Principles & Practices of Principles & Practices of

Banking Banking
Module A Module A
Indian Financial System Indian Financial System
K Chockalingam K Chockalingam
IIBF IIBF
Financial System Financial System
An institutional framework existing in a country An institutional framework existing in a country
to enable financial transactions to enable financial transactions
Three main parts Three main parts
Financial assets (loans, deposits, bonds, equities, etc.) Financial assets (loans, deposits, bonds, equities, etc.)
Financial institutions (banks, mutual funds, insurance Financial institutions (banks, mutual funds, insurance
companies, etc.) companies, etc.)
Financial markets (money market, capital market, forex Financial markets (money market, capital market, forex
market, etc.) market, etc.)
Regulation is another aspect of the financial Regulation is another aspect of the financial
system (RBI, SEBI, IRDA, FMC) system (RBI, SEBI, IRDA, FMC)
Financial assets/instruments Financial assets/instruments
Enable channelising funds from surplus units to Enable channelising funds from surplus units to
deficit units deficit units
There are instruments for savers such as There are instruments for savers such as
deposits, equities, mutual fund units, etc. deposits, equities, mutual fund units, etc.
There are instruments for borrowers such as There are instruments for borrowers such as
loans, overdrafts, etc. loans, overdrafts, etc.
Like businesses, governments too raise funds Like businesses, governments too raise funds
through issue of bonds, Treasury bills, etc. through issue of bonds, Treasury bills, etc.
Instruments like PPF, KVP, etc. are available to Instruments like PPF, KVP, etc. are available to
savers who wish to lend money to the savers who wish to lend money to the
government government
Money Market Instruments Money Market Instruments
Call money Call money-- money borrowed/lent for a day. No money borrowed/lent for a day. No
collateral is required. collateral is required.
Inter Inter--bank term money bank term money-- Borrowings among Borrowings among
banks for a period of more than 7 days banks for a period of more than 7 days
Treasury Bills Treasury Bills-- short term instruments issued by short term instruments issued by
the Union Govt. to raise money. Issued at a the Union Govt. to raise money. Issued at a
discount to the face value discount to the face value
Certificates of Deposit Certificates of Deposit-- Issued by banks to raise Issued by banks to raise
money. Minimum value is Rs. 1 lakh, tradable in money. Minimum value is Rs. 1 lakh, tradable in
the market the market
CDs can be issued by banks/FIs CDs can be issued by banks/FIs
Money Market Instruments (2) Money Market Instruments (2)
Commercial Paper (CPs) are issued by Commercial Paper (CPs) are issued by
corporates to raise short term money corporates to raise short term money
Issued in multiple of Rs.25 lakhs, can be Issued in multiple of Rs.25 lakhs, can be
issued by companies with a net worth of issued by companies with a net worth of
at least Rs. 5 crores at least Rs. 5 crores
CP is an unsecured promissory note CP is an unsecured promissory note
privately placed with investors at a privately placed with investors at a
discount rate to face value. The maturity discount rate to face value. The maturity
of CP is between 3 and 6 months of CP is between 3 and 6 months
Financial Institutions Financial Institutions
Includes institutions and mechanisms Includes institutions and mechanisms
which which
Affect generation of savings by the community Affect generation of savings by the community
Mobilisation of savings Mobilisation of savings
Effective distribution of savings Effective distribution of savings
Institutions are banks, insurance Institutions are banks, insurance
companies, mutual funds companies, mutual funds--
promote/mobilise savings promote/mobilise savings
Individual investors, industrial and trading Individual investors, industrial and trading
companies companies-- borrowers borrowers
Financial Markets Financial Markets
Money Market Money Market-- for short for short--term funds (less term funds (less
than a year) than a year)
Organized (Banks) Organized (Banks)
Unorganized (money lenders, chit funds, etc.) Unorganized (money lenders, chit funds, etc.)
Capital Market Capital Market-- for long for long--term funds term funds
Primary Issues Market Primary Issues Market
Stock Market Stock Market
Bond Market Bond Market
Organized Money Market Organized Money Market
Call money market Call money market
Bill Market Bill Market
Treasury bills Treasury bills
Commercial bills Commercial bills
Bank loans (short Bank loans (short--term) term)
Organized money market comprises RBI, Organized money market comprises RBI,
banks (commercial and co banks (commercial and co--operative) operative)
Call money market (1) Call money market (1)
It deals with one It deals with one--day loans (overnight, to be day loans (overnight, to be
precise) called call loans or call money precise) called call loans or call money
Participants are mostly banks. Also called inter Participants are mostly banks. Also called inter--
bank call money market. bank call money market.
The borrowing is exclusively limited to banks, The borrowing is exclusively limited to banks,
who are temporarily short of funds. who are temporarily short of funds.
On the lending side, besides banks with excess On the lending side, besides banks with excess
cash and as special cases few FIs like LIC, UTI cash and as special cases few FIs like LIC, UTI
All others have to keep their funds in term All others have to keep their funds in term
deposits with banks to earn interest deposits with banks to earn interest
Call money market (2) Call money market (2)
Call loans are generally made on a clean basis Call loans are generally made on a clean basis--
i.e. no collateral is required i.e. no collateral is required
The main function of the call money market is to The main function of the call money market is to
redistribute the pool of day redistribute the pool of day--to to--day surplus funds day surplus funds
of banks among other banks in temporary deficit of banks among other banks in temporary deficit
of funds of funds
The call market helps banks earn interest and The call market helps banks earn interest and
yet improve their liquidity yet improve their liquidity
It is a highly competitive and sensitive market It is a highly competitive and sensitive market
It acts as a good indicator of the liquidity It acts as a good indicator of the liquidity
position position
Bill Market Bill Market
Treasury Bill market Treasury Bill market-- Also called the T Also called the T--Bill Bill
market market
These bills are short These bills are short--term liabilities (91 term liabilities (91--day, 182 day, 182--day, day,
364 364--day) of the Government of India day) of the Government of India
It is an IOU of the government, a promise to pay the It is an IOU of the government, a promise to pay the
stated amount after expiry of the stated period from stated amount after expiry of the stated period from
the date of issue the date of issue
They are issued at discount to the face value and at They are issued at discount to the face value and at
the end of maturity, the face value is paid the end of maturity, the face value is paid
The rate of discount and the corresponding issue The rate of discount and the corresponding issue
price are determined at each auction price are determined at each auction
Commercial Bill market Commercial Bill market-- Not as developed in Not as developed in
India as the T India as the T--Bill market Bill market
Indian Banking System Indian Banking System
Central Bank (Reserve Bank of India) Central Bank (Reserve Bank of India)
Commercial banks Commercial banks
Co Co--operative banks operative banks
Banks can be classified as: Banks can be classified as:
Scheduled (Second Schedule of RBI Act, 1934) Scheduled (Second Schedule of RBI Act, 1934)
Non Non--Scheduled Scheduled
Scheduled banks can be classified as: Scheduled banks can be classified as:
Public Sector Banks Public Sector Banks
Private Sector Banks (Old and New) Private Sector Banks (Old and New)
Foreign Banks Foreign Banks
Regional Rural Banks Regional Rural Banks
Indigenous bankers Indigenous bankers
Individual bankers like Shroffs, Seths, Sahukars, Individual bankers like Shroffs, Seths, Sahukars,
Mahajans, etc. Combine trading and other Mahajans, etc. Combine trading and other
business with money lending. business with money lending.
Vary in size from petty lenders to substantial Vary in size from petty lenders to substantial
Shroffs Shroffs
Act as money changers and finance internal Act as money changers and finance internal
trade through hundis (internal bills of exchange) trade through hundis (internal bills of exchange)
Indigenous banking is usually family owned Indigenous banking is usually family owned
business employing own working capital business employing own working capital
At one point, it was estimated that IB met about At one point, it was estimated that IB met about
90% of the financial requirements of rural India 90% of the financial requirements of rural India
RBI and indigenous bankers (1) RBI and indigenous bankers (1)
Methods employed by the indigenous bankers Methods employed by the indigenous bankers
are traditional with vernacular system of are traditional with vernacular system of
accounting. accounting.
RBI suggested that bankers give up their trading RBI suggested that bankers give up their trading
and commission business and switch over to the and commission business and switch over to the
western system of accounting. western system of accounting.
It also suggested that these bankers should It also suggested that these bankers should
develop the deposit side of their business develop the deposit side of their business
Ambiguous character of the hundi should stop Ambiguous character of the hundi should stop
Some of them should play the role of discount Some of them should play the role of discount
houses (buy and sell bills of exchange) houses (buy and sell bills of exchange)
RBI and indigenous bankers (2) RBI and indigenous bankers (2)
IB should have their accounts audited by IB should have their accounts audited by
certified chartered accountants certified chartered accountants
Submit their accounts to RBI periodically Submit their accounts to RBI periodically
As against these obligations the RBI promised to As against these obligations the RBI promised to
provide them with privileges offered to provide them with privileges offered to
commercial banks including commercial banks including
Being entitled to borrow from and rediscount bills Being entitled to borrow from and rediscount bills
with RBI with RBI
The IB declined to accept the restrictions as well The IB declined to accept the restrictions as well
as compensation from the RBI as compensation from the RBI
Therefore, the IB remain out of RBIs purview Therefore, the IB remain out of RBIs purview
Development Oriented Banking Development Oriented Banking
Historically, close association between banks Historically, close association between banks
and some traditional industries and some traditional industries-- cotton textiles in cotton textiles in
the west, jute textiles in the east the west, jute textiles in the east
Banking has not been mere acceptance of Banking has not been mere acceptance of
deposits and lending money to include deposits and lending money to include
development banking development banking
Lead Bank Scheme Lead Bank Scheme-- opening bank offices in all opening bank offices in all
important localities important localities
Providing credit for development of the district Providing credit for development of the district
Mobilising savings in the district. Service area Mobilising savings in the district. Service area
approach approach
Progress of banking in India (1) Progress of banking in India (1)
Nationalisation of banks in 1969: 14 banks were Nationalisation of banks in 1969: 14 banks were
nationalised nationalised
Branch expansion: Increased from 8260 in 1969 Branch expansion: Increased from 8260 in 1969
to 68500 in 2005 to 68500 in 2005
Population served per branch has come down Population served per branch has come down
from 64000 to 15000 from 64000 to 15000
A rural branch office serves 15 to 25 villages A rural branch office serves 15 to 25 villages
within a radius of 16 kms within a radius of 16 kms
Still only 32,180 villages out of 5 lakh have been Still only 32,180 villages out of 5 lakh have been
covered covered
Progress of banking in India Progress of banking in India (2) (2)
Deposit mobilisation: Deposit mobilisation:
1951 1951--1971 (20 years) 1971 (20 years)-- 700% or 7 times 700% or 7 times
1971 1971--1991 (20 years) 1991 (20 years)-- 3260% or 32.6 times 3260% or 32.6 times
1991 1991-- 2006 (11 years) 2006 (11 years)-- 1100% or 11 times 1100% or 11 times
Expansion of bank credit: Growing at 20 Expansion of bank credit: Growing at 20--30% 30%
thanks to rapid growth in industrial and thanks to rapid growth in industrial and
agricultural output agricultural output
Development oriented banking: priority sector Development oriented banking: priority sector
lending lending
Progress of banking in India (3) Progress of banking in India (3)
Diversification in banking: Banking has Diversification in banking: Banking has
moved from deposit and lending to moved from deposit and lending to
Merchant banking and underwriting Merchant banking and underwriting
Mutual funds Mutual funds
Retail banking Retail banking
ATMs ATMs
Anywhere banking Anywhere banking
Internet banking Internet banking
Venture capital funds Venture capital funds
Factoring Factoring--
Profitability of Profitability of Banks(1) Banks(1)
Reforms has shifted the focus of banks Reforms has shifted the focus of banks
from being development oriented to being from being development oriented to being
commercially viable commercially viable
Prior to reforms, banks were not profitable Prior to reforms, banks were not profitable
and in fact made losses for the following and in fact made losses for the following
reasons: reasons:
Declining interest income Declining interest income
Increasing cost of operations Increasing cost of operations
Profitability of banks (2) Profitability of banks (2)
Declining interest income was for the Declining interest income was for the
following reasons: following reasons:
High proportion of deposits impounded for High proportion of deposits impounded for
CRR and SLR, earning relatively low CRR and SLR, earning relatively low
interest rates interest rates
System of directed lending System of directed lending
Political interference Political interference-- leading to huge NPAs leading to huge NPAs
Rising costs of operations for banks was Rising costs of operations for banks was
because of several reasons: economic and because of several reasons: economic and
political political
Profitability of Banks (3) Profitability of Banks (3)
As per the Narasimham Committee (1991), the As per the Narasimham Committee (1991), the
reasons for rising costs of banks were: reasons for rising costs of banks were:
Uneconomic branch expansion Uneconomic branch expansion
Heavy recruitment of employees Heavy recruitment of employees
Growing indiscipline and inefficiency of staff due to Growing indiscipline and inefficiency of staff due to
trade union activities trade union activities
Low productivity Low productivity
Declining interest income and rising cost of Declining interest income and rising cost of
operations of banks led to low profitability in the operations of banks led to low profitability in the
90s 90s
Bank profitability: Suggestions Bank profitability: Suggestions
Some suggestions made by Narasimham Some suggestions made by Narasimham
Committee are: Committee are:
Set up an Asset Reconstruction Fund to Set up an Asset Reconstruction Fund to
take over doubtful debts take over doubtful debts
SLR to be reduced to 25% of total deposits SLR to be reduced to 25% of total deposits
CRR to be reduced to 3 to 5% of total CRR to be reduced to 3 to 5% of total
deposits deposits
Banks to get more freedom to set minimum Banks to get more freedom to set minimum
lending rates lending rates
Share of priority sector credit be reduced to Share of priority sector credit be reduced to
10% from 40% 10% from 40%
Suggestions (contd) Suggestions (contd)
All concessional rates of interest should be All concessional rates of interest should be
removed removed
Banks should go for new sources of funds such Banks should go for new sources of funds such
as Certificates of Deposits as Certificates of Deposits
Branch expansion should be carried out strictly Branch expansion should be carried out strictly
on commercial principles on commercial principles
Diversification of banking activities Diversification of banking activities
Almost all suggestions of the Narasimham Almost all suggestions of the Narasimham
Committee have been accepted and Committee have been accepted and
implemented in a phased manner since the implemented in a phased manner since the
onset of Reforms onset of Reforms
NPA Management NPA Management
The Narasimham Committee The Narasimham Committee
recommendations were made, among recommendations were made, among
other things, to reduce the Non other things, to reduce the Non--
Performing Assets (NPAs) of banks Performing Assets (NPAs) of banks
To tackle this, the government enacted To tackle this, the government enacted
the Securitization and Reconstruction of the Securitization and Reconstruction of
Financial Assets and Enforcement of Financial Assets and Enforcement of
Security Act (SARFAESI) Act, 2002 Security Act (SARFAESI) Act, 2002
Enabled banks to realise their dues Enabled banks to realise their dues
without intervention of courts without intervention of courts
SARFAESI Act SARFAESI Act
Enables setting up of Asset Management Companies to Enables setting up of Asset Management Companies to
acquire NPAs of any bank or FI (SASF, ARCIL are acquire NPAs of any bank or FI (SASF, ARCIL are
examples) examples)
NPAs are acquired by issuing debentures, bonds or any NPAs are acquired by issuing debentures, bonds or any
other security other security
As a second creditor can serve notice to the defaulting As a second creditor can serve notice to the defaulting
borrower to discharge his/her liabilities in 60 days borrower to discharge his/her liabilities in 60 days
Failing which the company can take possession of Failing which the company can take possession of
assets, takeover the management of assets and appoint assets, takeover the management of assets and appoint
any person to manage the secured assets any person to manage the secured assets
Borrowers have the right to appeal to the Debts Tribunal Borrowers have the right to appeal to the Debts Tribunal
after depositing 50% of the amount claimed by the after depositing 50% of the amount claimed by the
second creditor second creditor
The Indian Capital Market (1) The Indian Capital Market (1)
Market for long Market for long--term capital. Demand term capital. Demand
comes from the industrial, service sector comes from the industrial, service sector
and government and government
Supply comes from individuals, Supply comes from individuals,
corporates, banks, financial institutions, corporates, banks, financial institutions,
etc. etc.
Can be classified into: Can be classified into:
Gilt Gilt--edged market edged market
Industrial securities market (new issues Industrial securities market (new issues
and stock market) and stock market)
The Indian Capital Market (2) The Indian Capital Market (2)
Development Financial Institutions Development Financial Institutions
Industrial Finance Corporation of India (IFCI) Industrial Finance Corporation of India (IFCI)
State Finance Corporations (SFCs) State Finance Corporations (SFCs)
Industrial Development Finance Corporation (IDFC) Industrial Development Finance Corporation (IDFC)
Financial Intermediaries Financial Intermediaries
Merchant Banks Merchant Banks
Mutual Funds Mutual Funds
Leasing Companies Leasing Companies
Venture Capital Companies Venture Capital Companies
Industrial Securities Market Industrial Securities Market
Refers to the market for shares and Refers to the market for shares and
debentures of old and new companies debentures of old and new companies
New Issues Market New Issues Market-- also known as the also known as the
primary market primary market-- refers to raising of new refers to raising of new
capital in the form of shares and capital in the form of shares and
debentures debentures
Stock Market Stock Market-- also known as the also known as the
secondary market. Deals with securities secondary market. Deals with securities
already issued by companies already issued by companies
Financial Intermediaries (1) Financial Intermediaries (1)
Mutual Funds Mutual Funds-- Promote savings and mobilise Promote savings and mobilise
funds which are invested in the stock market funds which are invested in the stock market
and bond market and bond market
Indirect source of finance to companies Indirect source of finance to companies
Pool funds of savers and invest in the stock Pool funds of savers and invest in the stock
market/bond market market/bond market
Their instruments at savers end are called units Their instruments at savers end are called units
Offer many types of schemes: growth fund, Offer many types of schemes: growth fund,
income fund, balanced fund income fund, balanced fund
Regulated by SEBI Regulated by SEBI
Financial Intermediaries (2) Financial Intermediaries (2)
Merchant banking Merchant banking-- manage and underwrite new manage and underwrite new
issues, undertake syndication of credit, advise issues, undertake syndication of credit, advise
corporate clients on fund raising corporate clients on fund raising
Subject to regulation by SEBI and RBI Subject to regulation by SEBI and RBI
SEBI regulates them on issue activity and SEBI regulates them on issue activity and
portfolio management of their business. portfolio management of their business.
RBI supervises those merchant banks which are RBI supervises those merchant banks which are
subsidiaries or affiliates of commercial banks subsidiaries or affiliates of commercial banks
Have to adopt stipulated capital adequacy norms Have to adopt stipulated capital adequacy norms
and abide by a code of conduct and abide by a code of conduct
Conclusion Conclusion
There are other financial intermediaries such as There are other financial intermediaries such as
NBFCs, Venture Capital Funds, Hire and Leasing NBFCs, Venture Capital Funds, Hire and Leasing
Companies, etc. Companies, etc.
Indias financial system is quite huge and caters Indias financial system is quite huge and caters
to every kind of demand for funds to every kind of demand for funds
Banks are at the core of our financial system Banks are at the core of our financial system
and therefore, there is greater expectation from and therefore, there is greater expectation from
them in terms of reaching out to the vast them in terms of reaching out to the vast
populace as well as being competitive. populace as well as being competitive.
hank ou hank ou
K Chockalingam K Chockalingam
TEL : 9322295394 TEL : 9322295394
e.mail: chockalingam_2000@yahoo.com e.mail: chockalingam_2000@yahoo.com
chockalingam@iibf.org.in chockalingam@iibf.org.in