CHAPTER1 : INTRODUCTION OF INDIAN BANK

1.1INTRODUCTION

The robust macroeconomic environment continued to underpin the financial

performance of Indian banks during 2004-05, with major bank groups successfully
weathering the impact of an upturn in interest cycle. The demand for credit was
broad-based during 2004-05 with agriculture and industry joining the housing and
retail sectors to drive up the demand for credit. A sharp increase in net interest
income mitigated to a large extent the impact of a sharp decline in non-interest
income mainly on account of decline in trading profits. Banks continued to earn
sizeable profits albeit somewhat lower than last year. Asset quality of scheduled
commercial banks improved further during 2004-05. Capital base of banks kept pace
with the sharp increase in risk-weighted assets.

1.2ORIGIN AND EVOLUTION OF INDIAN BANKING

Opinions differ as to the origin of the work "Banking". The word "Bank" is said to
be of Germanic origin, cognate with the French word "Banque" and the Italian word
"Banca", both meaning "bench". It is surmised that the word would have drawn its
meaning from the practice of the Jewish money-changers of Lombardy, a district in
North Italy, who in the middle ages used to do their business sitting on a bench in
the market place. Again, the etymological origin of the word gains further relevance
from the derivation of the word "Bankrupt" from the French word "Banque route"
and the Italian word "Bancarotta" meaning "Broken bench" due probably to the then
prevalent practice of breaking the bench of the money-changer, when he failed.
Banking is different from money-lending but two terms have in practice been taken
to convey the same meaning. Banking has two important functions to perform, one
of accepting deposits and other of lending monies and/or investment of funds. It
follows from the above that the rates of interest allowed on deposits and charged on
advances must be known and reasonable. The money-lender advances money out of
his own private wealth, hardly accepts deposits and usually charges high rates of
interest. More often, the rates of interest relate to the needs of the borrower. Money-

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lending was practiced in all countries including India, much earlier than the recent
type of Banking came on scene.

1.3 DEFINITION AS PER BANKING REGULATION ACT 1949

A Bank borrow by accepting deposits of money from the public, the deposits are to
be repaid on demand or after fixed period. They can be withdrawn by the depositors
by means of cheque draft, order or any other way. A Bank accepts deposits (i.e.
borrows) for the purposes of lending mainly to traders, industrialists and
manufacturers and the like as also, for the purposes of investing in government
securities to fulfill statutory obligations. Thus, Banking Regulations Act, 1949
defines “Banking as accepting for the purposes of lending or investment of deposits
of money from the public repayable on demand or otherwise and withdrawable by
cheque, draft,order or otherwise.”

By and large, this definition can be satisfactory. As per the provision of the Banking
Regulation Act, every company willing to do banking business must obtain license
from the Reserve Bank for carrying on banking business in India. Besides, all
companies carrying on banking business must use the word bank, banker or banking
as per of their names. It may be noted that money-lenders are not bankers.

Basic Concepts of Banking :

Banking is different from money lending, but the two terms, usually carry the same
significance to the general public. The money lender, advances money out of his
own private wealth, hardly accepts deposits from general public and usually charges
high rate of interest. More often, the rates of interest relate to the needs of the
borrower and at times the rates may be exorbitant. On the other hand the banking is
defined in section 5(b) of the Banking Regulation Act, 1949, as the acceptance of
deposits of money from the public for the purpose of lending or investment. Such
deposits of money from the public are used for the purpose of lending or investment.
Such deposits may be repayable on demand or otherwise and with drawable by
cheque, draft order or otherwise. Thus a bank must perform two basic and essential
functions:

(i) acceptance of deposits and

(ii) lending or investment of such deposits.

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The deposits may be repayable on demand or a for a period of time as agreed by
the banker and the Customer. In terms of the definition, the banker can accept
deposits of money and Not Anything Further accepting deposits form frolic
unapplied that a banker accepts deposits form anyone who offers money for such
purpose Accepting of deposits for lending and investments have been the
original functions of banking but gradually there functions were extended and
others were added from time to time and presently banks perform a number of
economic activities which may affect all walks ofeconomic life.

1.4SIGNIFICATION OF BANK

The importance of a bank to modern economy, so as to enable them to develop,

can be stated as follow:

(i) The banks collect the savings of those people who can save and allocate them to
those who need it. These savings would have remained idle due to ignorance of the
people and due to the fact that they were in scattered and oddly small quantities. But
banks collect them and divide them in the portions as required by the different
investors.
Banks preserve the financial resources of the country and it is expected of them that
they allocate them appropriately in the suitable and desirable manner.
(ii) They make available the means for sending funds from one place to
another and do this in cheap, safe and convenient manner.
(iii) Banks arrange for payments by changes, order or bearer, crossed and
uncrossed, which is the easiest and most convenient, besides they also
care for making such payments as safe as possible.
(iv) Banks also help their customers, in the task of preserving their precious
possessions intact and safe.
(v) To advance money, the basis of modern industry and economy and
essential for financing the developmental process, is governed by banks.
(vi) It makes the monetary system elastic. Such elasticity is greatly desired in
the present economy, where the phase of economy goes on changing and
with such changes, demand for money is required. It is quite proper and
convenient for the government and R.B.I. to change its currency and
credit policy frequently, This is done by RBI, by changing the supply of

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 money with the changing the supply of money with the changing needs
of the public.
Although traditionally, the main business of banks is acceptance of
deposits and lending, the banks have now spread their wings far and wide
into many allied and even unrelated activities.

The following banks were constituted as subsidiary of SBI:

·State Bank of Bikaner & Jaipur

·State Bank of Indore

·State Bank of Travancore

·State Bank of Hyderabad

·State Bank of Patiala

·State Bank of Saurashtra

·State Bank of Mysore

In 1960, the Palai Central Bank in Kerala failed and that gave suspicion to the
depositors. As such Deposit Insurance of Credit Guarantee Corporation
(DIGGC) was established to guarantee repayment of deposits up to Rs. 10,000 to
each depositor in case of failure of banks. On 19th July, 1969, 14 Joint Stock
banks were nationalized which were having minimum depositors of Rs.50 crores
and above. This brought into its fold 50% of banks' operations Again in April,
1980, 6 more banks were brought under area of nationalised banks, to total
business of 95% in its fold. These 6 banks were giving tough competition to
nationalized bankers and were indulged into irregularities causing concern to
depositors.

Business Position of scheduled banks as on 29/4/05

Deposits Rs. 17,81,580 Crore

Credits Rs. 11,27,433 Crore

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 Rate 6% (even in Oct 2005)

Prime Lending Rate (PLR) in between 10.5% -11.50%

CRR 4.50%

SLR 25%

Presently, as a part of deregulation many new generation private sector banks

have been permitted viz. ICICI 1 (IDBI) HDFC and the nationalized banks are
being privatized to the extent of 49%.

CHAPTER 2 : COMMERCIAL BANK

2.1.INTRODUCTION ON COMMERCIAL BANK

Commercial banks are the oldest, biggest, and fastest growing intermediaries in India. They are
also the most important depositories of public saving and the most important disburses of
finance. Commercial banking in India is a unique systems, the like of which exist nowhere in the
world. The truth of this statement becomes clear as one studies the philosophy and approaches
that have contributed to the evolution of the banking policy, programmes and operation in India.

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The banking systems in India work under the constraints that go with social control and public
ownership. The public ownership of banks has been achieved in three stages:1955,July1969, and
April 1980. Not only the private sector and foreign banks are required to meet targets in respect
of sectoral development of credit, regional distribution of branches, and regional credit- deposits
ratios. The operations of banks have been determined by Lead Bank Scheme, Differential Rate
of Interest Scheme, Credit Authorization Scheme, inventory norms and lending systems
prescribed by the authorities, the formulation of the credit plans, and Service Area Approach.

Balancing Profitability with Liquidity Management

Commercial banks ordinarily are simple business or commercial concerns which provide various
types of financial services to 'customers in return for payments in one form or another, such as
interest, discounts, fees, commission, and so on. Their objective is to make profits. However;
what distinguishes them from other business concerns (financial as well as manufacturing) is the
degree to which they have to balance the principle of profit maximization with certain other
principles.

In India especially, banks are required to mod their performance in profit-making if that clashes
with their obligations in such areas as 'social welfare, social justice, and promotion of regional
balance in development. In any case, compared to other business concerns, banks in general
have to pay much more attention to balancing profitability with liquidity/It is true that all
business concerns face liquidity constraint in various areas of their decision-making and,
therefore, they have to devote considerable attention to liquidity management. But with banks,
the need for maintenance of liquidity is much greater because of the nature of their liabilities.
Banks deal in other people's money, a substantial part of which is repayable on demand. That is
why for banks, unlike other business concerns, liquidity management is as important as
profitability management.
This is reflected in the management and control of reserves of commercial banks.

2.2.MANAGEMENT OF RESERVES

The banks are expected to hold voluntarily a part of their deposits in the form of ready cash
which is known as cash reserves; and the ratio of cash reserves to deposits is known as the
(cash) reserve ratio. As banks are likely to be tempted not to hold adequate amounts of reserves
if they are left to guide themselves on this point, and since the temptation may have extremely
destabilising effect on the economy in general, the Central Bank in every country is empowered
to prescribe the reserve ratio that all banks must maintain. The Central Bank also undertakes, as
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the lender of last resort, to supply reserves to banks in times of genuine difficulties. It should be
clear that the function of the legal reserve requirements is two-fold:

(a) To make deposits safe and liquid, and

(b) To enable the Central Bank to control the amount of checking deposits orbank money which
the banks can create.

Since the banks are required to maintain a fraction of their deposit liabilities as reserves, the
modern banking system is also known as the fractional reserve banking.

2.3.CREATION OF CREDIT

Another distinguishing feature of banks is that while they can create as well as transfer money
(funds), other financial institutions can only transfer funds. In other words, unlike other financial
institutions, banks are not merely financial intermediaries. This aspect of bank operations has
been variously expressed. Banks are said to create deposits or credit or money, or it can be said
that every loan given by banks creates a deposit. This has given rise to the important concept of
deposit multiplier or credit multiplier or money multiplier.

The import of this is that banks add to the money supply in the economy, and since money
supply is an important determinant of prices, nominal national income, and other macro-
economic variables, banks become responsible in a major way for changes in economic activity.
Further, as indicated in Chapter One, since banks can create credit, they can encourage
investment for some time without prior increase in saving.

2.4.BASIS AND PROCESS OF CREDIT CREATION

Creation of money by banks. In modern economies, almost all exchanges are affected by money.
Money is said to be a medium of exchange, a store of value, a unit of account. There is much
controversy as to what, in practice in a given year, is the measure of supply of money in any
economy. We do not need to go into that controversy here. Suffice it to say that everyone agrees
that currency and demand deposits with banks are definitely to be included in any measure of
money supply. Thus, apart from the currency issued by the government and the Central Bank,
the demand or current or checkable deposits with banks are accepted by the public as money.
Therefore, since the loan operations of banks lead to the creation of checkable deposits, they add
to the supply of money in the economy. To recapitulate, the money-creating power of banks
stems from the fact that modern banking is fractional reserve banking, and that certain liabilities
of banks are accepted (used) by the public as money.
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Credit Ratio

Non-food credit grew at a high rate during 2004-05.Normally, the rate of credit is higher than
the rate of growth of deposits due to the base effect- the outstanding deposits is much higher
than the outstanding credit. For instance, while the outstanding deposits at end-March 2005 were
Rs,18,19,900 crore, the outstanding credit was Rs, 11,04,913 crore. Also, in any given year, the
accretion to credit has generally remained lower than the accretion to deposits. During 2004-05,
however, incremental credit and deposits were more or less of the same magnitude, while
incremental investments in relation to deposits during the year were much lower than in the
previous year. This resulted in some unusual behaviour of the credit-deposit (C-D) ratio and
investment-deposit (I-D) ratio. Among bank-groups, the new private sector banks had the
highest C-D ratio, followed by foreign banks, old private sector and public sector banks
Bank Credit

Volume of Credit Commercial banks are a major source of finance to industry and commerce.
Outstanding bank credit has gone on increasing from Rs 727 crore in 1951 to Rs 19,124 crore in
1978, to Rs 69,713 crore in 1986, Rs 1,01,453 crore in 1989-90, Rs 2,82,702 crore in 1997, and
to Rs 6,09,053 crore in 2002. Banks have introduced many innovative schemes for the
disbursement of credit. Among such schemes are village adoption, agricultural development
branches and equity fund for small units. Recently, most of the banks have introduced attractive
educational loan schemes for pursuing studies at home or abroad. They have moved in the
direction of bridging certain defects or gaps in their policies, such as giving too much credit to
large scale industrial units and commerce, and giving too little credit to agriculture, small
industries, and so on.

Types of Credit Banks in India provide mainly short-term credit for financing working capital
needs although, as will be seen subsequently, their term loans have increased over the years. The
various types of advances provided by them are:

(a) loans, (b) cash credit, (c) overdrafts (0D), (d) demand loans, (e) purchase and
discounting of commercial bills, and (h) installment or hire-purchase credit.

Cash Credit and Overdraft

Cash credits and overdrafts are said to be running accounts, from which the borrower can
withdraw funds as and when needed up to the credit limit sanctioned by his banker. Usually,
while cash credit is given against the security of commodity stocks, overdrafts are allowed on
personal or joint current accounts. Interest is charged on the outstanding amount borrowed and
8
not on the credit limit sanctioned. In order to curb the misuse of this facility, banks used to levy
a commitment charge on unutilised portion of the credit limit sanctioned. However, this practice
has now been discontinued. Although these advances are mostly secured and of a self-
liquidating character, banks are known to provide them on 'clean basis' in certain cases.
Technically, these advances are repayable on demand, and are of a short-term nature. Actually,
the widespread prevalent practice is to roll over these advances from time to time.
As a result, cash credits actually become long-term advances in many cases. Although,
technically these advances are highly liquid, it has been pointed out that it is a myth to regard
them so because even the most profitable borrower would hardly be in a position to repay them
on demand.

2.5.Purchasing and Discounting of Bills

Purchasing and discounting of bills-internal and foreign-is another method of advancing credit
by banks. It is adopted mainly to finance trade transactions and movement of goods. Bill finance
is either repayable on demand or after a period not exceeding 90 days. It has been observed that
bills traded in India are often fake bills created out of book debts of industrial and business units.
Bill financing has certain favorable features. Banks can raise funds in the secondary markets by
rediscounting bills with the RBI and financial institutions like IDBI and Discount and Finance
House of India (DFHI).

They can also earn some money if the rediscount rate is lower than the discount rate. Further, the
buying and selling of bills expand the banks' business more quickly by the faster recycling of
funds.

Among these different systems of bank credit, cash credit/overdraft system remains the most
important one. The shift away from it has been slow. Of the total bank credits, the outstanding
cash credit and overdrafts accounted for about 66 per cent in 1935, 69 per cent in 1949, 57 per
cent in 1973, 52 per cent in 1976, 45 per cent in 1986 and 48 per cent in 1994, and 36 per cent in
2002.

2.6.SPECIAL ROLE OF BANKS

As said earlier, commercial banks have a special role in India. In fact, many financial experts
even abroad have, of late, been emphasising the special place that banks hold in their countries
also. The "privileged role" of the banks is the result of their unique features. For example, the
liabilities of banks are money, and, therefore, they are an important part of the payments

9
mechanism of any country; they also have access to the discount window of the RBI, call money
market (as both borrowers and lenders), and the deposit insurance. It would be difficult to
eliminate such distinctive features of banks in the near future. There is also an important
question as to whether they should be wiped out, and, if it is done, whether it would not have
adverse consequences on the financial system.

For a financial system to mobilise and allocate savings of the country successfully and
productively, and to facilitate day-to-day transactions, there must be a class of financial
institutions that the public views as safe and convenient outlets for its savings. In virtually all
countries, the single dominant class of institutions that has emerged to play this crucial role as
both the repository of a large fraction of the society's liquid savings and the entity through which
payments are made is the commercial banks. The structure and working of the banking system
are integral to a country's financial stability and economic growth.

Bank lending is especially important for companies. The theory of financial contracting under
asymmetric information holds that information-intensive and information-problematic firms
submit to the tight and detailed loan covenants so as to reduce agency costs. They delegate the
tasks of monitoring and renegotiating debt contracts to financial intermediaries because these
tasks are costly and the intermediaries are in a better position to reduce the costs. Intermediaries
are more efficient in monitoring debt contracts because they are unlikely to free-ride on
information-production by others as they have a larger stake, and they can renegotiate contracts
more cheaply than the dispersed debenture holders. The public bond covenants tend to set their
conditions on events that are relatively easy to verify, viz., a major change in capital structure or
a downgrading of credit rating. In contrast, the intermediary loan contracts are conditioned by
performance measures such as working capital and net worth which are less easily controlled by
the managers.

The Indian banking system has a very wide reach and deep presence in metropolises, cities,
semi-urban areas, and the remotest corners of the rural areas with its vast number of branches. It
is one of the largest banking systems in the world. It has been rightly claimed in certain circles
that the diversification and development of the Indian economy are in no small measure due to
the active role banks have played in financing economic activities of different sectors,They have
been playing an important role in developing mutual funds, merchant banks, Primary Dealers,
asset management companies, and debt markets. They operate as issuers, investors,
underwriters, guarantors in financial-markets. By their participation, banks influence the growth
and liquidity of debt markets.

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They would help in securitization of debt market. They hold about 60 per cent of debt stock of
government securities, and they account for more than 50 per cent of the issuance of bonds
through public issues and private placements.

Because of such considerations, the important position which banks have historically come to
occupy in India should not be unwittingly destroyed or undermine in the name of promoting
equity culture. Otherwise, monetary authorities would find it more and more difficult to achieve
the goal of stability of the financial system and of the prices. The banking reforms, therefore,
must aim not only at profitable banking but also at a viable, sound, safe, and social banking.

2.7.AGGREGATE DEPOSITS OF SCHEDULED COMMERCIAL BANKS

Aggregate deposits of SCBs increased at a lower rate during 2004-05 as compared with the
previous year during 2004-05 on account of slowdown in demand deposits and savings deposits.
Decline in demand deposits was due mainly to the base effect as demand deposits had witnessed
an unusually high growth last year. Reversing the trend of the previous year, bank credit
registered a robust growth during the year. Although banks investment in government securities
during the year 2004-05 slowed down significantly, the banking sector at end March 2005 held
about 38.4% of its net demand and time liabilities in SLR securities, much in excess of the
statutory minimum requirement of 25%. The non SLR investments of SCBs continued to decline
during 2004-05, reflecting the portfolio adjustments by banks subsequent to guidelines on non-
SLR securities issued by the Reserve Bank in November and December 2003

OWNERSHIP AND GOVERNANCE OF BANKS

Banks are special for several reasons. They accept and deploy large amount of collateralized
public funds and leverage such funds through credit creation. Banks also administer the payment
mechanism. Accordingly, ownership and governance of banks assume special significance.
Legal prescription relating to ownership and governance laid down in the Banking Regulation
Act, 1949 have, therefore, been supplemented by regulatory prescriptions issued by the Reserve
Bank from time to time.
The existing legal framework and significant current practices cover the following aspects:

i) composition of Boards of Directors:

ii) guidelines for acknowledgement of transfer/allotment of shares in private sector banks
issued as on February 3, 2004:
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iii) guidelines and corporate governance
iv) Foreign Investment in the banking sector, which is governed by he Press Note of March
5, 2004 issued by the Ministry of Commerce and Industry, Government of India.

The Reserve Bank in consultation with government of India, laid down a comprehensive policy
frame work on February 28, 2005.

The broad principles underlying the framework ensure that

i) ultimate ownership and control is well diversified

ii) important shareholders are ‘fit and proper’
iii) Directors and CEO are ‘fit and proper’ and observe sound corporate governance
principles.
iv) Private sector banks maintain minimum capital (initially Rs 200 crore, with a
commitment to increase to Rs 300 crore within three years)/net worth (Rs. 300 crore
at all times) for optimal operations and for systematic stability:

2.8IMPLEMENTATION OF THE NEW CAPITAL ADEQUACY FRAMEWORK

(BASEL II NORMS)

Given the financial innovations and growing complexity of financial transactions, the Basel
Committee on Banking Supervision released the New Capital Adequacy Framework on June
26, 2004 which is based on three pillars of minimum capital requirements, supervisory
review and market discipline. The revised framework has been designed to provide options
to banks and banking systems, for determining the capital requirements for credit risk,
market risk and operational risk and enables banks/supervisors to select approaches that are
most appropriate for their operations and financial markets. The revised framework is
expected to promote adoption of stronger risk management practices in banks. Under Basel
II, banks’ capital requirements will be more closely aligned with the underlying risks in
banks’ balance sheets. One of the important features of the revised framework is the
emphasis on operational risk.

NPA Management by Banks

The Reserve Bank and the Central Government have initiated several institutional measures
to contain the levels of NPAs. These include Debt Recovery Tribunals (DRTs), LokAdalats
(people's courts), Asset Reconstruction Companies (ARCs) and Corporate Debt
Restructuring (CDR) mechanism. Settlement Advisory Committees have also been formed at

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 regional and head office levels of commercial banks. Furthermore, banks can also issue
notices under the Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002 for enforcement of security interest without
intervention of courts. Thus, banks have a menu of options to resolve their NPA problem.
With a view to providing an additional option and developing a healthy secondary market
for NPAs, guidelines on sale/purchase of nonperforming assets were issued in July 2005
where securitization companies and reconstruction companies are not involved.

The guidelines include several specific provisions:

i) A nonperforming asset in the books of a bank shall be eligible for sale to other banks
only if it has remained a non-performing asset for at least two years in the books of the
selling bank and such selling should be only on a cash basis;
ii) A nonperforming financial asset should be held by the purchasing bank in its books at
least for a period of 15 months before it is sold to other banks;
iii) A bank may purchase/sell non-performing financial assets from/to other banks only on a
'without recourse' basis;
iv) Banks should ensure that subsequent to sale of the non-performing financial assets to
other banks, they do not have any involvement with reference to assets sold and do not
assume operational, legal or any other type of risks relating to the financial assets sold;
v) A non-assume operational, legal or any other type of risks relating to the financial assets
sold; performing financial asset may be classified as 'standard' in the books of the
purchasing bank for a period of 90 days from the date of purchase. Thereafter. the asset
classification status of the account shall be determined by the record of recovery in the
books of the purchasing bank with reference to cash flows estimated while purchasing
the asset. The asset shall attract provisioning requirement appropriate to its assets
classification status in the books of the purchasing bank;
vi) Any recovery in respect of a non- performing asset purchased from other banks should
first be adjusted against its acquisition cost. Recoveries in excess of the acquisition cost
can be recognized as profit;
vii) The asset classification status of an existing exposure to the same obligor in the books
of the purchasing bank will continue to be governed by the record of recovery of that
exposure and hence may be different;
viii) For the purpose of capital adequacy, banks should assign 100 per cent Risk weights to
the non-performing financial assets purchased from other banks;

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ix) In the case the non- performing asset purchased is an investment, then it would attract
capital charge for market risk also; and
x) The purchasing bank should ensure compliance with the prudential credit exposure
ceilings (both single and group) after reckoning the exposures to the obligors arising on
account of the purchase.

DEBT RECOVERY TRIBUNALS

Debt Recovery Tribunals (DRTs) were set up under the Recovery of Debts Due to Bank and
financial Institutions Act, 1993 for expeditious adjudication and recovery of debts due to banks
and financial institutions. On the recommendation of the Reserve Bank, the Government of
India set up a Working Group in July 2004 to improve the functioning of DRTs. The Working
Group is expected to examine issues and recommend appropriate measures regarding:

(a) The need to extend the provisions of the Recovery of Debts Due to
Banks and Financial Institutions Act to cases for less than Rs.10 lakh;

(b) Redistribution of jurisdiction of the various DRTs;

(c) Modification in the existing strength of the DRTs/Debt RecoveryAppellate Tribunals

(DRATs); and

(d) Legal and institutional provisions.

Progress in Implementation of Risk Based Supervision

Several initiatives have been taken for a gradual roll out of the risk based supervision (RBS)
process since the announcement made in the Monetary and Credit Policy of April 2000. There
were two rounds of pilot run of RBS covering 23 banks in public sector, private sector (old and
new) and foreign banks categories during 2003-2005. Evaluation of the findings of first pilot
run revealed that the bank level preparedness for RBS/Risk Based Internal Audit (RBIA)
process was very slow. There were certain overlaps under both the business and control risks.
Several steps were, therefore, taken to streamline the RBS process.

¨ First, pending amendment to risk profile templates, changes were made in the structure of
inspection report to capture and report business risk and control risk in one place.
¨ Second, a work book together with a sample of on-site inspection report was designed to help
the inspecting officers to undertake the RBS.
¨ Third, natural resource group with officers from different departments of the Reserve Bank

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and the Executive Director Chairperson is in existence to analyze risk models employed by
banks in India.

¨ Fourth internal group was formed to revisit the Profile Templates (RPTs).The revised RPTs,
methodology for risk assessment and also guidelines for arriving at the supervisory rating of the
bank were discussed in Conference of Regional Offices of the Reserve Bank held on July 22
and 23, 2005.

Monitoring of Frauds

With a view to reducing the incidence of frauds, the Reserve Bank advised banks in October
2002 to look into the existing mechanism for vigilance management in their institutions and
remove the loopholes, if any, with regard to fixing of staff accountability and completion of
staff side action in all fraud cases within the prescribed time limit, which would act as a
deterrent. Banks were also urged to bring to the notice of the Special Committee of the Board
constituted to monitor large value frauds and the actions initiated in this regard.

A Technical Paper on Bank Frauds covering various aspects such as nature of frauds, present
arrangement for follow-up of frauds, international legal framework relating to frauds, possible
further measures with regard to legal and organizational perspectives was prepared and placed
in the BFS meeting held on April 8, 2004.
The Technical Paper recommended the constitution of a separate Cell to monitor frauds not
only in commercial banks but also in financial institutions, Local Area Banks, urban co-
operative banks and non-banking finance companies. As the proposal was accepted by the BFS,
a separate Fraud Monitoring Cell (FrMC) was constituted on June I, 2004 under the overall
administrative control of the Department of Banking Supervision. The FrMC is expected to
adopt an integrated approach and pay focused attention on the frauds reported by financial
entities mentioned above.

A Master Circular dated October 18, 2002 on "Frauds - Classification and Reporting" was
revised on August 7, 2004 and was placed on Reserve Bank's website. The formats in the
Master Circular have been revised according to requirements of Fraud Reporting and
Monitoring System (FRMS) package.

With a view to having integrated approach and ensure uniformity in reporting requirements for
all the institutions under the ambit of Fraud Monitoring Cell, the Master Circular was made
applicable to FIs local area banks (LABs) as well.

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Modification in Format of Declaration Indebtedness from Statutory Auditors

Statutory auditors of banks were required to provide a declaration to banks in which are
undertaking audit to the effect that no Credit facility (including guaranteeing any facilities
availed of by third party) was availed of by the proprietor/any of the partners of the audit firm/
members of his/their families or by the firm/ company in which he/they are partners/ or
Director/s from any other bank/financial institution.

Banks were also advised that while appointing their statutory central/branch auditors, they
should obtain a declaration from concerned audit firms duly signed by their main
partner/proprietor to the effect that credit facilities, if any, availed of from other banks/FIs by
them/their partners/members of family/company in which they are partners/ Directors or the
credit facilities from such institutions guaranteed by them on behalf of third parties had not
turned non-performing in terms of the prudential norms of the Reserve Bank.

The format of declaration of indebtedness to be obtained from the partners/proprietors of audit

firms to be appointed as statutory auditors of banks was modified in January 2005 to include
that neither the proprietor/main partner nor of the partners/members of their families or the
firm/company in which they are partners/directors has been declared as a willful defaulter by
any bank/financial institution.

Payment and Settlement Systems

The payment and settlement systems are at the core of financial system infrastructure in a
country. A well-functioning payment and settlement system is crucial for the successful
implementation of monetary policy and maintaining the financial stability. Central banks have
therefore, always maintained a keen interest in the development of a payment and settlement
system as part of their responsibilities for monetary and financial stability .In India, the
development of a safe, secure and sound payment and settlement system has been the key
policy objective. In this direction, the Reserve Bank, apart from performing the regulatory and
supervisory functions, has also been making efforts to promote functionality and modernization
of the payment and settlement systems on an on-going basis, In order to provide focused
attention to the payment and settlement systems, the Reserve Bank constituted the Board for
regulation and supervision of Payment and Settlement Systems (BPSS) as a Committee of its
Central Board.

Functions and powers of the BPSS include formulating policies relating to the regulation and
supervision of all types of payment and settlement systems, setting standards for existing and
16
future systems, authorising the payment and settlement systems and determining criteria for
membership. The National Payments Council, which was set up in 1999, has been designated
as a Technical Advisory Committee of the BPSS. To assist the BPSS in performing its
functions, a new department, the Department of Payments and Settlement Systems (DPSS), was
set up in Reserve Bank in March 2005.

The BPSS has met three times since constitution in March 2005.

The Board at its meetings, inter alia, has emphasized that

(i) Payment system services in India should taken to a level comparable with the best in
world;
(ii) Appropriate legal infrastructure may be created as early as possible;
(iii) A plan drawn up to "leapfrog" from cash to electronic modes of payment, Wherever
possible; cheque clearing system would have to be made more efficient through cheque
truncation system; and
(iv) Usage of the Real Time Gross Settlements (RTGS) System be increased both in terms
of opening additional branch outlets and more number of transactions being put
through.

For modernising the payment and settlement systems in India, a three-pronged approach has
been adopted with due emphasis on consolidation, development and integration. The
consolidation of the existing payment systems involves the strengthening of computerized
cheque clearing and expanding the reach of Electro Clearing Services (ECS) and Electronic
Fund Transfer (EFT).

Legal Reforms in the Banking Sector

An efficient financial system requires a regulatory framework with well-defined objectives,

adequate and clear legal framework and transparent supervisory procedure. This, in turn,
requires comprehensive legislations to enable the regulatory authorities to discharge their
responsibilities effectively. The Reserve Bank has, therefore, been making constant efforts to
upgrade and strengthen the legal framework in tune with the changing environment.

The Enforcement of Security Interest, Recovery Debts Laws (Amendment) Act, 2004 (Act
NO.30 of 2004) has amended Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest 2002 (SARFAESI), the Recovery of Debts to Banks and

17
Financial Institutions Act, 1993 and the Companies Act, 1956. By this amendment Act, the
SARFAESI Act has been amended, inter alia, to:

(i) Enable the borrower to make application before the Debt Recovery Tribunal against the
measures taken by the creditor without depositing any portion of money due;
(ii) Provide that the Debt Recovery Tribunal shall dispose of the application as
expeditiously as possible within a period 60days from the date of application; and
(iii) Enable any person aggrieved by any order made by Debt Recovery Tribunal to file an
appeal before the Debt Recovery Appellate Tribunal after depositing with the Appellate
Tribunal fifty percent of the amount of debt due from him as claimed by the secured
creditor or as determined by the Debt Recovery Tribunal, whichever is less.

The Credit Information Companies (Regulation) Act, 2005 is aimed at providing for regulation
of credit information companies and to facilitate efficient distribution of credit. The Act will
come into force after it is notified by Government in the official Gazette. After the Act comes
into force, no company can commence or carry on the business of credit information without
obtaining a certificate of registration from the Reserve Bank.

The Act also lays down the functions of credit information companies, powers and duties of
auditors, obtaining of membership by credit institutions in credit information companies,
information privacy principles, alterations of credit information files and credit reports,
regulation of unauthorized access to credit information, offences and penalties, obligations as to
fidelity and secrecy. Other salient features of the Act include settlement of disputes between
credit institutions and credit information companies or between credit institutions and their
borrowers. The Act also provides for amendment of certain enactments so as to permit
disclosure of credit information.

18
 CHAPTER 3 :LIABILITIES OF BANKS

Deposits

Commercial banks deal in other people's money which they receive as deposits of various types.
These deposits serve as a means of payment and as a medium of saving, and are a very
important variable in the national economy. Deposits constitute the major source of funds for
banks, and in 1996 they were about 92 per cent of total liabilities of all scheduled commercial
banks.

Types of Deposit Indian banks accept two main types of deposits-demand deposits and term
deposits.

3.1Demand Deposits: Demand deposits can be sub-divided into two categories-current and
savings.

3.2Current Deposits: Current deposits are chequable accounts and there are no restrictions on
the amount or the number of withdrawals from these accounts. It is possible to obtain a clean or
secured overdraft on current account. Banks also extend to the account-holders certain useful
services such as free collection of out-station cheques and issue of demand drafts. At present
banks generally do not pay interest on current deposits. All current deposits are included in order
to estimate the volume of money supply in a given period of time.

Savings deposits earn interest; the rate of this interest was 5 per cent in 1990 and is 4.5 per cent
at present. Certain categories of banks are however allowed to pay interest (both on saving and
fixed deposits) at rates higher than the general level fixed for them. For example, with effect
from July 1, 1977, banks with demand and time liabilities of less than Rs 25 crore were allowed
to pay interest rate higher by 0.25 to 0.50 per cent per annum on savings deposits and term
deposits up to and inclusive of five years. Although cheques can be drawn on savings accounts,
the number of withdrawals and the maximum amount that might, at any time, be withdrawn
from an account without previous notice are restricted. The practice with regard to the division
of savings deposits into demand and time liabilities has undergone a change.

Earlier, in respect of each account, the maximum amount withdrawable without prior notice (or
where the balance in the account was not more than this maximum, the whole of the balance)
was regarded as a demand liability; and the excess over the maximum amount was treated as a
time liability.
19
With effect from August 16, the average of the monthly minimum balances in a savings account
on which interest is being credited is to be regarded as a time liability and the excess over the
said amount, as a demand liability. In other words, before August 1978, demand deposits
included that portion of savings deposits which was freely withdrawable, whereas after the new
regulation, what is included is the portion of savings deposits that is freely drawn upon by the
depositors, while the portion which remains with the banks earning interest is taken as time
deposits. The new rule has resulted in an increase in time deposits, and a decrease in demand
deposits and money supply.

3.3Call Deposit: a Call deposit is the third sub-category of demand deposits. They are accepted
from fellow bankers and are repayable on demand. These deposits carry an interest charge. They
form a negligible part of total bank liabilities.
Term Deposits Time deposits are also known as fixed deposits or term deposits and they are a
genuine saving medium. They have different maturity periods on which depends the rate of
interest.

CHAPTER 4 :BANKING ASSETS

20
Investments

Banks have four categories of assets:

¨ Cash in hand and balances with the RBI,

¨ Assets with the banking system,

¨ Investments in government and other approved securities, and

¨ Bank credit.

Among these assets, investment in cash and government securities serves the liquidity
requirements of banks and is influenced by the RBI policy. Quantitatively, bank credit and
investment in government securities are banks' most important assets. Commercial banks in
India invest a negligible part of their resources in shares and debentures of joint stock
companies. In fact, for a long time they were discouraged from undertaking such investments.
However, since 2/3 years, the policy in this regard has been liberalised and at present banks are
allowed to invest five per cent of their incremental deposits in corporate shares and convertible
debentures.

Commercial banks' investments are of three types:

(a) Government of India securities;

(b) Other approved securities, and

(c) Non- approved securities.

While the first two types are known as SLR securities, the third one is known as non-SLR
securities.

4.1Investment in SLR Securities

At present, the banks are statutorily required to invest 25 per cent of their demand and time
liabilities in the first two types of securities. The investments in the first type of securities is the
major part of banks' investments. The government securities accounted for 95.59 per cent of
their total investment portfolio in 2002-03. Their investments in the second type are marginal,
while those in the third type are emerging as substantial investments.

The commercial banks' investments in Central government securities were 28.1 per cent and 31.

21
6per cent of their total assets in 2001-02 and 2002-03, respectively.The other approved securities
accounted for hardly one-or two per cent of the assets of commercial banks in the years just
mentioned.

The phenomenon of investments in government securities far in excess of statutory requirements

has been due to

(a) high fiscal deficit effect,

(b) capital adequacy norms effect,

(c) foreign exchange sterilization effect, and

(d) slack credit demand effect.

All these effects are easy to understand. The fiscal deficit has been largely financed through
public borrowings, and the banks have been the major subscribers to the government borrowing
programmers. Similarly, due to unprecedented and heavy increase in foreign exchange accruals,
the RBI has been carrying out an intensive sterilizationProgrammers’ which has resulted in a
significant increase in the supply of government securities, which the banks have been
purchasing. Further, all scheduled banks are required to maintain minimum capital to total risk
weighted assets ratio which was nine per cent in 2002-03. Given the very-low-risk (risk less)
nature of the government securities, banks have preferred to buy and hold substantial amount of
government securities for this purpose also. Finally, due to industrial recession in the recent past,
the industrial sector's credit off take has been slack, and banks, therefore, have invested their
surplus liquidity in government securities.

4.2Investment in Non-SLR Securities

After 1985, there has been a liberalization of investment norms for banks which hasenabled
them to be active players in financial markets. The ambit of eligible investments has been
enlarged to cover Commercial Paper (CP)" units of mutual funds, shares and debentures of
PSUs, and shares and debentures of private corporate sector, which are all known as non-SLR
investments. Similarly, the limit on investments in the capital market has been gradually
increased. Now, banks can invest in equities to the extent of five per cent of their outstanding
(and not incremental as earlier) advances. Effective May 2001, the total exposure of a bank to
stock markets with sub-ceilings for total advances to all stock brokers and merchant bankers has
been limited to five per cent of the total advances (including CPs) as on March 31 of the
previous year.
22
The aggregate balance sheet of SCBs expanded at a higher rate of 19.3% excluding the impact
of conversion of a non-banking entity into a banking entity since October 1, 2004) during 2004-
2005 as compared with 16.2 percent in 2003-04. The ratio of assets of SCBs to GDP at factor
cost at current prices increased significantly to 80% from 78.3% in 2003-04 reflecting further
deepening of leverage enjoyed by the banking sector. The degree of leverage enjoyed by the
banking system as reflected in the equity multiplier declined to 15.8-16.9 in the previous year.

The behavior of major balance sheet indicators show that a divergent during 2004-05. On the
back of robust economic growth and industrial recovery, loans and advances witnessed strong
growth, while investment in rising interest rate scenario, slowed down significantly. Deposits
showed a lackluster performance in the wake of increased competition from other saving
instruments. Borrowings and net-owned funds however, increased sharply underscoring the
growing importance of non-deposits resources of SCBs.

Bank group-wise, assets of new private sector banks grew at the highest rate.(19.4%),followed
by public sector banks(15.1%eacluding the conversion impact),foreign banks (13.6%) and old
private sector banks (10.6%).PSBs continued to accounts for the major share in he total assets,
deposits, advances and investments of SCBs at end-March 2005, followed distantly by new
private sector banks. The share of foreign banks in total assets and advances was higher than that
of old private sector ban

CHAPTER 5 : DEPOSIT

INTRODUCTION

Deposits of SCBs grew at a lower rate 15.4 per cent (excluding the conversion impact) during
2004-05 as compared with 16.4 per cent in the previous year on account of slowdown in demand
deposits and savings deposits. Deceleration in demand deposits was due mainly to the base

23
effect as demand deposits had witnessed an usually high growth last year. The growth in
demand deposit, however was in line with the long-term average. Savings deposits, which
reflect the strength of the retail liability franchise and are at the core of the banks’ customer
acquisition efforts grew at a healthy rate, though the growth was somewhat lower than the high
growth of last year. The higher growth of term deposits was mainly o account of NRI deposits
and certificate of deposits (CDs).Excluding these deposits, the growth rate of term deposits
showed a declaration, which was on account of a possible substitution in favor of postal deposits
and other investments products, which continued to grow at a high rate benefiting from tax
incentives and their attractive rate of return in comparison with time deposits.

Factors Affecting Composition of Bank Deposits

The following factors appear to be relevant:

(a) Increase in national income.

(b) Expansion of banking facilities in new areas and for new classes of people.

(c) Increase of banking habit.

(d) Increase in the relative rates of return on deposits.

(e) Increase in deficit financing.

(f) Increase in bank credit.

(g) Inflow of deposits from Non-Resident Indians (NRIs).

(h) Growth of substitutes.

5.1DEPOSIT INSURANCE

Bank deposits are insured up to a specified amount by the Deposit Insurance and Credit
Guarantee Corporation (DICGC). Deposit Insurance Corporation (DIC) was set up in January
1962, and it became a part of DICGC subsequently: The insured amount has been increased in
successive stages from Rs 1,500 in 1962, to Rs 5,000 in January 1968, Rs 10,000 in April 1970,
Rs 20,000 in July 1976, Rs 30,000 in June 1980, and Rs 100000 in May 1993. It is necessary to
raise this amount further now. The fully protected accounts as a proportion of the total number
of accounts have increased from 78 per cent in 1962 to 99 per cent in 1995-96. The proportion
of insured deposits to total assessable deposits (i.e., the entire amount of deposits including those
24
which are not provided insurance cover) has also gone up from 24 per cent in 1962 to 75 per
cent in 1995-96.

Deposit Insurance Scheme covers commercial banks, co-operative banks, and the RRBs. As at
the end of March 1996, it covered 2,122 banks comprising 102 commercial banks, 196 RRBs
and 1,824 cooperative banks.

Maturity profile of Assets and Liabilities of Banks

The maturity structure of commercial banks’ assets and liabilities reflects various concerns of
banks pertaining to business expansion, liquidity management, cost of funds, return on assets,
assets quality and also risk appetite during an industrial upturn. In general, major components of
balance sheet, including deposits, borrowings, loans and advances and investments, for all bank
groups encompassed a non-linear portfolio structure across the spectrum of maturity during
2004-05. Furthermore, for all banks groups, the maturity structure of loans and advances
depicted a synchronous behaviour with that of deposits. The maturity structure of deposits and
that of investments differed across bank groups.

PSBs and old private banks held a larger share of their investment in higher maturity bucket,
particularly more than five year maturity bucket, while private sector and foreign banks held
more than 50% of their investments in up to one year maturity bucket. The residual maturity
classification of consolidated international claims reveals that banks continued to prefer to invest
in/lender for short-term purposes, particularly ‘up to 6 months’ period whose share in total
claims increased by3.4% points to 73.6% during 2004-05.

5.2MONETARY CONDITION

Monetary condition remained comfortable during 2005-06, despite a sustained pick-up in credit
demand from the commercial sector. Banks were able to finance the higher demand for
commercial credit by curtailing their incremental investments in Government securities. Strong
growth in deposits on the current fiscal year and higher investment by non-bank sources in
government securities also enabled banks to meet credit demand. The year on year growth in M
at 16.6% up to September 30, 2005 was higher than the indicative trajectory of 14.5% indicated
in the Annual Policy Statement for 2005-06.

Banks’ Operations in the Capital Market

25
In an increasing market oriented environment, banks need to continuously raise capital to sustain
the growth in their operations. Several banks therefore, accessed the capital market during 2004-
05 to strengthen their capital base.

BANK GROUP WISE DISTRIBUTION OF BRANCHES OF SCHEDULED COMMERCIAL

BANKS (As at end-June 2005)

5.3CAPITAL BASED

The capital base of commercial banks has become a subject of great attention in the whole world
in the recent past. In India, it had become progressively very weak; the ratio of paid-up capital
and reserves to deposits of Indian banks had declined from 6.7 per cent in 1956 to 4.1 per cent in
1961, 2.4 per cent in 1969, 1.2 per cent in 1984, and 2.1 per cent in 1986. It increased to 7.53 per
cent in 1995. This was the result of the prescription of capital adequacy norms by the authorities
since 1992-93.

The Base Committee on Banking Supervision appointed by the Bank for International
Settlement (BIS) established in 1988 a system in which minimum capital requirements were set
for banking firms based on the risk of bank assets. It specified Capital to Risk (weighted) Assets
Ratio (CRAR) of eight per cent as the capital adequacy norm. This risk-based capital standard
has been adopted by many countries including India where it came into force in 1992-93. In the
following years, a multi-pronged policy has been implemented to reach the said eight per cent
level. First, the government has been providing budgetary support to banks for this purpose.

In fact, it has contributed Rs 20,446 cr. by way of capital to the banks during 1985 to 2002.
Since 1992, it has contributed over Rs 17,746 cr. to the capital base of the nationalized banks.
Second, a number of banks have raised equity capital on the stock market. In addition, banks
have been allowed since 1993-94 to issue, with the prior approval of the RBI, subordinated debts
in the form of unsecured redeemable bonds qualifying for Tier II capital. Seven public sector
banks raised a sum of Rs 1145.74 cr. during 1995-96 through such an instrument. The twelve
PSBs have raised capital through fresh capital issues to the tune of Rs 6501 cr. during 1993-
2002. Three PSBs raised another Rs 773 cr. of equity capital during 2002-03. Further, the
nationalized banks have returned the capital of Rs 1253 cr. to the government till the end of
2002-03. As a result, the government shareholding in PSBs has declined. The share of the
government in the equity capital of various banks ranged from 57 per cent to 75 per cent in
2003.

26
By the end of March 2003, all the PSBs have achieved CRAR above the stipulated minimum. In
fact, 26 out of 27 PSBs had a CRAR above 10 per cent. For PSBS as a whole, the CRAR stood
at 12.64 percent at the end of March 2003. Similarly, now all the old private sector banks and
foreign banks also have the CRAR above the stipulated level now. The number of PSBs paying
dividend to the government has increased from seven in 1995-96 to 14 (out of 19) in 2000-01,
and the total amount of dividend paid has been about Rs 2294 cr. during 1995-96 to 2001-01.

5.4RISK EXPOSURES OF BANKS

The overall risk exposure of banks is determined by their lending to sensitive sectors such as
capital market, real estate, and commodities' and off-balance sheet activities. Comprising
forward exchange contracts, guarantees, acceptances and endorsements. The exposure of
scheduled commercial banks in India on both of these counts has gone up significantly at
present.

5.5BANKS FOREIGN BUSINESS

Indian banks do business in foreign countries also and this business has grown slowly over time.
Banks' foreign business actually began during early 1940s on a very modest scale; it expanded to
a certain extent during the 1950s and 1960s; and the fastest growth of this business occurred
really during 1975-1982. This business is mainly concentrated in areas inhabited largely by
Indian expatriate population, and in countries which are important trading partners of India.

In 1985, 13 Indian banks had 139 offices in 26 countries. Bank of Baroda, Bank of India, State
Bank of India, and Indian Overseas Bank accounted, respectively, for 41, 17, 17, and 8 per cent
of total branches. Indian banks also have three deposit-taking companies, three wholly-owned
subsidiaries, two majority-owned subsidiaries and four joint venture banks abroad. There was a
reduction in this business after 1985. As a result of the closure of branches by some banks, the
number of foreign offices of nine banks was 114 as on 30 April, 1990, and the four banks had 11
representative offices in that year. The banks have never done well in their overseas business.
About $1 billion had to be provided in 1992-93 Jo meet provisioning requirements of overseas
branches, some of which are being closed even now.

The total number of overseas branches of Indian banks was reduced from 101 to 97 as at the end
of June 1996, of which 96 branches belonged to eight public sector banks, and the remaining
one belonged to a private sector bank. The number of wholly-owned subsidiaries, joint venture
banks, and representative offices were 11, 7, and 14, respectivelyin 1996.

27
BANKS AS AUTHORISED DEALERS

The RBI has designated 92 banks, including 35 foreign banks, as Authorized Dealers (ADs) in
foreign exchange, an they are functioning in this capacity through their 27,762 branches. ADs
can buy and sell foreign exchange on behalf of their clients, subject to limits deemed sufficient.
Increase in capital flows and the relaxation of balance sheet restrictions in respect of foreign
exchange operations has transformed banks into active participants in the foreign exchange
market. The changes in capital flows directly affect bank liquidity, profitability. The turnover in
the foreign exchange business of banks has increased over the years.

Resources Raised by Banks From the Primary Capital Market Scheduled Commercial banks,
both in public and private sectors, raised large resources from the domestic and international
capital markets. Total resource mobilization by banks through public issues (excluding offer for
sale) in the domestic capital market increased sharply by 263.3 per cent during 2004-05.
Encouraged by a firm trend in the prices of the banking sector scrips in the secondary market
and satisfactory financial results, seven banks raised Rs. 7,444 crore from the equity market
during 2004-05. This included two equity issues aggregating Rs.3,336 crore (including
premium) by public sector banks and five equity issues aggregating Rs.4,108 crore by private
sector banks.

28
Regional Rural Banks

Regional Rural Banks (RRBs) form an integral part of the Indian banking system with focus on
serving the rural sector. There are 196 RRBs operating in 26 States across 518 districts with a
network of 14,446 branches as on March 31, 2004. Majority of the branches of RRBs are located
in rural areas. RRBs combine the local feel and familiarity with rural problems, which the co-
operatives possess, and the degree of business organisation as well as the ability to mobilise
deposits, which the commercial banks possess. RRBs are specialised rural financial institutions
for catering to the credit requirements of the rural sector. In the context of recent focus of the
Government of India on doubling the flow of credit to the agricultural sector, it is felt that the
RRBs could be used as an effective vehicle for credit delivery in view of their rural orientation

Development of co-operative bank

Co-operative banks in India have come a long way since the enactment of the Agricultural
Credit Co-operative Societies Act in 1904. The century old co-operative banking structure is
viewed as an important instrument of banking access to the rural masses and thus a vehicle for
democratisation of the Indian financial system. Co-operative banks mobilise deposits and purvey
agricultural and rural credit with a wider outreach. They have also been an important instrument
for various development schemes, particularly subsidy based programmes for the poor.

The co-operative banking structure in India comprises urban co-operative banks and rural co-
operative credit institutions. Urban co-operative banks consist of a single tier, viz., primary co-
operative banks, commonly referred to as urban co-operative banks (UCBs). The rural co-
operative credit structure has traditionally been bifurcated into two parallel wings, viz., short-
term and long-term. Short-term co-operative credit institutions have a federal three-tier structure
consisting of a large number of primary agricultural credit societies (PACS) at the grass-root
level, central co-operative banks (CCBs) at the district level and State co-operative banks
(StCBs) at the State/apex level. The smaller States and Union Territories (UTs) have a two tier
structure with StCBs directly meeting the credit requirements of PACS.

The long-term rural co-operative structure has two tiers, viz., State co-operative agriculture and
rural development banks (SCARDBs) at the State level and primary co-operative agriculture and
rural development banks (PCARDBs) at the taluka/tehsil level. However, some States have a
unitary structure with the State level banks operating through their own branches; three States
have a mixed structure incorporating both unitary and federal systems

PUBLIC SECTOR BANKS

29
The term public sector banks by itself connotes a situation where the major/full stake in the
banks are held by the government.

Excepting the Reserve Bank of India which was nationalized in 1949 there was no other bank
which had the tag of public sector bank till 1969. with the nationalization of banks brought in by
Banking Companies Act,1970, 14 Banks each of which had a level of more than Rs 50 crores in
time and demand liabilities acquired the character of nationalized banks effective from 19 July
1969. This was subsequently followed by nationalization of 6 more private Sector Commercial
banks, each of which had crossed the deposit limit of Rs 200 crore in the year 1980, effective
from 15/4/1980. Thus, as on date there are totally 19 nationalised banks existing as on date,
consequent to the merger of New Bank of India with Punjab National Bank in September 1993.
Consequent to an Amendment made to the Banking Companies Acts, 1970/1980 in 1994,
Nationalised banks have been permitted to offer their equity shares to the public to the extent of
49% of their capital.

Public sector banks are as follows

Nationalised Banks

Ø Allahabad Bank

Ø Andhra Bank

Ø Bank of India

Ø Bank of Baroda

Ø Bank of Maharashtra

Ø Canada Bank

Ø Central Bank of India

Ø Corporation Bank

Ø Dena Bank

Ø Indian Bank

Ø Indian Overseas Bank

Ø Oriental Bank of Commerce

30
Ø Punjab and Sind Bank

Ø Punjab National Bank

Ø Syndicate Bank

Ø UCO Bank

Ø Union Bank of India

Ø United Bank of India

State Bank Group

1. State Bank of India

2 State Bank of Bikaner and Jaipur

3 State Bank of Hyderabad

4 State Bank of Indore

5.State Bank of Mysore

6 State Bank of Patiala

7.State Bank of Saurashtra

8. State Bank of TravancoreIDBI LTD.

Private Sector Banks

By private sector banks we mean those banks where equity is held by private share holders, that
is to say there is no government holding of the equity shares.
This category of banks also occupies a significant position in the Banking Scenario. There are
already 25 private Sector operating in our country for quite some time. These banks are also
listed as under

v The ING Vysya Bank Ltd.

v The Federal Bank Ltd.

v The Jammu Kashmir Bank Ltd.

31
v Bank of Rajasthan Ltd.

v Karnataka Bank Ltd.

v The South Indian Bank Ltd.

v The United Western Bank Ltd.

v The Catholic Syrian Bank Ltd.

v The KarurVysya Bank Ltd.

vTamilnadu Mercantile Bank Ltd.

v The Laxmi Vilas Bank Ltd.

v The Sangli Bank Ltd.

v The Dhanlaxmi Bank Ltd.

v Bharat Overseas Bank Ltd.

v City Union Bank Ltd.

v Lord Krishna Bank Ltd.

v Bareilly Corporation Bank Ltd.

vNanital Bank Ltd.

v The Ratnakar Bank Ltd.

v The Ganesh Bank of Kurundwad Ltd.

v SBI Comm. & Int. Bank Ltd

v Development credit Bank Ltd

v Madura Bank Ltd.

There has been a growing presence of private sector banks more so, after the introduction of
financial sector reforms from 1991. Six new private banks listed as under were issued licence in
1994-95.

New Private sector Banks ¨

32
Centurion Bank of Punjab Ltd.¨

HDFC Bank¨

ICICI Bank Ltd.¨

Indusland Bank Ltd.¨

Kotak Mahindra Bank Ltd.¨

UTI Bank Ltd.

Again, during 1995-96, the following three banks were issued the licence and commenced their
operations:

v Times Bank Ltd.

v Bank of Punjab Ltd.

v IDBI Bank Ltd.

Thus apart from the twenty-five old private sector banks, we have got nine private sector banks
which became operational subsequent to 1992.
The size of the private sector banks in our country as on date is furnished hereunder (as at
June’97)

v Number of private sector banks in operation : 35

v Number of bank branches of private sector banks : 4,473

vAmount of advances(as at March’96) : 31,692 crores

v Amount of advances(as at March’96) : 21,5888 crores( Sources RBI)

Private Sector Banks have been rapidly increasing their presence in the recent times and offering
a variety of newer services to the customer and possing a stiff competition to the group of public
sector banks

New Technology in Banking

The importance of sophisticated or high technology for improving customer service,

productivity, and operational efficiency of banks is well-recognized. As a part of their action
plans, banks in India have introduced many new techniques and a considerable degree of
33
mechanization and computerization in their operations. By the end of June 1996, they had
installed 13,522 Advance Ledger Posting Machines (ALPM) at 4,238 branches, and 895 mini-
computers at their regional and zonal offices at 441 branches. Three banks had installed
mainframe computers and others were at various stages of doing so. They are developing and
standardizing suitable computer software in a big way. They have introduced mechanizedcheque
clearance, using magnetic ink character recognition (MICR) technology. The computerization of
clearing house settlement has been completed at a number of centres. They are in the process of
setting up exclusive data communication network for banks known as BANKNET. For this, the
RBI and 36 banks have become members of the Society for Worldwide Inter-bank Financial
Telecommunications (SWIFT) and have installed two SWIFT Regional Processors at Mumbai.
Through this network, any bank will be able to establish connection with its own offices and
with any other banks' offices/computers in the national and international network.

Banks are now switching to Personal Computers (PCs) and LAN/W an systems. At the end of
June 1996, the banks had installed 2,120 PCs, LAN at 916 branches, WAN at 175 branches, 937
signature storage and retrieval systems, and 315 on-line terminals. The RBI has put in place
Electronic Funds Transfer (EFT) system, Delivery vs. Payments (DVP) system, Electronic
Clearing Services, and RBINET. It has also taken steps to set up a Very Small Aperture
Terminal (VSAT) Network which will cover all banks and financial institutions to serve a
number of tasks like MIS, data warehousing, transaction processing, currency chest accounting,
ATMs, EFT, EDT, Smart/Credit cards, etc. It will cover 2,800 centres soon. So far all the PSBs
have crossed the 70 per cent level of computerisation of their business. As a part of Indian
Financial Network (INFINET), the number of VSATs has increased from 924 in March 2002 to
more than 2000 in June 2003. Banks are sharing A TMs by forming alliances as it was done by
UTI Bank, Citi bank, IDBI Bank, and Standard Chartered Bank, which formed "Cashnet"
alliance in 2003. Now, there are 27 cities where cheque clearing is performed using mechanised
technology of reader sorter which process cheques at more than 2000 per minute. The 'currency
verification and processing systems' have been made operational at various offices of the RBI
which has resulted ill the "clean note policy".

Asset-Liability Management

In the recent past, banks in India have started using the Asset-Liability Management (ALM) as
the technique or strategy for financial management. ALM aims at planning, directing, and
regulating the levels, changes, mixes of assets and liabilities of banks in the short-run, usually
three to twelve months, with a view to enable them to achieve their long-term objectives. The
34
net interest margin and its variability are the focus of its attention so as to maximise Return On
Equity (ROE), and to minimise fluctuations in ROE. It also links capital, non-interest income
and expenses, and strategic choices regarding products, markets, and bank structure.

CHAPTER 6 : CO-OPERATIVE BANK

6.1INTRODUCTION

Co-operative banks are an important constituent of the Indian financial system, judging by the
role assigned to them, the expectations they are supposed to fulfills, their number, and the
number of offices they operate. The co-operative movement originated in the West, but the
importance that such banks have assumed in India is rarely paralleled anywhere else in the
world. Their role in rural financing continues to be important even today, and their business in
the urban areas also has increased in recent years mainly due to the sharp increase in the number
of primary co-operative banks.

6.2ORIGIN AND GROWTH OF CO-OPERATIVE BANKS

Co-operative banks are a part of the vast and powerful superstructure of co-operative institutions
which are engaged in the tasks of production, processing, marketing, distribution, servicing, and
banking in India. The beginning of co-operative banking in this country dates back to about
1904 when official efforts were initiated to create a new type of institution based on the
principles of co-operative organisation and management, which were considered to be suitable
for solving the problems peculiar to Indian conditions. In rural areas, as far as agricultural and
related activities were concerned, the supply of credit, particularly institutional credit, was
woefully inadequate, and unorganised money market agencies, such as money lenders, were
providing credit often at exploitatively high rates of interest. The co-operative banks were
conceived in order to substitute such agencies, provide adequate short-term and long-term
institutional credit at reasonable rates of interest, and to bring about integration of the
unorganised and organised segments of the Indian money market.

When the national economic planning began in India, co-operative banks were made an integral
35
part of the institutional framework of community development and extension services, which
was assigned the important role of delivering the fruits of economic planning at the grassroot
levels. In other words, they became a part of the arrangements for decentralised plan formulation
and implentation for the purpose of rural development in general, and agricultural development
in particular. Today co-operative banks continue to be a part of a set of institutions which are
engaged in financing rural and agricultural development. This set-up comprises the RBI,
NABARD, commercial banks, regional rural banks, and co-operative banks. The relative
importance of co-operative banks in financing agricultural and rural development has undergone
some changes over the years. Till 1969, they increasingly substituted the informal sector lenders.
After the nationalisation of banks and the creation of RRBs and NABARD, however, their
relative share has somewhat declined. All the institutional sources contributed about 4 per cent
of the total rural credit till 1954. The contribution increased to 62 per cent by 1990. The share
of co-operative banks in this institutional lending has declined from 80 per cent in 1969 to about
42 per cent at present. The percentage of rural population covered by the agricultural credit co-
operatives was 7.8 in 1951, 36 in 1961, and about 65 per cent at present.

Cooperative banks in India finance rural areas under:

· Farming

· Cattle

· Milk

· Hatchery

· Personal finance

Cooperative banks in India finance urban areas under:

· Self-employment

· Industries

· Small scale units

· Home finance

· Consumer finance

· Personal finance

36
6.3FEATURES OF CO-OPERATIVE BANKS

Some distinguishing characteristics of the nature of co-operative banks are as follows:

(i) they are organized and managed on the principles of co-operation, self-help, and
mutual help. They function with the rule of "one member, one vote".
(ii) They function on "no profit, no loss" basis. For commercial banks also, profitability
is no longer the main objective, but in their case this change has been brought about
as a result of social or public policy, while co-operative banks, by their very nature,
do not pursue the goal of profit maximisation.
(iii) Co-operative banks perform all the main banking functions of deposit mobilisation,
supply of credit and provision of remittance facilities. However, it is said that the
rang~, of services offered is narrower and the degree of product differentiation in
each main type of service is much less in the case co-operative banks, compared to
commercial banks. In other words, co-operative banks are characterised by functional
specialisation. It should be added that this is true with much less force now, because
many changes have taken place in the co-operative banking system since the Banking
Commission arrived at the above-mentioned conclusion. For example,\co-operative
banks now provide housing loans also. The UCBs provide working capital loans \and
term loans as well. The State Co-operative Banks (SCBs), Central Co-operative
Banks (C0)3s) and Urban Co-operative Banks (UCBs) can normally extend housing
loans up to Rs one 1akh to an individual. The scheduled UCBs, however, can lend up
to Rs three lakh for housing purpose. The UCBs can provide advances against shares
and debentures also.
(iv) As said earlier, co-operative banks do banking business mainly in the agricultural and
rural sector. However, certain types of banks viz., UCBs, SCBs and CCBs operate in
semi-urban, urban, and metropolitan areas also. The urban and non-agricultural
business of these banks has grown over the years. The co-operative banks
demonstrate a shift from rural to urban, while the commercial banks, from urban to
rural.
(v) Co-operative banks are perhaps the first government-sponsored, government-
supported, and government-subsidised financial agency in India. They get financial
and other help from the RBI, NABARD, Central government and state governments.
37
 They constitute the "most favoured" banking sector with no risk of nationalisation.
For commercial banks, the RBI is a lender of last resort, but for co-operative banks, it
is the lender of first resort which provides financial resources in the form of
contribution to the initial capital (through state governments), working capital, and
refinance. The promotional role of the RBI can be seen in respect of co-operative
banks, and this role supersedes its regulatory role, in respect of these banks.
A corollary of government help to co-operative banks is that there is much
government intervention in their working. Co-operative banks are subject primarily
to the control, audit, supervision and periodic inspection of the co-operative
department of the state government under the Cooperative Societies Act, but less
rigorously, by the RBI under the Banking Regulation Act. The RBI and the state
government lay down rules for investment of surplus resources, reserves, and the
loan policy of co-operative banks. Consequently, compared to commercial banks,
they have less freedom and flexibility in conducting their operations.
(vi) Co-operative banks belong to the money market as well as to the capital market.
Primary agricultural credit societies provide short-term and medium-term loans.
Land Development Banks LDBs) provide long-term loans, DCBs meet working
capital as well as fixed capital requirements, and SCBs and CCBs also provide both
short-term and term loans. Similarly, they accept short-term and long-term deposits,
and some of them mobilise resources through the issue of debentures.
(vii) Co-operative banks are financial intermediaries only partially. The sources of their
funds resources) are: (a) Central and state governments, (b) the RBI and NABARD,
(e) other cooperative institutions, (d) ownership funds, and (e) deposits or debenture
issues. It is interesting to note that intra-sectoral flows of funds are much greater in
co-operative banking than in commercial banking. Inter-bank deposits, borrowings,
and credit form a significant part of assets and liabilities of co-operative banks. This
means that intra-sectoral competition is absent and intra-sectoral integration is high
for co-operative banks.
(viii) Co-operative banks have a federal structure of three-tier linkages. Further, their
of mixed banking type. Primary credit societies are unit banks;
Many DCBs also are unit banks. But SCBs, DCBs (CCBs), and SLDBs, PLDBs and
many DCBs have a number of branches. Object to this, it can be said that each co-
operative institution in each tier is a separate entity with definite jurisdiction and has
an independent board of management.

38
 (ix) Some co-operative banks are scheduled banks, while others are non-scheduled
banks. For instance, SCBs and some DCBs are scheduled banks but other co-
operative banks are non-scheduled banks.At present, 28 SCBs and 11 DCBs with
Demand and Time Liabilities over Rs 50 crore each are included in the Second
Schedule of the RBI Act.
xi) As said earlier, co-operative banks accept current, saving, and fixed or time deposits
from individuals and institutions including banks. Some DCBs numbering about 40 in
1989 are allowed open and maintain NRI accounts in rupees but not in foreign currency.
Deposits mobilised by them in a given area are used for financing activities in that
locality.
Some co-operative banks, namely, Land Development Banks (LDBs), issue debentures
to raise resources for their operations. These debentures are secured by mortgaging
lands belonging to borrowers from LDBs and are often guaranteed by the state
government. They are regarded as -tee securities and are treated on par with government
securities for making advances. There are three types of such debentures: ordinary,
rural, and special. These debentures are almost entirely subscribed by such institutional
investors as banks, LIC, and the government.
The co-operative banks are subject to CRR and liquidity requirements as other
scheduled non-scheduled banks are. However, they are required to maintain the CRR
and SLR only at = level of three per cent and 25 per cent respectively, at present. They
are subject to SCCs also. Further, the DCBs have been advised to lend 60 per cent of
their total advances to the priority ors. It means that the target for priority sector lending
has been fixed at a higher level for these banks compared to commercial banks.
Similarly, while the CAS has nowbeen withdrawn in the e of commercial banks, it is
still applicable to the DCBs, although in a liberalized form. With effect from January
1989, they have to seek prior approval of the RBI for grant of advances to a single party
exceeding certain credit limits, which vary from bank to bank depending on their size.
xii) Since 1966, the lending and deposit rates of commercial banks have-been directly
regulated by the RBI. Although the RBI had powers to regulate the 'rates of co-
operative banks also, these powers were not exercised much till about 1979, in respect
of their lending rates. From the early years till 1979, the SCBs and CCBs were expected
to provide finance for agricultural and allied activities to the ultimate borrowers at
reasonable rates, i.e., at concessional rates, by virtue of their being entitled to
concessional refinance from the RBI. In case of their non-agricultural advances for the
purpose of production and marketing activities of cottage and small scale industries, the
39
RBI imposed certain conditions as regards rates to be charged by these banks for such
purposes. In respect of their non-agricultural advances, they were free to charge any
rates at their discretion. The RBI did not regulate at all the lending rates of DCBs,
because of which there was little uniformity in the rates charged by different DCBs. The
SCBs were also exempted from the levy of interest tax.
In early 1979, the RBI decided to maintain parity with regard to the rates of interest on
all agricultural advances irrespective of the credit agency. As a result, the rates of
interest charged to the ultimate borrowers by co-operative banks were also brought in
line with those charged by commercial banks. Accordingly, the RBI advised all SCBs in
1980 to charge certain ceiling rates on agricultural advances. While ceiling rates were
prescribed for short-term agricultural advances, the lending rates for medium-term
agricultural credit were stipulated as fixed rates. Similarly, lending rates of co-operative
banks including DCBs for non-agricultural advances also became subject to the
directives issued by the RBI with effect from 1981. As a result of measures adopted by
the RBI in 1980 and 1981, a certain amount of uniformity has been brought about with
regard to the lending rates charged by co-operative banks in different states, and
between commercial banks and co-operative banks.
However, since 1974, the deposit rates of co-operative banks including DCBs, have
been regulated by the RBI. To begin with, the RBI policy in this respect was to specify
that the rates prescribed for commercial banks should be considered as the minimum to
be offered by the cooperative banks. This was unlike the directives in the case of
commercial banks for whom fixed rates have been stipulated for different types of
deposits. Their current accounts were also excluded from the purview of the directive,
while commercial banks were prohibited from paying interest on current accounts. This,
however, led to relatively higher rates being paid by co-operative banks on their
deposits which adversely affected the deposit mobilisation efforts of the commercial
banks. Therefore, the RBI once again changed its policy in 1974 and began to direct co-
operative banks not to pay interest at rates in excess of certain percentages over the
minimum rates prescribed by the RBI for commercial banks. The ceilings laid down
over the minimum rate were 0.25, 0.5, and 1.0 per cent with regard to SCBs, CCBs, and
Primary Agricultural Credit Societies (PACSs) respectively, on term and saving
deposits. Likewise, they have been prohibited since 1975, from paying interest at a rate
exceeding 0.5 per cent per annum on current accounts. deposits up to 14 days, and those
subject to withdrawal or repayment after a notice of 14 days or less. The latter facility,
however, has been withdrawn with effect from March 1989 in respect of DCBs.
40
(xiii) Although the main aim of the co-operative banks is to provide cheaper credit to
the members, and not to maximise profits, they may access the money market to
improve their income so that they remain viable. This is in keeping with the opening up
of the non-farm sector to them in the recent past. Their need to access money market
arises due to a variety of factors. First, CCBs are mainly in the field of financing
seasonal agricultural operations, which creates cycles of flows of funds. Second, the
short-term agricultural loans are given at a concessional rate of interest whereas interest
rates paid on deposits by co-operative banks are higher than those paid by the
commercial banks. It is true that they get concessional refinance from the NABARD,
but its availability depends upon fulfilling conditions such as minimum involvement,
non-overdue cover, etc. Similarly, many DCBs often have surplus funds which they
mostly keep with the SCBs at a fixed rate of interest. There is, therefore, a need for co-
operative banks to access money market to deploy their short-term funds profitably and
cross-subsidise their lending operations.
(xiv) Co-operative banks (COBs), in short, have played a pivotal role in the
development of short-term and long-term rural credit structure in India over the years.
The co-operative credit endeavour is said to be the first ever attempt at micro-credit
dispensation in India. The entire cooperative credit system covers more than 74 per cent
of rural credit outlets, and it has a market share of about 46 per cent of total rural credit
in the country. From being the providers of loans for redemption of debt, COBs have
gone on to meet the investment requirements of all activities in rural areas.

6.4SALIENT FEATURES OF THE OPERATION OF CO-OPERATIVE

BANKING' SYSTEM
A few salient features of the operations of the co-operative banking system which
emerge from this, and related information are as follows:
(1) There was an increase in the number of all types of co-operative banks except the
CCBs (which declined), during the two decades after 1951. During the 1970s and
1980s, the number of all types of banks except thy PACSs remained constant; the
number of the latter declined drastically. As a result, the total number of co-
operative banks increased till 1970 and declined thereafter.
The co-operative banks now operating in India outnumber the commercial banks.
At present, we have about 297 commercial banks (including RRBs) compared to

41
 about 92,571 co-operative banks including the PACSs and 3101 co-operative banks
excluding the PACSs.
(2) In 1989, the total number of offices of co-operative banks was 1,02,184 including
those of PACSs and 15,184 excluding them, the latter being one-fourth the size of
the total number of offices of commercial banks. Similarly, the deposits and credit
of co-operative banks were about 15 per cent and 35 per cent respectively of those
of commercial banks in 1988-89. In 1996, the total number of offices of co-
operative banks was 1,10,137 including those of PACSs and 20,137 excluding
them, the latter being about 32 per cent of the offices of the commercial banks.
Similarly, the deposits and credit of co-operative banks were about 14 per cent and
29 per cent respectively of those commercial banks in 1994-95. The co-operative
banks excluding PACs had the total deposits of Rs 2,12,859 crore, or about 17 per
cent of the total deposits of scheduled commercial banks in 200-03. Similarly, their
total outstanding credit was Rs 1,81,912 crore or about 25 per cent of commercial
bank credit in that year. The SBI alone has a far higher amount of deposits than the
whole of the co-operative banking sector. It follows that co-operative banking,
unlike commercial banking, is small-scale banking and it does not suffer from the
concentration of business in the hands of a few. Table 9.2 gives an idea about the
average (per bank) size of different types of co-operative banks in 1950-51, and
1994-95 and 2002-03 in terms of deposits and credit. The average size has
increased over the years.
(3) Deposits, credit, working capital and other indicators of all types of co-operative
banks and the co-operative banking sector as a whole have also grown manifold
over the period, 1951 to 2003. Their growth has not been uniform over the span of
53 years. On the whole, the annual rate of growth of all co-operative banks (in
terms of deposits) has varied between 13 to 19 per cent in different quinquenniums
during 1961-1986.
(4) If we rank different types pf banks, it would be found that in terms of deposits,
CCBs were the most important, followed by UCBs, SCBs and PACSs, in that
descending order in 1988-89. However, in terms of outstanding credit, the
descending order in that year was CCBs, PACSs, SCBs, and LDBs. in 1994-95 was
CCBs, UCBs PACSs, SCBs and SLDBs. In period 2002-03, the descending order
was UCBs, CCBs, SCBs, SLBs and PLDBs in term of deposits as well as
outstanding credit.

42
 (5) The composition of resources and other operational ratios of different types of co-
operative banks differ significantly from those of commercial banks. The ratios also
vary among the cooperative banks themselves.
(6) In the recent past, a number of COBs have come under stress or failed. Many DCBs
are in precarious conditions. Some of them have been found to have manipulated
government securities transactions. In 2003, as many as 163 DCBs out of the total
number of 2104 of DCBs were under liquidation.
(7) The co-operative banks are not allowed to approach debt recovery tribunals, and are
not covered under the Securitisation and Reconstruction Ordinance. They are also
not allowed to access capital markets, bullion markets, and derivatives markets.

6.5PROBLEMS AND POLICY

As in the case of commercial banks, the quantitative growth of co-operative banks has not been
accompanied by a qualitative growth. There have always been a number of weak.1esses in their
performance. Many of these weaknesses were identified by the All India Rural Credit Survey
Committee (AIRCSC) in the early 1950s. By that time, co-operative banks had been in the
business for 45 years and the AIRCSC had concluded that co-operatives had failed, but that they
must succeed. In the same vein, the Khusro Committee asserts: "No credit system has been
subjected to as much experimentation at the dictates of those outside the system as the co-
operative credit system has been The history of co-operative credit system has been the history
of alternating periods of growth, stagnation and reorganisation and yet quantitatively the
achievements of the co-operative systems have by no means been insignificant. Thus looking to
the stake of the movement even in the limited sphere of credit, the classic assertion of the Rural
Credit Survey made 35 years ago still seems valid that Co-operation has failed but Co-operation
must succeed.”

Main weakness of Co-operative Banks

The main weaknesses of co-operative banks are as follows:

(a) The vital link in the co-operative credit system namely, the PACSs, themselves remain very
weak. They are too small in size to be economical and viable; besides too many of them are
dormant, existing only on paper.

(b) With the expanding credit needs of the rural sector, the commercial banks have come in
actively to meet the credit requirements of this sector, and this has aggravated the difficulties of

43
co-operative banks. The theory that co-operative banks would be buoyed up by the competition
from other financial institutions does not appear to have worked.

(c) Co-operative banks are not doing well in all the states; only a few account for a major part of
their business. For example, 75 per cent of total deposits mobilised by SCBs was from only
seven states in 1987-Andhra Pradesh, Gujarat, Karnataka, Madhya Pradesh, Maharashtra, Tamil
Nadu, and Uttar Pradesh.

(d) These banks still rely very heavily on refinancing facilities from the government, the RBI,
and NABARD. They have yet not been able to become self-reliant in respect of resources
through deposit mobilisation.

(e) They suffer from dangerously low or weak quality of loan assets, and from highly
unsatisfactory recovery of loans.

(f) They suffer from infrastructural weaknesses and structural flaws. They do not look like banks
and do not inspire confidence in the potential members, depositors and borrowers.

(g) They suffer from too much officialisation and politicisation. Undue governmental
interventions have prevented them from developing steadily as a self-reliant and resilient credit
system. Most of them are headed by politicians.

(h) They unduly depend on government capital rather than member capital. (i) There is no active
participation of their members in their working, which can come about if they work with
members' money rather than government largesse.

(i) They have been resorting to unethical practices. There are many regulators for them, but still
there are many lacunea in their regulation. In fact, the existence of multiple regulatory
authorities has come in the way of effective regulation, control.

6.6GOVERNMENT INITIATIVES TO STRENGTHEN THE DEVELOPMENT OF CO-

OPERATIVE BANKS

Even before the submission of the Khusro Committee Report, the government and the RBI had
initiated certain measures to strengthen the development of co-operative banks. Some of these
policy initiatives were as follows:

(i) The NABARD had formulated a scheme for the reorganisation of PACSs and the
implementation of this scheme had started in those states which have accepted it.

44
 (ii) The programme for development of selected P ACSs into truly multi-purpose co-
operative societies has been implemented in many states and Union Territories.
(iii) In addition to such programmes, certain state governments like Andhra
Pradesh Madhya Pradesh West Bengal had also initiated development programmes.

CHAPTER 7 :CONCLUSION

A well developed banking system is a necessary pre-condition for economic Development in a

modern economy. Besides providing financial resources for the growth of industrialization,
banks can also influence the direction in which these resources are to be utilized. In developing
countries not only the banking facilities are limited to a few developed urban areas, but also the
banking activities are limited mostly to trade and commerce, paying little attention to industry
and agriculture. Structural as well as functional reforms in the banking system are needed to
enable the banks to perform developmental roles in developing countries. In a modern economy
banks are to be considered not merely as dealers in money but also as the leaders in
development. They are not only the storehouses of the country’s wealth but also are the
reservoirs of resources necessary for economic development. It is the growth of commercial
banking in the 18th and 19th centuries that facilitated the occurrence of Industrial Revolution in
Europe.

45
Kerala has been blessed with the presence of a very large number of commercial banks side by
side with co-operative banks performing more or less the very same functions. Even though their
functions are more or less similar commercial banks are under the control of the Banking
Regulation Act and the guidance of the RBI, where as co-operative banks are under the control
of the respective State governments and State Co-operative Laws and enjoy government
patronage and subsides. Thus commercial banks are facing stiff competition from co-operative
banks in all fields ranging from deposit mobilization to granting of loans.

46