Banking institutions
The banking sector is the lifeline of any modern economy. It is one of the important financial
pillars of the financial system which plays a vital role in the success/failure of an economy.
Banks are one of the oldest financial intermediaries in the financial system. They play an
important role in the mobilisation of deposits and disbursement of credit to various sectors of
the economy. The banking system is the fuel injection system which spurs economic
efficiency by mobilising savings and allocating them to high return investment. Research
confirms that countries with a well- developed banking system grow faster than those with a
weaker one. The banking system reflects the economic health of the country. The strength of
economy of any country basically hinges on the strength and efficiency of the financial
system, efficiently deploys mobilised savings in productive sectors and a solvent banking
system ensures that the bank is capable of meeting its obligation to the depositors. The
banking sector is dominant in India as it accounts for more than half the assets of the
financial sector.
Section 5(1) (b) of the Banking Regulation Act defines banking as 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. Section 5(I) (c) defines
banking company as any company which transacts the business of banking in India.
However , the acceptance of deposits by companies for the purpose of financing their own
business is not regarded as banking within the meaning of the act. The essential
characteristics of the banking business as defined in Section 5(b) of the Banking Regulation
Act are as follows.
Acceptance of deposits from the public
For the purpose of lending or investment
Repayable on demand or otherwise
Withdrawable by means of any instrument whether a cheque or otherwise
From the definition, two important functions of commercial banks emerge: acceptance of
deposits and lending of funds. For centuries, banks have burrowed and lent money to
business, trade, and people, charging interest on loans and paying interest on deposits. These
two functions are the core activities of banking.
FUNCTIONS OF BANK
Deposits
Deposits are the main source of funds for commercial banks. The amount mobilised as
deposits is then lent in the form of advances. The higher the amount of deposits mobilised,
the higher is the amount of funds lent. The growth of deposits on savings. Savings held in the
form of currency or gold and jewellery are unproductive. For economic growth to take place,
it is essential that these savings are mobilised and channelized for capital formation which, in
turn, accelerates economic growth. Banks are important financial intermediaries between
savers and borrowers. Banks mobilise savings by accepting deposits. Deposits may be
categorised into (i) demand deposits and (ii) time deposits.
Demand deposits are deposits which can be withdrawn without notice and can be repaid on
demand. Current accounts and savings accounts are classified as demand deposits.
Time deposits are deposits which are repayable after a fixed date or after a period of notice.
Fixed deposits, recurring/cumulative deposits, miscellaneous deposits, and cash certificates
are classified as time deposits.
A significant proportion of funds is contributed by deposits which account for more than 80
percent liabilities of scheduled commercial banks(SCBs)
Credit creation
Bank are a special type of financial intermediaries which not only accept and deploy large
amounts of uncollateralised deposits in a fiduciary capacity, but also leverage such finds
through credit creation. Banks are creators of credit. The creation of credit is an important
function of a bank and this function distinguishes banks from the non-banking institutions.
Banks create deposits in the process of their lending operation. When banks mobilise savings,
it lends the amount that remains after providing for reserves. The amount lent is either
deposited in the same bank or in some other bank. For instance, when a banks extends
overdraft facility or discounts a bill of exchange, the banks first of all credits this amount in
the account of the customer, who creates a deposits. The bank, after keeping aside a certain
portion of this deposits in the form of reserves, lends this amount. This process continues and
repeats in all the banks or in the banking system as a whole. This leads to the creation of
credit, which in turn, increases the liabilities and assets in the banking system.
For instance, a bank receives Rs. 1,000 in the form of deposits. The bank after keeping aside,
say, 10 percent in the from of reserves, lends the remaining amount, i.e., Rs. 900. The amount
lent is either deposited in the same bank or in some other bank. The bank again, after keeping
aside reserves of 10 per cent, lends the remaining amount, i.e., Rs 810. This process continues
and repeats in all banks simultaneously leading to creation of credit. Credit creation leads to
an increase in the total amount of money for circulation.
Lending of funds
Commercial banks mobilise savings from the surplus- spending sector and lend these funds to
the deficit-spending sector. They facilitate not only flow of funds but also flow of goods and
services from producers to consumers through this function of lending. Commercial banks
facilitate the financial activities of not only the private sector but also of the government.
Funds are lent in the form of cash credit, overdraft, and loan system. Banks discount bill of
exchange, give venture capital, and guarantees. Loans and advances form around 50 per cent
of the aggregate deposits of SCBs.
Ancillary functions
Besides the primary function of mobilising deposits and lending funds, banks provide a range
of ancillary services, including transfer of funds, collection, foreign exchange, safe deposit
locker, gift cheques, and merchant banking, thus banks provide a wide variety of banking and
ancillary services.
Banks are distinct entities as they have fiduciary responsibility, are highly leveraged and the
future of any one bank can threaten the integrity of the payments system which is the
backbone of any modern economy.
DEVELOPMENT OF BANKING IN INDIA
The history of banking dates back to thirteenth century when the first bill of exchange was
used as money in medieval trade.
Banking has its origin in Vedic times, i.e., 2000 to 1400 BC. Indigenous bankers and money
lenders have played a vital role for centuries. Modern banking in India emerged between the
eighteenth and the beginning of the nineteenth centuries when European agency houses
erected a structure of European controlled banks with limited liability. In 1683, the first bank
was set up in Madras by the officers of East India Company. The first joint stock bank was
Bank of Bombay , established in 1720 in Bombay, followed by Bank of Hindustan in
Calcutta, which was established in 1770 by an agency house. The principal of limited
liability, which was first applied to joint stock companies in 1860, was a landmark in Indian
banking.
Schedule commercial banks
Schedule commercial banks are those included in the second schedule of the Reserve Bank of
India Act, 1934. In terms of ownership and function, commercial banks can be classified into
four categories: public sector banks, foreign banks in India, and regional rural banks.
Public sector banks
Public sectors banks are banks in which the government has a major holding. These can be
classified into two groups: (i) the State Bank of India and its associates and (ii) nationalised
banks.
State Bank of India.
The State Bank of India was initially known as the Imperial Bank. Imperial Bank was formed
in 1921 by the amalgamation of three presidency banks- the Bank of Bengal, the Bank of
Bombay, and the Bank of Madras. These presidency banks were created as a charter to deal in
bills of exchange payable in India and were an integral part of the Indian treasury.
Many foreign banks such as the common wealth Bank of Australia , the Royal Bank of
Scotland, and UBS are planning to start their operation in India.
Types of NBFCs
NBFCs can be classified in different segments depending on the type of activities they
undertake.
1. Asset Finance Company (AFC)
2. Investment Company (IC)
3. Loan Company (LC)
Types of Non-Banking Financial Entities (Regulated by the RBI)
1. Non-Banking financial Company
a) Equipment leasing company (EL)
b) Hire purchase finance company (HP)
c) Investment company (IC)
This are now known as Asset finance company (AFC)
Principal business
NBFCs flourished during the stock market boom of the early 1990s. In the initial years of
liberalisation, they not only became prominent in a wide range of activities but they outpaced
banks in deposit raising owing to their customised services. They have backed many small
entrepreneurs. They have also lent small- ticket personal loans of size Rs. 25000 to customers
and thereby fuelled the consumption boom.