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PRINCIPLES OF BANKING
Module A & B
April 15/2008
 Financial System in India
• Financial Sector consists of three
main segments viz.,
• 1) Financial institutions -banks,
mutual funds, insurance
companies
• 2) Financial markets -money
market,
debt market,capital market, forex
market
• 3) Financial products -loans,
deposits, bonds, equities
 Financial Sector - Regulators

Regulators

Insurance Regulatory
Reserve Bank of Securities Exchange
and Development
India Board of India
Authority
(RBI) (SEBI)
(IRDA)

Capital Markets/ Insurance

Banks
Mutual Funds Companies
 Banking in India

Legal frame work

of
Banks

Banking Regulation Reserve Bank of India

Act,1949 Act,1934
 Banking in India
- Banking in India is governed by
BR Act,1949 and RBI Act,1934
- Banking in India is controlled/monitored
by RBI and Govt of India
- The controls for different banks are
different
based on whether the bank/s is/are
a) statutory corporation
b) a banking company
c) a cooperative society
Banking Regulation Act,1949 (BR Act)-1

- BR Act covers banking companies and

cooperative banks, with certain modifications.
- BR Act is not applicable to
a) primary agricultural credit societies b) land
development banks
- BR Act allows RBI (Sec 22) to issue
licence for banks
Banking Regulation Act,1949 (BR
Act)-2

Penalities Regulation

Suspension
Control over
&
management
Winding up
Reserve Bank of India
Act,1934(RBI Act)-1
- RBI Act was enacted to constitute the
Reserve Bank of India
- RBI Act has been amended from time to
time
- RBI Act deals with the constitution,
powers and functions of RBI
Reserve Bank of India Act,1934(RBI
Act)-2
- RBI Act deals with:
- incorporation, capital management and
business of banks
- central banking functions
- financial supervision of banks and
financial institutions
- management of forex/reserves
- control functions : bank
rate,audit,accounts
- penalities for violation
 Reserve Bank of India - 1
 Reserve Bank of India was established in
 1935, after the enactment of the Reserve
 Bank of India Act 1934 (RBI Act).
 Banking Regulation Act,1949 (BR Act)gave
wide powers to RBI as regards to
establishment of new banks/mergers and
amalgamation of banks,opening of new
branches,etc
 BR Act,1949 gave RBI powers to
regulate,superivse and develop the banking
system in India
 Reserve Bank of India – 2

CENTRAL BANK
RBI

REGULATOR SUPERVISOR FACILITATOR

Money Market Instruments
• Inter bank call money/deposit
• Inter bank notice money/deposit
• Inter bank term money/deposit
• Certificates of Deposit
• Commercial Paper
• Treasury Bills
• Bill rediscounting
• Repos
Certificates of Deposit
• CDs are short-term borrowings in the form of
UPN issued by scheduled commercial banks
and are freely transferable by endorsement
and delivery.
• Introduced in 1989
• Minimum period 7 days and maximum period
one year. FIs are allowed to issue CDs for a
period between 1 year and up to 3 years
• Minimum amount is Rs 1,00,000.00
• Subject to payment of stamp duty under the
Indian Stamp Act, 1899
• Issued to individuals, corporations, trusts,
funds and associations
• Issued at a discount rate freely determined by
the market/investors
 Commercial Paper

• Short-term borrowings by corporates, financial

institutions, primary dealers from the money
market
• Can be issued in the physical form (Usance
Promissory Note) or de mat format
• Introduced in 1990
• When issued in physical form are negotiable by
endorsement and delivery and hence, highly
flexible
• Maturity is 7 days to 1 year
• Unsecured and backed by credit rating of the
issuing company
• Issued at discount to the face value
 Repos
• Repo (repurchase agreement)
instruments enable collateralised short-
term borrowing through the selling of
debt instruments
• A security is sold with an agreement to
repurchase it at a pre-determined date
and rate
• Reverse repo is a mirror image of repo
and reflects the acquisition of a security
with a simultaneous commitment to
resell
INDIAN CAPITAL MARKET
• Indian Capital Market plays an important role
in the economic development of the country

• It provides opportunities for investors to invest

in the market and also to earn attractive rate
of return.

• It also creates source of funds for the various

sectors

• National Stock Exchange (NSE) and Bombay

Stock Exchange (BSE) are the major stock
exchanges in India
Securities & Exchange Board of India
(SEBI)
• SEBI was constituted on April 12/1988,
and obtained the statutory powers in
March,1992
• SEBI’s functions:
• To protect the interests of investors
• To recognize the business in stock
exchanges and other security markets
• To supervise and regulate work of
intermediaries, such as stock brokers
merchant bankers/custodians
depositories/bankers to the issues
Association of Mutual Funds in India
(AMFI)
• AMFI is an association as a non
profit organization.
• AMFI represents mutual funds in
India and working for healthy
growth of the Mutual Funds.
• AMFI conduct examinations for MF
executives as part of their training
activities
Insurance Regulatory & Development
Authority (IRDA)
• The regulator for insurance
business in India is IRDA.
• IRDA was established in 2000
• IRDA’s functions:
• To regulate, promote and ensure
orderly growth of the insurance
business and reinsurance business
in India
• To protect the interests of policy
holders
Insurance Sector
• Insurance Sector
in India can be
divided into two
main sections
Life Insurance

General Insurance
Financial Intermediaries (1)
• Mutual Funds- As financial intermediary
promote savings and mobilise funds which are
invested in the stock market and bond market
• MFs are associations or trusts of public
members and assist them in making
investments in the financial instruments of the
business/corporate sector for the mutual
benefit of its members.
• MFs aims to reduce the risks in investments
Mutual funds help their investors to enhance
their value by investing the funds in capital
market.
• Mutual funds offer various schemes: growth
fund, income fund, balanced fund,sector wise
funds, etc.,
• Regulated by SEBI
Financial Intermediaries (2)
• Merchant banking- Another important
financial intermediary which manages
and underwrites new issues, undertake
syndication of credit, advise corporate
clients on fund raising
• Subject to regulation by SEBI and RBI
• SEBI regulates them on issue activity
and portfolio management of their
business.
• RBI supervises those merchant banks
which are subsidiaries or affiliates of
commercial banks
 Indian Banking - Significant events
1 • Three presidency banks were established in Calcutta
(1806) in Bombay (1840) and in Madras (1843)
• In the early part of 20th century, on account of the
Swadeshi movement a number of join stock banks were
established by Indians like Bank of India, Bank of Baroda
and Central Bank of India.
• In 1921 the three presidency banks were merged and
the Imperial Bank of India was created.
• During the period 1900 to 1925 many banks failed, and
the Government appointed in 1929 a Central Banking
Enquiry Committee to trace the reasons for the failure
of banks.
• The Reserve Bank of India Act was passed in 1934 and
the RBI came into existence in 1935 and RBI was
nationalised in 1949
• The Banking Regulation Act,1949 gave wide powers to
RBI to act as the regulator for banks in India
Indian Banking -Significant events 2
• In 1955 State Bank of India became the
successor to the Imperial Bank of India ,under
the State Bank of India Act,1955.
• In 1959 State Bank of India (Subsidiary Banks)
Act was passed to enable SBI to take over
State Associated banks as SBI’s subsidiaries
• In 1969 the Government of India nationalised
14 major commercial banks having deposits of
Rs.50 crore or more
• In 1975 Regional Rural Banks were established
under RRB Act 1976, which was preceded by
RRB Ordinance in 1975
• In 1980 six more commercial banks were
nationalised, with a deposit of Rs.200 crore or
more
Progress of banking in India

• In the liberalised, privatised and

globalised environment, banks
opeating
in India have diversified their
banking activities by offering Para
Banking facilities like
– Merchant banking/Mutual funds
– ATMs/Credit Cards/Internet banking
– Venture capital funds
– Factoring
–
Classification of Banks-1

Regional Central
Rural Bank
Banks RBI

Co-operative Public Sector

Banks Banks

New Private
Foreign Banks Sector
Banks

Old
Private
Sector
Classification of Banks-2

PUBLIC SECTOR
BANKS

STATE BANK OF
SBI ASSOCIATE NATIONALISED
INDIA
BANKS BANKS
SBI
Classification of Banks-3
• Public Sector Banks =State Bank of
India+SBI’s associate banks+
Nationalised banks
• Private Sector Banks=Indian
Private Sector Banks (Old/New
generation banks)+Foreign banks
in India
• Other Banks=Regional Rural
Banks(RRB)
 Functions of Banks - 1
CENTRAL BANK
RBI

REGULATOR SUPERVISOR FACILITATOR

RESERVE BANK OF INDIA

 SUPERVISORY & REGLATORY

 Issuance of currency notes
 Banker’s Banker
 Lender of the last resort
 Credit Control & Monetary Policy
 Exchange Control & Forex Management
 Funds Transfer
CREDIT CONTROL

• QUANTITATIVE CREDIT CONTROL

• QUALITATIVE CEDIT CONTROL’
• CRR & SLR
• BANK RATE
• OPEN MARKET OPERATIONS
Functions of Banks - 2
 Commercial Banks-Core Banking
Functions
- Acceptance of deposits from public
- Lending funds to public/corporates
- Investing funds in various
opportunities
- Collecting cheques/drafts and
other Negotiable Instruments
-
Functions of
Banks-3
 Commercial Banks – Para Banking
Services
 Providing safe deposit lockers
 Acceptance of safe custody items
 Acceptance of standing instructions
 Offering internet banking facilities
 Issuance of credit and other cards
including ATM cards
 Offering various products like Mutual
funds,insurance products, merchant
banking services
 Acting as executors and trustees
Commercial Banks
DEPOSIT PRODUCTS

CURRENT

CERTIFICATE SAVINGS

DEPOSITS

FLEXI FIXED

RECURRING
Non-Resident Accounts - 1

Rupee accounts

Non-resident Non-resident
Ordinary account External account
(NRO) (NRE)
resident
Deposit Accounts –FCNR
(B)
 FCNR (B) accounts
 NRIs,PIOs,residing outside India can open
FCNR (B) accounts
 FCNR (B) accounts are maintained as fixed
deposits in certain designated currencies
 The designated currencies are:
 US$, GBP, Japanese Yen, Euro, Cad$, Aus $
 Maintained in Banks in India in the above
mentioned foreign currencies and interest is
also earned in such foreign currencies
 Repatriation of funds (principal, interest) is
allowed
Loan Products – Fund Based

CASH CREDIT

BILLS
OVERDRAFT
FINANCE

LOANS
&
ADVANCES

RETAIL
TERM
FINANCE
FINANCE
Loan Products –Non Fund Based

Co-Acceptance
Letters of
Of
Credit
Bills

Bank Guarantee
 Know Your Customer (KYC) -1
 KYC: Know Your Customer
 Know your customer (KYC) norms are
applicable to all types of customer a/cs.
 It deals with not only to identify the
customer but also to understand the
activities of the customer, and to ensure
that the operations in the customer
account/s is/are for genuine purpose
Know Your Customer (KYC) -2
• Application of KYC norms have
become
important due to various reasons.
• In view of many issues on account
of drugs smuggling, money
laundering, terrorist activities,
arms dealing,etc.,
banks need to be careful in dealing
with their clients.
Know Your Customer (KYC) -3

Customer
Risk Management Acceptance
Policy

Customer
Monitoring of
Identification
Transactions
Procedure
Bank Customers - 1

Individuals

Power of
Joint account
Attorney
hoders
Holders

Bank Customers

Executors/Trustees Minors

Illiterate
Perons
Bank Customers - 2

Clubs/ Sole
Socities Proprietor

Partnership
Coproates

Hindu
Undivided
Family
BANKER-CUSTOMER
RELATIONSHIP
 DEBTOR-CREDITOR
 CREDITOR-DEBTOR
 AGENT-PRINCIPAL
 LESSOR-LESSEE
 BAILEE-BAILOR
CHEQUES
BEARER

ORDER

CROSSED

OPEN
NEGOTIABLE INSTRUMENTS
Paying Banker:
Payment in
Due
Course

Apparent Without
In good faith
Tenor Negligence
NEGOTIABLE
INSTRUMENTS
BANKER’S DUTIES HOLDER IN
DUE
& COURSE
RESPONSIBILITIES
CONSIDERATION BEFORE
C0LLECTING TITLE
MATURITY
BANKER
COLLECTION OF
CHEQUES
 Six Cs

 Character
 Capital
 Capacity
 Collateral
 Condition
 Compliance
Working Capital Cycle

Bills receivables Cash

sales Raw material

Finished goods Semi finished goods

CHARGES

 HYPOTHECATION
 PLEDGE
 MORTGAGE
 ASSIGNMENT
 LIEN
 SET OFF
Risk Management

Operations Credit
Risk Risk

Interest Rate Liquidity

Risk Risk

Price
Risk
 SRFAESI Act,2002
- Securitisation and Reconstruction of
Financial Assets and Enforcement of
Security Interest Act (SRFAESI) was
enacted in 2002
_ Securitisation Company/Reconstruction
Company (SCRC) can finance the
acquistion from own resources or rise
sources from Qualified Institutional
Buyers (QIBs)
SRFAESI Act,2002

Enforcement of
Legal framework
Security interest

Transfer of NPA
 Priority Sector 1

Priority Sector

Primay Secondary Teritary

Priority Sector – 2

Primary Sector

Agriculture Allied Activities

Direct Indirect
 Priority Sector – 3

Secondary Sector

SSI/SME SSSBE
 Priority Sector 4
Tertiary Sector

Small road/water Small business/businee Professional/self

Transport operator enterprises employed

Educational loans

Housing finance

Others
Small & Medium Enterprises
(SMEs)
• SMEs are classified based on Small &
Medium Enterprises Development
Act,2006
• SMEs are divided into micro,small &
medium sized entities.
• SMEs are classified based on two
categories
viz., manufacturing units and service
companies.
• In case of manufacturing units
investments
in plant and machinery and for service
companies investments in equipment
are
Credit Management in Banks

Credit appraisal Capital adequacy

system norms

Prudential
Risks-ALM
norms

Exposure
norms
 Documentation 1
- Loan documents are classified as
primary and secondary
- Documents are obtained based on the
type of credit facility/constitution of the
borrower/nature of securities offered by the
borrowers
- Documents should have a clear title
and can be valid to be enforced in a
court of law
- Wherever required documents need to be
stamped appropriately
- Documents should be properly filled up and
duly
executed by authorised persons.
 Documentation 2
• Documentary evidence as per
Sec 61
of Evidence Act :
c) Primary: original documents
needs to
be produced for inspection of
court
b) Secondary:
- certified copies
- copies made from or compared
with
 E banking

E Banking

Core
Credit Internet
Banking
Cards Banking
Solutions
ALL THE BEST & THANK YOU
• T.M.C.VARADARAJAN
• TEL : 022-25638965 (R)
• 022-66364206 (O)
• e.mail:
t.varadarajan@scotiabank.com
•
tmc_varadarajan@yahoo.co.in