MBFS Module 1 Banking Revised

8/4/2019 MBFS Module 1 Banking Revised

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Merchant Banking &Financial Services

Module- 1 Bank & Banking

BY: VIKAS JAIN(MBA)


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Definition of Bank & Banker

As per Sec.5 (b) of the Banking Regulation Act

Banking' means accepting, for the purpose of lending orinvestment, of deposits of money from the public

repayable on demand or otherwise and withdrawable by

cheque, draft, order or otherwise."

According to Sec. 2 of the Bill of Exchange Act, 1882,

banker includes a body of persons, whether

incorporated or not who carry on the business ofbanking.


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Role of Banking

Banks provide funds for business as well as personal needs

of individuals. They play a significant role in the economyof a nation. Let us know about the role of banking.

It encourages savings habit amongst people and therebymakes funds available for productive use.

It acts as an intermediary between people having surplusmoney and those requiring money for various businessactivities.

It facilitates business transactions through receipts and

payments by cheques instead of currency. It provides loans and advances to businessmen for short

term and long-term purposes.


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CONTINUED

It also facilitates import export transactions.

It helps in national development by providing credit to

farmers, small-scale industries and self-employed people

as well as to large business houses which lead tobalanced economic development in the country.

It helps in raising the standard of living of people in

general by providing loans for purchase of consumer

durable goods, houses, automobiles, etc.

There are various types of banks which operate in our

country to meet the financial requirements
http://upload.wikimedia.org/wikipedia/commons/b/bd/Scheduled_banking_structure_in_India.png


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http://upload.wikimedia.org/wikipedia/commons/b/bd/Scheduled_banking_structure_in_India.png


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Central Bank

The Reserve Bank of India is the central Bank that is fully ownedby the Government. It is governed by a central board (headed by a

Governor) appointed by the Central Government. It issues

guidelines for the functioning of all banks operating within the

country.The Bank was constituted for the need of following:

To regulate the issue of banknotes

To maintain reserves with a view to securing monetary stability

and To operate the credit and currency system of the country to its

advantage
http://www.rbi.org.in/home.aspxhttp://www.rbi.org.in/home.aspx


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Commercial Banks

Commercial Banks are banking institutions thataccept deposits and grant short-term loans andadvances to their customers.

In addition to giving short-term loans, commercial

banks also give medium-term and long-term loan tobusiness enterprises.

Now-a-days some of the commercial banks are alsoproviding housing loan on a long-term basis toindividuals.

There are also many other functions of commercialbanks, which are discussed later in this lesson.


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SCHEDULE COMMERCIAL BANK

All banks which are included in the Second Schedule to

the Reserve Bank of India Act, 1934 are scheduled

banks. These banks comprise

a) Scheduled Commercial Banks

b) Scheduled Cooperative Banks.


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SCHEDULE COMMERCIAL BANK

Scheduled Commercial Banks in India are categorizedinto five different groups according to their ownershipand / or nature of operation. These bank groups are

(i) State Bank of India and its associates,

(ii) Nationalized Banks

(iii) Regional Rural Banks

(iv) Foreign Banks

(v) Other Indian Scheduled Commercial Banks

(in the private sector).


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Types of Commercial banks

Commercial banks are of three types i.e.,

Public sector banks,

Private sector banks and

Foreign banks.


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Public Sector Banks

State Bank of India and its associatebanks called the State Bank Group

20 nationalized banks

Regional rural banks mainly sponsoredby public sector banks


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Private Sector Banks

In case of private sector banks majority of share capitalof the bank is held by private individuals. Thesebanks are registered as companies with limitedliability. For example: The Jammu and KashmirBank Ltd., Bank of Rajasthan Ltd., Development

Credit Bank Ltd, Lord Krishna Bank Ltd., BharatOverseas Bank Ltd., Global Trust Bank, VysyaBank, etc.

Old generation private banks

New generation private banks Foreign banks operating in India

Scheduled co-operative banks

Non-scheduled banks


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Foreign Banks

These banks are registered and have theirheadquarters in a foreign country but operatetheir branches in our country. Some of the

foreign banks operating in our country are HongKong and Shanghai Banking Corporation(HSBC), Citibank, American Express Bank,Standard & Chartered Bank, Grindlays Bank,

etc. The number of foreign banks operating inour country has increased since the financialsector reforms of 1991.s


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Development Banks

Business often requires medium and long-termcapital for purchase of machinery and equipment,for using latest technology, or for expansion andmodernization. Such financial assistance isprovided by Development Banks. They alsoundertake other development measures likesubscribing to the shares and debentures issued bycompanies, in case of under subscription of the

issue by the public. Industrial Finance Corporationof India (IFCI) and State Financial Corporations(SFCs) are examples of development banks inIndia.


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Development Banks/FinancialInstitutions

IFCI IDBI ICICI

IIBI SCICI Ltd.NABARD Export-Import Bank of India

National Housing Bank Small Industries Development Bank of IndiaNorth Eastern Development Finance

Corporation
http://www.ifciltd.com/http://www.idbibank.com/http://www.idbibank.com/http://www.nabard.org/http://www.eximbankindia.com/http://www.nhb.org.in/http://www.sidbi.in/http://www.nedfi.com/http://www.nedfi.com/http://www.nedfi.com/http://www.nedfi.com/http://www.sidbi.in/http://www.nhb.org.in/http://www.eximbankindia.com/http://www.eximbankindia.com/http://www.eximbankindia.com/http://www.nabard.org/http://www.idbibank.com/http://www.idbibank.com/http://www.ifciltd.com/


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Co-operative Sector - Definition

People who come together to jointly serve theircommon interest often form a co-operative societyunder the Co-operative Societies Act. When a co-operative society engages itself in banking business it

is called a Co-operative Bank. The society has toobtain a license from the Reserve Bank of India beforestarting banking business. Any co-operative bank as asociety is to function under the overall supervision of

the Registrar, Co-operative Societies of the State. As regards banking business, the society must follow

the guidelines set and issued by the Reserve Bank of

India.

CONTINUED


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CONTINUED

The co-operative sector is very much useful for rural people. The co-

operative banking sector is divided into the following categories.

State co-operative Banks: These are the apex (highest level) co-

operative banks in all the states of the country. They mobilize funds

and help in its proper channelization among various sectors. The

money reaches the individual borrowers from the state co-operative

banks through the central co-operative banks and the primary creditsocieties.

Central co-operative banks :These banks operate at the district

level having some of the primary credit societies belonging to the

same district as their members. These banks provide loans to theirmembers (i.e., primary credit societies) and function as a link

between the primary credit societies and state co-operative

banks.


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Primary Agriculture Credit Societies: These are

formed at the village or town level with borrower and

non-borrower members residing in one locality. The

operations of each society are restricted to a small areaso that the members know each other and are able to

watch over the activities of all members to prevent

frauds.


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Specialized Banks

There are some banks, which cater to the requirements and

provide overall support for setting up business in specificareas of activity. EXIM Bank, SIDBI and NABARD areexamples of such banks. They engage themselves in somespecific area or activity and thus, are called specialized

banks. Let us know about them i. Export Import Bank of India (EXIM Bank): If you want to set

up a business for exporting products abroad or importing productsfrom foreign countries for sale in our country, EXIM bank can

provide you the required support and assistance. The bank grantsloans to exporters and importers and also provides information aboutthe international market. It gives guidance about the opportunities forexport or import, the risks involved in it and the competition to befaced, etc.


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(ii). Small Industries Development Bank ofIndia (SIDBI): If you want to establish a small-scale business unit or industry, loan on easyterms can be available through SIDBI. It alsofinances modernization of small-scale industrialunits, use of new technology and marketactivities. The aim and focus of SIDBI is to

promote, finance and develop small-scaleindustries s


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iii. National Bank for Agricultural and Rural Development

(NABARD): It is a central or apex institution for financing

agricultural and rural sectors. If a person is engaged in agriculture or

other activities like handloom weaving, fishing, etc. NABARD can

provide credit, both short-term and long-term, through regional rural

banks. It provides financial assistance, especially, to co-operative credit, in

the field of agriculture, small-scale industries, cottage and village

industries handicrafts and allied economic activities in ruralareas.


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Functions of Commercial Banks

The functions of commercial banks are of

two types.

(A) Primary functions; and

(B) Secondary functions.

Let us discuss details about these functions.

Primary functions


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Primary functions

The primary functions of a commercial bank include:

a) Accepting Deposits: The most important activity of acommercial bank is to mobilize deposits from the public.People who have surplus income and savings find itconvenient to deposit the amounts with banks.

Depending upon the nature of deposits, funds deposited

with bank also earn interest. Thus, deposits with the bankgrow along with the interest earned. If the rate of interest ishigher, public are motivated to deposit more funds with thebank. There is also safety of funds deposited with the bank

Generally the following three types of deposits are accepted:Current deposit or demand deposits

Savings deposits

Fixed or time deposits


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Current Deposits or Demand Deposits

These deposits are repayable on demand. They are

known as demand deposits in USA and current

deposits in England. These deposits are usually

opened with a minimum balance prescribed by thebank and any amount can be deposited in the account.

These deposits can be withdrawn by the issue of

cheque. Generally no interest is allowed on current

account. These accounts are normally opened bybussiness houses


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Savings Deposits

Savings deposit accounts are maintained by the

commercial banks to pool the small savings of low and

middle income groups. This is a device to encourage

thrift among the persons who earn only fixed incomeevery month.

Certain restrictions may vary from bank to bank.

Usually, all banks restrict the maximum amount that can

be deposited in or withdrawn from savings accounts.

The number of cheques that can be drawn against the

account within a specified period is also restricted.


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Fixed Deposits or Time Deposits

These are deposits for a fixed period. These deposits areknown as fixed deposits in England and time deposits in

the United States.

Fixed deposits are advantageous to both the banker and

the depositor. The depositors prefer this type of deposits

as they earn a higher rate of interest. The banker is

interested in such deposits because they get the money

for a fixed period. As the repayment is certain, thedepositors are able to invest the money for long periods

and thus, earn a higher return on the investment. Cheque

system is not allowed against fixed deposits.

CONTINUED


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CONTINUED

b) Grant of loans and advances: The second importantfunction of a commercial bank is to grant loans and

advances. Such loans and advances are given to members ofthe public and to the business community at a higher rate ofinterest than allowed by banks on various deposit accounts.The rate of interest charged on loans and advances varies

according to the purpose and period of loan and also themode of repayment

i) Loans: A loan is granted for a specific time period.Generally commercial banks provide short-term loans. But

term loans, i.e., loans for more than a year may also begranted. The borrower may be given the entire amount inlump sum or in installments. Loans are generally grantedagainst the security of certain assets. A loan is normally

repaid in installments. However, it may also be repaid inlum sum.


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ii) Advances

An advance is a credit facility provided by the bankto its customers. It differs from loan in the sensethat loans may be granted for longer period, butadvances are normally granted for a short period oftime.

Further the purpose of granting advances is to meetthe day-to-day requirements of business.

The rate of interest charged on advances variesfrom bank to bank.

Interest is charged only on the amount withdrawnand not on the sanctioned amount.

Types of Advances


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Types of Advances

Banks grant short-term financial assistance by way of cashcredit, overdraft and bill discounting.

a) Cash Credit: Cash credit is an arrangement whereby thebank allows the borrower to draw amount up to a specifiedlimit. The amount is credited to the account of the customer.The customer can withdraw this amount as and when he

requires. Interest is charged on the amount actuallywithdrawn. Cash Credit is granted as per terms andconditions agreed with the customers.

b) Overdraft: Overdraft is also a credit facility granted bybank. A customer who has a current account with the bankis allowed to withdraw more than the amount of creditbalance in his account. It is a temporary arrangement.Overdraft facility with a specified limit may be allowedeither on the security of assets, or on personal security, or

both.


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c) Discounting of Bills: Banks provide short-term

finance by discounting bills, that is, making payment

of the amount before the due date of the bills after

deducting a certain rate of discount. The party gets

the funds without waiting for the date of maturity of

the bills. In case any bill is dishonoured on the due

date, the bank can recover the amount from the

customer.


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Secondary functions

In addition to the primary functions of accepting deposits

and lending money, banks perform a number of otherfunctions, which are called secondary functions. These areas follows

Issuing letters of credit, travellers cheque, etc

Undertaking safe custody of valuables, importantdocument and securities by providing safe deposit vaults orlockers.

Providing customers with facilities of foreign exchangedealings.

Transferring money from one account to another; andfrom one branch to another branch of the bank throughcheque, pay order, demand draft.


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CONTINUED

Standing guarantee on behalf of its customers, for makingpayment for purchase of goods, machinery, vehicles etc.

Collecting and supplying business information.

Providing reports on the credit worthiness of customers.

Providing consumer finance for individuals by way of loanson easy terms for purchase of consumer durables like

televisions, refrigerators, etc. Educational loans to students at reasonable rate of interest

for higher studies, especially for professional courses.


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Banker & Customer Relationship

Banking is a trust-based relationship. There arenumerous kinds of relationship between the bank and

the customer. The relationship between a banker and a

customer depends on the type of transaction. Thus the

relationship is based on contract, and on certain termsand conditions.

The banker customer relationship is fiducial

relationship. The terms and conditions governing the

relationship is not be leaked by the banker to a third

party


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Classification of Relationship

The relationship between a bank and itscustomers can be broadly categorized into -

General Relationship and

Special Relationship


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General Relationship

If we look at Sec 5(b) of BankingRegulation Act, we would notice thatbanks business hovers around accepting

of deposits for the purposes of lending.Thus the relationship arising out of thesetwo main activities are known as General

Relationship.

D b C di


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Debtor-Creditor:

When a 'customer' opens an account with a bank, he fills inand signs the account opening form. By signing the form heenters into an agreement/contract with the bank.

When customer deposits money in his account the bankbecomes a debtor of the customer and customer a creditor.The money so deposited by customer becomes banksproperty and bank has a right to use the money as it likes.The bank is not bound to inform the depositor the manner ofutilization of funds deposited by him.


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Continued

Bank does not give any security to the depositor i.e.debtor. The bank has borrowed money and it is onlywhen the depositor demands, banker pays.

Banks position is quite different from normal

debtors.Banker does not pay money on its own, as banker isnot required to repay the debt voluntarily. Thedemand is to be made at the branch where the accountexists and in a proper manner and during working

days and working hours.

Creditor Debtor:


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CreditorDebtor:Lending money is the most important activities of a bank.The resources mobilized by banks are utilized for lending

operations. Customer who borrows money from bank ownsmoney to the bank. In the case of any loan/advancesaccount, the banker is the creditor and the customer is thedebtor.

when he borrows money from the bank. Borrower executesdocuments and offer security to the bank before utilizing thecredit facility.

In addition to opening of a deposit/loan account banks

provide variety of services, which makes the relationshipmore wide and complex. Depending upon the type ofservices rendered and the nature of transaction, the bankeracts as a bailee, trustee, principal, agent, lessor, custodian

etc.


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Special Relationship

In addition to these two activities banksalso undertake other activities mentionedin Sec.6 of Banking Regulation Act.

Relationship arising out of the activitiesmentioned in Sec.6 of the act is termed asspecial relationship.


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1. Bank as a Trustee

In case of trust banker customer relationship is a

special contract. When a person entrusts valuableitems with another person with an intention thatsuch items would be returned on demand to thekeeper the relationship becomes of a trustee and

trustier. Customers keep certain valuables orsecurities with the bank for safekeeping or depositscertain money for a specific purpose (Escrowaccounts) the banker in such cases acts as atrustee. Banks charge fee for safekeepingvaluables .

2 Bailee Bailor:


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2. Bailee

Bailor:

Sec.148 of Indian Contract Act, 1872, defines "Bailment""bailor" and "bailee".

A "bailment" is the delivery of goods by one person toanother for some purpose, upon a contract that they shall,when the purpose is accomplished, be returned or otherwisedisposed of according to the directions of the persondelivering them.

The person delivering the goods is called the "bailor". Theperson to whom they are delivered is called, the "bailee".

Banks secure their advances by obtaining tangiblesecurities. In some cases physical possession of securities

goods (Pledge), valuables, bonds etc., are taken. Whiletaking physical possession of securities the bank becomesbailee and the customer becomes bailor.

Banks also keeps articles, valuables, securities etc., of itscustomers in Safe Custody and acts as a Bailee. As a baileethe bank is required to take care of the goods bailed.

3 Lessor and Lessee:


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3 Lessor and Lessee:

Providing safe deposit lockers is as an ancillary serviceprovided by banks to customers. While providing Safe

Deposit Vault/locker facility to their customers bankenters into an agreement with the customer. Theagreement is known as Memorandum of letting andattracts stamp duty.

The relationship between the bank and the customer is thatof lessor and lessee.

Banks lease (hire lockers to their customers) theirimmovable property to the customer and give them the

right to enjoy such property during the specified period i.e.during the office/ banking hours and charge rentals.

4 Agent and Principal:


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4 Agent and Principal:

Sec.182 of The Indian Contract Act, 1872 defines an

agent as a person employed to do any act for another orto represent another in dealings with third persons. Theperson for whom such act is done or who is sorepresented is called the Principal.

Thus an agent is a person, who acts for and on behalf ofthe principal and under the latters express or impliedauthority and the acts done within such authority arebinding on his principal and, the principal is liable to theparty for the acts of the agent.

C ti d


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Continued

Banks collect cheques, bills, and makes payment to

various authorities viz., rent, telephone bills,insurance premium etc., on behalf of customers. .Banks also abides by the standing instructions givenby its customers. In all such cases bank acts as an

agent of its customer, and charges for theses services.As per Indian contract Act agent is entitled tocharges. No charges are levied in collection of localcheques through clearing house. Charges are levied in

only when the cheque is returned in theclearinghouse.


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5 As a Custodian

A custodian is a person who acts as a caretaker of some

thing. Banks take legal responsibility for a customers

securities. While opening a de-mat account bank

becomes a custodian.

Bank has the right to break-open the locker in case the

locker holder defaults in payment of rent.

Banks do not assume any liability or responsibility in

case of any damage to the contents kept in the locker.Banks do not insure the contents kept in the lockers by

customers


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6 As a Guarantor

Banks give guarantee on behalf of their customers

and enter in to their shoes. Guarantee is acontingent contract.

As per sec 31,of Indian contract Act guarantee is a

" contingent contract ". Contingent contract is acontract to do or not to do something, if some

event, collateral to such contract, does or does not

happen. It would thus be observed that bankercustomer relationship is transactional relationship.


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IT Products & Services

E-banking (Electronic Banking)

With advancement in information andcommunication technology, banking services arealso made available through computer. Now, inmost of the branches you see computers being

used to record banking transactions. Informationabout the balance in your deposit account can beknown through computers.

In most banks now a days human or manual tellercounter is being replaced by the Automated Teller

Machine (ATM). Banking activity carried on through computers and

other electronic means of communication is calledelectronic banking or e-banking.


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Debit Card

Banks are now providing Debit Cards to theircustomers having saving or current account in thebanks.

The customers can use this card for purchasing goodsand services at different places in lieu of cash.

The amount paid through debit card is automaticallydebited (deducted) from the customers account.

C C


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Credit Card

Credit cards are issued by the bank to persons who may

or may not have an account in the bank. Just like debit cards, credit cards are used to make

payments for purchase, so that the individual does nothave to carry cash.

Banks allow certain credit period to the creditcardholder to make payment of the credit amount.Interest is charged if a cardholder is not able to payback the credit extended to him within a stipulated

period. This interest rate is generally quite high.

Net Banking


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Net BankingWith the extensive use of computer and Internet, banks

have now started transactions over Internet.

The customer having an account in the bank can log intothe banks website and access his bank account. He can

make payments for bills, give instructions for money

transfers, fixed deposits and collection of bill, etc under

internet banking, one can do any transaction simply at in

front of a computer the following type of transaction can

be done online

Pay utility bills, view and print your statements

Transfer funds online between accounts

Stop cheques, request cheque books

Ph B ki


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Phone Banking

In case of phone banking, a customer of the bank

having an account can get information of hisaccount, make banking transactions like, fixeddeposits, money transfers, demand draft, collectionand payment of bills, etc. by using telephone .

As more and more people are now using mobilephones, phone banking is possible through mobilephones.

In mobile phone a customer can receive and sendmessages (SMS) from and to the bank in additionto all the functions possible through phonebanking.

T f A t


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Types of Accounts

Saving account: a saving account is a type of account that can be

opened in any commercial bank, the deposits made


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Savings Account

A Savings bank account is the most common operating

account for individuals and others for non-commercialtransactions.

A Savings account helps people to put through day-to-day banking transactions besides earning some return onthe savings made. Banks generally put some ceilings on

the total number of withdrawals permitted duringspecific time periods.

Banks also stipulate certain minimum balance to bemaintained in savings accounts.

Normally a higher minimum balance is stipulated incheque operated accounts as compared to non-chequeoperated accounts.

Banks as a rule do not give overdraft facility in a saving

account,

Current Account


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Current Account

Current accounts are cheque operated accounts maintained

for mainly business purposes.Unlike savings bank account no limits are fixed by banks on

the number of transactions permitted in the Account.

Banks generally insist on a higher minimum balance to bemaintained in current account.

Considering the large number of transactions in the accountand volatile nature of balances maintained overnight banksgenerally levy certain service charges for operating aCurrent account.


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continued

In terms of RBI directive banks are not allowed to

pay any interest on the balances maintained in

Current accounts.

However, legal heirs of a deceased person are paidinterest at the rates applicable to Savings bank deposit

from the date of death of the account holder till the

date of settlement.


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Fixed deposits

Fixed deposits are saving instruments, in which a specifiedamount is deposited in an account for a specified tenure

and the bank pays the interest accordingly. Generally fixed

deposits carry a high rate of interest as the money is locked

for a longer time period, such as one year, three year orfive to ten year also. A fixed deposit is a very useful

instrument for long-term planning. Some of the important

features of this deposits are as follows-

Interest may be paid monthly, quarterly or yearly.

Interest earned can also be reinvested

Minimum deposit has to be maintained

Recurring Deposit


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Recurring Deposit

Recurring deposit is another important form

of savings instrument. A recurring depositcan be opened by an individual, wherein aspecified amount is deposited every monthin the account. A recurring deposit provides

the following advantages:Encourages savings

Has a high rate of interest

Loans are available against the depositsNon applicability of tax deducted at source.

D t A t


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De-mat AccountDemat refers to a dematerialised t account maintained by

the Stock broking agencies, for the purpose of buying andselling of stocks in stock market by the account holder like

maintaining a savings/current account by an individual in a

bank.

Demat account is a safe and convenient means of holdingsecurities just like a bank account is for funds. Today,

practically 99.9% settlement (of shares) takes place on

demat mode only.

The dematerialised account is used to avoid holding

physical shares: the shares are converted in to electronic

form.

MBFS Module 1 Banking Revised

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