An Overview of India’s Banking Sector
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Published: Mon, 26 Feb 2018
A bank is a financial institution whose primary activity is to act as a payment agent for customers, to borrow and to lend money.
‘BANK’ the name is derived from the italian word ‘banco’, which means ‘desk/bench’.
The history of banks pave their way back to 3rd millenium B.C. They were probably the religious places where they started off. Then they developed gradually over years and currently it has taken a very complex shape.
There are certain financial institutions whicu provide banking services but do not have the banking license,they are called NBFCs.
There are various types of banks on the basis of activities and on the basis of ownership and above all is the central bank which is the last resort for all commercial banks in the country.
Banks ought to get license for their working as a bank and there are regulations regarding the capital requirements and their reserves.
The current scenario of banking industry is bad due to the net interest margin getting thinner because of incresed inflation and resultant hike in repo rates.
MEANING AND DEFINITION
The definition of a bank varies from country to country.
Under English law, a bank is defined as a person who carries on the business of banking, which is specified as
- conducting current accounts for his customers
- paying cheques drawn on him, and
- collecting cheques for his customers.
A Bank can be defined as :
A bank is an institution that acts as an agent that provides financial services and that holds a banking license granted by bank regulatory authorities for carrying out the most fundamental banking services.
There are also financial institutions that provide certain banking services without meeting the legal definition of a bank, a so called non-banking financial company. Banks are a subset of the financial services industry.Banks are a sub set of the financial services industry.
Bank can be more clearly understood by the activities it perform:
- Accepting deposits and granting loans to customers.
- It also acts as credit intermediary- borrow and lend back-to-back on their own account as middle men.
- It also act as a collection agent, participate in inter-bank clearing and settlement systems.
- Issuer of money, in the form of banknotes and current accounts subject to cheque or payment at the customer’s order.
In other words can be said that, Banker includes a body of persons, whether incorporated or not, who carry on the business of banking.
‘BANK’, the name is derived from the italian word ‘banco’ , which means ‘desk/bench’ , used during the Renaissance by Florentines bankers , who used to make their transactions above a desk covered by a green tablecloth. In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders would set up their stalls in the middle of enclosed courtyards called ‘macella’ on a long bench called a ‘bancu’ , from which the words banco and bank are derived.
The first banks were probably the religious temples of the ancient world, and were probably established sometime during the 3rd millennium B.C. Banks probably predated the invention of money. Deposits initially consisted of grain and later other goods including cattle, agricultural implements, and eventually precious metals such as gold.There are some extant records of loans from the 18th century B.C. in Babylon that were made by temple priests monks to merchants.
Ancient Greece holds further evidence of banking. There is evidence too of credit, whereby in return for a payment from a client, a moneylender in one Greek port would write a credit note for the client who could “cash” the note in another city.
In the late third century B.C., the barren Aegean island of Delos, known for its magnificent harbor and famous temple of Apollo, became a prominent banking center.
Ancient Rome perfected the administrative aspect of banking and saw greater regulation of financial institutions and financial practices. Charging interest on loans and paying interest on deposits became more highly developed and competitive.
The first modern bank was founded in Italy in Genoa in 1406, its name was Banco di San Giorgio (Bank of St. George).
HISTORY OF BANKING IN INDIA:
Banking in India originated in the first decade of 18th century with The General Bank of India coming into existence in 1786. This was followed by Bank of Hindustan. Both these banks are now defunct. The oldest bank in existence in India is the State Bank of India being established as “The Bank of Bengal” in Calcutta in June 1806.
The first fully Indian owned bank was the Allahabad Bank, which was established in 1865.
By the 1900s, the market expanded with the establishment of banks such as Punjab National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai – both of which were founded under private ownership. The Reserve Bank of India formally took on the responsibility of regulating the Indian banking sector from 1935. After India’s independence in 1947, the Reserve Bank was nationalized and given broader powers.
At the end of late-18th century, there were hardly any banks in India in the modern sense of the term. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century. At the beginning of the 20th century, Indian economy was passing through a relative period of stability. Around five decades have elapsed since the India’s First war of Independence, at that time there were very small banks operated by Indians, and most of them were owned and operated by particular communities. The banking in India was controlled and dominated by the presidency banks, namely, the Bank of Bombay, the Bank of Bengal, and the Bank of Madras – which later on merged to form the Imperial Bank of India, and Imperial Bank of India, upon India’s independence, was renamed the State Bank of India. There was potential for many new banks as the economy was growing. many Indians came forward to set up banks, and many banks were set up at that time, a number of which have survived to the present such as Bank of India and Corporation Bank, Indian Bank, Bank of Baroda, and Canara Bank.
During the Wars
The period 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 the Indian banking. The years of the First World War were turbulent, and it took toll of many banks which simply collapsed despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed during the years 1913 to 1918.
The partition of India in 1947 had adversely impacted the economies of Punjab and West Bengal, and banking activities had remained paralyzed for months.
- In 1948, the Reserve Bank of India, India’s central banking authority, was nationalized, and it became an institution owned by the Government of India.
- In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) “to regulate, control, and inspect the banks in India.”
- The Banking Regulation Act also provided that no new bank or branch of an existing bank may be opened without a licence from the RBI, and no two banks could have common directors.
By the 1960s, the Indian banking industry has become an important tool to facilitate the development of the Indian economy.
Indira Gandhi, the-then Prime Minister of India expressed the intention of the GOI in the annual conference to nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. A second dose of nationalisation of 6 more commercial banks followed in 1980. The stated reason for the nationalisation was to give the government more control of credit delivery. With the second dose of nationalisation, the GOI controlled around 91% of the banking business of India.
After this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy.
In the early 1990s the then Narsimha Rao government embarked on a policy of liberalisation and gave licences to a small number of private banks.
This move, along with the rapid growth in the economy of India, kickstarted 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 setup with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%,at present it has gone up to 49% with some restrictions.
Currently, India has 88 scheduled commercial banks (SCBs) – 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.
The Indian Banking industry is one of the most robustly developed banking system in the world comprising 28 PSU banks, 33 private banks and 35 foreign banks. Together these are known as scheduled commercial banks (SCBs). Apart form the SCBs, there exists 133 regional rural banks (RRBs) and four local area banks, 1853 urban co-operative banks and 109924 rural co-operative banks. The government of India nationalised 14 banks in 1969 and another six in 1980. Privatisation in the sector was allowed in 1993. ICICI Bank and HDFC Bank were the first to thrive thereafter. PSU major Sate bank of India is one of the 100 largest banks in the world.
The size of India’s financial and banking sector is quite low when compared to other countries.
Banking is the only sector influencing all components of the GDP in one way or the other. It is the only sector that can help you capitalise on all the three key themes of the India growth story — consumption, investment and foreign trade. It drives acts as a source of funds for the infrastructure sector (construction, basic materials like cement & metals and engineering). It promotes consumption through its complex machanisms for the FMCG, auto, pharma and the real estate sector.
From a Banking and Financial Services perspective, India is an under penetrated market. The total credit as a percentage of GDP is 53% as compared to 80% in case of Japan, 83% incase of Korea.China and Malaysia have the highest credit penetration of 108% and 109% respectively. Retail credit penetration is a measly 13% in India much lower than 61% in Malaysia and 41% & 23% in case of Korea and Japan. Also, India is under-insured when it comes to life and non-life insurance (penetration of just 4% in case of life insurance and 1% in case of non life insurance).
TYPES OF BANKS
§ ON THE BASIS OF ACTIVITIES:
Banks’ activities can be divided into:
- Retail banking, dealing directly with individuals and small businesses.
- Business banking, providing services to mid-market business.
- Corporate banking, directed at large business entities.
- Private banking, providing wealth management services to High Net Worth Individuals and families.
- Investment banking, relating to activities on the financial markets
Most banks are profit-making, private enterprises. However, some are owned by government, or are non-profits.
Central banks are normally government owned banks: charged with quasi-regulatory responsibilities, e.g. supervising commercial banks. They generally provide liquidity to the banking system and act as Lender of last resort in event of a crisis.
ON THE BASIS OF OWNERSHIP:
Banks as classified on ownership basis can be categorised into:
- Public banks,owned and managed by government.
- Private banks,owned and managed by private enterpreneurs.
- Foreign banks,owned and managed by foreign institutions.
Commercial banks can have two meanings:
- Commercial bank is the term used for a normal bank to distinguish it from an investment bank.
- Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses, as opposed to normal individual members of the public (retail banking).
Commercial bank is engaged in the following activities:
- processing of payments by way of telegraphic transfer, EFTPOS, internet banking or other means
- issuing bank drafts and bank cheques
- accepting money on term deposit
- lending money by way of overdraft, installment loan or otherwise
- providing documentary and standby letter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures
- safekeeping of documents and other items in safe deposit boxes
- currency exchange
- sale, distribution or brokerage, with or without advice, of insurance, unit trusts and similar financial products as a “financial supermarket”
Types of loans granted by commercial banks
A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral (i.e., security) for the loan.
A mortgage loan is a very common type of debt instrument, used to purchase real estate. Under this arrangement, the money is used to purchase property. Commercial banks, however, are given security – a lien on the title to the house – until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it.
Unsecured loans are monetary loans that are not secured against the borrowers assets (i.e., no collateral is involved). These may be available from financial institutions under many different guises or marketing packages:
- credit card debt,
- personal loans,
- bank overdrafts
- credit facilities or lines of credit
- corporate bonds
Retail banking refers to banking in which banks undergo transactions directly with consumers, rather than corporations or other banks.
Services offered include: savings and checking accounts, mortgages, personal loans, debit cards, credit cards, and so forth.
Investment banks are financial intermediaries that perform a variety of services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients. In other words can be said that, Investment banks help companies and governments raise money by issuing and selling securities in the capital markets (both equity and debt), as well as providing advice on transactions such as mergers and acquisitions
Types of investment banks
- Investment banks “underwrite” (guarantee the sale of) stock and bond issues, trade for their own accounts, make markets, and advise corporations on capital markets activities such as mergers and acquisitions.
- Merchant banks were traditionally banks which engaged in trade financing. The modern definition, however, refers to banks which provide capital to firms in the form of shares rather than loans. Unlike venture capital firms, they tend not to invest in new companies.
Private banking is a term for banking, investment and other financial services provided by banks to private individuals disposing of sizable assets. The term “private” refers to the customer service being rendered on a more personal basis than in mass-market retail banking, usually via dedicated bank advisers. Personalized financial and banking services that are traditionally offered to a bank’s rich,high net worth individuals (HNWIs).
Banks, which are incorporated, owned and regulated by government.
Private banks are banks that are not incorporated. A non-incorporated bank is owned by either an individual or a general partner(s) with limited partner(s). In any such case, the creditors can look to both the “entirety of the bank’s assets” as well as the entirety of the sole-proprietor’s/general-partners’ assets. “Private banks” and “private banking” can also refer to non-government owned banks in general, in contrast to government-owned (or nationalized) banks.
NON-BANKING FINANCIAL CORPORATION
Non-bank financial companies (NBFCs) are financial institutions that provide banking services without meeting the legal definition of a bank, i.e. one that does not hold a banking license. Operations are, regardless of this, still exercised under bank regulation. However this depends on the jurisdiction, as in some jurisdictions, such as New Zealand, any company can do the business of banking, and there are no banking licences issued.
NBFCs are doing functions akin to that of banks, however there are a few differences:
(i) A NBFC cannot accept demand deposits;
(ii) it is not a part of the payment and settlement system and as such cannot issue cheques to its customers; and
(iii) deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks.
It is mandatory that every NBFC should be registered with RBI to commence or carry on any business of non-banking financial institution as defined in clause (a) of Section 45 I of the RBI Act, 1934.However, to obviate dual regulation, certain category of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI viz. Venture Capital Fund/Merchant Banking companies/Stock broking companies registered with SEBI, Insurance Company holding a valid Certificate of Registration issued by IRDA, or Housing Finance Companies regulated by National Housing Bank.
All NBFCs are not entitled to accept public deposits. Only those NBFCs holding a valid Certificate of Registration with authorization to accept Public Deposits can accept/hold public deposits. The NBFCs accepting public deposits should have minimum stipulated Net Owned Fund and comply with the Directions issued by the Bank.
There is ceiling on acceptance of Public Deposits. A NBFC maintaining required NOF/CRAR and complying with the prudential norms could accept public deposits as follows:
Category of NBFC
Ceiling on public deposits
AFCs maintaining CRAR of 15% without credit rating.
AFCs with CRAR of 12% and having minimum investment grade credit rating.
1.5 times of NOF or Rs.10crore whichever is less.
4 times of NOF
LC/IC with CRAR of 15% and having minimum investment grade credit rating.
1.5 times of NOF
AFC-Asset financing Company
If a NBFC defaults in repayment of deposit, the depositor can approach Company Law Board or Consumer Forum or file a civil suit to recover the deposits
Some other types of banks:
An advising bank (also known as a notifying bank) advises a beneficiary (exporter) that a letter of credit (L/C) opened by an issuing bank for an applicant (importer) is available and informs the beneficiary about the terms and conditions of the L/C. The advising bank is not necessarily responsible for the payment of the credit which it advises the beneficiary of.
Community development banks (CDBs) are banks designed to serve residents and spur economic development in low- to moderate-income (LMI) geographical areas. When CDBs provide retail banking services, they usually target customers from “financially underserved” demographics.
a custodian bank, or simply custodian, refers to a financial institution responsible for safeguarding a firm’s or individual’s financial assets. The role of a custodian in such a case would be the following: to hold in safekeeping assets such as equities and bonds, arrange settlement of any purchases and sales of such securities, collect information on and income from such assets, provide information on the underlying companies and provide regular reporting on all their activities to their clients
A depository bank is a bank organized in the United States which provides all the stock transfer and agency services in connection with a depository receipt program. This function includes arranging for a custodian to accept deposits of ordinary shares, issuing the negotiable receipts which back up the shares, maintaining the register of holders to reflect all transfers and exchanges, and distributing dividends.
Islamic banking refers to a system of banking or banking activity that is consistent with Islamic law (Sharia) principles and guided by Islamic economics. In particular, Islamic law prohibits the collection and payment of interest.In addition, Islamic law prohibits investing in businesses that are considered unlawful.
A mutual savings bank is a financial institution chartered through a state or federal government to provide a safe place for individuals to save and to invest those savings in mortgages, loans, stocks, Bonds and other securities.
An offshore bank is a bank located outside the country of residence of the depositor, typically in a low tax jurisdiction that provides financial and legal advantages.
Banking Industry Strucure in India
A central bank, reserve bank, or monetary authority is the entity responsible for the monetary policy of a country. 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 “bailout” lender of last resort to the banking sector during times of financial crisis. ).
It may also have supervisory powers, to ensure that banks and other financial institutions do not behave recklessly or fraudulently.
The oldest central bank in the world is the Riksbank in Sweden, which was opened in 1668 with help from Dutch businessmen. This was followed in 1694 by the Bank of England, created by Scottish businessman William Paterson in the City of London at the request of the English government to help pay for a war.
Activities and responsibilities
Functions of a central bank
- implementation of monetary policy
- controls the nation’s entire money supply
- the Government’s banker and the bankers’ bank (“Lender of Last Resort”)
- manages the country’s foreign exchange and gold reserves and the Government’s stock register;
- regulation and supervision of the banking industry:
- setting the official interest rate – used to manage both inflation and the country’s exchange rate – and ensuring that this rate takes effect via a variety of policy mechanisms
Central banks implement a country’s chosen monetary policy. At the most basic level, this involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency, currency board or a currency union.
Many central banks are “banks” in the sense that they hold assets (foreign exchange, gold, and other financial assets) and liabilities.
Central banks generally earn money by issuing currency notes and “selling” them to the public for interest-bearing assets, such as government bonds.
Interest rate interventions:
Typically a central bank controls certain types of short-term interest rates. These influence the stock- and bond markets as well as mortgage and other interest rates.
The main monetary policy instruments available to central banks are:
- open market operation
- bank reserve requirement
- interest rate policy
- credit policy
capital adequacy is important, it is defined and regulated by the Bank for International Settlements, and central banks in practice generally do not apply stricter rules.
Open Market Operations:
Through open market operations, a central bank influences the money supply in an economy directly. Each time it buys securities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.
Another significant power that central banks hold is the ability to establish reserve requirements for other banks. By requiring that a percentage of liabilities be held as cash or deposited with the central bank (or other agency), limits are set on the money supply.
Interest Rate Policy:
By far the most visible and obvious power of many modern central banks is to influence market interest rates. The mechanism to move the market towards a ‘target rate’ is generally to lend money or borrow money in theoretically unlimited quantities, until the targeted market rate is sufficiently close to the target. Central banks may do so by lending money to and borrowing money from (taking deposits from) a limited number of qualified banks, or by purchasing and selling bonds.
All banks are required to hold a certain percentage of their assets as capital, a rate which may be established by the central bank or the banking supervisor. Capital requirements may be considered more effective than deposit/reserve requirements in preventing indefinite lending: when at the threshold, a bank cannot extend another loan without acquiring further capital on its balance sheet.
Currently in most jurisdictions commercial banks are regulated by government entities and require a special bank licence to operate. Unlike most other regulated industries, the regulator is typically also a participant in the market, i.e. government owned bank (a central bank). The requirements for the issue of a bank licence vary between jurisdictions but typically incude:
- Minimum capital
- Minimum capital ratio
- ‘Fit and Proper’ requirements for the bank’s controllers, owners, directors, and/or senior officers
- Approval of the bank’s business plan as being sufficiently prudent and plausible.
- A branch, banking centre or financial centre is a retail location where a bank or financial institution offers a wide array of face-to-face service to its customers
- Telephone banking
- Online banking
liquidity risk -the risk that many depositors will request withdrawals beyond available funds
credit risk -the risk that those who owe money to the bank will not repay
interest rate risk- the risk that the bank will become unprofitable if rising interest rates force it to pay relatively more on its deposits than it receives on its loans.
A bank generates a profit from the differential between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities. This difference is referred to as the spread between the cost of funds and the loan interest rate.
Bank regulations are a form of government regulation which subject banks to certain requirements, restrictions and guidelines.
The objectives of bank regulation, and the emphasis are:
- Prudential — to reduce the level of risk bank creditors are exposed to
- Systemic risk reduction — to reduce the risk of disruption resulting from adverse trading conditions for banks causing multiple or major bank failures
- Avoid Misuse of Banks — to reduce the risk of banks being used for criminal purposes, e.g. laundering the proceeds of crime
- To protect banking confidentiality
- Credit allocation — to direct credit to favoured sectors .
General Principles of Bank Regulation
Banking regulations can vary widely across nations and jurisdictions. Thes are some of the general principles of bank regulation throughout the world
Requirements are imposed on banks in order to promote the objectives of the regulator. The most important minimum requirement in banking regulation is minimum capital ratios.
Banks are required to be issued with a bank licence by the regulator in order to carry on business as a bank, and the regulator supervises licenced banks for compliance with the requirements and responds to breaches of the requirements through obtaining undertakings, giving directions, imposing penalties or revoking the bank’s licence.
The regulator requires banks to publicly disclose financial and other information, and depositors and other creditors are able to use this information to assess the level of risk and to make investment decisions. As a result of this, the bank is subject to market discipline and the regulator can also use market-pricing information as an indicator of the bank’s financial health.
Instruments and Requirements of Bank Regulation
The capital requirement is a bank regulation, which sets a framework on how banks and depository institutions must handle their capital. The categorization of assets and capital is highly standardized so that it can be risk weighted. The capital ratio is the percentage of a bank’s capital to its risk-weighted assets.
The reserve requirement sets the minimum reserves each bank must hold to demand deposits and banknotes. The purpose of minimum reserve ratios is liquidity rather than safety.
Corporate governance requirements are intented to encourage the bank to be well managed and also to achieve certain objectives as to maintain it as a body corporate, maintaining minimum number of members and organisational structure etc.
Financial Reporting, Disclosure and Prospectus Requirements
Banks may be required to:
- Prepare annual financial statements according to a financial reporting standard, have them audited, and to register or publish them .
- Prepare more frequent financial disclosures.
- Have directors of the bank attest to the accuracy of such financial disclosures.
- Prepare and have registered prospectuses detailing the terms of securities it issues.
Credit Rating Requirement
Banks may be required to obtain
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