Indian Financial System

Ramesh Subramanian
M.com., C.A.I.I.B.,F.C.S.,LL.M
 Overview
•History of Banking
•Financial System – Key Elements
•Commercial Banks
• Public Sector Banks
• Private Sector Banks
• Foreign Banks
• Regional Rural Banks
• Local Area Banks
• Co-operative Banks

•Reserve Bank of India –Various Departments

•Banking Ombudsman
•Financial Sector Reforms
 History of Banking
• As early as 2000 B.C.the Babylonians had
developed a banking system.
• The Temples of Babylon were used as banks,
and such great Temples as those of EPHESUS
and DELPHI were the most powerful of the
Greek banking institutions.
• But the spread of irreligion soon destroyed
The public sense of security in depositing money
and valuable in Temples and the priests were no
longer acting as financial agents.
• Aristotle’s dictum that the charging of interest
was unnatural and consequently immoral was
adhered to.
 History of Banking
• Even now Mohammedans, in obedience to the
commands contained in that behalf in their religious
books, refuse to accept interest on money loans.
• Islamic Banking
• Growing necessity forced the issue of banking in the
middle of the 12th century, and banks were established in
VENICE.
• Origin of modern banking may be traced to the money
dealers in Florence who received money on deposit and
were lenders of money in the 14th century.
• Bardi, Acciajuoli, Peruzzi, Pitti and Medici soon became
famous throughout Europe as Bankers
 History of Banking
• In England – during the reign of Edward
III, money changing, an important function
of the bankers was taken up by a Royal
Exchanger for the benefit of the Crown. He
exchanged the various foreign coins,
tendered to him by travelers and
merchants entering the kingdom into
British money and supplied persons going
out of the country with foreign money.
 History of Banking
• In England due to growth of Trade there was influx of
gold from America.
• Town merchants began to hold gold.
• Charles I in 1640 seized 130,000 pound sterling worth of
bullion left for safe custody by the city merchants at the
Royal Mint.
• Due to this Royal repudiation, the merchants began to
entrust their cashiers with large sums of money.
• The servants also misappropriated their masters money
for their own benefit.
• Then the city merchants decided to keep their cash with
goldsmiths, who had strong rooms.
 History of Banking
• Thus goldsmiths had large sums of money and
they issued a receipt known as goldsmiths
notes.
• These receipts were payable to the bearer and
so got transformed from RECEIPT to a BANK
NOTE.
• The goldsmiths realised that the large sums of
money were lying for a long time and thought it
safe to lend out a part provided that the loans
were repaid within a fixed period of time.
• In 1672, Charles II borrowed heavily from the
goldsmiths and like his father repudiated his
debts.
 Banking History – India
• Giving and taking of credit must have
existed as early as the Vedic period.
• Manu devoted a special section to the
section to the subject of deposits and
pledges, where he says “ a sensible man
should deposit his money with a person
of good family, of good conduct, well-
acquainted with the law……
honourable(Arya)” (The Laws of Manu by
Buhler, The Sacred Books of the East,
Vol.XXV p.286, 1866)
 History
• The word bank is derived from the words “bancus” or
“banque”, this is a BENCH.
• the Jews in Lombardy, the early bankers transacted their
business on benches in the market place.
• When a Banker failed his “banco” was broken up by the
people, whence the word “bankrupt”.
• Others however feel the “bank” is originally derived from
the German “back” meaning a joint stock fund, which was
Italianised into “banco” when the Germans were masters
of a great part of Italy.
• It can thus be traced in Europe from the Middle Ages.
 Financial System
• Key elements of a well- functioning FS:
– Strong legal and regulatory environment
– Stable money
– Sound public finance and public debt
management
– A central bank
– A sound banking system
– An information system
– A well functioning securities market
 Financial System
• Since finance is based on contracts strong
legal and regulatory system that produce
and strictly enforce laws alone can protect
the right and interest of depositors/investors
• Stable money- it serves as a medium of
exchange, a store of value ( a reserve of
future purchasing power and standard of
value for all goods and services. Large
fluctuations and depreciation in the value of
money leads to financial crisis and impedes
economic growth.
 Financial System
• Sound public finance includes setting and controlling
public expenditure priorities and raising revenues
adequate to fund them efficiently. Fiscal Responsibility
and Budget Management Act (FRBM), 2003 enacted.
Central Govt to reduce fiscal deficit to 2% of GDP by
2006 and eliminate revenue deficit by 2008.
• Central bank operations of the banking system. The
monetary policy of the central bank influences the pace
of economic growth. RBI announces the monetary policy
every year and is reviewed every quarter. Latest review
done on November 1, 2010. An autonomous central
bank paves the way for the development of a sound
financial system.
 Financial System
• A good financial system must have a
variety of banks both domestic and
international. Banks are core financial
intermediaries world over. The operate the
clearing and payment system, participate
in the foreign exchange market, in addition
to their basic functions. The banking
system is the main fulcrum for transmitting
the monetary policy actions. Sound
banking system depends on a robust Risk
Management.
 Financial System
• Information - all participants in the FS
should have information. Only when
proper disclosure practices and
networking of information systems are
adopted a sound FS can develop.
• Securities Market – facilitate the issue and
trading of both Debt and Equity. Efficient
securities markets promote economic
growth by channalising resources in the
most productive use. An efficient securities
market strengthens market discipline.
 Commercial Banks
• Public Sector Banks
– Two groups – State Bank of India & Associates
– Nationalised Banks
• State Bank of India has 7 subsidiaries
• SBI was initially known as Imperial Bank and
• Was formed in 1921 by amalgamation of 3 Presidency Banks –
Bank of Bengal, Bank of Bombay, Bank of Madras.
• Imperial Bank acted as a Banker to the Government till RBI was
established in 1935.
• Imperial Bank was nationalised in 1955 (July 1, 1955)
• Objective of Nationalisation – Extend Banking facilities in Rural and
Semi-urban areas and
– To promote agricultural finance
– Help RBI in its credit policies
– Help Government to pursue broad economic policies
 State Bank of India
• Seven Subsidiaries:
• State Bank of Bikaner and Jaipur
• State Bank of Hyderabad
• State Bank of Indore
• State Bank of Mysore
• State Bank of Patiala
• State Bank of Saurashtra
• State Bank of Travancore
 Nationalised Banks
• 1969, FOURTEEN big Indian Banks were
nationalised.
• Nationalisation was done by issue of an
Ordinance which was later replaced by
“The Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970.
• August 15, 1980 – SIX commercial banks
in the Private Sector with deposits over Rs.
200 crore
 Bank Nationalisation
– In all 28 banks were nationalised from 1955-
1980.
– At present, there are 27 nationalised banks –
SBI and 7 subsidiaries, 19 nationalised banks
( New Bank of India was merged with Punjab
National Bank)
– Objectives of Nationlisation:
• Widen the network, particularly in Rural Areas/semi
urban areas
• Greater mobilisation of savings and flow of credit to
neglected sectors like agriculture, SSI etc.
• Socio-economic needs of the population.
 Private Sector Banks
• Narasimhan Committee – I recommended
establishment of new private sector banks.
• Some conditions like fully computerised bank
branches, minimum capital etc were
suggested.
• Banks set up in 1990s are known as New
Private Sector Banks. (HDFC, Axis etc.)
• Superior Financial services, innovative
products, new markets, lowcost funds
(CASA), greater efficiency etc.
 Regional Rural Banks
– Ordinance was promulgated on September 26,
1975 to be later replaced by Regional Rural
Banks Act, 1976.
– Although cooperative and commercial banks
achieved high reach and disbursed credit still a
vast gap existed in RURAL CREDIT.
– RRBs were set up which combine the local feel
and familiarity with commercial banking.
– Capital was Rs.1 crore with 50% contributed by
GOI, 15% by State Govt and 35% by the
sponsor bank.
 Regional Rural Banks
• Low productivity
• High transaction cost
• Negative margins
• Low recovery rates
• High NPAs
• Lack of dynamism/motivation
• Both sponsor banks and RRBs compete to get
business in the rural market.
 Local Area Banks
• The Local Area Bank Scheme was introduced in August 1996 pursuant
to the announcement of the then Finance Minister. The Local Area
Banks (LABs) were expected to bridge the gaps in credit availability and
strengthen the institutional credit framework in the rural and semi-urban
areas.
• Setting up of local area banks in private sector to cater to the credit needs of the
local people and to provide efficient and competitive financial intermediation
services in their area of operation.
• The area of operation of the proposed bank shall be a maximum of three
geographically contiguous districts.
• The promoters of the bank may comprise individuals, corporate entities, trusts
and societies with a minimum share capital of Rs.5 crore.
• The bank shall be registered as a public limited company under the Companies
Act, 1956. It will be licensed under the Banking Regulation Act, 1949.
 Local Area Banks

• Only four LABs are functioning at present- Coastal Local Area Bank Ltd.
established in 1999 with an area of operation comprising three contiguous
districts viz. Krishna, Guntur and West Godavari with its head office at
Vijayawada (Andhra Pradesh),
• Capital Local Area Bank Ltd. established in January 2000 with its area of
operation comprising three districts viz. Jalandhar, Kapurthala and
Hoshiarpur with its head office at Phagwara (Punjab),
• South Gujarat Local Area Bank Ltd., established in October 2000 with an
area of operation comprising three contiguous districts viz. Navsari, Surat
and Bharuch with its head office at Navsari (Gujarat)
• Krishna Bhima Samruddhi Local Area Bank Ltd. established in 2001 with
an area of operation comprising three contiguous districts of Mahbubnagar
in Andhra Pradesh and Raichur and Gulbarga in the state of Karnataka
with its head office at Mahbubnagar(Andhra Pradesh).
• The licence of Vinayak Local Area Bank Ltd., Sikar (Rajastan) established
on 21st October 2000 was cancelled by Reserve Bank on 16th January
2002 as major irregularities were noted in its functioning.
 Co-operative Structure

• Includes - State Cooperative Banks (SCBs)

• District Central Cooperative Banks (DCCBs)
• Regional Rural Banks (RRBs)
• State Cooperative Agriculture and Rural
Development Banks (SCARDBs)
• Primary Agriculture Credit Societies
• Apex Weavers Societies
• Marketing Federations
 Co-Operative Structure
• NABARD-
• Undertakes inspection of (RRBs)
• Cooperative Banks (other than urban/primary cooperative banks)
under the provisions of Banking Regulation Act, 1949.  
• Undertakes inspection of State Cooperative Agriculture and Rural
Development Banks (SCARDBs) and apex non-credit cooperative
societies on a voluntary basis 
• Undertakes portfolio inspections, systems study, besides off-site
surveillance of Cooperative Banks and Regional Rural Banks
(RRBs)  
• Provides recommendations to Reserve Bank of India on opening of
new branches by State Cooperative Banks and Regional Rural
Banks (RRBs) 
• Administering the Credit Monitoring Arrangements in SCBs and
CCBs.
 NABARD
• National Bank for Agriculture and Rural Development –
set up in 1981.
• NABARD is set up by the Government of India as a
development bank with the mandate of facilitating credit
flow for promotion and development of agriculture and
integrated rural development. The mandate also covers
supporting all other allied economic activities in rural
areas, promoting sustainable rural development and
ushering in prosperity in the rural areas.
• With a capital base of Rs 2,000 crore provided by the
Government of India and Reserve Bank of India , it
operates through its head office at Mumbai, 28 regional
offices situated in state capitals and 391 district offices at
districts
 Reserve Bank of India
Organisation – Departments
 Overview

• Central Office Departments

• Regional Office Departments
• Governor
• 4 Deputy Governors (UT, SG, KC, SG)
• 8 Executive Directors
 Central Office Departments
•Department of Banking Supervision
•Department of Banking Operations &
Development
•Department of Non-Banking Supervision
•Department of External Investment and Operations
•Foreign Exchange Department
•Monetary Policy Department
•Rural Planning & Credit Department
•Urban Bank Department
•Etc. etc.
 Central Office Departments

•Department of Government & Bank Accounts

•Department of Expenditure & Budgetary Control
•Department of Currency Management
•Premises Department
Etc.etc
 Central Office Departments
Department of Banking Operations & Development
(Banking Regulatory Department)

•Branch Licensing
•Banking Policy
•Regulatory circulars
•Reserve requirements
•Appointment of CEOs, Directors of Banks
•New Capital Adequacy Framework
 Central Office Departments
Department of Banking Supervision
(Banking Supervisory Department)
•Inspection of Commercial Banks and FIs
•Pattern -CAMELS & RBS
•Onsite inspection
•Off site surveillance
•Scrutiny of books
•Off site monitoring returns(OSMOS)
 Central Office Departments

•Department of Non-Banking Supervision

(NBFCs Regulatory &Supervisory Department)

•Policy regarding NBFCs

•Inspection of NBFCs
•Pattern –CAMELS
•Off site surveillance
•Scrutiny of books
•Off site monitoring returns
•Market Intelignence
 Central Office Departments

Foreign Exchange Department

•FEMA, 2000
•FDI
•ECB
•ODI
•Other related matters
 Central Office Departments
Rural Planning and Credit Department
•Monitoring and facilitating flow of credit to rural,
agricultural and small scale industries' sectors.
•Framing policies on priority sector lending.
•Implementing and monitoring Lead Bank Scheme which
aims at forging a co-ordinated approach for providing
bank credit to achieve overall rural development.
•Acting as regulators for Regional Rural Banks and
State/Central Co-operative Banks.
•Monitoring implementation of Government-sponsored
poverty alleviation schemes.
•Implementation of Banking Ombudsman Scheme
 Ombudsman
• An ombudsmanis a person who acts as a
trusted intermediary between an organization
and some internal or external constituency
while representing not only but mostly the
broad scope of constituent interests.
• An indigenous Danish, Norwegian and Swedish
term, Ombudsman is etymologically rooted in the
word umbuðsmann, essentially meaning
"representative".
• An ombudsman is an official, usually appointed
by the Government or by Parliament, who is
charged with representing the interests of the
public by investigating and addressing complaints
reported by individual citizens.
 Banking Ombudsman Scheme
• The Banking Ombudsman Scheme enables an expeditious and
inexpensive forum to bank customers for resolution of complaints
relating to certain services rendered by banks. The Banking
Ombudsman Scheme is introduced under Section 35 A of the Banking
Regulation Act, 1949 by RBI with effect from 1995.
• The Banking Ombudsman is a senior official appointed by the Reserve
Bank of India to redress customer complaints against deficiency in
certain banking services.
• All Scheduled Commercial Banks, Regional Rural Banks and Scheduled
Primary Co-operative Banks are covered under the Scheme.
• The scheme provides a forum to bank customers to seek redressal of their
most common complaints against banks, including those relating to credit
cards, service charges, promises given by the sales agents of banks, but not
kept by banks, as also, delays in delivery of bank services. The bank
customers would now be able to complain about non-payment or any
inordinate delay in payments or collection of cheques towards bills or
remittances by banks, as also non-acceptance of small denomination notes
and coins or charging of commission for acceptance of small denomination
notes and coins by banks.
 Banking Ombudsman Scheme
• One may lodge his/ her complaint at the office of the Banking
Ombudsman under whose jurisdiction, the bank branch
complained against is situated.
• For complaints relating to credit cards and other types of
services with centralized operations, complaints may be filed
before the Banking Ombudsman within whose territorial
jurisdiction the billing address of the customer is located.
• The complainant can be filed by one’s authorized representative
(other than an advocate).
• The Banking Ombudsman does not charge any fee for filing and
resolving the dispute.
• The amount, if any, to be paid by the bank to the complainant by
way of compensation for any loss suffered by the complainant is
limited to the amount arising directly out of the act or omission of
the bank or Rs 10 lakhs, whichever is lower.

 
 Banking Ombudsman Scheme
• Procedure – to make a written complaint
to the bank and a period of one month has
lapsed.
• The complaint does not pertain to a
pending proceedings in a Court.
• Any person aggrieved by the order of the
Ombudsman may within 30 days prefer an
appeal before the Appellate Authority.
 Central Office Departments

Urban Banks Department

•Supervisor and Regulator for Urban Co-op Banks

•Inspection of Urban Co-op Banks

•Policy relating to Urban Co-op Banks

 Central Office Departments

Department of External Investments & Operations

•Management and investment of the foreign currency and gold
assets of the Reserve Bank of India.

•Handling external transactions on behalf of Government of India

(GOI) including transactions relating to IMF.

•All matters incidental to India's membership of the Asian Clearing

Union.

•Other matters relating to gold policy, membership of the Bank for

International Settlements (BIS) and matters incidental to
international cooperation/arrangements
 What is sterilisation ?
• It refers to the process by which the RBI takes
away money from the banking system to
neutralise the fresh money that enters the
system.
• Suppose the RBI decides to buy US dollars (USD) from
the market. Now, the money held by the RBI does not
form part of the banking system. So, if the RBI releases
rupees from its coffers to buy dollars, the money supply
in the banking system increases. That can be a problem.
So to mop up the extra liquidity in the system RBI issues
bonds.
 Market Stabilisation Scheme
• to strengthen the Reserve Bank in its ability to conduct
exchange rate and monetary management operations in a
manner that would maintain stability in the foreign
exchange market and enable it to conduct monetary policy
in accordance with its stated objectives.
• The bills/bonds issued under MSS would have all the
attributes of the existing Treasury Bills and dated
securities.
• the intention of introducing MSS is essentially to differentiate the
liquidity absorption of a more enduring nature by way of sterilisation
from the day-to-day normal liquidity management operations.
• the liquidity absorption will get apportioned among the
instruments of LAF, MSS and normal open market
operations (OMOs).
 Central Office Departments
Internal Debt Management Department

•Management of Public Debt of -

Government of India & State Governments
•Regulates and Supervises Primary Dealers in
Government Securities
•Floatation of Central and State Government Loans
•T-Bills
•Ways and Means Advances
•Banker to the Government
 Ways & Means Advances
• Under Section 17(5) of RBI Act, 1934, the RBI provides
Ways and Means Advances (WMA) to the Central &
States banking with it to help them to tide over temporary
mismatches in the cash flow of their receipts and
payments. Such advances, are under the Act,
'..repayable in each case not later than three months
from the date of making that advance'.
• There are two types of WMA – normal and special. While
normal WMA are clean advances, special WMA are
secured advances provided against the pledge of
Government of India dated securities. The operative limit
for special WMA for a State is subject to its holdings of
Central Government dated securities upto a maximum of
limit sanctioned.
 Ways & Means Advances
• Until 1994-95, the needs of Government were accommodated through
automatic monetisation by issuing ad hoc Treasury Bills at 4.6 per cent.
• Considering the ill effects of automatic monetisation of Government deficit,
the Reserve Bank and the Government agreed mutually in September 1994
to restrict the issue of ad hocs for the year-end and also within the year and
for scrapping the issue of ad hoc treasury bills from 1 April 1997.
• Accordingly the issue of ad hoc treasury bills was discontinued with
effect from 1 April 1997.
• Simultaneously, a scheme of granting Ways and Means Advances
by the Reserve Bank to Government of India has been introduced to
accommodate temporary mismatches in Government receipts and
payments
• The limit for Ways & Means Advances for 2001-2002 to Central Government has been
fixed at Rs.10,000 crore for the first half year and at Rs. 6,000 crore for the second
half year. When the Government utilizes 75 per cent of the WMA limit, the Reserve
Bank considers fresh floatation of market loan depending on market conditions .
 Central Office Departments

Department of Currency Management

•Designing of banknotes
•Forecasting demand for notes and coins
•Ensuring smooth distribution of banknotes and coins
throughout the country and retrieval of unfit notes and
uncurrent coins from circulation,
•Clean Note Policy
•Exchange of Note - administering the RBI (Note
Refund) Rules
• Inspection of Currency Chests
•Maintenance of Small Coin Depots
 Central Office Departments
Department of Payment & Settlement System
•Formulation of Payment and Settlement Systems
policies.
•Regulation of Payment and Settlement Systems.
•Supervision of Payment and Settlement Systems.
•Implementation of the Core Principles relating to
payment systems (as enunciated by the Bank for
International Settlements).
•Laying down standards for payment and settlement
systems.
•NEFT, ECS, Clearing House
 Central Office Departments
Other important departments
•Department of Government and Bank Accounts (DAD, PAD,
PDO)
•Department of Expenditure and Budgetary Control
•Premises Department
•Secretary’s Department
•Legal Department
•Central Security Cell
•Department of Administration & Personnel Management
•Human Resources Development Department
•DICGC
•Internal Debt Management Department
•Department of Information Technology
 Central Office Departments
New departments
Monetary Policy Department
•Monetary Policy Department is entrusted with the responsibility of
designing, formulating and implementing monetary policy of the
Reserve Bank. Accordingly, the Department prepares Governor's
Statements on Monetary Policy
•The Policy Statements are currently brought out four times in a year.
• The Annual Policy (April)
•The First Quarter Review (July)
•Second Quarter Review (October)
• Third Quarter Review (January)
•Monetary Policy comprise of two parts: Part A: Monetary Policy
and Part B: Developmental and Regulatory Policies.
 Central Office Departments
New departments
Financial Markets Department
• Constituted in July 2005
•Monetary operations such as open market operations(OMO),
liquidity adjustment facility (LAF), and market stabilisation
scheme(MSS);
•Regulation and development of money market instruments such
as call/term/notice money, market repo, collateralised borrowing
and lending obligation, commercial paper(CP) and certificate of
deposits (CD); and
•Monitoring of money, government securities and forex markets.
 Central Office Departments
New departments
Customer Service Department
•The Customer Service Department was constituted to
provide proper focus to the entire range of customer service
related activities of banks and the Reserve Bank of India. The
Department started functioning from July 1, 2006.
•Dissemination of instructions/information relating to customer
service and grievance redressal by banks and Reserve Bank
of India.
•Overseeing the grievance redressal mechanism in respect of
services rendered by various RBI offices/departments.
Administering the Banking Ombudsman (BO) Scheme.
Acting as a nodal department for the Banking Codes and
Standards Board of India (BCSBI).
 Central Office Departments
New departments
Financial Stability Unit
• Set up in July, 2009
•Conduct of macro-prudential surveillance of the financial
system on an ongoing basis;
•Preparation of financial stability reports;
•Development of a data base of key variables which could
impact financial stability in co-ordination with the supervisory
wing of the Bank;
•Conduct of systemic  stress tests to assess resilience; and
Following India's inclusion in the Financial Stability Board
(FSB), the Financial Stability Unit provides the Secretariat to
the Bank's representative in the FSB.
 Regional Office -General Departments
Regional Director’s Department (DAPM &
HRMD)
Establishment Section (Payroll and Overheads)
Estate Department (Premises)
Department of Currency Management (Cash Dept)
Deposits Accounts Department
Public Accounts Department
Public Debt Office
 Regional Office Departments

Department of Banking Supervision

Department of Non-Banking Supervision
Foreign Exchange Department
Rural Planning and Credit Department
Urban Banks Department
 Financial Sector Reforms
• Gulf war in 1990 – increase in oil prices, sharp
drop in remittances from migrant workers in the
Gulf – forex crisis in India.
• Fear of default by Govt led to outflow of forex.
• Root of crisis – increasing fiscal deficit leading to
macro-economic imbalances.
• Task of Govt – to restore macro-economic
stability by reducing fiscal deficit & BoP
• June 1991- Economic reforms to provide an
environment of sustainable growth and stibility.
 Financial Sector Reforms
• Economic reforms were undertaken with
two broad objectives
– Reorient the economy from a statist, state-
dominated and highly controlled to a market
friendly, reduce controls and reduce trade
barriers.
– Macro-economic stability by reducing fiscal
deficits.
 Financial Sector Reforms
• In August 1991 the Government appointed
the high level committee under the
chairmanship of M.Narasimhan (former
Governor of RBI) to look into all aspects of
the financial system and make
comprehensive recommendations for
reforms. These recommendations were
implemented from 1992 onwards.
 NARASIMHAN COMMITTEE
• Deregulation of interest rates
• Capital adequacy as per BIS norms ( 8% but Indian
banks asked to maintain 9%)
• Income Recognition & Asset Classification norms
(IRAC)
• Entry of new private sector banks
• Branch licensing should be abolished. Should be left to
the commercial judgement of individual banks.
• No excessive control over banks.
• Creation of Assets Reconstruction Fund for taking over
of NPAs. Now Asset Reconstruction Companies have
been set up.
Thank YOU