1st Year_Banking and Insurance_Cm1_Banking.pdf

Bureau’s HIGHER SECONDARY (+2) BANKING & INSURANCE (For +2 First Year Commerce) (Approved by the Council of Higher Secondary Education, Odisha) BOARD OF WRITERS Dr. Satyabrata Tripathy D...

Bureau’s HIGHER SECONDARY (+2) BANKING & INSURANCE (For +2 First Year Commerce) (Approved by the Council of Higher Secondary Education, Odisha) BOARD OF WRITERS Dr. Satyabrata Tripathy Dr. Ajoy Mohanty Retired Reader in Commerce Retired Principal Ravenshaw Junior College, Cuttack Sushilabati Govt. Women’s College, Rourkela Dr. Banamali Panda Dr. Sunil Kumar Jena Associate Professor of Commerce Assistant Professor of Commerce Khallikote University, Berhampur B.J.B. Autonomous College, BBSR REVIEWED BY Prof. (Dr.) Girija Prasad Acharya Former Principal, Ravenshaw College (Now Ravenshaw University), Cuttack and Former Director, Odisha State Bureau of Textbook Preparation and Production, BBSR Published by THE ODISHA STATE BUREAU OF TEXTBOOK PREPARATION & PRODUCTION PUSTAK BHAVAN, BHUBANESWAR Published by The Odisha State Bureau of Textbook Preparation and Production Pustak Bhavan, Bhubaneswar, Odisha, India First Edition : 2016 / 5000 copies Publication No. : 190 ISBN : 978 - 81 - 8005 - 370 - 2 © Reserved by The Odisha State Bureau of Textbook Preparation & Production, Bhubaneswar. No part of this publication may be reproduced in any form or by any means without the written permission from the Publisher. Type Setting at : M/s Jagannath Process Pvt. Ltd., Cuttack Printed at : M/s. Devi Graphics, Cuttack Price : Rs. 78/– (Rupees Seventy eight only)  FOREWORD The Odisha State Bureau of Textbook Preparation and Production, Bhubaneswar has made a pioneer attempt to publish text books for +2 Commerce Stream with an excellent team of teachers in different subjects. The present book ‘‘Banking and Insurance’’ is meant for Higher Secondary Commerce students. This book has been written by a team of learned academicians namely Dr. Satyabrata Tripathy, Dr. Ajoy Mohanty, Dr. Banamali Panda and Dr. Sunil Kumar Jena and reviewed by Prof. (Dr.) Girija Prasad Acharya. I would like to record my sincere gratitude to all them for accomplishing this maiden venture in time. The main purpose of developing this text book is to provide a thorough exposure to the students of Commerce in this subject. The book, prepared according to the new syllabus prescribed by the CHSE, Odisha shall cater to the needs of young students. I believe that the students and teachers of Commerce stream shall welcome and appreciate the book. I would also like to welcome constructive suggestions for further improvement of the book. (Dr. Geetika Patnaik) Director The Odisha State Bureau of Textbook Preparation and Production, Pustak Bhavan, Bhubaneswar  PREFACE There has been a manifold increase in the demand for banking services along with an increase in insurance services to cover various commercial and personal risks arising out of increasing complexities of modern life. Over the years, the banking sector has witnessed a substantial transformation in its operations with the emergence of information technology by taking an innovative approach with the objective of creating more value for customers. Similarly, insurance has evolved as a process of safeguarding the interest of people for loss and uncertainty and thus contributes a lot for the general economic growth of the society. Considering the importance of banking and insurance Council of Higher Secondary Education, Odisha has introduced a paper on ‘Banking and Insurance’ as a part of the prescribed new syllabus for +2 Commerce students. This book has been designed in accordance with the prescribed new syllabus of Council of Higher Secondary Education, Odisha for students of +2 First Year Commerce. All possible attempts have been made to present the book in a simple, lucid and comprehensive form. Each chapter is followed by many typical multiple choice questions, very short, short and long type questions for the benefit of the students. We are confident that the students will find the book extremely helpful. No originality is claimed in the subject, rather literature from different sources have been referred to and collected. The authors owe to the original thinkers. Despite our best efforts, errors still might have remained undetected. We, therefore, invite constructive suggestions which would be instrumental in further improving our work in the next edition. We express our deep sense of gratitude to Prof. (Dr.) Girija Prasad Acharya, former Principal, Ravenshaw College (now Ravenshaw University), Cuttack and former Director, Odisha State Bureau of Textbook Preparation and Production, who has taken pains in reviewing the manuscript thoroughly and making necessary modifications. The authors are indeed thankful to the Council of Higher Secondary Education, Odisha for giving an opportunity to prepare the manuscript and the Odisha State Bureau of Textbook Preparation and Production, Bhubaneswar for timely publication of the book. We are also thankful to all persons associated with the publication of this book in its present form. Board of Writers  CONTENTS CHAPTER TITLE PAGE 1. Definition, Meaning, Types of Functions of Commercial Bank 1 2. Income Statement and Balance Sheet of Commercial Bank 25 3. Credit Creation and Role of Commercial Banks in a Developing Economy 41 4. Central Banking 61 5. Innovative Banking 87 6. Risk and Insurance 115 7. Fundamentals of Insurance 125 8. Basic Insurance Concepts 136 9. Insurance Contracts and Fundamental Principles of Insurance 146 10. Insurance Act and IRDA 156 11. Life Insurance 164 12. Policy Conditions 178 13. Premium Components & Computation 187 14. Mortality Table 196   SYLLABUS BANKING AND INSURANCE +2 1st Year Commerce 4th ELECTIVE (PAPER-I) Objectives  To provide students an understanding of the Concept, functions, typ+es and role of commercial bank with their credit creation policy;  To help the students in learning functions of commercial bank and methods of credit control;  To enable students to learn the concept and types of innovative banking;  To make the students able to know the concept, functions, types and principles of Insurance;  To help students understand the concept, importance, process of effecting a life insurance policy along with its types;  To enable the students to learn the concepts of various types of insurance like Marine, Fidelity, Crops, Motor and Credit Insurance Course Inputs Unit-I : Commercial Banking Meaning and Functions of Commercial Banks, Types of Commercial Banks, Income Statement and Balance Sheet of a Commercial Bank, Credit Creation, Portfolio Management and Nationalisation of Commercial Banks, Role of Commercial Banks in a Developing Economy. Unit-II : Central Banking Central Bank- Functions, Methods of Credit Control, Quantitative Control, Bank Rate, Open Market Operations, Cash Reserve ratio and Selective control. Innovative Banking- Merchant banking, Consortium Approach, Credit Card Facilities, On- Line Banking, Telephone Banking, Internet Banking, ATM cum Debit Card, E-Banking and Social Responsibilities of Banks. Unit-III : Introduction to Insurance Risk - Its classification and how to deal with it, Insurance-Meaning, Definition and Mechanism of Insurance, Functions of Insurance, Basic Concepts, Double Insurance, Re-insurance, Co- insurance, Insurance Market) Insurance Contract, Contingent Contract, Wagering.Contract, Fundamental Principles of Insurance Contract, Insurance Act and Role of IRDA. Unit-IV : Life Insurance & Other Insurances Life Insurance : Element of protection and investment, Importance of Life Insurance, Procedure of effecting a Life Policy, Premium computation including Mortality table, Various Policy conditions,   Banking and Insurance 1 CHAPTER - 1 DEFINITION, MEANING, TYPES AND FUNCTIONS OF COMMERCIAL BANK STRUCTURE 1.1 Introduction 1.2 Evolution of Commercial Banking– A global view. 1.3 Evolution and Growth of Commercial Banking in India 1.4 Definition, Meaning and Features of Commercial Bank 1.5 Types of Commercial Bank 1.5.1 On the basis of Inclusion in Schedule 1.5.2 On the basis of Ownership 1.5.3 On the basis of place of Registration 1.6 The State Bank Group and Other Nationalised Commercial Banks 1.7 Regional Rural Banks 1.8 Co-operative Banks 1.9 Functions of Commercial Bank 1.9.1 Primary Functions 1.9.2 Secondary Functions Questions 1.1. INTRODUCTION : Perhaps very few man made economic institutions worldwide have proved so much powerful as effective instruments of socio-economic transformations or catalysts of socio-economic growth as the banking institutions have. In the spheres of finance, they function as the main arteries and veins chanelising flow of finance from the sources where they are available to the point where they are much needed for optimal productive utilization. They render varieties of  2 Banking and Insurance money related services to almost every sections of the society - be they individuals or institutions like business houses, industrial undertakings Governmental bodies or international agencies. So powerful are these institutions that the overall health and strength of the economy of a nation is always linked and correlated with the health and strength of its banking system. The banking institutions, in short, are universally recognised in modern economies, as the most powerful growth catalysts or propellers of economic growth and development. The recent global slowdown in economic growth which created a worldwide shock-wave had its origin in the banking performance and it vochsafes the commanding influence of banking system on the economy of nations. 1.2. EVOLUTION OF COMMERCIAL BANKING – GLOBAL VIEW A systematic glance at the evolution of the banking global scenario depicts five successive stages. In the first stage, it was the merchant banker who first introduced the system of banking by way of facilitating remittances in trading commodities. As these trading activities required remittance of money from one place to another, they issued 'hundies' to remit funds. In our country this role of merchant banking was played by a category of persons known as 'seths'. The impetus for the second stage of growth of banking came from goldsmiths. The goldsmiths were, as a basic need of their profession, in possession of safe and strong rooms. Their basic duty was to take special precautions against theft of valuables like gold, bullion, money made of gold and silver coins and jewellery of people and merchants. In lieu of this, the goldsmiths received some money and issued receipts which later on acquired the status of bank notes or a cheque which served as a medium of exchange and a means of payment. Further, the gold and silver coins had no mark of the owner. Hence, the goldsmiths started lending out such money to the needy which subsequently proved profitable for them. The third stage in the growth of banking can be attributed to the money lenders. The goldsmiths who indulged themselves in accepting valuable and money and lending them out found the business to be profitable. Therefore, they started advancing coins on loan by charging interest. This became a regular feature. Regular accounts were maintained and passbooks were also issued. In due course, the goldsmiths started lending money to the government. Thus, the goldsmith- money-lender became a banker who started performing the two most important functions of modern banking i.e., accepting deposits and advancing loans. The fourth stage of growth in banking sector was demand driven. With population increasing, trade and commerce expanding, the demand for more loans and safe keeping of savings increased. This gave rise to the development of a more developed form of money handling institutions  Banking and Insurance 3 known as modern banking institutions. The first modern bank called the 'Bank of Venice was established in Venice, Italy in 1157 to finance the monarch in his wars which is recognised as the oldest commercial bank in the world. The bankers of Lombardy were famous in England. But modern banking in true sense only began with the Bank of England established in 1694. Banks in many countries in Europe came into existence on the pattern of the banks in England which led to the spread of modern banking system all over the world. However, the growth of joint stock company based commercial banks started only after the enactment of Banking Act in 1833 in England. The latest stage of growth and development may be regarded as electronic driven banking stage or e-banking stage which characterised extensive use of modern electronic gadgets. 1.3. EVOLUTION AND GROWTH OF COMMERCIAL BANKING IN INDIA Indigenous banking is an old tradition in India. The evidence of money lending operations can be traced to Vedic times. The Manu Sanghita of Saint Manu contained enough references regarding credit transactions. Similarly, Kautilya's Arthashastra had also enough indications about credit operations. Hundies, the indigenous version of modern 'Bills of Exchange' came to be used in the 12th century which is clearly evidenced from the writings of a few Muslim historians, European travellers and different state records. Thus, the indigenous bankers in different forms used to be the only players that continued till the Britishers entered into the field through English Agency Houses established at Calcutta and Bombay (presently Kolkata and Mumbai). These 'Agency Houses' paved the way for establishing joint stock banks in India. Bank of Hindustan was established in 1770 by the Calcutta based English Agency House which failed in 1782 with the closure of the agency house. Three presidency banks viz, Bank of Calcutta (1806), Bank of Bombay (1840), Bank of Madras (1843) were established in subsequent years with gaps of time. These three banks were, however, merged together to form the Imperial Bank of India in 1921 which was later nationalised in 1955 and named as State Bank of India. However, the first bank which was established with Indian ownership and management was the Oudh Commercial Bank formed in 1881 followed by Ajodhya Bank in 1884, the Punjab National bank in 1894 and Nedungadi Bank in1899. Many other banks like Allahabad Bank (1865), Bank of India (1906) Indian Bank (1907), Bank of Baroda (1909), Central Bank of India (1911) came into existence. However, Indian Banking system experienced a series of crisis and witnessed failure of a number of banks more so in the post world war - I period. Therefore, the Reserve Bank of India was established in 1935 to function as the Apex Central Bank of India to regulate and to  4 Banking and Insurance control the banking system in India. With a view to laying a strong foundation for a sound banking system in the country, the Banking Companies Regulations Act was passed in 1949. The entire banking scenario till 1968, however, was mostly class based and not mass based with little importance given for the growth and development needs of the country. Therefore, to make them mass based and development oriented and more specifically to use them as effective instruments for financing priority sector, twenty of the private owned big commercial banks were nationalised (14 banks in 1969 and 6 banks in 1980). The years 1991 and also the period thereafter, however, proved to be a turning point for commercial banks in India, as a fall out effect of the recommendation of a high level committee headed by Mr. M. Narasimham. This phase is referred as second banking revolution phase. Varieties of new reforms were introduced during this phase, the important ones being permission for establishment of private banks, more operational freedom to banks, varieties of other structural reforms. With the changes made, the banking scene in the country has totally transformed. The banks have not only grown in size but they have also became robust by changing their scope and ambit of functioning and integrating themselves with the global changes. 1.4. DEFINITION, MEANING AND FEATURES OF COMMERCIAL BANK : As has already been explained earlier, banks are classified into different categories principally depending upon their ownership pattern, the clients they mostly serve and the nature of finance they provide. One such broad classification is Industrial Banks and Commercial Banks. Banks which mostly deal with long-term financial needs of the industrial and commercial organisation are categorised as Industrial Banks and banks which generally deal with short term and medium- term credits mostly out of the deposits mobilised by them from individual and institutional customers, are classified as Commercial Banks. Commercial banks have been defined in different ways as explained below : Crowthey defines it as an institution ‘‘that collects money from those who have to spare or who are saving it out of their income and lends the money so collected to those who require it.’’ F. Agger states that ‘‘The term bank is ordinarily applied to an institution which receives deposits of money or of credit and which seeks profit through the extension or sale of its own credit.’’ The Banking Regulation Act 1949 which was enacted to regulate banking system in India although does not provide a direct definition of commercial banks but it defines in a very comprehensive way explaining what banking means and what may come under other forms of business of banking.  Banking and Insurance 5 Under Sec. 5(b) it is provided that "banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise". Under Sec. 6 it is provided that in addition to the above, other functions as mentioned below (only a few major activities mentioned here as illustrations) would also be regarded as banking business: borrowing or raising of money carrying on and transacting every kind of guarantee indemnity business granting and issuing of letters of credit,, travelers' cheque and circular notes providing safe deposit of valuables collecting and transmitting money and securities managing, selling and realizing any impurity which may come into its possession in satisfaction of its claims acquiring, constructing and maintaining any building for its own purposes. Acting as agents for any Government, Local authority, or any other Person or persons Do all such things which are incidental or conducive to the promotion or advancement of the business of the company etc. In the light of the above definitions, Commercial Banks can be simply defined as financial institutions routinely engaged in granting short and medium term loans and advances to individuals and institutions out of the resources they mobilise from public in different forms of deposits and also in carrying on all such other activities which are incidental and conducive to the promotion or advancement of the business. They thus perform the role of intermediaries between the depositors and borrowers. ESSENTIAL FEATURES OF COMMERCIAL BANKS The following are the main features of Commercial Banks : 1. They are financial institutions enjoying legal entity being duly registered under the Companies Act if privately owned or incorporated under special Acts of Parliament if they are public owned or public sector banks. 2. They are primarily concerned with accepting deposits and advancing loans to the public.  6 Banking and Insurance 3. They usually provide a variety of utility based services to the customers. 4. They generally provide short and medium term loans and advances. 5. They mostly cater to the credit needs of trade and industries besides meeting the needs of individual customers. 6. They cover clients across the country through their net work of branches. 7. They play a significant role as most effective instrument of Socio-Economic transformation of the nation. 1.5 TYPES OF COMMERCIAL BANKS : In our country, commercial banks can be classified into different categories depending upon the criterion of classification. On the basis of their inclusion in the Schedules maintained by RBI, they may be classified as Scheduled or Non-scheduled banks. These may be further classified as Indian or Foreign Banks depending on their place of registration, Public sector or Private sector banks on the basis of their ownership pattern and on the basis of nationalisation as Nationalised or Non-Nationalised Banks. 1.5.1. On the basis of Inclusion in Schedule (A) Scheduled Banks : All banks whose names are enlisted or included in the Second Schedule of the Reserve Bank of India Act, 1934 are called as Scheduled Banks. A bank must satisfy the following three conditions in order to be a Scheduled Bank. i) It must have a paid up capital and reserves of an aggregate value of at least Rs. Five Lakhs ii) It must satisfy the Reserve Bank of India that its affairs are not conducted in a manner detrimental to the interests of its depositors and iii) It must be a corporation or a company or a state cooperative bank and not a partnership or a single-owner firm. Scheduled Banks enjoy certain privileges like free or concessional remittance facilities through the offices of the RBI and its agents and borrowing facilities from the RBI. In return, the Scheduled banks are under obligation to (i) maintain an average daily balance of Cash reserves with the RBI which varies between 3 percent and 15 percent of their total liabilities (ii) submit periodical returns to the RBI under various provisions of the Reserve Bank of India Act. 1934 and the Banking Regulation Act. 1949.  Banking and Insurance 7 (B) Non-Scheduled Banks : Non-Scheduled banks on the other hand are those which are not included in the Second Schedule of Reserve Bank of India Act, 1934. These banks have to maintain the cash reserve requirements. But they are not required to keep them with the RBI. These banks cannot also borrow from the RBI for normal banking purposes but they may approach the RBI under abnormal circumstances like shortage of funds. 1.5.2. On the basis of Ownership (A) Public Sector Banks The public-sector bank means the banks owned, managed and controlled by Government. They constitute the dominant part of commercial banking system in India. The Government first entered into the field with the nationalisation of the then Imperial Bank of India on 1st July, 1955 and renamed it as State Bank of India. This bank has five other State Banks as its subsidiaries. In July 1969, fourteen other large banks and in 1980 six more banks were nationalised. Of this, one nationalised bank namely New Bank of India was later merged with Punjab National Bank. Thus we are having now a total of 25 such banks in the public sector. (B) Private Sector Banks Private Sector Banks are the banks which are established, managed and controlled by private parties. For starting such banks by private people, permission from RBI is absolutely necessary and when permitted, they are to operate strictly under the provisions of Act and under the control and guidance of RBI. The private sector banks started their operation after the issuance of licences by the RBI from 1994-95. ICICI Bank, HDFC Bank Ltd. IDBI Bank Ltd. etc. are the glaring examples of private sector banks. 1.5.3 On the basis of place of Registration (A) Indian Banks Banks which are incorporated in India and have their head offices in India are known as National Banks or Indian Banks. Indian banks may also have their branches abroad. The major part of banking business in India is in the hands of the Indian banks. (B) Foreign Banks Banks which have been incorporated in foreign countries and have their head offices outside India but having operational branches in India are known as Foreign Banks. They occupy a place of importance in the Indian banking industry, especially in the financing of foreign trade and  8 Banking and Insurance in the field of merchant banking i.e. underwriting and promotion of new Capital issues. All foreign banks are Scheduled banks. The following are the list of foreign banks. Foreign Banks ABN Amro Bank ABU Dhabi Commercial Bank American Express Banking Corporation Antwerp Diamond Bank AB Bank Bank International Indonesia Bank of America Bank of Bahrain & Kuwait Bank of Ceylon Bank of Nova Scotia Bank of Tokyo Mitsubishi UFJ Barclays Bank BNP Paribas Calyon Bank China Trust Commercial Bank DBS Bank Deutsche Bank Hongkong & Shanghai Banking Corporation 1.5.4 On the basis of Nationalisation (A) Nationalised Banks When Banks owned and managed by the private entities are taken over by the Government under its control and management they are called as Nationalised Banks. As stated earlier, the first privately owned bank namely The Imperial Bank of India was nationalised in 1955 followed by 14 such private banks in 1969, 6 more in 1980 and 1 in 2003. (B) Non-Nationalised Banks Banks which are established, controlled and managed by private parties or entities but are controlled and regulated by the RBI are called Non-Nationalised or Private Sector Banks.  Banking and Insurance 9 1.6. THE STATE BANK GROUPAND OTHER NATIONALISED COMMERCIAL BANKS : This group comprises of State Bank of India and its five subsidiaries. In 1955 the Government of India nationalised the then Imperial Bank of India to form SBI under SBI Act of 1955. Most of the shares of the bank are held by RBI and Central Government. Later on in 1959, the State Bank of India (Subsidiary Bank) Act was passed enabling SBI, to take over 8 princely state associated banks, as its subsidiaries. After the merger of two associated banks (State Bank of Jaipur and State Bank of Bikaner into State Bank of Bikaner and Jaipur) the number reduced from eight to seven. Again, during the later part of last decade, two more associate banks namely State Bank of Indore and State Bank of Saurashtra were merged with SBI further reducing the number of associates to five. The name of five associate banks are : 1. State Bank of Bikaner and Jaipur 2. State Bank of Hyderabad 3. State Bank of Mysore 4. State Bank of Patiala 5. State Bank of Travancore The other nationalised banks consist of a total number of 20 banks. The Government of India passed Banking Companies Amendment Act (Acquisition and transfer of undertaking) and nationalised fourteen major commercial banks in July 1969. Subsequently, in 1980 the Government nationalised another six bank having deposits more than Rs. 200 crores than making the total to twenty. But, in 1990 New Bank of India was merged with Punjab National Bank. Hence, the total number was reduced to nineteen. Again inclusion of IDBI Bank in the nationalisation list during 2003 increased the total number to twenty. The followings are the nationalised commercial banks in India : A) Nationalisation of Banks in 1969 1. Central Bank of India 2. Bank of India 3. Punjab National Bank 4. Bank of Baroda 5. UCO Bank  10 Banking and Insurance 6. Canara Bank 7. United Bank of India 8. Dena Bank 9. Syndicate Bank 10. Union Bank of India 11. Allahabad Bank 12. Indian Overseas Bank 13. Indian Bank 14. Bank of Maharashtra B) Nationalisation of Banks in 1980 1. Andhra Bank 2. Corporation Bank 3. Oriental Bank of Commerce 4. Punjab & Sind Bank 5. Vijaya Bank 6. New Bank of India* (* This bank was merged with Punjab National Bank in 1990) C) Nationalisation of Banks in 2003 1. IDBI Bank 1.7 REGIONAL RURAL BANKS : The Regional Rural Banks (RRBs) the newest form of banks, came into existence in the middle of 1970s (sponsored by individual nationalised commercial banks) with the enactment of Regional Rural Banks Act, 1976. The basic objective of government was to develop rural economy by providing credit and deposit facilities for agriculture and other productive activities of all kinds in rural areas. The emphasis is on providing such facilities to small and marginal farmers, agricultural labourers, rural artisans and other small entrepreneurs in rural areas. In our state, Odisha Gramya Bank and Utkal Gramya Bank serve this purpose. Odisha Gramya Bank is operating in east and northern part of the state consisting 13 districts and Utkal Gramya Bank in 17 balance districts. There is a proposal to merge both the RRBs and to operate under one name and administrative control all over the State.  Banking and Insurance 11 Other special features of these banks are : i) Their area of operation is limited to a specified region, comprising one or more districts in any state; (ii) their lending rates cannot be higher than the prevailing lending rates of cooperative credit societies in any particular state; (iii) the paid-up capital of each rural bank is Rs. 25 lakhs, 50 percent of which has been contributed by the Central Government, 15 percent by State Government and 3.5 percent by sponsoring public sector commercial banks which are also responsible for actual setting up of the RRBs. These banks are helped by higher-level agencies. The sponsoring banks lend them funds and advise and train their senior staff. The NABARD (National Bank for Agriculture and Rural Development) gives them short-term and medium-term loans. The RBI has kept CRR (Cash Reserve Requirements) for them at 3% and SLR (Statutory Liquidity Requirement) at 2.5% of their total net liabilities, whereas for other commercial banks, the required minimum ratios have been varied over time. 1.8. COOPERATIVE BANKS : Cooperative banks are so-called because they are organised under the provisions of the Cooperative Credit Societies Act of the states. The major beneficiary of the Cooperative Banking is the agricultural sector in particular and the rural sector in general. The cooperative credit institutions operating in the country are mainly of two kinds : agricultural (dominant) and non-agricultural. There are two separate cooperative agencies for the provision of agricultural credit: one for short and medium-term credit, and the other for long- term credit. The former has three tier and federal structure. At the apex is the State Co-operative Banks (SCBs), at the intermediate (district) level are the Central Cooperative Banks (CCBs) and at the village level are Primary Agricultural Credit Societies (PACSs).Long-term agriculture credit is provided by the Land Development Banks (LDBs). It has a two tier structure with State Land Development Bank (SLDB) as the apex bank at state level and Primary Land Development Banks (PLDBs) operating at village levels. The funds of the NABARD meant for the agriculture sector actually pass through SCBs and SLDBs. Originally based in rural sector, the cooperative credit movement has now spread to urban areas also and there are many urban cooperative banks coming under SCBs. 1.9. FUNCTIONS OF COMMERCIAL BANK Banks were originally established to discharge the basic function of accepting deposits for the purpose of giving loans. But in course of time they have assumed greater responsibilities and  12 Banking and Insurance the functions performed by them have multiplied. The functions of a bank may be broadly divided into two categories as Primary functions and Secondary functions. 1.9.1 Primary Functions : Acceptance of deposits in various forms, granting of loans and advances for variety of purposes and investment of funds in securities constitute the primary functions of a commercial bank. However in modern economies, creation of credit and transactions in foreign exchange are also treated as primary functions of such banks. The various primary functions of a commercial banks viz. (A) Acceptance of Deposits, (B) Granting of Loans and Advances and (C) Investment of funds are discussed as under : (A) Acceptance of Deposits It is important to note that commercial banks mostly generate resources for lending purposes through the collection of deposits from public. Hence to mobilise the maximum possible deposits, the banks provide wide scope for various types of deposits to suit the needs and expectations of various types of customers. One of the primary functions of all commercial banks is to accept deposits of money from the public. The deposits accepted by such banks may be broadly classified into (a) Demand Deposits (b) Time Deposits. (a) Demand Deposits : Such deposits are withdrawable on demand and thus no prior notice for withdrawal is needed. Deposits in savings accounts or saving deposits and deposits in current accounts or current deposits come under this category as discussed below : i) Savings Bank Deposit : This deposit can be opened with a very small amount. Money in the savings account can be withdrawn at will but there are certain limitations on the total number of withdrawals per week. The rate of interest on this deposit is higher than current deposit but less than fixed deposit. By mobilising small amounts from large number of individuals through savings bank deposits, banks are able to gather huge amount of funds. Such types of deposits are more popular with the people belonging to lower and middle income groups who wish to save a part of their unspent income to meet their future needs and also intend to earn an income from their savings. ii) Current Account Deposits : It is also known as Demand Deposit as the deposited amount is payable on demand. Such accounts suit the requirements of business houses, public institutions and authorities as they require numerous transactions on every working day. There are no limitations on the amount to be deposited and on times of withdrawals. It can be operated upon any number of times during a working day. The bank, however, opens this account only  Banking and Insurance 13 after satisfying itself about the credit worthiness of the customer. Normally no interest is paid on current deposit, but overdraft facilities are provided. (b) Time Deposits : Such deposits are only withdrawable on the expiry of the period pre-fixed at the time of deposits although there is also provision for withdrawal earlier with loss of interest. Fixed deposits, recurring deposits are included in such category which are discussed below : i) Fixed Deposits : A fixed deposit, also known as Term Deposit, is one where a customer keeps a specific amount with the bank for a fixed period. Fixed deposit holder gets interest on the deposit for that period. In case the depositor withdraws before the completion of the stipulated period, he loses interest earned on that deposit. The rate of interest on the fixed deposits is the highest compared to other forms of deposits. ii) Recurring Deposits or Cumulative Deposits : In this type of deposit, the depositor is required to deposit regularly a fixed amount generally a multiple of Rs. 5 or Rs. 10 once in every month for a specified number of years. The depositor gets the principal amount along with interest after the expiry of that specified period. The rate of interest offered on these deposits is generally the same as that offered on fixed deposits. (B) Granting of Loans and Advances This constitutes another most important function of commercial banks and a major portion of the banks' funds is used for giving loans and advances. The interest earned on such loans and advances constitute the major source of earning and profits for banks. Classification of Loans and Advances The loans and advances are classified on period basis as Short-term, Medium-term and Long-term loans. On the basis of securities, they are classified as Secured loans which means loans backed or supported by property or personal guarantee as security and Unsecured loans with no need for any security. Purpose-wise they are classified as trading / business loans, industrial loans, agricultural loans, consumption loans, loans and advances for priority sectors or export and import loans. Form of Loans and Advances Banks grant loans and advances in the following forms : Overdraft : It means over drawing or drawing more money than one has in his account with the bank. It is thus an arrangement by which the borrower is allowed to withdraw more  14 Banking and Insurance money than what he/she has deposited. It is a short-term facility extended by the bank to some of its trusted business customers who are having current account only. Interest is charged by the bank on the exact amount of overdraft and for the period the amount actually overdrawn. The bank may demand some collateral security or allow overdrafts on the personal security of the borrowers. Cash Credit : It means permission to draw cash upto a certain limit fixed by bank known as cash credit limit and it is fixed on an annual basis. Such facility is granted against the security of goods or personal security of one or more persons other than the principal borrower. Cash Credit limit is fixed on the basis of volume of sales, amount of transactions with the bank, stock of inventory etc. Once the amount of cash credit is sanctioned, payment is not made in the form of cash rather the amount is credited to the customer's account. The peculiarity of this loan is that the bank can withdraw the facility or reduce the sanctioned limit whenever it likes. Interest is charged only on the amount made use of by the customer under this arrangement. In India, this is the main method of lending and it accounts for more than 70 percent of total bank credit. Direct Loans : It means giving of loans directly to the borrowers for a definite purpose and for a pre-determined period. Such loans are granted against security of movable properties or on personal securities. Borrower has to pay interest on the entire amount of loan sanctioned from the date of taking the loan till the time of repayment. Such loans may be granted in the form of short-term, medium-term or long-term loans. Discounting of Bills : It is yet another way of providing loan under which bills before maturity are kept by the bank and the amount mentioned in the bill is paid deducting a certain amount known as discount. If trade bills are allowed by banks for discounting, they are called bills discounted. (C) Investment of funds : Banks also employ a significant portion of their funds in different types of securities which generate huge returns for the banks. In fact, over the years the investments in total assets of the commercial banks has grown remarkably. In the balance sheets, banks' investment in securities are shown under the following six heads :- i) Government securities ii) Other approved Securities iii) Shares iv) Debentures and Bonds  Banking and Insurance 15 v) Subsidiaries and Joint ventures vi) Others (Certificate of Deposits, Mutual Funds etc.) 1.9.2 Secondary Functions For the convenience of customers, banks perform a lot of non-banking functions called secondary functions These functions are - Agency services, Public utility services and E-Banking services. (A) Agency Services : Various functions performed by a banker as an agent on behalf of the customers, whenever duly authorised, are called agency services. The agency services include collection of cheques / drafts, payments, sale and purchase of securities, trustee executor and attorney, and correspondence on behalf of the customers. i) Collections : Commercial banks when requested take up collection of cheques, bills, dividends, promissory notes, subscriptions, rents on behalf of their customers as agents. The bank charge 'services charges' for providing these services to the customers. ii) Payments : Banks also accept the responsibility to pay insurance premium, rents, taxes electricity bills periodically on behalf of their customers for which they charge commission. iii) Sale and purchase of securities : Customers sometimes approach the bankers for sale and purchase of their securities. For these services the banks charge commission. iv) Trustee, executor and attorney : Banks act as trustees, executors and attorney on behalf of their customers. As a trustee, the banker takes care of funds of the customers, helps in proper management of trust. As executor it carries out the desires of the deceased customer in terms of the will left by him. As an attorney, the banker signs transfer form deeds and documents on behalf of the customer. v) Correspondence : Banks serve as correspondent agents or representatives of their customers and in that capacity they may write letters, serve notices, reminders etc. on their behalf. vi) Executing Standing Instructions : Sometimes, customer may direct his banker to make specific amount of payments to certain persons or institutions in a regular time interval like payment of insurance premium, loan installment, house rent etc. The written order is called standing instruction. The bank being the agent of its customer executes the standing instructions.  16 Banking and Insurance vii) Acting as Tax Consultant : Commercial bank when requested acts as tax consultant to its client. The prepares general sales tax return, income tax return, etc. and also files the same with tax authorities. viii) Portfolio Management or Merchant Banking Services : They can asct as issue managers, lead managers and under writer of issues. ix) Special Purpose Vehicle (SPV) services are also provided for scrutinisation of assets under Securitization & Reconstruction of Financial Assets and Enforcement of Security Interest Act. (B) Public or General Utility Services Commercial banks render various services useful to the customer. These services include issuing letters of credit, providing draft facilities, underwriting, giving guarantee for deferred payments, providing locker facilities, references, business and statistical information and facilitating foreign exchange dealings. i) Letters of Credit : Banks issue Letters of credit to their Customers. These are useful to traders to buy goods from foreign countries on credit as through letters they certify the credit worthiness of their customers. ii) Draft Facilities : Banks issue drafts to customers and enable them to transfer funds from place to place. iii) Underwriting : Banks underwrite share capital and debenture capital, raised by Government and Joint stock companies, thereby provide them relief from the tension of raising funds. iv) Guarantee for Deferred Payments : Importers may not be in a position to pay for their imports immediately. Exporters in such cases may allow them to pay in future but only if the payment is guaranteed. In such cases banks may give guarantee for deferred payments to the exporters. v) Locker Facility : Banks provide locker facility to customers to keep their valuables like securities, jewellery and documents. vi) Referee : Banks serve as referee for unifying the financial standing and business reputation and honesty and responsibility of their customers. vii) Business and statistical information : Banks collect and classify information regarding different aspect and issues of trade, commerce and industry and provide the same to their  Banking and Insurance 17 customers. Some banks also publish bulletins, journals etc. other form of information for use by the customers as well as the general public. viii) Consultalcy services & payment of pensions : When requested, banks also provide consultancy services and undertake the responsibilities of disbursing pensions. (C) E-Banking Services Indian banking industry, today is in the midst of an IT revolution. A combination of regulatory and competitive reasons has led to increasing importance of total banking automation in the Indian banking industry. Information Technology has basically been used under two different avenues in banking. One is Communication and Connectivity and other is Business Process Reengineering. 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. The bank which used the right technology to supply timely information will see productivity increase and thereby gain a competitive edge. To compete in an economy which is opening up, it is imperative for the Indian banks to observe the latest technology and modify it to suit their environment. Banks need greatly enhanced use of technology to the customer friendly, efficient and competitive services. They also need technology for providing newer products and newer forms of services in an increasingly dynamic and globalise environment. Information technology offers a chance for banks to build new systems that address a wide range of customer needs including many that may not be imaginable today. Following are the innovative e-banking services offered by different banks in the recent past : i) Electronic Payment Services - E Cheques Nowadays we are hearing about e-governance, email, e-commerce, e-tail, etc. In the same manner, a new technology is being developed in US for introduction of e-cheque, which will eventually replace the conventional paper cheque. India, as harbinger to the introduction of e-cheque, the Negotiable Instruments Act has already been amended to include, Truncated cheque and E-cheque instruments. ii) Real Time Gross Settlement (RTGS) Real Time Gross Settlement system, introduced in India since March 2004, is a system through which electronics instructions can be given by banks to transfer funds from their account to the account of another bank. The RTGS system is maintained and operated by the RBI and provides a means of efficient and faster funds transfer among banks facilitating their financial  18 Banking and Insurance operations. As the name suggests, funds transfer between banks takes place on a 'Real Time' basis. Therefore, money can reach the beneficiary instantaneously and the beneficiary's bank has the responsibility to credit the beneficiary's account within two hours. iii) Electronic Funds Transfer (EFT) Electronic Funds Transfer (EFT) is a system whereby anyone who wants to make payment to another person / company etc. can approach his bank and make cash payment or give instructions / authorization to transfer funds directly from his own account to the bank account of the receiver / beneficiary. Complete details such as the receiver's name, bank account number, account type (savings or current account), bank name, city, name of the branch etc. should be furnished to the bank at the time of requesting for such transfers so that the amount reaches the beneficiaries account correctly and faster. RBI is the service provider of EFT. iv) Electronic Clearing Service (ECS) Electronic clearing services is a retain payment system that can be used to make bulk payments / receipts of a similar nature especially where each individual payment is of a repetitive nature and of relatively smaller amount. This facility is meant for companies and government departments to make / receive large volumes of payments rather than for funds transfer by individuals. v) Automatic Teller Machine (ATM) Automatic Teller Machine is the most popular device in India, which enables the customers to withdraw their money 24 hours a day 7 days a week. It is a device that allows customer who has an ATM card to perform routine banking transactions without interacting with a human teller. In addition to cash withdrawal, ATMs can be used for payment of utility bills, funds transfer between accounts, deposit of cheques and cash into account, balance enquiry etc. vi) Point of Sale Terminal Point of Sale Terminal is a computer terminal that is linked online to the computerised customer information files in a bank and magnetically encoded plastic transaction card that identifies the customer to the computer. During a transaction, the customer's account is debited and the retailer's account is credited by the computer for the amount of purchase. vii) Tele Banking Tele Banking is a concept of providing 24 hours entire non-cash related banking services to the customers on telephone. Under this system Automatic Voice Recorder is used in the bank  Banking and Insurance 19 computers for simpler queries and transactions. The caller generally a customer of the bank will be able to call the bank anytime and inquire balances or transaction history, and to transfer funds between accounts. In this system computer, at the bank end is connected to a telephone linked with modem. The voice processing facility provided in the software identifies the caller, by key word and provides him services with suitable reply whenever necessary. viii) Online Banking It is a system of banking which facilitates a customer to monitor the performance of portfolio, movement of savings and current accounts, view market dynamics, do scenario analysis, run queries and execute transactions on a real time basis. All these facilities can be available anytime, anywhere in houses, offices and while a person is on move even with an internet connection to PCs and laptops. ix) Mobile Banking The services provided under online banking system are also available under a system called 'Mobile Banking' in mobile telephones. The biggest limitation of online banking is the requirement of a PC/laptop or access to a computer terminal is addressed through this service. The explosive growth of mobile users in India is the main reason that Mobile Banking scores over Online Banking which enables customers 'Anytime Anywhere Banking'. x) Electronic Data Interchange (EDI) Electronic Data Interchange is the electronic exchange of business documents like purchase order, invoices, shipping notices, receiving advices etc. in a standard, computer processed, universally accepted format between trading partners. Both EDI and e-mail involve the transmission of electronics messages between computer systems but the content of an e-mail message is not intended to be processed in any way by the receiving system, whereas EDI messages are intended for and are therefore structured for automated processing. EDI can also be used to transmit financial information and payments in electronic form thus brings significant benefits to the organisations.   20 Banking and Insurance QUESTIONS No. 1. Form the given alternatives choose and write serially the correct answer: i) The first stage of evolution of banking is : a) Merchant Banker b) Goldsmith, c) Goldsmith accepting valuables d) None of these ii) The name of the State Bank of India prior to its nationalisation was : a) Bank of Bombay b) Bank of Hindustan c) Bank of Madras, d) Imperial Bank iii) The Reserve Bank of India was established in the year : a) 1921 b) 1934 c) 1935 d) 1955 iv) The most ancient bank in the world is : a) Bank of Venice b) Bank of England c) Bank of Bombay d) Bank of Calcutta v) ABN Amro Bank is a a) Public Sector Bank b) Private Sector Bank c) Foreign Bank d) None of the above vi) Fixed deposit is otherwise known as : a) Term Deposit b) Demand Deposit c) Savings Deposit d) Current Deposit vii) The main source of funds for a bank is : a) Acceptance of deposit from public b) Borrowings from public c) Borrowings from other banks d) Borrowings from Govt. viii) RTGS stands for : a) Real Time Goods Settlement b) Real Time Gross Settlement c) Real Trade Goods Settlement d) Real Time Goods Security ix) The bank which is not an associate of SBI is : a) State Bank of Mysore b) State Bank of Patiala c) State Bank of Hyderabad d) State Bank of Bengaluru  Banking and Insurance 21 (x) HDFC Bank Ltd. is a : a) Nationalised Bank b) Public Sector Bank c) Private Sector Bank d) None of these (xi) Which of the followings is a regional rural bank of Odisha : a) Bhubaneswar Gramya Bank b) Utkal Gramya Bank c) Jagannath Gramya Bank d) None of these (xii) ATM stands for : a) Automatic Teller Machine b) Automatic Tailoring Machine c) Autocratic Tailor Machine d) None of these 2. Fill in the blanks with appropriate words : a) The English Agency Houses established__________banks in India. b) Imperial Bank of India was formed in the year_________. c) The first commercial bank with Indian ownership was_________formed in 1881. d) In the year________the Reserve Bank of India was formed. e) IDBI Bank was nationalised in the year_________. f) Generally commercial banks provide _________ and _________ term loans to its customers. g) All schedule banks are included in_________schedule of the RBI Act. h) BNB Paribas is an example of__________bank. i) In1959 SBI has taken over _______ numbers of princely state associated banks. j) Union Cabinet in June, 2016 has approved to merge all________banks of SBI and Bharatiya Mahila Bank with SBI. k) Odisha Gramya Bank and_________are the regional rural banks in the State of Odisha. I) Acceptance of deposits comes under________functions of commercial banks. 3. Correct the underlined words in the following sentences : a) Bank of Calcutta, Bank of Bombay and Bank of Madras were merged to form Reserve Bank of India.  22 Banking and Insurance b) Punjab National Bank was formed in the year 1955. c) The name of Central Bank in India is State Bank of India. d) In the year 1969 the Banking Companies Regulation Act was passed e) Prior to 1969 the focus of commercial banks was mostly mass based. f) Commercial Banks are primarily concerned with accepting deposits and advancing of gold coins. g) On the basis of place of registration banks were classified as public sector and private sector banks. h) The bank incorporated in India but operating abroad through its branches is called as foreign bank. i) The State Bank of Indore was merged with State Bank of Patiala in 2008. j) During 1980, 10 leading commercial banks were nationalised by the Govt. of India. k) Current Account deposits normally carry a high rate of interest. l) Overdraft facility given by a commercial bank to its customers having Savings A/c. 4. Answer the following questions in not more than two sentences each : a) Define a 'Bank'. b) What do you mean by general utility functions of a bank? c) What is cash credit? d) Which banks are the associates of State Bank of India? e) Name those banks merged to form Imperial Bank of India? f) Name any three commercial banks operating in India. g) What is meant by Indian Bank? h) Mention in which area of our State Utkal Gramya Bank is operating. i) What do you mean by 'Bank Overdraft'? j) State the meaning of 'Underwriting'.  Banking and Insurance 23 k) What is the meaning of term 'hundi' ? l) Write any two features of commercial bank. m) State what is 'time deposit'. n) Name any three types of loans and advances given by the banks. o) What is meant by 'mobile banking' ? p) Write what is 'online banking'. 5. Answer the following questions in not more than six sentences each : a) State the agency functions of a bank. b) What was the role of goldsmith in the evolution of banks? c) Explain the meaning of savings bank deposit.. d) What is letter of credit ? e) Name the banks which were nationalised in 1980. f) Write any six names of foreign banks operating in India. g) Write a note on cash-credit system of lending money. h) Distinguish between scheduled and non-scheduled bank. i) Discuss the meaning of Electronic Data Interchange (EDI). j) Explain what is Electronic Funds Transfer (EFT). k) Make a distinction between time deposits and demand deposits. l) Write a note on co-operative bank. m) State the basis on which the commercial banks are classified in our country. n) Explain the importance of e-banking services. LONG TYPE QUESTIONS 1. Discuss the different stages of evolution of banking in India. 2. Explain the meaning and features of a commercial bank.  24 Banking and Insurance 3. Describe in brief the primary functions of a commercial bank. 4. Briefly discuss various secondary functions of a commercial bank. 5. Classify commercial banks on the basis of different criteria. 6. What e-banking ? Briefly discuss various services offered by the commercial banks under e-banking. 7. Write short notes on : (a) State Bank of India and its associates (b) Regional Rural Banks (c) Foreign Bank ANSWERS 1. (i) a (ii) d (iii) c (iv) a (v) c (vi) a (vii) a (viii) b (ix) d (x) c (xi) b (xii) a 2. (a) Joint Stock (b) 1921 (c) Oudh Bank (d) 1935 (e) 2003 (f) Short, Medium (g) Second (h) Foreign (i) 8, (j) Associate (k) Utkal Gramya Bank (l) Primary. 3. (a) SBI (b) 1894 (c) RBI (d) 1949 (e) Class based (f) Loans (g) Ownership (h) Indian Banks (i) State Bank of India (j) 6 (k) No (l) Current Account.   Banking and Insurance 25 CHAPTER - 2 INCOME STATEMENT AND BALANCE SHEET OF COMMERCIAL BANK STRUCTURE 2.1 Introduction 2.2 Income Statement or Profit and Loss Account of Commercial Bank 2.3 Balance Sheet of Commercial Bank Questions 2.1. INTRODUCTION As per Sec. 29 of the Banking Act 1949 every Banking Company incorporated in India is required to prepare the Balance Sheet and Profit & Loss Account in respect of all business transacted by it and through its branches in India as on the last working day of the Accounting year (which was earlier calender year, now it is 1st April to 31st March) in the Form A for Balance Sheet and in the Form B, for Profit & Loss Account as prescribed in the Third Schedule of the Act. The amalgamated Balance Sheet and Profit & Loss Account are required to be signed by the CMD and atleast 3 Diectors where there are more than 3 Directors or where there are not more than 3 Directors, by all the Directors. In case of Banking Company incorporated outside India, by the principal officer of the company in India. Commercial Banks are required to prepare the Profit and Loss Account and Balance Sheet at the end of one year to know the profitability and the financial position of the bank. 2.2. INCOME STATEMENT OR PROFIT AND LOSS ACCOUNT OF A COMMERCIAL BANK Every year as stated above commercial banks are required to prepare its Income Statement or Profit and Loss Account only in the prescribed format known as Form B of Schedule III attached to the Banking Regulation Act 1949. The Form B has been revised w.e.f. 1st April 1991 and since then the Profit and Loss Account of a bank for the year ending March 31, 1992, and onwards has to be prepared in the prescribed new format as given below : 26 Banking and Insurance Form 'B' Third Schedule Form of Profit and Loss Account Profit and Loss Account (for the year ended 31st March, ……) Schedule Year ended Number (Rs.) I. INCOME Interest earned 13 …… Other Income 14 …… Total …… II. EXPENDITURE : Interest expended 15 …… Operating expenses 16 …… Provisions and contingencies …… Total …… III. PROFIT / Loss …… Net Profit / (Loss) for the year …… TOTAL ____ IV. APPROPRIATIONS : Transfer to statutory reserves …… Transfer to other reserves …… Transfer to Govt. / Proposed dividend …… Balance carried over to balance sheet …… TOTAL ___  Banking and Insurance 27 Schedules to be annexed with Profit and Loss Account This Act also requires banks to prepare and attach explanatory notes in respect of every items of income and expenditure in the form of Schedules. Therefore a Schedule can be defined as a short explanatory note mentioning the different items to be included under different heads. The revised format of Profit and Loss Account therefore has two Schedules (13 and 14) in respect of incomes and two Schedules (15 and 16) in respect of expenditures as given below : SCHEDULE 13: INTERST EARNED Rs. i. Interest / Discount on advances / Bills …. ii. Income on investments …. iii. Interest on balances with RBI and other inter-bank funds …. iv. Other … TOTAL ____ SCHEDULE 14: OTHER INCOME Rs. i. Commission, exchange and brokerage …. ii. Profit on sale of investments …. Loss : Loss on sale of investments …. iii. Profit on revaluation of investments Loss : Loss on revaluation of investments iv. Profit on sale of land / building and other assets …. Loss : Loss on sale of land, Bldg. and other assets …. v. Profit on exchange transactions …. Loss : Loss on exchange transactions …. vi. Income earned by way of dividends etc. from subsidiaries / … Companies and /or joint ventures abroad / in India … vii. Misc Income … TOTAL ___ Note : Under Items II to V loss figures may be shown in brackets.  28 Banking and Insurance SCHEDULE 15 : INTEREST EXPENDED Rs. I. Interest on deposits …. II. Interest on RBI / Inter-Bank borrowings …. III. Others …. TOTAL ___ SCHEDULE 16 : OPERATING EXPENSES Rs. i. Payments to and provisions for employees …. ii. Rent, taxes and lighting …. iii. Printing and stationery ….. iv. Advertisement and publicity …. v. Depreciation on Bank's property …. vi. Directors' fees, allowances and expenses …. vii. Auditors' fees and expenses (including branch auditors) …. ix. Law charges …. x. Insurance …. xi. Other expenditure …. TOTAL ___ Note : Corresponding figures for the immediately preceding financial year should be shown in separate columns. 2.3. BALANCE SHEET OF A COMMERCIAL BANK In order to know about the financial position of a business establishment, it becomes imperative to analyse its Balance Sheet. The financial status of a bank, which is also a business establishment, is revealed from its Balance Sheet. Balance sheet of a bank depicts complete details about its assets and liabilities. It indicates the sources from which the bank collects its funds and the manner in which it deploys them. Therefore, the balance sheet is viewed as a true index of the activities, managerial prudence and solvency of the bank. The total of the liabilities matches exactly with the total of assets. As a matter of principle, the bank prepares its balance sheet at the end of each financial year and publishes it for the information of the public. It is therefore a statement of assets and liabilities of an enterprise prepared on a particular date.  Banking and Insurance 29 The Balance Sheet of a bank has to be prepared in the prescribed format known as Form A of Schedule III, attached to the Banking Regulation Act. 1949. The Form of Balance Sheet has been revised w.e.f. April 1. 1991 and a bank has to prepare its Balance Sheet in the prescribed new form for the year ending 31st March 1992, and onwards as given below : As in the case with Profit and Loss Accounts, for Balance Sheets also, there is a provision for attachment of Schedules in respect of each item of assets and liabilities. A Balance Sheet therefore has five Schedules (from 1 to 5) in respect of liabilities and seven Schedules (from 6 to 12) in respect of assets as given below : Form 'A' Third Schedule : Form of Balance Sheet Balance Sheet as on 31st March…………. _______________________________________________________________________ Particulars Schedule Current Previous Year Year CAPITAL AND LIABILITIES : Capital 1 …. …. Reserves and surplus 2 …. …. Deposits 3 …. …. Borrowings 4 …. …. Other liabilities and provisions 5 …. …. Total ___ ASSETS : Cash in hand and balance with RBI 6 …. …. Balance with banks and money at call and short notice 7 …. …. Investments 8 …. …. Advances 9 …. …. Fixed assets 10 …. …. Other assets 11 …. …. TOTAL ___ Contingent liabilities : 12 Bills for collection ….....  30 Banking and Insurance The following schedules are required to be furnished with the Balance Sheet : As in the case with Profit and Loss Accounts, for Balance Sheets also, there is a provision for attachment of Schedules in respect of each item of assets and liabilities. A Balance Sheet therefore has five Schedules (from 1 to 5) in respect of liabilities and seven Schedules (from 6 to 12) in respect of assets as given below : SCHEDULE 1 : CAPITAL Rs. I. FOR NATIONALISED BANKS : ___ Capital (Fully owned by Central Government) ….. II. FOR BANKS INCORPORATED OUTSIDE INDIA : I) Capital (the amount brought in by banks by way of start-up capital as Prescribed by RBI should be shown under this head) …. Rs. a) Amount of deposit kept with RBI under Section 11(2) of the Banking….. Regulation Act. 1949. Total ____ ….. ____ III For Other Banks Authorised Capital (….. Shares of Rs. …. Each) …….. Issued capital (…. Shares of Rs... each) ……. Subscribed capital (.. shares of Rs. … each) ……. Called up capital (…. Shares of Rs. … each) …… Less : calls unpaid Add : Forfeited shares ….. __________Schedule 2 : Reserves and Surplus Rs. I. Statutory reserves : ….. Opening balance …. Additions during the year ….. Deductions during the years ____ Banking and Insurance 31 II. Capital reserves : Opening balance ….. Additions during the year ____ Deductions during the year …… III. Share premium : Opening balance …… Additions during the year …… Deductions during the years _____ IV. Revenue and other reserves : Opening balance …… Additions during the year ….. Deductions during the year …… V. Balance in profit and loss A/c : ____…… Total (I,II,III, IV and V)_____ Schedule 3 : Deposits Rs. A. I Demand deposits : (i) From banks …… (ii) From others …. II Savings bank deposits (i) From banks …… (ii) From others.….. ______ Total (I, and II) B. (i) Deposits of branches in India …..…. (ii) Deposits of branches outside India …..… TOTAL ________ 32 Banking and Insurance Schedule 4 : Borrowings Rs. I. Borrowings in India …. (i) Reserve Bank of India …. (ii) Other banks …. (iii) Other institutions and agencies ___… II. Borrowings outside India …. Total (I and II) …. Secured borrowing in / and //above Rs.…. Schedule 5 : Other Liabilities and Provisions Rs. I. Bills payable …. II. Inter-office adjustments (net) …. III Interest accrued …. IV Others (Including provisions) …. Total ___ Schedule 6 : Cash and Balances with RBI Rs. I.Cash in hand (including foreign currency notes …. II. Balance with RBI in : (i) Current A/c … (ii) Other A/c … Total (I & II) …. Banking and Insurance 33 Schedule 7 : Balance with Banks & Money at Call and Short Notice Rs. I In India (i) Balance with banks : (a) In Current A/c ….. (b) In Other deposit A/c ….…. (ii) Money at call and short notice (a) With banks …. (b) With other institutions ….…. Total (i) and (ii) ____ II. Outside India (i) In Current A/c …. (ii) In Current A/c …. (iii) Money at call and short notice …. Total (i), (ii) and (iii) …. Grand Total (I and II) …. SCHEDULE 8 : INVESTMENTS Rs. i. Investment in India in (i) Govt. securities …. (ii) Other approved securities …. (iii) Shares … (iv) Debentures and bonds … (v) Subsidiaries and /or joint ventures … (vi) Others (to be specified … Total : ___ 34 Banking and Insurance II. Investments outside India in (i) Govt. Securities (including local authorities …. (ii) Subsidiaries and / or joint ventures abroad … (iii) Other investment (to be specified) … Total ___ Grand Total (I and II) ….. Schedule 9 : Advances Rs. A. (i) Bills discounted and purchased … (ii) Cash credits, overdrafts and loans payable on demand … (iii) Term loans … Total ___ B. (i) Secured by tangible assets …. (ii) Covered by Bank / Govt. guarantees …. (iii) Unsecured …. Total …. C. I Advances in India : (i) Priority sectors …. (ii) Public sectors …. (iii) Banks ….. (iv) Others ….. Total …. II. Advances outside India : (i) Due from banks …. (ii) Due from others : (a) Bills purchased and discounted …… (b) Syndicated loans ….. c) Others ….. …. Total : …. Grand Total (CI and CII) ….  Banking and Insurance 35 Schedule 10 : Fixed Assets Rs. I. Premises : At cost as on 31st March of the preceding years …. Additions during the year …. Deductions during the year ….. Depreciation to date …. II. Other fixed assets (incl. furniture and fixture ): At cost as on 31st March of the preceding year …. Additions during the year ….. Deductions during the year …. Depreciation to date …. Total (I and II) …. …. Schedule 11 : Other Assets Rs. Inter-office adjustment (net) ….. Interest accrued …... Tax paid in advance / tax deducted at source …. Stationery and stamps …. Non-banking assets acquired in satisfactions of claims ….. Others* …. Total …. *In case there is any unadjusted balance of loss (i.e. when the loss exceeds the aggregate of capital, reserves and surplus), the same may be shown under this item under appropriate footnote.  36 Banking and Insurance Schedule 12: Contingent Liabilities Rs. I Claims against the bank not acknowledged as debts. ….. II Liability for party paid investments ….. III Liability on account of outstanding forward exchange contracts …. IV Guarantees given on behalf of constituents : (i) In India …. (ii) Outside India …. V. Acceptances, endorsements and other obligations ….. VI. Other items for which the bank is contingently liable …. Total …. Importance of Balance sheet The true picture of bank's activities get reflected in its balance sheet. The balance sheet provides basic information about the sources of bank's funds and the avenues of their investment. The study of the balance sheet indicates as to whether the bank is able to maintain a healthy ratio between its assets and liabilities. The balance sheet not only throws light on the liquidity and solvency position of the bank, but it also indicates the extent to which the bank is able to protect the interests of its share holders, debtors and creditors. A year-wise comparison of a bank's balance sheet reveals the true picture of the growth or decay. A comparison of the balance sheets of different banks in given year indicates the real status of a particular bank in the banking system of the country. A bank’s ability to inspire the confidence of the public can also be gauged from the increase and decrease in its deposits which get reflected in the balance sheet.   Banking and Insurance 37 QUESTIONS 1. Choose the correct answer from the given alternative answers against each bit : i) Income statement of a bank is prepared to know : a) Amount of loans b) Financial position c) Profitability d) Amount of borrowings ii) Balance Sheet of a bank shows the : a) Financial position b) Total expenditures c) Gross profit d) Total income iii) The Profit and Loss Account of commercial banks are prepared in : a) Form A b) Form B c) Form C d) Form D iv) The Balance Sheet of commercial banks are prepared in : a) Form A b) Form B c) Form C d) Form D v) The format for preparing final account of a bank has been revised w.e.f. : a) 1st April 1935 b) 1st April 1949 c) 1st April 1971 d) 1st April 1991 vi) The number of Schedules shown in Profit and Loss Account of banks are : a) Four b) Six c) Seven d) Ten vii) The number of Schedules shown in Balance Sheet of banks are : a) Seven b) Ten c) Twelve d) Fifteen viii) Provisions and Contingencies are coming under the head : a) Incomes b) Expenditures c) Appropriations d) None of these ix) Profit on sale of investment of a bank is treated as : a) Other income b) Interest earned c) Income on investments d) None of these (x) In a bank Balance Sheet number of Schedules allotted for capital and liabilities are: a) Four b) Five c) Seven d) Ten  38 Banking and Insurance (xi) Customers' savings deposit amount is shown in bank Balance Sheet as : a) Asset b) Liability c) Capital d) None of these xii) The deposits by customers in a bank repayable after a specified period is known as : a) Demand deposit b) Current deposit c) Term deposit d) None of these 2. Fill in the blanks with appropriate words. a) Final account of a bank is prepared on_______of every year. b) Profit and loss account of commercial bank are to be prepared in_____of schedule III attached to Banking Regulation Act., 1949. c) Profit on sale of investment comes under schedule ____ as other income of commercial banks. d) The main source of _______ of a commercial bank is interest and dividend from investment. e) Schedule 16 of profit and loss account shows _____of a commercial Bank. f) The financial position is revealed from the_____of a bank. g) The liabilities of a bank consists of______schedules. h) The schedule I of the balance sheet shows the_____of a bank. i) Savings bank deposits comes under______in a balance sheets of bank. j) Bills payable is treated as_______of commercial banks. k) ______liabilities are not shown under the head capital and liabilities of a bank balance sheet. l) ‘Money at call and short notice’ is an item of ______ in the balance sheet of a bank. 3. Correct the underlined protions in the following sentences : a) Final account of a commercial bank consists of trial balance and balance sheet. b) The explanatory notes attached to profit and loss account and balance sheet is known as working notes. c) Profit and loss account of commercial banks contain 12 numbers of schedules. d) Schedule 15 of profit and loss account shows interest earned. e) Expenses on printing and stationary comes under interest expended in a profit and loss account.  Banking and Insurance 39 f) The assets and liabilities of a commercial bank are shown in income statement. g) Balance sheets of commercial banks are prepared in form B of schedule III attached to the Banking Regulation Act, 1949. h) The assets of a bank shown through twelve number of schedules, i) The reserves and surplus are coming under assets of a Bank, j) Borrowing from RBI and other institutions by a commercial bank are shown as assets in balance sheet. k) Bills discounted and purchased is coming under liabilities of a bank. l) Schedule -10 of a bank’s balance sheet shows loans and advances, m) Tax paid in advance comes under fixed assets of a bank balance sheet. No.4 Answer the following questions in not more than two sentences each. a) What is final account of a bank ? b) Why Profit and Loss Account of banks are prepared ? c) What is the objective of preparing Balance Sheet of a bank ? d) What is a Schedule ? e) Name the items coming under the head 'Interest Earned'. f) What is meant by appropriation of profit ? g) Write any three items of 'Operating Expenses' in an Income Statement. h) What items are included under the head 'Provisions and Contingencies' ? i) How investment in Govt. Securities are treated in a Balance Sheet ? j) Define the term 'Held to Maturity' in respect of investment in securities. k) Why Investment Fluctuation Reserve is created by the banks ? l) Explain the term 'Cash Credit' system of a bank. m) What is meant by 'Bills for Collection' ? n) Name any three types deposits accepted by the banks. No.5. Answer the following questions in not more than six sentences each : a) Write a note on Profit and Loss Account of a bank. b) Make a list of items included under the head 'Other Income'.  40 Banking and Insurance c) Show the treatment of 'Auditors' Fees and Expenses while preparing Profit and Loss Account of a bank.. d) Write a note on Investment Fluctuation Reserve. e) How 'contingent liabilities' are treated in Balance Sheet ? f) Why preparation of Balance Sheet is important for a bank ? g) Discuss the meaning of 'Bills Payable'.. h) Distinguish between Profit and Loss Account and Balance Sheet. i) What are the items included under the head 'Investment in India' as an asset in Balance Sheet ? j) Explain 'Cash Credit' system of advances given by a commercial bank. k) Make a distinction between securities 'Held to Maturity' and securities 'Held for Trading'. l) How the item 'Premises' treated in a bank's Balance Sheet ? m) Name the items coming under the head 'Contingent Liabilities' of a commercial bank. Long Type Questions 1. Discuss various expenditure items in a Profit and Loss Account of a Commercial bank. 2. What is a Schedule ? Explain Schedule 13 and 14 of a commercial bank's Income Statement. 3. What do you mean by Balance Sheet of a commercial bank ? Draw a proforma of Balance Sheet as per Banking Regulation Act. 4. Briefly discuss various items of 'Advances' (Schedule-9) in a Balance Sheet of commercial bank. 5. What is a Profit and Loss Account of commercial bank ? Distinguish its Profit and Loss Account from Balance Sheet. ANSWERS No.1. (i) c (ii) a (iii) b (iv) a (v) d (vi) a (vii) c (viii) b (ix) a (x) b (xi) d (xii) c No.2. (a) 31st March (b) Form B (c) 14 (d) Income (e) Operating expenses (f) Balance Sheet (g) Five (h) Capital (I) Liabilities (j) A liability (k) Contingent (l) Asset No.3. (a) Profit & Loss Account (b) Schedule (c) 04 (d) 13 (e) Operating expenses (f) Balance Sheet (g) Form A (h) Six (i) Capital and Liabilities (j) Liabilities (k) Assets (l) 9 (m) Current.   Banking and Insurance 41 CHAPTER - 3 CREDIT CREATION AND ROLE OF COMMERCIAL BANKS IN A DEVELOPING ECONOMY STRUCTURE 3.1 Introduction 3.2 Credit Creation 3.2.1 Mechanism of Credit Creation 3.2.2 Limitations of Credit Creation 3.3 Portfolio Management of Commercial Banks 3.4 Nationalisation of Commercial Banks 3.5 Role of Commercial Banks in a Developing Economy Questions 3.1 INTRODUCTION Banks play an important role in the development of a country. Commercial Banks as well as the Central Bank or the banking system as a whole constitute an important and integral part of the financial system that helps in mobilising the idle resources of a country in the right direction for its overall development. Banks also render many essential services to the society. Development process in agricultural sector, rural and cottage industries in different remote areas of our country started after nationalisation of commercial banks in 1969 and 1980. Alongwith the developmental and welfare activities, commercial banks managed their portfolio for getting returns. In the light of the above, the credit creation, portfolio management, nationalisation and role of commercial banks are discussed below. 3.2 CREDIT CREATION : Creation of credit refers to the power of banks to multiply loans and advances through creating deposits. In the words of Newlyn, credit creation refers to the "the power of commercial banks to expand secondary deposits either through the purpose of making loans or through investment in securities". It is a unique function of commercial banks by which it can manufacture credit.  42 Banking and Insurance At the time when a bank accepts cash from customer and opens an account in his/her name, that deposit in the bank is called the primary deposit. Huge amount of money is deposited by a large number of customers with a bank. Every depositor does not demand to withdraw his/her deposit money at one time nor all the depositors collectively demand the bank at one time for withdrawal of their full deposit money. For that reason, banks do not keep cent per cent reserve of deposit money but are able to meet the demand of their customers with a very small reserve amount, because some may withdraw, while others may also deposit at the same time. Therefore, the banker is always left with some of the deposits without being demanded by depositors which they use for granting loans and earn profits thereon. The banker, however, is required to keep a certain percentage of the deposit as reserve to meet the demands of the depositors. This percentage of reserve is called cash reserve ratio. The primary deposit left after meeting requirement of cash reserve ratio are available with the bank for being used for giving loans and advances to needy parties. The amount of the loan sanctioned is not directly paid in cash to the borrower but is credited to his account. So the amount sanctioned as credit is immediately shown as a new deposit by the bank. Thus every bank credit creates an equivalent amount of bank deposit and each borrower becomes a depositor for the bank. Such deposits are called secondary or derivative deposits. Again, keeping certain percentage of these derivative deposits as cash reserve, banks grant further credit. This facility or process of granting credit results in creation of credit. According to Prof. Sayers, ‘Every loan creates a deposit’’. Creation of credit is the power of banks to multiply loans and advances by creating deposits. The banks can multiply a given amount of cash or primary deposit to many times of credit or derivative deposits. The ratio of total derivative deposits to the total primary deposits of a bank is called credit multiplier. A commercial bank operating as a single unit is able to create very little amount of credit, but the entire banking system is able to create credit several times larger than the original deposit money. Therefore, Prof. Sayers remarks, ‘‘banks are not merely purveyors but also in an important sense, manufacturers of money.’’ 3.2.1 Mechanism of Credit Creation Every banker generally prefers to have a minimum amount of idle cash. The banker wants to increase the circulation of money which does not mean that the banker increases the total amount of currency notes or coins. When a loan is sanctioned to a customer, the customer is not  Banking and Insurance 43 paid the amount in cash but the amount is credited to the customer’s account. In this way the customer or borrower acquires a claim against the bank, just like the way a certain sum of money deposited by the customer with the banker creates a claim against the bank. When the customer issues cheques in favour of other people, they deposit the cheques into the banks for collection, and their deposit increase. The process of multiple credit creation may be explained through an example. Suppose Mr. A has deposited Rs. 20,000 in a bank. This amount of deposit is known as primary deposit. Out of this deposit, bank maintains a minimum percentage of reserve as fixed by RBI as Cash Reserve Ratio (CRR) and the balance can be advanced as loan to the parties who are in need of funds. The balance sheet of the bank would in that case appear as : Liabilities Assets Deposits Rs. 20,0