TOPIC NAME :Banking v/s Non-Banking Companies.

GROUP MEMBERS :Akansha Rekhee. Pragati Sanklap.

Class :F.Y.B.B.I

Introduction to Banking Companies

Bank is an important organ of the modern trade and commerce. Banks in India are regulated by the Banking Regulation Act, 1949. The banking activities in India are regulated by the Banking Regulations Act, 1949. Under Section 5(b) of the said Act Banking means, the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise. Any bank which transacts this business in India is called a banking company. However, any company which is engaged in the manufacturer of goods or carries on any trade and which accepts deposits of money from the public merely for the purpose of financing its business as manufacturer or trader shall not be deemed to transact the business of banking. It may be mentioned that the Banking Regulation Act, 1949 is not applicable to a primary agricultural society, a co-operative land mortgage bank and any other co-operative society except in the manner and to the extent specified in Part V of the Act. Some banks are included in the Second Schedule to the Reserve Bank of India Act, 1934; these are called Scheduled Banks.

Introduction to Non-Banking Companies A non-banking finance company may be defined as an institution which mobilizes the savings of the community and diverts them for financing different activities. A bank also performs similar type of activities A non-banking financial intermediary does not fulfill any of these two criteria. The activities of non-banking companies are similar to those of banks and they are often referred to as Para banking institutions. Such intermediaries cover a wide range of institution differing in their main activities and the services they offer, the one essential feature being the same, viz., mobilization of the savings of the public and their utilization for financing various types of economic activities. Non-banking financial companies (NBFCs) are fast emerging as an important segment of Indian financial system. It is an heterogeneous group of institutions (other than commercial and cooperative banks) performing financial intermediation in a variety of ways, like accepting deposits, making loans and advances, leasing, hire purchase, etc. They raise funds from the public, directly or indirectly, and lend them to ultimate spenders. They advance loans to the various wholesale and retail traders, small-scale industries and self-employed persons. Thus, they have broadened and diversified the range of products and services offered by a financial sector. Gradually, they are being recognized as complementary to the banking sector due to their customeroriented services; simplified procedures; attractive rates of return on deposits; flexibility and timeliness in meeting the credit needs of specified sectors; etc.

Types Of Banks You are probably most familiar with retail banking. Commercial banks are the most common, and include global banks such as Bank of Americaand Citigroup. Community banks are smaller commercial banks. They focus on the local market, and provide more personalized service that's based on relationships. Online banksoperate over the Internet. There are some that are online-only banks, such as ING and HSBC. However, most banks now offer online services. Savings and loans target mortgages. Credit unions provide personalized service, but are usually restricted to employees of companies or schools. Shariah banking was developed to conform to the Islamic prohibition against interest rates. Investment banking has become much more important since many banking laws were deregulated in the 1990s. These banks traditionally were small, privately-owned companies that helped corporations find funding through initial public stock offerings (IPOs) or issuing bonds, facilitating mergers and acquisitions (M&A), and operating hedge funds for high net-worth individuals. The Glass-Steagall Act protected commercial banks' deposits from commingling with these profit- and risk-seeking banks. When Glass-Steagall was repealed in 1999, the lines became blurred. Some commercial banks began investing in derivatives, such as mortgage-backed securities, and depositors panicked. This led to the largest bank failure in history, Washington Mutual, in 2008.

How Banking Rates Changed Between 1980 and 2000, the banking business doubled. If you count all the assets and thesecurities they created, it would be nearly as large as the entire economic output (GDP) of the U.S. During that time, the profitability of banking grew even faster. Banking represented 13% of all corporate profits during the late 1970s. By 2007, they represented 30% of all profits. The largest banks grew the fastest. From 1990-1999, the ten largest banks share of all bank assets grew from 26% to 45%. Their share of deposits also grew during that time period, from 17% to 34%.The two largest banks did the best. Citigroup assets grew from $700 billion in 1998 to $2.2 trillion in 2007 (plus $1.1 trillion in off-balance sheet assets). Bank of America grew from $570 billion to $1.7 trillion during that same time period. How did this happen? Deregulation. The repeal of Glass-Steagall allowed commercial banks to get into investment banking and securitization. The Riegal-Neal Interstate Banking and Branching Efficiency Act of 1994 repealed constraints on interstate banking. This allowed the large regional banks to become national. The large banks gobbled up smaller ones, so that by the 2008 financial crisis there were, in effect, only 13 banks that mattered in America: Bank of America, JPMorgan Chase, Citigroup, American Express, Bank of New York Mellon, Goldman Sachs, Freddie Mac, Morgan Stanley, Northern Trust, PNC, State Street, US Bank and Wells Fargo. (Source: Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Pantheon Books:New York. 2010)

A. Primary Functions of Banks

How Intreset Rate Works

Interest rate is the percent charged, or paid, for the use of money. It is chargedwhen the money is being borrowed, and paid when it is being loaned. Interest is paid by a bank when money is deposited because the bank uses that money to make loans. The bank then charges the borrower a little more for that same money so it can make a profit for its service. When interest rates are high, fewer people and businesses can afford to borrow, so this usually slows the economy down. However, more people will save (if they can) because they receive more on their savings rate. When the central banks set interest rates, such as the U.S. Fed Funds rate, it is the amount they charge other banks to borrow money. This is a critical interest rate, in that it affects the entire supply of money, and hence the health of the economy. Examples: High interest rates can cause a recession.

types f bank There are various types of banks which operate in our country to meet the financial requirements of different categories of people engaged in agriculture, business, profession, etc. On the basis of functions, the banking institutions in India may be divided into the following types: Types of Banks Central Bank Development Banks Specialised Banks (RBI, in India) (EXIM Bank SIDBI, NABARD) Commercial Banks Co-operative Banks (i) Public Sector Banks (i) Primary Credit Societies (ii) Private Sector Banks (ii) Central Co-operative Banks (iii) Foreign Banks (iii) State Co-operative Banks Now let us learn about each of these banks in detail.
Banking

7 a) Central Bank
A bank which is entrusted with the functions of guiding and regulating the banking system of a country is known as its Central bank. Such a bank does not deal with the general public. It acts essentially as Governments banker, maintain deposit accounts of all other banks and advances money to other banks, when needed. The Central Bank provides guidance to other banks whenever they face any problem. It is therefore known as the bankers bank. The Reserve Bank of India is the central bank of our country. The Central Bank maintains record of Government revenue and expenditure under various heads. It also advises the Government on monetary and credit policies and decides on the interest rates for bank deposits and bank loans. In addition, foreign exchange rates are also determined by the central bank. Another important function of the Central Bank is the issuance of currency notes, regulating their circulation in the country by different methods. No other bank than the Central Bank can issue currency.

b) Commercial Banks
Commercial Banks are banking institutions that accept deposits and grant short-term loans and advances to their customers. In addition to giving short-term loans, commercial banks also give medium-term and long-term loan to business enterprises. Now-a-days some of the commercial banks are also providing housing loan on a long-term basis to individuals. There are also many other functions of commercial banks, which are discussed later in this lesson. Types of Commercial banks: Commercial banks are of three types i.e., Public sector banks, Private sector banks and Foreign banks. (i) Public Sector Banks: These are banks where majority stake is held by the Government of India or Reserve Bank of India. Examples of public sector banks are: State Bank of India, Corporation Bank, Bank of Boroda and Dena Bank, etc. (ii) Private Sectors Banks: In case of private sector banks majority of share capital of the bank is held by private individuals. These banks are registered as companies with limited liability. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd., Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank Ltd., Global Trust Bank, Vysya Bank, etc. (iii) Foreign Banks: These banks are registered and have their headquarters in a foreign country

but operate their branches in our country. Some of the foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, Grindlays Bank, etc. The number of foreign banks operating in our country has increased since the financial sector reforms of 1991.

c) Development Banks
Business often requires medium and long-term capital for purchase of machinery and equipment, for using latest technology, or for expansion and modernization. Such financial assistance is provided by Development Banks. They also undertake other development measures like
Public Sector Banks comprise 19 nationalised banks and State Bank of India and its 7 associate banks. Business Studies

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subscribing to the shares and debentures issued by companies, in case of under subscription of the issue by the public. Industrial Finance Corporation of India (IFCI) and State Financial Corporations (SFCs) are examples of development banks in India.

d) Co-operative Banks
People who come together to jointly serve their common interest often form a co-operative society under the Co-operative Societies Act. When a co-operative society engages itself in banking business it is called a Co-operative Bank. The society has to obtain a licence from the Reserve Bank of India before starting banking business. Any co-operative bank as a society is to function under the overall supervision of the Registrar, Co-operative Societies of the State. As regards banking business, the society must follow the guidelines set and issued by the Reserve Bank of India.

Types of Co-operative Banks

There are three types of co-operative banks operating in our country. They are primary credit societies, central co-operative banks and state co-operative banks. These banks are organized at three levels, village or town level, district level and state level. (i) Primary Credit Societies: These are formed at the village or town level with borrower and non-borrower members residing in one locality. The operations of each society are restricted to a small area so that the members know each other and are able to watch over the activities of all members to prevent frauds. (ii) Central Co-operative Banks: These banks operate at the district level having some of the primary credit societies belonging to the same district as their members. These banks provide loans to their members (i.e., primary credit societies) and function as a link between the primary credit societies and state co-operative banks. (iii) State Co-operative Banks: These are the apex (highest level) co-operative banks in all the states of the country. They mobilise funds and help in its proper channelisation among various sectors. The money reaches the individual borrowers from the state co-operative banks through the central co-operative banks and the primary credit societi

benefits
NBFIs come into existence for various reasons. Some offer financial services that are not appropriate for banks because of the nature of the risks (insurance is an example). Some evolve to fill gaps in the market place (development banks). They often operate as niche providers, capitalising on the benefits of specialisation, especially in information and knowledge. They tend to be more efficient and less costly. The activities of NBFIs serves to enhance competition and increase the depth of the financial market. By reducing concentration and providing alternative sources of finance, NBFIs, as Federal Reserve Chairman Alan Greenspan has said, enhance the resilience of the financial system to economic shocks by providing it with an effective spare tyre in times of need. I am aware that interest spreads are a concern in the region. To the extent that lending rates have been kept high by anti-competitive behaviour, more intemediaries may bring some relief. We know, however, that lack of competition is not the only reason for the lending-deposit spreads in some of the island countries. Weak legal and judicial framework that does not offer appropriate protection of credit rights or enforcement of prudential standards is another impediment to the development of financial intemediation. For both banks and NBFIs to flourish in a healthy financial sector, we need a sound legal and regulatory infrastructure, a widespread credit and savings culture, and the intitutional capactiy for the efficient enforcement of financial contracts.

Risks As I alluded to earlier, NBFIs come with their risks. NBFIs can be used as a means to circumvent regulations imposed on banks, thereby reaping a competitive advantage on the regulated institutions. Because they fall out of the regulatory net, they are exposed to the risks that regulations have been designed to mitigate and they are vulnerable when crises hit. So while competition brought about by NBFIs is healthy, it is unhealthy when it is based on lax regulation. Countries should guard against regulatory arbitrage when different institutions subject to different regulatory constraints can offer the same type of products. Here in particular, we have to be careful that banks would not be allowed to operate large NBFIs without regulation. This has been the cause of demise of a few banks in the last decade. We dont have to look very far to find examples two State banks in Australia have to be taken over because of high-risk activities undertaken in their unregulated and very large non-bank subsidiaries. NBFIs can also be popular vehicles for money laundering and financing of terrorism. In recognition of this, the Financial Action Task Force has expanded its definition of financial institutions in the FATFs recommendations to cover a wide range of NBFIs.

Provident funds/superannuation Mandatory contributions from both employees and employers have resulted in a significant growth in the size of provident funds in a number of Pacific countries in the last few years. The growth is set to continue with fund assets making up an increasing share of total financial sector assets. Longer life spans generally have heightened the need for a reliable source of retirement income. A major risk for superannuation is investment or portfolio risk and one of the key mitigants is proper portfolio diversification. This has posed difficulties in the Pacific countries because of a lack of investment media and opportunities, made more restrictive when overseas investments are forbidden or restricted under exchange control rules. As a result these funds carry substantial systemic risks from the financial system and the economy. A general downturn in the economy can have multiple impacts with forced retirements or redundancies coincident with negative investment returns and a loss of contributions. Provident funds are highly exposed to operational risks like fraud, misfeasance, malfeasance, exorbitant fees, or outright theft of assets. Generally the bank supervisory process including licensing, prudential standards, ongoing monitoring and enforcement apply to the supervision of provident funds. Here in the region where most countries only have one government provident fund, licensing is irrelevant. However, rules for fitness and propriety of the board (where there is one) and the managers and administrators are essential. A key prudential standard will be in respect of investment regulation, to ensure diversification and minimize portfolio risk. Regulations typically restrict holdings by issuer, by type of investment, by risk, by concentration of ownership, and by asset class. The last is controversial. Some regulators set ceilings by asset class while others adopt the prudent man rule, ie, simply requiring those that make the investment decisions to exercise diligence and expertise having regard to the funds characteristics. For funds with explicit obligation to produce minimum returns, reserving requirements would need to be commensurate with the obligation.

Conclusion NBFIs have much to contribute but they also bring with them risks. The risks should be contained by sound regulation that seeks to create a generally level playing field, without stifling growth or the individuality of the different types of institutions. How do we do it? There is no one size fits all solution. The approach taken should reflect the countrys individual conditions state of economic development, size of the NBFIs, nature of their businesses. The strategy should keep pace with market developments, to achieve an optimal balance between risks and benefits. Generally, effective supervision requires appropriate legal powers, prudential standards and regulations and expertise in implementation and enforcement. Proper sequencing is important - take one step at a time and dont extend the net too widely. The pre-requisite is to build an effective and efficient supervisory agency - resource it properly with skilled staff; give it independence but demand accountability and transparency.

PFTAC stands ready to help build skills and capacity. Sharing experiences and learning from each other also help regulatory staff deal with evolving challenges. Please support the Association of Financial Supervisors of Pacific Countries towards achieving its objectives - to promote closer co-operation and coordinate information sharing in financial regulation and supervision in Pacific countries; enhance supervisory skills; encourage the development of high professional standards; and strengthen the financial sectors of Pacific countries es.