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BANKING IN INDIA

Name: Debashis Mondal

Program of Study: Master of Business Administration

Session of study: 2009 - 2011

Name of Internal guide: Prof. Sushmit Mitra

Name of the Topic: Banking in India

Date of Project Report Submission:

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ACKNOWLEDGEMENT

First of all I would like to thank my parent and all my teachers for helping me to be
where I am today. The project bears the imprint of many people without whom the
project would not be successful. I like to acknowledge all of them for their kind support,
co operation, and help.

I express my gratitude to Prof. Sushmit Mitra who gave me the opportunity for selecting
this as my topic. As I have got a job in the banking sector so for me this is a very good
opportunity to now the area through this project.

I also take the opportunity to thank all my colleagues and by boss and all my well wishers
for being a constant source of inspiration to me throughout the project. I shall forever
remain indebted to them.
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CONTENTS

PARTICULARS Page No.

Declaration by student 4
Declaration by Internal Guide 5

Executive Summary 6
Objective of Study 7

Introduction 8
Types of Banks 12
Banking Sector in India 13
Role of Banks 14
Role of Banks in Indian Economy 16
Evolution of Banking 17

Methodology
Limitations of The Study
Recommendation

Conclusion

Bibliography
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DECLARATION BY STUDENT

I declare that the project titled “Banking in India’’ has been done by me and has not
been submitted in part or full to any authority for award of any Degree/Diploma.

Debashis Mondal

Date:
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DECLARATION BY INTERNAL GUIDE

This is to certify that the work embodied in the project report titled “Banking in India”
done by Debashis Mondal was conducted under my supervision.

Signature:

Prof. Sushmit Mitra

Date:
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EXECUTIVE SUMMARY

The banking system remains, as always, the most dominant segment of the financial
sector. Indian banks continue to build on their strengths under the regulator's watchful
eye and hence, have emerged stronger.

The project is primarily focused on the banking sector in India and how they are working
in the Indian scenario. Indian banking industry is becoming one of the most dominant
banking system in the world. It has starched greatly after the globalization. So here I have
tried to analyze the industry and how it work. In this project I have shown the different
types of banks that we have in our country and their different functions.
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OBJECTIVE OF STUDY

Banks play very important role in the economic life of the nation. The health of the
economy is closely related to the soundness of its banking system. Although banks create
no new wealth but their borrowing, lending and related activities facilitate the process of
production, distribution, exchange and consumption of wealth. In this way they become
very effective partners in the process of economic development. A bank as a matter of
fact is just like a heart in the economic structure and the Capital provided by it is like
blood in it. As long as blood is in circulation the organs will remain sound and healthy. If
the blood is not supplied to any organ then that part would become useless. So the main
objectives of this project are stated bellow.

Broad Objectives:

 To have a clear idea about the banking sector.

 To find out the working process of a bank.

 To know the current scenario of the banking system in India.

 To know the growth and the future prospects.

Specific Objectives:

 To understand the different function of a bank.

 To find out the difference between the private sector and the public
sector banks.

 To find out the role of the RBI and the Government of India.

 To understand the modern banking system and its advantages.

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INTRODUCTION

Banks over the years have become a significant aspect of an economy. With the ongoing
financial depression, the position of banks have become all the more important in the
course of
working of the money market and hence the economy of a nation. The banking sector
forming a
portion of the financial sector primarily works as a financial intermediary generating
money
supply. From the different macroeconomic models, banks have been found to be a part of
the
supply side of the economy. However, over time banks have transformed from merely
money
generating organizations to a multi tasking entity. In this paper, we shall deal with the
role of
banks in the context of the world economy as well as the Indian economy . The first
section will
illustrate the functions of a bank along with its classification. In the second section, we
shall
discuss the role of a banks as a major component of the service sector rendering to the
economy
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as a whole. In the third section, we would like to empirically validate our hypothesis with
a
comprehensive data analysis.

What is a Bank? While the question may seem elementary, the answer can be quite
complex. Understanding what banking is all about will help the paper to illustrate the role
of banks better.

A bank is a financial institution where an individual can deposit money. Banks provide a
system for easily transferring money from one person or business to another. Using banks
and the many services they offer saves an incredible amount of time, and ensures that the
funds of micro as well as macroeconomic agents "pass hands" in a legal and structured
manner. There are also other types of financial institutions that operate just like banks.

Functions of a bank : Functioning of a Bank is among the more complicated of

corporate operations. Since
Banking involves dealing directly with money, governments in most countries regulate
this sector rather stringently. In India, the regulation traditionally has been very strict and
in the opinion of certain quarters, responsible for the present condition of banks, where
NPAs are of a very high order. The process of financial reforms, which started in 1991
has
cleared the cobwebs somewhat but a lot remains to be done. The multiplicity of policy
and
regulations that a Bank has to work with, makes its operations even more complicated,
sometimes bordering on illogical. This section attempts to give an overview of the
functions in as simple manner as possible.

Banking Regulation Act of India, 1949 defines Banking as "accepting, for the purpose of
lending or investment of deposits of money from the public, repayable on demand or
otherwise and withdraw able by cheques, draft, order or otherwise". Deriving from this
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definition and viewed solely from the point of view of the customers, Banks essentially
perform the following functions:

1. Accepting Deposits from public/others (Deposits)

2. Lending money to public (Loans)

3. Transferring money from one place to another (Remittances)

4. Credit Creation

5. Acting as trustees
6. Keeping valuables in safe custody
7. Investment Decisions and analysi

8. Government business
9. Other types of lending and transactions.

In addition to providing a safe custodian of money, banks also loan money to businesses
and consumers. A large portion of a bank's business is lending. How do banks get the
money they loan? The money comes from depositors who intend to save a portion of
their wealth. Banks acting as intermediaries, use these deposits as loans to prospective
borrowers.

The objective of commercial banks like any other organization is profit maximisation.
This profit
generally originates from the interest differential between borrowers and lenders. In the
present
day, however, the banking operation has extended much beyond simple lending exercise.
So
there are other different channels of profit ensuing from other investment programmes as
well.
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However, it should be mentioned in this context that the entire deposit held by a bank
cannot be
given as loans as the Central Bank retains a portion of this money in the form of cash-
reserve for
unforeseen circumstances.

Banks create money in the economy by making loans. The amount of money that banks
can
lend is directly affected by the reserve requirement set by the Federal Reserve. The
reserve
requirement is currently 3 percent to 10 percent of a bank's total deposits. This amount
can be
held either in cash on hand or in the bank's reserve account with the Fed. To see how this
affects
the economy, think about it like this. When a bank gets a deposit of $100, assuming a
reserve
requirement of 10 percent, the bank can then lend out $90. That $90 goes back into the
economy,
purchasing goods or services, and usually ends up deposited in another bank. That bank
can then
lend out $81 of that $90 deposit, and that $81 goes into the economy to purchase goods or
services and ultimately is deposited into another bank that proceeds to lend out a
percentage of it.
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In this way, money grows and flows throughout the community in a much greater amount
than
Physically exists. That $100 makes a much larger ripple in the economy than you may
realize.

Other services offered by banks:

• Credit Cards

• Personal Loans

• Home and Car Loans

• Mutual Funds
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• Business Loans

• Safe Deposit Boxes

• Debit Cards

• Trust Services

• Signature Guarantees

….and many other investment services.

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TYPES OF BANKS:

Central Bank: A central bank, reserve bank, or monetary authority is the entity
responsible for the monetary policy of a country or of a group of member states. Its
primary responsibility is to
maintain the stability of the national currency and money supply, but more active duties
include
controlling subsidized-loan interest rates, and acting as a lender of last resort to the
banking
sector during times of financial crisis (private banks often being integral to the national
financial
system). It may also have supervisory powers, to ensure that banks and other financial
institutions do not behave recklessly or fraudulently.

Commercial Banks: A commercial Bank performs all kinds of banking functions such as
accepting deposits, advancing loans, credit creation & agency functions. They generally
advance short term loans to their customers; in some cases they may give medium term
loans also.

Industrial Banks: Ordinarily, the industrial banks perform three main functions: Firstly,
Acceptance of Long term deposits: Since the industrial bank give long term loans, they
cannot
accept short term deposits from the public. Secondly, Meeting the credit requirements of
companies: Firstly the industries require to purchase land to erect buildings and purchase
heavy
machinery. Secondly the industries require short term loans to buy raw materials & to
make
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payment of wages to workers. Thirdly it does some Other Functions - The industrial
banks
tender advice to big industrial firms regarding the sale & purchase of shares &
debentures.

Agricultural Banks: As the commercial & the industrial Banks are not in a position to
meet the credit requirements of agriculture, there arises the need for setting up special
types of banks to
finance agriculture. Firstly, the farmers require short term loans to buy seeds, fertilizers,
ploughs
and other inputs. Secondly, the farmers require long term loans to purchase land, to effect
permanent improvements on the land to buy equipment & to provide for irrigation works.

Foreign Exchange Banks: Their main functions are to make international payments
through the purchase and sale of exchange bills. As is well known, the exporters of a
country prefer to receive the payment for their exports in their own currency. Hence their
arises the problem of converting the currency of one country into the currency of another.
The foreign exchange banks try to solve this problem. These banks specialize in
financing foreign trade.

Indigenous Banks: According to the Indian Enquiry Committee, “Indigenous banker is a

person or a firm which accepts deposits, transacts business in hundies and advances loans
etc”.

BANKING SECTOR IN INDIA

Central Bank:
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The Reserve Bank of India is the central Bank that is fully owned by the
Government. It is governed by a central board (headed by a Governor) appointed by the
Central Government. It issues guidelines for the functioning of all banks operating within
the country.

Public Sector Banks:

a. State Bank of India and its associate banks called the State Bank Group
b. 20 nationalized banks
c. Regional rural banks mainly sponsored by public sector banks

Private Sector Banks:

a. Old generation private banks

b. New generation private banks
c. Foreign banks operating in India
d. Scheduled co-operative banks

e. Non-scheduled banks

Co-operative Sector:

The co-operative sector is very much useful for rural people. The co-operative banking
sector is divided into the following categories.

a. State co-operative Banks

b. Central co-operative banks
c. Primary Agriculture Credit Societies

Development Banks/Financial Institutions:

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IFCI, IDBI , ICICI Bank , IIBI

SCICI Ltd.
NABARD
Export-Import Bank of India
National Housing Bank
Small Industries Development Bank of India
North Eastern Development Finance Corporation

ROLE OF BANKS

A proper financial sector is of special importance for the economic growth of developing
and
underdeveloped countries. The commercial banking sector which forms one of the
backbones of
the financial sector should be well organized and efficient for the growth dynamics of a
growing
economy. No underdeveloped country can progress without first setting up a sound
system of
commercial banking. The importance of a sound system of commercial banking for a
developing
country may be depicted as follows:

Capital Formation: The rate of saving is generally low in an underdeveloped economy

due to the existence of deep-rooted poverty among the people. Even the potential savings
of the country cannot be realized due to lack of adequate banking facilities in the country.
To mobilize dormant savings and to make them available to the entrepreneurs for
productive purposes, the development of a sound system of commercial banking is
essential for a developing economy.
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Monetization: An underdeveloped economy is characterized by the existence of a large

non monetized sector, particularly, in the backward and inaccessible areas of the country.
The existence of this non monetized sector is a hindrance in the economic development
of the country. The banks, by opening branches in rural and backward areas, can promote
the process of monetization in the economy.

Innovations: Innovations are an essential prerequisite for economic progress. These

innovations are mostly financed by bank credit in the developed countries. But the
entrepreneurs in underdeveloped countries cannot bring about these innovations for lack
of bank credit in an adequate measure. The banks should, therefore, pay special attention
to the financing of business innovations by providing adequate and cheap credit to
entrepreneurs.

Finance for Priority Sectors: The commercial banks in underdeveloped countries

generally hesitate in extending financial accommodation to such sectors as agriculture
and small scale industries, on account of the risks involved there in. They mostly extend
credit to trade and commerce where the risk involved is far less .But for the development
of these countries it is essential that the banks take risk in extending credit facilities to the
priority sectors, such as agriculture and small scale industries.

Provision for Medium and Long term Finance: The commercial banks in
underdeveloped countries invariably give loans and advances for a short period of time.
They generally hesitate to extend medium and long term loans to businessmen as it is
well known, the new business need medium and long term loans for their proper
establishment. The commercial banks should, therefore, change their policies in favor of
granting medium and long term accommodation to business and industry.

Cheap Money Policy: The commercial banks in an underdeveloped economy should

follow cheap money policy to stimulate economic activity or to meet the threat of
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business recession. In fact , cheap money policy is the only policy which can help
promote the economic growth of an underdeveloped country . It is heartening to note that
recently the commercial banks have reduced their lending interest rates considerably.

Need for a Sound Banking System: A sound system of commercial banking is an

essential prerequisite for the economic development of a backward country.

ROLE OF BANKS IN INDIAN ECONOMY

In India, as in many developing countries, the commercial banking sector has been the
dominant element in the counters’ financial system. The sector has performed the key
functions of providing liquidity and payment services to the real sector and has accounted
for the Bulk of the financial intermediation process. Besides institutionalizing savings,
the banking sector has contributed to the process of economic development by serving as
a major source of credit to households, government, and business and to weaker sectors
of the economy like village and small-scale industries and agriculture. Over the years,
over 30-40% of gross household savings, have been in the form of bank deposits and
around 60% of the assets of all financial institutions accounted for by commercial banks.
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An important landmark in the development of banking sector in recent years has been
the initiation if reforms following the recommendations of the first Narasimham
Committee on Financial System. In reviewing the strengths and weaknesses of these
banks, the Committee suggested several measures to transform the Indian banking sector
from a highly regulated to a more market oriented system and to enable it to compete
effectively in an increasingly globalised environment. Many of the recommendations of
the Committee especially those pertaining to interest rate, an institution of prudential
regulation and transparent accounting norms were in line with banking policy reforms
implemented by a host of developing countries since 1970‟s.

EVOLUTION OF BANKING IN INDIA

Introduction: Banking in India originated in the last decades of the 18th century. The
first banks were The General Bank of India, which started in 1786, and Bank of
Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in
India is the State Bank of India, which originated in the Bank of Calcutta in June 1806,
which almost immediately became the Bank of Bengal. This was one of the three
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presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all
three of which were established under charters from the British East India Company. For
many years the Presidency banks acted as quasi-central banks, as did their successors.
The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's
independence, became the State Bank of India.

Growth: Indian merchants in Calcutta established the Union Bank in 1839, but it failed
in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank,
established in 1865 and still functioning today, is the oldest Joint Stock bank in India.
(Joint Stock Bank: A company that issues stock and requires shareholders to be held
liable for the company's debt) It was not the first though. That honor belongs to the Bank
of Upper India, which was established in 1863, and which survived until 1913, when it
failed, with some of its assets and liabilities being transferred to the Bank of Shimla.

When the American civil war stopped the supply of cotton to Lancashire from the
Confederate States, promoters opened banks to finance trading in Indian cotton. With
large exposure to speculative ventures, most of the banks opened in India during that
period failed. The depositors lost money and lost interest in keeping deposits with banks.
Subsequently, banking in India remained the exclusive domain of Europeans for next
several decades until the beginning of the 20th century.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The
Comptoire d’Escompte de Prais opened a branch in Calcutta in 1860, and another
in Bombay in 1862; branches in Madras and Puducherry, then a French colony,
followed. HSBC established itself in Bengal in 1869. Calcutta was the most active
trading port in India, mainly due to the trade of the British Empire, and so became
a banking center.

The first entirely Indian joint stock bank was the Oudh Commercial Bank,
established in 1881 in Faizabad . It failed in 1958. The next was the Punjab
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National Bank, established in Lahore in 1895, which has survived to the present
and is now one of the largest banks in India.

Around the turn of the 20th Century, the Indian economy was passing through a
relative period of stability. Around five decades had elapsed since the Indian
mutiny, and the social, industrial and other infrastructure had improved. Indians
had established small banks, most of which served particular ethnic and religious
communities.

The presidency banks dominated banking in India but there were also some
exchange banks and a number of Indian joint stock. All these banks operated in
different segments of the economy. The exchange banks, mostly owned by
Europeans, concentrated on financing foreign trade. Indian joint stock banks were
generally undercapitalized and lacked the experience and maturity to compete
with the presidency and exchange banks. This segmentation let Lord Curzon to
observe, "In respect of banking it seems we are behind the times. We are like
some old fashioned sailing ship, divided by solid wooden bulkheads into separate
and cumbersome compartments."

The period between 1906 and 1911, saw the establishment of banks inspired by
the Swadeshi movement. The Swadeshi movement inspired local businessmen
and political figures to found banks of and for the Indian community. A number
of banks established then have survived to the present such as Bank of India,
Corporation Bank, Indian Bank, Bank of Boroda, Canara Bank, and Central Bank
of India.

During the First World War (1914-1918) through the end of the Second World
War (1939-1945), and two years thereafter until the independence of India were
challenging for Indian banking. The years of the First World War were turbulent,
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and it took its toll with banks simply collapsing despite the Indian economy
gaining indirect boost due to war-related economic activities. At least 94 banks in
India failed between 1913 and 1918 as indicated in the following table:

Years Number of Authorized capital Paid-up Capital

banks (Rs. Lakhs) (Rs. Lakhs)
that failed
1913 12 274 35
1914 42 710 109
1915 11 56 5
1916 13 231 4
1917 9 76 25
1918 7 209 1

Nationalization:

Despite the provisions, control and regulations Reserve Bank of India, banks in
India except the State Bank of India or SBI, continued to be owned and operated
by private persons. By the 1960s, the Indian banking industry had become an
important tool to facilitate the development of the Indian Economy. At the same
time, it had emerged as a large employer, and a debate had ensued about the
nationalization of the banking industry. Indira Gandhi and the Prime Minister of
India expressed the intention of the Government of India in the annual conference
of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank
Nationalization." The meeting received the paper with enthusiasm.

Thereafter, her move was swift and sudden. The Government of India issued an
ordinance and nationalized the 14 largest commercial banks with effect from the
midnight of July 19, 1969. Jayprakash Narayan, a national leader of India,
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described the step as a "masterstroke of political sagacity." Within two weeks of

the issue of the ordinance, the parliament passed the Banking Companies
(Acquisition and Transfer of Undertaking) Bill, and it received the presidential
approval on 9 August 1969.

A second dose of nationalization of 6 more commercial banks followed in 1980.

The stated reason for the nationalization was to give the government more control
of credit delivery. With the second dose of nationalization, the Government of
India controlled around 91% of the banking business of India. Later on, in the
year 1993, the government merged New Bank of India with Punjab National
Bank. It was the only merger between nationalized banks and resulted in the
reduction of the number of nationalized banks from 20 to 19. After this, until the
1990s, the nationalized banks grew at a pace of around 4%, closer to the average
growth rate of the Indian economy.

Liberalizations:

In the early 1990s, the then Narshima Rao government embarked on a policy of
liberalization , licensing a small number of private banks. These came to be
known as New Generation tech-savvy banks, and included Global Trust Bank (the
first of such new generation banks to be set up), which later amalgamated with
Oriental Bank of Commerce, Axis Bank, ICICI Bank and HDFC Bank . This
move, along with the rapid growth in the economy of India, revitalized the
banking sector in India, which has seen rapid growth with strong contribution
from all the three sectors of banks, namely, government banks, private banks and
foreign banks.

The next stage for the Indian banking has been set up with the proposed relaxation
in the norms for Foreign Direct Investment, where all Foreign Investors in banks
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may be given voting rights which could exceed the present cap of 10%,at present
it has gone up to 74% with some restrictions.

The new policy shook the Banking sector in India completely. Bankers, till this
time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%;Go home at 4) of
functioning. The new wave ushered in a modern outlook and tech-savvy methods
of working for traditional banks.All this led to the retail boom in India. People not
just demanded more from their banks but also received more.

Currently (2007), banking in India is generally fairly mature in terms of supply,

product range and reach-even though reach in rural India still remains a challenge
for the private sector and foreign banks. In terms of quality of assets and capital
adequacy, Indian banks are considered to have clean, strong and transparent
balance sheets relative to other banks in comparable economies in its region. The
Reserve Bank of India is an autonomous body, with minimal pressure from the
government. The stated policy of the Bank on the Indian Rupee is to manage
volatility but without any fixed exchange rate-and this has mostly been true.

With the growth in the Indian economy expected to be strong for quite some time-
especially in its services sector-the demand for banking services, especially retail
banking, mortgages and investment services are expected to be strong. One may
also expect M&As, takeovers, and asset sales.

In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its
stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first
time an investor has been allowed to hold more than 5% in a private sector bank
since the RBI announced norms in 2005 that any stake exceeding 5% in the
private sector banks would need to be vetted by them.
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In recent years critics have charged that the non-government owned banks are too
aggressive in their loan recovery efforts in connection with housing, vehicle and
personal loans. There are press reports that the banks' loan recovery efforts have
driven defaulting borrowers to suicide.