UNIT-I

IMPORANT CONCEPTS
1) BANK VS FINANCIAL INSTITUTION
Financial institutions can be divided into two types: banking financial institutions
and non-banking financial institutions. Banking financial institutions include
commercial banks whose primary role is to accept deposits and make loans. Non-
banking financial institutions include investment banks,insurance companies, finance
firms, leasing companies, etc.

2) BANK VS BANKING
BANKThe oxford dictionary defines bank as “an organization offering financial
services, especially loans and safe keeping of customers money”.
BANKING is the business activity of a bank. Simply, any activity carried out by a
bank for business purposes is called banking.
Accepting savings, Lending money, leasing properties to needy people, paying for
cheques, providing mortgage facilities, acting on to standing orders, statement of
instructions, providing safety locker facilities for valuable things, providing over
draft facilities to current account holders, acting as institutional investors in
financial market, issuing ‘letter of credit’ in the business of import and export, act
as money changer, issuing travelers’ cheques are some of the activities carried out
by modern banks in the banking industry. Nowadays, banking can be done via the
internet, which is called on line banking.

ORIGIN & GROWTH OF BANKING

INTRODUCTION
1) Today we know well that banks play a very important role in the economic
development of any country.
2) They are not only the creators of money; they are also purveyors (providers or
suppliers) of money.
3) Banks are known as financial intermediaries that act as middlemen between
depositors or suppliers of funds and lenders who are the users of funds.
4) The main tasks of a banking financial institution are to accept deposits and then to
use those funds to offer loans to its customers, who will in turn utilize them to
fund purchases, education, to expand business, to invest in development, etc.
5) Banks act as vehicles for government programmes that aim at reducing the severity
of poverty.
6) Now-a-days, banking sector acts as the backbone of modern business. Development
of any country mainly depends upon the banking system.

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In olden days, people were not aware of this most influential financial institution -- Bank.
Hence, in order to study the economic significance of banks, we have to review the origin
of banks at global as well as national level.

WHAT IS A BANK ? DEFINE A BANK ?

In simple words, we can say that Bank is a financial institution that undertakes the banking
activity ie.it accepts deposits and then lends the same to earn certain profit.

ORIGINATION OF BANKING IN INDIA

Banking Sector is the Backbone of Indian Economy. And since the inception of First Bank
in India, it has undergone major changes.
The advancement in the Indian banking system is classified into 3 distinct phases:
1) The pre-independence phase i.e. before 1947
2) Second phase from 1947 to 1991
3) Third phase 1991 and beyond
PHASE :- I -THE PRE-INDEPENDENCE PHASE I.E. BEFORE 1947

1970-1st Bank- 1865-1st Commercial 1921 Merged 3 Banks

Bank of Hindustan @ Bank
Calcutta Presidency Bank of
Allahabad Bank
Calcutta
+Presidency Bank
of Bombay
1806-1st Bank opened 1881-1stbank with +Presidency Bank
by British – Limited Liability to be of Madras
Presidency Bank of managed by Indian =
Calcutta Board – Imperial Bank of India
OUDH Commercial (Now it is called as SBI)
Bank @ Faizabad
1840 Presidency Bank
of Bombay
1934-As per Hilton
1843 Presidency Bank 1894-Punjab National Young Commission we
of Madras bank @ Lahore- All hadRBI Act 1934 and
Indians as employees finally in 1st April
but head was Britisher 1935 birth of
1861-1st Joint Sector
Reserve Bank of
Bank-Bank of Upper
India (RBI)
India @ Calcutta
1911-1stSwadeshi bank
(Owned & Managed by
Indians)
Central Bank of India

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Phase II
Broadly the main characteristic feature of this phase is the nationalization of bank. With
the view of economic planning, nationalization emerged as the effective measure.
Need for nationalization in India:
a) The banks mostly catered to the needs of large industries, big business houses.
b) Sectors such as agriculture, small scale industries and exports were lagging
behind.
c) The poor masses continued to be exploited by the moneylenders.
Following this, in the year 1949, 1st January the Reserve Bank of India was nationalized.
14 commercial banks were nationalized in 19th July, 1969. Smt. Indira Gandhi was the
Prime Minister of India, during in 1969. These were –
1) Central Bank of India
2) Bank of India
3) Punjab National Bank
4) Bank of Baroda
5) United Commercial Bank
6) Canara Bank
7) Dena Bank
8) United Bank
9) Syndicate Bank
10) Allahabad Bank
11) Indian Bank
12) Union Bank of India
13) Bank of Maharashtra
14) Indian Overseas Bank
6 more commercial banks were nationalized in April 1980. These were:
1) Andhra Bank
2) Corporation Bank
3) New Bank of India
4) Oriental Bank of Commerce
5) Punjab & Sindh Bank
6) Vijaya Bank.
Note: In 1993, New Bank of India got merged with Punjab National Bank.
Meanwhile on the recommendation of M.Narsimhan committee, RRBs (Regional Rural Banks)
were formed on Oct 2, 1975. The objective behind the formation of RRBs was to serve
large unserved population of rural areas and promoting financial inclusion.
With a view to meet the specific requirement from the different sector (i.e. agriculture,
housing, foreign trade, industry) some apex level banking institutions were also setup like
1) NABARD (est. 1982)
2) EXIM (est. 1982)
3) NHB (est. 1988)
4) SIDBI (est. 1990)

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Impact of Nationalisation:
a) Improved efficiency in the Banking system – since the public ‘s confidence got boosted.
b) Sectors such as Agriculture, small and medium industries started getting funds – led to
economic growth.
c) Increased penetration of Bank branches in the rural areas.

Phase III
This period saw a remarkable growth in the process of development of banks with the
liberalization of economic policies. Even after nationalization and the subsequent
regulations that followed, a large portion of masses are untouched by the banking services.
Considering this, in 1991, the Narsimhan committee gave its recommendation i.e. to allow
the entry of private sector players into the banking system. Following this RBI gave
license to 10 private entities, of which 6 are survived, which are- ICICI, HDFC, Axis Bank,
IDBI, Indus, DCB.
In 1998, the Narsimhan committee again recommended entry of more private players. As a
result RBI gave license to
1) Kotak Mahindra Bank (2003)
2) Yes Bank (2004)
In 2013-14, 3rd round of bank licensing took place. And in 2014 IDFC bank and Bandhan
Bank emerged.
In order to further financial inclusion, RBI also proposed to set up 2 kind of banks
i.e.Payment Banks and Small Banks.

MEANING AND FUNCTIONS OF BANKING

WHAT IS A BANK? INTRODUCTION

Finance is the life blood of trade, commerce and industry. Now-a-days, banking sector acts
as the backbone of modern business. Development of any country mainly depends upon the
banking system.
The term bank is either derived from old Italian word banca or from a
French word banque both mean a Bench or money exchange table. In olden days, European
money lenders or money changers used to display (show) coins of different countries in big
heaps (quantity) on benches or tables for the purpose of lending or exchanging.

DEFINITIONS
1) A bank as "an establishment for custody of money, which it pays out on customer's
order."

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 2) A bank is a financial institution which deals with deposits and advances and other
related services. It receives money from those who want to save in the form of
deposits and it lends money to those who need it.
3) A bank is a financial institution licensed to receive deposits and make loans. Banks
may also provide financial services, such as wealth management, currency exchange
and safe deposit boxes.

FUNCTIONS OF BANKS

Functions of Bank

Primary Functions Secondary Functions

Accepting Granting Agency Utility

Deposits Advances Functions Functions

 Cash Credit  Transfer of Funds

 Saving Deposits  Overdraft  Periodic Payments
 Current Deposits  Loans  Collection of Cheques
 Recurring Deposits  Discounting of Bills  Portfolio Management
 Fixed Deposits
 Periodic Collection
 Other Agency Functions

 Drafts
 Lockers
 Underwriting
 Project reports
 Social Welfare Programmes
 Other utility Functions

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:

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Accepting Deposits The bank collects deposits from the public. These deposits can be
of different types, such as:-
1) Saving Deposits
2) Fixed Deposits
3) Current Deposits
4) Recurring Deposits
Saving Deposits:This type of deposits encourages saving habit among the public. The rate
of interest is low. At present it is about 4% p.a. Withdrawals of deposits are allowed
subject to certain restrictions. This account is suitable to salary and wage earners. This
account can be opened in single name or in joint names.
Fixed Deposits:Lump sum amount is deposited at one time for a specific period. Higher
rate of interest is paid, which varies with the period of deposit. Withdrawals are not
allowed before the expiry of the period. Those who have surplus funds go for fixed
deposit.
Current Deposits :This type of account is operated by businessmen. Withdrawals are
freely allowed. No interest is paid. In fact, there are service charges. The account holders
can get the benefit of overdraft facility.
Recurring Deposits:This type of account is operated by salaried persons and petty
traders. A certain sum of money is periodically deposited into the bank. Withdrawals are
permitted only after the expiry of certain period. A higher rate of interest is paid.

Granting of Loans and AdvancesThe 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 difference in the interest rates (lending rate and the deposit rate) is its profit.
The types of bank loans and advances are :-
1) Overdraft
2) Cash Credits
3) Loans
4) Discounting of Bill of Exchange
Overdraft: This type of advances are given to current account holders. No separate
account is maintained. All entries are made in the current account. A certain amount is
sanctioned as overdraft which can be withdrawn within a certain period of time say three
months or so. Interest is charged on actual amount withdrawn. An overdraft facility is
granted against a collateral security. It is sanctioned to businessman and firms.
Cash Credits: The client is allowed cash credit upto a specific limit fixed in advance. It
can be given to current account holders as well as to others who do not have an account
with bank. Separate cash credit account is maintained. Interest is charged on the amount
withdrawn in excess of limit. 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 amount of
loan is sanctioned than that of overdraft.
Loans: It is normally for short term say a period of one year or medium term say a period
of five years. Now-a-days, banks do lend money for long term. Repayment of money can be

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in the form of installments spread over a period of time or in a lumpsum amount. Interest
is charged on the actual amount sanctioned, whether withdrawn or not. The rate of
interest may be slightly lower than what is charged on overdrafts and cash credits. Loans
are normally secured against tangible assets of the company.
Discounting of Bill of Exchange: The bank can advance money by discounting or by
purchasing bills of exchange both domestic and foreign bills. The bank pays the bill amount
to the drawer or the beneficiary of the bill by deducting usual discount charges. On
maturity, the bill is presented to the drawee or acceptor of the bill and the amount is
collected.

SECONDARY FUNCTIONS OF BANKS

The bank performs a number of secondary functions, also called as non-banking functions.
These important secondary functions of banks are explained below:
Agency Functions: The bank acts as an agent of its customers. The bank performs a
number of agency functions which includes :-
1) Transfer of Funds
2) Collection of Cheques
3) Periodic Payments
4) Portfolio Management
5) Periodic Collections
6) Other Agency Functions
Transfer of Funds: The bank transfer funds from one branch to another or from one
place to another.
Collection of Cheques: The bank collects the money of the cheques through clearing
section of its customers. The bank also collects money of the bills of exchange.
Periodic Payments: On standing instructions of the client, the bank makes periodic
payments in respect of electricity bills, rent, etc.
Portfolio Management: The banks also undertakes to purchase and sell the shares and
debentures on behalf of the clients and accordingly debits or credits the account. This
facility is called portfolio management.
Periodic Collections: The bank collects salary, pension, dividend and such other periodic
collections on behalf of the client.
Other Agency Functions: They act as trustees, executors, advisers and administrators on
behalf of its clients. They act as representatives of clients to deal with other banks and
institutions.
General Utility Functions: The bank also performs general utility functions, such as :-
Issue of Drafts, Letter of Credits, etc.
1) Locker Facility
2) Underwriting of Shares
3) Dealing in Foreign Exchange
4) Project Reports

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 5) Social Welfare Programmes
6) Other Utility Functions
Issue of Drafts and Letter of Credits: Banks issue drafts for transferring money from
one place to another. It also issues letter of credit, especially in case of, import trade. It
also issues travellers'cheques.
Locker Facility: The bank provides a locker facility for the safe custody of 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: The 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 Programmes: It undertakes social welfare programmes, such as adult
literacy programmes, public welfare campaigns, etc.
Other Utility Functions: It acts as a referee to financial standing of customers. It
collects creditworthiness information about clients of its customers. It provides market
information to its customers, etc. It provides travellers'cheque facility.

IMPORTANCE/ROLE OF BANKING
Banking plays an important role in the financial life of a business, and the importance of
banks can be seen from the fact that they are considered as to be the life-blood of
modern economy. Although no wealth is created by Bank, but their essential activities
facilitates the process of production, exchange and distribution of wealth. In this way
they become the effective partners in the process of economic development and growth.
In the words of Stephenson & Britain “Banks are the custodians and distribution of liquid
capital, which is the life-blood of our commercial and industrial activities and upon the
prudence of their administration depend the economic well-being of the nation”.

Collections of Savings and Advancing Loans: Acceptance of deposit and advancing the
loans is the basic function of commercial banks. On this function, all other functions
depend accordingly. Bank operates different types of accounts for their customers.
Money Transfer: Banks have facilitated the making of payments from one place or
persons to another by means of cheques, bill of exchange and drafts, instead of cash.
Payment though cheques, draft is more safe and convenient, especially in case of huge
payments, this facility is a great help for traders and businessmen. It really enhances the
importance of banks for business community.
Encourages Savings:Banks perform an invaluable service by encouraging savings among the
people. They induce them to save for profitable investment for themselves and for
national interest. These savings help in capital formation.

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Transfer Savings into Investment: Bank transfer the savings collected from the people
into investment and thus increase the amount of effective capital, which helps the process
of economic growth.
Overdraft Facilities: The banks allow the overdraft facilities to their trusted customers
and thus help them in overcoming of temporary financial difficulties.
Discounting Bill of Exchange: Importance of banks can be seen through the facility of
discounting bill of exchange. Banks discount their bill of exchange of consumers and help
them in the financial difficulties. By discounting bill of exchange, they able to get the
desire amount for investment they want.
Financing Internal & External Trade:Banks help merchants and traders in financing
internal and external trade by discounting foreign bill of exchange, issuing of letter of
credit and other guarantees for their customers.
Act as an Agent:The bank act as a agent and help their customers in the purchase and
sales of shares, provision of lockers payment of monthly and dividends on stock.
Issue of Traveler’s Cheques:For the convenience and security of money for travelers and
tourists, bank provides the facility of traveler’s cheques. These cheques enable the
travelers and tourists to meet their expenses during their journey, as these are accepted
by issuing bankers, restaurants, and other businessmen both at home and abroad. No
doubt, this is also one of the great functions of banks and shows the importance of banks
for us in more precise ways.
General Utility Services:Existence of commercial banks is essential for contribution to
general prosperity. Banks are the main factors in raising the level of economic development
of the world. In addition to above-cited advantages, banks also provide many services of
general utilities to the customers and the general public.
Capital Formation: Banks play an important role in capital formation, which is essential for
the economic development of a country. They mobilize the small savings of the people
scattered over a wide area through their network of branches all over the country and
make it available for productive purposes. Now-a-days, banks offer very attractive
schemes to attract the people to save their money with them and bring the savings
mobilized to the organized money market. If the banks do not perform this function,
savings either remains idle or used in creating assets, which are low in scale of plan
priorities.
Channelizing the Funds to Productive Investment: Banks invest the savings mobilized by
them for productive purposes. Capital formation is not the only function of banks. Pooled
savings should be distributed to various sectors of the economy with a view to increase
the productivity of the nation. Then only it can be said to have performed an important
role in the economic development of the nation.Banks aid the economic development of the
nation through the capital formed by them. In our country, loan lending operation of banks
subject to the control of the RBI. So our banks cannot lend loan, as they like.
Encouraging Right Type of Industries: The banks help in the development of the right
type of industries by extending loan to right type of persons. In this way, they help not
only for industrialization of the country but also for the economic development of the

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country. They grant loans and advances to manufacturers whose products are in great
demand. The manufacturers in turn increase their products by introducing new methods of
production and assist in raising the national income of the country.
Finance to Government: Government is acting as the promoter of industries in
underdeveloped countries for which finance is needed for it. Banks provide long-term
credit to Government by investing their funds in Government securities and short-term
finance by purchasing Treasury Bills.
Bankers as Employers: After the nationalization of big banks, banking industry has grown
to a great extent. Bank’s branches are opened in almost all the villages, which leads to the
creation of new employment opportunities. Banks are also improving people for occupying
various posts in their office.
Banks are Entrepreneurs: In recent days, banks have assumed the role of developing
entrepreneurship particularly in developing countries like India. Developing of
entrepreneurship is a complex process. It includes the formation of project ideas,
identification of specific projects suitable to local conditions, inducing new entrepreneurs
to take up these well-formulated projects and provision of counseling services like
technical and managerial guidance. Banks provide 100% credit for worthwhile projects,
which is also technically feasible and economically viable. Thus commercial banks help for
the development of entrepreneurship in the country

CHARACTERISTICS / FEATURES OF A BANK

Dealing in Money: Bank is a financial institution which deals with other people's money i.e.
money given by depositors.
Individual / Firm / Company: A bank may be a person, firm or a company. A banking
company means a company which is in the business of banking.

Acceptance of Deposit: A bank accepts money from the people in the form of deposits
which are usually repayable on demand or after the expiry of a fixed period. It gives
safety to the deposits of its customers. It also acts as a custodian of funds of its
customers.
Giving Advances: A bank lends out money in the form of loans to those who require it for
different purposes.
Payment and Withdrawal: A bank provides easy payment and withdrawal facility to its
customers in the form of cheques and drafts, It also brings bank money in circulation. This
money is in the form of cheques, drafts, etc.
Agency and Utility Services: A bank provides various banking facilities to its customers.
They include general utility services and agency services.
Profit and Service Orientation: A bank is a profit seeking institution having service
oriented approach.
Ever increasing Functions: Banking is an evolutionary concept. There is continuous
expansion and diversification as regards the functions, services and activities of a bank.

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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
are in need of money.
Banking Business: A bank's main activity should be to do business of banking which should
not be subsidiary to any other business.
Name Identity: A bank should always add the word "bank" to its name to enable people to
know that it is a bank and that it is dealing in money.

TYPES OF BANKS

Although banking is said to have originated in the affluent cities of Italy in the
14th century, it was introduced in India in the late 18th century. The first banks
to come up in the country were Bank of Hindustan (1770), The General Bank of
India (1786), and the State Bank of India (1806). The banking system has come
along way and the banking sector has witnessed a rapid growth in the country in
the past few decades. The Reserve Bank of India functions as the central bank and
has a control over all the nationalized banks of the country.
There are various types of banks and they can be divided into s ome of the
following categories:

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CENTRAL BANKEvery country has a Central Bank of its own generally regulated by a
special act. Central banks are bankers’ banks, and these banks trace their history from the
Bank of England. It is called a Central Bank because it occupies a central position in the
banking system and acts as the highest financial authority. The main function of this bank
is to regulate and supervise the whole banking system in the country. It is a banker's bank
and controller of credit in the country. They guarantee stable monetary and financial
policy from country to country and play an important role in the economy of the country.
Typical functions include implementing monetary policy, managing foreign exchange and
gold reserves, making decisions regarding official interest rates, acting as banker to the
government and other banks, and regulating and supervising the banking industry.

SCHEDULED BANKS: Scheduled banks have been included in the second schedule of the
Reserve Bank, and fulfils the following three criteria:
1) It must have a paid up capital of at least Rs. 5 lakhs.
2) It must fulfil the RBI norms about no activity that may be detrimental to the
depositors interests.
3) It must be a Corporation(not a partnership or a single ownership firm).

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Commercial banks: These banks function to help the entrepreneurs and businesses. They
give financial services to these businessmen like debit cards, banks accounts, short term
deposits, etc. with the money people deposit in such banks. They also lend money to
businessmen in the form of overdrafts, credit cards, secured loans, unsecured loans and
mortgage loans to businessmen. The commercial banks in the country were nationalized in
1969. So the various policies regarding the loans, rates of interest and loans etc are
controlled by the Reserve Bank. These days, the commercialized banks provide some
services given by investment banks to their clients.
The commercial banks can be further classifies as: public sector
bank, private sector banks, foreign banks and regional banks:
1) Public Sector Banks are owned and operated by the government, who has a major
share in them. The major focus of these banks is to serve the people rather earn
profits. Some examples of these banks include State Bank of India, Punjab National
Bank, Bank of Maharashtra, etc.
a) State Bank of India and its Associate Banks: These associate banks are
State Bank of Bikaner & Jaipur, State Bank of Hyderabad, State Bank of
Mysore, State Bank of Patiala, and State Bank of Travancore.
b) Nationalised Banks– These are those commercial banks that have been
nationalized for fulfilling the social objectives of the government. There are
20 Nationalised banks in India. These are – Allahabad Bank, Andhra Bank,
Bank of Maharashtra, Bank of Baroda, Canara Bank, Central Bank of India,
Bank of India, , Corporation Bank, Dena Bank, Indian Overseas Bank, IDBI
Bank Ltd., Oriental Bank of Commerce, Indian Bank, Punjab & Sind Bank,
Punjab National Bank, Union Bank of India, Syndicate Bank, United Bank of
India,UCO Bank, and Vijaya Bank.
c) Regional Rural Banks(RRB)– These banks have been established to
strengthen the rural economy. They facilitate the credit and deposit flow
for farmers, artisans, labourers in their limited local area. These banks are
jointly owned by the central and state government along with a sponsor
commercial bank.
2) Private Sector Banks are owned and operated by private institutes. They are free
to operate and are controlled by market forces. A greater share is held by private
players and not the government. For example, Axis Bank, Kotak Mahindra Bank etc.
a) Old Private Sector Banks:Not all private sector banks were nationalized in
1969, and 1980. The private banks which were not nationalized are
collectively known as the old private sector banks and include banks such as
The Jammu and Kashmir Bank Ltd., Lord Krishna Bank Ltd etc.
b) New Private Sector Banks:Entry of private sector banks was however
prohibited during the post-nationalization period. In July 1993, as part of
the banking reform process and as a measure to induce competition in the
banking sector, RBI permitted the private sector to enter into the banking
system. This resulted in the creation of a new set of private sector banks,

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 which are collectively known as the new private sector banks. As at end
March, 2009 there were 7 new private sector banks and 15 old private
sector banks operating in India.
3) Foreign Banks are those that are based in a foreign country but have several
branches in India. Some examples of these banks include; HSBC, Standard
Chartered Bank etc.
4) Regional Rural Banks were brought into operation with the objective of providing
credit to the rural and agricultural regions and were brought into effect in 1975 by
RRB Act. These banks are restricted to operate only in the areas specified by
government of India. These banks are owned by State Government and a sponsor
bank. This sponsorship was to be done by a nationalized bank and a State
Cooperative bank. Prathama Bank is one such example, which is located in
Moradabad in U.P.
Cooperative Banks: These banks are controlled, owned, managed and operated by
cooperative societies and came into existence under the Cooperative Societies Act in 1912.
these banks are located in the urban as well in the rural areas. Although these banks have
the same functions as the commercial banks, they provide finance to farmers, salaried
people, small scale industries, etc. and their rates of interest of interest are lower as
compared to other banks.
There are three types of cooperative banks in India, namely:
1) Primary Credit Societies: These are formed in small locality like a small town or a
village. The members using this bank usually know each other and the chances of
committing fraud is minimal.
2) Central Cooperative Banks: These banks have their members who belong to the
same district. They function as other commercial banks and provide loans to their
members. They act as a link between the state cooperative banks and the primary
credit societies.
3) State Cooperative Banks: these banks have a presence in all the states of the
country and have their presence throughout the state.
NON-SCHEDULED BANKS: are excluded from the Second schedule of RBI. The Reserve
Bank does not exercise much control over them, but they report monthly to RBI.
SPECIALIZED BANKS: Specialized banks are dedicated banks that excel in a particular
product, service or sector and provide mission-based services to a section of society.
Some examples of specialized banks are industrial banks, land development banks, regional
rural banks, foreign exchange banks, and export-import banks etc. addressing specific
needs of these unique areas. These banks provide distinctive services or products like
financial aid to industries, heavy turnkey projects and foreign trade. Some specialized
banks are discussed below:
1) Investment Banks: An investment bank is a financial institution that assists
individuals, corporations and governments in raising capital by underwriting and/or
acting as the client's agent in the issuance of securities. An investment bank may
also assist companies involved in mergers and acquisitions, and provide ancillary

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 services such as market making, trading of derivatives, fixed income instruments,
foreign exchange, commodities, and equity securities. Investment banks aid
companies in acquiring funds and they provide advice for a wide range of
transactions. These banks also offer financial consulting services to companies and
give advice on mergers and acquisitions and management of public assets.
2) Industrial Banks target to promote rapid industrial development. They provide
specialized medium and long term loans to industrial sector backed by consultancy,
supervision and expertise. They support industrial growth by rendering other
services like project identification, preparation of project reports, providing
technical advice and managerial services etc. They also do underwriting of public
issues by corporate sector or help industrial units get finance through consortium
or provide guarantee to other financial institutions. We have a number of such
banks in India like Industrial Development Bank of India (IDB), Industrial Finance
Corporation of India (IFCI), Industrial Credit and Investment Corporation of India
Ltd. (ICICI), Industrial Reconstruction Bank of India (IRBI), etc.
3) Retail banks provide basic banking services to individual consumers. Examples
include savings accounts, recurring and fixed deposits and secured and unsecured
loans. Products and services offered by retail banks include safe deposit boxes,
checks and savings accounting, certificates of deposit (CDs), mortgages, consumer
and car loans, personal credit cards etc. Retail Banks can be further classified as:
a) Community Development Banks:Provide services to underserved markets
or populations, example Rural Banks in India, generally incentivized and
regulated by the government.
b) Private Banks: Some private retail banks manage the assets of high-net-
worth individuals and provide specialized services like wealth
management.
c) Savings Banks: These are deposit oriented branches, also could be an
extension counter of an existing bank branch that accept savings
deposits and provide basic banking.
d) Postal Savings Banks: Postal banks are the banks operated and
controlled by National Postal Departments and provide basic banking
services to retail customers. These banks are very effective in small
towns and villages and provide financial inclusion to a section of society
which otherwise would not have been catered by other banks.
4) Land Development Banks:These banks support the development of agriculture and
land. They provide long-term credit to agriculture for purposes such as pump sets,
tractors, digging up wells, land improvement, etc. These banks get funding by
issuing debentures, which are generally subscribed by the State Bank Group, other
commercial banks, LIC and Reserve Bank of India. These banks grant loans to
farmers against the security of their land.
5) Import-Export banks are generally setup by government like central banks to
promote trade activities in import and export. They support exporters and

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 importers by providing financial assistance, acting as principal financial institution,
coordinating working of other institutions engaged in export and import to
facilitate the growth of international trade. They provide traditional export
finance and also do financing of export oriented units. The bank finances and
insures foreign purchases of goods for customers unable or unwilling to accept
credit risk. Some examples are Export-Import Bank of India (Exim Bank), Export–
Import Bank of the United States etc.

RESERVE BANK OF INDIA [RBI]

The Reserve Bank of India was established in 1935 under the provisions of the Reserve
Bank of India Act, 1934 in Calcutta, eventually moved permanently to Mumbai. Though
originally privately owned, was nationalized in 1949.As a central bank, the Reserve Bank
has significant powers and duties to perform. For smooth and speedy progress of the
Indian Financial System, it has to perform some important tasks. Among others it includes
maintaining monetary and financial stability, to develop and maintain stable payment
system, to promote and develop financial infrastructure and to regulate or control the
financial institutions.
FUNCTIONS OF RBI

Functions of RBI

Traditional Developmental / Supervisory Reserve Bank

Functions Promotional Functions of India's
Functions Credit Policy

TRADITIONAL FUNCTIONS OF RBI

Traditional functions are those functions which every central bank of each nation
performs all over the world. Basically these functions are in line with the objectives with
which the bank is set up. It includes fundamental functions of the Central Bank. They
comprise the following tasks:
1) Issue of Currency Notes : The RBI has the sole right or authority or monopoly of
issuing currency notes except one rupee note and coins of smaller denomination.

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 These currency notes are legal tender issued by the RBI. Currently it is in
denominations of Rs. 2, 5, 10, 20, 50, 100, 500, and 1,000. The RBI has powers not
only to issue and withdraw but even to exchange these currency notes for other
denominations. It issues these notes against the security of gold bullion, foreign
securities, rupee coins, exchange bills and promissory notes and government of
India bonds.
2) Banker to other Banks : The RBI being an apex monitory institution has obligatory
powers to guide, help and direct other commercial banks in the country. The RBI
can control the volumes of banks reserves and allow other banks to create credit in
that proportion. Every commercial bank has to maintain a part of their reserves
with its parent's viz. the RBI. Similarly in need or in urgency these banks approach
the RBI for fund. Thus it is called as the lender of the last resort.
3) Banker to the Government : The RBI being the apex monitory body has to work as
an agent of the central and state governments. It performs various banking
function such as to accept deposits, taxes and make payments on behalf of the
government. It works as a representative of the government even at the
international level. It maintains government accounts, provides financial advice to
the government. It manages government public debts and maintains foreign
exchange reserves on behalf of the government. It provides overdraft facility to
the government when it faces financial crunch.
4) Exchange Rate Management : It is an essential function of the RBI. In order to
maintain stability in the external value of rupee, it has to prepare domestic policies
in that direction. Also it needs to prepare and implement the foreign exchange rate
policy which will help in attaining the exchange rate stability. In order to maintain
the exchange rate stability it has to bring demand and supply of the foreign
currency (U.S Dollar) close to each other.
5) Credit Control Function : Commercial bank in the country creates credit according
to the demand in the economy. But if this credit creation is unchecked or
unregulated then it leads the economy into inflationary cycles. On the other credit
creation is below the required limit then it harms the growth of the economy. As a
central bank of the nation the RBI has to look for growth with price stability. Thus
it regulates the credit creation capacity of commercial banks by using various
credit control tools.
6) Supervisory Function : The RBI has been endowed with vast powers for supervising
the banking system in the country. It has powers to issue license for setting up new
banks, to open new braches, to decide minimum reserves, to inspect functioning of
commercial banks in India and abroad, and to guide and direct the commercial banks
in India. It can have periodical inspections an audit of the commercial banks in
India.
DEVELOPMENTAL / PROMOTIONAL FUNCTIONS OF RBI
Along with the routine traditional functions, central banks especially in the developing
country like India have to perform numerous functions. These functions are country

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specific functions and can change according to the requirements of that country. The RBI
has been performing as a promoter of the financial system since its inception. Some of the
major development functions of the RBI are maintained below:
1) Development of the Financial System : The financial system comprises the
financial institutions, financial markets and financial instruments. The sound and
efficient financial system is a precondition of the rapid economic development of
the nation. The RBI has encouraged establishment of main banking and non-banking
institutions to cater to the credit requirements of diverse sectors of the economy.
2) Development of Agriculture : In an agrarian economy like ours, the RBI has to
provide special attention for the credit need of agriculture and allied activities. It
has successfully rendered service in this direction by increasing the flow of credit
to this sector. It has earlier the Agriculture Refinance and Development
Corporation (ARDC) to look after the credit, National Bank for Agriculture and
Rural Development (NABARD) and Regional Rural Banks (RRBs).
3) Provision of Industrial Finance : Rapid industrial growth is the key to faster
economic development. In this regard, the adequate and timely availability of credit
to small, medium and large industry is very significant. In this regard the RBI has
always been instrumental in setting up special financial institutions such as ICICI
Ltd. IDBI, SIDBI and EXIM BANK etc.
4) Provisions of Training : The RBI has always tried to provide essential training to
the staff of the banking industry. The RBI has set up the bankers' training colleges
at several places. National Institute of Bank Management i.e NIBM, Bankers Staff
College i.e BSC and College of Agriculture Banking i.e CAB are few to mention.
5) Collection of Data : Being the apex monetary authority of the country, the RBI
collects process and disseminates statistical data on several topics. It includes
interest rate, inflation, savings and investments etc. This data proves to be quite
useful for researchers and policy makers.
6) Publication of the Reports : The Reserve Bank has its separate publication division.
This division collects and publishes data on several sectors of the economy. The
reports and bulletins are regularly published by the RBI. It includes RBI weekly
reports, RBI Annual Report, Report on Trend and Progress of Commercial Banks
India., etc. This information is made available to the public also at cheaper rates.
7) Promotion of Banking Habits : As an apex organization, the RBI always tries to
promote the banking habits in the country. It institutionalizes savings and takes
measures for an expansion of the banking network. It has set up many institutions
such as the Deposit Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD-
1982, NHB-1988, etc. These organizations develop and promote banking habits
among the people. During economic reforms it has taken many initiatives for
encouraging and promoting banking in India.
8) Promotion of Export through Refinance : The RBI always tries to encourage the
facilities for providing finance for foreign trade especially exports from India. The
Export-Import Bank of India (EXIM Bank India) and the Export Credit Guarantee

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 Corporation of India (ECGC) are supported by refinancing their lending for export
purpose.
SUPERVISORY FUNCTIONS OF RBI
The reserve bank also performs many supervisory functions. It has authority to regulate
and administer the entire banking and financial system. Some of its supervisory functions
are given below:
1) Granting license to Banks : The RBI grants license to banks for carrying its
business. License is also given for opening extension counters, new branches, even
to close down existing branches.
2) Bank Inspection : The RBI grants license to banks working as per the directives
and in a prudent manner without undue risk. In addition to this it can ask for
periodical information from banks on various components of assets and liabilities.
3) Control over NBFIs : The Non-Bank Financial Institutions are not influenced by the
working of a monitory policy. However RBI has a right to issue directives to the
NBFIs from time to time regarding their functioning. Through periodic inspection,
it can control the NBFIs.
4) Implementation of the Deposit Insurance Scheme : The RBI has set up the
Deposit Insurance Guarantee Corporation in order to protect the deposits of small
depositors. All bank deposits below Rupees. One lakh are insured with this
corporation. The RBI work to implement the Deposit Insurance Scheme in case of a
bank failure.
RESERVE BANK OF INDIA'S CREDIT POLICY
The Reserve Bank of India has a credit policy which aims at pursuing higher growth with
price stability. Higher economic growth means to produce more quantity of goods and
services in different sectors of an economy; Price stability however does not mean no
change in the general price level but to control the inflation. The credit policy aims at
increasing finance for the agriculture and industrial activities. When credit policy is
implemented, the role of other commercial banks is very important. Commercial banks flow
of credit to different sectors of the economy depends on the actual cost of credit and
arability of funds in the economy.

MONETARY POLICY
Monetary policy is the macroeconomic policy laid down by the central bank. It involves
management of money supply and interest rate and is the demand side economic policy
used by the government of a country to achieve macroeconomic objectives like inflation,
consumption, growth and liquidity.

DEFINITION
"A policy employing the central banks control of the supply of money as an instrument for
achieving the objectives of general economic policy is a monetary policy."
- - -Prof. Harry Johnson

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"A policy which influences the public stock of money substitute of public demand for such
assets of both that is policy which influences public liquidity position is known as a
monetary policy."- - - - A.G. Hart

From both these definitions, it is clear that a monetary policy is related to the availability
and cost of money supply in the economy in order to attain certain broad objectives. The
Central Bank of a nation keeps control on the supply of money to attain the objectives of
its monetary policy.

OBJECTIVES OR GOALS OF MONETARY POLICY

Full Employment:Full employment has been ranked among the foremost objectives of
monetary policy. It is an important goal not only because unemployment leads to wastage of
potential output, but also because of the loss of social standing and self-respect.
Price Stability:One of the policy objectives of monetary policy is to stabilise the price
level. Both economists and laymen favour this policy because fluctuations in prices bring
uncertainty and instability to the economy.
Economic Growth:One of the most important objectives of monetary policy in recent years
has been the rapid economic growth of an economy. Economic growth is defined as “the
process whereby the real per capita income of a country increases over a long period of
time.”
Balance of Payments:Another objective of monetary policy since the 1950s has been to
maintain equilibrium in the balance of payments.

TYPES OF MONETARY POLICY

Types of Monetary Policy

Contractionary Monetary Policy Expansionary Monetary Policy

Contractionary Monetary Policy

A contractionary monetary policy is an macroeconomic strategy used by a central bank to
decrease the supply of money in the market in an effort to control inflation. The Federal
Reserve and the government control the money supply by adjusting interest rates,
purchasing government securities on the open market, and adjusting government spending.
Expansionary Monetary Policy
A monetary policy designed to increase aggregate demand is called expansionary monetary
policy. It is used to overcome a recession or a depression or a recessionary gap. When
there is a fall in consumer demand for goods are services, and in business demand for
investment goods, i.e. a recessionary gap, the central bank begins an expansionary

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monetary policy that eases the credit market conditions and leads to an upward shift in
aggregate demand. For this purpose, the central bank purchases government securities in
the open market, downs the reserve requirements of member banks, decreases the
discount rate and motivates consumer and business credit through selective credit
measures. By such measures, it lowers the cost and availability of credit in the money
market and progresses the economy.

TOOLS/INSTRUMENTS OF MONETARY POLICY

Tools/Instruments of Monetary Policy

Quantitative Instruments Qualitative Instruments

Instruments

1) Bank Rate Policy (BRP) 1) Fixing Margin Requirements

2) Repo rate 2) Consumer Credit Regulation
3) Cash Reserve Ratio 3) Moral Suasion
4) Statutory Liquidity Ratio (SLR) 4) Control Through Directives
5) MSF (Marginal Standing Facility) 5) Credit Ceiling
6) Reverse Repo Rate 6) Credit Authorisation
7) Liquidity Adjustment Facility
8) Open Market operations

QUANTITATIVE INSTRUMENTS

Bank Rate: Bank Rate refers to the official interest rate at which RBI will provide loans
to the banking system which includes commercial / cooperative banks, development banks
etc.
Repo Rate :Repo rate is the rate through which RBI lends money to commercial bank with
security for Short period of time in the event of short fall of funds. Current Repo rate is
6.25%
Reverse Repo Rate: Reverse Repo rate is the rate through which Commercial Bank lends
money to Central Bank of India i.e. RBI, for Short period of time. Current reverse repo
rate is 5.75%.
Cash Reserve Ratio Every bank Maintain a certain % of their total deposits with RBI in
the form of Cash and Net demand & Time liabilities. Current CRR is 4%. Every Bank has to
pay the amount to RBI on every 15 Days.

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Statutory Liquidity Ratio (SLR) Every bank has to maintain a certain % of their total
deposits in the form of (Gold + Cash + bonds + Securities) with themselves at the end of
every business days. Current SLR is 20.75%.
MSF (Marginal Standing Facility) MSF is the rate through which bank can borrow
funds for Short time – Overnight basis. Current MSF is 6.75%.
Open Market Operations: In the case of excess liquidity, RBI resorts to sale of G-secs
to suck out rupee from system. Similarly, when there is a liquidity crunch in the economy,
RBI buys securities from the market, thereby releasing liquidity.

QUALITATIVE INSTRUMENTS
Moral Suasion : Moral Suasion refers to a request by the RBI to the commercial banks to
take certain measures as per the trend of the economy. For example, RBI may ask banks
to not to give out certain loans. It includes psychological means and informal means of
selective credit control.
Credit Ceiling: Under the credit ceiling, RBI informs the banks to what extent / limit they
would be getting credit. When RBI imposes a credit limit, the banks will get tight in
advancing loans to public. Further, RBI may also direct the banks to provide certain
fractions of their loans to certain sectors such as farm sector or priority sector
Consumer Credit Regulation: This refers to issuing rules regarding down payments and
maximum maturities of installment credit for purchase of goods.
Credit Authorisation: Under this instrument of Credit the commercial banks are required
to obtain the RBI prior authorization for sanctioning any credit beyond the limits.

OPEN MARKET OPERATIONS(OMO)?

Open market operation is the means of implementing monetary policy by which a central
bank, such as Reserve Bank Of India (RBI) in India, controls the term interest rate and
the supply of base money within the economy. Generally speaking, Open market operation is
buying and selling of government securities by a central bank in the open market in order
to control the money supply and credit conditions of the banking system. When the central
bank buys securities on the open market, it actually facilitate growth in the economy as it
increases the reserves of commercial banks making it possible for them to expand their
loans and investments while sales of securities do the opposite. This buying and selling of
securities helps in stabilizing the economy.
During an inflation, when too much of money in the market affects the value of a currency,
sale of securities helps in taking out the money from the economy and stabilizing it. The
targets used in implementation of open market operations include inflation, interest rates,
exchange rates etc. The targets of these operations differ from one section to another.
The most important goals of open market operations include attaining a specific short
term interest rate in the debt markets, growth of the money supply, achieving and
maintaining a fixed exchange rate etc.

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Open-market operations are usually carried out with short-term government securities. As
dealing in both short-term and long-term securities would distort the interest-rate
structure and therefore the allocation of credit.

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