Slide - 01

DEFINITION OF BANKING
AND
FUNCTIONS OF BANKS

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Outline/Learning Objectives

Definition of Banking and Banking Company

Primary Activities/Core Functions of Banks
Ancillary/Subsidiary Activities of Banks
Prohibited Activities for Banks in India
Basic Principles of Banking
Types of Banking Groups in India
Traditional & Modern Functions of Banks
Emerging Trends and Challenges in Banking
Key Words/Terminologies/Glossary

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Functions and Forms of Banking

What do banks do for their customers?

Why do banks perform those services?
How do banks compare to other financial service
organizations?
What factors have affected the operations of commercial
banks and other financial service organizations?
What are the principal sources and uses of funds for banks?
Mobilisation & Deployment of Resources by Banks

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MEANING AND DEFINITION OF BANK/BANKING

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The word Bank is derived from the Greek word

Banque or the Italian word Banco both meaning a
bench at which moneylenders and money changers
used to display their coins and transact their business
in market places. A bank is a profit seeking firm dealing
in money and credit (loans). It accepts deposits and
keeps it under safe custody.

According to Cambridge International Dictionary of

English, the word Bank means an organisation
where people and businesses can invest (deposit) and
borrow money, change it to foreign currency, etc. As
against this word Bankrupt in relation to an individual
or a corporate entity signifies a status of being unable
to pay its debt (what is owed) as declared by a Court of
Law.

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MEANING AND DEFINITION OF BANK/BANKING

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The dictionary meaning of these 2 words indicates

mutually opposite connotations; bankrupt indicates an
inability to pay ones obligation or debt owed to others,
while bank essentially connotes an ability to pay its
obligations to others (its customers) always in time the
cash are due.

Another word bank on meaning depend on is

derived from the intrinsic quality of a bank, viz.
dependability. Therefore, in ordinary parlance, the
financial soundness, inherent ability to meet ones
financial obligations, honouring ones commitments or
dependability, are the distinguishing features of a bank.

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DEFINITION OF BANK/BANKING u/r INDIAN LAW

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Definition of Banking as per Indian Banking Regulation Act,

1949 :

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 5b)
A Banking Company is a Company which transacts the business of
banking in India. (Section 5c)
As per the above definition the following are the core or primary or
essential functions/activities of a Bank/Commercial Bank.

Acceptance of Deposits of money from the public

And deploying such money either for the purpose of Lending i.e.
giving loans
Or for making Investments (Mandated/Statutory Investments for
Statutory Liquidity Ratio (SLR) Purposes known as SLR
Investments and Non-SLR/Non-Mandated Investments)

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DEFINITION OF BANK/BANKING u/r INDIAN LAW

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The other salient features of this banking definition are :

Subject to the obligation to repay the deposits to the customers on
demand or otherwise as per the terms of the deposits.
The definition also specifies the time and mode of withdrawal of
deposits. The deposited money should be repayable to the
depositor on demand made by the latter or according to the
agreement reached b/w the 2 parties. Thus the banker does not
refund the money on its own accord, even if the period for which it
was deposited expires. The depositor has to make a demand for
the same .

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DEFINITION OF BANK/BANKING u/r INDIAN LAW

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Deposits are withdrawable by means of any instrument in writing

whether a Cheque, Draft and Order or otherwise (withdrawal slip,
letter, voucher).
Thus the demand should be made in a proper manner through an
instrument in writing and not merely by a verbal order or a
telephonic message.
The phrase deposits of money from the public has great
significance. The banker accepts deposits from the public i.e., who
ever offers his money as deposit. However, a banker can refuse to
open accounts for undesirable persons. Hence, moneylenders and
indigenous bankers are Not considered as Banks because they do
business on their own resources and do not accept deposits from
the public.

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DEFINITION OF BANK/BANKING u/r INDIAN LAW

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The essential functions of a banking company are the acceptance

of deposits, and lending and/or investing such deposits. If the
purpose of acceptance of deposits is Not for lending or investing,
the business cannot be called banking. Hence, a manufacturing
company accepting deposits of money from public for financing its
own business is not considered as a banking company.
Its only a bank/banking company which can issue Cheques/Drafts,
i.e., accepts chequable deposits. Hence, a Non-banking finance
company (NBFC) accepting deposits of money from public and
engaged in lending and/or investing such deposits are Not
considered as banks as they cannot issue Cheques/Drafts.

The Use of word Bank (Sec. 7 of BR Act, 1949) : No

company other than a banking company is permitted to
use
as
part
of
its
name
words
like
Bank/Banker/Banking.

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PRIMARY FUNCTIONS OF A COMMERCIAL BANK

What are the Primary Activities or Principal Functions of a

Commercial Bank?
Accepting Deposits of money from Public
Giving Loans and advances to Public (Individuals, Business Units)
Making Investments (both Mandated (SLR) investments and Nonmandated (Non-SLR) investments)
Cheque Writing Facility and Payment and Settlement Services (i.e.
Funds Transfer or Remittance Services)

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Ancillary Permitted Banking Activities

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As per section 6 of BR act, 1949, Banks are authorised to carry out the
following functions in addition to the above principal functions :

Discounting of Bills
Collection of Cheques and Bills
Payment Function/Remittance Services (DD, BC, MT, TT, ECS,
NEFT, RTGS, SWIFT, Credit/Debit Card/Smart Card etc.)
Safe Custody of Articles
Hiring Safe Deposit Lockers
Conducting Foreign Exchange Transactions
Conducting Government Transactions
Issuing Letter of Credit and Guarantees
Merchant Banking Functions
Collection of Utility Bills/School fees
Distribution of Insurance and Mutual Fund Products

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PROHIBITED BANKING ACTIVITIES

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Section 8 of BR act prohibits a banking company

from engaging in the following activities :
Directly or indirectly in trading activities and
undertaking trading risks
Buying or Selling or Bartering of Goods directly
or indirectly
Section 9 prohibits a banking company from
holding immovable properties, howsoever
acquired, except as is required for its own use,
for a period exceeding 7 years from the
acquisition of the property. RBI may extend this
period by another 5 years.

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BANKING REGULATIONS IN INDIA

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Banking in India is governed by the following

statutes :
Banking Regulation Act, 1949
RBI Act, 1934
SBI Act, 1955 & SBI (Subsidiary Banks) Act,
1959
Banking Companies (Acquisitions & Transfer of
Undertakings) Act, 1970 and 1980 (more
popularly known as Bank Nationalisation Act)

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BASIC PRINCIPLES OF BANKING

Principle of Intermediation

Principle of Prudence

Principle of Liquidity

Principle of Profitability

Principle of Solvency

Principle of Trust

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TYPES OF BANKING GROUPS IN INDIA-1

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Commercial banks in India may broadly be classified on

the basis of two criteria: (i) statutory, and (ii) ownership.
On the statutory basis, the banks are of two types; (i)
Scheduled banks; and (ii) Non-scheduled banks.
On the ownership basis, the banks may be classified into
two groups: (i) Public sector commercial banks, and (ii)
Private sector commercial banks.
In the category of scheduled banks, there are private
sector banks and public sector banks.
In fact, all the public sector banks are scheduled banks,
whereas in the private sector it is not so.

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TYPES OF BANKING GROUPS IN INDIA-2

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Scheduled and Non-Scheduled Banks

(a) Scheduled Banks : Scheduled Banks in India constitute those banks

which have been included in the Second Schedule of Reserve Bank of
India(RBI) Act, 1934. RBI in turn includes only those banks in this schedule
which satisfy the criteria laid down vide section 42 (6) (a) of the Act. These
are (i) Paid up capital and Reserves = or > Rs.5 lakh and (ii) they have
convinced RBI that their affairs are Not conducted in a manner detrimental
to the interest of their depositors.
These Banks are required to maintain a certain %age of their Net Demand
and Time Liabilities (NDTL) as Cash Reserve (CRR) with RBI as
prescribed by RBI from time to time (currently 4% as on 20/06/2013).
Scheduled banks enjoy certain privileges/ facilities like refinance,
rediscounting of bills and remittance facilities at concessionary rates from
RBI. Scheduled banks should submit many returns to RBI and must
comply with the directions received from RBI. The affairs from scheduled
banks are closely observed and largely regulated by RBI to safeguard the
general health of the banking system in India.

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TYPES OF BANKING GROUPS IN INDIA-3

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Scheduled and Non-Scheduled Banks

Scheduled Banks are classified as under :

1.1 Scheduled Co-operative Banks (State and Urban Co-op Banks)
1.2 Scheduled Commercial Banks (SCBs) including RRBs (165 in Nos. out
of which RRBs are 82 in Nos. as in March 2011)
1.2.1 Foreign Scheduled Banks (about 36)
1.2.2 Indian Scheduled Banks
(a) Private Sector Scheduled Banks : Both Old and New (about 21)
(b) Public Sector Scheduled Banks (total 108 as of now)
(i) State Bank Group : SBI + its 5 subsidiaries (total 6)
(ii) Nationalised Banks : 19 + IDBI Bank 1 b (total 20)
(iii) Regional Rural Banks (RRBs) : 82

(b) Non-Scheduled Banks : Not included in the 2 nd schedule of the

RBI act. Their No. has progressively reduced over the years. 4 Nos.
of LABs as on March 2011. They are not entitled to receive facilities
like refinance and rediscounting of bills etc. from RBI and do not get
the pride like that of scheduled banks.

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STRUCTURE OF ORGANISED
INDIAN BANKING INDUSTRY

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GENESIS OF INDIAN
BANKING INDUSTRY

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What do banks do for their customers?

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Role and Functions of Commercial Banks :

(a) Traditional Functions : These are performed by almost
every bank, irrespective of its size, ownership pattern and
operational area.
(b) Modern Functions : These are mostly performed by
large sized/modern banks, situated in commercial centres
or metro cities.
Traditional Functions /(Core or Primary or Essential):
Financial Intermediation : (a) Deposit Function/Accepting
Deposits, (b) Loan Function/Making Loans and (c)
Investment Function/Making Investments
Payment & Settlement System : Remittances of Funds
and settlement of financial/economic transactions within the
country and across countries.

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What do banks do for their customers?

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Role and Functions of Commercial Banks :

Traditional
Functions/(Ancillary
activities
or
Miscellaneous Financial Services) : These are agency
services aka non-fund based/Off-Balance Sheet Services
or fee-based services, e.g., Issue of Credit/Debit Cards,
Issue of Travellers Cheques, Drafts, Letter of Credits (LC),
Bank Guarantees (BG or LG), Collection of Cheques, Bills,
Safe Custody of Valuables, Safe Deposit Lockers,
Conducting Govt. Business (Cllection of Taxes/Payment of
Pensions), Collection of Utility Bills/School fees etc.

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What do banks do for their customers?

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Modern Banking Functions :

(a) Cross-border fund raising services like :
External Commercial Borrowings (ECB)
Global Depository Receipts (GDRs)/American Depository Receipts
(ADRs)/International Depository Receipts (IDRs)
Non-Resident External (NRE) Rupee Accounts/Foreign Currency NonResident (FCNR) Accounts
Syndication of Foreign Currency Loans
(b) Cross-border Banking Services/International Trade Finance
Import Financing/Leasing/
Export Financing/Forfaiting/Factoring/Leasing
(c) Merchant Banking/Investment Banking Services : Non-fund based
or fee-based services. Financial Dis-intermediation. Project Appraisal,
Financial Advisory Services including Fund Raising Services in
domestic and international markets

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What do banks do for their customers?

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(d) Portfolio Management Services (PMS)/Wealth Management and

Private Banking Services like (i) Advisory Services : Flexible, unbiased
investment advices customised to meet clients needs (ii) Transaction
Support : Brokerage Services (3 in 1 account) (iii) Custodial Services :
Demat Accounts for Shares/Bonds/Mutual Fund Units.
(e) Bancassurance and Bank Mutual Fund Business : Banks have
made entry into Insurance and Mutual Fund Business either with or
without risk participation basis. Some Banks are floating Insurance
(Life/Non-Life) Ventures and MF House and some banks are only
marketing the Insurance and Mutual Fund Products by tying up with
Insurance Companies and MF Houses.

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Why do banks perform those services?

Banks are private firms with a public purpose. They seek

to maximize shareholder wealth (represented by the
market value of bank stock and dividends paid).
Banking is the management of risk. By taking risks, they
earn a profit.
-- Credit risk
-- Interest rate risk
-- Liquidity risk
-- Price risk

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-- Foreign exchange risk

-- Compliance risk
-- Strategic risk
-- Reputation risk

Various factors that affect banks include market, social,

and legal and regulatory constraints.

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What factors have affected the operations of commercial

banks and other financial service organizations?

Inflation and volatile interest rates:

Securitization:

Rising interest rates caused shorter-term deposit costs to

rise faster than longer-term loans. Also, as rates rose, the
market value of their assets declined and borrowers
defaulted on loans with greater frequency than normal.
Banks are pooling loans for various kinds and selling
securities with claims on these loans.

Technological advances:

Telecommunications and computers are increasing

economies of scale and economies of scope for banks.

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What factors have affected the operations of commercial

banks and other financial service organizations?

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Fundamental Forces of Change in the

Banking & Financial Sector :

Consumers/Customers have become better informed, more

sophisticated, more demanding, less forgiving and less loyal.
Capital and Money markets have increased their competition with
banks in attracting firms seeking debt funds.
Deregulation/Reregulation and Liberalisation :
The elimination of laws that placed geographic limits on banks, their
products and services, and the interest rates they can pay on
deposits and charge on loans has increased banking risks for the
customers as well as for the banks themselves and this has also
stimulated bank mergers and consolidation.
De-specialization and Rising competition among financial institutions
with one-stop shopping centers leading to Universal or Umbrella
Banking. Intense Competition from Banks as well as Non-Banks and
Capital & Money Markets

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What factors have affected the operations of commercial

banks and other financial service organizations?

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Global integration of financial markets (Globalisation) and

Privatisation of Banking Sector is increasing competition from
foreign financial service firms.
Disintermediation & Securitisation
Technological Revolution/Convergence of Technology
Financial Innovation/Service or Product Proliferation
Rising Funding Costs and Shrinking Spreads
Consolidation and Geographic Expansion
Convergence of Business/Universal Banking
Capital
Corporate Governance
Inclusive Banking/Financial Inclusion and Micro Finance
Need for Multi-Skilled Banking & Finance Professionals
Increased risk of failure and weakness of Government Deposit
Insurance System

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What are the principal sources and uses

of funds for banks?
Assets

Loans
commercial and industrial (C&I) loans
real estate loans
consumer loans
Investments
short-term, liquid securities (e.g., Govt. Treasury securities)
long-term securities (Govt. as well as Corporate)
Cash
Other assets
buildings, equipment, etc.

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What are the principal sources and uses

of funds for banks?

Liabilities

Deposits
Transactions or demand deposits
Non-transactions or Term (Time) deposits

Non-deposit sources of funds (Borrowings/Refinancing)

Equity

Relatively small compared to debt sources of funds. Highly

leveraged compared to nonfinancial firms.

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Mobilisation of Resources and Deployment of

Resources by Banks

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Mobilisation of Resources = f(Cost and Stability of Deposits Core or Stable

Deposits and Non-Core or Unstable or Volatile Deposits, Maturity Profile of
Deposits Short Term, Medium Term, Long Term)

Deposits/Funds Raising: Deposits constitute the bulk of funds/resources of

the bank
Low Cost and No Cost Deposits like Current Deposit A/c (No interest)
and Savings Deposit A/c (Low interest) (CASA Deposits)
Term (Time) or Fixed deposits

Non-deposit sources of funds (Borrowings/Refinancing from

RBI/NABARD/SIDBI/EXIM Bank etc., bonds, Paid up capital, reserves
& surplus): This constitute a very small portion of banks
funds/resources

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Mobilisation of Resources and Deployment of

Resources by Banks

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Deployment of Resources

Lending or giving loans and advances (aka Credit): Lending or giving

loans is the major deployment of funds/resources by the banks. Lending =
f(Risk or Safety of loans, Liquidity or Cash flow generating capacity/ability
of the loan proposition/Project being financed, Return or Yield, Security,
Maturity Profile of loans vis--vis Maturity Profile of Deposits, Credit
Concentration or Exposure Norms, Diversification, Govt. of India/RBI
Regulation, Banks Credit or Loan Policy) Directed Credit Like Priority
Sector Credit, Credit to Export Sector etc. and Non-Priority Credit.

Investments: Investments= f(Risk or Safety, Liquidity, Return or Yield,

Maturity Profile, Concentration or Exposure Norms, Diversification, Govt. of
India/RBI Regulation, Banks Investment Policy) SLR or Mandated or
Directed Investments and Non-SLR or Non-Mandated Investments.

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Mobilisation of Resources and Deployment of

Resources by Banks - 2

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CD Ratio : What it is Credit (Loans) to Deposit Ratio. During

periods of high economic activity, credit demand/credit off take
will be high leading to high CD ratio (CDR). Higher CDR means
higher revenue and profit.
What is credit off take or loan
demand? Low and high credit off take. Relation between Deposit
mobilisation and Credit Off take/Loan Demand. Relation between
Credit Off take/Loan Demand and Economic activity/Business
Confidence. Relation between Deposit mobilisation and Stock
Market Performance/Sentiment/Level of Interest Rate (Bank
Deposit Rates). When or under what circumstances CDR will go
up and go down ? A higher CDR is better or a lower CDR is better
for the bank? Relation between a Banks CD ratio and Banks
Profitability.

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Mobilisation of Resources and Deployment of

Resources by Banks - 2
ID Ratio : What it is Investment to Deposit Ratio.
During periods of low economic activity/recession,
credit demand/off take will be low; banks will deploy
more money in Investment leading to higher ID ratio
(IDR) and consequently lower CDR. On an average
Credit/Loans earn higher return for the bank than the
average investments, so a higher CDR is better for the
bank. Relation between CD ratio and ID ratio. When or
under what circumstances IDR will go up and go down
? A higher IDR is better or a lower IDR is better for the
bank? Relation between a Banks ID ratio and Banks
Profitability.

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EMERGING TRENDS & CHALLENGES IN BANKING

UNIVERSAL

BANKING
(BANCASSURANCE/PARA BANKING
ACTIVITIES)

ELECTRONIC

BANKING

GLOBALISATION

CRM

OF BANKING

IN BANKS

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KEY WORDS/TERMINOLOGIES/GLOSSARY
Banking,

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Scheduled Banks, SLR, ECS,

EFT, NEFT, RTGS, SWIFT
Deregulation, Globalisation, CD ratio, ID
ratio, Intermediation, Solvency
Universal
Banking,
Bancassurance,
Electronic Banking
Primary
or Core Banking Activities,
Ancillary
or
Subsidiary
Banking
Activities, CASA Deposit & CASA ratio
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Home Task for Next Class For Self Check

HOME

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TASK/CONCEPT
CHECK
QUESTIONS FOR SELF REVIEW :
Question #1. Core or Primary activities of
a Bank.
Q. #2. Explain the Process of Financial
Intermediation.
Q. #3. Explain the concepts of SLR, CD
ratio, ID Ratio. How CDR & IDR are
related to economic activity and each
other ?
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Topics for Next Class All of you Should get

prepared before coming to the class
Process

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of Financial Intermediation
Different types of Intermediation and
various risks of Financial Intermediation.
Why Banks and FIs are special ? Why
they are regulated ?
Legal & Regulatory framework of Indian
Banking System.
Banking Regulation/Role and Functions
of RBI.
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Web Resources
For

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information on regulation of depository

institutions and investment firms visit:
SEBI www.sebi.gov.in
RBI www.rbi.org.in
IBA www.iba.org.in
BIS www.bis.org
IIBF www.iibf.org.in

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