Chapter 5: Banking PDF

Chapter 5: BANKING BANK: The term 'Bank' is derived from the words, 'Banco', 'Banck', 'Banque' which means a 'bench' or a 'table'. European moneylenders and moneychangers in the past used to exhibit, on a bench or a table, coins of different countries in big heaps for the purpos...

Chapter 5: BANKING BANK: The term 'Bank' is derived from the words, 'Banco', 'Banck', 'Banque' which means a 'bench' or a 'table'. European moneylenders and moneychangers in the past used to exhibit, on a bench or a table, coins of different countries in big heaps for the purpose of changing and lending money. A bank is an institution which deals in money and credit. It is often described as a credit institution. It performs a large variety of functions in the modern society. It accepts deposits from the public and lends money. On deposits, the bank pays interest and for lending money, it charges higher rate of interest from the borrower. The sum earned from the difference between these two rates is the profit of the bank. Definitions: 1. Banking Regulation Act of India (1949): "Banking means the accepting, for the purpose of lending or investment of deposits of money from the public repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise." 2. Crowther: "The banker's business is to take the debts of other people to offer his own in exchange, and thereby create money". COMMERCIAL BANKS: These are joint stock banks which receive deposits from the public and business firms. They also provide short-term and medium-term loans to customers. These banks carry on all kinds of banking functions within the framework of the Banking Regulations Act, 1949. Commercial banks are classified into two broad categories scheduled and non-scheduled banks. Scheduled banks are those included in the second schedule to the Reserve Bank of India Act. Commercial banks not included in this schedule are non-scheduled banks commercial banks are owned and controlled by the Government, private businessmen and foreign businessmen. State Bank of India and Bank of Baroda are examples of public sector banks. Global Trust Bank and Bank of Rajasthan are examples of private sector banks. Citi Bank, American Express Bank are examples of foreign banks. State Bank of India is the largest commercial bank of our country. CENTRAL BANK: The central bank of a country serves as the leader of the banking system and the money market. Every country has a central bank which regulates money supply and credit with the help of the Government. It exercises supervision and control over all other banks in the country. The Reserve Bank of India is the central bank of our country. It acts as the bankers' bank. It carries out the country's monetary policy. It occupies a central position in the banking system of the country. The central bank of the country is called 'central' because it is the apex institution of the entire banking system of the country. It has certain special rights, powers and privileges, so that it can regulate the whole financial sector and can exercise control over the monetary and credit policies of the nation. Definition: 1. De Cock: "Central bank is that bank which constitutes the apex of the monetary and banking structure of the country". DIFFERENCE BETWEEN CENTRAL BANK AND COMMERCIAL BANK Point of Difference Central Bank (Reserve Bank) Commercial Bank 1. Status It is the apex institution of the country's It is one of the organs of the money monetary and banking structure. market. 2. Ownership It is owned by the Government. It is owned by shareholders. 3. Objective It is a non-profit institution. It is a profit making institution. 4. Customers It is a banker to the Government. It is a banker to the general public. 5. Issue of Notes It has the monopoly of note issue. It cannot issue notes but only cheques. 6. Credit Control It controls credit according to the It creates credit to meet the needs of country's needs. business.  7. Number Every country has only one Central bank. There are several commercial banks in a country. 8. Foreign Exchange It is the custodian of the country's foreign It is the dealer in foreign currencies. currency reserves. 9. Banker's Bank It is the bankers' bank. It keeps their cash It receives deposits from and grants reserves, grants financial accommodation loans to public. & clears their balances. 10. Role It helps in setting up financial institutions It helps industry and commerce by to strengthen money and capital markets providing finance and other services. in the country. 11. Designation of the Its chief is called "Governor". Its chief executive is called "Chairman". Chief Executive FUNCTIONS OF A COMMERCIAL BANK: 1. Accepting Deposits: Accepting deposits is the main function of a commercial bank. It attracts deposits for the purpose of making loans and investments. People deposit their money in banks for the sake of safety and for earning interest. A commercial bank receives deposits from individuals, firms and other institutions. Banks offer different types of deposit accounts to suit the needs of various depositors. Public deposits constitute the main resources of a bank. Banks receive the following types of deposits. (a) Fixed Deposits: A lump sum is deposited for a fixed time period. These deposits are repayable on the expiry of the stated period. Generally, the time period varies from three months to five years. The rate of interest on these deposits is higher than that payable on other deposits. The actual rate depends on the period for which the deposit is made. A receipt is issued to the depositor. (b) Savings Deposits: This account is opened for the purpose of depositing small savings. In these deposits money can be withdrawn for a specified number of times in a week. But deposits can be made any number of times. Rate of interest allowed on such deposits is higher than that on current deposits but lower than that allowed on fixed deposits. The depositor has to open an account with the bank and is given a pass book. The main objective of savings deposits is to promote the habit of savings among people. (c) Current Deposits: Such deposits are made by business firms in current accounts. Money can be deposited and withdrawn as often as the depositor wants. Generally, no interest is allowed on these deposits. A small fee, known as 'bank charge' or 'incidental charge' is often charged for maintaining current deposits. Overdraft facility is available on current accounts.  (d) Recurring Deposits: In these deposits, the deposit holder is required to make a deposit of fixed amount every month for a specified period. The amount goes on accumulating along with interest. At the end of the prescribed period, the depositor can withdraw the deposit or renew the same for another term. No cheque facilities are allowed in fixed deposits and recurring deposits. 2. Granting Credit: Commercial banks lend money in the following ways. (a) Loans and Advances: A specified amount is granted for a specified time period. The borrower may withdraw the entire amount in lump sum or in instalments. However, interest is charged on the full amount of loan. Loans are generally granted against the security of certain assets or on personal guarantee. Banks also grant term loans for a longer period. A loan may be repayable in lump sum or in instalments. (b) Cash Credit: Under this arrangement, the bank allows the borrower to borrow up to a specified limit. The amount is credited to the account of the customer. The customer can withdraw this amount as and when he requires. Interest is charged on the amount actually withdrawn. Cash credit is usually granted on a bond or some other security. (c) Overdraft: A customer who has a current account with the bank can withdraw more than the amount standing to his credit up to a specified limit. This is a temporary arrangement on which interest is charged by the bank. It may be allowed on the security of assets or on personal guarantee. (d) Discounting of Bills: Banks make payment against the bills before the date of maturity. In case the bill is dishonoured on the due date, the bank can recover the amount from the customer. Banks charge some commission for this service. 3. Agency Functions: A commercial bank serves as an agent for its customers in the following ways: (a) Collects cheques, bills, dividends, interest, rent, etc., on behalf of customers. (b) Pays cheques, bills, rent, taxes, interest, insurance premium, fees, subscriptions, etc., on behalf of customers. (c) Purchases and sells securities on behalf of customers as per their instructions. (d) Acts as trustee, executor; guarantor etc. in financial matters for their customers. (e) Carries out correspondence for and on behalf of customers. (f) Acts as agent or correspondent for other banks at home and abroad. 4. General Utility Services: (a) Transfer of funds from one branch to another. (b) Issuing letter of credit and standing as surety for customers. (c) Accepting valuables, jewellery and securities for safe custody. (d) Underwriting capital issues. (e) Providing foreign exchange to persons going abroad and to importers. (f) Issuing travellers' cheques, drafts, circular notes, etc. (g) Providing trade information to customers. (h) Providing reports on the creditworthiness of customers. (i) Accepting and discounting bills of exchange of exporters. (j) Advising customers with regard to investments and other financial matters. TYPES OF BANK ACCOUNTS 1. Current Deposit Account: A current account is opened generally by businessmen. A person or a firm can open this account with a bank by depositing a certain amount, usually Rs 5000. The person who wants to open the account must be introduced by an old customer of the bank. The bank takes his specimen signature and enters the money deposited to the credit of his account. A pass book showing the credit balance is issued to the customer. The customer can freely deposit more money from time to time and withdraw without notice through the medium of cheques. There is no restrictions on the number of withdrawals. However, a minimum credit balance must be kept as per the rules of the bank. He can also deposit cheques, bills of exchange, promissory notes, bank drafts, etc., in his account for collection by the bank. No interest is paid by banks on current accounts. Rather a small charge (called bank charge) is debited for providing bank services. Overdraft facility is available on current accounts. 2. Savings Deposit Account: Such a bank account is meant for the general public. The object of a savings bank account is to encourage thrift and foster the habit of savings and to collect the small savings of people. A person can open a savings account by depositing a small amount of money, usually ₹ 500. A savings bank account can be opened by two persons in joint names. A pay-in- slip book, a cheque book and a pass book are supplied to the account holder. The account holder can deposit money, cheques, etc., in his savings account by filling in a pay- in-slip. He can withdraw money at reasonable intervals with or without prior notice through withdrawal forms or cheques. Withdrawals are limited and a minimum balance has to be kept by the account holder. A reasonable rate of interest is allowed on the credit balance in the savings account. No overdraft facility is available on savings accounts. 3. Recurring Deposit Account: In this type of account, a customer is allowed to deposit a certain amount of money (say₹10, 50, 100 etc.) every month for a specified period of time. At the end of the period, he is given the total deposit amount along with interest at the prescribed rate. Such an account is also called cumulative time deposit. Thus, a person can gradually save money for purchase of costly articles, for education or marriage of children, etc. Withdrawal and cheque facilities are not available in this account. A pass book showing the instalments deposited by the customer is issued. 4. Fixed Deposit Account: Under this account, a person makes a deposit of money in one lumpsum for a specified period of time, say, one year, three years, five years or more. Pass book and cheque book facilities are not required in this type of account. The customer is not allowed to withdraw from the account before the expiry of the specified period but he can borrow against the security of his deposit. At the end of the period, the customer may withdraw his deposit along with the interest or he may renew the deposit for another term. The main advantage of fixed deposit is that the depositor is allowed a much - higher rate of interest than what is available on other types of deposits. A fixed deposit receipt is issued to the depositor. It contains the name and address of the depositor, the amount and period of deposit, rate of interest, signature of the bank manager, etc. The depositor can claim back his money by submitting the receipt on the due date. A specimen of the fixed deposit receipt is as follows. COMPARISON BETWEEN TYPES OF BANK ACCOUNTS Basis of Fixed or Time Savings Current/Demand Recurring Difference deposit account deposit deposit account account 1. Object To earn interest To cultivate To provide facilities to To accumulate habit of saving industrialists and small savings. and thrift businessmen to deposit or withdraw the money as and when they need. 2. Period of Deposits are made No fixed It is an open and a One year to five deposit for a fixed period. period for running account for years. deposits which there is no fixed period for deposits. 3. Frequency of The deposit in this Deposits can There is no restriction Every month. deposits account is made only be made any on making deposits in at one time. number of such account. times in this account. 4. Restrictions on The amount There are There is no restriction No withdrawals withdrawals deposited can restrictions on on withdrawals from before the due generally be withdrawals. this account. date are withdrawn at At present 50 allowed. maturity. When withdrawals withdrawal is made are permitted before maturity, in half year by interest is not most of the allowed. banks. 5. Rate of interest As the cost of Interest is No interest is allowed A operations of these allowed at a on this account as the comparatively accounts are low, rate lower than costs of operations are low rate of high rates of interest in fixed high. interest is given. are allowed on this deposit account. account but higher than in current accounts. 6. Cheque facility Cheque facility is not Cheques Cheques can be Cheque facility available on this type facility is frequently used for is not allowed. of accounts. available on withdrawals from this maintenance of account. a minimum balance.