Banking Operations Unit 1 PDF

Banking Operations UNIT 1 Introduction The Banking system of a country is an important pillar holding up the financial system of the country’s economy. The major role of banks in a financial system is the mobilization of deposits and disbursement of credit to various sectors of the economy. T...

Banking Operations UNIT 1 Introduction The Banking system of a country is an important pillar holding up the financial system of the country’s economy. The major role of banks in a financial system is the mobilization of deposits and disbursement of credit to various sectors of the economy. The existing, elaborate banking structure of India has evolved over several decades. Meaning of a Bank A Bank is a financial institution which performs the deposit and lending function. A bank allows a person with excess money (Saver) to deposit his money in the bank and earns an interest rate. Similarly, the bank lends to a person who needs money (investor/borrower) at an interest rate. Thus, the banks act as an intermediary between the saver and the borrower. The bank usually takes a deposit from the public at a much lower rate called deposit rate and lends the money to the borrower at a higher interest rate called lending rate. The difference between the deposit and lending rate is called ‘net interest spread’, and the interest spread constitutes the banks income. Definitions of Bank Oxford Dictionary defines a bank as “an establishment for custody of money, which it pays out on customer’s order.” According to R.S. Sayers, “Banks are institutions whose debts are commonly accepted in final settlement of other people’s debts.” According to Peter Rose, a “Bank is a financial intermediary accepting deposits and granting loans.” According to F.E. Perry, “Bank is an establishment which deals in money, receiving it on deposit.” According to Cairn Cross, “Bank is an intermediary financial institution which deals in loans and advances.”  Characteristics / Features of a Bank A bank is a financial institution licensed to receive deposits and make loans. Banks may also provide financial services like wealth management, currency exchange, and safe deposit boxes. Characteristics/features of a bank are; *Dealing in Money *Individual/Firm/Company *Acceptance of Deposit *Giving Advances *Payment and Withdrawal *Agency and Utility Services *Profit and Service Orientation *Ever-increasing *Name Identity 1. Dealing with Money The bank is a financial institution that deals with other people’s money, i.e., the money given by depositors. 2. Individual/Firm/Company A bank may be a person, firm, or company. A banking company is a company that is in the business of banking. 3. Acceptance of Deposit A bank accepts money from people in deposits that are usually repayable on demand or after a fixed period expires. It gives safety to the deposits of its customers. It also acts as a custodian of funds of its customers. 4. Giving Advances A bank lends out money in loans to those who require it for different purposes. 5. Payment and Withdrawal A bank provides its customers with an easy payment and withdrawal facility in checks and drafts. It also brings bank money into circulation. This money is in the form of checks, drafts, etc. 6. Agency and Utility Services A bank provides various banking facilities to its customers. They include general utility services and agency services. 7. Profit and Service Orientation A bank is a profit-seeking institution with having service- oriented approach. 8. Ever-increasing Functions Banking is an evolutionary concept. There is continuous expansion and diversification regarding a bank’s functions, services, and activities. 9. Connecting Link A bank acts as a connecting link between borrowers and lenders of money. Banks collect money from those who have surplus money and give the same to those who require money. 10. Banking Business A bank’s main activity should be to do banking business that should not be a subsidiary of any other business. 11. Name Identity A bank should always add the word “bank” to its name to let people know that it is a bank that deals in money. Functions of Banks The functions of banks are briefly highlighted in the following diagram or chart. 1. Primary Functions of Banks. (i) Accepting Deposits. *Saving Deposits. *Fixed Deposits. *Current Deposits. *Recurring Deposits. (ii) Granting of Loans and Advances. *Overdraft *Cash Credits *Loans *Discounting of Bill of Exchange 2. Secondary Functions of Banks. 3. Agency Functions. *Transfer of Funds. *Collection of checks. *Periodic Payments. 4. General Utility Functions. *Issue of Drafts, Letters of Credit, etc. *Locker Facility. *Underwriting of Shares. *Dealing in Foreign Exchange. *Project Reports. *Social Welfare Programs. *Other Utility Functions. A. Primary Functions of Banks The primary functions of a bank are also known as banking functions. They are the main functions of a bank. These primary functions of banks are explained below. 1. Accepting Deposits The bank collects deposits from the public. These deposits can be of different types, such as Saving Deposits: This type of deposit encourages saving habits among the public. The rate of interest is low. At present, it is about 4% p.a. Fixed Deposits: The lump sum amount is deposited at one time for a specific period. A higher rate of interest is paid. Current Deposits: This type of account is operated by businessmen. Withdrawals are freely allowed. No interest is paid. Recurring Deposits: This type of account is operated by salaried persons and petty traders. Withdrawals are permitted only after the expiry of a certain period. A higher rate of interest is paid. 2. Granting of Loans and Advances The bank advances loans to the business community and other members of the public. The rate charged is higher than what it pays on deposits. The types of bank loans and advances are: Overdraft: This type of advance is given to current account holders. It is sanctioned to business people and firms. An overdraft facility is granted against collateral security. Cash Credits: The client is allowed cash credit up to a specific limit fixed in advance. The cash credit is given against the security of tangible assets and or guarantees. The advance is given for a longer period, and a larger loan amount is sanctioned than that of an overdraft. Loans: It is normal for the short term, say a period of one year, or medium- term, says a period of five years. Nowadays, banks do lend money for the long term. Loans are normally secured against the tangible assets of the company. Discounting of the bill of exchange: The bank can advance money by discounting or purchasing bills of exchange, both domestic and foreign. The bill is presented to the drawee or acceptor of the bill on maturity, and the B. Secondary Functions of Banks The bank performs some secondary functions, also called non-banking functions. These important secondary’ functions of banks are explained below. 1. Agency Functions The bank acts as an agent of its customers. The bank performs several agency functions, which include:- *Transfer of Funds: The bank transfers funds from one branch or place to another. *Collection of checks: The bank collects the checks’ money through its customers’ clearing section. The bank also collects money from the bills of exchange. *Periodic Payments: On standing instructions of the client, the bank makes periodic payments regarding electricity bills, rent, etc. *Portfolio Management: The banks also undertake to purchase and sell the shares and debentures on behalf of the clients and accordingly debit or credit the account. This Periodic Collections: The bank collects salary, pension, dividend, and other periodic collections on behalf of the client. Other Agency Functions: They act as trustees, executors, advisers, and administrators on behalf of their clients. They act as representatives of clients to deal with other banks and institutions. 2. General Utility Functions The bank also performs general utility functions, such as, Issue of Drafts and Letter of Credits: Banks issue drafts for transferring money from one place to another. It also issues letters of credit, especially in the case of import trade. It also issues travelers’ checks. Locker Facility: The bank provides a locker facility to safely store valuable documents, gold ornaments, and other valuables. Underwriting of Shares: The bank underwrites shares and debentures through its merchant banking division. Dealing in Foreign Exchange: Commercial banks are allowed by.RBI to deal in foreign exchange. Project Reports: The bank may also undertake to prepare project reports on behalf of its clients. Social Welfare Programs: It undertakes social welfare programs, such as adult literacy programs, public welfare campaigns, etc. Other Utility Functions: It acts as a referee to customers’ financial standing. It collects creditworthiness information about clients of its customers. It provides market information to its customers, etc. It provides travellers’ check facilities. Structure of the Indian Banking System  Reserve Bank of India is the central bank of the country and regulates the banking system of India. The structure of the banking system of India can be broadly divided into scheduled banks, non-scheduled banks and development banks. Scheduled banks Banks that are included in the second schedule of the Reserve Bank of India Act, 1934 are considered to be scheduled banks. All scheduled banks enjoy the following facilities: *Such a bank becomes eligible for debts/loans on bank rate from the RBI *Such a bank automatically acquires the membership of a clearing house. Non-scheduled Banks All banks which are not included in the second section of the Reserve Bank of India Act, 1934 are Non-scheduled Banks. They are not eligible to borrow from the RBI for normal banking purposes except for emergencies. Scheduled banks are further divided into commercial and cooperative banks.  Commercial Banks The institutions that accept deposits from the general public and advance loans with the purpose of earning profits are known as Commercial Banks. Commercial banks can be broadly divided into public sector, private sector, foreign banks and RRBs. *In Public Sector Banks the majority stake is held by the government. After the recent amalgamation of smaller banks with larger banks, there are 12 public sector banks in India as of now. An example of Public Sector Bank is State Bank of India. *Private Sector Banks are banks where the major stakes in the equity are owned by private stakeholders or business houses. A few major private sector banks in India are HDFC Bank, Kotak Mahindra Bank, ICICI Bank etc. *A Foreign Bank is a bank that has its headquarters outside the country but runs its offices as a private entity at any other location outside the country. Such banks are under an obligation to operate under the regulations provided by the central bank of the country as well as the rule prescribed by the parent organization located outside India. An example of Foreign Bank in India is Citi Bank.  Regional Rural Banks were established under the Regional Rural Banks Ordinance, 1975 with the aim of ensuring sufficient institutional credit for agriculture and other rural sectors. The area of operation of RRBs is limited to the area notified by the Government. RRBs are owned jointly by the Government of India, the State Government and Sponsor Banks. An example of RRB in India is Arunachal Pradesh Rural Bank. Cooperative Banks A Cooperative Bank is a financial entity that belongs to its members, who are also the owners as well as the customers of their bank. They provide their members with numerous banking and financial services. Cooperative banks are the primary supporters of agricultural activities, some small-scale industries and self-employed workers. An example of a Cooperative Bank in India is Mehsana Urban Co-operative Bank. At the ground level, individuals come together to form a Credit Co-operative Society. The individuals in the society include an association of borrowers and non-borrowers residing in a particular locality and taking interest in the business affairs of one another. As membership is practically open to all inhabitants of a locality, people of different status are brought together into the common organization. All the societies in an area come together to form a Central Co- operative Banks. Cooperative banks are further divided into two categories - urban and rural. Rural cooperative Banks are either short-term or long-term. Short-term cooperative banks can be subdivided into State Co-operative Banks, District Central Co-operative Banks, Primary Agricultural Credit Societies. *Long-term banks are either State Cooperative Agriculture and Rural Development Banks (SCARDBs) or Primary Cooperative Agriculture and Rural Development Banks (PCARDBs). *Urban Co-operative Banks (UCBs) refer to primary cooperative banks located in urban and semi-urban areas. Development Banks Financial institutions that provide long-term credit in order to support capital-intensive investments spread over a long period and yielding low rates of return with considerable social benefits are known as Development Banks. The major development banks in India are; Industrial Finance Corporation of India (IFCI Ltd), 1948, Industrial Development Bank of India' (IDBI) 1964, Export-Import Banks of India (EXIM) 1982, Small Industries Development Bank Of India (SIDBI) 1989, National Bank for Agriculture and Rural Development (NABARD) 1982. The banking system of a country has the capability to heavily influence the development of a country’s economy. It is also instrumental in the development of rural and suburban regions of a country as it provides capital for small businesses and helps them to grow their business. The organized financial system comprises Commercial Banks, Regional Rural Banks (RRBs), Urban Co-operative Banks (UCBs), Primary Agricultural Credit Societies (PACS) etc. caters to the financial service requirement of the people. The initiatives taken by the Reserve Bank and the Government of India in order to promote financial inclusion have considerably improved the access to the formal financial institutions. Thus, the banking system of a country is very significant not only for economic growth but also for promoting economic equality.