Rise of American Accounts. "Hollywood. "

BANKING INSTITUTIONS - COMMERCIAL BANKS

Introduction

Indian banking industry is subject to the control of the Central Bank ( i.e., Reserve Bank of India ). The RBI as the apex institution organises, runs, supervises, regulates and develops the monetary system and the financial system of the country. The main legislation governing commercial banks in India is the Banking Regulation Act, 1949. The Indian banking institutions can be broadly classified into two categories :

1. Organised Sector

2. Unorganised Sector

The organised banking sector consists of commercial banks, cooperative banks and the regional rural banks. The unorganised banking sector includes indigenous bankers, money lenders, seths, sahukars etc. carrying out the banking functions. We have discussed below in this chapter commercial bank in detail.

COMMERCIAL BANKS

Commercial banks are very important segment of the money market. They play a very important role in the economy by mobilising savings from various sectors, which is the foundation for the growth and development of the economy. In turn, the growth and development of economy determines the growth of banks as well. In other words, when the economy grows the commercial banking also undergoes changes as is evident from the changes taking place in the banking industry since 1991. These changes are intimately connected with the basic economic policy of the country.

Earlier , the country , under the influence of socialist thought, witnessed the emergence of public sector banks and the private sector banks had little role in the economy. With the initiation of the process of liberalisation and globalisation of the economy , the financial sector, particularly the commercial banks are the first to experience the winds of change.

MEANING

Commercial banks are commercial concerns who collect money from those who have it to spare or who are saving it out of their income, and lend to those who require it. In other words, Commercial bank is an organisation that accepts deposits for the purpose of lending. They provide various types of financial services to customers in consideration of some payments in the form of interest, discounts, fees, commission etc. Commercial banks deal in other people's money, which is repayable on demand through cheques, drafts or otherwise. The word 'bank' is used to denote 'Commercial banks' only. Various definitions of a 'bank' have been given by various authors. Few of them are listed below.

DEFINITIONS

Kinley has defined a bank as "an establishment which makes to individuals such advances of money or other means of payments as may be required and safely made : and to which individuals entrust money or means of payment when not required by them for use." This definition brings out that banks not only deal with money but also with other means of payment.

H.L.Hart defines a bank as " the one who in the ordinary course of his business honours cheques drawn upon by persons from and for whom he receives money on current account." This definition emphasises the chequeable nature of accounts of the banker.

John Paget has attempted to give a functional definition of a bank by stating : " Nobody can be a banker who does not - (1) take deposit accounts, (2) take current accounts, (3) issue and pay cheques and (4) collect cheques-crossed and uncrossed for its customers." Paget had further emphasized that a person or an establishment to be called a banker should not only perform these functions but also be acknowledged as the one who earns livelihood through the banking business.

Prof.Sayers has given a more clear definition of the terms 'bank' and 'banking'. His definitions are better than most of the definitions discussed earlier as he has been able to bring out the nature and functions of a bank more clearly. He defines a bank as "an institution whose debts (bank deposits) are widely accepted in settlement of other people's debts to each other." He has further defined the term banking in the following words, " Ordinary banking business consists of changing cash for bank deposits and bank deposits for cash : transferring bank deposits from one person or corporation to another, giving bank deposits in exchange for bills of exchange , government bonds, are secured promises of businessmen to repay and so forth."

The discussion on definition will be inconclusive and incomplete unless we discuss the definition given by The Banking Companies (Regulation) Act of India, 1949 , which is not only most acceptable but comprehensive as well. According to the Act, banking means " the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft or otherwise ."

FUNCTIONS OF COMMERCIAL BANKS

Commercial banks have emerged as the single most important source of institutional credit . They are performing multifarious functions, some of which, truly speaking, are not commercial in nature. So much so that in the light of services rendered by them even the name 'commercial bank' is being considered a wrong nomenclature for the modern commercial banks. Such is the variety of functions performed and the services rendered by the banks that they can be described as departmental stores of financial services. Perhaps, it is not possible to make an all inclusive list of the bank's functions and services. However, an attempt is being made to discuss most of them.

The two 'acid test' functions of a commercial bank are :

1. Accepting deposits.

2. Lending or advancing loans.

These are treated as acid test functions because, unless an establishment satisfies the test of these two functions, it simply cannot be a bank or a banker. These functions are also known as primary or basic functions of commercial banks, alongwith credit creation and cheque system of payment of funds.

PRIMARY FUNCTIONS

1. Accepting Deposits.

The first major function of a commercial bank is acceptance of deposits from the public. Although a bank accepts non-chequeable deposits also, it must accept the chequeable deposits from the public. It is these deposits i.e. deposits withdrawable by cheques which distinguish a commercial bank from certain other non-banking institutions . For example, even the public limited companies and financing firms accept term deposits but they do not accept chequeable deposits. The deposits must be of money and not of other assets. Secondly, the deposits are accepted from the public at large, and not merely from its share-holders or members. Most of the trading firms accept deposits from the partners from time to time but it does not make them bankers.

It is important to understand that acceptance of chequeable accounts is a necessary, but not sufficient function of a bank. For example, post office savings banks are not commercial banks, even if some of them accept chequeable accounts. The reason is that post office savings banks do not perform the other essential function of commercial banks , i.e., lending to the public.

Banks accept deposits by mobilising the savings of the public. To mobilise the savings and to hold deposits , bank pay interest on the depisits. To attract the depositors banks maintain different types of accounts like (a) Fixed deposit account (b) Savings bank deposit account (c) Current account (d) Flexible account.

2. Lending of Advancing Loans.

Lending or advancing loans is the other acid test function of a commercial bank. A commercial bank must lend the deposits or make advances to the public directly or indirectly. However, mere lending will not make an establishment a bank. In fact, all other financial institutions like Industrial Development Bank of India (IDBI), Life Insurance Corporation (LIC) , Unit Trust of India (UTI), state financial corporations lend money or advance loans, but are not called commercial banks. Lending must be on the basis of funds raised through acceptance of deposits from the public. The usual methods adopted by commercial banks to make advances are discussed as follows :

(a) Money at call. It is the money lent for a very short period, generally varying from 1 to 14 days . Such advances are usually made to other banks and financial institutions only. Money at call ensures liquidity . The amount invested and the interest earned depends upon the conditions prevailing in the money market. In the interbank market it enables banks to make adjustments according to their liquidity requirements.

(b) Overdraft. As the name suggests, an overdraft is an advance given by allowing a customer to overdraw his current account upto an agreed amount. An overdraft account is operated the same way as a current account. In overdraft the interest is charged only on the credit actually utilised, i.e., to the extent account is overdrawn. In case an overdraft facility is obtained through a current account there is no restriction on number of withdrawals. The amount of overdraft availed can be increased or decreased anytime during the business hours of the bank. It is a short term and temporary accomodation. Overdraft is normally against the security of negotiable instruments or securities like National Savings Certificate etc. However, an overdraft in case of creditworthy customers may be allowed without security.

(c) Cash credit. Advancing credit as cash credit is also very popular . Under this system the bank advances loans to the customer on the basis of his current assets, receivables or fixed assets by hypothecating them in favour of the banker. Basically cash credit differs from overdraft in two respects-(1) security and (2) duration. Genetally cash credit is advanced against current assets and receivables , while overdraft is allowed against the negotiable security. Further, overdraft, usually, is a temporary facility , while cash credit is relatively a longer run facility. The rate of interest charged on overdraft may also be lower because of lesser risk and service cost.

(d) Discounting of bills. This is another very popular method of advancing credit. It is not only the banker who extends credit but the traders also in the normal course of business allow credit. This invariably is done with the help of negotiable instruments, the most important of them being a bill of exchange. In a bill of exchange the debtor accepts a bill drawn upon him by the creditor and thus agrees to pay the amount mentioned on maturity. In discounting the bank takes the bill and after making deductions for the margin makes the payment to the holder. For a number of reasons , this is an ideal method for making advances. Firstly, it is self-liquidating as the amount is payable on maturity. Secondly, the value of security does not fluctuate.

(e) Term loans. This is a lump sum loan advanced with a fixed maturity period of more than one year. Term loans are usually secured and provide medium to long term funds to the borrowers. The entire loan sanctioned is paid or credited to the account of the customer. The entire amount of the loan is chargeable to interest. Repayment is made either on maturity or in instalments. Sometimes to ensure the proper utilisation of the loan sanctioned it is released in instalments after examining the progress of the work for which it is sanctioned. Like overdraft it is not a continuing sort of arrangement. Each loan is a separate contract.

(f) Credit to Government(s). The commercial banks provide indirect credit to the central and or state governments by investing in their securities. Investment in securities from an important part of the portfolio of a bank. It enables it to meet requirement of statutory liquidity ratio (SLR).

It is once again emphasised that only when an institution performs both these functions can it be called a commercial bank. That is why these two functions are called acid test functions.

3. Credit Creation.

As a monetary institution credit creation is another distinct function performed by the commercial banks. In fact, this function is automatically performed while advancing credit or loans or by accepting deposits. Banks are able to create credit because the demand deposits i.e., a claim against the bank is accepted by the public in settlement of their debts. Thus, when a bank advances a loan or credit, it does not lend cash but opens an account in favour of the customer and credits the amount to the account. It creates a claim against itself which is acceptable by the public for settlement of debts. As these claims against the banks are accepted by the public for settling their debts, it is an important constituent of money supply. In this process the bank creates money. For this reason Prof. Sayers has called banks 'the manufacturers of money.'

Banks need not keep the entire deposits in cash. Only a part of the deposits is required to be kept in cash because the bank in practice is never required to repay all the deposits in cash. This enables the bank to create money many times more than the depisits with it.

4. Cheque system of Payment of Funds.

A cheque, a negotiable instrument, which in fact is a bill of exchange drawn upon a banker, is the most popular credit instrument used by the client to make payments. The cheque system was evolved in very early stages of banking and now it has become the main credit instrument in the banking world.

The importance of the chequeable account and its essentially for the commercial banks has already been discussed under the heading 'Accepting Deposits'. Through a cheque the customer/depositer directs the banker to make payment to the payee. Although a cheque is not a legal tender money, it serves as a medium of exchange in a limited way as it is a negotiable instrument.

Because of 'clearing houses' and 'clearing' opetations of the banks , cheques can be and are used for transferring funds from one centre to another. In the modern days they can also be used for transferring funds from one country to another.

AGENCY FUNCTIONS OR SERVICES.

Banks, apart from performing the primary or acid test functions of acceptance of deposits and lending, render a number of useful services to the customers. In rendering these services sometimes the bank acts as an agent of the customer. Such services are called agency services and are discussed below.

(1) Collection and payment of credit and other instruments. The commercial banks collect and pay the various negotiable instruments like cheques, bills of exchange, promissory notes, hundies, coupons, dividend warrants, etc. They also pay subscriptions , rents, income tax, fees, insurance premia, etc. on behalf of the customers.

Customers can leave standing instructions with the banker for various periodic payments ensuring the regular payments and avoiding the trouble of performing it themselves.

(2) Sale and purchase of stock exchange securities. The modern commercial banks also undertake the purchase and sale of various securities like shares, stocks, bonds units and debentures, etc. on behalf of the customers. Banks do not give any advice regarding the suitability or otherwise of a security but simply perform the functions of a broker.

(3) Administration of wills and trusteeship. Through expert staff and specialised departments banks also undertake administration of Will or settlements and trusteeship functions. Sometimes banks also undertake income-tax services on behalf of the customer.

(4) Remittance of funds. The commercial banks remit funds on behalf of clients from one place to another through cheques, drafts , mail transfers, etc.

(5) Representation and correspondence. Sometimes commercial banks act as representatives and/ or correspondents of the clients especially in handling various applications. For instance, passports and travel tickets, booking of vehicles, plots, etc.

(6) Bullion trading. In many countries , the commercial banks trade is bullions like gold and silver. In October 1997 , Eight banks including SBI, IOB, Canara Bank and Allahabad Bank have been allowed import of gold which has been put under open general licence category . This aparently is follow up on S.S. Tarapore Committee on Capital Account Convertibility. The Committee recommended that in Phase 1 banks fulfilling well defined criteria be allowed to operate freely in domestic and international markets. In the opinion of the committee. "Capital Account Convertibility is inextricably linked with the liberalisation of gold in India."

GENERAL UTILITY SERVICES OR FUNCTIONS.

In addition to agency services, banks render many more utility services to the public. These services are :

(1) Receiving of valuable for safe custody. Banks accept the valuable articles and documents for safe custody. Now the bankers have evolved the locker system, under which lockers are rented out to the public. We can keep the valuables in these lockers.

(2) Acting as a referee. If desired by the customer, the bank can be a referee i.e., who could be referred by the third parties for seeking information regarding the financial position of the customer. The bank will act as referee only and only if it is desired by the customer, otherwise the secracy of a customer's account is maintained very carefully.

(3) Issuing letters of credit. Bankers in a way by issuing letters of credit certify the credit worthiness of the customers. Letters of credit are very popular in foreign trade.

(4) Acting as underwriters. Bank also underwrite the securities issued by the Government and corporate bodies for a commission. The name of a bank as an underwriter encourages investors to have faith in the security.

(5) Acting as information banks. Commercial banks also act as 'information' bureau as they collect the financial, economic and statistical data relating to industry, trade and commerce. The information is made available to various interested parties.

The banks are getting ready to use latest information technology as information banks. ICICI bank is providing information relating to NRI schemes and commentories of experts on development in the areas of finance through 'Internet' . Internet is a network of computer networks where tens of thousands of computers located worldwide 'talk' to one another through a common communications protocol. The bank plans to provide the facility to domestic users in due course of time.

(6) Issuing of traveller's cheques and credit cards. Banks have been rendering great service by issuing traveller's cheques, which enable a person to travel without fear of theft or loss of money. Now, some banks have started credit card system under which a credit card holder is allowed to avail credit from the listed outlets without any additional cost or effort. Thus a credit card-holder need not carry or handle cash all the time. In India examples of such cards are Andhra Bancard of Andhra Bank, Central card of Central Bank of India. Many other banks like State Bank of India, Canara Bank, Bank of Baroda etc. have launched their own credit card schemes. Credit cards are extremely popular in western countries . Now, international credit cards are joining hands with Indian banks.

(7) Issuing of gift cheques. Certain banks issue gift cheques of various denominations , e.g. some Indian banks issue gift cheques of the denominations of Rs 11, 21, 31, 51, 101, etc, They are generally issued free of charge.

(8) Dealing in foreign exchange. Major branches of commercial banks also transact business of foreign exchange. Commercial banks are the main authorised dealers of foreign exchange in India.

(9) Merchant banking services. Commercial banks also render merchant banking services to the customers. They help in availing loans from non-banking financial institutions . Howevet, in recent past most of the banks have transferred the merchant banking services to separate subsidiaries.

In view of the functions performed by banks and the services rendered by them, they have been appropriately described as 'public conservators of commercial virtues' and ' the universal arbiter of the world's economy'.

RESULTATIVE FUNCTIONS

As a result of the performance of above-mentioned functions, the commercial banks perform other functions like :

(a) mobilisation of savings of the people.

(b) channelising savings into productive channels.

(c) extension of financial services to rural areas.

(d) making credit to weaker sections of society.

MANAGEMENT OF COMMERCIAL BANKS

Like any other company or corporate body, a banking company also is an artificial person existing only in the eyes of law. It is a separate legal entity without any physical existence of its own. Therefore, like any other company it can act only through a human agency. The human agents through which it will act are known as directors. Collectively, they constitute its Board of Directors. They are the supreme authority in the management of affairs of a company. The Board of Directors have onerous respinsibility of managing public deposits in a way that gives them the confidence. Confidence is the most important asset for a commercial bank. Only through an efficient organisational structure and management the bank can build an image and attract deposits.

Board of Directors

The Board of Directors is the apex management. The Board is more concerned with policy and strategic issues. The routine operations are left with managers/officers. However, ultimate responsibility for efficient operations and management of the banks is with the Board. The Banking Companies (Regulations) Act, 1949 has tried to tone up the administration and management of banks through various amendments from time to time. Section 10A of the amended act states that the majority (not less than 51%) of the persons on the Board, shall have special knowledge of, or practical experience in, accountancy, agriculture, rural economy, co-operation, small-scale industries , banking, finance, law or of such other matters as may be of use to the banking company. These directors should not have any substantial interest in, or active association with, any large or medium sized industrial or business undertaking. Not less than two directors should represent agriculture and rural economy , co-operation and small scale industries. The Chairman of a bank is to be a whole time professional and not an industrialist. His term can not exceed 5 years , but he shall be eligible for re-election or re-appointment.

Prohibitory Provisions

In addition to the provisions of section 10-A , section 10 of the Act provides for following prohibitions regarding the management of banks.

No banking company-

(a) shall employ or be managed by a managing agent, or

(b) shall employ or continue the employment of any person.

(1) who is, or at any time has been, adjudicated insolvent, or had suspended payment or has compounded with his creditors, or who has been convicted by a criminal court of an offence involving moral turpitude, or

(2) whose remuneration or part of whose remuneration takes the form of a commission or of a share in the profits of the company. But this restriction does not extend to the bonus paid to the employees and the commission payable to any broker, cashier, contractor, clearing and forwarding agent, auctioneer or some other person who is not on the regular staff of the bank.

(3) whose remuneration in the opinion of the Reserve Bank is excessive.

(c) shall be managed by any person who (1) is a director of any other company, (2) engaged in any other business or vocation, (3) has a contract with the company for its management for a period exceeding 5 years at any time.

Further section 16 of the act prohibits the appointment of any person as a director who is a director (1) of any other banking company, or (2) of companies which among themselves are entitled to exercise voting rights in excess of 25% of the total voting rights of all the shareholders of the banking company. These provisions, however, do not extend to persons appointed as directors by the Reserve Bank.

Further, the prior permission was made necessary for the appointment , removal or termination of the services of the chairman. The Reserve Bank of India has the power to remove any officer or employee, if it is deemed to be necessary to do so in the interest of the banking policy or in the interest of the public or of the bank or its depositors'. It also has the power to appoint a director or observor on the Board of Directors of a bank.

MANAGEMENT OF NATIONALISED BANKS

After the nationalisation of 14 commercial banks in 1969 , a scheme called The Management of nationalised Banks ( Management and Miscellaneous Provisions ) Scheme 1970' was implemented. The scheme provides that the Board of Directors of a nationalised bank will be composed of 15 members ( including the Chairman ) of the following categories :

(a) One or two wholetime directors.

(b) A director to represent workmen (staff) of the bank.

(c) A director to represent non-workmen (officers) of the bank.

(d) One director to represent the depositors of the bank.

(e) Three directors to represent the interests of farmers, workers and artisans.

(f) Not more than 5 directors having special knowledge or practical experience of one or more matters which are likely to be useful for the working of the banks-they may be industrialists, economists, financial experts, management experts, lawyers, cooperators, etc. ( though this is not so specified in the scheme ).

(g) One director, who will be an official of the Reserve Bank of India , and

(h) One director, who will be an official of the Government of India.

Each of the nationalised banks will have separate officers of the rank of the Chairman and the Chief Executive.

According to this scheme, the managing committee of each bank shall consist of -

(1) the chairman.

(2) the managing director.

(3) directors appointed under clause (g) & (h).

(4) and not more than 4 other directors nominated by the Government holding office for not more than one year at a time.

The chairman and the directors appointed under clause (g) & (h) will be continuing members. Other directors will hold position on managing committee by rotation. The scheme also provided for the constitution of Regional Consultative Committee to advise Government and the RBI , regarding banking problems in respective regions.

The duties of the directors are similar to those of directors of other companies.

PRESENT STRUCTURE OF COMMERCIAL BANKS

The following figure represents the structure of commercial banks in the country.

Commercial banks can be divided into two main categories as mentioned below :

(1) Scheduled banks.

(2) Non-scheduled banks.

1. Scheduled Banks. A scheduled bank is so called because it has been included in the Second Schedule of the Reserve Bank of India Act 1934. To be included in the schedule, a bank must satisfy the following three conditions :

(1) it must have a paid-up capital and reserves of an aggregate value of at least Rs 5 lakhs.

(2) it must satisfy the Reserve Bank that its affairs are not conducted in a manner detrimental to the interest of its depositors , and

(3) it must be a corporation or co-operative society and not a partnership or a single owner firm.

The commercial banking system in India consisted of 297 scheduled banks ( including foreign banks ) and one non-scheduled bank at the end of December 2000. Of the scheduled banks, 223 are in public sector and these account for about 82% of the deposits of all scheduled banks.

2. Non-Scheduled Banks. Banks whose names do not figure in the Second Schedule of the Reserve Bank of India Act are non-scheduled banks. These banks are also subject to the statutory cash reserve requirements. But unlike scheduled banks, they are not required to keep them with the Reserve Bank of India. The category of non-scheduled banks are on the way out . Their numbers was 16 in June 1969 which has decreased to 1 only on June, 1997.

The share of Non-Scheduled Banks (NSBs) has been declining progressively over the years. It has become almost nil now.

Scheduled banks can be further categorised into

(a) Indian banks

(b) Foreign banks

INDIAN BANKS

Indian banks are those banks which are registered or incorporated in the country. These banks are the dominant segment of total commercial banks and have their presence in every nook and corner of the country.

Indian banks can be categorised into :

(1) Public sector banks.

(2) Private sector banks.

1. Public sector banks

Public sector banks dominate commercial banking in India. The Government of India entered commercial banking when it took over the Imperial Bank of India in 1955 and converted it into the State Bank of India on 1 July 1955. Now the State Bank of India had seven subsidiary banks . These banks are collectively known as the State Bank Group. It is notable that the State Bank of India at no stage was wholly owned by the Government of India.

In July 1969, the Government of India took an important step of nationalising 14 large banks. In April 1980 , 1 six more banks were nationalised increasing the number of nationalised banks to 20.

In October 1975 another category was added to the public sector banks in the form of Regional Rural Banks. These banks have been set up with the objective of providing credit and other facilities for agriculture and other productive activities in rural areas. These banks are public sector banks as 50% of their capital is provided by the Central Government , 15% by the State Government concerned and the balance 35% by sponsoring public sector commercial bank.

The public sector commercial banking scene is also undergoing change. The New Bank of India has been merged with the Punjab National Bank. Beginning with Oriental Bank of Commerce more and more banks will be going public by making public issue of capital. The government of India does not want to contribute more to the capital of commercial bank, Therefore, public sector bank will be raising capital by making public issues.

In view of the recommendations in second report (1998) of Narsimham Committee, some mergers or closures may take place in future.

Public sector banks are further classified into :

(1) State Bank of India.

(2) Nationalised Banks.

(3) Regional Rural Banks.

State Bank of India

The public sector commercial banking in India started with setting up of State Bank of India, in 1955, by taking over the Imperial Bank of India. In next 5 years the princely states banks were made associate banks of the State Bank of India. These banks taken together are known as State Bank of India Group or SBI Group.

The State Bank of India was the first one to make a public issue in 1993-94. At present the bank has authorised capital of Rs 1000 crores and the issued subscribed and paid-up capital of the bank is more than Rs 474 crores. After the publuc issue RBI's shareholding has come down to 68.93% from 92%. There is a proposal to bring it down to 33%.

Nationalised Banks

Another important step towards public sector banking was taken in July 1969, when 14 banks with a deposit base of Rs 50 crores or more were nationalised . Again in 1980, six more private sector banks were nationalised bringing up the total number of banks nationalised to twenty.

Out of these banks in 1993-94, New Bank of India was merged with Punjab National Bank.

After the nationalisation of banks, the locus standi of modern banking, has been shifted from the passive traditional commercial role towards the active role of contributing to the social welfare of the country by accelerating the process of economic development. One of the main objectives of nationalisation of the banks was to help achieve balanced regional sectoral and sectional development of the economy by way of making the banks to reach out to the small man and to the remote areas of the country. In other words, it was a measure towards 'mass banking' from 'class banking' enabling them to pay a supportive role in the country's balanced economic development.

The records of aggregate development and innovations of banks after nationalisation are unparellel in the Indian banking history. While in 1969 , the size of population served by a bank branch was 65000, it has come down to nearly 10000. This itself speaks volume of the effort of public sector banks in mobilising the household savings which are so essential for the economic development of the country.

But, this tremendous explosion of activities has thrown out "Waste and inefficiency" as the by product of its operations. The symptoms of malfunctioning have started manifesting during the later half of 1980's and have resulted in undermining the general financial health of the sector. In addition to administered pricing policy and uniformity in most of aspects, number of factors associated with public sectors working can be held responsible for the state of affairs.

Some of the reasons responsible for the strain in the banking sector are :

1.