Banking

(Paper 6 - Module 34)

Developed By:-

CA Tanvi Jain

Banking Page 1
INDEX

 BANKING BASICS
 EVOLUTION OF BANKING
 OVERVIEW OF BANKING SYSTEM
1. INDIAN BANKING SYSTEM
2. FINCTIONS OF BANKS
3. BANKING TECHNOLOGY
4. BANKING PRODUCTS AND SERVICES
 SCHEDULED AND NON- SCHEDULED BANKS
 INDIAN V/S FOREIGN BANKS
 REGULATIONS ON FOREIGN BANKS- INDIAN REGULATOR , DOMESTIC
REGULATOR
 GOVERNMENT AND RBI REGULATIONS
 GENERAL BANKING
 RETAIL BANKING
 CORPORATE BANKING
 GOVERNMENT BUSINESS
 TREASURY
 TRADE FINANCE
 INTERNATIONAL BANKING SYSTEM
 INTERRNATIONAL FUND TRANSFER
 OFFSHORE BANKING
 CAPITAL PLANNING AND CAPITAL ADEQUACY OF BANKS
 LIABILITIES MANAGEMENT( INCLUDING NRI DEPOSITS)
 COST OF FUNDS AND TRANSFER PRICING

Banking Page 2
 BANKING

EVOLUTION OF BANKING

Divine Deposits

Banks have been around since the first currencies were minted, perhaps even before
that, in some form or another. Currency, particularly the use of coins, grew out of
taxation. In the early days of ancient empires, a tax of on healthy pig per year might be
reasonable, but as empires expanded, this type of payment became less desirable.
Additionally, empires began to need a way to pay for foreign goods and services, with
something that could be exchanged more easily. Coins of varying sizes and metals
served in the place of fragile, impermanent paper bills. (To read more about the origins
of money, see What Is Money?, Cold Hard Cash Wars and From Barter To Banknotes.)

Flipping a Coin

These coins, however, needed to be kept in a safe place. Ancient homes didn't have the
benefit of a steel safe, therefore, most wealthy people held accounts at their temples.
Numerous people, like priests or temple workers whom one hoped were both devout
and honest, always occupied the temples, adding a sense of security. There are records
from Greece, Rome, Egypt and Ancient Babylon that suggest temples loaned money
out, in addition to keeping it safe. The fact that most temples were also the financial
centers of their cities, is the major reason that they were ransacked during wars.

Coins could be hoarded more easily than other commodities, such as 300-pound pigs,
so there emerged a class of wealthy merchants that took to lending these coins, with
interest, to people in need. Temples generally handled large loans, as well as loans to
various sovereigns, and these new money lenders took up the rest.

The First Bank

The Romans, great builders and administrators in their own right, took banking out of
the temples and formalized it within distinct buildings. During this time moneylenders
still profited, as loan sharks do today, but most legitimate commerce, and almost all

Banking Page 3
governmental spending, involved the use of an institutional bank. Julius Caesar, in one
of the edicts changing Roman law after his takeover, gives the first example of allowing
bankers to confiscate land in lieu of loan payments. This was a monumental shift of
power in the relationship of creditor and debtor, as landed noblemen were untouchable
through most of history, passing debts off to descendants until either the creditor's or
debtor's lineage died out.

The Roman Empire eventually crumbled, but some of its banking institutions lived on in
the form of the papal bankers that emerged in the Holy Roman Empire, and with the
Knights Of The Temple during the Crusades. Small-time moneylenders that competed
with the church, were often denounced for usury.

Visa Royal

Eventually, the various monarchs that reigned over Europe noted the strengths of
banking institutions. As banks existed by the grace, and occasionally explicit charters
and contracts, of the ruling sovereign, the royal powers began to take loans to make up
for hard times at the royal treasury, often on the king's terms. This easy finance led
kings into unnecessary extravagances, costly wars and an arms race with neighboring
kingdoms that lead to crushing debt. In 1557, Phillip II of Spain managed to burden his
kingdom with so much debt, as the result of several pointless wars, that he caused the
world's first national bankruptcy, as well as the second, third and fourth, in rapid
succession. This occurred because 40% of the country's gross national product (GNP)
was going toward servicing the debt. The trend of turning a blind eye to the
creditworthiness of big customers, continues to haunt banks up into this day and age.

Adam Smith and Modern Banking

Banking was already well established in the British Empire when Adam Smith came
along in 1776 with his "invisible hand" theory. Empowered by his views of a self-
regulated economy, moneylenders and bankers managed to limit the state's
involvement in the banking sector and the economy as a whole. This free market
capitalism and competitive banking found fertile ground in the New World, where the
United States of America was getting ready to emerge. (To learn more, read Economics
Basics.)

In the beginning, Smith's ideas did not benefit the American banking industry. The
average life for an American bank was five years, after which most bank notes from the
defaulted banks became worthless. These state-chartered banks could, after all, only

Banking Page 4
issue bank notes against gold and silver coins they had in reserve. A bank robbery
meant a lot more before, than it does now, in the age of deposit insurance and the
Federal Deposit Insurance Corporation - FDIC. Compounding these risks was the
cyclical cash crunch in America. (To learn more, read Are Your Bank Deposits
Insured?)

Alexander Hamilton, the secretary of the Treasury, established a national bank that
would accept member bank notes at par, thus floating banks through difficult times. This
national bank, after a few stops, starts, cancellations and resurrections, created a
uniform national currency and set up a system by which national banks backed their
notes by purchasing Treasury securities, thus creating a liquid market. Through the
imposition of taxes on the relatively lawless state banks, the national banks pushed out
the competition.

The damage had been done already, however, as average Americans had already
grown to distrust banks and bankers in general. This feeling would lead the state of
Texas to actually outlaw bankers, law that stood until 1904.

Merchant Banks

Most of the economic duties that would have been handled by the national banking
system, addition to regular banking business like loans and corporate finance, fell into
the hands of large merchant banks, because the national banking system was so
sporadic. During this period of unrest that lasted until the 1920s, these merchant banks
parlayed their international connections into both political and financial power. These
banks included Goldman and Sachs, Kuhn, Loeb, and J.P. Morgan and Company.
Originally, they relied heavily on commissions from foreign bond sales from Europe,
with a small backflow of American bonds trading in Europe. This allowed them to build
up their capital.

At that time, a bank was under no legal obligation to disclose its capital reserve amount,
an indication of its ability to survive large, above-average loan losses. This mysterious
practice meant that a bank's reputation and history mattered more than anything. While
upstart banks came and went, these family-held merchant banks had long histories of
successful transactions. As large industry emerged and created the need for corporate
finance, the amounts of capital required could not be provided by any one bank, so
IPOs and bond offerings to the public became the only way to raise the needed capital.

The public in the U.S. and foreign investors in Europe knew very little about investing,
due to the fact that disclosure was not legally enforced. Therefore, these issues were
largely ignored, according to the public's perception of the underwriting banks.

Banking Page 5
Consequently, successful offerings increased a bank's reputation and put it in a position
to ask for more to underwrite an offer. By the late 1800s, many banks demanded a
position on the boards of the companies seeking capital, and, if the management
proved lacking, they ran the companies themselves.

Morgan and Monopoly

J.P. Morgan and Company emerged at the head of the merchant banks during the late
1800s. It was connected directly to London, then the financial center of the world and
had considerable political clout in the United States. Morgan and Co. created U.S.
Steel, AT&T and International Harvester, as well as duopolies and near-monopolies in
the railroad and shipping industries, through the revolutionary use of trusts and a
disdain for the Sherman Anti-Trust Act. (To find out more about this subject, read
Antitrust Defined.)

Although the dawn of the 1900s had well-established merchant banks, it was difficult for
the average American to get loans from them. These banks didn't advertise and they
rarely extended credit to the "common" people. Racism was also widespread and, even
though the Jewish and Anglo-American bankers had to work together on large issues,
their customers were split along clear class and race lines. These banks left consumer
loans to the lesser banks that were still failing at an alarming rate.

The Panic of 1907

The collapse in shares of a copper trust set off a panic that had people rushing to pull
their money out of banks and investments, which caused shares to plummet. Without
the Federal Reserve Bank to take action to calm people down, the task fell to J.P.
Morgan to stop the panic, by using his considerable clout to gather all the major players
on Wall Street to maneuver the credit and capital they controlled, just as the Fed would
do today.

The End of an Era

Ironically, this show of supreme power in saving the U.S. economy ensured that no
private banker would ever again wield that power. The fact that it took J.P. Morgan, a
banker who was disliked by much of America for being one of the robber barons with
Carnegie and Rockefeller, to do the job, prompted the government to form the Federal
Reserve Bank, commonly referred to today as the Fed, in 1913. Although the merchant

Banking Page 6
banks influenced the structure of the Fed, they were also pushed into the background
by it. (To learn about robber barons and other unseemly financial entities, see
Handcuffs And Smoking Guns: The Criminal Elements Of Wall Street.)

Even with the establishment of the Federal Reserve, financial power, and residual
political power, was concentrated in Wall Street. When the First World War broke out,
America became a global lender and replaced London as the center of the financial
world by the end of the war. Unfortunately, a Republican administration put some
unconventional handcuffs on the banking sector. The government insisted that all
debtor nations must pay back their war loans which traditionally were forgiven,
especially in the case of allies, before any American institution would extend them
further credit.

This slowed down world trade and caused many countries to become hostile toward
American goods. When the stock market crashed in on Black Tuesday in 1929, the
already sluggish world economy was knocked out. The Federal Reserve couldn't
contain the crash and refused to stop the depression; the aftermath had immediate
consequences for all banks. A clear line was drawn between being a bank and being an
investor. In 1933, banks were no longer allowed to speculate with deposits and the
FDIC regulations were enacted, to convince the public it was safe to come back. No one
was fooled and the depression continued.

World War II Saves the Day

World War II may have saved the banking industry from complete destruction. WWII,
and the industriousness it generated, lifted the American and world economy back out
of the downward spiral.

For the banks and the Federal Reserve, the war required financial maneuvers using
billions of dollars. This massive financing operation created companies with huge credit
needs that in turn spurred banks into mergers to meet the new needs. These huge
banks spanned global markets. More importantly, domestic banking in the United States
had finally settled to the point where, with the advent of deposit insurance and
mortgages, an individual would have reasonable access to credit.

The Bottom Line

Banks have come a long way from the temples of the ancient world, but their basic
business practices have not changed. Banks issue credit to people who need it, but
demand interest on top of the repayment of the loan. Although history has altered the

Banking Page 7
fine points of the business model, a bank's purpose is to make loans and protect
depositors' money. Even if the future takes banks completely off your street corner and
onto the internet, or has you shopping for loans across the globe, the banks will still
exist to perform this primary function.

INDIAN BANKING SYSTEM

Structure of organized banking industry

Credit: www.wikipedia.com

Banking Page 8
Current Structure

Currently the Indian banking industry has a diverse structure. The present structure of
the Indian banking industry has been analyzed on the basis of its organised status,
business as well as product segmentation.

Organisational Structure

The entire organised banking system comprises of scheduled and non-scheduled

banks. Largely, this segment comprises of the scheduled banks, with the unscheduled
ones forming a very small component. Banking needs of the financially excluded
population is catered to by other unorganised entities distinct from banks, such as,
moneylenders, pawnbrokers and indigenous bankers.

Scheduled Banks

A scheduled bank is a bank that is listed under the second schedule of the RBI Act,
1934. In order to be included under this schedule of the RBI Act, banks have to fulfill
certain conditions such as having a paid up capital and reserves of at least 0.5 million
and satisfying the Reserve Bank that its affairs are not being conducted in a manner
prejudicial to the interests of its depositors. Scheduled banks are further classified into
commercial and cooperative banks. The basic difference between scheduled
commercial banks and scheduled cooperative banks is in their holding pattern.
Scheduled cooperative banks are cooperative credit institutions that are registered
under the Cooperative Societies Act. These banks work according to the cooperative
principles of mutual assistance.

Scheduled Commercial Banks (SCBs):

Scheduled commercial banks (SCBs) account for a major proportion of the business of
the scheduled banks. As at end-March, 2009, 80 SCBs were operational in India. SCBs
in India are categorized into the five groups based on their ownership and/or their
nature of operations. State Bank of India and its six associates (excluding State Bank of
Saurashtra, which has been merged with the SBI with effect from August 13, 2008) are
recognised as a separate category of SCBs, because of the distinct statutes (SBI Act,
1955 and SBI Subsidiary Banks Act, 1959) that govern them. Nationalised banks and
SBI and associates , together form the public sector banks group and control around
70% of the total credit and deposits businesses in India. IDBI ltd. has been included in

Banking Page 9
the nationalised banks group since December 2004. Private sector banks include the
old private sector banks and the new generation private sector banks- which were
incorporated according to the revised guidelines issued by the RBI regarding the entry
of private sector banks in 1993. As at end-March 2009, there were 15 old and 7 new
generation private sector banks operating in India.

Foreign banks are present in the country either through complete branch/subsidiary
route presence or through their representative offices. At end-June 2009, 32 foreign
banks were operating in India with 293 branches. Besides, 43 foreign banks were also
operating in India through representative offices.

Regional Rural Banks (RRBs):

RRBs were set up in September 1975 in order to develop the rural economy by
providing banking services in such areas by combining the cooperative specialty of local
orientation and the sound resource base which is the characteristic of commercial
banks. RRBs have a unique structure, in the sense that their equity holding is jointly
held by the central government, the concerned state government and the sponsor bank
(in the ratio 50:15:35), which is responsible for assisting the RRB by providing financial,
managerial and training aid and also subscribing to its share capital.

Between 1975 and 1987, 196 RRBs were established. RRBs have grown in
geographical coverage, reaching out to increasing number of rural clientele. At the end
of June 2008, they covered 585 out of the 622 districts of the country. Despite growing
in geographical coverage, the number of RRBs operational in the country has been
declining over the past five years due to rapid consolidation among them. As a result of
state wise amalgamation of RRBs sponsored by the same sponsor bank, the number of
RRBs fell to 86 by end March 2009.

Scheduled Cooperative Banks:

Scheduled cooperative banks in India can be broadly classified into urban credit
cooperative institutions and rural cooperative credit institutions. Rural cooperative banks
undertake long term as well as short term lending. Credit cooperatives in most states
have a three tier structure (primary, district and state level).

Banking Page 10
Non-Scheduled Banks:

Non-scheduled banks also function in the Indian banking space, in the form of Local
Area Banks (LAB). As at end-March 2009 there were only 4 LABs operating in India.
Local area banks are banks that are set up under the scheme announced by the
government of India in 1996, for the establishment of new private banks of a local
nature; with jurisdiction over a maximum of three contiguous districts. LABs aid in the
mobilisation of funds of rural and semi urban districts. Six LABs were originally licensed,
but the license of one of them was cancelled due to irregularities in operations, and the
other was amalgamated with Bank of Baroda in 2004 due to its weak financial position.

Banking Page 11
FUNCTION OF BANKS:

A. Primary Functions of Banks

The primary functions of a bank are also known as banking functions. They are the
main functions of a bank.

These primary functions of banks are explained below.

1. Accepting Deposits
The bank collects deposits from the public. These deposits can be of different
types, such as:-

a) Saving Deposits
b) Fixed Deposits
c) Current Deposits
d) Recurring Deposits

Banking Page 12
a. Saving Deposits

This type of deposits encourages saving habit among the public. The rate of interest is
low. At present it is about 5% p.a. Withdrawals of deposits are allowed subject to certain
restrictions. This account is suitable to salary and wage earners. This account can be
opened in single name or in joint names.

b. Fixed Deposits

Lump sum amount is deposited at one time for a specific period. Higher rate of interest
is paid, which varies with the period of deposit. Withdrawals are not allowed before the
expiry of the period. Those who have surplus funds go for fixed deposit.

c. Current Deposits

This type of account is operated by businessmen. Withdrawals are freely allowed. No

interest is paid. In fact, there are service charges. The account holders can get the
benefit of overdraft facility.

d. Recurring Deposits

This type of account is operated by salaried persons and petty traders. A certain sum of
money is periodically deposited into the bank. Withdrawals are permitted only after the
expiry of certain period. A higher rate of interest is paid.

2. Granting of Loans and Advances

The bank advances loans to the business community and other members of the public.
The rate charged is higher than what it pays on deposits. The difference in the interest
rates (lending rate and the deposit rate) is its profit.

The types of bank loans and advances are :-

a) Overdraft
b) Cash Credits
c) Loans
d) Discounting of Bill of Exchange

Banking Page 13
a. Overdraft

This type of advances are given to current account holders. No separate account is
maintained. All entries are made in the current account. A certain amount is sanctioned
as overdraft which can be withdrawn within a certain period of time say three months or
so. Interest is charged on actual amount withdrawn. An overdraft facility is granted
against a collateral security. It is sanctioned to businessman and firms.

b. Cash Credits

The client is allowed cash credit upto a specific limit fixed in advance. It can be given to
current account holders as well as to others who do not have an account with bank.
Separate cash credit account is maintained. Interest is charged on the amount
withdrawn in excess of limit. The cash credit is given against the security of tangible
assets and / or guarantees. The advance is given for a longer period and a larger
amount of loan is sanctioned than that of overdraft.

c. Loans

It is normally for short term say a period of one year or medium term say a period of five
years. Now-a-days, banks do lend money for long term. Repayment of money can be in
the form of installments spread over a period of time or in a lumpsum amount. Interest is
charged on the actual amount sanctioned, whether withdrawn or not. The rate of
interest may be slightly lower than what is charged on overdrafts and cash credits.
Loans are normally secured against tangible assets of the company.

d. Discounting of Bill of Exchange

The bank can advance money by discounting or by purchasing bills of exchange both
domestic and foreign bills. The bank pays the bill amount to the drawer or the
beneficiary of the bill by deducting usual discount charges. On maturity, the bill is
presented to the drawee or acceptor of the bill and the amount is collected.

B. Secondary Functions of Banks:

The bank performs a number of secondary functions, also called as non-banking

functions.

These important secondary functions of banks are explained below

Banking Page 14
1. Agency Functions

The bank acts as an agent of its customers. The bank performs a number of agency
functions which includes:-

a. Transfer of Funds
b. Collection of Cheques
c. Periodic Payments
d. Portfolio Management
e. Periodic Collections
f. Other Agency Functions

a. Transfer of Funds

The bank transfer funds from one branch to another or from one place to another.

b. Collection of Cheques

The bank collects the money of the cheques through clearing section of its customers.
The bank also collects money of the bills of exchange.

c. Periodic Payments

On standing instructions of the client, the bank makes periodic payments in respect of
electricity bills, rent, etc.

d. Portfolio Management

The banks also undertakes to purchase and sell the shares and debentures on behalf of
the clients and accordingly debits or credits the account. This facility is called portfolio
management.

e. Periodic Collections

The bank collects salary, pension, dividend and such other periodic collections on
behalf of the client.

f. Other Agency Functions

They act as trustees, executors, advisers and administrators on behalf of its clients.
They act as representatives of clients to deal with other banks and institutions.

Banking Page 15
2. General Utility Functions

The bank also performs general utility functions, such as :-

a. Issue of Drafts, Letter of Credits, etc.

b. Locker Facility
c. Underwriting of Shares
d. Dealing in Foreign Exchange
e. Project Reports
f. Social Welfare Programs
g. Other Utility Functions

a. Issue of Drafts and Letter of Credits

Banks issue drafts for transferring money from one place to another. It also issues letter
of credit, especially in case of, import trade. It also issues travellers'cheques.

b. Locker Facility

The bank provides a locker facility for the safe custody of valuable documents, gold
ornaments and other valuables.

c. Underwriting of Shares

The bank underwrites shares and debentures through its merchant banking division.

d. Dealing in Foreign Exchange

The commercial banks are allowed by RBI to deal in foreign exchange.

e. Project Reports

The bank may also undertake to prepare project reports on behalf of its clients.

f. Social Welfare Programmes

It undertakes social welfare programmes, such as adult literacy programmes, public

welfare campaigns, etc.

g. Other Utility Functions

It acts as a referee to financial standing of customers. It collects creditworthiness

information about clients of its customers. It provides market information to its
customers, etc. It provides travellers' cheque facility.

Banking Page 16
BANKING TECHNOLOGY

Information technology is one of the most important facilitators for the transformation of
the Indian banking industry in terms of its transactions processing as well as for various
other internal systems and processes. The various technological platforms used by
banks for the conduct of their day to day operations, their manner of reporting and the
way in which interbank transactions and clearing is affected has evolved substantially
over the years.

The technological evolution of the Indian banking industry has been largely directed by
the various committees set up by the RBI and the government of India to review the
implementation of technological change. No major breakthrough in technology
implementation was achieved by the industry till the early 80s, though some working
groups and committees made stray references to the need for mechanization of some
banking processes. This was largely due to the stiff resistance by the very strong bank
employees unions. The early 1980s were instrumental in the introduction of
mechanisation and computerisation in Indian banks. This was the period when banks as
well as the RBI went very slow on mechanisation, carefully avoiding the use of
‗computers‘ to avoid resistance from employee unions. However, this was the critical
period acting as the icebreaker, which led to the slow and steady move towards large
scale technology adoption.

Banking Page 17
Computerisation

The process of computerisation marked the beginning of all technological initiatives in

the banking industry. Computerisation of bank branches had started with installation of
simple computers to automate the functioning of branches, especially at high traffic
branches. Thereafter, Total Branch Automation was in use, which did not involve bank
level branch networking, and did not mean much to the customer.

Satellite Banking

Satellite banking is also an upcoming technological innovation in the Indian banking

industry, which is expected to help in solving the problem of weak terrestrial
communication links in many parts of the country. The use of satellites for establishing
connectivity between branches will help banks to reach rural and hilly areas in a better
way, and offer better facilities, particularly in relation to electronic funds transfers.
However, this involves very high costs to the banks.

Development of Distribution Channels

The major and upcoming channels of distribution in the banking industry, besides
branches are ATMs, internet banking, mobile and telephone banking and card based
delivery systems.

Automatic Teller Machines

ATMs were introduced to the Indian banking industry in the early 1990s initiated by
foreign banks. Most foreign banks and some private sector players suffered from a
serious handicap at that time- lack of a strong branch network. ATM technology was
used as a means to partially overcome this handicap by reaching out to the customers
at a lower initial and transaction costs and offering hassle free services. Since then,
innovations in ATM technology have come a long way and customer receptiveness has
also increased manifold. Public sector banks have also now entered the race for
expansion of ATM networks. Development of ATM networks is not only leveraged for
lowering the transaction costs, but also as an effective marketing channel resource.

Banking Page 18
Growth of ATM network in India

Introduction of Biometrics

Banks across the country have started the process of setting up ATMs enabled with
biometric technology to tap the potential of rural markets. A large proportion of the
population in such centers does not adopt technology as fast as the urban centers due
to the large scale illiteracy. Development of biometric technology has made the use of
self service channels like ATMs viable with respect to the illiterate population.

Multilingual ATMs

Installation of multilingual ATMs has also entered pilot implementation stage for many
large banks in the country. This technological innovation is also aimed at the rural
banking business believed to have large untapped potential. The language diversity of
India has proved to be a major impediment to the active adoption of new technology,
restrained by the lack of knowledge of English.

Multifunctional ATMs

Multifunctional ATMs are yet to be introduced by most banks in India, but have already
been recognized as a very effective means to access other banking services.
Multifunctional ATMs are equipped to perform other functions, besides dispensing cash
and providing account information. Mobile recharges, ticketing, bill payment, and

Banking Page 19
advertising are relatively new areas that are being explored via multifunctional ATMs,
which have the potential to become revenue generators for the banks by effecting sales,
besides acting as delivery channels. Most of the service additions to the ATM route
require specific approval from the regulator.

ATM Network Switches

ATM switches are used to connect the ATMs to the accounting platforms of the
respective banks. In order to connect the ATM networks of different banks, apex level
switches are required that connect the various switches of individual banks. Through
this technology, ATM cards of one bank can be used at the ATMs of other banks,
facilitating better customer convenience. Under the current mechanism, banks owning
the ATM charge a fee for allowing the customers of some other bank to access its ATM.

Internet Banking

Internet banking in India began taking roots only from the early 2000s. Internet banking
services are offered in three levels. The first level is of a bank‘s informational website,
wherein only queries are handled; the second level includes Simple Transactional
Websites, which enables customers to give instructions, online applications and balance
enquiries. Under Simple Transactional Websites, no fund based transactions are
allowed to be conducted. Internet banking in India has reached level three, offering Fully
Transactional Websites, which allow for fund transfers and various value added
services.

Phone Banking and Mobile Banking

Phone and mobile banking are a fairly recent phenomenon for the Indian banking
industry. There exist operative guidelines and restrictions on the type and quantum of
transactions that can be undertaken via this route. Phone banking channels function
through an Interactive Voice Response System (IVRS) or telebanking executives of the
banks.

Card Based Delivery Systems

Among the card based delivery mechanisms for various banking services, are credit
cards, debit cards, smart cards etc. These have been immensely successful in India

Banking Page 20
since their launch. Penetration of these card based systems have increased manifold
over the past decade. Aided by expanding ATM networks and Point of Sale (POS)
terminals, banks have been able to increase the transition of customers towards these
channels, thereby reducing their costs too.

Payment and Settlement Systems

The innovations in technology and communication infrastructure in recent years have

impacted banks in a large way through the development of payment and settlement
systems, which are central to the major portion of the businesses of banks.

Paper Based Clearing Systems

Among the most important improvement in paper based clearing systems was the
introduction of MICR technology in the mid 1980s. Though improvements continued to
be made in MICR enabled instruments, the major transition is expected now, with the
implementation of the Cheque Truncation System for the processing of cheques.

Cheque Clearing in India (Volume)

Cheque Truncation System (CTS)

Truncation is the process of stopping the movement of the physical cheque which is to
be truncated at some point en-route to the drawee branch and an electronic image of

Banking Page 21
the cheque would be sent to the drawee branch along with the relevant information like
the MICR fields, date of presentation, presenting banks etc. Thus, the CTS reduces the
probability of frauds, reconciliation problems, logistics problems and the cost of
collection.

Electronic Clearing Service

The Electronic Clearing Service (ECS) introduced by the RBI in 1995, is akin to the
Automated Clearing House system that is operational in certain other countries like the
US. ECS has two variants- ECS debit clearing and ECS credit clearing service. ECS
credit clearing operates on the principle of ‗single debit multiple credits‘ and is used for
transactions like payment of salary, dividend, pension, interest etc.

ECS Transactions (Volume)

Electronic Funds Transfer Systems

The launch of the electronic funds transfer mechanisms began with the Electronic
Funds Transfer (EFT) System. The EFT System was operationalised in 1995 covering
15 centres where the Reserve Bank managed the clearing houses.

Special EFT (SEFT) scheme, a variant of the EFT system, was introduced with effect
from April 1, 2003, in order to increase the coverage of the scheme and to provide for
quicker funds transfers. SEFT was made available across branches of banks that were
computerised and connected via a network enabling transfer of electronic messages to
the receiving branch in a straight through manner (STP processing). In the case of EFT,

Banking Page 22
all branches of banks in the 15 locations were part of the scheme, whether they are
networked or not.

RTGS

The other payment and settlement systems deployed were mostly aimed at small value
repetitive transactions, largely for the retail transactions. The introduction of RTGS in
2004 was instrumental in the development of infrastructure for Systemically Important
Payment Systems (SIPS).

Progress in RTGS transactions

Technology Vendors

Many Indian banks handled technological issues in house till the late 1990s. Thereafter,
the complications of the business necessitated the engagement of specialized vendors
to handle complex issues. Due to the complexities involved, most banks now prefer to
engage IT vendors to introduce specialized softwares to help in their risk management
systems, retail and corporate banking, card management systems, complete back office
support including data management systems.

Banking Page 23
SCHEDULED AND NON- SCHEDULED BANKS

Criteria for Scheduled Banks

Scheduled banks are Indian banks that comply with the classifications defined in the
Second Schedule of the 1934 act. Criteria include paid-up capital, reserves, total value
and certification by the RBI ensuring their fiduciary responsibilities to depositors. They
include several nationalized banks, the State Bank of India, Regional Rural Banks and
scheduled co-operative banks.

Criteria for Non-Scheduled Banks

Non-scheduled banks are depository or lending institutions that do not meet the Second
Schedule of Reserve Bank of India Act. These banks may be legal entities, but they do
not have procedural endorsement of the government. Non-scheduled banks are not just
identified as banks that do not meet the criteria in the Second Schedule of the 1934 Act;
they are defined in Section 5, clause C of the Banking Regulation Act of 1949.

SCHEDULED BANKS

Scheduled Banks in India constitute those banks which have been included in the
Second Schedule of Reserve Bank of India(RBI) Act, 1934. RBI in turn includes only
those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a)
of the Act.

The banks included in this schedule list should fulfil two conditions.

1. The paid capital and collected funds of bank should not be less than Rs. 5 lac.

2.Any activity of the bank will not adversely affect the interests of depositors.

Every Scheduled bank enjoys the following facilitiess.

1. Such bank becomes eligible for debts/loans on bank rate from the RBI

2. Such bank automatically acquire the membership of clearing house.

The following are the Scheduled Banks in India (Public Sector):

Banking Page 24
  State Bank of India
 State Bank of Bikaner and Jaipur
 State Bank of Hyderabad
 State Bank of Indore
 State Bank of Mysore
 State Bank of Saurashtra
 State Bank of Travancore
 Andhra Bank
 Allahabad Bank
 Bank of Baroda
 Bank of India
 Bank of Maharashtra
 Canara Bank
 Central Bank of India
 Corporation Bank
 Dena Bank
 Indian Overseas Bank
 Indian Bank
 Oriental Bank of Commerce
 Punjab National Bank
 Punjab and Sind Bank
 Syndicate Bank
 Union Bank of India
 United Bank of India
 UCO Bank
 Vijaya Bank

The following are the Scheduled Banks in India (Private Sector):

 ING Vysya Bank Ltd

 Axis Bank Ltd
 Indusind Bank Ltd
 ICICI Bank Ltd
 South Indian Bank
 HDFC Bank Ltd
 Centurion Bank Ltd
 Bank of Punjab Ltd
 IDBI Bank Ltd

Banking Page 25
  YES Bank Ltd

The following are the Scheduled Foreign Banks in India:

 American Express Bank Ltd.

 ANZ Gridlays Bank Plc.
 Bank of America NT & SA
 Bank of Tokyo Ltd.
 BanqucNationale de Paris
 Barclays Bank Plc
 Citi Bank N.C.
 Deutsche Bank A.G.
 Hongkong and Shanghai Banking Corporation
 Standard Chartered Bank.
 The Chase Manhattan Bank Ltd.
 Dresdner Bank AG.

Credit: www.wikipedia.com

Banking Page 26
REGULATIONS ON FOREIGN BANKS

Obstacles Facing Foreign Banks

Foreign Banks looking to start operations in India are likely to face challenges that are
both unique and specific to any foreign entity that wants to do business in India. The
difference is that the risks associated with setting up and operating a bank will be far
greater than in any other type of business.

Regulatory Issues

For any bank looking to start operations in India – foreign or domestic – compliance with
stringent RBI regulations is a major challenge. For example: No differential licensing —
The RBI does not encourage banks whose business model doesnot take into account
the RBI‘s objective of financial inclusion. Thus, foreign banks that are looking to offer
very specialized banking services in India must apply for a universal banking license
that mandates the roll-out of full-fledged banking services in the country. Consequently,
giving precedence to financial inclusion may not be viable for all foreign banks entering
the banking sector. However, this issue might be resolved soon.

The RBI‘s discussion paper, ―Banking Structure in India – The Way Forward‖ (August,
2013),9 supports differential licensing for banks in India, and mentions that this is a
―desirable step‖ in a changing economic environment.

Financial inclusion — Complying with the RBI‘s guidelines on financial inclusion

requires offering banking products and services to unbanked and under banked areas
and customers. This involves costs that foreign banks with few branches and fewer
sources of raising low cost funds may find difficult to implement. As of 31 March 2013,
out of the 331 branches of foreign banks in India, only 17 were located in the rural and
semi-urban areas. Out of the total 1,261 ATMs set up by foreign banks, only 51 were in
rural and semi-urban areas.10 More stringent monitoring and follow-up by regulators
may slightly rectify this skewed ratio. However, a better solution would be to evolve a
business model that enables foreign banks to benefit from opening rural/ semi-urban
branches.

Priority sector lending (PSL) — Foreign banks with less than 20 branches are
supposed to lend to the priority sector to the extent of 32% of Adjusted Net Bank Credit
Banking Page 27
(ANBC). For banks that have 20 or more branches, this figure stands at 40%. Lending
to the priority sector includes lending to agriculture, micro and small enterprises, and
providing export credit and advances to weaker sections of the society. Meeting PSL
targets is especially difficult for foreign banks, given the high NPAs and defaults
associated with this sector.11, 12 To ease the impact of PSL targets, the Nair
committee (formed in 2011 to re-examine the existing classification and suggest revised
guidelines with regard to priority sector lending and related issues) recommended that
foreign banks with more than 20 branches achieve PSL targets over a period of five
years, starting April 1, 2013. Banks must share a relevant action plan with the RBI.

Setting up a wholly owned banking subsidiary (WOS) — Currently, foreign banks in

India operate as branches of the parent bank located overseas. However RBI has
recently released guidelines for setting up wholly owned subsidiaries (WOS) by foreign
banks in India. A WOS would have to be in the form of a locally incorporated entity.
These new guideline swill result in banks losing the advantages of a branch structure
(greater operational flexibility, support from the parent, reduced corporate governance
requirements, etc.). Such new entities are also likely to attract significant tax liabilities
that arise with operating a WOS.13

Longer gestation period —Traditionally, the RBI has been tight-fisted about issuing
banking licenses. Banking licenses in the private sector were last issued in 2003; new
licenses will likely be issued in 2014. Licenses for foreign banks are even harder to
come by due to the complexities involved. Apart from regulatory issues, licenses to
foreign banks are issued on the basis of relations between India and the home country
of the foreign bank, and reciprocal arrangements between the banking regulators of
both countries. This results in a wide time gap from applying for and eventually getting
the license. In the interim, the cost of setting up and operating a bank in India is likely to
go up substantially, and may require a rework of the business plan. The proposed
banking sector reforms may provide a solution in the form of banking licenses ―on tap.‖

Marketplace Challenges

Foreign banks have to factor in the challenges they are likely to encounter from the
Indian banking environment, as well as the unique market in which they are expected to
operate:

Banking Page 28
Diverse banking environment — As of March 31, 2009, India housed 27 public sector
banks; seven new private sector banks; 15 old private sector banks; 31 foreign banks;
86 Regional Rural Banks (RRBs); four Local Area Banks (LABs); 1,721 urban
cooperative banks; 31 state cooperative banks, and 371 district central cooperative
banks. As of March 31, 2013, the number of foreign banks operating in India hadrisen to
43. Any foreign bank planning to enter India faces intense competition from existing
players with a large network of branches/ATMs

and a largely loyal customer base. Currently, foreign banks are prohibited from starting
operations in India‘s Tier 3 - Tier 6 towns and cities. The proposed guidelines14 may
remove this restriction. This could be an opportunity for foreign banks, as existing
players may not have a significant presence in such areas. However, apart from the
difficulty in achieving financial viability in those locations, new players will also face
competition from non-banking finance corporations (NBFCs), credit cooperative
societies and individual money lenders operating beyond the scope of regulations –
hindering any formal set-up.

Unique product mix — Products offered by banks in India are generally skewed
towards the retail banking business; for most banks, the retail customer is their primary
source of cheap funds and fee income. What the retail customer cannot make in value
is made up in volume. As a result, product innovation also focuses on these customers.
For foreign banks that derive value largely from specialized banking services, such as
private banking, investment banking, trade finance and the like, it is a challenge to offer
innovative retail banking products, since domestic competitors already offer them. Also,
products offered by foreign banks in their home countries may not be permitted by the
regulator in India.

Social Issues

Acknowledging and overcoming social challenges is vital for a bank operating in a

foreign country. Among these:

Social integration — Even today, a lot of banking in India is carried out on the basis of
relationships and trust. For example, customers expect the bank to contact them when
the balance in their account is insufficient to cover a check they issued, even though
banks are not obligated to do so. Such practices may not fit the model for foreign banks.
The bank would also need to understand the complex guidelines that are issued by the

Banking Page 29
RBI from time and time, and how they apply to their institution. The RBI, especially in
the case of regulatory reporting, is known to leave it to banks‘ discretion to accurately
report numbers.

Master Circulars – a one-point reference of instructions issued by the Reserve Bank of

India on a particular subject between July- June15 – can often be vague. In such cases,
foreign banks need to understand and follow industry best practices.

Conflicting objectives — The reason behind RBI‘s stated objective of giving out new
banking licenses – whether to domestic or foreign entities – is to promote financial
inclusion. The CRISIL Inclusive score, which measures financial inclusion on three
parameters – branch penetration, deposit penetration and credit penetration – stands at
40.1 for banks in India, which is quite low. India‘s six largest cities have 11% of the total
bank branches, while regions such as the Northeast are severely under banked (four
districts in the Northeast have just one bank branch among them). Foreign banks will
find it difficult to balance this objective with the expectations of their stakeholders and
their own reasons for starting Indian operations.

Branding and publicity — As mentioned earlier, a lot of banking in India is based on

relationships and trust. In this regard, public sector banks, on account of their
government antecedents, tend to score heavily over private sector and foreign banks.
Foreign banks especially are associated with high costs and fees and aggressive
marketing tactics, and are more prone to upheavals in the global financial markets.
Foreign banks looking to enter India will need to counter this perception with smart and
effective branding. They can highlight their strengths, such as technology
advancements in banking, a better understanding of financial markets and/or a proven
track record in various geographies.

Infrastructure Issues

Foreign banks entering India are likely to face infrastructure challenges in terms of
systems and branch infrastructure.

System challenges — Banks in India already use some of the best core banking
solutions available on the market. Since retail and commercial banking are the most
developed lines of business (LOBs) in India, innovation and product implementation
concentrate on these areas. Foreign Banks with robust private banking, wealth
management, Anti Money Laundering (AML), trade finance, and investment banking

Banking Page 30
systems and processes may not find much use for them until the market attains a
certain level of maturity. The current volume of transactions in these areas may not
justify implementation of the systems.

Branch infrastructure — The number of branch walk-ins in Indian banks is much

higher compared to other countries, where the focus is on keeping customers engaged
through channels such as the Internet, phone and mobile banking. Foreign banks will
need to develop an infrastructure (both physical and human) equipped to handle more
footfalls. Additionally, setting up a new infrastructure and processes takes much longer
in the Indian banking scenario. A good example is CTS (Cheque Truncation System),
which has yet to be implemented across the country – even 10 years after the pilot
program was launched.

Banking Page 31
MAIN RBI FUNCTIONS:

Monetary Authority:

 Formulates, implements and monitors the monetary policy.

 Objective: maintaining price stability and ensuring adequate flow of credit to
productive sectors.

Regulator and supervisor of the financial system:

 Prescribes broad parameters of banking operations within which the country's

banking and financial system functions.
 Objective: maintain public confidence in the system, protect depositors' interest
and provide cost-effective banking services to the public.

Manager of Foreign Exchange

 Manages the Foreign Exchange Management Act, 1999.

 Objective: to facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in India.

Issuer of currency:

 Issues and exchanges or destroys currency and coins not fit for circulation.
 Objective: to give the public adequate quantity of supplies of currency notes and
coins and in good quality.

Developmental role

Performs a wide range of promotional functions to support national objectives.

Related Functions

 Banker to the Government: performs merchant banking function for the central
and the state governments; also acts as their banker.
 Banker to banks: maintains banking accounts of all scheduled banks.

Banking Page 32
General Banking

General Banking consists the management of deposit, cash, clearing house, bills,
account opening, security instruments handling, customer services, locker facilities and
other ancillary services of the bank besides Advance and Foreign Trade.

General Banking Services-

■Current Account
■Savings Account
■Time Deposit
■Scheme Deposits
■Bank Certification
■Wealth Management Service
■Other Services

Types of Deposits
Deposit is the major source of fund for commercial banks. The deposit-mix may be
categorized in the following manner

(a) No-cost deposit

(b) Low-cost deposit
(c) High-cost deposit.

Opening of bank account requires different types of prescribed forms/ documents for
different nature of accounts. The account-holders or authorized signatories are allowed
to operate their bank account on the basis of instruction given by them at the time of
opening of account.

1. INDIVIDUAL ACCOUNT

An individual can open an account under the following terms and conditions:

01. Name of the branch and date

02. Account number

03. Name of the account: in Bengali and in English (capital letter)

04. Type of account

05. Father‘s name

06. Mother‘s name

Banking Page 33
07. Husband / Wife‘s name

08. Currency

09. Special Instruction of the account holder

10. Present address

11.Permanent address

12. Date of birth

13. Occupation

14. National ID number

15. Passport number, if any

16. Driving license, if any

17. Tax ID number (TIN)

18. Vat registration number, if any

19. Other accounts of the customer, if any

20. Introducer‘s details

21.Two copies of photograph attested by the introducer

22. Initial deposit

23. Nominee Information

24. Source of Fund

25. KYC profile form

26. TP (transaction profile)

27. Declaration and Signature

28. Signature of the Authorised Officer

29. Specimen Signature Card

30. Cheque Requisition Slip

31. Other Terms and Conditions

Banking Page 34
2. JOINT ACCOUNT

1. The account should be opened only on receiving application signed by all persons.

2. The Bank should obtain specific directions as to whether one or more of the joint
accountholders shall operate the account.

3. A joint account holder cannot delegate his authority to operate the account

4. When the intention is that all joint accountholders should jointly operate the account:
the account shall be operated by all jointly.

5. When the intention is that any one can operate the account: the account shall be
operated by either or survivor.

6. In case of partnership firm the clause will be : All partners to operate jointly or Any
one partner can operate the account.

7. The authority of operation in the joint account shall stand automatically revoked on
account of death, insanity or insolvency of any person giving the authority.

8. In case of death of one or more joint accountholders, any balance in the account is
payable to the legal representative.

9. In case of a joint accountholder dies while the account is showing a debit balance, his
legal representative jointly with the surviving joint accountholders remain liable for the
debt.

10. Any other formalities as contained under Individual account will be applicable.

3. Sole-Proprietorship Firm:

A sole-proprietorship firm is a business concern carried on by an individual owner in a

trade name.

Formalities/ Guidelines:

(a) The title of the account shall be in the name of the business establishment;

(b) A declaration should be obtained from the owner of the firm to the effect that he is
the sole- proprietor and no other person has any interest in the business as partner or
otherwise.

Banking Page 35
 (c) The declaration should also contain that the owner, as the proprietor, will be
personally liable for all dealings and obligation in the name of the business.

(d) Specimen signature should be obtained on the specimen signature card.

(e) Seal of the proprietor of the firm to be affixed.

(f) Other formalities:

4. Partnership Firm:

Partnership arises of the contract between persons and by virtue of this contract , they
associate themselves with a business.

Formalities and Guidelines:

(a) The title of the account should be in the name of the firm.

(b) Special Instruction should be specific in the account opening form.

( c) The Authorized persons should sign on the specimen signature card.

(d) The letter of partnership should be signed by all the partners to the effect that they
are jointly and severally liable for the debts of the firm.

(e) Valid Trade License.

(f) Partnership deed ( if registered, registration certificate to be obtained).

(g) VAT Registration (if any).

(h) Any partner, on behalf of the partnership firm, is empowered to sign on the
document.

(i) Any partner, on behalf of the partnership firm, is authorized to borrow money.

(j) A partnership firm is dissolved on the death, insanity and insolvency of a partner.

(k) A partner relinquishes his responsibility on being retired.

(l) Other formalities as stated under proprietorship firm.

Banking Page 36
5. Joint Stock Company:

A company means a company formed and registered under Companies Act 1913 as
revised in 1994.

Types of Company:

(a) Private Limited Company

(b) Public Limited Company

1 Company Limited by Shares

2 Company Limited by Guarantee

Formalities and Guidelines:

(a) The title should be in the name of the company.

(b) Special Instructions should be specifically spelled out in the application form as per
resolution of the board / Memorandum of Association.

(c) Signature of the Authorized Person as per resolution of the board / Memorandum of
Association.

(d) Memorandum of Association.

(e) Articles of Association.

6. Club, Society, School, College, University etc.

Formalities and Guidelines:

(a) The title should be in the name of the respective institution.

(b) Rules / By-laws of the institution.

(c) Copy of Resolution of meeting of Managing Committee / Governing Body for

operation in the account.

Banking Page 37
5. Autonomous / Local Bodies:

Formalities and Guidelines:

(a) The title should be in the name of the respective authorities.

(b) Special Act or Statutes should be referred to regarding formation and constitution of
the organization.

(c) Specific Instructions should be noted for selection of bank regarding dealing with its
funds.

(d) Specific Rules and Special Instructions regarding mode of operation of the account.

Banking Page 38
RETAIL BANKING:

Retail banking is when a bank executes transactions directly with consumers, rather
than corporations or other banks. Services offered include savings and transactional
accounts, mortgages, personal loans, debit cards, and credit cards. The term is
generally used to distinguish these banking services from investment banking,
commercial banking or wholesale banking. It may also be used to refer to a division of a
bank dealing with retail customers and can also be termed as Personal Banking
services.

Products

Typical products offered by a retail bank include:

 Transactional accounts

1. Checking accounts (American english)

2.Current accounts (British english)

 Savings accounts
 Debit cards
 ATM cards
 Credit cards
 Traveler's cheques
 Mortgages
 Home equity loans
 Personal loans
 Certificates of deposit/Term deposits

In some countries, such as the US, they may also offer more specialized accounts such
as:

 Sweep accounts
 Money market accounts
 Individual Retirement Accounts (IRA's)

Banking Page 39
Products and Services – Corporate Banking

The corporate banking segment of banks typically serves a diverse range of clients,
ranging from small to mid-sized local businesses with a few millions in revenues to large
conglomerates with billions in sales and offices across the country. Commercial banks
offer the following products and services to corporations and other financial institutions:

•Loans and other credit products – this is typically the biggest area of business within
corporate banking, and as noted earlier, one of the biggest sources of profit and risk for
a bank.

•Treasury and cash management services – used by companies for managing their
working capital and currency conversion requirements.

•Equipment lending – commercial banks structure customized loans and leases for a
range of equipment used by companies in diverse sectors such as manufacturing,
transportation and information technology.

•Commercial real estate – services offered by banks in this area include real asset
analysis, portfolio evaluation, debt and equity structuring.

•Trade finance – involves letters of credit, bill collection, and factoring.

•Employer services – services such as payroll and group retirement plans are typically
offered by specialized affiliates of a bank.

Through their investment banking arms, commercial banks also offer related services to
their corporate clients, such as asset management and securities underwriters.

TREASURY BANKING

Treasury management (or treasury operations) includes management of an enterprise's

holdings, with the ultimate goal of maximizing the firm's liquidity and mitigating its
operational, financial and reputational risk. Treasury Management includes a firm's
collections, disbursements, concentration, investment and funding activities. In larger
firms, it may also include trading in bonds, currencies, financial derivatives and the
associated financial risk management.

Most banks have whole departments devoted to treasury management and supporting
their clients' needs in this area. Until recently, large banks had the stronghold on the
provision of treasury management products and services. However, smaller banks are
increasingly launching and/or expanding their treasury management functions and
offerings, because of the market opportunity afforded by the recent economic

Banking Page 40
environment (with banks of all sizes focusing on the clients they serve best), availability
of (recently displaced) highly-seasoned treasury management professionals, access to
industry standard, third-party technology providers' products and services tiered
according to the needs of smaller clients, and investment in education and other best
practices.

For non-banking entities, the terms Treasury Management and Cash Management are
sometimes used interchangeably, while, in fact, the scope of treasury management is
larger (and includes funding and investment activities mentioned above). In general, a
company's treasury operations comes under the control of the CFO, Vice-President /
Director of Finance or Treasurer, and is handled on a day to day basis by the
organization's treasury staff, controller, or comptroller.

Bank Treasuries may have the following departments:

A Fixed Income or Money Market desk that is devoted to buying and selling interest
bearing securities

A Foreign exchange or "FX" desk that buys and sells currencies

A Capital Markets or Equities desk that deals in shares listed on the stock market. In
addition the Treasury function may also have a Proprietary Trading desk that conducts
trading activities for the bank's own account and capital, an Asset liability management
(ALM) desk that manages the risk of interest rate mismatch and liquidity; and a Transfer
pricing or Pooling function that prices liquidity for business lines (the liability and asset
sales teams) within the bank.

Banks may or may not disclose the prices they charge for Treasury Management
products, however the Phoenix Hecht Blue Book of Pricing may be a useful source of
regional pricing information by product or service.

Banking Page 41
TRADE FINANCE

Trade Finance is basically related to 'Domestic as well as International Trade

Transaction'.

The term "Trade Finance" means, finance for Trade. For a trade transaction there
should be a Seller to sell the goods or services and a Buyer who will buy the goods or
use the services. Various intermediaries such as (banks), (Financial Institutions) can
facilitate this trade transaction by financing the trade.

While a seller (the exporter) can require the purchaser (an importer) to prepay for goods
shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to
document the goods that have been shipped. Banks may assist by providing various
forms of support. For example, the importer's bank may provide a letter of credit to the
exporter (or the exporter's bank) providing for payment upon presentation of certain
documents, such as a bill of lading. The exporter's bank may make a loan (by
advancing funds) to the exporter on the basis of the export contract.

Other forms of trade finance can include Documentary Collection, Trade Credit
Insurance, Factoring or Forfaiting. Some forms are specifically designed to supplement
traditional financing.

Since secure trade finance depends on verifiable and secure tracking of physical risks
and events in the chain between exporter and importer, the advent of new
methodologies in the information systems world, has allowed the development of risk
mitigation models which have developed into new advanced finance models. This
allows very low risk of advance payment given to the Exporter, while preserving the
Importer's normal payment credit terms and without burdening the Importer's Balance
Sheet. As the world progresses towards more flexibility and growth in Trade
Transactions, the demand for these new methodologies has increased amongst
Exporters, Importers and Banks.

The following are the most famous products/services offered by various Banks and
Financial Institutions in Trade Finance Segment.

1. Letter of Credit: It is an undertaking/promise given by a Bank/Financial Institute on

behalf of the Buyer/Importer to the Seller/Exporter, that, if the Seller/Exporter presents
the complying documents to the Buyer's designated Bank/Financial Institute as
specified by the Buyer/Importer in the Purchase Agreement then the Buyer's
Bank/Financial Institute will make payment to the Seller/Exporter.

Banking Page 42
2. Bank Guarantee: It is an undertaking/promise given by a Bank on behalf of the
Applicant and in favour of the Beneficiary. Whereas, the Bank has agreed and
undertakes that, if the Applicant failed to fulfill his obligations either Financial or
Performance as per the Agreement made between the Applicant and the Beneficiary,
then the Guarantor Bank on behalf of the Applicant will make payment of the guarantee
amount to the Beneficiary upon receipt of a demand or claim from the Beneficiary.

3. Collection and Discounting of Bills: It is a major trade service offered by the

Banks. The Seller's Bank collects the payment proceeds on behalf of the Seller, from
the Buyer or Buyer's Bank, for the goods sold by the Seller to the Buyer as per the
agreement made between the Seller and the Buyer.

Banking Page 43
INTERNATIONAL BANKING

Definition of international banking

Banking transactions crossing national boundaries International lending:

• all claims of domestic banks offices on foreign residents

• Claims of foreign bank offices on local residents

• claims of domestic bank offices on domestic residents in foreign currency

Deposits similarly classified (by residence of bank or depositor, or

currency)

Eurocurrency deposits – placed with banks outside the country whose currency the
deposits are denominated in (not necessarily in euros!)

Features of international banking

 Key aspects: currency risk and complexity of credit risk besides typical banking
risks
 Competition for market share among banks (typically spreads very narrow)
 Cyclical nature, with periodic crises Competition for bank loans from the
international bond market (close substitutes for loans)
 Importance of international interbank market (IIBM) as source of liquidity and
funding for banks, and risks arising
 Role of risk management activities (swaps, options, futures)

Reasons for international banking

Migration of domestic customers, notably MNEs growing foreign activities .Effects of

regulatory differences (structural and prudential)

Input cost differences (e.g. in cost of domestic funding) - Japanese in the past

Comparative advantages in retail banking (Citibank)

Development of major financial centres offering benefits to banks:

Banking Page 44
• Business contacts

• Location of customers

• Pool of skilled labour

• Trades and professions

• Liquidity and efficiency of markets (thick market externalities)

• Interrelation of markets (e.g. derivatives and underlying)

Potential for increasing returns to scale and self sustaining growth of centers.

Banking Page 45
INTERNATIONAL FUND TRANSFER:

OFFSHORE BANKING :

OFFSHORE BANKING UNIT

A shell branch located in an international financial center. Offshore banking units

(OBUs) make loans in the Eurocurrency market when they accept deposits from foreign
banks and other OBUs. OBUs' activities are not restricted by local monetary authorities
or governments, but they are prohibited from accepting domestic deposits.

OBUs have proliferated across the globe since the 1970s. They are found throughout
Europe, as well as in the Middle East, Asia and the Caribbean. U.S. OBUs are
concentrated in the Bahamas, the Cayman Islands, Hong Kong, Panama and
Singapore.

An offshore bank is a bank located outside the country of residence of the depositor,
typically in a low tax jurisdiction (or tax haven) that provides financial and legal
advantages. These advantages typically include:

 greater privacy (see also bank secrecy, a principle born with the 1934 Swiss
Banking Act)
 little or no taxation (i.e. tax havens)
 easy access to deposits (at least in terms of regulation)
 protection against local, political, or financial instability

Offshore banking has often been associated with the underground economy and
organized crime, via tax evasion and money laundering; however, legally, offshore
banking does not prevent assets from being subject to personal income tax on interest.
Except for certain persons who meet fairly complex requirements,the personal income
tax of many countries makes no distinction between interest earned in local banks and
those earned abroad.

Advantages of offshore banking

 Offshore banks can sometimes provide access to politically and economically

stable jurisdictions. This will be an advantage for residents in areas where there
is risk of political turmoil, who fear their assets may be frozen, seized or
disappear (see the corralito for example, during the 2001 Argentine economic

Banking Page 46
 crisis). However it is often argued that developed countries with regulated
banking systems offer the same advantages in terms of stability.
 Some offshore banks may operate with a lower cost base and can provide higher
interest rates than the legal rate in the home country due to lower overheads and
a lack of government intervention. Advocates of offshore banking often
characterize government regulation as a form of tax on domestic banks, reducing
interest rates on deposits. However this is scarcely true now; most offshore
countries offer very similar interest rates than those that are offered back home.
 Offshore finance is one of the few industries, along with tourism, in which
geographically remote island nations can competitively engage. It can help
developing countries source investment and create growth in their economies,
and can help redistribute world finance from the developed to the developing
world. But equally, well resourced and developed countries such as New Zealand
offer a safe and well administered background for these financial services.
 Interest is generally paid by offshore banks without tax being deducted. This is
an advantage to individuals who do not pay tax on worldwide income, or who do
not pay tax until the tax return is agreed, or who feel that they can illegally evade
tax by hiding the interest income.
 Some offshore banks offer banking services that may not be available from
domestic banks such as anonymous bank accounts, higher or lower rate loans
based on risk and investment opportunities not available elsewhere.
 Offshore banking is often linked to other structures, such as offshore companies,
trusts or foundations, which may have specific tax advantages for some
individuals.

Disadvantages of offshore banking

 Offshore bank accounts are sometimes less financially secure. In a banking crisis
which swept the world in 2008, some savers lost funds that were not insured by
the country in which they were deposited. Those who had deposited with the
same banks onshore received all of their money back. In 2009 The Isle of Man
authorities were keen to point out that 90% of the claimants were paid, although
this only referred to the number of people who had received money from their
depositor compensation scheme and not the amount of money refunded. In
reality, only 40% of depositor funds had been repaid: 24.8% in September 2009
and 15.2% in December 2009. Both offshore and onshore banking centres often
have depositor compensation schemes. For example: The Isle of Man
compensation scheme guarantees £50,000 of net deposits per individual
depositor, or £20,000 for most other categories of depositor. Potential depositors

Banking Page 47
 should be aware that any deposits over the guaranteed amount are at risk.
However, only offshore centres such as the Isle of Man have refused to
compensate depositors 100% of their funds following Bank collapses. Onshore
depositors have been refunded in full, regardless of what the compensation limit
of that country has stated. Thus, banking offshore is historically riskier than
banking onshore.
 Offshore banking has been associated in the past with the underground economy
and organized crime, through money laundering. Following September 11, 2001,
offshore banks and tax havens, along with clearing houses, have been accused
of helping various organized crime gangs, terrorist groups, and other state or
non-state actors. However, offshore banking is a legitimate financial exercise
undertaken by many expatriate and international workers.
 Offshore jurisdictions are often remote, and therefore costly to visit, so physical
access and access to information can be difficult. This problem has been
alleviated to a considerable extent with the advent and realisation of online
banking as a practical system.
 Offshore private banking is usually more accessible to those on higher incomes,
because of the costs of establishing and maintaining offshore accounts.
However, simple savings accounts can be opened by anyone and maintained
with scale fees equivalent to their onshore counterparts. The tax burden in
developed countries thus falls disproportionately on middle-income groups.
Historically, tax cuts have tended to result in a higher proportion of the tax take
being paid by high-income groups, as previously sheltered income is brought
back into the mainstream economy. The Laffer curve demonstrates this
tendency.
 The Bank Secrecy Act requires U.S. Taxpayers to file a Department of the
Treasury Form 90-22.1 Report of Foreign Bank and Financial Accounts (FBAR:
Each person (including a bank) subject to the jurisdiction of the United States
having an interest in, signature or other authority over, one or more bank,
securities, or other financial accounts in a foreign country must file an FBAR if
the aggregate value of such accounts at any point in a calendar year exceeds
$10,000. (31 CFR 103.24). A recent District Court case in the 10th Circuit may
have significantly expanded the definition of "interest in" and "other Authority"
 Offshore bank accounts are sometimes touted as the solution to every legal,
financial and asset protection strategy but this is often much more exaggeration.

Scope of offshore banking

Offshore banking constitutes a sizable portion of the international financial system.

Experts believe that as much as half the world's capital flows through offshore centers.

Banking Page 48
Tax havens have 1.2% of the world's population and hold 26% of the world's wealth,
including 31% of the net profits of United States multinationals. An estimated £13-20
trillion is hoarded away in offshore accounts.

Some $3 trillion is in deposits in tax haven banks and the rest is in securities held by
international business companies (IBCs) and trusts. Among offshore banks, Swiss
banks hold an estimated 35% of the world's private and institutional funds (or 3 trillion
Swiss francs), and the Cayman Islands (1.9 trillion US dollars in deposits) are the fifth
largest banking centre globally in terms of deposits. However, recent data by the Swiss
National Bank show that the assets held by foreign persons in Swiss bank accounts
declined by 28.1% between January 2008 and November 2009.

Banking Page 49
LIABILITIES MANAGEMENT

Use and management of liabilities, such as customer deposits, by a bank in order to

facilitate lending and allow for balanced growth. Management of money accepted from
depositors as well as funds secured from other institutions constitute liability
management. It also involves hedging against changes in interest rates and controlling
the gap between the maturities of assets and liabilities

Banks began to actively manage liabilities in the 1960s with the issuance of negotiable
CDs. These could be sold in the secondary market, prior to maturity in order to raise
additional capital in the money market. Liability management constitutes an important
part of a bank's bottom line.

COST OF FUNDS AND TRANSFER PRICING

The interest rate paid by financial institutions for the funds that they deploy in their
business. The cost of funds is one of the most important input costs for a financial
institution, since a lower cost will generate better returns when the funds are deployed
in the form of short-term and long-term loans to borrowers. The spread between the
cost of funds and the interest rate charged to borrowers represents one of the main
sources of profit for most financial institutions.

For lenders such as banks and credit unions, cost of funds is determined by the interest
rate paid to depositors on financial products including savings accounts and time
deposits. Although the term cost of funds usually refers to financial institutions, most
corporations that rely on borrowing are impacted by the costs they must incur to gain
access to capital.

TRANSFER PRICING

The price at which divisions of a company transact with each other. Transactions may
include the trade of supplies or labor between departments. Transfer prices are used
when individual entities of a larger multi-entity firm are treated and measured as
separately run entities.

In managerial accounting, when different divisions of a multi-entity company are in

charge of their own profits, they are also responsible for their own "Return on Invested
Capital". Therefore, when divisions are required to transact with each other, a transfer
price is used to determine costs. Transfer prices tend not to differ much from the price in
the market because one of the entities in such a transaction will lose out: they will either

Banking Page 50
be buying for more than the prevailing market price or selling below the market price,
and this will affect their performance.

Tax Treaties

Double taxation can occur if one country does not accept the taxation imposed by
another country, perhaps because it considers the other country a tax haven, where
unrealistically low taxes are collected. Most tax treaties and many tax systems provide
mechanisms for resolving disputes among taxpayers and governments to reduce the
potential for double taxation. Many systems also permit advance agreement between
taxpayers and one or more governments regarding mechanisms for setting related party
prices.

Many systems impose penalties where the tax authority has adjusted related party
prices. Some tax systems provide that taxpayers may avoid such penalties by preparing
documentation in advance regarding prices charged between the taxpayer and related
parties. Some systems require that such documentation be prepared in advance in all
cases.

Types of transactions

Most systems provide variations of the basic rules for characteristics unique to particular
types of transactions. The potentially tested transactions include:

 Sale of goods. Identical or nearly identical goods may be available. Product-

related differences are often covered by patents.
 Provision of services. Identical services, other than routine services, often do
not exist.
 License of intangibles. The basic nature precludes a claim that another product
is identical. However, licenses may be granted to independent licensees for the
same product in different markets.
 Use of money. Comparable interest rates may be readily available. Some
systems provide safe haven rates based on published indices.
 Use of tangible property. Independent comparables may or may not exist, but
reliable data may not be available.

Banking Page 51
CASE STUDY

INDIAN SERVICE SECTOR: “A CASE STUDY OF BANKING SECTOR”

Introduction

It emphasizes on a very important factor that the success of any financial institution
(bank) depends upon the service delivery of the products offered and the satisfaction of
the customers. It also covers the various quantitative products offered to the customers
for their maximum retention and tells that the products and services should along with
being quantitative be qualitative. The study reveals that during recent times there has
been a quantitative expansion of banking services but qualitatively the scenario has
been far from satisfactory. The qualitative improvement provides upthrust in the success
of the banking industry and is the need of the hour in today‘s era of cut throat
competition and to provide customer satisfaction.

Collin Clark in his book ―Conditions of Economic Progress‖ agrees that there is
close relationship between development of the economy on one hand and occupational
structure on the other and economic progress is closely associated with certain distinct
necessary and predictable changes in the occupational structure.

Our Indian Economy is divided into three sectors—

1. The Primary Sector, comprising Agriculture, Fisheries, Forestry, Animal Husbandry.

2. The Secondary Sector, comprising Small and Large scale industries

3. The Tertiary Sector, comprising Transport, Communication, Banking, Finance and

other services.

According to A.G.B. Fisher ―In every progressive economy, there has been a steady
shift of employment and investment from the essential primary activities to secondary
activities of all kinds and to a still greater extent into tertiary production‖

Banking Page 52
Agriculture forms the backbone of the Indian economy and occupies a place of pride but
the share of agriculture is decreasing continuously and that of industrial and service
sector is continuously increasing.

Today, service sector contributes the maximum share of India‘s Gross Domestic
Product (GDP). It comprises of trade, communication, financial system, insurance,
community, social and personal services.

Banking Page 53
INDIAN BANKING SYSTEM

The resources of the financial systems are held by financial institutions in trust and have
to be deployed for the maximum benefit of their owners— viz. depositors and investors.
The safety of their funds should be the primary concern of banks and regulatory
authorities and hence ensuring solvency, health and efficiency of the institutions should
therefore be central to effective financial reforms.

More than three decades have passed since Mrs. Indira Gandhi nationalized the banks.
The last decades witnessed the maturity of India‘s Financial Market. Since 1991,
Government of India has been taking various steps in reforming the financial sector of
the country. Almost 80% of the business is still controlled by Public Sector Banks (PSB).
PSBs are still dominating the commercial banking system. Shares of leading PSBs are
listed on the stock exchange with private sector banks.

The RBI has given licenses to new private sector banks as a part of the liberalization
process. Many banks are successfully running in retail and consumer segment but are
yet to deliver services to industrial finance, retail trade, small business and agricultural
finance.

Today the banking industry, which was tightly protected by regulations is now
experiencing a rapid change. Now it is no more confined to nationalized and
cooperative banks but has emerged with multinational banks who have spread their
branches across the length and breadth of the country.

The entry of private players in the industry has altogether transformed the banking
arena. Now the consumers have a choice of transacting either in traditional way or the
new multi channel banking i.e. A.T.M., Net banking, Tele banking etc. Banks today are
thus providing large number of quantitative services along with qualitative dimensions.

According to K.P. Padamakumar, Chairman, Federal Bank, ―Banks are increasingly

facing sliding margins and fierce competitions. It is imperative to increasing volumes
and reduce operational cost.‖ Thus due to tough competition in the banking sector and
due to the entry of private players, the quantity of services of the banks are increasing

Banking Page 54
day by day but as far as quality is concerned, it is continuously deteriorating. Today the
customer is interested in how he / she can benefit from the banks and their products.
That is why it becomes necessary for a bank to differentiate its products from the
others.

Indian banks have now realized that it no longer pays to have transaction based
operating. This has shifted their focus from operational services to customer centric
services. Today they are looking at newer ways to make a customer‘s banking
experience more convenient and effective. This can be done by using new technology,
tools and techniques to identify customer needs and then offering products to match
them. In the financial world, product superiority does not last long as it is relatively easy
to copy products. So the real strength comes from operational excellence and
understanding the customer and developing rapport with them.

The emerging need of the time is that the banks both in the public as well as private
sector should identify and cater the needs of the customers thereby practicing customer
retention and providing them efficient services. Customer service is concerned with the
creation, development and enhancement of indivisualized customer relationship with
carefully targeted customers resulting in maximising their total customer lifetime value
by giving them satisfaction against their expectations. Today approach towards
customer service, emphasizes on keeping as well as winning the customers. Today
focus of banks has shifted from customer acquisition to customer retention.

Besides rendering traditional services of accepting deposits and granting advances,

during the recent years, banks have gradually started providing various auxilliary
services to their customers which has completely revolutionized and enlarged the
banking sector. Today, with the help of Core banking solution, the operations have
shifted from branch banking to bank banking i.e. now the customers are not confined to
the branch in which they having their account rather now they can access their account
from any branch of the in which they are having their account. Core banking solution is
providing the competitive edge to scale unprecedented height in customer delight.

Banking Page 55
With the stepping in of Information Technology in the banking sector, the working
strategy of the banking sector has seen revolutionary changes. Today without the use of
Information Technology, the banking sector may become paralyzed. The various
customer service oriented products like internet banking, ATM services, telebanking,
electronic payment system, cheque processing system etc. have declined the workload
of the customers. Now they need not go to the banks each and every time for meager
tasks.

Debit and credit cards, are another beneficial products of the banks which have made
the life of the customers much easier are there for their use. Today anytime anywhere
shopping has become an easy task for the shoppers who now need not carry large
sums while going for shopping or any other transaction because credit cards are the
remedy for them. Today the use of debit cards has donated so much time to the
customers which was earlier wasted in standing in long queues of the cash counter
waiting for their turn to encash their cheques or get money. Earlier customers were
bound by a limit of 10:00 am to 2:00 pm for cash withdrawl or account statement, but
ATMs have made the life easier by removing the time limit.

A large number of services are provided by the banks Wide Area Networking (WAN) is
the most important of these services. Today all the branches of a particular Bank Group
spread all over the country are connected through WAN and all the details, circulars,
publications, balance sheets etc. related to them are displayed on the website for the
access of the customers.

Although the banks are providing the above enumerated services and many more i.e.
the quantity of services is continuously increasing but unfortunately there appears to be
total neglect in the quality. Today the customers have become harder to please. They
have become more smarter and demanding. Now the banks aim at T C S - Total
Customer Satisfaction i.e. they are making efforts to match the delivery and
performance of products and services which is multidimensional. But they have been
successful in only one aspect of their aim i.e. they have provided ample delivery of
products but their performance level is declining.

Banking Page 56
A comparative study of the various customer oriented services provided by Public
Sector and Private Sector banks is shown in the table beneath.

AVAILABILITY OF SCHEMES AND SERVICES IN THE VARIOUS PUBLIC AND

PRIVATE SECTOR BANKS IN ALLAHABAD

The table below gives a wide view about the availability of the services in the various
Public and Private sector banks.

Banking Page 57
Banking Page 58
Thus the quality and quantity of services provided by the Private Sector Banks is much
better than that provided by Public Sector Banks.

In the coming years, the deposit ratio will be 80% in private banks and 20% in public
sector banks which is a reverse of a decade before. Banking is and for the time to
come, will remain customer oriented business. If one can satisfy the customers
effectively, then customer becomes client. Thus to be successful, the banks should
satisfy their customers qualitatively as well as quantitatively. They should ―put the
customers first ― because ―Customer is the king ―for the proper functioning of the Indian
Banks today.

References:

Shikha Agarwal, Lecturer, S.S. Khanna Girl‘s Degree College, Allahabad

Banking Page 59
QUESTION AND ANSWERS

1. What is/are the main functions of RBI?

(i). Notes Issuance.

(ii). Government's Bankar.

(iii). Bankar's Bank.

(iv). Bank's Supervision.

A. Only (i)

B. Both (ii) and (iii)

C. Both (iii) and (iv)

D. All of these.

Answer: Option D

Explanation:

Reserve Bank of India (RBI) is the supreme banking authority of India. All the public &
private sector banks or any financial institution in India are controlled by RBI.

RBI is responsible for issuing, exchanging or destroying of currency.

RBI acts as a merchant banker for the Central and State Government. RBI maintains all
the banking accounts of the scheduled banks.

RBI operate all the financial and banking operations in India.

2. Which are the following rates are decided by the RBI is called "Policy Rate"?

A. Cash reserve ratio.

B. Lending rate.

Banking Page 60
 C. Bank rate.

D. Deposit rate.

Answer: Option A

Explanation:

Cash reserve ratio (CRR) is the funds that all the scheduled bank have to maintain with
RBI, the supreme banking authority of India. By increasing the CRR RBI drain out
excessive funds from the scheduled banks.

Example: Suppose the CRR is 5% . A person/customer open a Savings bank account

with Rs. 10,000 in Punjab National Bank. So now Punjab National Bank has to park Rs.
500 to Reserve Bank of India (RBI) as per the CRR rate.

5% of 10,000 = 500 (CRR= 5%).

3. Retail Banking refers to the dealing of commercial banks with individual

customers on,

i) Liabilities.

ii) Assets.

A. only i.

B. only ii.

C. both i and ii.

D. None of these.

Answer: Option C

Banking Page 61
Explanation:

Retail banking is a banking system where banks (Basically larger commercial banks)
directly deals with the customers.

In retail banking services offered like; Savings Account, Checking/Transactional

Account, Debit Cards, Credit Cards, Personal Loans, Mortgages, Certificate of Deposits
and etc.

4. Wholesale banking is also called,

i)Corporate banking.

ii)Commercial banking

A. only i.

B. only ii.

C. both i and ii.

D. None of these.

Answer: Option C

Explanation:

Wholesale banking is the services offered by a merchant bank to other banks and
financial institution (Large corporate clients, Real Estate Developers and etc.). Where
Retail banking is the banking with small individual customers.

5. Cash reserve ratio(CRR) refers to,

A. Cash that all banks are require to maintain with RBI.

B. Certain percentage of DTL of all banks.

C. Both a & b.

Banking Page 62
 D. None of these.

Answer: Option C

Explanation:

Cash reserve ratio (CRR) is the funds that all the scheduled bank have to maintain with
RBI.

Example: Suppose the CRR is 4% . Someone opens a bank account with Rs. 5000 in
SBI. So now SBI has to park Rs. 200 to RBI as per the CRR rate.

4% of 5000 = 200

6. Objective of SLR (Statutory Liquidity Ratio) is /are;

A. To restrict expansion of bank credit.

B. To increase banks investment in approved securities.

C. To ensure solvency of banks.

D. All of these.

Answer: Option D

Explanation:

SLR or Statutory Liquidity Ratio is the amount that all the commercial banks has to
maintain with RBI (Reserve Bank of India) in the form of cash, gold or government
securities. By increasing and decreasing the SLR RBI restrict the expansion of bank
credit. It also ensures the investment of commercial banks in government bonds and
shares.

With the help of SLR RBI can effectively control the inflation and money supply in the
system.

Banking Page 63
7. Interest payable on savings bank accounts is-

A. decided by banks without following any conditions by RBI.

B. not regulated by RBI.

C. regulated by central government.

D. decided by banks following the guidelines of RBI

Answer: Option D

Explanation:

In India banks are allowed to decide their interest rate on the basis of some conditions
made by RBI.

8. If the rate of inflation increases then the-

A. purchasing power of money increases.

B. purchasing power of money decreases.

C. purchasing power of money remains unaffected.

D. None of these.

Answer: Option B

Explanation:

Inflation is the sustainable increase of prices of the products and services of a certain
period of time. When the rate of the products or services increased, the purchasing
power of the money getting decreased.

Banking Page 64
9. Banks in India are regulated by-

A. Banking regulation Act, 1949

B. RBI Act, 1934

C. Companies Act.

D. None of these.

Answer: Option A

10. What is the full form of ULIP?

A. Unit linked insurance plan.

B. Unreserved linked insurance plan.

C. Unit liable insurance plan.

D. None of these.

Answer: Option A

11. A reduction of repo rate-

A. makes expensive for scheduled banks to borrow from RBI.

B. helps RBI to get money from scheduled banks at cheaper rate.

C. helps banks to get money from RBI at cheaper rate.

D. None of these.

Answer: Option C

Banking Page 65
12. What is the full form of ECB?

A. External Cooperative Borrowings.

B. Extra Cooperative Borrowings.

C. External Commercial Borrowings.

D. Extra Commercial Borrowings.

Answer: Option C

13. Non Banking Financial Companies (NBFCs) are financial institution that-

A. hold a banking licence.

B. does not hold a banking licence.

C. are government undertaking institutions.

D. None of these.

Answer: Option B

14. Who was the first governor of RBI?

A. Sir Osborne Smith.

B. Sir James Taylor.

C. Sir C D Deshmukh

D. None of these.

Answer: Option A

Banking Page 66
15. Loans of very small amounts given to low income groups is called-

A. Cash credit.

B. Micro credit.

C. Simple overdraft.

D. No frills loans.

Answer: Option B

16. Explain the functioning of scheduled banks in India.

A scheduled bank is a bank that is listed under the second schedule of the RBI Act,
1934. In order to be included under this schedule of the RBI Act, banks have to fulfill
certain conditions such as having a paid up capital and reserves of at least 0.5
million and satisfying the Reserve Bank that its affairs are not being conducted in a
manner prejudicial to the interests of its depositors. Scheduled banks are further
classified into commercial and cooperative banks. The basic difference between
scheduled commercial banks and scheduled cooperative banks is in their holding
pattern. Scheduled cooperative banks are cooperative credit institutions that are
registered under the Cooperative Societies Act. These banks work according to the
cooperative principles of mutual assistance.

17. What are the primary functions of a bank?

The primary functions of a bank are also known as banking functions. They are the
main functions of a bank.

These primary functions of banks are explained below.

1. Accepting Deposits
The bank collects deposits from the public. These deposits can be of different
types, such as:-

e) Saving Deposits
f) Fixed Deposits

Banking Page 67
 g) Current Deposits
h) Recurring Deposits

a. Saving Deposits

This type of deposits encourages saving habit among the public. The rate of interest
is low. At present it is about 5% p.a. Withdrawals of deposits are allowed subject to
certain restrictions. This account is suitable to salary and wage earners. This account
can be opened in single name or in joint names.

b. Fixed Deposits

Lump sum amount is deposited at one time for a specific period. Higher rate of
interest is paid, which varies with the period of deposit. Withdrawals are not allowed
before the expiry of the period. Those who have surplus funds go for fixed deposit.

c. Current Deposits

This type of account is operated by businessmen. Withdrawals are freely allowed. No

interest is paid. In fact, there are service charges. The account holders can get the
benefit of overdraft facility.

d. Recurring Deposits

This type of account is operated by salaried persons and petty traders. A certain sum
of money is periodically deposited into the bank. Withdrawals are permitted only after
the expiry of certain period. A higher rate of interest is paid.

2. Granting of Loans and Advances

The bank advances loans to the business community and other members of the
public. The rate charged is higher than what it pays on deposits. The difference in the
interest rates (lending rate and the deposit rate) is its profit.

The types of bank loans and advances are :-

e) Overdraft
f) Cash Credits
g) Loans
h) Discounting of Bill of Exchange

a. Overdraft

This type of advances are given to current account holders. No separate account is
maintained. All entries are made in the current account. A certain amount is
sanctioned as overdraft which can be withdrawn within a certain period of time say

Banking Page 68
 three months or so. Interest is charged on actual amount withdrawn. An overdraft
facility is granted against a collateral security. It is sanctioned to businessman and
firms.

b. Cash Credits

The client is allowed cash credit upto a specific limit fixed in advance. It can be given
to current account holders as well as to others who do not have an account with
bank. Separate cash credit account is maintained. Interest is charged on the amount
withdrawn in excess of limit. The cash credit is given against the security of tangible
assets and / or guarantees. The advance is given for a longer period and a larger
amount of loan is sanctioned than that of overdraft.

c. Loans

It is normally for short term say a period of one year or medium term say a period of
five years. Now-a-days, banks do lend money for long term. Repayment of money
can be in the form of installments spread over a period of time or in a lumpsum
amount. Interest is charged on the actual amount sanctioned, whether withdrawn or
not. The rate of interest may be slightly lower than what is charged on overdrafts and
cash credits. Loans are normally secured against tangible assets of the company.

d. Discounting of Bill of Exchange

The bank can advance money by discounting or by purchasing bills of exchange both
domestic and foreign bills. The bank pays the bill amount to the drawer or the
beneficiary of the bill by deducting usual discount charges. On maturity, the bill is
presented to the drawee or acceptor of the bill and the amount is collected.

18. What are the products offered by Retail banks?

Typical products offered by a retail bank include:

 Transactional accounts

1. Checking accounts (American english)

2.Current accounts (British english)

 Savings accounts
 Debit cards
 ATM cards
 Credit cards

Banking Page 69
  Traveler's cheques
 Mortgages
 Home equity loans
 Personal loans
 Certificates of deposit/Term deposits

19. Write a brief note on Transfer Pricing?

The price at which divisions of a company transact with each other. Transactions
may include the trade of supplies or labor between departments. Transfer prices are
used when individual entities of a larger multi-entity firm are treated and measured
as separately run entities.

In managerial accounting, when different divisions of a multi-entity company are in

charge of their own profits, they are also responsible for their own "Return on
Invested Capital". Therefore, when divisions are required to transact with each
other, a transfer price is used to determine costs. Transfer prices tend not to differ
much from the price in the market because one of the entities in such a transaction
will lose out: they will either be buying for more than the prevailing market price or
selling below the market price, and this will affect their performance.

20. What are the advantages of Offshore banking?

 Offshore banks can sometimes provide access to politically and economically stable
jurisdictions. This will be an advantage for residents in areas where there is risk of
political turmoil, who fear their assets may be frozen, seized or disappear (see the
corralito for example, during the 2001 Argentine economic crisis). However it is
often argued that developed countries with regulated banking systems offer the
same advantages in terms of stability.
 Some offshore banks may operate with a lower cost base and can provide higher
interest rates than the legal rate in the home country due to lower overheads and a
lack of government intervention. Advocates of offshore banking often characterize
government regulation as a form of tax on domestic banks, reducing interest rates
on deposits. However this is scarcely true now; most offshore countries offer very
similar interest rates than those that are offered back home.
 Offshore finance is one of the few industries, along with tourism, in which
geographically remote island nations can competitively engage. It can help
developing countries source investment and create growth in their economies, and
can help redistribute world finance from the developed to the developing world. But

Banking Page 70
 equally, well resourced and developed countries such as New Zealand offer a safe
and well administered background for these financial services.
 Interest is generally paid by offshore banks without tax being deducted. This is an
advantage to individuals who do not pay tax on worldwide income, or who do not
pay tax until the tax return is agreed, or who feel that they can illegally evade tax by
hiding the interest income.
 Some offshore banks offer banking services that may not be available from
domestic banks such as anonymous bank accounts, higher or lower rate loans
based on risk and investment opportunities not available elsewhere.
 Offshore banking is often linked to other structures, such as offshore companies,
trusts or foundations, which may have specific tax advantages for some individuals.

Banking Page 71
NOTES:

Banking Page 72