A

PROJECT REPORT

ON

INDIAN BANKING SYSTEM

At

Submitted for the partial fulfilment of the degree

Of

BACHELOR OF COMMERECE

SUBMITTED TO SUBMITTED BY

ASST. PROF. MANDEEP KAUR KIRANJEET KAUR

MANAGEMENT Roll No:15140712
BCOM 5TH SEM

NORTHWEST GROUP OF INSTITUTIONS, DHUDIKE, MOGA

2015-2018

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CERTIFICATE

2
 PREFACE

I have prepared this Project on the topic “BANKING INDUSTRY IN INDIA” The project
was made after analyzing the data of BANKING INDUSTRY IN INDIA. This Report is
prepared during my semester training. Training is life’s greatest treasure as it is full of
experience, observation and knowledge. The training held was gainful as it took us close to
real life. This period also provide a chance to give theoretical knowledge a practical shape
and to learn from practical results

Thank you

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 ACKNOWLEDGEMENT

It gives me great pleasure while submitting this project on the topic ‘BANKING INDUSTRY
IN INDIA’. This project provides an overview of the banking sector which is the backbone of
India’s growing economy.

I would like to begin by thanking my Project Guide, ASST. PROF. MANDEEP KAUR for
helping me throughout the project and for motivating me to give my best effort. It was a
pleasure working with such knowledgeable and helpful guide.

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 DECLARATION

This is to state that the project titled “Indian Banking System” is based on the original work
carried out by me. This is submitted in partial fulfilment of the requirements of the B.COM
course in Maharaja Ranjit Singh Punjab Technical University, Bathinda.

The matter embodied in this project report has not been submitted to any other University or
Institution for the award of degree.

Student Name

Kiranjeet Kaur

1514712

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 INDEX

Ch. No. Particulars Page no.

1. Executive Summary 7
2. Introduction 8
3. Objective of study 9
4. Significance of Study 10
5. Scope of Study 11
6. Research Methodology 12
7. Scope of Banking Sector 13
8. Banking in India 14
9. Indian Banking Industry 15
10. Types of Banking 18
11. Structure of Indian Banking System 20
12. 3 Phase of Indian Banking System 23
13. Services Provided by Banks 27
14. Reserve Bank of India 39
15. 42
Guidelines on Ownership and Governance in Private Sector
Banks

16. Micro Factors Affecting Banking System 49

17. Organization Profile 55
18. Limitations of Study 59
19. Conclusion 60
20. Bibliography 61

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CHAPTER-1

EXECUTIVE SUMMARY

The pace of development for the Indian banking industry has been tremendous over the past
decade. As the world reels from the global financial meltdown, India’s banking sector has
been one of the very few to actually maintain resilience while continuing to provide growth
opportunities, a feat unlikely to be matched by other developed markets around the world.
FICCI conducted a survey on the Indian Banking Industry to assess the competitive
advantage offered by the banking sector, as well as the policies and structures required to
further stimulate the pace of growth.

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CHAPTER-2

INTRODUCTION

Recent time has witnessed the world economy develop serious difficulties in terms of lapse of
banking & financial institutions and plunging demand. Prospects became very uncertain
causing recession in major economies. However, amidst all this chaos India’s banking sector
has been amongst the few to maintain resilience. A progressively growing balance sheet,
higher pace of credit expansion, expanding profitability and productivity akin to banks in
developed markets, lower incidence of nonperforming assets and focus on financial inclusion
have contributed to making Indian banking vibrant and strong. Indian banks have begun to
revise their growth approach and re-evaluate the prospects on hand to keep the economy
rolling. The way forward for the Indian banks are to innovate to take advantage of the new
business opportunities and at the same time ensure continuous assessment of risks. A rigorous
evaluation of the health of commercial banks, recently undertaken by the Committee on
Financial Sector Assessment (CFSA) also shows that the commercial banks are robust and
versatile. The single-factor stress tests undertaken by the CFSA divulge that the banking
system can endure considerable shocks arising from large possible changes in creditquality,
interest rate and liquidity conditions. These stress tests for credit,market and liquidity risk
show that Indian banks are by and large resilient. Thus, it has become far more imperative to
contemplate the role of the Banking Industry in fostering the long term growth of the
economy. With the purview of economic stability and growth, greater attention is required on
both political and regulatory commitment to long term development programme. FICCI
conducted a survey on the Indian Banking Industry to assess the competitive advantage
offered by the banking sector, as well as the policies and structures that are required to further
the pace of growth.

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CHAPTER-3

OBJECTIVES OF STUDY

 To study broad outline of management of credit, market and operational risks

associated with banking sector.

 To understand the importance of banking sector.

 To study the Indian banking scenario and its problems.

 Long- term and short-term finances.

 To study the role of Bank in Indian market.

 Different types of services provided by the Banks.

 To study various bank, corporate and commercial.

 To study aims at learning the techniques involved to manage the various types of
Banks, various methodologies undertaken.

 To offer suggestions based upon various technologies used in banking sector.

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CHAPTER-4

SIGNIFICANCE OF THE STUDY

 To make a detailed study of various financial services provide by the different banks.
 To analyse customers view point regarding their banks.
 To study effective and most popular bank among the customers regarding its
services.
 To find out the rate of interest of banks and reaction of customers on it.
 To make analysis on the economic benefits provided by various Banks.
 Suggest the investors whether to invest in shares of Banking Companies.

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CHAPTER-5

SCOPE OF STUDY

A healthy banking system is essential for any economy striving to achieve good growth and
yet remain stable in an increasingly global business environment. The Indian banking system
with one of the largest banking network in the world, has witnessed a series of reform over
the past few years like the deregulation of interest rates, dilution of the Government state in
public sector banks (PSBs) and the increased participation of private sector banks. The
growth of the retail financial services sector has been a key development on the market front.
Indian banks (both public and private) have not only been keen on top the domestic market
but also to compete in the global market place.

 Studying the increasing business scope of the bank.

 Market segmentation to find the potential customers for the banks.
 Customer’s perception on the various product of the Bank.
 The corporate sector has stepped up its demand for credit to fund its expansion plans
there has also been a growth in retail banking.
 The report seeks to present a comprehensive picture of the various types of banks the
banks can be broadly classified into two categories. 1. Nationalise Bank 2. Private
Bank.
 Within each of these broad groups, an attempt has been made to cover as
comprehensively as possible, under the various sub-groups.

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 CHAPTER-6

RESEARCH METHODOLOGY

While conducting any study, the method adopted for it is to be given due consideration.
Wide ranges of alternative approaches are available to choose from therefore ultimate
choice of the optimal methodology becomes complicated. Once the researcher is satisfied
that the method adopted is the best as compare to those rejected, only them proceed
further.

Research Methodology in a way is systematic representation of research or any other

problem. It is a written game plan for conducting research. It tends to describe the step
taken by researches in studying the research problem along with logical background.

It tends to describe methodology for solution of the problem that has been taken fo r the
purpose of study. This project focuses on the methodology for technique used for the
collection, classification & tabulation of the data. This plan throws light on the research
problem, the objective of the study & limitation of study.

Therefore, In order to solve a problem, it is necessary to design a Research Methodology

for problem as the same way differs from problem to problem.

The main motive behind the research is to know the various services provided by banking
sector with special reference to merchant banking.

The research design conducted by me for my study is described as follows: -

Research Design: -

A research design is the specification of the methods and procedures for acquiring the
information needed to structure or to solve the problem. It is overall framework of the project that
stipulates what information is to be collected from which sources and which procedure.

Sources of Data Collection: -

 Secondary Data within the help of one organization sample.

Research Type:-

 Descriptive Collection: -

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CHAPTER-7

SCOPE OF BANKING SECTOR

Banking business has history of over 200 years. From the times of the Bank of Bengal
(1806) the sector has been witnessing qualitative and quantitative changes. Main players
during the pre-independence period were credit Lyonnais, Allahabad Bank, Punjab National
Bank and Bank of India was proclaimed the central Bank of India and was vested with
controlling powers over the commercial banks.

The drastic development taken places during the first 25 years since independence
was Nationalization of many private banks. With this, central government become major
policy maker for these nationalized banks

With economic liberalization measures many private and foreign banking companies
were allowed to operate in the country. Favourable economic climate and a variety of other
factors such as demand for wide range of financial products from various sections of the
society led to mutually beneficial growth to the banking sector and economic growth process.
This was coincided by technology development in the banking operations. Today most of the
Indian cities have networked banking facility as well as Internet banking facility. A customer
is empowering to operate his account from any part of the country. UTI bank, ICICI Bank
and Bank of Punjab are the main winners of the race.

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CHAPTER-8

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 the existence in India is the State Bank of India
being established as “The Bank Bengal” in Calcutta in June 1806. A couple of decades later,
foreign banks like Credit Lyonnais started their Calcutta operations in the 1850s. At that
point of time, Calcutta was the most active trading port, mainly due to the trade of the British
Empire, and due to which banking activity took roots there and prospered. 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 nationalizing and given broader powers.

Definition of the Bank: - Financial institution whose primary activity is to act as

a payment agent for customers and to borrow and lend money. Banks are important players of
the market and offer services as loans and funds.

 Banking was originated in 18th century.

 First bank were General Bank of India and Bank of Hindustan, now defunct.
 Punjab National Bank and Bank of India was the only private bank in 1906.
 Allahabad bank was first fully India owned bank in 1865

Bank of
Bengal

Bank of Imperial State bank

Bombay Bank of of India
India

Bank of
Madras
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CHAPTER-9

INDIAN BANKING INDUSTRY

In India, given the relatively underdeveloped capital market and with little
internal resources, f i r m s a n d e c o n o m i c e n t t i e s d e p e n d , l a r g e l y, o n
f i n a n c i a l i n t e r m e d i a r i e s t o m e e t t h e i r f u n d requirements. In terms of supply of
credit, financial intermediaries can broadly be categorized as institutional and non-
institutional. The major institutional suppliers of credit in India are banks and non-bank
financial institutions (that is, developmen t financial institutions or DFIs),
other financial institutions (FIs), and non-banking finance companies (NBFCs). The non-
institutional or unorganized sources of credit include indigenous bankers and
money-lenders. Information about the unorganized sector is limited and not readily
available.

An important feature of the credit market is its term structure:

(a) Short-term credit

(b) Medium-term credit

(c) Long-term credit.

While banks and NBFCs predominantly cater for short-term needs, FIs provide mostly
medium and long-term funds.

Indian Banking Sector Experience

India inherited a weak financial system after Independence in 1947. At end-1947, there were
625commercial banks in India, with an asset base of Rs. 11.51 billion. Commercial banks
mobilized household savings through demand and term deposits, and disbursed
credit primarily to large corporations. Following Independence, the development
of rural India was given the highest priority. The commercial banks of the
country including the IBI had till then co nfined their o p e r a t i o n s t o t h e u r b a n
sector and were not equipped to respond to the emergent needs
o f economic regeneration of the rural areas. In order to serve the economy in general and the

15
rural sector in particular, the All India Rural Credit Survey Committee recommended the
creation of a state-partnered and state-sponsored bank by taking over the IBI, and
integrating with it, the former state -owned or state-associate banks.

Accordingly, an act was passed in Parliament in M a y 1 9 5 5 , a n d t h e S t a t e

B a n k o f I n d i a ( S B I ) w a s c o n s t i t u t e d o n J u l y 1 , 1 9 5 5 . M o r e t h a n q uarter
of the resources of the Indian banking system thus passed under the direct control of the
State. Subsequently in 1959, the State Bank of India (Subsidiary Bank) Act was
passed (SBI Act), enabling the SBI to take over 8 former State-associate banks as its
subsidiaries (later named Associates).

The GOI also felt the need to bring about wider diffusion of banking facilities and to change
the u n e v e n d i s t r i b u t i o n o f b a n k l e n d i n g . T h e p r o p o r t i o n o f c r e d i t g o i n g
t o i n d u s t r y a n d t r a d e increased from a high 83% in 1951 to 90% in 1968. This increase
was at the expense of some crucial segment of the economy like agriculture and the
small-scale industrial sector. Bank failures and mergers resulted in a decline in number
of banks from 648 (including 97 scheduled commercial banks or SCBs and 551 non-SCBs) in
1947 to 89 in 1969 (comprising 73 SCBs and16 non-SCBs). The lop-sided pattern of
credit disbursal, and perhaps the spate of bank failures during the sixties, forced the
government to resort to nationalization of banks. In July 1969, the GOI nationalized 14
scheduled commercial banks (SCBs), each having minimum aggregate deposits
of Rs. 500 million. State-control was considered as a necessary catalyst fo r
economic growth and ensuring an even distribution of banking facilities.
Subsequently, in 1980, the GOI nationalized another 6 banks2, each having deposits of
Rs. 2,000 million and above.

The nationalization of banks was the culmination of pressures to use

t h e b a n k s a s p u b l i c instruments of development. The GOI imposed `social control’ on
banks. However, by the 1980s, it was generally perceived that the operational
efficiency of banks was declining. Banks were characterized by low profitability,
high and growing non-performing assets (NPAs), and low capital base. Average
returns on assets were only around 0.15% in the second half of the 1980s, and capital

16
aggregated an estimated 1.5% of assets. Poor internal controls and the lack of
proper disclosure norms led to many problems being kept under cover. The quality of
customer service did not keep pace with the increasing expectations. In 1991, a fresh era in
Indian banking began, with the introduction of banking sector reforms as part of the overall
economic liberalization in India.

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CHAPER-10

TYPES OF BANKING

Commercial bank has two meanings:

o Commercial bank is the term used for a normal bank to distinguish it from an
investment bank. (After the great depression, the U.S. Congress required that
banks only engage in banking activities, whereas investment banks were limited
to capital markets activities. This separation is no longer mandatory.)
o Commercial bank can also refer to 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). It is the most
successful department of banking.
 Community development Bank are regulated banks that provide financial
services and credit to underserved market or populations.
 Private Banks manage the assets of high net worth individuals.
 Offshore Banks are banks located in jurisdiction with low taxation and regulation.
Many offshore banks are essentially private banks.
 Saving Banks accept saving deposits.
 Postal saving Banks are saving banks associated with national postal system.
There is some example of banks in India: -
 Private Sector Banks
 HDFC, ICICI, Axis bank, Yes bank, Kotak Mahindra bank, Bank of
Rajasthan
 Rural Banks
 United bank of India, Syndicate bank, National bank for agriculture
and rural development (NABARD)
 Commercial Banks
 State Bank, Central Bank, Punjab National Bank, HSBC, ICICI,
HDFC etc.
 Retail Banks
 BOB, PNB

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 Universal Banks
 Deutsche bank

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CHAPTER-11

STRUCTURE OF ORGANIZED INDIAN BANKING SYSTEM

The organized banking system in India can be classified as given below:

Reserve Bank of India (RBI):

The country had no central bank prior to the establishment of the RBI. The RBI is the
supreme monetary and banking authority in the country and controls the banking system in
India. It is called the Reserve Bank’ as it keeps the reserves of all commercial banks.

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Commercial Banks:

Commercial banks mobilize savings of general public and make them available to large and
small industrial and trading units mainly for working capital requirements.

Commercial banks in India are largely Indian-public sector and private sector with a few
foreign banks. The public sector banks account for more than 92 percent of the entire banking
business in India—occupying a dominant position in the commercial banking. The State
Bank of India and its 7 associate banks along with another 19 banks are the public sector
banks.

Scheduled and Non-Scheduled Banks:

The scheduled banks are those which are enshrined in the second schedule of the RBI Act,
1934. These banks have a paid-up capital and reserves of an aggregate value of not less than
Rs. 5 lakhs, hey have to satisfy the RBI that their affairs are carried out in the interest of their
depositors.

All commercial banks (Indian and foreign), regional rural banks, and state cooperative banks
are scheduled banks. Non- scheduled banks are those which are not included in the second
schedule of the RBI Act, 1934. At present these are only three such banks in the country.

Regional Rural Banks:

The Regional Rural Banks (RRBs) the newest form of banks, came into existence in the
middle of 1970s (sponsored by individual nationalized commercial banks) with the objective
of developing rural economy by providing credit and deposit facilities for agriculture and
other productive activities of all kinds in rural areas.

The emphasis is on providing such facilities to small and marginal farmers, agricultural
laborers, rural artisans and other small entrepreneurs in rural areas.

Other special features of these banks are:

(i) their area of operation is limited to a specified region, comprising one or more
districts in any state

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 (ii) (ii) their lending rates cannot be higher than the prevailing lending rates of
cooperative credit societies in any particular state
(iii) (iii) the paid-up capital of each rural bank is Rs. 25 lakhs, 50 percent of which has
been contributed by the Central Government, 15 percent by State Government and
35 percent by sponsoring public sector commercial banks which are also
responsible for actual setting up of the RRBs.

These banks are helped by higher-level agencies: the sponsoring Banks lend them funds and
advise and train their senior staff

The NABARD (National Bank for Agriculture and Rural Development) gives them short-
term and medium term loans the RBI has kept CRR (Cash Reserve Requirements) of them at
3% and SLR (Statutory Liquidity Requirement) at 25% of their total net liabilities, whereas
for other commercial banks the required minimum ratios have been varied over time.

Cooperative Banks:

Cooperative banks are so-called because they are organized under the provisions of the
Cooperative Credit Societies Act of the states. The major beneficiary of the Cooperative
Banking is the agricultural sector in particular and the rural sector in general.

The cooperative credit institutions operating in the country are mainly of two kinds:
agricultural (dominant) and non-agricultural. There are two separate cooperative agencies for
the provision of agricultural credit: one for short and medium-term credit, and the other for
long-term credit. The former has three tier and federal structure.

At the apex is the State Co-operative Bank (SCB) (cooperation being a state subject in India),
at the intermediate (district) level are the Central Cooperative Banks (CCBs) and at the
village level are Primary Agricultural Credit Societies (PACs).

Long-term agriculture credit is provided by the Land Development Banks. The funds of the
RBI meant for the agriculture sector actually pass through SCBs and CCBs. Originally based
in rural sector, the cooperative credit movement has now spread to urban areas also and there
are many urban cooperative banks coming under SCBs.

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CHAPTER-12

PHASES OF INDIAN BANKING SYSTEM

Phases of Indian Banking System are summarized below:

Without a sound and effective banking system in India it cannot have a healthy economy. The
banking system of India should not only be hassle free but it should be able to meet new
challenges posed by the technology and any other external and internal factors

For the past three decades India’s banking system has several outstanding achievements to its
credit. The most striking is its extensive reach; it is no longer confined to only metropolitans
or cosmopolitans in India. In fact, Indian banking system has reached even the remote comers
of the country. This is one of the main reasons of India’s growth process.

The government’s regular policy for Indian bank since 1969 has paid rich dividends with the
nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft
or for withdrawing his own money. Today, he has a choice, gone are days when the most
efficient bank transferred money from one branch to other in two days. Now it is simple as
instant messaging or dial a pizza. Money have become the order of the day.

The first bank in India, though conservative, was established in 1786. From 1786 till today,
the journey of Indian Banking System can be segregated into three distinct phases.

They are as mentioned below:

Phase I:

i. Early phase from 1786 to 1969 of Indian banks.

ii. Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms.

iii. New phase of Indian Banking System with the advent of Indian Financial and Banking
Sector Reforms after 1991.

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To make this write-up more explanatory, I prefix the scenario as Phase I, Phase II and Phase
III.

The Genera; Bank of India was set up in the year 1786. Next came Bank of Hindustan and
Bengal Bank. The East India Company established Bank of Bengal (1806), Bank of Bombay
(1840) and Bank of Madras (1843) as independent units and called them Presidency Banks.
These three banks were amalgamated m 1921 and imperial Bank of India was established
which started as private shareholder’s banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab
National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1885 and 1913,
Bank of India Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank
of Mysore were set up Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failures
between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline
the functioning and activities of commercial banks, the Government of India came up with
the Banking Companies Act, 1949 which was later changed to Banking Regulation Act, 1949
as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with
extensive power for the supervision of banking in India as the Central Banking Authority.

During those day’s public has lesser confidence in the banks. As an aftermath deposit
mobilization was slow. Abreast of it the savings bank facility provided by the Postal
department was comparatively safer. Moreover, funds were largely given to traders.

Phase II:

Government took major steps in the Indian Banking Sector Reform after independence. In
1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale
especially in rural and semi urban areas. It formed State Bank of India to act as the principal
agent of RBI and to handle banking transactions of the Union and State Governments all over
the country.

Seven banks forming subsidiary of State Bank of India were nationalized on 19th July 1959.
In 1969, major process of nationalization was carried out. It was the effort of the then Prime

24
Minister of India, Mrs. Indira Gandhi 14 major commercial banks in the country was
nationalized.

Second phase of nationalization in Indian Banking Sector Reform was carried out in 1980
with six more banks. This step brought 80% of the banking segment in India under
Government ownership.

The following are the steps taken by the Government of India to Regulate Banking
Institutions in the country.

i. 1949: Enactment of Banking Regulation Act.

ii. 1955: Nationalization of State Bank of India.

iii. 1959: Nationalization of SBI subsidiaries.

iv. 1961: Insurance cover extended to deposits.

v. 1969: Nationalization of 14 major banks.

vi. 1971: Creation of credit guarantee corporation.

vii. 1975: Creation of regional rural banks.

viii. 1980: Nationalization of 6 banks with deposits over 200 crores.

After the nationalization the branches of the public sector banks in India rose to
approximately 800% and deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and
immense confidence about the sustainability of these institutions.

Phase III:

This phase has introduced many more products and facilities in the banking sector in its
reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was setup
by his name which worked for the liberalization of banking practices.

25
The country is flooded with foreign banks and their ATM stations. Efforts are being made to
give a satisfactory service to customers. Phone banking and net banking is introduced. The
entire system became more convenient and swift. Time is given more importance than
money.

The financial system of India has shown a great deal of resilience. It is sheltered from any
crisis triggered by any external macro-economic shock as other East Asian Countries
suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the
capital account is not yet fully convertible, and banks and their customers have limited
foreign exchange exposure.

26
CHAPTER-13

SERVICES PROVIDED BY BANK

Banks provide two types of services: -

1. Fund based
2. Non-fund Based

Banking services

Fund Based Non-Fund Based

Services Services

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 FUND BASED AND NON-FUND BASED FUNCTIONS

The difference between fund-based and non-fund based credit assistance lies mainly in the
cash outflow. While the former involves all immediate cash outflow, the latter may or not
involve cash outflow a banker. In other words, a fund based credit facility to a borrower
would result in depletion of actual liquidity of a banker immediately whereas grant of non-
fund based credit facilities to a borrower may or may not affect the banker’s liquidity.

Fund Based Services

Fund Based services

Loans & Advances Leasing & Hire Investment

Purchase

Commercial Personal Capital Debt Market

Loans Loans Market Investments
Investments

28
 FUND BASED FACILITY

Fund based functions of bank are those in which banks make development of their
funds either by granting advances or by making investments for meeting gaps in funds
requirements of their customers / borrowers. Fund-based functions of a bank may be
classified into two parts: -

 Granting of Loans and Advances

 Making Investments in shares / debentures / bonds.

I. LOANS AND ADVANCES

1. Commercial Loans segment
a. Working capital: -Working capital is current assets minus current liabilities.
Working capital measures how much in liquid assets a company has available to
build its business. The number can be positive or negative, depending on how
much debt the company is carrying. In general, companies that have a lot of
working capital will be more successful since they can expand and improve their
operations. Companies with negative capital may lack the funds necessary for
growth, also called net current or current capital.
A loan whose purpose is to finance everyday operation of a company. A
working capital loan is not used to buy long term assets or investments. Instead it
used to clear accounts payable, wages, etc.

b. Cash Credit: -this facility is given by the banker to the customer by way of a
certain amount of credit facility. Its limit is fixed on the basis of security of the
company’s current assets.
c. Overdraft: -Banks allow selected customers to write cheque in excess of the
balances in their current account, ie, to overdrafts are arranged up to limits which
depend on the customer’s credit standing and the bank manager’s humour. The
arrangements allow flexibility in the amount spent and, equally, allow flexibility in
repayments (although technically a bank can demand repayment of an overdraft

29
 within 24 hours). In that respect overdrafts are unlike personal loans, which are
structured with regular repayments. Interest on overdraft is changed on the
fluctuating daily balance.
d. Bills Discounting: -This is the most important form in which a bank lends
without any collateral security. The seller draws bills of exchange on the buyer of
goods on credit. Such a bill may either be a clean bill or documentary bill which is
accompanied by documents of title to goods, viz railway receipts. The bank
purchase bills payable on demand and credit the customer’s account with the
amount of bills less the discount. On maturity of the bills, the bank present them to
its acceptor for payment. In case the discounted bill is dishonoured by the non-
payment, the bank can recover the full amount from the customer along with the
expense in that connection.

II. Term Loan: -A bank loan to a company, with a fixed maturity and often
featuring amortization of principal. If this loan is in the form of a line of credit, the
funds are drawn down shortly after the agreement is signed. Otherwise, the
borrower usually uses the funds from the loan soon after they become available.
Bank term loans are very a common kind of lending.

a. Capital Expenditure: -Money spent to acquire or upgrade physical assets such as

building and machinery also called capital spending or capital expenses.

b. Project finance: - Financing arrangements where the funds are made available for a
specific purpose (the project), with the loan repayment geared to the project’s cash
flow. Project finance is used in connection with raising large amount of money for big -
ticket, energy-related facilities. The term has come to be loosely applied to various
forms of financing. ‘A financing of a particular economic unit in which a lender is
satisfied to look initially to the cash flows and earnings of that economic unit as the
source of funds from which a loan will be required and to the assets of the economic
unit as collateral for the loan’.

30
 c. Education Loan: -Education in India (popularly known as Education loans) have
become a popular method of funding higher education in India with the cost of
educational degrees going higher. The spread of self-financing institutions (which has
less to no funding from the government) for higher education in fields of engineering,
medical and management which has higher fees than their government aided
counterparts have encouraged the trend in India. Most large public sector and private
sector banks offer educational loans.

III. Personal Loan Segment: -

Loan granted for personal, family, or household use, a distinguished from a
loan financing a business. Though in some situations the lender may require a
co-signer or guarantor. If unsecured, the loan is made on the basis of the
borrower’s integrity and ability to pay. Generally, these loans are used for debt
consolidation, or to pay for vacations, education expenses, or medical bills,
and are amortized over a fixed term with regular payments of principal and
interest

NON FUND BASED FACILITY

It is generally perceived that the non-fund based business is very remunerative to bank and
the borrowers. The banks, besides getting handsome commission or fee and some other
service charges, also get the low cost deposits in the shape of margin and ancillary business.
The funds of the borrower are not blocked in the advances to be given to the suppliers or
beneficiaries and this keeps his liquidity position comfortable, production smooth and costs
low.

31
 Non Fund Based Services

Funds Letter of Agency Merchant

remittance/Trans Credit/Bank Functions Banking
fer facilities Guarantee Functions

Purpose for Non-Fund Based Facility

The borrowers need such facilities not only for purchases of current assets or financing there
of or take benefit of certain services with the help of non-fund based facilities. They also
need the facilities for acquisition of fixed assets including their financing.

Prudential exposure norms as per extent guidelines of Reserve Bank of India provides that the
maximum exposure of a bank for all its fund based and non-fund based credit facilities,
investments, underwritings, investments in bonds and commercial paper and other
commitment should not exceed 25% of its net worth to an individual borrower and 50% of
its, net worth to ‘group’. It may however, be rioted that while calculating exposure, the non-
fund based facilities are to be taken at 50% of the sanctioned limit. To illustrate the point let
us consider the following example: -

32
Example 1

Particulars Rs. Rs. In

Crores

Net worth of the bank 700

Maximum Exposure permitted for an individual borrower (25%
of net worth of the bank) Working Capital Control and Banking 175
Policy
Maximum Exposure permitted for all borrowers
Under the same group (50% of the net worth of the bank) 657

350

Example 2

Particulars Rs. In
Crore

Limit Sanctioned to Borrowers

Fund based 100

Non Fund Based 100

Total 200

Total Exposure
100
For Fund based limits @50% of limits
50
For Non Fund based limits @50% of limits

150
Total

33
 Total credit limits to the above borrower are Rs.200 crores which are in excess of the
maximum exposure norm of Rs.175 crores. But for the purpose of determining exposure we
have taken non fund based limits at 50% of its value and total exposure is taken at Rs. 150
crores which is well within the norm.

Fund Remittance / Transfer Facilities: -

 Issue of demand draft

 Collection of Bills and Cheque

Letter of Credit / Bank Guarantee

Letter of Credit

 Bank should normally open letters of credit for their own customers who enjoy credit
facilities with them Customers maintaining current account only and not enjoying any
credit limits should not be granted L/C facilities except in cases where no other credit
facility is needed by the customer.
 The request of such customer for sanctioning and opening of letter of credit should be
properly scrutinised to establish the genuine need of the customer. The customer may
be, required to submit a complete loan proposal Including financial statements to
satisfy the bank about his, needs and also his financial resources, to mire the bills
drawn under
 Where a customer enjoys credit facilities with some other bank, the reasons for his
approaching the bank for sanctioning L/C limits have to be clearly stated. The bank
opening L/C on behalf of such customer should invariably make a reference to the,
existing banker of the customer.
 In all cases of opening of letters of credit, the bank has to ensure that the customer is
able to retire the bills drawn under L/C as per the financial arrangement already
finalised.

34
 Bank Guarantee

 The conditions relating to obliging being a customer of the bank enjoying credit
facilities as discussed in case of letters of credit are equally applicable for guarantees
also. In fact, guarantee facilities also cannot be sanctioned in isolation.
 Financial guarantees will be issued by the banks only if they are satisfied that the
customer will be in a position to reimburse the bank in case the guarantee is invoked
and the bank is required to make the payment in terms of guarantee.
 Performance guarantee will be issued by the banks only on behalf of those customers
with whom the bank has sufficient experience and is satisfied that the customer has
the necessary experience and means to perform the obligations under the contract and
is not likely to commit any default.
 As a rule, banks will guarantee shorter maturities and leave longer maturities to be
guaranteed by other institutions. Accordingly, no bank guarantee will normally have a
maturity of more than 10 years.
 Banks should not normally issue guarantees on behalf of those customers who enjoy
credit facilities with other banks.

Agency Function
The banks render important services as agent on behalf of their customers in
return for a small commission. When banks act as agent, law of agency applies. The
agency functions or services of bank are as follows:

1. Collection of Cheques: -
Commercial banks collect the cheques, bills of exchange, etc, on behalf of their
customers. Banks collect local and outstation cheques and bills of exchange through
clearing house facilities provided by the central bank.

2. Collection ofIncome: -
The commercial banks collect dividends, interest on investment, pension and rent
of property due to the customers. When any income is collected by the bank, a credit
voucher is sent to the customer for information.

35
3. Payment ofexpenses: -
The banks make payment of insurance premiums, rent, trade subscription, school
fee and other obligation of the customers. When any expense is paid by the bank, a
debit voucher is sent to the customer for information.

4. Dealer in Securities: -
The banks carry out purchase and sale of securities on behalf of their customers.
Banks do it well because they are aware of the market conditions.

5. Act as Trustee: -
The banks act as trustee to manage trust property as per instructions of property
owners. Banks are required to follow the terms and conditions of trust deed.

6. Act as an Agent: -
Commercial bank sometimes acts as an agent on behalf of its customers at home
or abroad in dealing with other banks or financial institutions.

7. Obeys Standing Instructions: -

Sometimes, customer may order his bank to do something on his behalf
regarding the conduct of his account. This written order is called standing
instruction. The bank being the agent of its customer obeys the standing instructions.

8. Acts as Tax Consultant: -

Commercial bank acts as tax consultant to its client. The commercial
bank prepares general sales tax return, income tax return, etc. Tiles the same with tax
authorities.

36
 Merchant Banking

In India merchant banking services were started only in 1967 by National Grind lays
Bank followed by City Bank in 1970. The State Bank of India was the first Indian
Commercial Bank having set up separate Merchant Banking Division in 1972. In India
merchant banks have been primarily operating as issue houses than full- fledged merchant
banks as in other countries.

A merchant bank may be defined as an institution or an organization which provides a

number of services including management of securities issues, portfolio services,
underwriting of capital issues, insurance, credit syndication, financial advices, project
counseling etc. There is a distinction between a commercial bank and a merchant bank. The
merchant banks mainly offer financial services for a fee. while commercial banks accept
deposits and grant loans. The merchant banks do not act as repositories for savings of the
individuals.

Functions of Merchant Banks:

The basic function of a merchant banker is marketing corporate and other securities.
Now they are required to take up some allied functions also.

1. Issue management: -

In the past, the function of a merchant banker had been mainly confined to the
management of new public issues of corporate securities by the newly formed
companies, existing companies (further issues) and the foreign companies in dilution
of equity as required under FERA in this capacity the merchant banks usually act as
sponsor of issues.

They obtain consent of the Controller of Capital Issues (now, the Securities and
Exchange Board of India) and provide a number of other services to ensure success in
the marketing of securities. The services provided by them include, the preparation of
the prospectus, underwriting arrangements, appointment of registrars, brokers and

37
bankers to the issue, advertising and arranging publicity and compliance of listing
requirements of the stock-exchanges, etc.

They act as experts of the type, timing and terms of issues of corporate securities and
make them acceptable for the investors on the one hand and also provide flexibility
and freedom to the issuing companies.

2. Loan syndication: -

Merchant banks provide specialized services in preparation of project, loan

applications for raising short-term as well as long- term credit from various bank and
financial institutions, etc. They also manage Euro-issues and help in raising funds
abroad.

3. Leasing and Finance: -

Many merchant bankers provide leasing and finance facilities to their

customers. Some of them even maintain venture capital funds to assist the
entrepreneurs. They also help companies in raising finance by way of public deposits.

38
 CHAPTER-14

RESERVE BANK OF INDIA

Establishment

The Reserve Bank of India was established on April 1, 1935 in accordance with the provision
of the Reserve bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and
where policies are formulated.

Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully
owned by the Government of India.

RBI Guidelines for Licensing of New Banks in the Private Sector:

The Guidelines for Licensing of New Banks in Private Sector’s key features of the guidelines
are:

(i) Eligible Promoters: Entities / groups in the private sector, entities in

public sector and Non-Banking Financial Companies (NBFCs) shall be
eligible to set up a bank through a wholly-owned Non-Operative Financial
Holding Company (NOFHC).
(ii) ‘Fit and Proper’ criteria: Entities / groups should have a past record of
sound credentials and integrity, be financially sound with a successful track
record of 10 years. For this purpose, RBI may seek feedback from other
regulators and enforcement and investigative agencies.
(iii) Corporate structure of the NOFHC: The NOFHC shall be wholly
owned by the Promoter / Promoter Group. The NOFHC shall hold the bank as
well as all the other financial services entities of the group.
(iv) Minimum voting equity capital requirements for banks and
shareholding by NOFHC: The initial minimum paid-up voting equity

39
 capital for a bank shall be `5 billion. The NOFHC shall initially hold a
minimum of 40 per cent of the paid-up voting equity capital of the bank which
shall be locked in for a period of five years and which shall be brought down
to 15 per cent within 12 years. The bank shall get its shares listed on the stock
exchanges within three years of the commencement of business by the bank.
(v) Regulatory framework: The bank will be governed by the provisions of
the relevant Acts, relevant Statutes and the Directives, Prudential regulations
and other Guidelines/Instructions issued by RBI and other regulators. The
NOFHC shall be registered as a non-banking finance company (NBFC) with
the RBI and will be governed by a separate set of directions issued by RBI.
(vi) Foreign shareholding in the bank: The aggregate non-resident
shareholding in the new bank shall not exceed 49% for the first 5 years after
which it will be as per the extant policy.
(vii) Corporate governance of NOFHC: At least 50% of the Directors of
the NOFHC should be independent directors. The corporate structure should
not impede effective supervision of the bank and the NOFHC on a
consolidated basis by RBI.
(viii) Prudential norms for the NOFHC: The prudential norms will be
applied to NOFHC both on stand-alone as well as on a consolidated basis and
the norms would be on similar lines as that of the bank.
(ix) Exposure norms: The NOFHC and the bank shall not have any exposure
to the Promoter Group. The bank shall not invest in the equity / debt capital
instruments of any financial entities held by the NOFHC.
(x) Business Plan for the bank: The business plan should be realistic and
viable and should address how the bank proposes to achieve financial
inclusion.
(xi) Other conditions for the bank:

 The Board of the bank should have a majority of independent Directors.

 The bank shall open at least 25 per cent of its branches in unbanked rural
centers (population up to 9,999 as per the latest census).

40
  The bank shall comply with the priority sector lending targets and sub-targets
as applicable to the existing domestic banks.
 Banks promoted by groups having 40 per cent or more assets/income from
non-financial business will require RBI’s prior approval for raising paid-up
voting equity capital beyond `10 billion for every block of `5 billion.
 Any non-compliance of terms and conditions will attract penal measures
including cancellation of license of the bank.

(xii) Additional conditions for NBFCs promoting / converting into a

bank: Existing NBFCs, if considered eligible, may be permitted to promote a
new bank or convert themselves into banks.

Procedure for application:

In terms of Rule 11 of the Banking Regulation (Companies) Rules, 1949, applications shall
be submitted in the prescribed form (Form III). The eligible promoters can send their
applications for setting up of new banks along with other details mentioned in Annex II to the
Guidelines to the Chief General Manger-in-Charge, Department of Banking Operations and
Development, Reserve Bank of India, Central Office, 12th Floor, Central Office Building,
Mumbai – 400 001

Procedure for RBI decisions:

 At the first stage, the applications will be screened by the Reserve Bank.
Thereafter, the applications will be referred to a High Level Advisory
Committee, the constitution of which will be announced shortly.
 The Committee will submit its recommendations to the Reserve Bank. The
decision to issue an in-principle approval for setting up of a bank will be taken
by the Reserve Bank.
 The validity of the in-principle approval issued by the Reserve Bank will be
one year.
 In order to ensure transparency, the names of the applicants will be placed on
the Reserve Bank website after the last date of receipt of applications.

41
CHAPER-15

GUIDELINES ON OWNERSHIP AND GOVERNANCE IN PRIVATE

SECTOR BANKS

Banks are “special” as they not only accept and deploy large amount of uncollateralized
public funds in fiduciary capacity, but they also leverage such funds through credit creation.
The Banks are also important for smooth functioning of the payment system. In view of the
above, legal prescriptions for ownership and governance of banks laid down in Banking
Regulation Act, 1949 have been supplement by regulatory prescription issued by RBI from
time to time. The existing legal framework and significant current practice in particular cover
the following aspects:

i. The composition of Board of Directors comprising members with demonstrable

professional and other experience in specific sector like agriculture, rural economy,
co-operation, SSI, law, etc., approval of Reserve Bank of India for appointment of
CEO as well as terms and conditions thereof, and powers for removal of managerial
personnel, CEO and directors, etc. in the interest of depositors are governed by
various sections of the Banking Regulation Act, 1949.

ii. Guidelines on corporate governance covering criteria for appointment of directors,

role and responsibilities of directors and the Board, signing of declaration and
undertaking by directors, etc., were issued by RBI on June 20, 2002 and June 25,
2004, based on the recommendations of Ganguly Committee and review by the BFS.

iii. Guidelines for acknowledgement of transfer/allotment of shares in private sector

banks were issued in the interest of transparency by RBI on February 3, 2004.

iv. Foreign investment in the banking sector is governed by Press Note dated March 5,
2004 issued by the Government of India, Ministry of Commerce and Industries.

v. The earlier practice of RBI nominating directors on the board of all private sector
banks has yielded place to such nomination in select private sector banks.

vi. Against this background, it is considered necessary to lay down a comprehensive

framework of policy in transparent manner relating to ownership and governance in
the Indian private sector banks as described below.

42
  The broad principles underlying the framework of policy relating to ownership
and governance of private sector banks would have to ensure that

 The ultimate ownership and control of private sector banks is well

diversifying. While diversified ownership minimizes the risk of misuse or
imprudent use of leveraged funds, it is no substitute for effective regulation.
Further, the fit and proper criterion, on a continuing basis, has to be the over-
riding consideration in the path of ensuring adequate investments, appropriate
restructuring and consolidation in the banking sector. The pursuit of the goal
of diversified ownership will take account of these basis objectives, in a
systematic manner and the process will be spread over time as appropriate.

 Important shareholders (i.e., shareholding of 5per cent and above) are “fit and
proper”. As laid down in the guidelines dated February 3, 2004 on
acknowledgment for allotment and transfer of shares.

 The directors and the CEO who manage the affairs of the bank are ‘fit and
proper’ as indicated in circular dated June 25, 2004 and observe sound
corporate governance principles.

 Private sector banks have minimum capital/net worth for optimal operations
and systemic stability.

 The policy and the processes are transparent and fair.

Minimum Capital:

The capital requirement of existing private sector should be on par with the entry capital
requirement for new private sector banks prescribed in RBI guidelines of January 3, 2001,
which is initially Rs.200crore, with a commitment to increase to Rs.30 crores within three
years. In order to meet this requirement, all banks in private sector should have a net worth
will have to submit a time-bound programmed for capital augmentation to RBI. Where the
net worth declines to a level below Rs.300 crores, it should be restored to Rs.300 crores
within a reasonable time.

Foreign investment in private sector banks:

43
In terms of the Government of India press note the aggregate foreign investment in private
banks from all sources (FDI, FII, NRI) cannot exceed 74 per cent. At all times, at least 26 per
cent of the private sector banks will have to be held by resident Indians.

Foreign Direct Investment (FDI) (other than by foreign banks or foreign

bank group):

i. The policy already articulated in guidelines for determining ‘fit and proper’ status
of shareholding of 5 per cent and above will be equally applicable for FDI. Hence
any FDI in private banks where shareholding reaches and exceeds 5 per cent
either individually or as a group will have to comply with the criteria indicated in
the aforesaid guidelines and get RBI acknowledgment for transfer of shares.

ii. To enable assessment of ‘fit and proper’ the information on ownership/beneficial

ownership as well as other relevant aspects will be extensive.

Foreign Institutional Investors (FIIs):

i. Currently there is a limit of 10 per cent for individual FII investment with the
aggregate limit for all FIIs restricted to 24 per cent which can be raised to 49 per
cent with the approval of Board/General Body. This dispensation will continue.

ii. The present policy requires RBI’s acknowledgment for acquisition/transfer of

shares of 5 per cent and more of a private sector bank by FIIs based upon the
policy guidelines on acknowledgment of acquisition/transfer of shares issued. For
this purpose, RBI may seek certification from the concerned FII of all beneficial
interest.

Non-Resident Indian (NRIs)

Currently there is limit of 5 per cent for individual NRI portfolio investment with the
aggregate limit for all NRIs restricted to 10 per cent which can be raised to 24 per cent with
the approval of Board/General Body. Further, the policy guidelines on acknowledgment for
acquisition/transfer will be applied.

Due diligence process

44
The process of due diligence in all cases of shareholders and directors as above, will involve
reference to the relevant regulator, revenue authorities, investigation agencies and
independent credit reference agencies as considered appropriate

Transition Arrangements

i. The current minimum capital requirement for entry of new bank is Rs.200 crores
to be increased to Rs.300 crores within three years of commencement of business.
A few private sector banks which have been in existence before these capital
requirements were prescribed have less than Rs.200 crore net worth. In the interest
of having sufficient minimum size for financial stability, all the existing private
banks should also be able to fulfil the minimum net worth requirement of Rs.300
crore required for a new entry. Hence any bank with the net worth below this level
will be required to submit a time bound program for capital augmentation to RBI
for approval.

ii. Where any existing shareholding of any individual entity/group of entities is 5 per
cent and above, due diligence outlined in the guidelines will be undertaken to
ensure fulfillment of ‘fit and proper’ criteria.

iii. Where any existing shareholding by any individual entity/group of related entities
is in excess of 10 per cent, the bank will be required to indicate a time table for
reduction of holding to the permissible level. While considering such cases, RBI
will also take into account the terms and conditions of the banking licenses.

iv. Any bank having shareholding in excess of 5 per cent in any other bank in India
will be required to indicate a time bound plan for reduction in such investments to
the permissible limit. The parent of any foreign bank having presence in India,
having shareholding directly or indirectly through any other entity in the banking
group in excess of 5 per cent in any other bank in India will be similarly required
to indicate a time bound plan for reduction of such holding to 5 per cent.

45
 v. Banks will be required to undertake due diligence before appointment of directors
and Chairman/CEO on the basis of criteria that will be separately indicated and
provide all the necessary certification/information to RBI`

vi. Banks having more than one member of a family, or close relatives or associates
on the Board will be required to ensure compliance with these requirements at the
time of considering any induction of renewal of terms of such directors.

vii. Action plans submitted by private banks outlines the milestones for compliance
with the various requirements for ownership and governance will be examined by
RBI for consideration and approval.

Continuous monitoring arrangements

i. Where RBI acknowledgment has already been obtaining for transfer of shares of 5 per
cent and above, it will be the bank’s responsibility to ensure continuing compliance of
the ‘fit and proper’ criteria and provide an annual certificate to the RBI of having
undertaken such continuing due diligence.

ii. Similar continuing due diligence on compliance with the ‘fit and proper’ criteria for
directors/CEO of thee bank and certified to RBI annually.

iii. RBI may, when considered necessary, undertake independent verification of ‘fit and
proper’ test conducted by banks through a process of due diligence.

Guidelines on Fair practices code

 Loan application forms shall be comprehensive to include information about rate of

interest (fixed/floating) and manner of charging (monthly/quarterly/half yearly/rest),
process fees and other charges, penal interest rates, pre-payment option and any other
matter which affects the interest of the borrower, so that a meaningful comparison
with that of other banks can be made and informed decision can be taken by the
borrower.
46
 Banks and Financial Institution should devise a system of giving acknowledgment for
receipt of all loans application. Banks/Financial Institutions should verify the loan

application within a reasonable period of time. If additional details /documents are

required, they should intimate the borrowers immediately. If all the requirements are
complied with the borrowers, banks/financial institution should acknowledge for the
same and state the specific time period from the date of acknowledgement within
which a decision on the specific loan request will be conveyed to the borrowers.

 Acknowledgment should also state the amount of process fees paid or to be paid and
the extent to which such fees shall be refunded in the event of rejection of any
application for loan.

 In the case of rejection of any loan application, lenders, should convey in writing the
specific reason thereof.

 Lenders should ensure that there is proper assessment of credit requirement of

borrowers. The credit limit, which may be sanctioned, should be mutually settled.

 Terms and conditions and other caveats governing credit facilities given by
banks/Financial Institution arrived at after negotiation by the lending institution and
the borrower should be reduced in writing duly witnessed and certified by the
authorized sanctioning authority; in respect of advances sanctioned by the Board of
Directors or its committee the documents of understanding should be certified by the
authorized signatory preferably at company secretary level. A copy of such agreement
should be made available to the borrowers for their record.

 Lenders should ensure timely disbursement of loans sanctioned.

 Stipulation of margin and security should be based on due diligence and credit
worthiness of borrowers.

47
 Lenders should keep the borrowers apprised of the state of their accounts from time to
time and shall give notice of any changes in the terms and conditions including
interest rates and charges are effected only prospectively. To ensure the above,
Banks/Financial institution should create appropriate information dissemination
mechanism.
 The loan agreement should clearly specify the liability of lenders to borrowers in
regard to allowing drawings beyond the sanctioned limits, honoring the cheques
issued for the purpose other than agreed, disallowing large cash withdrawals and
obligation to meet further requirements of the borrowers on account of growth in
business etc. without proper vision and sanction in credit limit, and disallowing
drawings on a borrower account on its classification as a non-performing assets or on
account of non-compliance with the terms of sanction.

 Lenders should give reasonable notice to borrowers before taking decision to recall /
accelerate payment or performance under the agreement or seeking additional
securities.

 Lenders should release all securities on receiving payment of loan or realization of

loan subject to any other claim lenders may have against borrowers. If such right of
set off is to be exercised, borrowers shall be given notice about the same with full
particulars about the remaining claims and the documents under which lenders are
entitled to retain the securities till the relevant claims are settled/paid.

48
CHAPTER-16

MICRO FACTORS AFFECTING INDIAN BANKING INDUSTRY

The major micro factors effecting Indian Banking Industry are discussed below:

 Loan Demand:

Over the past three years, Indian Banking Industry has seen sustained strength in credit
growth, which is not just a function of economic buoyancy but also the broad-basing of loan
demand. This has recently been articulated by the central bank too:
“A contextual analysis of the co-movement between macroeconomic performance and bank
credit in the current phase of the business cycle suggests that factors other than demand may
also be at work: financial deepening from a low base; structural shifts in supply elasticity’s;
rising efficiency of credit markets; and competitive pressures augmenting the overall supply
of credit.” (Reserve Bank of India, Monetary Policy Review, October 2006).
Loan growth sustained for very long

Source: RBI

45

49
The slowdown of the mid-1990s hit the banks very hard because corporate, which accounted
for a lion’s share of bank credit, went into a less profitable and hence a financial restructuring
mode. There was no retail credit then, banks did not focus on Small and Medium Enterprises
and farm lending was done grudgingly, under compulsion. Along with the diversification of
the pie that keeps the tempo of demand intact, after a long time industry has also started
demanding higher levels of credit. In the five years prior to FY05, growth in industrial credit
was almost wholly driven by infrastructure. There is a perceptibly wider participation from
other segments during FY05 and FY06.
If a substantial portion of loan growth gets driven by the banking system taking away market
shares from informal sectors – this is clearly happening to farm credit, SMEs and to a limited
extent non-mortgage retail – interest rate considerations influencing demand will be relatively
low. SMEs and the rural folk have accessed credit from other sources at exorbitant interest
rates, and hence banks’ rates going by 200-300bps is not so meaningful. That explains the
apparent lack of correlation between rates that have been rising and loan demand.

 Rising funding costs with soft lending rates irrational:

Plenty of historical evidence of return of pricing power to banks:

Concerns are often expressed about banks’ ability to increase lending rates in the face of
competition and government pressure. The reality is that banks, which led the mortgage price
war, have increased mortgage rate by 200-300bps from the bottom, and is yet to see
significant resistance. That PSU banks raised prime lending rates twice in. Competition from
overseas borrowings is a serious factor only with AAA companies, and banks have reduced
exposure to them considerably during the last 3-4 years.

Government stand is understandably against higher interest rates. However, it is unlikely that
the government will be able to influence the course of interest rates single-handedly.

Inflexibility of deposit growth a myth:

With 100-200bps increase in the card rates of deposits, banks have managed to move the
deposit growth rate from 15-16% to 19- 20%, on a larger base. In the last five years,
household financial savings have moved out of equities and long-term products to bank
deposits in percentage terms. The point to note here is that component of cash (currency) has

50
marginally risen – that’s the real, incremental opportunity as more cash from chests moves
into bank deposits first before potentially going to other avenues.
The Q4FY07 is expected to be a period of margin pressure. This is because as the last
interest-rate cycle showed, deposit costs increase first, and followed by lending rates. Q4 is
also usually a period of tight liquidity, and the RBI could be increasing CRR or SLR
requirements to further tighten the liquidity. Also, banks will be cautious about the actual
implementation of the lending rate increases and may do it in a graduated fashion so as not to
invite outright resistance or overt attention from the government. HDFC Bank, PNB, SBI and
a few others have nevertheless already made a beginning by increasing their prime lending
rates after the cash reserve ratio hike by the RBI. However, the fight for deposits has
intensified and it is possible that in Q4FY07 banks could be increasing their exposure to
high-cost wholesale deposits, taken at higher than card rates.

Banks’ increased risk appetite good for loan yields:

The banks’ lending risk appetite has increased significantly over the last five years – banks
veering more towards lending at increasing spreads rather than investing in risk-free bonds.
Accordingly, banks are willing to take higher risks, which is good for overall asset yields.

Investment spreads may increase in future:

As long-duration bonds at high interest rates have been coming up for maturity and getting
re-priced at lower interest rates, yields on investments have been continuously falling over
the last few years.

 Non – Performing Loans (NPLs): concerns overstated:

Loan growth-NPL:
The asset price deflation (read real estate prices) may hurting banks’ asset quality has been
blown out of proportion.

Residential mortgages:
It is very unlikely in near term that there can be a large-scale increase in delinquencies on
loans taken for the first house (typically self-occupied); unless there is a household income
problem, it does not matter to the borrower whether the price of the house he is staying in is

51
rising or falling. Even then, with an average loan-to-value of 75%, a 25% fall is theoretically
not possible. LTV ratios had gone up to more risky levels at the peak of the mortgage boom.
Problems can arise more frequently for loans taken for the second house, typically for
investment/speculation. Banks have been reluctant to disclose the exact volume of second
houses financed. Most banks claim that it is in the range of 2-5% of incremental mortgage
lending. There is a possibility that some individuals have been hiding from banks the fact that
they

Already have one more loan, but this is becoming increasingly difficult with a credit bureau
now in full swing. Even if the assumption that 10% of the outstanding mortgages are for the
second house and all of that goes bad, it will mean 1% of the banking system’s loans go bad.
Commercial real estate: According to figures disclosed by the RBI itself, real estate loans
constituted 2.0% of gross non-food credit of banks as of end-June 2006. Even if it has been
growing at high percentage rates is not material as the base was very low.

In any case, by increasing standard assets provisioning on these loans to 100bps from 25bps,
risk weights from 100% to 150% and instructing banks not to lend unless the developer has
“all the permissions.

One stark example of this is the largest bank SBI itself. In the mid 1990s, SBI’s portfolio was
distributed between large corporate, farm credit and trade, with little coming from others. The
Sep’06 portfolio looks dramatically different.

SBI’s loan portfolio now quite diversified

52
 Source: Company
data,
Cost of borrowing has risen, but so have incomes:
The apparent disconnect between interest rates rising now for two years and lending not
losing steam can be explained by i) rising incomes in case of individuals, thereby imparting
increased thrust to retail lending, and ii) improved corporate profitability through better
pricing power.
While there are several studies illustrating the household income growth in India, according
to National Council for Applied Economic Research, an explosive growth is underway in the
percentage of households earning Rs91, 000-1,000,000 pa, the most prominent individual
borrowers for banks.
The corporate pricing power story is less known because of the media harping on high
competition and margin compression. While these issues cannot be summarily dismissed, it is
a fact that manufactured product inflation has been rising. Even the RBI has recently
commented on the increased ability of manufacturers to pass on cost increases. And with a
considerably de-leveraged corporate India compared with the early/mid 1990s, these levels of
increases in interest costs have been easily absorbed by companies.

 Technology:

The trend in banking is changing from computerization of branches to laying a common

platform by having a core banking solution in all the branches. At the same time, Indian
banks are looking at internet banking which promises to grow into an alternate self-service

53
channel. As the mindset of the Indian customer undergoes a change, Indian banks need to
encompass the extension of all the services that are required and dictated by customers.

In future, banks will need to focus on value-differentiating services by keeping in-Houser

their competitive advantages while partnering with others who complement its services. The
emergence of peer-to-peer money transmission mechanisms (such as Western Union Money
Transfer) poses a challenge to current role of bankers and emphasizes the role of robust
payment systems like RTGS in maintaining and promoting financial stability.

Areas of Improvement:
Few challenges associated with technology adoption by banks are:
 Indian banks still don’t have the robust systems required for efficient
functioning of online banking. RBI has provided guidelines relating to security
and other issues and hopefully, online banking will see a surge in the usage
from current 1% to at least 10% in the next couple of years.
 Banks need to explore newer channels such as SMS, WAP and 3G mobile
telephony applications to facilitate online access to customers.
 Banks, in a drive to carry on with tremendous expansion in terms of customer
base, needs to have employees who are well informed about products and
services and are comfortable with technology which requires extensive
training.

Potential Pitfalls:

Banks should not get overwhelmed by the concept of automation and online banking. The
banks need to realize that they need to maintain different delivery for different generations.
Banks still need to maintain brick-and-mortar locations that people feel comfortable with.

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CHAPTER-17

ORGANIZATION PROFILE

 FORMATION OF THE COMPANY

The Housing Development Finance Corporation Limited (HDFC) was amongst the
first to receive an ‘in principle’ approval from the Reserve Bank of India (RBI) to set
up a bank in the private sector, as part of the RBI’s liberalization of the Indian
Banking Industry in 1994. The bank was incorporated in August 1994 in the name of
‘HDFC Bank Limited’, with its registered office in Mumbai, India. HDFC Bank
commenced operations as a Scheduled Bank in January 1995.

 PROMOTER

HDFC is India’s premier housing finance company and enjoys an impeccable track
record in India as well as in international markets. Since its inception in 1977, the
Corporation has maintained a consistent and healthy growth in its operations to
remain the market leader in mortgages. Its outstanding loan portfolio covers well over
a million dwelling units. HDFC has developed significant expertise in retail mortgage
loans to different market segments and also has a large corporate client base for its
housing related credit facilities. With its experience in the financial markets, a strong
market reputation, large shareholder base and unique consumer franchise, HDFC was
ideally positioned to promote a bank in the Indian environment.

 BUSINESS FOCUS

HDFC Bank’s mission is to be a world-class Indian Bank. The objective is to build

sound customer franchises across distinct business so as to be the preferred provider
of banking services for target retail and wholesale customer segment, and to achieve
healthy growth in profitability, consistent with the bank’s risk appetite. The bank is
committed to maintain the highest level of ethical standards, professional integrity,
corporate governance and regulatory compliance. HDFC Bank’s business philosophy
is based on four core values – Operational Excellence, Customer Focus, Product
Leadership and People.

55
 CAPITAL STRUCTURE

The authorized capital of HDFC Bank is Rs.550 crores (RS.5.5 billion). The paid-up
capital is Rs.424.6crore (Rs.4.2 billion). The HDFC group holds 19.4% of the bank’s
equity and about 17.6% of the equity is held by the ADS Depository (in respect of the
bank’s American Depository Shares (ADS) Issue). Roughly 28% of the equity is held
by the Foreign Institutional Investors (FIIs) and the bank has about 570,000
shareholders. The shares are listed on the Stock Exchange, Mumbai and the National
Stock Exchange. The bank’s American Depository Shares are listed on the New York
Stock Exchange (NYSE) under the symbol ‘HDB’.

 TIMES BANK AMALGAMATION

In a milestone transaction in the Indian banking industry, Times Bank Limited

(another new private sector bank promoted by Bennett, Coleman & Co) was merged
with HDFC Bank Ltd., effective February 26, 2000. As per the scheme of
amalgamation approved by the shareholders of both banks and the Reserve Bank of
India, shareholders of Times Bank received 1 share of HDFC Bank for every 5.75
shares of Times Bank. The acquisition added significant value to HDFC Bank in
terms of increased branch network, expanded geographic reach, enhanced customer
base, skilled manpower and the opportunity to cross-sell and leverage alternative
delivery channels.

 DISRTUBUTION NETWORK

HDFC Bank is headquartered in Mumbai. The Bank at present has an enviable

network of over 1229 branches spread over 444 cities across India. All branches are
linked on an online real-time basis. Customers in over 120 locations are also serviced
through Telephone Banking. The Bank’s expansion plans take into account the need
to have a presence in all major industrial and commercial centers where its corporate

56
 customers are located as well as the need to build a strong retail customer base for
both deposits and loan products. Being a clearing/settlement bank to various leading
stock exchange, the bank has branches in the centers where the NSC/BSC has a strong
and active member base. The bank also has a network of about over 2526 networked
ATMs across these cities. Moreover, HDFC Bank’s ATM network can be accessed by
al domestic and international Visa/MasterCard, Visa Electron/Maestro, Plus/Circus
and American Express Credit/Charge cardholders.

 TECHNOLOGY

HDFC Bank operates in a highly automated environment in terms of information

technology and communication systems. All the bank’s branches have online
connectivity, which enables the bank to offer speedy funds transfer facilities to its
customers. Multi-branches access is also provided to retail customers through the
branch network and Automated Teller Machines (ATMs). The bank has made
substantial efforts and investments in acquiring the best technology available
internationally, to build the infrastructure for a world class bank. The bank’s business
is supported by scalable and robust systems which ensure that our clients always get
the finest services we offer. The bank has prioritized its engagement in technology
and the internet as one of its key goals and has already made significant progress in
web-enabling in core business in each of its businesses, the bank has succeeded in
leveraging its market position, expertise and technology to create a competitive
advantage and build market share.

 BUSINESS FOCUS

HDFC Banks mission is to be a World Class Indian Bank. The objective is to build
soundcustomer franchises across distinct businesses so as to be the preferred provider of
banking services to target retail and wholesale customer segments, and to achieve healthy
growth in profitability, consistent with the banks risk appetite. The bank I committed to
maintain highest level of ethical standards, professional integrity, corporate governance

57
and regulatory compliance. HDFC Banks business philosophy is based on four core
values – Operational Excellence, Customer Focus, Product Leadership and People.

 PRODUCT SCOPE

HDFC Bank offer a bunch of products and services to meet every need of the people. The
company cares for both, individuals as well as corporate and a small and medium
enterprises. For individuals, the company has a range accounts, investment, and pension
scheme, different types of loans and cards that assist the customers. The customers can
choose the suitable one for range of products which will suit their life stage and needs.
For organizations the company has the host of customized solutions that range from
Funded services, Non funded services, Value addition services, Mutual Fund etc. These
affordable plans apart from providing long term value to the employees help in enhancing
goodwill of the company. The product of the company is categorized into various sections
which are as follow:

o Accounts and Deposits

o Loans
o Investments and Insurance
o Forex and Payment Services
o Cards
o Customer center

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CHAPTER-18

LIMITATIONS OF STUDY

Every work has its own limitation. Limitations one extent to which the process should not
exceed. Limitations of this projects are: -

 The project was constrained by the time limit of 42 days.

 The major limitations of this study is data availability as the data is propriety and not
readily for dissemination.
 Due to ongoing process of globalization and increasing competition, no one model or
method will suffice over a long period of time and constant up graduation will be
required. As such the project can be considered as an overview of the various banks
prevailing in Punjab National Bank and in the Banking Industry.
 The project study is restricted to banking sector used in India only.
 The conclusion made is based on sample study and does not apply to all the
individuals.
 In India the banks are being segregated in different groups has their own benefits and
limitations in operating in India.
 All banks are not included.

PROBLEMS: - The corporate sector has stopped up its demand for credit to fund its
expansion plans, there has also been a growth in retail banking. However, even as the
opportunities increase, there are some issues and challenges that Indian banks will
have to control with if they are to emerge successful in the medium to long term.

59
CHAPTER-19

CONCLUSION

The project involves valuation of major Indian Banks including ICICI Bank, SBI and HDFC
Bank. The methodology followed is Target Pricing, which including estimating growth rate
by regression on historical sales to forecast next year sales, earning and Profit and Loss
account. Then EPS is calculated which is multiplied to Historical P/E to forecast intrinsic
value of share. All shares are undervalued and expected to give positive risk adjusted returns
to investors. Since the intrinsic value is more than current market price for all the companies,
the share can be recommended to conservative investors.

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CHAPTER-20

BIBLIOGRAPHY

i) http://finance.indiamart.com/investment_in_india/banks.html
ii) economics.about.com/cs/finance/a/india_banking.htm
iii) www.bankreport.rbi.org.in
iv) www.giichinese.com.tw/chinese/rnc41934-banking-sector.html
v) www.thokalath.com/banks
vi) www.qualisteam.com/Banks/Asia/India/
vii) http://economics.about.com/b/2005/11/24/banking-in-india.htm
viii) http://business.mapsofindia.com/banks-in-india
ix) www.iloveindia.com/finance/bank/foreign-banks/index.html
x) www.bestindiansites.com/banks
xi) http://explore.oneindia.in/finance/banks
xii) www.economywatch.com/business-and-economy/banks.html
xiii) http://en.wikipedia.org/wiki/Banking_in_India

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