STRUCTURE OF BANKING SYSTEM IN

INDIA
The banking system plays an important role in promoting economic growth not
only by channelling savings into investments but also by improving allocative
efficiency of resources. The recent empirical evidence, in fact, suggests that
banking system contributes to economic growth more by improving the
allocative efficiency of resources than by channelling of resources from savers
to investors. An efficient banking system is now regarded as a necessary pre-
condition for growth.

The banking system of India consists of the RBI, commercial

banks, cooperative banks and development banks (development finance
institutions). These institutions, which provide a meeting ground for the savers
and the investors, form the core of India’s financial sector. Through
mobilization of resources and their better allocation, banks play an important
role in the development process of underdeveloped countries.

Banks that are included in the second schedule of the Reserve Bank of India
Act, 1934 are considered to be scheduled banks.
All scheduled banks enjoy the following facilities:
 Such a bank becomes eligible for debts/loans on bank rate from the RBI
 Such a bank automatically acquires the membership of a clearing house.
All banks which are not included in the second section of the Reserve Bank of
India Act, 1934 are Non-scheduled Banks. They are not eligible to borrow
from the RBI for normal banking purposes except for emergencies.
Scheduled banks are further divided into commercial and cooperative banks.
Scheduled, Non-Scheduled Banks and Development Banks
 Commercial Banks
The institutions that accept deposits from the general public and advance loans
with the purpose of earning profits are known as Commercial Banks.
Commercial banks can be broadly divided into public sector, private sector,
foreign banks and RRBs.
 In Public Sector Banks the majority stake is held by the government. After the
recent amalgamation of smaller banks with larger banks, there are 12 public
sector banks in India as of now. An example of Public Sector Bank is State
Bank of India.
 Private Sector Banks are banks where the major stakes in the equity are owned
by private stakeholders or business houses. A few major private sector banks in
India are HDFC Bank, Kotak Mahindra Bank, ICICI Bank etc.
 A Foreign Bank is a bank that has its headquarters outside the country but runs
its offices as a private entity at any other location outside the country. Such
banks are under an obligation to operate under the regulations provided by the
central bank of the country as well as the rule prescribed by the parent
organization located outside India. An example of Foreign Bank in India is Citi
Bank.
 Regional Rural Banks were established under the Regional Rural Banks
Ordinance, 1975 with the aim of ensuring sufficient institutional credit for
agriculture and other rural sectors. The area of operation of RRBs is limited to
the area notified by the Government. RRBs are owned jointly by the
Government of India, the State Government and Sponsor Banks. An example of
RRB in India is Arunachal Pradesh Rural Bank.
Cooperative Banks
A Cooperative Bank is a financial entity that belongs to its members, who are
also the owners as well as the customers of their bank. They provide their
members with numerous banking and financial services. Cooperative banks are
the primary supporters of agricultural activities, some small-scale industries and
self-employed workers. An example of a Cooperative Bank in India is Mehsana
Urban Co-operative Bank.
At the ground level, individuals come together to form a Credit Co-operative
Society. The individuals in the society include an association of borrowers and
non-borrowers residing in a particular locality and taking interest in the business
affairs of one another. As membership is practically open to all inhabitants of a
locality, people of different status are brought together into the common
organization. All the societies in an area come together to form a Central Co-
operative Banks.
Cooperative banks are further divided into two categories - urban and rural.
 Rural cooperative Banks are either short-term or long-term.
o Short-term cooperative banks can be subdivided into State Co-operative Banks,
District Central Co-operative Banks, Primary Agricultural Credit Societies.
o Long-term banks are either State Cooperative Agriculture and Rural
Development Banks (SCARDBs) or Primary Cooperative Agriculture and Rural
Development Banks (PCARDBs).
 Urban Co-operative Banks (UCBs) refer to primary cooperative banks located
in urban and semi-urban areas.
Development Banks
Financial institutions that provide long-term credit in order to support capital-
intensive investments spread over a long period and yielding low rates of return
with considerable social benefits are known as Development Banks. The major
development banks in India are; Industrial Finance Corporation of India (IFCI
Ltd), 1948, Industrial Development Bank of India' (IDBI) 1964, Export-Import
Banks of India (EXIM) 1982, Small Industries Development Bank of India
(SIDBI) 1989, National Bank for Agriculture and Rural Development
(NABARD) 1982.
The banking system of a country has the capability to heavily influence the
development of a country’s economy. It is also instrumental in the development
of rural and suburban regions of a country as it provides capital for small
businesses and helps them to grow their business. The organized financial
system comprises Commercial Banks, Regional Rural Banks (RRBs), Urban
Co-operative Banks (UCBs), Primary Agricultural Credit Societies (PACS) etc.
caters to the financial service requirement of the people. The initiatives taken by
the Reserve Bank and the Government of India in order to promote financial
inclusion have considerably improved the access to the formal financial
institutions. Thus, the banking system of a country is very significant not only
for economic growth but also for promoting economic equality.
 Commercial Bank:

Meaning of Commercial Banks:

A commercial bank is a financial institution which performs the functions of
accepting deposits from the general public and giving loans for investment with
the aim of earning profit.

In fact, commercial banks, as their name suggests, axe profit-seeking

institutions, i.e., they do banking business to earn profit.

They generally finance trade and commerce with short-term loans. They charge
high rate of interest from the borrowers but pay much less rate of Interest to
their depositors with the result that the difference between the two rates of
interest becomes the main source of profit of the banks. Most of the Indian joint
stock Banks are Commercial Banks such as Punjab National Bank, Allahabad
Bank, Canara Bank, Andhra Bank, Bank of Baroda, etc.

Functions of Commercial Banks

The two most distinctive features of a commercial bank are borrowing and
lending, i.e., acceptance of deposits and lending of money to projects to earn
Interest (profit). In short, banks borrow to lend. The rate of interest offered by
the banks to depositors is called the borrowing rate while the rate at which
banks lend out is called lending rate.

The difference between the rates is called ‘spread’ which is appropriated by the
banks. Mind, all financial institutions are not commercial banks because only
those which perform dual functions of (I) accepting deposits and (ii) giving
loans are termed as commercial banks. For example, post offices are not bank
because they do not give loans. Functions of commercial banks are classified in
to two main categories—(A) Primary functions and (B) Secondary functions.

Let us know about each of them:

(A) Primary Functions:

1. It accepts deposits:
A commercial bank accepts deposits in the form of current, savings and fixed
deposits. It collects the surplus balances of the Individuals, firms and finances
the temporary needs of commercial transactions. The first task is, therefore, the
collection of the savings of the public. The bank does this by accepting deposits
from its customers. Deposits are the lifeline of banks.

Deposits are of three types as under:

(I) Current account deposits:
Such deposits are payable on demand and are, therefore, called demand
deposits. These can be withdrawn by the depositors any number of times
depending upon the balance in the account. The bank does not pay any Interest
on these deposits but provides cheque facilities. These accounts are generally
maintained by businessmen and Industrialists who receive and make business
payments of large amounts through cheques.

(ii) Fixed deposits (Time deposits):

Fixed deposits have a fixed period of maturity and are referred to as time
deposits. These are deposits for a fixed term, i.e., period of time ranging from a
few days to a few years. These are neither payable on demand nor they enjoy
cheque facilities.

They can be withdrawn only after the maturity of the specified fixed period.
They carry higher rate of interest. They are not treated as a part of money
supply Recurring deposit in which a regular deposit of an agreed sum is made is
also a variant of fixed deposits.

(iii) Savings account deposits:

These are deposits whose main objective is to save. Savings account is most
suitable for individual households. They combine the features of both current
account and fixed deposits. They are payable on demand and also withdraw able
by cheque. But bank gives this facility with some restrictions, e.g., a bank may
allow four or five cheques in a month. Interest paid on savings account deposits
in lesser than that of fixed deposit.

Difference between demand deposits and time (term) deposits:

Two traditional forms of deposits are demand deposit and term (or time)
deposit:
(I) Deposits which can be withdrawn on demand by depositors are called
demand deposits, e.g., current account deposits are called demand deposits
because they are payable on demand but saving account deposits do not qualify
because of certain conditions on withdrawal. No interest is paid on them. Term
deposits, also called time deposits, are deposits which are payable only after the
expiry of the specified period.

(ii) Demand deposits do not carry interest whereas time deposits carry a fixed
rate of interest.

(iii) Demand deposits are highly liquid whereas time deposits are less liquid,

(iv) Demand deposits are cheatable deposits whereas time deposits are not.
2. It gives loans and advances:
The second major function of a commercial bank is to give loans and advances
particularly to businessmen and entrepreneurs and thereby earn interest. This is,
in fact, the main source of income of the bank. A bank keeps a certain portion of
the deposits with itself as reserve and gives (lends) the balance to the borrowers
as loans and advances in the form of cash credit, demand loans, short-run loans,
overdraft as explained under.

(I) Cash Credit:

An eligible borrower is first sanctioned a credit limit and within that limit he is
allowed to withdraw a certain amount on a given security. The withdrawing
power depends upon the borrower’s current assets, the stock statement of which
is submitted by him to the bank as the basis of security. Interest is charged by
the bank on the drawn or utilised portion of credit (loan).

(ii) Demand Loans:

A loan which can be recalled on demand is called demand loan. There is no
stated maturity. The entire loan amount is paid in lump sum by crediting it to
the loan account of the borrower. Those like security brokers whose credit
needs fluctuate generally, take such loans on personal security and financial
assets.

(iii) Short-term Loans:

Short-term loans are given against some security as personal loans to finance
working capital or as priority sector advances. The entire amount is repaid
either in one instalment or in a number of instalments over the period of loan.

Investment:
Commercial banks invest their surplus fund in 3 types of securities:
(I) Government securities, (ii) Other approved securities and (iii) Other
securities. Banks earn interest on these securities.

(B) Secondary Functions:

Apart from the above-mentioned two primary (major) functions, commercial
banks perform the following secondary functions also.

3. Discounting bills of exchange or bundles:

A bill of exchange represents a promise to pay a fixed amount of money at a
specific point of time in future. It can also be encashed earlier through
discounting process of a commercial bank. Alternatively, a bill of exchange is a
document acknowledging an amount of money owed in consideration of goods
received. It is a paper asset signed by the debtor and the creditor for a fixed
amount payable on a fixed date. It works like this.
Suppose, a buys goods from B, he may not pay B immediately but instead give
B a bill of exchange stating the amount of money owed and the time when A
will settle the debt. Suppose, B wants the money immediately, he will present
the bill of exchange (Hundi) to the bank for discounting. The bank will deduct
the commission and pay to B the present value of the bill. When the bill matures
after specified period, the bank will get payment from A.

4. Overdraft facility:
An overdraft is an advance given by allowing a customer keeping current
account to overdraw his current account up to an agreed limit. It is a facility to a
depositor for overdrawing the amount than the balance amount in his account.

In other words, depositors of current account make arrangement with the banks
that in case a cheque has been drawn by them which are not covered by the
deposit, then the bank should grant overdraft and honour the cheque. The
security for overdraft is generally financial assets like shares, debentures, life
insurance policies of the account holder, etc.

Difference between Overdraft facility and Loan:

(I) Overdraft is made without security in current account but loans are given
against security.

(ii) In the case of loan, the borrower has to pay interest on full amount
sanctioned but in the case of overdraft, the borrower is given the facility of
borrowing only as much as he requires.

(iii) Whereas the borrower of loan pays Interest on amount outstanding against
him but customer of overdraft pays interest on the daily balance.

5. Agency functions of the bank:

The bank acts as an agent of its customers and gets commission for
performing agency functions as under:
(I) Transfer of funds:
It provides facility for cheap and easy remittance of funds from place-to-place
through demand drafts, mail transfers, telegraphic transfers, etc.

(ii) Collection of funds:

It collects funds through cheques, bills, bundles and demand drafts on behalf of
its customers.

(iii) Payments of various items:

It makes payment of taxes. Insurance premium, bills, etc. as per the directions
of its customers.
(iv) Purchase and sale of shares and securities:
It buys sells and keeps in safe custody securities and shares on behalf of its
customers.

(v) Collection of dividends, interest on shares and debentures is made on behalf

of its customers.

(iv) Acts as Trustee and Executor of property of its customers on advice of its
customers.

(vii) Letters of References:

It gives information about economic position of its customers to traders and
provides similar information about other traders to its customers.

6. Performing general utility services:

The banks provide many general utility services, some of which are as
under:
(I) Traveller’s cheques. The banks issue traveller’s cheques and gift cheques.

(ii) Locker facility. The customers can keep their ornaments and important
documents in lockers for safe custody.

(iii) Underwriting securities issued by government, public or private bodies.

(iv) Purchase and sale of foreign exchange (currency).

Credit (Money) Creation by Commercial

RBI produces money while commercial banks increase the supply of money by
creating credit which is also treated as money creation. Commercial banks
create credit in the form of secondary deposits.

Mind, total deposits of a bank is of two types:

(I) Primary deposits (initial cash deposits by the public) and (ii) Secondary
deposits (deposits that arise due to loans given by the banks which are assumed
to be redeposited in the bank.) Money creation by commercial banks is
determined by two factors namely (I) Primary deposits i.e. initial cash deposits
and (ii) Legal Reserve Ratio (LRR), i.e., minimum ratio of deposits which is
legally compulsory for the commercial banks to keep as cash in liquid form.
Broadly when a bank receives cash deposits from the public, it keeps a fraction
of deposits as cash reserve (LRR) and uses the remaining amount for giving
loans. In the process of lending money, banks are able to create credit through
secondary deposits many times more than initial deposits (primary deposits).
Types of Commercial Banks:
The following chart depicts main types of commercial banks in India.

Scheduled Banks and Non-scheduled Banks:

Commercial banks are classified in two broad categories—scheduled banks and
non-scheduled banks.

Scheduled banks are those banks which are included in Second Schedule of
Reserve Bank of India. A scheduled bank must have a paid-up capital and
reserves of at least Rs 5 lakh. RBI provides special facilities including credit to
scheduled banks. Some of important scheduled banks are State Bank of India
and its subsidiary banks, nationalised banks, foreign banks, etc.

Non-scheduled Banks:
The banks which are not included in Second Schedule of RBI are known as
non-scheduled banks. A non-scheduled bank has a paid-up capital and reserves
of less than Rs 5 lakh. Clearly, such banks are small banks and their field of
operation is also limited.

A passing reference to some other types of commercial banks will be

informative.

Industrial Banks provide finance to industrial concerns by subscribing (buying)

shares and debentures of companies and also give long-term loans to acquire
machinery, plants, etc. Foreign Exchange Banks are commercial banks which
are branches of foreign banks and facilitate international financial transactions
through buying and selling of foreign bills.

Agricultural Banks finance agriculture and provide long-term loans for buying
tractors and installing tube-wells. Saving Banks mobilise small savings of the
people in savings account, e.g., Post office saving bank. Cooperative Banks are
organised by the people for their own collective benefits. They advance loans to
their members at fair rate of interest.
Significance of Commercial Banks:
Commercial banks play such an important role in the economic development of
a country that modern industrial economy cannot exist without them. They
constitute nerve centre of production, trade and industry of a country. In the
words of Wick-sell, “Bank is the heart and central point of modern exchange
economy.”

The following points highlight the significance of commercial banks:

(I) They promote savings and accelerate the rate of capital formation.

(ii) They are source of finance and credit for trade and industry.

(iii) They promote balanced regional development by opening branches in

backward areas.

(iv) Bank credit enables entrepreneurs to innovate and invest which accelerates
the process of economic development.

(v) They help in promoting large-scale production and growth of priority sectors
such as agriculture, small-scale industry, retail trade and export.

(vi) They create credit in the sense that they are able to give more loans and
advances than the cash position of the depositor’s permits.

(vii)They help commerce and industry to expand their field of operation.

(viii) Thus, they make optimum utilisation of resources possible.

 Reserve Bank of India (RBI)

RBI is an institution of national importance and the pillar of the surging Indian
economy. It is a member of the International Monetary Fund (IMF).

 The concept of Reserve Bank of India was based on the strategies

formulated by Dr. Ambedkar in his book named “The Problem of the
Rupee – Its origin and its solution”.
 This central banking institution was established based on the suggestions
of the “Royal Commission on Indian Currency & Finance” in 1926. This
commission was also known as Hilton Young Commission.
 In 1949, the Reserve Bank of India was nationalized and became a member
bank of the Asian Clearing Union.
 RBI regulates the credit and currency system in India.
 The chief objectives of the RBI are to sustain the confidence of the public
in the system, protect the interests of the depositors, and offer cost-effective
banking services like cooperative banking and commercial banking to the
people.

Reserve Bank of India (RBI) – Timeline

1926 Set-up of Hilton and Young commission for central bank in India

1934 Enacted the RBI ACT

1935 RBI established on 1st April in Kolkata

1951 Nationalisation of RBI

 Important Functions of RBI (Reserve Bank of India)
Being a central bank of India, RBI serves a critical role in regulating the
financial transactions in the country. Some of the important functions of
RBI are listed below:
 Issue of Bank Notes
 Banker to the Government
 Custodian of the Cash Reserves of Commercial Banks
 Custodian of country’s forex reserves
 Lender of last resort
 Controller of credit
Now let us discuss these RBI functions in detail:

The Issuer of Bank Notes

The most important function of RBI is the issuance of currency notes
and coins, except the one rupee note and coin which are issued by the
Ministry of Finance. All other notes bear the signature of the RBI
Governor. However, the agency of distribution of all notes and coins
issued by the Government of India is the Reserve Bank of India.

Banker to the Government

Another chief function of RBI is that it takes care of the banking needs
of the government, which includes maintaining & operating the deposit
accounts of the government, collecting the receipts of funds, and making
payments on behalf of the Government of India. It also represents the
Indian Government, as a member of the International Monetary Fund
and the World Bank.

Custodian of Cash Reserves of Commercial Banks

The commercial banks are required to maintain the cash reserves at a
rate decided by the RBI in its monetary policy.

Custodian of Foreign Exchange Reserve

Another of the important functions of RBI is maintaining a reserve of
foreign currencies that enables the RBI to deal with any crisis situation.
Lender of the Last Resort
Often regarded as the banker of banks, the RBI acts as a parent to all
commercial banks in India. Thus, it becomes the lender of the last resort
for all banks when they are in a crisis situation. RBI helps them by
lending money, although at higher RoI, to sail through the tide of
financial difficulties.

Controller of Credit
RBI controls the credit created by the commercial banks in India, in
accordance with the economic priorities of the government of India. RBI
uses quantitative and qualitative methods to control and regulate the
flow of money in the market. These are implemented by announcing
monetary policies at regular intervals. The monetary policy involves the
management of interest rates and money supply. The central bank of
India tweaks the money supply to achieve objectives such as liquidity,
inflation, and consumption.
This is an extremely topic to prepare for because not only is it the exam
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of RBI will help you in understanding it better. Further, over the years,
questions from the RBI functions, structure, or the latest
announcements/ notifications/guidelines that RBI announces are asked
in the exam.
According to the current trends, as many as 16% of the total questions
from the Finance section are asked from RBI and monetary policy.
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Prelims and Main exam.
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RBI’s Developmental role

 Promotional functions that support national objectives are organized by

RBI that encourage rural and agricultural economic development.
  The RBI will regularly issue directives to the commercial banks to lend
loans to small-scale industrial units.

Composition of RBI

 Reserve Bank of India is controlled by a central board of directors. The

directors are appointed for a 4-year term by the Government of India in
keeping with the Reserve Bank of India Act.
 The Central Board consists of:
 Governor
 4 Deputy Governors
 2 Finance Ministry representatives
 4 directors to represent local boards headquartered at Mumbai,
Kolkata, Chennai, and New Delhi
 The executive head of RBI is Governor.
 The Governor is accompanied by 4 deputy governors.

 The First Governor of RBI was Sir Osborne Smith and the First Indian
Governor of RBI was C D Deshmukh.
 The First Woman Deputy Governor of RBI was K J Udeshi.

 The only Prime Minister who had been the Governor of RBI was
Manmohan Singh.
The current governor of RBI (2021) is Shaktikanta Das
 State Bank of India
The State Bank of India is the biggest commercial bank and holds a special
position in the modern commercial banking system in India.

Brief history of SBI:

*It originated as the Bank of Calcutta in June 1806.

* In 1809, it was renamed as the Bank of Bengal. This was one of the three
banks funded by a presidency government (British Govt.), the other two were
the Bank of Bombay (1840) and the Bank of Madras (1843).

*The three banks were merged in 1921 to form the Imperial Bank of India, it
acted as central bank of India or quasi central bank till establishment of RBI in
1935.

*After India’s independence, Imperial Bank of India became the State Bank of
India in 1955.
*SBI acquired the control of seven banks in 1960. These are called as
subsidiaries of SBI. They are
 State Bank of Bikaner and Jaipur (SBBJ)
 State Bank of Hyderabad (SBH)
 State Bank of Mysore (SBM)
 State Bank of Saurashtra (SBS)
 State Bank of Indore (SBN)
 State Bank of Patiala (SBP)
 State Bank of Travancore (SBT)
*To make SBI a mega bank with trillion-dollar business its associate banks
were started to merge with it. In 2008 SBS merged with SBI. The very next
year, State Bank of Indore (SBN) also merged.
*Other five associate banks besides Bharatiya Mahila Bank (BMB), merged
with SBI with effect from 1 April,2017. With this merger, the bank joins the
league of top 50 banks globally in terms of assets.

Organisation of State Bank of India:

The organisation of the State Bank of India can be discussed under the
following heads:
I. Capital:
The state Bank of India has an authorised capital of Rs. 20 crore which has been
divided into 20 lakh shares of Rs. 100 each. The issued capital of the State Bank
is Rs. 5.6 crore. The shares of the State Bank are held by the Reserve Bank,
insurance companies and the general public. At the end of March 2001, the
paid-up capital and the reserves of the State Bank were Rs. 13461 crores.
ii. Management:
The management of the State Bank of India is under the control of a Central
Board of Directors consisting of 20 members.
The break-up of the Central Board is as given below:
(a) A Chairman and a Vice-Chairman are to be appointed by the Central
Government in consultation with Reserve Bank.
(b) Two Managing Directors are to be appointed by the Central Board with the
approval of the Central Government,
(c) Six directors are to be elected by the private shareholders.
(d) Eight directors are to be nominated by the Central Government in
consultation with the Reserve Bank to represent territorial and economic
interests. Not less than two of them should have special knowledge in the
working of cooperative institutions and of the rural economy,
(e) One director is to be nominated by the Central Government,
(f) One director is to be nominated by the Reserve Bank.
Objectives and Functions of State Bank of India:
The main objectives and functions of the State Bank of India are given below:

1. Objectives:
The State Bank of India has been established to operate on the normal
commercial principles, with the only difference that, unlike other commercial
banks in the country, it takes into consideration and responds in a progressively
liberal manner the financial requirements of cooperative institutions and small
scale industries, particularly in the rural areas of the country.
The main objectives of the State Bank are:
(I) To act in accordance with the broad economic policies of the government;
(ii) To encourage and mobilise savings by opening branches in rural and semi-
urban areas and to promote rural credit;
(iii) To establish government partnership in the provision of cooperative credit;
(iv) To extend financial help for the establishment of licensed warehouses and
cooperative marketing societies;
(v) To provide financial help to the small scale and cottage industries;
(vi) To provide remittance facilities to the banking institutions.
The State Bank of India acts as an agent of the Reserve Bank in all those places
where the latter does not have its branches.
As an agent of the Reserve Bank, the State Bank performs the following
functions:
(I) It acts as the government’s bank, i.e., it collects money and makes payments
on behalf of the government and manages public debt.
(ii) It acts as the bankers’ bank. It receives deposits from and gives loans to
commercial banks. It also acts as the clearing house for the commercial banks,
rediscounts the bills of exchange of the commercial banks and provides
remittance facilities to the commercial banks.
3. Ordinary Banking Functions:
The State Bank of India performs all kinds of commercial banking
functions:
(I) It receives deposits from the public.
(ii) It gives loans and advances against eligible securities including goods, bills
of exchange, promissory notes, fully paid shares of companies, immovable
property or documents of title, debentures, etc.
(iii) It invests its surplus funds in government securities, railway securities and
securities of corporations and treasury bills.
4. Other Functions:
The State Bank of India also performs the following other functions:
(I) It buys and sells gold and silver.
(ii) It acts as agent of cooperative banks.
(iii) It underwrites issues of stocks, shares, debentures, and other securities in
which it is authorised to invest funds.
(iv) It administers, singly or jointly, estates for any purpose as executor, trustee
or otherwise.
(v) It draws bills of exchange and grants letters of credit payable out of India.
(vi) It buys bills of exchange payable out of India with the approval of the
Reserve Bank; it subscribes buys, acquires, holds and sells shares in the capital
of banking companies.
5. Prohibited Functions:
The State Bank of India has been prohibited from doing certain businesses
by the State Bank of India Act:
(I) The State Bank cannot grant loans against stocks and shares for a period
more than six months.
(ii) It can purchase no immovable property other than its own offices.
(iii) It can neither rediscount nor offer loans against the security of exchange
bills whose maturity period exceeds six months.
(iv) It cannot rediscount bills which do not carry at least two good signatures.
(v) It can neither discount bills nor grant credit to individuals or firms above the
sanctioned limit.
 Banking Regulation Act, 1949

The Banking Regulation Act, 1949 is a law. It regulates the functioning of banks
and provides details on several aspects including licensing, management, and
operations of banks in India. It had been passed as the Banking Companies Act,
1949 and came into force from March 16, 1949. Further the Banking Companies
Act 1949 had been changed to the Banking Regulation Act 1949 and being
implemented as the same from March 1, 1966.

It extends to entire India. The provisions of this Act shall be in addition to, and
not, save as hereunder expressly PROVIDED, in derogation of the Companies
Act, 1956 and any other law for the time being in force.

History of Banking Regulation Act 1949

Banking in India originated in the last decades of the 18 the century. Prior to
Nationalization, the majority of the banks were private banks. Private Banks were
class based and there would be monopolies that would only benefit a few people.
With the nationalization of the banks, the credit scenario changes benefitted all
Sections of society and contributed to overall prosperity. The Indian government
recognized the need to bring the banks under some form of government control,
to be able to finance India’s growing financial needs. On 19th July 1969, 14 major
Indian commercial banks of the country were nationalized. After independence,
the Government of India came up with the Banking Companies Act, 1949, later
changed to Banking Regulation Act 1949 as per the amending Act of 1965, under
which the Reserve Bank of India was bestowed with extensive powers for the
supervision of banking in India as the central banking authority.

Objectives of Banking Regulation Act 1949

 The provision of the Indian Companies Act 1913 was found inadequate
and unsatisfactory to regulate banking companies in India. Therefore, a
need was felt to have a specific legislation having comprehensive coverage
on banking business in India.
  Due to inadequacy of capital many banks failed and hence prescribing a
minimum capital requirement was felt necessary. The banking regulation
act brought in certain minimum capital requirements for banks.
 One of the key objectives of this act was to avoid cut throat competition
among banking companies. The act was regulated the opening of branches
and changing location of existing branches.
 To prevent indiscriminate opening of new branches and ensure balanced
development of banking companies by system of licensing.
 Assign power to RBI to appoint, reappoint and removal of chairman,
director and officers of the banks. This could ensure the smooth and
efficient functioning of banks in India.
 To protect the interest of depositors and public at large by incorporating
certain provisions, viz. prescribing cash reserve and liquidity reserve ratios.
This enable bank to meet demand depositors.
 Provider compulsory amalgamation of weaker banks with senior banks,
and thereby strengthens the banking system in India.
 Introduce few provisions to restrict foreign banks in investing funds of
Indian depositors outside India.
 Provide quick and easy liquidation of banks when they are unable to
continue further or amalgamate with other banks.
Some Provisions of the Banking Regulation Act, 1949
The Act provides a structure under which commercial banking in India is
supervised and regulated. The Act supplements the Companies Act, 1956.
Primary Agricultural Credit Society and cooperative land mortgage banks are
excluded from the Act.

Several powers are provided by the Act to the Reserve Bank of India:

 to license banks, have regulation over shareholding and voting rights of

shareholders;
 to supervise the appointment of the boards and management;
 to regulate the operations of banks;
 to lay down instructions for audits; control moratorium, mergers and liquidation;
 to issue directives in the interests of public good and on banking policy, and
impose penalties

Amendment to the Banking Regulation Act, 1949

Initially, the law was applicable only to banking companies. But in 1965 the Act
was amended to form it applicable to cooperative banks under its purview by
adding Section 56 to the Act. Cooperative banks, which operate only in one state,
are formed and run by the state government. But, licensing is controlled by RBI
and also regulates the business operations. The Banking Act was a supplement to
the previous acts associated with banking.

Recently, the Lok Sabha has passed an amendment to the Banking Regulation
Act, 1949. The Banking Regulation (Amendment) ordinance is replaced by the
bill and to the same effect promulgated in June 2020.

The amendment will bring cooperative banks under the direct supervision of the
RBI and convey them under some of the same governance norms as commercial
banks. Without first imposing a moratorium, it will also allow the RBI to
amalgamate or reconstruct a stressed cooperative bank. These amendments are
proposed so as to guard the interests of the depositors.
 Cooperative banks
Meaning of Cooperative Bank:
Cooperative bank is an institution established on the cooperative basis and
dealing in ordinary banking business. Like other banks, the cooperative banks
are founded by collecting funds through shares, accept deposits and grant loans.
The cooperative banks, however, differ from joint stock banks in the
following manner:
(I) Cooperative banks issue shares of unlimited liability, while the joint stock
banks issue shares of limited liability.
(ii) In a cooperative bank, one shareholder has one vote whatever the number of
shares he may hold. In a joint stock bank, the voting right of a shareholder is
determined by the number of shares he possesses.
(iii) Cooperative banks are generally concerned with the rural credit and provide
financial assistance for agricultural and rural activities. Joint stock companies
are primarily concerned with the credit requirements of trade and industry.
(iv) Cooperative banking in India is federal in structure. Primary credit societies
are at the lowest rung. Then, there are central cooperative banks at the district
level and state cooperative banks at the state level. Joint stock banks do not
have such a federal structure.
(v) Cooperative credit societies are located in the villages spread over entire
country. Joint stock banks and their branches mainly concentrate in the urban
areas, particularly in the big cities
History of Cooperative Banking in India:
Cooperative movement in India was started primarily for dealing with the
problem of rural credit. The history of Indian cooperative banking started with
the passing of Cooperative Societies Act in 1904. The objective of this Act was
to establish cooperative credit societies “to encourage thrift, self-help and
cooperation among agriculturists, artisans and persons of limited means.”
Many cooperative credit societies were set up under this Act. The Cooperative
Societies Act, 1912 recognised the need for establishing new organisations for
supervision, auditing and supply of cooperative credit. These organisations
were- (a) A union, consisting of primary societies; (b) the central banks; and (c)
provincial banks.
Although beginning has been made in the direction of establishing cooperative
societies and extending cooperative credit, but the progress remained
unsatisfactory in the pre-independence period. Even after being in operation for
half a century, the cooperative credit formed only 3.1 per cent of the total rural
credit in 1951-52.
Structure of Cooperative Banking:
There are different types of cooperative credit institutions working in India.
These institutions can be classified into two broad categories- agricultural and
non-agricultural. Agricultural credit institutions dominate the entire cooperative
credit structure.
Agricultural credit institutions are further divided into short-term agricultural
credit institutions and long-term agricultural credit institutions.
The short-term agricultural credit institutions which cater to the short-term
financial needs of agriculturists have three-tier federal structure- (a) at the apex,
there is the state cooperative bank in each state; (b) at the district level, there are
central cooperative banks; (c) at the village level, there are primary agricultural
credit societies.
Long-term agricultural credit is provided by the land development banks. The
whole structure of cooperative credit institutions is shown in the chart given.

Short-Term Rural Cooperative Credit Structure:

In rural India, there exists a 3-tier short-term rural cooperative structure. Tier-I
includes state cooperative banks (SCBs) at the state level; Tier-II includes
central cooperative banks (CCBs) at the district level; and Tier- III includes
primary agricultural credit societies (PACSs).
In 19 states, there exists a 3-tier short-term cooperative credit structure,
comprising SCBs, CCBs and PACSs. And in 12 states, there exists a 2-tier
short-term cooperative structure. In the north-eastern states, including Sikkim,
the structure is 2-tier, comprising only SCBs and PACSs.
ADVERTISEMENTS:

As on March 31, 2013, the number of SCBs was 31, of CCBs was 370 and of
PACSs was 92432. As on March 31, 2012, the loans advanced by SCBs were
Rs. 75600 crore, by CCBs were Rs. 14400 crore and by PACSs were Rs. 91200
crores.
1. State Cooperative Banks (SCBs):
Functions and Organisation:
State cooperative banks are the apex institutions in the three-tier cooperative
credit structure, operating at the state level. Every state has a state cooperative
bank.
State cooperative banks occupy a unique position in the cooperative credit
structure because of their three important functions:
(a) They provide a link through which the Reserve Bank of India provides credit
to the cooperatives and thus participates in the rural finance,
(b) They function as balancing centres for the central cooperative banks by
making available the surplus funds of some central cooperative banks. The
central cooperative banks are not permitted to borrow or lend among
themselves,
(c) They finance, control and supervise the central cooperative banks, and,
through them, the primary credit societies.
Capital:
State cooperative banks obtain their working capital from own funds,
deposits, borrowings and other sources:
(I) Own funds include share capital and various types of reserves. Major portion
of the share capital is raised from member cooperative societies and the central
cooperative banks, and the rest is contributed by the state government.
Individual contribution to the share capital is very small;
(ii) The main source of deposits is also the cooperative societies and central
cooperative banks. The remaining deposits come from individuals, local bodies
and others.
(iii) Borrowings of the state cooperative banks are mainly from the Reserve
Bank and the remaining from state governments and others.
Loans and Advances:
State cooperative banks are mainly interested in providing loans and advances
to the cooperative societies. More than 98 per cent loans are granted to these
societies of which about 75 per cent are for the short-period. Mostly the loans
are given for agricultural purposes.
The number of state cooperative banks rose from 15 in 1950-51 to 21 in 1960-
61 and to 28 in 1991-92. The loans advanced by these banks increased from Rs.
42 crore in 1950-51 to Rs. 260 crores in 1960-61, and further to Rs. 7685 crores
in 1991-92.
2. Central Cooperative Banks (CCBs):
Functions and Organisation:
Central cooperative banks are in the middle of the three-tier cooperative credit
structure.
Central cooperative banks are of two types:
(a) There can be cooperative banking unions whose membership is open only
to cooperative societies. Such cooperative banking unions exist in Haryana,
Punjab, Rajasthan, Orissa and Kerala.
(b) There can be mixed central cooperative banks whose membership is open to
both individuals and cooperative societies. The central cooperative banks in the
remaining states are of this type. The main function of the central cooperative
banks is to provide loans to the primary cooperative societies. However, some
loans are also given to individuals and others.
Capital:
The central cooperative banks raise their working capital from own funds,
deposits, borrowings and other sources. In the own funds, the major portion
consists of share capital contributed by cooperative societies and the state
government, and the rest is made up of reserves.
Deposits largely come from individuals and cooperative societies. Some
deposits are received from local bodies and others. Deposit mobilisation by the
central cooperative banks varies from state to state.
For example, it is much higher in Gujarat, Punjab, Maharashtra, and Himachal
Pradesh, but very low in Assam, Bihar, West Bengal and Orissa. Borrowings
are mostly from the Reserve Bank and apex banks.
Loans and Advances:
The number of central cooperative banks in 1991-92 was 361 and the total
amount of loans advanced by them in 1991-92 stood at Rs. 14226 crores. About
98 per cent loans are received by the cooperative societies and about 75 per cent
loans are short-term. Mostly the loans are given for agricultural purpose.
About 80 per cent loans given to the cooperative societies are unsecure and the
remaining loans are given against the securities such as merchandise,
agricultural produce, immovable property, government and other securities etc.
3. Primary Agricultural Credit Societies (PACSs):
Functions and Organisation:
Primary agricultural credit society forms the base in the three-tier cooperative
credit structure. It is a village-level institution which directly deals with the
rural people. It encourages savings among the agriculturists, accepts deposits
from them, gives loans to the needy borrowers and collects repayments.
It serves as the last link between the ultimate borrowers, i.e., the rural people,
on the one hand, and the higher agencies, i.e., Central cooperative bank, state
cooperative bank, and the Reserve Bank of India, on the other hand.
A primary agricultural credit society may be started with 10 or more persons of
a village. The membership fee is nominal so that even the poorest agriculturist
can become a member.
The members of the society have unlimited liability which means that each
member undertakes full responsibility of the entire loss of the society in case of
its failure. The management of the society is under the control of an elected
body.
Capital:
The working capital of the primary credit societies comes from their own funds,
deposits, borrowings and other sources. Own funds comprise of share capital,
membership fee and reserve funds. Deposits are received from both members
and non- members. Borrowings are mainly from central cooperative banks.
In fact, the borrowings form the chief source of working capital of the societies.
Normally, people do not deposit their savings with the cooperative societies
because of poverty, low saving habits, and non-availability of better assets to
the savers in term of rate of return and riskiness from these societies.
Loans Advanced:
The loans advanced by the primary credit societies have been Showing 3
Continuously increasing trend. They rose from Rs. 23 crore in 1950-51 to Rs.
202 crores in 1960-61 and further to Rs. 13600 crores in 1999-2000.
Only the members of the societies are entitled to get loans from them. Most of
the loans are short-term loans and are for agricultural purposes. Low interest
rates are charged on the loans.
The societies are expected to increase amounts of loans to the weaker sections
of the rural community, particularly the small and marginal farmers. There,
however, exists a serious problem of overdue loans of the societies which have
increased from Rs. 6 crores in 1950-51 to Rs. 44 crore in 1960-61 and to Rs.
2875 crore in 1991-92.
.
Importance of Cooperative Banks:
The cooperative banking system has to play a critical role in promoting rural
finance and is especially suited to Indian conditions.
Various advantages of cooperative credit institutions are given below:
I. Alternative Credit Source:
The main objective of cooperative credit movement is to provide an effective
alternative to the traditional defective credit system of the village money lender.
The cooperative banks tend to protect the rural population from the clutches of
money lenders. The money lenders have so far dominated the rural areas and
have been exploiting the poor people by charging very high rates of interest and
manipulating accounts.
II. Cheap Rural Credit:
Cooperative credit system has cheapened the rural credit both directly as
well as indirectly:
(a) Directly, because the cooperative societies charge comparatively low interest
rates, and
(b) Indirectly, because the presence of cooperative societies as an alternative
agency has broken money lender’s monopoly, thereby enforcing him to reduce
the rate of interest.
III. Productive Borrowing:
An important benefit of cooperative credit system is to bring a change in the
nature of loans. Previously the cultivators used to borrow for consumption and
other unproductive purposes. But, now, they mostly borrow for productive
purposes. Cooperative societies discourage unproductive borrowing.
IV. Encouragement to Saving and Investment:
Cooperative credit movement has encouraged saving and investment by
developing the habits of thrift among the agriculturists. Instead of hoarding
money the rural people tend to deposit their savings in the cooperative or other
banking institutions.
V. Improvement in Farming Methods:
Cooperative societies have also greatly helped in the introduction of better
agricultural methods. Cooperative credit is available for purchasing improved
seeds, chemical fertilizers, modern implements, etc. The marketing and
processing societies have helped the members to purchase their inputs cheaply
and sell their produce at good prices.
VI. Role of Cooperative Banks before 1969:
Till the nationalisation of major commercial banks in 1969, cooperative
societies were practically the only institutional sources of rural credit.
Commercial banks and other financial institutions hardly provided any credit for
agricultural and other rural activities. Cooperative credit to the agriculturists as a
percentage of total agricultural credit increased from 3.1 per cent in 1951-52 to
15.5 per cent in 1961-62 and further to 22.7 per cent in 1970-71.
On the other hand, the agricultural credit provided by the commercial banks as a
percentage of total agricultural credit remained almost negligible and fell from
0.9 percent in 1951-52 to 0.6 percent in 1961-62 and then rose to 4 per cent in
1970-71.
VII. Role of Cooperative Banks after 1969:
After the nationalisation of commercial banks in 1969, the government has
adopted a multi-agency approach. Under this approach, both cooperative banks
and commercial banks (including regional rural banks) are being developed to
finance the rural sector.
But, this new approach also recognised the prime role to be played by the
cooperative credit institutions in financing rural areas because of the
following reasons:
(a) Co-operative credit societies are best suited to the socio-economic
conditions of the Indian villages.
(b) A vast network of the cooperative credit societies has been built over the
years throughout the length and breadth of the country. This network can
neither be duplicated nor be surpassed easily.
(c) The cooperative institutions have developed intimate knowledge of the local
conditions and problems of rural areas.
VIII. Suitable Federal Structure of Cooperative Banking System:
Cooperative banking system has a federal structure with- (a) primary
agricultural credit societies at the village level, (b) higher financing agencies in
the form of central cooperative and state cooperative banks, (c) land
development banks for providing long- term credit for agriculture. Such a
banking structure is essential and particularly suited for effectively meeting the
financial requirements of the vast rural areas of the country.
Considering the great importance of cooperative banks, particularly in the rural
areas, it is not surprising that every committee or commission, that has
examined the working of the cooperative banking system in India, has
expressed the common view that “cooperation remains the best hope of rural
India.”
Weaknesses of Cooperative Banking:
Various committees, commissions and individual studies that have reviewed the
working of the cooperative banking system in India have pointed out a number
of weaknesses of the system and have made suggestions to improve the system.
Major weaknesses are given below:
I. General Weaknesses of Primary Credit Societies:
Organisational and financial limitations of the primary credit societies
considerably reduce their ability to provide adequate credit to the rural
population.
The All India Rural Credit Review Committee pointed out the following
weaknesses of the primary credit societies:
(a) Cooperative credit still constitutes a small proportion of the total borrowings
of the farmers,
(b) Needs of tenants and small farmers are not fully met.
(c) More primary credit societies are financially weak and are unable to meet
the production-oriented credit needs,
(d) Overdoes are increasing alarmingly at all levels,
(e) Primary credit societies have not been able to provide adequate and timely
credit to the borrowing farmers.
II. Inadequate Coverage:
Despite the fact that the cooperatives have now covered almost all the rural
areas of the country, its rural household membership is only about 45 per cent.
Thus, 55 per cent of rural households are still not covered under the cooperative
credit system.
In fact, the borrowing membership of the primary credit societies is
significantly low and is restricted to a few states like Maharashtra, Gujrat,
Punjab, Haryana, Tamil Nadu and to relatively rich land owners.
Criteria of determining borrowing membership include:
(a) Borrowing members as a proportion of rural households,
(b) The average amount of loan issued per borrowing member, and
(c) The proportion of loans going to weaker sections.
The banking Commission 1972 has brought out the following reasons for
the low borrowing membership cooperative societies:
(a) Inability of the people to provide the prescribed security;
(b) Lack of up-to-date land records;
(c) Ineligibility of certain purposes for loans;
(d) Inadequacy of prescribed credit limits;
(e) Onerous conditions prescribed for loans such as share capital contribution at
10 or 20 per cent of loans outstanding and compulsory saving deposits; and
(f) Default of members to repay loans.
III. Inefficient Societies:
In spite of the fact that the primary agricultural credit societies in most of the
states have been reorganised into viable units, their loaning business has not
improved. As the Seventh Plan has observed that out of 94089 primary
agricultural credit societies in the country in 1982-83, only 66000 societies had
full time paid secretaries. About 34000 societies were running at loss.
IV. Problem of Overdoes:
A serious problem of the cooperative credit is the overdue loans of the
cooperative institutions which have been continuously increasing over the years.
In 1991-92, percentage of overdoes to demand at the level of land development
banks was 57, at the level of central cooperative banks was 41 and at the level
of primary agricultural credit societies was 39.
The overdoes in the short-term credit structure are most alarming in North-
Eastern States. In the long-term loaning sector, the problem of overdoes has
almost crippled the land development banks in 9 states, viz., Maharashtra,
Gujarat, Madhya Pradesh, Bihar, Karnataka, Assam, West Bengal, Orissa and
Tamil Nadu.
Large amounts of overdoes restrict the recycling of the funds and adversely
affect the lending and borrowing capacity of the cooperative societies.
The Banking Commission 1972 pointed out the following reasons for the
overdue loans:
(a) Indifferent management or mismanagement of primary societies;
(b) Unsound lending policies resulting in over-lending or lending unrelated to
actual needs, diversions of loans for other purposes;
(c) Vested interests and group politics in societies and wilful defaulters;
(d) Inadequate supervision over the use of loans and poor recovery efforts;
(e) Lack of adequate control of central cooperative banks over primary
societies;
(f) Lack of proper links between credit and marketing institutions;
(g) Failure to take quick action against wilful defaulters; and
(h) Uncertain agricultural prices.
V. Regional Disparities:
There have been large regional disparities in the distribution of cooperative
credit. According to the Seventh Plan, the eight states of Andhra Pradesh,
Gujarat, Haryana, Kerala, Madhya Pradesh, Maharashtra, Punjab and Rajasthan
account for about 80 per cent of the total credit disbursed. The per hectare short-
term credit disbursed varied from Rs. 4 in Assam to Rs. 718 in Kerala.
VI. Benefits to Big Land Owners:
Most of the benefits from the cooperatives have been covered by the big land
owners because of their strong socio-economic position. For instance, in 1984-
85 the farmers having holdings less than two hectares got only 38.8 per cent of
the total loans granted by the primary agricultural credit societies, whereas the
land owners with holdings of more than 2 hectare received 55 per cent. The
share of the poorest rural population (i.e. tenants, share croppers and landless
labours) was only 6.2 per cent.
VII. Lack of Other Facilities:
Besides the provision of adequate and timely credit, the small and marginal
farmers also need other facilities in the form of supply of inputs (i.e., better
seeds, fertilisers, pesticides, etc.), extension and marketing services.
These facilities will enable them to utilise the borrowed credit in a proper way.
Therefore, the credit societies should be reorganised into multi-purposes
cooperatives.

REGIONAL RURAL BANKS

In India, Regional Rural Banks (RRBS) was established with a view to
supplement the efforts of the commercial banks and the co-operative societies in
extending credit to weaker sections of the rural community i.e. small and
marginal farmers, landless labourers, artisans and other rural residents of small
means. The rural poor need a low cost, low profile credit institutions into which
they could walk in without trepidation. The staff of RRBs was to be recruited
from the neighbouring area and as such would have a better understanding of
the local problems and the local people, their needs and their constraints.

Based upon the recommendations of the working group on Rural Banks, 5

RRBs were initially set up in 1975. Their number later rose to 196.

Structure and Organisation of the RBB

The authorised capital of RRB is fixed at Rs. 5 crores, and its issued capital at
Rs.1 crore. Of the issued capital, 60 percent is to be subscribed by the Central
Government, 20 per cent by the concerned State Government and the rest 20
percent by the sponsoring bank.

The working and affairs of the RRB are directed and managed by a Board of
Directors. The Board of Directors consists of a Chairman, three directors to be
nominated by the Central Government concerned and not more than two
directors to be nominated by the State Government concerned, and not more
than 3 directors to be nominated by the sponsoring bank. The chairman is
appointed by the Central Government and his term of offices does not exceed
five years.
 Objectives and Functions of Regional Rural Banks
The major functions and objectives of RRBs are as under:

1. To grant loans and advances to the weaker sections of the rural population
specially to the small and marginal farmers, agricultural labourers, artisans and
small entrepreneurs who are engaged in agriculture, trade, commerce, industry
and other productive activities.
2. To grant loans and advances to co-operative societies, including marketing
societies, agricultural processing societies, cooperative farming societies,
primary agriculture credit societies or farmers service societies for agricultural
purpose.
3. To take banking services to the doorsteps of the rural masses, particularly in
hitherto unbanked rural areas.
4. To mobilize rural savings by accepting deposits and channelizing them for
productive activities in the rural areas.
5. To create a supplementary channel for flow of credit from the urban money
market to the rural areas.
6. To generate employment opportunities in rural areas.
7. To bring down the cost of supplying credit in rural areas.

With the progress of RRBs they have been permitted to undertake following
functions also:

1. To extend advances for purchase of consumer durables.

2. To sanction loans for meeting various personal purposes against gold
ornaments, National Savings Certificates, Indira Vikas Patra which are fully
safe securities. However, such loans should not be more than 10 percent of fresh
loans every year within the overall ceiling of 60 percent of loans to non-target
groups.
3. To issue guarantee on behalf of banks customers without any limit on 100
percent cash margin and up to Rs.20 lakhs on cash margin plus collateral
security of more than 50 percent.
4. The limit for purchase of demand drafts, cheques have been raised per customer
and per branch to Rs. 25,000 and Rs.1 lakh respectively.
5. RRBs have been allowed to issue travellers cheques as an agent of their sponsor
banks. 6. The RRBs can also provide locker facilities.

Thus, the RRBs have been providing all those facilities which are being
provided by commercial banks.

Differences between RRBs and Scheduled Commercial Banks

The Regional Rural Banks are also scheduled banks. The RRB, however, differs
from a scheduled commercial bank in the following respects:
1. The RBB is deemed to be a cooperative society for the purposes of Income-tax
Act, 1961.
2. The area of operations of the RRB is limited to a specified region relating to one
or more districts in the concerned state.
3. The RRB grants loans and advances to the small and marginal farmers,
agriculture labourers, rural artisans and small entrepreneurs or small traders.
4. The RRB charges interest rates as adopted by the cooperative societies in the
State.
5. The interest paid by the RRB on its term deposits may be 1/2 percent more than
that is paid by the commercial banks.
6. If an RRB crosses the limit of 100 branches, it has to seek Reserve Bank’s
permission before going beyond 100 branches,
7. The RRB is a sponsored bank. It is sponsored by a scheduled commercial bank.

Major Problems Faced by RRBs

The RRBs have a mixed record of success’ on some front and ‘failures’ on
some others in their business and attainment of goals. Their failure in achieving
their targets may be attributed to several problems they encounter in practice.
Some of the major problems faced by the RRBs are as under.

1. Haste and Lack of Co-ordination in Branch Expansion: Haste in branch

expansion programme in many cases have resulted in lop-sidedness due to lack
of co-ordination. In several case, it could not be ensured that the branches of the
RRBs are opened at centres where no commercial or co-operative banking
facilities were provided.
2. Organisational Problems: Each RRB is sponsored by a commercial bank. The
Central Government and the concerned State government also contribute to its
capital. Thus there is a multi-agency control of RRBs. This has contributed to a
lack of uniformity in their functioning. Besides, it has resulted in lack of support
from state government and lack of proper monitoring by sponsor banks.
3. Difficulties in Deposit Mobilisation: The RRBs encountered a number of
practical difficulties in deposit mobilisation. On account of their restrictive
lending policy which excludes richer sections of the village society, these
potential depositors show least interest in depositing their money with these
banks.
4. Slow Progress in Lending Activity: The RRBs’ pace of growth in loan
business is slow. For this the following reasons may be given: (I) There have
been limited scope for direct lending by RRBs in their fields of operations; (ii)
It is always difficult to identify the potential small borrowers and the bank staff
have been require make special and sincere efforts in this regard; (iii) Most of
the small borrowers do not like the bank formalities and prefer to borrow from
the informal/indigenous sources of finance, such as money-lenders; (iv) The
anomalies in the Differential Interest Rate (DIR) Scheme also posed a special
 problem to the RRBs. While the RRBs charge 14 percent interest, the
commercial banks charge only 4 percent under the DIR scheme in rural areas.
Thus, no borrower would go to RRBs or co-operative societies in the area when
a loan from the commercial bank is available under the DIR Scheme; (v)There
is no effective link between the RRBs and PACS and the farmers’ service
societies; (vi) There is lack of co-ordination between officials of the district
credit planning committees and the RRBs.
5. Problems of Recovery: Recovery position of RRBs is bad. Their recovery has
varied between 51 percent to 61 percent. Thus, overdues have varied between
39 percent to 49 percent. The high incidence of overdues is attributable to a
number of internal and external factors. The internal factors include defective
loaning policies, weak monitoring and supervision, apathy towards recovery,
failure to link lending with development and to ensure proper end use of the
loan. Among the external factors, political interference, wilful default, droughts
and floods, lack of legal and administrative support from the State government
in the matter of loan recovery are main factors.
6. Urban-Orientation of Staff: A crucial practical difficulty experienced in their
working by the RRBs is the urban-orientation of their staff which is rarely
inclined to server in rural areas. There is no true local involvement of the bank
staff in the villages where they serve.
7. Procedural Rigidities: The RRBs follow the procedures of the scheduled
commercial banks in the matter of deposits and advancing loans which are
highly complicated and time-consuming from the villagers’ point of view. The
rural borrowers always appreciate informal ways and simple procedures as have
been followed by the money-lenders and the indigenous bankers.
8. Lack of proper Supervision: RRBs are under control and supervision of
NABARD which is finding it difficult to inspect all banks regularly and there
are no adequate and timely guidelines on credit policy, rate of interest, security
etc.
9. Mounting Losses Leading to Non-Viability: Most of the RRBs are running in
losses and many had completely wiped out their equity and reserves and in
some the losses were eating into their deposits. This was indeed an
unsustainable situation. A number of factors had contributed to the problem of
mounting losses. Some of these were as follows: First, the RRBs are so
structured as to confine their lending to weaker sections where the interest
earned on loans is the lowest in the banking system. Second, low margins
coupled with high cost of servicing a large number of small accounts added to
the losses. Third, in the absence of loans which could yield higher returns,
RRBs did not have any scope for cross-subsidisation. In the opinion of the
ACRC, it is the absence of cross-subsidisation that introduced ‘built-in non-
viability in the working of the RRBS. Fourth, opening of RRB branches year
after year added to the overhead costs without proportionate increase in income.
Fifth, non-availability of competent and trained staff also posed serious
 problems. Lastly, the economic environment of many RRB branches is not
satisfactory.

NABARD
In the light of recommendations of the committee to review arrangements for
institutional credit for agriculture and rural development, the Government of
India set-up the National Bank for Agriculture and Rural Development
(NABARD) in July 1982 with an initial capital of Rs. 100 crores which has now
been increased to Rs. 2,000 crores.

According to the preamble of the Act, NABARD was established “for providing
and regulating credit and other facilities for the promotion and development of
agriculture, small scale industries, cottage and village industries, handicrafts and
other rural crafts in rural areas”.

Functions of NABARD
NABARD is the apex institution in respect of credit for agriculture and other
economic activities in the rural areas in India. Thus, it is entrusted with all
matters concerning policy, planning and operations in the above-mentioned
fields.

NABARD took over the functions of the Agriculture Credit Department and
Rural Planning and Credit Cell of the RBI; as well as of the Agriculture
Refinance and Development Corporation.

NABARD performs the following function:

1. It serves as an apex refinancing alertly for the institutions providing investment

and production credit in the rural areas;
2. It has the responsibility of institution-building’ for increased effectiveness of the
rural credit delivery mechanism;
3. It undertakes monitoring and evaluation of projects refinanced by it;
4. It co-ordinate the rural financing activities of all institutions engaged

in development work at the field level and liaison with the Government of India,
The State Government, the Reserve Bank and other national level institutions
concerned with policy formulation.