in Lieu of Security Deposit/EMD/Performance Guarantees
1. Guarantees in favor of Government departments, such as Railways, PWD, etc.
who may require guarantees from their contractors in lieu of tender money or
performance of contracts to supply goods, etc.
2. Sales tax/Income-tax Authorities in respect of payment of taxes.
3. Companies of repute towards payments in respect of supply of materials.
4. Suppliers of machinery and plants on deferred payments basis require bank
guarantees in respect of instalments and interest payable by their purchasers.
5. Guarantees in favor of the Coffee Board in connection with renewal of the pool
sales permit for participation in the pool sales by dealers.
6. Guarantees are issued to Railway Authorities or Shipping Companies to take
delivery of relative goods without production of Railway Receipts (RRs) and Bills
of Lading and undertaking to produce them on receipt.
7. Besides the above, several other commercial transactions involve execution of
bank guarantees.
Security: Security provided for the guarantee may be in the form of our own deposits
or other acceptable tangible security, such as GP Notes, Insurance Policies having
adequate surrender value and easily marketable shares. Mortgage of immovable property
may be accepted as security only in exceptional cases where customers are well known,
provided at least 25% of the guarantee amount is covered by cash margin.
Commission: 100 plus 0.75% or 0.5% per quarter or part thereof towards financial
or performance guarantee respectively.
Financial Guarantee against Collateral Securities/Cash Margin:
1. Guarantees on behalf of constituents who are selling agents/lottery tickets/
airline tickets in favour of Government departments, Airlines, and other
companies in lieu of cash deposit or earnest money.
2. All mobilization guarantees issued on behalf of contractors.
3. Guarantees for release of retention money.
4. Guarantees for due payment of moneys for goods supplied, services rendered,
etc. (guarantees in favour of oil companies, fertiliser companies, airlines, excise
guarantees, etc.)
5. Guarantees in lieu of sales tax, income tax, excise duties/Government demands
against 100% cash deposit.
6. Guarantees given to courts for release of deposits/in lieu of payment to court.
7. Deferred Payment Guarantees.
C. Assets Based Lending
Asset based lending provides businesses with immediate funds and ongoing cash
flow based on a percentage of the value of the companys assets such as commercial
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Notes
accounts receivable, inventory, business equipment and machinery and recurring revenue
contracts. Funds from asset based finance can be used for day-to-day operating expenses
or as capital for restructuring, turnarounds, mergers and acquisitions and buyouts. First
Capital can custom tailor an asset based loan that fits your business needs. Asset based
finance can be underwritten relatively quickly and easily by First Capital to get the funding
that need when need it.
123
Notes
Borrowers are the individuals who borrow money via bankers loans for short-term
needs or longer-term mortgages to help finance a house purchase. Companies borrow
money to aid short-term or long-term cash flows. They also borrow to fund modernization
or future business expansion. Governments often find their spending requirements exceed
their tax revenues. To make up this difference, they need to borrow. Governments also
borrow on behalf of nationalized industries, municipalities, local authorities and other public
sector bodies.
Public Corporations typically include nationalized industries. These may include the
postal services, railway companies and utility companies. Many borrowers have difficulty
raising money locally. They need to borrow internationally with the aid of foreign exchange
markets. Borrowers having similar needs can form into a group of borrowers. They can
also take an organizational form like Mutual Funds. They can provide mortgage on weight
basis. The main advantage is that this lowers the cost of their borrowings.
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Notes
A saver who desires the higher average return of stock markets without the research
required to make quality stock selections can buy shares in a mutual fund. The mutual
fund manager will pool the money of many savers, taking the time and expense to study
different companies that trade stock shares. The goal is to make an educated selection
of shares that offer the highest possible return.
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Notes
Is the appraisal process well documented, with key documents signed, showing
ownership and agreement, and allowing the appraisal documentation to act as
a basis for future management, monitoring and evaluation?
Does the appraisal system comply with any relevant government guidance.
Are the right people involved at various stages of the process and, if necessary,
how can you widen involvement?
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Notes
1. Financial Appraisal
Financial appraisal is an objective evaluation of the profitability and financial strength
of a business unit. Many a times, the terms financial performance appraisal and financial
statement analysis are used as synonymous. The techniques of financial statement
analysis are used for the purpose of financial appraisal.
2. Economic Appraisal
Economic appraisal is a type of decision method applied to a project, programme
or policy that takes into account a wide range of costs and benefits, denominated in
monetary terms or for which a monetary equivalent can be estimated. Economic appraisal
is a methodology designed to assist in defining problems and finding solutions that offer
the best value for money (VFM). This is especially important in relation to public
expenditure and is often used as a vehicle for planning and approval of public investment
relating to policies, programmes and projects.
The principles of appraisal are applicable to all decisions, even those concerned with
small expenditures. However, the scope of appraisal can also be very wide. Good economic
appraisal leads to better decisions and VFM. It facilitates good project management and
project evaluation. Appraisal is an essential part of good financial management, and it
is vital to decision-making and accountability.
3. Technical Appraisal
Technical appraisal is an in-depth study to ensure that a project is: (i) soundly
designed, (ii) appropriately engineered and (iii) follows accepted standards. These
considerations differ from project to project. But, in any case, the emphasis is on the
inputs needed for the project and the resulting outputs of goods and services.
Put another way, such an appraisal determines whether the pre-requisites of a
successful project have been covered and good choices have been made in regard to
(i) location, (ii) plant capacity, (iii) raw materials requirements and (iv) other such factors
as availability of required professional, technicians and workers. In addition, project costs
are estimated and subsequently manufacturing costs are worked out. Adverse
environmental impact, if any, is also visualized and efforts are made to reduce it through
a better project design incorporating treatment of effluents and noise abatement.
4. Management or Organizational Appraisal
Management or Organizational Appraisal is a process which can look at an
organization and appraise it in a given context. Some tools appraise an organisation in
preparation of an award, others look at the performance of an organisation in preparation
for a buy-out/buy-in, raising venture capital, etc. Management appraisal is related to the
technical and managerial competence, integrity, knowledge of the project, managerial
competence of the promoters, etc. The promoters should have the knowledge and ability
to plan, implement and operate the entire project effectively. The past record of the
promoters is to be appraised to clarify their ability in handling the projects.
5. Marketing Appraisal
Marketing appraisal is an estate agents recommendation on how we can achieve
the best price for your property in a timescale that suits you. A valuation can only be
carried out by a qualified surveyor and is an evidence-based opinion on how much your
property is worth.
127
6. Commercial Appraisal
Notes
In the commercial appraisal many factors are coming. The scope of the project in
market or the beneficiaries, customer-friendly process and preferences, future demand of
the supply, effectiveness of the selling arrangement, latest information availability on all
areas, government control measures, etc. The appraisal involves the assessment of the
current market scenario, which enables the project to get adequate demand. Estimation,
distribution and advertisement scenario also to be considered here into.
128
Notes
world, which is market driven and banks have had to face up to this emerging scenario.
In fact, it may not be out of place to reiterate that quality in future will be the sole
determinant of successful banking ventures and marketing has to focus on this most
crucial need of the hour.
3. Growing Competition
Increased competition is being faced by the Indian banking industry from within the
system with other agencies both, local and foreign, offering value added services.
Competition is no more confined to resource mobilization but also to lending and other
areas of banking activity. The foreign commercial bank with their superior technology,
speed in operations and imaginative positioning of their services has also provided the
necessary impetus to the Indian banks to innovate and compete in the marketplace.
4. Technological Advances
Technological innovation has resulted in financial product development especially in
the international and investment banking areas. The western experience has demonstrated
that technology has not only made execution of work faster but has also resulted in greater
availability of manpower for customer contact.
129
Notes
Prudential norms are the guidelines and general norms issued by the regulating
bank (the central bank) of the country for the proper and accountable functioning of bank
and bank-like establishments.
In recent years, we have across the term prudential norms too often particularly
in relation to the non-performing assets of the commercial banks. In the light of the
existence of huge non-performing asset in the balance sheets of the commercial banks
leading to the erosion of their capital base, the relevance of these prudential has acquired
particular significance.
The main elements of prudential norms are income recognition, asset classification,
provisioning for loans and advances and capital adequacy. In keeping with latest practices
at the international levels, commercial banks are not supposed to recognize their incomes
from non-performing assets on an accrual basis and these are to be booked only when
these are actually received.
If the balance sheet of a bank is to reflect the factual and true financial state of affairs
of the bank, it is pragmatic and desirable to have a system of recognition of income,
classification of assets and provisioning for sticky debts on a prudential basis. Banks have
been directed not to charge and take interest on non-performing assets to the income
account and classify their assets under three broad categories of Standard Assets, Substandard Assets, Doubtful Assets and Loss Assets. Taking into account the time-lag
between an account becoming doubtful of recovery, its recognition as such, the realization
of the security and the erosion over time in value of security charged to the banks, banks
are required to make provision against sub-standard assets, doubtful assets and loss assets.
The prudential accounting norms which were put into place in 1992-93 have been
further strengthened over the years. In respect of accounts where there are potential threats
of recovery on account of erosion in the value of the security or absence of security and
other factors such as fraud committed by the borrowers exist, such accounts are to be
classified as doubtful or loss assets irrespective of the period to which these remained
as non-performing. All the members banks in a consortium are required to classify their
advances according to each bank's own record of recovery. Depreciation on securities
transferred from the current category to the permanent category has to be immediately
provided for. Banks should value the specified government securities under ready forward
transactions at market rates on the balance date.
130
Notes
131
functions of banks boards with a view to make them responsible for enhancing shareholder
value through formulation of corporate strategy and reduction of government equity.
Notes
To implement this, criteria for autonomous status was identified by March 1999
(among other implementation measures) and 17 banks were considered eligible for
autonomy. But some recommendations like reduction in Governments equity to 33%, the
issue of greater professionalism and independence of the Board of Directors of public
sector banks is still awaiting Government follow-through and implementation.
Reform in the Role of RBI
First, the committee recommended that the RBI withdraw from the 91-day treasury
bills market and that inter-bank call money and term money markets be restricted to banks
and primary dealers. Second, the Committee proposed a segregation of the roles of RBI
as a regulator of banks and owner of bank. It observed that The Reserve Bank as a
regulator of the monetary system should not be the owner of a bank in view of a possible
conflict of interest. As such, it highlighted that RBIs role of effective supervision was not
adequate and wanted it to divest its holdings in banks and financial institutions.
Pursuant to the recommendations, the RBI introduced a Liquidity Adjustment Facility
(LAF) operated through repo and reverse repos in order to set a corridor for money market
interest rates. To begin with, in April 1999, an Interim Liquidity Adjustment Facility (ILAF)
was introduced pending further upgradation in technology and legal/procedural changes
to facilitate electronic transfer. As for the second recommendation, the RBI decided to
transfer its respective shareholdings of public banks like State Bank of India (SBI), National
Housing Bank (NHB) and National Bank for Agriculture and Rural Development (NABARD)
to GOI. Subsequently, in 2007-08, GOI decided to acquire entire stake of RBI in SBI,
NHB and NABARD. Of these, the terms of sale for SBI were finalized in 2007-08
themselves.
Stronger Banking System
The Committee recommended for merger of large Indian banks to make them strong
enough for supporting international trade. It recommended a three tier banking structure
in India through establishment of three large banks with international presence, eight to
ten national banks and a large number of regional and local banks. This proposal had
been severely criticized by the RBI employees union. The Committee recommended the
use of mergers to build the size and strength of operations for each bank. However, it
cautioned that large banks should merge only with banks of equivalent size and not with
weaker banks, which should be closed down if unable to revitalize themselves. Given the
large percentage of non-performing assets for weaker banks, some as high as 20% of
their total assets, the concept of narrow banking was proposed to assist in their
rehabilitation.
There were a string of mergers in banks of India during the late 90s and early 2000s,
encouraged strongly by the Government of India in line with the Committee's
recommendations. However, the recommended degree of consolidation is still awaiting
sufficient government impetus.
Non-performing Assets
Non-performing assets had been the single largest cause of irritation of the banking
sector of India. Earlier the Narasimham Committee-I had broadly concluded that the main
reason for the reduced profitability of the commercial banks in India was the priority sector
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132
Notes
lending. The committee had highlighted that priority sector lending was leading to the
buildup of non-performing assets of the banks and thus it recommended it to be phased
out. Subsequently, the Narasimham Committee-II also highlighted the need for zero nonperforming assets for all Indian banks with International presence. The 1998 report further
blamed poor credit decisions, behest-lending and cyclical economic factors among other
reasons for the buildup of the non-performing assets of these banks to uncomfortably high
levels. The Committee recommended creation of Asset Reconstruction Funds or Asset
Reconstruction Companies to take over the bad debts of banks, allowing them to start
on a clean-slate. The option of recapitalization through budgetary provisions was ruled
out. Overall the committee wanted a proper system to identify and classify NPAs, NPAs
to be brought down to 3% by 2002 and for an independent loan review mechanism for
improved management of loan portfolios. The Committees recommendations let to
introduction of a new legislation which was subsequently implemented as the
Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 and came into force with effect from 21 June 2002.
Capital Adequacy and Tightening of Provisioning Norms
In order to improve the inherent strength of the Indian banking system, the committee
recommended that the Government should raise the prescribed capital adequacy norms.
This would also improve their risk taking ability. The committee targeted raising the capital
adequacy ratio to 9% by 2000 and 10% by 2002 and has penal provisions for banks that
fail to meet these requirements. For asset classification, the Committee recommended
a mandatory 1% in case of standard assets and for the accrual of interest income to be
done every 90 days instead of 180 days.
To implement these recommendations, the RBI in October 1998, initiated the second
phase of financial sector reforms by raising the banks capital adequacy ratio by 1% and
tightening the prudential norms for provisioning and asset classification in a phased manner
on the lines of the Narasimham Committee-II report. The RBI targeted to bring the capital
adequacy ratio to 9% by March 2001. The Mid-term Review of the Monetary and Credit
Policy of RBI announced another series of reforms, in line with the recommendations with
the Committee, in October 1999.
Entry of Foreign Banks
The committee suggested that the foreign banks seeking to set up business in India
should have a minimum start-up capital of $25 million as against the existing requirement
of $10 million. It said that foreign banks can be allowed to set up subsidiaries and joint
ventures that should be treated on a par with private banks.
Implementation of Recommendations
In 1998, RBI Governor Bimal Jalan informed the banks that the RBI had a three to
four year perspective on the implementation of the Committees recommendations. Based
on the other recommendations of the committee, the concept of a universal bank was
discussed by the RBI and finally ICICI Bank became the first universal bank of India. The
RBI published an Actions Taken on the Recommendations report on 31 October 2001
on its own website. Most of the recommendations of the Committee have been acted upon
(as discussed above) although some major recommendations are still awaiting action from
the Government of India.
133
Criticism
Notes
There were protests by employee unions of banks in India against the report. The
Union of RBI employees made a strong protest against the Narasimham II Report. There
were other plans by the United Forum of Bank Unions (UFBU), representing about
1.3 million bank employees in India, to meet in Delhi and to work out a plan of action
in the wake of the Narasimham Committee report on banking reforms. The committee was
also criticized in some quarters as anti-poor. According to some, the committees failed
to recommend measures for faster alleviation of poverty in India by generating new
employment. This caused some suffering to small borrowers (both individuals and
businesses in tiny, micro and small sectors).
134
Notes
Follow-up Action
(i) Statutory Liquidity Ratio (SLR) on incremental Net Domestic and Time Liabilities
(NDTL) reduced from 38.5% in 1991-92 to 28% by December 1996.
(ii) Effective Cash Reserve Ratio (CRR) on the NDTL reduced from 14% to 10%
in January 1997.
(iii) In April 1992, the RBI introduced a risk assets ratio system for banks (including
foreign banks) in India as a capital adequacy measure. Under this, banks will
have to achieve a Capital to Risk Weighted Asset ratio (CRAR) of 8%. By March,
1996 out of 27 public sector banks 19 banks (including SBI and all its
subsidiaries) have attained 8% CRAR norm. In case of foreign banks, all of them
have already attained these norms.
(iv) New prudential norms for income recognition, classification of assets and
provisioning of bad debts introduced in 1992.
(v) In regard to regulated interest ratio structure: (a) considerable rationalization has
been effected in banks lending rates with the number of concessive slabs
reduced and some of the ratio have been raised thereby reducing the element
of subsidy; (b) regulated deposit late has been replaced by single prescription
of not exceeding 13% (revised to 11%) per annum for all deposit maturities of
46 days and above.
(vi) The SBI and some other nationalized banks have been allowed to seek capital
market access.
(vii) Less strong nationalized banks are being recapitalized by government through
budget provisions of ` 15000 crore till 1994-95.
(viii) Existing private sector banks given signal for expansion, more private sector
banks allowed to set up branches provided they confirms to the RBI guidelines.
(ix) Supervision system of the RBI is being strengthened with establishment of new
board for Financial Bank Supervision within the RBI.
(x) Banks given freedom to open new branches and upgrade extension counters
on attaining capital adequacy norms and prudential accounting standards. They
are permitted to close non-viable branches other than in rural areas.
(xi) Rapid computerization of banks being undertaken.
(xii) Agreement signed between the public sector bank and RBI to improve their
managerial and quality of performance.
(xiii) Recovery of debts due to banks and the Financial Institution Act 1993 recently
passed to facilitate quicker recovery of loans and arrears. Accordingly, six
special Debt Recovery Tribunals were set up along with an Appellate Tribunal
at Mumbai to expedite the recovery of bank loan arrears.
(xiv) Under the Banking Ombudsmen Scheme 1995, eleven Ombudsmen already
functioning out of a total of 15 to expedite inexpensive resolution of customers
complaints.
(xv) Ten new private banks have started functioning out of the thirteen in principle
approvals given for setting up new banks in private sector.
135
has been 106 studied in the context of branches and employees in terms of efficiency
indicators and profitability indicators. In a service industry like banking, it is not possible
to measure physical output in the absence of clear definition. However, most of the
measures that are used to study banks performance can be interpreted more correctly
as measuring the banks efficiency target rather than directly measuring their productivity.
The level of efficiency of banks is commonly measured at the level of branches and
employees, which are the two important wheels on which banking industry moves.
Considering the national priorities, involvement of banks in rural areas and development
schemes and vast infrastructure developed in terms of branches and manpower resources,
it is thought appropriate to assess the efficiency of banks in terms of the performance
at the level of branches and employees. Further, the size of banks varies widely; hence
it is more meaningful to study the performance of parameters indicating efficiency at the
level of branch and employee. In order to measure efficiency at the branch and employees
level, the following parameters are employed: (1) Business per Branch, (2) Operating
expenses per Branch, (3) Profit per Branch, (4) Business per Employee, (5) Establishment
expenses per Employee, and (6) Profit per Employee. The study, thus, measures
efficiency of a bank at the level of operational units, i.e., branch and employee, The
efficiency of each branch and employee in terms of averages of indicators can be compared
to assess the relative performance of different banks and bank groups.
Notes
Financial statements for banks present a different analytical problem than statements
for manufacturing and service companies. As a result, analysis of a banks financial
statements requires a distinct approach that recognizes a banks unique risks.
Banks take deposits from savers and pay interest on some of these accounts. They
pass these funds on to borrowers and receive interest on the loans. Their profits are derived
from the spread between the rate they pay for funds and the rate they receive from
borrowers. This ability to pool deposits from many sources that can be lent to many
different borrowers creates the flow of funds inherent in the banking system. By managing
this flow of funds, banks generate profits, acting as the intermediary of interest paid and
interest received, and taking on the risks of offering credit.
Banking is a highly leveraged business requiring regulators to dictate minimal capital
levels to help ensure the solvency of each bank and the banking system. A bank's primary
regulator could be the Federal Reserve Board, the Office of the Comptroller of the Currency,
the Office of Thrift Supervision or any one of 50 state regulatory bodies, depending on
the charter of the bank. Within the Federal Reserve Board, there are 12 districts with
12 different regulatory staffing groups. These regulators focus on compliance with certain
requirements, restrictions and guidelines, aiming to uphold the soundness and integrity
of the banking system.
As one of the most highly regulated banking industries in the world, investors have
some level of assurance in the soundness of the banking system. As a result, investors
can focus most of their efforts on how a bank will perform in different economic
environments.
As financial intermediaries, banks assume two primary types of risk as they manage
the flow of money through their business. Interest rate risk is the management of the spread
between interest paid on deposits and received on loans over time. Credit risk is the
likelihood that a borrower will default on a loan or lease, causing the bank to lose any
potential interest earned as well as the principal that was loaned to the borrower. As
investors, these are the primary elements that need to be understood when analyzing a
banks financial statement.
136
Notes
The primary business of a bank is managing the spread between deposits (liabilities,
loans and assets). Basically, when the interest that a bank earns from loans is greater
than the interest it must pay on deposits, it generates a positive interest spread or net
interest income. The size of this spread is a major determinant of the profit generated
by a bank. This interest rate risk is primarily determined by the shape of the yield curve.
As a result, net interest income will vary, due to differences in the timing of accrual
changes and changing rate and yield curve relationships. Changes in the general level
of market interest rates also may cause changes in the volume and mix of a banks balance
sheet products. For example, when economic activity continues to expand while interest
rates are rising, commercial loan demand may increase while residential mortgage loan
growth and prepayments slow.
Banks, in the normal course of business, assume financial risk by making loans
at interest rates that differ from rates paid on deposits. Deposits often have shorter
maturities than loans and adjust to current market rates faster than loans. The result is
a balance sheet mismatch between assets (loans) and liabilities (deposits). An upward
sloping yield curve is favorable to a bank as the bulk of its deposits are short-term and
their loans are longer term. This mismatch of maturities generates the net interest revenue
banks enjoy.
137
Notes
SEBI Act, 1992: Securities and Exchange Board of India (SEBI) was first established
in the year 1988 as a non-statutory body for regulating the securities market. It became
an autonomous body in 1992 and more powers were given through an ordinance. Since
then, it regulates the market through its independent powers.
(iii) Insurance Regulatory and Development Authority
The Insurance Regulatory and Development Authority (IRDA) is a national agency
of the Government of India and are based in Hyderabad (Andhra Pradesh). It was formed
by an Act of Indian Parliament known as IRDA Act 1999, which was amended in 2002
to incorporate some emerging requirements. Mission of IRDA as stated in the act is to
protect the interests of the policyholders, to regulate, promote and ensure orderly growth
of the insurance industry and for matters connected therewith or incidental thereto.
(B) Part of the Ministries of the Government of India
(iv) Forward Market Commission India (FMC)
Forward Markets Commission (FMC) headquartered at Mumbai, is a regulatory
authority which is overseen by the Ministry of Consumer Affairs, Food and Public
Distribution, Government of India. It is a statutory body set up in 1953 under the Forward
Contracts (Regulation) Act, 1952 This Commission allows commodity trading in
22 exchanges in India, out of which three are national level.
(v) PFRDA under the Finance Ministry
Pension Fund Regulatory and Development Authority: PFRDA was established by
Government of India on 23rd August, 2003. The Government has, through an executive
order dated 10th October 2003, mandated PFRDA to act as a regulator for the pension
sector. The mandate of PFRDA is development and regulation of pension sector in India.
138
Notes
139
For a long period up to 1990-91, the rate remained unchanged at 10%. Later, from
October 1991 to April 1997, the rate remained at 12.00%. During 1997-98, the rate was
reactivated to serve as a reference rate for Commercial Banks lending rates.
Notes
When Reserve Bank wants a reduction in general lending rates of Commercial Banks,
it will signify its intention by reducing Bank Rate and vice versa. The Bank Rate was
changed five times during 1997-98. The Bank Rate which was 8% in November 1999 was
changed to 7.00% in April 2001.
It was brought down to 6.50% in October 2001, 6.25% in October 2002 and 6.00%
in April 2003. The rate frequently changes these days depending upon immediate monetary
policy objectives. Of late, the Reserve Bank makes changes in Bank Rate often depending
upon liquidity position of banks, short-term interest level, and inflation of the situation.
Ever since, Exchange Rate of rupee was allowed to be determined by market forces in
March 1993. Bank Rate has been changed a little more often.
The bank rate policy as an instrument of monetary control was not successful in
India for a long time. The main factors responsible for this are:
(i) Inherent inflexibility involved in the use of this instrument.
(ii) The dominance of the public sector whose investment requirements are cost
inelastic.
(iii) The higher rate of inflation experienced in the economy.
(iv) Restricted availability of refinance facilities to banks.
(v) As the government expenditure increase, the tax burden also increases. Under
heavy taxation, the businessmen feel that the interest rate is a minor factor.
And the decrease in the importance of interest rate has led to the decline in
the importance of bank rate.
2. Open Market Operations
Open market operations are conducted by the RBI mainly with a view to manage
short- term liquidity in the market. These operations directly or indirectly affect the reserves
of the commercial banks and thereby the extent of credit creation is controlled. Section
17(8) of the Reserve Bank of India Act confers legal powers on the Reserve Bank to use
this instrument of monetary policy. Under this section, the Reserve Bank is authorized
to purchase and sell the securities of the Central or State Government of any maturity
and the security of a local authority specified by the central government on the
recommendation of the banks central board.
However, at present, the Reserve Bank deals only in the securities issued by the
central government and not in those of State Governments and local authorities. It may
be noted that in terms of Section 33 of the Reserve Bank of India Act, securities issued
by the State Governments or local bodies are not eligible to be used as reserve assets
against note issue.
The Government securities market in India is narrow and is dominated by financial
institutions especially by commercial banks. The Reserve Bank of India occupies a pivotal
position in the market. It is continuously in the market, selling government securities of
different maturities on tap; it stands ready to buy them in switch operations. The Reserve
Bank of India does not ordinarily purchase securities against cash. There are no dealers
in the market who are engaged in continuous sale and purchase of securities on their
own account. Incidentally, it may be noted that the Reserve Bank affects purchases and
sales from time to time out of the surplus funds of IDBI, EXIM Bank, and NABARD under
special arrangement.
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Notes
The market, however, is served by stock brokers who act as intermediaries between
prospective buyers and sellers of government securities. The Reserve Bank also enlists
the services of brokers, if necessary.
The role of open market operation as an instrument of credit control will assume
importance in the restructured monetary system. With the interest rate offered on
government securities becoming truly competitive, a broad enough securities market may
emerge for the Reserve Bank to use open market operations as an instrument of credit
control.
It will sell the securities in open market to drain out excess liquidity from the financial
system and thereby contraction of credit. When it buys securities, it injects additional
funds into the market and consequently credit expansion may take place. Repos and
Reverse Repos transactions may be considered a supplementary operation to this
system.
3. Variation of Cash Reserve Ratio
Under this requirement, certain percentage of deposit liabilities of banks is impounded
in cash form with RBI and/or to be maintained in liquid assets like government securities.
The reserve requirements were originally evolved as a means for safeguarding the interests
of depositors.
Later, it was developed as an instrument of credit control. The variation in the reserve
requirements has the effect of increasing or decreasing the funds available with commercial
banks for lending. In India, the reserve requirements are of two types. They are:
(a) Cash Reserve Ratio, and
(b) Statutory Liquidity Ratio.
(a) Cash Reserve Ratio
Under the provisions of the RBI Act, the scheduled banks were required to maintain
a minimum amount of cash reserve with the Reserve Bank. The reserve is made out of
demand and time liabilities at certain percentage fixed by the RBI.
The Cash Reserve Ratio is required to be maintained in cash with RBI, in addition
to the percentage to be maintained under the Statutory Liquidity Ratio. The Cash Reserve
Ratio cannot exceed 15% of the net demand and time liabilities.
The Cash Reserve Ratio at the time of notification of banks was 3% which having
been revised a number of times. The flat rate of 15% was introduced in the credit policy
for the first half of 1989-90.
It was observed that the credit control instruments in the hands of RBI have been
used to maintain the economic growth with controlled inflation and as a sharp knife to
curb inflation. RBI has used these flexibilities to ensure that institutional finances for
productive purposes are not lacking.
The CRR is being gradually reduced after initiating banking sector reforms from
1994- 95. The rate was 10.5% as on April 1999. It stands reduced to 10.0% from May
1999 and from November 1999 it stands further reduced to 9.0%.
Ever since financial sector reforms and market determined exchange for Rupee, the
RBI uses this instrument to influence liquidity in money market and thereby exchange
rate fluctuations.
In the recent past, when the exchange rate of rupee came under attack from bank
speculators, it increased the CRR thereby impounding excess liquidity in the market. This
141
policy helped RBI to maintain stable rate in short-term. The CRR was drastically reduced
during 2001, to 4.75% in November 2002. It stands at 4.50% from June 14, 2003.
Notes
142
Notes
143
Notes
144
Notes
145
2. To regulate and control the business on stock exchanges and other security
markets. For this, SEBI keeps supervision on brokers. Registration of brokers
and sub-brokers is made compulsory and they are expected to follow certain
rules and regulations. Effective control is also maintained by SEBI on the
working of stock exchanges.
Notes
146
Notes
147
A common theory in lender liability actions is breach of contract, and the first contract
that is considered in the borrower-lender relationship is the loan commitment. This is the
most litigated loan contract, whether the initial contract to make the loan or a commitment
to extend or recast the loan as a result of borrower difficulties.
Notes
Although the lender has the right to refuse to make a loan, the lender must comply
with the laws governing the loan application process. For example, the lender cannot
discriminate against the borrower on the basis of race, religion, national origin, sex, marital
status, or age. The lender also has a duty to process a loan application with reasonable
care. The negligent calculation of the applicant's qualifications under standard industry
criteria may give rise to a cause of action against the lender for failure to use due care.
Processing the application is one thing; protecting the borrower from an improvident
deal is quite another. In the commercial loan setting, the lender is generally not required
to protect the inexperienced borrower from a bad business decision. A greater duty must
be established for the lender to be held liable.
Once the borrower and the lender agree on the terms of a loan, a contract, usually
a conditional contract, is formed. If a party breaches that contract, the usual contract
remedies apply. Lender liability is found when the lender breaches its promise to extend
financing. Similarly, the lender is liable for breach of its promise to forbear from the exercise
of remedies otherwise available to it under the loan documents or failing to honor previously
agreed-upon loan modification terms.
For example, in one case, a lump sum payment was due under a note. The borrower
had financial difficulties and agreed with the loan officer to convert the obligation to an
installment loan.
When the loan officer went out of town, the loan officers superior refused to convert the
note, accelerated its due date, and exercised the lender-banks offset rights against the other
accounts of the borrower. The court held the lender liable for the borrower's damages.
This does not mean that the lender as a matter of course is obligated to extend
the loan opening date. Rather, the lender is entitled to demand strict compliance with
the terms of the commitment and upon the borrowers breach, retain the commitment fee.
The lender will not be liable for breach of the covenant of good faith and fair dealing when
the loan commitment clearly states that the borrower was not entitled to a refund under
any circumstances and there was no contractual obligation on the lender to grant an
extension of time to perform. Further, the borrower must comply with the requirements
of the loan commitment, notwithstanding alleged oral statements by an officer of the lender
amending commitment requirements.
Although the lender may be liable for damages incurred by the borrower as a result
of the lenders breach of the loan commitment, punitive damages are generally not
recoverable.
Damages for breach of contract are limited to those necessary to compensate the
borrower for the lenders breach, that is, the excess interest required to be paid on
replacement financing. The old rule that the borrower could not specifically enforce the
loan commitment is falling into disfavor and borrowers are being granted the right to do
so. The opposite is not true, however; the courts generally do not allow the lender to enforce
a long-term commitment against the borrower.
Law of Lender Liability provides a comprehensive explanation of the major legal issues
that arise between lenders and borrowers at the various stages of the loan relationship.
It also provides practical guidance for developing and implementing protective measures
at every stage of the life of the loan.
Amity Directorate of Distance and Online Education
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Notes
149
Many analysts predict still more revolutionary changes in the banking sector in India.
The chief of these are likely to be the concept of Universal Banks and the introduction
of Smart Card technology.
Notes
Although the Indian banking sector has made rapid progress particularly in the
number of innovations introduced, some analysts are skeptical about the efficacy and
practical use of many of these services.
Banking in India has already undergone a huge transformation in the years since
Independence. The rate of transformation was particularly high in the 1990s and 2000s,
when a number of innovations changed the way banking was perceived.
Information technology is one of the most important facilitators for the transformation
of the Indian banking industry in terms of its transactions processing as well as for various
other internal systems and processes. The various technological platforms used by banks
for the conduct of their day-to-day operations, their manner of reporting and the way in
which inter-bank transactions and clearing is affected has evolved substantially over the
years.
A combination of regulatory and competitive reasons has led to increasing importance
of total banking automation in the Indian Banking Industry. Information technology enables
sophisticated product development, better market infrastructure, implementation of reliable
techniques for control of risks and helps the financial intermediaries to reach geographically
distant and diversified markets. In view of this, technology has changed the contours of
three major functions performed by banks, i.e., access to liquidity, transformation of assets
and monitoring of risks. Information technology and the communication networking
systems have a crucial bearing on the efficiency of money, capital and foreign exchange
markets.
New Technology in Banking
The technological evolution of the Indian banking industry has been largely directed
by the various committees set up by the RBI and the Government of India to review the
implementation of technological change. No major breakthrough in technology implementation
was achieved by the industry till the early 80s, though some working groups and
committees made stray references to the need for mechanization of some banking
processes. This was largely due to the stiff resistance by the very strong bank employees
unions. The early 1980s were instrumental in the introduction of mechanization and
computerization in Indian banks. This was the period when banks as well as the RBI went
very slow on mechanization, carefully avoiding the use of computers to avoid resistance
from employee unions. However, this was the critical period acting as the icebreaker, which
led to the slow and steady move towards large-scale technology adoption.
The process of computerization marked the beginning of all technological initiatives
in the banking industry. Computerization of bank branches had started with installation
of simple computers to automate the functioning of branches, especially at high traffic
branches. Total Branch Automation was in use which did not involve bank level branch
networking and did not mean much to the customer.
Networking of branches are now undertaken to ensure better customer service. Core
Banking Solutions (CBS) is the networking of the branches of a bank, so as to enable
the customers to operate their accounts from any bank branch, regardless of which branch
he opened the account with. The networking of branches under CBS enables centralized
data management and aids in the implementation of internet and mobile banking. Besides,
CBS helps in bringing the complete operations of banks under a single technological
platform.
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Notes
CBS implementation in the Indian banking industry is still underway. The vast
geographical spread of the branches in the country is the primary reason for the inability
of banks to attain complete CBS implementation.
Satellite banking is also an upcoming technological innovation in the Indian banking
industry, which is expected to help in solving the problem of weak terrestrial
communication links in many parts of the country. The use of satellites for establishing
connectivity between branches will help banks to reach rural and hilly areas in a better
way, and offer better facilities, particularly in relation to electronic funds transfers. However,
this involves very high costs to the banks. Hence, under the proposal made by RBI, it
would be bearing a part of the leased rentals for satellite connectivity, if the banks use
it for connecting the north-eastern states and the underbanked districts.
151
populated by central bankers and regulators who either hailfrom or are otherwise beholden
to the banking industry. The focus of the Basel Accords has always been on regulating
bank capital and not bank practices. But capital requirements cannot protect against the
sorts of abuses that came to light in the two recent financial crises.
Notes
The Basel Committee on Banking Supervision's work is organized under four main
sub-committees:
(i) The Standards Implementation Group was originally established to share
information on, and promote consistency in, the implementation of the Basel
II Framework. In 2009, the Standards Implementation Groups goals were
broadened to concentrate on implementation of general Basel Committee
guidance and standards.
(ii) The Policy Development Group identifies and reviews emerging supervisory
issues. The Policy Development Group also proposes and develops policies
designed to create sound banking systems and supervisory standards.
(iii) The Accounting Task Force helps ensure that international accounting and
auditing standards and practices promote risk management at banks. The
Accounting Task Force also develops reporting guidance and takes an active
role in the development of these international accounting and auditing standards.
(iv) The Basel Consultative Group facilitates supervisory dialogue with non-member
countries on new committee initiatives by engaging senior representatives from
various countries, international institutions and regional groups of banking
supervisors that are not members of the committee.
BCBS members include representatives from Argentina, Australia, Belgium, Brazil,
Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea,
Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa,
Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The
BCBS encourages contact and cooperation between its members and other banking
supervisory authorities. It also circulates papers providing guidance on supervisory matters
to banking regulators all over the world.
3.5%
4.5%
8%
Since such pronouncements are frequently updated, please consult the Bank of
International Settlements website for latest guidance.
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Notes
Formula:
Capital Adequacy Ratio = Tier 1 Capital + Tier 2 Capital
Risk-weighted Exposures
Tier 1 Capital = Common Equity Tier 1 + Additional Tier 1
Total Capital = Tier 1 Capital + Tier 2 Capital
Risk-weighted exposures include weighted sum of the banks credit exposures
(including those appearing on the banks balance sheet and those not appearing). The
weights are determined in accordance with the Basel Committee guidance for assets of
each credit rating slab.
153
Management, Earnings appraisal, Liquidity and Systems and controls) approach, which
was more of a transaction testing model. The supervisory stance of RBS will extend to
an analysis of a banks propensity for failure and its likely impact on the financial system.
With banks moving into this uniform methodology of supervision, India will now be at par
with best practices around the world.
Notes
RBS can be termed forward looking as it seeks to assess risk buildup by examining
whether the supervised entity/bank follows regulatory prescriptions, and if its internal risk
management practices are aligned with regulatory expectations. In short, its goals are
to help banks optimize the utilization of supervisory resources and minimize the impact
of crises scenarios in the financial system.
Risk-based supervision is a supervisory approach that has either been implemented,
or is in the process of being implemented, by many supervisory authorities. In addition,
risk-based supervision concepts are embedded in the Basel Core principles for effective
banking supervision and are part of the IMF and World Banks Financial Sector
Assessment Programs (FSAPs) of countries.
In todays fast moving and interconnected world, along with carrying out on-site and
off-site activities at banks, supervisors need to be forward-looking, and develop plans for
intervening early, if a material problem surfaces at one or more of their domestic
systemically-important banks.
As such, we have designed a comprehensive program, which covers a variety of
current and relevant topics, to assist supervisors in becoming more effective and nimble
in their work.
Over 5 days, we plan to cover the following topics:
(a) Key concepts, principles and general approach for an effective risk-based
supervision framework.
(b) How to identify the significant activities in a bank and, in turn, rate the inherent
credit, market, operational and other risks for these activities.
(c) How to assess and rate the performance of board, senior management and the
independent oversight functions such as internal audit, risk management and
compliance, that oversee a bank.
(d) A walk-through on how FIN-FSA conducts its supervisory planning process as
well as how it carries out its on-site work for credit and liquidity.
(e) Macro prudential activities that enable one to identify and deal with problems
early.
(f) Cross-border cooperation and supervisory colleges, plus recovery and resolution
plans for Systemically Important Financial Institutions (SIFIs).
(g) Crisis preparedness and the importance of developing a crisis handbook.
154
Notes
155
cash outflows in the respective time buckets in order to recognize the cumulative impact
on liquidity.
Notes
The Boards of the banks have been entrusted with the overall responsibility for the
management of risks and is required to decide the risk management policy and set limits
for liquidity, interest rate, and foreign exchange and equity price risks.
Asset-Liability Committee (ALCO) is the top most committee to oversee the
implementation of ALM system and it is to be headed by CMD or ED. ALCO considers
product pricing for deposits and advances, the desired maturity profile of the incremental
assets and liabilities in addition to monitoring the risk levels of the bank. It will have to
articulate current interest rates view of the bank and base its decisions for future business
strategy on this view.
3.49 E-Banking
World over banks are reorienting their business strategies towards new opportunities
offered by e-banking. E-banking has enabled banks to scale borders, change strategic
behavior and thus bring about new possibilities. E-banking has moved real banking behavior
closer to neoclassical economic theories of market functioning. Due to the absolute
transparency of the market, clients both business as well as retail can compare the
services of various banks more easily. For instance, on the internet, competitors are only
one click away. If clients are not happy with the products, prices or services offered by
a particular bank, they are able to change their banking partner much more easily than
in the physical or real bank-client relationship. From the banks point of view, use of the
internet has significantly reduced the physical costs of banking operations.
Around the world electronic banking services, whether delivered online or through
other mechanisms, have spread quickly in recent years. It must be noted that the impact
of e-banking is not limited to industrial and advanced emerging economies. Even in
countries with underdeveloped banking systems, E-banking has offered many new
business opportunities.
E-business is a monolithic term encompassing the various business processes that
aim to integrate the vendors or traders with the consumers and suppliers using the Internet.
The entire process of setting up a website, helping the prospective customers navigate
through the website, showing them the available products, offering discounts and vouchers
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Notes
and doing everything possible to woo the prospective clients and converting them into
customers, comes under the purview of e-business. E-commerce, on the other hand, is
a subset of e-business and refers to online transactions that can be accounted for in
monetary terms. For instance, accepting credit card payment for products sold to
consumers or making payments for shopping online are examples of e-commerce. In other
words, e-commerce refers to the last stage of e-business, which involves collecting
payments for the goods sold by the business firm.
Meaning of E-Banking
E-banking is defined as the automated delivery of new and traditional banking
products and services directly to customers through electronic, interactive communication
channels.
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Notes
ATM is a modern device introduced by the banks to enable the customers to have
access to money day-in/day-out without visiting the bank branches in person. The system
is known as Any Time Money or Any Where Money because it enables the customers
to withdraw money from the bank from any of its ATMs round the clock.
(ii) Internet Banking
Internet banking is an electronic payment system that enables customers of a
financial institution to conduct financial transactions on a website operated by the
institution. Internet banking does offer many benefits for both banks and their customers.
So, the banks are doing what they can to encourage customers to try it.
(iii) Mobile Banking
Mobile banking is a system that allows customers of a financial institution to conduct
a number of financial transactions through a mobile device such as a mobile phone or
tablet. With the use of a mobile device, the user can perform mobile banking via call,
text, website or applications. It utilizes the mobile connectivity of telecom operators and
therefore does not require an internet connection. With mobile banking, users of mobile
phones can perform several financial functions conveniently and securely from their mobile.
(iv) Tele Banking
Telephone banking is a service provided by a bank or other financial institution that
enables customers to perform financial transactions over the telephone, without the need to
visit a bank branch or automated teller machine. Telephone banking times can be longer than
branch opening times, and some financial institutions offer the service on a 24 hour basis.
(v) Electronic Fund Transfer
Electronic Funds Transfer (EFT) is a system of transferring money from one bank
account directly. Transactions are processed by the bank through the Automated Clearing
House (ACH) network. The benefits of EFT include reduced administrative costs, increased
efficiency, simplified bookkeeping and greater security.
(vi) Standing Instructions
Standing instructions are a way of making an automatic payment of a fixed amount
to a loan, bill or credit card at the same time every week or month. It can be made from
deposit account and is most commonly used to make payments to a mortgage, car loan
or to pay bills.
(vii) Online Mutual funds Investment
Mutual fund is a professionally-managed trust that pools the savings of many
investors and invests them in securities like stocks, bonds, short-term money market
instruments and commodities such as precious metals. Investors in a mutual fund have
a common financial goal and their money is invested in different asset classes in
accordance with the funds investment objective. Indian banks and financial institutions
offer online mutual fund investment facilities.
(viii) Smart Cards
The banking industry enjoyed the benefits of magnetic stripe card technology for a
long time. This technology has revolutionized the payment card industry and increased
the level of card security. These cards use encryption and authentication technology which
is more secure than other methods associated with payment system. Example: State
Bank Smart Payout Card can be used for cash withdrawal at ATMs, for purchase
transactions at merchant establishments and for e-Commerce.
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Notes
159
office. To access the account, the customer has to establish security measures
such as usernames and passwords. To complete the set up of account,
customer has to just print, sign and send in a form.
Notes
2. Internet banking costs less. Because there are fewer buildings to maintain, and
less involvement by salaried employees, there is a much lower overhead with
online banks. These savings allow them to offer higher interest rates on savings
accounts and lower lending rates and service charges. Even traditional brick
and mortar banks offer better deals such as free bill paying services to encourage
their customers to do their banking online.
3. Comparing internet banks to get the best deal is easy. In a short time,
customers can visit several online banks to compare what they offer in savings
and checking account deals as well as their interest rates. Other things that
can be easily done is research about credit cards availability, credit card interest
rates, loan terms and the banks own rating with the FDIC.
4. Bouncing a cheque (accidentally) should be a thing of the past because it can
be monitored in the account online any time, day or night. Customers can track
your balance daily, see what cheques have cleared and when and know when
automatic deposits and payments are made. This is all possible by simply going
online to the banks website and logging into your account.
5. Banks keep the account balanced using computer and the monthly statement.
Customers bank account information can be downloaded into software
programs such as Microsoft Money or Quicken; making is easy to reconcile
with the account with just a few mouse clicks. The convenience of the data
capture online makes it much easier to budget and track where the money goes.
The internet bank account even allows to view copies of the cheques that have
been written each month.
6. With the ability to view the account at anytime, it is easier to catch fraudulent
activity in the account before much damage is done. As soon as the customer
logs into the account, he will be able to quickly see whether there is anything
amiss when there is a cheque on deposits and debits. If anyone writes a cheque
or withdraws funds from the account and customer is known, it wasnt the
intended person. This lets the customer to get started on correcting the problem
immediately rather than having to wait a month, even if it has a clue, it is
happening as would be the case with a traditional bank.
7. Internet banking offers a great deal more convenience than from a conventional
bank. Customers arent bound by bankers hours and dont have to go there
physically. Time is not wasted when there is work to do because the customer
can do offices banking without leaving the office. No matter wherever we are
or what time it is, customer can easily manage the money.
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Notes
2. Security Concerns
With hacking and identity theft on the rise, Internet banking customers have to place
a certain amount of trust in the bank that their account information and personal information
are safe.
3. Customer Service
If the customer banks at a traditional bank, they can go to the bank and speak to
someone face to face about their problem but, with an Internet bank, they will likely spend
a lot of time on the phone being passed around and placed on hold.
4. Accessibility
If the Internet goes down in the area or the area of the banking office, the customer
will be unable to access the accounts. This includes being unable to withdraw money
from ATMs or to use the debit card.
5. Fees
Many Internet banks dont have ATMs, which means the customer will have to pay
ATM fees. This can cost more money than paying the regular monthly fees at a brick
and mortar bank.
161
transaction history. It usually also allows them to transfer funds, pay bills, request cheque
books, etc.
Notes
162
Notes
Nowadays, most banks use core banking applications to support their operations
where CORE stands for centralized online real-time environment. This basically means
that all the banks branches access applications from centralized datacenters. This means
that the deposits made are reflected immediately on the banks servers and the customer
can withdraw the deposited money from any of the banks branches throughout the world.
These applications now also have the capability to address the needs of corporate
customers, providing a comprehensive banking solution.
A few decades ago, it used to take at least a day for a transaction to reflect in the
account because each branch had their local servers and the data from the server in each
branch was sent in a batch to the servers in the datacenter only at the end of the day
(EoD).
Normal core banking functions will include deposit accounts, loans, mortgages and
payments. Banks make these services available across multiple channels like ATMs,
Internet banking, and branches.
Core banking functions differ depending on the specific type of bank. Retail banking,
for example, is geared towards individual customers; wholesale banking is business
conducted between banks; and securities trading involves the buying and selling of stocks,
shares and so on. Core banking systems are often specialized for a particular type of
banking. Products that are designed to deal with multiple types of core banking functions
are sometimes referred to as universal banking systems.
History of Core Banking
The major objectives of bank automation are better customer service, flawless book
keeping and prompt decision-making that leads to improved productivity and profitability.
The concept of bank automation started in the year 1981, but it was during the period
1984-1987 banks in India started the branch level automation, making use of the then
available MSDOS based stand-alone computers. This initiative was taken by the banks
on the basis of First Rangarajan Committee Report on bank computerization submitted
in the year 1984. ALPMs (Advance Ledger Posting Machines) were the fashion in those
days. However, the pace of bank automation was very slow in the banks primarily owing
to the lack of trade union consensus on bank automation.
Another committee was in 1988 under the chairmanship of Dr. C. Rangarajan, the
then Deputy Governor of RBI to slate down a perspective plan on automation of banks
for a five year period. This paved way to the implementation of multi-user Total Branch
Automation packages running on a LAN (Local Area Network), either on a Network or
a UNIX operating system. With the implementation of TBA, banks started to offer the
facilities of exclusive Customer Terminal, Single window transaction, online and off-site
ATMs, Tele Banking, etc.
But with the advent of new generation, private sector banks in India during 19941996, the real era of bank marketing started and these banks started to offer anywhere
and anytime banking facilities to its customers. This was possible for them mainly owing
to the fact that they opted for the implementation of a WAN (Wide Area Network) based
centralized banking solution rather than a LAN based banking solution to network their
limited number of branch outlets.
The old generation banks in India hesitated to follow this banking fashion on account
of its large network of branches on one hand and the then prevailing exorbitant IT cost
on the other hand. But with the globalization and liberalization of Indian market and with
the enactment of TRAI (with a mission to create and nurture conditions for growth of
163
telecommunications in the country in a manner and at a pace which will enable India to
play a leading role in emerging global information society) during the late nineties, there
happened a drastic reduction in IT cost.
Notes
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Notes
(d) Mobile banking is available round the clock 24/7/365, it is easy and convenient
and an ideal choice for accessing financial services for most mobile phone
owners in the rural areas.
(e) Mobile banking is said to be even more secure than online/internet banking.
Disadvantages of Mobile Banking
(a) Mobile banking users are at risk of receiving fake SMS messages and scams.
(b) The loss of a persons mobile device often means that criminals can gain access
to your mobile banking PIN and other sensitive information.
(c) Modern mobile devices like smartphones and tablets are better suited for mobile
banking than old models of mobile phones and devices.
(d) Regular users of mobile banking over time can accumulate significant charges
from their banks.
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of security controls based on their assessment of the sensitivity of the information to the
customer and to the institution and on the institutions established risk tolerance level.
Notes
2. Credit Risk
Generally, a financial institutions credit risk is not increased by the mere fact that
a loan is originated through an E-banking channel. However, management should consider
additional precautions when originating and approving loans electronically, including
assuring management information systems effectively track the performance of portfolios
originated through E-banking channels. The following aspects of online loan origination
and approval tend to make risk management of the lending process more challenging.
If not properly managed, these aspects can significantly increase credit risk.
Verifying the customers identity for online credit applications and executing an
enforceable contract;
Monitoring and controlling the growth, pricing, underwriting standards and ongoing
credit quality of loans originated through E-banking channels;
Monitoring and over sight of third-parties doing business as agents or on behalf of
the financial institution (for example, an Internet loan origination site or electronic payments
processor);
Valuing collateral and perfecting liens over a potentially wider geographic area;
Collecting loans from individuals over a potentially wider geographic area;
Monitoring any increased volume of, and possible concentration in, out-of-area
lending.
Liquidity, interest rate, price/market risks Funding and investment-related risks
could increase with an institutions E-banking initiatives depending on the volatility and
pricing of the acquired deposits. The Internet provides institutions with the ability to market
their products and services globally. Internet-based advertising programs can effectively
match yield-focused investors with potentially high-yielding deposits. But Internetoriginated deposits have the potential to attract customers who focus exclusively on rates
and may provide a funding source with risk characteristics similar to brokered deposits.
An institution can control this potential volatility and expanded geographic reach through
its deposit contract and account opening practices, which might involve face-to-face
meetings or the exchange of paper correspondence. The institution should modify its
policies as necessary to address the following E-banking funding issues:
Potential increase independence on brokered funds or other highly rate-sensitive
deposits;
Potential acquisition of funds from markets where the institution is not licensed to
engage in banking, particularly if the institution does not establish, disclose, and enforce
geographic restrictions;
Potential impact of loan or deposit growth from an expanded Internet market,
including the impact of such growth on capital ratios;
Potential increase in volatility of funds should E-banking security problems negatively
impact customer confidence or the markets perception of the institution.
3. Reputational Risks
This is considerably heightened for banks using the Internet. For example, the
Internet allows for the rapid dissemination of information which means that any incident,
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Notes
either good or bad, is common knowledge within a short space of time. The speed of
the Internet considerably cuts the optimal response times for both banks and regulators
to any incident. Any problems encountered by one firm in this new environment may affect
the business of another, as it may affect confidence in the Internet as a whole. There
is, therefore, a risk that one scoundrel E-bank could cause significant problems for all
banks providing services via the Internet. This is a new type of systemic risk and is causing
concern to E-banking providers. Overall, the Internet puts an emphasis on reputational
risks. Banks need to be sure that customer rights and information needs are adequately
safeguarded and provided for.
4. Transaction/Operations Risk
Transaction/Operations Risk arises from fraud, processing errors, system disruptions,
or other unanticipated events resulting in the institutions inability to deliver products or
services. This risk exists in each product and service offered. The level of transaction risk
is affected by the structure of the institutions processing environment, including the types
of services offered and the complexity of the processes and supporting technology.
3.62 E-finance
E-finance is defined as the provision of financial services and markets using
electronic communication and computation. The term E-Finance is used differently by
different people. It can be defined as a provisioning of financing instruments to business
organizations using electronic tools and technology for the lengthwise process and this
incorporates the use of electronic channels for mobilizing e-finance services and electronic
methods to set up proper finance conditions and deal with the risk related to the finance
itself. E-finance, in simple words, is use of Internet and technologies in financial services.
It has enabled the people to have any financial transactions without any human interaction.
It saves time, reduces paperwork and chances of fraudulent. Nowadays, with the
emergence of e-commerce, E-finance has become a buzzword among the entrepreneur,
business firms and investors. Due to the increasing awareness about the use of internet
and computer technology in commercial purpose, E-finance has emerged as solution to
simplify the complexions involved in dealing with finance. It is somewhat the shift of system
of financial service from the real world to a virtual one. E-Finance to banking services has
been more varied across countries. It allows countries to establish a financial system
without first building a fully functioning financial infrastructure by its much cheaper since
it lowers processing costs for providers and search and switching costs for consumers.
Internet banking and e-commerce is changing the finance industry, having the major effects
on banking relationships. Banking is now no longer confined to the branches where one
has to approach the branch in person, to withdraw cash or deposit a cheque or request
a statement of accounts. In true, Internet banking is increasingly becoming a need to
have than a nice to have service. The net banking, thus, now is more of a norm rather
than an exception in many developed countries due to the fact that it is the cheapest
way of providing banking services. As of 2013, there are more than 15 million online banking
users in India and 53 banks are providing ATM facilities across the country.
The facility of e-banking can be provided solely through the internet without having
any physical office. The adoption of mobile banking has increased substantially in the
past year, in a world nearly 28% of mobile phone users in the survey report that they
used mobile banking in the past 12 months. E-banking provides enormous benefits to
consumers in terms of ease and cost of transactions, either through the Internet, telephone
or other electronic delivery. Electronic finance (E-finance) has become one of the most
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Notes
Banking plays a vital role in E-financing which allows countries to establish a financial
system without functioning financial infrastructure. In India, the position of E-finance is
still in its initial stage and has a lot to grow up, counted in one of the newest digitalized
part of E-commerce. It has put a great impetus on the other parts of business like
international market and financial accounting. It is a tool to overcome the lacuna of physical
delivery of financial services and has been proved as an aid for SMEs and developing
countries.
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Notes
(c) There is also a pressing issue regarding the technology involved in digital cash.
Power failures, loss of records and undependable software often cause a major
setback in promoting the technology.
(d) Privacy questions have also been raised; there is a fear that the use of debit
cards and the like will lead to the creation by the banking industry of a global
tracking system. Some people are working on anonymous e-cash to try to
address this issue.
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3.66 RTGS
Notes
The acronym RTGS stands for Real Time Gross Settlement, which can be defined
as the continuous (real-time) settlement of funds transfers individually on an order by order
basis (without netting). Real Time means the processing of instructions at the time they
are received rather than at some later time. Settlement in real time means payment
transaction is not subjected to any waiting period. The transactions are settled as soon
as they are processed. Gross Settlement means the settlement of funds transfer
instructions occurs individually (on an instruction by instruction basis). Gross settlement
means the transaction is settled on one-to-one basis without bunching with any other
transaction. Considering that the funds settlement takes place in the books of the Reserve
Bank of India, the payments are final and irrevocable. This is the fastest possible money
transfer system through the banking channel.
Features of RTGS
1. The RTGS system is primarily meant for large value transactions. The minimum
amount to be remitted through RTGS is ` 2 lakh. There is no upper ceiling for
RTGS transactions.
2. Under normal circumstances, the beneficiary branches are expected to receive
the funds in real time as soon as funds are transferred by the remitting bank.
The beneficiary bank has to credit the beneficiarys account within two hours
of receiving the funds transfer message.
3. The RTGS service window for customers transactions is available from 9.00
hours to 16.30 hours on weekdays and from 9.00 hours to 13.30 hours on
Saturdays for settlement at the RBI end. However, the timings that the banks
follow may vary depending on the customer timings of the bank branches.
4. With a view to rationalize the service charges levied by banks for offering funds
transfer through RTGS system, a broad framework has been mandated as under:
(a) Inward transactions Free, no charge to be levied.
(b) Outward transactions ` 2 lakh to ` 5 lakh not exceeding ` 30 per
transaction. Above ` 5 lakh not exceeding ` 55 per transaction.
5. The remitting customer has to furnish the following information to a bank for
effecting a RTGS remittance:
(a) Amount to be remitted.
(b) Remitting customers account number which is to be debited.
(c) Name of the beneficiary bank.
(d) Name of the beneficiary customer.
(e) Account number of the beneficiary customer.
(f) Sender to receiver information, if any.
(g) The IFSC Number of the receiving branch.
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Notes
3.68 Summary
Bank lending refers to the process of disposing of money or property with the
expectation that the same thing will be returned. Credit is the provision of resources (such
as granting a loan) by one party to another party where that second party does not
reimburse the first party immediately, thereby generating a debt, and instead arranges
either to repay or return those resources (or material(s) of equal value, where the first
party would be the banker (lender or creditors) and the second partly would be the customer
(borrower or debtor).
Loan is an arrangement in which a lender gives money to a borrower and the borrower
agrees to return the money along with interest after a fixed period of time. Examples:
Home Loans, Car Loans, Personal Loans, etc.
Cash credit is a short-term cash loan to a company. A bank provides this type of
funding, but only after the required security is given to secure the loan. Once a security
for repayment has been given, the business that receives the loan can continuously draw
from the bank up to a certain specified amount.
Overdraft is the amount by which withdrawals exceed deposits or the extension of
credit by a lending institution to allow for such a situation.
Letter of Credit refers to a letter from a bank guaranteeing that a buyers payment
to a seller will be received on time and for the correct amount. In the event that the buyer
is unable to make payment on the purchase, the bank will be required to cover the full
or remaining amount of the purchase. It is a payment term generally used for international
sales transactions.
171
Borrowers are the individuals borrow money via bankers loans for short-term needs
or longer-term mortgages to help finance a house purchase. Companies borrow money
to aid short-term or long-term cash flows. They also borrow to fund modernization or future
business expansion. Governments often find their spending requirements exceed their tax
revenues. To make up this difference, they need to borrow. Governments also borrow on
behalf of nationalized industries, municipalities, local authorities and other public sector
bodies.
Notes
Balance sheet analysis can be defined as an analysis of the assets, liabilities, and
equity of a company. This analysis is conducted generally at set intervals of time, like
annually or quarterly. The process of balance sheet analysis is used for deriving actual
figures about the revenue, assets, and liabilities of the company.
Project appraisal is the structured process of assessing the viability of a project or
proposal. It involves calculating the feasibility of the project before committing resources
to it. It is a tool that companys use for choosing the best project that would help them
to attain their goal. Project appraisal often involves making comparison between various
options and this done by making use of any decision technique or economic appraisal
technique.
Management or Organizational Appraisal is a process which can look at an
organization and appraise it in a given context. Some tools appraise an organization in
preparation of an award others look at the performance of an organization in preparation
for a buy-out/buy-in, raising venture capital, etc.
Marketing appraisal is an estate agents recommendation on how we can achieve
the best price for your property in a timescale that suits you. A valuation can only be
carried out by a qualified surveyor and is an evidence-based opinion on how much your
property is worth.
Technological innovation has resulted in financial product development especially in
the international and investment banking areas. The western experience has demonstrated
that technology has not only made execution of work faster but has also resulted in greater
availability of manpower for customer contact.
Prudential norms are the guidelines and general norms issued by the regulating
bank (the central bank) of the country for the proper and accountable functioning of bank
and bank-like establishments.
The prudential accounting norms which were put into place in 1992-93, have been
further strengthened over the years. In respect of accounts where there are potential threats
of recovery on account of erosion in the value of the security or absence of security and
other factors such as fraud committed by the borrowers exist, such accounts are to be
classified as doubtful or loss assets irrespective of the period to which these remained
as non-performing. All the members banks in a consortium are required to classify their
advances according to each banks own record of recovery.
The financial system in India is regulated by independent regulators in the field of
banking, insurance, capital market, commodities market, and pension funds. However,
Government of India plays a significant role in controlling the financial system in India
and influences the roles of such regulators at least to some extent.
Reserve Bank of India is the apex monetary Institution of India. It is also called as
the central bank of the country. The Reserve Bank of India was established on April 1,
1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central
Office of the Reserve Bank was initially established in Calcutta but was permanently moved
to Mumbai in 1937. The Central Office is where the Governor sits and where policies are
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formulated. Though originally privately owned, since nationalization in 1949, the Reserve
Bank is fully owned by the Government of India.
Credit Control is an important tool used by Reserve Bank of India, a major weapon
of the monetary policy used to control the demand and supply of money (liquidity) in the
economy. Central Bank administers control over the credit that the commercial banks
grant. Such a method is used by RBI to bring Economic Development with Stability.
It means that banks will not only control inflationary trends in the economy but also boost
economic growth which would ultimately lead to increase in real national income with
stability.
Innovation derives organization to grow, prosper and transform in sync with the
changes in the environment, both internal and external. Banking is no exception to this.
In fact, this sector has witnessed radical transformation of late, based on many innovations
in products, processes, services, systems, business models, technology, governance and
regulation.
Capital adequacy ratio (CAR) is a specialized ratio used by banks to determine the
adequacy of their capital keeping in view their risk exposures. Banking regulators require
a minimum capital adequacy ratio so as to provide the banks with a cushion to absorb
losses before they become insolvent. This improves stability in financial markets and
protects deposit-holders. Basel Committee on Banking Supervision of the Bank of
International Settlements develops rules related to capital adequacy which member
countries are expected to follow.
Risk weighted assets is a measure of the amount of a banks assets, adjusted for
risk. The nature of a banks business means it is usual for almost all of a banks assets
will consist of loans to customers. Comparing the amount of capital a bank has with the
amount of its assets gives a measure of how able the bank is to absorb losses. If its
capital is 10% of its assets, then it can lose 10% of its assets without becoming insolvent.
Debt restructuring is a process that allows a private or public company, or a sovereign
entity facing cash flow problems and financial distress to reduce and renegotiate its
delinquent debts in order to improve or restore liquidity so that it can continue its
operations.
Corporate Debt Restructuring (CDR) mechanism is a voluntary non-statutory
mechanism under which financial institutions and banks come together to restructure the
debt of companies facing financial difficulties due to internal or external factors, in order
to provide timely support to such companies.
E-banking is defined as the automated delivery of new and traditional banking
products and services directly to customers through electronic, interactive communication
channels.
Internet banking system is a method in which a personal computer is connected
by a network service provider directly to a host computer system of a bank such that
customer service requests can be processed automatically without need for intervention
by customer service representatives. The system is capable of distinguishing between
those customer service requests which are capable of automated fulfillment and those
requests which require handling by a customer service representative. The system is
integrated with the host computer system of the bank so that the remote banking customer
can access other automated services of the bank.
Internet banking refers to a system allowing individuals to perform banking activities
at home, via the internet. Internet banking allows customers to conduct financial
transactions on a secure website operated by their retail or virtual bank.
173
Mobile banking is a term used to refer to systems that allow customers of a financial
institution to conduct a number of financial transactions through a mobile device such
as a mobile phone or tablet.
Notes
E-banking has unique characteristics that may increase an institutions overall risk
profile and the level of risks associated with traditional financial services, particularly
strategic, operational, legal, and reputation risks.
Electronic money, or e-money, is the money balance recorded electronically on a
stored-value card. These cards have microprocessors embedded which can be loaded with
a monetary value.
E-money is electronic money which is exchanged electronically over a technical
device such as a computer or mobile phone. E-money in circulation operates as a prepaid
bearer instrument.
Digital signature is a mathematical technique used to validate the authenticity and
integrity of a message, software or digital document. The digital equivalent of a handwritten
signature or stamped seal, but offering far more inherent security, a digital signature is
intended to solve the problem of tampering and impersonation in digital communications.
The acronym RTGS stands for Real Time Gross Settlement, which can be defined
as the continuous (real-time) settlement of funds transfers individually on an order by order
basis (without netting). Real Time means the processing of instructions at the time they
are received rather than at some later time. Settlement in real time means payment
transaction is not subjected to any waiting period.
National Electronic Funds Transfer (NEFT) is electronic funds transfer system, which
facilitates transfer of funds to other bank accounts in over several bank branches across
the country. This is a simple, secure, safe, fastest and cost-effective way to transfer funds
especially for retail remittances.
174
Notes
175
Notes
176
Notes
Mobile banking: Mobile banking is a term used to refer to systems that allow
customers of a financial institution to conduct a number of financial transactions
through a mobile device such as a mobile phone or tablet.
177
in 1809 and operated as one of the three premier presidency banks (the presidency banks
had the exclusive rights to manage and circulate currency and were provided capital to
establish branch networks). In 1921, the government consolidated the three presidency
banks into the Imperial Bank of India.
Notes
Question:
1. Do you think the SBI is self-sufficient to provide maximum satisfaction to
customers? Discuss.
3.75 Bibliography
1. Kem, H.J. (2005), Global Retail Banking: Changing Paradigms, Chartered
Financial Analyst, ICFAI Press, Hyderabad, Vol. XI, No. 10, pp. 56-58.
2. Neetu Prakash (2006), Retail Banking in India, ICFAI University Press,
Hyderabad, pp. 2-10.
3. Dhanda Pani Alagiri (2006), Retail Banking Challenges, ICFAI University Press,
Hyderabad, pp. 25-34.
4. Manoj Kumar Joshi (2007), Growth Retail Banking in India, ICFAI University
Press, Hyderabad, pp. 13-24.
5. Manoj Kumar Joshi (2007), Customer Services in Retail Banking in India, ICFAI
University Press, Hyderabad, pp. 59-68.
6. S. Santhana Krishnan (2007), Role of Credit Information in Retail Banking: A
Business Catalyst, ICFAI University Press, Hyderabad, pp. 68-74.
7. Sunil Kumar (2008), Retail Banking in India, Hindustan Institute of Management
and Computer Studies, Mathura.
8. Divanna, J.A. (2009), The Future Retail Banking", Palgrave Macmillan, New
York.
9. Birendra Kumar (2009), Performance of Retail Banking in India, Asochem
Financial Pulse (AFP), India.
10. Sapru R.K. (1994), Development Administration, Sterling, New Delhi.
11. United Nations Industrial Development Organization (1998), Manual for
Evaluation of Industrial Projects, Oxford and IBH, New York.
12. T.E. Copeland and J.F. Weston (1988), Financial Theory and Corporate Policy,
Addison-Wesley, West Sussex (ISBN 978-0321223531).
13. E.J. Elton, M.J. Gruber, S.J. Brown and W.N. Goetzmann (2003), Modern
Portfolio Theory and Investment Analysis, John Wiley & Sons, New York (ISBN
978-0470050828).
Amity Directorate of Distance and Online Education
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Notes
14. E.F. Fama (1976), Foundations of Finance, Basic Books Inc., New York (ISBN
978-0465024995).
15. Marc M. Groz (2009), Forbes Guide to the Markets, John Wiley & Sons, Inc.,
New York (ISBN 978-0470463383).
16. R.C. Merton (1992), Continuous Time Finance, Blackwell Publishers Inc. (ISBN
978-0631185086).
17. Keith Pilbeam (2010), Finance and Financial Markets, Palgrave (ISBN 9780230233218).
18. Steven Valdez, An Introduction to Global Financial Markets, Macmillan Press
Ltd. (ISBN 0-333-76447-1).
19. The Business Finance Market: A Survey, Industrial Systems Research
Publications, Manchester (UK), New Edition 2002 (ISBN 978-0-906321-19-5).
179
Notes
Unit 4:
Structure:
4.1 Introduction
4.2 Developmental Banks
4.3 Features of a Developmental Bank
4.4 Role of Developmental Banks in Industrial Financing
4.5 Types of Developmental Banks in India
4.6 Origin of Industrial Developmental Bank of India (IDBI)
4.6.1 The Present Scenario of IDBI
4.6.2 Objectives of Industrial Developmental Bank of India
4.6.3 Functions of Industrial Developmental Bank of India
4.6.4 Services of Industrial Developmental Bank of India
4.7 Origin of State Financial Corporations (SFCs)
4.7.1 Features of State Financial Corporations
4.7.2 Objectives of State Financial Corporations
4.7.3 Financial Resources of the SFCs
4.7.4 Functions of State Financial Corporations
4.7.5 SFCs Contributory to Development of Small-scale Industries in the
Indian Economy
4.8 Origin of State Industrial Developmental Corporations (SIDCs)
4.8.1 Objectives of State Industrial Developmental Corporations
4.8.2 Functions of State Industrial Developmental Corporations
4.9 Origin of Life Insurance Corporation of India (LICI)
4.9.1 Milestones in the Life Insurance Business in India
4.9.2 Milestones in the General Insurance Business in India
4.9.3 Objectives of Life Insurance Corporation of India
4.9.4 Features of Life Insurance Corporation of India
4.9.5 Functions of Life Insurance
4.10 Origin of Export-Import Bank of India (EXIM Bank)
4.10.1 Capital of Export-Import Bank
4.10.2 Objectives of Export-Import Bank of India
4.10.3 Functions of Export-Import Bank of India
4.11 National Bank for Agriculture and Rural Development (NABARD)
4.11.1 Objectives of NABARD
4.11.2 Role and Functions of NABARD
4.12 Resource Mobilization of Developmental Banks
4.13 Project Examination by Developmental Banks
4.14 Summary
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Notes
4.1 Introduction
Developmental Finance Institutions (DFIs) are national and international institutions
that provide loans, grants and other investments for projects and activities around the world.
While banks have traditionally met short-term working capital requirements of industry,
developmental finance institutions (DFIs) have mainly catered to the medium to long-term
financing requirements. Industrial Finance Corporation of India (IFCI) was the first DFI which
was established to extend long-term finance to industry. This was followed by the
establishment of several DFIs, both in public and private sector. DFIs can be classified
as: (i) term lending institutions such as Industrial Investment Bank of India (IIBI) Ltd.,
Export-Import Bank of India (EXIM) and Tourism Finance Corporation of India (TFCI) Ltd.
which provide long-term finance to various sectors; and (ii) refinance institutions such as
National Bank for Agriculture and Rural Development (NABARD), Small Industries
Developmental Bank of India (SIDBI) and National Housing Bank (NHB) which provide
finance to banking as well as non-banking financial intermediaries.
All the DFIs were government-owned; their operations were marked by near absence
of competition up to 1990. Moreover, DFIs were extended funds at concessional rates
in the form of Long-term Operations Fund of the RBI and government guaranteed bonds
on a long-term basis, with their maturity ranging from 10-15 years. Despite this, the
operations of DFIs became less profitable over the years. Thus, in order to impart market
orientation to operations of DFIs, various reform measures such as gradual phase out of
the market borrowing allocations of government guaranteed bonds and discontinuing the
access to low cost funds of RBI were announced in 1990s. Apart from this, prudential
norms pertaining to capital adequacy, income recognition, asset classification and
provisioning were recommended in 1994.
Between the period 1993 to 1998, DFIs took several measures such as offering
innovative products and diversification of activities into new areas of business, viz.,
investment banking, stock broking and custodial services to cope with the increased
competition. However, softening of interest rates and slowdown in industrial activity in the
second half of 1990s had adverse impact on the asset quality of DFIs. With declining
interest rates, high cost of funds raised by DFIs in the past became a cause of concern.
Despite increase in cost of funds, DFIs had to lend at a very competitive rate due to
increased competition from banks which ventured into project financing, in turn, resulting
in decline in spread and profitability of DFIs. Further, in January 2001, the RBI permitted
Amity Directorate of Distance and Online Education
181
reverse merger of ICICI with its commercial bank subsidiary. This was followed by
conversion of IDBI into a banking company on October 1, 2004. The conversion of these
two large DFIs into banking companies led to the decline in share of DFIs in infrastructure
project finance. The earlier mentioned developments led to substantial decline in financial
assistance sanctioned and disbursed by DFIs during initial years of the current decade.
On an average, the financial assistance sanctioned and disbursed by DFIs declined to
` 389.1 billion during FY02-FY07 as compared with ` 836.8 billion during FY96-FY01.
The financial assistance sanctioned by DFIs, however, witnessed an upturn during FY08FY09 owing to increased sanction by investment institutions (especially LIC). During FY09,
the financial assistance sanctioned by DFIs witnessed an increase of 70.2% (y-o-y) while
disbursements witnessed an increase of almost 93.3%.
Notes
The intensification of global financial crisis and consequent liquidity crunch in the
domestic financial system led the RBI to take a slew of measures in order to provide
liquidity support to DFIs. For instance, the RBI provided refinance facility of ` 160 billion
(includes ` 70 billion for SIDBI, ` 50 billion for EXIM Bank and ` 40 billlion for NHB) to
DFIs to facilitate on-lending to Housing Finance Companies (HFCs), NBFCs, mutual funds
and exporters. Under the refinance facility, ` 213.98 billlion were drawn up to June 26,
2009, while total disbursements amounted to ` 153.12 billion (up to June 26, 2009). The
refinance facility had as many as 5,283 beneficiaries including 33 State Finance
Corporation and Banks, 22 NBFCs and 14 HFCs. In addition to this, the ceiling on
aggregate resources mobilized by SIDBI, NHB and EXIM Bank was raised to 12 times
of net owned funds (NOF) for SIDBI and NHB and 13 times of NOF for EXIM Bank. This
led to a 9.1% increase in resource mobilization by DFIs during FY09. Further, the umbrella
limit was raised for EXIM Bank and NHB and select DFIs were allowed to offer market
related yield to maturity.
182
Notes
6. It provides financial assistance not only to the private sector but also to the
public sector undertakings.
7. It aims at promoting the saving and investment habit in the community.
8. It does not compete with the normal channels of finance, i.e., finance already
made available by the banks and other conventional financial institutions. Its
major role is of a gap-filler, i.e., to fill up the deficiencies of the existing financial
facilities.
9. Its motive is to serve public interest rather than to make profits. It works in the
general interest of the nation.
183
Notes
184
Notes
185
Notes
Today, IDBI Bank is counted amongst the leading public sector banks of India, apart
from claiming the distinction of being the 4th largest bank, in overall ratings. It is presently
regarded as the tenth largest developmental bank in the world, mainly in terms of reach.
This is because of its wide network of 509 branches, 900 ATMs and 319 centers. Apart
from being involved in banking services, IDBI has set up institutions like The National Stock
Exchange of India (NSE), The National Securities Depository Services Ltd. (NSDL) and
the Stock Holding Corporation of India (SHCIL).
4.6.2 Objectives of Industrial Development Bank of India
The main objectives of IDBI are to serve as the apex institution for term finance for
industry in India. Its objectives include:
(i) To grant loans to any industrial concern.
(ii) To guarantee deferred payment due from any industrial concern.
(iii) To guarantee loans raised by industrial concerns in the market or from
institutions.
(iv) To provide consultancy and merchant banking services in or outside India.
(v) To provide technical, legal, marketing and administrative assistance to any
industrial concern or person for promotion, management or expansion of any
industry.
(vi) To act as trustee for the holders of debentures or other securities.
4.6.3 Functions of Industrial Development Bank of India
The IDBI has been established to perform the following functions:
(i) Coordination, regulation and supervision of the working of other financial
institutions such as IFCI, ICICI, UTI, LIC, Commercial Banks and SFCs.
(ii) Supplementing the resources of other financial institutions and thereby widening
the scope of their assistance.
(iii) Planning, promotion and development of key industries and diversification of
industrial growth.
(iv) Devising and enforcing a system of industrial growth that conforms to national
priorities.
(v) It grants loans and advances to IFCI, SFCs or any other financial institutions
by way of refinancing of loans granted by such institutions which are repayable
within 25 years.
(vi) It grants loans and advances to scheduled banks or state cooperative banks
by way of refinancing of loans granted by such institutions which are repayable
in 15 years.
(vii) It contributes loans and advances to IFCI, SFCs, other institutions, scheduled
banks and state cooperative banks by way of refinancing of loans granted by
such institution to industrial concerns for exports.
(viii) It underwrites or subscribes to shares or debentures of industrial concerns.
(ix) It subscribes to or purchase stock, shares, bonds and debentures of other
financial institutions.
(x) It grants line of credit or loans and advances to other financial institutions such
as IFCI, SFCs, etc.
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Notes
(xi) It ensures the planning, promoting and developing industries to fill up gaps in
the industrial structure in India.
4.6.4 Services of Industrial Developmental Bank of India
In order to increase its customer base, the Industrial Developmental Bank of India
offers a number of customized and innovative banking services. The services are meant
to offer cent per cent satisfaction to the customers. Some of the well-known services
offered by the bank are:
1. Wholesale Banking Services
Wholesale banking service is the provision of services by banks to the likes of
Mortgage Brokers, large corporate clients, mid-sized companies, real estate developers
and investors, international trade finance businesses, institutional customers (such as
pension funds and government entities/agencies), and services offered to other banks or
other financial institutions. The wholesale banking services form a major part of the banking
services of the bank.
The services that are offered under the wholesale division are:
(i) Cash Management
(ii) Transactional services
(iii) Finance of working capital
(iv) Agro based business transactions
(v) Trade services
The wholesale banking services are an important source of income in a number of
infrastructure projects such as power, transport, telecom, railways, roadways, and
logistics and so on.
2. Retail Banking Services
Retail banking service is banking activity in which banking institutions execute
transactions directly with consumers, rather than corporations or other banks. Services
offered include savings and transactional accounts, mortgages, personal loans, debit
cards, and credit card.
The Industrial Development Bank of India is also a leader in the retail banking
services. The Net Interest Income amounted to around ` 2166 crores while the Net Profit
amounted to around ` 187 crores. The main objective of the retail services is to provide
high quality financial products to the target market to give that one-stop solution to the
banking needs.
The retail products offered by the banks include:
(i) Housing loans
(ii) Personal loans
(iii) Securities loans
(iv) Mortgage loans
(v) Educational loans
(vi) Merchant establishment overdrafts
(vii) Holiday travel loans
(viii) Commercial property loans
187
Notes
The net interest income of this sector amounts to around ` 1283 crores while the
net profit amounts to around ` 44.8 crores. One can get an array of financial products
such as cash management services, deposit, treasury products, trade finance services
and so on.
The three segments in this sector are:
(i) Local Currency Money Market.
(ii) Debt Securities and Equities.
(iii) Foreign Exchange and Derivatives.
4. Other Services of Industrial Development Bank of India
In addition to these, IDBI also offers some allied services and financial solutions to
cater to the target audience. To cater to the capital market, the bank has floated the IDBI
Capital Market Services Limited, also known as IDBI Capital.
The various services offered in this section are:
(i) Corporate advisory services.
(ii) Financial product distribution.
(iii) Pension fund management.
(iv) Corporate and retail services.
(v) Debt management services.
The IDBI Home Finance Limited is also a subsidiary of the Industrial Development
Bank of India. It is used for the purpose of providing long-term loans and other financial
benefits to various companies of the industrial sector.
In addition to these, there is also the IDBI Intech Limited which is a trusted name
in the field of system support and implementation, applications, server hosting, system
integration and other related services. Another subsidiary of the Industrial Development
Bank of India is the IDBI Gilts Limited. The main services of this segment is trading of
bonds, offering insurance, auction underwriting and so on.
188
Notes
189
(v) To provide assistance to new as well as existing industrial concerns for the
purpose of establishment, modernization, renovation, expansion and
diversification.
Notes
190
Notes
performing assets. Over 70% of the total assistance sanctioned and disbursed by all SFCs
is provided to small-scale industries. Attempts are now being made to strengthen the role
of SFCs as regional developmental banks. The SFCs sanctioned seed capital assistance
under the seed capital schemes introduced and operated by IDBI. This assistance is
available to promoters of small business units. Since June 1989, SFCs have also been
implementing special schemes of seed capital assistance to women entrepreneurs.
Assistance is extended in the form of loan or grant or a combination of both to voluntary
agencies working for women in decentralized industries.
191
(vi) To establish and maintain at the Registered Office a commercial and technical
library and information centre for use of member corporations.
Notes
192
Notes
193
(c) To acquire, hold and dispose of any property for the purpose of its business;
Notes
(d) To transfer the whole or any part of the life insurance business carried on outside
India to any other person or persons, if in the interest of the Corporation it is
expedient to do so;
(e) To advance or lend money upon the security of any movable or immovable
property or otherwise;
(f) To borrow or raise any money in such manner and upon such security as the
Corporation may think fit.
(g) To carry on either by itself or through any subsidiary any other business in any
case where such other business was being carried on by a subsidiary of an
insurer whose controlled business has been transferred to and vested in the
Corporation by this act;
(h) To carry on any other business which may seem to the Corporation to be
capable of being conveniently carried on in connection with its business and
calculated directly or indirectly to render profitable the business of the
Corporation; and
(i) To do all such things as may be incidental or conducive to the proper exercise
of any of the powers of the Corporation.
4.9.4 Features of Life Insurance Corporation of India
The main features of LIC are given below:
1. Saving Institution
Life insurance both promotes and mobilizes saving in the country. The income tax
concession provides further incentive to higher income persons to save through LIC
policies. The total volume of insurance business has also been growing with the spread
of insurance-consciousness in the country. The total new business of LIC during 199596 was ` 51815 crore sum assured under 10.20 lakh policies. The LIC business can grow
at still faster speed if the following improvements are made:
(i) The organizational and operational efficiency of the LIC should be increased.
(ii) New types of insurance covers should be introduced.
(iii) The services of LIC should be extended to smaller places.
(iv) The message of life insurance should be made more popular.
(v) The general price level should be kept stable so that the insuring public does
not get cheated of a large amount of the real value of its long-term saving through
inflation.
2. Term Financing Institution
LIC also functions as a large term financing institution (or a capital market) in the
country. The annual net accrual of investible funds from life insurance business (after
making all kinds of payments liabilities to the policyholders) and net income from its vast
investment are quite large. During 1994-95, LICs total income was ` 18,102.92 crore,
consisting of premium income of ` 1152,80 crore investment income of ` 6336.19 crore,
and miscellaneous income of ` 238.33 crore.
3. Investment Institution
LIC is a big investor of funds in government securities. Under the law, LIC is required
to invest at least 50% of its accruals in the form of premium income in government and
other approved securities. LIC funds are also made available directly to the private sector
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Notes
through investment in shares, debentures, and loans. LIC also plays a significant role in
developing the business of underwriting of new issues.
4. Stabilizer in Share Market
LIC acts as a downward stabilizer in the share market. The continuous inflow of new
funds enables LIC to buy shares when the market is weak. However, the LIC does not
usually sell shares when the market is overshot. This is partly due to the continuous
pressure for investing new funds and partly due to the disincentive of the capital gains
tax.
4.9.5 Functions of Life Insurance
The various functions of a Life Insurance Corporation are given below:
(a) Life Insurance Corporation carries on capital redemption business, annuity
certain business or reinsurance business insofar as such reinsurance business
relating to life insurance business;
(b) It invests the funds of the Corporation in such manner as the Corporation may
think fit and to take all such steps as may be necessary or expedient for the
protection or realization of any investment; including the taking over of and
administering any property offered as security for the investment until a suitable
opportunity arises for its disposal;
(c) It acquires, holds and disposes of any property for the purpose of its business;
(d) It transfers the whole or any part of the life insurance business carried on outside
India to any other person or persons, if in the interest of the Corporation it
is expedient so to do;
(e) It advances or lends money upon the security of any movable or immovable
property or otherwise;
(f) It borrows or raises any money in such manner and upon such security as the
Corporation may think fit;
(g) It carries on either by itself or through any subsidiary any other business in
any case where such other business was being carried on by a subsidiary of
an insurer whose controlled business has been transferred to and vested in the
Corporation by this act;
(h) It carries on any other business which may seem to the corporation to be
capable of being conveniently carried on in connection with its business and
calculated directly or indirectly to render profitable the business of the
Corporation.
195
by way of term loans in Indian rupees or foreign currencies for setting up new production
facility, expansion/modernization or upgradation of existing facilities and for acquisition
of production equipment or technology. EXIM Bank helps Indian companies in their
globalization efforts through a wide range of products and services offered at all stages
of the business cycle, starting from import of technology and export product development
to export production, export marketing, pre-shipment and post-shipment and overseas
investment.
Notes
The Bank has introduced a new lending programme to finance research and
development activities of export-oriented companies. R&D financed by Exim Bank is in
the form of term loan to the extent of 80% of the R&D cost. In order to assist in the creation
and enhancement of export capabilities and international competitiveness of Indian
companies, the Bank has put in place an Export Marketing Services (EMS) Programme.
Through EMS, the Bank pro-actively assists companies in identification of prospective
business partners to facilitating placement of final orders. Under EMS, the Bank also
assists in identification of opportunities for setting up plants or projects or for acquisition
of companies overseas. The service is provided on a success fee basis.
EXIM Bank supplements its financing programmes with a wide range of value-added
information, advisory and support services, which enable exporters to evaluate international
risks, exploit export opportunities and improve competitiveness, thereby helping them in
their globalization efforts.
4.10.1 Capital of Export-Import Bank
The authorized capital of the EXIM Bank is ` 200 crore and paid-up capital is ` 100
crore, wholly subscribed by the Central Government. The bank can raise additional
resources through:
(i) Loans/grants from Central Government and Reserve Bank of India;
(ii) Lines of credit from institutions abroad;
(iii) Funds rose from Euro Currency markets;
(iv) Bonds issued in India.
4.10.2 Objectives of Export-Import Bank of India
The various objectives of Export-Import Bank of India are:
(i) To translate national foreign trade policies into concrete action plans.
(ii) To provide alternate financing solutions to the Indian exporter, aiding him in his
efforts to be internationally competitive.
(iii) To develop mutually beneficial relationships with the international financial
community.
(iv) To initiate and participate in debates on issues central to Indias international
trade.
(v) To forge close working relationships with other export development and financing
agencies, multilateral funding agencies and national trade and investment
promotion agencies.
(vi) To anticipate and absorb new developments in banking, export financing and
information technology.
(vii) To be responsive to export problems of Indian exporters and pursue policy
resolutions.
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Notes
197
(d) It coordinates the rural financing activities of all the institutions engaged in
developmental work at the field level and maintains liaison with Government of
India, State Governments, Reserve Bank of India and other national level
institutions concerned with policy formulation.
Notes
(e) It prepares, on an annual basis, rural credit plans for all districts in the country.
(f) It undertakes monitoring and evaluation of projects refinanced by it.
(g) It promotes research in the fields of rural banking, agriculture and rural
development.
Loans for Specific Projects are designed to finance one or more specific projects
or subprojects that are wholly defined at the time the Banks loan is approved.
Loans for Multiple Works Programmes are designed to finance groups of similar
works which are physically independent of each other and whose feasibility does
not depend on the execution of any given number of the works projects.
Sector Adjustment Loans provide flexible support for institutional and policy
changes on the sector or sub-sector level, through fast-disbursing funds. At the
request of the borrower, a sector adjustment loan may include an investment
component, in which case it becomes a Hybrid Loan.
Time Slice Operations are investment loans in which the investment programme
for a sector or sub-sector is adjusted from time to time within the general criteria
and global objectives agreed upon with the Bank for a project.
198
Notes
2. Technical Cooperation
The Bank finances technical cooperation activities to transfer technical know-how
and expertise for the purpose of supplementing and strengthening the technical capacity
of entities in the developing member countries. The financing is determined largely on the
basis of the field of activity into which a project falls and the relative development status
of the region, country, or countries involved. It may take one of the following forms:
z
Parallel Credit from Other Public Financial Institutions, in which the Bank
coordinates its activities with national and international public financial
institutions with an interest in offering financing for projects or programmes in
the regional developing member countries. To facilitate COFINANCING for such
projects, the Bank is prepared to perform studies and undertake missions in
conjunction with other organizations for project identification and evaluation and
to enter into agreements with those organizations to administer financing
granted by them on their behalf.
Other Parallel Credits, in which at the request of borrowers, the Bank cooperates
with them in obtaining parallel loans from banks or institutional investors of other
countries.
199
4. Banks Guarantees
Notes
According to the Agreement establishing the Bank, and to promote the investment
in the borrowing countries, the Bank can guarantee loans made by private financial sources
to public and private sectors.
The Bank can provide guarantees with or without counter-guarantees of the borrowing
countrys government. Guarantees to private sector lenders without government counterguarantee of the borrowing country, in whose territory the project is to be carried out,
will not exceed 25% of the total cost of the project or $75 million, whichever is less.
The guarantees could be used for any kind of investment project, although the initial
emphasis in guarantee operations will be on infrastructure projects.
Other Financing
z
Export Financing, in which the Bank grants national agencies in the borrowing
countries a revolving line of credit to finance intra-regional exports of
nontraditional goods.
The Bank may carry out other forms of financing with Funds under Administration
that it manages on behalf of third parties, in accordance with the terms of the
contracts they have signed for the administration of said funds, for example,
loans for the purchase of shares and direct equity investments.
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Notes
4.14 Summary
Development Finance Institutions (DFIs) are national and international institutions
that provide loans, grants and other investments for projects and activities around the world.
While banks have traditionally met short-term working capital requirements of industry,
development finance institutions (DFIs) have mainly catered to the medium- to long-term
financing requirements. Industrial Finance Corporation of India (IFCI) was the first DFI which
was established to extend long-term finance to industry.
Developmental Bank is a financial institution dedicated to fund new and upcoming
businesses and economic development projects by equity capital or loan capital.
Developmental banks are those financial institutions engaged in the promotion and
development of industry, agriculture and other key sectors.
Developmental bank is essentially a multi-purpose financial institution with a broad
development outlook. A developmental bank may, thus, be defined as a financial institution
concerned with providing all types of financial assistance (medium as well as long term)
to business units, in the form of loans, underwriting, investment and guarantee operations,
and promotional activities economic development in general, and industrial development,
in particular.
Developmental banks play an important role in the promotion and development of
the small-scale sector. Government of India (GOI) started Small industries Developmental
Bank of India (SIDBI) to provide medium- and long-term loans to Small-scale Industries
(SSI) units. SIDBI provides direct project finance, and equipment finance to SSI units.
It also refinances banks and financial institutions that provide seed capital, equipment
finance, etc. to SSI units.
Developmental banks provide finance for the development of the housing sector. GOI
started the National Housing Bank (NHB) in 1988.
Developmental banks promote and develop large-scale industries (LSI). Development
financial institutions like IDBI, IFCI, etc. provide medium- and long-term finance to the
corporate sector. They provide merchant banking services, such as preparing project
reports, doing feasibility studies, advising on location of a project, and so on.
Developmental banks like National Bank for Agriculture and Rural Development
(NABARD) helps in the development of agriculture. NABARD started in 1982 to provide
refinance to banks, which provide credit to the agriculture sector and also for rural
development activities. It coordinates the working of all financial institutions that provide
credit to agriculture and rural development. It also provides training to agricultural banks
and helps to conduct agricultural research.
Developmental banks help to promote foreign trade. Government of India started
Export-Import Bank of India (EXIM Bank) in 1982 to provide medium- and long-term loans
to exporters and importers from India. It provides Overseas Buyers Credit to buy Indian
capital goods. It also encourages abroad banks to provide finance to the buyers in their
country to buy capital goods from India.
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IIBI is the main credit and reconstruction institution for revival of sick units. It facilitates
modernization, restructuring and diversification of sick units by providing credit and other
services.
Developmental banks facilitate rural and regional development. They provide finance
for starting companies in backward areas. They also help the companies in project
management in such less developed areas.
Developmental banks contribute the growth of capital markets. They invest in equity
shares and debentures of various companies listed in India. They also invest in mutual
funds and facilitate the growth of capital markets in India.
State authorized ea6ch state of the Indian Union to establish an SFC. Punjab
Government took the lead in organizing financial corporation and set up State Financial
Corporation in 1953. Gradually, financial corporations were established in different states.
By now, there are 18 SFCs functioning in different states in India. Of these, 17 were set
up under the SFCs Act, 1951. Tamil Nadu Industrial Investment Corporation Ltd. was
established in 1949 under the Companies Act as Madras Industrial Investment Corporation
Ltd. also functions as SFC.
The State Industrial Development Corporations act as catalyst for the promotion and
development of medium and large enterprises in their respective states. In tune with the
changing business environment and the challenges emanating from it, SIDCs are making
efforts to diversify their activities to cover a range of fee-based activities besides widening
the scope of fund-based activities.
The nationalization of insurance business in the country resulted in the establishment
of Life Insurance Corporation of India (LIC) in 1956 as a wholly owned corporation of the
Government of India. The broad objectives of LIC are to serve people through financial
security by providing products and services of aspired attributes with competitive returns,
and by rendering resources for economic development. With a view to spreading life
insurance across the country, particularly, in the rural areas and to the socially and
economically backward classes, LIC currently offers over 50 plans to cover life at various
stages through a network of 2048 branches, all of which are fully computerized. LIC has
installed information kiosks at select locations for dissemination of information on its
products as also for accepting premium payments. It has also installed Interactive Voice
Response Systems in 59 urban centers, enabling its customers to get select information
about their policies.
Export-Import Bank of India was set up in 1982 by an Act of Parliament for the
purpose of financing, facilitating and promoting Indias foreign trade. It is the principal
financial institution in the country for coordinating the working of institutions engaged in
financing exports and imports. EXIM Bank is fully owned by the Government of India and
the Banks authorized and paid up capital are ` 10,000 crore and ` 2,300 crore respectively.
NABARD has been established as an apex developmental bank with a mandate for
facilitating credit flow for the promotion and development of agriculture, small-scale
industries, cottage and village industries, handicrafts and other rural crafts. It is also
mandatory for NABARD to support all other allied economic activities in rural areas,
promote integrated and sustainable rural development and secure prosperity of the rural
areas.
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Notes
203
Notes
204
Notes
205
4.21 Bibliography
Notes
206
Notes
Unit 5:
Insurance Institutions
Structure:
5.1 Introduction
5.2 Meaning of Insurance
5.3 Definition of Insurance
5.4 Historical Background of Insurance
5.5 Historical Background of Insurance in India
5.6 Types of Insurance
5.6.1 Life Insurance
5.6.2 General Insurance
5.7 Role of Insurance Companies
5.8 Role of Insurance Companies in Industrial Financing
5.9 Principles of Insurance
5.10 Life Insurance
5.11 Meaning of Life Insurance
5.12 Purposes of Life Insurance
5.13 The Importance of Life Insurance
5.14 Life Insurance Products and Policies
5.15 General Insurance
5.16 Meaning of General Insurance
5.17 Objectives for Practicing of General Insurance
5.18 Principles of General Insurance
5.19 Features of General Insurance
5.20 Functions of General Insurance
5.21 General Insurance Corporation of India (GICI)
5.22 The General Insurance Business (Nationalization) Amendment Act, 2002 Act
No. 40 of 2002
5.23 Insurance Sector Reforms in India
5.24 Major Policy Changes under IRDA Act
5.25 Insurance Companies in India
5.26 Protection of the Interest of Policyholders
5.27 New Developments in Insurance as a Sector in the Indian Financial System
5.28 Bancassurance
5.29 Various Models for Bancassurance
5.30 Status of Bancassurance in India
5.31 Bancassurance Models in Europe
5.32 Bancassurance Models in India
5.33 The Major Need for Bancassurance in India
Amity Directorate of Distance and Online Education
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Notes
5.1 Introduction
Insurance is a contract between two parties whereby one party agrees to undertake
the risk of another in exchange for consideration known as premium and promises to pay
a fixed sum of money to the other party on happening of an uncertain event (death) or
after the expiry of a certain period in case of life insurance or to indemnify the other party
on happening of an uncertain event in case of general insurance.
Insurance provides financial protection against a loss arising out of happening of an
uncertain event. A person can avail this protection by paying premium to an insurance
company. A pool is created through contributions made by persons seeking to protect
themselves from common risk. Premium is collected by insurance companies which also
act as trustee to the pool. Any loss to the insured in case of happening of an uncertain
event is paid out of this pool.
Insurance works on the basic principle of risk-sharing. A great advantage of insurance
is that it spreads the risk of a few people over a large group of people exposed to risk
of similar type. Insurance is the equitable transfer of the risk of a loss, from one entity
to another in exchange for payment. It is a form of risk management primarily used to
hedge against the risk of a contingent, uncertain loss.
An insurer, or insurance carrier, is a company selling the insurance; the insured,
or policyholder, is the person or entity buying the insurance policy. The amount of money
to be charged for a certain amount of insurance coverage is called the premium. Risk
management, the practice of appraising and controlling risk, has evolved as a discrete
field of study and practice.
The concept behind insurance is that a group of people exposed to similar risk come
together and make contributions towards formation of a pool of funds. In case a person
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Notes
actually suffers a loss on account of such risk, he is compensated out of the same pool
of funds. Contribution to the pool is made by a group of people sharing common risks
and collected by the insurance companies in the form of premiums.
Insurance may be described as a social device to reduce or eliminate risk of life
and property. Under the plan of insurance, a large number of people associate themselves
by sharing risk, attached to individual. The risk, which can be insured against include
fire, the peril of sea, death, incident and burglary. Any risk contingent upon these may
be insured against at a premium commensurate with the risk involved.
Insurance is actually a contract between two parties whereby one party called insurer
undertakes in exchange for a fixed sum called premium to pay the other party on happening
of a certain event. Insurance is a contract whereby, in return for the payment of premium
by the insured, the insurer pays the financial losses suffered by the insured as a result
of the occurrence of unforeseen events. With the help of Insurance, large number of people
exposed to similar risks makes contributions to a common fund out of which the losses
suffered by the unfortunate few, due to accidental events, are made good. An insurer is
a company selling the insurance; an insured or policyholder is the person or entity buying
the insurance. The insurance rate is a factor used to determine the amount to be charged
for a certain amount of insurance coverage, called the premium.
Insurance Institutions
209
a gift was worth more than 10,000 Derrik (Achaemenian gold coin) the issue was registered
in a special office. This was advantageous to those who presented such special gifts.
For others, the presents were fairly assessed by the confidants of the court. Then the
assessment was registered in special offices.
Notes
A thousand years later, the inhabitants of Rhodes (an island in Greece) created the
general average, which allowed groups of merchants to pay to insure their goods being
shipped together. The collected premiums would be used to reimburse any merchant
whose goods were jettisoned during transport, whether to storm or sinkage. The ancient
Athenian maritime loan advanced money for voyages with repayment being cancelled
if the ship was lost. In the 4th century BC, rates for the loans differed according to safe
or dangerous times of year, implying an intuitive pricing of risk with an effect similar to
insurance.
The Greeks and Romans introduced the origins of health and life insurance c. 600
BCE when they created guilds called benevolent societies which cared for the families
of deceased members, as well as paying funeral expenses of members. Guilds in the
Middle Ages served a similar purpose. The Talmud deals with several aspects of insuring
goods. Before insurance was established in the late 17th century, friendly societies
existed in England, in which people donated amounts of money to a general sum that
could be used for emergencies.
Separate insurance contracts (i.e., insurance policies not bundled with loans or other
kinds of contracts) were invented in Genoa (a city and important seaport in northern Italy)
in the 14th century, as were insurance pools backed by pledges of landed estates. The
first known insurance contract dates from Genoa in 1343, and in the next century maritime
insurance developed widely and premiums were intuitively varied with risks. These new
insurance contracts allowed insurance to be separated from investment, a separation of
roles that first proved useful in marine insurance. The first printed book on insurance was
the legal treatise on Insurance and Merchants Bets by Pedro de Santarm (Santerna),
written in 1488 and published in 1552. Insurance as we know it today can be traced to
the Great Fire of London, which in 1666 devoured 13,200 houses. In the aftermath of this
disaster, Nicholas Barbon opened an office to insure buildings. In 1680, he established
Englands first fire insurance company, The Fire Office, to insure brick and frame homes.
The concept of health insurance was proposed in 1694 by Hugh the Elder Chamberlen
from the Peter Chamberlen family. In the late 19th century, accident insurance began
to be available, which operated much like modern disability insurance. This payment model
continued until the start of the 20th century in some jurisdictions (like California), where
all laws regulating health insurance actually referred to disability insurance.
The first insurance company in the United States underwrote fire insurance and was
formed in Charles Town (modern-day Charleston), South Carolina in 1732, but it provided
only fire insurance.
The sale of life insurance in the US began in the late 1760s. The Presbyterian Synods
in Philadelphia and New York founded the Corporation for Relief of Poor and Distressed
Widows and Children of Presbyterian Ministers in 1759; Episcopalian priests created a
comparable relief fund in 1769. Between 1787 and 1837, more than two dozen life insurance
companies were started, but fewer than half a dozen survived.
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Notes
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This millennium has seen insurance come a full circle in a journey extending to nearly
200 years. The process of reopening of the sector had begun in the early 1990s and the
last decade and more has seen it been opened up substantially. In 1993, the Government
set up a committee under the chairmanship of R.N. Malhotra, former Governor of RBI,
to propose recommendations for reforms in the insurance sector. The objective was to
complement the reforms initiated in the financial sector. The committee submitted its report
in 1994 wherein, among other things, it recommended that the private sector be permitted
to enter the insurance industry. They stated that foreign companies are allowed to enter
by floating Indian companies, preferably a joint venture with Indian partners.
Notes
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Notes
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Notes
Term insurance can help protect your beneficiaries against financial loss resulting
from your death; it pays the face amount of the policy, but only provides protection for
a definite, but limited, amount of time. Term policies do not build cash values and the
maximum term period is usually 30 years. Term policies are useful when there is a limited
time needed for protection and when the dollars available for coverage are limited. The
premiums for these types of policies are significantly lower than the costs for whole life.
They also (initially) provide more insurance protection per dollar spent than any form of
permanent policies. Unfortunately, the cost of premiums increases as the policy owner
gets older and as the end of the specified term nears.
5.6.2 General Insurance
General insurance or non-life insurance policies, including automobile and
homeowners policies, provide payments depending on the loss from a particular financial
event. General insurance typically comprises any insurance that is not determined to be
life insurance.
Types of General Insurance
(i) Motor Insurance Plans
A standard motor insurance or better known as a car insurance policy is usually
the insurance coverage mandated by law to drive on the road. Thus, it primarily covers
you against liability damages and unexpected repairs. These liability damages can be
of two types. First is when a bodily injury has been caused to a third person. Second
is where the property of a third person and own car.
(ii) Health Insurance
Health is insurance against the risk of incurring medical expenses among individuals.
By estimating the overall risk of health care and health system expenses among a targeted
group, an insurer can develop a routine finance structure, such as a monthly premium
or payroll tax, to ensure that money is available to pay for the health care benefits specified
in the insurance agreement. The benefit is administered by a central organization such
as a government agency, private business, or not-for-profit entity.
(iii) Marine Insurance
Marine Insurance and marine cargo insurance cover the loss or damage of vessels
at sea or on inland waterways, and of cargo in transit, regardless of the method of transit.
When the owner of the cargo and the carrier are separate corporations, marine cargo
insurance typically compensates the owner of cargo for losses sustained from fire,
shipwreck, etc., but excludes losses that can be recovered from the carrier or the carriers
insurance. Many marine insurance underwriters will include time element coverage in
such policies, which extends the indemnity to cover loss of profit and other business
expenses attributable to the delay caused by a covered loss.
(iv) Travel Insurance
Travel insurance is insurance that is intended to cover medical expenses, financial
default of travel suppliers, and other losses incurred while travelling, either within ones
own country, or internationally. Temporary travel insurance can usually be arranged at
the time of the booking of a trip to cover exactly the duration of that trip, or a multitrip policy can cover an unlimited number of trips within a set time frame.
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Notes
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215
Because crime insurance loss exposures can vary significantly among policyholders
and require special underwriting skills, insurers prefer to insure certain types of crime
insurance loss under separate Commercial Crime Insurance forms. These forms allow
organizations to cover crime losses that are not insured under other insurance policies.
Notes
Briefly described, commercial crime insurance covers money, securities and other
property against a variety of criminal acts, such as employee theft, robbery, forgery,
extortion and computer fraud. Many insurers use Insurance Service Offices (ISOs)
commercial crime forms.
Deductible: The amount that the insured must pay before the insurer will pay
anything.
Co-pay: An expense that the insured pays when sharing the cost with the
insurer.
Claim: The act of reporting an insurable incident to request that the insurer
pay for coverage.
Benefits: The money the insured receives from the insurance company when
something goes wrong.
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Notes
The IAIS has presented its position on key financial stability issues in insurance,
initially in November 2009 and more recently in June, as described in this article. As part
of the analysis, the basic insurance business model is described. Following this, the
potential for systemic risk to emerge in the insurance sector is discussed. Then the
applicability to insurance of recognized systemic characteristics and insurance resolution
is considered, followed by some proposals by the IAIS for insurance supervisory
enhancements.
Insurance Business Model
Traditionally, the primary purpose of insurance is to indemnify policyholders (both
individuals and corporations) from claims associated with adverse events (e.g., property
damage, premature death, liability claims, etc.) and to provide stable long-term savings,
including during the future lifetimes of retirees and other policyholders. Diversification of
risk is the main tool used in the insurance process; diversification takes place by pooling
policyholders risks, by insuring a wide variety of policyholder pools, by underwriting in
different geographic areas and by diversifying across different types of risks (such as
underwriting and investment risk).
To the extent that risk remains after diversification, further mitigation techniques are
used by insurers, including reinsurance, hedging, insurance linked securities and the use
of certain life insurance products (whereby policyholders take most or all investment risk,
often via separate accounts). Generally, insurers incorporate strong risk management
practices, including asset-liability management, to mitigate asset and liability mismatches.
In addition, supervisory processes and regulatory requirements (such as capital and claim
provisioning requirements) help to maintain solvency in the industry. In many parts of the
world, there is a strong involvement by the actuarial profession in insurance risk
management, with statutory requirements in some jurisdictions for insurers to obtain
appropriate actuarial advice and reports.
In spite of such strong risk management practices, insurers sometimes become
financially distressed and, in a competitive market, financial distress and insolvencies may
occur from time to time. The financial distress of an insurer usually plays out over a long
time horizon. That is, assets of the insurer do not need to be liquidated until claims or
benefits under the policies need to be paid, and this will not occur until months or even
years in the future. Accordingly, regulators usually have the time to intervene to reduce
potential losses to policyholders from the insolvency, although this will not always be the
case.
Insurers and banks share some common characteristics and risks because they are
both financial intermediaries (for example, financial guarantee insurance bears some
similarity to banking type products); however, the roles of banks and insurers in the
economy differ substantially. That is, banks are part of the payment and settlement system
and are involved in the transmission of monetary policy, while insurers are not. Banks
tend to rely to a larger extent on short-term borrowed money, and hence are exposed
to liquidity risk; on the other hand, insurers receive premium payments in advance of claims
so that liquidity risk is not usually an issue but can be so if large borrowings have been
utilized to finance acquisitions or rapid organic growth.
Systemic Relevance and Systemic Risk
The insurance sector is susceptible to systemic risks generated in other parts of
the financial sector. For most classes of insurance, however, there is little evidence of
insurance either generating or amplifying systemic risk, within the financial system itself
Insurance Institutions
217
or in the real economy. This is because of the fundamentally different role of insurers in
the economy as compared to banks. It is also important to note the stabilization role that
the insurance sector typically plays in the economy may help to limit systemic risk. This
stabilization role was an important factor during the financial crisis, as the majority of
insurers were able to withstand the fluctuations in capital markets, without having to resort
to fire-sales of assets or similar drastic actions.
Notes
The G20, International Monetary Fund (IMF), Financial Stability Board (FSB) and
Bank for International Settlements (BIS) reports have focused on three characteristics of
systemically important financial institutions: size, interconnectedness and substitutability.
These characteristics warrant careful inspection from an insurance perspective.
By itself, size is not a particularly good measure for assessing the potential for
systemic risk in insurance. In fact, size has a beneficial effect for most insurers by allowing
for greater diversification of risk (via the law of large numbers). Also, because premiums
are funded in advance of claims, insurers typically are required by operation of the business
model and regulatory requirements to have a large amount of assets on hand relative to
liabilities in comparison to banks, which can be critical in the event of insolvency.
Reinsurance activities help redistribute risks among insurers; but also contribute to
interconnectedness within the insurance sector. Hypothetically, failure of a large reinsurer
and/or a reinsurance spiral could conceivably have a significant impact on capacity among
primary insurers and cause disruption to the real economy (although neither such
occurrence has occurred to date). IAIS monitors these potential risks with its Global
Reinsurance Market Report, which has shown that reinsurance risk exposures have so
far been well managed and diversified.
Insurers are interconnected with financial and non-financial firms, including through
equity shareholdings, corporate debt holdings, other investments, treasury operations and
securities lending. However, whether these interconnections are of systemic importance
would depend on how much the total exposure of insurers investments account for in
the overall economy. Further, as already indicated, immediate liquidation of an insurers
investments does not occur when an insurer becomes insolvent. Hence, a fire-sale of large
blocks of investments which might depress asset prices does not typically occur in the
insolvency of an insurer.
Lack of substitutability in the insurance sector may lead to market disruptions,
especially when insurance coverage is necessary to conduct business. For example, a
market disruption can occur when compulsory or widely used insurance products become
unavailable. This occurred in Australia following the failure of the countrys second largest
insurer, HIH, in 2001; and to some extent after the World Trade Centre attacks in 2001.
Also, insurance against catastrophes can become unavailable or extremely costly after
a catastrophic event. There is also a possibility that a market failure will occur where
insurance capacity disappears in a particular segment of the insurance market, such that
parts of the real economy are disrupted and government intervention is required. Market
disruptions or failures of this nature are typically relatively short term, as new insurers
and/or reinsurers can usually move into the affected region to create capacity for the
product(s) in question, although this is not always the case. An effective regime of
regulation and supervision can help mitigate this possibility.
An important part of the IAIS analysis has been exploring ways in which insurers
may amplify systemic risk under certain circumstances. For example, the participation
of life insurers in capital markets can contribute to selling pressure, if the insurers
collectively hold significant positions in equities, bonds or hedging instruments and need
to liquidate their positions simultaneously in a falling market.
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Notes
Of course, as conditions change in the future, in theory, the possibility exists that
insurers may become systemically important. Some cases where insurers might generate
systemic risk include: (1) widespread distribution of financial products that contain a
minimum guarantee and/or distribution of other types of banking-like products;
(2) widespread (naked) derivatives trading, especially extensive distribution of credit default
swaps (CDSs); (3) expansive offering of financial guarantee insurance; and (4) insurers
using regulatory arbitrage to offer products or services that end up being systemically
important.
Indeed, the nature of the insurance industry has already been changing. Some parts
of the industry have been growing in complexity, diversity and global reach. Financial
innovation and the rapidly changing financial environment have contributed to the formation
of some insurance entities and groups spanning jurisdictional borders and/or sectors. In
light of continuing financial instability since 2007, there has been an increased focus, by
many parties, on issues of financial stability and the risks associated with large and
complex financial organizations operating on a cross-border and/or cross-sector basis.
This is a major concern of the FSB and G20 discussions and will be one of the key issues
considered by G20 Leaders during their summit in Seoul in November.
Of particular concern has been the potential risks emerging from non-regulated
entities of financial conglomerates (as in the case of AIG) and some insurance activities
(such as financial guarantee insurance) which can generate or amplify systemic risk and
may be instrumental to contagion within conglomerates or between sectors. Further,
contagion effects might also occur if a member of a group exhibits financial distress.
Resolvability
The ease with which an insolvent insurer can be resolved depends on many factors,
including the role of insurance guarantee schemes, where they exist. For insurers (unlike
banks), there can be life after death. That is, failed insurers often can be managed through
orderly run-off, and sometimes even brought back to life with new capital.
All insurers are regulated at the solo entity (company) level. However, there is
widespread recognition that the resolvability of internationally operating financial entities,
groups, or conglomerates poses significant legal challenges. Enhanced supervisory
oversight for such entities is underway and cooperation with other sectors will be required.
Again, this is another major concern of the FSB and G20 discussions and will be
considered by G20 Leaders in November, when they focus on how to better control
systemically important financial institutions.
Proposed Supervisory Enhancements
The IAIS agrees that it is necessary for insurers and insurance groups to be
supervised on a solo entity basis and on a group-wide basis. Group supervision should
include consideration of non-regulated entities and/or non-operating holding companies
within a group. Other supervisory enhancements are under consideration and/or
development (particularly in cooperation with the Joint Forum) to reduce the potential for
regulatory arbitrage. These enhancements should reduce the probability and potential
impact of future insolvencies and insurance market failures. The enhancements should
increase the role of insurers as stabilizers and decrease their potential susceptibility to
systemic risk or their roles as potential transmitters or amplifiers of systemic risk. The
enhanced insurance supervisory framework should contribute to financial stability and
should also improve micro-prudential supervision and policyholder protection.
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Since interdependencies between the sectors may increase in the future through
products, markets and conglomerates, the IAIS is promoting enhancements to supervision
and supervisory processes, combined with stronger risk management and enhanced
approaches to resolvability to minimize adverse externalities. These enhancements include
group-wide supervision and the development of a Common Framework for the Supervision
of Internationally Active Insurance Groups (ComFrame). The IAIS is also promoting crosssectoral macro-prudential monitoring of potential build-up of systemic risk and planning
to develop measures for national authorities to assess degrees of systemic risk.
Notes
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Notes
3. Principle of Indemnity
Indemnity means security, protection and compensation given against damage, loss
or injury. According to the principle of indemnity, an insurance contract is signed only
for getting protection against unpredicted financial losses arising due to future
uncertainties. Insurance contract is not made for making profit, else its sole purpose is
to give compensation in case of any damage or loss. In an insurance contract, the amount
of compensations paid is in proportion to the incurred losses. The amount of
compensations is limited to the amount assured or the actual losses, whichever is less.
The compensation must not be less or more than the actual damage. Compensation is
not paid if the specified loss does not happen due to a particular reason during a specific
time period. Thus, insurance is only for giving protection against losses and not for making
profit. However, in case of life insurance, the principle of indemnity does not apply because
the value of human life cannot be measured in terms of money.
4. Principle of Contribution
Principle of Contribution is a corollary of the principle of indemnity. It applies to all
contracts of indemnity, if the insured has taken out more than one policy on the same
subject matter. According to this principle, the insured can claim the compensation only
to the extent of actual loss either from all insurers or from any one insurer. If one insurer
pays full compensation, then that insurer can claim proportionate claim from the other
insurers.
For example: Mr. John insures his property worth ` 100,000 with two insurers AIG
Ltd. for ` 90,000 and MetLife Ltd. for ` 60,000. Johns actual property destroyed is
worth ` 60,000, then Mr. John can claim the full loss of ` 60,000 either from AIG Ltd.
or MetLife Ltd., or he can claim ` 36,000 from AIG Ltd. and ` 24,000 from MetLife Ltd.
So, if the insured claims full amount of compensation from one insurer, then he cannot
claim the same compensation from other insurer and make a profit. Secondly, if one
insurance company pays the full compensation, then it can recover the proportionate
contribution from the other insurance company.
5. Principle of Subrogation
Subrogation means substituting one creditor for another. Principle of Subrogation is
an extension and another corollary of the principle of indemnity. It also applies to all
contracts of indemnity. According to the principle of subrogation, when the insured is
compensated for the losses due to damage to his insured property, then the ownership
right of such property shifts to the insurer.
This principle is applicable only when the damaged property has any value after the
event causing the damage. The insurer can benefit out of subrogation rights only to the
extent of the amount he has paid to the insured as compensation.
For example: Mr. John insures his house for ` 1 million. The house is totally destroyed
by the negligence of his neighbour Mr. Tom. The insurance company shall settle the claim
of Mr. John for ` 1 million. At the same time, it can file a law suit against Mr. Tom for
` 1.2 million, the market value of the house. If insurance company wins the case and
collects ` 1.2 million from Mr. Tom, then the insurance company will retain ` 1 million
(which it has already paid to Mr. John) plus other expenses such as court fees. The balance
amount, if any will be given to Mr. John, the insured.
6. Principle of Loss Minimization
According to the Principle of Loss Minimization, insured must always try his level
best to minimize the loss of his insured property, in case of uncertain events like a fire
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221
outbreak or blast, etc. The insured must take all possible measures and necessary steps
to control and reduce the losses in such a scenario. The insured must not neglect and
behave irresponsibly during such events just because the property is insured. Hence, it
is a responsibility of the insured to protect his insured property and avoid further losses.
Notes
For example: Assume, Mr. Johns house is set on fire due to an electric short-circuit.
In this tragic scenario, Mr. John must try his level best to stop fire by all possible means,
like first calling nearest fire department office, asking neighbors for emergency fire
extinguishers, etc. He must not remain inactive and watch his house burning hoping, Why
should I worry? Ive insured my house.
7. Principle of Causa Proxima (Nearest Cause)
Principle of Causa Proxima (a Latin phrase), or in simple English words, the Principle
of Proximate (i.e., Nearest) Cause, means when a loss is caused by more than one
causes, the proximate or the nearest or the closest cause should be taken into
consideration to decide the liability of the insurer. The principle states that to find out
whether the insurer is liable for the loss or not, the proximate (closest) and not the remote
(farest) must be looked into.
For example: A cargo ships base was punctured due to rats and so sea water entered
and cargo was damaged. Here, there are two causes for the damage of the cargo ship
(i) The cargo ship getting punctured because of rats, and (ii) The sea water entering
ship through puncture. The risk of sea water is insured but the first cause is not. The
nearest cause of damage is sea water which is insured and therefore the insurer must
pay the compensation.
However, in case of life insurance, the principle of Causa Proxima does not apply.
Whatever may be the reason of death (whether a natural death or an unnatural death),
the insurer is liable to pay the amount of insurance.
222
Notes
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223
that the policyholder can earn dividends and borrow against or cash-in upon
surrendering the policy.
Notes
(vi) Customize your policy and coverage. If you have dependent children, a spouse
and parents to care for, youd want a policy that would protect them after death.
Typically, policies are opened for the breadwinner of the family, but a stay-athome spouses contributions are often overlooked. You might consider a policy
to cover childcare, carpooling and household chore expenses in the event of
a stay-at-home spouses death. On the flip side, as you get older and children
or parents are no longer dependent on you for income, you can reduce your
coverage or drop it entirely.
(vii) Adequate coverage makes a difference. An old school rule of thumb is that your
life insurance policy equals five to ten times your annual income. Nowadays,
advisors will look at the number of dependents you have, how long they will
be dependent upon you, and the lifestyle they expect to live after your death.
Its not a simple equation, but in general, you will need more coverage than
a typical plan offered by an employer, which usually totals one or two years
of your gross salary.
(viii) You can improve your credit rating. A life insurance policy is considered a
financial asset and may increase your credit score, which could be beneficial
when trying to obtain medical insurance or a home or business loan.
(ix) Life insurance may be exempt from bankruptcy. Most life insurance plans will
not be affected by bankruptcy and will remain intact if you claim bankruptcy.
However, youll need to confer with a bankruptcy expert, as each case is unique.
(x) Life insurance is not a simple product. Its wise to talk to an expert who can
walk you through the pros and cons of available plans and help choose coverage
that works best for your individual situation, now and in the future.
224
Notes
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Suitable general insurance covers are necessary for every family. It is important to
protect ones property, which one might have acquired from ones hard earned income.
A loss or damage to ones property can leave one shattered. Losses created by
catastrophes such as the tsunami, earthquakes, cyclones, etc. have left many homeless
and penniless. Such losses can be devastating but insurance could help mitigate them.
Property can be covered, so also the people against Personal Accident. A Health
Insurance Policy can provide financial relief to a person undergoing medical treatment
whether due to a disease or an injury.
Notes
226
Notes
(viii) To carry on of any part of the general insurance business if it thinks it is desirable
to do so.
(ix) To advice the companies in the matter of controlling their experience and
investment of funds.
(x) To provide need-based and low-cost general insurance covers to rural population.
(xi) To administer a crop insurance scheme for the benefit of the farmers.
(xii) To develop and introduce covers with social security benefits
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227
3. The insured must stand in a formal or legal relationship with the subject matter
of the Insurance. Whereby he benefits from its safety, well-being or freedom
from liability and would be adversely affected by its loss, damage existence
of liability.
Notes
228
Notes
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Similarly, in certain types of life policies, payment is not certain due to uncertainty
of a particular contingency within a particular period. For example, in term insurance,
payment is made only when death of the assured occurs within the specified term, may
be one or two years. Similarly, in Pure Endowment, payment is made only at the survival
of the insured at the expiry of the period.
Notes
5. Amount of Payment
The amount of payment depends upon the value of loss occurred due to the particular
insured risk provided insurance is there up to that amount. In life insurance, the purpose
is not to make good the financial loss suffered. The insurer promises to pay a fixed sum
on the happening of an event.
If the event or the contingency takes place, the payment does fall due if the policy
is valid and in force at the time of the event, like property insurance, the dependents will
not be required to prove the occurring of loss and the amount of loss. It is immaterial
in life insurance what was the amount of loss at the time of contingency. But in the property
and general insurances, the amount of loss as well as the happening of loss, are required
to be proved.
6. Large Number of Insured Persons
To spread the loss immediately, smoothly and cheaply, large number of persons
should be insured. The cooperation of a small number of persons may also be insurance
but it will be limited to smaller area. The cost of insurance to each member may be higher.
So, it may be unmarketable.
Therefore, to make the insurance cheaper, it is essential to insure large number of
persons or property because the lesser would be cost of insurance and so, the lower would
be premium. In past years, tariff associations or mutual fire insurance associations were
found to share the loss at cheaper rate. In order to function successfully, the insurance
should be joined by a large number of persons.
7. Insurance is Not a Gambling
The insurance serves indirectly to increase the productivity of the community by
eliminating worry and increasing initiative. The uncertainty is changed into certainty by
insuring property and life because the insurer promises to pay a definite sum at damage
or death.
From a family and business point of view, all lives possess an economic value which
may at any time be snuffed out by death, and it is as reasonable to ensure against the
loss of this value as it is to protect oneself against the loss of property. In the absence
of insurance, the property owners could at best practice only some form of self-insurance,
which may not give him absolute certainty.
Similarly, in absence of life insurance, saving requires time; but death may occur
at any time and the property, and family may remain unprotected. Thus, the family is
protected against losses on death and damage with the help of insurance.
From the companys point of view, the life insurance is essentially non-speculative;
in fact, no other business operates with greater certainties. From the insured point of view,
too, insurance is also the antithesis of gambling. Nothing is more uncertain than life and
life insurance offers the only sure method of changing that uncertainty into certainty.
In fact, insurance is just the opposite of gambling. In gambling, by bidding, the person
exposes himself to risk of losing; in the insurance, the insured is always opposed to risk,
and will suffer loss if he is not insured.
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Notes
By getting insured his life and property, he protects himself against the risk of loss.
In fact, if he does not get his property or life insured, he is gambling with his life on property.
8. Insurance is Not Charity
Charity is given without consideration but insurance is not possible without premium.
It provides security and safety to an individual and to the society although it is a kind
of business because in consideration of premium it guarantees the payment of loss. It
is a profession because it provides adequate sources at the time of disasters only by
charging a nominal premium for the service.
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Notes
232
Notes
In November 2000, GIC was renotified as the Indian Reinsurer and through
administrative instruction, its supervisory role over the four subsidiaries was ended. With
the General Insurance Business (Nationalization) Amendment Act 2002 (40 of 2002)
coming into force from March 21, 2003, GIC ceased to be a holding company of its
subsidiaries.
The ownership of the four erstwhile subsidiary companies and also of the General
Insurance Corporation of India was vested with Government of India. GIC Re is a wholly
owned company of Government of India.
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233
Section 7: Amendment of section 24A.In section 24A of the principal Act, the
following proviso shall be inserted, namely:Provided that the Corporation shall, on and
from the commencement of the General Insurance Business (Nationalization) Amendment
Act, 2002, cease to carry on general insurance business.
Notes
Section 8: Amendment of section 39.In section 39 of the principal Act, in subsection (2), for clause (b), the following clauses shall be substituted, namely:(b) the
conditions, if any, subject to which the Corporation shall carry on reinsurance business;
(ba) the conditions, if any, subject to which the acquiring companies shall carry on general
insurance business.
Government should take over the holdings of GIC and its subsidiaries so that
these subsidiaries can act as independent corporations.
2. Competition
z
No Company should deal in both Life and General Insurance through a single
entity.
3. Regulatory Body
z
4. Investments
z
234
Notes
GIC and its subsidiaries are not to hold more than 5% in any company (Their
current holdings to be brought down to this level over a period of time).
5. Customer Service
z
The Committee emphasized that in order to improve the customer services and
increase the coverage of the insurance industry should be opened up to competition.
But at the same time, the Committee felt the need to exercise caution as any failure
on the part of new players could ruin the public confidence in the industry. Hence, it was
decided to allow competition in a limited way by stipulating the minimum capital
requirement of ` 100 crores. The Committee felt the need to provide greater autonomy
to insurance companies in order to improve their performance and enable them to act as
independent companies with economic motives. For this purpose, it had proposed setting
up an independent regulatory body.
The minimum paid-up equity capital for life or general insurance business is
` 100 crores.
The minimum paid-up equity capital for carrying on reinsurance business has
been prescribed as ` 200 crores.
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Notes
IRDA has so far granted registration to 12 private life insurance companies and
9 general insurance companies. If the existing public sector insurance companies are
included, there are currently 13 insurance companies in the life insurance business and
13 companies operating in general insurance business. General Insurance Corporation has
been approved as the Indian reinsurer for underwriting only reinsurance business.
Particulars of the life insurance companies and general insurance companies including
their web address is given below:
LIFE INSURERS
Websites
Public Sector
www.licindia.com
Private Sector
Allianz Bajaj Life Insurance Company Limited
www.allianzbajaj.co.in
www.birlasunlife.com
www.hdfcinsurance.com
www.iciciprulife.com
www.ingvysayalife.com
www.maxnewyorklife.com
www.metlife.com
www.omkotakmahnidra.com
www.sbilife.co.in
www.tata-aig.com
www.ampsanmar.com
www.avivaindia.com
GENERAL INSURERS
Public Sector
National Insurance Company Limited
www.nationalinsuranceindia.com
www.niacl.com
www.orientalinsurance.nic.in
www.uiic.co.in
Private Sector
Bajaj Allianz General Insurance Co. Limited
www.bajajallianz.co.in
www.icicilombard.com
www.itgi.co.in
www.ril.com
www.royalsun.com
www.tata-aig.com
Amity Directorate of Distance and Online Education
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Notes
www.cholainsurance.com
www.ecgcindia.com
www.gicindia.com
The insurers are required to maintain solvency margins so that they are in a
position to meet their obligations towards policyholders with regard to payment
of claims.
All insurers are required to set up proper grievance redressal machinery in their
head office and at their other offices.
The Authority takes up with the insurers any complaint received from the
policyholders in connection with services provided by them under the insurance
contract.
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237
Market Size
Notes
Indias life insurance sector is the biggest in the world with about 36 crore policies
which are expected to increase at a compound annual growth rate (CAGR) of 12-15%
over the next five years. The insurance industry plans to hike penetration levels to 5%
by 2020, and could top the US$ 1 trillion mark in the next seven years.
The total market size of Indias insurance sector is projected to touch US$ 350-400
billion by 2020 from US$ 66.4 billion in FY13.
The general insurance business in India is currently at ` 77,000 crore (US$ 12.41
billion) premium per annum industry and is growing at a healthy rate of 17%.
The ` 12,606 crore (US$ 2.03 billion) domestic health insurance business accounts
for about a quarter of the total non-life insurance business in the country.
Investment corpus in Indias pension sector is anticipated to cross US$ 1 trillion by
2025, following the passage of the Pension Fund Regulatory and Development Authority
(PFRDA) Act 2013, according to a joint report by CII-EY on Pensions Business in India.
Indian insurance companies are expected to spend ` 117 billion (US$ 1.88 billion)
on IT products and services in 2014, an increase of 5% from 2013, as per Gartner Inc.
Also, insurance companies in the country could spend ` 4.1 billion (US$ 66.11 million)
on mobile devices in 2014, a rise of 35% from 2013.
Investments
Insurance sector of India needs capital infusion of ` 50,000 crore (US$ 8.06 billion)
to expand, maintain a healthy capital base and improve solvency standards, according
to Insurance Regulatory Development Authority (IRDA).
The following are some of the major investments and developments in the Indian
insurance sector.
z
Aditya Birla Financial Services Group has signed an agreement to form a health
insurance joint venture (JV) with MMI Holdings of South Africa. The two will enter
into a formal JV in which the foreign partner will hold a 26% stake.
South African Financial Services Group Sanlam plans to increase stake in its
Indian JV Shriram Life Insurance from 26% to 49%.
JLT Independent plans to develop India as a service hub for all countries that
are a part of South Asian Association for Regional Cooperation (SAARC),
according to Mr. Sanjay Radhakrishnan, CEO, JLT Independent.
Kotak Mahindra Bank became the first bank to get the permission from Reserve
Bank of India (RBI) to set up a wholly-owned non-life insurance company.
Government Initiatives
The Government of India has taken a number of initiatives to boost the insurance
industry. Some of them are as follows:
z
The Reserve Bank of India (RBI) has allowed banks to become insurance
Amity Directorate of Distance and Online Education
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Notes
The select committee of the Rajya Sabha gave its approval, permitting 49%
composite foreign equity investment in insurance companies. A broad
agreement has also been achieved with the states on most of the issues
concerning the implementation of the single goods and services tax (GST),
which is scheduled to be rolled out from April 1, 2016.
The Government of India plans to implement a ` 1,900 crore (US$ 306.41 million)
e-governance project called Panch Deep to automate transactions of the
Employees State Insurance Corporation (ESIC), said Mr. Bandaru Dattatreya,
Union Minister for Labour and Employment with Independent Charge,
Government of India. Under the project, enterprise resource planning (ERP)
solution would be installed across the country which will give a unique card to
the employees and facilitate clearance of third party bills.
The Government of India plans to launch a new insurance scheme to protect
farmers and their incomes against production and price risks.
Under the Pradhan Mantri Jan Dhan Yojana, it has been decided that even those
accounts which had been opened prior to August 28, 2014 and have zero
balance will get ` 100,000 (US$ 1,612.55) insurance cover.
Road Ahead
Indias insurable population is anticipated to touch 75 crore in 2020, with life
expectancy reaching 74 years. Furthermore, life insurance is projected to comprise 35%
of total savings by the end of this decade, as against 26% in 2009-10.
The future looks interesting for the life insurance industry with several changes in
regulatory framework which will lead to further change in the way the industry conducts
its business and engages with its customers.
Demographic factors such as growing middle class, young insurable population and
growing awareness of the need for protection and retirement planning will support the
growth of Indian life insurance.
Exchange Rate Used: INR 1 = US$ 0.016 as on February 25, 2015
5.28 Bancassurance
Bancassurance is a French term referring to the selling of insurance through a banks
established distribution channels. In other words, we can say Bancassurance is the
provision of insurance (assurance) products by a bank. The usage of the word picked up
as banks and insurance companies merged and banks sought to provide insurance,
especially in markets that have been liberalized recently. It is a controversial idea, and
many feel it gives banks too great a control over the financial industry. In some countries,
bancassurance is still largely prohibited, but it was recently legalized in countries like
USA when the Glass Steagall Act was repealed after the passage of the Gramm Leach
Bililey Act.
Bancassurance is the selling of insurance and banking products through the same
channel, most commonly through bank branches. Selling insurance means distribution
of insurance and other financial products through banks. Bancassurance concept
originated in France and soon became a success story even in other countries of Europe.
In India, a number of insurers have already tied up with banks and some banks have already
flagged off bancassurance through select products.
Amity Directorate of Distance and Online Education
Insurance Institutions
239
Bancassurance has become significant. Banks are now a major distribution channels
for insurers, and insurance sales a significant source of profits for banks. The latter partly
being because banks can often sell insurance at better prices (i.e., higher premiums) than
many other channels, and they have low costs as they use the infrastructure (branches
and systems) that they use for banking.
Notes
Bancassurance primarily rests on the relationship the customer has developed over
a period of time with the bank. And pushing risk products through banks is a much more
cost-effective affair for an insurance company compared to the agent route, while, for
banks, considering the falling interest rates, fee based income coming in at a minimum
cost is more than welcome.
240
Notes
Insurance Institutions
241
constructed by another, or may have a joint venture with an insurer, sharing capabilities
in distribution and manufacturing. The magnitude of the operations may also differ. The
insurance business may provide a marginal concern for the banking institution or represent
a significant share of total revenue and income. The benefits earned by each participant
must, therefore, be assessed carefully before arriving at any conclusion as to the success
of bancassurance activities. Pertinent considerations include how a bank benefits from
any insurance practices, how an insurer or insurance operation benefits from its
association with the bank, the links between the businesses and if the grouping will ever
generate an operation greater than the mere sum of its parts.
Notes
242
Notes
(j) Banks provided services are immediate whereas insurance provided services
are futuristic.
(k) Bank provides short-term finance whereas insurance companies provide longterm finance.
(l) Banks generally deal with their customers directly whereas insurance
companies deals with their customers through intermediaries.
(m) Bank customers have their accounts in banks whereas insurance customers
unaware of their accounts.
(n) Dealing with banks is highly personal whereas dealing with insurance is less
personal.
(o) The Reserve Bank of India in its 2009-2010 circular made it mandatory for bank
to disclose in the Notes to Accounts from the year ending March 31, 2010,
the details of fees or remuneration received in respect of bancassurance
business undertaken by them.
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243
Notes
Banks which are not eligible for joint venture can invest in an Insurance company
without risk participation. Currently, banks can invest up to 10% of the net worth of the
bank, or ` 50 crores, whichever is lower.
Merger and Acquisition
This model is not very popular in India due to various national laws forbidding mergers
between banks and insurance sectors. In this model, either a bank acquires the insurance
company or merges with it or vice versa.
Organic Start-up
Under this model instead of merger or acquisition of the bank or insurance company,
believe in building skills organically. The advantage of this model is that it reduces the
chance of cultural differences between the Bank and insurance company.
244
Notes
policy basis. For all this purpose, there is need of proforma for memorandum of agreement
between bank and insurer with minimum requirement.
As far as inspection and supervision is concerned, the proposed regulation must
contain separate provision which empowers IRDA and RBI to inspect any of the
Bancassurance partner.
The regulation must have provisions of maintaining accounts and certification which
should be furnished in periodical returns to the authority. Corporate governance norms
regarding disclosure should be complied by the banks treating bancassurance as integral
part of banks business operation.
Regulations should make it mandatory that the bank staff be fully trained in handling
insurance products so that the sale process is transparent and the policyholder gets full
disclosure of the features of the product.
The Committee gave the green light for multiple insurers but only if a bank fulfills
all other conditions specified in the Committees recommendations. The Committee
recommended abolition of the referral system of bancassurance because it is costlier than
corporate agent model. The reason behind the high cost is that the insurer has not only
to pay the higher amount of first year premium as referral fee but also has to deploy staff
and infrastructure in the bank premises.
5.38 Summary
Insurance is a contract between two parties whereby one party agrees to undertake
the risk of another in exchange for consideration known as premium and promises to pay
a fixed sum of money to the other party on happening of an uncertain event (death) or
after the expiry of a certain period in case of life insurance or to indemnify the other party
on happening of an uncertain event in case of general insurance.
Insurance provides financial protection against a loss arising out of happening of an
uncertain event. A person can avail this protection by paying premium to an insurance
company. A pool is created through contributions made by persons seeking to protect
themselves from common risk. Premium is collected by insurance companies which also
act as trustee to the pool. Any loss to the insured in case of happening of an uncertain
event is paid out of this pool.
Amity Directorate of Distance and Online Education
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245
Notes
246
Notes
Indemnity means security, protection and compensation given against damage, loss
or injury. According to the principle of indemnity, an insurance contract is signed only
for getting protection against unpredicted financial losses arising due to future
uncertainties. Insurance contract is not made for making profit, else its sole purpose is
to give compensation in case of any damage or loss.
Insurance sector has been opened up for competition from Indian private insurance
companies with the enactment of Insurance Regulatory and Development Authority Act,
1999 (IRDA Act). As per the provisions of IRDA Act, 1999, Insurance Regulatory and
Development Authority (IRDA) was established on 19th April 2000 to protect the interests
of holder of insurance policy and to regulate, promote and ensure orderly growth of the
insurance industry. IRDA Act 1999 paved the way for the entry of private players into the
insurance market which was hitherto the exclusive privilege of public sector insurance
companies/corporations.
IRDA has so far granted registration to 12 private life insurance companies and
9 general insurance companies. If the existing public sector insurance companies are
included, there are currently 13 insurance companies in the life insurance business and
13 companies operating in general insurance business. General Insurance Corporation has
been approved as the Indian reinsurer for underwriting only reinsurance business.
Bancassurance is a French term referring to the selling of insurance through a banks
established distribution channels. In other words, we can say Bancassurance is the
provision of insurance (assurance) products by a bank. The usage of the word picked up
as banks and insurance companies merged and banks sought to provide insurance,
especially in markets that have been liberalized recently. It is a controversial idea, and
many feel it gives banks too great a control over the financial industry. In some countries,
bancassurance is still largely prohibited, but it was recently legalized in countries like
USA when the Glass Steagall Act was repealed after the passage of the Gramm Leach
Bililey Act.
Insurance Institutions
3.
247
Life Insurance refers to the insurance which gives a protection against the loss
of income that would result if the insured passed away.
Notes
4. The economic crisis of late 2007 and early 2008 highlighted the growing
importance of the role of the worlds financial sectors in ensuring global financial
stability.
5. The principle of insurable interest states that the person getting insured must
have insurable interest in the object of insurance.
III. Multiple Choice Questions
1. Which of the following is a contract between two parties whereby one party
agrees to undertake the risk of another in exchange for consideration?
(a) Insurance
(b) Banking
(c) Lending
(d) All the above
2. Insurance concept started by considering the methods of transferring or
distributing risk were practiced by _____________
(a) Chinese traders
(b) Babylonian traders
(c) Both (a) and (b)
(d) None of these
3. The sale of life insurance in the US began in the late _____________
(a) 1750s
(b) 1760s
(c) 1740s
(d) 1780s
248
Notes
Life Insurance: Life Insurance refers to the insurance which gives a protection
against the loss of income that would result if the insured passed away.
Principle of Utmost Good Faith: The Principle of Utmost Good Faith is a very
basic and first primary principle of insurance.
Insurance Institutions
249
Notes
Recognizing the need for large-scale centralized systems expertise, SBI sought
proposals from a number of vendor consortiums that were headed by the leading systems
integrators. From these proposals, the bank narrowed down the potential solutions to
vendor consortiums led by IBM and TCS. The TCS Group included Hewlett-Packard,
Australia-based Financial Network Services (FNS), and China Systems (for trade finance).
Although SBI favoured the real-time processing architecture of FNSs BaNCS system over
that of the IBM consortiums memo post/batch update architecture, the bank had several
concerns about the TCS consortium proposal. They included the small size and relatively
weak financial strength of FNS (TCS would eventually purchase FNS in 2005) and the
ability of the UNIX-based system to meet the scalability requirements of the bank.
Therefore, it was agreed that TCS would be responsible for the required systems
modifications and ongoing software maintenance for SBI. Additionally, scalability tests
were performed at HPs lab in Germany to verify that the system was capable of meeting
the banks scalability requirements. These tests demonstrated the capability of TCS
BaNCS to support the processing requirements of 75 million accounts and 19 million daily
transactions. Tata Consultancy Services and TCS BaNCs Tata Consultancy Services,
headquartered in Mumbai, India, is one of the worlds largest technology companies with
particular expertise in systems integration and business process outsourcing. The
company has more than 130,000 employees located in 42 countries and achieved revenues
of $ 5.7 billion in fiscal 2008. Although TCS has long been a leader in core systems
integration services for banks, after it purchased FNS in 2005, the company also became
a leading global provider of core banking software for large banks. The BaNCS system
is based on service-oriented architecture (SOA) and is platform and database independent.
In addition to SBI, TCS BaNCS clients include the Bank of China (installation in process),
China Trust, Bank Negara Indonesia, Indias Bank Maharashtra, National Commercial
Bank (Saudi Arabia), and Koram Bank (Korea). TCS has also expanded its US footprint
with the opening of its largest resource delivery center in North America (near Cincinnati,
Ohio) that can house 20,000 personnel. The company is seeking to license and implement
the BaNCS system in North America and recently completed a major part of an effort
to ensure that the BaNCS system meets US regulatory and compliance requirements.
Question:
1. Do you think the Vendor Consortium Selection is up to the mark? Discuss.
5.45 Bibliography
1. Adams, J. (2012), The Impact of Changing Regulation on the Insurance Industry,
Financial Services Authority.
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Notes